Bank Earnings Taxed by QE2, Massive Regulation

rcwhalen's picture

Forget about Cyprus, a land of stifling heat and Russian hostess bars.  It’s time once again for bank earnings.  In Q1 2013, the themes are peaking mortgage banking revenues and almost no reserve releases to pad results.  Even as some of the biggest banks are (supposedly) reporting record mortgage banking revenues coming off of the refinance boom of 2012, these same institutions are laying off thousands of front office personnel from, you guessed it, the mortgage department.  

As I noted in a presentation to American Enterprise Institute this week, the combination of Basel III, Dodd-Frank and the ongoing inquisition over foreclosure abuse will force the commercial banks out of the mortgage business over the next several years.  The TBTF banks may be, well, big and dumb, but they are not going to continue producing mortgage loans if their cost to process these assets is 2x their profit – even including the gain on sale.  Nobody in Washington understands what the combination of regulations and court decisions is doing to the world of mortgage finance.

Jay Brinkman, chief economist of the Mortgage Bankers Association, noted in a presentation to the same American Enterprise Institute audience that the cost to a bank to originate a new mortgage loan is over $5,000 today, a significant data point since that amount is 2x the average income to the bank from the same loan and several times the pre-crisis cost. Just imagine how financial markets will react when Wells Fargo, the largest US mortgage lender, announces its withdrawal from much of the mortgage business.  My friend Mark Fogarty, veteran mortgage market watcher at Source Media, reminds us that Wells actually did drop out of the mortgage business in 1990 after the S&L crisis. (This graph is from a longer article on the mortgage market to be published in next week.)

With Dick Bove predicting record bank earnings in Q1, it is useful to recall that all US banks made $33 billion in operating income last quarter.  The record quarter for the industry was $37.5 billion in Q2 2006, so what Dick is basically saying is that the industry could meet or beat $40 billion in net income.  Even with the decline of reserve releases relative to the last several years, mortgage revenue could account for a large chunk of earnings.  The industry sold $641 billion worth of loans into securitizations in Q4 2012, down 12% YOY, but servicing revenue nearly doubled to almost $5 billion.  The drop in loan volumes is why the POTUS invited the banksters to the White House two weeks hence to talk about “opening the spigot” for mortgage finance. 

As the chart above shows, bank dividends have just about caught up with net income, meaning that the banks are giving roughly amounts equal to operating income to shareholders.  The Fed blesses this transfer even though most of the large banks are still woefully undercapitalized vs. their true risks.  If you understand the difference between nominal and risk weighted assets, no more need be said.   If not, read FDIC Vice Chairman Tom Hoenig in a speech last week that despite the higher capital standards implied by Basel III, the effect is largely an illusion in terms of reducing the riskiness of large banks.

Notice in the chart how much larger was the destruction of value by the banking industry during the subprime crisis vs. the S&L bust in nominals terms, when losses reached almost -$40 billion and dividends just about disappeared.  In real terms, the numbers are pretty close.  If systemic risk were taxed as some influential members of Congress are considering, what would the dividend flow of US banks look like?      

So let’s wander through the banks reporting today and see what to expect.  First is JPMorganChase, which is currently rated “A” by Institutional Risk Analytics.  The bank’s tier one leverage ratio is just 6%, but its ratio of tier one capital to risk weighted assets is 14%.  You get the joke now?  The leverage ratio is the measure that matters.  The bank also had a slightly negative RAROC as of 12/31/12, meaning that the bank’s income is not actually positive vs. risk taken.  

With a price to book of just under 1, JPM is actually considered cheap by many analysts.  The market value of equity is up about as much as home prices YOY, some 9% for those of you who get out less than most, and the 1.6 beta is about right for a large money center bank.  The Street has JPM down revenue 5.4% in Q1, but up double digits in Q2 2013 and finishing the year up less than one percent.  The fact that the bank is laying off people in the mortgage unit, sad to say, tells the story on future volumes, but earnings are supposed to be up 5% for 2013 and 7.4% next year.  

Wells Fargo was also rated “A” by Institutional Risk Analytics at the end of 2012.  Of note, WFC’s tier one leverage ratio is two points better than JPM, but its ratio of tier one capital to risk weighted assets is just 12%, reflecting the different business mix of the nation’s largest mortgage originator.  WFC had a positive RAROC of 3.4% as of 12/31/13.  The market value of equity is up 10% YOY.

