Markets: US Equities
Theme: Fourth Quarter Financial Results from the Large-Cap Banks
Companies Discussed:
We are now right in the middle of the fourth-quarter reporting season for US stocks. The early part of the reporting season is dominated by large-cap financials.
We have analysed and considered the results reported for the above institutions and listened to all the post results Conference Calls with Management.
Key Points
- The companies reported very strong numbers for the full year (2021) but many noted a decline in trading revenues in the last quarter. This creates worries about the cyclicality of trading revenues.
- M&A activity and Investment Banking more broadly had a record year and companies report strong pipelines into 2022.
- Strong markets and healthy inflows boosted AUM and Client assets at Asset Management Divisions and Wealth Management/Private Banking division.
- There is concern about the sharp increase in compensation which led to concerns about whether trading banks business models have any real operating leverage. The risk is that banks are greatly raising compensation after a record year and pay will remain elevated at the new higher levels but profits will decline.
- Banks noted huge ongoing investment in trading and systems. For what seems like decades, banks have been major investors in technology and key clients for consultants such as Accenture, IBM, and Infosys.
- In Q1 2020, in anticipation of huge credit losses due to Covid. Banks started releasing these in late 2020 and continued to do so in 2021. This has helped to boost headline numbers.
- The pandemic has helped individual cash holding and improved credit card loss metrics and generally improved the credit quality of the personal sector.
- For the large lending banks, there is a modest pickup in credit growth.
- Banks are modelling the impact of the likely much higher interest rates on their net interest income and overall profits.
- Regulatory capital requirements are likely to rise as new Basle rules on capital required for counter party risk and higher capital buffers for the largest systemic institutions come into view.
Summary Data
| JP Morgan(JPM) | Morgan Stanley (MS) | Citibank (Citi) | Bank of America (BAC) | Goldman Sachs (GS) | S&P 500 | |
|---|---|---|---|---|---|---|
| Market Cap (US$ bn) | 428.00 | 173.00 | 124.00 | 360.00 | 120.00 | – |
| Total Assets (US$ bn) | 3743.00 | 1190.00 | 2291.00 | 3169.00 | 1463.00 | – |
| Revenue (US$ bn) | 125.30 | 59.80 | 70.90 | 89.20 | 59.00 | – |
| Net Profit (US$ bn) | 46.80 | 14.90 | 20.75 | 30.60 | 21.60 | – |
| Tier 1 Equity Ratio (%) | 13.00% | 16.00% | 12.20% | 10.60% | 14.20% | – |
| Price to Book Ratio (X) | 1.65 | 1.80 | 0.68 | 1.47 | 1.20 | – |
| 20 Year CAGR Return (%) | 10.35% | 5.78% | -7.70% | 4.16% | 8.41% | 9.10% |
| 10 Year CAGR Return (%) | 17.40% | 20.45% | 9.31% | 21.65% | 13.70% | 14.89% |
| 5 Year CAGR Return (%) | 14.13% | 20.56% | 4.82% | 16.70% | 9.42% | 15.74% |
Source: Bloomberg and Stockpedia
Market Capitalisation and Price to Book data as of 24 January 2022. Other data is end-December 2021.
The data on long term returns shows that it has been difficult for the sector to outperform the S&P 500 though the out performance of Morgan Stanley in the last 10 years has been remarkable. Given the high level of leverage that deposittaking institutions (after the global financial crisis, securities firms got banking licenses to get direct access to Fed lending) can take, one would expect financial institutions to be able to outperform the index.
However, in practice, it is not so simple due to the minimum amount of capital required by regulators, the high-cost income ratios and, in recent years, the huge and ongoing investments, especially in technology.
