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Wednesday, 22 April 2009

Robust profits mask problems in bank sector

WASHINGTON (AFP) - - A string of surprisingly strong earnings reports suggests US banks are emerging from a near-death experience, but some analysts say the troubled sector faces more pain.

Bank of America on Monday joined the parade of financial firms reporting robust results -- a profit of 4.2 billion dollars in the first quarter, beating its performance for all of 2008.

Last week, Citigroup, JPMorgan Chase and Goldman Sachs all topped expectations with strong profits, a hopeful sign for an industry critical to recovery from the severe recession. Wells Fargo said its results would show "record" profits in the January-March quarter.

The apparent renewed health of banking sector comes in part from record-low interest rates from the Federal Reserve, which has cut its base rate to near zero as part of an effort to stimulate lending and growth.

"The banks are benefitting from a jump in mortgage refinancing as well as the fact that with interest rates so low, they are able to borrow cheaply and therefore profit more from lending," said John Wilson at Morgan Keegan.

"It ought to be difficult for a bank not to make money in this environment."

But banks are also setting aside large chunks of cash for bad loans, suggesting they anticipate more mortgages and credit card debt may sour.

Bank of America for example added a hefty 6.4 billion dollars to its loan loss reserve. Citigroup charged off some 4.6 percent of its loans.

Although Citi managed to show a profit of 1.6 billion dollars in the first quarter after losses of more than 18 billion in 2008, some analysts were unimpressed.

Citi's results included "several one-time items which muddied the waters in assessing the franchises underlying performance," said Goldman Sachs analyst Richard Ramsden.

Some analysts say that below the surface, banks are still fragile and may face another round of deep problems ahead, especially if the economy remains weak.

Martin Weiss at Weiss Research called the surge in earnings "bogus," and a result of tricks including an easing of mark-to-market accounting rules.

"Regulators have now agreed to let banks cover up their toxic assets by booking them at fluffy-high values, bearing little resemblance to actual market prices," he said. "Like magic, the bad assets are suddenly worth more."

Leahey said most banks have written off troubled mortgage securities but now face issues with rising defaults on other loans and credit cards.

"Banks are making money in traditional business lines but that could be swamped by a second tidal wave of losses tied to the economy," Leahey added.

Skewing bank results, say analysts, has been payments from bailed-out insurer American International Group (AIG), which shelled out tens of billions of dollars to banks to cover soured investments or so-called credit default swaps.

Goldman Sachs, for example, received nearly 13 billion dollars from AIG before it posted a quarterly profit of 1.8 billion dollars.

"In the case of Goldman, the AIG payments dwarfed the positive earnings," said Bob Eisenbeis, economist at Cumberland Advisors. "That's the reason that people are justifiably skeptical about these earnings."

Eisenbeis said banks "have every incentive to squeeze a lot of positives into this quarter" to end the vicious cycle of falling asset and stock prices that has led to a death spiral for some institutions.

Some skeptics say AIG, which has gotten a US government bailout worth some 180 billion dollars, is being used to "funnel" cash into the banking system.

"Anybody owed money by AIG got bailed out 100 cents on the dollar, and some people don't thing that is fair," Leahey said. "But you cannot not avoid paying 100 cents on the dollar without going to bankruptcy court."

Robert Brusca of FAO Economics said AIG is indeed a funnel but possibly the only way to avert a calamity in the banking sector that would deal a further blow to the economy.

"If you didn't help AIG, then AIG would not be able to pay off the banks, and we would be stuck with a collapsing banking system," he said.

Brusca said it remains unclear how much AIG has helped the bottom line of the banks because earnings reports lack such details.

"We know the banks are very impaired, they have a lot of problems," he said. "And we know they will get worse as long as the housing problems get worse."

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