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How the Big Banks Are Stacking Up

Pat Dorsey, CFA

Pat Dorsey: Hi, I'm Pat Dorsey, director of equity research at Morningstar. Well, the big three banks have all reported, and we now know a little bit more about their health and, by extension, the health of the American economy and consumer.

With me is Jaime Peters who follows all three and is going to tell us a little bit about the earnings and what they might mean for the outlook going forward. Thanks for joining me, Jaime.

Jaime Peters: Hello.

Dorsey: So, very big picture, the trend kind of stayed the same with J.P. Morgan knocking the ball out of the park, Bank of America kind of struggling along, and Citigroup, well, picking up the rear.

[laughter]

Peters: You have it right. Bank of America is kind of the middle player there. They just reported this morning, and they just looked kind of weak. They had consumer problems just like we have seen them in the past, and their investment bank unlike J.P. Morgan's is not quite as big. J.P. Morgan, bigger investment bank, kind of hit the ball out of the park. You are correct.

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Dorsey: And, they are reportedly getting bigger. You said you saw some very interesting signs in the releases that kind of confirm what we had theorized for some time, which is that J.P. Morgan would begin to take share as the reputational balance sheet advantages came to the fore. You saw some of that this quarter?

Peters: Really did, the big story in investment banking was a lot of debt and equity issuance this quarter. M&A advisory was kind of down, so what you had was people going to J.P. Morgan to run their equity and their debt issue much more than Bank of America or Citigroup.

Citigroup actually was the one that was noticing that their increase was very small compared to J.P. Morgan, who had a huge increase, and it really does suggest J.P. Morgan is taking share from Citigroup as people are trying to avoid the government-run company.

Dorsey: And, turning to the consumer, again we saw this differentiation where J.P. Morgan seems to have underwritten a bit better in its credit card book, and so losses weren't as large there. Whereas Bank of America and Citigroup again, the sins of the past in terms of lax lending are coming back to haunt them?

Peters: Yes, actually all three look bad. I don't want you to think that J.P. Morgan looks good. Actually, all three look bad. They are all struggling in their credit card portfolio. As unemployment rises, there just seems so many people default on those things, but you are correct. J.P. Morgan again looks better than Bank of America, which looks better than Citigroup.

Dorsey: And, thinking about the consumer overall, I think you had mentioned to me earlier that you know the first wave of credit card defaults were coming from mortgage resets and people losing their homes to mortgage-related issues, and now we are seeing just the big unemployment, "I don't have a job, I can't pay my bills" issue coming on?

Peters: That's really the story across all consumer lending. What we had was exotic mortgages and people seeing resets and their home price decline and not being able to refinance as being the first wave of this credit crisis that we are going through, and now we are actually starting to see much more traditional reasons, and that number one is simply unemployment or underemployment in the case of many things.

And that's actually also preventing some of these government pushing of refinancing troubled mortgages and doing modifications. There are modifications and every company is touting how much they are doing because it sounds like good publicity, but the reality is they are not that much because you can't refinance somebody who doesn't have a job and expect them to pay a lower mortgage payment. They just can't afford any mortgage payment.

Dorsey: Yeah. If there is no job, there is no income, there is no payment. It is not rocket science.

Peters: That's the problem, and so we saw foreclosing start again.

Dorsey: And, you did say some maybe small early signs of improvement in the consumer book I think? Early delinquencies ticked down a little bit in all three banks?

Peters: That seems to be the case. Early delinquencies have kind of come down a little bit and also in BB&T, which is a small bank that has reported today, and it is a good sign that maybe we are going to start seeing at least the increase in consumer losses come down maybe eventually. Ken Lewis ventured to suggest that maybe at the end of the year we would see some peaking of loan losses but that...

Dorsey: And, taking Ken Lewis' predictions with a grain of salt...

Peters: [laughs] but that they would probably remain elevated into 2010, which we definitely think is probable.

Dorsey: So, aside from investment banks being profitable and J.P. Morgan taking share, the consumer continuing to be weak--any other big picture trends you drew from these three earnings releases?

Peters: We have commercial loan stuff, and they are deteriorating, and pretty rapidly. Now this is a very lumpy type of lending because it is very specific. They are usually very large loans, and so any one credit going bad can create a very lumpy picture in your earnings.

And, all three really saw steady decreases in performance, both in commercial real estate and in C&I, but more in commercial real estate. And, they are kind of what are considered a latecomer to the game, meaning that you are going to see first consumer losses, and, even as the recession potentially gets over and improves, you might still see losses on the commercial side continue to increase because it takes so much more time to figure out how much you are going to lose because you have to potentially go through bankruptcy courts. You are doing negotiations with the individual seller and they are much more complicated.

Dorsey: Any final takeaways from these three?

Peters: Well, things are still bad I think is the number one thing, and we had a lot of optimism in the second quarter when we had this window open that gave everybody these debt and equity issuances, not only in the banks, but across a lot of industries, and the banks profited from that.

That's probably going to go away a little bit in the third quarter. In addition to that, you have the mortgage refinancing that happened in the second quarter as interest rates dipped. That's also going to go away, which means the third quarter is going to be even tougher than the second quarter.

Dorsey: Thanks for joining us, Jaime. With Wells Fargo and USBancorp calls next week, I am sure we will be watching those for more signs about the health of the American economy.

Peters: Thanks.

Dorsey: I am Pat Dorsey, and thanks for watching.