JP Morgan (JPM)
The company’s reporting segments are given below:
| Segment | Revenue Share (%) | Quarterly Revenue Run rate | ROE% | Description |
|---|---|---|---|---|
| Consumer & Community Banking (CCB) |
41% | US$ 11bn | 33% | Offers services to consumers / SMEs through branches, ATMs, online, mobile and telephone banking. |
| Corporate & Investment Bank (CIB) | 39% | US$ 10 – 11bn | 26% | Offers Banking, markets and other services to institutions, large companies, and governments. |
| Commercial Banking (CB) | 12% | US$ 3 – 4bn | 21% | Offers financial solutions, including lending, treasury services etc. |
| Asset Management (AM) | 8% | US$ 2 – 3bn | 30% | Investment and Wealth Management includes Private Banking. |
Source: Company Reports
As can be seen above, JP Morgan has a huge and very profitable retail banking presence (built out of the combination of Chase Manhattan, Washington Mutual and Bank One after the financial crisis). Asset Management in JPM is a relatively small contributor to revenue. CIB and CCB are roughly equal in size as they account for about 40% of revenue each.
Summary of the 2021 Q4 Results of JPM
Q4 Revenue was US$ 30.3bn (up 1% y-o-y) compared with consensus expectations of US$ 29.9bn (a slight beat).
Q4 Net Profit was US$ 10.4bn (down 14% y-o-y) due to higher non-interest expense (compensation and technology investment) and weaker performance by the trading business. US$ 1.4bn worth of credit reserves were released back and without this Q4 Quarterly income would have been close to US$ 9.4bn.
Q4 Markets revenue (within CIB) fell 11% y-o-y (FICC was down 16% while equities were down 2%) reflecting the difficult trading conditions.
Summary of the Full Year 2021 Results of JPM
- Full-year revenue was US$ 125.3bn revenues was a record high and up 2.4%(y-o-y).
- Full-year net income was US 48.3bn was a record and up 38.5% (y-o-y).
- Return on Average Tangible Common Shareholders Equity (ROTCE) was 23.9 % for the year as a whole but only 15.6 % in Q4. A key indication of the deterioration of trading conditions in the last quarter of 2021.
- So, in summary, 2021 was a record year for revenues, profits and profitability. However, trading conditions deteriorated greatly in the fourth quarter due to difficulties in FICC and Equities markets to cause poor Q4 Results.
- These difficult conditions are likely to continue in 2022 where the strong H1 2021 numbers will prove to be difficult comparatives but as a major lender, JPM will benefit from the growth in lending.
JPM Conference Call Highlights
| Conference Call Comment | Our View / Comment |
|---|---|
| “We have started to see a pickup in loan growth, 8% year-onyear and 3% quarter-on-quarter”. | This is a good sign. A pick-up in loan growth after a subdued period. |
| (We) delivered a return on tangible common equity of 23% or 18%, excluding the reserve releases. | Since you can control timing of release of the 23% is irrelevant. The meaningful number for ROTCE is 18%. |
| Credit Card outstanding were up 5% year-on-year, but remain down 8% versus 4Q ’19 (pre-pandemic). | People are using pandemic cash balances to pay down cash balances. |
| We’ve expanded our reach across the US and are thrilled to be the first bank in all contiguous US 48 states. | This is important when you consider that 30 years ago – interstate banking restrictions meant banks could only operate in one state. |
| Almost every CEO is talking about wages and certain inflation and stuff like that. But I just — I don’t want to be a CEO — please don’t say I’m complaining about wages. I think wages going up is a good thing for the people who have the wages going up. | Markets did well and people are being paid due to the war for talent, but compensation is in danger of becoming a fixed rather than a variable cost. Shareholders need to be rewarded for putting up capital not just the Investment Bankers and traders who risk the capital to generate profits. |
| Like I said, with 17% return on tangible capital, I would take that. If I could push a button and give you that the next 20 years, I would take it. | 17% ROCE is good for banking but for the unconstrained investor, there are other industries with the prospect of higher risk-adjusted returns. |
Morgan Stanley (MS)
The company’s reporting segments are given below:
| Segment | Revenue Share (%) | Quarterly Revenue Run rate | Description |
|---|---|---|---|
| Institutional Securities (ISG) |
41% | US$ 5.5 – 8.5bn | Provides investment banking, sales and trading, and other services to corporations, governments, and financial institutions. |
| Wealth Management (WM) |
36% | US$ 5 – 6bn | Provides financial services/ solutions to individual investors and SMEs covering brokerage and investment advisory services, market-making activities in fixed income securities, financial and wealth planning services, annuity and insurance products, credit and other lending products, banking, and retirement plan services. E-trade acquired recently is located here. US$ 5 trillion of Client Assets in WM. |
| Investment Management(IM) | 13% | US$ 1.4 – 1.7bn | Provides a range of investment strategies and products to institutions. Eaton Vance acquired recently is located here. |
Source: Company Reports
MS has had a decade long plan to diversify earnings away from the volatile Institutional Securities Group (ISG) business. In Q4 2021 IS business did well and accounted for 50% of revenues. WM accounted for 36%. However, trading conditions are unlikely to be as favourable going forward and MS’s aim of having both ISG and WM contribute about 40%-45% of revenues seems to have been achieved. As is the case with JPM, Investment Management is a relatively small business at MS.
