Bank Earnings: Economic Woes Persist

More than a year after the start of the credit crisis, financial firms seem far from fit. And that has some analysts and strategists worried that the economic recovery that most people assume is under way will be slower than expected.

"Seeing an improvement is not the same as things being completely copasetic," says Anthony Chan, an economist at JPMorgan's private bank. "The credit crunch is still alive."

This week the largest financial firms in the nation have been reporting how they did in the last three months of 2009. In two words: not good. Citigroup and Bank of America lost roughly $8 billion and $5 billion, respectively. The credit-card and mortgage businesses of JPMorgan Chase, which reported their earnings last week, were a disappointment. Wells Fargo posted a profit, but nonperforming loans and related charge-offs both jumped. Morgan Stanley turned a profit in the fourth quarter, but it was less than what analysts expected. Even earnings growth at Wall Street powerhouse Goldman Sachs somewhat slowed. (See the best business deals of 2009.)

The worry is that problems at the banks will restrict credit and make it harder for businesses to grow and individuals to spend. That could put the brakes on the economic rebound. What's more, the continued loan losses at the banks show that individuals and companies are still having trouble paying their bills and meeting their debt obligations. Lastly, the losses at the banks, at a time when the government is offering significant stimulus to the financial sector, suggest that the firms remain far from fixed.

"The Federal Reserve has pressed the cost of the capital for the banks down to zero, and they still can't earn a large profit," says top Wall Street strategist Robert Arnott of Research Affiliates. "That's a problem."

Of course, some say it is normal that banks would be hurting at this part of the recovery cycle. People and companies continue to fall behind on their debt obligations long after the economy turns. While the banks' lending operations still look weak, the volume of bad loans at many of the banks, including Citigroup and JPMorgan, are piling up slower than in the past.

"Banks write-offs usually come after the economy has already cracked," says James Paulson, chief investment officer of Wells Capital Management. "The charge-off rate looks to have peaked." (See the worst business deals of 2009.)

Many had expected the earnings at financial firms to drop in the fourth quarter of 2009. A number of the biggest firms at the end of last year rushed to repay the tens of billions of dollars they had received under the government's Troubled Asset Relief Program. Analysts said the rapid exit would be costly but would ultimately show that the banks had done a lot to repair their finances.

But even excluding the payments the banks made to the government, the fourth quarter was still a doozy. Sales at Citigroup, for instance, fell in three of its biggest units — investment banking, consumer banking and transaction processing — compared with the prior quarter. So while Citi's government-assistance repayment accounts for a big part of its losses, even without that, the bank still lost $1.4 billion in the last quarter of 2009. (See pictures of TIME's Wall Street covers.)

"The story is weak revenue," says analyst Christopher Whalen of Institutional Risk Analytics. "So the Street can shrug [because of TARP repayments], but it does not get better next quarter."

Worse, some analysts say that even the banks' recently deflated earnings are likely stronger than they would have been without government help. Banks have been reporting that consumer credit is improving, with fewer individuals falling behind on their mortgage or credit-card bills. But programs like the government's Home Affordable Modification Program are allowing some borrowers to skip mortgage payments and temporarily lower their bills. If that is the main reason banks are reporting fewer bad loans, that improvement may not last.

"Forbearance and modification programs are helping for now," says analyst Paul Miller, who follows the banks at FBR Capital Markets. "We still have a lot of people who owe more than their house is worth. It's not sure how that will play out."

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