As Earnings Portray a Thriving J.P. Morgan, Small Banks' Story Differs

By Binyamin Appelbaum
Washington Post Staff Writer
Thursday, October 15, 2009

A banking industry goliath, J.P. Morgan Chase, reported third-quarter earnings of $3.59 billion Wednesday, its strongest results in two years. Hours later, regulators testified on Capitol Hill that many small banks are struggling to survive mounting losses.

The day's events highlighted a divergence in the banking industry. Large banks have found renewed profit in areas outside traditional banking, such as helping companies raise money on Wall Street. But small banks wholly focused on making and collecting loans find their business in a state of steep decline.

The nation's roughly 7,000 community banks, which lost $2.7 billion in the second quarter, are likely to report that the third quarter was at least as bleak. The share of borrowers who have fallen behind on payments is at the highest level in more than two decades. At the same time, increased caution and diminished demand have limited new lending, leaving banks hard-pressed to find new sources of profit.

Ninety-eight banks, mostly small, have failed so far this year, and regulators predict the harvest from the current recession is less than halfway complete.

"The banking system remains fragile," Federal Reserve Governor Daniel K. Tarullo testified Wednesday before the Senate Banking Committee. Small banks in particular, he said, "have yet to report any notable improvement in earnings or condition since the crisis took hold."

Rising Loan Delinquencies

J.P. Morgan, a Wall Street powerhouse that also operates one of the nation's largest retail banks, faces the same problems as its smaller peers. Rising loan delinquencies forced it to set aside another $2 billion to cover projected losses. The company also reduced lending for the fourth consecutive quarter. But the strength of its investment bank, which reported that its profit more than doubled, overcame the press of the recession.

The company's earnings amounted to 82 cents a share, up from 9 cents a share, or $527 million, during the third quarter last year.

The rest of the nation's giant banks are expected to post results roughly in proportion to the depth of their involvement with Wall Street. Goldman Sachs, wholly focused on investment banking, is expected by financial analysts to report a healthy profit Thursday. Main Street titans Bank of America, which reports Friday, and Wells Fargo, which reports next week, both are expected by analysts to report mixed results.

During the financial crisis, banks struggled with an extraordinary problem -- they could not find money to fund their operations. Massive government intervention into the financial markets lifted that stranglehold, but in its wake, banks have been left in throes of a more traditional crisis: Borrowers are not repaying loans.

The share of loans not being repaid on time climbed to 4.35 percent at the end of June, the highest level on record, and it is expected that data for the end of September will show that delinquencies continued to climb during the third quarter.

Real estate development loans have become a particular trouble spot, with delinquencies at 16 percent at the end of June. Loans on existing commercial real estate also are showing increased signs of problems as struggling businesses begin to fall behind on payments.

Banks have been forced to divert earnings into reserves to cover expected losses, but those reserves still are not increasing fast enough to keep pace, regulators said.

Banks can most easily exit this quagmire by making new loans that are repaid. But regulators said Wednesday that renewed demand for loans was likely to lag behind economic recovery. Borrowing lags because businesses in particular first put existing equipment back to work before they again need to start borrowing money to expand.

"It would be unusual to see a return to a robust and sustainable expansion of credit until after the overall economy begins to recover," Tarullo said.

The government's assistance to the financial industry has mostly helped large banks to recover.

J.P. Morgan relied on federal aid in buying the distressed investment bank Bear Stearns and the mortgage lender Washington Mutual. It then accepted $25 billion in emergency aid from the Treasury Department, which it subsequently repaid, and borrowed billions of dollars more with help from the Federal Deposit Insurance Corp. The company borrowed from some of the Fed's aid programs, but the Fed has refused to disclose the amounts that individual companies borrowed.

Benefiting from U.S. Aid

The company's relative strength also has allowed it to claim an outsize share of the benefits from the government's massive intervention into financial markets.

Joseph A. Smith Jr., the North Carolina commissioner of banks, testifying on behalf of state banking regulators, said Wednesday that the government's failure to extend equal help to community banks had contributed to their struggles. He said the Treasury Department should inject more capital into smaller banks.

"Federal policy has not treated the rest of the industry with the same expediency, creativity or fundamental fairness," Smith said. "This has been a lost opportunity for the federal government to support community and regional banks and provide economic stimulus."

The government's role in reviving financial markets also has raised questions about the plans of the largest banks to reward employees with billions of dollars in bonuses for profits achieved in large part through the investment of taxpayer dollars.

J.P. Morgan set aside $2.78 billion in compensation for its investment bankers in the third quarter, a 28 percent increase over the same period last year. Chief executive Jamie Dimon strongly defended the company's pay practices during a conference call with financial analysts.

"We've looked at the contribution people make to building a great franchise at J.P. Morgan," Dimon said. "We think we've done it right and fair, and we're going to continue doing what we're doing."

At the same time, J.P. Morgan said it reduced its workforce by about 7,600 jobs, or 3 percent, compared with the same period last year. That is part of a broader trend in which firms have continued to slash jobs even as profits begin to recover.

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