Big bank reporting season kicks off with a bang

| January 16, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Bank earnings kicked off with a bang thanks to a strong recovery in FICC. Results of all six big money center banks were largely positive and final equity reactions punctuated a very impressive three month stretch in share returns. Credit recommendations include waiting for further weakness in Wells Fargo spreads before moving to an overweight, and a continued preference for Morgan Stanley debt over Goldman Sachs despite a modest pick in spread.

Banks rapidly began tapping the capital markets to begin funding their sizable maturities of $160 billion in 2020 and $193 billion in 2021. This should keep US bank gross issuance levels relatively high in the months ahead; but expectations for net issuance remain much lower, possibly even crossing over into negative territory this year or next. Initial activity as the biggest banks exit blackout periods was concentrated in preferred debt classes, including $1.5 billion Citi PerpNC5 4.7%, $3 billion JPM PerpNC5 4.6%, $1.75 billion WFC PerpNC5 4.75%. Subsequent issues have spread into more traditional senior deals across short and intermediate maturities, like $6 billion MS 11NC10s and 3NC2s, €3 billion GS 3NC2 and 10-years. This certainly is not all that should be expected early. Last year the banks wavered a bit immediately following 4Q earnings; but tapped the market aggressively in the weeks that followed, maintaining their recent behavior of front-loading maturity funding in January through April.

US Bank Earnings 4Q19 Recap

JP Morgan (JPM: A2/A-/AA-) delivered an unquestionably strong quarter on the shoulders of an outstanding performance in Fixed Income (FICC) trading. EPS of $2.57 topped the $2.36 consensus estimate, and shares Granted, YoY performance in FICC versus last year’s comps in an absolutely abysmal 4Q18 industry-wide were going to be an easy fix for the big banks this year, but JPM shattered expectations ($2.4 bn est) with an +86% YoY gain to $3.45 bn. Putting the revenue number into better context, the bank generated $3.56 bn in the prior quarter, which doesn’t compare seasonally, but supports the narrative that JPM FICC executed extremely well in 4Q19. JPM’s FICC results not surprisingly became the standard bearer for the quarter. Equity Trading saw a more measured +14.5% gain to $1.51 bn. I-banking was up +6%, as modestly better underwriting results helped offset the drop-off in M&A activity. Traditional banking results were reflective of the broader economy with modest loan growth overall, while stronger card lending reflected the still strong consumer.

Bottom-line: Investors could nitpick but the proof is in the numbers. The franchise remains at the top of the industry.

Wells Fargo (WFC: A2/A-/A+) was likely to deliver a more mixed bag than the rest of the peer group – not just because they wouldn’t be able to post gaudy gain in FICC or Equities trading for 4Q1, but also given  the uncertainty of how new management would choose to approach their first reporting period at the helm. Oddly, the headline results almost identically matched the prior quarter: 4Q19 EPS was $0.93 vs $1.11 estimates (3Q19 was an EPS miss of $0.92 vs the $1.13 consensus), negatively impacted by $1.5 bn in litigation accruals (WFC took a $1.6 bn charge related to litigation expenses in 3Q19). Also in the mix was a +24% YoY increase in credit losses to $644mm. Combined, the added expenses pushed the Efficiency Ratio (all-in costs-to-revenue%) from 64% to 79% – which while temporary, is still unnerving given the industry-wide efforts to tamp to expenses over the past decade, and peers that are pushing the metric all the way down to the low 50s. New CEO Charlie Scharf, just under 100 days on the job, is wisely doing some early clean-up rather than focus on bottom-line results and equity market expectations.

Bottom-line: Still a lot of work left to do in repairing WFC’s severely bruised reputation, but investors should remain buyers of WFC credit on any hint of earnings or headline related weakness (unfortunately little to speak of so far). WFC’s share price is modestly weaker on the report. The cost issues are disappointing, but appear to be a priority for management. Net Interest Margin (NIM) declined 12 bp as a result of the higher costs as well as persistent rate pressure, so the company needs to do a better job regardless of whether rates/yield curve remain stubbornly low/flat. Despite lengthy challenges and long-term solutions, still not enough weakness in WFC spread (Exhibit 1) to justify an overweight relative to peers (Exhibit 1).

Exhibit 1: JP Morgan and Wells Fargo debt spreads

Source: Bloomberg/TRACE G-spread Indications, Amherst Pierpont Securities

 Citigroup’s (C: A3/BBB+/A) 4Q19 earnings were probably the least interesting of the first day’s results, but that’s not necessarily a bad thing. EPS of $2.90 beat the $2.37 estimates, but top-line revenue grew just +7%, more reflective of the somewhat aggressive buybacks that helped bring the share count down in the quarter. Like JPM, FICC trading revenue recovered from the prior year period and exceeded expectations (just not by the same order of magnitude), up +49% year-over-year to $2.90 billion (-10% quarter-over-quarter). Equity trading however was down -23% year-over-year, which management ascribed to some wrong-way derivatives trading, while I-banking saw moderate gain of +6% to $1.35 billion. NIM and efficiency ratio both improved modestly from the prior quarter despite higher credit costs.

