Morgan Stanley pulls away from the pack

Trading places

Goldman Sachs and Morgan Stanley have kept sentiment on big U.S. banks aloft after both comfortably beat quarterly expectations. Crucially, and unlike rivals that reported last week, the fifth and sixth largest U.S. lenders by assets also managed upside surprises in trading revenue after all major banks warned brokerage returns would be fallow. Whilst the theme continued at Morgan Stanley, where bond revenues slumped 20%, overall, MS trading confounded to the upside with a 3.6% advance to $2.07B, the only rise in Q3 trading revenues in the bulge bracket. Erstwhile prime of prime broker Goldman didn’t escape a third straight slide in bond dealing revenues either, though still saw relief in market transaction revenues, as they were down in line with rivals.

Institutionalisation

Goldman and particularly Morgan Stanley benefited from switches of emphasis to institutional investment banking and wealth management. MS’s wealth division notched its best ever quarter with an 8.7% rise on the year to $4.2bn, and 12.7% rise in investment banking to $1.38bn. The brokerage-to-investment bank rebalancing is likely to continue too, with MS’s CEO noting trading “faces a subdued environment”.  At Goldman, an institutional revenue fall of 17% was more than offset by an investment banking surge at the same 17% rate to $1.80bn. Goldman also saw further success at taming its cost structure than during earlier quarters, with operating expenses flat.

Bodes ill for Wells

Overall, the cross-sector upscaling of wealth management as a means of circumventing the impact of a chronic dearth of volatility in trading once again trains the spotlight on the quarter’s laggard, Wells Fargo. Combined with rivals eyeing deeper inroads into loans, increased emphasis on investment management—one of Wells’ stronger segments in the quarter—raises competition in what is, for now, one of its few growth segments. Note WFC is still roiled by a scandal that has hamstrung its dominant Community Banking unit. With all big bank earnings now in, we can also corroborate signs that the acceleration of loan losses in North America’s credit market has, so far, been fastest at Wells, easily the biggest U.S. lender.

Solid, in places

Elsewhere, whilst acknowledging the quarter’s biggest surprises were staged by Goldman Sachs, we reserve judgement on its view that Q3 contributed to a “solid” overall performance for the year. And we drop our caution on the sector as a whole only a little after this Tuesday’s better-than-forecast earnings. That’s largely because progress on return on common equity was patchy. Goldman’s quarterly annualised ROE fell to 10.9% from 11.2%. Citigroup also missed the mark. Predictably, Wells Fargo’s ROE eroded in line with the rest of its unsatisfactory results. Morgan Stanley’s was ambiguous: 9.6% in Q3 slipped against the 9-month tally of 9.8%. Still, Morgan Stanley, like Bank of America now looks on track to hit its target for the year. Both of the latter two ROEs remain below 10%—the minimum at which a large lender can be profitable overall. It all goes to show that progress on measurable profitability is still halting across America’s huge banks.

Wall St. eyes Washington

A hard won battle to ramp returns helps explain why lenders are seeking solace in investment and wealth management and backing away from dwindling businesses like trading. The trend can be expected to continue, though the damage for the year is done. Dented business lines in the bulge bracket have capped revenue growth to around 0.4% on average over three quarters, versus a more ebullient 2016. As we noted last week, this makes banks and their shares—which rebounded sharply from late-summer lows—ever more dependent on tax cuts. But we continue to expect taxation reform to materialise no sooner than late 2018, with a clear impact on the outlook for large U.S banks. Hence forthcoming quarters will favour lenders capable of keeping a lid on costs – something particularly seen at Goldman and Morgan Stanley in Q3.