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Have banks turned a corner?

The improved earnings reports of recent days are welcome news, but a rising tide of loan losses still threaten the industry.

By Staff writer / April 18, 2009

The headquarters of Wells Fargo are in San Francisco. The bank recently forecast a first-quarter profit of about $3 billion, easily surpassing analysts' estimates.

Eric Risberg/AP

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A week of good news about profits doesn't mean that banks are on the road to recovery.

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Despite billions of dollars in first-quarter earnings, announced in recent days, troubled loans still pose a major problem for the health of banks.

That's a problem not just for the banks but for the US economy overall as it struggles to emerge from a deep recession. If banks remain fundamentally weak, economists say, it will affect their ability to lend – and a solid economic rebound will be hard to achieve.

So how healthy are the banks, really?

On the face of it, the news in recent days is encouraging. Profits are a sign that bank performance isn't plunging off a cliff. JPMorgan Chase, Wells Fargo, Goldman Sachs, and the credit arm of General Electric have reported billions in black ink. Even the laggard Citigroup cited progress Friday, reporting a smaller-than-expected loss for the quarter.

But the problem is that a rising tide of loan losses still threaten the industry – not just home foreclosures, but also defaults on credit cards and business loans.

"The housing-market decline is not over," says Desmond Lachman, a finance expert at the American Enterprise Institute in Washington. "You've got a commercial real estate bust that we're really just at the start of. You're getting a lot of corporate defaults."

All this, he says, means that banks will need a lot more capital to cover those losses, while also allowing them to fuel a recovery with new loans.

Some banks, it's true, hope to repay the capital invested by the government in recent months from the Treasury's Troubled Asset Relief Program (TARP). They want to get out from the stigma and constraints that go along with that money.

But whether the funds come from government or private investors, banks' need for capital remains large, say economists who track the industry.

Here are a few gauges of bank-industry health, pro and con. First, some positive factors:

• Profit margins on good loans are rising. Interest-rate cuts by the Federal Reserve are allowing banks to widen their spreads between their borrowing costs and what they earn on loans. Insiders call this a boost from the "yield curve" – the difference between short- and long-term interest rates.

• There's no "run on the bank" by depositors. The Federal Deposit Insurance Corp. (FDIC) has bolstered its guarantees, insuring accounts up to $250,000 for this year, up from $100,000 normally.

• Banks can still borrow by issuing bonds. Since the launch last fall of a special FDIC program, banks have been able to issue $269 billion in new bonds with a federal backstop.

• Some banks are able to raise capital in private markets, a stamp of solvency. Goldman Sachs, which converted last year from an investment bank to a bank holding company, announced plans this week to offer $5 billion in new stock.

• Banks are selling or writing off many of their bad assets. Citigroup, for instance, said that a pool of its riskiest loans declined in size from $227 billion at the end of 2007 to $101 billion now.

In addition, banks have been cutting expenses through layoffs. All this helps explain the recent news: Wells Fargo forecast a profit of about $3 billion for the quarter, JPMorgan Chase reported earnings of $2.1 billion, Goldman earned $1.8 billion, and Citigroup lost money but at a slower pace than last year – red ink of $966 million for the quarter.

Now, the negatives: