North American Banking & Capital Markets - EY

North American Banking & Capital Markets Key themes from the Q4 2015 earnings calls February 2016

Contents Top 10 key themes: 4Q 2015 earnings season

3

Key themes overview

5

Theme 1. Earnings performance — net income grows despite muted revenue trends

5

Theme 2. Macro-environment — concerns about the global economic outlook escalate as banks report earnings

7

Theme 3. Expense trends — new cost-reduction programs launched to offset slow revenue growth

8

Theme 4. Capital — capital strength remains a bright spot in earnings reports

10

Theme 5. Regulatory and compliance — banks continue to assess the impact of proposed rules

11

Theme 6. Credit quality trends — oil drops below $30 a barrel, raising concerns about the adequacy of reserves

12

Theme 7. Cross-border activities — investments in global operations yield results

13

Theme 8. Innovation — banks are increasingly willing to partner on digital initiatives

14

Theme 9. Lending trends — a “responsible” approach to loan growth will minimize future credit problems

15

Theme 10. Acquisitions and divestments — appetite for bolt-on deals remains intact

16

Appendix

17

Summary of key banking sector themes

17

Select key performance indicators (KPIs)

18

Scope, limitations and methodology of the review

19

Top 10 key themes: 4Q 2015 earnings season “Our performance in the fourth quarter reflects the continued challenges presented throughout 2015, including the challenging global equity markets — particularly in emerging markets — persistent low interest rates, strengthening US dollar and heightened regulatory expectations.” Jay Hooley, CEO, State Street The difficult operating environment that characterized the third quarter of 2015 showed no signs of improvement in the fourth quarter. Oil prices continued to fall, stock markets remained unsettled, and concerns about slowing economic growth in China and other emerging markets (EM) persisted. And, while the US Federal Reserve finally raised interest rates by 25 basis points in midDecember, the widely expected decision still triggered anxiety in the market about how it would impact EM currencies and whether it was premature. In the early weeks of 2016, however, the macro-environment deteriorated sharply. On 6 January, the World Bank lowered its global economic growth forecast for the third consecutive year, the Dow Jones Industrial Average and the S&P 500 both plunged 8% by the end of the second week of the year, oil prices dipped below $30 a barrel on 15 January, and the International Monetary Fund on 19 January downgraded its growth forecasts for the second time since October 2015. JPMorgan Chase led the reporting season for major US banks on 14 January against this backdrop. Analysts’ questions and market reactions to the earnings announcements reflected escalating worries about the state of the global economy and implications for banks in the coming year. Key concerns that emerged during the earnings season included the following: •

Do banks have sufficient reserves to withstand a prolonged period of low oil prices and slower EM growth?

•

Is a new credit crisis looming?

•

How will banks grow revenues in a slower growth environment?

•

Will market volatility impact M&A activity and equities trading, which were key revenue sources for big banks in 2015?

•

How can banks meet profitability targets without new revenues?

Management offered reassurances where they could, but also acknowledged that it is difficult to answer many of these questions. Reported full-year return on equity (ROE)

24.0

13.4

6.3

BAC

7.4

GS

8.5

8.6

MS

BK

9.8

STT

11.0

JPM 2015

12.7

WFC

TD

18.6

18.7

RBC

CIBC

14.0

USB

AXP

2014

Source: Company reports.

North American Banking & Capital Markets

3

Top 10 themes: a quarter-over-quarter comparison 4Q15 Rank

3Q15 Earnings season’s top 10 themes (arranged from most common to least common) — 13 banks

Rank

Earnings season’s top 10 themes (arranged from most common to least common) — 13 banks

1

Earnings performance

1


2

Macro-environment

2

Macro-environment

3

Expense trends

3

Expense trends

4

Capital

4

Capital

5

Regulatory and compliance

5


6

Credit quality trends

6


7

Cross-border activities

7


8

Innovation

8

Innovation

9

Lending trends

9

Lending trends

10

Acquisitions and divestments


10


4

Key themes overview Theme 1. Earnings performance — net income grows despite muted revenue trends “Trying to generate significant revenue growth is a challenge for everybody.” Gerald Hassell, CEO, Bank of New York Mellon Banks reported positive bottom-line results. Only 4 of the 13 banks included in this analysis — American Express, CIBC, Goldman Sachs and U.S. Bancorp — reported lower quarterly net income in 4Q15 compared with the year-earlier period. Full-year net income results were similarly positive, with growth evident at all banks except American Express, Goldman Sachs and State Street. •

JPMorgan Chase, Royal Bank of Canada and U.S. Bancorp reported record net income for 2015.

•

At Bank of America, full-year earnings of $15.9 billion were described as “the highest net income we’ve had in a long time.”

•

And at Citigroup, “The $17.1 billion we generated in net income [in 2015] was the highest since 2006.”

As has been the case in previous reporting periods, results were strongly influenced by legal charges. Bank of America, Citigroup and Morgan Stanley benefited from a steep drop in litigation costs in 2015, while net earnings at Goldman Sachs were negatively impacted by legal costs of $1.95 billion in 4Q15 and $4.0 billion for the full year. Management appeared optimistic that the settlements reached in the past two years are a strong Percentage change in full-year legal costs from 2014, selected indication that crisis-era legal issues are nearing an end. banks • Jon Pruzan, CFO, Morgan Stanley: “We believe that the most significant items related to the credit crisis are largely behind us.” GS 431% •

Harvey Schwartz, CFO, Goldman Sachs: “The residential mortgage-backed securities (RMBS) Working Group matter [that we just settled] was the most significant outstanding piece of litigation facing the firm. As you would expect, following the settlement, there has been a significant decline in our reasonably possible loss number. We are currently estimating a more than 60% decline compared to thirdquarter levels of $5.3 billion.”

