JPMorgan Chase (JPM) Presents at Bank of America Merrill Lynch Banking & Financial Services Brokers Conference (Transcript)

| About: JPMorgan Chase (JPM)

JPMorgan Chase & Co. (NYSE:JPM)

Bank of America Merrill Lynch Banking & Financial Services Brokers Conference Call

November 15, 2015 10:45 am ET

Executives

Douglas B. Petno - Commercial Banking CEO

Analysts

Erika Najarian - Bank of America Merrill Lynch

Erika Najarian

Good morning, everybody. We are about to get started on our next presentation. So, up next, again rolling along in large cap bank presentations for the morning, we have JPMorgan taking the stage with me. Shares of JPMorgan have outperformed not just peers but the broad market this year, and it's the only big bank in the U.S. to do so meaningfully.

Joining us today is Doug Petno, the CEO of JPMorgan's Commercial Bank. Doug is a JPMorgan veteran, having joined the Bank in 1989 and has held several senior IB positions at the Bank. Doug, thank you so much for joining us today.

So before I get to our conversation, I wanted to pick the brain of our audience to see how they are thinking about the incremental upside to the stock from here. So Eddie, if we could pull up the first polling question for JPMorgan?

As a current or prospective JPMorgan shareholder, what do you think is the most important for the stock to continue its outperformance next year? One, top line revenue growth; two, continued expense management; three, positive shift in the interest rate backdrop, clearly I wrote these questions a week ago; four, accelerating capital return; and five, more clarity on regulatory and/or litigation issues facing the industry. Everyone has 5 seconds to respond.

Overwhelmingly, 62% of you say top line revenue growth. The second most popular answers with 14% each, one is positive shift in interest rate backdrop, the other is more clarity in regulatory and litigation issues. More interestingly, none of you picked expense management. Any response to these answers, Doug?

Douglas B. Petno

Hopefully that's evidence [indiscernible] meet our guidance. So far, I think we've been able to do that and it's encouraging that there is a lot of focus on number one. I mean we have a lot to talk about there. I think there is a lot of connectivity as well with number one and number three. Obviously if we see a shift, a real meaningful shift in rates, we'll see a lot of revenue benefit there, but we've been continuing to invest as a company and I think you are going to say that in our top line. So it's encouraging that all of you are focused on that.

Erika Najarian

Great. So maybe we'll get started on talking about the business climate. Clearly the market share gains in commercial banking have been pretty significant, and I'm just wondering how the conversations progress in terms of appetite for business expansion from your clients, and I'm wondering if there's a difference between middle-market and corporate or specialized industry clients.

Douglas B. Petno

I mean, I think if you just look at our third quarter, I think it's pretty emblematic of our client base, specifically sort of the commercial bank system between our retail bank and our investment bank. We are meant to cover the middle-market in a segment of larger corporate. In our third quarter you saw very healthy loan growth across the businesses and you saw very benign credit both C&I and CRE. And it's very hard to generalize like sort of what's a typical client and what's on the mind of a typical middle-market client. So you have sort of a full spectrum of outcomes in that conversation.

So, at the weaker end, obviously oil and gas and agriculture and the deep cyclical commodities, related equipment companies, and at the upper end you have the knowledge, economy, technology, life sciences that sort of like never skipped a beat and there is a lot of capital formation and things feel really good.

So, I think that sort of transcends size. I think it's more of an industry story where you sit in the economy, where you sit geographically. Sentiment is impacted by a combination of factors and you can sort of see the election effect on sort of management confidence and board's confidence sort of once you get certainty around something like a big outstanding event like that. But depending on where you are in the country, the story is a little different and it's not so much a size issue, more the industry specific dynamics that we see amongst our client base.

Erika Najarian

So, just maybe diving into that, so Texas is clearly an outlier, but what are the pockets of strength either by industry or by geography that you are referencing to?

