Seeking Alpha
Long only, deep value, growth at reasonable price
Profile| Send Message|
( followers)  

The stock price for JPMorgan Chase (NYSE:JPM) has appreciated by 9% since the beginning of the year. A number of factors came into play as the bank further improved its standing in the industry. JPMorgan reported first quarter profits at an all time high. This occurred despite a decline in interest rates. Jamie Dimon, CEO of JPMorgan, has already stated his optimism regarding the economy as housing sector recovers and the performance of the business improves due to a sizable contribution from reserve releases.

First Quarter Financial Performance

For the first quarter of 2013, JPMorgan reported earnings of $1.59 per share, which beat analysts' estimates of $1.39 per share. The bank also reported an improvement of 6% in its net revenue figure of $25.1 billion as compared to $23.6 billion in the last quarter. The non-interest expense declined by 4% sequentially and 16% compared to the last year. The bank reported a reduction of $2.4 billion in funds set aside for legal expenses. The expense cuts have been used by all other large banks, which include Bank of America (NYSE:BAC) and Citigroup (NYSE:C), to improve profits.

Despite beating analysts' estimates of earnings per share and net revenues, JPMorgan's share price has remained stagnant after the announcement of these results due to concerns about the sustainability of profits. Many analysts have emphasized that the bank reduced its loan reserve losses by $1.2 billion in order to improve its profits figure, which cannot be sustained in the long run. In simple words, these analysts take the stance that the improvement in earnings is not coming from core business activities of the bank. On the other hand, it is argued that the economic conditions have shown an improvement. The reserves were stacked when the uncertainty reached undesirable levels. Now that the dust seems to be settling, the bank can go out and release these reserves for their businesses. A substantial improvement has also occurred in the investment banking operations.

Net Interest Margins of JPMorgan

The US economy is facing a low interest rate environment. This has adversely affected the interest margins of banks across the industry. The net interest margin of JPMorgan has declined from 2.61% in the first quarter of 2012 to 2.37% in this quarter. In 2009, the interest margin was above 3.5%. The bank's estimates suggest an estimated 1% decline in margins for 2013; however, these adverse factors have been partially offset by the improvement in yields of investment securities. As a result of this decline in margins, the loan-deposit ratio of the bank has declined from approximately 80% in 2005 to 60% in this quarter. This shrinkage in core business activities has shifted the focus of profits towards expense cuts and reserve releases.

Mortgage Banking and Job cuts

The impact of lower margins was also felt in the mortgage business as the pre-tax income declined by $317 million to $427 million. An increase in expenses was experienced in this segment which was offset partially by improvement in volume. Mortgage service revenue decreased by 3% as compared to the first quarter of 2012. Mortgage originations were reported at $52.7 billion demonstrating an increase of 37% as compared to first quarter of 2012 and 3% compared to last quarter.

JPMorgan has announced that it will cut approximately 15,000 jobs from its mortgage segment and approximately 4,000 from community banking. Most of these job cuts have already taken place in the first quarter. These efforts are aimed at reducing the expenses of the bank.

Conclusion: What Should Investors Expect?

It is clear that the core business activities are not running in full swing, and are expected to remain slow until the economic recovery gathers pace. In order to come up with presentable results, banks have turned to strategies that are deemed unsustainable. Despite these facts, the bottom line is that JPMorgan is the cheapest large capitalization bank. It is trading at a P/E of 8.73 whereas all the other large US banks have a P/E of more than 10, and the industry average is around 14.55. The shrinkage of margins is affecting the business adversely but the management is doing a commendable job of competing with the industry despite unfavorable circumstances. Therefore, JPMorgan appears to be an attractive opportunity for investors.

Source: Is JPMorgan Chase A Good Investment?