Bank Earnings Reports: JPMorgan Chase Versus Wells Fargo

Apr.13.14 | About: JPMorgan Chase (JPM)

Summary

Wells Fargo net earnings up 14 percent.

JPMorgan Chase net earnings down 19 percent.

These results exemplify two different banking business models.

It is interesting to have the first two commercial banks reporting earnings each quarter have such different business strategies.

The headlines in the Wall Street Journal capture this in the secondary headlines to its front page story. The article on the front page is continued on page A5 and the headline there reads, "Fortunes Shift From Wall Street To Main Street For Big Banks."

As the story reads, JPMorgan Chase & Co. (NYSE:JPM) is the Wall Street Bank and Wells Fargo & Co. (NYSE:WFC) is the Main Street Bank. Or, JPMorgan relies more and more on investment banking operations to achieve its profits whereas Wells Fargo relies more on mortgage and consumer lending to attain its performance.

And, with trading in fixed income, currency and commodities down, net income at JPMorgan has suffered. Commercial and industrial loans didn't increase at all during the first quarter of 2014 and while analysts reported that JPMorgan had experienced no loan growth at all, year-over-year.

The story was different at Wells Fargo. The bank showed an increase of business lending of about 7.0 percent and there was also growth in lending for mortgages, auto loans, and credit cards.

In fact, "Wells Fargo said it originated $7.8 billion in auto loans, a 15 percent increase from the same period a year earlier." This from the New York Times. "The gains cemented Wells Fargo as one of the nation's largest auto lenders." And, why not? It is also the nation's largest originators of mortgages.

It seems as if Wells Fargo is priming itself to be the largest consumer lender in the nation…in all areas of household borrowing. The problem with this, as the authors of the New York Times article points out, is the strategy that the bank is using to achieve this position.

"I don't have any question that this rising growth in auto loans is tied to declining credit quality," said Joshua Rosner, a managing director at Graham Fisher & Company, a research firm. "That is where the borrowers are."

The New York Times article continues, "Wells Fargo has become a leading player in the subprime auto market, where loans often carry high interest rates and are typically used to buy previously owned cars.

As of the end of 2013, Wells Fargo was the second-largest lender to used car buyers with credit scores below 620, was a market share of 10.3 percent, according to J. D. Power & Associates (Capital One is the largest lender in this market with an 11.8 percent share. JPMorgan's market share was 3.6 percent)."

Wells Fargo has a history of good risk management. The New York Times article mentions this stating that "Wells Fargo, a lender that unlike so many of its rivals was not gravely wounded by subprime mortgages and the exotic investment products tied to them." It came through the Great Recession better than most.

Still there is concern that Wells Fargo is stretching for performance. "In recent months, Wells Fargo reduced its minimum credit score requirements on loans backed by the Federal Housing Administration to 600 from 640. Wells said the move was meant to increase access to credit-especially for first-time and low- to moderate-income buyers-and remained consistent with F. H. A. guidelines."

Of course, this reduction came at a time when there was "a steep industrywide decline in the mortgage origination business."

Wells Fargo posted a 14 percent rise in net income in the first quarter of 2014, helped by a $500 million loan loss reserve release and some additional reductions in expenses. Net income for the quarter was $5.9 billion. Furthermore, Wells Fargo's added to its three-and-one-half streak of record quarterly profits.

JPMorgan Chase reported a decline of 19 percent in net income, posting a $5.3 billion increase in earnings.

Yet Jamie Dimon and JPMorgan seemed to be comfortable with where the bank was. They recognize that placing so much emphasis on trading and stock market transactions exposes it to a risk of general market movements that might not be favorable to it. It also seems to be very comfortable with where it is relative to credit risk. It is not stretching to achieve earnings right now…and $5.3 billion in net earnings is not too shabby.

The year 2013 is not a year Jamie Dimon wants to repeat. It was a year in which earnings performance was not the greatest and, in addition, the bank had to fork over about $20.0 billion to the government to settle claims against it. Given the way that Mr. Dimon's banks have performed in the past, it is my feeling that he is really bringing JPMorgan together and position the bank to weather the financial restructuring that is going to take place over the next several years.

In doing this, Mr. Dimon seems to want to minimize credit risks going into a period where there will be an effort to reduce financial liquidity in the banking system and a period of higher interest rates. I believe that he is being very cautious.

And, some people are already pointing to some red flags in the financial world. Already there are many articles about the growth in collateralized loan obligations (CLOs) and other innovations that populated the financial world in the early 2000s. Securitized loans are another rising phenomenon in the current environment.

A little closer to this post is the concern over the rapid return of subprime lending. Gillian Tett, in the Financial Times, writes about "American Subprime Lending Is Back On The Road."

Ms. Tett writes "A few short years ago 'subprime' was almost an expletive. During the financial crisis, mortgages linked to subprime borrowers caused devastating losses…"

She continues "But the financial world has a short memory…. In recent months subprime lending has quietly staged a surprisingly powerful return, not in relation to real estate, but another American passion-cars."

In car finance…"Five years ago subprime loans represented barely a 10th of the total: today they account for a third. A particularly high proportion of GM car sales are financed by subprime loans. Meanwhile a 10th of new loans are now going to so-called 'deep subprime,' or consumers who would previously have had little chance of getting funding…"

And, this is taking place when most "other forms of consumer credit have remained weak since the 2007 financial crisis."

I am not mentioning this development just to pick on Wells Fargo. Wells Fargo, as I mentioned earlier, has a stellar record of controlling credit risk. I do mention this within the context of what is happening in the consumer lending market overall because this raises questions of systemic risk and that could hurt anyone. It is a little concerning, however, that given the weakness in household credit demand that credit scores are being lowered in more than one lending area. It is something to watch in the future.

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.