Key Themes From The 1Q16 Earnings Calls by EY
Top 10 themes: a year-over-year comparison
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Main topics discussed in the 1Q 2016 earnings calls
Revenues and profitability falter in what should have been the strongest quarter of the year
“1Q 2016 was extraordinarily challenging for the global capital markets and for the industry. While there has been improvement in the last month or so, there remain a number of macroeconomic and geopolitical risks to the global markets and the global economy. As such, we would expect the revenue environment to remain challenged in 2016.” — Marcus Schenck, CFO, Deutsche Bank
- Banks faced an extremely difficult operating environment in 1Q 2016.
- Despite macro challenges, most banks were able to maintain strong capital and leverage ratios …
- … However, trends in profit drivers were markedly less resilient.
- Revenue weakness reflected extreme market volatility in January and February.
- Concerns about credit quality escalated sharply, although higher provisions were more evident at North American banks with exposure to the oil and gas sector than in Europe.
- Expenses remained high, driven by investments in regulatory compliance and digital initiatives.
- Returns on equity (ROE) were down at most of the banks included in this analysis.
In 1Q 2016, positive earnings performance was elusive. Net income was down at almost all of the banks included in this analysis. While there were a few instances of improved results — Macquarie Group reported record full-year earnings; Bank of New York Mellon, BNP Paribas and Societe Generale reported an increase in quarterly earnings from 1Q 2015; and Royal Bank of Scotland turned in a narrower net loss — the prevalent trend for 1Q 2016 was disappointing performance.
Typically, the first quarter of the year is the strongest for the banking sector. However, in January and February 2016, banks around the world faced stiff headwinds from a range of macro challenges that significantly curtailed client activity levels and impacted revenue performance. Market conditions eased somewhat in March, but by then it was too late to reverse the impact on 1Q 2016 profitability.
The weak start to the year does not bode well for the rest of 2016. Anxiety about global economic growth, the trajectory of oil prices and geopolitical issues remain firmly in place, clouding the revenue outlook for the year and raising questions about whether banks should be doing more to cut costs and reposition their businesses. Notably, management at many banks did not appear to be optimistic about near-term prospects:
- Bill Winters, Group Chief Executive, Standard Chartered: “Is the economic environment going to stay as relatively benign as it has been for the past month or is it going to look more like January and February? We don’t know.”
- David Mathers, CFO, Credit Suisse: “This is a very challenging macro environment. Some of the conditions that obviously resulted in 4Q 2015 being difficult and 1Q 2016 being difficult could easily recur in the balance of this year. There are still the same macro effects that we saw in the first quarter. So just be cautious.”
Market challenges impacted trading, investment banking and wealth management segments
“Markets were challenging, equity issuance was effectively non-existent and retail activity was extremely subdued, reflecting the many uncertainties with which investors grappled.” — James Gorman, CEO, Morgan Stanley
As expected, trading revenues tumbled when compared to the first quarter of 2015. The steep decline was partially due to the fact that last year’s first quarter performance benefited considerably from the Swiss National Bank’s move to decouple the Swiss franc from the euro. The bigger problem, however, was the extreme market volatility driven by macroeconomic uncertainties in the first two months of 2016. Trading woes were exacerbated by a drop in investment banking revenues, as companies delayed IPOs, equity issuance and M&A plans amid the market turbulence.
Weakness was also evident in banks’ wealth management operations, which normally help to offset more volatile performance in wholesale segments. Many banks reported lower transaction and incentive fees as clients fled to the sidelines.
- UBS reported “the lowest level of transaction volumes recorded for a first quarter.”
- At Citigroup, CFO John Gerspach noted: “The first quarter is historically a strong period for wealth management in Asia, with higher transaction activity driving strong investment sales revenues. Given weak investor sentiment during the quarter, we didn’t see the typical rebound in transaction activity, and therefore, our wealth management revenues declined significantly from last year.”
- Goldman Sachs CFO Harvey Schwartz said 1Q 2016 was “the first quarter in a while that we faced significant headwinds across each of our business segments.”
- Deutsche Bank’s wealth management revenues were down 8% from 1Q 2015. CFO Marcus Schenk said: “The decline versus the first quarter 2015 was driven by lower performance and transaction fees as a result of the current market environment, with lower client activity.”
North American banks boost provisions, while European banks highlight lower cost of risk
“The cost of risk stands at 46 basis points versus 64 basis points in 4Q 2015. … From a historical point of view, you have to go back before the beginning of the financial crisis to find such a low level of cost of risk.” — Philippe Heim, Group CFO, Societe Generale
During the 1Q 2016 earnings season, management at banks across regions highlighted a continuation of positive trends in overall credit quality. Lower non-performing loan (NPL) ratios, higher coverage ratios, a drop in new impairments and lower cost of risk in Europe all point to a normalization in the credit cycle and more rigorous underwriting standards.
