JPMorgan Faces Headwinds But Still Undervalued

| About: JPMorgan Chase (JPM)

Edited by Kate Boehme

JPMorgan (NYSE:JPM) is one of the largest banks in the world. The company documented a net income of $4.96bn, or $1.21 per diluted share, for the second quarter of 2012. JPMorgan also reported plans to restate its first quarter income, lowering its net income by $459 million. While there will likely not be any notable variations-to-fair-value estimates available, the stock is still undervalued. I think macroeconomic challenges, as well as low interest rates and European sovereignty issues; will have a profound effect on operations for the foreseeable future.

Asset Management [AM]

JP Morgan Asset Management ("AM"), with assets under $1.9 trillion, is an internationally recognized innovator in investment and wealth management services. The company's net income for the second quarter this past year was $391 million; this represented a decrease of $48 million, or 11 percent, from the same period last year. These results show a small net revenue and greater provision for credit deficits partly balanced out by lower noninterest expense. AM customers are mainly companies, retail shareholders, and individuals with a high net worth, from nearly every significant industry worldwide. This segment offers global investment operations in equities, hedge funds, private equity, fixed income, real estate, and liquidity products, as well as money-market instruments and bank deposits.

Commercial Banking Activities

JP Morgan's commercial banking sector was a shining spot through a rather dull quarter. The division's net income amounted to $673 million, with an increase of $66 million, or 11 percent, on the previous year. This progress was influenced by gains from the provision for credit losses and rises in net revenue, which were partly balanced out by higher expenses. JP Morgan Chase increased its revenues from gains in market share as well as industry wide loan progress in this particular arena. The company increased its commercial loan portfolio by four percent in this quarter, while simultaneously bringing in record amounts of revenue.

Treasury & Securities Services

In this department, JP Morgan's net income was $463 million, with a boost of $130 million, or 39 percent, from the same period last year. The net income improved by $112 million, or 32 percent, largely due to a higher Global Corporate Bank credit allocation benefit. Seasonal activities in securities lending and depositary receipts also helped the company to increase profits.

Meanwhile, the company's net revenue for this field amounted to a staggering $2.2 billion, showing an increase of $220 million, or 11 percent, from the same time last year. Furthermore, Treasury Services ("TS") alone showed net revenue of $1.1 billion, increased $144 million, or 15 percent, from last year. The increase was mainly due to greater deposit balances, higher trade finance loan volumes, and spreads. In comparison, the Universal Securities Services net revenue amounted to $1.1 billion, with an increase of $76 million, or eight percent, compared with the previous year, due to higher deposit balances.

Corporate/Private Equity

Corporate/Private Equity net earnings were diminished as income in the Private Equity and Corporate sectors decreased. The net loss amounted to $1.8 billion, in comparison with a net income of $502 million in the previous year. Decreases in private equity gains were mainly the result of net write-down's on privately-held investments and the shortage of previous-year gains from sales in the Private Equity stock portfolio. Internally, the decrease in net interest income was mainly caused by a rearranging of the investment securities portfolio and lower backing gains from financing portfolio positions. Lower securities benefits also forced the drop in net income.

CIO Synthetic credit

CIO Synthetic credit trades contributed $4.4 billion in losses to the company's final results. Synthetic credit losses were balanced out by a number of items, including $1 billion in securities gains and $755 million in debt valuation adjustment gains. JP Morgan also sacrificed $545 million toward recovery and a $2.1 billion reserve release to set off 4.4 billion losses. Most importantly, the company substantially decreased its synthetic credit positions, resulting in a substantial fall in both notional exposure and value at risk. Despite such unfortunate deficits, I am encouraged by the fact that these losses did not too much exceed the company's earlier estimates.

Dimon holds responsibility for the losses

It is important to acknowledge the role that CEO Jamie Dimon played in causing these losses. JP Morgan's own internal evaluation even indicated an absence of "clear goals" or "strenuous analysis" of the CIO unit. The internal task force also pointed out "ineffective" risk management procedures.

The internal task force belittled the CIO for giving "assurances that scale of possible losses was manageable." However, in my opinion, a bank's "CEO" must to be heavily involved in establishing goals, scrutinizing operations and, most importantly, managing risk. In this arena, Dimon most assuredly failed.

Poor Operating Environment

Besides from the CIO fiasco, JP Morgan performed comparatively well in such an unsatisfactory operating environment. Predictably, this investment bank's success was somewhat hindered by a poor underwriting atmosphere. Debt underwriting charges dropped 26 percent, year-over-year, and equity underwriting charges dropped 45 percent. In addition, advisory charges, not including the DVA, dropped by 41 percent. Fixed income and equity revenue also dropped 15 percent annually.

In the near future, I think we can expect that an uncertain economic atmosphere, as well as European concerns, will generate weak and possibly volatile results.


Impressively, the banking giant managed to survive the London Whale fiasco, still performing relatively well in such a poor operating environment. It is encouraging that JP Morgan has announced plans to resume its repurchase arrangement by the end of the year, assuming regulatory approval. Such a plan would add considerable value per shareholders, if the corporation's stock continues to trade significantly below our fair value estimate. While it's challenging to forecast the behavior of regulators, I think that JP Morgan should be able to return capital quickly. JP Morgan's internal estimated Basel III Tier 1 Common ratio was 7.9 percent on June 30. I do not, therefore, expect the company to have any issues meeting a 9.5 percent standard in a reasonable time frame.

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