Is JPM Still a High Risk Stock?
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Reuters reported that JPMorgan (NYSE: JPM), America’s largest bank by assets, faces regulatory orders to improve compliance in order to correct lapses in its internal control and risk management systems that led to the over $6 billion trading loss last year and potentially allow suspect money flows. Action from the office of the Comptroller of the Currency and the Federal Reserve is expected as soon as Friday, which might be in the form of cease-and-desist order. No monetary penalty is expected.
Earlier, the Comptroller of the Currency identified weaknesses in the compliance systems and demanded formal remedial actions. The management at JPM also agreed at the end of the first quarter that the bank’s internal control system has material weakness. The bank uses a different approach to risk management in contrast to the rest of the US money center banks. The bank assigns limits to groups of traders instead of individual traders as is the standard. This allows individual traders within the groups to take outsized positions resulting in unwanted exposures.
Apart from JPM, the Comptroller of the Currency identified major lapses in Citigroup’s (NYSE: C) internal control systems. Earlier, British based Standard Chartered was forced to pay $667 million, while HSBC Holdings has to pay $1.9 billion to settle the US inquiry on money laundering.
4Q Earnings Preview
Analysts’ consensus mean estimate for JPM’s earnings per share is $1.21 on revenues of $24.2 billion. It is expected that JPM’s core revenues from trading and investment banking will be $4.3 billion, down 10% sequentially. A DVA loss of around $385 million is also expected given the tightening of CDS spreads. Core fixed income trading of $3.3 billion is expected, which is down 11% compared to the linked quarter, while revenue from core equities will be $990 million. Management fees from investment banking of $1.5 billion are expected at the end of the fourth quarter, up 7% sequentially.
Spread income for the bank’s Consumer and Community Banking is expected to decline 1% sequentially, while the real estate portfolio will shrink 3% over the same time period to $6 billion. Commercial banking revenues are expected to edge up by 1% compared to the linked quarter to $1.75 billion, while annual loans growth is forecasted at 4%.
The bank is scheduled to report this fourth quarter performance on the Jan. 16.
Capital & Credit Quality
At the end of the fourth quarter of 2012, JPMorgan is expected to maintain a Basel III tier 1 common ratio of 8.7%, up 30 basis points from the linked quarter. Bank of America (NYSE: BAC) and Citigroup maintained tier 1 common ratios of 9% and 8.6%, respectively. JPM's 8.4% common ratio falls 10 basis points short of the regulatory requirement of 8.5%.
The credit quality is expected to improve when the bank reports its performance. Total charge-offs are forecasted at $2.2 billion, down 21% quarter over quarter.
JPM trades at an 8% discount to its third quarter book value, compared to a 5% discount for Goldman Sachs and 33% discount for Citigroup. Analysts have a consensus mean price target of $50 for the share of JPMorgan, which are currently trading at $46.15. This presents an upside of 8%.
In conclusion, I believe JPMorgan is still a high risk stock despite its improved fundamentals. Therefore, I recommend risk averse investors to stay away from the stock until the bank discloses significant improvements in its internal control systems.
equityfinancials has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!