JPM C

3% -73%

BAC

-93%

MS

-100%

Source: Company reports. However, ROE slipped and revenues stagnated. ROE and revenue performance reflected the challenging operating environment and difficulties that banks are facing in successfully and sustainably growing their businesses.

Eight banks reported a decline in quarterly ROE from 4Q14, and six banks reported lower ROE for the full year. Revenues were also weak across the board. When compared with 4Q14, only CIBC and Toronto Dominion delivered revenue growth in excess of 5%. While U.S. Bancorp reported record revenues for 4Q15, the growth rate was a muted 0.8% from 4Q14. On a fullyear basis, none of the banks included in this report grew their revenues by more than 5%. Management acknowledged the persistent impact of macro challenges on their growth prospects and seemed to indicate that they expect more of the same in 2016. •

Bharat Masrani, CEO, Toronto-Dominion: “In a simplistic way, revenue growth comes in two ways, at least from TD’s perspective. First and foremost is in our outperformance, our desire to grow the Bank. … The second part of revenue growth comes from the macro environment. And what we’ve seen over the recent past, and we’ve been talking about it, is that the operating environment is challenging.”

•

Mike Bell, CFO, State Street: “The year-to-date weakness in equity markets will adversely affect total revenue. As a reminder, a 10% decline in global equity markets is expected to result in approximately 2% of downward pressure on our total revenue.”

•

Paul Donofrio, CFO, Bank of America: “Although the US economy is improving slowly, revenue growth remains challenging.”

•

Jeff Campbell, CFO, American Express: “We have not seen volume and revenue growth accelerate as we expected over the past year, and the competitive, economic and regulatory environment has become more challenging. As a result, we have become more cautious in our outlook.”


5

Percentage change of quarterly net income from 4Q14* BK

171%

STT

18%

RBC

11%

JPM

10%

BAC

9%

TD

5%

WFC

0%

USB

-1%

CIBC

-4%

AXP

-38%

GS

-65%

Source: Company reports. *Morgan Stanley is not included in the chart because it reported a net loss of $1.6 billion in 4Q14 and net income of $936 million in 4Q15. Citigroup is not included in the chart because its net income increase from $344 million in 4Q14 to $3.3 billion in 4Q15 was too large to display meaningfully.

Percentage change of annual net income from 2014 BAC

229%

C

136%

MS

71%

BK

22%

JPM

12%

CIBC

12%

RBC

11%

TD

2%

USB

0%

WFC

0%

STT

-2%

AXP GS

-12% -28%



6

Theme 2. Macro-environment — concerns about the global economic outlook escalate as banks report earnings “As the early days of 2016 have shown, the environment hasn’t gotten and isn’t likely to get any less challenging. And while there are bright spots such as the US, Mexico or India, growth globally remains muted and makes other factors, whether they be the price of oil or interest rates, difficult to predict.” Mike Corbat, CEO, Citigroup Anxiety about the global economy intensified during the earnings season. The earnings season for US banks began on 14 January 2016, against a backdrop of steadily dropping oil prices and a sharp plunge in global stock markets. In addition, both the IMF and the World Bank downgraded their global gross Oil prices* 1 October 2015 to 25 January 2016 domestic product (GDP) forecasts in the early weeks of the year, prompting concerns that weakness in emerging 60 markets could stall growth in the US. While management 50 addressed the escalating anxiety caused by the macro challenges, their comments were cautious and reflected 40 market pessimism. Notably, the performance of banks’ share 30 prices in the wake of earnings announcements indicated that the reassurances they provided were not convincing. 15 January 20 •

•

Jamie Dimon, CEO, JPMorgan Chase: “The US economy has been chugging along at 2% to 2.5% growth for the better part of five years now. In the last two years, it has created 5 million jobs. If you look at household formation, car sales, wages, [unemployment], it still looks okay. … Hopefully, this will all settle down, and it’s not the beginning of something really bad.”

2016: oil dips below $30/barrel

10 0 1-Oct-2015

1-Nov-2015

1-Dec-2015

1-Jan-2016

Source: US Energy Information Administration. *Cushing OK WTI Spot Price FOB

Jon Pruzan, CFO, Morgan Stanley: “In the first two weeks we have seen a significant rise in volatility across markets and asset classes and an intense focus on the China economy, market and currency, as well as declining oil prices. We have had a reasonable start in sales and trading, as clients have been engaged as they try and navigate this period of volatility and keep their risk positions close to home. M&A has remained active. We are cautious, however, as prolonged volatility is not conducive to M&A activity. The underwriting calendar has been challenged. The capital markets pipeline is healthy, but market volatility could delay new issues coming to market. And on the retail side, clients remain cautious.”

Separately, the US Federal Reserve raised interest rates by 25 basis points in mid-December for the first time in almost a decade. The long-awaited increase was largely welcomed by banks, but it did not have a material impact on earnings for the quarter or the year. •

John Shrewsberry, CFO, Wells Fargo: “A 25-basis-point move, while important and symbolic, doesn’t really do much. … It’s the subsequent ones that would have a meaningful impact on margin.”

