) -- Throw your valuation formulas out the window - the next quarter will likely continue the bumpy ride for big bank stocks.

Investors have become more bearish as earnings reports have rolled out over the past two weeks.

Sure, the six largest banks reported $15.7 billion in core earnings, excluding special items. Sure, credit costs have continued to decline. Sure, the government is planning to divest another big tranche of


(C) - Get Report

stock over the next few months - signaling federal regulators' increased confidence in the foundation of the banking system.

Yet a healthy portion of those earnings came from "reserve releasing," not fundamental improvements in lending or market activity. From the looks of the housing market - or lack thereof - it may take quite some time for those improvements to materialize.

The investigations and legal claims surrounding foreclosure processes and mortgage buybacks are only further stalling a recovery. The litigation risk has hamstrung foreclosure sales as well as the mortgage-backed securities market. By bank executives' own account, there's no clear line of sight as to when the pressures will ease.

When an analyst misinterpreted the remarks of

JPMorgan Chase

(JPM) - Get Report

CEO Jamie Dimon, and suggested the foreclosure mess will be over in a matter weeks, Dimon quickly corrected him.

"I didn't say weeks to clean up the files....I don't know exactly when," said Dimon. "I'm hopeful that it all starts to move at one point. I don't know if it's going to be three weeks or five. But I think it will be a real shame if we don't get this resolved and moving again."

In a follow-up question, Dimon was asked whether proceedings could resume by the start of 2010, he responded: "I hope so. It's not up to me."

As bank-stock investors know, uncertainty breeds bearishness.

Bank of America

(BAC) - Get Report

, which is believed to have the greatest exposure to buyback and foreclosure risk, has fallen more than 5% since its earnings report on Tuesday - setting fresh 52-week lows under $12. The stock has slumped nearly 12% since JPMorgan's report on Oct. 13.

One might shrug off "robosigning" and buyback demands as sideshows that are generating a lot of negative buzz, but won't have a huge financial impact. But even drilling down into last quarter's numbers should give investors room for pause.

The most profitable businesses are facing economic and regulatory challenges poised to intensify in the coming months. The $10.4 billion valuation decline of Bank of America's card business will be followed by more goodwill write downs in coming quarters. The $380 million decline in Wells Fargo's card revenue won't come back unless consumers decide they want to be assessed large fees for small purchases.

The proprietary trading desks that have been wound down at

Goldman Sachs

(GS) - Get Report

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and JPMorgan aren't coming back. While Goldman - in its successful, if perplexing, manner - was able to offset the challenges everyone else seemed to be facing, results at the other investment-banking powerhouses were muted at best. Corporations are waiting for consumer demand to return before they start borrowing, acquiring or raising capital to grow.

Morgan Stanley

(MS) - Get Report

CEO James Gorman put it bluntly when reporting a sharp decline in profit this week: "I am not satisfied with our overall performance."

Reserves can't be released forever and, if pessimists are right about housing and the economy,

they may need to be built back up again. It's worth noting that, even when massaging numbers to exclude special items and discontinued operations, big-bank earnings were essentially flat last quarter vs. the previous one.

More telling, perhaps, is that the $108 billion in net revenue from BofA, JPMorgan, Wells, Citi, Goldman and Morgan Stanley declined 6% on a quarterly basis and 9% from the year-ago period.

Few expect that trend to reverse by year-end. Fee income is being held back by regulatory restrictions and lack of investor demand, while net interest margins are being pressured by the low-interest rate environment that the Fed has promised to maintain for an "extended period" of time.

Cracks have even begun to emerge in the optimism expressed by sell-side analysts - long criticized for remaining bullish on bank stocks amid obvious "sell" signals.

The industry still has a collective "buy" rating on big banks.

Of 163 stock recommendations for the big six banks, 69% are bullish. Only seven warn clients to avoid a big-bank stock. On average, analysts see prices rising 35% in the near-term, though Goldman hasn't seen its target price of $190 in more than a year.

This week, two analysts downgraded Bank of America from "buy" to "hold" as the chorus of noise surrounding foreclosures and buybacks heated up. In a particularly emotional note to clients, Stifel Nicolaus' Christopher Mustascio called the action a "bitter pill" -- he was forced to downgrade the stock on essentially a gut feeling, not the valuation measures his profession adheres to.

"I am sure some will view this action as throwing in the towel and capitulating. That criticism is probably fair and accurate," Mustascio said in a note to clients on Wednesday. But, he later added, "stepping back from fundamental we had to ask how can the stock outperform while working through this issue? Perhaps we can get a bit of a relief rally off the 52-week lows, but does that only last until the next law suit?"

-- Written by Lauren Tara LaCapra in New York


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