The US Tax Cuts and Jobs Act, implemented in December, could not have come at a better time for banks wanting to sink the results of their poorly performing markets businesses into a swamp of one-off tax charges.
Its timing enabled them to load up what was already a poor fourth quarter with big hits to their after-tax profits, rather than have those spill into what may well be a much more positive first quarter of 2018. That paves the way for a happier year ahead.
Substantially lower effective tax rates after the reforms offer a windfall for the banks in the future. And the fact that those exposed to losses relating to the Steinhoff accounting scandal were also able to funnel those into the fourth-quarter 2017 mix will have only added to the relief.
Fixed income, currencies and commodities (FICC) sales and trading businesses looked grim across the board, although some fared better than others. The fourth quarter of 2017 looked especially bad in comparison with the same period the year before, which had seen a flurry of activity in the wake of the US presidential election. But even on a full-year basis, low volatility and low client activity hurt all the big players.
It was a different story in financing and advisory, however, where Morgan Stanley’s advisory line was the only one to record a fall from 2016. Combined investment banking revenues (equity and debt capital markets and advisory fees) rose by double digits at each of the big five US firms, with equity underwriting leading the way – Citi and Morgan Stanley saw gains of almost 70% for the year.
At a group level, revenues were up most at Morgan Stanley, by 10%, while the worst performer, Citi, still saw an increase of 2%. Morgan Stanley also topped the gains in pre-tax profits, up 18%, with JPMorgan lagging the others at 4%. Bank of America Merrill Lynch’s (BAML) 17% profit rise was notable given its modest 4% rise in revenues.
Corporate and investment bank (CIB) divisional revenues fell at JPMorgan (-2%) and Goldman (-7%) but were up by single digits at the others. JPMorgan was the only firm to report a fall in CIB profits, although Goldman is still to report that number – it never discloses its divisional P&L until it files its 10-Q report with the SEC. Citi was the standout performer, with its CIB profits up 17%.
Margin loans on Steinhoff stock hurt JPMorgan, Citi, BAML and Goldman, with CFOs curiously reticent to name the company itself in their prepared remarks.
BAML saw a $333 million impact from charge-offs and reserve build related to “a single commercial exposure”. The hit was divided between its global banking and global markets divisions.
Chief executive Brian Moynihan told analysts that issues such as these were always a wake-up call and the bank had to go back and see what lessons could be learned.
“We weren’t happy with it from the top of the house through to the actual people who are involved in it,” he said.
Having elected the fair-value option for its treatment of “a single margin loan”, JPMorgan was marking it to market and so booked a $143 million loss in its equities division. CFO Marianne Lake said the firm was disappointed with the outcome, “but it’s the business we are in”.
At Citi, it was a “single client event”, with a loss of about $130 million. Goldman said a “single structured loan” led to a $130 million hit.
One analyst dared to ask Morgan Stanley if it had seen any pain from Steinhoff: “No we did not!” said chief executive James Gorman. He didn't mention the September IPO of Steinhoff Africa Retail where the bank was a global co-ordinator, but that mandate doubtless made the bank much happier about its experience with Steinhoff than competitors were with their margin loan exposures.
Morgan Stanley chief executive James Gorman
Gorman had other reasons to be upbeat after 2017, including disclosing one of the more specific data points to feature in any of the results calls – 88% of days in 2017 saw revenues of above $60 million, compared with just 42% in 2015. More importantly, he had achieved the targets he set out in a two-year strategic plan in 2016, including a return on equity target of 9% to 11% (it was 9.4% in 2017, if you stripped out the tax charges), and was able to announce that he was introducing a new medium-term target of 10% to 13%.
He said that for a long time Morgan Stanley management had been asked when the firm was going to hit 10%, so the fact that he could now say they would not be below that level was “a pretty important inflection point for this firm”.
Yes, it had been higher before the crisis, but back then the firm was operating with leverage levels in the 40s. Today it is 11.
With all the uplift that is expected from the tax reforms, however, the new target was not enough to please all analysts; Mike Mayo at Wells Fargo wondered if Gorman was being a little unambitious.
Gorman knows Mayo well.
“Oh my god, Mike Mayo – we’ve got a target,” he said. “I thought you’d be calling up to say: ‘You finally have a 10%-plus target’.” But he conceded that it was a fair question, given the lower effective tax rate and the fact that the firm was already at or close to its efficiency and wealth management margin targets.
Morgan Stanley’s business mix is very US-focused and before the new laws paid a net tax rate of 32% – one of the highest of any S&P500 firms.
That said, it was also not relevant to how he ran the business.
“We don’t do less because we’re suddenly getting ahead of one of our targets,” Gorman said. “We don’t stop and not work.”
