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Bank Earnings: Strong, But Lots of Tricky Crosscurrents

Adam Jeffery | CNBC

Bank earnings will be one of the bright spots for Q2 earnings. S&P 500 breaks financials down into several categories. Commercial Banks--mostly regional banks, but including Wells Fargo (WFC)--are expected to have an 11 percent earnings increase, according to S&P Capital IQ. Diversified Financial Services, a separate industry within the Financials sector, which include the big money center banks (JPMorgan, Bank of America, Citigroup, etc.) are expected to be up 32 percent.

That's pretty impressive, especially considering total earnings expectations for the S&P 500 are expected to be up a measly 2.9 percent.

There's a lot to like with bank earnings this quarter. A few of the positives:

  • Improving credit quality/reserves
  • Wealth management growing
  • Yield curve steepening
  • Trading activity higher on underwriting, bond trading


But there's also a few serious issues that will be the focus of the conference calls:

  1. Loan growth is still very modest...roughly three percent, with much of that in Commercial and Industrial...mortgages will likely be down, but as rates rise the banks may hold more of the mortgages...will it speed up purchases to lock in higher rates?
  2. Bond prices have been dropping. Bonds that are held in active trading accounts will have to be marked to market, which will likely reflect losses, but it's not clear how great the losses will be.
  3. Mortgage refinancings are dropping, big time. Refinancings are about 70 percent of mortgage applications.


The issue of mortgages is of particular importance to a small group of the biggest banks. Roughly 50 percent of all mortgage originations are controlled by only five banks.

Largest Mortgage Originators:

  • Wells Fargo: 23%
  • JPMorgan: 11%
  • Bank of America: 5%
  • U.S. Bancorp: 5%
  • Citigroup: 4%

Source: Scotiabank


Five banks control 50 percent ofthe mortgage originations in the country. Kind of shocking, no?

I've got two broader problems with banks:

  1. The stocks already reflect stronger earnings performance. Banks have been big outperformers: since the start of the second quarter, the KBW Bank Index (BKX) is up 13 percent, the S&P 500 is up five percent. Valuations have improved as well. There are far fewer bargains than a year ago.
  2. The reason banks have rallied--because the yield curve is steepening--may reflect a misunderstanding by investors about the type of loans that banks make. Generalists are thinking, "buy banks because the yield curve is steepening."


But that's not the way it works. The commercial loans for most banks are priced off of LIBOR. So, for example, if you have a donut shop and you get a, say, three-year floating rate loan from a bank, your rate is likely based on 30-day LIBOR plus some kind of spread.

Here's the issue: LIBOR won't move just because long-term Treasury rates move up...LIBOR will only move if Fed funds move, and that's not happening, because the Fed is a long way from raising rates.

My point: just because the yield curve is steepening, it doesn't necessarily mean that lenders are going to be able to charge higher rates.

I think you will hear banks making just this point shortly.


By CNBC's Bob Pisani

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

Wall Street