I really can't complain about how the market has been treating JPMorgan Chase (NYSE:JPM) this year. I've long thought this is one of the best-run large bank franchises, and the shares are up almost 20% from my last article - well ahead of the likes of Wells Fargo (NYSE:WFC), Citigroup (NYSE:C), Bank of America (NYSE:BAC), U.S. Bancorp (NYSE:USB), and PNC (NYSE:PNC). Not bad for a supposedly "sluggish" franchise, right?
I continue to be impressed with the combination of expense reduction, balance sheet shrinkage, credit quality, and loan growth that JPMorgan is delivering, and that's all in an environment that isn't especially conducive to bank profit growth. Weak rates remain a headwind and banks are clearly economically-sensitive companies, but nothing about JPMorgan's performance leads me to think that double-digit ROEs are an aggressive expectation if/when rates head back up. While the shares would look about 10% overvalued if those rate increases never come, I believe these shares remain undervalued below $71 to $72.
Strong Relative Performance
JPMorgan came through with a strong second quarter performance. Net interest margin declined 5bp sequentially, but that was exactly in line with the average of what other large banks saw and almost every large bank saw some NIM pressure as there's just no meaningful upward pressure on rates. What's more, pretty much every bank that has reported and/or put out their 10-Q expects this to continue through the second half.
And that brings me to JPMorgan's surprisingly strong loan growth. If your net interest margin is flat or down, the only way you can really improve your net interest income is to increase the volume of interest-generating assets. Given the low yields out there, buying more securities isn't really going to help, and so lending growth is the primary driver of the mid single-digit NII growth that JPMorgan has been reporting in recent quarters.
Average core loans were up 16% in the second quarter (with period-end reported loan balances up 10% and reported average loans up 11%). Even allowing for variation in what is "core", that's way above the roughly 6% average for large banks in the quarter. While BB&T (NYSE:BBT) did beat JPMorgan on that metric, it was only through M&A. Acquisitions also helped Wells Fargo deliver 9% growth, while U.S. Bancorp's 8% growth was more "natural". Other rivals like Citi, Bank of America, and PNC continue to kick around in the low single digits (or negative, for Citi, due to run-off).
JPMorgan also did better than average with its expenses, continuing a theme that has been going on for a few quarters now. This is another metric where a lot of analysts have homebrew "core" calculations, but JPMorgan was one of the few banks to see expense reductions. JPMorgan is also in good company with its credit, as its change in NPAs was consistent with the average peer (with Bank of America showing some nice improvement).
The Plan Was To Grow Loans, And They're Doing It
Criticize JPMorgan if you want, but they tend to do a lot of what they say they will. Loan growth has been on the table as a corporate goal and while some have scoffed at those projections given the overall environment, JPMorgan is delivering. With the second quarter, that's three straight quarters of 10%-plus loan growth.
Mortgage loans were up more than 30% in the second quarter, as the bank chooses to keep more loans on its balance sheet. Auto lending was up 14% and charge-offs remain relatively attractive. Card lending is growing nicely, though originations in the sub-700 FICO area have grown to 20% and that worries me some. I'd also note that commercial real estate lending is really growing well; JPMorgan has been targeting Wells Fargo's market leadership in this space and it seems to be paying off.
Provisions were up 50% in the second quarter (taking the provision/loan ratio up 17bp to 0.65%), but non-performing assets were up 3% and the reserves/NPLs looks healthy at almost 200%. According to JPMorgan's 10-Q, criticized loans were stable from the first to the second quarter. About 25% of the energy portfolio is now criticized, but the bank has been reducing its exposure (down 7% qoq) and over 6% of the energy portfolio is reserved (more than Citi and Bank of America in the 4%'s, but less than USB, Wells Fargo, and BB&T in the vicinity of 9%).
At this point, JPMorgan does seem to be aggressive but not irresponsible. I do worry that a full-blown recession would endanger those auto loans and the recent expansion into lower-FICO credit cards. By comparison, PNC seems to be keeping a lot of dry powder on hand, but that also means they're going to under-earn so long as they don't expand lending. For JPMorgan's part, the 10-Q included a full-year goal of 10%-15% loan growth, so some deceleration in the second half seems reasonable to expect.
I'm still bullish on JPMorgan's management. Even in a pretty "meh" environment, the bank is growing its loan book but still decreasing risk-weighted assets. At the same time, JPMorgan remains committed to its lucrative trading operations when many of its rivals are pulling back. With the bank about halfway through its expense reduction targets and opportunities still remaining to reduce capital costs, I like the outlook. Higher rates would certainly help, though JPMorgan isn't the most rate-sensitive bank out there.
With rates stagnating a little more than I'd expected, I've trimmed back some of my near-term expectations, but the long-term picture is more or less unchanged. I think JPMorgan shares are worth around $71 on the assumption of medium-term earnings growth of around 3% and long-term growth of 4%, which works out to a long-term ROE in the low double-digits. My near-term fair TBV multiple goes down a bit (by 0.05), but the growth in TBV compensates, supporting a fair value of about $72. Keep in mind, too, there is a dividend yield of around 3% and I use a double-digit discount rate for my earnings-based modeling.
The Bottom Line
JPMorgan's outperformance mitigates the undervaluation I saw before, but this is still a solid bank to hold and maybe still a good name to consider if you want a strong performer. Wells Fargo, PNC, and Bank of America may have more to offer on a "we can do better than this" basis, and I also still like BB&T, but I think JPMorgan's qualities still merit "core bank holding" consideration.
Disclosure: I am/we are long JPM, BBT.
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.