Look To Canadian Banks, Not JPMorgan, For Stability

By Maxwell Fisher - August 28, 2012 | Tickers: BMO, CM, JPM, WFC | 0 Comments

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The beat goes on for JPMorgan Chase (NYSE: JPM). It is painful to look at the statements that were made by management last spring and contrast that with the developing reality of now. That is exactly what I am going to do here.

For a reference point, let’s look at CEO Jamie Dimon's spring letter to shareholders. On Page 4, Dimon wrote “the best way to build shareholder value is to build a great company” which he defined as having “exemplary products and services, excellent systems, quality accounting and reporting, effective controls, and outstanding people.” One out of four isn't even very good in baseball.

Part Four of the letter, pages 17 to 18, discussed new Dodd Frank regulations, Basel III capitalization requirements, and the general over zealousness of the financial reform movement. From 2009 until April 2012, no one argued as loudly, frequently, or eloquently about the need to temper federal regulation than did Jamie Dimon. The letter itself lacked the sharp tone about regulation that had frequently been employed, but made the point nonetheless.

Pages 27 – 32 covered Dimon's opinions on JPMorgan's role in the mortgage business and that business in general. After establishing how dire things were, the section ends on an optimistic note that the big bank had cleaned up its handling of mortgage woes, and it would be an efficient and productive provider of mortgages in the future. Yet in the second quarter of this year, the bank's mortgage income, a factor that had Wells Fargo (NYSE: WFC) and many regional banks reporting excellent quarterly earnings, fell to $604 million, less than half the $1.25 billion of the second quarter of 2011. JPMorgan has lost a lot of ground to Eastern competitors including PNC Financial (PNC) and Fifth Third Bancorp (FITB) in the mortgage arena, a business now dominated nationally by Wells Fargo.

The next section of the Dimon opus concerned the investment banking unit. There is a swell in this country to reinstate Glass Steagall, which would make those pages of the letter moot. If we are to take the notion of removing plausible risk from the banking industry, segregating investment banking from commercial banking is a necessary step.

Finally, there was the aggressive, eight figure per year stock buyback plan, which Dimon characterized as fool proof so long as the stock price remained under nominal book value, which exceeded $47 per share for a few weeks back in the spring. But even then, the tangible book value was less than $32 per share, as the company was carrying over $50 billion of intangible assets on its balance sheet. In times of profit uncertainty, it makes far more sense to cut the dividend than to cut the share repurchase plan, as the latter is by definition flexible at the discretion of management. In May, it was announced JPMorgan was suspending its $15 billion stock buyback plan. In July, JPMorgan announced its intent to reinstate the buyback plan during the fourth quarter of this year. Now, that date has been pushed back again until the first quarter of 2013.

 It is not that the $6 billion trading loss will in any way endanger the existence of JPMorgan, which otherwise I expected to earn in excess of $20 billion this year. It is a question of trust, and in light of what was said just a few weeks before the London Whale scandal broke in the news. The nature of the trading loss was known to insiders during the first quarter of the year, when Dimon called the issue a “tempest in a teapot”at about the same time the annual letter to shareholders was being released.

JPMorgan is among the many banks that are being investigated in the LIBOR scandal. There are many investigations also ongoing pertaining to the London Whale losses. I cannot endorse a company with as many large unknowns as JPMorgan has at this time.

Yet, everything that JPMorgan used to be, I believe Bank of Montreal (NYSE: BMO) still is. Bank of Montreal is among the largest of the Canadian banks with just under $500 billion in assets, and has the largest presence in the United States of any Canadian bank through its ownership of the Harris Bank franchise. There are Bank of Montreal retail offices in twenty states.

Bank of Montreal's biggest advantage and distinction from JPMorgan is that Bank of Montreal is Canadian. Canada's banking system is inherently simpler, safer and stronger than the American system, and I wish that under moves for financial reform, the Canadian system would have been looked upon as a model. Due largely to an energy boom, the Canadian economy had been showing great strength, though the strong Canadian dollar and a weakening world economy have recently forced a slowdown. But while that may constrain new loan demand, the psychology of loans north of the border simply will not allow for a need for write downs such as was necessary in this country last decade.

Bank of Montreal is on pace to post earnings of about $5.75 per share this year, about 9% over fiscal 2011. It trades with a 5 year PEG of 1.03, and pays a generous dividend of 4.8%. I believe this is an excellent choice for conservative investors interested in the financial sector.

I believe all large Canadian banks are suitable choices for conservative investors. But another bank I believe merits special highlighting is Canadian Imperial Bank of Commerce (NYSE: CM). It is on pace to earn about $8 per share this year, and analysts foresee profit growth averaging 10% annually over the next five years, driving its 5 year PEG to less than 1. The company has limited international exposure, and at the close of its second quarter had a Tier One capital ratio of 14.7%. As is customary among all large Canadian Bank stocks, it pays an above average dividend, in its case of 4.7%. This again is an excellent choice for the conservative investor.

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