•

Harvey Schwartz, CFO, Goldman Sachs: “The Federal Reserve did a very good job of communicating to the marketplace the first rate increase in December. I think to a great extent it ended up being a non-event, which is a good thing.” S&P 500 performance 1 October 2015 to 2 February 2016 (rebased) 120 110 100 90 80 70 60 1-Oct-2015

15-Oct-2015 29-Oct-2015 12-Nov-2015 26-Nov-2015 10-Dec-2015 24-Dec-2015 7-Jan-2016 21-Jan-2016 S&P500

MS

GS

WFC

BAC

JPM

C

Source: Thomson Reuters.


7

Theme 3. Expense trends — new cost-reduction programs launched to offset slow revenue growth “We have been using our ‘simplify and improve’ initiatives to find savings that more than offset increased compliance, merit and other inflationary costs. But most importantly, those savings fund investments in our business, whether it’s in technology, our salesforce growth or other infrastructure costs.” Brian Moynihan, CEO, Bank of America Low expectations for revenue growth led to a heightened focus on costs. When compared with 2014, efficiency ratios improved at 7 of the 13 banks included in this analysis. However, as reduced legal expenses were the primary factor contributing to the improvement at three of the banks, it seems unlikely that further efficiency gains will come easily, given that banks do not expect robust revenue growth in 2016. During the 4Q15 earnings season, analysts once again pressed management to detail what more can be done to reduce expenses in the low-growth environment. As per usual, management at most banks reiterated their preference for achieving positive operating leverage or meeting target efficiency ratios instead of setting specific expense reduction goals. However, a few notable exceptions emerged as Morgan Stanley and American Express both announced initiatives to cut $1 billion in expenses by 2017, while State Street offered additional details about the new cost-reduction program it launched in 3Q15. •

Jeff Campbell, CFO, American Express: “On costs, as we moved through 2015 and gained more clarity on [the Costco] portfolio sale, as well as our revenue growth outlook, it became clear that we needed to accelerate and expand our cost reduction efforts to right size our cost base with the evolving business environment. As a result, we have launched cost initiatives that are designed to remove $1 billion from our overall cost base by the end of 2017.”

•

James Gorman, CEO, Morgan Stanley: “We have launched a major company-wide initiative called Project Streamline, an effort led by our CFO Jon Pruzan and COO Jim Rosenthal, which is designed to identify and implement significant infrastructure expense reductions by the end of 2017. Now is the time to tackle head-on our infrastructure costs and maximize low-cost deployment of talent. We have too many legal entities, too much duplication of operations and processes, and too many employees based in high-cost centers doing work that can sensibly be done in lower-cost centers. You will hear a lot more about Project Streamline in the coming quarters. … We’ve set a new target [efficiency] ratio of 74% in 2017, which translates into $1 billion in expense reductions over the next two years.”

•

Jay Hooley, CEO, State Street: “Knowing we are off to a difficult start in 2016, we’re focused on identifying levers to improve our performance in 2016 and help us outperform in the current macro environment. This includes a focus on managing expenses that is in addition to our multi-year transformation program and targeted staff reductions that we discussed on the Q3 2015 earnings call, which is called State Street Beacon. We currently expect State Street Beacon to generate approximately $550 million in annualized pretax net run rate expense savings by the end of 2020 with approximately $75 million of that run rate savings being achieved in 2016.” Efficiency ratios

52.7

53.8

RBC

USB

57.0

57.5

57.8

C

TD

WFC

63.0

63.9

JPM

CIBC 2015

68.6

70.0

71.1

BAC

AXP

BNY

74.0

75.8

77.7

GS

MS

STT

2014



8

Percentage change of quarterly revenues and expenses from 4Q14* 50% 40%

GS

30%

RBC

TD

USB

AXP STT

10% 0%

BAC

WFC JPM

20%

-10% -20%

C

BK

Expenses

CIBC

-30% -40%

MS -10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

-50% 10%

8%

Revenues Source: Company reports. *Gold markers indicate banks at which the rate of revenue growth exceeded the rate of expense growth.

Percentage change of annual revenues and expenses from 2014* 15.0%

GS TD RBC CIBC

STT USB

5.0%

JPM

-5.0% WFC

BK

-10.0% MS

-15.0% -20.0%

C BAC

-4.0%

-3.0%

-2.0%

Expenses

0.0%

AXP

-5.0%

10.0%

-25.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

-30.0% 6.0%

Revenues

Source: Company reports. * Gold markers indicate banks at which the rate of revenue growth exceeded the rate of expense growth.


9

Theme 4. Capital — capital strength remains a bright spot in earnings reports “We’re ending the year well ahead of our capital targets, with the firm’s advanced fully phased in CET1 ratio at 11.6%, and our standardized fully phased in ratio at 11.7%. The improvement to both ratios was driven by net capital generation, along with an overall reduction in risk-weighted assets.” Marianne Lake, CFO, JPMorgan Chase Capital ratios were not impacted by market turmoil. All banks continued to be well-capitalized in 4Q15 and reported Common Equity Tier 1 (CET1) ratios in excess of both internal management buffers and regulatory requirements as they are currently understood. While there was little pushback from analysts about capital strength, management at a number of banks detailed the factors contributing to quarter-over-quarter fluctuations in ratios and provided guidance about expected declines in CET1 ratios in coming quarters. •

Janice Fukakusa, CFO, Royal Bank of Canada: “Our CET1 ratio was 10.6%, up 50 basis points from last quarter, reflecting strong internal capital generation and lower risk-weighted assets from effective balance sheet management. … Looking ahead to 1Q16, we now expect that the closing of the City National [acquisition] will impact our CET1 ratio by approximately 75 to 80 basis points, up slightly from our previous estimate, largely due to the impact of foreign exchange translation on risk-weighted assets.”

