Strong Q4 Retail Banking Performance Helps JPMorgan Post Record Results For 2015

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JPMorgan Chase (NYSE:JPM) comfortably beat investor expectations with its fourth quarter results on Thursday, January 14, as a notable improvement in profits for its retail banking division helped it tide over continuing weakness in the securities trading and commercial lending businesses. [1] Notably, the country’s largest bank managed to slash its non-interest expenses to below $14.3 billion in Q4 2015 – the lowest since Q4 2009 – thanks to prudent cost-cutting measures and also because there weren’t any major legal expenses this time around. This was instrumental in the bank reporting a 12% increase in EPS year-on-year despite higher loan provisions and tax expenses.

Another important factor behind JPMorgan’s earnings beat was the sharp increase in net interest income. Although the benefits from the Fed’s rate hike in late December will only reflect fully across JPMorgan’s businesses over the coming months, the bank’s sizable custody banking division would have gained the most from higher interest rates. Also, the bank did well to increase the size of its loan portfolio by 3% quarter-on-quarter – something that helped boost its loan-to-deposit ratio. As a result of these two factors, JPMorgan’s net interest margin (NIM) jumped to 2.23% in Q4 2015 from 2.16% in Q3 2015 and 2.14% in Q4 2014.

Despite concerns about the outlook for trading, debt underwriting, mortgage banking and commercial lending activities in the short term, we believe that JPMorgan’s diversified business model and focus on managing costs will allow it to tide over this period of uncertainty with little trouble. The fact that the bank managed to churn out a relatively strong performance for a weak quarter while also boosting its capital ratio figures only reiterates our belief. Accordingly, we maintain our $71 price estimate for JPMorgan’s stock, which is about 20% ahead of the current market price.

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Investment Banking Operations Suffer On Multiple Fronts

JPMorgan reported total revenues of below $7.1 billion for its corporate and investment banking division, which includes its advisory, underwriting, trading, treasury and securities services operations. This compares to a figure of $7.4 billion for Q4 2014 and a substantially higher $8.2 billion for Q3 2015, and is the lowest quarterly revenue figure for the division in two years. Although the bank’s trading desks fared better in Q4 2015 than a year ago, the gains were insufficient to nullify the impact of weaker fees from advisory and underwriting activities, and also a sharp decline in interest income.

JPMorgan’s FICC (fixed income, currency and commodities) trading revenues for the quarter were less than $2.6 compared to $2.65 billion a year ago and $2.9 billion in the previous quarter. Poor equity market conditions around the world for most of the last quarter also dragged down equity trading revenues, which fell to $1 billion from an average of $1.55 billion over the first three quarters of the year.

Although Q4 2015 was one of the best quarters since the economic downturn for JPMorgan’s M&A advisory unit, the period also saw an exceptionally bad level of activity in global debt capital markets. As debt underwriting contributes a bulk of the bank’s investment banking fees, the net effect was a 15% reduction in the total fee figure year-on-year.

But things were not all bad for the investment banking division. The notable decline in operating expenses for the division stands out, with total costs of $4.4 billion for the division being the lowest since the bank adopted its current reporting structure 4 years ago. Without any one-time settlement costs weighing against results for the quarter, the bank’s cost-to-revenue figure fell to 63% in Q4 2015 from 75% in Q4 2014 and 76% in Q3 2015.

Retail Banking Operations Anchor Results With Strong Loan Growth

JPMorgan’s consumer and community banking division, which includes banking services offered to retail customers as well as small businesses, saw the size of total deposits and total loans swell to $558 billion and $446 billion, respectively, by the end of Q4 2015 – a sequential growth of 3-4%. While this drove gains in fee income from these services, faster growth in the loan base also had a positive impact on interest revenues. Moreover, the holiday season also had a positive impact on revenues for the card division, which saw fee-based revenues increase 14% quarter-on-quarter and 33% year-on-year to cross the $1.5-billion level.

Fortunes for the mortgage division dwindled in Q4, though, as the unit only originated $22.5 billion worth of new mortgage loans for the quarter – marginally lower than the $23 billion for Q4 2014 and a good 25% below the $29.9 billion figure in the previous quarter. This caused the mortgage production fee figure to slump to $123 million in Q4 from $325 million a year ago. The impact of this on the top line, however, was largely mitigated by record levels of auto originations for the period. JPMorgan originated $9.2 billion in auto loans in Q4 – a 33% improvement year-on-year.

Commercial Lending Stable For Now, Losses Could Be Coming 

JPMorgan’s commercial lending business, which has been an important source of profits for the bank in nearly every single quarter since early 2010, posted another decent performance in Q4. Revenues for the division improved 7% sequentially, which helped pre-tax profits grow 6% compared to Q3 2015 despite higher compensation-related costs. However, the division has been forced to increase its loan provisions from $82 million in Q3 2015 to $117 million in Q4 2015 due to the impact of low oil prices on the loans it has handed out to clients in the energy sector. This compares to net loan recoveries of $48 million a year ago.

Loan provision figures are likely to swell considerably over coming quarters if oil prices do not recover in the near future. According to the bank’s quarterly SEC filing for Q3 2015, it has roughly $42.1 billion in loans to companies in the oil & gas industry. Out these loans, more than $14 billion fall under the noninvestment-grade category – $3 billion of them carrying a high risk of default. You can make changes to the chart below to understand how an increase in commercial loan provisions impacts JPMorgan’s total value.

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Notes:
  1. 4Q15 Earnings Press Release, JPMorgan Earnings Release, Jan 14 2016 []