Financials Sector Earnings Outlook: Big Banks Seen Resilient Despite Quarter's Turmoil

The banking industry was in the news last quarter for all the wrong reasons. Bank failures and worries about tighter government regulations hurt share prices, even among large banks that appeared to have less exposure to the immediate crisis.

Now we approach Q1 earnings season, and banks are in the spotlight again as investors seek more insight into how the crisis affected balance sheets and future expectations.

Bank earnings frequently set the tone for the entire reporting season. Banks by their very nature are closer to the heartbeat of the economy than most industries, so their results and observations merit close scrutiny. With recent turmoil inside the industry itself, observations from banking leaders could be even more instructive to investors now.

Bank earnings start Friday morning before the open with expected results from JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC). That’s followed next Tuesday by Bank of America (BAC) and Goldman Sachs (GS). Morgan Stanley (MS) is due next Wednesday.

Smaller banks will also be under investors’ microscopes this earnings season because that segment suffered the earliest impact of the crisis. Regional bank earnings to watch include PNC Financial Services (PNC) expected Friday, M&T Bank (MTB) next Monday, and U.S. Bancorp (USB) on April 19, among others.

Though many may focus on smaller banks for signs of trouble on deposit rates and credit quality, deposit worries may also extend to larger banks. Money market funds have been siphoning off billions of dollars’ worth of savings from banks’ deposit holdings, according to New York Fed data recently reported by Bloomberg.

This means pressure could be growing on banks to raise their deposit rates to keep customers from fleeing, but that would potentially be painful for their margins.

Credit questions

Back to the elephant in the room—credit. Depending on future rate moves from the Federal Reserve and other operating and economic factors ahead, lending could tighten for consumers and businesses. If banks and their balance sheets come under more scrutiny, institutions may become more reluctant to lend to certain businesses and could dry up venture capital, commercial real estate, and other businesses dependent on a relatively free flow of funds.

There have also been more calls for bank regulation in the wake of this instability. Tighter regulation, if it comes, often means narrowing opportunity for banks to grow their businesses.

Meanwhile, the usual zebras and wildebeests roam the bank earnings landscape and are worth keeping in mind as you pore over results. Questions to consider include:

• How was loan volume in Q1, and what are banks’ forecasts for loan volume in Q2 and beyond?
• Are defaults likely to rise, and if so, in which industries?
• How are deposit trends, and are banks paying more interest to keep depositors? If so, what would be the impact on margins?
• Do banks think recession is likely, and, if so, how deep will it be?
• How much did banks put aside in Q1 loan loss reserves to protect from possible credit defaults?

The Nasdaq Bank Index (BANK)—which includes all bank stocks, not just the biggest ones—fell 18% in 2022 and then dropped another 22% in Q1.

Will banks still beat analysts’ estimates? 

Keep in mind, the biggest banks have a long history of exceeding Wall Street’s expectations. Analysts expect the behemoths of banking to hold their own as far as year-over-year earnings and revenue. A resilient U.S. housing market and generally strong consumer spending in Q1 may have helped the biggest banks, and volatile trading in the capital markets could support revenue in banks’ trading businesses.

Beyond the raw numbers, it’s also important to listen closely to what banking executives say on their earnings calls and in their press releases. That’s where they often paint a more detailed picture of the economy and the industry.

The government and the Federal Reserve recently touted “resilience” in the banking industry, and the biggest banks often emphasize their “fortress balance sheets” built in part to protect them and their customers from financial contagion. Will investors be convinced big banks can sustain these historic strengths coming out of Q1 earnings season? 

What about the more tentative outlook for regional banks facing even heavier exposure to a pandemic-battered commercial real estate sector? A lot of their commercial borrowers could have loans expiring soon and will likely be forced to refinance at much higher rates. There’s concern many of these businesses could default, leaving smaller banks holding the bag.

PAIN IN THE VAULT: Banking industry stocks (BANK—candlesticks) lagged the S&P 500® index (SPX—purple line) during Q1. Data sources: Nasdaq, S&P Dow Jones Indexes. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results. 

Parsing portfolios

When big banks report, keep an eye on the general level of loan activity and the quality of their existing loans. If the quality of their loan portfolios is starting to deteriorate and people are having trouble with payments, that could be a sure sign of a weakening economy. It might also reinforce views that banks are battening down the hatches as higher interest rates weigh on their businesses.  

The main thing to watch here is how much, if anything, they added to provisions for credit losses. More capital set aside for that indicates increased fears of default and also weighs on earnings. Check loan growth too. For instance, JPM saw overall average loans up 6% in Q4—see what it looked like in Q1.

Here’s a quick look at what to watch for as some major banks report:

JPMorgan Chase (JPM)

Scheduled report date: Friday, April 14, before opening bell

• Expected Q1 EPS (analysts’ consensus): $3.41
• Year-ago EPS: $2.63
• Year-over-year EPS expected change: +29.5%
• Expected Q1 revenue (analysts’ consensus): $36.08 billion
• Year-ago revenue: $31.59 billion

Last time out, JPM kicked earnings season off by beating analysts’ Q4 earnings per share (EPS) and revenue estimates, helped by a positive tailwind from net interest income, which is the spread between the interest banks generate from their loans and the interest they pay to depositors. The bank saw average loans rise 6% in Q4.

