Banks Earnings May Surprise in First Quarter

This column originally posted on RealMoney.com on Monday, March 16. For more information about subscribing to RealMoney, please click here.

Don't dismiss the bank stock rally over the past week, as the prospects for relatively strong first-quarter earnings results from Citigroup (C Quote), JPMorgan Chase (JPM Quote) and Bank of America (BAC Quote) are good.

CEOs at each of the three banks last week expressed optimism about their companies and the economy, boosting financial sector stocks and the Dow Jones Industrial Average. While there's always the risk of an idiotic statement from political quarters crushing the market on any given day, there are several short-term factors working in the favor of these banks.

A quick analysis of 2008 loan loss provisions by the largest U.S. bank holding companies shows that there's plenty of room for them to maneuver in their quest for improved first-quarter earnings. For Citigroup, JPMorgan and Bank of America, decisions to reduce quarterly provisions for loan loss reserves could be justified, since the companies reserved sufficiently to keep ahead of the pace of loan losses during 2008. This would boost earnings considerably.

In fact, there's potential not only for sequential improvement in quarterly earnings, but in year-over-year earnings growth, a comparison loved by investors and the business media.

Suggestions from Federal Reserve Chairman Ben Bernanke that mark-to-market accounting rules for banks should be reviewed also fed the market fire.

Wells Fargo (WFC Quote) is the only one of the big four national banks that has not been making happy talk of late. The company recently cut its quarterly dividend 85% to 5 cents a share, as its executives grumbled about restrictions of the government's bailout program.

Investors will need to brace for inevitable "sell the good news" reactions in late April and it's also important to remember that macroeconomic indicators may continue to slide, potentially putting all the bank stocks right back into the doldrums.

But for now, these big banks look like interesting short-term plays.

Building Reserves During 2008

Here's a snapshot of quarterly net income for the largest four holding companies during 2008:

Quarterly Net Income ($Mil) Dec. 2008 Sep. 2008 June 2008 March 2008 Citigroup -$17,263 -$2,815 -$2,495 -$5,111 JPMorgan Chase $702 $527 $2,003 $2,373 Bank of America -$1,789 $1,176 $3,410 $1,210 Wells Fargo -$2,734 $1,637 $1,753 $1,999 Source: Consolidated Financial Statements for Bank Holding Companies (Fed. Reserve Y-9LP) via SNL Financial.

One of the underlying factors in the earnings performance was large provisions for loan loss reserves, which exceeded quarterly net loan charge-offs (actual loan losses) for all four of the largest holding companies through 2008:

Provisions for Loan Loss Reserves and Net Loan Charge-offs and ($Mil) Dec. 2008 Sep. 2008 June 2008 March 2008 Provision for Loan Loss Reserves Net Loan Charge-offs Provision for Loan Loss Reserves Net Loan Charge-offs Provision for Loan Loss Reserves Net Loan Charge-offs Provision for Loan Loss Reserves Net Loan Charge-offs Citigroup $12,171 $6,143 $8,732 $4,679 $7,020 $4,397 $5,751 $3,802 JPMorgan Chase $7,434 $3,315 $5,760 $2,484 $3,624 $2,130 $4,419 $1,906 Bank of America $8,662 $5,550 $6,420 $4,347 $5,841 $3,619 $5,999 $2,715 Wells Fargo $7,908 $2,804 $2,475 $1,995 $3,080 $1,512 $2,029 $1,528 Source: Consolidated Financial Statements for Bank Holding Companies (Fed. Reserve Y-9LP) via SNL Financial.