JPMorgan Chase: Too Big To Fail May Be Just Big Enough To Succeed

| About: JPMorgan Chase (JPM)
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JPMorgan Chase (NYSE:JPM) has been arguably the most stable major U.S. bank throughout the credit crisis. It suffered along with other banks when the real estate market crashed. As of Q3 2012, it was the #2 mortgage originator in the U.S. and the #3 mortgage servicer. Like its compatriots JPM is still trying to dig itself out of the quagmire of the real estate market crash and the ensuing legal difficulties associated with it. However, it has been doing its usual good job of this. The U.S. Federal Reserve's QE programs, etc. have been a huge help. The Fed has clearly been trying to buoy the real estate market, and it has been succeeding. The Fed just as clearly intends to continue to do this. For Christmas, the real estate market provided JPM with several presents. The November Existing Home Sales were 5.04 million. This was a great improvement over the previous month's 4.76 million Existing Home Sales. Existing Home Sales prices for November 2012 were up +10.1% year over year. The Case-Shiller Home Prices Indices confirmed good growth in home prices in 20 major metropolitan areas (not in just existing homes sold) with a growth figure of +4.3% year over year. This factor alone makes virtually all of JPM's outstanding loans better risks (more valuable). The above news may be the light at the end of the tunnel.

The table below shows JPM's recent performance in the Mortgage Banking arena.

Accounting Category

Q3 2012

Q3 2011

Production Revenues (millions)



Production Income Before Taxes



Servicing Revenues (millions)



Servicing Income Before Taxes



Real Estate Portfolios Revenues (millions)



Real Estate Portfolio Net Charge Offs (millions)



Real Estate Income Before Taxes (millions)



Mortgage Banking Net Income (millions)



In its real estate portfolio JPM charged off 4.60%. Then it decreased its allowance for further charge offs by $900,000,000. The Existing Home Sales news above says that this action was likely justified, and it indicates that this part of JPM's business is improving rapidly. When it really starts to grow, it will be a huge part of JPM's profit generation. Don't forget that JPM grew dramatically in this area when it bought Washington Mutual. Long term the future of JPM's Mortgage Banking business is very bright, especially with the Fed effectively ensuring a consistent recovery of the business until mid-2015 at least. Further the biggest banks will benefit from economies of scale for compliance with FinReg. They can easily spread the cost of the bank of lawyers needed to decipher and plan for the thousands of pages of new laws over their vast businesses. This gives major banks like JPMorgan Chase, Bank of America (NYSE:BAC), Citigroup, and Wells Fargo (NYSE:WFC) a significant advantage over their smaller competitors.

JPM has also been improving its Corporate and Investment Banking Businesses. The table below shows recent year-over-year gains.

The revenue increase from $74 million in Q3 2011 to $8,360 million in Q3 2012 and the net income increase from $51 million to $1,992 million tell the story of how well JPM has been doing in this area lately. JPM is #1 in Global Investment Banking fees. It is #1 in Fixed Income Markets income share. It is one of the biggest derivatives traders. One might at first think that the new rules for FinReg that are set to be implemented in 2013 would hurt JPM more than others. However, the opposite may be true. There are two derivatives laws that are particularly important.

The first law would require that most derivatives be traded on open electronic platforms, with prices visible to all participants before deals are done. This would over time lead to much lower prices for derivatives. It would mean lower prices (margins) for JPM in this area. However, the big traders say that large transactions if done openly would disrupt the markets. They are lobbying for exemptions. The big traders such as JPM will be the ones to get these exemptions. They are the ones that will get the higher prices for their large trade services.

Another rule would require that derivatives rules apply to trades made through foreign branches, affiliates, or subsidiaries of U.S. banks. Banks are instead lobbying for "substituted compliance" in which foreign affiliates will be regulated by the foreign country as long as that country has similar rules. However, derivatives rules are weaker or non-existent elsewhere. This means big U.S. banks with a lot of foreign subsidiaries or affiliates will likely be able to continue to trade in a relatively unregulated way. This may force more U.S. banking jobs offshore. Overall the effect should be to make the "big multi-national banks" more competitive than smaller, more U.S. geographically centric banks. Since worldwide compliance with new U.S. laws is a pipe-dream of U.S. legislators and an "out of the loop" Volcker, compliance of foreign countries is likely to happen slowly if at all. When you consider non-compliance would give the Chinese or the Indians a decided business advantage, you are left to conclude the U.S. banking businesses will suffer from these new rules. The U.S. Congress has already weakened U.S. banking. It is unlikely that it will insist on going through with this rule in the face of the now more obvious competitive disadvantage. If it doesn't, JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), etc. are better situated than their smaller U.S. competitors to continue to profit as they have in the past. They should lose less business than the smaller banks. In fact it may mean they will get a greater share of the mainland U.S. business.

