JPMorgan Chase (JPM) Q2 2013 Earnings Call July 12, 2013 8:30 AM ET
Jamie Dimon - Chairman and CEO
Marianne Lake - CFO
John McDonald - Sanford Bernstein
Brennan Hawken - UBS
Betsy Graseck - Morgan Stanley
Matt O’Connor - Deutsche Bank
Mike Mayo - CLSA
Erika Penala - Bank of America Merrill Lynch
Andrew Marquardt - Evercore Partners
Matt Burnell - Wells Fargo Securities
Gerard Cassidy - RBC
Jim Mitchell - Buckingham Research
Paul Miller - FBR Capital Markets
Guy Moszkowski - Autonomous Research
Chris Kotowski - Oppenheimer
Moshe Orenbuch - Credit Suisse
Nancy Bush - NAB Research
Chris Whalen - Carrington
Eric Wasserstrom - SunTrust Robinson Humphrey
Christopher Wheeler - Mediobanca
David Hilder - Drexel Hamilton
Good morning, ladies and gentlemen. Welcome to JPMorgan Chase’s second quarter 2013 earnings call. This call is being recorded. Your line will be muted for the duration of the call. We will now go live to the presentation. Please stand by.
At this time, I would like to turn the call over to JPMorgan Chase’s Chairman and CEO, Jamie Dimon, and Chief Financial Officer Marianne Lake. Ms. Lake, please go ahead.
Thank you, operator. Good morning everyone. I’m going to take you through the earnings presentation, which is available on our website, and please refer to the display regarding forward looking statements at the back of the presentation.
So turning to page 1, we carried strong momentum into the second quarter, with net income of $6.5 billion and an EPS of $1.60 a share, on revenue of $26 billion, up 13% year on year and flat versus the seasonally strong first quarter, with a return on tangible common equity of 17%.
And you can see on the page that we’ve highlighted several significant items up front here: A $950 million reserve release in mortgage, and this quarter we saw net chargeoffs less than half of what they were a year ago; a $550 million reserve release in cards, with chargeoffs remaining historically low; and $600 million of expenses for additional litigation reserves in corporate. In addition, the results for the quarter included a $355 million DVA gain in the corporate and investment bank.
Outside of these four items, we had a number of other small items, both positive and negative in the quarter, which offset each other, many of which I’ll call out as we go through the presentation. And we want to be very transparent with you. We don’t count items like reserve releases and other noncore items when we think about our own performance, so if we adjust for all of these items both big and small, our return on tangible common equity would have been about 15%, reflecting strong underlying core performance.
This quarter, a couple of important themes: The market’s environment in June, as well as several capital developments. So just a quick note on each. Rising long term rates and higher levels of volatility in June had an impact both on the quarter as well as in terms of our mortgage outlook guidance.
Our market businesses held up well in June, and our asset management platform outperformed during the backup. And importantly, remember that given the firm’s positioning, rising rates will drive significant benefit in higher NII over time, but during the near term, higher long term rates and wider spreads drove a significant reduction in the unrealized gains in our securities portfolio, or a reduction in AOCI, which did impact Basel III capital negatively.
Despite that impact, we were able to add to our capital and improve capital ratios as we began to realize some of the runoff and model benefits that we’d previously guided you to. And finally, higher rates will have a significant impact on mortgage refi volumes and margins in the second half of the year.
On capital, we’ve added a new page in the deck on leverage, which I’ll cover in a moment, but our headline capital number is a Basel III tier one common ratio of 9.3%, including the impact of the final Basel III capital rules approved this month by our regulators.
In general, the approvals are the same or similar to the NPRs, and in that sense, we’re broadly in line with our expectations, including the confirmation of no exception to AOCI. The estimated impact on our ratio was a modest benefit.
So on page three let me take you through the details. We ended the quarter with Basel III tier one common of $148 billion, up from the prior quarter. We set a Basel III capital walk here on the page in the blue callout box, which steps you through each component of the change quarter on quarter.
Our Basel III tier one common ratio before the impact of final U.S. rules increased to 9.1% from 8.9%, even after the 20 basis point impact from the change in AOCI. This impact is offset by a $40 billion reduction in risk-weighted assets, reflecting the impact of portfolio runoff as well as lower levels of risk.
So then adding in the benefit of final rules, which were principally related to changes in MSR rules and securitization benefits, our ratio at the quarter end was estimated at 9.3%. And as you know, although we reflect our best understanding of all the rules in our ratio, we don’t pull forward the impact of passive runoff or model enhancements, some of which we saw this quarter.
Together, these will deliver approximately an additional 75 basis points of benefits by the end of 2014. And we remain committed to reaching a 9.5% Basel III tier one common ratio by year-end.
