As Bob Dylan sang: A Hard Rain’s a-Gonna Fall. U.S. banks have been dramatically boosting their loan loss provisions, aka “rainy-day funds,” to prepare for a looming recession. This precautionary move has in turn eroded their net income.

The big banks kicked off third-quarter earnings season last Friday and further operating results are pouring in this week. A few banks have surpassed estimates, but overall, the news has been mixed.

For Q3 2022, with 7% of S&P 500 companies reporting actual results, 69% of S&P 500 companies have reported a positive earnings per share (EPS) surprise and 67% have reported a positive revenue surprise.

As of this writing, the “blended” earnings growth rate for the S&P 500 is 1.6%. Blended combines actual results with projections. If 1.6% turns out to be the actual growth rate for the quarter, it will mark the lowest earnings growth rate reported by the index since Q3 2020 (-5.7%).

Earnings have been getting revised downwards; the estimated earnings growth rate on September 30 for Q3 was 2.8%.

Four of the 11 S&P 500 sectors are reporting, or are projected to report, year-over-year earnings growth, led by energy. Seven sectors are reporting, or are projected to report, a year-over-year decline in earnings, led by financials.

The financials sector is the largest contributor to the decrease in earnings for the S&P 500 since September 30. From that date, the sector’s estimated EPS performance went from -12.0% to -16.2%.

At the sub-sector industry level, four of the five industries in financials are reporting, or are predicted to report, a year-over-year earnings decline of more than 10%: insurance (-23%); consumer finance (-21%); capital markets (-20%); and banks (-13%). The only financials sub-sector projected to grow is diversified financial services, at a paltry 1%.

JPM and BAC beat expectations…

As the Federal Reserve aggressively tightens, a clear beneficiary of higher interest rates is the financials sector, starting with the money center behemoths such as JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC). Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC), and down the food chain to the regional banks.

Higher interest rates boost the net interest spread that determines banks’ profit margins. JPMorgan and Bank of America beat Q3 profit estimates. And yet, despite the benefit of climbing rates, banks as a whole are reporting a double-digit decline in earnings. The major culprit: loan loss provisions in Q3 2022 relative to Q3 2021.

Provisions for loan losses have no impact on revenue growth, but do have an impact on bottom-line growth, because they are reported as an expense on a company’s income statement.

Banks drastically boosted their loan loss provisions in the first half of 2020 to account for the economic lockdowns precipitated by the coronavirus pandemic. As COVID faded and economic conditions improved, banks slashed those provisions.

Now, as a recession lurks around the corner, banks are increasing those provisions again this year, but they’re grappling with tough comparisons to considerably lower numbers from 2021.

FactSet tracks this metric for all 18 companies in the banks industry in the S&P 500. In aggregate, the blended provision for loan losses for these 18 banks is $6.0 billion for Q3 2022, compared to -$4.9 billion for Q3 2021 (see chart).

Regardless, the major U.S. stock market indices are rebounding, as analysts start to think that perhaps the bear market has bottomed.

WATCH THIS VIDEO: Preparing For The Post-Bear Bounce

The major U.S. stock market indices closed sharply higher Monday, a powerful rally driven in part by BAC surpassing estimates on the top and bottom lines.

On Tuesday, buoyed by an earnings beat by Goldman Sachs (NYSE: GS), the major indices closed higher again, as follows: the Dow +1.12%; the S&P 500 +1.14%; the NASDAQ +0.90%; and the Russell 2000 +1.16%. Volatility has been lifting the investment bank’s trading activity.

Is the bear coming to an end, or are we witnessing a short-lived bear market rally? Investors endured a brutal September. Forthcoming earnings results, especially from the bellwether financials sector, will help determine whether we’re in for a better October.

Editor’s Note: To discuss a wide range of investment opportunities related to the booming marijuana industry, I’m holding a special Town Hall on November 1. Be on the lookout for an invitation in the coming days.

John Persinos is the editorial director of Investing Daily.

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