The spike in interest rates slows activity at the end of the quarter. 2Q13 began strong, with continued momentum in debt underwriting, strength in mortgage banking originations and expectations for meaningful year-over-year growth in trading says David Konrad, CFA of Nomura in a new note. However, David thinks the recent spike in interest rates resulted in a material slowdown in debt issuance and created headwinds for mortgage banking in June. Moreover, the elevated VIX has created a choppy trading environment later in the quarter. Perhaps a correction was overdue? After increasing approximately 80% since August S&P 500 (.INX) up 19%, the universal banks have pulled back 9% over the past two weeks S&P 500 (.INX) down 4% due to volatility in interest rates and concerns regarding growth in emerging markets. Despite these macro concerns, David is optimistic but remain more cautious on names with exposure to debt capital markets and mortgage banking over the next few quarters such as JPMorgan Chase & Co. (NYSE:JPM) and Bank of America Corp (NYSE:BAC). Excerpt from the report below.
Our top idea is Morgan Stanley (NYSE:MS). We expect the quarter’s earnings to be supported by strength in equities and Global Wealth Management. Also, Morgan Stanley has less reliance than peers in FICC and DCM, which may face headwinds due to rate volatility. Near term catalysts represent purchasing the remaining stake in the MSSB JV, which is expected to increase earnings and liquidity due to acquired deposits. Finally, we believe concerns over the estimated below-peer leverage ratio may be overdone due to Morgan’s excess liquidity and de-emphasis of FICC. Also, we believe it is unlikely that the leverage ratio requirement will increase to 6%, as this level would supersede the Basel III tier 1 common requirement rather than complement it.
Estimate Revisions For JPMorgan, Citi, BAC and Goldman
JPMorgan Chase & Co. (NYSE:JPM): Maintaining above-consensus 2Q13 estimates of $1.50 per share (consensus is $1.41) due to strong ECM, loan syndication fees and reserve releases. However, due to headwinds in DCM and mortgage banking, we are lowering our 2013 by $0.04 to $5.66 and 2014 and 2015 by a nickel to $5.65 and $5.90 respectively.
Citigroup Inc. (NYSE:C): Due to lower expected investment banking fees (particularly in DCM), we are lowering 2Q13 to $1.19 (consensus $1.18) from $1.23 and full year 2013 to $4.72 from $4.81. Maintaining 2014 and 2015 estimates of $5.50 and $6.25 per share.
Morgan Stanley (NYSE:MS): We are lowering 2Q13 to $0.46 from $0.47 (consensus is $0.49) and full year 2013 to $2.04 from $2.08 due to lower FICC expectations. We are maintaining our 2014 and 2015 estimates of $2.70 and $3.15 per share, respectively.
Bank of America Corp (NYSE:BAC): We are lowering our 2Q13 estimate to $0.23 (consensus is $0.25) and full year 2013 to $0.90 from $0.92 and 2014 to $1.22 from $1.25 owing to lower investment banking and mortgage banking expectations.
Goldman Sachs Group, Inc. (NYSE:GS): Due to lower than expected Investment and Lending, trading and DCM revenues, we are lowering 2Q13 estimates to $2.75 from $3.26 and full year 2013, 2014 and 2015 to $14.40 (from $15.04), $14.72 (from $15.15) and $15.70 (from $16.00), respectively. Based on the lower estimates, we are lowering our Price Target to $165 from $170, or approximately 1.1x forward TBV.
Highlights for the Quarter
Spread Income: We expect net interest income to be up modestly linked quarter, as loan growth benefits should exceed continued modest NIM compression. However, spread income growth is expected to be less than 1% linked quarter. We expect Citi to post the best results with y/y growth of 3.2% and 0.6% growth linked quarter owing to a year-over-year improvement in NIM (2.85% versus 2.81%) due to the run-off of lower margin business in Citi Holdings. We expect core spread income to be relatively flat linked quarter for Bank of America Corp (NYSE:BAC); however, reported spread income could benefit from the increase in rates this quarter because lower premium amortization may offset hedging activity. That said, both management and the Street tend to back out the market sensitive results.
Credit: Overall, we expect net charge-offs to be fairly consistent with last quarter, with the net chargeoffs to loans ratio forecast to be down 2 to 5 basis points compared with the prior quarter. In addition, we are expecting relatively flat provision expense fro Bank of America Corp (NYSE:BAC) and Citigroup Inc. (NYSE:C) at $1.8 billion and $2.6 billion, respectively. However, we expect meaningfully lower provisions from JPMorgan Chase & Co. (NYSE:JPM) of $372 million, or approximately 20 basis points of loans. This level of provision is expected to contribute $0.23 per share in earnings through reserve releases in the quarter. Although this provision will help near term earnings and capital, it will likely be a long-term headwind to earnings growth, given normalized credit costs for JPMorgan is expected to be over 100 basis points.
Investment Banking: Although an improvement from last year, we expect investment banking revenues to be down low double digits linked quarter largely due to lower debt underwriting, given the volatility on interest rates late in the quarter. Two firms breaking that trend are Morgan Stanley (NYSE:MS) and JPMorgan Chase & Co. (NYSE:JPM). Morgan Stanley is expected to report a modest increase in investment banking QoQ due to strong advisory revenues. For JPMorgan, we expect over 8% linked quarter increase in investment banking due to strong loan syndication fees and to equity capital markets. We expect ECM to come in at $400 million, up from $273 million last quarter.
Equity Trading: Overall, we expect pretty solid results from equities, as volumes held up well compared to the prior quarter. However, given the elevated VIX and choppiness of the market during the last month of the quarter, we believe market making was more challenging than the prior quarter.
As a result, we are forecasting double digit year-over-year growth rates in equities but down 10% to 15% linked quarter. Goldman Sachs Group, Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS) continue to have the largest share in equities.
FICC Trading: Given the volatility of interest rates and of many banks’ trading results making comparisons difficult, FICC results will be very interesting this quarter. Specifically, after two months of seemingly strong results and good guidance out of JPMorgan Chase & Co. (NYSE:JPM), the market ran into significant volatility over the past few weeks, giving a decent chance that some firms will give back some