Industry Report Card:
U.S. Large Banks' Year-Over-Year
Earnings Rose On Expense Controls
And Capital Market Revenues
Primary Credit Analyst:
Rian M Pressman, CFA, New York (1) 212-438-2574; [email protected]
Secondary Contacts:
Brendan Browne, CFA, New York (1) 212-438-7399; [email protected]
Stuart Plesser, New York (1) 212-438-6870; [email protected]
Devi Aurora, New York (1) 212-438-3055; [email protected]
Research Contributor:
Prateek Nanda, CRISIL Global Analytical Center, an S&P affiliate, Mumbai
Table Of Contents
Industry Ratings Outlook
Issuer Review
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Industry Report Card:
U.S. Large Banks' Year-Over-Year Earnings Rose
On Expense Controls And Capital Market
Revenues
Industry Ratings Outlook
The eight U.S. global systematically important banks (G-SIBs) posted higher fourth-quarter earnings than the year
before. Continued reduction in operating expenses, lower credit provisions, solid growth in fixed-income sales and
trading revenues, and an increase in spread income supported the banks' bottom lines. Although earnings were down
compared with the third quarter, overall fourth-quarter operating performance was largely in line with S&P Global
Ratings' expectations.
The eight G-SIBs are Bank of America Corp., Bank of New York Mellon Corp., Citigroup Inc., Goldman Sachs Group
Inc., JPMorgan Chase & Co., Morgan Stanley, State Street Corp., and Wells Fargo & Co. (We also include a review of
the earnings of Northern Trust Corp., which is a peer of the trust banks--Bank of New York Mellon and State Street).
Greater capital markets activity boosted noninterest income, which could continue in 2017
Revenue benefited from solid capital markets activity, particularly in fixed income, currencies, and commodities
(FICC) (up 43% year over year), and to a lesser extent in equity trading and debt underwriting. Those factors more
than offset the decline in advisory fees and equity underwriting. FICC trading benefitted from client repositioning
coupled with improved market conditions, including rising interest rates and tighter credit spreads that boosted client
activity across all regions and most products. Equity trading revenues rose 4% year over year because of increased
trading activity following the U.S. elections and a strong performance in derivatives. Although capital market revenues
were up 18% year over year, lower mortgage banking, insurance, and card revenues (reflecting the industrywide trend
of increasing reward costs) weighed on noninterest income. Additionally, a few bank-specific factors hampered overall
fee income. Examples included the absence of large gains on asset sales for Citigroup (stemming from the wind-down
of Citi Holdings) and losses related to hedge ineffectiveness for Wells Fargo.
Table 1
Adjusted Revenue
(bil. $)
Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Quarter over quarter (%) Year over year (%)
Bank of America Corp.
20.0
20.9
21.7
22.0
20.3
(7.6)
1.6
Citigroup Inc.
18.6
17.6
17.5
17.8
17.0
(4.2)
(8.7)
Goldman Sachs Group Inc.
JPMorgan Chase & Co.
Morgan Stanley
7.3
6.3
7.9
8.2
8.2
0.0
11.3
23.7
24.1
25.0
25.5
24.3
(4.6)
2.5
7.9
7.8
8.9
8.9
9.0
1.3
14.7
Wells Fargo & Co.
21.6
22.2
22.2
22.3
21.6
(3.3)
(0.0)
Median
19.3
19.2
19.6
19.9
18.7
(3.8)
2.0
Source: Company reports.
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Table 2
Income Statement
--Quarter over quarter, %-Net
interest
income
Noninterest
income*
4
(14)
(0)
(3)
(7)
JPMorgan
Chase &
Co.
1
Bank of
America
Corp.
1
Wells
Fargo &
Co.
Citigroup
Inc.
--Year over year, %--
Net
income
Net
interest
income
Noninterest
income*
0
(6)
7
(5)
5
(3)
(6)
(2)
(1)
(7)
(2)
26
(10)
(23)
7
(10)
(5)
(21)
7
5
2
(4)
(25)
24
(15)
(2)
(7)
(5)
6
2
(4)
(6)
43
Noninterest
expense Provisions
Noninterest
expense Provisions
Net
income
*Excluding gains from securities transactions (if reported) and nonrecurring items.
All banks posted sharp year-over-year declines in equity underwriting, reflecting lower IPO volumes. Debt
underwriting revenues were up 23% year over year because of strong refinancing volumes, particularly in the
speculative-grade category. Overall advisory revenues fell 12% year over year, reflecting a decline in industrywide
volumes; however, Morgan Stanley reported a 25% increase due largely to an increase in completed mergers and
acquisitions (M&A). Goldman Sachs and Morgan Stanley--which depend on fee income the most--saw especially large
increases in FICC revenue, while other banks benefited to a lesser extent.
Table 3
Capital Markets Revenue*
(%)
--Debt
--Advisory-- underwriting--
--Equity
underwriting--
--Total
investment
banking--
--FICC--
--Equity--
--Total
capital
markets--
Q/Q
Y/Y
Q/Q
Y/Y
Q/Q
Y/Y
Q/Q
Q/Q
Y/Y
Q/Q
Y/Y
25
22
16
22
(5)
(36)
15
5
(1)
167
4
7
2
44
5
31
Goldman
Sachs
Group Inc.
8
(19)
(13)
28
(7)
(7)
(3)
(4)
2
70
(14)
(11)
(5)
27
(4)
15
Citigroup
Inc.
24
(2)
(8)
4
30
(8)
4
0
(13)
36
5
15
(10)
31
(7)
22
JPMorgan
Chase & Co.
