The Q2 earnings season is about to begin! UBS's major outlook on U.S. bank stocks: Behind the flourishing business, these five key themes will become the decisive factors for investment

According to the Zhitong Finance APP, as the U.S. bank stocks are about to kick off the second quarter earnings season, UBS recently released a research report providing a forward-looking analysis and layout suggestions for investors in the atmosphere of "banking industry prosperity peaking."

UBS first pointed out that the banking business is flourishing almost universally. Direct loan growth is accelerating. The capital markets are experiencing a recovery. Regarding the deposit environment, according to the latest statements from various banks, competition still exists but is not intense enough to drag down market expectations. Regulatory easing continues to advance. The U.S. economy remains resilient. The market has not felt this kind of "banking industry prosperity peaking" atmosphere for a long time, but the investor group in bank stocks inherently maintains a skeptical attitude.

Currently, the expected price-to-earnings ratio for Global Systemically Important Banks (GSIB) in 2027 is about 13 times, while the expected price-to-earnings ratio for regional banks in 2027 is about 11 times, thus the threshold for new funds to enter has become relatively high. The KBW Bank Index (BKX) outperformed the market in the second quarter, and since the beginning of the first quarter earnings season, GSIBs, regional banks, and the consumer finance sector have all averaged performances that outperformed the S&P 500 index.

UBS expects that the main sources of better-than-expected performance for bank stocks in the second quarter will still come from capital markets and trading businesses, while the risks of underperformance mainly stem from unexpected increases in deposit costs and rising costs driven by increased trading-related expenses due to strong performance in the stock market (especially Asian stock markets).

Five Key Themes to Watch

UBS pointed out that the key themes to focus on in the second quarter include:

1) Capital Markets Business - Will actual performance and future outlook meet the market's high expectations?

The momentum in capital markets is hard to resist, although it may not be as optimistic as the data from Dealogic suggests. Dealogic data shows that among the five major banks in the U.S. - Bank of America, Citigroup, Goldman Sachs, JP Morgan, and Morgan Stanley - the median growth in M&A advisory revenue is 16%, median growth in bond underwriting revenue is 17%, median growth in equity underwriting revenue is 88%, and median growth in investment banking revenue is 43%.

However, UBS stated that it will not fully extrapolate based on Dealogic's data, as there has historically been a discrepancy between Dealogic's fee model and the final disclosed revenues of banks. Combining management comments, the bank expects GSIB investment banking revenue to grow significantly year-on-year, but closer to the guidance provided by company management.

Overall, UBS remains optimistic about the capital markets business but maintains a certain level of discipline. The bank expects GSIB overall investment banking revenue to grow approximately 23% year-on-year; M&A advisory business will maintain steady growth; equity underwriting business will be the biggest highlight, benefiting from the reopening of the IPO market, the resumption of asset monetization windows, and SPCX-related fees; bond underwriting business will benefit from a lower comparative base and still healthy bond issuance demand.

At the same time, the market business also has a constructive outlook, with market volatility, trading volume, and client trading activities still providing support. Goldman Sachs' outlook for trading business is closer to Bank of America rather than Citigroup. Morgan Stanley stated that a growth range of 9%-18% among peers is reasonable. Wells Fargo's market business revenue is more reliant on net interest income, with trading fee income expected to remain basically flat quarter-on-quarter Overall, the second quarter of 2026 is expected to be another strong quarter for capital market business performance, especially for banks with a high proportion of stock underwriting and trading business. The bank expects that GSIB's market business revenue will grow by approximately 16% year-on-year in the second quarter.

2) Direct loan growth - Can the momentum of loan growth be sustained throughout the year?

UBS pointed out that commercial borrowers remain strong and resilient, even though there are still uncertainties in the macro environment. As of the end of the second quarter, the balance of commercial and industrial loans (C&I) increased by approximately 2.5% quarter-on-quarter, and loans to non-deposit financial institutions (NDFI) grew by about 3%.

This strong performance is not surprising—there has been continuous guidance previously, and the bank believes that in an environment where the outlook for investment banking is improving, overall corporate operating activities should remain active. The bank believes that the resilience of commercial borrowers is likely to persist at least in the short term, as companies have so far demonstrated the ability to cope with a complex operating environment.

