With just a week remaining in the second quarter of the current year and the earnings season in sight, it’s important to know what to expect from your favorite banking stock when it discloses its performance in the current quarter. This article features the second-quarter earnings outlook for Goldman Sachs Group Inc (NYSE:GS) and Morgan Stanley (NYSE:MS).
The second quarter
The second quarter of the current year was marked with climbing interest rates due to the confusion surrounding the unwinding of the third round of quantitative easing. The interest rates, as denoted by the 10-year Treasuries, have reached 2.52% from 1.86% at the beginning of the quarter. Overall, business conditions remained mixed and uneven, largely led by global debate over monetary policy.
Other highlights of the quarter include continuous demand by the regulators to improve the banking system’s stability by increasing individual banks’ capital bases so that they can withstand another severe financial crisis. Anticipating stringent capital requirements from the regulators, the banks have come up with their own coordinated plan to make the system more stable.
Within investment banking, the industry-wide investment activity has broadly improved with healthy new issue activity offsetting continued weak industry-wide merger and acquisition volumes.
The advisory activity, which includes merger and acquisitions (M&A), remained weak during the second quarter. M&A volumes were down 13% from a quarter ago. Even more disappointing is the fact that pipeline of the newly announced M&A volumes is down another 16% over the prior quarter, and the industry backlogs are now at the lowest levels in nearly two decades.
The tone within equity underwriting remained positive during the quarter but stalled in June. Going forward, a sustained recovery is seen in the activity levels for the remainder of the year given the still positive tone of the equity markets and some digestion of the current backlog.
Solid expense and capital management
Looking at the situation, Goldman Sachs Group Inc (NYSE:GS) is expected to produce impressive investment banking results for the second quarter, particularly on account of better than anticipated underwriting revenue over the course of the past couple of months. While a stronger investment banking top line is expected, it will still be behind the first quarter’s revenue.
At the same time, the revenue coming from Fixed Income, Currencies and Commodities (FICC) sales, and trading are also expected to plunge another 20% over the prior quarter due to the more challenging market conditions during the second quarter. Asset prices of most of the fixed income instruments are down so far during the quarter.
Better expense management will remain one of the key drivers of the second-quarter results. Compensation expense is accrued at 43% of revenue, in line with the first quarter accrual level, while stable non-compensation expenses are also expected.
The bank is also expected to remain an active acquirer of its own stock during the second quarter. Given the sales of the reinsurance business and the remaining ICBC stake, you should expect risk weighted asset mitigation, and Basel III readiness will be another focal point in the bank’s upcoming earnings.
Mixed quarter but good expense control
Overall, Morgan Stanley (NYSE:MS) should experience a good quarter of fundamental performance while good expense control should continue to help the bottom line.
Based on the Dealogic data since the beginning of the quarter, I have slightly better expectations for Morgan Stanley (NYSE:MS)’s investment banking revenue. I believe the bank will be able to post higher revenue from investment banking than the prior quarter.
However, within the Institutional Securities business segment, the expectations are not encouraging for its FICC revenue. The bank is expected to produce around 10% lower revenue from core income activities. This is largely due to a more challenging environment for the interest rates and some pullback with respect to the mortgage business.
The first-quarter results demonstrated better than expected expense control. I believe it’s fair to expect this better expense control to continue through the second quarter. However, some seasonally higher non-compensation expense can be expected for the second quarter. Aggregate core compensation expense is expected to be accrued at around 50% of total revenue, which is higher compared to Goldman Sachs Group Inc (NYSE:GS)’.
Both Goldman Sachs Group Inc (NYSE:GS) and Morgan Stanley (NYSE:MS) compete with JPMorgan Chase & Co. (NYSE:JPM) in the U.S. JPMorgan Chase & Co. (NYSE:JPM) is the largest bank by assets in the U.S. and has the second largest market share in the rebounding U.S. housing market.
The bank is expected to produce a higher top line during the second quarter, largely due to the climbing interest rates during the second quarter. JPMorgan Chase & Co. (NYSE:JPM) is expected to make another $2 billion in revenue if the 10-year Treasury yield increases 100bps. If the yield increases 300 bps, the bank will make $5 billion in additional revenue. Since the beginning of the current year, the 10-year Treasuries have gone up 71bps to as high as 2.57%. This means, the bank is definitely going to report some additional revenue in the second quarter.
Given the situation, Goldman Sachs Group Inc (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) are expected to report higher revenue at the end of the second quarter. While JPMorgan Chase & Co. (NYSE:JPM) will benefit from higher yields, Goldman Sachs Group Inc (NYSE:GS) will benefit from sold expense and capital management. Therefore, I am bullish on both the stocks. Morgan Stanley (NYSE:MS) is expected to report a mixed quarter with a focus on expense control.
Adnan Khan has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of JPMorgan Chase & Co (NYSE:JPM).. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article What to Expect From Banking Stocks originally appeared on Fool.com is written by Adnan Khan.
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