(5)
(17)
(16)
32
(19)
(5)
(13)
5
(22)
31
(19)
8
(21)
24
(19)
18
(20)
(36)
(11)
31
(30)
(36)
(16)
(4)
(29)
12
(1)
7
(22)
11
(20)
6
6
(12)
(9)
23
(11)
(20)
(4)
0
(16)
43
(6)
4
(13)
27
(11)
18
Morgan
Stanley
Bank of
America
Corp.
Total
Y/Y Q/Q Y/Y Q/Q Y/Y
--Total sales
and trading--
*We define capital markets revenues as sum of equity underwriting, debt underwriting, advisory, equity trading and FICC trading. Q/Q--Quarter
over quarter. Y/Y--Year over year.
Looking ahead, we estimate capital market revenues will increase in 2017, underpinned by a strengthening U.S.
economy. Other potential factors such as divergent global monetary policies, more M&A activity, and regulatory and
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tax reform could also spur activity. That said, capital market revenue is hard to predict, and uncertainty amid higher
market volatility could arise due to numerous factors including political uncertainty, Brexit, and other global issues,
which could constrain capital markets revenues (see "Banks' Capital Markets Results Have Rebounded After A Tough
First Quarter, But Further Improvement Remains Uncertain," published Oct. 20, 2016). For example, it remains unclear
how successful the Trump Administration will be in boosting the economy through its various proposals.
Beyond capital markets, other noninterest income sources may also get a boost if economic growth accelerates.
Asset/wealth management could benefit from higher equity market valuations (banks with assets under management
[AUM] skewed toward fixed-income assets will likely see a decline in value as rates rise). Credit card spending should
also get a lift from higher consumer confidence. In contrast, we expect mortgage banking revenue to face some
headwinds. Higher rates are already weighing on origination volumes. According to the Mortgage Bankers Assn.
(MBA), mortgage originations in the fourth quarter fell by about 16% from the third quarter. Refinance volumes were
down 10% because of an increase in the 30-year mortgage rate. The MBA expects the refinance volume to decrease to
$471 billion in 2017 from $901 billion in 2016.
Net interest income rose modestly and may benefit from higher rates in 2017
Net interest income benefitted from growth in earning assets and higher short-term rates following the Federal
Reserve's (Fed) recent rate hike in December. However, the net interest margin (NIM) was little changed at the median
and down for some banks for the fourth quarter because of marginally higher deposit and borrowing costs (driven by
higher debt levels). Bank management teams noted that they have not yet significantly raised deposit pricing, despite
the 50-bps rise in the Fed's target rates, although they expect deposit costs to rise more meaningfully with additional
rate hikes.
In our opinion, the steepening of the yield curve bodes well for margin expansion (the 10-year Treasury yield rose 82
basis points [bps] in the fourth quarter, with most of the increase taking place after the presidential election in
November). That said, in January the 10-year Treasury yield has declined somewhat, thus lessening the steepening
effect of the yield curve. All banks were asset sensitive as of the end of fourth-quarter 2016, implying that the yield they
earn on their assets would increase more than the cost of their liabilities if market interest rates rose. However, we
expect that a gradual rise in interest rates will result in a moderate, rather than an outsize, improvement in net interest
income and NIMs. That's largely because the cost of banks' liabilities could rise faster than what the banks forecast for
a variety of reasons. For instance, when the Fed raises rates, more non-interest-bearing deposits could exit the banking
system or shift to interest-bearing accounts than the banks expect (see "Higher Rates May Not Help U.S. Banks As
Much As They Expect," published Nov. 29, 2016).
Table 4
Net Interest Margin (Reported)
(%)
Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Quarter over quarter Year over year
Bank of America Corp.
2.14
2.33
2.23
2.23
2.23
0.00
0.09
Citigroup Inc.
2.92
2.92
2.86
2.86
2.79
(0.07)
(0.13)
JPMorgan Chase & Co.
2.23
2.30
2.25
2.24
2.22
(0.02)
(0.01)
Wells Fargo & Co.
2.92
2.90
2.86
2.82
2.87
0.05
(0.05)
Median
2.58
2.62
2.56
2.53
2.51
(0.01)
(0.03)
Source: Company reports.
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Good expense control supported positive operating leverage--a trend that should continue in 2017
The G-SIBs as a group posted positive operating leverage by maintaining strong expense discipline. Most banks noted
they will continue to improve their efficiency ratios in 2017 and 2018 through digitalization, process automation, and
reduction in branch count. For example, Bank of America closed 179 branches in 2016; Wells Fargo closed 84
branches in 2016 and plans to close another 200 branches in both 2017 and 2018. Although difficult to predict, legal
expenses for 2017 should not be a major factor because we aren't aware of any imminent industry settlements that
would meaningfully hurt bank bottom lines. Despite the new Administration's initiatives to reduce regulation, we
believe it is too early to determine the ultimate changes in regulation for the U.S. banking sector. As such, we believe
regulatory expenses will likely remain at current elevated levels. Further, investments in technology to improve digital
footprints and protect cybersecurity should also continue to rise through 2017.
Table 5
Adjusted Operating Expenses
($ bil.)
Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Quarter over quarter (%) Year over year (%)
Bank of America Corp.
14.0
14.8
13.5
13.5
13.2
(2.4)
(6.1)
Citigroup Inc.
11.4
10.7
10.4
10.4
10.2
(2.0)
(10.6)
6.2
4.8
5.5
5.3
4.8
(9.9)
(23.0)
15.1
14.7
14.5
15.3
14.8
(3.3)
(2.2)
6.1
6.1
6.4
6.5
6.8
3.8
10.3
Wells Fargo & Co.
