JPMorgan: Best-Of-Breed Large-Cap U.S. Bank

Summary

• JPMorgan was the biggest winner from the 2017 CCAR.
• The bank’s fundamentals remain strong with solid loan growth, rising margins, improving cost-efficiency metrics and benign asset quality trends.
• Elevated uncertainty over actions by global central banks bodes well for the bank’s FICC franchise.
• We continue to prefer JPMorgan over Bank of America and Citigroup.

Higher dividends and buybacks

In our view, JPMorgan (NYSE:JPM) was the biggest winner from the 2017 CCAR (Comprehensive Capital Analysis and Review). Most investors had been expecting lower capital returns and particularly a more modest buyback. However, JPM has found the right balance between a strong capital position and attractive capital returns to shareholders. The bank increased its quarterly dividend to $0.56 per share from $0.50 per share, while the size of buybacks was boosted to $19.4B. As a result, the stock offers a 2.4% dividend plus a 5.9% buyback for a total shareholder yield of 8.3%.

JPM has recently mentioned that its minimum required CET1 capital ratio is 11%, around 140 bps lower than the bank has today. As such, JPM is likely to continue increasing its buybacks and dividends, given its strong capital position.

Strong FICC franchise

Global central banks have recently deepened uncertainty over their actions and the future path of rate hikes. First, European sovereign yields got a decent boost from hawkish statements made by the ECB (European Central Bank) President at a banking conference. Mario Draghi said that the threat of deflation risks had decreased. As a result, the yield on the 10-year German sovereign note has surged from 25 bps to 57 bps over the last two weeks.

Source: Bloomberg

The probability of a rate hike by the ECB has increased.

Source: Bloomberg

In addition, Mark Carney, the Bank of England’s governor, said that the regulator might need to raise its policy rate. That was unexpected given his dovish stance. Finally, New York Fed President William Dudley recently reaffirmed that the Fed had taken a more hawkish stance. Mr. Dudley said that a tightening labor market and gradual wage growth should trigger a pick-up in U.S. inflation. However, the bond market is pricing in a lower-for-longer interest rate environment in the U.S.

We believe elevated uncertainty over actions by global regulators bodes well for JPM’s FICC (Fixed Income, Currencies and Commodities) division. As a reminder, JPM is more weighted towards the rates business, compared to Bank of America (BAC) and Citigroup (C). While volatility around global regulators' actions should be a tailwind for the whole FICC segment, the rates business will be the main beneficiary due to rapidly changing policy rate expectations.

Q2 preview

The global banking industry enjoyed exceptionally strong market revenues in Q216, thanks to the Brexit vote. As a result, we should expect a material y/y decline in trading revenues in Q217. That being said, this has been already well flagged by JPMorgan’s management. According to the bank, total capital market revenues are expected to decline by 15% y/y in Q2. It is important to note that while trading revenues are a significant part of JPM’s top-line, they are extremely volatile and notoriously difficult to forecast.

As for traditional banking metrics, we expect JPM to deliver another strong quarter. The bank’s NII (Net Interest Income) should increase markedly, driven by higher margins and robust loan growth. We expect JPM’s cost-efficiency metrics to improve, while asset quality trends are likely to remain benign.

Valuation

Importantly, JPMorgan is still reasonably valued. We believe the stock should trade at a premium to its peers, given that it is a quality name with a strong franchise, solid asset growth and attractive capital returns.

Source: Bloomberg, Renaissance Research

Source: Bloomberg, Renaissance Research

Bottom line

If you have read our prior articles on JPMorgan, you will know that the bank has been our top pick in the U.S. banking space for quite a long time now. We still think it is the best-of-breed large-cap U.S. bank with a very attractive risk/reward ratio. It is important to note that JPM has significant exposure to capital markets revenues and, as a result, the stock will remain volatile. With that being said, for long-term investors who can take on higher-than-average volatility, JPMorgan is a no-brainer.

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Analyst’s Disclosure: I am/we are long JPM. 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.