It's still early, but it's looking like this quarterly earnings cycle might not be holding much in the way of surprises for bank investors. That ought to be particularly welcome in the case of JPMorgan Chase (JPM), as surprises at large money-center banks like this tend to be of the negative variety. While loan losses are still elevated and both loan and spread growth are looking feeble at present, JPMorgan continues to look like an undervalued opportunity in the financial sector.
Q4 Earnings - Plenty Of Moving Parts, But A Strong Core
Some readers will find the idea of "core earnings" at a company like JPMorgan to be laughable, what with the seemingly never-ending charges, losses, benefits and gains. Nevertheless, operating revenue rose 10% from last year and fell about 6% sequentially, coming in solid relative to the average of sell-side guesses.
Overall net income rose about 1% sequentially, and kept the net interest margin shrinkage to three basis points - better than expected, and pretty good relative to Wells Fargo (WFC) and U.S. Bancorp (USB). Core NIM performance was a bit softer, down 7bp, while average earning assets increased 2% sequentially.
Fee income fell 2% sequentially and was a little soft relative to expectations - mostly due to lower mortgage banking income. Mortgage fee income fell 11%, while card income increased 5%. JPMorgan saw good volume performance in its merchant processing business, suggesting that the company may have gained some incremental share on the likes of U.S. Bancorp (though there is an apples-to-oranges risk here).
Expenses ticked up another 2%, and the company's efficiency ratio of over 61% is not so impressive relative to the other commercial banks that have reported so far.
Still Growing, Just Not Very Quickly
Business is still sluggish, but JPMorgan is still growing. The company expanded its balance sheet, with securities up about 1% and loans up just 2%. This loan figure was pretty soft, even though commercial lending (up 4%) wasn't bad. That commercial lending figure ought to be encouraging for investors in other big commercial lenders like PNC Financial (PNC) and BB&T (BBT), but U.S. Bancorp's weaker performance offers an offsetting note of caution.
Consumer lending volume is not very strong right now - Wells Fargo talked about substantially weaker conditions in mortgage lending, and while JPMorgan has grown into the second-largest mortgage originator (behind Wells Fargo), that has a great deal more to do with the precipitous drops at Bank of America (BAC) and Citigroup (C) than huge strength at JPMorgan, and Wells Fargo holds about one-third of the market against JPMorgan's roughly 10% share.
On a more positive note, credit conditions continue to improve. Non-performing loan balances fell 6% from the third quarter (though rose 7% year-on-year), and the NPA ratio declined 13bp sequentially, while the net charge-off ratio saw a sizable sequential drop. That enabled the company to make another sizable reserve release - $972 million (or $0.17 per share), of which about $700 million was tied to lower mortgage loan losses.
It's also worth noting that, like U.S. Bancorp, JPMorgan's credit card portfolio continues to see lower losses, with charge-offs of 3.5% this quarter (versus 4.29% last year and 3.57% in the third quarter). Perhaps it's a bit ironic given the perception of risk appetite between the two banks, but JPMorgan presently has a lower card charge-off ratio than U.S. Bancorp. Either way, these lower levels of credit card charge-offs could create some challenges for the debt recovery firms (as I highlighted earlier in this piece on Portfolio Recovery Associates (PRAA)).
Weak lending could be explained by uncertainty regarding the economy and a lack of confidence among both businesses and consumers. Not helping the growth picture at JPMorgan is the ongoing weakness in spreads. The bank's loan yields contracted another 15bp this quarter (down about 40bp from last year), while the securities yield has fallen to about 2% (from 2.6% last year). While the bank has been able to offset this by lower-cost deposits (non-interest deposits were up 5% sequentially and the all-in cost of deposits fell to 0.2%), there's not much room left for these to go lower, and that will squeeze the bank's ability to make a profit.
Other Businesses Looking Solid
JPMorgan's capital markets operations are quite significant, and the bank saw good growth in banking fees (up 20% sequentially), though trading revenue wasn't all that special (down 15%, but at the better end of company guidance). Asset management was likewise pretty solid this quarter, as revenue rose 12% from last year on a 9% increase in assets under management.
The Bottom Line
Investors are likely to see a little more detail on what exactly went wrong on the London Whale trading losses, but otherwise the bad news cycle seems to have largely worked itself out. The company settled its IFR liability for $2 billion, and it would seem that most of the parties with standing to sue JPMorgan over mortgage-related issues have done so (with many of those cases already settled or reserved). That said, with the low interest rate environment compressing growth potential this year, there is likely to be a heightened sensitivity to any additional bad news.
I continue to value JPMorgan on the basis of a return on capital model in which I assume a long-run return on equity of 11.5% and a discount rate a little higher than that of Wells Fargo or U.S. Bancorp to account for the added risk of the operations. Assuming $15 billion in capital returned to shareholders this year (dividends and buybacks), those assumptions lead to a fair value target of $57.50, while a valuation analysis on the basis of tangible book value suggests a value in the low $50s.
In either case, I continue to believe that JPMorgan is a financial stock worth owning today, and still a worthwhile buy for investors who do not already own it.