Douglas B. Petno

I mean like I mentioned, life sciences, so you know all the obvious clusters nationally around there, so Boston, Texas San Francisco. Boston, still a tremendous amount of capital formation, even though there has been slight correction in some of those markets. We see new company formation in capital markets access being something that's continuing to build. So those geographies tend to have those kinds of companies. And oil and gas you mentioned, the energy patches held up quite well and the local economies have performed well. It helps – both commodities are up 60% since their lows earlier in the year, but those are the various geographic variations.

Erika Najarian

And when you talked about the uncertainty that your clients had around the presidential election, was it more about that huge catalyst ahead rather than the result? And then I'm just wondering whether or not there is some, now that that's behind us, there could be sort of pent-up pickup in activity levels.

Douglas B. Petno

There is definitely pent-up demand. I mean, I think we have seen a big recovery in the U.S. consumer. That story has not been as robust for small business and it really gets to like lack of management confidence, lack of Board confidence, lots of uncertainty, they face the Affordable Care Act, they face an onslaught of regulation across all industry categories. And so I think the election, the beginning of the election is just behind us and there is an outcome regardless of the winter. And now I think the big thing is, it looks like there's going to be an orderly transition of power and then the [indiscernible] in the details in terms of what the new President's policies look like, but anything that brings certainty brings confidence and there is a lot of dry powder.

Revolver utilization has been essentially flat for us, about 30%, since the financial crisis. And there is a tremendous cash build across corporate America and I think there is a lot of appetite to invest in R&D, Company expansion, M&A, and I think the other thing that's outstanding and on the minds of a lot of our clients is sort of local fiscal uncertainty put aside the federal situation and tax climate and fiscal climate in Washington is one thing, but a lot of these businesses are more impacted by what's happening in their towns and in their states. And so if that stuff can get resolved, you'll see an even bigger catalyst behind these businesses, but there is definitely a lot of pent-up appetite.

Erika Najarian

My next question, I thought I'd dive into the four strategic priorities that you laid out during Investor Day. The first that I wanted to talk about was executing a disciplined growth strategy. You talked about where your momentum is already strong, you mentioned life sciences, and you talked about pent-up demand from your current customers. Wondering, as we look forward two to three years and think about market share gains, what industry specializations or MSAs will improve the most in terms of their CB contribution?

Douglas B. Petno

It's a great question. We're really excited about momentum behind the business, and one of the things we haven't really talked about for the commercial bank and may have been lost on all of you in sort of the history of what we've been going through since the downturn is that we've been very inwardly focused digesting the intersection of all these new regulations, we derisked dramatically, we've had several product exits across our business.

We've exited sort of almost 5,000 clients over the last several years. And why that matters is that that's been a huge distraction on our banking team. I mean to exit a client is much harder than to win business, you got to sort of unravel yourself from the relationship, it's a big distraction, it's demoralizing, it's been hard.

So, substantially all of that is behind this, and so you can now see sort of the business on its front foot. Our calling activity is up over 30% year-over-year, so think about 26,000 more client calls in the middle-market than we had year-over-year. That's without making any incremental investment in our platform.

So, on top of that we've been making greenfield investments coming through the downturn, and as you mentioned, in the new industry coverage, we have added eight new industry dedicated teams in the last six years and we've added a physical presence in 44 new markets since the downturn. So essentially in the last eight years, 14 of those new markets are in the top 20 MSAs in the country.

So, these are where the prospects are, where our clients are, future clients are. And so, I think it's really hard to pick a geography but there is huge potential across all of those markets. These are major sports team cities, so cities like LA, Nashville, Boston, Tampa, San Diego, San Francisco. For instance, Los Angeles, second largest market in the country, our revenues in Los Angeles are less than a quarter of what they might be on some of our more mature markets. So sitting here in New York, we have been in New York City for 200 plus years, it's one of our biggest middle-market businesses, and so we have an LA which could easily be a New York for us over the next several years. It has just huge potential.

So, we're excited about the footprint we've been building out and we're excited about the industry dedicated coverage we're bringing to those clients.

Erika Najarian

So the competitive focus on your business has always been high, but it feels like from the regionals, what they say is, look, we have an advantage, we're not a GSIB, we don't have to hold liquidity against your deposits, and we have lower capital buffer. How does that manifest in terms of how they compete with JPMorgan from pricing and how do you win those clients given higher capital and liquidity requirement?

