Key Takeaways

Big banks begin reporting Friday as JPMorgan Chase, Citigroup, Wells Fargo, and Bank of America kick off earnings season

Consumer spending helped drive growth in Q4, but can it continue at current pace?

Impact of expected rate cuts, loan-loss plans, and credit quality all on front burner as banks report

The economic “hurricane” a U.S. bank executive famously forecast back in 2022 slowed to a tropical storm by spring and finished as a partially cloudy day at the beach by late 2023. Banks that battened down the hatches amid rising rates became hot stocks as the financials sector showed signs of life over the last few months. Now, they face a test as they report Q4 earnings starting later this week.

The biggest story for banks in Q4 arguably was the Federal Reserve’s potential pivot toward rate cuts and the sharp drop in Treasury yields that accompanied it. Back in October when big banks last reported, the benchmark 10-year Treasury yield (TNX) appeared to be on an unstoppable path toward 5%, a 16-year high.

By late December, the yield was well below 4% and many investors built in five to six Fed rate cuts in 2024, according to the CME’s FedWatch Tool. That said, the Fed and many economists only project two to three cuts ahead, and strong December jobs growth reported early this month might push back on hopes for a rate cut as soon as March.

Improved macro landscape

For any banks that have bonds (specifically long-term Treasuries or mortgage-backed securities) on their balance sheets, the drop in yields means their values have risen a lot lately. “The surge in yields is what crushed financials earlier last year, so the drop in yields helps them,” said Collin Martin, director of fixed income strategy at the Schwab Center for Financial Research.

Signs of improvement in the U.S. economy also could provide a tailwind for banks as 2024 continues. A healthy economy often gets reflected in the banking industry. More consumers and businesses borrow to expand or upgrade their homes or factories. That leads to more hiring, which generally spurs more investing, and new companies launch shares on Wall Street to participate in the growth.

All this activity tends to help banks, and credit spreads have narrowed recently to levels that could make borrowing more attractive. That said, many banks continue to be cautious about loans given last spring’s crisis, which saw several banks fail under the weight of high yields.

U.S. Gross Domestic Product (GDP) grew 4.9% in Q3, the government reported last month, driven partly by robust consumer spending, but the Atlanta Fed’s GDPNow indicator predicts Q4 growth to drop to about half that level.

“From a macro perspective, lending standards are still tight, delinquencies are still moving up (though not high relative to history), and consumer credit is still growing at a relatively healthy clip,” said Kevin Gordon, senior investment strategist at Schwab.

While consumer spending remains the primary driver of U.S. economic growth, bank earnings can offer perspective on how other key players are holding up. “We should also be paying attention to what banks are saying when it comes to the health of businesses and capital expenditure trends,” Gordon said.

Another tailwind for banks could be signs of revival in the mergers and acquisitions (M&A) space during Q4. M&A activity helps drive revenue for big Wall Street investment firms. Hopes for a better initial public offerings (IPO) market in 2024 also could boost growth in the year ahead, but banking executives offered mixed views on the IPO outlook last earnings season.

Bond and equity trading appeared to boom in Q4 amid rallies in both the Treasury market and on Wall Street, which may have helped improve trading revenue for big banks.

Financials seen leading S&P Q4 revenue growth

All five industries in the financials sector are expected to report year-over-year revenue growth in Q4, and analysts expect financials revenue growth to lead all sectors at 7% over a year ago, according to research firm FactSet. However, analysts expect a 3.1% decline in the financials sector’s earnings per share (EPS), down from their September 30 consensus estimate of 6.4% growth. The estimate has been pulled down by banks, which analysts now expect to report a 21% Q4 earnings decline from a year ago, according to FactSet. Soft investment banking and mortgage trends might play into this.

Banks begin their quarterly reporting period this Friday, January 12, when JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) are expected to open their books to investors. Morgan Stanley (MS) and Goldman Sachs (GS) follow on January 16, according to Earnings Whispers.

One thing that helped bank earnings, as the Fed hiked rates 11 times starting March 2022, was net interest income—the money banks make lending minus what they pay to customers. Net profit margins for the financials sector were 17.7% in Q3, up from 15.9% a year earlier, according to FactSet. A lot of that reflects net interest income.

One challenge: Lapping last year’s margin strength

Eventually, those strong net-interest, income-driven results are going to get “lapped,” meaning banks could face tougher comparisons to year-ago earnings performance.

Still, falling yields could help banks by reducing pressure to match high yields in the bond market, which over the last few years posed stiff interest competition. In the long run, lower Treasury yields, if they persist, might help banks keep deposits on their books instead of losing them to more lucrative opportunities investors see in the Treasury market. And they’ll likely pay customers less for the privilege of holding and lending out their money.

When the big banks report, keep an eye on each institution’s general level of loan activity and the quality of their existing loans. While yields are down, banks still have a good deal of outstanding loans on their books due for refinancing this year. With rates still much higher now than a few years ago, businesses and households could remain wary about renewing or taking on new debt, and there are signs of credit quality slipping. The commercial office space market—under a cloud amid financials sector wobbles last spring—also isn’t out of the woods as the work-from-home trend persists. Vacant office space could lead to foreclosures or force banks to modify loans.  

“On the credit side, spreads are low as markets anticipate a ‘soft landing’ and financing is still available for publicly traded firms,” said Kathy Jones, chief fixed income strategist at Schwab. “Nonetheless, we are concerned that credit quality is declining.”

Caution flag still waving?

Another item to watch is loan loss provisions, or the funds banks put aside in case loans go bad. These detract from earnings and have been a near-constant drag on bank results since they began adding to these reserves during the pandemic. One question is whether recent drops in rates and hopes for even lower borrowing costs could make banks feel safe keeping levels where they are. Their decisions here could speak volumes about what bank executives expect for the U.S. and global economy over the coming year. 

From a policy standpoint, bank executives gathered on Capitol Hill in late 2023 to voice their disapproval of a government proposal to rewrite capital obligations for big banking institutions. The proposal would force banks to keep more capital on hand, which banks say would hurt their ability to lend. Supporters of the rules say the changes would protect the industry from regulatory gaps that helped lead to last year’s high-profile bank failures, according to reporting by American Banker.

The deadline for comment on the proposal is January 16, so it wouldn’t be a surprise to hear bank leaders give their final thoughts on the matter when they address investors and analysts this week and next.

What to listen for: The first earnings season of any year also is a natural time for banking industry leaders to give their take on where the economy’s been and where it might be going. Investors might want to pay close attention to bank earnings calls and press releases for any interesting nuggets. Topics analysts might ask bank executives to address this time include:

Is a U.S. recession still likely, and, if so, when might it to hit?How is consumer spending holding up and could it start flagging?Can the U.S. jobs market continue its strong growth?How are credit spreads likely to shape up this year amid lower rates?How soon do bank executives expect the Fed to start cutting rates, and how many rate cuts do they expect?Is recent strong U.S. economic growth sustainable?Will lower mortgage rates give the housing market a boost and perhaps lead to rising home supplies?

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Charles Schwab & Co., Inc. (“Schwab”) and TD Ameritrade, Inc., members SIPC are separate but affiliated subsidiaries of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank.