A Big Bank Rally Is About To Be Put To The Test

(Yahoo! Finance) - The stocks of big banks are outperforming the rest of the S&P 500 (^GSPC) this year, and that investor confidence is about to be put to the test.

JPMorgan Chase (JPM), Wells Fargo (WFC), and Citigroup (C) all report their second quarter results this Friday, kicking off another earnings season for the US banking industry. Bank of America (BAC) reports the following Tuesday.

The stocks of these banks — the four largest in the US — have each climbed more than 20% since January, outperforming the S&P 500. That performance is also roughly double the gains of an index that tracks the wider industry, the KBW Nasdaq Bank Index (^BKX).

Big bank investors are optimistic about the ability of the biggest financial institutions to thrive as the Federal Reserve slowly lowers interest rates, regulators water down a set of new bank capital rules, and Wall Street dealmaking stages a comeback.

The Fed’s policy path — which currently is expected to be one or two cuts in 2024, followed by more in 2025 — “really bodes well” for the group of big banks over the next year, said RBC Capital Markets bank analyst Gerard Cassidy.

But the actual results from the big banks during the second quarter are not expected to stun, despite a headline number from JPMorgan that will likely blow away all rivals.

JPMorgan is expected to report a sizable net profit due partly to a pre-tax multibillion-dollar accounting boost from an exchange of shares in credit card giant Visa (V), but analysts say that won’t grab a lot of attention from market watchers.

"I think the market will pretty quickly pull that out as sort of an unusual or one-time event," said Scott Siefers, a large bank analyst with Piper Sandler.

Where there will likely be more focus is what JPMorgan has to say about a key measure of lending profit known as net interest income.

That profit — which measures the difference between what banks pay out in deposits and take in from their loans — is expected to be down from the sequential quarter. The same goes for the other three big banks.

Even the biggest banks have been struggling with this measure as deposit costs stay elevated, loan demand remains weak, and the Fed takes longer than expected to bring interest rates back down.

"Investors are hoping to see that net interest income for the second quarter will, ideally, be the trough for big banks this year," Siefers added.

The results from the big banks are also likely to reveal the cautionary stance these lenders are taking on credit as higher rates pose more challenges for their borrowers.

New provisions set aside to cover future loan losses at the big four banks are expected to rise 26% from last quarter. By comparison, the pace of loan loss provisions across all commercial banks began to stabilize earlier this year, rising 0.30% over the quarter, according to Federal Reserve data.

Where results should be considerably brighter are within the Wall Street operations of these big banks as dealmaking stages a comeback from poor performances in 2023 and 2022.

The big four banks, along with Wall Street specialists Goldman Sachs (GS) and Morgan Stanley (MS), are all expected to show sizable jumps — an average of more than 30% — in investment banking fees compared with a year ago. Goldman and Morgan Stanley report their earnings on Monday and Tuesday.

The big event that all banks are waiting for is when the Fed finally decides to start lowering rates from a 23-year high. The current market bet is that it could happen as early as September.

For smaller regional banks, the sooner rate cuts come, the better. They are more reliant on lending income and thus have been hit harder by a drop in net interest income across the industry. They are also more exposed to the weaknesses in the commercial real estate market.

Investors have pushed down the stocks of various regional and small banks this year as new problems or concerns surface.

It happened last week after Dallas bank First Foundation (FFWM) announced a $228 million infusion from new investors to help it reduce its concentration of multifamily apartment loans.

It also happened in June following an analyst report calling out debt held by Bank OZK (OZK) and in May when a short seller targeted Axos Financial (AX) over the quality of its property loans.

Commercial real estate worries first ignited at the start of this year when New York Community Bancorp (NYCB) set aside a surprising amount of money in case of loan losses in part to rent-regulated apartment complexes in the New York City area.

NYCB's stock plummeted but it was able to calm the market with an emergency equity infusion from a group that included former Treasury Secretary Steven Mnuchin.

All of this turmoil has "subdued investor expectations" for regional banks, Bank of America analyst Ebrahim Poonawala said.

Investors will be on the watch for more vulnerabilities as many midsize institutions report in the coming weeks.

For these lenders, “the bull case is that their actual credit losses will be significantly lower than what is being priced into their stocks,” Chris McGratty, a regional bank analyst with KBW, told Yahoo Finance.

But the institutions that rely heavily on commercial real estate lending aren’t likely to be given the benefit of the doubt until the credit cycle has come full circle, McGratty added.

An index tracking regional bank stock prices (KRE) has fallen more than 7% since the beginning of the year.

By David Hollerith - Senior Reporter

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