by Robert Gordon
JP Morgan (JPM) is the nation's largest bank holding company, with about $2.3 trillion of combined assets. It is a member of the Financial Stability Board's 29 global banks deemed too big to fail. JPM stock was recently trading just over $35 per share. Its 52 week range is from $48.36 to $27.85, and it trades at a P/E of 7.5. Its market capitalization of $134.2 is second among domestic banks only to Wells Fargo & Company (WFC), and JPM pays a quarterly dividend of $0.25 per share, for an annual yield of 2.8%.
JPM will report 4th quarter and full year 2011 earnings on January 13. In the third quarter of 2011, earnings were $4.26 billion, which was off about 4% from the year earlier quarter. Because JPM has been aggressively repurchasing its stock, per share net actually rose year to year by 1%, to $1.02 per share. A large chunk of the quarter's earnings came from a one time credit adjustment of $1.9 billion. Eventually, it is entirely possible that one time credit may have to be unwound, but as it was the benefit contributed $0.29 per share, after tax, to the earnings. The company cited slowness in its investment banking business, plus continuing losses from soured mortgages.
Investment banking has always been a cyclical business. But what I see is that JPM continues to struggle to grow its loan portfolio. After reaching a high in loans outstanding of $722 billion in 2008, loans totaled $668 billion at the end of the third quarter. All things being equal, loan growth means profit growth.
When I look at any bank, there are only a few things I pay attention to in its balance sheet and income statement. In JPM's case, to my surprise, it fails those tests. First, realize the current JPM is the result of ten years of consolidations from such names as Chase Manhattan Bank, JP Morgan Securities, and Bank One, among others. Each of these was proud and profitable in its own right. The mean analyst expectation for 4th quarter, 2011 earnings for JPM is $0.93 per share. If true, the bank will have had full year earnings of $4.50, which would give it 0.85% return on assets. I believe any bank should be able in time to achieve at least a 1.0% annualized return on assets. This is a level that since the year 2000, JPM has reached only once when it achieved a 1.01% turn on assets in 2006. For the sake of comparison, Wells Fargo has a 12 month trailing return on assets of 1.23%, and U.S. Bancorp (USB) has a trailing 12 month return on assets of 1.42%.
The other thing that is important to me when I look at a bank is its efficiency ratio. That is, the ratio of non interest expenses, to the sum of net interest income plus non interest income. I want that ratio to be 0.60 or lower, as a sign that a bank has its cost structure under control. JPM has a 12 month ratio of 0.65. WFC has an efficiency ratio of 0.595, and USB has an efficiency ratio of 0.52.
I am not expecting much from JPM in 2012. Margins will continue to be under pressure from the Federal Reserve's commitment to keep short term interest rates low. So too, JPM will miss the easy $1 billion in revenue it collected from debit card interchange fees, which have been extremely restricted by the Durbin Amendment to the Frank-Dodd financial reform package.
JPM also has some exposure to distressed European economies. Specifically, it held just over $15 billion dollars in securities and loans in the “PIGS” countries as of September 30, 2011-- the vast majority of it in Spain and Italy. JPM's capital and reserves are sufficient to deal with the issue, but it is just one more headache for management.
Not all is doom and gloom for JPM-- far from it. While the merger / acquisition market is on a down cycle, JPM's investment bank is the largest in the world. In the third quarter of 2011, high margined credit card volume was up 10% year over year. And its acclaimed “fortress” balance sheet indeed has over $120 billion of capital and a Tier One capital ratio of 9.9%. JPM repurchased $8 billion of its own stock in 2011, which-- given the share price-- fell steadily though the year after touching its 52 week high in early March. This was not the wisest use of the money.
JPM also has fans in high places. While Warren Buffett does not own any shares, he clearly has high regard for CEO Jamie Dimon. The mean analyst rating for the stock is a strong 1.8. I obviously disagree, and continue to consider JP Morgan to be a value trap. JPM may be the strongest money center bank in New York, but that is not saying much these days! I believe your bank investment dollars are better spent on any number of stronger regional banks, including those mentioned in this article.