Lucky Friday the 13th for JPMorgan - Analyst Blog

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Proving pessimists wrong, JPMorgan Chase & Company ( JPM ) reported second quarter earnings per share of $1.21, way ahead of the Zacks Consensus Estimate of 78 cents. However, this compares unfavorably with $1.27 earned in the prior-year quarter.

Most importantly, due to an imprudent hedging strategy, the company incurred a derivative trading loss of $4.4 billion (before taxes) in its chief investment office (CIO) for the period, up more than two-fold from what was disclosed on May 10.  

Despite the huge trading loss, JPMorgan's better-than-expected earnings signal good going by the sector. A marked recovery of the bond and equity market and the consequent strong performances by its business segments, which helped JPMorgan overcome its difficulties to a great extent, should lift the results of other mega banks during the quarter.

Apart from the CIO trading loss, which impacted the results by 69 cents per share (after tax), JPMorgan's earnings per share for the reported quarter included certain significant nonrecurring items such as a benefit of 16 cents from gains in the CIO's investment securities portfolio, a benefit from reduced loan loss reserves of 33 cents, a gain of 12 cents from debit valuation adjustment (DVA) in the Investment Bank and gain of 9 cents related to loss recovery at Bear Stearns. All these are after-tax numbers. Excluding these items, JPMorgan's earnings came in at $1.20 per share.
 
Results for the reported quarter primarily benefited from lower non-interest expenses and a substantial slowdown in provision for credit losses, partially offset by lower revenue. Almost all the segments except Corporate/Private Equity performed well to result in such impressive earnings during the controversial quarter.

Investment banking results witnessed deterioration from the prior-year quarter due to lower revenue and higher provisions. However, the results were much better than the prior quarter on improved market conditions. With a healthy market share, the segment maintained its #1 rank in Global Investment Banking Fees.

Retail Financial Services and Commercial Banking divisions demonstrated good underlying performances, with improved revenue and earnings. However, despite positive credit trends and an expansion in credit card sales volume, the overall performance of the Card business was not very impressive. Treasury & Securities Services reported higher deposit balances during the quarter and performed better than the prior and prior-year quarters.
   
Quarter in Detail

Managed net revenue of $22.9 billion in the quarter was down 16% from the year-ago quarter. The figure, however, compares favorably with the Zacks Consensus Estimate of $22.7 billion.

Managed non-interest revenue decreased 25% from the year-ago period to $11.6 billion. The decrease ensued from $4.4 billion CIO losses and lower investment banking fees, partially offset by higher mortgage fees and related income. Net interest income fell 5% from the year-ago quarter to $11.3 billion.

Non-interest expense was $15.0 billion, down 11% from the year-ago quarter. The decrease was primarily due to lower non-compensation expense.
 
Managed provision for credit losses decreased 88% from the year-ago quarter to $214 million. Total consumer provision for credit losses was $171 million, down from $1.8 billion in the year-ago quarter. This reflects improved delinquency trends across mortgage and credit card portfolios as well as reduced estimated losses.
 
Credit Quality

JPMorgan's credit quality showed a decent improvement during the quarter. As of June 30, 2012, nonperforming assets were $11.4 billion, down 5% from $12.0 billion in the prior quarter and 15% from from $13.4 billion in the prior-year quarter. Consumer net charge-offs decreased 23% to $2.3 billion. As a result, the consumer net charge-off rate improved to 2.51% from 3.25% a year ago.

Capital Position

JPMorgan maintained a strong capital position with Basel I Tier 1 common ratio of 10.3% as of June 30, 2012, up from 10.1% as of June 30, 2011. The estimated Basel III Tier 1 common ratio was approximately 7.9% as of June 30, 2012.

Book value per common share was $48.40 as of June 30, 2012, compared with $47.48 as of March 31, 2012 and $44.77 as of June 30, 2011.

Our Viewpoint

The company had returned to its form with solid first quarter results after profit declines in two straight quarters. It again reported strong second quarter numbers despite its huge trading loss. The positive developments of the sector and gradually improving macroeconomic elements helped the banking behemoth report more or less as usual.

JPMorgan has not left any stone unturned to address the fiasco during the period. It offloaded the majority of its derivative positions that were the culprits of its trading loss. It also temporarily suspended its $15 billion share repurchase program and significantly reduced its total synthetic credit risk in CIO.

In addition, the company considerably shifted the remaining synthetic credit positions to its Investment Bank which has the expertise, capacity, trading platforms and market franchise to manage these positions. 

However, JPMorgan has been fighting with poor capital market revenues, low liquidity and a tough regulatory environment, which might mar its results to some extent. However, reduction in reserves for future losses, gradually improving retail banking performance, and steady credit trends in its credit card business are expected to be on the positive side going forward. 

Despite the macro pressure on credit quality, JPMorgan's credit metrics have been steadily improving since the final quarter of 2009. We are also impressed to see a modest improvement in delinquency trends and net charge-offs. We expect credit quality to continue improving, thereby providing more room for bottom-line growth.

Though there are concerns related to the future of its recent trading loss and exposure to the European economy, equity-centric activities in the U.S. are expected to support JPMorgan's results in the upcoming quarters with continued recovery in the capital markets.

Yet net interest income remains under pressure, affecting the traditional banking businesses. Also, with the thrust of new banking regulations, there will be pressure on fees, and loan growth could remain feeble.

In Conclusion

The company has diverted its attention to some extent from enhancing shareholder value to address its CIO loss. For instance, it has temporarily suspended its share repurchase program following the trading debacle.

However, an income-seeking investor with the appetite to absorb risks related to market volatility should not be disappointed with an investment in JPMorgan over the long haul as it pays an impressive quarterly dividend of 30 cents that yields 3.50%.

Also, from the risk perspective, as JPMorgan cleared the most difficult stress test, it will surely be able to withstand another financial crisis.
 
JPMorgan shares currently retain a Zacks #4 Rank, which translates into a short-term Sell rating. However, considering the company's business model and fundamentals, we still have a long-term Neutral recommendation on the stock.

As JPMorgan is a banking giant with exposure in almost all banking businesses and one of the first two important bankers to kick start second quarter results, the release should be a significant indicator of performance in the key banking sector. Wells Fargo & Company ( WFC ) is the other bank that reported with JPMorgan.

Close on the heels of JPMorgan and Wells Fargo, the other major banks, namely Citigroup Inc. ( C ) is scheduled to report on April 16, Goldman Sachs Group Inc. ( GS ) on April 17 and Bank of America Corporation ( BAC ) and Morgan Stanley ( MS ) on April 19.


 
BANK OF AMER CP (BAC): Free Stock Analysis Report
 
CITIGROUP INC (C): Free Stock Analysis Report
 
GOLDMAN SACHS (GS): Free Stock Analysis Report
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
MORGAN STANLEY (MS): Free Stock Analysis Report
 
WELLS FARGO-NEW (WFC): Free Stock Analysis Report
 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: BAC , C , DVA , GS , JPM

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