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Merrill Slashes Outlook for Banks

Many banks stocks were sinking Friday, despite a few buoyed by other news that bucked the trend.

Bank stocks remained volatile on Friday, as a growing chorus of analysts expect higher loan losses and necessary reserve building as the first half of the year comes to an end.

Large and regional bank stocks took an initial nosedive after Merrill Lynch cut earnings estimates for 12 companies including

Bank of America

(BAC) - Get Report

,

BB&T

(BBT) - Get Report

,

Fifth Third Bancorp

(FITB) - Get Report

,

National City

(NCC)

,

Regions Financial

(RF) - Get Report

,

SunTrust Banks

(STI) - Get Report

,

Wachovia

(WB) - Get Report

and

Wells Fargo

(WFC) - Get Report

.

The

NYSE

Financial Sector Index was falling 118 points Friday afternoon, but a few banks, like

Huntington Bancshares

(HBAN) - Get Report

and Fifth Third, were able to buck the trend, aided by other news.

Merrill analyst Ed Najarian is increasingly bearish on the sector. He cut his 2008 earnings estimates by an average of 22% and 2009 earnings estimates by an average of 19%. Najarian is now below the Street estimates by approximately 25%. He has no buy ratings on any of the 12 large banks he covers, which do not include

Citigroup

(C) - Get Report

or

JPMorgan Chase

(JPM) - Get Report

.

"

We are increasing our credit loss assumptions across nearly all consumer and commercial loan categories, with especially significant increase in residential construction and second-lien home equity loans," Najarian writes in a report. "

Due to higher credit loss estimates and rapidly rising loan delinquencies and

non-performing assets we are also materially increasing our assumptions for additional loan loss reserve building."

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He expects loans written off by the largest regional banks to rise to 1.14% of loans this year and 1.52% of loans next year, compared to just 0.38% in 2007.

Others industry analysts agree that

banks still need to step up their reserve levels

, in some cases significantly.

"We expect continued sizable loan loss reserve builds ... due to weakening credit quality as they all fall below reserves required under our reserve adequacy test," writes Vivek Juneja, an analyst at JPMorgan Chase.

"Loan loss reserves at our bank universe are rising, but still below the levels seen in the early 1990s during the credit cycle and also below the 2000-2003 cycle," he says. "Reserves were up to 1.7% of loans on average at March 31, for our banks, but this is below the 2.1% average from 1990-1994."

SunTrust and Wells Fargo have the lowest reserve ratios, among the banks Juneja covers. On the other hand, Wells Fargo has stronger capital ratios than SunTrust, he writes.

These days banks are feverishly pulling in the oars as the extended housing and credit crisis takes a toll on just about every size bank and begins to move past just residential real estate and creep into other parts of their loan portfolios.

These days banks are feverishly pulling in the oars as the extended housing and credit crisis takes a toll on just about every size bank and begins to move past just residential real estate, creeping into other parts of their loan portfolios.

Capital preservation has been of utmost importance for the banks over the past few quarters.

But bank stocks have floundered over the past few weeks, despite the myriad of capital injections by troubled banks such as

Washington Mutual

(WM) - Get Report

, Wachovia and Nat City, to name a few, as investors worry about further credit losses.

"We do not expect credit metrics to begin to recover until 2010," Najarian writes.

The Keefe, Bruyette & Woods Bank Index, which comprises 100 of the largest banking stocks has dropped 26% over the past seven weeks. The index dipped nearly 3% at the beginning of the day but has since moved into positive territory.

Analysts expect more dividend cuts from banks that either haven't already done so or those that have and need to slash their dividends more. Wachovia, Nat City, WaMu,

KeyCorp

(KEY) - Get Report

and Fifth Third have slashed their dividends.

The Fox-Pitt and Merrill analysts say BofA, SunTrust, Regions,

Comerica

(CMA) - Get Report

,

Marshall & Ilsley

(MI)

are vulnerable to dividend reductions, and Wachovia may cut its payout even more.

The regional banks are much more susceptible to falling real estate markets in their footprint since they typically have significant exposures to small- and midsize commercial clients. A host of banks have already acknowledged that the residential construction market has taken a hit in many areas, but now commercial construction loans are also increasingly at risk.

"The commercial real estate market has become very soft, particularly hard-hit residential markets such as Florida, California, Arizona and Nevada," writes Citi analyst Tobias Levkovich in a note Thursday. "This represents a challenge for regional banks that made loans to developers of small commercial buildings, strip malls and professional office structures."

Huntington Bancshares

(HBAN) - Get Report

was the latest bank to pre-warn late Thursday, but the news coming from the Columbus, Ohio-based bank was more positive than the recent warnings of its Midwest competitors

KeyCorp

and

Fifth Third

.

Huntington expects charged-off loans in the range of 0.60% to 0.65% of average total loans and leases this quarter and plans to take a provision charge in excess of charge offs by $55 million to $65 million. It also reaffirmed the target for charge-offs this year saying that the ratio "would be near the high end" of its previous target of 0.60% to 0.65%.

The stock surged 31% on the relatively positive news. Huntington also said its capital ratios were sufficient and its relationship with

Franklin Credit Management

(FCMC)

--

a trouble spot

for the bank over the past three quarters -- "continues to perform consistent with expectations."

Fifth Third shares were rising 7.2% after a Keefe, Bruyette & Woods analyst upgraded the stock to outperform, citing increased recent interest in the stock.