•

Colleen Johnston, CFO, Toronto-Dominion: “Our Basel III Common Equity Tier 1 ratio was 9.9% in the fourth quarter versus 10.1% in Q3. The decrease was driven primarily by the impact of the Q4 restructuring charge and growth in RWA, due to strong loan growth in wholesale and the US.”

•

Harvey Schwartz, CFO, Goldman Sachs: “The [RMBS Working Group] settlement added $21 billion to operational risk assets, and we had a corresponding decline in the CET1 ratio of roughly 40 basis points.”

•

Richard Davis, CEO, U.S. Bancorp: “We’ve got a 9.1% CET1 ratio [under the standardized approach]. That’s about 110 basis points above our target of 8%. And if you think about it, we’re holding that excess rate between our target and where we’re actually performing because we haven’t been able to really reinvest or grow our loan balances as much as we would want to.”

•

Jeff Campbell, CFO, American Express: “The [Costco] portfolio sale will increase our capital ratios due to a significant reduction in risk-weighted assets. We plan to leverage this additional capital flexibility to support business-building opportunities, including growth in the loan portfolio, and potential strategic acquisitions.”

US banks fielded questions about the upcoming Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act Stress Tests (DFAST). In previous years, banks were required to submit their capital plans to the Fed in early January and results were released in mid-March. Deadlines shifted three months for the 2016 exercise and capital plan submissions are now due on 5 April 2016, with results announced by 30 June 2016. Supervisory scenarios for this year’s CCAR and DFAST were published on 28 January 2016, following the end of earnings announcements. As a result, management declined to provide specific comments about the tests, and instead answered as Bank of America CEO Brian Moynihan did, saying, “We haven’t seen the scenarios yet so I think it’s probably premature to discuss that. Our long-term goal is to return more and more capital to shareholders through dividends and stock buybacks.” CET1 ratios*

9.3 9.5

BK

9.7 9.8

10.1 9.9

10.6 10.1

BAC

TD

RBC

11.6 10.7 10.8 10.8 11.4 10.6

WFC

CIBC

JPM 3Q15

11.6 11.2

11.9 11.7

STT

GS

12.4

11.9

USB

12.0 11.7

C

13.2 12.4

AXP

14.1 12.6

MS

4Q15

Source: Company reports. * All-in basis for Canadian banks; standardized transitional for American Express; and advanced, fully phased for remaining US banks. North American Banking & Capital Markets

10

Theme 5. Regulatory and compliance — banks continue to assess the impact of proposed rules “We await clarification on the impact in timing of the G-SIB buffer and CCAR. When that clarity is provided, we believe we will be near the end of supervisory changes, and therefore our capital is appropriately sized to support our business going forward.” James Gorman, CEO, Morgan Stanley Banks move closer to full clarity on regulatory requirements. During 4Q15 and the first month of 2016, a number of new regulatory communications were published. Most of the rules were aimed at global systemically important banks (G-SIBs) as regulators seek to avoid future taxpayer bailouts of “too-big-to-fail” banks. Major releases included the following: •

30 October 2015: The Federal Reserve released a Notice of Proposed Rulemaking (NPR) on total loss-absorbing capacity (TLAC) for the eight US G-SIBs. According to the NPR, the banks will have to issue a combined $120 billion in long-term debt to meet the new requirements.1

•

3 November 2015: The Financial Stability Board released its annual update of the list of G-SIBs.

•

9 November 2015: The Financial Stability Board issued international standards for TLAC to be applied to G-SIBs.

•

14 January 2016: The Basel Committee published the final version of its fundamental review of the trading book (FRTB). According to the explanatory note accompanying the release, “the revised market risk standard would result in a median increase of 27% in the total capital requirement for market risk.”2

•

28 January 2016: The Federal Reserve published the supervisory scenarios for the 2016 CCAR and DFAST exercise.

Comments on regulation in 4Q15 FRTB

TLAC

G-SIB buffers

1

•

Marianne Lake, CFO, JPMorgan Chase: “The problem with this particular rule is that based upon the four quantitative impact studies that were done, there were some significant challenges with respect to the rules as written. And we were expecting there to be a number of meaningful changes, and there have been — in many cases, meaningful improvements. But it’s very technical, and there have been a lot of changes, so we need to sift through it to figure out everything.”

•

John Gerspach, CFO, Citigroup: “My initial impression is that they still need to do a lot more work. … But don’t forget, our risk-weighted assets (RWA) coming out of market risk currently are $77 billion. It’s roughly 6% of the total RWA. So while this proposal could have a significant impact on our market risk RWA, you’ve got to gauge it against the fact that we’re talking about 6% of our total RWA.”

•

John Shrewsberry, CFO, Wells Fargo: “While the NPR is out, there is a little ambiguity about what’s eligible and what’s not. And so that will slow down issuance during the NPR period, so that none of us issues something that turns out not to be either conforming or grandfathered.”

•

Paul Donofrio, CFO, Bank of America: “We’re going to have a capital structure that meets our regulatory requirements, which require us to have a certain amount of CET1. We’re going to have the appropriate amount of preferred and subordinate [debt], and of course, we have to meet the TLAC requirements.”

•

John Gerspach, CFO, Citigroup: “In 2014, when the topic of G-SIB first came out, our estimate was that we would actually be in the 4% bucket. However, [our] continued efforts to improve the efficiency of our balance sheet resulted in us actually appearing in the 3.5% bucket by last year-end. And as you can see, we’ve continued to make progress in 2015 on improving the efficiency of the balance sheet, and those efficiency efforts naturally also do have some impact on our key G-SIB drivers.”

