4 things investors must know before big bank earnings hit the Street next week

Published Fri, Oct 8 20219:34 AM EDTUpdated Fri, Oct 8 20214:16 PM EDT

After a range-bound few months for bank stocks, analysts are looking ahead to catalysts that could ignite the next phase in their recovery. Banks including JPMorgan Chase and Wells Fargo surged in the first half of the year after releasing billions of dollars in reserves for loan losses that never came. Firms with large Wall Street operations like JPMorgan and Goldman Sachs also benefited from a trading and investment banking boom. But then the industry got hammered in July amid concern that the delta strain of the coronavirus would derail the U.S. economic recovery. That triggered a decline in bond yields, squeezing the interest income the companies earn. Shares have recovered since then along with climbing yields. The KBW Bank Index has gained 38% this year, led among big banks by Wells Fargo, which has surged 58%. Meanwhile Citigroup , led by CEO Jane Fraser since February, trails its peers with a 17% gain. Here's what analysts are focusing on when JPMorgan kicks off third-quarter earnings Oct. 13: Inflection point for loans? Banks have struggled with weak loan growth all year as government stimulus to individuals and businesses resulted in declining credit-card balances and commercial loans. But loan growth may be at an inflection point in the second half, according to Goldman Sachs and Morgan Stanley analysts. Loans will swell by about 1% at big banks in the third quarter compared to the second, according to Goldman analysts led by Richard Ramsden. While modest, that points to better loan growth next year for large banks of about 4%, Ramsden said this week in a research note. "We think we're at an inflection point and could begin to hear management teams speak more positively around loan growth," Morgan Stanley's Betsy Graseck said in an Oct. 6 note. "Demand is finally starting to pick up, as seen in the most recent Fed Senior Loan Officer Survey, which showed increasing demand and easing standards across all lending categories." Rates matter A key part of the bull thesis for banks is that the industry will reap more interest income if and when rates begin to normalize. That played out in the recent recovery in bank shares, with the 10-year yield at about 1.5% this week, up 20 basis points from July. The Federal Reserve signaled last month that rate hikes and a tapering in bond purchases could be coming sooner than expected . That should help steepen the yield curve, benefiting net interest income at banks, Wells Fargo analyst Mike Mayo said this week in a note. If the yield curve rises 100 basis points, net interest income should improve by 13% in the first year and 18% in the second, according to Goldman's Ramsden. The spread between what banks pay depositors and earn on loans is called net interest margin, and that is forecast to have bottomed out in the third quarter, he said. "There's justifiably far more focus on the forward look i.e., the pace of economic recovery and its manifestation in higher interest rates, with more solidly net positive loan growth reflective of the transition to a healthy, new normal," Credit Suisse analysts led by Susan Katzke said in an Oct. 5 note. Wall Street boom fading? For much of the pandemic, Wall Street activities like trading and IPO issuance have propped up bank earnings while consumer businesses were weighed by the prospect of heavy loan losses. That dynamic is expected to moderate in the third quarter. Last month, JPMorgan executive Marianne Lake said that trading revenue will be 10% lower than a year ago, which was an unusually strong quarter. But robust investment banking fees from acquisitions are expected as well. "We see the magnitude of capital markets normalization as a key question for the quarter, and market data and management commentary lead us to forecast capital markets revenue roughly flat year-over-year for 3Q21," Ramsden said. That said, banks including Goldman, Morgan Stanley and JPMorgan frequently exceed expectations for trading and advisory revenue, and that would boost results. How big reserve releases? Last year, banks were forced to set aside tens of billions of dollars for potential loan losses tied to the pandemic. This year, they've been allowed to release some of those funds because government actions to stave off disaster resulted in better-than-expected economic data. The magnitude of those releases will likely taper off from here because the industry has already released 60% of the roughly $50 billion in reserves built last year, according to Ramsden. He expects banks in his coverage to release about $5 billion in reserves in the third quarter, which goes directly to the bottom line. "We continue to see a benign credit environment, supported by improving economic data and modest loan growth," Ramsden said. "In our view, the bulk of reserve releases is now behind us."

A combination file photo shows Wells Fargo, Citibank, Morgan Stanley, JPMorgan Chase, Bank of America and Goldman Sachs.

Reuters

After a range-bound few months for bank stocks, analysts are looking ahead to catalysts that could ignite the next phase in their recovery.