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Bank earnings may disappoint

Outlook for rest of 2010 clouded by pending reform

NEW YORK – The bank industry’s earnings winning streak may be over.

A terrible spring in the financial markets is expected to leave the nation’s big banks with second-quarter earnings that fall short of their stellar results from the first three months of the year. That’s bad news for companies that relied on trading profits to mask a still-miserable banking climate with high losses from failed loans and low demand for credit.

Banks begin their second-quarter reports Thursday, when JPMorgan Chase & Co. issues its results. But there may be problems in the coming quarters as well. A number of unknowns are weighing on full-year earning projections and the stocks of big names like JPMorgan, Goldman Sachs and Morgan Stanley. Among the biggest wild cards: how banks will be affected by the financial regulatory overhaul that’s awaiting congressional approval. Fears of a “double-dip” recession and Europe’s debt crisis have added to the gloomy outlook.

The news isn’t all bad, though. Smaller banks that don’t bet heavily in the financial markets, including State Street Corp. and Fifth Third Bancorp, are expected to post good to strong results for the April-June period.

Citigroup Inc. and Bank of America Corp. report earnings Friday, followed by Goldman Sachs Group, Morgan Stanley and Wells Fargo & Co. next week. All six are expected to post profits. Yet nobody predicts a repeat of the first quarter, when Goldman, Bank of America, Citigroup and JPMorgan were models of perfection, literally: All four went without a single day of trading losses.

During the second quarter, worries over debt problems in Europe unnerved investors and sent stocks and commodities sliding. The Standard & Poor’s 500 index fell nearly 12 percent during a three-month period of chaotic market swings best illustrated by the historic May 6 “flash crash.” On that day, the Dow Jones industrial average fell to a loss of 1,000 points before recovering to close down 347.

“It was a very, very bad trading quarter,” banking analyst Nancy Bush of NAB Research said. “I hope everyone has gotten the message.”

Banks most active in capital markets could take the biggest hit. At Goldman and Morgan Stanley, revenue from fixed income, currency and commodities trading could plunge 30 percent or more from the first quarter, Credit Suisse analyst Howard Chen said.

Citing a “heinous trading environment,” well-known banking analyst Meredith Whitney last week dramatically slashed her second-quarter earnings estimate for Goldman from $4.75 a share to $1.70 a share. That’s below the industry consensus of $2.34 a share. Whitney also lowered her full-year forecast for Goldman’s earnings from $20 per share to $15.70.

Trading profits have allowed banks to offset losses in their residential and consumer loan portfolios. Analysts believe losses from home foreclosures and other failed loans have likely peaked, but they remained high in the quarter. Banks still have to set aside billions in what are called loan loss reserves, further eating into their profits.

“How much does the loan loss reserving affect the bottom line? That will be a big question,” said analyst Nick Kalivas at MF Global in Chicago.

Investment banking revenue is unlikely to help overcome losses from loans. Banks’ fees from stock and bond financing and advising on mergers and acquisition deals are expected to be down from the first quarter. Companies made fewer deals amid worries that the worldwide economic recovery might slow or even stop.

Banks’ lending units also struggled. High unemployment and fears that the recovery could sputter again curbed consumers’ and businesses’ appetite for credit. Banks, meanwhile, have been hesitant to lend to all but the most qualified borrowers.

The consequences of making bad loans can still be seen in the rash of bank failures. With 90 bank closings nationwide this year, the pace of failures far outstrips that of 2009, which was already a brisk year for shutdowns. By this time last year, regulators had closed 45 banks. The pace has accelerated as banks’ losses mount on loans made for commercial property and development.


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