Banking Industry Likely To Post Lackluster First-Quarter Profits

Banking stocks have taken it on the chin in the first quarter because of the growing worries about subprime mortgages.

To some extent, it's justified as smaller banks and those that depend heavily on the mortgage market will see sharply weaker results. But earnings for some of the bigger banks, which depend more on underwriting stocks and bonds and mergers, are expected to remain relatively healthy, helped by the robust activity in this segment.

“While first-quarter results will likely be uninspiring, most importantly, we believe asset quality will remain manageable,” said Jason Goldberg, an analyst at Lehman Brothers, who tracks the largest U.S. banks.

Banks are certainly dealing with a challenging environment as they grapple with slower loan growth, continued pressure on interest rate spreads and a quarter that is typically a seasonally slow period for profit growth. At the same time, fears are palpable among investors that troubles in the subprime home mortgage market are spreading to higher-quality loans. Profit warnings from companies such as Buffalo’s M&T Bank and Melville, N.Y.-based American Home Mortgage Investment have only served to reinforce these suspicions.

M&T Bank, which is partly owned by Warren Buffett’s Berkshire Hathaway, blamed its expected earnings shortfall partly on higher delinquencies among “Alternate A” mortgages, which are loans made under looser standards than traditional mortgages, but that are not considered subprime, the highest risk category.

Meanwhile, American Home said it saw a sharp deterioration in the mortgage market in March due to a lack of buyers for the home loans it pools into securities and sells to investors. Chief Executive Michael Strauss said he expects it is possible margins on loan sales may not recover this year.

As investors wade through the earnings reports from the banking industry, they will be looking for assurance that the subprime woes are not casting further shockwaves through the mortgage sector. So far, the trouble in the subprime segment has claimed companies such as New Century Financial, which filed for chapter 11 bankruptcy protection.

Inflection Point For Credit Quality

“The main question is whether we are at an inflection point for credit quality,” said Joseph French, an analyst at Sandler O’Neill. He expects that even if there is a modest deterioration the banks will have to build-up reserves back.

Offsetting these negatives were favorable trends in the capital markets.

According to Morgan Stanley analyst Betsy Graseck, global investment grade debt underwriting volume rose 22% from the fourth quarter, while the volume of initial public offering underwriting rose 10% from the year-ago quarter.

Meanwhile, global merger and acquisition volume remained stable at the fourth-quarter’s high levels, or an increase of about 33% year-over-year, Graseck said.

“Trends should drive positive earnings results at custody banks and some positive bias at banks with sizable capital markets exposure,” she said, citing JPMorgan Chase, PNC Financial Services Group, Citigroup and Bank of America as examples.

Overall, Graseck’s earnings estimates for the quarter are below the consensus view for about 70% of the banks Morgan Stanley covers.

“Mortgage/subprime credit and decelerating loan growth (are) driving our below-consensus estimates on National City, Fifth Third Bancorp, Suntrust Banks, Wells Fargo,” Graseck wrote, in a research note. “Thinner net-interest margin expectations (are) driving below consensus estimates for BB&T Capital Markets and Wachovia.”

Season Kicks Off On Monday

The reporting season for the sector gets underway on Monday with reports from Wachovia and Citigroup. Both companies are in the process of cost-cutting drives.

Citigroup, the largest U.S. bank by assets, unveiled its restructuring plan on Wednesday, and said it will take a first-quarter charge of about $1.4 billion, or $871 million after taxes. Excluding that charge, analysts surveyed by Thomson Financial expect the bank to earn $1.09 a share, down from earnings of $1.11 a share a year ago.

Wells Fargo ranks fourth among the nation’s banks with a market value of about $116 billion, but it is a leading issuer of subprime mortgage loans. Its results are sure to be heavily scrutinized when they are released on April 17.

Although the company has been known for his careful watch on its credit, it has recently moved to tighten its credit standards and it announced layoffs as it looked to get its costs under control.

Still, Bob Maneri, a managing director at Victory Capital Management, expects Wells Fargo could be one the companies that bucks the trend of weak results due to its strong management and its ability to generate multiple revenue streams from customers. Both Maneri and Victory own Wells Fargo shares.

“Much of the time, the loans Wells Fargo writes help consumers improve their cash flow and improve their ability to pay back what they borrow,” he said.

The San Francisco-based bank is expected to see its earnings rise to 65 cents a share from 60 cents a share last year, according to Thomson Financial.

With the financial services stocks making up 21.6% of the Standard & Poor's 500 Index's $12.7 trillion market value in the first quarter, the sector will be closely watched.

"The banks have clearly been one of the most underperforming groups since the beginning of the year," said Angel Mata, managing director, equity trading at Stifel, Nicolaus Capital Market, said on CNBC. "I have a hard time believing that the market can sustain any kind of upward momentum without the banks turning around.

With the financial services stocks making up 21.6% of the Standard & Poor's 500 Index's $12.7 trillion market value in the first quarter, the sector will be closely watched.

"The banks have clearly been one of the most underperforming groups since the beginning of the year," said Angel Mata, managing director, equity trading at Stifel, Nicolaus Capital Market. "I have a hard time believing that the market can sustain any kind of upward momentum without the banks turning around.

Company	1Q Est.	Year Ago
Citigroup	$1.09	$1.11
Bank of America	$1.15	$1.08
JP Morgan Chase	$1.02	$0.86
Wachovia	$1.16	$1.12
Wells Fargo	$0.65	$0.60
SunTrust Banks	$1.41	$1.46
National City	$0.62	$0.74
BB&T Corp.	$0.78	$0.80
Fifth Third Bancorp	$0.65	$0.65
PNC Financial	$1.32	$1.19
M&T Bank	$1.58	$1.77

Source; Thomson Financial

Christina Cheddar Berk is a News Editor at CNBC.com. She can be reached at [e-mail].

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