Goldman Sachs and Morgan Stanley are set to triumph over their Main Street rivals in the second quarter as the pair of investment banking powerhouses benefited from surging trading revenues and advisory fees.

Frenzied trading around the coronavirus crisis has boosted markets revenues, while Goldman and Morgan Stanley have also profited from their limited exposure to the widespread loan losses stemming from the pandemic that are sweeping through the global banking sector.

JPMorgan Chase, the world’s biggest investment bank by revenues, kicks off the earnings season on Tuesday. It has already predicted a 50 per cent year-on-year rise in its markets revenues for the second quarter, with fixed-income trading outperforming equities even during a period when daily US equity trading volumes surged 90 per cent as clients scrambled to reposition their portfolios.

Amrit Shahani, research director at industry monitor Coalition, said banks would also be helped by a reversal of some of the markdowns they took on some trading assets in the first quarter, particularly in areas such as US municipal bonds where a buying spree by the Federal Reserve had boosted prices. “That’s going to be a big ticket,” he said of the potential for valuation gains on banks’ holdings.

All of this sets the scene for the second consecutive quarterly bonanza for trading businesses, marking a welcome turnround for divisions that fell out of favour after the financial crisis because of their high capital costs and risky profiles.

Despite a collapse in mergers in acquisitions, investment banks enjoyed record fees, driven by lucrative debt sales as companies sought cash to tide them through the crisis.

Column chart of Year-to-date global investment banking fees ($bn) showing Investment banking fees hit a record in the first half of 2020

As a result of these trends, in the past month analysts have increased second-quarter net income forecasts for Goldman and Morgan Stanley by about a fifth, according to data submitted to Bloomberg. Their businesses have the highest relative exposure to investment banking and trading.

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While JPMorgan, Bank of America, Wells Fargo and Citigroup also have big investment banks, any gains there will probably be overshadowed by another bumper quarter for loan losses as lenders continue to brace for the cost of defaults in the deepest global recession in peacetime.

Analysts surveyed by Bloomberg expect these four banks to record collective loan-loss provisions of $24.6bn in the second quarter, beating the first quarter’s $24bn to set a new post-crisis high for charges to cover future losses. However, this is still far lower than the $40.1bn of provisions the group booked in the second quarter of 2009.

Bar chart of Loan loss provisions in $m  showing America's big lending banks expected to post higher loan losses

Main Street banks are also being hammered by a fall in core lending margins after the Fed cut interest rates to zero in mid March to relieve some of the economic devastation wrought by the coronavirus pandemic.

Analysts at Barclays said net interest margins — the gap between a bank’s borrowing costs and lending rates — would show the steepest contraction since the first quarter of 2009 for the three months to end June.

Shares in the KBW US banks index have fallen about 43 per cent this year. Wells Fargo, which is considering cutting thousands of jobs, is down 55 per cent, the most of any big bank.

The higher loan charges stem partly from new accounting standards requiring banks to create provisions based on a quarterly assessment of a loan’s lifetime losses. Those estimates are heavily influenced by banks’ economic forecasts, which have worsened since the first quarter.

Still, bank insiders said the figures obscure the true potential distress in their loan books, because banks have agreed payment holidays and other forbearance measures with borrowers who might otherwise have defaulted.

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Risk managers are trying to understand the long-term outlook for those borrowers and for customers whose incomes are being propped up by special government unemployment payments or the Paycheck Protection Programme. This initiative has given small businesses $520bn of free money that can be used to keep employees on their books through the crisis.

Marty Mosby, an analyst at Vining Sparks, said those supports were a key reason for the “dichotomy” between rising loan-loss provisions and the small level of actual write-offs that banks are expected to post for the quarter. “There’s that shock that’s hit the economy, and we don’t know what the ripples are going to be yet,” he added.

Loan-loss charges are the biggest driver in a significant fall in net income expected across the big lending banks for the three months ended in June.

Bar chart of % fall in Q2 net income versus a year earlier showing US banks expected to post big fall in Q2 net income

Wells Fargo is expected to experience the biggest hit to its profit, as $4.2bn of predicted loan losses drives it down by more than 99 per cent, to just $9.5m. The bank is cutting its quarterly dividend to stay on the right side of new Fed rules aligning payouts to earnings.

Bank of America is the least affected, with profits predicted to fall less than 60 per cent to $2.9bn, after $5.3bn of loan losses.

Additional reporting by Eric Platt in New York

Via Financial Times