Douglas B. Petno

I get the question a lot. I'd say a few things. One, I think it's sort of an overly simplistic argument to suggest that the GSIB capital requirement, the regulatory capital requirement is what's driving the capital that's being held across my peer group and my competitive group. So if you actually look at the capital levels, we're all sort of capitalized almost not exactly the same levels but that GSIB requirement is not sort of where the industry is mapping out. So, most of my competitors actually hold more capital than the GSIB regulatory requirement. So that's point one.

Point two is, we fully built in the full regulatory framework into our operating model and we are adding loans. I mean we have added 600 new clients this year, we are near the top of the industry in loan growth in C&I and CRE. So we are competing with that fully loaded capital in our business. On top of which, being a part of JPMorgan Chase, we have broad-based capabilities to augment our economics, and our loan pricing models allow our bankers to take a loss on the loan because of the confidence they have in the potential to build a broad-based relationship with the clients.

So, $2 billion-plus of investment banking revenues for commercial banking clients, I mean that alone, just the investment banking revenue stream that we get from our commercial bank is as big as one of the biggest investment banks in the country. That adds tremendously to the economics of the business, on top of which we have commercial card, merchant services, broad-based treasury services capabilities, that a lot of those regional banks don't have. So, we have more ways to improve the economics in our business and it more than compensates for the incremental capital.

We also feel good about the credit cost in the business, the expense structure of having the scale advantages we have as being a part of JPMorgan Chase. So there is lots of reasons why it really hasn't affected our competitiveness very much.

Erika Najarian

There are a lot of skeptics about our model exactly as you described it. That sounds great sitting on stage, but your detractors would say, it's very hard to deliver the entire bank customer. Maybe speak a little bit about how culturally and maybe incentive-wise, if you're comfortable, how the firm is successful at doing so?

Douglas B. Petno

I think the operative word is cultural. I mean you said it for us. We have active and thriving partnerships across the Company. So for me, I work very closely with our retail banking partners, so half my clients use our branches. And then as I mentioned, 40%, nearly 40% of our Company's investment banks, North American investment banking revenue comes from commercial banking clients. We also work closely with our card partners to offer our commercial card products, merchant services. These are cross line of business capabilities that we deliver for our commercial banking clients. It just kind of happens for us. I mean these relationships have been in place for a long time. There are revenue sharing mechanisms behind the scenes, but core to our operating model is to deliver the entire Company through our clients. That's how we measure each other's performance. That's how we measure sort of our partnership, the individual partnerships that we build.

So I'd like to say like we've got these very specific accounting mechanisms and that drives behavior, but nobody really even – I mean, I'll speak first person, you don't even really think about that. The customer is at the center of what we're doing and we want to deliver broad-based capabilities and it's usually not an investment banking client or commercial banking client or consumer banking client, it's a JPMorgan Chase client and we want to deliver a solution or be there for whatever is most important to them.

Erika Najarian

So, in terms of your revenue targets, I think you laid out at Investor Day incremental middle-market revenue expansion target of $1 billion, and I think in 2015 you achieved $351 million of this incremental expansion. And I'm wondering if you could share with us your progress in reaching that $1 billion incremental goal.

Douglas B. Petno

One of the things I'd say is, and I mentioned we moved into 44 new markets in the last eight years, one of the things importantly that we did is we didn't put a specific time commitment to that $1 billion target. I think it's very dangerous thing when you're in the lending business to sort of say, hey, I'm going to hang a shingle in this market and you better get to this loan growth level by a time certain in three years, five years, 10 years. That's not what we want to do. The message was more like hire good people, pick good clients, make good loans, and in the passage of time if we do everything right we will be a top three player in the coming decades.

So I mentioned we've been in New York for over 200 years, we've been in LA for less than eight, and we're slowly moving up the food chain and we're doing that by hiring great people and picking good clients. These are prospect-rich geographies. So as we use big data to map out where these private clients are, where these middle-market clients are, half of them in the country are in markets where we've been in for less than eight years.