•

Harvey Schwartz, CFO, Goldman Sachs: “With respect to our Method 2 G-SIB surcharge, we currently estimate that we are at or near the lower bucket, given a decline in level 3 assets and derivative notionals over the course of the year.”

•

Marianne Lake, CFO, JPMorgan Chase: “Based upon the actions we’ve taken throughout the course of 2015, we believe that we have just reached the 3.5% Method 2 G-SIB bucket, and that we are in or close to the 2% Method 1 G-SIB bucket. So the task ahead is to solidify this position.”

“Notice of Proposed Rulemaking,” Federal Register, www.federalregister.gov/articles/2015/11/30/2015-29740/total-loss-absorbing-capacitylong-term-debt-and-clean-holding-company-requirements-for-systemically#h-34, accessed February 2016. 2 “Explanatory note on the revised minimum capital requirements for market risk,” Basel Committee on Banking Supervision, www.bis.org/bcbs/publ/d352_note.pdf, accessed February 2016. North American Banking & Capital Markets 11

Theme 6. Credit quality trends — oil drops below $30 a barrel, raising concerns about the adequacy of reserves “If we’re sitting here in the $30 area a year from now, we believe that our allowance accurately or appropriately reflects the loss content that we may have.” John Shrewsberry, CFO, Wells Fargo Have banks built reserves sufficiently to handle an extended period of sub-$30 oil prices? During the 4Q15 earnings season, banks in both the US and Canada provided detailed disclosures about their oil and gas portfolios, including the amount of loans outstanding, proportion of investment-grade versus non-investment-grade exposure, increases in nonperforming loans and reserves built against these portfolios. As the major US banks were reporting results, however, oil prices dipped below $30 per barrel, prompting analysts to pepper management with questions about the adequacy of their reserves and the potential for an associated deterioration in other portfolios. The stress on oil and gas portfolios also contributed to an increase in provisions for credit losses, particularly at US banks. Management stated that higher provisions also reflected a normalization of the credit cycle and were necessary to support loan growth. However, it is important to note that increased provisioning in coming quarters will eliminate a key tail wind that has boosted net income in recent years.

Percentage change in provisions for credit losses from 4Q14 for selected banks JPM

270%

USB

71%

C

49%

CIBC

37%

TD

25%

WFC

6%

RBC BAC AXP

2% -2% -20%


Oil- and gas-related credit disclosures for 4Q15 Paul Donofrio, CFO, Bank of America

“Our stress analysis of the energy portfolio includes various sustained low oil prices over extended periods. As an example, if we held oil prices at $30 per barrel for nine quarters, we estimate our potential losses on the energy portfolio would be roughly $700 million.”

Laura Dottori“When we look across the broad spectrum of accounts, so including our small business accounts in the oil Attanasio, Chief space, we’ve had 100 names that have been downgraded. That represents an increase in our risk-weighted Risk Officer, assets over the year of just under C$400 million.” CIBC John Gerspach, CFO, Citigroup

“The guidance that I [have given of] roughly $600 million worth of cost of credit in the first half of the year, that’s really based on a scenario where oil prices remain at around $30 a barrel for a sustained period. … If oil were to drop to $25 a barrel and stay there for a sustained period of time, then that first half cost of credit might double.”

Marianne Lake, CFO, JPMorgan Chase

“We said last quarter, if oil reached $30 a barrel — and here we are — and stayed there for 18 months, you could expect to see reserve builds of up to $750 million. That assessment hasn’t fundamentally changed.”

Mark Chauvin, Chief Risk Officer, TorontoDominion

“With respect to our oil and gas exposure, we were not surprised by the level of impaired loan formations this quarter. Ongoing analysis indicates that the oil and gas non-retail credit portfolio continues to perform within expectations, given the current level and near-term outlook for commodity prices in this sector. … I remain comfortable that the potential impact of low energy prices on the Bank’s credit losses remains well within a range of a 5% to 10% increase over 2015 levels.”

Bill Parker, Chief Risk Officer, U.S. Bancorp

“[Credit is] overall very strong. Of course the one exception is energy and some of the metals and miningrelated credits. We do have that small energy portfolio; it’s about 1.2% of our total loans. So obviously we have seen some downgrades there, and we’ve been building our allocated reserves for that all year long. But we’ve built that [reserve] at low $30s price of oil. So we feel like we’re good for now.”


12

Theme 7. Cross-border activities — investments in global operations yield results “We have stepped up investments in our international business with strong results — adjusted billed business rose by 12% last year. We expanded our merchant network, adding more than 1.2 million new merchants globally in the past year.” Ken Chenault, CEO, American Express Commitment to global footprint pays off, despite uneven economic trends. North American banks have adopted a variety of strategies for building out their global footprints. Areas of focus include Caribbean banking, global equities businesses, consumer franchises in Asia and Latin America, and payments businesses in Europe and beyond. During the 4Q15 earnings season, management at a number of banks commented on their international priorities, highlighting that even in a difficult operating environment, investments continue to yield benefits. •

Dave McKay, CFO, Royal Bank of Canada: “Turning to Caribbean Banking, we returned the business to profitability this year through a disciplined strategy, which included exiting noncore markets, taking out cost and focusing on quality asset growth. I’m pleased that we’ve been able to achieve these results, despite ongoing economic headwinds in the region.”

•

Marianne Lake, CFO, JPMorgan Chase: “We’ve built our [prime brokerage] platform internationally; in Europe, we are seeing strong demand. In Asia, we’re adding clients; we’ve got the wind to our backs. It’s an important business to our clients. … And if we can take share, we certainly will.”

