Key Takeaways for Investors From Big Bank Q3 Earnings

Our Thesis: The market is implying US banks are positioned for a supercycle of solid profits. We think there is a scenario wherein money-center banks do very well in the near term, along with others in which their fundamental performance deteriorates.

• A bullish case for big bank stocks can potentially be made and supported by another round of easy-money policies, continued excitement for artificial intelligence that powers investment and productivity growth, strong capital market valuations and activity, low unemployment, a supportive macro environment for higher loan growth, and relaxed regulatory requirements.
• While the market is fully convinced about the bright near-term outlook (as reflected in valuations), we would warn about the possibility of a negative surprise. Major risks around macro, sharp rate cuts, trading normalization, asset prices correction, fiscal deficits, higher credit costs, geopolitical uncertainty, normalization of AI expectations, and trade and tariff policy have not really materialized in recent quarters, and it seems the market is largely discounting them.
• Overall, we think banks can continue to enjoy elevated profitability in the near term, but we believe recent relatively high profitability is unlikely to be sustained in the long run on a midcycle basis. When exactly the cycle will turn is difficult to predict, but we think investors should wait for a higher margin of safety, given the significantly uncertain macro outlook.

Putting the Current Profitability in Context: JPMorgan Chase JPM is earning returns on equity of around mid-30% in its retail banking business. On a consolidated level, JPMorgan’s return on tangible equity has averaged around 20% since 2021. That’s very strong profitability in a competitive banking business. The previous period in which returns went above 20% was before the global financial crisis. We would like to point out that the common equity tier 1 ratio for JPMorgan in those years was around 7%, and it’s currently around 15%. Adjusted for the different capital levels, the current profitability is almost double that of the pre-crisis years.

Changes to Guidance: There weren’t many material changes. Wells Fargo’s WFC change to its long-term guidance was the biggest highlight.

• Management announced a revised medium-term return on tangible equity target of 17%-18% from the current target of 15%, as the bank’s growth is no longer restrained. The target revision was higher than our and the market’s expectations, leading to a 7% rally in the stock price.
• Bank of America BAC also hinted at increasing its long-term guidance. They have an investor day coming up soon and can potentially announce something.

What could drive bank stocks further from the current level? The M&A and investment banking boom story sounds more plausible now, and it could be argued that it is already playing out. We don’t think trading revenues can rise much further, but they can potentially be maintained at these elevated levels.

The biggest thing that can drive stocks even further is loan growth. Balance sheets have a lot of room to grow loan balances because of low loan/deposit ratios, a lot of liquidity, and tons of excess capital. A substantial pickup in loan growth (both on the commercial and consumer side) can be a big boost to NII and EPS.

Management Outlooks on the Economy: In recent commentary, economists have highlighted some concerns around softening in the labor market and some weakness with lower-income households. Meanwhile, commentary from large banks pointed to the US economy generally remaining resilient. Asset quality indicators like charge offs and provisioning paint a similar picture for macroeconomic stability.

Key Monitorable for Each of the Money-Center Banks

• JPMorgan: They need to gain share to justify these valuations. Will they be able to maintain these returns when short-end of the curve heads lower?
• Bank of America: Dynamics around repricing of long-duration loans and securities, and how does that impact net interest income? Expense growth lower than NII/Revenue growth leading to efficiency improvement.
• Wells Fargo: At what pace are they able to grow their balance sheet (grow businesses like trading) after lifting the asset cap? (Saw some strong early indications in the current quarter). The benefits of asset cap removal can probably be higher than we had initially thought. To us, it seems like we are potentially in the early phases of Wells Fargo’s revival to its prior glory. (Also, in terms of business mix, Wells is slowly but surely becoming more like BAC and JPM)
• Citigroup: Continued progress in their turnaround efforts. How do they perform when the external environment becomes unfavorable? Can they sustain 10%-12% ROTE on a midcycle basis? If yes, they are worth more than where they currently trade.

Deposit and Loan Growth: Bank deposits stopped declining in late 2023 and have been growing steadily since that time. Deposit growth is largely a function of monetary policy and money supply. We expect deposits to continue to grow in the upcoming year. If the Fed eases its monetary policy faster, it can lead to higher growth in 2026. Deposit growth won’t be the binding factor for loan growth (in near term) given the amount of liquidity in the system.

• There is some possibility that we get another round of easy-money policies. If this happens, on the whole, it’d be positive for the banks.
• Loan growth continues to pick up. Some areas are stronger than others, but we are seeing indications of broad-based growth. There is a lot of scope for higher loan growth in the upcoming years. This will remain the key driver.
• Loan growth should pick up if rates head lower and the outlook remains stable.

Net Interest Income: This will depend a bit on the rate outlook, and it keeps changing rapidly. Lower rates on the short end of the curve or a parallel shift in rates lower will lead to net interest margin compression. On a positive side, NIM compression should be offset by balance sheet growth for money-center banks. This is part of the reason the market is not worried about rate cuts that much. We have been seeing this dynamic play out in the last three or four quarters.

• Balance sheet positioning really matters. We argued in 2024 that Bank of America is going to hugely outperform JPMorgan in a rate-cutting cycle. It did not play out then, but we see this strongly in recent quarters. Bank of America will continue to outperform JPMorgan for a few more quarters if they execute well.

Credit costs/provisions/allowances: There were some one-offs (Tricolor and First Brands), but the consolidated credit costs improved on average. Management commentary was also fairly solid.

• We think that the current charge offs and provisioning are materially lower than what investors should expect on a midcycle perspective. Banking is a cyclical business, and credit costs have an even higher level of cyclicality. We have penciled in a higher charge off rate for large on a through-the-cycle basis.

Fee income: The banks’ fee-based businesses are doing really well. Card-related fees and service charges are resilient fee streams and are performing as expected. Asset and wealth management fees and brokerage fees continue to benefit as markets rise. Investment banking was also strong across segments. Trading revenue can be highly volatile, but these businesses are making a lot of money currently. The trading business can benefit amid increased volatility in the markets as bid-ask spreads widen, and increased volatility also leads to higher transaction volume. We think trading revenues are near cyclical peaks and are about 20%-30% higher than midcycle levels. This revenue has pretty high operating leverage.

Valuation: We do not like money-center banks’ valuations. JPMorgan is expensive but very high quality. Citi C can be thought of as high risk, high return name.