So we see a tremendous open runway, greenfield opportunity for us and we feel like we can compete against a lot of the incumbent local players because we have the broad-based product offerings that I mentioned earlier, but also an international capability that no community or regional bank can have. And more and more of these small and midsize clients are going to international geographies, so a bank like us can follow them to China, can follow them to Europe, can follow them to Brazil. And so, there is a reason they talk to us.

And there is also a reason to join our team. It's easy to attract high-quality people in these geographies. So, if they know, if you are an incumbent banker in a great market and you've been sitting there a long time, JPMorgan hangs a shingle and they know where they are to compete, they want to be a part of it. It's a chance to build something, have our business card, have our product offering and be a part of building a new business.

Erika Najarian

So you mentioned big data. That's actually a good segue to your second priority, which is driving business innovation. We thought we would ask the audience first what they thought about investment spend in innovation before we move on to this topic. So, Eddie, if you could please pull-up the second polling question?

As a shareholder, what statement most closely aligns with your view on how traditional financial institutions should allocate investment spending on innovation? One, investment spending in innovation should be top priority for financial institutions as leading the charge in innovation will better generate long-term shareholder value rather than short-term expense management. Two, given the revenue environment, institution should invest in innovation projects, but be mindful of self funding these investments with savings elsewhere in the firm. And three, given the challenging revenue environment, institution should focus on improving the bottom line through expense management even if this means delaying innovation projects. So, we have two seconds left on the clock.

So 61% of you very much in line with your response during the BofA presentation say that given the revenue environment, institutions should certainly focus on innovation projects but self-fund, while 34% of you believe that investment spending in innovation should be top priority, regardless of the impact to short term expense management. Again, interestingly Doug, only 5% say that you need to use expense management as a lever to protect the bottom line no matter about.

Douglas B. Petno

I chuckled when I read the question. So we're in budget season as a company, and so for me…

Erika Najarian

You can take this to the Board.

Douglas B. Petno

No, when I go in front of Jamie, it's more of a conversation about like what's not in your [investment] [ph] that should be in there and tell me why you took it out, and I think our point of view is that self-disruption innovation is all about bringing more value to our client. We have the financial wherewithal to do it. Now is the time to seize the opportunity. The landscape is shifting dramatically. These are not discretionary investments in many respects. A lot of it is for cyber, better control on your operations and product offering. A lot of the innovation will drive dramatic efficiency across our operations.

So, his point of view is, if you're taking it out to dress up your P&L, you are borrowing from your future and you better be explaining to me why you're doing it, and those are not the easiest conversations to have because you obviously are mindful of near term performance, but as I said, it's very often the case that you're going to borrow from your future if you under-invest today.

Erika Najarian

So you touched upon your Investor Day three priorities, digital, payments and big data, and maybe let's talk about digital for a second. Could you walk us through what specific projects or innovations you've already undertaken in order to improve your digital interaction with clients?

Douglas B. Petno

So I mean everything is digital, everything is mobile, it's just kind of that consumer expectations are driving that and you see that across the consumer businesses and consumer products and so forth, and you can see that with my partners in our consumer bank. Those guys have spent a tremendous amount of capital, have excellent market resources and have designed very good offering for our consumer clients. We want to do the same, essentially leverage the technology that the investment bank has and the investments that our consumer bank has to build the right digital and mobile platforms for our clients.

So, we have the largest investment budget we have ever had this year and we'll likely increase that next year. We have the largest digital budget we've ever had this year and we will likely increase that next year. I think importantly, we have secured specific CB digital expertise. So we have a Head of Small Business Digital, and the advantage we have is we have Gordon Smith has spent a lot of money building the market-leading digital offering for our consumer clients. I have the intellectual property at my fingertips. Likewise, we have the market-leading digital platform for large corporate, JPMorgan ACCESS, I have that in my fingertips.

