Banks' Earnings Season: Wells Fargo Leads the Way

After settling at (yet another) all-time high during Thursday's pre-holiday trading, U.S stocks are slightly lower on Monday morning, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (^DJI -0.11%) down 0.2% and 0.22%, respectively, at 10:15 a.m. EDT. Still, after the Dow reached a milestone 17,000 points, the S&P 500 could well cross the 2,000 level this week (we're roughly 1% below that now), which would be a symbolic marker of the stock market's extraordinary resurgence from its March 2009 crisis low. Banks, which were at the crux of the crisis, have been at the forefront of that rally, with the KBW Bank Index rising more than 180%. However, as the group heads into its earnings season, with Wells Fargo (WFC -0.56%)kicking things off on Friday, it continues to face regulatory challenges and a difficult environment in fixed-income markets.

Wells Fargo, which doesn't have a significant sales and trading operation, will not be much affected by the decline in bond trading activity and is expected to report earnings per share of $1.01 for the quarter ended June 30, a 3% year-on-year rise. Wells and Morgan Stanley are the only representatives of the six major U.S. banks (the others being Bank of America, Citigroup, Goldman Sachs, and JPMorgan Chase) believed to have achieved positive earnings-per-share growth last quarter:

Source: Yahoo! Finance.

At the end of May, Citigroup's chief financial officer announced that the bank's trading revenue could fall as much as 20% in the second quarter from the year-ago period. That followed an early May warning from JPMorgan Chase that its market revenue was likely to drop 17% in the quarter. That did not bode well for Goldman Sachs, which relies heavily on its markets division for profits and doesn't have a commercial banking franchise to help smooth out earnings volatility.

Wells Fargo's focus may help explain why its shares have outperformed those of the five other banks this year, as well as its premium 1.76 price-to-book value multiple. (BofA and Citi still trade at a discount to their book value, while JPMorgan, Goldman, and Morgan Stanley trade close to book value.)

Meanwhile, banks could face an additional headwind on the regulatory front, as The Wall Street Journal reported yesterday that the Basel Committee on Banking Supervision, which sets global rules on bank capital, is reviewing the way lenders calculate their "risk-weighted" assets. In particular, the assumption that government bonds are risk-free could be in question. A higher risk weighting could force banks to raise more capital: that's good news for taxpayers, bad news for bank investors (at least in the short term).