Bloomberg News

Morgan Stanley Seen Leading Profit Gains Amid Trading Drop (1)

October 08, 2013

Morgan Stanley Headquarters

Morgan Stanley signage is displayed outside of the company's headquarters in New York. Morgan Stanley’s third-quarter profit probably will rise 30 percent to $819 million, adjusting for one-time items, the estimates show. Photographer: Scott Eells/Bloomberg

Morgan Stanley (MS:US), Bank of America Corp. (BAC:US) and Wells Fargo & Co. (WFC:US) are poised to lead the six largest U.S. lenders by reporting a jump in earnings that may surprise some investors fixated on a slump in trading and mortgage lending.

The three banks probably will post combined third-quarter profit of $8.64 billion, or 14 percent more than a year earlier, according to analysts’ estimates compiled by Bloomberg. JPMorgan Chase & Co. (JPM:US), Citigroup Inc. (C:US) and Goldman Sachs Group Inc. will report a 7.8 percent drop, the estimates show. Five of the six firms may have squeezed more profit from each dollar of revenue as they benefited from expense cuts and a stronger U.S. economy.

“I see companies that are improving their profitability,” said David Hilder, an analyst at Drexel Hamilton LLC in New York who recommends buying stock in five of the banks including Morgan Stanley. Investors may be caught off guard “if individual analysts or the market have been too focused on lower fixed-income trading revenue or mortgage refinancing revenue.”

JPMorgan is among lenders that said results will suffer from a bond-trading slump, while Wells Fargo guided analysts to expect mortgage originations to fall by almost 30 percent. The forecasts reflected clients pulling back amid speculation the Federal Reserve will slow its $85 billion in monthly bond buying. That led analysts to cut estimates for earnings at the six banks by 6.7 percent in September.

Cutting Estimates

It was the biggest drop in average estimates in the final month of a quarter since a decline of more than 24 percent in June 2012. The revisions this time began before the Fed announced Sept. 18 it would maintain purchases, which may have given banks a bump in trading during the quarter’s final days.

The headwinds until then mean Morgan Stanley probably generated more revenue than Goldman Sachs for the first time in two years, according to the estimates. Goldman Sachs, (GS:US) once the most profitable Wall Street firm, gets the largest share of its income from trading of any of the six banks. Morgan Stanley Chief Executive Officer James Gorman, 55, has been reshaping his firm to rely more on its brokerage for earnings as U.S. stock markets reach record highs.

In total, the six banks probably will report revenue of $100.9 billion for the quarter, a 3.4 percent decline from a year earlier, according to analysts’ estimates.

‘Very Benign’

JPMorgan, the biggest U.S. bank by assets, and Wells Fargo, the nation’s top mortgage lender, kick off earnings Oct. 11. Bank of America (BAC:US), Citigroup, Morgan Stanley and Goldman Sachs release results the following week. Spokesmen for the lenders declined to comment on earnings before the reports.

“With mortgage and trading revenue pressures now understood and asset quality very benign, we expect most companies to be able to post in line with or above these lowered expectations,” Jason Goldberg, a Barclays Plc analyst in New York, wrote today in a note to clients. Goldberg predicts that more than half of the 25 banks he covers will beat Wall Street profit estimates.

Banks have countered revenue declines by dismissing workers, consolidating offices and wringing costs out of operations -- efforts that are starting to pay off. In the first few years after the crisis, many firms talked about expense reductions with limited success.

Cost Savings

Wells Fargo announced in July 2011 it would cut $1.5 billion in quarterly costs before backtracking a year later in favor of an efficiency-ratio target. Bank of America’s program, announced two years ago, is designed to achieve $8 billion in annual cost savings by 2015.

In this year’s first half, JPMorgan reduced noninterest expense by $2.02 billion compared with the year-earlier period. San Francisco-based Wells Fargo cut $735 million from costs, and Bank of America trimmed $671 million. Citigroup’s expenses rose by $234 million.

The cost-cutting hasn’t helped firms raise their returns on equity, or ROE, to pre-crisis levels, when they averaged more than 20 percent. Wells Fargo led banks with a 14 percent ROE in the first half, while JPMorgan and Goldman Sachs posted 13 percent and 12 percent, respectively. Citigroup, Morgan Stanley and Bank of America were all below 9 percent.

Morgan Stanley’s third-quarter profit (MS:US) probably will rise 30 percent to $819 million, adjusting for one-time items, the estimates show. Earnings for Charlotte, North Carolina-based Bank of America, the nation’s second-largest lender, may climb 14 percent to $2.55 billion, while Wells Fargo’s increase 12 percent to $5.28 billion.

Legal Disputes

Goldman Sachs’s earnings may slide 12 percent to $1.29 billion. JPMorgan’s profit could fall 11 percent to $5.3 billion as it sets aside more funds to end legal disputes. Citigroup may say earnings fell 1 percent to $3.24 billion.

While Goldman Sachs and Morgan Stanley grappled with a drop in trading, Morgan Stanley probably boosted revenue 16 percent at its retail brokerage, the largest in the U.S. by adviser count, according to estimates from Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. Wells Fargo, owner of the third-biggest brokerage, also may benefit from commissions, Hilder said.