12.6
13.0
12.9
13.3
13.2
(0.4)
4.9
Median
12.0
11.9
11.6
11.8
11.7
(2.2)
(4.1)
Goldman Sachs Group Inc.
JPMorgan Chase & Co.
Morgan Stanley
Source: Company reports.
Reserve releases supported earnings, but asset quality metrics will likely worsen
For all G-SIBs, nonperforming assets decreased from the third quarter, mainly reflecting improvements across
consumer and commercial loan portfolios. Within commercial loans, the improvement was primarily attributable to
stabilization in oil and gas portfolios, due largely to a rebound in oil prices and receptive capital markets. After building
reserves consecutively in the last four quarters, the G-SIBs as a group released reserves (net charge-offs exceeded
credit provisions) in the fourth quarter. The exception was Citigroup, which added reserves due to growth in credit
card loans.
We will monitor in 2017 for potential asset quality deterioration credit cards, automobile loans (particularly to
nonprime borrowers), commercial real estate (CRE), and leveraged loans. Although early-stage delinquencies are still
relatively benign, they've been ticking up (particularly within credit card and auto loan portfolios), and we expect net
charge-offs to move higher from historically low levels. Further, we expect rising interest rates will put the greatest
pressure on floating-rate loans such as CRE--and on banks' weak marginal borrowers in other asset classes, which
were able to borrow at low rates, thus constraining monthly payment amounts. The Fed's recently released January
2017 Senior Loan Officer Survey suggests that banks tightened lending standards on CRE, credit card, and automobile
loans, whereas standards on commercial and industrial (C&I) loans were unchanged. We are closely monitoring other
critical indicators that may presage asset quality problems, including the impact of potentially lower used-car prices
and maturity expansions of auto loans, as well as rent and occupancy levels for CRE.
In regard to energy exposure, although prices stabilized in the second half of 2016, energy prices are volatile and could
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fall again in response to geopolitical volatility. That said, we believe that the credit risk to the G-SIBs from falling oil
prices is manageable given low direct energy exposures of 2%-4% of total loans. (For our hypothetical loss rates across
three scenarios of differing severities, see "How Bad Can It Get: Possible Loss Scenarios For Energy-Exposed U.S.
Regional Banks," published March 31, 2016.)
Table 6
Asset Quality
--NPAs*-(bps)
--NCOs¶--
--Reserves to loans--
Q/Q
Y/Y
Q/Q
Y/Y
Q/Q
Y/Y
Wells Fargo & Co.
(7)
(22)
4
1
(2)
(8)
Citigroup Inc.§
(2)
6
13
(3)
(3)
(12)
JPMorgan Chase & Co.
(3)
0
6
6
(6)
(8)
Bank of America Corp.
(7)
(20)
(0)
(13)
(5)
(13)
*NPAs are reported nonperforming loans divided by total loans. ¶NCOs are total net charge-offs divided by average loans. §Citi's fourth-quarter
average loans is the average of gross loans from the fourth quarter and the third quarter. NA--Not applicable. Q/Q--Quarter over quarter.
Y/Y--Year over year.
Loan growth has slowed somewhat but should follow the trajectory of U.S. economic growth in 2017
On a quarter-over-quarter basis, loans were little changed and growth slowed from the moderate pace reported in the
prior two quarters. Loans rose in the mid-single digits for the year for the G-SIBs in aggregate. Consumer
loans--particularly credit cards and auto--accounted for most of the growth in the fourth quarter. Commercial loan
growth trends were mixed. For instance, commercial loans declined across all regions for Citigroup and ended lower
for JPMorgan (because of a decline in loans at its Corporate & Investment bank unit). On the other hand, C&I and CRE
loan growth improved for Wells Fargo and Bank of America.
We expect the U.S. banking industry to experience overall loan growth in the mid-single digits in 2017. Loan growth
should be broad based, although C&I loans could be a leading source of this growth depending on the trajectory of the
U.S. economy. Growth in consumer disposable income should help push card balances higher. CRE growth should
moderate somewhat because of banks' conservative risk posture toward this loan category. We expect higher rates to
weigh on residential mortgage originations. Auto loans, which have grown robustly for several years, could show less
growth if banks become more cautious.
Table 7
Balance Sheet
(Quarterly change, %) Assets Loans Deposits
Wells Fargo & Co.
(0.6)
0.8
2.4
Citigroup Inc.
(1.4)
(2.2)
(1.2)
JPMorgan Chase & Co.
(1.2)
0.9
(0.1)
Bank of America Corp.
(0.3)
0.3
2.3
As of Dec. 31, 2016.
Capital and liquidity remain strong
The G-SIBs as a group indicated stronger capitalization quarter over quarter, with the average estimated fully
phased-in Basel III common equity Tier 1 ratio rising by about 15 bps to 12.5%. All banks already exceed their
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expected fully phased-in 2019 required minimums (including the Fed G-SIB surcharges). Given the banks' comfortable
position against the minimums, some banks announced additional share buybacks beyond the planned capital actions
included in their 2016 Comprehensive Capital Analysis and Review (CCAR) submissions. For example, Citigroup
announced a $1.75 billion increase to its share repurchases in November 2016 and Bank of America followed with a
$1.8 billion increase in February 2017. Separately, capital ratios of most advanced approach banks were hurt by higher
interest rates, which increased unrealized losses as the value of banks' available-for-sale securities declined (under
Basel III, all large banks that use advanced approaches are required to deduct these unrealized losses from capital).
Further, the Fed released its supervisory scenarios for the 2017 annual stress test and updated the CCAR instructions.
