Why Are Big Banks Doing Better Than Expected?

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There was a common thread between the second-quarter earnings of three major banks, which all reported over the past few days. JPMorgan (NYSE:JPM), Citigroup (NYSE:C), and Goldman Sachs (NYSE:GS) all released earnings that beat market expectations — smashed them, in some cases.

JPMorgan reported profit of $6 billion, or $1.46 per share, on revenue of $25.3 billion. This beats Wall Street expectations for earnings of $1.29 per share on revenue of about $23.8 billion. Within investment banking, profit was down 31 percent to $2 billion from a year ago. Revenues from fixed-income trading fell 15 percent to $3.5 billion, due to “historically low levels of volatility and lower client activity across products.”

Adjusting for legal charges and accounting changes, Citigroup reported earnings of $1.24 per share, beating the mean analyst estimate of $1.05 per share. Revenues at the bank were down 5.6 percent on the year to $19.34 billion but still beat analyst expectations for $18.93 billion.

And finally, trading giant Goldman Sachs reported a 5.5 percent increase in net profits to $2.04 billion, or $4.10 per share, in its second quarter, beating the $3.05 a share estimates of Wall Street analysts.

First, they all beat market expectations; second, they all reported a drop in trading revenues. But in all the cases, earnings were redeemed by banks having either aggressively cut expenses this quarter, as many are nearing the end of legal settlements with regard to financial misconduct surrounding the 2008 financial crisis, or having focused on new business areas.

This trio of beats piqued the interest of market watchers for a couple of reasons, and one of the issues at the forefront of the conversation is whether these banks intentionally lowered market expectations ahead of the earnings report.

In May, JPMorgan indicated that revenue from fixed-income and equities trading could fall by as much as 20 percent, a severe blow that caused some traders to distance themselves from the stock and lower their earnings forecasts. While trading revenues did bleed, the impact was less than expected.

But JPMorgan wasn’t the only bank to report better-than-expected trading results, suggesting that maybe it was actually an industrywide phenomenon. Citigroup reported a 15 percent decline in second-quarter trading revenues, better than the 20 to 25 percent drop that CFO John Gerspach warned investors about in May. Fixed-income trading revenues fell 12 percent to $3 billion, while equities-trading revenue fell 26 percent to $659 million.

A slump in the mortgage market continued to hit Citigroup, too. Mortgage originations dropped 64 percent from a year ago, and overall revenue from the consumer-banking unit was down 3.5 percent from the year earlier to $9.38 billion. Investment-banking revenues rose 16 percent from a year earlier to $1.34 billion, led by a 17 percent jump in fees from debt underwriting and a 31 percent rise in equity underwriting. Advisory fees were down 10 percent from a year earlier due to delays in some merger deals, according to Gerspach.

Even Goldman Sachs’ famous trading division struggled. Net revenue in the division fell 10 percent to $2.2 billion in the second quarter. Net revenues in investing and lending rose 46 percent to $2.07 billion for the second quarter of 2014. Investing and lending included revenues of $1.25 billion from investments in equities and net interest income of $604 million from debt securities and loans.

The firm posted $9.1 billion in net revenue in the quarter ended June 30, up 6 percent from $8.6 billion in the second quarter last year, much higher than analyst expectation of $7.9 billion. One bright spot was its investment banking revenue, which rose 15 percent to of $1.78 billion year on year.

“It’s like owning an orchard,” Brad Hintz, an analyst with Sanford C. Bernstein & Co., told The New York Times about the bank’s robust performance in its investment banking business. “There are periods of time where you’re just sitting there looking at trees, and then you’re just up to your knees in apples. We happen to be at the point where the harvest is coming in.”

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