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DealBook: JPMorgan and Wells Fargo Feel First Chill of Rising Interest Rates

Mark Wilson/Getty ImagesJamie Dimon, the chief executive of JPMorgan Chase.

Even as two of the nation’s largest banks reported record profits on Friday, beneath the rosy earnings were signs that a sharp uptick in interest rates could spell trouble ahead for Wall Street and the broader housing market.

Kicking off bank earnings season, JPMorgan Chase and Wells Fargo handily beat analysts’ expectations. Profit at JPMorgan surged 31 percent, bolstered by gains in the bank’s trading and investment banking business. Wells Fargo, the biggest home lender in the country, posted a 19 percent increase in its second-quarter profit.

The gains were spread across the banks except for one important source: mortgage banking. The results showed that refinancing activity slowed, as did demand for mortgage loans.

The results could worsen. If rates continue to rise, fewer borrowers are likely to refinance or buy a house. And if the mortgage bond market weakens, banks will take a smaller gain when selling the mortgages.

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While these concerns have loomed for months, the earnings on Friday offered the clearest picture yet of how the interest rate turmoil could affect the banks, whose fortunes hinge in part on their lending businesses.

“We’re trying to be clear with you that this would be a significant event,” Marianne Lake, JPMorgan’s chief financial officer, said on Friday, referring to the potential effect of rising rates on the industry. She cautioned analysts that the volumes of mortgage refinancing could plunge by an “estimated 30 percent to 40 percent” in the second half of this year.

The results from JPMorgan and Wells are a barometer for the housing market because the two banks together account for the majority of all mortgages in the United States. In recent years, the recovery in the market has fueled the earnings of both companies and has also played a significant role in the broader economic rebound.

Until now, the banks have benefited from government policies intended to stimulate the economy in the wake of the financial crisis. As the Federal Reserve cut interest rates in recent years, for example, it spurred millions of borrowers to refinance their home loans to take advantage of the lower costs.

But the Fed has signaled in recent weeks that it could ease its stimulus as the economy continues to recover. The warning has prompted investors to drive up interest rates around the globe. Since Fed officials first hinted that they might retreat, the rate for a 30-year fixed mortgage has risen to 4.78 percent from a low of 3.54 percent.

The banks’ second-quarter results show the early results of the sudden surge. In the second quarter, Wells Fargo received $146 billion worth of quarterly home loan applications, down from $208 billion in the period a year earlier. Its mortgage originations totaled $112 billion, down from $131 billion.

At JPMorgan, mortgage originations rose 12 percent in the quarter, to $49 billion, but overall profit in mortgage banking fell by 14 percent, to $1.1 billion.

On Friday, JPMorgan executives said the slowdown could be even more extreme than previous forecasts have suggested. While both banks might be able to seize on the uptick in interest rates to create a bigger spread between the income they derive from lending and the ultimate cost of borrowing, those benefits proved elusive.

Net interest margin, a critical measure that reveals how much profit banks earn on their loans, fell at JPMorgan, settling in at 2.60 percent for the quarter, from 2.83 percent in the previous quarter. At Wells Fargo, it was 3.46 percent, down from 3.48 percent in the first quarter.

The results suggested that the surge in interest rates came too late in the second quarter to significantly affect the banks, but that the increase could cause deeper problems in the second half of the year.

Christopher Whalen, an investor and housing market analyst at Carrington Investment Services, said that the numbers that Wells and JPMorgan presented were a “very big deal.”

“Everybody in the mortgage industry is going to have to reassess their view of this year and next,” Mr. Whalen said.

Rising rates, though, might help other parts of the banks’ business. Within its fixed-income trading operations, for example, JPMorgan reported an 18 percent increase in revenue. Fees in JPMorgan’s investment banking unit surged 38 percent, to $1.7 billion.

Wells Fargo executives played down the significance of the rate change, noting that mortgage rates were still extremely low by historical standards. John Stumpf, the bank’s chief executive, pointed to the interest he paid for his own mortgages.

“If you were in the mortgage market before 2000, you know that these are unbelievably good rates,” Mr. Stumpf said. “My first mortgage was at 8.5 percent. My second one was at 11.5 percent, and I thought those were great rates at those times.”

Mr. Stumpf noted that the uptick in rates stemmed from the Fed’s indication that the economy was improving. Housing prices are rising and demand for homes has soared.

As the improvements continue, he said, a growth in loans for new home purchases will more than make up for any losses in refinancing.

“I’ll take that trade all day,” Mr. Stumpf said. “It’s good for America, it’s good for the economy and in the long term, it’s good for our business.”

Wells’s overall loan portfolio, which includes commercial and consumer lending, actually rose 3 percent to $802 billion in the second quarter. A bump in credit cards and commercial lending — and record origination of auto loans — further offset the home loan slowdown. The bank’s total average deposits reached $1 trillion, up 9 percent from a year ago.

But important drivers of the returns at Wells Fargo and JPMorgan did not stem from substantial growth in the underlying businesses. Instead, they came from reduced expenses.

Wells Fargo, for example, reduced a crucial expense — building a reserve for bad loans. This move reflected improvements in the quality of loans.

In the second quarter, JPMorgan also lifted its profits by reducing loan-loss reserves by $1.5 billion. The bank defended the practice, saying it pointed to the improving condition of its loans.

Yet Jamie Dimon, JPMorgan’s chief executive, conceded that fresh loan growth was still “soft.”

Nathaniel Popper contributed reporting.

Article source: http://dealbook.nytimes.com/2013/07/12/jpmorgan-quarterly-earnings-surge-31-percent/?partner=rss&emc=rss

DealBook Column: Mitt Romney’s Run Puts Spotlight on Private Equity

David L. Ryan/The Boston GlobeMitt Romney at Bain Capital in 1993. Mr. Romney has largely avoided getting into the details of the private equity business.

