Goldman Sachs Group Inc., whose shares have fallen 43 percent this year, may report its lowest quarterly profit since the 2008 financial crisis. Far from Wall Street, Wells Fargo & Co. is headed for record earnings.
Third-quarter U.S. bank earnings, which kick off with JPMorgan Chase & Co. on Oct. 13, will show that investment-banking businesses such as bond trading and merger advice declined, while retail operations like mortgage lending prospered, according to analysts including Richard Staite at Atlantic Equities LLP in London.
It’s a reversal from 2009 and early 2010, when rising markets and a perfect trading record propelled New York-based Goldman Sachs to its highest profits ever, as commercial lenders including SunTrust Banks Inc. in Atlanta charged off billions of dollars of delinquent mortgages.
“You’re going to see a big divergence between very poor earnings from pure capital-markets businesses and quite solid performance from the pure retail banks, particularly those that have a mortgage-origination business,” said Staite.
Slowing economic growth and heightened worries about European sovereign debt has weighed on bank stocks all year. None of the 24 members of the KBW Bank Index has posted a gain in 2011, and the worst performer, Bank of America Corp., is down 53 percent. A jump in borrowing costs at some banks, including New York-based Morgan Stanley, began to subside last week as investors became more optimistic that European policy makers would solve the region’s sovereign debt and banking crisis.
“I hope European governments manage to come to a solution that causes an end to the kind of fear that the markets have lived through for the last 90 days,” said David Hilder, a New York-based analyst at Susquehanna Financial Group LLP. “And if that happens, then I think you’ll see activity levels pick up, possibly in the fourth quarter and certainly in 2012.”
A decline in trading revenue over the past two quarters has led large investment banks to focus on cost reductions, including job cuts. Goldman Sachs, led by Chief Executive Officer Lloyd C. Blankfein, 57, said in July that it will cut about 1,000 jobs after its second-quarter drop in trading revenue was bigger than analysts estimated.
Bank of America, the largest U.S. lender by assets, announced plans last month to eliminate 30,000 jobs in the next few years. UBS AG, Switzerland’s biggest bank, said in August it will cut about 3,500 positions, or 5.3 percent of its workforce, to reduce expenses. Morgan Stanley said it wants to bring down annual costs by $1 billion over the next three years.
The focus on expenses is likely to lead to lower compensation. Year-end bonuses for fixed-income traders and salespeople across Wall Street may fall 20 percent to 30 percent from last year, Johnson Associates Inc., a New York-based compensation-consulting firm, estimated on Aug. 12. Johnson said bonuses for equity traders will be flat to down 15 percent.
Executives at some Wall Street firms are planning more cuts to jobs and compensation after third-quarter results are released because they don’t expect the industry to recover soon from a slowdown that’s partly driven by regulatory changes, Richard Bove, an analyst at Rochdale Securities in Lutz, Florida, wrote in a note to investors on Oct. 6.
“The only action that they can take to deal with the expected environment is to cut costs,” Bove wrote. “Translated, this will mean lower bonuses and fewer jobs.”
Stock- and bond-market investors were spooked during the quarter by Standard & Poor’s decision to downgrade the U.S. government’s debt rating, a protracted Congressional debate over raising the government’s borrowing limit, and by the Federal Reserve’s decision to leave rates near zero until 2013 to combat stalling economic growth. Debate among European policy makers about how to solve deteriorating government finances and whether to add capital to banks also sparked fears that a misstep could lead to a new financial crisis.
The S&P 500 Index dropped 14 percent during the quarter, the worst decline since the fourth quarter of 2008, and the Chicago Board Options Exchange Volatility Index, or VIX, which measures the cost of buying insurance against drops in the S&P 500 Index, surged 160 percent to its highest quarterly reading since the first three months of 2009.
Credit markets and commodities were also shaken during the quarter. The Markit CDX North America Investment Grade Index, which measures the price of buying derivatives to protect against a default on the corporate debt of 125 borrowers, climbed the most in the quarter since 2008. The average yields demanded on U.S. commercial-mortgage bonds in excess of Treasuries soared 108 basis points, the most since the last quarter of 2008, to 3.51 percent, according to Barclays Capital Index data. A basis point is 0.01 percentage point.
Brent crude oil futures lost 8.6 percent in the third quarter, extending a 4.2 percent drop in the second, in its longest slump since the 2008 financial crisis.
Across the Board
“What I think was surprising when you got into September from August was how across-the-board the weakness was,” said Charles Peabody, an analyst at Portales Partners LLC in New York. “Very often you get weakness in fixed income, but equities do well. This was literally every product. Every capital markets event was negative.”
Goldman Sachs, which made more than 70 percent of its revenue in the first six months from investing its own money and trading, will likely be most affected by the market declines. The company’s earnings will collapse to breakeven in the third quarter from $2.98 per share a year earlier, according to the average of 24 analysts’ estimates compiled by Bloomberg. That would be the lowest since the fourth quarter of 2008, when the firm posted its only quarterly loss since going public in 1999.
