Merrill Slashes Outlook for Banks

Bank stocks remained volatile on Friday, as a growing chorus of analysts expect higher loan losses and necessary reserve building as the first half of the year comes to an end.

Large and regional bank stocks took an initial nosedive after Merrill Lynch cut earnings estimates for 12 companies including Bank of America(BAC Quote), BB&T(BBT Quote), Fifth Third Bancorp(FITB Quote), National City(NCC Quote), Regions Financial(RF Quote), SunTrust Banks(STI Quote), Wachovia(WB Quote) and Wells Fargo(WFC Quote).

The NYSE Financial Sector Index was falling 118 points Friday afternoon, but a few banks, like Huntington Bancshares(HBAN Quote) and Fifth Third, were able to buck the trend, aided by other news.

Merrill analyst Ed Najarian is increasingly bearish on the sector. He cut his 2008 earnings estimates by an average of 22% and 2009 earnings estimates by an average of 19%. Najarian is now below the Street estimates by approximately 25%. He has no buy ratings on any of the 12 large banks he covers, which do not include Citigroup(C Quote) or JPMorgan Chase(JPM Quote).

"[W]e are increasing our credit loss assumptions across nearly all consumer and commercial loan categories, with especially significant increase in residential construction and second-lien home equity loans," Najarian writes in a report. "[D]ue to higher credit loss estimates and rapidly rising loan delinquencies and [non-performing assets] we are also materially increasing our assumptions for additional loan loss reserve building."

He expects loans written off by the largest regional banks to rise to 1.14% of loans this year and 1.52% of loans next year, compared to just 0.38% in 2007.

Others industry analysts agree that banks still need to step up their reserve levels, in some cases significantly.