Despite a record end to 2017 for US stock markets as whole, profits at the major US investment banks have taken a hit in the last quarter of the year. Unusually low volatility in equity markets and lower transactions in fixed-income or bond markets have harmed trading divisions' profits. The fourth quarter of 2016, which Q4 2017 is measured against, was an usually turbulent one for markets because of the US presidential election. And tax changes have put a large hole in firms' quarterly profits. Nevertheless, in terms of earnings per share (EPS), the highest-profile Wall Street firms all beat analysts’ forecasts for the quarter. Rising interest rates last year also boosted banks’ income payments.
Banks have had to account for one-off charges in the period after the Trump administration’s tax reforms – while big corporations will ultimately benefit from the drop in the company tax rate from 35% to 21%, they are having to absorb the costs of changes to how overseas earnings are taxed and how deferred taxes are treated.
Citigroup, JPMorgan and Bank of America
Citigroup (C) was the hardest hit by these tax changes: it lost $18.3 billion in the fourth quarter as it took a one-off charge of $22 billion. Morningstar analyst Jim Sinegal said: “The change is an overall positive for the company as future cash flows will increase in perpetuity under the lower tax regime.” Analysts, are concerned however, that Citigroup is making “slow progress toward an appropriate level of core profitability” and that higher salaries and technology spending will keep costs high.
In summary, Citigroup has “not yet returned to form” since the financial crisis, Sinegal says, and “has a long way to go before it out-earns its cost of capital”. Citigroup is rated as a three-star stock by Morningstar analysts, and is currently trading a few dollars above our fair-value estimate of $74 a share.
JP Morgan (JPM) was one of a number of banks to be affected by what on the surface looks like benign economic conditions. Analyst Jim Sinegal says: “While JPMorgan is benefiting from a strong economy, rising markets, and exceptionally good credit quality, stability in the interest rate and credit environment is making it hard to earn money via trading.” Bond trading revenue fell 27% during the period.
The bank took a one-off charge of $2.4 billion and reported profits of over $4 billion for the quarter, after the tax charge. The figure in the same quarter of last year was $6.7 billion.
JP Morgan is rated as a two-star stock by Morningstar analysts, with a fair value estimate of $87 a share – the shares are currently trading at $112. “2017 results were consistent with our expectations, and we don’t expect to significantly alter our $87 fair value estimate,” says Sinegal. Looking ahead, analysts expect JPMorgan’s scale and spending power will help give it an advantage over rivals.
Bank of America (BAC), which has two-star Morningstar rating, reported quarterly profits of $2.37 billion, above analysts’ estimates, after a charge of $2.9 billion for tax changes.
Like all the firms in the sector, Bank of America expects the tax changes to boost profitability in the future.
“Most of the benefits will fall to the bottom line and be used to return to shareholders,” chief executive Brian Moynihan said. This is likely to take the form of higher dividends or share buybacks.
Jim Sinegal, who covers Bank of America for Morningstar, raised the fair-value estimate for the company’s shares from $24 to $27 after the quarterly update, taking into account the tax changes and higher growth estimates. The company’s shares are currently trading above $31.
Analysts did note a rise in loan losses in the quarter, and a fall in fixed-income revenues.
Goldman Sachs and Morgan Stanley
Goldman Sachs (GS) reported a 50% slide in trading fixed income, commodities and currencies – the worst performance since 2008 – on Wednesday after revealing its first quarterly loss since 2011. It made a loss for the quarter of $1.93 billion after taking a one-off tax charge of $4.4 billion. In the fourth quarter of 2016, the company’s net profit was $2.35 billion. Without the tax charge, the most recent quarter would have seen profits $2.47 billion, higher than in 2016.
Its overall revenues were the standout figure in the earnings report, however, rising 5% to $7.37 billion, with the vast majority of that produced by the investment banking division.
Goldman Sachs is rated a three-star stock by Morningstar analysts, and is trading around $9 above our fair value of $245 a share.
Morgan Stanley (MS), the last of the big-name banks to report, also took a one-off tax charge in the fourth quarter. But at $1.2 billion, it was the smallest hit taken by the Wall Street giants. Like all the banks above, the company beat EPS estimates. Profits for the quarter were $686 million, against $1.67 billion the same quarter last year.
Morningstar analyst Michael Wong says in his most recent update: “Based on the fundamentals of Morgan Stanley’s business, we see questions about its fixed-income business as largely a distraction; in our view, its wealth-management business is where value will be created”. Indeed, this division generated revenues of $4.4 billion in Q4, against $4bn the year before.
He goes on to say, in ascribing a “narrow moat” or slender competitive advantage to the company: “Its status as one of the largest financial institutions by both headcount and global reach means that the company has a competitive advantage derived from the personal networks of its employees and financial product distribution channels to garner transaction mandates.”
