What Third Quarter Earnings Really Say About the Largest U.S. Bank
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JPMorgan Chase (NYSE: JPM), this country's largest banking company, has had a rough 2012. Civil suits, real estate clawbacks by agencies, the London Whale, criminal issues; a lackluster world economy in general and investment banking climate in particular; the list goes on and on. Yet despite it all, JPMorgan posted a pretty spectacular third quarter.
In evaluating quarters, I am bound to look at CEO Jaime Dimon's statement in the second paragraph of his 2012 letter to shareholders in the spring that JPMorgan's “normalized” earnings should be $23 to $24 billion per year. I suppose this number would go up as the bank's balance sheet grows in time. But for right now, management is apparently looking for quarterly earnings of close to $6 billion per quarter, and that is just what happened in the third quarter. Earnings came to $5.7 billion, or $1.40 per share. In last year's third quarter the bank earned $4.26 billion, or $1.02 per share. This 34% jump in profit surprised analysts, who had been expecting earnings of $1.22 per share.
In a nutshell, all of the company's divisions performed at least adequately, and some were very solid stand outs. JPMorgan's big investment bank chipped in $1.57 billion in profits, despite a $211 million DVA loss due to tightening credit spreads. In last year's third quarter, the investment bank earned $1.64 billion, built on the back of a $1.9 billion DVA credit. I find it an odd coincidence that the investment bank took a nearly $2 billion credit last year, and a $211 charge this year, but came up with about the same bottom line profit.
JPMorgan has also forecasted lower payroll expenses, which will add to the income from the investment banking unit. The bank set aside $2.07 billion for payroll in the third quarter, just 32% of revenue, a sharp drop from 41% in the third quarter of 2011. The bank had previously stated its goal of holding down employee costs to be no more than 35% of revenue, but in recent years it had been much closer to 40%.
The investment bank is slowly coming back from a disastrous 2011. Conditions in both equity and debt underwriting had been quite dismal worldwide. JPMorgan's investment bank remains among the top ranked such institutions in the world, and if the climate in the worldwide debt and equities markets continue to improve, the investment bank will return to its role as the main driver of JPMorgan's profits. It has long been a secret to the bank's success that its investment bank might pick up the commercial bank during banking weakness, and vice versa. Maybe soon, both main divisions will simultaneously do well.
The star of the quarter was JPMorgan's residential real estate business. Mortgage underwriting and servicing income came to $563 million, more than double the $205 million this division earned in the third quarter of 2011. Other standout units included the credit card services division, which reported income of $954 million, or 12% more than the same quarter a year ago, and the commercial banking unit, where income advanced 21% from the same quarter a year ago to $690 million.
JPMorgan still has plenty of issues with which to contend. There is no guarantee of growth in the European economy, which hinders the investment banking unit. Our nation's careening toward a financial cliff is a danger to all companies, none more so than banks. And legal issues continue to crop up, as demonstrated by the increased litigation reserve described above. The losses from the London Whale chapter are winding down, as the bank anticipates one final charge of about $300 million in the fourth quarter as the positions are fully wound down. But prosecutors are preparing criminal charges against the bank from that incident. The New York Attorney General has also sued JPMorgan as successor to Bear Stearns, over the latter's alleged mortgage fraud. Investor civil suits are near certainties and will go on for years, depending on statutes of limitations of the affected individuals.
Elsewhere, there is the feeling that the mortgage business may well have reached its peak, and revenues from that sector that have supported many banks' profits in recent quarters will be receding going forward. Surely, JPMorgan has a rock solid balance sheet, but there are enough risks that I cannot endorse purchase of this bank by those not in a position to accept risk. For those who can tolerate risk, the upside is that this quarter is emblematic of what is likely to happen going forward, with 2013 earnings of $23 billion to $24 billion which would represent a return on assets of just under 1%.
Wells Fargo (NYSE: WFC) also released earnings, and also beat analysts’ expectations. Its earnings of $4.9 billion, or $0.88 per share represented increases of 27% and 29% respectively. Annualized return on assets was 1.45%, and its efficiency ratio fell to an excellent 57.1. Wells Fargo is much more focused upon retail banking than is JPMorgan, and also more dependent upon interest income. It achieved its record earnings level despite a drop of 18 basis points in its net interest margin down to 3.66% in the third quarter versus the year earlier quarter. This helped drop overall interest income, but that was more than made up for by mortgage income and lower reserve provisions. At the end of the third quarter, Wells Fargo's overall loan portfolio of $782 billion had grown by about $22 billion, or nearly three percent from the same point of 2011.
The market reacted poorly to earnings, dropping the stock about three percent over the course of the day. It was partly a sign of “sell on news”, and partly a sign of concern, I believe, of Wells Fargo's over reliance on mortgage income. All the low lying fruit has been taken, and continued growth in mortgage income is unlikely. I will write more fully on Wells Fargo in the days ahead.
I am also looking forward to earnings from Citigroup (NYSE: C) and Bank of America (NYSE: BAC) in particular. The bar is set far lower for these two banks than most other financial institutions, and there is more upside potential in these two banks than in most others. I need to see some consistency in earnings from these two before endorsing them, and I will be looking at their upcoming earnings reports with care.
I am particularly confident that Citigroup has turned the corner. As much as I dislike the big bank's relative abandonment of domestic retail banking in favor of “emerging economies”, there is little reason to doubt the bank will be steadily profitable going forward. Analysts are looking for third quarter earnings of a little under $1.00 per share. I am looking for better than that, in the $1.05 per share area.
Bank of America is a little more problematic. It is this country's largest retail bank, but seems conflicted in that role. Its earnings of late have been a buffet of one time items, and I am looking first and foremost for a sense of stability from operating earnings. Bank of America is undergoing two different large cost cutting measures, that that alone will help earnings comparisons going forward.
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StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.