Summary of the 2021 Q4 Results of MS
Q4 Revenue was US$ 14.5bn (up 7% y-o-y) which just fell a little short of expectations.
Q4 Net Profit was US$ 3.7bn (up 9% y-o-y) which was higher than expectations.
Q4 ISG revenue fell 4.8% y-o-y reflecting the difficult trading conditions in global markets. Within that, Fixed-income was down 15% y-o-y.
Q4 WM revenues grew 10% y-o-y.
Q4 IM revenues grew 8% y-o-y.
Summary of the Full Year 2021 Results of MS
- Full-year revenue was US$ 59.8bn revenues, a record high and up 24% (y-o-y). This was boosted by the inclusion of the Eaton Vance acquisition (which brought in AUM of 1.6 trillion) which closed last March.
- Full-year net income was US 14.9bn was a record and up 25% (y-o-y).
- Return on Average Tangible Common Shareholders Equity (ROTCE) was 20% for the full year. Pre-tax Margin was 39.6% up from 34.6% in the previous year.
- So, in summary, 2021 was a record year for revenues, profits and profitability. However, trading conditions deteriorated greatly at the end of the year due to difficulties in FICC and Equities markets and led to poor Q4 Results.
- These difficult market conditions are likely to continue in 2022 where the strong H1 2021 numbers will prove to be difficult comparatives.
MS Conference Call Highlights
| Conference Call Comment | Our View / Comment |
|---|---|
| In Institutional Securities (50% of revenues), we showed strength and gained share. Investment Bank revenue is 30bn Margins are 40% today compared with 20% just a few years ago. |
It was a good performance but Q1-Q3 saw very strong market conditions. Trading businesses are always cyclical. These margins are unlikely to be maintained over the cycle. |
| Wealth Management (36% of revenues), we added over $430 billion of net new assets, bringing total client assets to nearly $5 trillion. As we look to the longer term, with the support of our track record behind us, we’re adding a new goal, a long-term goal to achieve $10 trillion in client assets across Wealth and Investment Management. |
This is impressive and growth has been aided by market rises and acquisitions. WM run rate revenues are US$ 25bn so suggests revenues are 0.5% of total client assets per annum. Target for 10 trillion across WM / IM is impressive though no time frame has been given. |
| On Wealth Management Margins we’ve gone from 5% to 10% to 15% to 20% to 25%, 27%, 28% margins with growth, that’s a phenomenal story. | Agreed and is a major factor behind the 20%+ CAGR Return in the MS stock in the last ten years. |
Citigroup Inc (C)
The company’s reporting segments are given below:
| Segment | Revenue Share (%) | Quarterly Revenue Run rate | Description |
|---|---|---|---|
| Institutional Clients Group (ICG) |
62% | US$ 10 – 11bn | Banking, Markets, and Securities services. Provides corporate, institutional, public sector and high-net-worth clients with a range of banking and financial products and services. |
| Global Consumer Banking (GCB) |
36% | US$ 6 – 7bn | A global, full-service consumer franchise delivering an array of banking, credit card, lending, and investment services through a network of local branches, offices, and electronic delivery systems. |
Source: Company Reports
As the data of returns above shows, Citigroup has underperformed their peers. They are currently trading at a Price to Book ratio of 0.68 times (well below book value) compared with 1.65 for JPM and 1.47 for BAC which indicates that the markets do not believe that Citi is going to change from being a laggard to a leader anytime soon.
