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US big banks earnings recap

| July 16, 2021

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.

Investment banking revenue and reserve releases helped offset trading and weaker loan demand as the big 6 US money center banks reported second quarter 2021 earnings. Net income largely came ahead of consensus expectations as banks benefited from additional reserve releases, better-than-expected investment banking revenues, and still strong trading performances (albeit lower from the extraordinary second quarter of last year). Top-line results were more mixed, and investors appeared critical of tepid loan demand across traditional banking categories. Difficult comps, the absence of additional reserve releases, and the weak operating environment for lending all present challenges going forward.

Below we re-cap each bank’s performance and provide an update of our trading recommendations for how bond investors should allocate big 6 bank holdings in the near-term. Our sector weighting view on the broad banking sector remains marketweight.

JP Morgan Chase (JPM: A2/A-/AA-) delivered a sizable beat on earnings expectations with EPS of $3.78 versus the consensus estimate of $3.15, but shares are slumping modestly as the collective view is that the performance was heavily buoyed by unsustainable sources. Specifically, JPM released $3 billion in reserves versus the better-than-expected $734 million in net charge-offs for a net benefit of $2.3 billion to 2Q21 earnings. That compares with a reserve release of $5.2 billion in the prior quarter and the $10.4 billion the bank set aside for credit costs in the second quarter of last year. Firmwide reserves now stand at $22.6 billion at mid-year, down from $25.6 billion in the prior quarter and a peak of $34.3 billion at this time last year. Earnings were also bolstered by record investment banking revenue, which was fueled by an extraordinary quarter of M&A advisory fees as the backlog of deals that built up during the pandemic began to work their way through the pipeline. Total managed revenue of $31.4 billion beat expectations ($30.1 billion) but was down 7% year-over-year, driven primarily by lower trading revenues versus the elevated levels of the mid-pandemic 2Q20 period. CEO Jamie Dimon conceded the temporary nature of the reserve releases and cautioned not to consider them a part of recurring profitability. On a more positive front he highlighted the economic recovery demonstrated through strength in card spending. Still, average loans remained flat in 2Q21 firmwide as average deposits grew 23%, demonstrating the slow growth in loan demand in the broader sector. Trading revenue of $6.8 billion was down 30% year-over-year. Fixed Income declined 44% to $4.1 billion while Equities trading revenue was better-than-expected up 13% YoY to $2.7 billion, which management attributed to prime brokerage, derivatives and cash equities. Investment Banking fees of $3.6 billion came in well ahead of estimate, driven by a 52% year-over-year gain in M&A Advisory fees to $916 million, as well as 26% growth in Debt Underwriting fees to $1.6 billion. Asset & Wealth Management saw 21% growth in Assets Under Management (AUM) to $3.0 trillion

Bottom-line: Our sector weighting view on Domestic Banks remains Marketweight since late 2020, reflecting tighter valuation in spreads and still present headwinds in the industry, such as low rates, constrained loan demand, and the relatively flat yield curve. As the nation’s largest lender and premiere franchise among US money center banks, JPM remains a core holding within the segment. While JPM is trading tight to peers, the bank’s “fortress balance sheet” and extraordinary capital position, as well as its continued strong performance in the challenging operating environment, dictate its leading stature among US money center banks.

Exhibit 1. We maintain our preference for JPM intermediate paper, as there does not appear enough additional spread available in WFC to compensate for lingering reputational and regulatory risk