Briefly on liquidity, in addition to building our capital, we accelerated compliance with the proposed Basel III liquidity coverage rules. And not only did we become compliant with the rule during the quarter, but at quarter end our estimated ratio was 118%, and we feel great about the progress we’ve made. Although there can be short term volatility in the number, you should expect that we will run around this level going forward.
And to finish on page three, in the bullets, the board increased the quarterly dividend to $0.38 a share from the previous $0.30, and during the quarter we repurchased $1.2 billion of common equity, as a reminder, that $1.2 billion of the $6 billion CCAR authorization.
So turning to page four, we’ve added this page to help walk you through our current thoughts on the new proposals regarding Basel III leverage. Let me start with two things. We believe the leverage ratio is an appropriate complement to our tier one common ratio if properly calibrated, and our holding company leverage ratio is estimated at 4.7% at the end of the quarter, based upon the U.S. proposed rules. To be clear, these rules do not reflect the most recent Basel proposal which would further increase our leverage balance sheet.
Just a few comments on the proposal in the U.S.: the denominated bills on GAAP assets with add-ons for derivative potential future exposures and off-balance sheet commitments resulting in a gross up for us and approximately $1 billion. And remember, included on our balance sheet is over $450 billion of cash and other high-quality liquid assets, which we think there’s a strong argument that they should not attract capital at these levels.
So I’m going to take you through the analysis on the page. We started with analysts’ estimates for net income, and we held our dividends flat and assumed repurchases generally consistent with our current levels. Given those assumptions, we would be able to add approximately 60 basis points to the leverage ratio by the end of 2014.
Additionally, we will continue to recalibrate our tier one capital through the issuance of preferreds. And finally, we will take appropriate actions to reduce our leverage assets, which may include some of the points on the slide. For example, repricing or restructuring our commitments or unwinding certain derivative positions.
And if you take those together, this could add another approximately 100 basis points over time, for a total of up to 160 basis points. So we will adjust our business, but we do expect the holding company to be able to be compliant in early 2015, with the bank to follow. Of course, a caution that this timeline could be impacted if there are significant changes to the rules, which are not yet final.
Changing gears, let’s turn to the business performance, starting on page five, with consumer and community banking. The combined consumer businesses generated $3.1 billion of net income for the quarter, on $12 billion of revenue, with an ROE of 27%.
Just a quick look at the franchise. We ended the quarter with over 5,600 branches, over 19,000 ATMs, and we now have nearly 1,700 Chase private client locations.
We continue to see really strong growth in the underlying drivers of the consumer businesses. Deposits were up over $40 billion year on year, an increase of 10%; customer attrition levels remain historically low; and our active mobile customer base grew by 32% year on year. So we’re adding customers, we’re retaining them through superior customer experience, and we’re deepening our relationships with them.
Also, mortgage and auto originations showed strong growth, up 12% and 17% year on year, respectively, and we had record credit card sales volume of $105 billion, up 10% year on year and record client investment assets of $172 billion, up 16%.
Turning to page six, consumer and business banking, net income of close to $700 million, and an ROE of 25%, on net revenue of $4.3 billion, down 1% year on year and up 3% quarter on quarter. While we continue to see pressure on deposit margins, 5 basis points down in the quarter, this continues to be largely offset by very strong growth. And on the noninterest revenue side, we’re seeing strong growth in both debit and investment revenue.
Expenses are up year on year, reflecting the investments we’re making in the business, including branch builds, as well as the absence of some one-time items that benefited the prior year.
During the quarter, we had record investment sales of $9.5 billion, up 53% year on year, and I’ll note that approximately 70% of those sales are managed money, driving strong recurring revenue for the business, up 13% year on year.
Average business banking loan balances are flat quarter on quarter, up 4% versus last year. And you can see here in the drivers that the loan production stabilized just above the very low levels we saw in the first quarter. We believe that we’re maintaining share despite increased competition, and the pipeline is up relative to the first quarter, which should support origination levels in the second half of the year.
Turning to page seven, and mortgage banking, overall mortgage banking net income was $1.1 billion, with an ROE of 23%. At the top of the table, looking at the first blue highlighted lines, production pretax income was $582 million. Top line production revenue, excluding repurchases, was up slightly quarter on quarter, with a higher reported gain on sale pretax margins of 116 basis points, more than offsetting lower closed loan volumes, down 7%.
$49 billion of mortgage production saw a change in mix this quarter as the purchase market continued to recover. Our purchase volumes increased over 40% quarter on quarter, and contributed 36% to volumes, up from 23% last quarter. And despite the strong start in April, the environment in late May and June drove mortgage rates up significantly, around 100 basis points.
