The Intrinsic Value Of JPMorgan (Part 2)

| About: JPMorgan Chase (JPM)

In part 1 of this series, I went over a few broader themes surrounding JP Morgan (JPM) stock. These have to do primarily with the sentiment of the company (and the financial sector in general), and especially the London Whale event which has triggered some radically negative speculation.

In addition, I went over my take on the CIO's contribution to JPM's earnings, and how the post-2009 years were atypical for the fixed-income market, and how this could have bloated this segment's profits significantly in proportion to the rest of the company. At the end, I mentioned that I wanted to focus more on the bulk of JP Morgan's earnings potential - its investment bank and its retail financial services.

The reason that we ought to focus on the investment bank and the retail division is based on the numbers. Consider that 38% of the earnings from last quarter were derived from the investment bank, and 45% from the retail financial services division. That's 83% put together.

Then, you can consider the revenue that these two divisions are generating this income out of. Roughly 2/3rds of JP Morgan's total revenue is derived from investment banking and retail financial services. Considering the 83% of earnings figure we just mentioned above, you can see that these divisions are pulling a lot more weight (in terms of earnings) than you might think. How is this happening?

Investment Banking

JP Morgan's investment bank earned $1.9 billion in the second quarter of 2012, which is a little bit lower than the same period in 2011 which saw over $2 billion. These decline in investment banking fees and fixed-income revenue would suggest lower numbers, but the firm has been playing defensively.

There's not doubt that this sector is in a downtrend though. JP Morgan's I-bank revenues seem to get consecutively worse every quarter. Looking at the revenue in the fixed-income markets leaves a particularly sour taste in one's mouth, but keep in mind that JPM has had significant enough declines in its expenses to keep a reasonable profit from this division.

Still, I reiterate that the current prognosis for this industry is not good. The inability for the bulge bracket investment banks to retain their (expensive) employees should be a telling factor, since the managers in charge of the hiring/firing are clearly sending out pessimistic signals. I think they know their market better than we do.

Catching the "bottom" of the investment banking industry will probably be similar to the attempts we've seen at catching the bottom of the housing market. While things are already bad out there, there is no catalyst to reverse the trend. We will just have to be patient and wait for the never ending Eurozone debt crisis (and recession) to end, and hopefully see the United States and emerging markets mitigate this damage with a better rate of organic, industrial growth. This could take years though, and investment banking cannot recover without this.

Retail Financial Services

Despite an increasingly flat yield curve which is likely eroding banks' interest revenue, JP Morgan has seemingly been able to squeeze blood from a stone. Net interest income was still a whopping $3.9 billion last quarter (only $126 million lower than the same period in 2011). Non-interest revenue is on the rise, with about $4 billion reported last quarter (30% higher than the same period in 2011).

Indeed, despite the dismal economic/banking climate, JP Morgan's retail division is doing quite well. Without the strength in its retail division, I think JP Morgan would be trading a lot lower.

There are a few bright points to suggest that this improvement in the retail sector can continue. The average total deposits of the consumer bank is on the rise - this allows continuous expansion of the bank's net interest income.

There's also the growth of mortgage loan originations, which challenges the idea that the housing market is poised to decline more. Most central to the post-2009 recovery is the real-estate portfolio, which is starting to generate noticeable increases in profits now that there are less and less bad loans to write off the balance sheets.


The takeaway from the analysis of real source of JP Morgan's earnings is relatively simple - retail financial services will likely be the main force propelling the bank's valuation higher while stagnation in investment banking will do the opposite. If we can see a recovery in the investment banking climate, JP Morgan's financial data will improve drastically.

In the next part (the third part), I will take a deeper look at the retail financial services branch and make progress on our mission to see what JP Morgan is really worth.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JPM over the next 72 hours.

Additional disclosure: I trade JP Morgan frequently in short time-frames. This is primarily because I'm accustomed to its price action. I usually favor the bull (long) side.