The banking sector had a difficult time since the collapse of several banks in early March. Now analysts and investors are turning their attention to first-quarter earnings, which will kick off on Friday with JPMorgan Chase (JPM 1.94%).
While some of these earning reports will provide some additional confidence to the sector, most banks do face a difficult time and that will be reflected. Deposit costs are likely to rise, squeezing bank margins, and banks may need to raise their provision for credit losses, depending on their outlook for the economy and how credit quality is holding up.
Still, there's one part of bank earnings, primarily for the larger banks, that could come in stronger than expected. Let's take a look.
Trading could help
Large megabanks like JPMorgan Chase, Bank of America (BAC 2.06%), and Citigroup (C 3.06%), as well as Morgan Stanley (MS 1.58%) and Goldman Sachs (GS 3.30%), have sizable investment banking and trading operations. These operations helped offset some of the pain these banks felt in their consumer and business banking divisions during the brunt of the pandemic, and this may be the case again in the first quarter. That's because trading businesses tend to benefit from volatility as investors reposition their portfolios, which results in more trading activity.
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Investment banking, which includes business segments such as mergers and acquisitions (M&A) and advisory as well as equity and debt underwriting, will likely continue to struggle because the market for initial public offerings is sluggish and M&A has slowed as well. Analysts at Oppenheimer believe investment banking revenue could be down an average of 40% in the first quarter on a year-over-year basis.
But trading could end up being a bright spot because of the volatility that hit the markets in March, stemming from the banking crisis.
"It's going to be a tale of two cities on the investment-banking revenue. Investment-banking fees [will be] down quite a bit, but trading revenues may be up on a year-over-year basis but certainly not down as much as investment banking," RBC Capital Markets analyst Gerrard Cassidy said during a recent interview with Yahoo! Finance. Trading revenue was also incredibly strong in Q1 2022, so being up year over year would be great.
This narrative was bolstered after the smaller investment bank Jefferies Financial Group (JEF 3.23%) reported Q1 earnings on March 28. Jefferies' first quarter of the year goes from the end of November to the end of February, so investors usually view it as a good indicator of what the larger investment banks may report.
Jefferies' investment banking revenue in the first quarter ending Feb. 28 came in slightly higher from the prior quarter, but was down about 49% year over year. Meanwhile, capital markets revenue jumped 33% year over year and was also up about 34% from the prior quarter. Remember, this does not include March. Fixed-income trading jumped the most, but equities trading rose as well.
Stephen Biggar, an analyst at Argus Research, recently told Reuters that trading "can either turn out to be lucrative or unprofitable for some banks depending on the key positions that they have taken."
The large banks win again
Better trading revenue will certainly benefit the largest banks more than community and regional banks. Some of the super regionals have investment banking and trading businesses, but it's nowhere near the size and scale of the largest banks like JPMorgan and Goldman Sachs.
This represents yet another way the large banks currently have an advantage over regional banks, and is also a potential reason why these stocks are less risky right now in the sector. The megabanks are viewed as a plight to safety, and they also have more diverse revenue streams at a time when typical loan-and-deposit spread income is likely going to come under pressure.
