Updated with comments on Bank of America from KBW analyst David Konrad, along with comments on Fifth Third Bancorp from Wells Fargo analyst Matthew Burnell, who downgraded the shares on Tuesday, and comments from Deutsche Bank analyst Matt O'Connor, who downgraded Wells Fargo and BB&T, while upgrading PNC. NEW YORK ( TheStreet) -- U.S. bank stocks remain volatile and, as usual, there is a mixed bag of opportunity and risk, heading into earnings season. Bank stocks reversed course during the third quarter after the sector's "annual" second-quarter decline. The KBW Bank Index ( I:BKX) rose 8% during the third quarter, closing at 49.58 Friday, following an 8% decline during the second quarter and a 26% return during the first quarter. Year-to-date through Friday, the index was up 26%, with all but two of the 24 index components seeing gains, with some of the most maligned industry names seeing stellar performance. While major industry players are still trading for low multiples to book value and forward earnings estimates when compared to stock valuations before the 2008 credit crisis, several concerns appear to be pushing "normalized earnings" further out than previously expected. After several years of seeing forward earnings estimates outpacing the current year's estimates, the story is beginning to change for some regional players. Among the 24 KBW Bank Index components, analysts polled by Thomson Reuters estimate that four will earn less during 2013 than in 2012, while two have consensus 2013 EPS estimates matching those for 2012. Out of 18 index components expected to improve their earnings next year, four are expected to see 2013 earnings 15% or higher than 2012 estimates, while 10 more are expected to see earnings improve by at least 10%. Here are some of the big themes for the nation's largest banks, heading into third-quarter earnings announcements:
Mortgage Refi Wave and Housing Recovery
It is no surprise that President Obama's expansion early this year of the Home Affordable Refinance Plan or HARP -- allowing qualified borrowers with mortgage loans held by Fannie Mae ( FNMA) or Freddie Mac ( FMCC) to refinance their entire loan balances at historically low rates no matter how much the home values have declined -- has been a resounding success. Banks continue to benefit from the high volume of refinancing, not only from origination fees, but from "record gain-on-sale margins" when selling newly originated loans to Fannie and Freddie, according to Sterne Agee analyst Todd Hagerman, who published his firm's third-quarter industry earnings preview last week. The analyst expects a particularly strong earnings benefit from the mortgage volume for Wells Fargo ( WFC) and Fifth Third Bancorp ( FITB). Banks will also see a benefit in lower delinquency rates going forward, as HARP 2.0 removes the temptation "just to walk away" for thousands of "underwater" borrowers. With the Federal Reserve last month increasing its volume of long-term mortgage-backed securities purchases by $40 billion per month to a total pace of roughly $85 billion a month, Rochdale Securities analyst Richard Bove said on Saturday that "the banking industry is likely to earn substantial gain-on-sale profits as the prices of mortgage backed securities rise in the secondary market." Bove also said that "housing prices are likely to rise as the Federal Reserve pours money into an industry that will be stretching to meet the demand for its product. As the prices rise homes that were valued below their mortgages will rise above the mortgage in value," stimulating even more refinancing, as well as the home equity loan market.
While the housing recovery is one of the most exciting banking themes, some major players still have to work through their legacy mortgage mess left over from the aggressive and creative mortgage lending and securitization they engaged in during the real estate bubble that ended in 2007. While Bank of America ( BAC) appears to have put the controversy over its acquisition of Merrill Lynch behind it, with last week's agreement to pay $2.43 billion to settle a class action lawsuit by investors, alleging that the company and "certain of its officers and directors" made misleading statements heading into the Merrill deal's completion in January 2009, the company still needs to turn the corner on mortgage repurchase demands. Total mortgage putback demands against the company -- mainly springing from former CEO Ken Lewis's decision to purchase Countrywide Financial in 2008 -- increased by 41% during the second quarter alone, to $22.7 billion, as of June 30. Investors will also be looking for indications on whether Bank of America is close to settling its long-term dispute with Fannie Mae, since the company and the government-sponsored mortgage giant disagree on "what constitutes a valid repurchase request," according to Bank of America CFO Bruce Thomson. The dispute has not only caused the putback request to increase, as BAC has refused to buy back Fannie Mae loans, it has caused the company to stop selling most newly originated mortgages to Fannie. Bank of America will announce its third-quarter results on Oct. 17, with analysts expecting the company to report third-quarter earnings of 14 cents a share, declining from 19 cents the during the second quarter, and 56 during a messy third quarter of 2011, when pretax earnings were boosted by $4.5 billion fair value adjustments on structured liabilities, a $3.6 billion gain from the sale of shares in China Construction Bank, and $1.7 billion in trading debit valuation adjustments (DVA), partially offset by $2.2 billion in losses "to private equity and strategic investments." Bank of America's shares closed at $8.97 Friday, returning 59% year-to-date, following a 58% decline during 2011. The shares trade for 0.7 times tangible book value, and for just 10 times the consensus 3013 EPS estimate of 91 cents. JPMorgan analyst Vivek Juneja on Friday reiterated his "Overweight" rating of Bank of America, with a said "we are establishing a December 2013 target of $11.50, which is based on 0.8x price to our YE 2013 tangible book value multiple, a 50% discount to expected peer median tangible book value multiple of 1.5x." A continuing theme that Bank of America CEO Brian Moynihan would love to have investors focus is cost savings. KBW analyst David Konrad, who rates the company "Market Perform," said on Tuesday that Moynihan's "Project New BAC" cost reduction initiatives "are just ramping up and we are only expecting $200 million to come in this quarter--but we are hopeful management can help investors walk through how the $17 billion to $18 billion per quarter current expense run rate should be $15 billion to $16 billion in the future." Konrad expects "a roughly in-line quarter" for Bank of America, but believes "investors could exit the call feeling better about the expense line. Lastly, we believe the capital ratios should improve slightly bolstering the view that BAC could get modest dividend increases and buyback authorization in the 2013 Federal Reserve stress test."