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

Goldman Sachs (GS: A2/BBB+/A) posted its second most prolific quarter on record in 2Q21, falling shy of the record-setting thresholds set in the first quarter of the year. Net revenue was up 16% YoY to $15.4 billion, coming in well ahead of the consensus estimate of $12.4 billion. Net income of $5.49 billion was the also the second highest ever achieved, resulting in EPS of $15.02 versus the $10.15 estimate. Like its more traditional banking peers, GS released reserves but only with an extremely modest $92 million benefit to earnings in 2Q21, as the bank had far less credit reserves built up during the pandemic. Similar to JPM, GS reported a 36% gain in Investment Banking revenue to $3.6 billion, well ahead of estimates, to help offset the year-over-year decline in trading revenue. M&A Advisory revenue was up 83% year-over-year to $1.26 billion, while Equity Underwriting grew 18% year-over-year to $1.24 billion and Debt Underwriting dipped 4% from the prior year to $950 million. Meanwhile, net trading revenue fell -32% YoY to $4.9 billion, as Fixed Income revenue declined 45% to $2.32 billion and Equities fell 12% to $2.58 billion. The Equities total was down 30% sequentially from the record-setting first quarter, which retook the top spot in the industry after being held for a long stretch by Morgan Stanley (MS). We will have to see if GS did enough in the second quarter to maintain the top position, or if MS retook it when they report later in the week. All-in-all, 2Q21 appears to have been another consecutive quarter of impressive results relative to the broader peer group for GS.

Bottom-line: Goldman had been subject to quarter-to-quarter fluctuations in performance in recent years, but in the past year-plus GS has demonstrated tremendous consistency and top-tier execution in volatile markets. The playing field does appear to have been leveled a bit with closest peer Morgan Stanley over the past few quarters, particularly with GS regaining its top spot among all equity trading shops on the street (which may or may not hold in the current quarter). We continue to see good relative value in GS intermediate bonds versus the broader peer group of US money center banks.

Shares were down sharply in response to Bank of America’s (BAC: A2/A-/A+) 2Q21 earnings results, which after a brief reprieve last quarter have commenced disappointing investors relative to peers. BAC reported net income of $9.2 billion or $1.03 per share versus the $0.77 consensus estimate. BAC took a $2.2 billion reserve release resulting in a $1.6 billion net benefit to earnings, which was comparable to the $2.7 billion release in the prior quarter and compares with the $5.1 billion reserve build in this quarter last year. Allowance for loan losses now stands at about $14 billion down from $16 billion in the prior quarter and appears unlikely to be a major source of earnings surprise going forward. Revenue declined 4% YoY to $21.5 billion, as trading revenue slumped versus the prior year and investment banking fees failed to demonstrate the impressive gains generated by rivals. What appeared to ruffle investors most was the lack of loan demand in traditional banking categories relative to peers, as firmwide average loan and lease balances in business segments declined 11% versus 14% growth in deposits, and consumer banking average loans declined by 12% in 2Q21. Total trading revenue declined 19% year-over-year to $3.6 billion (ex-DVA), as Fixed Income declined 38% to $1.97 billion, offsetting the 33% gain in Equities revenue to $1.34 billion. Total investment banking fees were $2.1 billion, down 2% YoY, as BAC appeared to miss out on the huge gains in M&A advisory fees that propelled results at rival money center banks. Expenses remain elevated as the firmwide Efficiency Ratio (all-in-costs relative to revenue) was 70% versus 60% in the prior year period.

Bottom-line: Despite disappointing results we maintain our view that investors in BAC credit continue to be properly compensated for the risk, particularly given the relative stability of the sector amidst a difficult operating environment. Our preference between the two names remains with closest peer Citigroup on better risk/reward.

Exhibit 2. We continue to see better risk/reward in Citigroup intermediate paper over Bank of America

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

For a second consecutive quarter, Wells Fargo (WFC: A2/BBB+/A+) avoided booking any one-time charges for restructuring costs or customer remediation, indicating the bank continues to move on from its past misdeeds and toward an eventual turnaround even as it continues to operate under the Fed-imposed asset cap. The only one-time items included another $1.6 billion reserve release, which provided a roughly $1.3 billion benefit to earnings net of the $379 million in 2Q21 net charge-offs. WFC also booked a small $147 million gain on the sale of student loans and a $79 million write-down of related goodwill. Net income swung to $6.0 billion from the $3.8 billion loss booked in 2Q20, or EPS of $1.38 versus the $0.98 consensus estimate. Top-line revenue of $20.3 billion also came in well ahead of consensus expectations. Similar to BAC, WFC saw a substantial firmwide drop in average loans of 12% in 2Q21, as average consumer loans fell 10% and commercial loans dipped 22%. Shares initially sold off modestly on these sentiments but appear to be firming up with the broader market. On the cost front, WFC continued to demonstrate improvement as the Efficiency Ratio improved to 66% from the 77% posted in the prior quarter and 80% at this time last year. Investors had been expecting the measure to remain roughly flat sequentially.