•

Harvey Schwartz, CFO, Goldman Sachs: “Our global equities franchise also posted strong results for the year. Clients continue to place significant value on the integration of our various services — electronic, cash, derivatives and prime brokerage — as well as our global footprint. Our performance in 2015 highlighted these strengths.”

•

Richard Davis, CEO, U.S. Bancorp: “We’re not only domestically quite large and capable, but when you start looking at how that is starting to build across the pond over in Europe with both our funds administration and classic corporate trust, we’re going to expect a lot from those two businesses as well in 2016.”

•

John Gerspach, CFO, Citigroup: “When you take a look at our EM consumer exposures around the world, we continue to feel good about the underlying credit quality overall. And again, that’s driven by our target client strategy. And we took actions early on. [We sold] the Credicard portfolio in Brazil. We’ve exited other portfolios in other countries. We reshaped the portfolios in India, in Mexico, in Korea. And there are also a lot of good regulatory controls that exist in Asia that may dampen our revenue prospects from time to time but actually form a pretty good basis then for a solid credit story.”

Separately, for US-based banks, the strong US dollar continued to negatively impact revenues and provide a tail wind for expenses. The opposite was true for Toronto-Dominion and Royal Bank of Canada, which generate approximately 20% and 30% of their revenues in the US, respectively. Appreciation of US dollar versus selected currencies (rebased)

108 106 104 102 100 98 96 94 92 1-Oct-2015

15-Oct-2015

29-Oct-2015

12-Nov-2015 CNY

C$

26-Nov-2015 €

10-Dec-2015

24-Dec-2015

£

Source: Bank of England and EY analysis.


13

Theme 8. Innovation — banks are increasingly willing to partner on digital initiatives “We’re developing a much smarter technology around who our customers are, what they expect and what their likely next needs are.” Richard Davis, CEO, U.S. Bancorp Digital innovation encompasses more than mobile banking. During the 4Q15 earnings season, banks continued to report on the gains that they are seeing in numbers of active mobile banking customers. •

Marianne Lake, CFO, JPMorgan Chase: “We added nearly 600,000 households, and our active mobile customer base continues to grow, up 20% to roughly 23 million customers, the largest of the major US banks.”

•

Dave McKay, CFO, Royal Bank of Canada: “Currently, almost 5 million clients actively access RBC products and services using our online mobile or tablet channels — this is a number that has grown more than 30% since 2012. We continue to design new products and services specifically for online and mobile channels and are excited about a number of digital product launches that we have planned for the coming year.”

However, mobile banking has essentially become a basic service that banks are expected to provide to their customers. Banks realize this and continue to invest in taking innovation to the next level. Notably, the banks included in this report are focused on a range of differentiated investment priorities related to the innovation agenda, including partnerships with fintech firms, exploration of blockchain applications and using big data to better understand their customers. •

Victor Dodig, CEO, CIBC: “We are the innovation leader today in banking. But the rapid pace of change in the industry, especially from fintech and disruptors, is forcing all of us and CIBC to continue to innovate for our clients as they adopt new technologies and look for secure, easier, more flexible ways to do their day-to-day banking. We recognize that we can’t build everything ourselves, and that’s why we’re open to collaborating with high-quality third parties where appropriate.”

•

Bharat Masrani, CEO, Toronto-Dominion: “New technologies provide us with opportunities to extend our leadership position in service and convenience. TD will lead new initiatives, make new investments and form new partnerships in the digital space over the coming years.”

•

Gerald Hassell, CEO, BNY Mellon: “We are spending a lot of time and energy in different parts of the company on blockchain technology and where it can be applied. Last quarter we said that we have two pilot programs actively engaged internally. We’re a participant in a couple of consortiums on blockchain technology. Interestingly, we’re hosting a blockchain technology day [on 1 February] with our own technologists and outsiders exploring all of the different opportunities that we see and others see. So we’re very actively engaged in the dialogue and the concept of where it can be applied. I think there’s some real opportunities for us to be a disruptor to the Active mobile customers of selected banks (in millions) existing infrastructure. I think it’s going to take quite a bit of time to get there. But we are not 25.0 sitting back waiting. We are actively engaged in the dialogue.” 20.0

•

Jay Hooley, CEO, State Street: “When we went into 15.0 the IT and Operations Transformation program, we were very determined that we wanted to create a 10.0 cloud environment. And we were also convinced 5.0 that the only cloud environment that was appropriate would be a private cloud, meaning 0.0 that we would own and operate and control it. Our 4Q14 1Q15 2Q15 3Q15 4Q15 thinking today is quite a bit different. … And I’d say if you talk to people that are deeply involved in this JPM BAC WFC world, you’d find that to be a fairly meaningful shift in philosophy. … For us to imagine what the Source: Company reports. technology [advances] will be five years out is pretty tough to do. I think, though, it gets back to a point that I made, which is, unfortunately you can’t leapfrog. So you have to modify along the way. And we think we’ve got a plan that not only enables us to get to that future real state, but it will also allow us to take advantage of advances in technology as they unfold over the next five years.”

•

Ken Chenault, CEO, American Express: “We’re focused on using our relationships, technology and data to better serve our customers and open up commerce opportunities for our partners. As the boundaries between online and offline blur, I believe our business model puts us in a great position to benefit from the convergence of payments and commerce.”


