JPMorgan Chase: Change Is Afoot

| About: JPMorgan Chase (JPM)

Summary

JPMorgan, like other money center banks, could benefit from the incoming Trump administration’s stated goal of dismantling the Dodd-Frank Act.

That being said, JPMorgan might look radically different in a few years if Trump succeeds in passing a 21st Century Glass-Steagall Act.

In the short term, the prospect of a looser regulatory regime is positive for JPMorgan, giving it a boost to its proprietary trading.

Higher interest rates from Trump’s fiscal policy could help boost its corporate and commercial banking profits.

Analysis

The Trump Effect

With the surprise election of Donald Trump, banks such as JPMorgan (NYSE:JPM) have seen their stocks bid up - JPM itself is up by 10% since the election day.

The impetus for the rally is that Trump will usher in a friendlier regulatory environment for banks. Specifically, it appears that one of Trump's cornerstone policy actions will be the dismantling of the Dodd-Frank Act, which, among other things, was intended to protect consumers from the sort of ruinous mortgage lending that helped cause the 2008 Financial Crisis.

The United States' big banks have paid an estimated $160 billion since the Financial Crisis, with JPMorgan itself paying $28 billion in fines. At the very least, a Trump administration would seem to draw a line under the past 8 years' era of fines.

Dividend and Outlook

JPMorgan's stock currently carries a 2.41% dividend yield, which is the highest among the Dow Jones Industrial Averages' financial stocks, but is just around average for a money center bank. Consequently, an investor who buys $10,000 worth of JPMorgan shares can expect annual passive income of $241 - but the main attraction of holding banking stocks in the post-election period is the potential for improved earnings as banks are allowed to operate more freely.

Of course, what is good for Goldman Sachs (NYSE:GS) isn't necessarily good for JPMorgan. While the rally in financial stocks is understandable in light of what it could mean for Dodd-Frank - and the Volcker rule, the implementation of which JPMorgan and other banks recently attempted to defer for five years, Trump has made seemingly conflicting comments about replacing Dodd-Frank with a '21st Century Glass Steagall' Act.

A 'new age' Glass Steagall would presumably have its predecessor's hallmark feature - the separation of Commercial and Investment Banking. This would be an uncertain development for JPMorgan. A look at its most recent earnings report shows that JPMorgan derived approximately $8.5 billion - or nearly 35% of its revenue - from its Investment Banking unit during the third quarter (if we exclude the $917 in Treasury Services that could presumably be folded into the main banks). Meanwhile, JPMorgan generated around $3 billion - 12% of its quarterly revenue - from its Asset Management unit.

Presumably, both the Investment Bank and Asset Management arms would have to be wound down or spun off since under Glass-Steagall-style regulations. They couldn't be part of an institution that accepted deposits, since both units would, broadly (and practically) speaking, be in the business of "issuing, underwriting, selling or distributing" securities.

Both these units together accounted for nearly 47% of JPMorgan's revenues in the last quarter - so spinning off these two units from their parent company would effectively be reverting JPMorgan Chase back to the days when it was two separate entities - Chase Manhattan Corp. and JPMorgan & Co. JPMorgan wouldn't be unfamiliar with such a development - in 1935, Morgan Stanley (NYSE:MS) was birthed from JPMorgan & Co. as a result of Glass-Steagall.

Indeed, a spun-off entity - essentially a 'new' JPMorgan (in the historical sense of JPMorgan brand) with approximately $47 billion in investment banking and wealth management revenues would be a formidable entity - Goldman Sachs' revenue run rate for 2016 is at around $30 billion while Morgan Stanley's $34 Billion. It would effectively be the leader in the investment banking business. However, it wouldn't have the same size of balance sheet that JPMorgan currently has and its cost of funds would be higher since it wouldn't have recourse to cheap deposits.

In short, JPMorgan would basically have to become two entities under new Glass-Steagall-style regulations - neither of which would be as big as the combined entity and both would be diminished over time since the commercial bank wouldn't have the benefit of fast-growing investment banking and wealth management revenues, while the investment bank wouldn't have the benefit of a bigger balance sheet.

For investors, this is a quandary - an investment banking spin-off would presumably give existing investors shares in the new entity. This entity could be more valuable in the long run, particularly without Dodd-Frank to impede its ability to trade - this is evident in the much higher Price-Earnings ratios for the Investment Services Industry compared with the Money Center Banks Industry. It could also mean lower dividend payments: a standalone investment bank, with a smaller balance sheet and needing to conserve equity capital to meet Basel III regulations, might elect to pay lower dividends - similar to what is seen with Goldman Sachs (1.26%) and Morgan Stanley (2.04%).

In any case, the prospect of such a split occurring would still be years in the future - Trump likely has a big fight ahead insofar as 'dismantling' Dodd-Frank and a new Glass-Steagall would presumably be a separate legislation that could take years to pass and would likely require a second term for Trump to see through.

Another potential impact a Trump presidency would have is in the form of higher interest rates driven by wider deficits arising from Trump's Trillion Dollar infrastructure plan. This would actually work two ways: it would reduce the burden on the Fed to keep rates low to support the economy and also increase the government's long-term borrowing to fund Trump's plan. Higher rates are beneficial to banks since it steepens the yield curve, allowing banks to charge more interest on terms loans and keep the wider spread.

Conclusion

In the near term, we view the potential neutering - or possible repeal - of Dodd-Frank as a positive for JPMorgan, as is the possibility of a higher interest rate environment. It likely precludes any more substantial fines in the future, gives banks short-term clarity insofar as their investment banking activities are concerned, and allows them to profit more from both their market-making operations and lending.

Analysts currently expect JPMorgan's profits to rise by around 4% over the next five years. In light of recent developments, we view this as low and see its revenues picking up by anywhere from 8% to 12%. This gives us a short-term price target of $85, which represents 10% upside from current levels.

In the long term, a potential return of Glass-Steagall would be an uncertain development, which means that investors shouldn't necessarily view JPMorgan as a long-term staple for their portfolios.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JPM over 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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.