Just how do banks make money?
That is an interesting question that people have been asking me the last two weeks, and they have reason to ask:
1) Wells Fargo had an earnings increase of 20% for the current quarter, and earned $5.27 billion that was applicable to common stock holders
2) JP Morgan announced earnings of $6.50 billion for current quarter
3) Citi announced a 26% rise in adjusted quarterly profit, and earned $3.89 billion for the quarter
4) Goldman Sachs doubled their profit from last quarter, and earned $1.86 billion
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Impressive numbers, no doubt about it, but how exactly do these big Wall Street institutions make their money? I can give you a hint; it isn’t by giving out free toasters to people when they open new accounts. Actually, although Goldman is technically now a bank holding company as opposed to an investment bank, their revenues are still almost all from trading.
There are some links at the end of this post that outline in detail just what comprises the earnings numbers for these institutions, but the short version of the long story is that a good chunk of their earnings come from their equity or capital markets divisions; their stock and bond trading desks. The specifics vary from bank to bank, but with the exception of Wells Fargo (which is the largest mortgage lender in the country) these earnings are due primarily to stock and bond trading.
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Additionally, and what oftentimes is overlooked in the revenue numbers is the amount of earnings from loan loss reserve releases. Keeping this short and sweet; loan loss reserve releases are when banks “release” reserves previously set aside for losses due to non-payment of loans. Something to definitely look into as you evaluate the financials.
This is different from regional banks; Hudson City, Oritani, Clifton Savings Bank and NVE are a few that I can think off the top of my head. These banks, which may very well have equity and debt trading personnel, earn their revenue and operate primarily as traditional banking institutions; they take deposits, pay interest on said deposits, and make loans and other investments. To simplify it even further, this is an old banking formula: 3-6-3. Borrow at 3%, lend out at 6%, and hit the golf course by 3 p.m.
Golf reference aside (not a fan personally), this was always the traditional banking model that was forever altered with the repeal of the Glass-Steagall Act. Relatively plain vanilla and boring, but comfortably profitable.
A question that I have been pondering lately – if these banks don’t really make their money from traditional banking operations, are they really banks? Or are they more like investment corporations? If so, what is the next step?
Thoughts?
http://www.cnbc.com/id/100880373
http://www.cnbc.com/id/100876681
