As the US banking sector prepares to kick off its second-quarter earnings season, UBS has released a forward-looking research report, offering investors guidance on positioning amid a perceived "peak banking cycle" environment.

The bank first notes that banking operations are flourishing across nearly all segments. Direct loan growth is accelerating, and capital markets are experiencing a recovery. Regarding the deposit environment, based on recent commentary from various banks, competition persists but has not intensified to a degree that would undermine market expectations. Regulatory easing continues to progress, and the US economy remains resilient.

The market has not experienced a "peak banking cycle" atmosphere like the current one in a long time, yet bank stock investors are inherently skeptical. Currently, the 2027 forward price-to-earnings ratio for Global Systemically Important Banks (GSIBs) is approximately 13x, while for regional banks it is around 11x, indicating a relatively high entry barrier for new capital.

The KBW Bank Index outperformed the broader market in the second quarter, and since the start of the first-quarter earnings season, GSIBs, regional banks, and consumer finance stocks have, on average, outperformed the S&P 500.

UBS anticipates that the primary sources of upside surprises for bank stocks in the second quarter will remain capital markets and trading activities. The main downside risks are seen as unexpected rises in deposit costs and increased expenses driven by higher transaction-related fees, fueled by strong equity market performance, particularly in Asia.

Five Key Themes to Monitor

UBS highlights five major themes to focus on for the second quarter:

1) Capital Markets Business – Can actual performance and future outlook meet elevated market expectations? The momentum in capital markets appears strong, though perhaps not as robust as Dealogic data suggests. Dealogic figures show median revenue growth among the five major banks (Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, and Morgan Stanley) of 16% for M&A advisory, 17% for debt underwriting, 88% for equity underwriting, and 43% for overall investment banking. However, UBS cautions against fully extrapolating from this data due to historical discrepancies between Dealogic's fee models and banks' final reported revenues. Considering management commentary, UBS expects GSIB investment banking revenue to show significant year-over-year growth, but more in line with company-provided guidance.

Overall, UBS remains positive on capital markets but advocates for discipline. The bank forecasts roughly 23% year-over-year growth in total GSIB investment banking revenue. M&A advisory is expected to show solid growth, while equity underwriting is poised to be the standout, benefiting from IPO market reopenings, asset monetization windows, and SPCX-related fees. Debt underwriting benefits from a low comparison base and still-healthy issuance demand.

Concurrently, trading business prospects are also constructive, supported by market volatility, volumes, and client activity. Goldman Sachs's trading outlook aligns more closely with Bank of America's than with Citigroup's. Morgan Stanley indicated that peers' growth guidance of 9%-18% is reasonable. Wells Fargo's trading revenue is more reliant on net interest income, with trading fee income expected to be roughly flat sequentially.

In summary, Q2 2026 is anticipated to be another strong quarter for capital markets, especially for banks with higher exposure to equity underwriting and equity trading. UBS projects GSIB trading revenue to grow approximately 16% year-over-year in Q2.

2) Direct Loan Growth – Can the momentum in loan growth be sustained throughout the year? UBS notes that commercial borrowers remain strong and resilient despite macroeconomic uncertainties. By the end of Q2, commercial & industrial loan balances grew about 2.5% sequentially, and non-depository financial institution loans grew about 3%. This strength is not surprising given prior guidance and the expectation that corporate activity should remain robust amid an improving investment banking outlook.

UBS believes the resilience of commercial lenders is sustainable, at least in the near term, as companies have demonstrated an ability to navigate complex operating environments. Consumer loan growth is also solid, with total consumer loan balances up about 2% sequentially by quarter-end, and credit card loan balances showing the most significant growth at approximately 3%.

UBS argues that attributing this trend solely to price increases is incorrect. Consumer finance management teams consistently highlight healthy discretionary spending, particularly on travel, and note that rising gasoline prices have not squeezed other spending categories. Therefore, credit card loan growth is seen as reflecting genuine consumption growth rather than just inflation.

3) The Deposit Growth Challenge – With loan growth currently running about twice the pace of deposit growth, how should deposit beta be assumed in the context of a potential 25-basis-point rate hike? Given positive loan growth prospects, UBS expects deposit competition to re-intensify, with pricing reflecting this shift. The bank has removed its prior rate cut forecast and now incorporates a 25-basis-point hike by the Fed in December this year.

UBS sees the period from Q2 1997 to Q3 1998 as a potential reference point, when the Fed paused and then implemented a 25-basis-point hike during that pause. During that hike, the industry's deposit cost beta was around 50%, later stabilizing; the final deposit cost as a percentage of the Fed funds rate settled near the cycle average of about 81%.

Based on its updated rate forecast, UBS assumes an average deposit beta of about 50% for its covered banks from the quarter before the hike (forecast for Q3 2026) through the end of 2027, translating to an average deposit cost increase of roughly 12 basis points for the sector.

4) Consumer Resilience – With consumer spending and credit trends consistently outperforming prior concerns, will this continue to drive a re-rating for credit card stocks? On the surface, robust consumer spending amid a noisy macro backdrop seems somewhat surprising. Heading into Q2 earnings, consumer fundamentals remain resilient, and importantly, this strength is evident not just in macro data but also in company management commentary.

