By the end of Q2 this year, around $10 billion was already lent by JPMorgan Chase & Co. (NYSE:JPM) to small businesses. "We know how important small businesses are to the economy, and $10 billion in loans to these businesses says how important they are to Chase," said Scott Geller, CEO of Chase Business Banking. "Helping business owners succeed is what thousands of Chase employees proudly do every day." Following up with that, the company has already lent $15 billion in total YTD, as reported in the third quarter results of 2012. $15 billion is not a small amount. More importantly, will the company see enough return on that money? Let's dig deeper into how profitable JPM actually is.
With total net revenue at $25.15 billion in the third quarter of 2012, up by 6% from that in the same period last year, and net income at $5.7 billion in this third quarter, up by 34% since last year, things "apparently" do seem to be going rather well for JPM. Other commentators have published articles on why JPM is better than the rest.
Even analyst Glenn Schorr said, "All in, we think it's a good quarter for JPM and other banks should see similar benefits, but after a good 3Q run-up, stocks have pulled back some as investors see continued headwinds and limited earnings lift near term (we think JPM is better than most)."
Yet I'm Not Satisfied
There are few things that don't really integrate well with the common opinion, to be honest. Here's an excerpt from a recent company press release:
"More Americans believe that their personal finances and the economy are stable or improving than did a year ago, according to the annual Chase Pulse of the Consumer Survey. The majority of Americans, 64 percent, believe that the economy is either at bottom and stable or has already bottomed out and is getting better, compared to only 33 percent last year.
The 2012 Chase Pulse of the Consumer Survey takes a comprehensive look at Americans' financial habits and their attitudes toward the economy and their own finances. The survey reveals that 65 percent of consumers believe that their personal finances have already bottomed out and are either constant or getting better compared to only 56 percent at this time last year. "
If Douglas L. Braunstein is right (and confident) about the survey, why do we find the phrase "lower deposit margins, lower loan balances" in the third quarter report so often, especially in the retail financial services, consumer and business banking, real estate portfolio, and card services segments of the Q3 results?
To make myself clearer, lower loan balances signify that people are not so adventurous as of yet and that it might still take some time to get the U.S. economy in forward momentum. But lower loan balances, no doubt, will lead to lower deposit margins, further pushing deposit balances down in the process, when people chase higher deposit margins in other banks. Are we speaking of a downward spiral here? I fear so.
And speaking of the real estate sector, mortgage loan applications have increased, but what about the decline in home equity and mortgage loans? We are more interested on how many house applications were seen through till the end and sold at a higher price.
According to recent Case Shiller housing prices index, prices have been on a steady decline of 1.9% on a YoY basis, and are forecasted to fall another 1% in the coming 12 months.
Prices are projected to rise between the first quarters of 2013 and 2014, but that relies on the steady low mortgage rates and inventory shrinkage over time. In short, the U.S. housing market still faces the plight of higher supply over demand, and it might take some time to close this gap (if possible at all).
To top that, there is still some speculation about mortgage rates going up. As Garry Marr says, "The logic is pretty simple. You hit rock bottom and there is nowhere else to go but up." What if the mortgage rates go up in 2013?
As of now, negative home equity is still a problem.
"However, negative equity remains a factor constraining supply in some markets, since many underwater homeowners cannot come up with the cash to cover the difference between their outstanding mortgage balances and the current market value of their homes," said David Stiff, chief economist, Fiserv.
It must be remembered that house buyers will be there, since buying is still more affordable than renting a house. But unless the housing market becomes a seller's market, home equity investors will not be participating in the rally and thus, mortgage and home equity loans will continue to be low, which might be a drawback for JPM.
I don't see how JPM is better than rest when it comes to dealing with the troubled economy. As a matter of fact, tanking deposits and loans can be devastating for a bank because higher transaction volume always leads to maximum interest rate margin. And JPM needs still needs some time to cope up to that.
Secondly, what's with these huge legal provisions?
From a recent Washington Post article:
The bank set aside an extra $684 million for legal expenses. Chief financial officer Doug Braunstein said the reserves were related to "a variety of issues," and not just a lawsuit filed last week by the New York attorney general over mortgage-backed securities sold by Bear Stearns.
Now, $684 million is still a high price to be allowed for legal expenses, to be honest. And that's not the end of it.
Here's an excerpt from another article by Richard Eskow with the Huffington Post:
"JPM was implicated in a recent municipal bid-rigging case which led to two convictions. It has disbursed settlements in six fraud cases over the last thirteen years. It paid over $2 billion to settle fraud charges in the WorldCom case, $135 million in the Enron case, and more than $153 million to settle charges of investor fraud regarding mortgage-backed securities (MBS).
JPM gave up nearly $750 million in fines and lost fees over the Jefferson County, Alabama bribery case. Then we have the $25 million for illegal IPO (stock) allocations; $25 million (and perhaps more than that) for what was essentially illegal restraint of trade in forcing retailers to use the credit card network it co-owned; and $6 million regarding illegal profit-sharing and tie-ins at JPMorgan Chase Securities."
That certainly doesn't seem to be an extraordinary, one-time expense to me, does it?
With the recent $25 billion Bear Stearns case pending, I can only see that the decrease in credit loss provisions is offset by increasing recurring legal expenses.
Legal expenses are ought to be just one-time item, which may not continue over time. But here's something (rather disturbing) I read in another article:
"You can make a lot of money doing corporate crime and unfortunately the risks are very low, as seen by how few people have gone to jail and how little money has been returned to people harmed in the fiscal crisis," said Ed Mierzwinski, the consumer program director for advocacy group U.S. PIRG. "These corporations so far are paying an infinitesimal amount of money compared to the havoc they wreaked on families, homes and the economy."
Perhaps, Doug Braunstein is fully supportive of that.
"Obviously we're in a litigious society," he said on a call with reporters. "We have a lot of mortgage suits coming and others. ... Hopefully it will come down over time but we can't promise you that."
If that is the case with JPM, I am sorry. I am steering clear of this company.
Finally, why forget about the new Value-at-Risk model? With the transfer of the $30 billion 'whale' portfolio to the investment bank segment, a new VaR model is introduced that reduces the total VaR of the bank by 24% or $36 million. In the beginning of this year, a new VaR model was introduced and as far as common opinion goes, it failed to mask the losses of the risky derivatives portfolio, resulting in a fallback on the old model once again and a VaR increase by $62 million.
With the new investment bank's VaR model, VaR fell across the board. As well as the headline reduction of 24% (which helped bring down VaR to $115 million currently from $201 million at the end of Q2), average fixed income VaR fell by $26 million (or 18%), total IB trading and credit portfolio VaR by $28 million (or 19%) and CIO VaR by $17 million (or 24%). So far so good, eh? The question is whether it is valid or not.
Moreover, reshuffling the portfolio here and there might be another way of masking losses, isn't it? There were signs that the "whale" portfolio may be creating a drag on the investment bank's own credit portfolio performance, which reported revenues of $90 million in Q3 compared to $544 million in Q2.
Additionally, the revenue and earnings yield have been almost stagnant for the last few years.
Strangely, the return on assets has dropped over time.
My alpha conclusion is that this company is not one I will focus my energy on, right now. Things can change now and then, and although it seems the price has already bottomed out and it can go only upward, I am still skeptical how much return I might expect in the long run.
Additional disclosure: Investing is subject to market risks. Please contact your personal financial adviser before taking any step.