Here’s Why Bank Earnings Could Be a Rude Awakening

While analyst have been the most bullish about banks heading into the third-quarter earnings season, key banking regulators, including those at the Office of the Comptroller of the Currency, have reservations.

Financial institutions in the Standard & Poor’s 500 Index climbed 24 percent in 2012 for the biggest rally in nine years. However, stock prices still remain 58 percent below their record high of February 2007, according to data compiled by Bloomberg.

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Even though prices are still far from their highs, signs of a recovering housing market prompted Wall Street firms to raise estimates for profit growth to 21 percent for the third quarter and 32 percent in the fourth. Bullish analysts say that as Federal Reserve stimulus boosts earnings, banks will continue to recover.

“As transactional volume increases for consumer, housing and business credit, there is an opportunity to increase earnings” among regional lenders, said Michael Shaoul, chairman of Marketfield Asset, in an October 3rd email to Bloomberg.

But a recent report from the Federal Deposit Insurance Corporation showed that banks’ quarterly provisions, the amount of money banks allocate for bad loans, have slowed to pre-crisis levels. Regulators now question the depletion of loan loss reserves.

In late September, the chief of the Office of the Comptroller, Thomas Curry, warned banks that “too much of the increase in reported profits is being driven by loan loss reserve releases.”

Citigroup (NYSE:C), which at the peak contributed the most of any bank to these allowances, released the most from its reserves in the last quarter. According to company filings, the bank cut contributions by $2.3 billion, or roughly 7 percent of its $34.4 billion reserves. For the same period, Bank of America (NYSE:BAC) cut $2 billion from its reserve of $31 billion in the second quarter. Its reserves cover mortgages as well as U.S. credit cards and consumer loans. JPMorgan Chase (NYSE:JPM) also cut $2 billion from reserves, and Wells Fargo (NYSE:WFC) slashed $500 million.

Data released last week by the American Banker’s Association showed that while consumer default rates fell to an 11-year low, delinquencies increased in eight other categories. Most notably, delinquencies have increased in home equity loans, to which most banks, still have sizable exposure.

Yet, after declining for 14 consecutive quarters, lending expanded 0.4 percent during the last three months of 2011 and less than 0.1 percent between March and June of this year. And while revenue per share remains less than half the amount it was in 2007, profits in the S&P 500 Financials Index will total $154.7 billion in 2012, an increased of 8 percent over last year.

However, despite evidence of an incomplete recovery, which has banking regulators concerned, many investors remain positive. “As the economy continues to improve, there should be a lot more improvement ahead for bank earnings,” said Timothy Ghriskey, the chief investment officer at Solaris Group, to Bloomberg.

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