Although it features a slightly more severe economic downturn in the U.S., it does not include negative short-term
interest rates (a feature of the 2016 stress test). It also features a larger decline in CRE prices (large banks' exposure to
CRE is generally less than 10% of total loans). Separately, the instructions mandate the inclusion of the supplementary
leverage ratio (SLR)--with a minimum requirement of 3% under the severely adverse scenario--into the CCAR process
for 2017. In our view, the SLR will act as a capital hurdle and could require some banks, particularly the trust banks
(which have lower SLR ratios), to be more circumspect regarding asset growth and possibly issue additional Tier 1
capital. Overall, we expect that payouts for most banks will be higher for the 2017 CCAR cycle given improved
earnings, as well as somewhat more lenient stress scenarios. Additionally, the amount of additional capital a firm can
distribute on top of the initial CCAR request (the "de minimis clause") will decline to 0.25% of Tier 1 capital from 1%.
Banks' funding remained solid throughout 2016, and we don't expect any major surprises for 2017. We believe funding
ratios have been abetted by strong deposit inflows, which partially reflect low interest rates, as the cost of holding a
noninterest deposit continues to be minimal compared with investment alternatives. For example, we estimate that
deposits in the U.S. banking system have grown roughly 60% since 2006, while loans have risen only approximately
28%. Should rates move higher, though, some deposits may exit the banking system, which could put pressure on
some banks' funding or perhaps pose a headwind to loan growth.
By our measure, liquidity was down slightly for some banks in 2016 but is still adequate for all the G-SIBs. We expect
liquidity to remain adequate through next year. One way we measure liquidity is by assessing how much a bank's
broad liquid assets exceed its short-term wholesale funding (as we define the terms). The coverage is about 2x for
money center banks and broker-dealers, which rely heavily on short-term funding, and the coverage is higher for trust
banks. In terms of liquidity regulatory ratios, most banks' liquidity coverage ratios (LCR) are already above their fully
phased-in requirement of 100%.
Table 8
Tier 1 Common Ratio
--Tier 1 common equity ratio - Basel III fully phased-in--
Basel III
minimum*
Current surplus
(deficit) from
estimated Basel
III minimum
Q4
2016
Q3
2016
Quarter-over-quarter
change (bps)
Advanced/standardized
(lower of the two)
U.S. Fed
G-SIB
surcharge
Bank of
America
10.8
10.9
(10)
A
2.5
9.5
1.3
Citigroup
12.5
12.6
(13)
A
3.0
10.0
2.5
(%)
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Table 8
Tier 1 Common Ratio (cont.)
--Tier 1 common equity ratio - Basel III fully phased-in--
Basel III
minimum*
Current surplus
(deficit) from
estimated Basel
III minimum
Q4
2016
Q3
2016
Quarter-over-quarter
change (bps)
Advanced/standardized
(lower of the two)
U.S. Fed
G-SIB
surcharge
JPMorgan
Chase
12.2
11.9
30
A
3.5
10.5
1.7
Wells Fargo
10.7
10.7
0
S
2.0
9.0
1.7
Morgan
Stanley
15.8
15.8
0
A
3.0
10.0
5.8
Goldman
Sachs
12.7
11.9
80
A
2.5
9.5
3.2
Bank of New
York Mellon
9.7
9.8
(10)
A
1.5
8.5
1.2
State Street
10.9
11.8
(90)
S
1.5
8.5
2.4
(%)
*Including the Fed G-SIB surcharge. Source: Company filings.
NIM expansion and higher fee income aid trust banks' bottom lines
The large U.S. trust banks--Bank of New York Mellon (BK), State Street Corp. (STT), and Northern Trust Corp.
(NTRS)--posted satisfactory operating earnings in fourth-quarter 2016 (on an adjusted basis excluding one-time items).
We estimate that the pretax operating margin for the trust banks, as a group, was about 28%. Revenues for the group
were up 4% year over year, primarily reflecting higher net interest income as yields rose amid higher rates, increased
investment management fees because of lower money market fee waivers and higher global equity markets (except BK
as performance fees declined due to exposure to the fixed income markets), and higher foreign exchange trading
revenues due to an increase in client volumes and volatility. Additionally, servicing fees were up 3% year over year
due to new business and higher equity markets. However, strength in the U.S. dollar (principally versus the British
pound) weighed on both servicing and management fees.
Expense trends were mixed as BK and NTRS generated positive year-over-year operating leverage, while STT's was
negative. STT's expenses were affected by a $249 million charge related to acceleration of deferred compensation
expense (excluding this charge, STT posted positive operating leverage). Expense management continues to be a top
priority for all the trust banks.
The AUM of all trust banks, as a group, were up 7% year over year because of higher market valuations, partly offset
by the stronger U.S. dollar. Regarding flows, STT saw strong inflows in exchange-traded funds, partly offset by
outflows in cash and sovereign funds; for BK, outflows occurred across all active strategy products; and NTRS saw
inflows in equities, partly offset by outflows in fixed income products. On a year-over-year basis, assets under custody
and administration improved for all the trust banks, mainly reflecting higher equity markets and new business, partly
offset by the stronger U.S. dollar. New business wins for STT were solid at $180 billion and totaled $141 billion for BK.
That said, STT announced that BlackRock Inc. would move a portion of its assets, largely common trust funds
currently with STT, to another service provider in an effort to diversify its exposure. STT noted that the transition will
not be fully completed until 2018 and will represent just over $1 trillion in assets--about 20% of BlackRock's AUM.
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Lastly, the estimated Basel III common equity Tier 1 ratios on a fully phased-in basis for all trust banks were affected
by higher interest rates as unrealized losses increased because of a decline in the value of available-for-sale investment
securities. Based on the size of the trust banks' payouts, we don't expect their capital ratios to improve significantly.
