Second-Half Outlook: Finance

After a spectacular first half of the year, banks and brokerages will likely see somewhat less dazzling but still strong results

After logging some of their best results ever in the first half, banks and brokerage firms are likely to see some slowing in growth for the rest of the year. Rising rates and a likely seasonal pause in public offerings and dealmaking, along with continuing uncertainty in the stock markets, could dampen gains.

Some of the powerhouse brokerage firms, such as Goldman Sachs (GS) and Lehman Brothers (LEH), have already seen slight declines in their earnings growth between the first and second quarters of this year. As they enter the traditionally slower summer stretch—historically a cool period for initial public offerings and deals—the gains are expected to slow.

" We think they will continue to have respectable earnings, but probably less than the first and second quarters," says Standard — Poor's senior analyst Tom Foley. He hastens to add that year-over-year gains could still be modestly higher than during the second half of last year, even as they cool compared with the first half of 2006. Blame rising rates, the uncertain market, and wider spreads in credit markets.

The same forces are likely to scale back the growth rates for commercial banks. The housing slowdown is already pinching their lending operations, as is a higher cost of funds, says Foley. S—P expects "less robust" gains over the rest of the year. Anticipating the slower pace of gains, investors have knocked a couple dollars per share off the stock price of Citigroup (C), for example, which now trades at about $48, down from a 52-week high of nearly $51 in May.


  Happily for the whole finance sector, hints that the Federal Reserve may take a break in raising interest rates are putting a bit more verve into the markets. The Fed boosted rates for the 17th consecutive time on June 29, hiking the short-term rate target a quarter-point, to 5.25%. But it did not suggest, contrary to past practice, that another hike might be in the offing.

Uncertainties about whether the economy can continue to operate at a turbocharged rate have been clouding the markets that the financial sector depends on. As a result, some of the big investment houses have been relying on areas other than investment banking for their growth. Derivatives such as futures contracts, for instance, have been engines for several of the firms, as companies try to reduce their risks in the uncertain markets with hedges of all sorts.

Some analysts, who have been bullish for months on the financial giants, believe skittish investors have avoided them—even as the results have continued to shine—out of fears that the uncertainties will eventually slam their growth rates. The firms have continued to prove pessimists wrong. Jeffery Harte, an analyst with Sandler O'Neill & Partners, expects the gains to keep coming "as long as the economic growth keeps chugging along."


  But odds are that the pace won't be quite as breakneck as it has been. It will be tough for Morgan Stanley (MS), for instance, to duplicate the 25% gain it posted in net income between the first and second quarter of this year.

On June 21 the firm reported fiscal second-quarter net income of $1.96 billion, up 111% from a year ago on a net revenue rise of 48% from the same period last year, to $8.9 billion. No wonder Chief Executive Officer John J. Mack said, "I could not be more pleased."

Now even Morgan's own officers are showing a bit of caution. David Sidwell, chief financial officer, warned in a conference call in June that the firm's second half historically tends to be weaker than the first. Even investment bankers like to get out of the office in the summer.

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