This pressure continued into July, and we expect it could have a significant impact on the refinance market side in the second half of the year. So if mortgage rates stay at or above current levels, the market could be reduced by an estimated 30% to 40%. Although we will adjust capacity, expense reductions will lag volume reductions, and will challenge profitability and production.
Moving down to servicing, pretax income of $133 million, up quarter on quarter and year on year, on lower expenses and modest gain in the MSR. Servicing expenses of $715 million decreased quarter over quarter in line with our expectations, and we continue to see servicing or expect servicing costs to decrease to $600 million by the fourth quarter.
At the bottom of the table, real estate portfolio pretax was $1.2 billion. Runoffs of the legacy portfolio continued, although in the quarter, given the positive economics of retaining certain loans, we added close to $5 billion of mortgage loans to our portfolio, which is up $1.3 billion quarter on quarter, and we expect to be able to sustain these levels in the second half.
On credit, delinquencies and foreclosure in our portfolio were each down around 10% quarter on quarter. Net chargeoffs continue to come down less than $300 million this quarter, which was in line with our guidance, and we released $950 million of reserves. The majority of this release related to to impact of lower severities, reflecting real and sustainable HDI improvements. Going forward, we expect quarterly net chargeoffs of less than $250 million, and as credit trends continue to improve, expect additional reserve releases in the next several quarters.
Turning to car merchant services and auto, on page eight, net income of $1.2 billion, up 21% year on year, with an ROE of 32%, or 23% if you exclude reserve releases, reflecting excellent underlying performance in the business. Revenue of $4.7 billion was up 3% year on year, and despite strong volumes, down slightly quarter on quarter as a result of spread compression.
In cards, year on year growth in both sales and merchant processing volumes was both strong and consistent at 10% and 15% respectively. And importantly, we saw a stabilization of outstandings at the end of the second quarter, after 15 quarters of net runoff. And we believe we’ve reached an inflection point and expect some modest growth from here.
Expenses are down year on year, primarily driven by lower remediation expenses on our legacy product. And the net chargeoff rate continues to be very low, and we released $550 million of credit card loan loss reserves this quarter. This reflected both the continued improvement in early stage roll rates as well as higher than expected levels of paydowns on modified loans.
The net chargeoff rate was 3.31%, down over 100 basis points year on year. And if we continue to see favorable roll rates, as well as our modified loans continuing to pay down, we will see incremental reserve releases in the second half of 2013.
And before we move on, a few words on auto. Originations up 17% year on year, reflecting market share gains and driving loan balances up 5%.
Moving on to slides nine and 10, and the corporate investment bank, a strong second quarter performance, which included a DVA gain of $355 million. This was versus a gain in the same quarter of last year of $755 million, both of which are shown in the credit adjustments line. As usual, we’ll focus on the numbers excluding DVA. $2.6 billion of net income was the highest second quarter net income since 2009, up 37% year on year and 3% quarter on quarter.
Revenue of $9.5 billion was up 16% year on year, and the business delivered an ROE of 19%. Total banking revenue of $3.1 billion, up 17% year on year, on higher IBCs of $1.7 billion, up 38%, primarily driven by strong debt and equity underwriting.
We continue to be bank number one year to date in IBCs, and despite weaker credit markets toward the end of the quarter, we had near record debt underwriting fees in the first half of 2013. And equity capital markets, we have the number-one wallet share for the first half of the year.
Moving on to markets revenue, which was up 18% year on year, in line with our guidance, a very strong performance, particularly given the challenging environment in June, reflecting strong client flows throughout the quarter, the diversification of the business, and trading risk discipline.
Fixed income markets revenue of $4.1 billion was up 17% year on year, with credit and spread related products benefitting from less Euro Zone uncertainty and a stronger U.S. housing market. Equity markets of $1.3 billion was up 24% year on year, with strong client flows in [pass] and equity derivatives.
And before we leave markets, just a quick update on OTC clearing. The implementation of phase II in June went very smoothly. Although volumes were relatively light at launch, we have seen activity pick up, and we feel we have the right level of participation.
Securities services revenue of $1.1 billion was up 1% year on year, and within this number you should note growth in custody fees is in line with asset growth, but is offset by declines in agent lending as well as lower volumes in clearance and capital management.
Just a comment on credit. Trends are stable at low levels, with small net recoveries for the quarter. Loans are down 6% quarter on quarter, driven by lower balances in trade and conduits, and expenses were up 8% year on year, driven primarily by higher comp on higher revenues, with a comp to revenue ratio, excluding DVA, of 31% for the quarter.
