Continued: Bank earnings and stock prices expected to fall

In the next couple of weeks, banks will report their financial performance in April, May and June. Prepare for wailing.

Nevertheless, despite their troubles -- or perhaps because of them -- bank shares these days can pay big dividends for investors willing to take a chance. Bank stocks offer yields far above the interest rates offered at the teller's window.

But the weeks ahead may test the nerves of investors, even those chasing income over capital gains.

Bank analyst Sean Ryan described expected earnings this way: "Terrible. ... I think it's going to be gruesome."

Morgan Stanley analysts went beyond words with their verdicts. They lowered their second-quarter earnings estimates -- 15 percent on average -- for 25 of the 30 midsized banks they follow.

Consider the lamentations J.P. Morgan Chase & Co. recited in ratcheting down expected earnings for Wayzata-based TCF Financial: "Reducing estimates tied to increased expected losses on home equity loans as unemployment has continued to escalate in the Midwest during the second quarter in the backdrop of declining home prices."

The consensus forecast for the second quarter for TCF is 35 cents a share, down from 46 cents a year earlier. For U.S. Bancorp, the consensus stands at 60 cents a share, compared with 65 cents in the second quarter of 2007. Analysts expect Wells Fargo to report earnings of 51 cents a share, down from 67 cents a year ago.

Ryan, an analyst at Sterne, Agee in New York City, reflects a consensus of forecasters. But some others see glimmers of good news in the offing. For instance, bank stocks have taken such a pounding in recent weeks that fresh whiffs of despair in earnings reports may do little to add to the gloom already reflected in the deflated prices of financial shares.

"The market has been delivering its verdict, day in and day out, on what the earnings are going to look like," Ryan said.

Better than Treasuries?

What's more, for those prone to leaps of faith, dividend yields on bank stocks make Treasury yields pale by comparison.

With the return on a 30-year Treasury at about 4.5 percent, investors with a taste for more risk might be tempted to buy Wells Fargo shares, yielding 5.4 percent; U.S. Bancorp, at 6.6 percent, or TCF, at 9 percent.

For anyone hungry for returns linked to risk, credit-battered Wachovia may be attractive with its yield of 10.8 percent, or Bank of America, at 11.9 percent.

But beware the risks born of continued uncertainty about loan defaults, margin squeeze and lagging loan demand.

"The dividend isn't sacrosanct," warned Robert Brusca, chief economist at Fact and Opinion Economics, in New York City. "Financial institutions are in trouble and may be forced to cut or suspend the dividend. That risk is priced in the stock," Brusca said.

Others agree.

"In an environment with a 2-to-2.5 percent Fed Funds rate [on short-term bank-to-bank loans] there's no such animal as a sustainable 9 percent dividend," Ryan said. "The payout ratio is really high," he said. "In an environment with deteriorating credit, regulators are not going to go for it. There will be a pressure on management to cut dividends."

The same warning was raised by Joe Morford, bank analyst at RBC Capital Markets in San Francisco.

"Many of the banks need to raise capital. As part of that, they may look to cut the dividend or eliminate it altogether," he said.

Performance varies

Some banks are doing better than others.

For instance, TCF Financial seems unlikely to cut its dividend, in the view of Ben Crabtree, bank analyst at Stifel Nicolaus in St. Louis, and Matthew O'Connor, bank analyst at UBS Investment Research in New York City.

"I don't think [former TCF Chief Executive] Bill Cooper would have bought $2 million in stock a month ago if he thought the dividend was going to be cut," Crabtree said.

But, he added, with TCF stock near 52-week lows, few are buying up the shares for the dividend.

"We're at the extreme end of a bear market for financial stocks," Crabtree said. "Investors don't believe earnings. They don't believe tangible book. They don't believe any numbers."

Yet Crabtree isn't alone in showing confidence that the TCF dividend won't be pared.

"While we expect credit costs to rise sharply the rest of 2008, unlike many banks that have had to raise capital, we think TCF's earnings power and capital are strong enough to absorb this," O'Connor wrote recently.

It's unclear how many more loan write-offs and loan loss reserve buildups remain -- adding to doubts hovering over bank stocks for months to come.

"In this situation, accounting is anything but cut and dried," said Brusca, the economist.

"That pretty much explains why the bank stocks are acting the way they are," he said. "They're not out of the woods."

Mike Meyers • 612-673-1746