Net servicing fees were down almost $2 billion in Q4 to $1.4 billion and net securitization income was just $150 million, but net income was almost $19 billion in Q4 2012 up 19% YOY.  This was more than half of the total industry income in the quarter, but only a quarter of the subsidy the Fed is giving the banks because of QE2.  As I noted in the AEI deck, the cost of the funds for the entire US banking sector was just $15 billion at the end of Q4 2012 – a direct tax upon individual and corporate savers c/o Ben Bernanke and the FOMC. But banks are savers too.  

WFC trades on a 1.2 beta, a good bit less volatile than JPM or Citigroup at 1.86, and reflects a very loyal shareholder base.  How many of these fellow travelers of Warren Buffett know that the bank is headed into a massive business model change?  Housing has been the leading revenue line item for WFC for years, but government regulation and the naked ambition of American politicians is about to threaten that opportunity.  At 1.36x book, WFC is fully valued with the current business.  What’s it worth if servicing goes away and mortgage banking is cut in half or more?  

The Street has revenue down in 2013, up small in 2014, so the business model change is at least partly priced into the stock, yet earnings are magically up 4x revenue growth.  The third theme, of course, in Q1 2013 financials is that earnings growth continues to outpace revenue by a significant multiple.  Cost reductions and layoffs are the drivers for bank earnings, but one has to wonder when investors are going to start hitting themselves in the heads with the tips of their skis.

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Son of Loki's picture

My friend just got the ax from that Big Bank in Cali mortgage department. He said 'there are simply much fewer loans then before. He is forced to try sell his (overpiced) house, yank the kids out of school and move East to Charlotte or Atlanta for a job.

Oh yeah, and take a big cut in salary also. The golden goose has flown the nest.

AcidRastaHead's picture

The phrase "Dick Bove predicting ...." to me is analogous to "Knock Knock, ...."

You're a good egg Whalen.  Anyone who appears on CNBC and mentions their post on Zero Hedge is okay in my books.

The Heart's picture

Knock, knock: Who's there?


Mototard at Large's picture

 It looks like the al-Qassam Cyber fighters will continue their DDOS cyber attacks on US banks and US allies (i.e. TD, Key Bank and Dutch banks).

The current targets identified today are Key Bank and HSBC. (12 April 2013)

The Qassam Cyber Fighters full name as claimed is: Izzad-Din al-Qassam Cyber Fighters

Despite the commonality of names, they are more likely allied to Iran rather than holding any allegience to a Palestinian agency. They claim the reaons for the attacks is the video "Innocence of Muslims" produced by US "pastor" Terry Jones.

They also have a strong anti-Saudi flavour which again suggests a Shia group with Iranian leanings.

For more on this see:

Or go to and search for "Izz ad-Din al-Qassam Cyber Fighters"

or go to: (NOTE: this site is a bit suspect as it functions as a spokesman for the Qassam Cyber Fighters. You may not want to access it from work if your employer is a bit sensitive about this sort of thing.....)

moneybots's picture

Bank earnings- pumped by an annual 83 billion annual tax payer subsidy.

BullyBearish's picture

Get used to it...even Jesus couldn't get rid of the money changers.  They will ALWAYS own this world.

Condere's picture

Maybe I'm missing something, but are they complaining that is costs them $5000 to process a mortgage loan because it costs them twice as much to process it? Where the hell does the interest payments from the mortgage go???

A $250,000 mortgage at 4% is going to incur about $180,000 worth of interest over it's 30-year life.

Sigep0612's picture

The Banks bundle the mortgages and sell them to investors.  The only investor in town right now is Fannie and Freddie.  The banks originate the loan, package them and sell.  When they sell to Fannie the bank picks up fees.  In your example, on a $250K loan the bank might make a one time fee of $6000.  If it costs $5000 to process...the $1000 net is too skinny.  The banks retain servicing (collecting customer payments for Fannie and Freddie) and for that they get maybe .375% annually.   Fannie and Freddie collect the 4% minus servicing.   

