Optimism about U.S. banks might be misplaced

The U.S. banking system showed some signs of thawing this week, but it may prove to be a false spring.

The U.S. government offered a plan to help banks sell toxic loans and securities and President Barack Obama launched a charm offensive to try to win back lenders alienated by recent legislative efforts to scale back Wall Street pay.

But analysts cautioned the government's efforts to jumpstart the markets for loans and securities will likely have limited success. Banks still face a series of difficult obstacles, including expected weakness in commercial property markets and losses on credit card loans.

Add it all up and some investors reckon recent optimism about banks -- which helped lift shares in the sector more than 50 percent over the last three weeks -- is excessive.

Let's not get our hopes up too high, said Marshall Front, chairman at Front Barnett Associates in Chicago.

Hope does seem to be rising. Citigroup Inc (C.N: Quote, Profile, Research, Stock Buzz) shares and Bank of America Corp (BAC.N: Quote, Profile, Research, Stock Buzz) have more than doubled over the last three weeks. Morgan Stanley (MS.N: Quote, Profile, Research, Stock Buzz) is up 40 percent.

And in the broader economy, there are a few glimmers of hope. U.S. consumer spending, which accounts for about two- thirds of economic activity, edged higher in January and February, a government report said on Friday.

A report on Monday said sales of previously owned U.S. homes rose at their fastest pace in nearly six years. The housing market crisis has been a huge source of pain for banks and consumers alike.

The Federal Reserve said last week it would buy more than $1 trillion of mortgage-related securities and government debt, as a means of pumping more money into the economy.

President Obama softened his criticism of banks this week and even held a meeting with major bank chief executives on Friday at which he cautioned against excess compensation, but also emphasized the importance of working together.

We seem to have passed some of the large issues and, hopefully, we're getting past the whole war between Washington and Wall Street, said Nancy Bush, an analyst at NAB Research.

TROUBLE BEHIND, TROUBLE AHEAD

But there is still reason to be concerned about the banking sector. Banks are choking on hundreds of billions of bad assets that prevent them from raising capital and boosting lending.

U.S. Treasury Secretary Timothy Geithner's plan to help private investors buy bank loans and securities is not expected to provide much benefit to loan books, analysts said, in part because most banks would have to record big losses if they sold their loans at market value.

It may be that they'll throw a party and no one comes, said Bert Ely, a bank consultant.

Some analysts still believe the banking sector is undercapitalized. Investment bank Westwood Capital estimates lenders will lose $300 billion to $500 billion from commercial real estate loans and investments.

Credit cards could result in another $200 billion of losses and corporate debt defaults could results in a few hundred billion more, Westwood estimates.

Add to that the remaining losses from areas including residential mortgages and the U.S. banking system could face more than $1 trillion of writedowns and losses. By some estimates, that amount is roughly equal to the capital in the system.

To be sure, banks might also earn profits in the coming year that create extra capital and, if losses are spread out over enough years, banks may be able to earn enough money to offset losses. Many major U.S. banks said they were profitable in January and February, although Jamie Dimon, CEO of second largest U.S. bank JPMorgan Chase & Co, said March was a tough month. If the economy does contract much further from here, banks could have to raise capital again.

Given all these risks, one risk manager at a major hedge fund said he was not reading too much into the recent bank stock rally.

People are assuming everything is getting better for the banks, but I'm not so sure, he added.

(Reporting by Dan Wilchins; Editing by Andre Grenon)