- JPMorgan reports declining second-quarter sales, yet it beat on lowered consensus estimates.
- Earnings beat is driven by a better-than-expected performance in trading, and resilient commercial banking, community banking and asset management.
- Despite appealing price-earnings valuation and dividends, I am not a buyer given asymmetric risk-return potential in the banking sector at this point in time.
JPMorgan (NYSE:JPM) reported an earnings beat on Tuesday, driven by strong performance in its markets business, just like competitors Goldman Sachs (NYSE:GS) and Citigroup (NYSE:C) have done in recent days.
The bank managed to limit the fall in earnings, despite continued legal issues, the fall in mortgage originations and poor financial market trading conditions.
Despite this "beat", I remain cautious, with shares trading around all-time highs. Shares furthermore trade far above tangible book value, resulting in an asymmetric risk-return by investing at this point in the financial cycle, in my opinion.
JPMorgan posted second-quarter revenues of $25.35 billion. While this was down 2% compared to the same period last year, revenues improved by 6% on a sequential basis.
On the bottom line, a profit of $5.99 billion appeared, which was about 8% lower compared to last year. Earnings improved by 13% from the difficult first quarter.
Reported earnings were down by fourteen cents to $1.46 per share. Despite the drop in earnings, it beat consensus estimates at $1.29 per share.
Looking Into The Quarter
Jamie Dimon took the opportunity to compliment the company for the solid results in a difficult environment given the headwinds faced by banks in financial markets, as well as the soft mortgage market.
Results were held up by a strong performance at consumer and community banking, business banking, as well as asset management, with equity and bond markets trading at elevated levels. It is also noticeable that Dimon sees improved signs for the economy towards the end of the second quarter, giving confidence in the economic recovery.
A Look At The Individual Businesses
The consumer and community banking business faced a difficult quarter, with revenues being down by 5% towards $11.43 billion, driven by a nine percent drop in non-interest revenues, which was driven by lower mortgage activity. Earnings fell by 21% towards $2.44 billion, as provision for credit losses amounted to $852 million, compared to a release of $19 million in the comparable period last year.
The corporate and investment banking business posted a 9% drop in revenues, which came in at $8.99 billion. Adjusting for DVA gains last year, the drop in revenues was limited to 6%. While the investment bank's revenues were rather flat, it was notably the financial markets' performance which hurt revenues.
Total market revenues were down by 12% to $5.9 billion, driven by weakness in FICC in particular. Still, the reported 15% drop in fixed income and equity trading was better than the bank's earlier forecast for a 20% drop in revenues. A bit disappointing was the 31% drop in earnings, which fell to $1.96 billion thanks to cost increases. This was due to $300 million in legal expenses, as well as a similar amount related to costs to simplify the business.
Commercial banking revenues fell by 2% to $1.70 billion due to yield compression in particular. A $67 million release in credit losses aided the bottom line, with earnings improving by 6% to $658 million.
Asset management was a bright spot, reporting an 8% jump in sales to $2.96 billion. Earnings were up by 10% as well to $552 million, with both revenues and earnings being aided by strong markets.
Balance Sheet And Capital Overview
JPMorgan is, of course, a giant bank, operating in virtually all of the sub-sectors of the banking industry. Economic growth and increased loans boosted the total balance sheet by 3% to $2.50 trillion. The bank was able to manage these assets with 3%-4% less employees, employing about 245,000 workers at the moment.
To support this balance sheet, the company has a Basel III Common Equity Tier 1 ratio of 9.8%. The supplementary leverage ratio under this Basel III approach came in at just 5.4%.
For the quarter, the company posted a common book value of $55.53 per share and a tangible book value of $43.17 per share. Trading at $58 per share, this values the stock at roughly 1.05 times normal book value and nearly 1.35 times its tangible book value.
Overall equity of the bank is valued at roughly $220 billion. Based on trailing revenues of $95 billion and adjusted earnings of about $23 billion, equity is valued at 2.3 times sales and roughly 10 times earnings.
Long-Term Growth, Combined With Shareholder Payouts
As one of the few major investment banks, JPMorgan has done well over the long run, driven by the massive outperformance during the financial crisis, of course, when shares still hit lows of around $15 per share.
Jamie Dimon has successfully led the company through the storm without causing a lot of dilution of the shareholder base. Under his command, the company has more than doubled its annual revenues over the past decade, while total dilution was limited to a cumulative 30%-40%.
To offset some of this past dilution, the bank has repurchased $1.5 billion worth of shares during the first quarter, retiring its shares at a rate of 2.7% per annum. The bank furthermore stresses that it has another $5.0 billion in repurchase capacity for the upcoming three quarters. During the quarter, JPMorgan hiked its dividend by two pennies to $0.40 per share on a quarterly basis, providing investors with a 2.7% yield.
Banks, at large, have underperformed the wider markets over the past year and so far in 2014. Obviously weak trading conditions in FICC in particular, the soft mortgage market and the legal overhang of multi-billion potential fines are to blame for that. Despite the modest performance, many banks including JPMorgan trade at multi-year, or in some cases, all-time highs.
Despite the strong results, investors in JPMorgan have plenty of things to worry about. The bank trades comfortably above its tangible book value, which warrants greater expectations and ROE targets by investors. Investors were furthermore happy with the "encouraging" signs in the economy which the bank saw during the second half of the quarter.
Worries are, of course, legal issues, with JPMorgan posting $500 million in legal expenses during the quarter. Another big recent worry among some has been the health of Jamie Dimon, the so prominent and admired leader of the bank, who currently still is both CEO as well as chairman of the bank. During the conference call, the company stressed that it has succession plans in place if Mr. Dimon had to put down his work amidst worsening health conditions.
Overall, I have never been a huge fan of investing in banks, given the asymmetric risk-return profile as many investors have witnessed during the crisis. While I appreciate the modest price-earnings ratio and ever-appealing dividends, I rather invest my cash in world-class businesses which offer similar dividends but operate outside of the financial sector.