Recently, we have upgraded our recommendation on JPMorgan Chase & Co. (JPM) to Neutral from Underperform, given the current market recovery and valued growth indicators.
JPMorgan’s fourth quarter earnings of 74 cents per share were well ahead of the Zacks Consensus Estimate of 61 cents, aided by better-than-expected results at its Investment Banking segment. However, persistent high levels of consumer credit costs and increased provisions for credit losses were the downsides. All segments except Consumer Lending and Card Services delivered solid results during the quarter.
JPMorgan is poised to benefit from its leading businesses and large scale acquisitions. Each of its businesses ranks among the top three players in their respective industries. The company is also pursuing acquisitions to build scale and volumes.
In May 2008, JPMorgan acquired Bear Stearns Companies and in Sep 2008, it acquired the banking operations of Washington Mutual Bank. In Feb 2010, JPMorgan announced its intention to acquire commodities trading firm RBS-Sempra Commodities for $1.7 billion. The deal is expected to close in the second quarter of 2010.
We view the prospective RBS-Sempra deal as positive for JPMorgan as its strong capital position should enable it to easily manage the business. There are likely to be meaningful revenue opportunities over time, driven by the production of credit cards and investment products for expanding its business. Also, management expects acquisitions to produce significant cost synergies in the years ahead.
We think that JPMorgan is in a relatively good shape from a capital perspective. Management remains focused on managing asset levels efficiently during this critical period of market stress. We expect JPMorgan’s capital position to be a major differentiator going forward vis-à-vis its peers as it implies a lower risk of additional capital raises and greater opportunity for market share gains.
Also, in the second quarter of 2009, the company repaid the full $25 billion in preferred capital it had received under the Troubled Asset Relief Program (TARP). Additionally, JPMorgan’s loan loss reserves are about double that of the overall industry. We expect the company to continue building capital over the next couple of years, resulting in a better relative capital position.
However, the Investment Banking segment continues to be negatively affected by the disruption in the credit and mortgage markets, as well as by overall lower levels of liquidity. The continuation of market turmoil could potentially lead to reduced levels of JPMorgan’s client activity, lower investment banking fees and lower trading revenue.
Also, earnings in Commercial Banking and Treasury & Securities Services could decline due to the impact of tighter spreads in a low interest rate environment or a decline in the level of liability balances. Overall, we don’t expect any significant improvement in segment results very soon.
Though JPMorgan’s credit quality showed a slight improvement in the fourth quarter of 2009, the overall pressure on credit quality remains a significant threat to profitability in the upcoming quarters. Early stage delinquencies across almost all of consumer lending areas (home equity, mortgage and credit card) are showing signs of stabilization; However, it is a bit early to comment on any sustainable trend.
Net charge-offs and non-performing asset ratios have deteriorated significantly during the last few quarters. Continued deterioration in the credit environment has resulted in an increased provision for credit losses during the past several quarters. We expect the provision for credit losses to increase in the near term, as the current state of the economy is expected to persist for a while.
While we anticipate continued synergies from JPMorgan’s diversification and strong capital position, increasing provisions and a pressured credit quality will stretch future earnings.
Read the full analyst report on “JPM”
Zacks Investment Research