Despite this, analysts appeared to be worried about the adequacy of banks’ provisions amid lower commodity prices and slower global economic growth. As a result, credit quality emerged as the single most dominant topic discussed in earnings calls around the world.
Of particular concern was banks’ exposure to energy borrowers in North America. Many banks have been forced to build reserves against oil and gas portfolios faster than anticipated as falling oil prices have put energy borrowers under considerable stress. Not only has this raised concerns about the potential for a new credit crisis, it is also taking place in a low revenue growth environment, essentially amounting to a one-two punch on bank profitability.
Other portfolios that are being carefully monitored include shipping; metals and mining; New Zealand dairy; and selected economies such as Brazil, Indonesia and Russia.
Management acknowledged that there are pockets of stress that they are closely monitoring for further deterioration, but defended the strength of their provisioning. In contrast to their cautious stance on revenue prospects, many provided an optimistic outlook for overall credit quality trends.
- John Stumpf, CEO, Wells Fargo: “While deterioration in the oil and gas portfolio drove a $200 million reserve build, the rest of our loan portfolio continued to have strong credit results.”
- Marcus Schenck, CFO, Deutsche Bank: “Loan loss provisions increased by €87 million in the quarter, reflecting specific events in a few portfolios. Overall, the outlook for our credit portfolio remains relatively benign.”
- Gary Lennon, Group Executive, Finance, National Australia Bank: “After several periods of declining new impaired assets, we’ve seen an uptick in the first half 2016 to AU$1.3 billion with the bulk explained by two key impacts; AU$522 million relating to the New Zealand dairy exposures and AU$358 million relating to the four large single names exposures which have specific provision coverage of circa 50%. Collective provisions (CP) coverage to credit risk weighted assets remains peer leading and is broadly stable at 0.98%. As I dig into a couple of areas of interest around asset quality, the resources sector is facing some challenges and we are alert to this. But overall we remain comfortable with our position.”
Will banks accelerate expense initiatives to offset weak revenues and drive improved ROE performance?
“There is no magic bullet that can fully offset material revenue headwinds without compromising sustainable profitability or, in fact, the future of our franchise. Therefore, we will continue to carefully balance our investments in structural growth with tactical adjustments to our cost base to mitigate the cyclical headwinds we are facing.” — Sergio Ermotti, Group CEO, UBS
In 1Q 2016, 23 of the banks included in this analysis reported a decline in expenses from the year-earlier period, which would appear to indicate that most are making progress on expense management. However, of the banks that cut costs, only eight actually achieved positive operating leverage. In an environment where revenue prospects are muted at best, one of the primary levers for boosting profitability and ROE is to keep the rate of expense growth well below revenue growth.
But, even with the lack of success on this front in 1Q 2016, only a few banks appeared to be willing to adjust the pace of reductions or take additional measures to improve efficiency. Nomura launched a strategic review of its businesses in EMEIA and the Americas, Lloyds Banking Group accelerated its cost plans and Deutsche Bank is “looking into potentially accelerating some of the cost measures that we have planned until the year 2018 as a reaction to what we’re now seeing in the market.” At Société Générale, Group CFO Philippe Heim announced a plan intended to deliver €220 million in additional cost cuts in Global Banking and Investor Solutions (GBIS).
The more common response to questions about what more could be done on costs in the ongoing low growth environment was to take an incremental approach to savings. Management appeared unwilling to launch new drastic expense reduction measures to counter what they view as cyclical revenue weakness. At some banks, there even seemed to be a reluctance to fine-tune their current approach to expense management. Many cited regulatory compliance costs and ongoing — and necessary — investments in innovation as a barrier to efficiency improvements.
- At U.S. Bancorp, the efficiency ratio has risen almost 300 basis points in the past three years. Nevertheless, CEO Richard Davis is reluctant to cut investments: “Nothing has gone in our industry’s favor in the last five years. … But we are [not going to] a 52% efficiency ratio by suffocating the company and not investing and then having to explain two years from now why we didn’t invest.”
- HSBC Group Finance Director Iain Mackay noted that “two bad months at the beginning of 2016 aren’t really the basis on which we’d make a decision that affects the long-term future of the Group.”
- Goldman Sachs CFO Harvey Schwartz said non-compensation costs were at “the lowest quarterly level since 2Q 2009.” However, revenues were at a four-year low, offsetting any earnings tailwind lower costs might have provided.
The operating backdrop that characterized 1Q 2016 was clearly much tougher than the markets and banks had anticipated. And while the near-term outlook has improved slightly, analysts and banks alike remain cautious about prospects for the remainder of the year. At the same time, management at global banks do not expect the 1Q 2016 environment to represent the new normal for the industry, and as such, most appear to be willing to wait out the cycle instead of tackling structural cost issues more aggressively.
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