3 Things Driving Bank Earnings From Bernstein (Update 1)

(Updated with Jefferies earnings results)

NEW YORK ( TheStreet) -- Analysts are beginning to raise estimates for first- quarter earnings for banks as the macro-economic environment improves.

On Thursday, Bernstein Research analyst John McDonald raised earnings estimates for 2012 and 2013 as well as price targets for six banks, including Bank of America ( BAC), Citigroup ( C), JPMorgan Chase ( JPM) and Wells Fargo ( WFC).

Morgan Stanley analyst Betsy Graseck also raised estimates for the big banks as well earlier this week.

Bank stocks have rallied strongly in the first few months of 2012, as investor concerns on the capital adequacy of banks have abated following mostly positive stress test results. Expectations of greater clarity on regulations, reducing uncertainty on legal risks stemming from mortgage putbacks and potentially higher dividends and buybacks have boosted valuations.

However, analysts have warned that investor focus will now shift to earnings power from the balance sheet and given the sharp increase in prices in recent weeks, there is little room for disappointment.

Still, McDonald cites atleast three earnings drivers that had shown a marked sign of improvement in the first quarter.

Capital Markets Revenue Rebounds: The improvement in the macro-economic environment has helped revive capital markets activity, particularly in fixed income, which has improved the outlook for the big banks. Equity trading volumes remain low, but fixed income trading could push total trading revenues to close to the strong levels witnessed in the first quarter of 2011, according to the analyst.

On Wednesday, Jefferies ( JEF) became the first Wall Street firm to report first quarter earnings.

The firm, whose first quarter ends a month earlier than peers such as Goldman Sachs and Morgan Stanley, beat analyst estimates as fixed-income trading climbed 6.6 percent from a year earlier and more than doubled from the fourth quarter.

McDonald expects fixed income trading revenues could still surprise on the upside even after his upgrade.

Mortgage Refi Booms: Mortgage origination volumes were expected to taper in the first quarter, but Bernstein notes that government programs such as the revised Home Affordable Refinance Program are buffeting refinance demand. Bernstein expects mortgage originations to increase 10% sequentially for banks, with the "majority of growth" flowing to Wells Fargo and JPMorgan.

Expense Cuts to Payoff: Lower compensation levels and declines in cyclically-elevated mortgage and litigation costs should help drive expenses lower by 4% in the first quarter 2012 versus a 1% decline in revenues, according to Bernstein estimates. McDonald says he sees potential for "longer-term expense leverage in the coming years."

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