Big Banks Expected To Be In The Green As Spotlight Shines On Q2 Earnings From JP Morgan, Citi, And Wells Fargo

A lethal combination of ultra-low interest rates, credit worries, a steep economic slowdown, and tough government regulations ganged up on big banks this year. Despite that, expectations for the group’s Q3 earnings performance are on the rise.

Granted, the numbers don’t look like something to throw a party over, with research firm FactSet predicting cumulative Financial earnings to fall 19.4% from a year ago. The good news is that those expectations look a lot sunnier than where analysts were back in June, when they predicted a Financials Q3 earnings cratering of 34.4%. 

Why the improvement? For one thing, many banks benefit from the energetic capital markets and the trading revenue they provide. Second, low rates have their good side, encouraging more loan activity.

Some of the big banks leading the upward earnings expectations meter include JP Morgan Chase & Co. JPM and Wells Fargo & Co WFC, FactSet reported. It appears likely they both could have relatively positive Q3 results despite all the headwinds they’ve faced and continue to face in this rough 2020. 

The same goes for Citigroup Inc C, which, like JPM, is expected to report Q3 earnings early tomorrow. Those will be followed Wednesday morning by WFC.

Before zeroing in on individual banks, let’s scroll back for a broader view. Big banks haven’t performed well in the market this year, but they’ve generally done a great job setting aside money for possible credit losses and cutting costs. This could position most of them pretty nicely for any economic rebound once the pandemic passes. 

That said, the credit loss provisions compressed earnings earlier this year, and it wouldn’t be surprising if we see additional money put aside for that this quarter.

If there’s positive news on a vaccine or treatment in coming months, the banks could get an outsize benefit, analysts say. That’s partly because their businesses are so exposed to the broader economy, and also because their shares generally remain more beaten down than many other sectors. The S&P 500 Financial sector was recently off more than 19% year-to-date, the worst performance of any sector in 2020 aside from Energy.

One possible worry is any changes in Washington following the election. Banks have generally enjoyed a rollback of regulations recently, but November’s voting could potentially mean a more active Treasury Department in coming years. It’s possible bank executives might be asked on their earnings calls to speculate about the election and its potential impact on their companies and the economy.

Bank stocks also remain bogged down by the Fed’s restrictions on dividends. The Fed put capital restrictions in place in June after it released the results of its annual stress tests. Many banks had already halted share repurchases in March, and buybacks historically accounted for roughly 70% of the banks’ capital return to shareholders, Barron’s noted. The restrictions on dividends might have weighed on investor interest in the sector. 

The Fed also announced in June that the banks would have to undergo a second stress test this year due to economic uncertainty and that the results would be released before the year ends.

Below we’ll preview JPM, C, and WFC. Stay tuned for a look at Bank of America Corp BAC, Goldman Sachs Group Inc GS, and Morgan Stanley MS.

Kicking Off Earnings Season With JP Morgan Tomorrow

JPM gets the ball rolling early tomorrow. As always, investors will likely listen closely to any words from the company’s CEO, Jamie Dimon. Like few other Wall Street leaders, Dimon’s thoughts can help set the tone for earnings season, and if he likes the economic and industry trends he sees, that could potentially give banking stocks and the entire market a psychological boost.

Things to listen for from Dimon include his take on the relatively improved economic data seen lately (other than the disappointing payrolls number for September), and when and whether JPM might be able to cut back on the credit loss provisions it’s taken to protect against possibly bad loans. Also consider listening to what Dimon might have to say about the general health of companies JPM deals with, the lending environment, and the impact on banks’ net interest income from these continued rock-bottom interest rates.

Speaking of “rock bottom rates,” JPM and the other big banks might be seeing some light on the horizon. The benchmark 10-year Treasury yield, stuck below 0.7% pretty much since early June, showed signs of breaking out last week. It’s unclear if this has any traction, and previous rally attempts in the yield haven’t gotten anywhere this year. Still, it’s a ray of hope that maybe the economy is improving.

Bank earnings are particularly vulnerable to low rates, because they can crimp profitability. That’s definitely been the case for JPM so far this year, but analysts say the company appears to be in good shape to come out of the recession without major damage. 

“Average deposits rose 20% in Q2 2020, and JPM has the lowest ratio of total net loans to total deposits at 49% compared to direct peers in the 60%-65% level,” research firm CFRA said in a recent note. “We believe this gives JPM an edge in terms of managing credit risk to nonperforming loans in 2020.”

Another potential advantage for JPM is that it factored in huge downside scenarios when building its reserves, Barron’s recently reported. Even if its pessimistic economic projections come true, the accounting treatment of those reserves might permit them to be released into earnings once the economy improves and losses are covered. That’s more of an issue for maybe next year, not Q3, but it could be something to watch.

FIGURE 1: TOUGH YEAR FOR JPM. This year-to-date chart for JP Morgan Chase (JPM—candlestick) demonstrates that it’s trailing the S&P Financial Sector (IXM—purple line) by quite a bit. Several rally attempts for JPM have been pushed down again over the last six months, in part because of weak interest rates and maybe due to banks like JPM being limited in their ability to raise dividends or buy back shares. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Plastic Watch At Citigroup

Citigroup might give investors a sense of where the consumer is, thanks in part to its hefty credit card business.

