It’s time for the U.S. banks to show how they endured the third quarter, which was not any different from how the year has been treating the industry from the start. The disadvantage of lower volatility in financial markets was accompanied by structural pressure. Soft trading volumes, lackluster client activities and high legal costs continued, while a downturn in fixed income, currencies and commodities (FICC) cropped up to mar bank financials.
Further, the uncertainty over interest rates kept mortgage activity feeble. With depressed demand for fresh mortgages, lenders might see a lower profit margin for the quarter.
On the other hand, sizable growth in underwriting fees on the back of an M&A boom and cost containment through reorganization acted in favor.
The overall backdrop has not changed significantly from what the industry witnessed in the first two quarters. However, the market is speculating whether the absence of seasonal pressure and some strategic actions helped banks perform better this time around.
We don’t expect negatives to dominate this quarter given the enhanced capability of banks to mitigate them, but there is no such visible strength that could lead to outstanding results.
The broader Finance sector, of which U.S. banks are part, is expected to witness a 3.9% earnings decline in the quarter, primarily due to a 3.3% decline in revenues. While earnings performance compares unfavorably with a 0.9% increase last quarter, revenue decline shows improvement.
Looking at the 6 medium-level (or M-level) industries in the sector, it appears that Major Banks suffered the most during the quarter with an expected 21.6% year-over-year earnings decline. However, Banks & Thrifts seems to have performed well and could witness 12.5% earnings growth.
However, the expectations do not point to the overall finance sector or Major Banks’ underperformance to a great extent. Actually, the incorporation of the impact of Bank of America’s (BAC) settlement with the DOJ and other government entities into its EPS estimates majorly dragged the sector and the industry estimates.
(For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)
Factors That Might Have Affected Q3 Results
Similar to last quarter, continued decline in capital market revenues with the downtrend in FICC remained a key dampener.
Mortgage banking activities that witnessed an improvement in Q2 after four straight quarters of decline were sluggish during Q3 due to depressed demand for fresh mortgages and fewer avenues for new originations.
High legal and restructuring costs, a dearth of significant loan growth and pressure on net interest margins from the prolonged low rate environment were the other nagging issues.
The Supporting Factors
The investment banking segment should majorly support the sector’s earnings this quarter. The quarter was characterized by significant fresh capital raising through IPOs and secondary offerings on the back of a strong equity market. M&A activity was also pretty strong. These led to a significant increase in underwriting and advisory fees of acting banks.
Aggressive cost control through streamlined operations and job cuts should also contribute to the bottom line.
Further, a favorable asset market backdrop as well as encouraging macroeconomic factors – falling unemployment, progressive housing sector and flexible monetary policy – is likely to have lent some support to the financials of banks.
Earnings of Forerunners in Focus
Based on our proven model, we are not confident about earnings beats for most of the industry leaders. According to the Zacks methodology, a stock needs to have both a positive Earnings ESP and a Zacks Rank #3 (Hold) or better for an earnings surprise call.
Earnings ESP is our proprietary methodology for identifying stocks that have the best chances to surprise with their upcoming earnings announcements. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
Here are the expected numbers from 4 major banks:
JPMorgan Chase & Co. (JPM)
This Zacks Rank #3 banking giant is scheduled to kick-off the Q3 banking earnings season before the opening bell on Oct 14.
- Zacks Consensus Estimate (earnings per share): $1.39 (versus $1.42 reported in Q3 2013)
- Zacks Consensus Estimate (revenues): $24 billion (versus $23.9 billion reported in Q3 2013)
- Earnings ESP: 0.00%
We cannot conclusively say that JPMorgan will beat the Zacks Consensus Estimate. Though the company’s Zacks Rank #2 (Buy) increases the predictive power of ESP, we also need to have a positive ESP to be confident of an earnings surprise call.
Wells Fargo & Company (WFC)
This Zacks Rank #3 company will also release Q3 results with JPMorgan on Oct 14, before the opening bell.
- Zacks Consensus Estimate (earnings per share): $1.02 (versus 99 cents in Q3 2013)
- Zacks Consensus Estimate (revenue): $21 billion (versus $20.9 billion in Q3 2013)
- Earnings ESP: 0.98%
Given the right combination of Zacks Rank and Earnings ESP, it is likely that Wells Fargo will beat the Zacks Consensus Estimate in the upcoming release.
Citigroup Inc. (C)
Again, this is a Zacks Rank #3 company which is scheduled to release its Q3 earnings before the opening bell on Oct 14.
- Zacks Consensus Estimate (earnings per share): $1.12 (versus $1.00 in Q3 2013)
- Zacks Consensus Estimate (revenues): $19 billion (versus $18.8 billion in Q3 2013)
- Earnings ESP: 0.00%
The combination of Zacks Rank and Earnings ESP doesn’t conclusively show that Citigroup will beat the Zacks Consensus Estimate.
Bank of America Corp.
This Zacks Rank #3 company is scheduled to release its Q3 results before the opening bell on Oct 15.
- Zacks Consensus Estimate (earnings per share): Loss of 9 cents (versus 28 cents earnings in Q3 2013)
- Zacks Consensus Estimate (revenues): $21.3 billion (versus $22.2 billion reported in Q3 2013)
- Earnings ESP: 0.00%
Here, too, we are not confident of an earnings beat as Bank of America does not have the right combination of Zacks Rank and Earnings ESP.
Bottom Line
While the releases on Oct 14 will signal the performance of the industry, the expectations show a disappointing picture for two of the three companies reporting. So, it is advisable for investors with a strong preference for banking stocks to wait until the releases of forerunners. If the results are encouraging, one could bet on those with a favorable combination of Zacks Rank and Earnings ESP.
However, investors with a strong risk appetite could go for stocks with such a combination even before the banking earnings kick off. If the reality depicts something else – a favorable performance – with hidden strengths working in favor, an early investment would be rewarding.
Keep an eye on our earnings preview and earnings report coverage in the coming days on www.zacks.com home page.
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