Q2 Financials Sector Earnings Outlook: Big Banks Kick off Season

 | Jul 13, 2023 03:28PM ET

The nation’s largest banks delivered resilient Q1 earnings driven by solid net interest income despite industry turmoil. However, because that unease surfaced midway through March, it’s arguable the last set of earnings results didn’t reflect the full extent of the troubles.

Now Q2 earnings season approaches, putting pressure on big banks to prove they stayed resilient through an entire quarter even as credit conditions tightened. They might get a continued boost from net interest income, the money they make lending minus what they pay to customers.

Bank earnings often set the tone for the entire reporting season. Banks are closer to the heartbeat of most industries, so their results and observations merit a close look. The parade of banks starts Friday, July 14, before the open with expected results from JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC). That’s followed on Tuesday, July 18, by Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS). Then Goldman Sachs (NYSE:GS) wraps things up next Wednesday.

Smaller banks remain under the microscope too, because that segment suffered most from the spring turmoil that included several U.S. bank failures. Regional bank earnings to watch include PNC Financial Services (NYSE:PNC), expected to report next Tuesday, M&T Bank Corp (NYSE:MTB) and U.S. Bancorp (NYSE:USB) next Wednesday, and Regions Financial (NYSE:RF) on Friday, July 21. Worries about smaller banks might be a boost for larger financial institutions in terms of deposits in Q2, assuming clients pulled money out of the smaller banks and sought “safety” at larger ones.

Deposit levels remain a concern. Though Treasury yields are down from their peaks last fall, they remain at levels high enough to provide competition for banks trying to attract deposits, and banks continue to raise the interest they pay out on short-term investments to try and keep cash in the system.

Another headwind that didn’t go away is the inverted yield curve, in which long-term U.S. rates remain well below short-term ones. The curve between the 2-year and 10-year Treasury note yields expanded sharply in Q2 to above 100 basis points again. This can hurt bank earnings because banks tend to borrow in the short term and lend for the long term.

On a more positive note, all major U.S. banks passed the Federal Reserve’s annual “stress test” that determines if they have enough capital to continue functioning through a major financial shock. BAC celebrated by raising its dividend last week. Earnings season might see more of its counterparts do so as well.

h2 Credit check/h2

Depending on future rate moves from the Fed and other operating and economic factors ahead, lending could still tighten for consumers and businesses. In fact, there’s already been some tightening since spring, though corporate credit appears to remain in relatively solid shape, judging from yields for both investment grade and high-yield debt offerings.

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If banks and their balance sheets come under more scrutiny, institutions may become more reluctant to lend to certain businesses and that could dry up venture capital, commercial real estate, and other businesses dependent on a relatively free flow of funds. One potential soft spot appears to be the automobile market, where credit availability could be a second-half challenge, according to Cox Automotive, an automotive services and technology provider.

h2 Ask your banker/h2

To get a better sense of things are going beyond simple top- and bottom-line numbers, here are some questions big bank CEOs might be asked on their earnings calls:

  • How was loan volume in Q2, and what are banks’ forecasts for loan volume in Q3 and beyond?
  • Are defaults likely to rise, and if so, in which industries?
  • How are banks doing in regard to unrealized losses in the bond market?
  • How are deposit trends, and are banks paying more interest to keep depositors? If so, what would be the impact on margins?
  • How did the expanding inversion between short-term and long-term yields in Q2 affect profitability for the big banks, and is that spread near a peak?
  • Could the mergers and acquisitions (M&A) market pick up in the second half as interest rates appear to be nearing a top?
  • Do banks think recession is likely, and, if so, how deep will it be?
  • Did banks continue to put aside loan loss reserves in Q2 to protect from possible loan defaults?

Whatever the answers to these questions, the financials sector remains relatively stuck in terms of stock market performance. Although things improved a bit in June, the Nasdaq Bank Index (BANK)—which includes all bank stocks, not just the biggest ones—lost additional ground in Q2 after a very tough Q1. It’s down 25% from a year ago.

h2 Will banks still beat analysts’ estimates?/h2

Big banks have a long history of exceeding Wall Street’s expectations. It happened again last quarter and injected vigor into the early days of Q1 earnings season.

Still, there are reasons to wonder if that’s necessarily the case going into Q2, especially considering that analysts pared their earnings per share (EPS) expectations for the financials sector over the last three months, according to FactSet. The sector’s EPS grew 5% year over year in Q1 despite a slight fall in profit margins and is seen growing 5.3% in Q2. However, that estimate is down from the March 31 average analyst EPS growth forecast of 8.4%. All five financials subindustries are seen reporting EPS growth, led by consumer finance (15%) and banks (14%), FactSet said.