On Wednesday, Mitt Romney, the Republican candidate for president, will attend fund-raisers in Manhattan given by his former private equity peers and Wall Street bankers, putting the spotlight on the private equity industry and Mr. Romney’s role in it.

Mr. Romney, a co-founder of Bain Capital, will spend time at the sprawling Park Avenue apartment of his former rival and sometime deal partner, Stephen A. Schwarzman, the co-founder of the Blackstone Group. He will also be toasted at the Waldorf Astoria by James B. Lee Jr., vice chairman of JPMorgan Chase, who helped orchestrate many of the private equity industry’s biggest deals, along with a smattering of other senior executives from the bank.

(Jamie Dimon, the bank’s chief executive and a longtime Democrat, will not be among them; as a board member of the Federal Reserve Bank of New York, he is prohibited from raising money for political candidates, and it is still unclear which candidate he will support.)

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While the fund-raisers are likely to generate many thousands of dollars and galvanize support among Mr. Romney’s former peers, they may also give an opening to critics like the Occupy Wall Street movement.

Already, Americans United for Change, a pro-union Democratic group, has begun a campaign comparing Mr. Romney to Gordon Gekko, the Michael Douglas character in “Wall Street.” It has even started a Web site, RomneyGekko.com.

The private equity industry’s titans have long been worried this moment would come — and about the effect Mr. Romney’s presidential campaign will have on the industry.

“If he is a nominee, well, hold your seats,” Henry Kravis, the co-founder of Kohlberg Kravis Roberts, told a room of executives at a dinner in Hong Kong last month, according to Reuters.

“They’re going to describe us all as asset strippers; we’re flippers of assets, we just put on a lot of debt, fire a lot of people and that’s how we make money,” he added. “You know that’s not the case. That’s absolutely not what we do.”

“There is no doubt that the Obama administration will clearly come out after Mitt Romney and the whole private equity industry,” Mr. Kravis said. “Mitt Romney may become the single source of all U.S. unemployment by the time the election happens.”

Peter Foley/Bloomberg NewsStephen A. Schwarzman, a Blackstone Group co-founder.

A looming issue for the private equity industry is the tax treatment of what is known as carried interest. Private equity executives pay only the capital gains rate — 15 percent — on most of their income instead of the ordinary income rate, which in their case would typically be 35 percent.

So far, however, Mr. Romney has managed to dodge most efforts to brand him as a true Gordon Gekko. And the private equity industry has managed to avoid becoming the focal point of criticism, which instead has been directed at the Wall Street banks.

The crucial question is whether that will change as the campaign becomes more heated. Already, Republican rivals like Newt Gingrich are seizing on his track record at Bain Capital. On Monday, Mr. Gingrich suggested that Mr. Romney “give back all the money he earned from bankrupting companies and laying off employees over his years at Bain.”

But Mr. Romney appears to have kept a studied distance from the most current Gilded Age. A profile of Mr. Romney in The New York Times on Sunday about his relationship with money described a penny-pinching cheapskate who enjoyed flying on JetBlue and frowned upon ostentatious displays of wealth — hardly the lavish spending habits of some of private equity’s current kingpins. (Mr. Romney does, however, have a soft spot for real estate.)

In truth, while Mr. Romney may be worth several hundred million dollars, he is a pauper next to the founders of the biggest firms since he left the industry in 1999, well before the bubble of the next decade that produced billion-dollar riches.

Mr. Romney’s opponents, of course, have combed through his former deals at Bain looking for tales of excesses and failure. Perhaps the worst deal he worked on — which has been highlighted by several news organizations — was the buyout of Dade International, a medical company, which filed for bankruptcy after Bain had cashed out with $242 million.

But criticism about the Dade deal has not stuck as a true talking point, in part because the details painted a complicated story.

Dade was on the verge of bankruptcy when Bain originally bought the company. While Mr. Romney made cuts at the company, he also invested heavily, turning it into the industry leader. At one point, he pushed back against colleagues who wanted to flip the business for a quick profit and instead directed them to make an acquisition to bolster it.

It was only after Dade had been turned around that Bain and the company’s other investors leveraged the company up even more and paid themselves a huge dividend, saddling the company with too much debt.

Some critics contend that private equity firms are skilled at cutting costs at businesses but can choke off growth with large amounts of debt. In the context of the government’s budget, Mr. Romney’s embrace of streamlining may just be what’s in order, but it still poses political challenges.

Mr. Romney’s former colleagues are quietly waiting to see whether he will try to leverage — pun very much intended — his role at Bain in his campaign or will continue to shy away from it.

While Mr. Romney often invokes his broad experience at Bain, he has typically avoided getting into the details of the private equity business, seemingly to avoid the negative connotation that the industry has for some Americans.

But given the clear bipartisan sense that the United States government is marred by inefficiency and is in need of a turnaround, it will be interesting to see whether he tries to highlight the details of his private equity work as a way to demonstrate how he would run the country.

In 2007, Mr. Romney famously said of his private equity work that “sometimes the medicine is a little bitter, but it is necessary to save the life of the patient.”

Some critics have taken that quotation to suggest he is a heartless mercenary. Others have said that the nation may need a dose of the same kind of medicine.

How well Mr. Romney manages those perceptions may determine whether private equity makes it into the White House.

Article source: http://feeds.nytimes.com/click.phdo?i=37321413d89521662cf5f35353e51e59

DealBook: JPMorgan and Wells Fargo Feel First Chill of Rising Interest Rates

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DealBook Column: Mitt Romney’s Run Puts Spotlight on Private Equity

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