14

Theme 9. Lending trends — a “responsible” approach to loan growth will minimize future credit problems “We continued to lend prudently, working directly with our clients to manage their debt.” Dave McKay, CEO, Royal Bank of Canada Loan growth gathers momentum. Positive lending trends appeared to solidify in 4Q15, as nine of the banks included in this analysis reported higher end-of-period loan balances when compared with 31 December 2014. Notably, JPMorgan Chase, Morgan Stanley and Toronto-Dominion all reported double-digit loan growth, and Bank of America CEO Brian Moynihan said the firm grew loans “on an absolute basis for the first time in several years.” Lower loan balances at American Express reflected the company’s move to reclassify a portion of its loans as held for sale in anticipation of the imminent sales of the Costco and JetBlue loan portfolios. The decline in loans at Citigroup reflected the continued wind-down of the non-core division, Citi Holdings, and CFO John Gerspach noted that core loans actually grew by 5%. Management addressed escalating concerns about the impact of global economic growth and the potential for a new recession on their growing loan books by highlighting strong underwriting standards and a prudent approach to growth. •

Jamie Dimon, CEO, JPMorgan Chase: “A bank is supposed to be there for clients in good times and bad times. So, to the extent we can responsibly support clients, we’re going to. And if we lose a little bit more money because of it, so be it. And we’ve done that around the world. We did it in 2007 and 2008 and 2009. We try to do it responsibly. If banks just completely pull out of markets every time something gets volatile and scary, you’ll be sinking companies left and right.”

•

Richard Davis, CEO, U.S. Bancorp: “Based on our geography, based on our mix of business, based on our history and based on our appetite for risk, I think we’re actually fairly immune from most of [the macro-environment] issues at this stage, and yet we stress test for the worst scenarios that could affect us. So I would say across the board from a lending perspective that we’re predicting the same [growth] range you’ve seen, the 1% to 1.5%, again for next quarter. We’re already off to a really nice start, and we’re not seeing any disruption either from the 25 basis point increase [in interest rates], which we knew would be more symbolic, or from the impacts of the stock market [volatility] or the China revaluation. So at this point we’re remaining optimistic in a cautious and careful way.”

•

Paul Donofrio, CFO, Bank of America: “Outside of energy we are not seeing asset quality changes nor are we seeing a reduction in appetite for credit. I would remind everybody that we are very, very focused on our customer framework and our risk framework. But within that framework we continue to see a lot of opportunities to help our customers grow their businesses. If you look at this quarter and you just focus on the core, we had 3% quarter-over-quarter growth or an annualized growth rate of a little over 12% or $22 billion. I’m not going to sit here and tell you that’s what it’s going to be next quarter. But we’re not seeing a material decline in conversations with our clients about how to help them grow.” Percentage change in end-of-period loans from 4Q14 * 16% 14% 11% 5%

6%

8%

8%

9%

BK

CIBC

RBC

3%

-4%

-17% AXP

C

BAC

USB

WFC

JPM

TD

MS

Source: Company reports. *Goldman Sachs and State Street do not disclose end-of-period net loans.


15

Theme 10. Acquisitions and divestments — appetite for bolt-on deals remains intact “Acquisitions generally either give us a capability that we don’t have today, and we think it’s better for us to bolt it on versus build it organically, or they actually fit a current strength where we can add scale.” Harvey Schwartz, CFO, Goldman Sachs No transformative deals are on the horizon. Only two US banks — Citigroup and Morgan Stanley — discussed divestments of noncore businesses in their fourth quarter earnings calls, perhaps indicating that efforts to reshape businesses are nearing the end stages for now. And while a number of banks reiterated the criteria that potential bolt-on acquisitions would have to meet, only Bank of New York Mellon and U.S. Bancorp actually announced new transactions. The small number of deals announced during the quarter could reflect uncertainties about the operating environment or end point capital requirements, or it could be that there are just no appropriate opportunities to consider. As Citigroup CEO Mike Corbat observed, “We’ve got the resources, balance sheet and capital capability. … Unfortunately in this environment, there’s not a lot of those out there, but we’ll continue to look.” Deals discussed in 4Q15 earnings calls Newly announced acquisitions

Updates on previously announced deals

Asset sales

•

Curtis Arledge, CEO of Investment Management, BNY Mellon: “We’re very excited about the acquisition that we announced yesterday afternoon of Atherton Lane. … We did this in Chicago with Talon in 2011, with I(3) in Toronto in 2010, and acquisitions that preceded that. It’s pretty much our strategy to get a toehold and then bring the full power of our institution to the clients in that region. We love that strategy.”

•

Richard Davis, CEO, U.S. Bancorp: “During the quarter we announced a new agreement with Fidelity Investments. U.S. Bank is now the exclusive issuer of the Fidelity Investments Rewards Card program. As part of this arrangement, which closed at the end of 2015, we purchased the existing card portfolio of $1.6 billion. This follows the announcement from last October about our card issuing partnership with the Auto Club Trust and the purchase of an existing $500 million portfolio. These agreements exemplify the strength of our payments business model and a continued commitment to strategic growth.”

•

John Shrewsberry, CFO, Wells Fargo: “The GE Capital transactions that we announced last quarter will start to be reflected in our first quarter results. The GE Railcar Services transaction with $4.1 billion of loans and leases closed on January 1, making us the largest railcar operating lessor in North America. We anticipate the North American-based portion, about 90% of the approximately $31 billion of assets we expect to acquire from GE Capital, to close late in the first quarter, with the remainder expected to close in the second quarter. We’re looking forward to having many talented and experienced people from these businesses join our team.”

•

Dave McKay, CEO, Royal Bank of Canada: “The US is our second home market, which is why we made the decision to acquire City National and create a powerful platform for long-term growth. As the transaction just closed this month, our focus now is on integrating to bring the best of both organizations to our commercial Capital Markets and Wealth Management clients.”

