Q3 Bank Earnings Up Next, With Results Likely Bolstered By Busy Trading Environment

Key Takeaways:

  • Surging IPO and M&A business appears to be helping big banks
  • Morgan Stanley MS making acquisitions as it grows money management business
  • Strong trading activity could bolster Goldman Sachs GS , Morgan Stanley, Bank of America BAC

A week before earnings season, Morgan Stanley (MS) lit a spark under the banking sector with its $7 billion purchase of fund manager Eaton Vance EV (EV).

MS isn’t the only company wheeling and dealing as earnings approach. Initial public offerings (IPOs) and mergers and acquisitions (M&A) are accelerating here in the Q4 across multiple industries. The surge began around mid-year, and might be enough to help buttress Q3 earnings for MS and some of the other big banks reporting in coming days.

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With fresh M&A accompanied by an upsurge in capital markets trading activity, it feels like things might finally be looking up the banking industry. Earnings season could bring some good news for Goldman Sachs (GS), MS, and Bank of America (BAC)—all of which report this week. Don’t expect any fireworks, but it does appear that sector-wide earnings losses will be far more subdued than they were in a historically horrible Q2.

The Financial sector suffered a 52.2% year-over-year drop in earnings per share for Q2, according to a FactSet analysis. The research firm predicts that to improve to a year-over-year loss of 19.4% in Q3.

Q3, like Q2 and Q1, probably was good for banks in one particular way: All the volatility in capital markets likely led to lots of trading activity. This could be a potential bright spot for banks like GS that have huge trading desks. Also, the market dynamics might provide a lift for the large wealth management business at MS. Volatile markets generally raise demand for help with wealth management.

In addition, the better economic data we generally saw in Q3 could bolster a more consumer-focused company like BAC, which possibly gets a lift from its mortgage banking as the housing market sizzles. Low rates that raised housing demand and propelled refinancing probably didn’t hurt. Credit card activity in the consumer banking arena is under scrutiny, however, as job growth appears to be slowing.

One other possible worry is any changes in Washington following the election. Banks have generally enjoyed a rollback of regulations recently, but November’s voting could potentially mean a more active Treasury Department in coming years. It’s possible bank executives might be asked on their earnings calls to speculate about the election and its potential impact on their companies and the economy.

Still a Long Slog Likely Ahead

All this doesn’t mean the Financial sector’s troubles are over. The sector is still in a deep hole when it comes to market performance, down about 18% year-to-date. Only Energy has done worse.

The crippling combined impact of low interest rates, a struggling economy, and credit loss provisions the banks took to protect against potential loan defaults haven’t gone away. Due to the crisis, banks are also less able to use traditional ways of rewarding investors—buybacks and dividend increases.

A good trading and M&A quarter and a hot housing market don’t solve all those problems, but do potentially blunt the impact. Until there’s an effective treatment or vaccine for the virus, it’s possible the economy could continue struggling, and that tends to hurt banks. As lending institutions, banks are exposed more than most sectors to the broader economy. Until other sectors start recovering, it’s hard for banks to achieve much on their own.

They have done a good job of controlling what they can, however. Those credit loss provisions mean the industry likely has a strong shield if things get worse in the event of a winter virus wave, for instance. The banks have generally done a great job cutting costs and also branching into new businesses that expand their customer base. Consider, for instance, the recent move by MS to build out its IPO and money management footprint. More on that below.

The Financials sector saw the fourth largest year-over-year earnings decline of all 11 sectors in the S&P 500 in Q2, the poorest performance it’s had since the 2008 financial crisis. Some of the worst-performing sub-sectors in Finance so far this year have been consumer finance, banks, and insurance.

For the mega-banks like GS, BAC, and MS, however, not all the same metrics apply. Unlike regional banks, they tend to do better when the capital markets are energetic, and that’s probably a good description for how they’ve been lately. 

In Q2, for instance, GS crushed analysts’ earnings per share and revenue estimates with amazing surges in bond and equity trading revenue. That could be hard to repeat, even though markets remained volatile through most of Q3. One potential limitation is that the bond market was pretty flat much of the time.

GS, like MS, has a huge trading business. We’ll be looking for results from there and for any different outcomes between the fixed income and equity sides of the quarter. GS is second only to MS when it comes to the size of banks’ trading shops, so these two could be well positioned from a capital markets perspective if things stay exciting in Q4. Considering we have an election right ahead, that doesn’t seem like too wild a prediction.

MS also outperformed Wall Street’s expectations last time out, bolstered by trading and wealth management strength. In fact, its wealth management business saw record Q2 revenue.

Like most of the other big banks, however, MS suffered in Q2 from weak net-interest income, and that probably didn’t change for MS or other mega-banks in Q3. The benchmark 10-year yield stayed below 0.7% for most of the quarter, not far off historic lows posted earlier this year.

