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Big Bank Earnings: A Make-or-Break Week Ahead

It's a make or break week for the financial sector with five of six of the nation’s largest banks scheduled to report fourth-quarter earnings results. JPMorgan (JPM) and Goldman Sachs (GS) report on Wednesday morning, followed by Citigroup (C) and Bank of America (BAC) on Thursday, and Morgan Stanley (MS) on Friday.

Bank stocks have seen strong gains ahead of these key earnings reports. The Financial SPDR ETF (XLF), which tracks over 80 diversified financials, is up over 4% since the start of the year and 23% from one year ago.

Earnings expectations for the group are relatively strong. According to FactSet, the overall financial sector is expected to post an earnings growth rate of 8.7%, but stripping out insurance companies, growth is expected to top 30%.

Wells Fargo (WFC) was the first mega-bank to report last week, jumping ahead of JPMorgan which typically starts off bank earnings. WFC posted profit and revenue above estimates, but raised concerns about net interest margins or NIM. Wells, the largest mortgage lender in the country, funded $125 billion in mortgages last quarter, which rose from $120 billion during the same quarter last year, but fell from $139 billion in the third quarter. Further, the bank reported a 2% drop in interest income compared to the same quarter last year, fueling fear that historically low rates are pressuring margins.

Pressure on bank margins is expected to be heavy and has some investors favoring smaller financials to avoid larger NIM compression.

“If you’re going to be in the financial services arena, I like the regional banks,” says Kyle Harrington, managing partner at Harrington Capital Management. “When this housing market comes back and people put cash back into the real estate market, those banks will benefit first.” Specifically he likes Regions Financial (RF) and BB&T Corp. (BBT), citing attractive valuation and better opportunity to capitalize from the improving real estate market.

“I think some of these big banks have a lot of these big mortgages and big loans that they’ve held on to that they still don’t know exactly how to flush out, and I feel like the risk-reward profile is not as great as the regionals,” he states.