And so, one of our largest investments is about knitting those together to have a digital continuum and offering of that service portal, cash management tool, integrating commercial card, merchant services and lending, all through a digital mobile capability, and it's called Chase Business Online. I don't really love the – we're going to try to rebrand that, that's not really that exciting, but it is at the heart of where we are spending a lot of our time on digital. And I think if what's happening in consumer is any indication, we expect to lead the market in our capabilities and in the simplicity and elegance that you can deliver to clients in a digital/mobile offering.

At the small business level, there is very little difference between what motivates a small business owner and a consumer. They want to do business when they want to, they want to do business on their iPad, they want to do business quickly and simply, and they don't want a lot of paper documentation. So we are very mindful of trying to be the easiest bank to do business with. It's something that permeates our Company and especially so at the small business and middle-market level, and digital is one way to really address that.

There are other applications for digital helping to use the digital interface, mobile interface for loan application processes in how we communicate with clients, how we secure information from clients. And so there's a lot of material investments happening there as well. It's an exciting part of our platform.

This Chase Business Online platform is just sort of the marquee investment for me and for the commercial bank. It is already being piloted. It's something we started this past year. It's already being piloted with several clients. And it will also help Gordon Smith's 4 million small business clients as well.

Erika Najarian

So you talked about where you are leaders elsewhere, and business payments being one of them.

Douglas B. Petno

Yes.

Erika Najarian

How is that developing within your part of the business?

Douglas B. Petno

Just same thing, I keep drawing an analogy with consumers, but just as in the case with consumer payments, there is huge room for disruption in business to business, business to consumer, across order payments. We estimate that our clients spend over $0.5 trillion on business to business payments. We estimated over half of the business-to-business transactions are still done by check. Sending a paper check can cost between $4 and $8 to simply send a check. And we also estimate that most of those transactions still have some degree of manual intervention, a human being that's actually going to involve and touch the process.

So, that feels like somewhere where technology can bring a big shift in efficiency, and on top of which, I touched on it briefly earlier, cyber is an increasing concern. So, the more we can digitize and put better controls around the payments process across the wholesale continuum, we think it's going to bring real safety, protection, speed and value to our clients. So we are spending a lot of time on our product offerings there. And again, we can leverage what we have done in consumer and get the leverage of what we have done in the investment bank to build product specific expertise for my part of the economy and my part of our client franchise.

Erika Najarian

So you mentioned big data earlier and how important that was for you in terms of prospecting big markets where you don't yet have market share you have in New York. I'm wondering, beyond prospecting, how are you using data either to maximize returns and/or doing that while keeping the risk management aspect of it in mind?

Douglas B. Petno

Again, this is an area where we have commercial banking specific data scientists. They can't go off and do things for the consumer business, they can't do things for the investment banker attached to my business thinking about ways to use big data machine learning specifically to augment our processes to bring, essentially to bring more value to our clients. At the very top, we have a tremendous amount of consumer information, a tremendous amount of small business information and we use that on an anonymized and aggregated basis to give good market insights to our clients.

So we have the JPMorgan Institute for instance that regularly produces research about where we see the market going and how we see our consumers behaving. For instance, they wrote a research piece on what we thought consumers were doing with the windfall savings from lower gasoline prices. It's just that kind of market information that we can clean from the big data pool that we have being who we are as a company.

So it starts with better content, more specific insights, sort of help de-commoditize our business because we can use big data to do that. Then you move into using data to speed and improve the precision in our risk decisioning and I think this is an area where we see dramatic opportunity. It's not about necessarily stopping the extension of credit, but with the information we have about our clients, we can anticipate and proactively offer credit before we even see financial statements. I mean that's something that technology could provide for today, it exists today, we just haven't put it in a commercial context. And so, risk decisioning is an area where we see a tremendous opportunity, one to add speed, one to add precision and then also to improve the client experience in the process.

Then, as you mentioned, one area where it's had a huge impact, it seems pretty basic but understanding where our prospectivity or client opportunity is was not something that the industry had reliable source. I mean private companies pop up, they come and go, they move in and out of markets, it wasn't easy to sort of determine in any given geography where the potential clients were and how to get a hold of them and we now have a big data capability that's mapped that, heat mapped that nationally. It helps us allocate our resources optimally and we know sort of by industry, by geography where the prospectivity is for the middle-market and small business clients domestically.