Positively, BK achieved its compliance with the bank-level SLR requirement of 6%.
We upgraded the operating subsidiaries of four U.S. G-SIBs following final TLAC rules
The Fed announced final total-loss absorbing capacity (TLAC) rules on Dec. 15. Regulators require banks to hold a
certain amount of debt, which the bank could convert to equity in a financial crisis (essentially, debtholders would "bail
in" a failing bank, as opposed to the bank receiving a government "bail out").
The Fed's final rules for TLAC have clarified that banks will be able to count their existing senior unsecured debt
toward TLAC--even though such debt contains certain types of qualitative acceleration clauses that will be
impermissible in TLAC-eligible debt issued after Dec. 31, 2016. Therefore, we now count such debt in our calculation
of the additional loss-absorbing capacity (ALAC) ratios of the eight U.S. GSIBs--causing those ratios to increase
significantly. As a result, we raised our ratings on the operating subsidiaries of Bank of America, Citigroup, Goldman
Sachs, and Morgan Stanley by one notch in December (see "Operating Subsidiaries Of Four U.S. Global Systemically
Important Banks Upgraded Following Final TLAC Rules," published Dec. 16, 2016). The outlooks on all four entities
are stable.
Separately, in October 2016, we revised our outlook on Wells Fargo & Co. and the company's main operating
subsidiaries, including Wells Fargo Bank N.A., to negative from stable. The outlook revision reflected increased
business risks stemming from the company's retail accounts sales misconduct (see "Wells Fargo Outlook Revised To
Negative From Stable On Potential Elevated Business Risks; Ratings Affirmed," published Oct. 18, 2016).
Other expectations for 2017
In regards to regulation, although President Trump recently signed an executive order calling for a broad review of the
Dodd-Frank Act, it will likely take time for any major changes to occur, assuming there is congressional support. Our
view in this regard is that a lighter touch on regulation could help bank profitability, but more substantial changes,
particularly lowering capital standards or substantially diluting stress testing, could be negative for ratings. Regulators
have the ability to apply existing rules less stringently, although that is probably unlikely to occur until the Trump
Administration makes appointments to the Fed board. We also believe that the Administration may focus on lightening
the regulatory burden on smaller banks because, even before the election, there seemed to be some bipartisan support
for reducing their burden. Over the near term, a delay in the April implementation of the Department of Labor
Fiduciary Rule designed to provide certain protections to retail investors is also a likely possibility. Still, we think the
GSIBs affected by the rule will likely proceed with some of the changes they have already implemented in anticipation
of the rule.
Below are our base-case expectations for U.S. G-SIBs' operating performance for the remainder of 2017 (see also "U.S.
Banks Should See Higher Profits In 2017, But Plenty Of Wild Cards Are In Play," published Dec. 21, 2016):
• We expect adjusted revenue to rise modestly, as higher loan growth and securities purchases should be abetted by a
steeper yield curve, while fee income should benefit from a rebound in capital markets activity and higher market
valuations.
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• We expect positive operating leverage in 2017, stemming from a continued rationalization of operating costs,
although regulatory expenses will likely remain at current elevated levels and should continue to present headwinds
to cost cutting.
• We expect credit quality will worsen amid higher rates, leading to continued reserve build. We will continue to
monitor credit trends in energy and exposure to other high growth segments, including CRE (multifamily and
investor CRE), leveraged loans, credit cards, and auto loans. We also expect charge-offs to gradually rise.
• We expect loan growth in 2017 to be more broad-based, although C&I loans will probably continue to be a leading
source of this growth. We also expect a pickup in growth of credit card loans, with some of the focus shifting away
from CRE. We expect the pace of auto loan originations to moderate.
• We expect capital ratios to remain mostly steady, given that all large banks are already above their minimum
required regulatory ratios. We expect dividends and buybacks to increase due largely to improved earnings.
However, the inclusion of the SLR in the CCAR cycle could restrict payout levels for some banks.
• With the finalization of the TLAC rules on Dec. 15, we estimate the combined shortfall for long-term debt and TLAC
requirement for the five G-SIBs at about $71 billion as of Sept. 30, 2016. We believe these banks will continue to
issue TLAC-eligible debt in 2017 and beyond to comply with the final rule, effective Jan. 1, 2019. Separately, most
banks are already in compliance with the fully phased-in liquidity coverage ratio requirements, but we still expect
them to maintain high-quality customer deposits and large securities balances.
• We expect trust banks to benefit from higher rates, continue to control expenses, and to remain modest in building
capital in 2017.
Issuer Review
Table 9
Company/Issuer Credit Rating*/Comments
Analyst
Bank of America Corp. (BBB+/Stable/A-2)
Bank of America Corp. (BAC) posted strong performance in the fourth quarter with relatively higher adjusted Rian Pressman
pretax earnings compared with the same quarter in 2015. Adjusted pretax income of $6.4 billion was up 23%
mainly due to a rebound in sales and trading revenue and continued expense management. Specifically on the
revenue side, earnings primarily benefitted from a 12% rise in FICC trading revenues, as well as higher debt
underwriting fees and mortgage banking revenues, partly offset by lower advisory and equity underwriting
revenues. Net interest income was relatively stable after considering the $600 million redemption of trust
preferred securities in the year-ago quarter. Credit provisions declined during the quarter with a modest
release in commercial loan reserves related to energy. Overall operating expenses were down 6% from the
year-earlier quarter, and efficiency metrics improved to 66%. Asset quality generally remained benign. The
NPA ratio improved eight bps from the third quarter to 0.89%, and criticized commercial exposure declined
$600 million due to credit quality improvements within the energy portfolio. Moreover, the net charge-off
(NCO) ratio improved marginally to a low 0.39% of average loans. BAC’s fully phased-in Basel III common
equity Tier 1 (CET1) ratio under the advanced approach was 10.8%, down 10 bps from the previous quarter.
