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Bank Earnings: A Weak Link in the Recovery

Posted by: Ben Steverman on April 01, 2010

The financial crisis may be easing, but don’t be fooled that it’s ending.

Yes, there is good news: Financial markets have healed somewhat, and most big banks have paid back federal bailout funds. In the last quarter of 2009, the large-cap companies in the S&P 500 financial sector actually made a profit, posting earnings of $3.2 billion after losses of $54.4 billion a year ago.

According to Bloomberg, analysts expect first-quarter financial earnings to rebound 75.6% from a year ago. Financial institutions start reporting those results later this month.

But look more closely at earnings expectations and it becomes clear that U.S. banks remain deeply troubled.

The predicted rebound in financial earnings is entirely due to insurance companies — which are expected to see a 179.1% rise in earnings from a year ago — and so-called “diversified financials,” expected to post a 142.5% earnings recovery. That category includes companies that are technically banks — like JPMorgan (JPM), Goldman Sachs (GS) and Morgan Stanley (MS) — but whose revenue streams include many other financial businesses. The “banks” category, limited to purer banking companies like U.S. Bancorp (USB) and Wells Fargo (WFC), is expected to see earnings fall 44.9% from a year ago.

This demonstrates a growing split in performance between Wall Street and Main Street financial institutions. The extent of the problems on Main Street are clearer when looking at a broader array of banks, including small- and medium-sized institutions.

The banking experts at Keefe, Bruyette & Woods (KBW) put out a 270-page “first-quarter 2010 bank preview” on Mar. 31, detailing estimates on the 175 banks they cover around the country.

Among KBW’s conclusions:

• For all KBW-covered banks, earnings will rise just 3% from the disastrous first quarter of 2009.

• An estimated 38% of banks will post losses, KBW predicts.

• The large-cap banks in the KBW Bank Index should see median earnings growth of 3.8%, while regional banks in the KBW Regional Banking Index should expect growth of just 0.9%.

The study’s authors write:

Despite the consensus view that the economic recovery is underway, the operating environment remains challenging, and we expect credit costs will remain elevated in [the first quarter] as both the realization of losses and reserve building continues.

Large-cap banks may be further along in the process of dealing with the aftermath of the credit crisis, the report says. While big banks were more exposed to bad consumer loans — which were hit early in the recession — smaller institutions have more exposure to commercial real estate and other credit problems that are still emerging.

The road to recovery could be long. KBW’s analyst write that most banks won’t reach a “normalized level of earnings until 2012 or later.”

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Businessweek’s Emily Thornton, Amy Feldman, Ben Levisohn, and Ben Steverman focus on matters great and small for investors, from the views of a hot fund manager to an explanation of the latest products devised by Wall Street’s rocket scientists. Exploring trends in any area, from bonds and stocks to closed-end funds and futures, always with an eye towards giving investors a better understanding of the sometimes confusing and often chaotic world of finance. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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