Banks Face Quality Questions

Bank earnings are at a turning point.

Investors obsessed the past two years with the Federal Reserve's interest rate moves and its impact on bank profits have started to shift their focus to the quality of all those loans banks have been making to consumers and businesses.

To be sure, the flattening yield curve -- or the narrowing of the spread between short- and long-term rates -- continues to plague banks that thrive by borrowing money on the cheap and investing in high-yielding bonds. But with the Fed done raising rates, investors are beginning to wonder whether borrowers will start having trouble paying their debts as the economy cools.

As the nation's banks begin reporting third-quarter earnings this week, investors and traders are looking for signs of a turn in credit-quality -- an indication that lenders are starting to gear up for some of the loans in their portfolios going sour. Up until this point, loan defaults have been a nonissue for most banks, with many lenders reducing the amount of money set aside each quarter for loan losses.

But look for investors and traders to pay stepped-up attention during conference calls to the words bank managers use to discuss their loan portfolios. A particular concern is all those homeowners who took out variable interest rate mortgages when interest rates were near all-time lows.