U.S. stock underwriting was the sole strong business in an otherwise bleak first quarter for U.S. investment banks.

Both Goldman Sachs Group Inc and Morgan Stanley are expected to report lower first-quarter earnings next week compared with the same quarter a year ago.

Revenue from trading, merger advisory and bond underwriting is expected to be weak as markets were choppy, relatively few mergers closed, and debt issuance declined relative to exceptionally strong levels a year ago.

Unfortunately for investment banks, stock underwriting is too small a business to make up for weakness in all these other areas.

Longer term, banks face other pressures, too. Trading profit could be crimped in the future as more markets move to exchanges and clearinghouses. And new rules will limit banks' ability to make bets with their own funds.

The greatest strategic challenge facing Goldman Sachs and Morgan Stanley, says Bernstein analyst Brad Hintz, is the uncertainty of new regulations.

But in the first quarter, banks did well with stock underwriting, thanks in part to massive initial public offerings from private equity firms looking to cash out of companies they bought before the financial crisis.

In the first three months of the year, companies issued $196.3 billion of stock globally, the best first quarter for equity issuance on record, according to Thomson Reuters data. Issuance volume rose 15 percent from a year earlier, and fees for underwriting increased 12 percent to $6.1 billion.

That helps banks, but only so much -- the stock underwriting business delivered just 7 percent of overall revenue for Goldman Sachs last year, and Goldman was the biggest underwriter. The business was even less substantial for Morgan Stanley, whose equity underwriting revenue comprised just 4.6 percent of its total revenue for 2010.


Stock underwriting could end up being a material part of earnings in the first quarter just because so many other businesses were relatively weak. Goldman raked in an estimated $491 million of fees from stock underwriting, Thomson Reuters data show, up 41 percent from a year earlier.

Analysts on average expect Goldman to report first-quarter net income of $459.5 million, or 81 cents per share, according to Thomson Reuters I/B/E/S. Even without a charge of $2.80 per share to buy back Goldman preferred stock from Warren Buffett's Berkshire Hathaway, that's well below earnings of $5.59 per share in the year-ago period. Goldman is slated to report results on Tuesday, April 19.

Morgan Stanley, scheduled to post results on Thursday, April 21, will see a boost from its role as lead underwriter for the conversion of $59 billion worth of American International Group Inc preferred stock into common shares.

Results for both investment banks could be even worse than analysts expect. Sell-side researchers with the best track records are forecasting results for Morgan Stanley that are 22 percent below analysts' average estimate, and 0.2 percent below for Goldman Sachs, according to Thomson Reuters Starmine Smart Estimates.

A key factor for Morgan Stanley will be how well its Morgan Stanley Smith Barney joint venture with Citigroup Inc performed during the quarter. Morgan Stanley Chief Executive James Gorman has staked the future of the bank on that wealth management business in a way that none of his rivals have.

Morgan Stanley's global wealth management division delivered $1.2 billion in pre-tax income last year, more than double the amount in 2009, and some investors are hopeful the business will continue to be a stable source of revenue.

JPMorgan Chase & Co garnered the most fees of any investment bank in the first quarter thanks to its advisory role in several key deals and its dominance in the high-yield debt market.

JPMorgan collected $1.4 billion in investment banking fees, or 6.2 percent of the industry total. It reported impressive results as other banks struggled to dodge unexpected interest rate moves.

JPMorgan is scheduled to report quarterly results on Wednesday, April 13.

(Reporting by Lauren Tara LaCapra; editing by John Wallace)