JP Morgan ( JPM ) is one the largest and most diversified bank in the U.S., and offers services such as retail banking, commercial banking, asset management, investment banking, consumer lending and credit cards. Its main competitors include Bank of America ( BAC ), Wells Fargo ( WFC ), Goldman Sachs ( GS ), Deutsche Bank ( DB ) and Morgan Stanley (MS).
JP Morgan has benefited from a decline in provisions for credit losses that raised operating margins for its retail banking business. However, a weak economic recovery has resulted in a decline in average interest earning deposits and presents a potential concern for the multinational bank.
Here we explore upside and downside scenarios for JP Morgan's retail banking business, which accounts for 19% of our $48.62 stock price estimate. Our JPM price estimate currently stands above market price.
3% Upside - Decline in Provision for Credit loss
JP Morgan's provision for credit losses for its retail banking segment declined by nearly 47% in 2010 to reach $607 million. The improvement in provision for credit loss can be attributed to a decline in adversely classified loans due to a better economic outlook. Reduced provisions caused operating margins for the retail business to rise from 33.6% in 2009 to 34.1% in 2010.
We estimate that this operating margin will remain stable at its current level during our forecast period. However, there could be a potential 3% upside to our price estimate for JP Morgan if further declines in provisions for credit losses (sparked by an effort to minimize its risk and adopt stricter loan standards) push retail banking operating margins towards 40%.
5% Downside - Decline in Average Deposits
Average deposits, which refers to the total average value of checking, savings, time and other deposits held by JP Morgan in their retail financial services group, declined marginally from $341 in 2009 to $339 billion in 2010.
Notably, average deposits increased at a striking 21.5% annual rate over the three years prior to 2009. The acquisition of Washington Mutual in September 2008 helped JP Morgan raise its average deposits, and we expect the deposits to continue to increase towards $545 billion by the end of our forecast period. There is a 5% downside to our price estimate for JP Morgan, however, if a weak economic recovery stifles the growth of average deposits, leaving this number at $400 billion at the end of our forecast period (vs. our $545 billion base estimate).