Morgan Stanley’s total revenue may climb 1.4 percent to $7.66 billion, while Goldman Sachs’s drops 12 percent to $7.35 billion, according to analysts surveyed.

Morgan Stanley shares (MS:US) rose most among the six banks during the quarter, climbing 10 percent. That compares with a 4.6 percent gain for Goldman Sachs and a 2.4 percent advance in the broader Standard & Poor’s 500 Financials Index of 81 firms.

Employment, Housing

The trading slump is being offset as U.S. employment and home prices rise, helping borrowers avoid default. Home values across the U.S. climbed 6.4 percent last year after declining 25 percent in the prior five years, according to the National Association of Realtors. Prices rose 11.2 percent this year through July, according to a S&P/Case-Shiller index.

“Revenue is coming in soft,” said Frederick Cannon, director of research at Stifel Financial Corp.’s KBW unit in New York. “You are offsetting that with credit and expense saves.”

JPMorgan may report it released $1.65 billion of reserves, Deutsche Bank AG analysts estimated in a Sept. 25 report. Bank of America may report $1 billion of releases, while Wells Fargo discharges $700 million.

Expenses will continue sliding at most firms, led by job cuts. Bank of America may shrink costs by $650 million from the second quarter, while Wells Fargo trims $600 million, JPMorgan analysts wrote in a Sept. 18 report.

‘Big Tailwind’

Wells Fargo has announced plans to dismiss more than 4,800 workers in its home-loan production business as rising rates curtail refinancings. Bank of America is cutting 2,100 jobs and closing 16 offices by Oct. 31, two people with direct knowledge of the plan said last month. New York-based Citigroup, the third-largest U.S. lender, said it’s cutting about 1,000 jobs in mortgage sales, underwriting and other roles.

Wells Fargo Chief Financial Officer Timothy Sloan, 53, said last month that the home lender would make 29 percent fewer mortgages in the third quarter than it did in the second. Gain-on-sale margins, what the bank makes when it sells home loans into the secondary market, would fall 32 percent, he said.

Mortgage lending “was a big tailwind to the industry for those guys that embraced it,” Paul Miller, an analyst with FBR Capital Markets in Arlington, Virginia, and former examiner for the Federal Reserve Bank of Philadelphia, said in an interview. Now as volumes shrink, “you are seeing capacity coming out.”

Fixed Income

Global investment banks such as New York-based Goldman Sachs and Morgan Stanley probably will report a 35 percent drop in fixed-income revenue from a year earlier, Kian Abouhossein, a JPMorgan analyst, said in an Oct. 2 note to clients.

Jefferies Group LLC, whose third quarter ended in August, said fixed-income trading revenue plunged 88 percent. European firms including Frankfurt-based Deutsche Bank and London-based Barclays Plc told investors that bond-trading revenue would probably fall significantly. Equity trading revenue may offset the slide and climb 10 percent, Abouhossein said.

“In terms of trading activity, July and August were soft,” said Devin Ryan, a bank analyst at JMP Group Inc. (JMP:US) in New York. Recent strength in bond trading is “probably too little, too late for the third quarter, but the question will be: Does this recent improvement persist?”

Claims ‘Crescendo’

Fed policy may also undercut capital positions at banks by pushing yields higher and eroding the value of bond portfolios. A 0.64 percentage-point rise on the yield of the 10-year Treasury note in the second quarter led to losses so big at Bank of America that shareholders’ equity fell, even while the firm had a $4 billion profit. The effects may be muted in the third quarter, with 10-year yields rising only 0.12 percentage points.

The trading headwinds were compounded by additional costs from litigation.

JPMorgan CFO Marianne Lake signaled at an investor conference last month that the New York-based bank led by CEO Jamie Dimon, 57, will boost its litigation reserve by more than $1.5 billion in the third quarter to help cover a “crescendo” of potential legal claims.

That figure might rise. The firm has been discussing an $11 billion settlement with federal and state authorities to resolve probes tied to mortgage bonds, according to a person with knowledge of the talks. Citigroup may report $700 million in legal costs, according to the Deutsche Bank analysts.

Weak Demand

Lenders also are facing weak demand from borrowers. Loans made to companies and held by the 25 largest U.S. banks rose to $855.9 billion in the week ended Sept. 25, a gain of less than 1 percent over June, according to Fed data. Consumer debt, including residential real-estate loans, fell 2.2 percent to $2.24 trillion, according to the data.

Combined profit at the five largest U.S. regional banks, which rely more on lending, may decline 18 percent in the third quarter from a year earlier, while revenue slides 12 percent, according to data compiled by Bloomberg from analysts’ estimates. That would be the biggest drop in revenue since at least the financial crisis, the data show.

Even if bank profits surpass estimates, investors may focus on the mounting litigation and sliding revenue.

“It’s the quality of earnings growth,” FBR’s Miller said. “The earnings are fine, it’s the growth that is fleeting.”

To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Christine Harper at charper@bloomberg.net


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Companies Mentioned

  • MS
    (Morgan Stanley)
    • $38.81 USD
    • -0.14
    • -0.36%
  • BAC
    (Bank of America Corp)
    • $17.98 USD
    • 0.05
    • 0.28%
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