•

Mike Corbat, CEO, Citigroup: “We had a substantial decrease in Citi Holdings assets during the quarter largely driven by the closing of the sale of OneMain and consumer franchises in several countries.”

•

Jon Pruzan, CFO, Morgan Stanley: “Commodity results were down quarter over quarter, primarily driven by our oil merchanting business. We closed the sale of this business on November 1. Given the sale of our two large physical oil businesses, we would expect to see less seasonality in our first quarter FIC results going forward.”


16

Appendix Summary of key banking sector themes 3Q15 earnings season This table provides a summary of the top 10 themes. Top initiatives and issues (arranged from most common to least common)

AXP

BAC

BK

C

CIBC

GS

JPM

MS

RBC

STT

TD

USB

WFC


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Macro-environment

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Expense trends

13

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Capital

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Innovation

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Lending trends

10

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9

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Legend AXP — American Express

BAC — Bank of America

BK — Bank of New York Mellon

C — Citigroup

CIBC — Canadian Imperial Bank GS — Goldman Sachs of Commerce

JPM — JPMorgan Chase

MS — Morgan Stanley

RBC — Royal Bank of Canada

TD — Toronto-Dominion Bank

USB — U.S. Bancorp

STT — State Street

WFC — Wells Fargo


17

Select key performance indicators (KPIs)

Compensation cost

Non-compensation cost

Revenues/employee (US$k)

Operating margin **

Net interest margin

Cost of equity

Return on average equity

KPIs

Assets

Operational metrics (% year-over-year growth)

15.0%

-28.5%

-52.6%

197.6

45.6%

3.1%

5.5%

17.1%

-10.6%

18.2%

64.2%

59.0

17.3%

1.0%

14.5%

3.5%

Average

2.4%

-1.9%

-8.5%

100.8

33.6%

2.1%

9.7%

10.0%

American Express

1.3%

-24.8%

9.1%

156.8

17.3%

NA

8.7%

17.1%

Bank of America

1.9%

-2.1%

-4.2%

90.7

30.1%

2.2%

9.4%

5.2%

Bank of New York Mellon

2.2%

4.4%

-41.2%

72.8

27.1%

1.0%

14.5%

7.2%

Canadian Imperial Bank of Commerce*

11.7%

18.2%

-13.0%

59.0

37.6%

2.0%

5.5%

14.6%

Citigroup

-6.0%

-6.2%

-31.1%

81.1

37.7%

3.0%

10.0%

6.0%

0.6%

5.3%

64.2%

197.6

40.3%

NA

9.1%

3.5%

JPMorgan Chase

-8.6%

-2.4%

-8.5%

97.2

37.3%

2.2%

12.9%

8.8%

Morgan Stanley

-1.7%

-28.5%

-52.6%

137.6

18.6%

NA

8.5%

4.9%

Royal Bank of Canada*

14.2%

5.8%

-16.4%

82.5

39.9%

1.7%

5.8%

16.5%

-10.6%

-3.4%

-11.5%

78.4

27.1%

1.1%

11.2%

10.9%

15.0%

4.1%

4.4%

74.2

34.9%

2.0%

6.0%

11.1%

US Bancorp

4.8%

6.3%

-5.9%

NA

45.6%

3.1%

13.0%

12.9%

Wells Fargo

6.0%

-1.1%

-3.3%

81.5

42.6%

2.9%

11.2%

11.9%

Text legend: Better than average Worse than average Best performer Worst performer

Goldman Sachs

State Street Toronto-Dominion Bank*

Notes: *4Q15 numbers for Canadian banks are for the period ended 31 October 2015. ** Operating margin = (net revenue – operating expenses)/net revenue. Individual bank numbers are from SNL Financial database. All numbers are non-annualized (except return on average equity and net interest margin).


18

Scope, limitations and methodology of the review The purpose of this review is to examine the key themes discussed during the 4Q15 earnings reporting season among 13 major North American institutions operating within the banking and capital markets sector. The identification of the top 10 themes is based solely on an examination of the transcripts and associated presentation materials of the earnings conference calls held from 2 December 2015 to 27 January 2016. For this analysis, the following North America-based banks reviewed were: •

American Express (AXP)

•

Bank of America (BAC)

•

Bank of New York Mellon (BK)

•

Canadian Imperial Bank of Commerce (CIBC)

•

Citigroup (C)

•

Goldman Sachs (GS)

•

JPMorgan Chase (JPM)

•

Morgan Stanley (MS)

•

Royal Bank of Canada (RBC)

•

State Street (STT)

•

Toronto-Dominion Bank (TD)

•

U.S. Bancorp (USB)

•

Wells Fargo (WFC)

The period covered was 3Q15, ended 31 December 2015. Exceptions include the following: •

CIBC, RBC and TD, for which the period covered, 4Q15, ended 31 October 2015

Unless otherwise noted, all currency amounts are in US dollars.


19

EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY Global Banking & Capital Markets In today’s globally competitive and highly regulated environment, managing risk effectively while satisfying an array of divergent stakeholders is a key goal of banks and securities firms. Global Banking & Capital Markets brings together a worldwide team of professionals to help you succeed — a team with deep technical experience in providing assurance, tax, transaction and advisory services. We work to anticipate market trends, identify the implications and develop points of view on relevant sector issues. Ultimately it enables us to help you meet your goals and compete more effectively. © 2016 EYGM Limited. All Rights Reserved. EYG no. EK0420 BMC Agency BACS 1003430 ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.

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