For banking earnings, flat may be where it's at

In a time of financial turmoil, good news is in the eye of the beholder.

Minnesota's biggest banks are getting set to report earnings for the tumultuous third quarter, and most analysts are projecting that they'll turn in flat, rather than falling, results.

In the banking industry right now, that's about as good as it gets.

Bad mortgages, weaker consumer credit demand and declining profit margins dragged down the performance of even the best-managed banks in the July-through-September period.

The Federal Reserve's move to cut short-term interest rates last month could help improve profit margins for many banks, but that balm is just beginning to work.

In the meantime, bank investors may have to look for encouragement where they can.

"Looking at this quarter's earnings, I think expectations are very low," said Tom Kersting, a financial services industry analyst at Edward Jones, the St. Louis-based brokerage.

"The numbers could be messy for some of these financial services companies," he said.

Banks all face the same challenge, said Richard Bove Sr., a securities analyst at the Tampa, Fla., office of Punk, Ziegel & Co.

"The issue with all banks around the country is there's likely to be an increase in loan losses, because there's been a general deterioration in the consumer's financial condition," he said.

That said, U.S. Bancorp, Wells Fargo and TCF -- the top players in Minnesota banking -- get better marks from market watchers than do the likes of Citigroup and UBS -- big international banks that have recently warned that their third-quarter results will be ugly.

"We don't think they have some of the lightning-rod issues that larger money-center banks have," said Jon Arfstrom, who covers U.S. Bancorp, TCF and M&I from the Minneapolis office of RBC Financial Group.

For instance, banks that have big footprints in the Midwest were less likely than money-center banks to sell their mortgages to third parties, many analysts noted. And a bank that holds on to mortgage debt has greater incentive to monitor the creditworthiness of borrowers.

"A bank that originates loans for its own books will pay attention to the quality of that loan, because it's going to bite them if it doesn't work out," said Ben Crabtree, a Minneapolis-based analyst with Stifel Nicholas.

Nevertheless, analyst Gary Townsend has pared a few pennies from his profit estimate on Wells Fargo's quarterly earnings. The headline on the advisory that Townsend sent to investors began, "Not immune."

The average consensus forecast for Wells Fargo calls for earnings of 70 cents a share for the third quarter, up from 64 cents for the period last year. The consensus for the year is $2.47 per share, up from $2.49 in 2006.

Townsend, who is with FBR Research in Arlington, Va., expects Wells Fargo to be a long-term beneficiary, however, of the turmoil in the banking industry, especially in the mortgage business.

Thinning the field

Weaker players are quitting the business, and after the home market bottoms out, Wells Fargo and other banks that have a large Midwest presence may gain market share.

In 2006, Wells Fargo had 13 percent of U.S. residential loan originations.

"If they were to grow that by a couple of percentage points, that would be quite material," Townsend said.

At U.S. Bancorp, new management has vowed to refocus attention on gaining market share in the consumer market. Analysts will be looking to its quarterly report to assess how much the bank is spending on its marketing efforts.

"U.S. Bancorp is in the midst of a change in strategy. The question is whether it will be costly," Bove said.

The change was needed, in Bove's view, because he never liked the former U.S. Bancorp strategy of stressing profit from back-office fees on managing money flows between businesses.

"To keep shareholders happy, U.S. Bank was driving away customers, because they were paying below-market rates on money," Bove said.

The consensus analyst earnings estimate for U.S. Bancorp is 67 cents per share for the third quarter, up from 66 cents a year earlier.

For the year, the consensus is $2.63 a share, up from $2.61 in 2006.

The trick for the bank will be to offer more competitive rates to consumers and target niche consumer markets without squeezing profit margins, Bove said.

For instance, U.S. Bancorp has embarked on tailoring more services to customers based on their stages in life -- from young, first-time borrowers to retirees eager to ensure lifetime income.

"The company now is doing some interesting things; the new product lines could be exciting," Bove said.

But courting consumers has risks, as TCF Financial can attest.

"TCF will have higher consumer credit losses," said Arfstrom, the RBC analyst. "They indicated that last quarter."

In the second quarter, TCF nearly tripled its reserve to cover bad debts, raising the total to $13.3 million, from $4.7 million in the first quarter.

Despite that warning signal, Arfstrom is positive about TCF.

"If you look at the fundamental trends in the company, they are strong enough to offset higher credit costs," he said.

The consensus analyst forecast for TCF is 49 cents per share for the quarter, down from 51 cents a year ago. The consensus for the year is $1.86 a share, down from $1.90 in 2006.

TCF has been the subject of rumors that the company is searching for a buyer, and the speculation has buoyed the firm's stock price. The latest report suggesting that TCF is on the block came in late September in the American Banker, a trade journal.

TCF declined to comment concerning that report.

On Tuesday, a Canadian bank announced plans to buy New Jersey-based Commerce Bancorp, a midsize regional, giving fresh life to speculation about TCF's futue.

"Commerce Bank looks a lot like TCF," Arfstrom said.

Mike Meyers • 612-673-1746

Mike Meyers • meyers@startribune.com