Much of the confidence that the current market rally has been founded on is the ability of the banks to earn their way out of this balance sheet recession. As we’ve been quick to note, the quality and sustainability of these earnings has been questionable at best. Banks are in business to lend money, but this business has evolved over the years to include a number of different revenue streams. As we all know, many of those revenue streams (M&A for instance) have died over the years. Regardless, the primary source of revenue remains a banks ability to loan money. As consumers continue to sink under the weight of stagnant wages, job losses and high household debt there have been little to no signs of strength in the lending markets. As we’ve previously noted, it’s unlikely that the securitization markets are coming back any time soon. The weakness in the securitization markets is perhaps best documented by the incredible decline in the commercial paper market:
As we noted over the weekend, banks have turned to a far less sustainable and potentially disastrous revenue stream as they try to compensate for the slowdown in lending: trading. If the equity market rally is going to have legs we’re going to need to see strength in future banks earnings. Unfortunately, the earnings that powered the banks higher in Q1 and Q2 appear not only unsustainable, but a terribly risky change in the banking business model.
Today’s comments from PNC and SunTrust CEO James Wells confirm this thinking:
“This credit cycle has yet to play itself out,” Wells said in a speech today at the Rotary Club of Atlanta. “We do not expect things to improve for the banking industry in the very near future. The industry is a long way from declaring any sort of victory.”
“Maybe we’re not completely out of the financial crisis” said E. William Stone, who oversees $101 billion as chief investment strategist at PNC Wealth Management in Philadelphia.