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Investment Overview for JPMorgan Chase (NYSE:JPM)
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Below are key drivers of JPMorgan's value that present opportunities for upside or downside to the current Trefis price estimate for the banking group:
Sales & Trading
- Yield on Trading Assets: JPMorgan's trading yield has been around 5% in recent years, after recovering from lows of 1.4% in 2008 at the peak of the global economic crisis. While we estimate yield figures to remain relatively steady at this level going forward, should the division perform worse than expected in coming years, the yield could decrease to below 4% over the Trefis forecast period. If that were to occur there would a downside of nearly 6% to the Trefis price estimate.
- Investment Banking Operating Margins: JPMorgan's investment banking business normally reports margins in the range of 36%-38%. We forecast an improvement in margins to around 40% in the years to come. However, if these margins do not grow at the rate we currently forecast, and remain around 36% over our forecast period then there would be a downside of about 5% to the current price estimate.
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JPMorgan Chase is a diversified financial services institution with operations spread cross the world. The largest bank in the U.S. in terms of total assets, JPMorgan is a leader in providing credit & debit cards and mortgages as well as investment banking, wealth management and sales & trading services.
Through its various business segments, JPMorgan serves millions of consumers in the U.S. and many of the world’s most prominent corporate, institutional and government clients across the globe.
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Diversified business model driving sustained growth
JPMorgan is a market leader in nearly every financial service, which includes retail banking, commercial banking, investment banking and even custody banking. This diversified business model allows the bank to provide its customers - individual and institutional - a wider range of services. Moreover, the business model also brings in significant cross-selling opportunities that are not readily available to its competitors.
Stronger Operating Margins compared to other divisions
The Sales and Trading division of JPMorgan, historically has had strong operating margins compared to other divisions in the firm.
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The past couple years have been tough for the global economy, particularly the banking sector. Even as the world economy recovers, economists have predicted that the pace of recovery will be modest. At a time when many other competitors such as Citigroup and Bank of America were haunted with the possibly of a collapse, JPMorgan performed much better than the rest because of its relatively conservative stance in home loan originations and other products. In fact JPMorgan never faced a quarterly loss during the downturn. Overall the banking sector still faces headwinds due to high levels of unemployment which are leading to banks increasing their cash reserves and tightening lending standards.
Regulatory reforms expected to pressurize revenue growth going forward
- Increased regulation on the financial industry is expected to reduce the top line for most financial institutions. In the past, decreased regulation led to greater risk-taking for many parts of the businesses, which drove earnings growth. Analysts at Goldman Sachs have said that new regulations could cut bank earnings by nearly 13%, with larger banks such as Bank of America and Citigroup expected to lose up to 25% of their earnings power moving forward. Regulation is expected to affect the banking industry in several ways:
- Banks will be required to hold additional amounts of capital which will slow lending growth
- The CARD Act passed by the congress is expected to reduce income by prohibiting issuers from raising rates, fees or finance charges on existing balances or on prospective accounts in the first year
- The Volcker rule will force banks to scale back trading operations
- Securitization will become less appealing as investors and regulators will demand that banks retain some risk as well
Strong Capital Position
JPMorgan has a strong liquidity and capital position across its lines of businesses. The average loans-to-deposit ratio for the country's eight biggest commercial banks was just under 90% in Q4 2012. In comparison, JPMorgan's loans-to-deposit ratio was the lowest at 61%, indicating its strong liquidity position. Its Tier 1 Capital Ratio was 12.6% in Q4 2012 compared to 8.4% in 2007. Its Tier 1 common capital ratio also rose to 11% by Q4 2012 from 7% in 2008. This strong liquidity and capital position will enable the company to meet its short-term and long-term obligations without facing any difficulty
Improvements in Efficiency
The JPMorgan Chase and Bank One Merger has led to improvements in efficiency for the firm. As a result of consolidating operating platforms, data centers financial and risk systems the company’s costs have declined significantly as determined by the service per dollar of revenue. If the company were running at the same cost per dollar of revenue as in 2005, it would have added nearly $9 billion of increased technology, operations and overhead costs.
Acquisitions have helped grow the company’s business lines
Past acquisitions, most notably those of Bear Stearns and Washington Mutual, have helped increase the Investment Banking and retail banking business for JPMorgan. In 2008 Washington Mutual operated in nearly 15 states and had more than 2,239 retail locations across the U.S.
Leader in Retail Banking
JPMorgan competes with Bank of America and Wells Fargo mostly in the retail banking business. It currently has more than 5,500 branches across 23 states.
Dominant Position in Investment Banking
JPMorgan holds a strong position in the Global Investment Banking space. For each of the years 2011 and 2012, it earned the most global advisory, debt origination and equity & equity-related underwriting fees, according to Thomson Reuters.
Consolidation expected to continue
As a result of the financial crisis, the banking industry saw a period of mergers and consolidation. The financial crisis has seen nearly 15-20% of market share change hands. The banking industry continues to see consolidation in almost every aspect of the business as players try and globalize and seek scale. Customers are also increasingly becoming more risk averse and turning to larger players with stronger deposit bases due to uncertainty. The number of operating commercial banks declined from 7,630 in 2004 to 6,096 at the end of 2012.
