JP Morgan’s Earnings Tell the Story They Want You to Hear

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JP Morgan Chase (NYSE: JPM) recently reported a massive increase in quarterly income in its Q4 results that seems to defy any concerns related to the volatility of the global economy. The better than expected results have come thanks to a mix of lower tax rates, an improved performance from the corporate and investment banking units of Bank of America (NYSE: BAC) and a large reduction in loan loss reserves – a common theme this earnings season for banks extending the narrative that all is well.

Net revenue for JP Morgan increased from $21.5 billion last year to $24 billion in 2012. JP Morgan earned $8.2 billion in corporate and investment banking, $182 million more than analysts’ estimates. Investment banking fees rose 54% to $1.7 billion and account for the positive performance by this division while equity and debt underwriting posted a 13% and 23% increase respectively. The bank’s net income increased by 35% from last year’s $3.7 billion to reach $5.7 billion. This growth was strongly supported by JP Morgan’s banking and asset management segment. EPS rose to $1.39, which is 23 cents more than analysts’ estimates and 49 cents more from the earnings of the year-ago-quarter.

Meanwhile, CEO and Chairman Jamie Dimon is being penalized by the board and will receive “only” $11.5 million as opposed to the $23 million he received as compensation in 2011 from the “London Whale” loss, which cost the company $6 billion. The scandal has been particularly embarrassing for JP Morgan and its chief Dimon, who has been openly opposing any moves towards tougher regulations on banks. The bank’s CIO and Treasury unit earned net revenue of negative $110 million as opposed to a positive $845 million last year, while its net loss was $157 million as opposed to $845 million in the previous year. However, the worst isn’t over yet as CIO and Treasury’s net loss is expected to widen to about $300 million in the current quarter.

In the end, the major U.S. banks operate in a near risk-free environment thanks to the Federal Reserve’s policies designed to keep their leveraged bets liquid when the markets were illiquid.  Now, with the long end of the yield curve rising liquidity in the shadow banking system will be even harder to maintain, requiring even more intervention on the FOMC’s part. 

Changes that occur within the U.S. banking sector continue to leave management intact while gutting staff.  JPM’s shutdown of part of its settlement over fraudulent foreclosures led to 529 job eliminations, and, according to the Wall Street Journal, the bank fired another 310 employees recently. The bank’s settlement amount is almost $2 billion out of which $753 million will be paid in cash. 

It is difficult to achieve sustainable growth in traditional banking at zero-bound interest rates. The latest rounds of QE are designed to get credit flowing, versus simply propping up failing credit pyramids in the shadow banking system, so we’ll see JP Morgan and others expanding their loan books.  Mortgage originations increased 33% from last year to $52 billion. Commercial loans also witnessed a 14% rise in the quarter to reach record levels of $128 billion. According to the bank, it has offered 1.4 million mortgage modifications since 2009, yet the value of its non-performing loan portfolio continues to rise.

In its last quarter, when JP Morgan’s nonperforming assets increased by $1.1 billion, it baffled analysts, including myself, by taking a reduction in loan loss reserves of $900 million. In this quarter, however, the value of nonperforming assets has seen a sequential decline of around $800 million, and it reduced its reserves by another $700 million, which boosted EPS by $0.11. However, since Q2, the bank’s nonperforming assets have seen a net increase of $300 million, and during this period, loan loss reserves have been reduced by $2.1 billion to $21.9 billion. This is a clear trend that implies the bank continues to operate with an air of recklessness in order to manipulate perception, i.e. its earnings report.  

As investments the U.S. banks in 2012 were one of the biggest stories of the year. Since the beginning of 2012, JPM has slightly outperformed the SPDR Financial Sector Select ETF (NYSEMKT: XLF),  and they have paled in comparison to the rise in Bank of America.  So much of this rise has come because of the resolution of litigation, the successful papering over of the Greek default and continued support by the Federal Reserve at the expense of the rest of the U.S. economy.  If you feel you must have exposure to the banks at this point, I would do so through the ETF, which insulates you from the risks of any one institution. 

With credit growth re-entering the U.S. economy versus the shadow banking system, the banks will likely post good numbers at times, but the fundamental weakness of the sector remains unsolved.  So, while there are likely good trades to be made on the banks, long and short, at times this year fundamental investors have to remain cautious until the system can stand on its own without a major dose of central bank support.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>JPMorgan & Chase Co.</strong></p> </td> <td> <p><strong>Bank of America</strong></p> </td> </tr> <tr> <td> <p>Stock 6M</p> </td> <td> <p>34.23%</p> </td> <td> <p>61.07%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>8.95</p> </td> <td> <p>45.68</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>5.20</p> </td> <td> <p>0.25</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>2.60%</p> </td> <td> <p>0.40%</p> </td> </tr> <tr> <td> <p>Beta</p> </td> <td> <p>1.66</p> </td> <td> <p>1.78</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>0.92%</p> </td> <td> <p>0.19%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>10.98%</p> </td> <td> <p>1.79%</p> </td> </tr> </tbody> </table>



PeterPham8 has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America 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!

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