Debt Trading Gains Help JPMorgan Report Strong Q3 Results Despite Lukewarm Retail Banking
JPMorgan Chase (NYSE:JPM) sent shares across the financial sector higher on Friday, October 14, as the bank’s stronger-than-expected performance figures for the third quarter set the stage for potentially more positive earnings surprises by its peers over the coming weeks. [1] Although the diversified banking giant continued to witness headwinds in the retail banking industry, notable improvements on the securities trading front boosted profits this time around. The commercial banking and asset management divisions also chipped in with one of their best-ever performances in the bank’s history.
JPMorgan’s results demonstrate the strength of its underlying business model – with the diversified nature allowing the bank to weather the impacts of the extended low interest rate environment and the overall uncertainty in global macro-economic conditions on its profits. If the current trend of a sharp increase in debt and rates trading activity continues over subsequent quarters, then JPMorgan should see sizable gains thanks to its market-leading position in the industry. Moreover, the bank’s retail operations are well positioned to capture customers looking to switch from troubled-ridden Wells Fargo, even as the impending Fed rate hike eases the pressure on revenues from these operations in the near future. Taking this into account, we have revised our price estimate for JPMorgan’s stock upwards from $72 to $75. The new price target is about 10% ahead of the current market price.
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FICC Trading Desk Notches Up Best Ever Third-Quarter Performance
The table above summarizes the factors that aided JPMorgan’s pre-tax profit figure for Q3 2016 compared to the figures in Q3 2015 and Q2 2016. Notably, Trading & Investment Banking revenues jumped considerably year-on-year, and were also well ahead of the elevated figure for the previous quarter. The increase can be traced to the bank’s FICC (fixed income, currency and commodities) trading revenues, which were over $4.3 billion in Q3 2016 compared to $2.9 billion a year ago and almost $4 billion in the previous quarter. In fact, excluding the first quarters of each year (when trading revenues are seasonally at their peak), this was the best performance by JPMorgan’s FICC trading desk since the economic downturn of 2008. These revenues primarily benefited from an increase in global debt and rates trading activity for the quarter in the wake of Brexit – a trend that is expected to continue for the next few quarters till the U.K. completes negotiations with other EU members over the terms of its exit.
Lower Card Fees Responsible For Lukewarm Retail Banking
Notably, revenues from JPMorgan’s Consumer Banking operations – which include cards and payments, mortgage banking and other retail banking services – nudged lower quarter-on-quarter. The decline was almost completely due to a reduction in card fees, which fell from over $1.3 billion in Q3 2015 to $1.25 billion in Q2 2016 and sharply to below $1.1 billion in Q3 2016. The reason for this was an overall reduction in the bank’s fee structure as a part of renegotiated co-branding agreements coupled with higher amortization costs linked to the origination of new card accounts. That said, card purchase volumes jumped 10% y-o-y and 2% q-on-q, and with the holiday season expected to boost these volumes further in the fourth quarter, card fees should see sizable gains for the current period.
Interest Rate Pressure Remains A Problem, But The Rate Hike Will Help
JPMorgan’s net interest income accounts for between 45-50% of the bank’s total revenues for any given quarter, which is why even slight changes to the bank’s net interest margin (NIM) figure have an amplified effect on its earnings. The Fed’s decision to hold interest rates at near-zero levels since the economic downturn of 2008 resulted in NIM figures across banks to shrink each quarter. JPMorgan mirrored this trend, with the NIM figure falling from a little over 3% in 2010 to a low of 2.07% in Q1 2015. The figure climbed for the next 4 quarters – partially aided by the Fed’s decision to hike benchmark rates by 25 basis points last December – to reach 2.3% in Q1 2016, but fell sequentially to 2.24% by Q3 2016. Fortunately, JPMorgan reported a marginal improvement in net interest revenues q-on-q as well as y-on-y thanks to steady growth in its interest-earning asset base – especially its loan portfolio, which has swelled 10% since Q3 2015.
The table above summarizes how changes in NIM and the interest-earning asset base have affected JPMorgan’s net interest revenues (fully-taxable equivalent basis) in Q3 2016. And as can be seen, the increase in interest-earnings assets drove an increase compared to both quarters. In the wake of the Brexit vote, the Fed has hinted that it may not hike interest rates until the end of the year. This is likely to keep NIM figures for JPMorgan under pressure over the fourth quarter too, with improvements only likely early next year. You can see how a change in JPMorgan’s net interest yield on deposits affects our estimate for its share price by making changes to the chart below.
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- 3Q16 Earnings Press Release, JPMorgan Earnings Releases, Oct 14 2016 [↩]