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Banks Face Serious Threat in Second Half

NEW YORK ( TheStreet) -- Bank stocks are likely see material weakness in the second half of 2014 unless the economy picks up and interest rates begin to rise, according to analysts.

Citigroup (C) drew attention last week in forecasting a 25% drop in second-quarter trading revenue from the second quarter of 2013, but few commentators bothered to mention that the bank was almost as pessimistic about loan losses, noted Richard Bove, analyst at Rafferty Capital Markets. Bove also pointed to bearish commentary from Bank of America (BAC - Get Report), PNC Financial Services (PNC - Get Report) and JPMorgan Chase (JPM) executives at two separate conferences in New York last week hosted by Deutsche Bank and Sanford Bernstein.

"Revenue is likely to disappoint for most banks for the foreseeable future," wrote Deutsche Bank analyst Matt O'Connor in a note summarizing the German bank's conference, which included presentations from 60 different institutions.

Bove pointed to a report last week from the Federal Deposit Insurance Corp. which shows that after 16 straight quarters of growing year over-year-earnings through the second quarter of 2013, banks have seen earnings shrink on that same metric in two of the last three quarters.

Referring to the 1% drop in first-quarter GDP reported last week, Bove said, "If we have another 1% downer, bank earnings are going to start turning down, loan losses are going to pick up and bank stocks are going to be in trouble."

Bove is nonetheless optimistic on the banks, because he believes that both the economy will improve in the second half and that interest rates will rise.

Still, he cautioned, "If you don't believe that you've got to get out of these stocks."

It seems quite plausible the economy could improve without interest rates rising since global demand for U.S. Treasuries appears insatiable.

Indeed, analysts at Keefe Bruyette & Woods have been more bearish on the view that rates will rise any time soon, so their EPS estimates already reflect a lower rate environment than others who believe rates are rising soon, said KBW analyst Christopher Mutascio.

Guggenheim Partners analyst Marty Mosby said he believes several banks will be able to withstand another year of low interest rates through continued reversals of bad loans they had written down during the financial crisis or by stealing market share from rivals in certain businesses.

However, he believes investors in banks including Bank of America, First Horizon National (FHN) and Comerica (CMA) will be disappointed if interest rates don't rise in the second half of the year as he sees those stocks as having been inflated by expectations of the higher earnings they will get if interest rates climb.

Even if interest rates do rise, PNC Financial CEO Bill Demchak argued last week it could lead to a "race for deposits" among banks, who as a result of new regulations will be more incentivized than ever to get a heavy portion of their funding from retail banking clients.

The historical assumption in banking that those retail clients will be slow to pull out their deposits if they can get better savings rates elsewhere is "going to be a challenged assumption," Demchak told attendees at the Deutsche Bank conference.

>>>

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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