Despite the increased volatility we've witnessed in the market over the past few months, broker-dealers appear to have come through the second quarter with flying colors (see Stephen Simpson's account of JPMorgan Chase's (NYSE: JPM ) Q2 earnings). Merrill Lynch (NYSE: MER ) is no exception -- on Tuesday, it reported net earnings of $1.6 billion, for diluted earnings of $1.63 per share versus a consensus estimate of $1.52 per share last year, a 43% increase. Let's break those numbers down by business (all percentage increases reflect changes versus the year-ago quarter).
Global Markets and Investment Banking had record net revenues of $4.6 billion and pre-tax earnings of $3.1 billion, up 33% and 38%, respectively. These results were driven by the Equity Markets business, which grew net revenues 84%.
Global Private Client, the firm's brokerage division, posted a 19% increase in net revenues to $3 billion and a 53% increase in pre-tax earnings to $701 million, reflecting its high operating leverage. Importantly, fee-based revenues, which are recurring, now make up over two-thirds of division revenues. Total client assets in GPC accounts now stand at $1.5 trillion, up 11%.
Merrill Lynch Investment Managers, the firm's asset management division, also posted strong results, as it prepares for its pending merger with Blackrock (NYSE: BLK ) .
For my money, Merrill Lynch is a well-managed firm that has built a set of good businesses methodically, and this quarter looks like it validates that view. But are there any chinks in Merrill's armor? Well, for one, the numbers underscore the increased emphasis at top investment banks on activities in which they act as principal (trading for their own account and private equity investing). The Global Markets & Investment Banking division's stellar performance was largely due to a threefold increase in revenue from its private equity investments, including Hertz. Private equity is a very profitable business, but the timing for realizing gains is uncertain and heavily linked to the health of the IPO and M&A markets. Investors must accept that these profits are lumpy -- looking at this quarter in isolation would give a skewed view of the firm's true earnings power.
Furthermore, private equity investing poses the risk of conflicts of interest with investment banking clients. Goldman Sachs (NYSE: GS ) , the investment bank with the largest presence in private equity, is widely admired for the skill with which it manages these conflicts. Nevertheless, even Goldman has come under criticism in this area.
Still, nearly all of Merrill's business lines showed strength and the firm seems to have navigated smoothly through a choppy market. That ought to keep investors running with this bull for now.
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Alex Dumortier
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