Update: U.S. Bancorp & Goldman Sachs

July 20, 2023 | Premium Service | U.S. Bancorp (USB) had a decent quarter in Q2 2023, but one that is still obscured by the accounting for the Union Bank purchase from Mitsubishi UFJ Financial Group, Inc. (MUFG). The Q2 numbers in terms of returns were down from Q1, but the analyst community took comfort from the fact that the capital levels rose.

In terms of USB, we need to see the efficiency for the combined entity down in the mid-50s before we are ready to declare success. That said, Buy Side manager are already buying USB on the assumption that management will ultimate return to trend earnings. The table below shows key performance indicators for USB from the Q2 2023 earnings presentation.

USB has guided to $1 billion in "notable items" due to expenses from the Union Bank purchase in 2023. The Union Bank acquisition added 1.2 million new consumer and small business accounts and 3,000 commercial customers to USB’s platform. Indeed, this purchase is one of the more significant bank M&A deals in recent years. The transaction also boosted USB’s mortgage volumes, pushing the bank up into the top-five issuers nationally.

“Second quarter mortgage banking revenue at USB came in at $161 million compared to $128 million in 1Q23,” Inside Mortgage Finance reported, but the bank announced layoffs in its mortgage unit last week. Q1 & Q2 results include almost $500 million in charges related to Union Bank. Even with adjustments considered, however, USB’s net interest margin is still sub 3%.

When we look at the public market’s valuation for USB, it is pretty clear that the drop in reported financial performance is affecting the stock. Market leader JPMorgan (JPM) is trading just shy of 1.6x book while USB is at 1.3x after the most recent equity market rally. In past years, USB traded even with JPM, but that is no longer the case today. We expect to see USB trading at a discount to JPM and Peer Group 1 until the bank improves its operating leverage to pre-COVID levels.

Of note, USB has grown its deposit base through the Union Bank acquisition and also organically, but the shift from non-interest bearing deposits to time deposits is quite pronounced and hurt Q2 results. As USB shrinks its balance sheet and makes other operational changes, we expect the bank’s performance to improve, but this process could take several more quarters.

Moving from the sublime to the problematic, we come to the Q2 2023 earnings results from Goldman Sachs (GS). In Q1, just to review, GS announced a restructuring of the Marcus banking unit and the sale of assets. In Q2, the board of GS endorsed the leadership of CEO David Solomon and a two part strategy focused on investment banking and asset management. The remaining loan portfolio of Marcus was sold at a $100 million gain in Q2.

Even as GS has completed the sale of over $1 billion in loans from Marcus, GS has been increasing exposures in other areas, particularly in residential mortgage lending. Our readers know from past reports that GS has no particular comparative advantage in terms of funding costs, nor has the bank covered itself in glory in terms of credit performance on it’s small loan book. We reviewed the Q1 results for GS in June (“Update: GS, MS, SCHW, RJF & SF”).

Source: FFIEC

GS was the only large bank to miss Street estimates to far. As GS sheds the consumer loan exposures to Marcus, it reportedly picked up commercial loan exposures in areas such as funding warehouse and mortgage servicing rights (MSR) for nonbank lenders. Rithm Capital (RITM), the largest nonbank holder of Ginnie Mae MSRs and a former customer of Credit Suisse (CS), is said to be working with GS. Of note, RITM has apparently acquired the last slug of consumer loans from Marcus.

When CS folded its tent in 2022, most of its clients migrated to Atlas SPG, a portfolio company of Apollo Global Management (APO). Many key bankers from CS also went to Atlas. But other than the credit line that CS extended to Atlas, APO has no comparative advantage for funding mortgage warehouse facilities, advance lines and/or MSRs. Given the low level of new loan volumes, an uptick in delinquency could quickly overwhelm some of the more high levered nonbank owners of Ginnie Mae servicing.

With Comerica (CMA) and Fifth-Third Bank (FITB), among others, exiting warehouse lending, GS may be getting more inquiries from nonbank lenders. We wonder about the staying power of GS and other commercial lenders in the mortgage channel, including Texas Capital Bank (TCBI) and M&T Bank (MTB). As the mortgage market consolidates into a primarily purchase market in 2023, roughly half of existing capacity will need to be eliminated. JPM and New York Community Bank’s (NYCB) Flagstar unit rank 1 and 2 in the warehouse space. The table below is from the Q2 2023 GS earnings release.

The other question regarding GS that we have addressed previously and which remains is whether the asset management side of GS is really creating value. GS reported $4.6 billion in fees in the first half of 2023 on $2.7 trillion in assets under supervision (AUS), which translates into 34bp annually. If you compare GS with the $1.8 trillion wealth management arm of Morgan Stanley (MS), the latter generates far more income vs AUS. The $1.4 trillion investment management unit at MS performs roughly in line with GS.

Without a banking strategy, we question whether GS is really viable as a stand alone business over the longer term. We have long advocated that GS consider a merger with a large regional bank as a way to consolidate its position as a global competitor of MS and UBS AG (UBS). Indeed, all of the “asset gathers” that we follow from MS to Charles Schwab (SCHW) to Raymond James (RJF) have superior funding and credit loss profiles compared with GS. In an environment where credit costs are again a primary concern for banks, GS would likely be an outlier in the asset gatherer group and would have net credit losses closer to mainstream lenders such as JPM.

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