Banks set to stumble again
Wall Street expects ugly first-quarter results from Citigroup and Merrill Lynch. And the worst may not be over for financials just yet.
NEW YORK (CNNMoney.com) -- When Citigroup and Merrill Lynch each fessed up to nearly $10 billion in losses last quarter, investors believed the companies had finally scrubbed their books clean.
Those hopes were a bit premature.
"The fourth quarter felt like the kitchen sink [quarter]," said Jaime Peters, a bank stock analyst at Morningstar. "We are going to find out it necessarily wasn't."
Citi and Merrill are among a group of major financial firms due to deliver ugly results for the first quarter in the coming week.
The first quarter was marked by the near collapse of Bear Stearns, continued credit market woes and increased signs that the U.S. economy is indeed in a recession.
Of the six banks and brokers scheduled to report results in the next few days, three are expected to post a loss - Merrill Lynch (MER, Fortune 500), Citigroup (C, Fortune 500) and Washington Mutual (WM, Fortune 500), according to estimates from earnings tracker Thomson Financial.
Overall, analysts anticipate that the banks' results won't be quite as bad as they were when they announced grim fourth-quarter results three months ago. But banks still find themselves squeezed by many of the same problems that plagued them at the end of 2007.
Old problems remain ... new ones crop up
Citi and Merrill are expected to announce yet another series of writedowns due to eroding values of mortgage-backed securities and leveraged loan portfolios.
Other areas have started to show increasing signs of deterioration as well. Home equity loans, for example, have become a source of trouble for banks as housing prices continue to spiral lower.
"Home equity is a well-telegraphed problem story right now," JPMorgan Chase bank analyst Vivek Juneja said in a recent conference call about the outlook for the financial services industry in 2008.
"The question simply there is how bad do losses get. The numbers, in some cases, are disastrous," he added.
To make matters worse, consumer spending has slowed and unemployment has ticked up - driving bigger losses in banks' consumer-related businesses such as credit card, small business and even their commercial real estate portfolios.
As a result, banks are having to set aside more money for potential loan losses.
Washington Mutual revealed on Tuesday that it had to set aside approximately $3.5 billion in loan loss provisions. Goldman Sachs analysts warned Friday that WaMu could see that number climb to $14 billion by year end.
Hit on all sides
The bad news isn't limited to loan portfolios, either.
When the Federal Reserve aggressively cut interest rates earlier this year, the expectation was the cuts would boost banks' net interest margins, a key measure of the profit banks make from taking in deposits and lending them back out.
But competition for customers has been so tough that banks have been unable to cut their deposit rates as much as they would have in the past.
At the same time, companies with sizeable investment banking divisions like Citigroup, JPMorgan Chase and Merrill Lynch are expected to be hit by a slowdown in merger and initial public offering activity. Merger advisory and equity underwriting are two key sources of lucrative fees for investment banks.
Still, bank CEOs will do their best to soothe investors, even as there are few signs that their results will improve anytime soon.
"I don't know if I would call this the end," said Malcolm Polley, chief investment officer at Stewart Capital Advisors in Pittsburgh, which owns shares of Bank of America, Wells Fargo and JPMorgan Chase.