Rally in Bank Stocks Doesn't Add Up

Financial reports for many banks in the second quarter have looked remarkably consistent: sliding profits, mounting loan losses and soaring stocks.

Large-cap banks such as Bank of America (BAC Quote), JPMorgan Chase(JPM Quote), Wells Fargo(WFC Quote), even Citigroup(C Quote) managed to beat the meager profit expectations of Wall Street analysts, despite smaller profits and a continued deterioration in credit trends.

Approximately 56% of the 39 financial companies in the S&P 500 that have posted results so far have beat earnings estimates, according to Thomson Reuters. Since the beginning of last week, the Keefe Bruyette & Woods Bank Index, which tracks the top 100 banks, is up 35%.

Even some banks that posted larger-than-expected losses, such as Wachovia(WB Quote), saw shares rise after it pointed out that a further public capital raise is so far unnecessary.

"The results for the most part were encouraging for the quarter," says Frank Barkocy, the director of research at Mendon Capital Advisors, which runs the Burnham Financial Services Fund. "I think there was a feeling that maybe we're moving in the right direction."

"Historically the group has tended to respond six months or more in front of the peaking of the problems," he said. "The fact that the stocks were oversold and there were some encouraging signs, have resulted in the rally."

Barkocy said that for the most part earnings were "in-line to modestly better than expectations." Even where there was a shortfall in results, a good portion of it was due to banks' continuing to build loan losses, and "in a number of instances we saw a slowing in the pace of new nonperforming assets being added," he said.