Citigroup is embarking on a process of radical change which will transform the structure of its business. They are in the process of getting out of the global retail consumer banking network. They announced a withdrawal out of 13 Asia/ EMEA markets last year and are looking at exiting from Mexico which is one of their largest consumer /retail franchises. They bought Banamex in 2001 and are the second-largest bank in Mexico. Once these changes are complete, their segments will look as follows:
- Institutional Clients Group (ICG).
- Personal Banking & Wealth Management- This will include the Global Private Bank.
- Legacy Businesses- residual Asia and Mexico consumer banking business as well as some remaining legacy holding assets. This segment will be wound down over time.
After the transformation is complete, the structure of Citigroup will look more like its peers, and this will make comparison easier.
Summary of the 2021 Q4 Results of Citi
Q4 Revenue was US$ 17bn (up 3% y-o-y) and 3% above analysts’ expectations.
Q4 Net Profit was US$ 2.9bn (down 25% y-o-y) Results were depressed by $1.1bn in expenses for ongoing divestitures of consumer banking businesses outside of the United States.
Q4 ROTCE was just 7.4%.
Q4 ICG revenue rose 4%. Within that Fixed-income was down 20-% y-o-y but investment banking was up 43% (y-oy).
Q4 GCB revenues were US$ 6.9bn (down 6% y-o-y).
Summary of the full year 2021 results of Citi
- Full-year revenue was US$ 71.8bn revenues and down 5% on the previous year.
- Full-year profits were US$ 21bn and were much higher than 2020 as the bank had taken USD 17bn of credit provision due to Covid fears in 2020. This was not an issue in 2021 and US$ 3bn of these reserves were released in 2021.
- Return on Average Tangible Common Shareholders Equity (ROTCE) was13.4% for the full year.
- Market conditions deteriorated greatly in the fourth quarter and led to difficulties in FICC and Equities markets to cause poor Q4 Results.
- These difficult market conditions are likely to continue in 2022 where the strong H1 2021 numbers will prove to be difficult comparatives. In addition, there will be most costs relating to the ongoing divestitures of global consumer banking businesses.
- As a major lender, JPM will benefit from the growth in lending.
Citi Conference Call Highlights
| Conference Call Comment | Our View / Comment |
|---|---|
| A 100bps rise in global interest rates would boost net interest income by US$ 2.5-3bn or 3-4x more than was disclosed in the third quarter. |
If this is correct, there will be a boost to NII due to the Fed raising interest rates. |
| We intend to focus our franchise in Mexico solely on our institutional and wealth management businesses. And therefore, to exit the consumer, small business, and middle market banking operations there. |
This is in line with the global strategy, but the Mexico business is one that has an ROTCE of 27%, well above the company average. |
| On stock compensation: We’ve moved to a 100% deferred stock versus a mix of stock in cash in the geographies that we’re permitted to do so. | This is part of a trend to defer stock compensation to encourage long-term thinking among risk-takers. |
| The CET1 ratio will get closer to 12% by the end of the year due to GSIB surcharge increase which will come at the beginning to 2023. | Citi’s capital adequacy position and profitability are weak. |
Bank of America (BAC)
The company’s reporting segments are given below:
| Segment | Revenue Share (%) | Quarterly Revenue Run rate | Description |
|---|---|---|---|
| Global Banking (GB) | 23.0% | US$ 3.5 – 5bn | Provides a range of lending-related products and service including Investment banking and advisory services. |
| Global Markets (GM) | 21.5% | US$ 4bn – 6bn | Offers sales and trading services for institutions and corporates globally. |
| Consumer Banking (CB) | 38.0% | US$ 8bn – 10bn | Deposits and Consumer Lending in the USA. |
| Global Wealth and Investment Management (GWIM) | 23.0% | US$ 4.5bn – 5.2bn | Two primary businesses: Merrill Lynch Global Wealth Management and U.S. Trust. |
Source: Company Reports
Summary of the 2021 Q4 Results of BAC
Q4 Revenue was US$ 22.1bn (up 9% y-o-y) and above analysts’ expectations of 22bn. This is equally split between net interest income and non-interest income.
