U.S. banks may post strong 2nd quarter: Peters

NEW YORK (Reuters) - U.S. banks appear on track to report strong second-quarter profits as yield curves steepen and the values of distressed assets rise, a Morgan Stanley analyst said on Monday.

In addition to the increased difference between short-term and long-term Treasury yields, less reliance on government aid could help profits in the second quarter, Greg Peters, Morgan Stanley's head of global fixed-income and economic research, told the Reuters Investment Outlook Summit in New York.

Banks, which borrow at short-dated interest rate levels and lend over the longer term, profit when the Treasury yield curve steepens. The spread between two-year Treasury notes and 10-year notes hit its highest on record in recent weeks.

Banks had robust first-quarter earnings, helped by strong trading revenue amid volatile and less crowded markets, and a sharp rise in mortgage refinancing.

Credit card losses and a further decline in housing prices, however, could create headwinds for the banks, Peters said.

Charge-offs on credit cards are likely to outstrip what the U.S. Treasury had used as its worst-case scenario in its recent stress tests of the adequacy of banks' capital levels, he said.

U.S. credit card defaults rose to record highs in May, with a steep deterioration of Bank of America Corp's (BAC.N) lending portfolio, in another sign that consumers remain under severe stress.

He predicts another 20 percent drop in housing prices lasting through the first quarter of 2010, for a peak-to-trough fall of 40 percent.

Peters is also concerned that the rush by banks to pay back government bailout money could undermine their financial strength.

"If there is some kind of relapse in the economy and the rest of the banking system, the backstops have been taken away," Peters said.

(Reporting by Vikram S Subhedar, editing by Leslie Adler)