Bank earnings are expected to shine, but their stocks may not
The second-quarter earnings season will kick off in earnest on Friday, when three of the nation’s biggest banks report, and analysts are expecting somewhat of a repeat of the first quarter, when the sector chalked up record gains.
Against the current backdrop of a flattening yield curve, however, it’s not clear that strong results will succeed in reviving stock prices that have underperformed the broader market since February, as the initial euphoria around the tax revamp, expected deregulation and the strong economy dimmed.
“Many bull thesis drivers were baked-in and the flatter curve and tariff concerns have led to a de-rating,” said Jefferies analyst Ken Usdin. “Rising rates will continue to help, but deposit costs are rising faster and loan growth needs to step up.”
Yields on the short end of the curve have been steadily climbing as the Federal Reserve telegraphs its planned interest rate hikes, while yields on the long end of the curve are flat or falling, raising the specter of an inverted yield curve, typically a harbinger of recession. But even without a recession, there are concerns that banks will be unable to benefit from rising interest rates if long-term rates remain subdued. That’s because net interest margins, or the difference between what they pay depositors and what they charge for loans, will remain compressed.
The yields on two-year and 10-year Treasury notes rose during the second quarter, but the spread between those yields narrowed to 33 basis points as of June 29 from 47 basis points as of March 29.
Read more: Here’s when the yield curve actually becomes a stock-market danger signal
“If the yield curve inverts, we expect bank loan growth to slow, as more borrowers shift to terming out their financing with longer term fixed rate loans, rather than shorter-term variable priced commercial and industrial loans,” said Morgan Stanley analyst Betsy Graseck. “The caveat is whether spreads expand, making borrowing in the capital markets too expensive, which could then slow and potentially shrink corporate leverage.”
JPMorgan Chase and Co. JPM, -0.35% Citigroup Inc. C, -1.34% and Wells Fargo & Co. WFC, -0.44% are slated to report on Friday, followed by Bank of America Corp. BAC, -0.94% on Monday, Goldman Sachs Group Inc. GS, -0.51% on Tuesday and Morgan Stanley MS, -0.39% on Wednesday.
The banks are expected to report robust trading revenue, given the volatility in stock markets, while capital markets activity was solid. The IPO market had its busiest quarter in three years, with more deals in the pipeline. The debt underwriting market was slower than a year ago, but busier than many were expecting.
U.S. mergers and acquisition activity rose 82% to a record $1.0 trillion, according to Thomson Reuters data, thanks to deals including General Electric Co.’s GE, +1.04% asset sales, the combination of Sprint Corp. S, -0.36% and T-Mobile US. Inc. TMUS, -0.49% and the approval of AT&T Inc.’s T, +0.33% planned takeover of Time Warner Inc. TWX, +0.59%
“Key points of interest on the conference calls will be trends in loan portfolios which have failed to live up to expectations and management’s plans on capital returns that recently got the Fed’s nod in the latest Comprehensive Capital Analysis and Review (CCAR) aka Fed Stress Tests,” said Sheraz Mian, research director at Zacks.
Here’s what to expect:
Earnings: JPMorgan is expected to report earnings of $2.22 a share, up from $1.82 a share a year ago, according to analysts polled by FactSet. Estimize, which crowdsources estimates from analysts, buy side investors, academics and others, is expecting the bank to post EPS of $2.28.
Revenue: The bank is expected to post revenue of $27.536 billion, according to FactSet analysts. Estimize pegs revenue at $27.824 billion.
JPMorgan has exceeded estimates for EPS for the past 13 quarters, and has beaten revenue estimates for the last 10 quarters, according to FactSet.
Earnings: Citigroup is expected to report EPS of $1.56, according to analysts polled by FactSet, up from $1.24 a year ago. Estimize analysts are expecting higher EPS of $1.62.
Revenue: Citi is expected to report revenue of $18.516 billion, according to FactSet analysts, up from $17.901 billion a year ago. Estimize analysts are expecting revenue of $18.611 billion.
Citi has beaten EPS estimates for the last 13 quarters and exceeded revenue estimates for the last five quarters.
Earnings: Wells Fargo is expected to report EPS of $1.12, according to FactSet analysts, up from $1.07 a year ago. Estimize is expecting the San Francisco-based bank to post EPS of $1.14.
Revenue: Wells is expected to report revenue of $21.697 billion, according to FactSet analysts, down from $22.169 billion. Estimize pegs revenue at $21.708 billion.
Wells Fargo has missed EPS estimates three times in the last six quarters and lagged revenue estimates for five of the last six quarters.
Stock price action: The Financial Select Sector SPDR ETF XLF, -0.48% has fallen 2.4% in 2018, weighed down by the weak performance of its big bank constituents. JPMorgan shares have eked out a 0.6% gain in the year to date, while Citigroup is down 8% and Wells Fargo is down 7%.
The S&P 500 SPX, +0.27% has gained 4.5% in the period and the Dow Jones Industrial DJIA, +0.50% is up 0.8%.
Other issues:The Federal Reserve in June gave a clean bill of health to all of the big U.S. banks following what it described as a “severely adverse” stress test.
The banks promptly announced plans to raise quarterly dividends and buy back stock, moves that bullish investors are hoping will help propel their stocks higher.
“Incremental loan growth and capital return are the biggest remaining upside deltas to our estimates from here, but each would be smaller add-ons relative to past benefits from higher rates and lower taxes,” said Jefferies’ Usdin.
Loan growth will have to replace rising rates as the main driver of net interest income growth, as the cycle lengthens and competitive pressures grow, he said.
Elsewhere, investors will be keen for updates on the outlook for credit risk amid concerns that the high-yield market is underpriced. Morgan Stanley analyst Adam Richmond is looking for high-yield spreads to widen by 60% year-on-year in the next 12 months to 575 basis points over Treasurys, and for investment-grade spreads to widen by 25% to 150 basis points.
“Over time, wider spreads could put pressure on corporate borrowers, driving up commercial loan non-performing loans and net charge-offs,” he said.
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