Large U.S. bank stocks will formally kick off the third-quarter earnings season when JPMorgan Chase (JPM 0.01%) and Citigroup (C -0.61%) report their results tomorrow morning.

All eyes will be on the large banks as investors try to gain further clarity into how the economy is doing, with many fearing a more severe recession on the horizon. Investors will also be trying to get a read on how the U.S. consumer is holding up. Lastly, results and guidance from management could lead to revisions on future earnings projections, which could impact stock prices.

While the higher-rate environment is expected to boost revenue in banks' lending and securities businesses, it has been a big headwind on investment banking. Will this trend continue for JPMorgan, Citigroup, and Bank of America (BAC -0.14%) in their third-quarter earnings reports? Let's take a look.

Conditions are still difficult

It's no secret that investment banking, which includes equity and debt underwriting and mergers and acquisitions (M&A) advisory services, has really struggled this year.

The market for initial public offerings has been virtually frozen at times this year due to higher interest rates, which have caused tons of volatility in the market. In the second quarter of the year, JPMorgan Chase reported investment banking fees being down 54% year-over-year. Bank of America and Citigroup have experienced similar trends.

One way to gauge investment banking trends is to look at results from the smaller investment bank Jefferies Financial Group (JEF -0.36%), which runs on a different quarterly schedule and reports ahead of the major banks.

For its third quarter ending Aug. 31, Jefferies saw many of the same trends in investment banking as the prior quarter, with total investment banking revenue down about 44% year-over-year and slightly down from the prior quarter.

However, M&A advisory revenue actually jumped by about 31% from the previous quarter, and was down about 16.6% year-over-year, which is better than I would have expected given the headlines. Equity underwriting revenue also actually jumped by 23% in the quarter, although was still down significantly year-over-year, and debt underwriting fell 28% and is now down almost 67% year-over-year.

A tough comparison

It's tough to know exactly how M&A advisory will come in at the major banks, but according to Bloomberg, global M&A volume in Q3 hit its lowest level since the second quarter of 2020. At a conference in September JPMorgan's COO Daniel Pinto said he expected investment banking fees in Q3 to still be down 45% or 50% year-over-year. 

Bank of America's CFO Alastair Borthwick also said in September that he didn't expect to see much improvement in Q3 in investment banking, although the pipeline is still pretty good. Executives at Citigroup made similar comments.

Pinto, however, reminded investors that the comparison to 2020 and 2021 is very difficult given how extraordinary the performance in investment banking was during those years. He also said that he expects the size of the overall wallet (the total amount of investment banking fees in the industry) to be similar this year to pre-pandemic levels.

Between 2011 and 2019, Pinto said the size of the overall wallet ranged from $70 billion to $85 billion. Then it jumped to $95 billion in 2020 and $123 billion in 2021. This year, data shows it will be around $69 billion or $70 billion, but Pinto thinks it will get back to 2020 levels over time, and on a more normalized basis.

A similar situation

Based on comments from the major bank executives and the Jefferies report, I'm expecting that headwinds in investment banking continued in the third quarter of the year for Bank of America, JPMorgan Chase, and Citigroup.

Jefferies did, however, report an improvement in M&A advisory and equity underwriting revenue in its recent quarter, so perhaps we see that in bank earnings reports. But this could also be due to the timing of the deals, and fees coming in from deals that were essentially made in prior quarters.

If there's a little bit of improvement like in the Jefferies report, I think that would be a good start -- but a lot of where investment banking activity is headed in the near term will likely be more dependent on how market conditions trend. A little less volatility could go a long way, but volatility might still be prevalent for some time.