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Investors question whether banks' robust profit growth will hold

The corporate logo of financial firm Morgan Stanley is pictured on the company's world headquarters in the Manhattan borough of New York City, January 20, 2015. REUTERS/Mike Segar

By Ryan Vlastelica

NEW YORK (Reuters) - Financial companies are among the standouts of the first-quarter earnings reporting season, but their dazzling profit growth has failed to impress investors, who are finding reasons for caution behind the headline numbers.

At a quick glance, the group appears well-positioned for outperformance. Analysts see the sector's first-quarter earnings rising 14.5 percent, Thomson Reuters data shows, with even greater earnings growth continuing all year.

That gives it the rosiest outlook of any major sector - earnings for the overall S&P 500 are seen down 1.9 percent in the first quarter - but shares of financial companies are among the weakest market performers of 2015.

The S&P financial sector down 2.4 percent year to date; the S&P 500 is up 2.1 percent.

The Financial Select Sector SPDR exchange-traded fund, a favorite investor way to play the sector, has seen outflows of $3.45 billion in 2015, by far the biggest outflow of any SPDR sector fund, according to ETF.com.


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Both Morgan Stanley and Goldman Sachs blew through expectations, with respective profit growth of 59 percent and 48 percent, but analysts responded with skepticism and investors held back. They each underperformed the S&P 500 the day they reported, with Goldman falling on the day.

Some results, like Goldman's, benefit from weak quarters last year, allowing for easier year-over-year comparisons. Others come with asterisks: Bank of America had a $6 billion legal charge in the first quarter of 2014, giving it first-quarter growth that was unrelated to business expansion.

So far this quarter, 55 percent of the sector has beaten earnings forecasts - the lowest beat rate among sectors and well under the 73 percent average of the S&P overall.

Much of the earnings growth has been at money center banks, which were aided by heightened trading revenues that could prove hard to duplicate going forward. Institutions spurred high trading activity as they repositioned for higher U.S. interest rates and lower European interest rates, resulting from divergent macroeconomic policies.

Trading revenue will have a smaller impact on other areas of the sector like insurance companies and regional banks, sub-sectors that are still left to report.

"There isn’t a lot of innate strength that would indicate there’s an acceleration in the economy, and since the money center banks have mostly reported by now, it could be the good news is behind us," said Marty Mosby, director of bank and equity strategies at Vining Sparks IBG in Hernando, Mississippi.

To be sure, banks stand to benefit when the Federal Reserve raises interest rates, which investors expect will happen later this year. The increase will allow banks to charge more for loans, boosting net interest margins in subsequent quarters.

But whether that will be enough to please investors is uncertain. Beyond earnings, other metrics are raising eyebrows. Morgan Stanley reported its most profitable quarter since 2007 this month, but even though the economy has been growing, its adjusted return on equity was 10.1 percent, barely over the 10 percent target considered the minimum for a bank to meet its cost of capital.

“We’re still a bit cautious given the backdrop is very favorable now,” said Shannon Stemm, an analyst with Edward Jones who covers Morgan Stanley. “They hit the 10 percent target in a really good time (for the market). How feasible is that when markets do pull back?”


(Additional reporting by Lauren LaCapra; Editing by Linda Stern and Nick Zieminski)