Guest post: How big banks earned so much money this quarter

Submitted by Edward Harrison of the site Credit Writedowns

We are a few weeks into earnings season and it should be abundantly clear that financial institutions are firing on all cylinders. In fact, financials are leading the broader market for the first time since 1993. Yet, loan losses have been absolutely enormous. What gives?

The Great Giveaway is the essence of recent market performance in a nutshell. Let’s look at U.S. Bancorp for a second as an illustration. In March, Warren Buffett mentioned in some CNBC interviews that he felt the underlying earnings power of his major holdings in financial shares, Wells Fargo and U.S. Bancorp, was pretty robust. Both have come out with some pretty bullish announcements since then. U.S. Bancorp announced its earnings yesterday. This is how Deal Book reported the event.

U.S. Bancorp, one of the 10 largest U.S. banks, reported higher-than-expected quarterly earnings on Tuesday on record revenue from mortgages, sending its shares up almost 21 percent, Reuters said.

The strong mortgage activity helped to offset losses from lease financing, construction and development loans, and credit cards.

The bank also put aside $1.3 billion for loan losses, $833 million more than a year earlier, as declining home prices affected both consumer and commercial loan portfolios. Chief Executive Richard Davis expects to set aside similar amounts in the next two quarters, before loan losses start to moderate toward year end.

“I don’t expect us to stop reserve-building until which time we see strength in the reduction of (losses),” he said on a call with analysts.

Shares soared on the results to finish up 20.9 percent at $19.27.

“Our credit costs are elevated like the rest of the industry but we were able to offset that with our core businesses,” Chief Financial Officer Andrew Cecere told Reuters in an interview.

The bank in November took over failed California lenders Downey Financial and PFF Bancorp, with support from the federal government.

“I would expect to see more of the same, but nothing large,” Mr. Cecere told Reuters, when asked about future acquisitions.

First-quarter profit for common stockholders fell to $419 million, or 24 cents per share, from $1.08 billion, or 62 cents per share, a year earlier.

Analysts on average were expecting the Minneapolis-based company to earn 20 cents a share.

Like Wells Fargo and JPMorgan Chase, which both reported last week, U.S. Bancorp saw record mortgage production revenues from new applications and refinancing.

But broader interest in loans started to decrease in the second half of the quarter, Mr. Davis said on the call, attributing this to customers becoming more careful.

“There are a number of customers who are neither as qualified as they were a year ago, nor are they interested in (more) debt,” he said.

U.S. Bancorp received $6.6 billion in taxpayer funds under the U.S. government’s Troubled Asset Relief Program last year, and TARP recipients have been under fire for not extending this money to customers.

“We have not denied a single credit-worthy customer since the beginning of this downturn,” Mr. Davis said. The bank hopes to repay the $6.6 billion once regulators approve, he said.

What you should have noticed is this:

  1. There were massive loan losses at U.S. Bancorp (“The bank also put aside $1.3 billion for loan losses, $833 million more than a year earlier, as declining home prices affected both consumer and commercial loan portfolios. Chief Executive Richard Davis expects to set aside similar amounts in the next two quarters, before loan losses start to moderate toward year end.”)
  2. So what. U.S. Bancorp made a lot of dosh anyway. How? “Like Wells Fargo and JPMorgan Chase, which both reported last week, U.S. Bancorp saw record mortgage production revenues from new applications and refinancing.”
  3. But, what’s more, they received $6.6 in bailout funds AND they got to pickup a few assets like Downey Financial’s carcass courtesy of the FDIC. (“The FDIC and U.S. Bank entered into a loss share transaction. U.S. Bank will assume the first $1.6 billion of losses on the asset pools covered under the loss share agreement, equal to the net asset position at close. The FDIC will then share in any further losses.”)
  4. And, finally U.S. Bank is getting massively subsidized debt issuance courtesy of every big bank’s new friend, the former Grim Reaper FDIC (“Fitch Ratings has assigned ‘AAA/F1+’ ratings to debt issued by U.S. Bancorp (USB) through the FDIC Temporary Liquidity Guarantee Program (TLGP). Specifically, USB issued $750 billion of 2.25% senior notes due March 13, 2012.”)

So, what you are seeing at U.S. Bancorp are real profits coming courtesy of Federal Government largesse. Now, I happen to believe that U.S. Bank is one of the better big banks in the U.S. But for the sake of argument, let’s assume they were in dire straits and were on the verge of collapse pre-TARP.

That’s not a problem now.

Lots of revenue. The Fed has engineered low long-term interest rates by buying into the treasury and MBS market with money they created out of thin air. The result has been a lot of refinancing and new mortgage applications. Check.

