The big gains JPMorgan Chase & Co. and Wells Fargo & Co. notched up in the second quarter mask potential banking pain down the road. Both beat analysts’ estimates despite the violent interest-rate spike in the second half of the quarter. Now investors seem confident the two firms will soon profit from the steeper yield curve – as banks often have in the past. But this time may well be different.
First, the mortgage refinancing boom is slowing quickly. JPMorgan’s Chief Executive Jamie Dimon made that clear on Friday, saying new loans may drop as much as 40 per cent if the 10-year Treasury sticks around its current level of 2.55 per cent. In the past, new mortgages would offset some or all of that. But tight credit standards and rising house prices make that harder to do.
The uptick in rates also dents securities portfolios. The mark-to-market value of JPMorgan’s cache of held-for-sale assets ended June at just $389-million (U.S.), an 89 per cent drop – though this only registers as a hit to capital, unless the securities are actually sold.
Nonetheless, JPMorgan still cranked out a $6.5-billion profit and a 13 per cent return on equity. Wells Fargo still managed record net income of $5.5-billion.
Both banks’ shares are now up 25 per cent this year and above the jittery levels of last month. That’s in part because shareholders know that over the medium term rising interest rates mean more lucre for banks as they charge more for loans while funding costs increase less. JPMorgan estimates that, all else being equal, a 1 percentage point jump in the 10-year rate creates almost $1-billion in extra revenue in the following year.
But that in part relies on banks extending more loans. In some areas they are – auto lending at JPMorgan jumped 19 per cent last quarter, for example. But its $726-billion overall loan portfolio is little changed from a year ago, even though deposits grew by 8 per cent. Its deposits-to-loans ratio now stands at 166 per cent, implying either a lot of older loans maturing or lackluster customer demand – or both. Wells Fargo, meanwhile, reckons lending may pick up, but not for a quarter or two.
That leaves both, and rivals, needing to fill revenue lost from both slower businesses and maturing loans that paid higher interest rates. That could mean disappointing earnings later this year.