New York, Frankfurt When the US Federal Reserve (Fed) raises interest rates, it makes financing more expensive for businesses and consumers. But the banks, which delivered very good figures last year, are also making money. When America’s financial institutions publish their figures for 2021 and at the same time outlook for the current year from Friday, investors will be waiting for clues as to who will benefit particularly from the monetary turnaround. Goldman Sachs has previously named JP Morgan and Bank of America (BofA) as favorites, with the latter also being Barclays’ favourite. Bank of America, in turn, names Citigroup as a top pick.
On Friday, three major banks, JP Morgan, Wells Fargo and Citigroup, will start announcing profits for 2021, plus the world market leader Blackrock as an asset manager. Wall Street was at its most profitable in 2021 thanks to low loan defaults and a boom in investment banking.
The financial sector benefited from three factors at once. At the beginning of the year, it was still flourishing stock trading and the high demand for shell IPOs, the so-called Spacs, where institutes made great money. Then, in recent months, it was an unprecedented global boom in mergers and acquisitions (M&A) that turned investment bankers back into the stars of Wall Street.
Morgan Stanley made more profit in the first quarter than usual in a year with four billion dollars. JP Morgan, America’s largest bank, is heading for $45 billion in full-year profit, up a quarter from the previous record set in 2019. Fourth-quarter results will be mixed, however, skewed in part by more or less large provisions for loan losses.
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The analysts expect an average of 20 to 30 percent less profit compared to the same quarter last year at JP Morgan and a discount of around 20 percent at Citigroup. Goldman Sachs should then report seven percent and Morgan Stanley two percent less. The fact that capital market business in the fixed-income area was somewhat weaker than in the excellent prior-year quarter also plays a role here. On the other hand, a 20 percent plus at BofA and even a 67 percent improvement at Wells Fargo are expected.
According to an analysis by the independent US analyst Ed Yardeni, the commercial banks that belong to the US stock index S&P 500 reduced their provisions for credit risks by a good 50 billion dollars to almost 170 billion last year. Thanks to aid programs worth billions, the loan defaults in the pandemic were by no means as high as initially feared.
Added to this was the good business with mergers and acquisitions. According to calculations by the news agency Reuters, the volume reached a record value of 5.8 trillion dollars, which corresponded to an increase of 64 percent compared to the previous year. “It was driven by the pandemic’s unprecedented access to cash and cheap capital for companies,” writes Yardeni.
He expects a further increase in the current year, albeit possibly at a slower pace – also because rising interest rates are making financing the deals more expensive. Nevertheless, this area should remain a good source of profit for investment banking.
In the year that is just beginning, banks are also likely to earn very well, although the analysts at Goldman Sachs believe that the full effect of rising interest rates will not have an impact until 2023. However, all banks will have to pay their employees significantly higher salaries, which will drive up costs.
The battle for talent is raging like never before. In the past year, practically all large banks have significantly increased the salaries of their young employees. After the record year, top managers are preparing for substantial bonuses. JP Morgan boss Jamie Dimon has already signaled that he is willing to spend big bucks to retain talent and also to keep the competition at bay. In November he said in the Handelsblatt interview. “We are able to invest a lot of money and our brand is strong.”
The JP Morgan boss is willing to pay significantly higher salaries.
(Photo: AP)
But the longest-serving head of a Wall Street bank also has words of caution about the future of his industry. “Basically, banking systems around the world are going to get smaller because so many things are happening outside of the banks,” he said. For a long time he has been speaking openly about the competition from fintech start-ups, crypto offers and large tech companies such as Google and Apple.
Richard Ramsden, banking analyst at Goldman Sachs, expects industry-wide net interest income to rise 7 percent this year. However, the Goldman experts also expect that activities on the capital markets will normalize again after the hectic pandemic years. The fees from the capital market business could drop by eleven percent. However, the new level would still be above the average of the past ten years.
Goldman analysts estimate that the return on equity will remain around 14 percent this year and only increase in 2023 when the better interest rate environment takes full effect. Goldman refers to the net profit in the core business in relation to the average “hard” (tangible) shareholders’ equity (Core ROTCE), in which, for example, goodwill is deducted from assets. Goldman even sees a slight decline in pre-provisioning income before a significant improvement in the coming year. Going into the money, it is said, will probably also result in higher expenses for technology and marketing.
They also warn that the improvement in the interest rate environment has already been taken into account in the prices. In addition, it is said that measured by the “hard” (tangible) book value, the bank shares are relatively expensive, but the valuation is still “reasonable”, especially for the strong financial institutions.
But the prospects for shareholders remain good overall. Barclays’ Jason Goldberg expects bank stocks to continue to outperform the market this year. Big bank stocks are up 37 percent in 2021, well ahead of the S&P 500, which was up 27 percent.
“We believe that outperformance can continue this year,” writes Goldberg. It is true that Omikron is causing new uncertainty in the short term. “However, we expect several positive trends in 2022. We expect demand for credit to pick up again and interest income to benefit from rising interest rates,” says Barclays.
The Goldman experts say that the highly profitable financial institutions in particular could benefit in the coming months. “We are seeing the market differentiate between banks with high and low yield profiles, and we expect the market to continue to favor banks with the more profitable platforms,” Ramsden said.
His favorites include JP Morgan and Bank of America. Both are convincing because of their size alone, and the changed interest rate environment is also having a particular impact on profits. Credit growth is expected to accelerate. The two groups are also well positioned in the capital market business.
Supported by high investments, JP Morgan is “continuously taking market share” from its European competitors. Overall, US banks stole around 20 percentage points from the financial institutions of the European Union between 2011 and 2020 and dominate around three quarters of the market in this sector.
BofA has also managed very well to distribute excess capital to investors, it is said. Collectively, both top picks each gave more than $30 billion to shareholders through dividends and buybacks in 2021 alone. In addition, both banks have shown in the past that they are good at turning investments into profits.
Goldman believes that the big houses will continue to increase their lead over medium-sized and small competitors, primarily through investments in technology. The number of branches is dwindling, and online offerings are being expanded at the same time. It also means that smaller banks’ earlier advantage of local presence is losing weight, Barclays analysts write.
DZ Bank notes that JP Morgan shares are trading at a significant valuation premium to the peer group. This is justified by strong earnings power, earnings stability and generous dividends and share buybacks
Bank of America analyst Ebrahim Poonawala has named Citigroup as one of his top picks. “For a share that is listed well below its material book value and has a number of attractive business areas, we see a convincing risk/reward profile.” The corporate and investment bank and transaction services are particularly strong at Citigroup.
More: “Banking systems are getting smaller everywhere” – Jamie Dimon prepares banks for more competition.