Is JP Morgan A Good Pick For 2012?

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JP Morgan Chase (NYSE: JPM) is probably the most respected large bank in the country. It, along with Citigroup (NYSE: C) and Bank of America hold nearly 40% of the nation's banking assets, but unlike the other two, JP Morgan has consistently posted profits in recent years. Also, alone among the “big three”, JP Morgan is ranked among the fifty safest banks in the country.

To no one's surprise, JP Morgan passed the recent Federal Reserve imposed stress test with some room to spare. In fact, it was so eager to announce to the world its relatively secure capital position that it actually broke the news to the world two days prior to when the Federal Reserve intended to release the report. That stress test measured the affected banks' Tier One common ratio over a two year period of substantial macro economic hardship. In coordination with the examination, each bank was to submit plans for capital distributions over the two year period. The Fed's report included capital levels after the two year period both not including the bank's distribution plans, and another ratio including the distribution plans. A bank like Regions Financial (NYSE: RF) was uniquely determined to have a higher capital level after including its distribution plans, due of course to its plan to dilute its current shareholders with a $900 million offering in order to pay back its TARP loans.

JP Morgan was not the highest rated bank by far. Its current capital ratio is 9.9%, lower than some large regional banks like PNC Financial Services Group's (PNC) 10.5% and Keycorp's (KEY) 11.3%. Taking into account a severe economic downturn, but no additional capital actions, JP Morgan's capital ratio would fall to 6.3%, a passing score, yet far behind other banks like Fifth Third Bancorp (FITB) or U.S. Bancorp (NYSE: USB) both of which would have a capital ratio under the scenario of 7.7%. Finally, assuming implementation of planned dividends or share buybacks, JP Morgan's capital fell further to 5.4%. That is hardly the kind of ratio I would expect of an institution that for years has boasted of a “fortress balance sheet”, but since the bulk of the capital distributions is via share repurchases of up to $15 billion, management can forestall or eliminate those distributions if conditions do deteriorate.

JP Morgan bought back a total of $9 billion of its stock in 2011, and  in 2012 has received Fed approval to purchase another $12 billion of its stock. For a bank of JP Morgan's scope and importance to be willing to, and to have the Fed allow it to skate by minimal capital standards by less than one half of a percent while returning billions of dollars to shareholders is irresponsible.

Perhaps the biggest reason why JP Morgan looks attractive is that its chief competitors are unsuitable investment choices for anyone except true speculators. Bank of America's status as poster child of mortgage and foreclosure clown has led to billions of losses, and fines and suits are undoubtedly still in its future. Citigroup has plenty of its own problems including the absurdity of its Citi Holdings unit and narrow profitability. A newer problem for Citigroup has cropped up concerning its ability to properly value its stake in the Morgan Stanley / Smith Barney unit. The joint venture was created during the depths of the recession in 2009, when the then Citigroup owned Smith Barney merged into the wealth management arm of Morgan Stanley (NYSE: MS). Under the terms of the agreement, Morgan Stanley owned 51% of the joint venture, and Citigroup the remaining 49%, and beginning in 2012 Morgan Stanley was to be able to begin to buy out Citigroup's interest in the joint venture for fair market value. Therein lays the issue.

Citigroup either optimistically or foolishly values the joint venture at roughly $20 billion. Morgan Stanley, realizing that 2012 was going to be a rough year for investment banks, values the venture more closely to $15 billion. The federal reserve has approved Morgan Stanley's initial plan to purchase an additional 14% of the joint venture, and it is probable that later on in 2012 the Fed would allow a full takeover if market forces allow. That would make sense for Morgan Stanley in its attempt to diversify from its highly volatile trading and sales core. And it would also allow Citigroup to instantly lift its capital level enough to pass the Federal Reserve stress test. But first, an agreement on price must occur, and the popular opinion is that Morgan Stanley's lower valuation will win, causing Citigroup to write down its investment by up to $2.8 billion pretax, or about $2 billion after tax.

I would not invest in any of the three large money center banks. By most statistical measures, U.S. Bancorp outstrips JP Morgan. The key measure of return on assets has U.S. Bancorp at 1.5% and JP Morgan at 0.84%. U.S. Bancorp has an efficiency rate hovering at about 50%, while JP Morgan has an efficiency rate of 0.64%. So, while it may be true, as I have said, that JP Morgan is the country's premier megabank, it is only because there are so few megabanks. Even against Wells Fargo (WFC), JP Morgan does not fare well statistically. But if you want real income and growth potential with reasonable risk, forget about this country and look north to Bank of Montreal (BOM), Royal Bank of Canada (RY), or virtually any of the other nationally chartered Canadian Banks. 


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