JPMorgan Remains on the Sidelines


We have maintained our long-term Neutral recommendation on JP Morgan Chase & Co. (JPM) based on the company’s slightly disappointing fourth quarter 2011 results, the overall weakness in the wider economy as well as the fundamental pressures on the banking sector. However, we expect continued synergies from a reduction in reserves for future losses, business diversification and steady capital deployment activities. 

JPMorgan’s fourth-quarter earnings marginally missed the Zacks Consensus Estimate. Quarterly results were negatively impacted by a substantial decrease in revenue. However, improved credit quality, lower non-interest expense and a strong capital position were among the positives.

Improving credit quality is a major positive for JPMorgan. Though provision continued to reflect elevated losses in the mortgage and home equity portfolios, we are impressed to see improvement in delinquency trends and net charge offs. We anticipate this trend to continue, providing some golden opportunities to drive earnings.

JPMorgan remains focused on improving its loan and deposit balances. Despite overall weak economic environment, the company’s total deposits surged 21% from the prior year to $1.13 trillion in 2011. Moreover, during 2011, there was a nearly 4% increase in the company’s total loan balance to $72.4 billion. Therefore, both loan and deposit balances are poised to grow in an improving economy.

Also, the recently announced foreclosure settlement deal removed a large litigation overhang from the company. JPMorgan, along with four other mortgage servicers – Wells Fargo & Co. (WFC), Citigroup Inc. (C), Bank of America Corporation (BAC) and Ally Financial reached a settlement worth $25 billion in total, regarding its alleged abuses in foreclosure practices, with the attorneys general from 49 states and several regulatory agencies. The company will pay $5.29 billion in settlement with states and federal authorities.

Moreover, we expect JPMorgan’s strong capital position to be a major differentiator going forward vis-à-vis its peers, as it implies a lower risk of raising additional capital and greater opportunity to gain market share. We also expect the company to continue building capital over the next couple of years, resulting in a better financial position.

On the flip side, JPMorgan’s revenue growth is expected to slow down in the next few quarters attributable to weak trading revenue and the contraction of net interest margin (NIM). Also, the pressure on NIM could put its traditional banking businesses at stake. Moreover, with the thrust of new banking regulations, there will be a pressure on fees, and loan growth is likely to remain feeble.

Further, along with other major U.S. banks, JPMorgan will have to go through the Federal Reserve’s stress tests every year to prove its financial ability to confront another recession. Additionally, banks with assets of $50 billion or more, like JPMorgan, will be subject to additional capital surcharge for meeting the international capital standards (such as Basel III). Stringent capital requirement is expected to lower the company’s flexibility with respect to its business investments, to some extent, in the mid term.

JPMorgan currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.

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