Twelve of the analysts expect Goldman Sachs to report a loss for the three months on Oct. 18, driven by declines in its investments in companies such as Industrial & Commercial Bank of China Ltd., which fell 35 percent in the quarter in Hong Kong trading, and other assets such as real estate.
Analysts including Edward Najarian at International Strategy & Investments in New York also expect Morgan Stanley and Charlotte, North Carolina-based Bank of America to report quarterly losses once non-recurring items and debt-valuation adjustments are excluded. The adjustments are accounting gains taken when the price of a company’s bonds declines.
Five of the largest U.S. banks -- Bank of America, JPMorgan Chase, Citigroup Inc., Goldman Sachs and Morgan Stanley -- will recognize $4.3 billion in such gains, according to estimates by Matthew Burnell, an analyst at Wells Fargo, the fourth-largest lender, which wasn’t included. Analysts’ estimates compiled by Bloomberg do not strip out debt-valuation adjustments.
Wells Fargo, based in San Francisco, and U.S. Bancorp in Minneapolis, which make most of their money from lending instead of investment banking, will probably report record earnings in the third quarter, according to an estimate by Richard Ramsden, a Goldman Sachs analyst in New York.
In an Oct. 9 report titled “Traditional Banking Is Doing Just Fine,” ISI’s Najarian noted that Fed data for the 25 largest banks showed total loans grew 1.2 percent in the third quarter from the prior three months and that core deposits surged 6.8 percent, helping to replace more expensive forms of funding such as bond issues.
Average loans by banks will climb by a median 2 percent in the third quarter from the previous three months, the first increase after 10 consecutive quarterly declines, analysts at Evercore Partners Inc. said in an Oct. 3 note to investors. The boost is being driven by more loans to businesses as well as by a “notable pick-up” in mortgage and consumer lending, the analysts wrote.
The Fed’s efforts to stimulate economic growth, most recently with the so-called Operation Twist plan to buy long- term Treasuries while selling shorter-term U.S. government debt, reduced the average rate on 30-year mortgages below 4 percent for the first time on record this month.
Banks including Wells Fargo and JPMorgan will benefit from a third-quarter increase in fees from homeowners refinancing their mortgages and from higher profits selling those mortgages to government-sponsored entities such as Fannie Mae and Freddie Mac, according to Ramsden’s Sept. 28 note. The Goldman Sachs analyst wrote that he expects mortgage-banking revenue to rise more than 40 percent from the prior quarter.
Wells Fargo, led by CEO John G. Stumpf, 58, will make 72 cents a share in the quarter, up 9 percent from a year earlier, according to the average estimate of 29 analysts surveyed by Bloomberg. The lender will earn a record $15.2 billion, or $2.82 per share, for the full year, according to the same analysts.
U.S. Bancorp, the largest bank in Minnesota, will earn 61 cents a share, up 36 percent from a year earlier, according to the average estimate of 29 analysts surveyed by Bloomberg.
Mary Eshet, a Wells Fargo spokeswoman, declined to comment, as did Stephen Cohen, a Goldman Sachs spokesman, and JPMorgan’s Jennifer Zuccarelli.
The split between Wall Street businesses and other types of banking will be demonstrated by JPMorgan, the second-biggest U.S. bank by assets. The New York-based company will report 95 cents of earnings per share for the quarter, just 6 percent lower than a year earlier, according to the average estimate of 30 analysts surveyed by Bloomberg.
Those earnings, the lowest in six quarters, may reflect gains in consumer lending and credit-card revenue as well as declines at the investment bank. James Staley, 54, who runs the investment bank, said at an investor presentation on Sept. 13 that “markets revenue” will decline about 30 percent from the second quarter and that fees from investment banking will be about $1 billion.
The last time fees at JPMorgan’s investment bank were below $1.2 billion was in the first quarter of 2006, company statements show. Revenue from fixed-income and equity trading totaled $5.5 billion in the second quarter and hasn’t been 30 percent lower than that since the fourth quarter of 2009, the statements show.
Staley said that the company’s revenue from asset management is “definitely correlated with the equity markets” and will probably decline as a result of the drop in stocks. He also said that the company’s private-equity business will probably report a loss of roughly $100 million.
Analysts are split on the outlook for bank stocks, even though all of them agree that their valuations are much lower than they’ve been historically compared with their book values.
Peabody, at Portales Partners, is advising investors to stay out of banks until key decisions are made in November by a U.S. deficit-cutting committee and by the Group of 20 countries, which are meeting to discuss capital requirements for the world’s biggest banks.
Investors who typically seek to buy undervalued stocks, known as “value” investors, have only about 4 percent of their funds in bank stocks, less than the industry’s weighting in the iShares S&P 500 Value Index Fund, according to a Sept. 29 analysis by ISI’s Najarian. That means there’s “considerable buying power” that could rush into large bank stocks whenever the outlook improves, he concluded.
“Everybody who’s been negative on the banks has been right, and if you’re positive on the banks you’re taking a risk,” said Roy Smith, a finance professor at New York University’s Stern School of Business and a former Goldman Sachs partner. “The consensus is so negative at the moment that it’s probably wrong.”
© Copyright 2015 Bloomberg News. All rights reserved.