Net interest could remain a tailwind in Q1, but that’s likely to level off for JPM and other banks as comparisons get tougher through 2023. Banks will likely feel pressure to raise deposit rates to keep customers from chasing higher yields elsewhere.

Another question is whether JPM will decide to add additional loan loss reserves that eat into profits. In Q4, it posted a $2.3 billion provision for credit losses, up 49% from Q3. With lots of talk about a possible recession ahead and many highly leveraged tech and energy firms out there, it wouldn’t be shocking if JPM and other big banks continue to build reserves that keep profit growth a bit muted.

As always, investors should listen closely to JPM’s CEO Jamie Dimon, who has a big megaphone on Wall Street. In a note last week, Dimon reassured shareholders that the current banking and economic situation isn’t comparable to the Great Recession of 2008. “This current banking crisis involves far fewer financial players and fewer issues that need to be resolved,” he wrote. Still, he added, the banking crisis isn’t over and could cause repercussions for years to come.

Citigroup  (C)

Scheduled report date: Friday, April 14, before opening bell

• Expected Q1 EPS (analysts’ consensus view): $1.68
• Year-ago EPS: $2.02
• Year-over-year expected EPS change: –16.8%
• Expected Q1 revenue (analyst’ consensus view): $20.09 billion
• Year-ago revenue: $19.19 billion

C saw a steep drop in Q4 profits as the company set aside more money for potential defaults on loans. The bank did enjoy Q4 strength in its services and markets divisions, however, with markets having a solid quarter driven by fixed income trading. The question is whether there’s follow-through in Q1. It’s possible considering recent market volatility that may have reflected heavy trading volume.

Its banking and wealth management businesses had some highlights in Q4, but private banking got hit by slowing loan growth while investment banking revenue remained weak. Focus on investment banking across C and other banks to see if there was any revival in Q1, but it’s somewhat doubtful considering how much investor money seemed headed into cash.

Outside core businesses, investors will look for an update on C’s regulatory issues. The company got hit in 2020 with a government consent order to improve its risk management and internal controls. Then last November the Federal Reserve cited a “shortcoming” pertaining to “data quality and data management” in part of the bank’s business. It had until January to submit a plan to address that.

Wells Fargo (WFC)

Expected report date: Friday, April 14, before opening bell

• Expected Q1 EPS (analysts’ consensus view): $1.14
• Year-ago EPS: $0.88
• Year-over-year expected EPS change: +29.5%
• Expected Q1 revenue (analysts’ consensus view): $20.14 billion
• Year-ago revenue: $17.59 billion

In Q4, WFC experienced a nice lift from rising net interest income like many of its competitors. Expenses also fell. WFC has suffered years of headlines about corporate malfeasance overshadowing more positive developments and weighing on shares. At the same time, WFC is an interesting canary in the coal mine for the consumer economy because it’s been a leader in both home and auto lending. It’ll be important to check Q4 results in those categories for WFC and to hear executives’ views on how demand is shaping up.

Significantly, WFC announced earlier this year it plans to downsize the home mortgage business it once dominated in light of rising rates and continued regulatory scrutiny. The nation’s No. 1 mortgage lender as late as 2019 will continue to offer home loans only to existing bank and wealth management customers and borrowers in minority communities. In its Q4 earnings conference call, WFC executives said reducing the bank’s exposure to the mortgage market reduces risk and improves returns in the long term.

Back then, WFC said depositors remained resilient with their balances. Investors might want to listen for an update given where rates have gone since then. WFC also said credit quality and consumer spending remained stronger than pre-pandemic levels, and that it expected to see deposit balances and credit quality continue to return toward pre-pandemic levels. Stay tuned.

Bank of America (BAC)

Expected report date: Tuesday, April 18, before opening bell

• Expected Q1 EPS (analysts’ average estimate): $0.83
• Year-ago EPS: $0.80
• Year-over-year expected EPS change: +3.7%
• Expected Q1 revenue (analysts’ average estimate): $25.57 billion
• Year-ago revenue: $23.33 billion

Like other major banks, BAC surpassed analysts’ Q4 estimates thanks to higher interest rates even as investment banking took a hit. At the same time, BAC told investors it expected net interest income to decline sequentially in Q1, CNBC reported, so one thing to watch when BAC reports is just how big a headwind this ended up being.

Also like other banks in Q4, BAC added more reserves for possible credit losses but at a lower level than JPM and down from a year earlier. If BAC adds more than Q4’s $1.1 billion for this line item, it might be interpreted as the company expecting a higher chance of recession.

When reporting Q4 results, BAC executives said they expected a “mild recession.” See if they change that wording. BAC has a massive consumer banking franchise, and it’ll be interesting to hear how that held up in Q1 as data toward the very end of the quarter pointed toward slower jobs and wages growth.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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