Big Banks Report Earnings This Week. Here’s What Wall Street is Watching.

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The big banks start to report their earnings this week, and Wall Street expects the second-quarter results to be “fine,” a tepidly enthusiastic call that encapsulates the performance of the stocks this year.

The

SPDR S&P Bank ETF

(ticker: KBE) is down 17.8% this year, tracking only slightly better than the

S&P 500
.
That wouldn’t be so bad, except that this year was supposed to be a good one for banks, which defied expectations and thrived during the pandemic. Profits were expected to grow as the Federal Reserve raises interest rates, making lending more profitable, but fear that those rate increases will lead to a recession has dragged on the stocks.

Still, the big banks have proven their resiliency, easily passing the Fed’s annual stress test last month. Sentiment is cautiously turning back in the sector’s favor.

“Bank results [are] likely fine,” David George, an analyst at Baird, wrote in a recent note, adding that the balance between risks and potential rewards looks attractive, with the banks he covers trading at a median 5.5 times forward earnings. “Given recent weakness in the group, we expect stocks to trade OK as we move through the reporting season,” he said.

That sort of sentiment makes it difficult to get excited about investing in the sector even though it may be one of the safer areas to park funds as the economy slows down. The Fed’s stress test showed that banks were able to withstand a hypothetical downturn much worse than the real one economists fear.

Banks look cheap, with many trading around book value. The dividend yield on the KBE is a respectable 2.1%, while

JPMorgan Chase

(JPM) and

Citigroup

(C) have yields well in excess of 3%.

JPMorgan and Morgan Stanley (MS) report their results on Thursday. Numbers from

Wells Fargo

(WFC) and Citigroup are due on Friday. Here are four areas Wall Street will be watching:

Rising Net Interest Income: Banks are one of the few beneficiaries of rising interest rates because they allow lenders to earn a wider spread between the interest they take in from loans and what they pay for deposits. Mike Mayo, analyst at Wells Fargo, recently wrote that he expects banks to post “the best NII growth in four decades over the next 6 quarters” thanks to a mix of rising interest rates and increased commercial lending.

Less Fee Revenue: While investors can get excited about rising net interest income, declining fees will likely partly offset the benefit. Rising interest rates lead to fewer mortgage originations, an important source of fees. Higher rates also make it more costly for companies to borrow for acquisitions, meaning the largest lenders will likely see a slowdown in investment-banking activity. Even wealth management, a typical bright spot for bank earnings, could see weaker fee revenue, according to George, the Baird analyst.

Trading May Be Surprisingly Strong: Markets’ recent market volatility hasn’t been good for most investors, but as viewers of the 1983 classic Trading Places learned, brokers get commissions no matter which way a trade goes. George said he expects banks to post a 5% year-over-year increase in fixed-income trading volume and a 10% increase from equities trading.

The Big Picture: As is often the case with earnings, the outlook matters as much as—if not more than—the posted results. This is particularly true for banks because the behavior of their clients gives them a clearer view of the health of the economy.

So far, executives of the big banks acknowledge that a slowdown is coming but they’re mixed on how severe it will be. At a conference last month, JPMorgan CEO Jamie Dimon warned of a “hurricane,” while

Bank of America

CEO Brian Moynihan appeared less worried, saying “we’re always prepared …we don’t have a choice.”

Write to Carleton English at [email protected]