Refi Done; Loss Reserves Gone; Bond Trading Punk; Commodities X'd---So Banks Head For Junk Credit And Next Crisis

By Suzanne McGee at theguardian.com

Where are the profits of yesteryear?

Hard to find, it seems. Certainly, the glee with which Jamie Dimon, CEO of JP Morgan Chase, and his fellow top bankers welcomed the government-assisted recovery in banking (and banking profits) in 2009 has dwindled and faded.

Indeed, most of the tailwinds helping banks have become headwinds holding them back. Homeowners aren’t refinancing any more, and new home sales hit their lowest levels in eight months in March. The result? Double digit dips in mortgage lending, already buffeted by an uptick in long-term interest rates. Fixed-income trading is in the doldrums, too. That leaves new mortgage lending at a 14-year low.

Bond trading is in no better shape, as risk aversion keeps market participants sitting grumpily on the sidelines. Commodities trading has been profitable, but has attracted far too much regulatory scrutiny – and legal bills – to make it worthwhile. (Deutsche Bank and JP Morgan Chase are just two to have walked away from those businesses.)

“Revenue growth in banking this decade for the banks is on pace to be worst since the Great Depression,” says Mike Mayo, an analyst with CLSA Americas LLC, who has tracked the banking industry for about a quarter of a century.

Just to make matters worse, a recent source of extra profits – the release of loan loss reserves, once set aside to provide a cushion against bad loans – is running low. It’s going to get tougher for the banks to make their earnings look better than they reall are.

If all these falling profits are the banks’ problem, their solution to the problem could end up being worse.

That’s because whenever growth falters, profit-hungry banks have a history of taking on more risk: risk they can’t afford, that they don’t understand or that they can’t manage.

They relax lending standards (remember no-doc loans and the subprime lending debacle?) or underwriting standards (the junk bond and leveraged buyout boom of the late 1980s; and during the dot.com bubble).

Allegations of mis-selling of products, ranging from annuities to complex derivatives, multiply like rabbits left unattended.

And right now, there are some warning signs already clearly visible.

For any bank, finding a way to lend profitably is half the puzzle. That means being able to convince people to borrow – and being able to winnow out those who are good credit risks from those who are less likely to repay the loans in a timely manner, with the help of credit scores.

With business lending sluggish and mortgage lending slumping, Wells Fargo has decided it can cut those credit standards. Last month, it raised eyebrows by cutting the minimum credit score required to qualify for an FHA mortgage. It’s also making a big push into another area of lending notorious for poor lending standards: auto loans. Forget subprime mortgages; by the end of 2013, Wells was the second-biggest subprime auto lender in the country....

“There is a chance that JP Morgan’s $6.2bn loss in the 'London Whale' trading fiasco might prove to be “the canary in the coal mine," Mayo says.

It all comes down to the question of what we want banks to do: take risks in search of earnings and revenue growth, or manage costs and keep risks low for dependability and stability.

Over the last few decades, we’ve tried the former model: banks as growth stocks. As Mayo says, succinctly, “it don’t always end pretty.”

Perhaps it’s time to get used to a world where a good bank is one that may be less exciting but whose employees aren’t constantly provided with a host of incentives to generate profits by piling on new risk.

Published by the Guardian. View original post here. 

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