JPMorgan: New Day, New Bank, Same Story

By James Kwak

JPMorgan Chase (JPM) reported its quarterly earnings today. The headline was $2.1 billion in net income, beating analysts’ estimates. Behind the headlines, it was similar to the story that Goldman (GS) told earlier this week: a huge jump in fixed-income trading, status quo everywhere else, and continuing writedowns. For example, if you look at the breakdown of revenue by type of activity (not line of business) on page 4 of the supplement, you’ll see that revenue was flat or down in every category except one: principal transactions, where it jumped from a loss of $7.9 billion to a gain of $2.0 billion. That $9.9 billion improvement more than explains the entire increase in pretax profit from negative $1.3 billion to positive $3.1 billion.

As with Goldman, it was clearly a good quarter for JPMorgan; making money beats losing money any day. But the question to ask is whether it is sustainable, either for JPMorgan or for the banking industry as a whole. To answer that question, here are some pictures.

First, if you look at the net revenues on a line-of-business basis (page 8), you see that virtually all the improvement came from investment banking, which improved from negative $0.3 billion to positive $8.3 billion. Here’s that $8.3 billion in historical perspective. (All the charts below are on the same scale.)

Now what was behind that super quarter? Here is the historical performance of all the investment banking business except fixed income trading:

And here’s fixed income trading:

So for JPMorgan to reproduce these results quarter after quarter, it would have to have unprecedented, exceptional, super-duper fixed income trading revenues quarter after quarter. Now, JPMorgan’s prospects may be better than they were before the bust, since two major investment banks are gone, one of them absorbed into JPMorgan itself, meaning less competition and higher fees all around. But we also know that last quarter was a bit unusual because of the massive unwind at AIG, which hopefully will not be repeated.

And here’s the dark side of the story: quarterly provisions for credit losses.

Note that these are income statement figures, so they are not cumulative: these are the provisions set aside each quarter, which should reflect the quarterly change in expectations about credit losses (defaults). The question is whether these big investment banks can make enough money from trading and fees to make up for the money they are still losing on credit exposures.

Note: I got my data from the financial supplements on this page. There’s a small discrepancy in the Q1 2006 numbers, depending on whether you look at the Q1 2006 release or the Q1 2007 release. But it’s only about $100 million, so I didn’t bother looking into it.

Comments

[adavoudi:]

Kwak, excellent article, well researched and more importantly, you don't need a Ph.D in astrophysics to understand it. thanks. -ali

Apr 16 11:00 PM

[Alan Young:]

What, exactly, is fixed-income trading? Is it just buying and selling bonds? If so, that's a low-margin business, and I can't imagine the bond market is so hot that they're raking in billions on the trade. So what is it.
Can anyone, if not pinpoint, at least speculate on how they got to that outsized figure?

Apr 16 11:38 PM

[CJJ:]

If I get into $5 of debt but make $1/year in profit to pay down the debt after all my other expenses. I am INSOLVENT for 5 years. At any point in that 5 years you could come tell me that I'm running my life terribly, etc and the Internet Experts would be on your side.
But as long as I'm making that $1, I WILL pay off the debt.

Same with banks. Their earnings power is not gone. It may be lower than 2 years ago, but the earnings they were making was HUGE. Once these losses run through the system, they will emerge from INSOLVENCY. All this noise about whether or not they are insolvent today is stupid and counter productive.

Implement rules for their future activities to ensure they don't do what they did in the last 5 years.

Apr 17 12:35 AM

[MDR:]

All the provisions number tells me is that risk management at JPM is best in class. And while I agree that this quarter will not necessarily be replicated, I think the quarter is proof that the big bank model can work when managed appropriately. When the consumer sector eventually picks up again, those units (cards, retail banking, home & auto loans) will become profitable and can maintain these profit levels in lieu of extraordinary IB gains. I would say the management team at JPM has set themselves apart from any other large corporate--they are in a league of their own.

Apr 17 09:39 AM

[uss?:]

Do you notice a similar pattern at GS and C, notwithstanding GS throwing out December losses?

Apr 17 10:52 AM

[kmf:]

I agree with this simple example but ask yourself the question: Do you really know how large the bank(s) debts are? The Stress Test is not going to tell you. All you have is the word of the CFO and CEOs of the bank(s) saying that "we can make it through this recession". This situation makes it difficult to buy banks for the long term. Also the dividends are gone. Is the govt. going to let them out of TARP so the can begin to pay those big salaries again?

