U.S. banks still not out of the woods

John W. Schoen Senior producer • Profile • E-mail

After more than a year of bruising financial turmoil, U.S. banks have some good news to report. Profits have been surprisingly strong for the first quarter of the year.

Beyond those headlines, though, the outlook is still tough. With big piles of bad assets remaining and a weak economy ahead, the banking industry is still a long way from regaining a solid footing.

The latest news came from Citigroup, which reported its smallest quarterly loss since 2007 on Friday and had better-than-expected results overall.

Banks haven’t been shy about getting the good news out. Last month, Citigroup CEO Vikram Pandit tried to calm nervous investors, customers and employees, issuing a widely read memo declaring that the bank was profitable in the first two months of the year.

Last week, Wells Fargo said it expected to post a profit for the latest quarter; the bank said loan losses would be far lower than Wall Street analysts had been expecting. On Thursday, J.P. Morgan Chase said it was able to set aside another $4 billion against future loan losses and still post a $2 billion profit for the first quarter.

Investors have responded accordingly. In the past week, shares of Citigroup, JPMorgan, Bank of America and Well Fargo have surged, and broad stock market indexes are at their highest levels since early February.

But the good news comes with a few important asterisks, according to some investors and bank analysts. The biggest one: Although the revenue coming in the door may be higher than the cost of doing business, the banking industry still has a gigantic mess to clean up from the misguided lending spree that produced trillions of dollars of losses and bad loans.

Wells Fargo’s results, for example, were clouded by the fact that it closed its acquisition of Wachovia during the quarter, combining two sets of books into one.

“There was a one-quarter benefit,” said Whitney Tilson, an investment manager at T2 Partners hedge fund. “The reason not to get overly excited about this is, as we look at Wells Fargo's loan book, they'll have a lot of losses over the next couple of years.”

Despite the industry’s huge pile of shaky loans, it’s no mystery why many banks are making cash hand over fist. Since the financial panic began last fall, the Federal Reserve has been leaning heavily on interest rates, pushing the bank industry’s borrowing costs down to nearly zero. If you’re a banker lending that free money back to customers for, say, 5 percent, it’s pretty hard not to make money.

The Fed’s hope is that banks can generate cash quickly enough to fill the multitrillion-dollar hole in their books created by the meltdown of the housing market and the recession. Overall, the strategy seems to be working.

As long as the Fed keeps interest rates near zero, banks should continue to generate fresh cash. But as that money comes in one door, it’s flowing out another as the slump in business activity and rise in unemployment pushes more borrowers into default.

"Certainly on the commercial and credit card (loan) portfolios, we're seeing credit quality continue to deteriorate there,” said Jeff Harte, a bank analyst at Sandler O'Neill.

While banks are hauling in cash on the loans they’re making, their return to the black won’t help get the economy moving again until the overall volume of loans begins expanding. The news on that front has not been promising this week.

The Treasury’s latest monthly tally of lending from the nation’s biggest banks showed nine reported increases and 12 posted declines. The median, or midpoint, for lending activity dipped 2.2 percent in February. The sharp drop in mortgage rates has boosted lending in that category by 35.4 percent; home equity lines of credit were up. 17.7 percent. But lending to businesses plunged 47 percent.

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