Consumer loan growth is also robust. As of the end of the second quarter, the balance of consumer loans increased by approximately 2% quarter-on-quarter, with credit card loans showing the most significant growth—an increase of about 3% quarter-on-quarter.

UBS believes it is incorrect to attribute this trend entirely to rising prices. Management at consumer finance companies continues to emphasize that discretionary spending remains healthy, especially in travel; rising oil prices have not squeezed other categories of consumption. Therefore, UBS believes that the growth in credit card loans reflects real consumption growth rather than inflation-driven growth. The resulting loan growth is expected to maintain healthy credit quality.

3) Challenges in deposit growth - Currently, the growth rate of loans is about twice that of deposits. How should the deposit beta rate be assumed in the context of a potential 25 basis point rate hike?

Given the positive outlook for loan growth, UBS expects deposit competition to heat up again, and deposit pricing will reflect this change.

UBS has removed its previous interest rate cut forecast and incorporated a 25 basis point rate hike by the Federal Reserve in December this year. The bank believes that the period from the second quarter of 1997 to the third quarter of 1998 is of certain reference significance—during which the Federal Reserve paused interest rate cuts and then raised rates by 25 basis points during the pause. During that rate hike, the industry's deposit cost beta was about 50%, then stabilized; ultimately, the deposit cost as a proportion of the federal funds rate stabilized at an average cycle value of about 81%.

Based on the updated interest rate forecast, UBS assumes: from the quarter before the rate hike (forecast for the third quarter of 2026) to the end of 2027, the average deposit beta for covered banks will be about 50%, corresponding to an average deposit cost increase of about 12 basis points across the entire sector.

4) Consumer resilience - With consumer spending and credit trends continuing to outperform previous market concerns, will this continue to drive a revaluation of credit card sector valuations?

On the surface, it seems somewhat surprising that consumer spending remains strong against a backdrop of macro noise. As we enter the second quarter earnings season, the consumer fundamentals remain resilient, and more importantly, this strong performance is reflected not only in macro consumption data but also in the statements from company management For example, according to the "Consumer Checkpoint" database published monthly by Bank of America, household credit card and debit card spending increased by 4.8% year-on-year in April and 5.1% year-on-year in May, significantly higher than the trends in the first quarter and the second quarter of 2025. Consumer spending remains robust, credit performance is stable, and high oil prices have not yet caused significant impacts.

In addition, First Capital Credit described consumers as the "strong shoulders" of the U.S. economy. The company stated that employment remains healthy; there is no evidence that gasoline spending is squeezing other categories of consumption; consumers are simply reallocating part of their budget to gasoline consumption; travel spending remains strong; and there is no widespread weakness in other areas of consumption.

American Express also expressed a more optimistic view. The company stated in mid-June that the current card spending amount is slightly higher than the first quarter level, and airline spending in April increased by 9% year-on-year.

Synchrony Financial (SYF.US) takes a slightly more cautious stance. The company's management believes that unless oil prices rise significantly and persistently, they will not directly push up delinquency rates; so far, this situation has not occurred.

5) Regulatory Easing - PNC Financial Group recently stated that under the Basel III framework, the eRBA method has advantages over the RSA method (is this applicable to other banks?), and liquidity regulatory reform plans are also about to be introduced.

UBS pointed out that the overall impact of this year's Stress Capital Buffer (SCB) test results is limited, as the Federal Reserve has decided to maintain the SCB mechanism unchanged until 2027. However, the bank believes that the significant differences in this test result further strengthen the rationale for continued reform in the future, especially since the 2027 stress test will adopt a new model that incorporates public feedback.

On the other hand, if the final Basel III Endgame is further clarified, it may bring more benefits.

As the bank noted after visiting the management of PNC Financial Group, under the eRBA method, some investment-grade (IG) assets can enjoy a 65% risk weight discount, which may be beneficial for the final calculation of risk-weighted assets (RWA).

PNC previously stated that early analysis shows limited differences between RSA and eRBA. The bank believes that for regional banks with a high proportion of investment-grade loans, this means there is still upward potential in the final RWA calculation. The bank expects management to face more questions about the risk weights of investment-grade loans during the conference call.

