Well, four of the five largest U.S. banks have reported their second quarter earnings and the results are nothing short of spectacular. Citigroup (NYSE:C), reporting on Monday, showed a 42 percent increase in net income. Goldman Sachs (NYSE:GS), reporting on Tuesday, showed a doubling of profits. Wow!
The problem is, investors are worried about whether or not the earnings performances are sustainable. The difficulty in getting a clear picture of what is going on at these banks is that each of the four that have reported have different business models and this has to be accounted for in any analysis that is done.
The one thread that weaves its way through all the earnings reports that have been received so far from these large institutions is that the basic business of banking is not doing so well. That is, the fundamental business of banking is not producing strong results. This, I believe, has strong implications for the understanding the state of the economy and for the sustainability of bank performance.
Look at the headlines. For Citibank we see in the New York Times, "Growth in Emerging Markets Lifts Citigroup Profit...". For Goldman we see in the Financial Times, "Goldman Trading Drives Profit."
In terms of their business models, Citigroup gets more than 50 percent of its revenue from outside the United States. Gains were reported in this business for the quarter, especially in the securities business and in basic credit business. One reason given for this performance is that economic growth in the emerging markets, even though it is not robust by any means, is stronger than that being experienced in the United States.
The earnings performance at Citigroup in the United States came in at $4.18 billion or $1.34 per share, which was up from the profit earned in the same quarter one year ago of $2.95 billion or $0.95 per share. Special interest is given to the performance of Citigroup this year to see how much impact the new CEO, Michael Corbat, who gained his current position last October, is having on the institution.
Of particular interest is how well expenses are being managed since Mr. Corbat has introduced plans to eliminate 11,000 jobs at the Citi this year. In the second quarter of 2013 expenses at the bank actually increased by 1 percent. However, expenses are expected to be down for the full year.
Citigroup did reduce assets in the quarter as it sold its remaining stake in Smith Barney to Morgan Stanley. In addition, Citigroup has been able to reduce its holdings in "Citi Holdings" the "bad bank" it had set up to house underperforming assets. Assets in Citi Holdings fell by 16 percent in the first half of 2013 to now total $131 billion.
Overall, total assets at the bank were down modestly in the second quarter helping the organization to become the first of the big five Wall Street institutions to report a double-digit capital ratio under the new Basel III standards with a 10 percent equity to risk-weighted assets. This is up from 9.3 percent at the end of the first quarter.
Citigroup earned just over a 5.0 percent return on equity, up from 4.65 percent in the first quarter.
Goldman Sachs earned a 10.5 percent return on equity. The general response to the report given by Goldman not encouraging even though the company's results exceeded analysts' estimates. This figure is up from the 5.4 percent earned last year although down from the 12.4 percent earned in the first quarter.
For one, Goldman's estimated cost of capital is estimated to be around 10.0 percent. So, without an improvement in core businesses, the concern is that the performance is not sustainable. As reported in the Financial Times article cited above, "The only core business area which beat expectations was debt underwriting and even that does not look sustainable."
Revenues from debt and equity underwriting were down slightly from the first quarter of this year although up to $1.55 billion in the second quarter, much higher than the $1.2 billion earned a year earlier.
Summary: the posted numbers look sensational compared with a year ago. However, the problem is that neither institution is doing that well in its core businesses.
This is due to the mediocre overall performance of the economy. Loan demand is tepid, at best. As I have reported in earlier posts, merger and acquisition activity is slow, new issues of debt and equity are not at exciting levels, consumers in the U.S. still seem to be deleveraging, and mortgage refinancings seem to be going soft as interest rates rise.
The one thing that still seems to remain is volatility in financial markets -- thank you Mr. Bernanke and the Federal Reserve -- and this pumps up trading profits.
Of course, this is a double sword. It is hard for the economy to grow if bank lending is practically non-existent. It is hard for bank lending to grow if economic growth is so tame. Then you add on the new regulatory rules and regulations that the banks have to adjust to and you don't have a very vibrant environment.
But, given what the banking system has had to go through over the past six years, hooray for the substantial gains in bank profits. Even this, however, has its downside: see the Financial Times article "Too Much Profit on Wall Street." As someone has said, banks are avoided when they are not making profits and they are hated when they make profits."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.