Analysts expect large banks' third-quarter earnings to decline from the previous quarter, but analysts remain hopeful some green shoots have started taking root.

Bankers have reported signs of loan growth emerging, long-term interest rates have moved higher and banks have accumulated excess deposits that are ready to be deployed into revenue-generating opportunities. Still, analysts do not anticipate the signs of strength to show up on income statements just yet. Consensus analyst estimates project sequential EPS declines at 12 of the 15 largest publicly traded U.S. banks by assets, according to data from S&P Global Market Intelligence, although credit loss reserve releases could help fuel another round of beats. Several of the industry's largest banks, including the "big four" of JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co., will report third-quarter earnings this week.

"It's all about revenue growth," said BofA Global Research analyst Ebrahim Poonawala. "The focus will be around: Are we finally seeing some momentum to loan growth as we head into the end of the year?"

Analysts at Keefe Bruyette & Woods said the key themes for the sector are loan growth, rates and liquidity. The opportunity for redeployment of high levels of cash into assets with higher yields represents "a coiled EPS spring," they said in a note Oct. 4.

But analysts do not expect those factors to play a material role in third-quarter earnings reports, making the "forward look" — incremental trends and guidance — most important. "A great deal of the bull case for banks continues to rest on the view that there is significant [net interest income] leverage to higher rates, excess liquidity deployment, and accelerating loan growth as we emerge from the pandemic," analysts at Baird Equity Research said in a note Oct. 4.

Long-term interest rates did start to rise toward the end of the third quarter as the Federal Reserve appears to be moving closer to pulling back on monetary stimulus. But rates were generally lower in the third quarter than in the second quarter, likely putting downward pressure on net interest income during the upcoming earnings season.

Consensus estimates anticipate further sequential deterioration or no improvement in net interest margins at nine of the 15 banks, according to Market Intelligence data.

Paycheck Protection Program loan forgiveness could offset some of the rate pressure as banks can recognize fee revenue as they process forgiveness applications. Also potentially boosting net interest income, balance sheets have continued to swell with strong deposit growth, which lowers funding costs, said Michael Rose, an analyst at Raymond James.

"I think you'll see probably more [net interest income] beats than not," Rose said. "Maybe not the magnitude that we saw last quarter, but definitely more beats than not just because of those factors."

Higher rates and continued increases in deposits could prompt banks to accelerate bond purchases, picking up yield as banks deploy cash into yield-producing assets. While banks have been growing their securities holdings, the increases have been outstripped by deposit growth: Commercial banks, in aggregate, increased their securities holdings by 3.5% from June 30 through Sept. 29, according to weekly Fed data — a slower pace of increase than in recent quarters — compared with a 13.1% increase in cash assets.

But banks' revenue prospects hinge on the lending picture. "We're hopeful that the loan growth will pick up into the fourth quarter and really into next year," Rose said. The optimism reflects the possibility that loan closings that may have been delayed by disruptions caused by the delta variant were only pushed off by a couple months, and robust extensions of new and bigger credit lines that support the medium-term outlook.

On credit quality, analysts remain positive and expect reserve releases will continue to boost earnings in the third quarter. However, they expect the benefit to continue waning as stockpiles built during the initial quarters of the pandemic run down.

Negative credit provisions, which banks book to aggressively draw down credit loss reserves, have already eased modestly, falling from $13.39 billion for the industry in the first quarter to a still-remarkable $11.23 billion in the second quarter. Many bankers and analysts have suggested credit loss reserves in a normalized environment would settle at roughly the levels seen at the beginning of 2020. After the releases in the first half of the year, reserves in excess of January 2020 are now about one-third of the excess coming into 2021, for the median publicly traded bank with more than $150 billion of assets.

The Baird analysts wrote that they will be looking for "more commentary on normalization" of credit losses from the low levels posted in recent periods. Still, "we believe reserve release is likely in [the second half of the year] and possibly early 2022," they said.

Concerns over the delta variant and reductions in GDP forecasts that feed into credit provisioning models might also slow the pace of releases and help spread them over a longer period of time, Rose said.

"A lot of banks talk about getting back to Day 1 CECL," or reserve levels when they first adopted current expected credit loss accounting, Rose said. "Most banks, especially in the [small and mid-cap] space, are I think holding out more for growth and growing into it. And so that's probably going to be a process that takes another year or two. So I think you're going to continue to see very low levels of provisioning for the next couple of years."

And some banks could actually grow credit loss reserves given concerns over the delta variant since the pandemic play heavily into the Moody's economic forecast many banks use in their CECL modeling, said Anton Schutz, founder of Mendon Capital, an investment firm focused on banks.

Consensus estimates expect higher sequential credit expenses at 11 of the 15 big banks, even with negative provision expenses penciled in for six of them, according to Market Intelligence data. Consensus estimates also expect net charge-off rates to rise sequentially at 13 of the 15 banks, though the increases would still leave loss rates at low levels by historical standards.

After recent gains in bank stocks, some analysts believe the group is positioned to weaken as results come out. "Investor sentiment is as constructive as it's been since March given the back-up in bond yields, and we wouldn't be surprised to see the stocks sell off during earnings season," the Baird analysts said.

But with coronavirus infections waning and interest rates rising, others believe the sector has room to run. In a note on Oct. 8, Poonawala said that the "path of least resistance for [the] stocks is higher."