Days of rapid growth and focus on trading are over for banks, analysts say

By Jia Lynn Yang
Washington Post Staff Writer
Monday, November 29, 2010; 7:22 PM

Two years after benefiting from an extraordinary government bailout, banks are hitting a wall.

Revenues at big financial firms are down across the board and could continue stalling for years as new regulations kick in and consumers borrow vastly less than before.

"They've already seen their glory days," said Matthew McCormick, a banking analyst and portfolio manager at Bahl & Gaynor. "Revenue growth is anemic. You're seeing essentially a bunch of banks surviving, not prospering."

It's an unusual position for an industry used to delivering growth that far outpaces the rest of the economy.

The problems are somewhat hidden because large banks are set to deliver banner profits again this year, even as their revenues drop. Much of the latest earnings, however, were fueled by short-term measures that temporarily boosted banks' bottom lines, such as reducing the amount of money they are holding to protect themselves against losses from loans.

But the long-term outlook is murkier. Analysts say it will be hard for these banks to replicate the kind of sustained, gangbusters growth they've enjoyed in recent years.

The industry is bracing for a slew of new rules that could force them to alter the way they make money. The regulations are designed to limit risky trading and curb certain fees charged to consumers - the exact activities that banks have leaned on to deliver impressive numbers quarter after quarter.

"The regulations in play right now are fundamentally redefining the business models of the nation's banks," said Karen Shaw Petrou, managing partner of the research firm Federal Financial Analytics.

Signs of the slowdown are already emerging.

At J.P. Morgan Chase, net revenue slipped 15 percent in the most recent quarter compared with last year. Citigroup's revenues fell 10 percent, and Goldman Sachs's was down 28 percent. At Morgan Stanley, net revenues dropped 20 percent, while Bank of America's revenues were essentially flat, growing 2 percent in the latest quarter.

Commercial banks, such as Bank of America, have traditionally relied on lending to make money. But that model is also running into trouble as businesses and consumers shed debt amid the economic slowdown.

Consumer debt, excluding mortgages, has dropped nearly 6 percent, or $150 billion, from a peak of $2.56 trillion in 2008.

"When you de-lever, you take debt out of the system," said Nancy Bush, a banking analyst at NAB Research. "Guess what banks manufacture? Debt."

Meanwhile, firms are still working off bad loans leftover from the housing bust. They're also contending with angry borrowers and investors who say they've mishandled the paperwork needed to justify foreclosures.

These headwinds - some of the banks' own making - are unlikely to provoke much sympathy after the industry sparked the financial crisis and drove the rest of the economy into a protracted slowdown in 2008.

The end result could be a fundamental rebalancing of the U.S. economy in which a smaller portion is devoted to finance.

That would be a reversal from the last two decades. From the 1950s through the 1980s, financial firms counted for 10 percent of all profits in the U.S. economy. In the 1990s, that figure rose to 22 percent. By the time of the financial crisis, it had hit 40 percent.

A healthy banking sector is critical to the functioning of the U.S. economy. Commercial banks accept deposits, make loans and essentially ensure that money is distributed to useful ends, such as investing in factories and buying homes. Investment banks on Wall Street, such as Goldman Sachs and Morgan Stanley, help governments and companies raise money by issuing securities and advising mergers.

Over time, however, many banks have built up bigger trading operations to boost their bottom lines, acting more like hedge funds than traditional banks.

This has introduced too much risk into the system, according to some critics who pushed for the financial regulatory overhaul to include a measure, known as the Volcker Rule, that will ban banks from speculating in the markets with their own money.

A smaller, slower-moving banking sector could be a good thing, the experts say.

Harvard University economist Benjamin Friedman recently posed the question, "Is our financial system serving us well?" in the fall 2010 issue of Daedalus, the journal of the American Academy of Arts and Sciences. "At the same time that the financial sector has been growing more expensive to operate - absorbing a larger fraction of the economy's total profits, claiming a larger share of the most talented workers, and so on - the economy's performance has been disappointing," he wrote.

President Obama also said recently that he wants to nudge the economy away from financial speculation toward manufacturing and exporting goods.

The industry is still delivering healthy profits, even as revenues slow down. According to a report this month by the New York state comptroller, profits on Wall Street are on pace in 2010 to deliver the industry's sixth most-profitable year. That will be 69 percent less than last year, which was "fueled by federal assistance and low interest rates."

The results could be ephemeral. At J.P. Morgan, net income rose 23 percent compared with last year, but the firm acknowledged that it was mostly because it reduced its loss provisions.

J.P. Morgan chief executive Jamie Dimon has said the bank will lose as much as $750 million in profit because of new rules restricting the fees that can be charged to credit card users.

Chris Whalen, a financial industry analyst and managing director of Institutional Risk Analytics, says that banks are much weaker than lawmakers realize. Saddled by soured loans, banks are facing an unusually bad environment. Not even low borrowing rates set by the Federal Reserve are enough to return the industry to its former dominance, he said.

"In most cycles, three years of [government assistance] would've been enough to fix the problem," Whalen said.

One way out, say some analysts, is for banks to become boring again.

"They essentially have to block and tackle like the banks of old," said McCormick, the Bahl & Gaynor analyst. "It's a difficult environment for them."

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