Better Credit Quality Should Boost Banks' Q2 Earnings

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Oja says he generally would expect revenues and fee income—including service charges on deposits, insurance, brokerage accounts, and mortgage banking, as well as gains and losses on securities—to be significantly higher than in the second quarter of 2009, which was still a fairly weak period. He also expects loan loss provisions to have declined in the last three months.

Commercial Construction Loans

He says he's wary of any regional bank whose commercial construction loans—the riskiest of the four kinds of commercial loans—account for more than 7.5 percent of the total loan portfolio, especially in distressed regions of the U.S. such as the Southwest and Southeast. At 21 percent, Wilmington Trust (WL) is one of the banks to be most cautious of, he says.

In a July 6 note, Macquarie Equity Research said it raised its second-quarter net charge-off assumptions for Wilmington to $100 million from $28.9 million and increased its loan loss provision expense estimate to $125 million from $50 million based on a third-party portfolio review being conducted and a slower economic recovery. Macquarie cut its second-quarter earnings forecast to a loss of 87 cents from a loss of 20 cents per share on higher provision expense, a shrinking balance sheet, and lower fee income. The added credit stress will postpone repayment of the money Wilmington received under the Troubled Asset Relief Program (TARP) from the fourth quarter of 2010 to the second quarter of 2011, which will put more pressure on earnings per share this year and the first half of 2011, according to Macquarie.

Among the regional banks with the lowest percentages of commercial construction loans, says Oja: Bank of Hawaii (BOH), TCF Financial (TCB), and Fifth Third Bancorp (FITB).

While bank balance sheets can't expand meaningfully until banks step up lending, they have good reason to be overly conservative in their lending practices right now, says Oja. If the Financial Accounting Standards Board rules that starting next year banks have to start marking to market all loans held to maturity, banks recognize that they'll be required to raise additional capital. Their capital requirements might also rise if a new set of international banking standards currently being worked on materializes, he adds.

Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.

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