JPMorgan - Still A Buy

Oct.15.13 | About: JPMorgan Chase (JPM)

The talks of firing Jamie Dimon after JPMorgan (NYSE:JPM) reported its first quarterly loss since 2004, due to a larger-than-expected legal charge, are absolutely ridiculous. Although the CEO of the country's biggest bank by assets looked a little vulnerable following the results, he still remains one of the greatest, if not the greatest, American bankers.

If one wants to know how good a manager Jamie Dimon is, he should listen to Laban Jackson, board member of JPM who recently said about Dimon,

"He's the best manager I've ever seen, and I'm old," Jackson, 71, said at the National Association of Corporate Directors' annual conference in Oxon Hill, Maryland. "He has, as we all do, flaws."

Looking at the results excluding the litigation charges, and the reserve release, the company reported adjusted EPS of $1.42 compared to the consensus estimates of $1.18. The adjusted results are not bad enough to talk about Dimon losing his job. Most business lines performed as expected and despite the charge, the capital ratios remained stable. The greater-than-expected legal reserve should be viewed positively as it gives investors greater comfort.

Despite of the larger-than-expected legal charge, JPMorgan still remains a very attractive investment opportunity. JPM's cheap valuations, strong Tier 1 common ratio and solid management places the bank in a strong competitive position. Going forward, higher loan growth and capital markets should prove to be a significant source of potential earnings upside. All these factors combined with the continued progress that the bank is making on its legal troubles, make it one of the better investment opportunities among large-cap banks.

Litigation Reserves

JPM recorded a $9.2 billion charge in 3Q13 to build litigation reserves for a number of matters including mortgage-related issues. The additions to the legal reserves reflect escalating demands and penalties from multiple government agencies. The company is seeking a reasonable settlement with the government on mortgage-related issues, which addresses both the Bear Stearns and Washington Mutual transactions. As of the end of third quarter, the litigation reserve balance stands at $23 billion. The bank started 2010 with $3 billion in reserves and through 3Q13 added $28 billion to the reserves, offset by about $8 billion of settlements and judgments since 2010. JPM expects the litigation costs to normalize over time, though they could still be volatile from quarter to quarter. JPM also estimates reasonably possible losses in excess of reserves at $5.7 billion, down $1.1 billion from $6.8 billion at 2Q13.

In the midst of all this, JPM continues to address its legal and compliance functions and is looking to simplify the business. The bank announced that among others it is exiting its physical commodities business, One Equity Partners, and its student loan business. JPM also remains rigorous with its expenses despite increased costs related to its control agenda.

Capital

Despite building $9 billion in litigation reserves, JPM's Basel 3 Tier 1 common ratio was flat q/q at 9.3%; the bank is targeting a 10-10.5% level. Capital, after dividends and share repurchases, in the third quarter declined by ~$2 billion, but this was offset by a reduction in RWAs driven by legacy portfolio run-off. Compared to holding company requirements of 5.0% and an internal target of 5.5%, JPMorgan's Basel 3 leverage ratio stands at 4.7%. However, JPM added that the shortfall is manageable and expects the holding company to be compliant with the leverage ratio within the allowed timeframe. The bank repurchased $740 million of common stock in 3Q13 following the $1.2 billion repurchased in the prior quarters. This was done as part of its CCAR 2013 JPM authorization to purchase up to $6 billion ($4.1 billion remaining) of shares through 1Q14.

Conclusion

JPM disclosed for the first time its total reserves for litigation, which now stands at $23 billion. It also warned that more could come, but this seems solid relative to government and private label litigation and should be viewed positively as it gives investors greater comfort. The bank was able to build $9 billion in litigation reserves in the third quarter with no change to Basel III capital ratios on solid core earnings. JPM remains a well-managed and strongly capitalized bank. The bank's growing market share, efficiency focus, share gain from Europe, and declining mortgage foreclosure costs should all lead to rising ROE. Despite the challenging economic environment, the company should benefit from its diversified business mix as well as an improving credit environment. At current valuation, JPMorgan offers the best risk/reward among the large-cap banks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.