Q4 Net Profit was US$ 7.07bn (up 27% y-o-y) beat analysts’ expectations.
Q4 GB recorded US$ 5.9bn of earnings (up 25% y-o-y) and US$ 2.6bn of net income.
Q4 GM recorded US$ 3.8bn of earnings and US$ 669mn of net income (down 20% y-o-y). FICC earnings fell 10% but equities rose 3%.
Q4 CB recorded US$ 9bn of earnings (up 8% y-o-y) and US$ 3bn of net income.
Q4 GWIM revenues were US$ 5.4bn and US$ 1.2bn of net income.
Summary of the Full Year 2021 Results of BAC
- Full-year revenue was US$ 89bn revenues and up 4.1% on the previous year.
- Full-year profits were US$ 30.7bn and were very slightly higher than the previous year.
- Return on Average Tangible Common Shareholders Equity (ROTCE) was 17.0% for the full year.
- Market conditions deteriorated greatly in the fourth quarter and led to difficulties in FICC where revenues fell 10% (y-o-y).
- These difficult market conditions are likely to continue in 2022 where the strong H1 2021 numbers will prove to be difficult comparatives. However personal credit has improved in the quarter and retail customers have built up cash balances. Therefore, consumer credit numbers have improved greatly. Credit card issuance and retail lending is growing strongly, and this should give a boost to earnings to a large lender like BAC.
BAC Conference Call Highlights
| Conference Call Comment | Our View / Comment |
|---|---|
| Customer balances being elevated in some cases up 5x where they were pre-pandemic. That’s probably what’s accounting for a lot of the consumer credit quality improvement. Those who worked though the pandemic did not have a chance to spend so they were able to accumulate balances and pay back debt and that led to an improvement in credit quality. | Interesting data points and anecdotal evidence on the improvement in consumer credit quality. |
| The number one point to remember is the organic growth engine that we had before the pandemic is fully back in gear and driving. We’re now up to two quarters of operating leverage and we’re working towards a driving our streak again. | Growth numbers as well as the release of credit provisions mean management is bullish on lending growth and net interest income. There is evidence of operating leverage which suggests that BAC may have controlled expenses better than peers. |
| The economic improvement and our strong credit allowed us to release much of the reserves we built in 2020. | Bank has taken huge reserves in anticipation of Covid in 2020 and many of these were released last year and this. This has flattered 2021 profit numbers, but this boost is for only one or two years. |
| On credit cards, roughly 1 million new accounts in the fourth quarter alone (were opened), that’s now operating at the same level of new card production as it was pre-pandemic. | Credit card business is in a growth phase. |
| $50 billion in record loan growth this quarter. We note these borrowers, both consumer and commercial, have strong capacity to continue to borrow if they so desire. | |
| Wealth Management generated more than $4 billion in earnings in 2021, on 3.8 trillion of assets in December. | WM earnings is about 0.48% per annum as a percentage of assets. |
Goldman Sachs (GS)
The company’s reporting segments are given below:
| Segment | Revenue Share (%) | Quarterly Revenue Run rate | Description |
|---|---|---|---|
| Investment Banking (IB) | 30% | US$ 3.5bn – 5bn | Financial advisory and underwriting. |
| Global Markets (GM) | 31% | US$ 4.0bn – 5bn | Makes markets and facilitates client transactions in fixed income, equity, currency, and commodity products. |
| Consumer & Wealth Management | 15% | US$ 1.8bn – 2.3bn | Mainly Private Banking ad Wealth Management. |
| Investment Management (IM) | 22% | US$ 2.5 – 2.8bn | Provides investment and wealth advisory services. |
Summary of the 2021 Q4 Results of GS
Q4 Revenue was US$ 12.6bn (up 8% y-o-y) and above analysts’ expectations of 12.13bn.