BAC reported that its method 2 G-SIB capital requirements has dropped by 50 bps to 2.5%, resulting in an
estimated total 2019 CET1 requirement of 9.5%. BAC’s SLR is already higher than the proposed minimum
requirements at both the bank and holding company.
Bank of New York Mellon Corp. (A/Stable/A-1)
Bank of New York Mellon Corp. (BK) posted good fourth-quarter results, with adjusted pretax income of $1.16 Stuart Plesser
billion, up 9% from the previous year quarter. Strength in investment services fees, higher net interest revenue,
and lower expenses abetted earnings, but investment management fees declined. Investment services fees
rose 4%, mainly reflecting higher money market fees (BK noted it has recovered 70% of its fees waivers and
expects to capture all of its fees waivers with additional rate hikes). Investment management was hurt by
lower performance fees (as BK is more exposed to fixed income markets, which were pressured after the
election) and a stronger U.S. dollar. Net interest revenue (NIR) was up 9% year over year due to an 18-bps
expansion in NIM to 1.17%. The NIR benefitted from higher yields on earning assets stemming from the rate
increases, partly offset by a decline in the level of earning assets. NIM expansion also included a five-bps
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positive impact related to interest rate hedging activities (offset in the foreign exchange and other trading
revenue line, which fell 7% year-over-year) and premium amortization adjustment. On a year-over-year basis,
BK posted operating leverage of more than 350 bps, mainly reflecting its continued focus on business
improvement process. We estimate that the pretax margin was a solid 30.6%. BK's fully phased-in Basel III
CET1 ratio of 9.7% (advanced approach) was down 10 bps from the third quarter as a decline in risk-weighted
assets was more than offset by increased share repurchases and unrealized losses in its investment securities
portfolio resulting from higher interest rates. BK is now in compliance with the SLR, at both the consolidated
and the bank level. The SLR was down 10 bps to 5.6% at the consolidated level. At its bank subsidiary, the
SLR rose 20 bps to 6.1% because of a relatively smaller balance sheet.
Citigroup Inc. (BBB+/Stable/A-2)
Citi’s fourth-quarter results were generally in line with our expectations for the quarter. Although revenues
Nikola Swann
decreased 9% year over year, adjusted pretax income rose 2% versus fourth-quarter 2015. The decline in the
revenues was due largely to the absence of gain-on-asset sales in Citi Holdings, which continues to
wind-down (assets declined 11% from the third quarter and comprised 3% of the total assets). Otherwise,
Citicorp revenues were up 6%, mainly reflecting an 11% growth in institutional client group (ICG), and a 2%
increase in Global Consumer Banking (GCB) revenues. Within ICG, fixed-income markets revenue rose a solid
36%, reflecting increased client activity and improved trading conditions in spread products, and rates and
currencies. Equity trading revenues were up 15% because of higher trading activity and improved
performance in derivatives. Investment banking revenues were flat as higher debt underwriting revenues were
offset by weaker equity underwriting and lower advisory fees. Further, treasury and trade solutions (up 3%
due to growth in transaction volumes) and private bank (up 6% due to higher loan balances and spreads) also
benefitted ICG revenues. Citi’s North America consumer banking revenues were up 5% as branded cards
revenue increased 15%, reflecting the contribution from Costco and modest organic growth. Revenue in Latin
America GCB increased 8%, reflecting higher retail loans and deposits, partially offset by lower card revenues.
Revenues in Asia GCB were up 4%, driven by improvement in wealth management and cards. Citigroup’s
NIM declined seven bps from the previous quarter to 2.79% due to lower trading NIM, higher funding costs,
and higher mix of promotional rate balances in cards. On a year-over-year basis, Citigroup posted positive
operating leverage in the fourth quarter as the decline in expenses outpaced the decline in revenues. The
reduction in expenses was primarily attributable to lower expenses in Holdings (due to the ongoing decline in
assets), coupled with efficiency savings, and lower repositioning costs in Citicorp. Management is targeting to
achieve an efficiency ratio of 58% in 2017 and mid-50% by 2018 (versus 59% in 2016). Consumer nonaccruals
decreased 11%, driven by improvements across all regions, but credit losses inched up to 2.10% from 1.87%
in the third-quarter, reflecting higher losses in North America stemming from the Costco portfolio. Corporate
nonaccrual loans were unchanged as improvement in North America was offset by an increase in EMEA. The
Basel III CET1 ratio was down 13 bps to 12.5% as earnings and a decrease in risk-weighted assets (RWAs)
was offset by higher unrealized losses in the investment securities portfolio (as rates increased) and share
buybacks and dividends.