It would be foolish of Congress to compound its error by insisting on full foreign compliance. The mistake is obvious now. This is just another case in which Obama wanted to make his rhetoric seem true, when it was not. Obama has hurt the U.S. banking business. He ignored the saner advice of Bernanke in order to pursue the pedantic aims of Volcker. Volcker's view of world banking seems stuck in the 1980s. One has to live in the world one is in. One cannot insist on an ideal world that one has little to no power to bring about. U.S. banks are now stuck with these non-competitive rules (especially the second one) for now. The big multi-national banks will likely be less stuck with them. JPM is a relative winner in this area.

Another area of weakness in the law is the following loophole. Traders are now required to post U.S. Treasuries as collateral for a bigger part of their trades. Many do not have these Treasuries handy. A new business has sprung up to service this. The big banks will lend the traders U.S. Treasuries or other qualified securities in exchange for lower rated securities (for a fee). This is being called collateral transformation. Experts say this is just a way of hiding risks this law was supposed to avert. In other words the law has created a lot of red tape, with little actual risk avoidance for this case (and many others). JPM should be able to benefit from providing this service.

Overall JPM is performing well. In Q3 2012 its revenue was down slightly year over year (about $2B). However, its reported net income was up by $344 million. It reported EPS of $3.81 versus the year-ago (Q3 2011) result of $3.57. This is not exciting growth, but it is good growth. In Q3 JPM's Basel 1 Tier 1 common ratio rose from 9.9% to 10.4% year over year. Its Basel 3 Tier 1 common ratio rose from 7.7% to 8.4% year over year. JPM has a 7.06% five-year EPS growth estimate per annum. This is not exciting, but it is good. If the U.S. economy does decently, JPM could well exceed this figure. JPM trades at a PE of 9.20 and an FPE of 8.19. Both of these show JPM is a strong value. JPM's Price/Book ratio of 0.87 confirms this. With a dividend of 2.78% and good growth opportunities JPM looks like a solid buy.

The two-year chart of JPM provides some technical direction for this trade.

The slow stochastic sub chart shows that JPM is overbought in the near term. The main chart shows that JPM could be very close to putting in a triple top. It is still in an uptrend. However, there has been little positive progress on the fiscal cliff issues. The U.S. is likely going over the cliff. Plus Geithner has recently stated that the U.S. will hit the national debt limit at the end of December 2012. This is approximately two months earlier than previous estimates. This has added to the uncertainty in the market. It has also made more think that the Republicans may be able to get some of their desired spending cuts. Such cuts would tend to depress the stock market.

The U.S. is already too close to the fiscal cliff to avoid a serious slowing of the U.S. economy. Most large businesses have already reined in their CAPEX spending for 2013. They will not change direction on this easily. A deal on the fiscal cliff between now and January 1, 2013, seems remote. The CBO has predicted a recession for the U.S. in 2013, if the U.S. goes over the fiscal cliff. The CBO expects U.S. economic growth to contract by about -2.9% in the first half of 2013 if there is no fiscal cliff deal. The CBO predicts a return to 9.1% unemployment.

The forecasts from the National Association of Manufacturers are far more dire. It forecasts an economic loss of -12.8% of the possible growth from 2012 to 2015. It thinks 2014 could be the peak job loss year with unemployment reaching 12% in 2014. It thinks the total job losses could reach -5.7million relative to the baseline. It predicts real personal income will drop by almost -10% by 2015. The U.S. Congress has not been acting with the best interests of the U.S. citizenry in mind. Perhaps this is also the fault of the U.S. citizenry who remain remarkably ignorant of the important factors in the U.S. fiscal budget debacle. Politicians often vote based on popularity of decisions in polls. If the U.S. citizenry does not truly understand the issues, the polls reflect that the citizenry can be easily swayed by political rhetoric. This gives the politicians even more reason to act in their own political interests instead of the citizenry's interests. The U.S. citizenry needs to wake up.

Even with all of this JPM is a good long-term buy. It has an average analysts' recommendation of 2.1 (a buy). The latest Fact Set forecast calls for S&P 500 Financials (excluding Insurance companies) to grow EPS by +42.9% in Q4 2012 (as of December 21, 2012). JPM is usually a leader among the banks. It should do well too. However, the overall market may be about to fall significantly due to the fiscal cliff and national debt issues. JPM with a Beta of 1.65 would likely fall as much or more than the overall market. You may wish to wait to buy JPM, or you may wish to average in slowly. If a new U.S. recession is coming, you will probably be able to get JPM stock more cheaply. Still JPM does look like a great, stable company for the long term. With its historically low Price/Book ratio (0.87), the stock has good upside and a decent dividend (2.78%). Averaging in would be a good strategy for this likely long-term star performer.

Note: Some of the fundamental data above is from Yahoo Finance.

Good Luck Trading.

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.