Bottom-line: WFC’s second-quarter results continued to move in the right direction, with the absence of restructuring charges, despite what clearly remains a difficult environment for loan demand. WFC is still working toward repairing its severely bruised reputation under new management but appears to be making some headway. We remain buyers of WFC credit on any short-term operational or headline related weakness that may still emerge. Bonds currently appear properly priced relative to peers, and we continue to monitor longer-term progress against the difficult operating backdrop.

Citigroup (C: A3/BBB+/A) appears to have reported results that were mostly in-line with the broader peer group, even as a modest warning on expenses for the remainder of the year seems to have slightly irked equity investors. Citi released $2.4 billion in reserves that provided a net benefit to earnings of $1.1 billion net of $1.3 billion in net charge-offs. Net income was $6.2 billion in 2Q21 or EPS of $2.85 versus the $1.94 consensus estimate. Revenue declined 12% year-over-year to $17.5 billion. Total trading revenue declined 30% YoY to $4.8 billion. Fixed Income trading revenue fell short of expectations at $3.2 billion and was down 43% YoY, while Equities trading revenue was up 37% year-over-year to $1.1 billion, which was modestly above estimates. Investment Banking revenue was roughly flat YoY at $1.77 billion and ahead of consensus expectations. M&A Advisory revenue jumped 77% year-over-year to $405 million, while Debt Underwriting revenue decreased 21% to $823 million and Equity Underwriting increased 11% to $544 million.

Bottom-line: Citi appears to have shaken off the regulatory issues from late 2020, delivering results that have been mostly in-line with peers over the past several quarters, and helping smooth the transition for relatively new CEO Jane Fraser. We maintain our view that Citi remains among the preferred risk/reward picks in the Big Bank peer group, within the context of our Marketweight for Domestic Banks within the IG Index.

Morgan Stanley (MS: A1/BBB+/A) posted 2Q21 results that were mostly in-line with the peer group, but substantial gains at its Wealth and Investment Management businesses helped demonstrate how recent acquisitions are helping to build out its franchises.  MS reported 2Q21 net income of $3.5 billion or EPS of $1.89 versus the $1.64 consensus estimate. There were no additional charges or disclosures related to the Archegos Capital trading scandal beyond those booked in the previous quarter. Net revenue increased 8% year-over-year to $14.8 billion, also ahead of expectations. Similar to peers, MS saw elevated levels of investment banking activity to help offset the year-over-year drop in trading revenue. Most notably, Fixed Income trading revenue was down 45% YoY to $1.68 billion, falling short of consensus expectations. Equities trading revenue increased 8% YoY to $2.83 billion, beating estimates and perhaps most importantly retaking the top spot in the entire industry after temporarily conceding it to peer Goldman Sachs in the previous quarter. MS attributed the strength in equities to activity in Asia and higher revenue in prime brokerage. Investment Banking revenue increased 16% YoY to $2.38 billion also coming in ahead of expectations. M&A Advisory revenue increased 44% year-over-year to $664 million, which along with a 22% year-over-year increase in Equity Underwriting to $1.07 billion helped offset the 9% decrease in Debt Underwriting to $640mm. Where MS stood out in 2Q21 versus the broader peer group was Wealth Management, where the impact of the E*TRADE acquisition resulted in a 30% increase in net revenue to $6.10 billion, and Investment Management where the Eaton Vance acquisition resulted in a 92% increase of net revenue to $1.70 billion.

Bottom-line: We maintain our view that MS boasts the preferred longer-term franchise for retail brokerage over GS. The integration of both the E*TRADE and Eaton Vance acquisitions was on full display during MS’ second most profitable quarter of all time. MS and GS both remain core holdings for the US Banking segment–which we currently view as Marketweight. Our trading preference has been for the spread pick in GS over MS in the intermediate part of the curve when available.

Exhibit 3. Spreads have gotten very tight between GS and MS, but we still prefer the spread pick-up in GS where available in the intermediate part of the curve

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

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