Bank earnings don't look pretty

After Bank of America's big profit tumble, other banking giants like Citi and JPMorgan Chase are expected to take it on the chin as the banking crisis intensifies.

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By David Ellis, CNNMoney.com staff writer

What will it take to get global markets back on track?
  • A bigger, coordinated rate cut by central banks
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  • Time

NEW YORK (CNNMoney.com) -- In case you forgot that the nation's financial system is a mess, banks will offer up a reminder next week when they are expected to start reporting another brutal round of quarterly results.

Earlier this week, Bank of America (BAC, Fortune 500) offered a glimpse of just how abysmal things will be. The Charlotte, N.C.-based bank issued its earnings more than a week in advance, posting a 68% decline in profits that fell far short of analysts' estimates.

"If you look at Bank of America, it is all rather ominous," said Joe Morford, equity analyst with RBC Capital Markets. "It is going to be challenging quarter for the banks."

Citigroup (C, Fortune 500) and brokerage Merrill Lynch (MER, Fortune 500), which is being bought by Bank of America, have racked up billions in losses over the past three quarters and are both widely expected to extend their losing streaks when they report results on October 15.

Wells Fargo (WFC, Fortune 500), which is in the midst of a merger battle with Citigroup over Wachovia, is expected to see profits fall by more than 30% from a year ago.

And even JPMorgan Chase (JPM, Fortune 500), which has won kudos for sidestepping the credit crunch, is expected to report its first quarterly loss in years, according to Wall Street estimates. That's due in large part to last month's purchase of the failed savings and loan giant Washington Mutual.

Given how dramatically the banking landscape has changed over the last few weeks, analysts have quickly slashed their outlooks for the third quarter --- which weren't that good to begin with even before September.

According to Thomson Reuters, analysts expected diversified financial services firms, which include JPMorgan Chase, Citigroup and Bank of America, to collectively book a profit of nearly $5 billion in the quarter at the beginning of September. That would have been nearly a 50% drop from a year ago.

Now, analysts are betting those same firms will report over $2 billion in losses.

Profit forecasts for regional banks have also worsened since Labor Day. Now, Wall Street is betting that regional bank earnings will fall 63% from a year ago compared to estimates of a 47% decline at the beginning of September

Credit still in focus

For all the banks on tap to report next week, the crisis in the credit markets is likely to be the biggest reason for their poor results.

Citigroup and Merrill Lynch are likely to mark down securities that are tied to the U.S. housing market, which continues to deteriorate.

JPMorgan Chase, on the other hand, will not only have to set aside a chunk of cash as a result of WaMu but some analysts expect the company to report that revenues in its investment banking business will be cut in half due to the chaos in the financial markets.

And if the latest numbers from Bank of America's commercial lending business are any indication, then Wells Fargo may also see signs of trouble since it also has a large business loan division.

Bank of America revealed that small business net charge-offs, or loans it doesn't think are collectable, spiked more than a full percentage point to 10.64% during the quarter.

"We are starting to see slippage in commercial credit for the first time," said Jaime Peters, a banking analyst at Morningstar. "In reality, it is still going to be about credit quality."

And those concerns about credit are spreading from the U.S. mortgage market to the consumer.

With unemployment on the rise and other parts of the economy showing signs of strain, an increasing number of Americans are finding it difficult to pay back loans and lines of credit like credit cards or auto loans.

Recognizing that, banks have had to set aside more money to cover those loan losses, which ultimately eats out of their bottom line. Bank of America, for example, blamed its dismal results in part, on the whopping $2 billion it set aside during the quarter to cover souring loans.

Hope on the horizon?

The current crisis will keep a lid of banks' profitability in the months ahead, but there have been some signs of encouragement at least for the industry's top players.

Consumers and businesses have flocked to brand name institutions that haven't folded under the weight of the current crisis looking for a safe place to park their cash.

Despite its profit plunge, Bank of America gained $21 billion in new deposits over the past 3 months, the company said Monday.

If other big banks report similar trends, that will not only improve their market share but also give them a reliable source of funding at a time when liquidity is crucial.

Along those same lines, top institutions that are actually lending are doing so at more favorable, i.e. higher interest rates. That should boost their profit margins.

"[They] are getting better pricing and terms as others have pulled back from the market," said Morford. "All that can help soften the blow."

Wednesday's emergency half-percentage point rate cut by the Federal Reserve and other foreign central banks won't hurt either.

Typically when interest rates are lowered, that drives down the short-term borrowing costs for banks and ultimately boosts their net interest margins, or the profits they make from taking in deposits and lending them back out.

But the rate cuts might hurt banks before they help them, notes Fred Cummings, a former bank analyst and president of the hedge fund Elizabeth Park Capital Management in Beachwood, Ohio.

He said banks will be forced to continue to pay higher rates on existing products like CDs even as rates are falling. That will squeeze one of the few areas that have been profitable for banks lately.

"Those companies are clearly going to be hurt by this decline in rates in the short term," said Cummings. "It's not, in my mind, a great deal of help fundamentally." To top of page

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