The Goldman Sachs Group Inc. (BBB+/Stable/A-2)
Goldman Sachs reported good fourth-quarter results, with adjusted pretax earnings of $3.4 billion versus $1.1 Stuart Plesser
billion a year ago. The prior-year quarter was affected by a $1.95 billion litigation charge. Earnings primarily
benefitted from increased trading activity. Goldman’s capital market revenues were propelled by a 70%
increase in FICC and a 28% rise in debt underwriting revenues, partially offset by lower equity trading,
advisory, and equity underwriting revenues. FICC benefitted from better market-making conditions, which
drove improvements across all products, with strong results in rates and credit. Equities trading results (down
11%) were weak compared to peers’ due largely to lower revenues in cash products, partly offset by higher
revenues in derivatives. Within investment banking, higher leveraged finance activity contributed to stronger
debt underwriting, whereas advisory fees fell (down 19%) because of a decline in industrywide transactions
and equity underwriting decreased (down 7%) due to lower IPO volumes. Revenues at the company’s
investing and lending unit were up 15% year over year, mainly reflecting higher net interest income and to a
lesser extent gains in private equities. The company’s investment management unit posted a 3% increase in
revenue due to higher incentive fees, but management fees were flat, reflecting higher average assets under
supervision (up $32 billion due to inflows in liquidity products), offset by shifts in the mix of client assets and
strategies. Full-year operating expenses (excluding the litigation charge) were down 6% year over year, with
compensation expenses declining 8%, reflecting strong expense controls and lower revenues. GS completed a
$700 million expense initiative in the first half of 2016 and noted it was able to generate $900 million of
savings for the full year by continuing to cut costs in the second half of the year. The fully phased-in Basel III
CET1 ratio (advanced approach) was 12.7%, up 80 bps from the third quarter due largely to lower RWAs,
particularly operational RWAs.
JPMorgan Chase & Co. (A-/Stable/A-2)
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JPMorgan Chase & Co. reported a sharp rise in fourth-quarter 2016 earnings compared to the prior year
Brendan
mostly on the back of rise in sales and trading revenue and reductions in the provision for loan losses and
Browne
legal expenses. Those factors more than offset a drop in earnings in the consumer and community bank (CCB)
unit, relating mostly to significantly lower card income. For the quarter, the company reported a return on
tangible common equity of 14%, up from 11% a year ago. On the balance sheet, total loans and assets were
little changed compared to the prior quarter, and regulatory capital ratios improved somewhat. Net income
rose 1% for the full year as a sharp decline in legal expenses and a modest rise in revenue roughly offset
higher taxes. In the Corporate and Investment Bank (CIB), net income in the quarter nearly doubled compared
to the prior year, driven by strong sales and trading revenue and a reduction in noninterest expenses and the
provision. Fixed income and equity markets sales and trading rose 31% and 8%, respectively, and investment
banking revenue rose modestly. The company said fixed income markets performed well across a number of
products. Higher client risk appetite helped credit and securitized products and more activity in energy
markets supported commodity sales and trading. Legal and compensation expense fell in CIB as well, and the
provision dropped with a release of reserves for oil and gas, and metals and mining exposure. That helped
drive a reduction in reserves for the company as a whole compared to the prior quarter. Earnings and revenue
in CCB both fell 2%. Lower card income drove both of those drops. The company pointed to higher new
account origination costs in cards. The company card originations increased 20% for the year, partially due to
more aggressive promotions and some reduction in credit standards. A drop in net mortgage servicing
revenue also weighed on CCB’s results. JPM partially offset those factors with a drop in the provision and
reserve release. On the balance sheet, credit card rose a strong 6% from the prior quarter and auto loans
increased 2%. Residential mortgages were flat after climbing meaningfully in prior quarters and were up 10%
for the year. Reserves rose for credit cards but fell overall with a decline in reserves for mortgages. Higher
earnings in Commercial Banking (CB) and Asset Management (AM) also contributed to the overall increase in
income and profitability. In CB, JPM reported higher revenue from lending, treasury services, and investment
banking, and it modestly reduced expenses. It reported particular strength in corporate client banking.
Commercial term lending continued to grow at a brisk pace, and loans for the unit as a whole were up 14% for
the year. In AM, higher wealth management revenue drove an 16% rise in earnings. The company’s net yield
on interest earning assets declined two bps from the prior quarter to 2.22% as its cost of liabilities rose four
bps, partially as its cost of long-term debt increased. On the balance sheet, total loans and what the company
calls core loans each rose 1% from the prior quarter and were up 7% and 10%, respectively, for the year.
Residential mortgages, credit cards, auto loans, CRE loans, and corporate loans all contributed to the annual
rise in loans. Deposits rose 7% for the year and were roughly flat in the quarter.
Morgan Stanley (BBB+/Stable/A-2)
Morgan Stanley reported a roughly 80% increase in fourth-quarter 2016 earnings compared to the prior year Brendan
predominantly due to a sharp improvement in its institutional securities (IS) business, where revenue from
Browne
fixed income sales and trading almost tripled. The company reported a return on average common equity of
8.7% for the quarter, up from 4.9% a year ago (ex-DVA) and 8.0% for the year, moving closer to its 9%-11%
goal for 2017. Revenues rose 17% in the quarter while non-interest expenses increased only 8%, helped by a
modest 2% rise in noncompensation expenses. The company continues to make progress in paring expense
as part of its Project Streamline initiative. Noninterest expenses fell 3% for the year with a 7% drop in
noncompensation expenses. In IS, fixed income sales and trading revenue rose to $1.5 billion in the quarter
from $550 million a year earlier (ex-DVA). Equity sales and trading rose 9%, and investment banking
increased 5% with strength in advisory and fixed income underwriting. Equity underwriting revenues fell. With
the sharp rise in revenue, earnings in IS rose to $1.1 billion from $341 million a year earlier, and the unit’s
return on average common equity rose to 9%, its highest level since second-quarter 2015. In the wealth
management (WM) unit, earnings increased a more moderate 11% from the prior year. That unit reported a
rise in asset management fees, on market appreciation and an inflow of funds, and net interest income, on a
larger balance sheet. WM’s 22% pretax margin was slightly below its 23%-25% target as noninterest expense
climbed 4%. The company’s smallest unit, investment management, reported a drop in earnings largely due to
markdowns on the sale of limited partnership investments in third-party sponsored funds. Asset management
fees were little changed. The company’s capital ratios were roughly flat. Its robust fully phased advanced
common equity Tier 1 capital ratio was unchanged from the prior quarter at 15.8% while its supplementary
leverage ratio rose modestly to 6.3%. WM loans and lending commitments continued to rise, climbing 4% in
the quarter and 24% for the year. IS loans and lending commitments rose 3% in the quarter but fell 7% for the
year. WM deposit rose 3% in the quarter and for the year.
