The dark side of the big banks' earnings surge

As the third-quarter earnings season trudges on, the highlight so far has to be the big banks. After years of paying for financial crisis-era sins, dealing with increased regulatory overnight and slashing headcounts, earnings are surging.

Not because of steady, low-risk activities like mortgage lending, but because of a return to form for riskier, big-bet trading. This has eclipsed concerns from earlier in the year about bank lending to vulnerable, high-cost U.S. shale oil companies. With OPEC flirting with a deal to freeze output, the focus has shifted and sentiment reversed.

While that’s great for bank stock investors who are enjoying upside surges, the reappearance of risky bets (and even larger balance sheets vs. precrisis levels) is a sad reflection of government officials’ inability to rein in an industry that nearly trampled the broader economy just eight years ago -- and threatens it anew now.

You can see the excitement underway with breakouts in stocks like Morgan Stanley (MS), Goldman Sachs (GS) and Bank of America (BAC), among others, that are pushing to levels not seen since late last year. From their February low, Morgan Stanley shares are up more than 57 percent. Goldman’s are up 27 percent. And BofA’s are up 50 percent.

On Wednesday morning, Morgan Stanley reported a top- and bottom-line beat with earnings of 81 cents per share (vs. 64 cents expected) on revenues of $8.91 billion (vs. $8.24 billion expected). Revenue from fixed-income, currency and commodities trading (or “FICC,” in Wall Street terminology) jumped to $1.5 billion from $583 million a year ago. Equity trading revenue was largely unchanged.

FICC is probably the single riskiest area for Wall Street banks to focus on because of the inherent volatility of the assets traded. The recent moves in the British pound, as traders digested the surprise Brexit event, is a case in point. As are the ongoing ups and downs in crude oil.

On Tuesday, Goldman similarly blew out expectations with earnings of $4.88 per share (vs. $3.86 estimated) on revenues of $8.2 billion (vs. $7.6 billion expected). FICC revenues grew 34 percent from last year to nearly $2 billion, while overall investing and lending revenue jumped 109 percent to $1.4 billion.

And on Monday, BofA reported better-than-expected results, with earnings of 41 cents per share (vs. 34 cents expected) on revenues of $21.6 billion (vs. $20.8 billion expected). Total global market sales and trading increased 14 percent from last year to $698 million.

To be sure, tighter standards have been proposed or implemented including the “Volcker Rule” under the Dodd-Frank Act and the new Basel III global standards for capital reserves. The former is designed to cull risky, speculative trading that a bank makes for its own account using customer deposits. The latter is about increasing a bank’s “capital buffer” to protect it from market declines and economic recessions.

But the industry is pushing back.

In August, Wall Street banks asked the Federal Reserve for a further five-year delay to comply with the Volcker Rule, so named for former Federal Reserve chairman Paul Volcker who proposed it to President Obama back in 2009. In September, European banks told the Basel Committee on Banking Supervision that new reforms to tighten how balance-sheet risk is measured must be scaled back or slowed down. Asian banks have echoed this sentiment as well.

Until another crisis increases the political pressure to act, the promise of higher stock prices and boosted financial-sector earnings will likely give the big banks the reprieve they want. 

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.