Into the heart of Q3 earnings# Stock
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The Finance sector gave us a decent start to the Q3 earnings season, with
improved investment banking revenues (both trading as well as advisory
services) helping offset some of the challenges in the core business. There
weren’t many surprises on the net interest margin, mortgage lending and
loan growth fronts – these have been weak spots for a while and we saw more
of the same in Q3 as well.
What came as a pleasant surprise were signs of modest improvement in
advisory and trading revenues, with the latter benefiting from the increased
market volatility towards the end of the quarter. This has raised hopes
that the steady decline in trading volumes and revenues over the last few
years isn’t reflective of an enduring shift in the industry’s dynamics as
a result of regulatory changes, but rather a function of the extremely
subdued levels of market volatility. Given the extreme volatility in the
current period, it will be interesting to see if Q4 trading results will
show a similar improving trend.
Total earnings for the 22 Finance sector companies that have reported
results already (out 80 total in the S&P 500 index) are down -2.9% on +4.9%
higher revenues, with a weak 50% beating earnings estimates and 45.5% coming
ahead of top-line expectations. Please note that these 22 Finance sector
companies combined account for 47% of the sector’s total market
capitalization and include all of the major banks and brokers.
The table below gives the sector’s scorecard at the constituent industry
level. As you can see, the earnings season is quite further along for the
two major industries in the sector – Major Banks and Investment Brokers/
Managers.
This is weak growth and beat ratios in Q3 relative to what we have been
seeing from the same group of 22 companies in other recent quarters, as the
charts below show.
The lower ratio of positive surprises for the Finance sector in Q3 thus far
is worrisome, though the sub-par earnings growth pace in the quarter is
solely due to the huge Bank of America (BAC) charge. The comparative growth
picture improves materially once Bank of America is excluded from the data,
as the chart below shows
The market’s negative response to otherwise decent banking results likely
reflects the recent sharp slide in treasury yields, which makes the
operating environment extremely difficult for the group to navigate. Low
interest rates squeeze net interest margins that forces banks to make their
earnings numbers primarily through cost cuts. Consensus estimates for the
current and coming quarters reflect steady improvement in the ‘core’
business.
It wouldn’t be much of a problem if the current downtrend in yields turns
out to be a temporary phenomenon. But if rates remain low for longer or
start moving even lower (with some calling for the 10-year treasury yield to
go to 1.5% in the not-too-distant future), the forward estimates for the
sector remain at risk of significant negative revisions. The reason for that
is current consensus estimates for the sector reflect a fair amount of
improvement in the ‘core’ banking business, which can only happen if net
interest margins start expanding as a result of rising interest rates.
The chart below shows consensus earnings growth expectations for the Finance
sector as a whole in the coming quarters. Please note that the +4.2%
earnings growth expected in Q3 is the composite growth rate for the sector,
meaning a blend of the 22 sector companies that have reported results and
estimates for the still-to-come 58 companies.
improved investment banking revenues (both trading as well as advisory
services) helping offset some of the challenges in the core business. There
weren’t many surprises on the net interest margin, mortgage lending and
loan growth fronts – these have been weak spots for a while and we saw more
of the same in Q3 as well.
What came as a pleasant surprise were signs of modest improvement in
advisory and trading revenues, with the latter benefiting from the increased
market volatility towards the end of the quarter. This has raised hopes
that the steady decline in trading volumes and revenues over the last few
years isn’t reflective of an enduring shift in the industry’s dynamics as
a result of regulatory changes, but rather a function of the extremely
subdued levels of market volatility. Given the extreme volatility in the
current period, it will be interesting to see if Q4 trading results will
show a similar improving trend.
Total earnings for the 22 Finance sector companies that have reported
results already (out 80 total in the S&P 500 index) are down -2.9% on +4.9%
higher revenues, with a weak 50% beating earnings estimates and 45.5% coming
ahead of top-line expectations. Please note that these 22 Finance sector
companies combined account for 47% of the sector’s total market
capitalization and include all of the major banks and brokers.
The table below gives the sector’s scorecard at the constituent industry
level. As you can see, the earnings season is quite further along for the
two major industries in the sector – Major Banks and Investment Brokers/
Managers.
This is weak growth and beat ratios in Q3 relative to what we have been
seeing from the same group of 22 companies in other recent quarters, as the
charts below show.
The lower ratio of positive surprises for the Finance sector in Q3 thus far
is worrisome, though the sub-par earnings growth pace in the quarter is
solely due to the huge Bank of America (BAC) charge. The comparative growth
picture improves materially once Bank of America is excluded from the data,
as the chart below shows
The market’s negative response to otherwise decent banking results likely
reflects the recent sharp slide in treasury yields, which makes the
operating environment extremely difficult for the group to navigate. Low
interest rates squeeze net interest margins that forces banks to make their
earnings numbers primarily through cost cuts. Consensus estimates for the
current and coming quarters reflect steady improvement in the ‘core’
business.
It wouldn’t be much of a problem if the current downtrend in yields turns
out to be a temporary phenomenon. But if rates remain low for longer or
start moving even lower (with some calling for the 10-year treasury yield to
go to 1.5% in the not-too-distant future), the forward estimates for the
sector remain at risk of significant negative revisions. The reason for that
is current consensus estimates for the sector reflect a fair amount of
improvement in the ‘core’ banking business, which can only happen if net
interest margins start expanding as a result of rising interest rates.
The chart below shows consensus earnings growth expectations for the Finance
sector as a whole in the coming quarters. Please note that the +4.2%
earnings growth expected in Q3 is the composite growth rate for the sector,
meaning a blend of the 22 sector companies that have reported results and
estimates for the still-to-come 58 companies.