After a bruising couple of years, banks are facing a novel burden as they prepare to report first-quarter results: high expectations.
Market watchers are looking for more lenders to say they've returned to profitability, and that those still mired in red ink will report smaller losses on bad home and commercial loans.
With the economy rebounding, observers expect banks to show key signs of progress on the credit front, including flat or declining loan chargeoffs, lower provisions and a slowdown in new past-due loans. And if a bank is not making money, it needs to show that it's moving in that direction by setting aside less money to cover loan losses.
"Obviously, expectations are very high going into the quarter. The reason is quite simple: We're at the inflection point on credit. That's the bottom line," said Todd Hagerman, a banking analyst with Collins Stewart LLC in New York. "What matters right now: Are we getting closer to profitability or are we getting further away? The expectation is that the hemorrhaging around credit has subsided significantly."
Hagerman said he would not be surprised if loan chargeoffs narrowed in the quarter as growth of nonperforming assets slowed dramatically.
Paul Miller, head of financial institutions research with Friedman, Billings, Ramsey & Co., agreed that there is a lot of optimism surrounding banks' loan books right now.
Though Miller predicts lots of pain from elevated loan losses, he said he may hold a minority view.
"All this talk about job growth and when the Fed is going to raise rates. … It's got investors confident," Miller said. "People are very bullish."
The first quarter is a somewhat strange test for banks because market watchers, for the most part, said they are not that concerned with how much money lenders are earning from bread-and-butter banking functions like collecting fees and lending out deposits at attractive spreads. That is partly because the first three months of the year are usually soft for banks. Expenses are high because of yearend bonuses and raises; corporate banking and capital markets activity slows after a flurry of yearend activity.
Banks have also been busy shrinking their loan books so industry watchers are not expecting a jolt from new earning-generating assets. So banks may get a pass if they do not show a lot of profit power in the form of healthy pretax, preprovision earnings, which are expected to be flat across the industry.
On the flip side, the standards for credit losses are higher in the first quarter because banks tend to aggressively write down and charge off loans at yearend.
"The first quarter is typically seasonally a good one for credit," said Jefferson Harralson, a banking analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc. in Atlanta.
Harralson said that while credit will remain the No. 1 issue for banks, market watchers are increasingly looking for signs of when banks may start returning to "normalized earnings," or a time when all their profits won't be eaten up by credit costs.
He said the 175 lenders in his coverage universe are moving in that direction, with his firm estimating that the group will post a collective $2 billion profit in the first quarter after losing $7.4 billion in the second half of last year.
The profits in the first quarter are generally projected to come from lower provisioning rather than wider spreads and higher fees, Harralson said. So, essentially, banks are expected to have lost less money on bad loans in the quarter. That's still positive, he said, because that means they can start using earnings to shore up their capital levels, rather than dilute shareholders by tapping the equity markets.
Some small and large banks are expected to return to the black in the first quarter, according to consensus analyst estimates from Thomson Reuters.
Bank of America Corp. is poised to report a modest profit after losing money the previous quarter. The consensus has Citigroup Inc. essentially breaking even for the quarter after booking a steep loss in the last three months of 2009. In regional banking, Old National Bancorp in Evansville, Ind., WSFS Financial Corp. in Wilmington, Del., and Berkshire Hills Bancorp Inc. in Pittsfield, Mass., are all projected to turn a profit again.
Still, not everyone is optimistic that banks are on sound financial footing.
Joseph Saluzzi, co-head of trading at Themis Trading LLC in Chatham, N.J., said the industry would still be crippled if it were not for generous government support in the form of low-interest rates. The government has also propped up the securities market by purchasing mortgage-backed securities. "The banks are continuing to be bailed out every day because of these short-term interest rates," Saluzzi said. "It's a phantom thing; are these banks really making loans and making money that way? They're not."