Lower liquidity constraints and unimpaired assets. The FDIC has given U.S. Bank the deposits of Downey after it was bankrupted, much as Wells Fargo got Wachovia and JPMorgan got Washington Mutual. These deals were done on extremely favourable terms because many of the losses will have been recorded before the takeovers. Therefore, U.S. Bank, Wells and JPM are getting huge deposit bases and a large asset book without most of the losses the legacy organizations would have carried in a merger. That means they all get low-cost funding not subject to rollover risk (the wholesale market which bankrupted Northern Rock) and relatively unimpaired assets. Check.

Capital injection. U.S. Bank also got a big fat check for $6.6 billion under the TARP. This should go a long way toward helping recapitalize the bank and insuring it as a safe counterparty and depositary institution. Check.

Low-cost funding. Finally, U.S. Bank is getting FDIC-subsidized funding. It’s kind of like the kind of sweet deal Fannie and Freddie have gotten in that investors felt agency debt was implicitly backed by the Federal Government.

The long and short, there fore is that U.S. Bank is getting a huge helping hand from the government. Even if it had been impaired beforehand, it would look much better now. The fact that their earnings STILL fell some 60 percent, gives you an insight into the magnitude of the problem i.e. loan losses.

The conclusion I have drawn from this is that the big banks will be earning a lot more money than had been anticipated before Q1 results were released. Nevertheless, continued problems in the prime mortgage and commercial real estate markets will be a drag on earnings as indicated by the huge writedowns at U.S. Bank and other banks like BofA. You should also note that credit card delinquencies are equally problematic. The regionals, with their construction loans and CRE exposure, are going to be taking it on the chin here.

Until and If these headwinds become insurmountable, big banks will be making money. Regional banks and local banks, not so much.

U.S. Bancorp Posts Higher-Than-Expected Profit – Deal Book
Fitch Rates U.S. Bancorp’s FDIC Guaranteed Debt ‘AAA/F1+’ – Market Watch

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. scattershot

    I have read recently that a number of banks had positive earnings this year due in large part to writedowns of the value of their debt. I guess the theory is that technically they can buy back their debt in the open market, and thus the resulting liability has a lower value as the price of that debt drops.

    It takes a pretty messed up accounting system to allow holding other companies debt that is considered likely to default at face value (due to the recent accounting changes), while allowint writing down their own debt (which they will never be in a position to buy back in any size at the current market prices as access to that much cash would cause the price of the debt to increase back towards face).

    How important are these debt writedowns in actuallity? They don’t seem to be that significant according to this post….

  2. profnickd

    Very insightful article — I just have a quibble with Harrison’s terminology.

    He keeps saying that Wells, USBank, etc. are “earning” money or “making” money.

    Not quite. Strictly speaking, these large (and insolvent) banks are “receiving” money, specifically from the federal government, which Harrison does clearly discuss.

    But he’s using thw wrong terminology. The distinction is important because if the federal government would cease giving money to these insolvent banks, their insolvency would immediately and unambiguously be clear. Right now, their insolvency is ambiguous because of the federal governmment’s subsidies.

  3. Doc Holiday

    In my post last night about Citi, an obvious problem stands out for all these banks:

    Average Assets (in billions of dollars) in Global Cards, is down 66% (this is just for Citi YOY).

    Citi has lost about $200 Billion in one year (anyone know the total for 4 years?) and as unemployment edges upward, these banks that were to big to fail, which did fail and continue to fail, are only in business because of taxpayer subsidies. Thus the question remains as to why taxpayers are being forced to infuse cash into failed businesses that have only one way out of this mess — which is through fraudulent accounting and further bailout methods.

    The theory by Timmy and Mr. O seems to be that we can continue a program of layering bandages on top of various bleeding areas and put out fires here and there, but essentially, the goal is to save the structures of these entities that are too big to fail. We are going to breath life back into the dead zombies, no matter the cost, and if God is willing and able, will roll back the clock and restore these zombie banks back to their previous level of robust health. Those good old days when life was good, when they were all busy with massive accounting fraud, which I seem to recall is why we were in this fuc-ing mess!

    Are the people at Treasury that retarded, are the people that are involved in solving this systemic problem really as stupid as the seem to be? Is the solution to this period of failure to simply adjust the books a little, screw the tax payers and then get the XMAS bonuses rolling like a freight train ASAP? I believe with all my heart and soul that there is nothing that will be changed in wall street besides the size of future rewards which will be directly linked to our governments interaction with lobby groups, lawyers and congressional fraudsters that are too big to fail!

    Good luck to them in all, as they hunt around for several Trillion Bucks that aint there!

    Full Disclosure: The author has just had a small serving of cereal and will now listen to Metric, then Yeah Yeah Yeahs and possibly sit in the sun pondering corruption…..

