iCapital Market Pulse: Financials in Focus – Testing Resilience Amid High Expectations

Key Takeaways:

• Financials enter Q3 earnings with momentum: Financials expected to grow Q3 earnings +11.5% and revenues +6.9%, driven by deal flow and loan demand.¹
• Capital markets rebound is a key earnings lever: Robust debt issuance, M&A pipelines, and IPO activity support fee income, especially for banks with strong capital markets franchises.
• Loan growth steady, credit solid: Lending is accelerating amid easing credit conditions, while credit metrics remain healthy despite modest stress at the margins.
• Valuations stretched, selectivity critical: We favor banks focused on asset-light, high-fee businesses, those positioned to benefit from industry consolidation, and those aligned with supportive policy tailwinds.

The financials sector, led by the largest banks, is entering a pivotal third quarter earnings season against a backdrop of anticipated rate cuts, a slowing labor market and falling but still elevated policy uncertainty. In our view, the market is looking for confirmation that recent positive trends – deal pipelines reopening (as we noted here), improving loan demand, and a more favorable regulatory climate – are translating into sustained revenue and earnings growth. Indeed, financials are expected to grow earnings and revenues by +11.5% and +6.9%, respectively, in Q3 2025, above their five-year medians.²

Expectations have risen. Banks – and financials more broadly – have re-rated sharply to the high-end of their historic range in recent months, making them vulnerable to disappointment.³  While balance sheet strength, robust capital buffers, and disciplined underwriting remain intact, we believe the path forward hinges on two critical factors: the durability of the capital markets recovery, and the resilience of consumer and commercial credit quality.

Capital Markets: Deals Drive Fees, Durability in Focus

U.S. capital markets activity is rebounding, and we see this as a core driver of earnings growth for banks over the next several quarters (especially as trading revenues are expected to slow marginally in 2026⁴ ). The pickup in underwriting along with broader deal flow is not just cyclical – it reflects improving corporate confidence, healthier balance sheets, and a normalization of risk appetite.

We are seeing this show up in the data (Exhibit 1):

• Debt issuance is building: U.S. high-yield bond issuance climbed over 50% year-on-year (YoY) in Q3, doubling the average quarterly pace since 2021.⁵  New-money leveraged loans in the U.S. are on track for their strongest year since the 2021–22.⁶
• M&A advisory is gaining momentum: Announced U.S. M&A deals have totaled $1.2 trillion year-to-date.⁷  With only $400 billion closed this leaves an $800 billion pipeline that should convert into advisory fees over the coming quarters.
• IPOs show life: U.S. listed IPO volumes were up over 300% YoY in Q3 and are pacing for their best year since 2021, though still softer than historical averages.⁸  However, our iCapital IPO Activity Barometer, currently in the 74th percentile over a 20-year lookback, signals a favorable setup into 2026.⁹

These trends are particularly supportive of banks with strong capital markets businesses given the capital-light nature and benefit directly from rising deal volumes. We expect the large US banks to be key beneficiaries.

But is the recovery durable heading into 2026? We believe so. Strong corporate balance sheets, easing funding costs, and ample liquidity provide a solid foundation. Years of pent-up demand – alongside a growing IPO backlog – suggest this rebound has legs beyond the recent strength. Indeed, across the five largest US banks, underwriting and advisory fees are forecasted to rise 17% YoY in 2026, marking one of the strongest years for capital market fee income in recent history (Exhibit 2).¹⁰

However, risks do remain, particularly in the near term. A prolonged government shutdown could delay M&A closings and IPOs (except for pre-cleared filings), modestly impacting Q4 fee income. An unexpected rise in policy uncertainty or an abrupt weakening in labor markets, while not our base case, could also weigh on sentiment. However, we expect a swift rebound once the government shutdown clears, and anticipate positive earnings commentary around deal pipelines and corporate sentiment.

Loan Growth and Credit Quality: Steady, Not Stellar

Loan growth is trending higher, while credit quality remains broadly intact – a dynamic we see as a stabilizing force for banks in the quarters ahead. Lower borrowing costs, easier credit standards, and policy tailwinds (deregulation, OBBBA tax bill) are driving demand for consumer and commercial loans.

Total loan balances rose 5.9% YoY in Q3.¹¹  Consumer lending – driven by mortgages and auto loans – accelerated 6.7% quarter-over-quarter (QoQ) annualized, while commercial and industrial (C&I) loans grew 3.2% YoY, though momentum slowed slightly QoQ, suggesting businesses are still cautious but beginning to re-engage.¹²

Net new lending continues to trend higher (Exhibit 3), with banks citing stronger pipelines.¹³  Regulatory clarity around capital requirements and deployment could further boost loan growth in 2026 – banks hold an estimated $250 billion in excess capital.¹⁴

Credit quality remains healthy, though stress is emerging at the margin, particularly among lower-income borrowers. Charge-offs have risen modestly above the 10-year average and delinquency rates have inched higher.¹⁵  But context matters as aggregate and low-income cohort charge-off rates around 2% today are still well below the 2009 peak of 10% (Exhibit 4), and recent upticks in delinquencies are largely tied to student loans, while auto and credit card delinquencies have stabilized.¹⁶

We largely see this as a continued normalization in credit trends, and isolated stress rather than a broad-based deterioration. Yes, we may get one-off credit issues here and there, but broader consumer health remains resilient, commercial credit metrics remain solid, and reserve coverage ratios remain elevated relative to pre-pandemic levels.¹⁷  This should help support loan growth (and earnings) into 2026.

Valuations: Rich, But Still Attractive Relative to Broader Market

After a strong run, bank valuations have re-rated toward historical averages.¹⁸  While they remain marginally cheaper relative to the broader market, the key question is whether earnings can justify further multiple expansion. It will be harder – but not impossible.

We see three areas of support that could help sustain valuation momentum:

1. (Further) Shift to asset-light, high-fee businesses: Leaning into wealth and private wealth management, where recurring fee income and long-term client relationships offer stability and scalability. At the same time, we’re seeing more banks engage in private markets which should help generate advisory and placement fees without deploying significant capital. This not only diversifies revenue streams but also reduces reliance on traditional lending, positioning banks to better weather changing macro backdrops.
2. M&A and consolidation: The Capital One–Discover megadeal, completed in May, and Fifth Third’s recent agreement to acquire Comerica signal a clear shift toward a more merger-friendly stance.¹⁹  With the Fed indicating openness to deregulation and the FDIC rolling back its 2024 merger policy, key obstacles that had stalled bank M&A over the past few years are being removed.²⁰  And with ~4,500 U.S. banks – most under $10B in assets – we believe this backdrop should unlock pent-up M&A and be supportive to valuations through scale and cost synergies.²¹
3. Broader deregulatory tailwinds: A more pro-business policy environment is emerging, with signs of easing regulatory burdens not just for banks but across capital markets. This backdrop could spur increased deal activity, as companies face fewer hurdles to transact – supporting fee income across advisory and underwriting. At the same time, bank-specific deregulation (lighter Basel III requirements, loosened lending constraints) could encourage higher-risk lending by banks, expanding net interest margins and boosting loan growth.

Bottom Line: Selectivity Matters

Financials have momentum, but the market demands proof that it will last. We believe it can. Capital markets activity looks durable, credit quality is holding up, and loan growth is steady enough to drive earnings through 2026. However, with valuations now on the high end, investors should focus on banks with an increasing fee-driven model, M&A upside, and policy tailwinds.