Q4 Net Profit was US$ 3.93bn (down 13% y-o-y).
Q4 EPS was US$ 10.81 compared with analyst expectations of US$ 11.81 (EPS Miss).
Q4 IB recorded US$ 3.8bn of earnings (up 45% y-o-y).
Q4 GM recorded US$ 3.8bn of earnings (down 7% y-o-y). FICC earnings fell 1% but equities rose 20%
Q4 IM recorded US$ 2.9bn of earnings (down10% y-o-y).
Summary of the Full Year 2021 Results of GS
- Full-year revenue was US$ 59bn revenues and up 33% on the previous year.
- Full-year profits were US$ 21.6.bn (up 129% y-o-y).
- Return on Average Tangible Common Shareholders Equity (ROTCE) was 24.3% for the full year.
GS Conference Call Highlights
| Conference Call Comment | Our View / Comment |
|---|---|
| While our results were supported by healthy operating environment, we delivered the highest annual return among our peer set with an ROE of 23%. | Trading conditions were favorable, but these were impressive full-year results. |
| We generated record full year revenues of $59 billion and record net earnings of $21.6billion, over 60% greater than the previous all-time high. | As above market conditions worsened in Q$ and have been difficult so far in 2022. |
| Investment Banking had an extraordinary year, as clients remained incredibly active and turned to Goldman Sachs time and time again. We produced segment revenues that exceeded the previous record by over $5 billion. | They have been no1 in this segment for 25 years and 2021 was a banner year for Investment Banking. |
| We are the fifth largest active asset manager globally, with assets under supervision of a record $2.5 trillion. | |
| We have a different business than some of our large commercial bank peers. But, given our expectation for the rate environment, we see ourselves as remaining modestly asset sensitive. | They would benefit from higher rates but to a much lesser extent than the large lenders like BAC and JPM. |
Conclusions:
- The banks have had a very strong 2021 and the 2021 full-year results reflect this. Financial market conditions were bad in Q4 2021 and this can be seen in the Q4 numbers.
- 2022 will be a more challenging year for trading business especially as the 2021 comparatives will be challenging.
- There is concern about the sharp increase in compensation which led to concerns about whether trading banks business models have any real operating leverage. The risk is that banks are greatly raising compensation after a record year and pay will remain elevated at the new higher levels but profits will decline.
- In terms of the stocks, we have a slight preference for MS and JPM.
- C is on a low valuation but it faces significant challenges as it seeks to divest several large businesses in its Global Retail/Consumer Bank Franchise.
- It must prove that even after the transformation, it can deliver strong returns to shareholders in line with peers.
- We are cautious on GS. The results are strong but too much of the rewards of higher profits and greater productivity seem to go to employees.
- The historical returns for our group of stocks (noted above)cover the great financial crisis of 2008.09 when the whole sector suffered greatly. However, the numbers show that these stocks have not as a group beaten the returns on the S&P 500.
- This raises the question of whether an unconstrained investor should invest in the sector at all.
- Terry Smith who manages US$ 29bn in assets has characteristically strong views on the subject. He does not invest in banks as he believes they are “black boxes”. Compared to other sectors, he believes we have little visibility on how banks (especially those with large and complex trading activities) make their money. Despite the ever-higher regulatory capital demanded by regulators and even greater compliance and risk management resources, there is always a risk of unacceptably high losses for shareholders due to trading losses.
- On the other hand, Warren Buffett has large stakes in Bank of America. He has huge amounts of capital to deploy and perhaps cannot ignore this sector completely. In addition, he can take advantage of his position and periodic crisis situations to invest on very attractive terms.
- My own view is closer to Smith rather than Buffett. This is an industry where the probability of very large losses is low but not low enough. In addition, too much of the profits accrue to employees but 100% of the losses fall on the providers of risk capital.
- We do have small exposures to MS and JPM but they are not the core of our portfolio.