In addition, UBS believes that the potential benefits brought by liquidity reforms still exceed market expectations. PNC Financial Group recently indicated to the bank that the Federal Reserve currently seems more focused on shortening the duration of the balance sheet rather than just continuing to reduce the size of the balance sheet (i.e., quantitative tightening, QT).

If regulators allow banks to count part of the pre-arranged discount window financing capacity towards the liquidity coverage ratio (LCR) in the future, banks can reduce the cash and securities assets being occupied while maintaining system liquidity If in the future it can be reallocated to loans or securities investments, it will create a significant net interest income (NII) tailwind. If the policy is ultimately implemented, this mechanism is expected to release a large amount of occupied liquidity across the banking industry and bring growth momentum for NII to the entire sector.

Overall, UBS believes that the regulatory environment and capital return environment remain constructive, and it expects the scale of share buybacks to remain strong until 2027, especially if JP Morgan's recently announced $50 billion stock buyback plan can serve as a bellwether for the entire industry. The bank expects the average stock buyback scale of the banks it covers to be about 5% of market capitalization by 2027.

How to Position GSIB?

Stock selection this quarter is quite challenging. UBS believes that JP Morgan (JPM.US) seems likely to exceed market expectations—previously, the bank had already released the "bad news" on the expense side in advance, but has not fully disclosed the "good news" on the revenue side. However, the topic of the earnings call is likely to be dominated by management succession issues.

UBS's earnings forecast for Bank of America (BAC.US) is 2 cents higher than the market consensus, but it believes that the stock has now become a crowded trade. For Goldman Sachs (GS.US) and Morgan Stanley (MS.US), the bank hopes the market is prepared for higher compensation and non-compensation expenses, while also accepting that Morgan Stanley's wealth management business's pre-tax profit margin may seasonally drop below 30%.

UBS believes that the cleaner and more likely outperforming targets are Citigroup (C.US) and Wells Fargo (WFC.US). Citigroup will benefit from a tailwind in net interest income (NII) outside of market operations, as well as improvements in capital markets business. Wells Fargo will benefit from lower buyer expectations and relatively light market positions.

UBS's ratings and target prices for GSIB are as follows:

Maintain JP Morgan "Buy" rating, target price raised from $375 to $384;

Maintain Wells Fargo "Buy" rating, target price lowered from $105 to $104;

Raise Citigroup target price from $134 to $150;

Maintain Bank of America "Buy" rating, target price raised from $63 to $68;

Maintain Goldman Sachs Neutral rating, target price raised from $940 to $1,120;

Maintain Morgan Stanley "Buy" rating, target price raised from $214 to $255.

Can Regional Banks Continue to Achieve Valuation Upside?

Compared to GSIB, regional banks still have some valuation attractiveness, although recent stock performance has actually been quite good. UBS emphasizes that it is optimistic about PNC Financial Services Group (PNC.US) during the second quarter earnings season and believes there is potential for upward guidance for the full year, especially considering that Wall Street's current earnings forecasts have not yet reflected the impact of potential securities asset reallocation after the sale of Visa shares. The bank reiterates its "Buy" rating on PNC Financial Services Group, with a target price raised to $288.

Meanwhile, UBS still believes that Huntington Bank (HBAN.US) is currently undervalued, but also points out that the market's forecast for the bank's second quarter net interest margin (NIM) is too high, while the expense forecast is too low The bank reiterated its "Buy" rating on Huntington Bank, raising the target price from $21 to $22.

What is the outlook for the consumer finance sector?

As gasoline prices at gas stations decline, market sentiment and valuations for consumer finance companies are expected to continue to improve overall. First Capital Credit (COF.US) has once again become a popular target favored by the market consensus, and UBS believes that Wall Street's expectations for expenses are being readjusted to higher levels. The bank raised its target price for First Capital Credit from $270 to $275.

However, the bank is uncertain whether the second quarter will be the point at which pre-provision net revenue (PPNR) is fully "released." Although expenses in the second quarter will be impacted by higher marketing expenditures, as well as investments related to Brex (which First Capital Credit announced it would acquire for $5.15 billion in January, accounting for $125 million each quarter) and Hopper (approximately $57 million), the bank expects that excess liquidity will remain high (thereby suppressing net interest margins), and reserves related to the macro economy will still be maintained at a high level