• US banks kick off Q4 earnings on Friday before opening bell

• Focus falls on the impact of declining yields and rate cut bets

• Valuation multiples rise but remain historically cheap

Tough quarter

The banking sector started 2023 with the best possible omens as it was expected to continue capitalising on higher net interest margins. This metric is essentially the difference between the interest income generated by long-term assets such as loans and the interest expense paid to short-term liabilities such as deposits. However, in the final quarter of the year, the aggressive decline in long-term yields, relative to the moves we have seen in money market rates, has negatively impacted net interest income.

For that reason, financial institutions are generally expected to experience a profit squeeze in the last quarter of what has been a solid year, but as always, some bright spots exist. The slide in yields coincided with an improved risk environment, which has probably bolstered banks’ wealth management and investment banking divisions' performance. Besides that, it clipped the unrealised losses in banks’ bond portfolios, significantly improving their capital base.

Focus on 2024

Undoubtedly, Q4 earnings calls include the outlook for next year, with investors paying special attention to what banks have to say about economic conditions moving forward. This time, the levels of loan provisions and capital set aside to cover for a potential wave of non-performing loans would indicate whether financial giants agree with markets' soft-landing narrative.

Meanwhile, banks might also share insights on the trade-off associated with falling interest rates. On the one hand, the declining interest rate trajectory would reduce mark-to-market losses on their fixed income portfolios and potentially boost investment banking and M&A activities, which have suffered in a high interest rate environment. Nevertheless, financial institutions with more exposure to the traditional loan business could come under pressure amid narrowing interest margins.

JP Morgan asserts dominance

JP Morgan was the best performer among the US investment banks in 2023 as its reputable status attracted significant inflows from regional banks at risk during the turbulence in March. Meanwhile, the synergies achieved by the acquisition of the First Republic bank seem to have helped the financial giant navigate in this year’s challenging environment, making it the only amongst the examined banks expected to have grown its net interest income for Q4 on an annual basis.

The leading financial institution is anticipated to record revenue of $39.77 billion, according to consensus estimates by Refinitiv IBES, which would represent a year-on-year increase of 11.84%. Despite that, earnings per share (EPS) are estimated to have taken a hit, dropping 5.52% from a year ago to $3.36.

From a technical perspective, JP Morgan’s stock posted a fresh all-time high in 2024 just a few days ahead of its earnings report. Can an impending upside surprise trigger more gains or are we headed to a reversal towards the $159.40 zone?

Wells Fargo benefits from cost-cutting

For Wells Fargo, the fundamental picture looks great but not for the perfect reasons. The bank is set to experience an expansion in both its revenue and EPS figures but the increase in the latter is mainly attributed to the reduction of operating expenses.

The bank is on track for a 3.13% annual jump in its revenue, which could reach $20.27 billion. Meanwhile, EPS is forecast to climb from $0.61 in the same quarter last year to $1.17, marking a stunning 92.59% increase.

Devastating quarter for Bank of America

Bank of America will face another tough earnings season, exhibiting major underperformance against the other two examined banks. The main reason behind this weakness is the 4.88% decline expected in its net interest income.

The financial giant is set to post an annual revenue drop of 3.51% to $23.78 billion. At the same time, its EPS is projected at $0.64, a 24.90% decrease relative to the same quarter last year.

Discount in valuations persists

Despite underperforming major benchmarks in 2023, US banks’ valuations appear rather compressed when compared both to the broader market and their historical averages. This is particularly strange as banks have historically outperformed in periods of high interest rates. Therefore, it seems that investors are pricing in difficult times ahead, while others could argue that this is an attractive entry point for long-term investors.

Surely though, the risks are asymmetric at current levels as there is not much room to the downside even if we get a major negative surprise in upcoming earnings reports.