America's Main Street banks struggle at the core

The Main Street banks of America should really be having a great time of it: business and consumer confidence is high, homes are affordable - outside the big coastal cities, at least - and the labour market has seen a record string of payroll gains.

As John Stumpf, chief executive of Wells Fargo, told analysts this week, "the underlying economic expansion that is approaching its sixth anniversary, remains largely on track".

But judging by the first-quarter results from five of the big six US banks this week, that benign backdrop is not doing a lot for their core businesses.

At Wells' community banking division net income fell 5 per cent to $3.7bn amid weaker fee business. Citigroup's best quarter for eight years was driven by a lack of one-off costs for lawsuits and solid earnings from the investment bank, with core operating revenues in the North American consumer banking business falling 4 per cent to $2.3bn. As for Bank of America, the best word for its domestic retail business was "static", says Brennan Hawken, analyst at UBS.

The main reason is rates. Until the Federal Reserve raises the cost of borrowing, banks' main earnings driver - the gap between what they pay for deposits and what they charge for loans and earn on investments - will remain under pressure.

In the first quarter, Wells' net interest margin fell 9 basis points, dropping below 3 per cent for the first time in decades, while JPMorgan Chase saw a 7 bps decline to 2.07 per cent.

Spreads "are unimaginably low for those of us who have followed this area for a long time," says Nancy Bush of Georgia-based NAB Research.

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But that might prove the last hurrah.

"We're coming off this refinance boomlet on the turn in the yield curve that no one expected," said David Stevens, head of the Mortgage Bankers' Association. "Most economists have been predicting a rise in 10 and 30-year mortgage rates yet here we are hitting historical lows a couple of times this year."

Mr Stevens noted that some banks had reported their biggest mortgage volume months in their history in recent weeks but his organisation expects volumes to decline over time, with $1.23tn this year and $1.17tn in 2016, as increased numbers of new purchases fail to take up the slack from an expected drought in refinancing when interest rates finally rise.

"Obviously you have to be a fairly remarkable mortgage finance company to convince someone on 3.5 per cent to take 4.5 per cent," he said.

Meanwhile, lenders are running out of levers to pull to boost profits. The release of provisions set aside for bad loans is now nearly tapped out, after five years of steady reductions.

Reserves across the system dwindled to 1.48 per cent of loans at the end of last year, according to the Federal Deposit Insurance Corporation, from a peak of 3.28 per cent in 2010 and not far off the 2006 lows of 1.15 per cent.

Costs can come down, of course. Citi, the big bank that came closest to collapse in the aftermath of the financial crisis, is busily exiting entire markets, dropping from 962 to 788 branches in North America over the past 12 months. Others like Bank of America and Chase are committed to "optimising" huge retail networks, closing underperforming branches while reducing square footage in others.

But many remain reluctant to cut staff from the front lines.

Richard Davis, chief executive of US Bancorp, the number seven bank by assets, said this week he did not want to cut more because "we've hung on here for eight years and done quite well". But outside of compliance and audit, where the group is still adding positions, remaining staff have been asked to boost performance, which is "really the way to manage through these difficult times".

Mergers are not really an option to lift returns, as regulators continue to look askance at deals likely to make banks bigger and more complicated.

The largest pending deal, between Hudson City Bancorp of New Jersey and M&T Bank of New York, has repeatedly stalled since the $3.7bn tie-up was announced in August 2012. This week the Fed pushed back on the timetable for a fourth time, saying it aimed to decide by the end of September. On Friday both banks reaffirmed their commitment to closing.

For banks without big capital markets activities there will probably be more downgrades to full-year profit forecasts than upgrades this season, says Fred Cannon, director of research at Keefe, Bruyette & Woods, which covers 225 lenders.

"Banks had a good few years coming out of the crisis when the smoke cleared and they put all these expense plans in place," says Mike Mattioli, a portfolio manager looking after about $2bn in assets at Manulife in Boston.

"But the longer you have to wait for rates to move, the more it hurts."

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