  4. Leo Kolivakis


    Let me ask you a question. Let’s say you and I had a billion dollars and we got a license to open up a bank in the U.S.. We had a clean balance sheet and carried no debt.

    If we are then able to borrow at virtually zero percent and lend at the prime rate, collecting a spread of almost 400 basis points, wouldn’t we be recording record profits in no time?

    It’s all about SPREAD. The problem with the U.S. banks is that they are plagued with bad assets, so they are making money hand over fist but using it to clean out their balance sheets.

    In Canada, they are just making money hand over fist and the banks are also charging higher rates on existing customers citing concerns on the “credit crunch”.

    It’s a scam. Anything to boost their ROE. Another scam is the loan shark rates of credit card companies. I hope the credit card CEOs get grilled on Thursday when they appear at Capitol Hill, but I doubt anything will come out of this.

    Politicians know its all about image, but when push comes to shove, they won’t bite off the hand that feeds them.



  5. sangellone

    Doesn’t that TLGP expire this year?

    While the banks have enjoyed a boom
    in refi’s this quarter, owing to the ‘historic’ low rates, one presumes those that could refi have and there will not be a follow
    on for this ‘bonanza’.

    OTOH, Diane Olick had an interesting bit from the FHFA, or whatever the acronym is for the GSE’s overseer is these days, in her CNBC blog. Seems the idea of the Obamamods is going to come a cropper in that 34% of current defaulting homeowners say loss of or reduced income has driven them to the brink. 20% said too much other debt, 8% said unemployment. The traditional excuses of illness or divorce were minuscule in comparison to the ‘just cannot afford the house’ reasons.

    Given that there is no reason to believe personal incomes will be growing, employment increasing or credit card and other debt reduced fast enough to save the distressed homeowner and with the foreclosure
    moritoriums ending can that mean anything but trouble for mortgage loans, housing prices and bank profits going forward?

    The TARP,TLGP, low bank borrowing costs and other Fed and Treasury gifts to the banks were nice palliatives, shots of adrenalin if you will, but they do nothing to cure the underlying rot which is now in the real economy amongst prime borrowers.

  6. Edward Harrison


    You’re right, it is a scam. Banks are getting handouts in complicated and opaque ways that hide the fact that many of them are NOT making money at all except for the helping hand of U.S. taxpayers.

    But, this is the chosen way the Obama administration has made to recapitalize banks. Not exactly change I believe in – at least on the finance front.

    As for the accounting dodge that scattershot talks about, this rule has been helpful to the likes of Citi for sure (I understand it will have the opposite effect on Morgan Stanley). But, this is an accounting rule that has been in effect for a while now. It is just because earnings have declined and debt prices have declined that they have taken on such a prominent role.


  7. sangellone


    an interesting theory posited by the folks over at Institutional Risk Analytics, is that the Chinese
    have told the US government that should bank bond holders be wiped out or seriously damaged by a TBTF going into bankruptcy they will retaliate by dumping or refusing to buy USG debt.

    This makes the inexplicable a bit more understandable if it is true.

  8. Doc Holiday


    Your comment helped me end up with the post by Black (below) after I read the bit on: Hindsight w/Teethmarks and a Chinese Gun to Our Heads

    William K Black Responds To Daily Kos Critics

    Regarding the mandate of the law:

    PCA (Section 1831o) was adopted in 1991 as part of FDICIA. It was based on the belief that regulatory discretion led to regulatory forbearance which increased moral hazard and increased losses during the S&L debacle. PCA was based on three central premises: (1) increase the capital requirement, (2) mandate that the regulators take "prompt corrective action" well before the insolvency so that S&Ls and banks could be resolved without cost to the insurance fund (or taxpayers), and (3)


    The purpose of this section is to resolve the problems of insured depository institutions at the least possible long-term loss to the Deposit Insurance Fund. (1831o (a) (1)).

    The statute is mandatory in its language, repeatedly using "shall."

    (2) Prompt corrective action required

    Each appropriate Federal banking agency and the Corporation (acting in the Corporation's capacity as the insurer of depository institutions under this chapter) shall carry out the purpose of this section by taking prompt corrective action to resolve the problems of insured depository institutions. (1831o (a) (2))….

    Thanks for that connection there and hope it doesn't seem off-topic! Banks got into this mess because of a lack of regulation and as the government refuses to regulate and offer substantially more ways and means to engage in fraud, one has to wonder why this will ever end any different that the same type of messes in Zimbabwe, Russia, Iceland, and Berkshire Hathaway….

    Full disclosure: The Author is currently listening to "Hustle Rose" and contmeplating sitting in the sun:

  9. B. Mull

    I don’t believe much of what U.S. Banks CEO says. He misrepresented the meeting with Obama (he said compensation didn’t come up). Now he’s going around blowing smoke about how un-American it is that the feds made him take TARP money. Doesn’t mean the shares won’t go up. Just kind of a red flag to me.