Erika Najarian

So this is a little bit of a leading question because you already had mentioned this earlier, but it seems like the path from a current overhead ratio of 42% to your 35% target, innovation is really going to help pave that path. Are we right to assume that?

Douglas B. Petno

It should. I mean in some examples that I gave you, it's kind of hard for me to sit here and sort of say, it's going to. I can't, I don't have complete line of sight into the quantum of expenses I can take out. You know it's going to be faster, you know it's going to be more efficient, you know it's going to lead to better outcomes. It's not the main driver behind our expense philosophy.

We think the primary driver is going to be top line growth as we capitalize on the investments that we've been making in our footprint. And we've added 120 bankers this year. They're going to, they are just starting to get ramped up, they are starting to make client calls, that's going to create a revenue wedge, it's going to really drive and impact the overhead ratio, but efficiency is one part of it. There may be a case where we'd spend more money if the process was faster or it was a better customer experience.

So I don't want to lead anybody to think that a lot of the innovation is driven by to drive down the expense base. I suspect it will have a meaningful impact. I think that the top line impact will far offset anything that we would expect to get in savings from an expense base.

Erika Najarian

So switching topics, the results of the election have clearly put out of vogue any asset class or sector that has benefited from low interest rates. Even before the election results, there was a lot of talk about commercial real estate, especially multifamily. So maybe before I ask you your viewpoint as the number one multifamily lender in the United States, I wanted to see how our audience is feeling about this asset class. So, Eddie, if we could pull up the next question for JPMorgan, please?

How do you view fundamentals for multifamily lending in 2017? One, softening fundamentals should lead to slower financing activity next year. Two, softening fundamentals should lead to worsening [indiscernible]. Three, softening fundamentals should lead to slower financing activity and worsening credit metrics. Four, some concern but only in certain regions and at certain rental price points. Or five, no concern.

So interestingly, 48% of you say that there is some concern but only in pockets and certain regions and at certain rental price points. The next most popular answer is at 35%, softening fundamentals should lead to slower financing activity and worsening credit metrics.

Douglas B. Petno

That's how I would have answered, sort of three or four. Look, there's no question, we are at later stages of the real estate cycle. I mean we watch it very, very carefully. We look at every component of every geography, we look at rental rates, vacancies, supply, permitting, every metric that you could possibly study, we study it at very granular level and there are parts of the United States where there's been a tremendous amount of new construction.

I think multifamily specifically, I think what you should be most worried about is construction financing for high-end luxury condos. That is not what our multifamily lending business is. And just to remind everybody, for stabilized properties, the average loan is about $2 million. We're substantially in markets where supply constraint rent by necessity, markets where construction costs are prohibitively expensive.

So what that means is, if you're going to build a new apartment building, because the construction costs are so high and the land costs are so high and there is such scarcity of land, you're going to have to build a high-end offering, otherwise the economics don't work. That is not what we are financing.

So think New York City rent controlled, and then New York Metro area in particular the average market rent is about $3,100 a month. The average rent for buildings we are financing is about $2,000 a month. So, sort of hard to envision an economic scenario in New York metropolitan area where a $2,000 a month apartment building would be unleased, especially now just given how tight the rental market is.

So I think [indiscernible] in the details for geographically where you're lending, who you are lending to, what leverage points – I should mention, our average loan-to-values are south of 60% and we have very strong debt service coverage for the loans we are making and [indiscernible] granular, so average loan of about $2 million.

Could you see worsening credit fundamentals if there was a significant downturn in the U.S. economy? Of course, but we think we're well insulated from that given where we are in sort of the value chain so to speak of multifamily.

Erika Najarian

About how much of your properties have stabilized rent cash flows?

