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3 Banks with 'Near-Term Catalysts' as Expenses Decline

NEW YORK ( TheStreet) -- Second-quarter earnings season has been great for bank stocks, but results for large-cap regional bans actually underlined some challenges for the industry, and for investors.

JPMorgan analyst Vivek Juneja in a note to investors on Thursday wrote "2Q earnings were largely led by a sharp drop in credit costs for regionals--the majority saw a decline in core pre-provision profit due to tepid loan growth, a faster drop in net interest margins (NIM), moderate growth in noninterest revenues, and a mixed trend in expenses (up for some)."

"Pre-provision profit" refers to earnings exclusive of provisions for loan loss reserves, which have a direct effect on pretax earnings for banks.

The KBW Bank Index (I:BKX) closed at 66.20 Thursday, rising 8% since the end of June, and up 29% this year, following a 30% during 2012.

Looking ahead, Juneja sees the banking sector continuing "to benefit from a gradually recovering economy and further housing market recovery--likely with a lag, but these expectations of future earnings benefit should drive the sector."

Several of the largest banks saw sharp improvements in earnings as their trading businesses rebounded and investment banking benefitted from increased market confidence. These include JPMorgan Chase (JPM - Get Report), Morgan Stanley (MS) and Goldman Sachs (GS) and Wells Fargo (WFC - Get Report).

Releases of loan loss reserves, which directly boost pretax earnings, provided a major boost for the "big four" U.S. lenders, as credit quality continued to improve:
  • JPMorgan Chase reported second-quarter earnings of $6.496 billion, or $1.60 a share, increasing from $6.529 billion, or $1.59 a share the previous quarter, and $4.960 billion, or $1.21 a share, a year earlier. The company released $1.396 billion in loan loss reserves during the second quarter, increasing from a release of $1.156 billion in the first quarter, but declining from a release of $2.080 billion in the second quarter of 2012.
  • Bank of America (BAC - Get Report) reported second-quarter earnings of $4.012 billion, or 32 cents a share, increasing from $1.483 billion, or 10 cents a share, in the first quarter, and $2.463 billion, or 19 cents a share, during the second quarter of 2012. The company had restated its first-quarter results to reflect a $1.6 billion settlement with bond insurer MBIA (MBI). Second-quarter earnings benefited from a $1.206 billion release of loan loss reserves, declining from releases of $1.738 billion the previous quarter and $1.923 billion a year earlier.
  • For Citigroup, second-quarter earnings rose to $4.182 billion, or $1.34 a share, from $3.808 billion, or $1.23 a share, the previous quarter, and $2.946 billion, or 95 cents a share, a year earlier. The company's allowance for loan losses declined by $2.147 billion during the second quarter. However, a Citi spokesman said part of the decline in the allowance reflected loan sales. Citi said in its earnings announcement that it actually released $784 million in reserves during the second quarter because of an improved outlook for credit losses, compared to a release of $1.0 billion a year earlier.
  • Wells Fargo reported record second-quarter earnings of $5.5 billion, or 98 cents a share, increasing from $5.2 billion, or 92 cents a share, in the first quarter, increasing from $4.6 billion for 82 cents a share, a year earlier. The company released $567 million in loan loss reserves during the second quarter, compared to releases of $284 million the previous quarter and $843 million a year earlier.

The release of reserves is justified, since regulators don't want to see banks as "over-reserved" during times of strong credit quality, for fear that banks may manipulate provisions for loan loss reserves to smooth-out earnings improvements over the long term. But the reserve releases can't go on indefinitely.

The good news for investors is that all of the "big four" members saw significant increases in pre-provision net revenue during the second quarter.

The story is a bit different for the large-cap regional banks, based on Juneja's comment above about lower core pre-provision profits, and the "mixed trend" in expenses.

According to the analyst, "Banks with additional near-term catalysts include SunTrust (STI - Get Report) (expense reduction), Wells Fargo (expense reduction and additional areas of revenue growth), and Bank of America (expense reduction)."
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