Lenders can cheer for their own survival, and not much else

BY THE time JPMorgan Chase finished reporting its fourth-quarter results on January 14th, any optimism about a lovely, if surprising, sign-off to a difficult year had been squashed. Its return on equity was just over 11%, and if that is how the institution widely thought to be the best managed and best balanced of the big American banks performed, the only question was how poorly the rest would fare.

If there was a positive spin on the final quarter of 2011, and the overall year, it was that things were worse three years ago. No big bank, for example, went bust or seems on the verge of doing so. Bank of America, notable for its vast potential to make both profits and losses, has seen its share price rise substantially off its lows so far this year, a consequence either of the innate benefits of scale or, as some mutter, a hesitation on the part of regulators to bury it in yet more mortgage-related litigation.

For all that, bank returns on equity are still too low to justify lenders’ existence. The big winner in the quarter was Wells Fargo, which benefited as much from what it did not have—a big investment-banking arm—as what it did: a vast retail operation now capturing economies of scale from its crisis-enabled acquisition of Wachovia. But even its return on equity was a modest 12%, a number praised as heroic but only within the context of a bleak period in the history of bank returns (see chart 1). Pre-provision, pre-tax income is one of the cleanest measures of banks’ health: according to Oliver Wyman, a consultancy, this gauge of the industry’s earnings was down at mid-1990s levels as a percentage of assets in the third quarter of last year (see chart 2).

The fourth quarter, like the three preceding ones, was particularly hard on investment banks. At Goldman Sachs, a reputed money machine, return on equity was under 6%. Even that number, which was better than most analysts predicted, was boosted by an unexpected reduction in two costs, compensation and taxes; the recipients of both will doubtless be eager to get back to higher payouts.

Also included in Goldman’s results was an entirely new line item: a billion-dollar cost for losses in “relationship lending”. That suggests Goldman’s efforts to expand from underwriting and trading, the one-night stands of finance, to more commercial-bank-like activities have begun to generate commercial-bank-like problems—such as an ongoing exposure to the underlying business of customers.

Optimists still see chinks of light. Credit expanded, marginally. There is also a suspicion circulating around Wall Street that, with 2011 already written off as a disaster, the fourth quarter provided an opportunity to throw in all sorts of expenses. Employees have, after all, already been prepped for lousy bonuses. A chorus of bank bashers, from President Barack Obama down, would find more to disparage about success than failure. And any costs taken upfront presumably enhance the prospects for a more favourable 2012.

These sorts of “kitchen-sink” costs are almost impossible for outsiders to track. But some fourth-quarter expense items were certainly suggestive. In Citigroup’s disclosure statement, for example, there is a $1 billion “investment” to meet regulatory requirements. All banks face a staggering amount of additional cost for regulatory compliance tied to the application of the 2010 Dodd-Frank act in America as well as moves taken by other countries. But most lenders appear to have put this into ongoing expenses.

Taking costs upfront is particularly important at the moment because how well American banks do in the near future seems to depend almost entirely on their ability to minimise spending. JPMorgan Chase has been one of the very few lenders to expand employee numbers, and was questioned for doing so. Cost controls and redundancies are the order of the day because revenue growth continues to be wretched. Goldman’s net revenues in 2011 were down 9% for investment banking; down 4% for financial advisory; and down 14% in underwriting. And all of these numbers were far worse in the fourth quarter, with investment banking down 43% year on year, financial advisory down 25% and underwriting more than halving.

Despite this grim environment, none of the banks announced shifts in strategy or approach, other than doing more with less. This suggests that most believe current conditions are temporary, or that institutions are floundering, or a bit of both. In an effort to sound positive some of the American banks, notably Citigroup, pointed to the embattled state of many European competitors and suggested they could grab market share. Perhaps. But given sluggish growth, copious regulations and wretched morale, American lenders face a war of attrition rather than the prospect of swift victories.

There is one financial institution in America, however, that has found a way to make money in classic, risk-be-damned fashion. The Federal Reserve announced provisional profits for 2011 of $77 billion (see chart 3). The comparison is inexact, of course, but the Fed has “outperformed” the rest of America’s financial industry put together for four years running. That might be a triumph in a state-controlled economy. In America, it is another cause for concern.