Recently, yields showed signs of life. That probably happened too late to come to the banks’ aid before the end of Q3.

With MS, it’s important to keep a close eye on trading results, and also to see if the company feels it’s making strides in its growing IPO business.

Also, investors will probably want to hear about the recent MS acquisitions, including that announced purchase of EV last week. The move continues the firm’s shift away from trading toward steadier, simpler businesses like money management, The Wall Street Journal reported.

The deal would nearly double the assets that MS manages on behalf of pension funds, insurance companies and other clients, to $1.2 trillion, the WSJ said, and add about $1.7 billion of annual revenue. Morgan Stanley’s asset-management arm is the most profitable of the bank’s four divisions but also its smallest, and had been seen as too niche to compete with larger rivals.

IPOs and M&A Heat Up, Potentially Providing Lift

GS and MS also could benefit in Q3 from a very hot IPO and M&A market, noted research firm Briefing.com. As things began reopening during Q2 and Q3, companies started looking again at how to maximize their profits or at least stay above water with some of the activities like M&A. This tends to help banks’ business.

One thing to potentially listen for on the big banks’ earnings calls is how they see IPO and M&A activity advancing from here, particularly with worries about more shutdowns if there’s a winter wave of the virus. Any concern about volatility around the election could also potentially put a damper on that sort of activity, though it would probably be a boost for banks’ trading businesses.

Last quarter, the bank earnings season followed news of some big layoffs across several industries. It seems like a repeat as we approach Q3, as airlines threaten major furloughs and Disney DIS (DIS) just laid off 28,000 workers. In addition, last week brought the bad news that cruise lines again are postponing their expeditions at least through November.

All this could spell trouble for banks, which took large provisions in Q1 against possible credit losses. One question heading into Q3, just as it was in Q2, is whether they’ll expand these provisions as the economy keeps struggling. A big expansion of banks’ defense against possible losses might signal that they see more trouble ahead, and some analysts expect them to take that step.

Also worth watching is how the banks see their cash positions now and in the future. Laws passed in the wake of the 2008 financial crisis force banks to keep more money on hand than they used to, which might have helped this time around.

Despite so much weakness around the economy, GS, MS, and BAC passed their 2020 Fed “stress tests” with flying colors, and said they’ll maintain their current dividends. However, they’re now being subjected to a second round of stress tests and results aren’t known yet.

More than GS and MS, BAC plays in the consumer banking industry. Solid economic data, especially around the housing market, could provide a boost for BAC in Q3. Also, strong demand for new mortgages and refinancing based on low rates might have given it some support.

Last time out, BAC raised its reserves for credit losses by $4 billion, so a big question heading into its Q3 results is how much more it needs to add, if any. Any funds put aside for this potentially detract from earnings performance.

Back in Q2, BAC barely surpassed analysts’ average revenue estimate, though it did beat Wall Street’s average earnings per share estimate. Bond trading and investment banking both appeared strong in Q2, so we’ll see if that extended into Q3 for BAC.

Bank of America Earnings and Options Activity

When BAC releases results, it is expected to report adjusted EPS of $0.49, vs. $0.56 in the prior-year quarter, on revenue of $20.81 billion, according to third-party consensus analyst estimates. Revenue is expected to fall 9.4% year-over-year. 

Options traders have priced in a 3.5% stock move in either direction around the upcoming earnings release, according to the Market Maker Move indicator on the thinkorswim® platform from TD Ameritrade. Implied volatility was at the 19th percentile as ofTuesday morning. 

Looking at the October 16 options expiration, there’s been a bit of activity to the downside, particularly at the 22 and 23 strikes. But a lot of the activity has been to the upside, with concentrations in the 27- and 30-strike calls.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

Goldman Sachs Earnings and Options Activity

GS is expected to report adjusted EPS of $5.49 vs. $4.79 in the prior-year quarter, on revenue of $9.4 billion, according to third-party consensus analyst estimates. Revenue is expected to be up 13% year-over-year.

Options traders have priced in a 3.2% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator on the thinkorswim platform. Implied volatility was at the 16th percentile as of Tuesday morning. 

Looking at the October 16 expiration, put activity has been light overall, with some activity at the 200 strike. Calls have seen concentrations at the 220 and 235 strikes.

Morgan Stanley Earnings and Options Activity

MS is expected to report adjusted EPS of $1.27, flat vs. the prior-year quarter, on revenue of $10.59 billion, according to third-party consensus analyst estimates. Revenue is expected to be up 5.5% year-over-year.

Options traders have priced in a 3.7% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility was at the 20th percentile as of Tuesday morning.

Put activity has been lighter, but with some concentration at the 45 strike. Calls have seen more activity, particularly at the 52.5 and 55 strikes.

TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

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