1 Reason Banks Did Well in the Second Quarter

By Markets Fool.com

One of the commonalities among banks in the first quarter was that most capital markets businesses did well, fueling top and bottom lines across the industry.

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To hear more about this, listen in below to this clip from theIndustry Focus: Financials, The Motley Fool's weekly podcast focusing on a different industry each day.

A full transcript follows the video.

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This podcast was recorded on Jul. 25, 2016.

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Gaby Lapera:Why don't we talk a little bit about capital markets, because a lot of these big universal banks are seeing that as market makers.

John Maxfield:Right, so if you look at these universal banks, there's two components of them. There's your depository and lending side of their operations, which is what your typical person thinks about when they think about a bank, but then there's also that Wall Street side of the business. That's taking companies public, that's issuing bonds for companies, that's acting as market makers in the trading markets, and those are known as capital markets business. What we saw in the first quarter was that because of all the volatility in the markets, caused by the European stuff, the concerns about China, the concerns in the energy market, volatility in the capital market is really high, and when volatility is really high in the capital markets, clients of these banks that need to trade securities step back from the market because there's just no reason to get in there when prices are going all over the place.

When they step back from the capital markets, these banks that act as market makers earn less in commissions. That drove down sales and trading revenue by double digits in the first quarter, and therewas a concern that that would be the same situation the second quarter, but it's actually the exact opposite. Almost all of the banks reported double digit year over year increases in their capital markets businesses, which in addition to that loan growth, really helped them in terms of trying to beat analysts' expectations.

Lapera:Yeah, that's fantastic. I think that we've just about covered everything. The only other thing that we haven't covered I guess is the energy sector. It's still weak right now, and the banks that have large portfolios that rely on energy are still shoring up their reserves, but it doesn't seem like it's ... I don't know, I don't think it will go on forever.

Maxfield:Yeah, all you have to do is just look at a chart of oil prices. They bottomed out below $30 a barrel in the first quarter, but they've since improved. I don't know exactly where they're at today, but on Friday they were at $44 or $45 a barrel, so a lot of banks had been modeling, when they're setting aside loan loss reserves for $30 a barrel oil. That's what they're modeling for in the first quarter. Now that the oil is way above that ... It's still significantly half as much as it was a couple of years ago, but the fact that it's above that $30 a barrel benchmark means that it's heading in the right directions for banks.

I think it's still fair to expect higher losses from banks in their energy portfolios, particularly this year, because the way that their energy customers work is that they hedge their own positions in the oil and gas markets, but you can only hedge out two years, so even the maximum hedge starting in 2014, which is when oil prices declined, extends into this year, so this is really where the rubber's going to meet the road in terms of the oil market's impact on banks.

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