As Q1 earnings season for giant U.S. banks is just a few weeks away, analysts have begun to decrease their estimates for the financial results of banks, pointing to a persistent fall in fixed income, currency and commodities trading.
Sandler O'Neill analyst Jeffery Harte recently cut his Q1 FY 2014 earnings estimate for all leading banks in the U.S., including JPMorgan Chase & Co. (NYSE:JPM), a popular financial services firm and banking institution. The analyst indicated a seasonal rebound in fixed-income (FICC) trading being not up to expectations, and historical norms as the reason behind the decrease. As a result, analysts seem to have some doubt about the bank's growth prospects. For the current quarter, analysts are expecting the bank's revenue to be reduced by 4.5% to $24.67 billion, and earnings to decrease by 10% to $1.43 per share.
Therefore, in this article, I will analyze the challenges faced by JPMorgan, and the areas that will support the company's growth in the coming period.
Now, let us proceed with the discussion over the issue of the lack of rebound in fixed-income trading.
Lackluster Rebound in Fixed-Income Trading, and its Impact
Analysts are expecting fixed-income trading revenue to decline by 19% year-on-year for the major banks.
Fixed-income trading revenue at the state's largest banks has faced deterioration in recent quarters, due to economic uncertainty and slow recovery in the U.S. and emerging markets. Additionally, geopolitical tension in Russia and Ukraine, and the rise in the risk-averse attitude and sentiment of investors have put a strain on the short-term revenue generating capacity of big capital markets and related businesses and firms.
As a consequence of these factors, JPMorgan has disclosed that the bank's Q1 FY 2014 trading revenue seems weak compared to last year's performance. Recently, analysts polled by Thomson Reuters have cut their EPS estimates by 3.4% for JPMorgan, along with a reduction in the EPS targets for the other peer banks of JPMorgan.
The company generated 16% of its total revenue of $96,606 million in FY 2013 from fixed-income markets. As a result, weakness in this business area is likely to have a material impact on the company's financial performance. The company's fixed-income markets revenue increased by only 0.36% in FY 2013 in comparison to FY 2012, as shown in the chart below.
Source: JPM 2013 10K Filing
In addition to the struggling fixed-income market business of the company, there are more challenges faced by the company, as discussed in the following paragraphs.
Problems with Mortgage Production Unit
Furthermore, like many other large financial institutions, JPMorgan also disclosed the enduring problems with its mortgage production unit. This is mainly a result of the rising interest rate environment that has depressed the demand for mortgage services. The company recorded a 40% decline in its mortgage fees and related income in FY 2013 in comparison to FY 2012, as shown in the chart below.
Source: JPM 2013 10K Filing
This fall was mainly due to lower volumes and margins, and higher legal expenses. As a result, the company plans to lay off a minimum of 2,000 additional employees from its mortgage business, in addition to the cuts it already made due to vanishing demand.
The third round of quantitative easing by the Fed in order to bolster the U.S. economy was meant to bring down long-term interest rates that would boost borrowing, specifically mortgage borrowing and refinancing. This made banks like JPMorgan add resources and expand their mortgage business in order to meet the rising demand. But as interest rates rise, as in January the average commitment rate for a 30-year fixed-rate mortgage was 4.43%, up from 3.41% in January 2013, the demand for the services provided by the mortgage businesses shrinks. This reflects the fact that the bank's mortgage business will also be a strain on the company's financial performance for Q1 FY 2014.
Physical Commodities Unit Sale
Since the previous year, the regulators turned their attention to the big financial institutions that rule the industry of physical commodities trading. The concerns of regulators resulted in new rules designed by Congress restricting the extent to which banks can trade for their own accounts, and an enduring investigation from the Commodity Futures Trading Commission.
These difficulties with respect to compliance with regulatory pressures forced JPMorgan to divest from the physical commodities trading business. After searching for an appropriate buyer for several months, the company finally announced its deal with Mercuria Energy Group, a fast-growing Swiss trading firm, to agree to purchase the company's physical commodities trading business for $3.5 billion in cash. Subject to regulatory approval, the all-cash transaction is anticipated to close in Q3 2014.
Despite this sale of the business, JPMorgan will continue to provide traditional banking activities in the commodities markets, including financial products and the vaulting and dealing in precious metals.
After a discussion of factors that will hurt the company, let us also determine some of the aspects that will work as tailwinds for the company's growth.
Asset Management Business Outlook is Supportive
The company's asset management, administration and commission revenues represented 15.64% of the company's total revenue for FY 2013. The business recorded around 9% growth in its revenue for FY 2013 in comparison to the previous year.
The company is making itself ready for upcoming business from insurers around the globe that are looking forward to outsourcing their investment in specialist areas, such as infrastructure, private equity and real estate. The company sees a huge opportunity for its asset management business in the insurance sector, as insurance companies hold $25 trillion in reserves worldwide, out of which just $2.8 trillion worth of reserves are currently outsourced.
Despite the forecast decline in some of the company's businesses, the bank's investors appear to be undaunted by the headwinds faced by the company. This optimism from investors for the company's future outlook can be seen from the company's share price that rose by 18.50% since the previous year, as shown in the chart below.
The headwinds for the company's near-term financial performance stem from macro-economic factors impacting the company's fixed income trading revenue and mortgage revenue. On the other hand, the company's asset management business has a strong growth potential that seems to be offsetting the weakness in the company's other businesses.
The company has recently been named the top dividend stock, with a yield of 2.62%. The stock has an outperform consensus recommendation, with insider buying, and the world's 26th richest man, George Soros, is reported to have recently purchased the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.