Evening Update

Bank Profits Outweigh Increasing Loan Losses

Building on the momentum in the financial services sector that began with Wells Fargo last week, JP Morgan Chase and Regions Financial both reported better-than-expected profits. JP Morgan Chase added to reserves for loan losses and said reserves will continue to rise, but reported profits from a range of businesses allowed the bank to beat estimates. Economic news was viewed positively, as jobless claims fell more than expected for a second week, the Philly Fed Manufacturing Index jumped much higher than anticipated and a fall in housing starts was seen as benefitting elevated inventories of homes for sale. In equity news, Illinois Tool Works, Harley Davidson and Sherwin-Williams all beat profit forecasts, while General Growth Properties filed for the largest real estate bankruptcy in U.S. history. Treasuries fell.

The Dow Jones Industrial Average rose 96 points (1.2%) to close at 8,125, the S&P 500 Index gained 13 points (1.6%) to 865, and the Nasdaq Composite advanced 44 points (2.7%) to 1,670. In moderate volume, 1.6 billion shares were traded on the NYSE, and 2.3 billion shares were traded on the Nasdaq. Crude oil gained $1.27 to $53.06 per barrel, wholesale gasoline rose $0.03 to $1.47 per gallon, and gold fell $16.70 to $874.35 per ounce.

Dow member JPMorgan Chase (JPM $33) reported 1Q EPS of $0.40, easily topping the Reuters estimate of $0.30, as revenues came in at $26.9 billion. CEO Jamie Dimon said the firm earned more than $2 billion this quarter, despite extremely high credit costs of $10 billion (including $4 billion added to reserves), largely in card services and retail financial services. He added that the firm achieved record revenue and profit in its investment banking unit, while it benefitted from underlying growth in its retail banking, which included higher mortgage refinancing volumes.

In terms of key financial strength ratios, JPM said its tier-1 capital ratio came in at 11.3%, or 9.2% excluding Troubled Asset Relief Program (TARP) capital—and its tangible common equity compared to risk-weighted assets was 7.2%. JPM's allowance for credit losses was $28 billion and its loan loss coverage ratio stood at 4.53%. Looking ahead, JPM said it is reasonable to expect additional increases to credit reserves if the economic environment worsens, but it is confident that even a highly adverse economic scenario would not compromise its overall strength and stability—or its ability to enhance its franchises.

JPM CEO Dimon said they don’t expect to participate, either as a buyer or a seller, in the Treasury’s Public-Private Investment Program, saying “we learned our lesson” about borrowing from the government, but said he expects the program to benefit the financial system. Dimon said that banks are lending, that “toxic assets aren’t the problem,” and CFO Cavanagh added that write-downs related to illiquid securities and loans were “getting to be much less noteworthy.”

Dimon called the $25 billion the bank received in the TARP a “scarlet letter” and said they could pay it back tomorrow, and that the bank didn’t need to raise capital to repay the capital. However, Dow Jones and CNBC are reporting the company is planning to sell $3 billion in 10-year notes not backed by the FDIC, and the company declined to comment on the deal. Shares were higher.

Adding to the bullish bank news, Regions Financial (RF $7) soared nearly 35% after the bank preannounced that they expect to report a profit for 1Q, significantly better than the Street’s estimate of a loss of $0.42 per share. The bank cited significant customer deposit growth and record mortgage application volume. Echoing other banks, they expressed a desire to repay $3.5 billion in government aid.

General Growth Properties (GGP $1), the second largest US mall owner, filed for the largest real estate bankruptcy in US history—according to Reuters. GGP said its decision to file for Chapter 11 bankruptcy protection came after extensive efforts to refinance or extend maturing debt outside of bankruptcy. The company said all of its day-to-day operations and business of all of its shopping centers and other properties will continue as usual.

The failed attempts and the need for GGP to refinance its debt, illustrates the severity of the credit crisis, which has been a major catalyst for the Federal Reserve to deploy aggressive unconventional methods to return normalcy to the credit markets. The Fed can theoretically lower rates for many different markets by purchasing Treasuries. However, there are consequences of this program, and "there's no such thing as a free lunch."

Illinois Tool Works (ITW $33) rose after announcing 1Q EPS ex-items of $0.17, four cents ahead of the Street's forecast, as revenues fell 24% to $2.9 billion. The company said the quarter represented historic challenges as its end markets continued to weaken, which led to the company taking aggressive restructuring actions to balance near-term conditions and invest in longer-term growth initiatives. The tool maker said it has limited visibility due to broad-based weakness in worldwide end markets and they are limiting their current guidance to 2Q, in which it sees revenues and the mid-point of its EPS range below analysts' estimates.

