A Prime-Brokerage Premium for Morgan Stanley, Goldman and J.P. Morgan

Fixed-income was the clear star of bank earnings season. But something interesting happened over in equities.

Instead of the across-the-board gains seen in fixed-income, the Wall Street pack was split on stock trading. Morgan Stanley, Goldman Sachs Group and J.P. Morgan Chase & Co. increased equities revenue by 6%, 2% and 1%, respectively.

At Bank of America Corp. and Citigroup, equities revenue declined by double digits, 34% in Citi’s case.

What unites the winners? They have the top three U.S. prime-brokerage businesses by revenue, according to financial-data firm Coalition. Those are the units within banks that cater to hedge funds, executing their trades, lending them money and helping to introduce them to investors.

It has become one of the less-attractive businesses on Wall Street because of the heavy capital charges it incurs.

But prime brokerage helped Morgan, Goldman and J.P. Morgan stand out in what was overall a blah quarter for equities trading, executives and analysts say. The reason, somewhat counterintuitively, is the recent rough spell for hedge funds.

Most hedge funds use one or two main prime brokers, with which they typically hold credit lines and custody their shares. They dole out smaller slices of business to two or three others.

Poor performance this year has reduced trading activity at many hedge funds. What little trading they’re doing, they seem to be sending to their top broker, which means the leaders are growing their market share.

“If a hedge fund is cutting back in its dealings with the Street, they’re going to make sure they feed their No. 1 prime broker first,” said Brennan Hawken, an analyst who covers banks for UBS AG.

Morgan Stanley and others have also likely benefited from troubles at European rivals like Deutsche Bank, which is a large player in prime brokerage.