No-Excuses Time Nears for Banks' Quarterly Results

Bankers will get one more credit-quality mulligan in the fourth-quarter earnings season kicking off this week — but expectations will rise afterward.

Bank stocks rebounded last year based in part on a belief that bad loans were increasing at a slower rate than in the earlier stages of the recession. Yet edgy shareholders will want to see more evidence in 2010 that problem assets have peaked and are on the decline.

The banking companies that can clearly show a turnaround will have a marked advantage in terms of stock price and an ability to resume bank acquisitions, some analysts said. Those that fail to turn the corner run the risk of upsetting shareholders, possibly to the point of having to sell themselves to stronger competitors.

Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets, called the potential divide a "new twist" on the credit front. "Stocks rallied nicely last year on expectations that things were less bad, but that won't work in 2010," he said in an interview. "Investor patience will start to wear thin."

Analysts believe banking companies have one last opportunity, with their fourth-quarter results, to get by with a "things are less bad" message. Investors are long familiar with the industry's "kitchen sink" mindset for the yearend quarter, which often includes one-time gains used to offset higher chargeoffs.

"I would expect to see hefty chargeoffs as they all pretty much try and clean the deck," said Frank Barkocy, the director of research at Mendon Capital Advisors.

Greg Ketron, an analyst at Citigroup Inc., is not expecting too much progress on the credit front in the fourth quarter. Though it is possible for some companies to report stabilizing inflows of nonperforming loans and lower loan-loss provisions compared with an "elevated" third quarter, he said, it "is too soon to call for a turning point." Instead, he said chargeoffs and troubled debt restructurings are likely to rise at most banking companies.

Bankers may be able to buy a bit more time with a message that was prevalent late last year: that early-stage delinquencies are leveling off or declining, especially in consumer books. But starting in April, with first-quarter results, analysts will want to see lower late-stage delinquencies and declines in nonperforming assets, along with a clearer timeline as to when chargeoffs could subside.

Robert Patten, an analyst at Regions Financial Corp.'s Morgan Keegan & Co. Inc., has already set the bar high with predictions of improved credit trends in coming quarters. "We expect valuations to improve as visibility on credit provisioning expenses begins to decline," he said.

RBC's Cassidy was blunt about the downside of sluggish improvement. "By April the banks that don't show some improvement will see their stocks prices negatively affected," he said.

Expectations may be the highest for banking companies with low exposure to commercial real estate; investors are likely to assume those banks have already confronted the worst of their problems. SunTrust Banks Inc., PNC Financial Services Group Inc., First Horizon National Corp. and U.S. Bancorp are among the companies with less than 20% of their loans in CRE and construction.

"Selection remains imperative as not all banks enter 2010 as equals," Patten cautioned.

"Anyone with a low concentration in commercial real estate is a good candidate to show improvement," said Robert Albertson, the chief strategist at Sandler O'Neill & Partners LP. Though some banks may be able to show better numbers later this year, he said, most meaningful improvement will come in 2011.

Conversely, several banking companies are still working through sizable CRE and construction loan exposures, analysts said, and these may take longer to turn the corner. Marshall & Ilsley Corp., Synovus Financial Corp., M&T Bank Corp., Regions Financial and Zions Bancorp. were among those with more than one-third of their loans tied up in commercial real estate and construction at Sept. 30, according to company filings.

Banks with big CRE positions may continue to contain their exposure or step up efforts to unload bad loans. Harris Simmons, Zions' chairman and CEO, noted at a Dec. 8 conference held by Goldman Sachs Group Inc. that his company had low loan-to-value ratios on much of its CRE book and that it had made "quite substantial progress" by reducing such loans by $5.3 billion since early 2008.

Determining the banks that will rebound most quickly could help analysts sort out which could raise dividends, buy back stock or become acquirers during the next round of bank consolidation. Those whose recoveries are sluggish may have to sit on the sidelines or even consider selling themselves, analysts said.

"Growth opportunities will be scarcer for those that are likely to come out of the cycle with capital needs" tied to credit hits, Citi's Ketron said. Marshall & Ilsley, Regions, Synovus and Zions are among the banks he covers that are likely to be hamstrung in a recovery, he said.

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