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Bank Earnings: It’s All About the Outlook

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Investors eagerly await the upcoming bank earnings reports, but their focus isn’t solely on the numbers. Rather, they are more interested in the outlook that bank executives will provide for the economy.

This Friday, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo are scheduled to release their earnings. Investors hope for a positive forecast that indicates 2024 will be a better year than its predecessor, 2023. Remember 2023? It was marked by rising Treasury yields that negatively impacted the valuation of banks’ bond holdings. This led to the receivership of First Republic Bancorp, Silicon Valley Bank, and Signature Bank.

Thankfully, the year seems to have ended on a positive note. As Treasury yields decreased, the value of banks’ bond portfolios increased, resulting in narrower unrealized losses. This was particularly beneficial for Bank of America, which faced potential losses of up to $130 billion. With this threat diminishing, bank stocks experienced a rally in the last quarter of the year, with the KBW Nasdaq Bank Index gaining 22.6%.

However, it is possible that these stocks became overvalued. While earnings are expected to be strong due to higher net interest income and favorable credit trends, the stocks face challenges ahead. They must confront the impact of the Federal Deposit Insurance Corp.’s assessment on large and midsize banks, necessary to replenish the deposit insurance fund after the collapse of aforementioned banks in the spring of last year. Analyst Christopher Marinac from Janney Montgomery Scott estimates that this one-time charge could reduce fourth-quarter earnings per share by up to 35% for large banks and 12% for midsize banks.

Additionally, the direction of Treasury yields remains uncertain, which could also weigh on the stocks. Should yields surge after the remarkable fourth-quarter rally, concerns regarding portfolio performance may resurface. Furthermore, the Federal Reserve is likely to decrease interest rates, possibly as early as March, according to the CME’s FedWatch tool. Such a move would lead to a drop in net interest income. Analysts at Goldman Sachs Group predict a 3% decrease in net interesst income for the year, following an anticipated 16% increase in 2023.

As investors eagerly await the bank earnings reports, they understand that the outlook for the economy will be the key factor in determining stock performance.

Credit Quality and Investor Concerns

The credit quality of consumers has been resilient in recent years. However, signs of weakness are starting to emerge in the form of delinquencies and charge-offs at banks. This has some investors on the sidelines, worried about potential further deterioration if the economy weakens. Analysts at Keefe, Bruyette & Woods remain neutral on banks and warn that declining credit could result in a drop in earnings per share of up to 25% across their coverage universe.

Selectivity is Key

Given the uncertain backdrop, it is crucial for investors to be selective. Keefe, Bruyette & Woods identify KeyCorp, Webster Financial, and Goldman Sachs as potential opportunities.

KeyCorp: Promising Outlook

KeyCorp had a strong performance in the previous year, and analysts predict further advancement with shares projected to rise by an additional 18%. While the bank was among the first to report weak net interest margins in 2023, analysts anticipate that it will also be among the first to benefit when interest rates stabilize in 2024. Investors can also enjoy a 5.8% yield.

Webster Financial: Flying Under the Radar

With assets totaling $73 billion, Webster Financial often goes unnoticed. However, this could work to its advantage as it is largely immune from forthcoming regulations targeting banks with assets above $100 billion. The bank boasts a return on tangible common equity of 21% and trades at 1.7 times tangible book value, aligning with its five-year average. Analysts at Keefe, Bruyette & Woods foresee shares advancing by 23%.

Goldman Sachs: Making a Comeback

After experiencing difficulties throughout 2023, Goldman Sachs looks poised for a strong year ahead. The divestment of its money-losing consumer businesses has allowed the bank to refocus on its core strength: investment banking. With interest rates returning to normal levels, deal activity and initial public offerings (IPOs) are expected to rebound. This positive outlook could lead to as much as 8% upside in Goldman Sachs shares.

Despite anticipated challenges in 2024, there are still ample opportunities for investors in the banking sector.

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