Bottom-line: Not “JPM good,” but certainly good enough. Shares are trading up in response. Maintain a preference for Citi senior paper in the intermediate part of the curve (Exhibit 2), and subs to the extent they become source-able.

Exhibit 2: Bank of America and Citigroup debt spreads

Source: Bloomberg/TRACE G-spread Indications, Amherst Pierpont Securities

Bank of America’s (BAC: A2/A-/A+) was also among those that might be considered at the lower-end of this quarter’s overwhelmingly positive earnings from big banks were BAC’s 4Q19 results. BAC reported EPS of $0.74, which beat the $0.69 consensus, and represented a -4% decrease in earnings but an uptick in EPS on share reduction since last year. Top-line net interest income also declined year-over-year to $12.3 billion, but did come in above analysts’ consensus expectation. In trading activity, BAC saw a +25% gain in FICC revenue year-over-year to $1.8 billion, among the softer increases from the weak 4Q18 vs peers, which also represented a fairly substantial -11% drop from the prior quarter. Equities trading revenue was down -4% from last year, and also off about -11% from the prior quarter. I-banking fees were up +9% year-over-year to $1.5 billion. Looking at the cost picture of traditional banking, net charge-offs increased year-over-year, which drove up the efficiency ratio to 59% from 57% in the prior three quarters (and 1 bp from 4Q18). New interest yield was expectedly down versus 4Q18, and loan growth was modest and in-line with the broader peer group at +6%.

Bottom-line: Overall result was pretty ho-hum, especially in the context of some of the massive gains in trading revenues that provided better top-lines across the industry. Still, there’s nothing here negative enough to move the needle on credit, nor should investors see this as any reason to change weightings versus the group.

Goldman Sachs (GS: A3/BBB+/A) For the second consecutive quarter, if there was a name among the group that qualified as a “loser” among the largely positive results, it was Goldman Sachs. GS once again missed EPS estimates with $4.69 vs the $5.52 consensus, despite the $9.96 billion net revenue handily beating the high end of top-line estimates ($8.94 billion). The miss was driven by the $1.1 billion legal charge related to the 1MDB scandal – a factor that can hardly be seen as a surprise and one that remains a critical overhang to GS going forward, as the prospect for additional settlements and potentially deeper findings from various regulatory bodies globally. Looking at FICC, which seemed to be the biggest determinant of success for the big banks once again: GS reported revenue of $1.77 billion in 4Q19, which was up +63% from a particularly weak 4Q18. This year-over-year gain was mostly in-line with peers, with nobody able to match the high bar set by JPM on the first day. In equities, GS saw a +12% gain over 4Q18 to $1.71 billion, which continues to trail peer Morgan Stanley on an absolute basis. Total I-banking fees were $2.1 billion in 4Q19, a -6% decline year-over-year as improved underwriting over the weak close to 2018 failed to offset the drop-off in M&A activity.

Bottom-line: Goldman’s recent quarter-to-quarter disappointments remain more of an equity story than an actual credit concern; and we maintain that over the long-run they tend to be offset by outsized upside in subsequent quarters on surprise gains in I&L investments that are unique to GS than peers. The 1MDB scandal overhang makes it difficult to recommend overweighting GS to the far more stable and consistent retail-focused franchise of MS, even at a moderate pick in spread (Exhibit 3).


Exhibit 3: Goldman Sachs and Morgan Stanley debt spreads

Source: Bloomberg/TRACE G-spread Indications, Amherst Pierpont Securities

Morgan Stanley (MS: A3/BBB+/A) once again capped the 4Q19 reporting period for the US money center banks, reporting an impressive EPS of $1.30 or adjusted EPS of $1.20 versus the $1.02 consensus estimate. Most notable was the best-in-show +126% gain in recovery in FICC revenue to $1.27 billion from the abysmal $564 million reported in 4Q18. Equity trading revenue was roughly flat at $1.92 billion, and remains the top nominal result for the industry (over peer GS) for several quarters running. Management’s decision over the past several years to shift toward a more retail model than they had previously operated under has paid off and driven substantial gains over GS over that time period (though likely sacrificing the kind of big, surprise one-time earnings upside that GS still maintains, but have been less frequent of late). I-Banking fees increased +11% year-over-year as a +35% gain in debt and equity underwriting helped offset the -11% decline in M&A activity.

Bottom-line: Shareholders are responding extremely favorably to the result, driving the share price up +7%, marking a nearly +44% run since MS’ recent low in early October. That compares to a +26.5% return by BAC and closest peer GS over the same period, and +23% returns from C and JPM. MS debt instruments were highlighted in the recent APS 2020 Outlook as among the best values for performance over the first 6 months of 2020. The additional spread available in GS over MS (Exhibit 3) comes at a steep price in the form of earnings inconsistency and continued regulatory uncertainty of further 1MDB fallout; recommend more balanced approach to positioning MS and GS.

john.killian@santander.us 1 (646) 776-7714

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