Wednesday, July 22, 2009

Too Big to Fail Mega-Banks Post Sizzling Hot Second Quarter Earnings While Maintaining Dismal Outlook for the Present and Future

Late last week several major banks including Bank of America Corp., JP Morgan Chase & Co., Goldman Sachs Group Inc., and Citigroup Inc., posted better-than-expected second quarter earnings; they made billions in three months. The collective earnings year-to-date of these 4 banks is approximately $13.6 billion. This has been a very good year. These results are interesting given that losses from failed loans continued to increase, and more interestingly, that the senior executives of these financial institutions previously stated that the banks would not perform well in the second quarter. For example, Kenneth Lewis, Bank of America’s CEO, said in a statement that continued weakness in the economy, rising unemployment and deteriorating credit quality would affect the company for the rest of this year and next. Yet, Bank of America posted earnings of $2.42 billion. Bank of America’s earnings per share were $0.33 which was much higher than the analyst forecast of $0.28.

This is an amazing achievement when the majority of the banking industry is fighting for survival and struggling to overcome bad debts, rising foreclosures, and escalating individual bankruptcies. These profits are especially intriguing when Bank of America, JPMorgan Chase, and Citigroup all reported they lost more money on loans during the second quarter. How did these banks manage to post such spectacular returns? And, more importantly, why did senior executives continue to make pessimistic forward looking statements when their banks posted significant profits within days of such statements?

This interesting dichotomy of pessimistic outlook and better-than-expected earnings was not particular to Bank of America. Senior executives from JPMorgan also reported continuing loan problems on Thursday evening, within hours JPMorgan posted a fantastic second-quarter earnings of $3.2 billion. JPMorgan’s earnings per share were $0.28. JP Morgan credits the strength of its consumer and investment banking businesses as well as increased bond trading activity for the profits that it earned in the second quarter. Not surprisingly, JPMorgan’s CEO, Jamie Dimon, cautioned that it’s not clear whether the economy will deteriorate further in the second half of the year, which presumptively would have a negative impact on JPMorgan’s earnings.

Leading the path of sizzling hot profits was Goldman, who earlier last week posted a stunning $3.44 billion profit. Goldman's earnings per share were $4.93. Goldman’s CFO, David Viniar, stated that Goldman continues to benefit from having virtually no direct exposure to the retail consumer business. Goldman’s profits were driven by record investment banking fees, including the underwriting of new stock sales for companies trying to raise cash. It must be noted that Goldman is the last of the original investment powerhouses left standing, given Lehman Brothers’ bankruptcy, Bear Stearns acquisition by JPMorgan, Smith Barney’s sale to Morgan Stanley and Merrill Lynch’s acquisition by Bank of America. This all seems to be a rather anti-competitive environment. Perhaps, Congress was willing to overlook the lack of arms length transactional nature of these arrangements given that survival of the investment banking industry was critical. Perhaps at some point in the not so distant future, Congress may want to revisit its decision regarding these arrangements.

Citigroup reported that it earned $4.3 billion in profits. Citigroup’s earnings-per-share were $0.49. Surprisingly, analysts had projected that Citigroup would post a loss of $0.37 per share for the second quarter. How did the analysts so grossly miscalculate earnings? The reality is that Citigroup’s earnings were boosted by an infusion of $6.7 billion from selling its majority stake in Smith Barney to Morgan Stanley. Citigroup’s CEO, Vikram Pandit, previously stated that losses in Citigroup’s consumer businesses have been growing for some time, and expects slow U.S. economic growth in coming years. To be fair, in examining the mega-banks’ strategy during the second quarter, it appears that the mega-banks under promised their earnings and were able to post profits from increased revenues from their trading activities and asset sales of desirable units. In addition, to Citigroup’s sale of Smith Barney, Bank of America sold its interests in China Construction Bank and a merchant processing business for $5.3 billion and $3.8 billion, respectively.
As to how these very profitable banks are doing with regard to repaying their bailout loans, Citigroup received $45 billion in funds from the government which it has yet to repay. The government is in the process of acquiring a 34 percent stake in Citigroup as part of a broader debt exchange program by converting preferred shares into common shares. Goldman and JPMorgan have already repaid their bailout loans, $10 billion and $25 billion, respectively. Bank of America’s don’t know; don’t tell policy may set the stage for the future. Bank of America received $45 billion in bailout funds. Despite its stellar earnings performance in the second quarter, Bank of America stated that it “did not know when” it will be able to repay the government. Interesting.


  1. The money trail is very complex. The TARP program implemented during the waning days of the Bush Administration, and inherited by the Obama Administration, lacks fundemental accountability. Neil Barofsky, the inspector general for the Treasury Department's TARP program, appeared before Congress this week to indicate that in total bailout packages could cost American taxpayers $23.7 trillion. This goes to show that Treasury's cash register was opened to the financial services industry with little thought or planning. Admittedly, some needed the money badly and others did not. The profits that Professor Pierre-Louis point out speak for themselves. The other facet we have to realize, is that aside from asset spin-offs, increased fees to bank customers and average consumers is the spark that is driving profitability to an extent.

  2. professor pierre-louis: great post. it seems to imply that the bank executives are acting in an underhanded way. what is the motivation? why is there no rush to repay TARP funds? are these profits being made on the backs of American consumers (increased fees) as professor grant implies?

  3. Hi Lydie!

    Thanks for the interesting post.


  4. It is very interesting that BOA has not made a more active effort to repay the bailout money, especially considering the extensive regulations placed on TARP money. Do you have any hypothesis as to why they have taken such approach? The only justification that I can think of is that BOA has experienced or believes that their potential for market appreciation is greater by holding onto the TARP money rather than paying it back.