July 10 (Reuters) - U.S. banks should report a solid second quarter as revenue from capital market operations, mortgage banking and improving net interest margin trends offset near-term concerns on rising credit costs, analysts at FBR Capital Markets said.
The analysts, led by Paul Miller, upgraded SunTrust Banks Inc (STI.N), BB&T Corp (BBT.N) and PHH Corp (PHH.N), and said: "We expect banks with capital markets or mortgage banking businesses should experience significant positive boosts to earnings in the second quarter."
However, they said they were "very cautious" about the second half of the year as strength in capital markets and mortgage banking could wane in the face of what could be credit costs well above most investors' expectations.
On the credit front, the analysts expect record levels of both non-performing assets and charge-offs, but said the sharp rise would not overly concern investors in this quarter, particularly if banks use one-time benefits to build reserves.
"However, if the jobs picture does not improve over the next couple of months, we believe credit costs will continue to rise at an alarming rate, pressuring bank returns to equity and valuations," they said.
The analysts upgraded SunTrust and BB&T to "market perform" from "underperform," while raising PHH to "outperform" from "market perform."
The analysts expect SunTrust to return to profitability in the second half of 2010, but said they would rather stay on the sidelines given the lender's risky profile and relative reserve shortfall compared to its peers.
The analysts were also cautious on BB&T shares, despite the upgrade, as they expect credit costs to continue weighing on the bank's earnings. BB&T is exposed to risky markets, such as Florida, Georgia, Tennessee and the Carolinas, they said.
However, its capital levels are healthy relative to peers and the downside risk to its shares remain limited, they said. (Reporting by Mary Meyase in Bangalore; Editing by Himani Sarkar)