Wednesday, January 15, 2014

JP Morgan Looks Like It's Positioned Well

Let's think back to the beginning of Bob Paulson's plan to save the global banking sector from itself, when the nine CEOs were invited to sign the famous one page deal injecting $250 billion of taxpayer money into their banks. On top of that, Wells absorbed Wachovia, JP Morgan absorbed WAMU, and Bank of America absorbed Merrill Lynch.  WWE-style chest thumping and outrage was shown by most of the participants, except by JP Morgan CEO Jamie Dimon, according to the newspaper. He apparently did the cost of capital calculation in his head and saw the Feds as a cheap source of funds.

Fast forward and we've concluded with the Feds now raiding the JP Morgan treasury for some $30 billion in fines for originating and selling bad mortgages to the GSEs and for not blowing the whistle on the Madoff Ponzi scheme.

So the fourth quarter of 2013 capped a pretty miserable year compared to 2012, but the fourth quarter showed all the signs of the bank being well positioned for an improving U.S. and global economy and for the concomitant steepening of the yield curve.

On a managed basis, 2013 corporate revenue of $99.8 billion was flat with 2012 revenue.  Reported, diluted EPS of $1.30 was down compared to $1.39 in the prior year, on the same basis.  However, excluding extraordinary items, 2013 diluted EPS was $1.40.  During this long waiting period for the economy to show a lasting rebound, banks like Morgan and Wells have been pulling out all the stops to generate some semblance of earnings stability.  JP Morgan has taken allowances into income in prior quarters, to the consternation of some analysts, but based on some of the underlying trends in credit cards, business loans, mortgages and deposits, the turn may be coming.

JP Morgan's efforts to position the bank for an economic rebound look like they've put the bank in a strong position,

JP Morgan's Consumer and Community Banking business now serves 43% of U.S. households, and its increased penetration has most certainly been helped by the acquisition and build-out of the old Washington Mutual branches.  What seemed like poison at the time may turn out to be honey for the shareholders. The base of 5,600 or so branches will not be expanded in the near-term as much as it will be reshaped and optimized for better productivity.

The CaCB business grew deposits in the fourth quarter of 2013 to $461 billion compared to $426 billion in the prior-year period, a solid 8% increase.  Allowances for loan losses, non-performing assets, and the net charge-off rates are all down year-over-year in the quarter, and its looks like the charge-off rates are near historic lows.

Fourth quarter 2013 provision for credit losses was $72 million, compared to $1.1 billion in the fourth quarter of 2012, a decline of 93%; the full year provision for Consumer and Community Banking declined similarly to $335 million compared to $3.8 billion in 2012.

The Mortgage Banking business, to no one's surprise, fell out of bed.  Full year 2013 net revenue of $10 billion was down 28% from 2012 revenue of $14 billion.  Provisions for credit losses benefited 2013 pre-tax income by $2.7 billion compared to a benefit of $0.5 billion in 2012. Non-interest expense declined 17% for the full year, driven by the large headcount reductions. Net income of $3.1 billion declined only 8% in 2013, year-over-year.

Mortgage production revenue was down 78% in the fourth quarter, and 54% for 2013, yielding $2.7 billion in production revenue.  According to a slide in a recent analyst presentation deck, the current mortgage underwriting standards look pretty strict, with average FICO scores of around 750+.

The credit card, merchant services and auto businesses had good solid quarters, and delinquencies on the card portfolio have been on a ski slope downward and the portfolio has been cleaned up.

A slide talking about earnings sensitivity to a rising rate environment back in June 2013 modeled earnings gains of $2.1 billion and $3.8 billion, respectively, from a 100 basis point and 200 basis point parallel shift in the yield curve.

The investment bank made gains in various underwriting segments, and the compensation levels ended the year so as to give opportunity should the global IPO and acquisitions cycles continue to heat up.

The one truly eye-watering item was the prevalence and magnitude of the legal expenses all over the financial statements.  The "Other Expense" category for 2013 showed expense of $19,761 million compared to $14,032 million in 2012.  Of these amounts, legal expenses comprised $11 billion (56%) in 2013 and $5 billion (36%) in 2012.

Legal expenses are also buried in some of the mortgage production operation results.  I couldn't follow the CFO's rapid fire presentation about reserves for litigation, but it sounded like large amounts. Because she is a British physics major by training, she has real command of numbers and of the Basel and mark-to-market modelling issues.  The speed of her delivery made me think of the classic Fed Ex commercials.

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