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Real Time Insight

Commerce Bancshares (CBSH), Zacks Rank #3 (Hold), released its second quarter profits yesterday. The company may provide a small insight into the health of bank profits and help set the stage for earnings reports from JP Morgan (JPM - Analyst Report), Zacks Rank #2, and Wells Fargo (WFC - Analyst Report), Zanks Rank #3.

Commerce Bancshares was able to match the Zacks Consensus estimate posting earnings per share of $0.72 in the June quarter. However, the comments from the press release stand out as the CEO noted continued strong loan growth, sequentially improved net interest margin, and fee income growth. Loan growth was reported up at a 10% annualized rate compared to the previous quarter. The one negative may rest in an increase in the provision for loan loss both sequentially and relative to a year earlier. Provision for loan loss was $7.4 mln compared to $3.3 mln in Q1 2013 and $5.2 mln in Q2 2012.

Data from the Federal Reserve has shown healthy growth in commercial and industrial (C&I) loans, but the pace of activity has eased. The graphic shows the trend in the level of C&I loans and year over year growth rate in C&I loans. Notice that the level of C&I loans now exceeds the pre-recession peak. The trend in C&I lending should be constructive for bank profits.

In contrast to C&I loans, real estate lending has been relatively flat. Year over year growth has been about unchanged in the past quarter and the level of lending sideways. Real estate lending is well below the pre-recession peak. Sluggish real estate lending is a drag on bank profits.

Unlike Commerce, which saw its Zacks Consensus Q2 EPS forecast rise 1 cent to $0.72 in the 30 days leading up to its earnings release, JP Morgan’s Q2 Zacks Consensus EPS forecast has risen 5 cents to $1.44 in the past 30 days. Wells Fargo’s Zacks Consensus EPS forecast rose 1 cent to $0.93 over the last 30 days. The market looks more optimistic about JP Morgan than Wells Fargo. According to Zacks Price and EPS Charts, JP Morgan has posted an upside surprise the past five quarters and Wells Fargo the past six quarters.

The table below provides a look at the trend in loss provision and net interest margin for both JP Morgan and Wells Fargo. Provision for loss has been trending choppy at JP Morgan and down at Wells Fargo. Net interest income has been trending flat to lower for both companies.

There is a wrinkle for the bank sector.Last night’s comments from Fed Chairman Bernanke have been spun dovish and caused the market to rethink the outlook for the end of QE and higher market interest rates. The bank “trade” has been in part driven by the view that higher interest rates would help expand net interest margin and profitability. A sharp run up in bank prices and rethinking of the outlook for Fed policy could lead to profit taking. At writing, Commerce Bancshares was trading lower.

What do you think? Will bank profits be strong enough to sustain the rally or is the financial sector ripe for profit taking? Is rotation to further fuel the stock market rally around the corner?

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