Banks Bracing for a Tough Recession

As stated before if you weathered the credit crisis you still have to negotiate the economic crisis that will follow. At this point no one knows how long it will last or how deep it will be. But, it is clear to most that the economy is slowing down dramatically and that it is under considerable deflationary pressure. Hence, my comments earlier this week that there is no guarantee that all the bail-out plans are going to work. Next week various investors file insurance claims against AIG for the Lehman Brothers bond losses. We will see if that will make things worse. Text in bold is my emphasis. From the NY Times:

JPMorgan Chase, Wells Fargo, and State Street have weathered these bad times better than most banks. But things are about to get worse.

Skip to next paragraph Sobered by the prospect of a drawn-out erosion in the economy, investors drove down the shares of all three Wednesday even after they reported earnings that beat the low expectations of Wall Street analysts.

“If you made it past the credit crisis, you are not making it past the economic carnage,” said Meredith A. Whitney, a banking analyst at Oppenheimer & Company. “And there is more to come.”

The banks are among the first to announce their results in what is expected to be yet another dismal quarter for nearly all financial firms. Bank of America already reported disappointing earnings as it struggled to raise $10 billion in fresh capital. And Citigroup, Merrill Lynch, PNC Financial, and Bank of New York Mellon are expected to release weak results on Thursday, followed by regional and small banks whose fortunes have been changed by the upheaval of the American financial landscape.

Profit at JPMorgan Chase slumped 84 percent, to $527 million, or 11 cents a share, in the third quarter as the bank weathered losses of $3.6 billion on bad investments, leveraged loans and a bevy of unusual charges, including ones tied to its takeover of Washington Mutual last month. In a sign it is preparing for more fallout from a contracting economy, the bank set aside another $2.2 billion to cover current and future losses on credit card, mortgages and commercial real estate loans.

Wells Fargo & Company said profit fell 25 percent, to $1.64 billion, or 49 cents a share, after absorbing big losses on investments in Fannie Mae, Freddie Mac and Lehman Brothers. It also bolstered its reserves by $2.5 billion as it braces for higher loan losses, and will soon inherit tens of billions in new losses from its takeover of Wachovia.

At State Street Corporation, a custodial bank based in Boston, profit rose 33 percent, to $477 million, or $1.09 a share, as it booked higher trading fees amid volatile markets. But it, too, faced heavy losses on investments, including loan collateral from Lehman Brothers. It also may need to set aside as much as $450 million to prop up some of its battered investors in its fixed-income funds.

The banks were among the nine firms compelled by Treasury Secretary Henry M. Paulson Jr. on Tuesday to take a big cash infusion from the government. Both JPMorgan Chase and Wells Fargo agreed to received $25 billion investments; State Street, which has a much smaller balance sheet, received about $2 billion. Though all of the firms denied needing the money, federal officials hope they use it to increase lending.

Even if the flow of credit improves soon, executives are planning for a future shaped by thousands of lost jobs in the economy, weaker consumer spending and more market turmoil and uncertainty. “We necessarily need to be prepared for a bad environment,” said Jamie Dimon, JPMorgan’s chairman and chief executive.

With losses on housing far worse than anticipated, he said the bank was “getting braced” to increase its reserves against losses on loans over the next couple of quarters, and for “very tough” trading results. The finance chief, Michael J. Cavanagh, said the bank believed the economy was already experiencing “recessionary conditions” that would worsen.

On Wednesday, Ben S. Bernanke, the chairman of the Federal Reserve, warned that the American economy was headed toward an extended period of difficulty in spite of a worldwide effort to stabilize the markets. Investors, fearful that the worst is still to come, sent financial stocks plummeting. The KBW Index, a popular measure of the sector, fell more than 7 percent on Wednesday. It is down more than 45 percent since last year.

A continued contraction may make it even tougher for consumers to pay off loans, especially credit card and auto debt, creating another layer of risk.

And banks are also being hurt by narrower lending margins. Without the volume of new business, banks will find it especially challenging to be profitable. “Profit pressure is picking up at a time when you are trying to build it up as fast as you can to handle these credit problems,” said Gerard Cassidy, an analyst at RBC Capital Markets.

Wells Fargo’s chief financial officer, Howard I. Atkins, warned that the bank faced intense pressure on its huge consumer loan portfolio. He cited weakness in residential real estate, rising unemployment and increases in bankruptcies.

JPMorgan outlined signs of strain already showing up in its big consumer businesses. Its Chase retail banking operations reported $247 million in net income, a 61 percent drop from the period last year. It has pulled back on new lending, tightening standards on mortgages and home equity loans. And Chase’s big credit card division reported $292 million in net income, a 63 percent drop from last year. The unit took a $2.2 billion write-down to buffer against potential losses, as more consumers struggled to pay their credit card balances.

“Credit has deteriorated meaningfully this quarter, and it is going to get worse before it gets better,” Mr. Cassidy said. “That is going to continue to drive the results well into 2009.”

Mr. Dimon, on a conference call with analysts, said he expected lending to return to normal eventually. But now, he added, is the time to be prudent. “We are not going to say, ‘Yahoo, this is over,’ and go extend credit like we did without fear,” he said. “If you are not fearful, you are crazy.”

Ms. Whitney, one of the most bearish banking analysts on the call, shot back, “I’m fearful, thanks.”

Mr. Dimon deadpanned: “We know you are. We are waiting for you to reverse your position.”