JPMorgan, Chase & Company: Record Earnings But Tepid Return On Equity

| About: JPMorgan Chase (JPM)

Summary

Jamie Dimon admitted in his earnings remarks that the performance JPMorgan, Chase & Co. produced in the fourth quarter was mainly attributable to cost cutting and not to outstanding execution.

Furthermore, fourth quarter earnings were hurt by a slowing economy and Mr. Dimon expects the economy to slow even further in 2016.

In summary, a good overall performance can hide some underlying weakness, something investors should take into consideration.

JPMorgan Chase & Company (NYSE: JPM) reported its second consecutive year of record annual earnings.

The reason, according to Chairman and CEO Jamie Dimon, was cost cutting.

That sure gives you a lot of confidence in the sustainability of the performance.

Total revenue for bank in 2015 fell by 2.0 percent.

The bank's return on equity in the fourth quarter was 9.0 percent, the same as it was over the same time period last year. JPMorgan Chase has not earned a double-digit return on equity since 2007.

I make such a big deal about return on equity because I consider myself to be a value investor and I look for organizations that are producing at least a 15 percent return on equity. The reason for this is that I am looking for an investment that has a competitive advantage and maintains its returns for at least five- to seven-years.

Commercial banking is not doing that these days. Daniel Davies, a former investment banker and a senior research advisor, writes in the Financial Times that the days when commercial banks earned a double-digit return and sustained the performance are over.

One reason for the decline in double-digit returns on equity is that banks cannot use as much financial leverage as they did in ten years or more ago. Well, a value investor does not rely upon financial leverage to gets the returns she wants. It is not an indication of a competitive advantage.

Anyhow, the regulators have taken much of the advantage off of using financial leverage to pump up returns on equity. JPMorgan Chase certainly understands this now.

Commercial banks, especially the larger ones, are well diversified these days, and a lot of their earnings come from investment banking rather than fundamental banking business. And, this "other" business at JPMorgan is not doing all that well and hence hurting earnings.

At JPMorgan, investment banking fees fell 15 percent, fourth quarter-over-fourth quarter. Although the bank participated in the merger and acquisition boom of 2015, up 43 percent, it also experienced a decline that offset the gain by a fall in underwriting fees.

Modern large banks have also relied on trading income to pump up earnings. But JPMorgan saw trading revenue decline in the fourth quarter, by 16 percent over the third quarter and by 4 percent of the fourth quarter of 2014.

The asset management unit profits in the fourth quarter that were more than 6 percent lower than a year earlier.

In terms of the basic business of banking, the commercial banking part of JPMorgan experienced a 21 percent decline in profits from a year ago while the consumer banking sector was roughly equal with a year ago. Profits in the mortgage division alone, were down by 21 percent from a year ago.

The increase in overall bank profit was achieved in spite of an increase in the reserve for loan losses. Like many other banks, loans to energy-related businesses are being impacted by the decline in oil prices. There is a lot of uncertainty about bank loan portfolios and how they will be impacted by what happens in the energy industry.

Mr. Dimon also issued a warning that the economy was likely to worsen in 2016 as the early impacts of the slowing economy were felt in the fourth quarter. He stated that this slowdown contributed to a decline in the bank's level of assets as well as to the decline in loans.

If the economy does continue to slow down in 2016, the basic businesses that the bank operates within will continue to suffer profit problems.

There is another factor that is also beginning to have an impact on the commercial banking industry and especially on the larger banks. This is the growth and development of the Internet and information technology. This is growth is going to have a great impact on banking, and one can gain some insight into the revolution that is really beginning to take place with the changes taking place at General Electric.

JPMorgan, Chase has modestly moved in this direction. For example the bank has recently combined with On Deck Capital, Inc., to "create an online small-business loan for its customers."

Still, JPMorgan is running behind in this technological space and must also continue to reduce its massive branch system. These changes are going to impact bank performance and the changing technological structure of the industry will further limit its profitability.

But, these statements apply to all banks and not JPMorgan, Chase & Company.

Disclosure: I/we 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.