Morgan Stanley analysts Betsy L. Graseck, Michael J. Cyprys, Manan Gosalia and Jeremiah Driansky peek into the crystal ball and come up with their industry view for large cap banks for the third quarter.

Large Cap Banks

Their view is that large cap banks are attractive, and that Q3, which is seasonally weak, presents a buying opportunity. Long-term industry fundamentals and the earnings outlook for 2015 are supported by improving credit in a modest growth environment.

Factors positive for the industry

Credit is improving on a surprising basis due to Fed stimulus, which is boosting housing values, and consumer sentiment and employment. The trend is expected to continue through Q3.

Non-Performing Loans and Net Charge Offs are expected to decline by 4 percent and 3 percent respectively.

Reserve releases could fall to 2 percent from 6 percent in Q2, primarily due to the increasing housing valuations, and the resulting lower “purchased credit impairments,” mostly for JPMorgan Chase & Co (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC).

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Banks are expected to benefit from higher long-end rates with improving Net Interest Margins. The analysts estimate that given the current rate trends, EPS would improve by 1 percent in the coming year and more in later periods.

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Industry headwinds

Rising rates are likely to significantly pressure mortgage refinancing, and the analysts have assumed a 42 percent decline in aggregate mortgage origination volume. The analysts also figure that gain-on-sale margins could decline almost 52bp q-on-q.

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The analysts also expect that capital markets would remain seasonally weak and that underwriting volumes could be lower compared to last year’s Q3, which was particularly strong given the massive easing and risk-on environment then prevailing.

Fixed Income, Currencies and Commodities (FICC) trading is expected to drag during Q3 because of lower volumes, higher volatility and taper uncertainty.

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Large cap banks bull, bear or base case

Bank-wise targets in a bear, bull or base case scenario are shown here:

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The following are Morgan Stanley (NYSE:MS)’s price targets for the large cap banks:

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