Sector Spotlight: As Banks Tumble, Earnings Get the Attention - TheStreet

Financial stocks were in free fall Friday. Don't expect third-quarter earnings, coming out over the next two weeks, to provide a safety net.

Most big banks' results will probably be fine in an uninspiring sort of way. But don't expect the kind of blowout earnings needed to pacify investors, who are now obsessing over the prospect that junk-bond losses, a troubled Europe and a prolonged

Nasdaq slide will mangle banks' future earnings.

Third-quarter earnings at

Citigroup

(C) - Get Report

,

Wells Fargo

(WFC) - Get Report

,

FleetBoston

(FBF)

,

Bank of America

(BAC) - Get Report

,

J.P. Morgan

(JPM) - Get Report

and

Chase

(CMB)

are expected to come in well above the year-ago level, according to analysts surveyed by

First Call/Thomson Financial

.

Broader Scope

From this group, only Wells, Fleet and Bank of America have estimates that also exceed second-quarter 2000 results. Analysts' third-quarter forecasts for Bank One and First Union -- both executing deep restructurings aimed at curing serious operating difficulties -- are below both year-ago and previous-quarter figures. Analysts don't expect to see big signs of recovery at either firm in third-quarter numbers.

An extra element of uncertainty will exist in this earnings season. The soon-to-be-effective

Securities and Exchange Commission

rule aimed at preventing selective disclosure has put the kibosh on the old game of companies meeting estimates that they themselves have guided analysts toward. No big surprise, then, if a couple of banks miss estimates that analysts have derived on their own. And if a bank comes in well below forecasts, the subsequent selloff could be steeper, as the shock will be more jarring.

Moreover, investors will also be looking beyond bottom-line numbers for indicators of health in the banking sector. Metrics such as revenue growth and bad-loan indicators will get just as much scrutiny as profits.

Those Darn Metrics

Investors have suddenly become all jittery about financial stocks, judging by the sharp 3.6% drop Friday in the

Philadelphia Stock Exchange/KBW Bank Index

, which tracks the stock prices of the nation's 24 largest bank stocks. In this environment, the focus will be on factors that might cause banks to spring unpleasant surprises.

And there are plenty of those. The weak euro has hurt a number of large U.S. corporations, but no large banks have yet warned about its corrosive effects on the dollar value of their European revenues. That may seem fishy when firms like Chase and J.P. Morgan earn big chunks of revenue from that continent. But the banks' boosters say that any euro weakness can be offset by higher income from their foreign exchange and derivatives operations, which often benefit in volatile times. Maybe, but losses can also pile up if the banks are on the wrong side of their customers' trades.

No bank watchers worth their salt will be taking their eyes off revenue -- banks' noninterest income plus net interest income -- this quarter. Higher interest rates have recently hurt lending income, pressuring revenue at certain banks. This can most clearly be seen at

FleetBoston and

Firstar

(FSR)

. Though relatively dependent on lending income, Wells Fargo has managed to avoid a big revenue slowdown. Jennifer Thompson, banks analyst at

Putnam Lovell

, thinks Wells will post revenue growth of 6% to 8% in the third quarter, from the year-ago period. That sort of number would reassure. But if it came in at 3% or lower, the impact on this highflying stock would be nasty. (Putnam Lovell rates Wells a buy and hasn't done underwriting.)

Bad, Bad Loans

The market is still concerned about credit quality, especially as bank regulators completed their annual examination of big corporate loans in the third quarter and may have told certain institutions to classify more loans as doubtful. (Any addition to bad-loan reserves has to be subtracted from earnings.)

Bank of America and Chase are big corporate lenders, and their earnings could be hit hard if they are holding credits the regulators don't like. Bank of America may also take a hit if, as expected, it decides to write down the value of its big book of auto leases. Other big banks -- like Bank One -- have been doing this type of writedown recently. Charles Peabody, banks analyst at

Mitchell Securities

, notes that Bank of America had $11 billion of auto leases at the end of June. If it wrote down the same proportion as Bank One, that could result in a charge of around $1 billion, or 35 cents a share. Bank of America declined to comment on third-quarter earnings. (Mitchell rates Bank of America a sell and hasn't done underwriting for the bank.)

The wild variable in third-quarter earnings will be capital markets and venture-capital revenues. For the most part, the independent brokerages, most of which report a month earlier than the banks, reported solid third-quarter results. But their numbers missed September, which was a tough month for tech stocks and junk bonds. As a result, J.P. Morgan and Citigroup's

Salomon Smith Barney

, as well as big investment banking units at FleetBoston, Chase and Bank of America, could all post lower-than-expected revenue.

The sliding Nasdaq will deprive Chase of a helping hand from its tech-focused private equity arm,

Chase Capital Partners

.

Keefe Bruyette & Woods

analyst David Berry this week reduced his third-quarter per-share earnings estimate to 85 cents from $1, to reflect a lower-valued Chase Capital portfolio. (Keefe rates Chase a buy and hasn't done underwriting for the company.)