Markets franchises suffered at all five of the big US banks, with large falls in FICC driving double-digit overall declines at Goldman and JPMorgan. Goldman fared worst, down 18%, while Morgan Stanley was down just 2%.
It was early days for 2018, but Goldman’s CFO Marty Chavez already felt more positive, even if he could scarcely have chosen a more confusing way to say it: “If you ask me this time last year, this time this year, I take this time this year all day.”
Citi’s results certainly showed the benefits of a greater focus on corporates – and why Goldman is set to chase those clients harder in the future. FICC was down 6% on the year, but Citi chief executive Mike Corbat reckoned that “in a down revenue, down wallet year, we fared pretty well.”
|Mike Corbat, Citi|
That was because the bank saw a 5% growth in revenues from corporate clients – enough to lead to an overall increase in client revenues in rates and currencies, where corporates now account for about 45% of revenues. Corbat also thought that the US tax reforms could lead to some useful FX business related to repatriations of earnings at corporate clients.
Morgan Stanley chief executive James Gorman was able to bask in the lowest fall in FICC revenues – just 4% – and an increase in market share, despite having slashed headcount in that business by 25% in late 2015. Since then he has been telling analysts that his strategy would bear fruit and enable the firm to do more with less – and so it has proved. The firm is sized for a $1 billion quarterly run rate; this year it made almost $5 billion.
Gorman name-checked those lieutenants who have made that happen: Sam Kellie-Smith, who moved over from the firm’s equities division to run fixed income; Ted Pick, the firm’s head of sales and trading and president Colm Kelleher, who has overseen the whole strategy.
“We had a real open question about whether we had taken the right strategy when we downsized by 25% – was it enough, was it too much, etc,” Gorman said. “And we feel really good about where that’s been.”
He thinks global revenues in FICC will pick up and that Morgan Stanley can hold its share through that.
JPMorgan CFO Marianne Lake was putting a brave face on the bank’s performance, saying that the FICC division included some $260 million of tax reform impact that accounted for fully six percentage points of the 26% fall in markets revenues in the fourth quarter. And she said that even in the bad times of the last three quarters, the FICC and equities divisions had each delivered above their cost of capital.
In contrast to FICC, equities saw a fairly flat year at all the banks. Four posted small, single-digit declines, while BAML rose 3%. The fourth quarter saw a few blips, including a 23% year-on-year drop at Citi. But stripping out the Steinhoff hit would have meant a fall of just 4%.
At Goldman, where the business dropped 4% in 2017, Chavez noted that US cash equities volumes fell by double digits in the year. But he took heart from the fact that commissions and fees were down just 5%, better than the decline in volumes. And some two thirds of the fall at Goldman was related to the firm’s on-exchange single stock options business in the US, which it pulled out of in the fourth quarter.
Morgan Stanley’s Gorman had reason to be happy again, with his firm ranking top in equities for the fourth year running – and maintaining revenues of about $8 billion for the year, despite the industry wallet shrinking.
BAML’s increase was down to growth in client financing, according to CFO Paul Donofrio, which was able to offset declines in cash and derivatives trading.
Reporting underwriting and advisory results was a more pleasant task at all the firms; several saw landmark achievements.
At Morgan Stanley, investment banking recorded its best year since the crisis and its second best ever. Goldman clocked up its second-best year since its IPO in 1999. BAML’s $1.7 billion of advisory revenues was a record for the firm. JPMorgan reported record fees in debt underwriting – booking more deals than ever before – and said it completed more advisory mandates than any other firm.
All posted double-digit gains overall, with JPMorgan’s 12% rise the worst of the lot. A chunky 44% increase in debt underwriting at Morgan Stanley helped drive its overall 24% rise, the best result. The firm was the outlier in DCM, with no one else posting more than 20% up.
BAML’s continued focus on grabbing more share of lucrative advisory work is paying off, with a 33% increase in that business line year on year. That was unusual, however, and other rises were more modest; the business was down at Morgan Stanley.
And while most firms saw hefty gains in equity underwriting, BAML did not share in that trend, up just 9%. Goldman’s 40% increase was thanks to a doubling of revenues in the fourth quarter – Chavez highlighted a ¥600 billion ($5.49 billion) private placement for Toshiba that the firm sole managed.
Morgan Stanley CFO Jonathan Pruzan said that a particular driver for the bank’s ECM business had been Asia, which saw a big improvement from the third to the fourth quarter. Dealogic data shows the bank was second in the bookrunner rankings after Goldman in the region in the quarter, rising one place and seeing its credit more than double to $9.1 billion.
Pruzan said that the firm expected the Asian franchise to continue to be important in the future.