Northern Trust Corp. (A+/Stable/A-1)
Northern Trust Corp. (NTRS) posted satisfactory fourth-quarter results, with net income of $266.5 million, up
from $239.3 million in fourth-quarter 2015 and $257.6 million in the third-quarter 2016. Assets under custody
rose 11% year-over-year, while AUM was up 8% as a result of new business and higher global equity markets,
partly offset by the stronger U.S. dollar. Compared to the prior-year quarter, earnings reflected higher net
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interest income, fees revenue, and foreign exchange trading income, partly offset by higher noninterest
expenses. Net interest income growth was strong because of higher earning assets and a large expansion in
the NIM, reflecting higher yields on earning assets, primarily as a result of higher short-term interest rates.
Fees revenue increased primarily due to reduced money market fee waivers, new business, and higher equity
market valuations but was hurt by the stronger U.S. dollar. Additionally, higher securities lending fees (due to
improved spreads) and an increase in foreign exchange trading income (reflecting higher client volumes and
currency volatility) also aided earnings. Several capital ratios rose in the quarter, and we anticipate the
company will maintain capital ratios near or slightly above current levels given that we expect modest growth
in RWAs, coupled with a high payout ratio. We also expect the company's financial performance will remain
strong, that its business strategy will remain conservative, and that its loan performance will remain better
than that of most commercial bank peers.
State Street Corp. (A/Stable/A-1)
State Street Corp. (STT) posted satisfactory fourth-quarter 2016 results, with adjusted pretax income
Stuart Plesser
(excluding acquisition costs related to GE Asset Management (GEAM) and restructuring charges) of $604
million versus $767 million in the previous year quarter. Earnings were affected by a $249 million charge
related to acceleration of deferred compensation expense. On a year-over-year basis, overall revenue rose 6%
due to higher fees revenue and increased net interest revenue. Fees revenue was up 6%, mainly reflecting
higher management fees (up 28% due to the GEAM acquisition, lower money market fees waivers, higher
global equity markets, and strong ETF inflows, partly offset by the stronger U.S. dollar and outflows in cash
and sovereign funds), increased foreign exchange trading (up 27% amid higher volatility and volumes), and
higher securities finance revenue (due to growth in enhanced custody). Servicing fees was up 1% due to net
new business, partially offset by the stronger U.S. dollar. Net interest revenue was up 7%, reflecting higher
rates, and disciplined liability pricing, partly offset by a continued decline in foreign security yields. The NIM
expanded seven bps from the previous year quarter to 1.08%. Excluding the GEAM operating expenses and
the acceleration of compensation expense, STT posted positive operating leverage in the fourth quarter. The
fully phased-in CET1 ratio fell 90 bps to 10.9% (comparing the binding approaches--standardized in
fourth-quarter 2016, versus advanced in third-quarter 2016) because of a reduction in the value of
available-for-sale securities due to higher interest rates and decrease in foreign exchange translation gains
because of the stronger U.S. dollar. The SLR at the holding company and bank declined about 40 bps and 10
bps, respectively, to 5.6% and 6.1% (both above the minimum requirements).
Wells Fargo & Co. (A/Negative/A-1)
Wells Fargo & Co. (WFC) reported net income applicable to common stock of $4.87 billion (an approximate
Barbara
1.00% return on assets), which was weaker than recent quarters but generally in line with our expectations.
Duberstein
The decline from $5.24 billion in net income in the prior quarter primarily resulted from lower noninterest
income, driven by a $592 million loss from hedge ineffectiveness. The hedge ineffectiveness mainly stemmed
from the impact of higher rates and currency changes on the fair value of swaps the company uses to hedge
its long-term debt; we expect this quarterly volatility and note that net hedge ineffectiveness resulted in only a
$15 million loss for full-year 2016. Otherwise, noninterest income from most businesses was largely stable,
although reduced client volumes (versus a strong third quarter) pressured trading results while mortgage
banking income was affected by lower servicing income and lower production margin. Net interest income
rose 4% from the third quarter due to higher earning assets and a five-bps expansion in NIM to 2.87%,
reflecting a modest benefit from higher interest rates. Regarding expenses, the company expects the efficiency
ratio will be at the higher end of its target of 55%-59% (the ratio was 59.3% in full-year 2016). The loan loss
provision was $805 million, flat versus the prior quarter, as the company released a small amount of reserves,
citing continuing improvement in the credit quality of its residential real estate loan portfolios and stabilization
in the oil and gas portfolio. Asset quality trends were good. The NPA ratio (excluding performing troubled
debt restructuring and loans 90 days past due) declined eight bps during the quarter to 1.17%, and the NCO
ratio inched up by only four bps to 0.37%. Capital levels remained adequate, with an estimated 10.7% Basel III
CET1 ratio, unchanged from last quarter, as the impact of a reduction in the value of available-for-sale
securities (stemming from higher rates) was offset by a slight decline in RWAs mainly from a decrease in
counterparty risk exposure. So far, Wells’ major retail sales practice issue is not substantially affecting the
company’s good core earnings power; however, we are watchful of client activity trends and potential legal
charges in 2017.
*Rating as of Feb. 16, 2017.
Only a rating committee may determine a rating action and this report does not constitute a rating action.
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