For instance, according to Bank of America's monthly "Consumer Checkpoint" database, household credit and debit card spending grew 4.8% year-over-year in April and 5.1% in May, notably higher than trends in Q1 and Q2 2025. Spending remains solid, credit performance stable, and higher gasoline prices have yet to show a significant impact.

Furthermore, Capital One described the consumer as the "broad shoulders" of the US economy, citing healthy employment, no evidence of gasoline spending crowding out other categories (with consumers reallocating budgets), strong travel spending, and no broad-based weakness elsewhere.

American Express also expressed optimism, noting in mid-June that billed business to date was slightly above Q1 levels, with April air travel spend up 9% year-over-year. Synchrony Financial struck a slightly more cautious tone, with management stating that delinquency rates wouldn't rise directly unless gasoline price increases were both large and sustained, a scenario not yet observed.

5) Regulatory Easing – PNC Financial recently noted that under the Basel III framework, the eRBA method offers advantages over the RSA method (could this apply to other banks?). Additionally, liquidity regulatory reforms are forthcoming.

UBS notes that this year's Stress Capital Buffer test results had limited overall impact as the Fed decided to maintain the SCB framework unchanged until 2027. However, the bank believes the wide variation in test results strengthens the case for future reforms, especially with the 2027 stress test using new models incorporating public feedback.

On another front, further clarity on the Basel III Endgame rules could provide additional benefits. As noted after meeting with PNC management, the eRBA method offers a favorable 65% risk weight for some investment-grade assets, potentially benefiting final risk-weighted asset calculations. PNC indicated limited difference between RSA and eRBA in early analysis. UBS believes this implies potential upside in final RWA calculations for regional banks with higher proportions of investment-grade loans and expects more questions on this topic during earnings calls.

Furthermore, USB sees potential benefits from liquidity reforms as still underappreciated by the market. PNC recently indicated the Fed appears more focused on shortening balance sheet duration than continuing quantitative tightening. If future regulations allow banks to include some pre-arranged discount window funding capacity in the Liquidity Coverage Ratio, banks could reduce tied-up cash and securities while maintaining system liquidity. If these funds could be redeployed into loans or securities investments, it would create a clear net interest income tailwind. This mechanism could potentially release significant tied-up liquidity across the banking system and provide an NII growth catalyst.

Overall, UBS views the regulatory and capital return environment as constructive and expects share repurchases to remain strong through 2027, especially if JPMorgan Chase's recently announced $50 billion buyback plan sets a tone for the industry. The bank forecasts its covered banks to repurchase shares equivalent to about 5% of market value on average in 2027.

Positioning Within Global Systemically Important Banks

Stock selection this quarter is challenging. UBS believes JPMorgan Chase appears positioned for a potential upside surprise, having already pre-released "bad news" on the expense side while not fully disclosing "good news" on the revenue side. However, the earnings call conversation is likely to be dominated by management succession topics.

UBS's profit forecast for Bank of America is 2 cents above consensus but views the stock as a crowded trade currently. For Goldman Sachs and Morgan Stanley, the bank hopes the market is prepared for higher compensation and non-compensation expenses and is also ready for Morgan Stanley's wealth management pre-tax margin to seasonally dip below 30%.

UBS sees Citigroup and Wells Fargo as cleaner, more likely outperformers. Citi benefits from net interest income tailwinds outside of trading and improving capital markets. Wells Fargo benefits from lower buy-side expectations and relatively light market positioning.

UBS ratings and price targets for GSIBs are as follows: Maintain JPMorgan Chase at Buy, raising the target price from $375 to $384; Maintain Wells Fargo at Buy, lowering the target from $105 to $104; Raise Citigroup target from $134 to $150; Maintain Bank of America at Buy, raising target from $63 to $68; Maintain Goldman Sachs at Neutral, raising target from $940 to $1,120; Maintain Morgan Stanley at Buy, raising target from $214 to $255.

Valuation Upside for Regional Banks

Compared to GSIBs, regional bank valuations remain relatively attractive, though recent stock performance has been quite strong. UBS highlights PNC Financial Services Group as a favored pick for the Q2 earnings season, seeing potential for full-year guidance upgrades, especially considering that Wall Street estimates largely do not yet reflect the potential impact of securities portfolio reallocation following the Visa share sale.

The bank reiterates its Buy rating on PNC, raising the price target to $288. Meanwhile, UBS continues to view Huntington Bancshares as too cheap but notes that market expectations for Q2 net interest margin are too high while expense forecasts are too low. The bank reiterates its Buy rating on Huntington, raising the target from $21 to $22.

Outlook for the Consumer Finance Sector

As gasoline prices at the pump decline, market sentiment and valuations for consumer finance companies should continue to improve broadly. Capital One has regained its status as a consensus favorite, and UBS believes Wall Street is readjusting expense expectations to higher levels, raising its target for the stock from $270 to $275.

However, the bank is uncertain if Q2 will be the quarter for a full "release" of pre-provision net revenue. While Q2 expenses will be impacted by higher marketing spend and investments related to Brex and Hopper, UBS expects excess liquidity to remain high (pressuring net interest margin) and macro-related reserves to stay elevated.