JPMorgan's Risk Management System, Flattening Of Yield Curve Say Stay Away From Stock

Jul.13.12 | About: JPMorgan Chase (JPM)

Today, JPMorgan (NYSE:JPM) released its second-quarter earnings results, with revenues exceeding consensus estimates. However, earnings remained below consensus estimates, as is shown in the table below:

JPM 2Q2012 Results

Actual

Expected

% Surprise

Revenues (Bn $)

22.9

21.9

4.6%

EPS ($)

1.21

1.27

-4.7%

Click to enlarge

As far as the top line is concerned, the bank was able to post a positive surprise. The bank posted revenues of $22.9 billion against consensus analyst estimates of $21.9 billion. This is a surprise of 4.6%. Earnings per share for the company remained at $1.21, against expectations of $1.27. This is due to the chief investment officer's hedging loss that ballooned to $4.4 billion from the earlier disclosure of $2 billion. Analysts were expecting the loss to balloon to $9 billion in extreme situations.

The bank has reported "a material weakness" in its internal control systems. As opposed to the rest of the banks, where individual traders are allotted risk-taking limits, JPMorgan allots limits to a group of traders, thereby allowing individual traders like Bruno Iksil (the London Whale) to take outsized positions. Investors are seeking more details of the risk management systems being practiced at the bank. Several investigations are also under way in this regard.

JPM 2Q2012 Results

2Q2012

1Q2011

% change

2Q2011

% change

Revenues ($Bn)

22.9

26.7

-14.2%

27.4

-16.4%

Net Income ($Bn)

4.96

5.43

-8.7%

5.4

-8.1%

EPS

1.21

1.31

-7.6%

1.27

-4.7%

Investment Banking

Profit ($Bn)

1.91

1.68

13.7%

2.06

-7.3%

Retail Services

Profit ($Bn)

2.27

1.75

29.7%

0.383

492.7%

Commercial Banking

Profit ($bn)

0.673

0.591

13.9%

0.6

12.2%

Treasury and Securities

Profit ($Bn)

0.463

0.351

31.9%

0.333

39.0%

Asset Management

Profit ($Bn)

0.391

0.386

1.3%

0.439

-10.9%

Corporate/ Private Equity

Profit ($Bn)

-1.77

1.02

-273.5%

0.502

-452.6%

Fixed Income & Equity

Revenues ($Bn)

4.54

5.36

-15.3%

Net Income Margin (%)

2.47

2.72

-9.2%

Mortgage Fee Revenues ($Bn)

2.27

1.1

106.4%

Click to enlarge

Both the bank's top line and bottom line remained below the first-quarter levels. Revenues of $22.9 billion dropped by 14% and 16% from the previous quarter and the second quarter last year, respectively. Net income of $4.96 billion plunged by 8.7% and 8% from the previous quarter and the same quarter last year, respectively. The bank also said that it restated first-quarter earnings, reducing net income by $459 million.

All of the bank's business divisions witnessed a surge in profits, except corporate/ private equity, which witnessed a decline of over 270% compared to Q1 2012. Investment banking and retail banking showed improvement from the previous quarter. Investment banking reported a surge of 14% in profits of $1.91 billion against $1.68 billion in Q1 2011; however, profits declined by 7% from Q2 2011. The decline was primarily due to lower net revenues and provision for credit losses. Retail banking reported a significant improvement of 30% in profits over the last quarter to reach $2.27 billion. The increase was largely due to a 30% increase in mortgage fees and related income.

The net interest margin that the company earned during the second quarter was 9.2% below what it earned during the second quarter last year. This is due to the continuous low interest rate environment and the Fed's efforts through Operation Twist and the maturity extension program.

Owing to the flattening of the yield curve and concerns about the bank's risk management system, we change our buy recommendation on JPMorgan. We recommend investors stay away from the stock until the bank gives a clear picture on its risk management system.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.