Trefis Forecast Rationale for Net Interest Yield
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JPMorgan provides private banking services to its high net worth clients. Net Interest Yield represents the interest income earned from loans and deposits originated in the private banking group less any interest expenses associated with the cost of funds expressed as a percentage of total earning assets.
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Net Interest Yield increased from 3.66% in 2006 to 4.56% in 2009 as a result of wider deposit spreads in the Private Banking group as well higher loan and deposit balances. It decreased to 3.1% by 2012.
Going forward, we expect ${forecast} to increase slightly over the Trefis forecast period.
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Trefis considered the following factors for its forecast:
- Loan Pricing (Interest) Expected to Adjust In Line with Borrowing Costs
- JPMorgan Net Interest Yield on Business Loans has been stable in recent years. The company adjusts the interest on its loans based on the costs of borrowing, demand for loans and the risk profile of borrowers
- We expect JPMorgan will increase the cost of loans (interest on loans) as borrowing costs increase, thereby maintain a net interest yield that is generally stable
- Excess Capital in the Banking Industry Could Lead to Net Interest Yield Compression
- During the financial crisis, banks raised significant capital to allay fears of solvency and to ensure protection against loan losses. If future loan losses turn out to be significantly less than expected, the excess capital is likely to create significant new lending capacity. Lending competition amongst excessively capitalized banks could lead to compression in net interest yields
- According to the Federal Reserve, in mid 2012, reserves held by U.S. depository institutions (e.g. U.S. banks) totaled about $1.6 trillion compared to required reserves of about $105 billion, indicating excess capital of about $1.5 trillion. In comparison, in October 2007, banks held capital roughly equal to the reserve requirement which was about $41 billion
- However, this effect could be mitigated by higher reserve requirements which would decrease the amount of loans that can be extended
- Reluctance of Businesses to Borrow Despite Economic Recovery Could Lead to Net Interest Yield Compression
- Businesses that experienced elimination or reductions of their credit lines during the financial crisis may be reluctant to borrow from banks, thereby reducing future demand for loans and leading to net interest yield compression amongst competing banks
- Consolidation in Banking Industry Can Reduce Competition and Lead to Higher Net Interest Yields
- Reducing competition could potentially give banks the ability to decrease the Net Interest Yields, as volume growth offsets the decline in Net Interest Income
- A decrease in competition in the banking system leads to higher spreads as there are less banks who are available to extend loans , thus being in a position to charge higher interest rates
- Higher Inflation Expectations Can Lead to a Temporary Rise in Net Interest Yield
- The February 2010 Economic Report of the President, prepared by the US Council of Economic Advisors, forecast that the Consumer Price Index (CPI), a benchmark for inflation, will be 1.3% in 2010, 1.7% in 2011 and 2% from 2012 to 2015. In comparison, CPI averaged about 2.5% annually from 1999 to 2009.
- Rising inflation expectations can lead to a steepening of the interest yield curve, a measure of interest rates demanded by lenders at different maturities (e.g. 6 months, 1 year, 2 years, etc.). A steeper yield curve indicates that long-term inflation is a significant risk to the value of the money being lent and consequently the lenders demand a higher interest rate to offset this risk
- Net Interest Yield can rise for the bank as the yield curve steepens since the bank often borrows money at short-term maturities and lends money at long-term maturities (loans typically have maturities greater than one year). A steeper yield curve has a larger discrepancy between short-term rates (the cost of money for the bank) and long-term rates (the price of money lent by the bank)
- However, such mismatches between short-term and long-term rates should not lead to long-term changes in the net interest yield since the short-term borrowings by the bank must be refinanced frequently and such re-financings will be more expensive over time (due to the steeper yield curve)
- Mix of Variable vs. Fixed Rate Loans Will Impact Net Interest Yields
- The average net interest yield can vary from year to year depending on the type of loan that is being used to generate the net interest income. Banks often earn more net interest income when rates are low if they are holding a large pool of fixed rate loans.
- Cost of Borrowing (Interest Rates) Expected to Increase in the Future
- JPMorgan's cost of borrowing depends primarily on the interest that it pays out on: (i) Consumer & Business Deposits (ii) Federal Funds (iii) JPMorgan's Corporate Debt
- The average interest that JPMorgan pays on these sources of financing is primarily dependent on the overall Federal Funds Rate which has been targeted at 0% - 0.25% since December of 2008
- In comparison, the Federal Funds Rate was mostly recently at a high of 5.25% in June of 2006 and 6.5% in May 2000 with the rate reaching a low during the intervening period of 1% in June 2003
- Based on the history of the Federal Funds Rate and long-term expectations for economic recovery, we expect that the Federal Funds Rate will rise to historical averages and that JPMorgan's borrowing costs will increase
- Banks with Stronger Capital Ratios Can Borrow More Cheaply
- Well capitalized banks generally have higher net interest margins and are more profitable. This is because banks with higher capital ratios face lower cost of funding due to lower bankruptcy costs. This helps improve the spread. In addition a bank with higher equity capital would need to borrow less to support a given level of assets
- In recent years, JPMorgan has reported better capital ratios than its peers including Bank of America and Citigroup
Back to Company OverviewHow Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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