• Funds Blog
• November 22, 2024

US Bank Stocks Set for Uneven Q2 Results

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The U.Sstock market has experienced a remarkable surge since the second quarter of this year, lifting the gloom cast by the banking crisis that plagued the first quarterAs we enter the earnings season, the focus shifts to assessing the robustness of American equities, with specific attention on the banking sector, which began releasing its second-quarter financial results starting July 14, led by major players such as JPMorgan Chase.

This earnings season is poised to deliver mixed results across the banking landscapeWith the impacts of rising interest rates at play, we anticipate that banks most affected may showcase impressive gainsHowever, the environment for trading and investment banking remains challengingFortunately, major financial institutions have successfully passed recent stress tests, alleviating concerns about their financial health post-crisis and enabling them to raise dividends

Large banks have seen notable gains in stock prices throughout 2023, avoiding the sharp sell-off faced by smaller rivals, yet they still lag behind the broader market indicesConversely, confidence in regional banks remains shaky, presenting yet another hurdle for these smaller financial entities.

The performance of U.Sbank stocks in the second quarter is expected to reflect this dichotomyThe reporting period started on July 14 and continues through the following week, providing a critical window for investors to scrutinize the performance metrics of key players in the sectorLooking ahead, Wells Fargo and JPMorgan Chase are projected to witness robust growth, whereas Citigroup, Morgan Stanley, and Goldman Sachs might experience a contraction in profit expansion, attributed primarily to two significant factors: the rise in interest rates and the difficult landscape for investment banking and trading operations.

Wells Fargo appears particularly poised for gains due to its high net interest margin, allowing it to capitalize on rising interest rates while focusing on traditional banking services that insulate it from the underperformance seen in other business areas

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On the other hand, JPMorgan Chase and Bank of America may experience slower growth trajectories, given their lower profit margins and the burdens placed on revenue from other sectorsMorgan Stanley and Goldman Sachs, meanwhile, have a different business model with a heavier dependence on trading, investment banking, and wealth management—all of which are struggling under current market pressures, compounded by tepid demand for IPOs and mergers and acquisitions.

As we delve deeper into the performance forecasts, Goldman Sachs stands at risk, heavily reliant on IPO business, which remains cyclical and currently weak, as international financing activities have yet to regain momentumCitigroup, too, continues to lag behind its peers, especially as its earnings per share are projected to decline for a seventh consecutive quarter amidst lower net interest margins and a sluggish trading environment.

This year's stress tests take on extra significance as they are the first conducted since the onset of the banking crisis in March

The ramifications of notable bank failures—including Silicon Valley Bank, Signature Bank, and First Republic Bank in the U.S., and Credit Suisse in Europe—have raised issues around stability and resilience within the banking systemThe Federal Reserve's hypothetical adverse scenario, anticipating a severe global recession with plummeting commercial real estate prices and skyrocketing unemployment, forecasts potential losses in the banking sector amounting to around $541 billionHowever, remarkably, all 23 banks involved in the stress tests continue to meet their minimal capital requirements, demonstrating that the banking system remains robust.

In considering the importance of stress testing, it serves as a critical assessment of each bank’s financial strength, relevant now more than ever given the current economic climateRising interest rates enhance profitability but concomitantly heighten the risks of an economic downturn

Furthermore, these tests are essential for determining how much surplus capital can be returned to shareholders via dividends or stock buybacksFollowing the stress test results, many of the largest banks have promptly signaled intentions to boost dividends starting in the third quarter, providing the market with a semblance of reassurance prior to earnings disclosures.

However, U.SBank has notably delayed announcing its dividend status, according to reports suggesting it surpassed expectations in the stress testsAs declarations of dividends come to light, market speculation is likely to shift towards stock buybacks, as the Fed’s positive evaluations grant banks the leeway to repurchase stockNonetheless, the banking sector is preparing for stricter capital requirements imposed post-crisis, which could make institutions more cautious in decision-making regarding cash expenditures.

This earnings season may serve as yet another pressure test for banks, as the realities of rising interest rates converge with recessionary expectations, resulting in lingering cautious sentiments among investors toward the banking industry

Key indicators in this quarter will include deposits and loan growth metrics, especially as we observe a decline in total deposits across the regulated banking system—a trend continuing from its peak in Q1 2022, now reaching a two-year low as of the first three months of 2023. Typically, larger banks benefit from last quarter's influx of cash, as funds shift from perceived-riskier smaller banks to more stable entities.

On the lending side, tightening capital requirements compel banks to maintain higher capital reserves while also fostering stricter lending standards, inhibiting their willingness to lendThis slowdown in loan growth may further decelerate, especially in the face of rising interest rates, which bring downward pressure on the housing market alongside persistently sluggish demand in commercial real estateGiven the uncertain economic outlook, U.Sbanks are continuing to allocate more reserves to potential credit losses, with JPMorgan Chase anticipating approximately $2.5 billion in reserve provisions for the second quarter—over double what was reserved the previous year—marking the fourth consecutive quarter of growing reserves, indicating an increasingly pessimistic outlook among banks.

In contrast, Goldman Sachs remains an outlier among its peers, with expectations of reduced reserves for the current quarter due to its different operational focus outside traditional banking

As regional banks face significant challenges post-crisis, there is growing talk of consolidations, especially as reports suggest stability despite ongoing risksThe very issues that led to the collapses of Silicon Valley Bank and others continue to loom large, due to rising interest rates eroding asset values, with hopes of a policy pivot now pushed back to 2024.

Additionally, uninsured deposits remain a pressing concern, as fears regarding a potential recession or issues surrounding commercial real estate come into sharp focusThe SPDR S&P Regional Banking ETF, comprised solely of smaller regional banks, has notably dropped over 27% since the turmoil began in MarchIn stark contrast, larger institutions like JPMorgan Chase, Wells Fargo, and Citigroup are trading significantly above their year-to-date lows, indicating a divergence in confidence and market perception toward these different tiers of banks.

As investors scrutinize the stability of each banking entity, the spotlight this quarter will be firmly on loan growth and deposit levels, particularly around the non-collateralized deposits

Quality within loan portfolios will also be pivotal, especially considering greater exposure to commercial real estate amidst elevated interest ratesMany regional banks are taking assertive steps to support their balance sheets and assure investors of their financial soundnessFor instance, PacWest Bancorp, one of the hardest-hit banks, recently offloaded $3.5 billion in loans to a private equity firm to enhance liquidity, an initiative that appeared to buoy its stock price after shedding a portion of its property loans to real estate investors.

As regional banks navigate adjustments and rethink their business strategies, further mergers and acquisitions appear on the horizonThe prevailing scenario suggests that larger banks will continue to grow, while smaller banks will need to streamline operationsJanet Yellen, the U.STreasury Secretary, conveyed that she is amenable to greater consolidation among bigger financial institutions, as long as it aligns with the overall health of the sector

In her statements on mergers, she noted, “We certainly don’t want excessive concentration, and we support competition, but that does not mean we would say no to mergers.”

The S&P 500 has encountered resistance as it approaches a series of highs recorded over the past eight monthsShould the upcoming earnings reports catalyze a further ascent of the S&P 500, the index could gravitate closer to the 78.6% retracement mark relative to its low in October of last year, thus enabling a potential return above the 4,500 markHowever, the relative strength index (RSI) is nearing overbought territory, suggesting that the index may be exhibiting excessive gains post the rebound observed last month.

Should the index face renewed pressure, it is likely to find support around the 4,300 level, coinciding with last month’s low, along with peaks from August of the previous year and the 61.8% retracement mark