American International Group (AIG $2) announced an agreement to sell 21st Century, its U.S. auto insurance unit, to Zurich Financial Services (ZFSVY $18) for $1.9 billion, representing the largest divestiture since the company was bailed out by the U.S. government. AIG will receive $1.5 billion in cash and $400 million in face amount of subordinated, euro-denominated capital notes backed by Zurich Insurance Company, Zurich’s principal operating unit, which will also assume $100 million of 21st Century debt. Zurich’s Farmers Group Inc will operate the combined company. The transaction is in addition to the $2.4 billion AIG has raised to-date, according to Bloomberg. Shares of AIG were higher.

Harley-Davidson (HOG $18) was up after posting 1Q EPS ex-items of $0.69, beating the consensus estimate that called for $0.52, as revenues came in at $1.3 billion. Worldwide retail sales of motorcycles declined 12% and US sales fell by 9.7%, versus last year, and the company said it was mildly encouraged by the fact that its US retail sales rate declined less than the prior two quarters. However, HOG said it remains cautious and continue to expect 2009 to be an extremely challenging business environment.

Sherwin-Williams (SHW $57) rose over 10% even after the paint firm reported a 50% drop in 1Q EPS to $0.32 compared to last year, as the bottom line results were well ahead of the Street's forecast of $0.21. Revenues fell 13% to $1.6 billion, due to weak paint sales volume and unfavorable foreign currency translation, which was offset by the impact of five recent acquisitions. SHW issued 2Q guidance that missed expectations, and lowered its full-year revenue forecast, while reiterating its full-year EPS estimate.

Housing starts and building permits fall, jobless claims drop

Housing starts and building permits (chart) came in lower than expected. Starts in March fell 10.8% to an annual rate of 510,000, below the Bloomberg estimate of 540,000. Building permits also came in lighter than expected as the more forward-looking indicator of homebuilding declined 9% to an annual rate of 513,000, below the forecast of 549,000. Additionally, February's figure for starts was revised lower, while permits were revised higher. The series can be somewhat volatile on a month-to-month basis, as starts rose a revised 17% in February, and the numbers have been influenced by large swings in multi-family starts, which rose 62% in February and fell 29% in March. The more relevant single-family start number actually rose 0.6% in February and was flat in March. Stabilization in the housing market would be a welcome sign.

Declining starts have been necessary to aid in lowering the elevated inventory of homes available for sale. However, sales and traffic of potential home buyers have picked up, notably in areas where prior price declines have been most severe. While we expect prices to fall another 10-15% before finding stability, if inventories can decline, the light at the end of the tunnel can get brighter.

Weekly initial jobless claims (chart) fell by 53,000 to 610,000, versus last week's figure that was upwardly revised by 9,000 to 663,000. The drop was much lower than the Bloomberg consensus, which called for claims to come in at 660,000. The four-week moving average declined by 8,500 to 651,000, and continuing claims jumped to 6,022,000—above the 6 million mark for the first time since records began—versus the forecast of 5,893,000. Despite the much larger-than-expected drop in initial claims, the report marks the eleventh straight week of claims above 600,000.

The Philly Fed’s Business Activity Index (chart) improved in April from -35.0 in March to -24.4, and above the consensus of -32.0. A reading of zero suggests conditions are neither contracting nor expanding. New orders improved to -24.3 from -40.7—which was the lowest reading since 1980—and employment improved after posting the lowest level in the history of the survey in March. Prices received fell from -32.6 to -41.4 and prices paid came in nearly unchanged at -31.5. Expectations for the future jumped to 36.2 from 14.5. Although the gauge of mid-Atlantic manufacturing continued to contract in April, the much better-than-expected improvement mirrors yesterday's Empire Manufacturing Index, adding to the argument that the worst of the global recession may be behind us as both reports suggest that the rate of contraction in the manufacturing sector may be slowing. Treasuries were lower. The yield on the 2-year note gained 5 bps to 0.90%, the yield on the 10-year note rose 6 bps to 2.83%, and the yield on the 30-year bond rose 6 bps to 3.72%.

The economic calendar is light tomorrow, with University of Michigan consumer sentiment the sole US economic release scheduled.