Douglas B. Petno

I don't know if we disclose specifically the quantum that's rent-controlled but it's a substantial percentage and those buildings, very low vacancies, obviously but definitely very stable rents, almost bond like economics. And our clients, I should really make sure I punctuate the point, we're not lending to speculative investors, we are lending to families where they have owned these assets for a long time. They are aware of all the same fundamentals that we are talking about, low cap rates, these are real estate bubble driven by low interest rates. They are not putting, they are intentionally not putting max leverage on these assets understanding where we are in the real estate cycle. They have no intention of losing their asset to a bank. And I think who you bank matters as much as anything in the business and that's something we spent a lot of time focused on.

Erika Najarian

So I wanted to go through some of the mechanics of what you mentioned given the concern in the marketplace. A lot of investors are concerned about LTV given sort of where interest rates are and where supply is in certain markets, but I think you quoted a 1.5% debt service coverage ratio during Investor Day. I'm wondering, if you could share with us as a banker if there is a property with that type of debt service coverage ratio and there is a little bit of volatility in the LTV, how are you thinking about the future credit quality of that?

Douglas B. Petno

I mean, look, we don't underwrite to rising rents. We don't assume interest rates are going to stay this low forever in our underwriting, and we look to have a meaningful cushion. So if you just sort of do the simple math, on a 1.5 debt service coverage for a particular apartment building, say that apartment building [indiscernible] $150 of operating cash flow, it has to cover $100 of debt service. So you have a $50 cushion that could get eaten away by either a decline in operating cash flow from higher vacancies or lower rents or unforeseen capital requirements or CapEx or you could have a rise in interest rates. So we think that $50 cushion is pretty meaningful especially since we have underwritten in that debt service coverage calculation is maybe not a market rent, spot market rent, but what we think the future forward rent is that sensitized to the fact that some of these markets are pretty frothy and have seen significant rent increases in the last several years.

Erika Najarian

So when loan comes up for renewal, and let's say you had underwritten it at 60% or below and that had moved up some in terms of the LTV, and that service coverage is stable, do you as a banker ask that borrower for more equity to get it back to 60% or do you work with them on an individual case basis?

Douglas B. Petno

I mean, I think it's a case-by-case conversation. I mean I wouldn't necessarily ask for more. We have lots and lots of financing for sub 40% loan to value, because as I said, the borrowers, it's not all about max leverage, I mean that's why they are banking with us and they are not interested in sort of putting their business or their company's assets and their family's assets in harm's way. So, depending on the situation you might just roll it over at the current leverage level or you may ask for more equity. It depends on the fundamentals and the performance of the asset and the overall leverage picture.

But look, there is $4 trillion of commercial real estate maturities over the next three or four years. So there is going to be a lot of refinancing. So I think the markets are going to be seeing – you have a chance as a financial institution to be able to be very selective and pick kind of which properties you want to finance.

Erika Najarian

So since we are on the topic of thinking about the credit quality of the portfolio that you oversee, it's [indiscernible] this is one of the last questions at oil and gas, something that you talked about a ton previously, maybe give us an update on how that portfolio is faring?

Douglas B. Petno

Sure. We're sitting here today in November we are in a lot different place than we were at the beginning of the year. Certainly at Investor Day oil was in the mid-20s. There was substantial amount of leverage across the sector. There wasn't any sense that commodity prices, both gas and oil, were at all stabilized and I think we have come a long way since then. I mentioned earlier, both commodities are up over 50%. A lot of the absolute leverage in the business has been dealt with because there has been a tremendous amount of private equity and public equity that's come into this sector.

So, for us, we have seen a significant stabilization across our client base. We remain very well reserved. We had a slight release in the third quarter. We have about 15 billion of oil and gas in the commercial bank of commitments, about 6 billion of that is funded and about half of that or a little more than half of that is in the reserve-based lending structure, which we believe is one of the safest ways you can lend money. It's very formulaic. We have a very strong window into the reserve values of these companies. Those assets have performed quite well amidst of a lot of this stress.

But I would say like this has been a 100-year flood for the industry, still a meaningful amount of leverage, there have been over [indiscernible] this year. So we are not out of the woods. I mean, I don't think anybody is saying that the industry is sort of back on its feet, but we're certainly in a much better place than we were in January or when we spoke to our portfolio at Investor Day in February. We feel very good about our underwriting. We've been actively banking this sector through this downturn and I think that we feel good about the portfolio where it sits today, especially given the reserve levels we have.