Monitoring that particular segment at C often provides decent insight into spending habits, which help drive so much of the economy. In the summer, consumer confidence came charging back and economic data recently began to improve, but there’s a sense that we’re far from out of the woods. Retail sales disappointed in August, and September job growth wasn’t anything to get too excited about. Weekly new jobless claims have remained stubbornly above 800,000, which is more than three times the rate people were used to for years before 2020.

The first fiscal stimulus has mostly dried up, and Congress and the White House are trying to get something done. It’s too late for that to mean anything for the banks’ Q3, however, and executives at C might have an interesting perspective on the consumer response to stimulus dying down. Has that had a major impact on the credit card business, and if so, is it something C expects to continue?

Citigroup also has been expanding its investment banking business, and might benefit from a nice pickup in initial public offerings  (IPOs) recently, along with some merger and acquisition (M&A) news. This could be a good sign for the entire big bank sector providing it continues into Q3. Typically, rising IPO and M&A activity are good barometers for an improving economy. 

Another potential positive for C and other big commercial banks like JPM and GS is potentially solid returns from the trading business. While Q3 market activity was relatively subdued compared to what we saw earlier this year—especially in bonds—volatility remained high for stocks most of the quarter and the market was generally on an upswing in July and August followed by steep losses in September. 

This kind of turbulence tends to stir up the need for hedging. That can mean higher trading volume that helps bottom lines for the banks. Especially those with big trading desks.

Looking deeper into C’s books, no bank has set aside a larger percentage of its loan book than Citigroup, Barron’s reported. Its allowance for credit losses totaled $28.3 billion as of the end of the second quarter, following reserve builds of $4.9 billion and $5.6 billion in the first and second quarters, respectively. Reserves now equal 3.9% of the bank’s total loans. Citi’s Q2 profit fell 73% from the year-ago period due to the reserve build and $2.2 billion in net charge-offs incurred.

Can Sizzling Housing Market Lift WFC After A Red Q2?

Mention Wells Fargo, and the word “housing” isn’t often far from investors’ minds. 

We all know economists seldom agree, but they might when it comes to housing this summer and fall. Boosted by low mortgage rates and people moving out of big cities during the pandemic, it’s generally been a good period for the housing sector. August new home sales were pretty much off the charts, exceeding a seasonally-adjusted annual rate of one million for the first time since November 2006. Specifically, they rose 4.8%  month over month and 43.2% year over year,

WFC has the biggest mortgage origination business of any of the three banks we’re talking about here. As we’ve noted in the past,, WFC’s CFO has called mortgage lending the “core” of the company’s business.

As we noted last quarter, regional banks are also big mortgage generators, so consider keeping an eye on those when they start reporting. Strength or weakness among regional banks can often be reflected by the Russell 2000 (RUT) index of small-cap companies, where regional banks have a large presence.

One worry which you often see when a surprising event (like coronavirus) causes changes in economic behavior is whether it’s pulled forward from future quarters. Meaning today’s strong housing demand could help WFC’s earnings in Q3 perhaps at the expense of future periods. That could be something to listen for on their call. Namely, keep an eye on whether WFC executives expect good times in the housing market to continue and for how long.

Also consider listening for updates on how WFC plans to cut costs, something it seems committed to. For instance, can it find a way to slice the expense of vendors, which its executives have complained about in the past.

WFC shares have performed worse than many other bank shares this year, in part because it’s still operating under restrictions the government imposed on it after its fake-accounts scandal. The bank posted its first quarterly loss in more than a decade when it reported Q2 earnings, and chopped its dividend

JPMorgan Chase Earnings And Options Activity

When JPMorgan Chase releases results, it is expected to report adjusted EPS of $2.23, vs. $2.68 in the prior-year quarter, on revenue of $28.29 billion, according to third-party consensus analyst estimates. Revenue is expected to fall 5.9% year-over-year. 

Options traders have priced in about a 3.1% stock move in either direction around the upcoming earnings release, according to the Market Maker Move indicator on the thinkorswim® platform from TD Ameritrade. Implied volatility was at the 19th percentile as of Monday morning.  Looking at the October 16 options expiration, puts have seen some activity at the 95 strike, with calls widely traded at the 102 and 105 strikes.  

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

Citigroup Earnings And Options Activity

Citigroup is expected to report adjusted EPS of $0.92 vs. $2.07 in the prior-year quarter, on revenue of $17.22 billion, according to third-party consensus analyst estimates. Revenue is expected to be down 7.3% year-over-year.

Options traders have priced in a 3.6% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility was at the 19th percentile as of this morning. 

Call activity for C has been highest at the 47.5 and 50 strikes, while puts have seen activity at the 42.5 strike.

Wells Fargo Earnings And Options Activity 

Wells Fargo is expected to report adjusted earnings of $0.44, vs. $0.92 in the prior-year quarter, on revenue of $17.97 billion, according to third-party consensus analyst estimates. Revenue is expected to be down 18.4% year-over-year.

Options traders have priced in a 5% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator on the thinkorswim platform. Implied volatility was at the 26th percentile as of Monday morning. 

For the October 16th expiration, put activity has been concentrated at the 22.5 and 24 strikes, while call activity has been highest at the 27.5 and 30 strikes.

TD Ameritrade^® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Photo by Erol Ahmed on Unsplash