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.
