Goldman/Morgan Earnings Previews: Is The Goldman/Morgan Banking Model A Fading Relic?

| About: Morgan Stanley (MS)

Summary

Dodd-Frank and the regulators seem to be targeting volatility.

In terms of the financial system, there is a higher premium being put on stability and certainty.

Choose asset gatherers which have more consistent and dependable earnings results.

Goldman Sachs (NYSE:GS) the iconic, white-shoe investment banking and trading firm, and Morgan Stanley (NYSE:MS), another highbrow Wall Street investment banker, both report their respective 2nd quarter earnings in the next few weeks.

Goldman Sachs is scheduled to report its 2nd quarter 2014 earnings on Tuesday, July 15th before the opening bell, with analyst consensus expecting $3.09 in earnings per share (EPS) on $7.98 billion in net revenue, for expected year-over-year declines of 17% and 7% respectively.

Consensus estimates for GS have come down rapidly the last month, as an uneventful bond market, low volatility in all markets, and the HFT "rigged markets" scandal has attracted additional regulatory scrutiny, which I can only suspect has forced the brokers to rethink dark pools, secondary trading, and some of the traditional revenue streams.

Morgan Stanley is scheduled to report Thursday, July 17th, with analyst consensus expecting $0.56 in EPS on $8.3 billion in net revenue, for expected y/y growth of 24% in EPS on flat revenue growth.

From a generic perspective, the traditional white-show firms are expected to report decent results from the investment banking business, given the robust health of the IPO market in 2014, but trading volumes, trading activity, and regulatory hot buttons depress the "flow" or trading businesses that the old-school firms have made big money off over the years.

It is just my personal opinion, but the most telling announcement in the last year from the old-school Wall Street banking firms was Morgan Stanley stating that it would emphasize the "asset management" or asset gathering model going forward.

Personally, I think the former trading and arbitrage businesses are going to go away at the traditional banking firms, simply because these businesses will result in more volatile financial results and attract the attention of regulators.

The other telling announcement that struck me was actually made years ago by Goldman Sachs, when GS announced its exit from the proprietary trading business, which, in my opinion, will cost GS about $8-$10 per share in ongoing EPS over the next few years. (Yes, GS will still do some prop trading; you can't stop a scorpion from its stinging its prey, but the size and scope of the trading will undoubtedly be diminished, as long as these practices can be turned into media bashing and the kind of class warfare arguments that surface every election cycle.)

The trend on Wall Street seems to be towards greater stability, less risk-taking in terms of shareholder capital, more capital held against financial risks, and more transparency around client and principal trading efforts.

From Goldman's perspective, EPS peaked at $24.73 per share in fiscal 2007, whereas I think today, Goldman's core EPS is closer to $15-$17 per share in this "sub-dude" (sic) world of kinder, gentler investment banks.

Our recent earnings preview of Charles Schwab here includes our opinion that the old traditional discount brokers like Schwab (NYSE:SCHW) and Ameritrade (NASDAQ:AMTD) are the optimum financial firms over the next few years. SCHW converted to the asset-gathering, asset-management model in the early 2000s, and now has $2.5 trillion in assets under management (AUM). SCHW and Chuck don't do proprietary trading, they don't do trading that risk shareholder equity, they focus on gathering assets, which has resulted in a much more stable and consistent revenue and earnings stream, and they have a solid Single-A credit rating to boot.

From a longer-term perspective, and using the editorial platform that Seeking Alpha can be for informed investors, if you ask me what happened in the 2008 financial crisis, from a broader level, the collapse of Lehman and Bear Stearns was the almost perfect storm of the repeal of Glass-Steagall by Grahan-Leach-Bliley (GLBA), which allowed banks, and particularly brokers, to lever up, with the cancerous tumor that grew slowly, starting with the Clinton-Reno Administration and the complete abrogation of housing lending and housing credit standards as if housing values would never decline in price. (Here is a good thread from Wikipedia on this topic, which I found while researching Glass-Steagall).

To be frank, and in terms of full and fair disclosure for readers, I never would have ever suspected 2008 to get as bad as it did. The rating agencies at the time of the demise of Bear Stearns and Lehman still had the investment banks and brokers as Single-A rated at the time of their default. Even Ben Bernanke and Hank Paulson thought "the mortgage crisis was contained", when it was on the verge of breaking like an afflicted appendix. The one aspect to the 2008 subprime, mortgage and banking crisis that tends to get overlooked is that we saw the first national decline in housing prices in the post-World War II area. Basically, a 60-to-70 year housing bull market came to an end.

To conclude, I think Goldman, Morgan Stanley, and JPMorgan (NYSE:JPM) are going to strive for consistent, dependable, less volatile revenue and earnings streams over the next few years, both from a regulatory and shareholder perspective. Firms like Schwab and Ameritrade are way ahead of this curve.

We would buy GS under tangible book value of $140 per share, and we haven't owned any MS for anything other than a trade in the last few years, given the shareholder dilution from Mitsubishi (OTCPK:MBFJF).

We are long JPMorgan, since JPM has a broader-based model which encompasses both the traditional commercial banks and investment banking models, which really means Jamie Dimon has his hands tied by both the Fed and Congress and the Attorneys General. Jamie is having double the fun, at twice the cost.

And one last aspect to consider: a change in Congress in November, to a more aggressive, pro-business, pro-"wealth creation" environment might loosen the "genital cuff" (think Dirty Rotten Scoundrels with Michael Caine and Steve Martin) that the regulators and the Attorneys General have around the traditional Wall Street firms today.

I don't think we'll ever return to the late 1990s-type Wild-West risk-trading by the old brokers, but I do think there is some room for trading and risk-trading to grow under the right circumstances and macro environment.

Disclosure: The author is long SCHW, JPM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.