Big banks hope to find a bottom in third quarter earnings

Bank stocks have gone unloved in the market rebound, but the largest U.S. banks hope to show investors this week that the worst is behind them.

JPMorgan Chase (JPM) and Citigroup (C) will tee off earnings season before the market bell on Tuesday, offering the first glimpse into how the financial heart of the economy performed in the three months ended September 30. Bank of America (BAC) and Wells Fargo (WFC) are scheduled to report Wednesday.

The megabanks are again likely to lean on non-interest income and trading revenues to keep earnings afloat in the second quarter. For the third quarter, the banks may release some of the $81.2 billion in loan loss reserves apportioned out last quarter to weather the depths of the COVID-19 crisis, providing another positive headwind to earnings.

But restrictions on buybacks and dividends, in addition to broader concerns about the path of the recovery, may continue to bog down the bank stocks. Investors have been cold to financials, and shares of the four largest banks continue to trade over 20% below levels at the beginning of 2020 (whereas the broader market has recovered its losses).

Analysts at RBC Capital Markets argue that the thesis for bank stock investors boils down to a simple thesis: buy the banks if you expect a recovery but stay away if you expect a double-dip return into recession.

“Investors who believe the economy will recover in the fourth quarter of this year and into 2021, combined with successful forbearance strategies implemented by the banks and regulators, should look to own banks stocks in this ‘bottoming’ phase,” said RBC bank analyst Gerard Cassidy in a note October 12.

With the Fed signaling its intention to keep interest rates near-zero, revenue is unlikely to find growth in its traditional sources: business and household loans.

Loan pipelines are expected to contract quarter-over-quarter as households and businesses pay down debt. Net interest margin, a key measure of interest collected on loans minus interest paid on deposits, will likely remain depressed in the third quarter.

RBC expects markets revenue to be the major driver of earnings in the third quarter, projecting a 12% year-over-year increase led by trading in fixed income, currencies, and commodities.

Earnings could be noisy with several banks facing unique business challenges.

Citigroup will likely be pressed on efforts to reform its risk management structure after the Federal Reserve and the Office of the Comptroller of the Currency identified “significant ongoing deficiencies” last week.

Morgan Stanley, meanwhile, will offer more color on its acquisition of investment manager Eaton Vance, its second blockbuster deal after closing its E-Trade Financial merger.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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