Finance Friday 22.04.2016

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Finance FridayBy Nikola Kedhi.

The first weeks of April have been quite tense for US banks. They had to undergo a stress test carried out by the Federal Reserve, while also publishing earnings reports for the first quarter of 2016. Both events had much to say about the current position of American banks and what it means to still be too-big-to-fail.

For the past five years, banks have submitted to an annual exercise performed by the Federal Reserve, called the Comprehensive Capital Analysis and Review. As the webpage of the Fed explains, this test evaluates whether the largest US banks have enough capital to continue operations even in the case of economic and financial distress. Additionally, banks must also show that they have enough capital to absorb losses if an adverse scenario were to occur. Both these test are performed over banks that have more than $10 billion in assets.

This is one of the most important financial events of the year for every major player in the world of finance. Regulatory institutions, the Fed and the government want to prevent another Lehman situation, where taxpayers had to bail out several financial institutions. Banks want to pass the test, so that they are free to return to pay dividends to shareholders. If they do not pass, not only they cannot make the dividend payments, but their shares will also probably suffer.

Regulators were not pleased with the five main banks, namely J.P. Morgan, Wells Fargo, Bank of America, BNY Mellon and State Street. The main problem was that the “living wills” were inadequate and not credible enough. These “wills” are strategies drawn up by the banks which provide contingency plans in case the financial institution becomes insolvent. These banks were warned that if they do not submit adequate plans by October 2016, they will face serious sanctions. The issue, however, is that in order to comply with the requested regulations, restructuring has to be made, which in turn may decrease their profitability. Nevertheless, the banks proved committed to make the necessary improvements by the deadline set by the regulators.

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One bank among the biggest ones that passed the test was Citigroup Inc. The Fed and the Federal Deposit Insurance Corporation (FDIC) agreed that the bank complied with the requirements of the 2010 Dodd-Frank financial reform Act, although there was room for improvement. More specifically, Citi had outlined how, in the case of a collapse, it would survive without taxpayers’ money by selling or reducing its businesses. The regulators noted that Citi had become significantly smaller in a time where the too-big-to-fail issue remains very much present with all the main banks.

After finishing their report to the Fed and FDIC, US banks had another type of publication to make. Morgan Stanley, JP Morgan Chase, Goldman Sachs, Citigroup, Bank of America and Wells Fargo disclosed their highly anticipated earnings for the first quarter of the year. Their revenues combined were down 9%, while the net profits decreased by 24% compared to the same period last year. According to the Financial Times, it is the steepest quarterly decline since 2011. Goldman was the worst performer, with a 60% decline in profits and 56% drop in revenues, even though Morgan Stanley came in at a close second place with a 53% drop in profits year to year.

However, the market decided to look at these result in a positive way, causing an 8% increase in bank stocks. Although the quarterly results for all the banks showed declines, some banks beat expectations. For example, for Morgan Stanley analysts had forecasted a 60% drop, for JP Morgan the outlook was for a 13% decline, when in fact it was only 7%, while Citi’s profits were $1.1 a share instead of the $1.08 estimate.

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Bad loans to energy companies, strong regulation and the lack of IPOs for the investment banking sector are among the main causes for this performance. Moreover, an increase in interest rates, which is good for banks, is not very likely to happen in the next few months. Still, consumer and commercial divisions remain the only ones with a strong performance. However, they are not enough to keep these banks afloat for long.

For the time being, it appears that the banking sector woes are not yet over.

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