Investment Banks & COVID-19: The Third Quarter Earnings

What’s occurring?

Following the announcement of third quarter earnings this week, investors have been able to gather an understanding of the impact that the coronavirus pandemic has had on various industries throughout 2020 thus far. Interestingly, there has been encouraging news from US investment banks with players such as Goldman Sachs, Morgan Stanley and JPMorgan reporting higher than expected earnings. Most notably, whilst M&A activity has decreased, Equity Capital Markets alongside FICC trading appear to be the key business areas with the most growth.

Third-Quarter Earnings – Key Drivers

On the surface level, it appears that the large US investment banks have been able to maintain themselves and grow their business areas during the COVID-19 pandemic thus far. With almost all reporting more profit than what analysts have previously predicted the economy appears to be looking up.

One main reason behind these strong earnings is the trading arms of these investment banks. Due to the uncertainty created by the coronavirus pandemic, alongside a volatile second quarter for markets, investors have continued to make major adjustments to their investment portfolios. As a result, the banks that have been administrating the changes have been able to earn high levels of commission. In particular, the gains in the trading operations of JPMorgan, Goldman Sachs and Morgan Stanley were facilitated by an increase in both FICC trading (fixed-income, currencies, and commodities) and Equities trading. The FICC trading business has grown 4% for Bank of America, 49% for Goldman Sachs and 50% for JPMorgan. 

Another reason for the growth within investment banks is Equity Capital Markets (ECM). Bank of America has noted that its global investment bank has had the second-best quarter in its history, facilitated mostly by its 147% increase in equity underwriting fees. Likewise, at Goldman Sachs, ECM revenues were up 134% year-on-year in Q3.

The increase in ECM revenues are due to a significant increase in initial public offerings this year. Refinitiv, the information provider, has observed that global ECM activity is currently at its highest level since records began during the first nine months of 2020.  IPOs were up 26% on 2020; secondary offerings were up 78%, convertibles were up 41%. The increase in IPOs can be attributed to companies attempting to take advantage of the US stock market rally over the last few months and also the pressure placed on raising money due to the pandemic.

Finally, the loan loss provisions set aside for banks is worth considering. Loan loss provisions, set aside as an allowance for uncollected loans and loan payments, are indicators for a bank’s confidence. In the second quarter, JPMorgan Chase, Wells Fargo, Bank of America and Citigroup together took loan loss charges of $35bn, illustrating the uncertainty that was rife during the period. However, following the third quarter, loan loss provisions are much lower than previously anticipated. For example, JPMorgan only set aside $611 million instead of the anticipated $2.3 billion.

Conclusion:

Overall, it appears that investment banks are weathering the storm of COVID-19 fairly well. With already $80 billion in 2020, major US banks are underway for their first year of $100 billion worth of collective trading revenue since 2010.

However, there are some caveats worth considering before jumping to the conclusion that US banks’ earnings are past the worst of the pandemic. Firstly, as support from the government and central banks start to wither, there is an anticipated wave of bankruptcies as companies soon find that they are unable to pay their costs. This, in turn, will have a severe impact on investment banks as companies fail to pay their loans which may lead to revisions in the loan loss provisions that banks have currently set out. Secondly, it is worth considering that pure play investment banks are the ones which have benefitted the most out of the pandemic so far. Banks with a higher emphasis on consumer and business loans to make money, for example, Bank of America and Citigroup, may soon start to feel the impacts of earning less interest than before. Furthermore, if struggling clients fail to repay their loans, these banks may be faced with more difficulties.

Therefore, despite a strong set of third quarter earnings, it is difficult to determine whether investment banks will fare well for the rest of the year. With the uncertainty induced by the US Elections coming up next month, alongside potential bankruptcies and reduced government support for businesses, it is still all up in the air.

By Bobby Zhu