Erika Najarian

And maybe a final question before we turn it over to the investors is, we are all in the middle of budgeting season and as you think about the prospects for next year, what are you most excited about? What's your final message about the commercial bank to the investor base?

Douglas B. Petno

I'll stay to the message that we come back to over and over again for Chase Commercial Banking is, being a part of JPMorgan Chase, we really believe we have unmatched capabilities to serve clients, the breadth of our product offering. I'd also say that the entire regulatory framework is built into our operating model and you can still see strong returns, loan growth, good operating margin growth in the business. We have tremendous greenfield growth in the business. I mentioned the expansion markets and the industry markets. This is, we don't have to invent anything new or step outside of our comfort zone or modify our risk appetite in any way. It's just calling on good clients with good bankers with these broad-based capabilities. So we feel good about the runway that's in front of us and we're going to grow with discipline. And I think at this point in both the C&I cycle and the CRE cycle, that's something that's important to highlight as well. I mean this is not a 'grow at all cost' kind of business and we feel very good about the future of commercial banking.

Erika Najarian

Great. With that, we have a few minutes for questions. Do you have any questions for Doug?

Question-and-Answer Session

Q - Unidentified Participant

Can you describe what you mean by $4 trillion of commercial finance opportunities, how does that…?

Douglas B. Petno

CMBS and Fannie agencies, we estimate it's sort of $4 trillion over the next four or five years. Sort of backup 10 years from today, there was a big wave of financings that happened. We've sort of already seen a lot of that now and much of what we're looking at refinancing is either not going back to CMBS or is coming out of Fannie or Freddie.

Unidentified Participant

So it incorporates new and refinancing, it's new purchasing and refinancing?

Douglas B. Petno

The $4 trillion that I'm referring to is refinancing.

Unidentified Participant

Your refinancing?

Douglas B. Petno

Yes

Unidentified Participant

And when you engage in, when you talk about the opportunities for commercial finance, are you working significantly out of your branches or I mean how are you sourcing nationally or at least in your footprint?

Douglas B. Petno

I mean we have – we call it in footprint and out of footprint. In footprint is building a middle-market presence where we have a branch presence. And remember, we really started in earnest our expansion effort coincident with our acquisition of Washington Mutual in 2008. So literally overnight we had 1,000 branches in California that we didn't otherwise have, and with that physical bricks and mortar presence and ability to serve small business clients and middle-market clients, we started to build a business banking franchise, a middle-market franchise in the South East and the West Coast because of the Washington Mutual footprint.

But we didn't let the lack of branch presence stop us. So we have also moved into big cities that had lots of density of prospects like Boston, Nashville, Washington DC, sort of the mid-Atlantic, where we don't in fact have a branch presence but have the ability to still add a lot of value and still see the ability to compete in those markets.

Having branches certainly helps. As I mentioned before, over half our clients use the branches. Just having a physical branch shows community presence and commitment. It matters a lot. It may not be intuitive to you sitting in the room but our clients care if you are there in the community and if you have a physical retail presence. But it doesn't preclude us from building out and we have seen great success in markets like Nashville and Boston, certainly places like DC, especially where there are areas where the branch matters but they are looking for industry acumen and industry expertise, sort of the capabilities that we have.

So, it's really no more complicated than getting some office space, exporting a Chase banker to that market, letting them decide who they want to cover and then selectively hiring from our competitors and exporting risk people and product people to support the franchise and then growing over time as the portfolio grows.

Unidentified Participant

So I apologize because I know this is not directly in your area of responsibility, but have you heard sort of internally anything in terms of how market activity is going quarter to date?

Douglas B. Petno

I'm not going to give any guidance on our market's activity. The only thing I'd say is, I'd refer back to Marianne's comments on our third quarter call and just that we continue to be busy and active and markets remain quite constructive for us.

Erika Najarian

Final questions for Doug? And with that, thank you so much for participating. Thanks Doug.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!