Finally on this page, at the bottom of the driver section you see CIB average VAR, which continued to decline to $40 million, reflecting generally lower levels of risk, but also lower volatility across asset classes. I’ll note that the increased volatility in June did, however, drive spot VAR up higher, to over $60 million.
Before we skip over page 10, just a comment. If you take a look at the numbers for first half of 2013, you can see we continue to make great progress in the international space, and had particular strength in Asia during this quarter.
Turning to page 11, commercial banking saw net income of $621 million on revenue of $1.7 billion, with an ROE of 18%. Revenue was up 3% quarter on quarter, despite the softer lending environment, driven by higher average loan balances, stable spreads, and positive momentum on cross-sell and IBCs.
Although end of period loans were flat this quarter, we saw very strong growth in commercial real estate, up 3% and gaining share, offset by lower corporate lending. Our clients have excess cash, and are keeping their utilization rates low, but we’ve also seen the continuation of competitive pricing and aggressive structuring. We’re holding the line and choosing quality over growth, and this of course is reflected in our strong credit performance. But we’re still adding very good clients, and doing more business with existing clients.
As we look forward, we expect continued strong growth in the real estate business, given our competitive position, and for C&I loans, pipelines are up from the first quarter and deal activity feels like it may be turning. We are expecting a more constructive second half, and therefore should see some growth, but the environment remains competitive.
Turning to page 12, and asset management, an excellent quarter, and despite challenging markets in June, we saw net income of $500 million, up 28% year on year and 3% quarter on quarter, with an ROE of 22%.
$2.7 billion of revenue, up 15% year on year, reflects an increase in management fees, driven by strong long term net inflows, $25 billion this quarter, marking the 17th consecutive quarter of long term inflows, and higher equity and fixed income markets, up 12% based on our business mix. We also saw higher performance fees driven by strong fund returns, and record loan balances, up $16 billion year on year across products and geographies.
A moment on expenses. Growth and performance in the business led to 11% year over year expense growth, but as our investments season, the business is delivering positive operating leverage, which you can see in the pretax margin, which is 30%, up from 27% last year.
We ended the quarter with assets under management of $1.5 trillion, up 9% year on year, and client assets of $2.2 trillion, up 10%, despite small net outflows in June. However, the breadth of our platform should enable us to continue to gather net new assets globally, looking forward, and we delivered strong relative performance in both fixed income and equities.
Moving on to page 13, and corporate and private equity, a net loss of $552 million for the quarter. Private equity generated net income of just over $200 million, which included over $400 million of gains in part driven by investments that are in active sales discussions. Treasury and CIO net loss was $429 million, driven by negative NII due to continued low rates and slower reinvestment, as well as a change in portfolio mix, shifting from higher yielding securities to [LTR] eligible securities and cash.
The result also included net securities gains and a modest loss on [unintelligible] redemption, which we guided to last quarter. Excluding the net of these two items, CIO Treasury would have been a net loss of about $350 million, which is generally in line with our guidance. And our quarterly guidance remains unchanged.
Finally, other corporate. A net loss of $335 million includes the $600 million of pretax expense for additional litigation reserves in the quarter. Excluding litigation, other corporate was around $100 million net income, in line with our guidance. And again, our guidance, which does include litigation and significant items, remains unchanged for other corporate.
Turning to page 14 and net interest margin, net interest income was down slightly and core NIM was down 23 basis points quarter on quarter. We acknowledge this is larger than you may have expected, but let me give you some color. Importantly, it was principally the result of actions we took to build liquidity to comply with Basel requirements more quickly, which we believe is a strong positive. And to the degree it was also a pull forward of compression we guided to over time.
So with that in the table on the slide, which shows our cash balances and how they progress over time, and what you can see circled is that our cash was up more than $100 billion quarter on quarter, with other interest earning assets being broadly flat. This changed the relative mix and also the size of our interest earning assets, and drove core NIM down the 18 basis points we circled on the page.
While the increase in cash does reflect accelerated LTR compliance, it does also reflect very strong deposit growth and slower reinvestments, and a little less robust loan growth. The balance of the reduction in NIM relates to loan yield compression, partially offset by the lower cost of debt.
So going forward, all else being equal, what we expect from here is relatively stable NIM in the second half of the year and net interest income to increase modestly next quarter. So finally on slide 15, here’s our outlook. I covered these items as we went through presentation, so in wrap up, overall a very strong quarter, returning 17% on tangible common equity with excellent underlying performance across businesses, while making significant progress on capital and liquidity ratios. And the firm overall is positioned to benefit from a higher rate environment.
Thank you for joining us. Operator, you can open up the call for Q&A.
Earnings Call Part 2: Q&A with JPMorgan Chase & Co. CEO at SeekingAlpha.com