Strong Operating Performance From Big Banks

Eric Compton: On Tuesday, three of the big four U.S. banks reported earnings, giving us greater insight into the overall health of the U.S. banking industry. While many are worried about an imminent recession, slowing global growth, and a flattening yield curve, underlying bank operating performances remained strong, which fits broadly within our current thesis on the space.

To start 2018, we were largely bearish on the banks, as most names were trading at 2 or 3 stars as we felt valuations were too optimistic. That has now switched with many names trading at 4 stars, as prices have become more pessimistic. We continue to think banks are an interesting place to look given the sentiment currently baked into valuations.

For Citigroup, much pessimism has been baked into the share price, and results showed the bank largely meeting the updated goals management set for themselves since investor day. Despite lighter revenues, largely due to market-sensitive items, the bank was able to adjust expenses and hit a 10.9% return on tangible equity, far improved over the 8% the bank hit last year. We continue to believe the bank has meaningful levers to pull to further improve returns, including a runoff of additional DTAs, further internal cost saves, the lapping of current card promotion costs, and more. Bottom line, Citi is meeting its goals to be a much improved franchise.

For JPMorgan, the bank was also hit by lower market-sensitive revenues, but despite this, the bank maintained its number one I-banking position, even gaining share, and reported earnings per share growth of over 40% compared to 2017, Further, full year return on tangible equity was 17%. This level of ROTE is already on par with management's long-term goal for the bank, which signals to us that the bank is operating at full capacity, therefore we do not expect much improvement for the bank from here. However, we believe the bank can maintain these types of returns while supporting its massive growth investments, including in technology, new branches, more bankers, and more advisors. Bottom line, JPMorgan is arguably the top performing bank these days, and the bank is poised to continue that dominance in 2019.

For Wells Fargo, results were a bit more disappointing, particularly with the announcement that the asset cap will stay in place through the end of 2019. This was despite previous guidance that the cap would likely be lifted in the first half of 2019. On the positive side, the bank is still seeing good retail customer retention and underlying loan growth, despite the cap. Wells also has outsize exposure to the mortgage market, and this is working against the bank currently, but even so, Wells was able to hit a return on tangible equity of over 15% in the fourth quarter. Management reiterated their expense guidance for 2019 and 2020, which was a positive. Bottom line, eventually the asset cap will be lifted, and mortgage headwinds will dissipate, and we see no reason Wells cannot consistently earn a mid- to upper-teens return on tangible equity, which should warrant a better valuation.