MrBoompi's picture

Too many regulations? I read your post and looked at your presentation, not one example of a regulation that should be eliminated. How about no reserve requirements and no laws at all? Would that be good enough for these people? Fuck no! $5000 to originate a mortgage? Why is that? Cuz management pays themselves $20 million? What kind of goddamn market do they expect when housing prices are at "2003" levels but wages are at 1965 levels? Sure, the poor banks don't have shit, but that's because their owners have bled them dry with government HELP. They're ruining markets and average people for their own gain. Cry me a fucking river.

donsluck's picture

I had the opportunity to research the banking regulations for California due to a disagreement I had with B of A. This was years ago, maybe 2003. All the regs are online, and as I searched, it appeared that at least 66% of the regs were removed. Perhaps the author is too young to remember the famous banking DE-REGULATION that occured in the last 20 years.

disabledvet's picture

interesting stuff. i think the need for "financial engineering" is only just beginning post "Japan thingy" and "Euro thingy." the first and only reason to have money in a bank is for security purposes...i think the USA is a real stand out right now (certainly vis a vis Europe) as a place where a bank is still a safe place to store one's money (if any of us have any left after 2008. do any of us?) i do agree the whole "Presidential" is there to juice the real estate market. the Fed and Fed's (suing the banks?!) isare out of bullets...and i get the feeling the securities firms are pulling back now. there is only one true way to restore confidence and that's by going all in on an economic recovery "and leaving the banks alone." if there is even an albeit mild recession in the Governments near term forecast...with the election now over...i'd say "just let it happen." sometimes you make things worse by trying to do something...i would argue this is one of those time. there's nothing unhealthy about a natural downturn in an economy during a recovery...i think they're quite common in all recoveries (1986 comes to mind). can the slowdown become something worse? sure. but if the policy front maintains "constantcy" then at least the private sector isn't getting any surprises...and normally that's all the private sector asks for. we shall see of course. the first goal of everyone should be to make sure the bank is a secure place to put your money...if i were the President that is all i would be saying. PERIOD. (especially post Cyprus.) we shall see of course. what were they called? "Fat Cat bankers"?

Thisson's picture

Let me get this straight - you think banks in the USA are safe places to park money?  Hahahahahahhahahaha!!!!!

sangell's picture

So WFC is a good short?

LawsofPhysics's picture

LMFAO!!!  Bank "earning"?  Is that anything like a financial "product"?  Banks get free fucking money from the Fed (ZIRP), these motherfuckers don't earn shit.  They buy treasuries with that free money (for a fee) and fucking profit.


Bankers use to "earn" a living when they could actually go fucking bankrupt and had to do some due diligence.  They use to "earn" a living when they paid the saver interest.  The problems we face are so fucking structural, people completely miss it.  Roll the motherfucking guillotines.

What do these fuckers actually produce of real fucking value?  NOTHING.  Go ahead chris, you arrogant cunt, bail these fuckers out with taxpayer and savers money, go ahead you stupid fuck, do it just one more time.

Temporalist's picture

It's like how Columbus "discovered" America.  Or how when someone breaks into your home they earn your stuff.

LawsofPhysics's picture

At least when someone breaks into your home, you have the opportunity to provide them with other "earnings", such as a bullet to the head.

bluskyes's picture

Grisham's Law, as it pertains to burglary? Exchange the less valuable metal, for the more valuable.

Miles Kendig's picture

Inquisition .. of state treason Chris.

Bicycle Repairman's picture

Basel III?  How'd Basels I & II work out?  And what's with the Roman numerals?  Oh, this stuff is important, like Super Bowl important.

Ghordius's picture

I would't compare the Basel Accord frameworks with the Super Bowl, to be frank. The interesting part about Basle III is that most US megabanks... can't implement them (yet). they don't know enough about their own balance sheet, they never integrated/expanded their accounting systems enough

why should they? they are TBTF, and so will be bailed out until the day the US is fed up enough to break them up

if this does not tell you in what kind of sorry state those giants are...

Bicycle Repairman's picture

As somebody who is well versed in the Basel accords and the history of them, I can tell you that they will never be implemented in the manner intended.

"The interesting part about Basle III is that most US megabanks... can't implement them (yet). they don't know enough about their own balance sheet, they never integrated/expanded their accounting systems enough"

Yes.  And the dog ate their homework. 

I worked for an accounting firm (Big 4) that couldn't report their financial situation to their partners, because their accounting system didn't work.  Because the senior partners didn't want it to work.

I have spent a lifetime gaming risk frameworks and I've been paid well (OK, I'd like more) to do so.  The Basel style regime will never work, because the "regulated" do not want it to.

LawsofPhysics's picture

In short, the "regulated" are not really regulated at all.  If they really were, there would be real consequences for bad behavior, they will not let that happen.

moonstears's picture

Bicycle...this is why I come here. Good info +1