Bad News Keeps Coming as Banks Post Earnings

Bank earnings have begun hitting the market, showering investors with evidence of stagnant investment revenue, losses from once-flush venture capital operations and surging bad loans.

Monday morning, big banks including Citigroup (C), Bank of New York (BK) and Bank of America (BAC) met Wall Street's expectations for a quarter of diminished profits. With the exception of a handful of fee-based banks, most financial firms are expected to follow suit in coming weeks, as banks undertake a spirited spring cleaning.

"We've got very low expectations," says Michael Plodwick, banks analyst at UBS Warburg. "We're trying to take a conservative tack, particularly for banks exposed to capital markets." Given how aggressively banks have branched into capital markets in hopes of a broader profit base, the list of names whose results may be hurt by the capital markets slowdown includes many major commercial banks, including Bank of America, says Plodwick.

Monday, bank stocks fell as investors overlooked First Union's (FTU) $13 billion planned acquisition of North Carolina rival Wachovia (WB) and continued to focus on a weakening profits outlook. Still, bank stocks have mostly held their own in recent months as investors have bet on the prospect of lower interest rates.

Weakness

In a bank earnings preview last week, the UBS bank team said it expected to see year-over-year earnings-per-share growth of just 1.1% for its 50-bank universe. A look at the money center banks, those doing business domestically and internationally and located in major financial centers, yields an expected 23% profit drop. Trust banks, which boast more stable, fee-based business such as asset management, are expected to hold up better, showing earnings growth of 7.5%, UBS wrote. Modest earnings growth is likely to be the standard at regional banks, those that operate in a single state.

Free Falling Bank earnings on the decline
	Report Date	Consensus EPS View	Year Ago EPS
Citigroup (C)	Monday	70c*	78c
First Union (FTU)	Monday	62c*	85c
Wachovia (WB)	Monday	$1.22*	$1.30
Bank One (ONE)	Tuesday	58c	60c
FleetBoston (FBF)	Wednesday	78c	84c
J.P. Morgan Chase (JPM)	Wednesday	66c	$1.06
Source: Yahoo! Finance. *Actual figure.

The slowing economy has hurt banks in many ways. "I think you've got a couple of challenges this quarter," says James Mitchell, banks analyst at Putnam Lovell. "Capital markets are pretty weak and credit quality will still be getting worse, even if the growth rate of nonperformers is slowing down," he says. Nonperforming assets, those that are past due but haven't been written off, can provide clues about future defaults. Additionally, "venture capital portfolios are going to be under pressure," says Mitchell.

J.P. Morgan Chase (JPM), for instance, has a considerable private equity business through its J.P. Morgan Partners arm. Since its inception in 1984, the private equity arm, formerly known as Chase Capital Partners, boasted a 42% annual internal rate of return. But when the red-hot technology market began to fall apart last March, so did the venture capital unit's gains. In the fourth quarter of 2000, J.P. Morgan Chase had what is known as a "mark-to-market" loss, reflecting the unrealized value of investments in its portfolio, of more than $300 million. The bank is scheduled to report earnings on Wednesday.

Fourth-quarter profits at the bank were down more than 60% from the prior year. The current consensus estimate for J.P. Morgan's first-quarter earnings is 66 cents a share, down sharply from the $1.06 it reported last year, according to Thomson Financial/First Call. Mitchell thinks a number of other banks with venture capital portfolios will be feeling the squeeze as well. Citigroup, for instance, Monday said core income in proprietary investments, which includes venture capital and other corporate investments, swung to a loss of $79 million from a year-earlier profit of $850 million.

FleetBoston Financial (FBF), for its part, reported an 80% rise in principal investing revenue for 2000. But much of that came in the first quarter, before tech stocks began to slide. "It certainly doesn't look like they are going to have a big cash gain" this time around, says Mitchell. The current consensus earnings estimate for Fleet is 78 cents a share, down from 84 cents a share a year ago.

Crunches

Credit quality also remains an issue for a number of banks. Chicago based Bank One (ONE) recently warned it expects commercial credit losses to "at least double" in the next several quarters, even before it factors in the risk of further economic slowing and the possibility of a "deep recession."

Even excluding Bank One, Plodwick estimates superregional banks (those that operate in two or more states) will realize the largest year-over-year increase, 39%, in nonperforming loans, as problem credits continue to emerge. Asked when he expects conditions to improve, Plodwick says, "You tell me when the economy is going to turn around."

Other analysts see a little bit of light at the end of the tunnel, even if it is well off in the distance, toward year-end. James Bradshaw, banks analyst at D.A. Davidson, says: "The only glimmer of hope I'm seeing is that most of the banks we talk to say there was a noticeable pickup in their business in March," following weak activity December through February. Bradshaw says lending in particular has started to pick up again for some of the banks.

Mitchell adds that fixed-income and credit derivatives have been a rare bright spot, as evidenced by decent results at Morgan Stanley (MWD) and Goldman Sachs (GS). On the upside for banks, says Mitchell, many of them have active fixed-income operations, without the kind of equity exposure that brokers do.

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