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Tickers in this Article: C, WFC, BAC, WB, NCC, WM, XLF
Citigroup (NYSE:C) and Bank of America (NYSE:BAC) were the latest banks to benefit from the law of diminished expectations when they reported earnings that weren't quite as bad as investors expected.

While many investors saw a silver lining in a very dark cloud, and bid up Citigroup to around $20 and Bank Of America up 10% to around $30 on the morning of Monday, July 21, investors should also realize that the earning season for banks is not yet over, and the manic-depressive market can reverse course very easily.

Lowered Expectations
Citgroup reported a net loss for the second quarter of 2008 of $2.5 billion, or 54 cents per share. The loss per share from continuing operations was 49 cents, which was17 cents better than the First Call consensus of 66 cents, and revenues were $18.65 billion versus the consensus of $17.55 billion. (Find out more on differences between forecasted and actual earnings in Surprising Earnings Results.)

The market apparently ignored some not so good news. Citigroup took $7.2 billion in pre-tax write-downs in its Securities and Banking Group, and credit costs increased $4.5 billion. Subprime related exposures remain high at approximately $4.3 billion of gross lending and structuring exposures and approximately $18.1 billion of net ABS CDO super senior exposures (ABS CDO super senior gross exposures of $27.9 billion.). Aside from beating consensus expectations, investors also took heart from a slight uptick in the Tier 1 capital ratio for Citigroup to 8.7%. (To learn how to break down these numbers, read Analyzing A Bank's Financial Statements.)

Bank of America reported diluted earnings per share of 72 cents, while analysts polled by FactSet Research expected earnings of 59 cents per share.

Credit quality is still poor at Bank of America, as the bank reported:

1) Net charge-offs of $3.62 billion, or 1.67% of total average loans and leases.
2) Non performing assets also rose to $9.75 billion or 1.13% of total loans, leases and foreclosed properties.
3) The allowance for loan and lease losses of $17.13 billion, or 1.98% of loans and leases.

The surprise report for Citi and Bank of America helped continue the rally in the financial sector, with the large cap Financial Select Sector SPDR (AMEX:XLF) up for a fourth straight day. After bottoming out at an all time low on the morning of July 16 at $16.89, the index has rallied back to $21.23 after the open on Monday, July 21.

Wells Fargo Beats Weak Estimates
There were other banks who helped fuel the rally also. On Wednesday, July 16, Wells Fargo (NYSE:WFC) reported earnings per diluted share of 53 cents and revenue of $11.5 billion. Both these numbers were a relief to investors, who were expecting the company to earn 50 cents per share on revenue of $10.65 billion. Wells Fargo also upped its Tier 1 capital to a ratio of 8.24% from 7.92% on March 31, 2008.

Well Fargo even rubbed salt into the wounds of bank bears by raising its dividend by 10%. It ended the day up 33 %, fueling a huge rally in all financials on Wednesday, July 16.

Not everything is solid at Wells Fargo, executive vice president and chief credit officer Mike Loughlin said, "Although losses declined, the portfolio continued to deteriorate as property values search for a bottom." Also, WFC reported that total nonperforming assets were $5.23 billion (1.31% of total loans) at the end of the quarter, up almost $730 million from just three months earlier.

Don't Rush
Next week several other major banks will report earnings, including Wachovia (NYSE:WB), Washington Mutual (NYSE:WM) and National City (NYSE:NCC). Investors will find out then if trends at other banks are stabilizing or continuing to deteriorate.

Investors should remember that the financial sector has displayed several false bottoms over the last year, and that sentiment and momentum work just as easily on the way down as on the way up. Hype is no substitute for thorough analysis.

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