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Depressed volatility poised to sway broker/dealers' Q3 results, analysts say


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Depressed volatility poised to sway broker/dealers' Q3 results, analysts say

Volatility in the stock market continued to bottom out in the third quarter, presenting a possible hurdle for some broker/dealers' earnings results, according to industry analysts.

While the geopolitical landscape is filled with "constantly shifting" headlines, trading activity in the markets has stagnated throughout 2017, a duality that Keefe Bruyette & Woods analyst Ann Dai called "a tale of two cities" in an Oct. 5 earnings preview.

"[The low levels of volatility is a result of] a lack of catalysts," she said in an interview. "There's not this giant bubble you can point to and say, 'Well, that's going to drive market dislocation.'"

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Implied volatility, as measured by CBOE's VIX, fell 32.26% in the first three quarters of the year, dropping 14.94% in the third quarter alone.

As broker/dealers report their quarterly results, the lack of volatility could negatively impact the results of trading-focused companies like Virtu Financial Inc.

In 2017, market makers like Virtu have been operating in what CEO Douglas Cifu previously called a "terrible environment." In an attempt to diversify its business, Virtu acquired KCG Holdings LLC to tap into its legacy client segment.

But Virtu will likely still be plagued by the sluggish trading activity, according to Sandler O'Neill & Partners LP analyst Richard Repetto, who expects to see year-over-year declines in revenue and some margin contraction from the acquisition. In an Oct. 16 earnings preview, Repetto lowered his expectations for Virtu's third-quarter EPS to 4 cents from 16 cents.

Broker/dealers with institutional equities businesses, such as Raymond James Financial Inc. and Evercore Inc., could also be susceptible to weakened trading activity, said KBW's Dai.

For Evercore, the lack of volatility is expected to play a considerable role in the quarter. Citing expectations for the institutional equity business and advisory space, Dai lowered her third-quarter EPS estimate for Evercore to $1.01 from $1.04 and her 2017 EPS estimate to $4.99 from $5.05.

Institutional equities makes up only a small fraction of Raymond James' total operations. Still, the company along with fellow retail brokers like LPL Financial Holdings Inc. and Stifel Financial Corp., could see gains in the quarter thanks to higher asset prices and the Federal Reserve's June rate hike, according to JMP Securities analyst Devin Ryan's Oct. 9 earnings preview.

Conversely, the lack of volatility in the markets could provide a boost for M&A brokers as companies are more likely to make deals in an environment with fewer market swings, Dai said.

While Dai expects most M&A brokers to have strong quarters, they are also facing high comparisons from the second quarter, which could lead to some sequential declines, she said. In a note to clients, she attributed a sequential decline in transaction activity to a lack of "mega-deals" in the space.

Advisory broker Greenhill & Co. Inc. on Oct. 18 reported a net loss allocated to common stockholders of $5.9 million, down from net income of $13.1 million in the year-prior period. The company saw advisory revenues plunge to $48.1 million in the third quarter from $76.5 million a year earlier.

"For a variety of probably completely idiosyncratic and somewhat random reasons, we've not had that many M&A deals of size get to announcement this year," Greenhill CEO Scott Bok said on a third-quarter earnings call.

Still, volatility is not the only remnant from the first half of the year expected to linger around third-quarter earnings.

Since President Donald Trump took office, many companies have clung to the hopes of tax reform as the market generally believes it could provide a bump to many companies' earnings, according to JMP's Ryan.

"Since the election, expectations for positive developments out of Washington D.C. have waffled," he wrote in a note. "If tax reform moves forward, we think the direct earnings implications for many would be significant."

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