On Apr 17 12:35 AM CJJ wrote:

> If I get into $5 of debt but make $1/year in profit to pay down the
> debt after all my other expenses. I am INSOLVENT for 5 years. At
> any point in that 5 years you could come tell me that I'm running
> my life terribly, etc and the Internet Experts would be on your side.
>
> But as long as I'm making that $1, I WILL pay off the debt.
>
> Same with banks. Their earnings power is not gone. It may be lower
> than 2 years ago, but the earnings they were making was HUGE. Once
> these losses run through the system, they will emerge from INSOLVENCY.
> All this noise about whether or not they are insolvent today is stupid
> and counter productive.
>
> Implement rules for their future activities to ensure they don't
> do what they did in the last 5 years.

Apr 17 11:57 AM

[Edward Ulys...:]

If you bother to read "The Best Way To Rob A Bank Is To Own One" you'll see that the same thing has happened in the 80's with mega S&Ls. Merge two insolvent financial organizations, mix in some fancy accounting, and you've got "profits." One must continue to lie in order to continue to steal, which explains the big bonuses.

Apr 17 12:08 PM

[MDR:]

The statement below would be accurate if JP were insolvent, when in fact it is the best capitalized bank on the street...


On Apr 17 12:08 PM Edward Ulysses Cate wrote:

> If you bother to read "The Best Way To Rob A Bank Is To Own One"
> you'll see that the same thing has happened in the 80's with mega
> S&Ls. Merge two insolvent financial organizations, mix in some
> fancy accounting, and you've got "profits." One must continue to
> lie in order to continue to steal, which explains the big bonuses.

Apr 17 01:02 PM

[John Lounsbury:]

I don't see is expressly discussed by James Kwak or the comment stream, but what about the CDS unwind via AIG (using government bailout $)?

Is revenue received through AIG to compensate for CDS unwinding included in "fixed income trading"? If that is the source, do these institutions have any more government money coming through that channel? Yes or no, the answer is bad news either way.

Yes - Further plundering of public capital.
No - Q1 revenue (and income) is a one-time event.

Perhaps another reader will comment on the AIG passthrough question.

Apr 17 01:07 PM

[nobby73:]

Yes, any AIG unwind profit will show in the fixed income trading, but I suspect it wasn't that big a part. The JPM gorilla is the interest rate derivatives trading operation, which always makes huge profits during such volatile times as a result of the flow. As for whether there's more AIG style things to come, it's anyone's guess - let's hope not. If the Q1 fixed income revenues are not repeated, it could be compensated for by revenue picking up in other areas. That's how the mega-banks are supposed to work, in JPMs case it may actually be true.


On Apr 17 01:07 PM John Lounsbury wrote:

> I don't see is expressly discussed by James Kwak or the comment stream,
> but what about the CDS unwind via AIG (using government bailout $)?
>
>
> Is revenue received through AIG to compensate for CDS unwinding included
> in "fixed income trading"? If that is the source, do these institutions
> have any more government money coming through that channel? Yes
> or no, the answer is bad news either way.
>
> Yes - Further plundering of public capital.
> No - Q1 revenue (and income) is a one-time event.
>
> Perhaps another reader will comment on the AIG passthrough question.

Apr 17 04:15 PM

[cholmley:]

nobby73,

Yes good comment, thats exactly how a diversified financial services firm is meant to work, blow the trading results out of the water when the markets are volatile and it seems the world is coming to an end and when the world returns to normal(ish) make money on traditional businesses such as credit cards and commercial loans having of course socked away billions in reserves thanks to those trading profits.

Of course you need a decent balance sheet to do this which is why it works for JPM and not so much for the others...

Apr 17 05:25 PM

[Alexander V...:]

Fixed Income Trading was a major contribution to the income of
JPM, GS. The Fed has a program in place where it is buying
$300 biliion of Treasuries, and $750 billion of the Mortgage Backed
Securities. Add other government programs. JPM, GS belong to the
primary dealers network, that benefits from the government business.

Apr 18 01:15 PM

[ron_paulite:]

It's all a sham. No fundamentals. No principles. And they can get away with it because they are the issuer of the world's reserve currency. If this were some other country, there would be total economic collapse by now.

Because of the unique position of the USD and the US, you can actually become wealthy here by borrowing and spending. Of course, not everybody can do that. You have to be connected to Wall Street. It is a confidence game.

Apr 19 10:29 AM