    I think the Chinese angle on bond-holders is interesting, but I’m pretty sure 90% of the political pressure comes from the big banks. When the U.S. starts calling for a new global currency I’ll admit the Chinese are in control.

  10. charles

    Considering that there is very little activity in the new transactions market, it is reasonable to believe that most of the mortgage activity comes from refinancing.
    This is in turn raises an adverse selection issue : only the best borrower can refinance, and therefore, all things being equal, the old vintages of securitization/loan portfolio are going to be negatively affected.
    Of course, Banks will incorporate this effect only later in their loan provisions …
    This is where repealing the mark-to-market rule becomes handy : the market has a nasty habit of uncovering this kind of facts quickly and discount them accordingly. If one had to listen to it, the “extra” revenue from mortgage origination would just go “poof” in the same period it was created !

  11. Market Seer

    Everyone is talking about how great it is to be a bank and how great the NIM are. They are only great compared to 2002 and 2003. NIM is still below mean compared to the last 20 years. I don't get how such a farce becomes a reality just because enough people say it.

    Random selection: BAC – 2.70%, BB&T – 3.57% (up 10 basis points) ZION – 3.93% (down from 4.2% last quarter), Citigroup – 3.30% (3.22% last quarter and 2.80% Q108), Regions 2.64% (2.98% last quarter and 3.53% Q108), U.S. Bancorp – 3.59% (3.81% in Q4 and 3.55% Q108)

    From UMBF Financial Corp Press Release Today:

    "Net interest margin decreased 11 basis points to 3.39 percent for the three months ended March 31, 2009 compared to the same quarter in 2008."


    "Earnings are down modestly for the first quarter, due primarily to two external forces impacting the industry: continued volatility in the equity markets and a sustained low interest rate environment causing pressure on net interest margin."

    If anyone has any contrary data for the industry as a whole I would love to read it. This is something I just started looking into and it seems that everyone just wants to believe something is going good for banking. While these NIM have improved, it hardly seems something to write home about.

  12. Chindit13

    Are banks making money? I suppose. But I also suppose any Cassandra can easily find fault with these earnings. Such as:

    Refi’s: Great for fee booking, but how soon will it be that no one is left with enough equity in the house to qualify? Also, rewriting an 8% mortgage at 4.7% is a lot better for the homeowner than the bank, as it costs the same to fund each one, but the spread for the bank is a lot worse. Finally, matching book in an environment of falling rates is a heck of lot easier than trying to match book when rates start to rise. What happens when rates are up and depositors demand a decent rate of return?

    TARP Money I: The marginal cost of taking billions in free money and putting it in, e.g., 10-year Treasuries is about zero, but adds a few hundred million dollars to the bottom line.

    TARP II, aka AIG CDS’s Payouts: Enough said.

    Mark-to-Market: Great deal here, as another poster noted. If you do not like what the market does to your CDS, CDO, MBS’s, etc., you can adjust according to your model (a gain). If the market does not like YOUR OWN debt, you can take the theoretical gain you would have if able to buy ALL the debt at that market price. This is a true cake-and-eat-it, too situation. ZH has a great piece on this showing the effect is not insubstantial. Look at MS in particular.

    Does any of this make me feel better about buying bank stocks for anything other than a quick trade?

    No. CRE is just getting started to smell rancid, CC problems likewise, consumers are still strapped and losing their jobs at a rapid rate. There is enough grumbling in the public and in some parts of Congress that the free hand and open wallet Geithner et al have had up to now may be in danger of getting cut off. It may well be coming to the time when the common shareholders and many of the bondholders are going to have to do what’s right and make the ultimate sacrifice for the good of the country.

  13. Richard Kline

    So charles at 10:37, that is a very interesting point, and certainly a reasonable argument. If I follow you, the most creditworthy current mortage holders—whose notes will all but certainly be in pools securitized somewhere presently—are taking advantage of low rates to re-fi, they are exiting those pools. Which means that the _actual_ value of the MSBs containing those pools are, in effect, driven down by the out-migration of the most creditworthy mortgage holders there. Soooo, whoever holds that MSB is actually going to take a LOSS as a result of that refi. It’s sort of zero-sum, if not 1:1 in effect.

    That being so, these current bank profits are infact income transfers _out_ of the asset value and revenue stream of existing MSBs. So just who holds those MSBs and, in effect, is losing money so that banks can show current profits. . . . I’d heard that *cough* the US Guvmint has been advised by the banks to buy all of said assets.

    —This is a great game, idn’t it?!!

  14. erich

    I think “MBS pools” will be content with the cash from refinancings in exchange for removal of the very fine MBS being paid off.

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