JPMorgan: Moving Ahead On The Right Path

Jan.20.14 | About: JPMorgan Chase (JPM)

On January 14, 2014, JPMorgan (NYSE:JPM) reported its fourth quarter 2013 results. The following are the results insights and my analysis of the results.

Results summary:

For the latest quarter, JPMorgan posted a revenue of $24.1 billion, down from $24.4 billion a year earlier, and net profit of $5.3 billion, down from $5.7 billion a year earlier. For the quarter, the earnings per share stood at $1.3.

Segments: (year over year)

The company reports its revenues under five segments: Consumer & Community Banking, Corporate & Investment Bank, Commercial Banking, Asset Management, and Corporate/Private Equity.

  • Consumer & Community Banking:

The segment comprise of three units namely: Consumer & Business Banking, Mortgage Banking and Card, Merchant Services & Auto.

During the quarter, the segment's revenues stood at $11.3 billion, down from 12.4 billion. The decline was mainly due to the decline in non-interest revenue, which declined by $849 million to touch $4.3 billion. Another thing that contributed to the revenue decline is the decline in the net interest income, which declined by $199 million to touch $7.1 billion. However, despite the decline in the revenues the segment showed an improvement in net income, which grew by $383 million to reach $2.4 billion.

Outcome:

The Consumer & Business banking unit continues to solidifying its base with 10% rise in average total deposits, 5% rise in number of accounts, and 19% rise in client investment assets. However, decline in deposit margin, which declined by 15 bps is a cause of concern as over 50% of the unit's revenues come by the way of the net interest income. The declining deposit margins directly affect the net interest income of the unit, which is evident from the fact that the unit's ROE declined from 32% to 28%. Any further decline in the deposit margins may lead to lower ROE.

Powered by the $950 million of write-backs, and steep decline ($819 million) in "default servicing expenses" Mortgage Banking unit reported a decent quarter in financial terms (partly off-set by the $404 million of non-MBS related legal expenses). The overall business environment is improving, which is evident from the fact that the unit's net charge-offs and delinquencies are coming down. Allowance for loan losses as a percentage to the real-estate portfolio came down to 2.23% as compared to 4.14%. However, despite an improving overall business environment the company reported a 54% decline in mortgage originations. Its real-estate portfolio showed a decline of $2.6 billion, and its serviced "third party mortgage loan" portfolio declined by 5% to touch $815.5 billion. The segment's future performance depends a lot on the housing-market, and if the market continues to improve the company may write-back more "allowance for loan losses", which stood at about $6.8 billion.

As mentioned by the company:

"We still have meaningful improvement expected in terms of delinquencies and foreclosures"

Card, Merchant Services & Auto unit showed an all around improvement. Sales volume for the card services grew by 11% to $112.6 billion. Net charge-off rate declined 65 bps to reach 2.85% from 3.50%. 30+ day delinquency rate declined 43 bps to reach 1.67% from 2.10%. Merchant processing, and transaction volumes grew by 14% and 9% respectively.

The improvement in the unit's performance clearly reflects the effect of healthy growth of the U.S. economy. The segment's future performance depends a lot on the economic growth, and if the economy continues to improve the company may write-back more "allowance for loan losses", which stood at about $4.75 billion.

  • Corporate & Investment Bank:

The segment comprise of two units namely: Banking and Markets & Investor Services.

The segment generated $6 billion in revenues during the last quarter, down from 7.6 billion. Net income declined by $1.2 billion to touch $858 million. The decline was mainly due to the decline in Markets & Investor Services revenue, which declined by $1.5 billion to touch $3 billion. However, excluding the effect of FVA (funding valuation adjustments, effective 4Q-13) and DVA (debit valuation adjustments) the segment reported a net income of $2.1 billion.

Outcome:

Despite a steep decline in net income the segment reported an excellent growth in its financial assets/portfolio. Assets under custody grew by $1.7 Trillion to reach $20.5 Trillion. Average client deposits grew 15% to reach $421.6 billion.

Going forward, the growing asset base should allow the company to report better results for the segment. The introduction of Funding Valuation Adjustments ("FVA") framework during the quarter for OTC derivatives and structured notes will increase the result fluctuations, but on the positive side will bring in much needed transparency.

  • Commercial Banking:

The segment's revenue grew by $102 million to touch 1.85 billion. Net income grew by $1 million to reach $693 million.

Outcome:

The Commercial Banking segment continues to solidifying its base with 3% rise in average client deposits, 7% rise in loan balances, and very low charge-off rate, which for the quarter stood at 0.07%. Growing asset-base, loan portfolio and very low charge-off rate shows the quality of assets and points towards a better future.

  • Asset Management:

The segment reported the record revenue of $3.2 billion, up 15% from $2.8 billion a year earlier. Net income stood at $568 million, up 18% from $483 million.

Outcome:

The segment showed an all around improvement, assets under management grew 12% to reach record $1.6 Trillion, client assets grew 12% and reached record $2.3 Trillion. The segment's investment performance was solid with 69% of mutual fund AUM ranked in the 1st or 2nd quartiles over 5 years. Growing asset base coupled with strong investment performance will allow the company to report better results as well as to attract more clients in the future.

  • Corporate/Private Equity:

The segment reported a net income of $787 million, which includes Private Equity net income of $13 million, gain on sale of Visa shares of $1.3 billion (pretax), and gain on sale of 1CMP of $0.5 billion (pretax), partly off-set by legal expense ($0.4 billion pretax and $0.8 billion after-tax) and Treasury and CIO net loss of $78 million.

Conclusion:

Most of the company's segments point towards a growing future due to the growing asset-base and asset-quality. The results (to much extent) reflects the improvement in the U.S. economy, which accounted for over 50% of the company's revenues.

During recent times, the company has been in the news due to regulatory and legal issues. Which on one side is costing the company billions of dollars, but on the other side is prompting the company to improve transparency and to take a cautious approach while making critical investment decisions. This will make the company a better financial institution. Other measures that the company is taking to make sure that the company emerges as a stronger financial institute include:

  • Liquidity:

The company is maintaining a very liquid balance-sheet.

As mentioned by the company:

"If you look at the balance sheet today, we have almost $350 billion at central banks, mostly the Fed, another $350 billion of very high quality investment securities. And those two things combined equal our loans of $700 billion. So the company is very, very liquid."

  • Cost reduction:

The company is increasingly focusing on cost-reduction to get better returns from its asset-base, particularly in Consumer & Business banking and Mortgage business units. The firm-wide headcounts has been reduced by 7557 (YoY). This will reduce the expenses in the future.

  • Capital position:

A strong capital position is essential for the company's future stability. The company is also looking forward to improve its "Tier 1 common ratio under Basel III" from 9.5 to 10 by the end of current year. This shows that the company is equally focusing on safety and growth.

All in all, the company is moving ahead on the right path, which will position the company as a much more reliable financial institute rather than just a huge and growing financial institute. But there still are lots of hurdles, particularly related to the regulatory and legal issues that may keep hurting the company from time to time.

Valuations:

The company is trading at PEx of 12.5, and offers a dividend yield of over 2.5%.

The company's growth, to a significant extent, depends on the economic growth of regions served. The healthy economic conditions improve the business prospectus and reduce the risk of defaults, on the other side economic slowdown reduces the business opportunities and increases the risk of defaults. Due to the improving economic outlook, share price of the company has seen a decent run-up in the last 12 months (see the chart below). Provided that the economy stays healthy and legal expenses stay within expectations, the valuations look reasonable (Barring unforeseen circumstances).

JPM Chart

JPM data by YCharts

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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.