Securities Trading Gains, Cost Cutting Efforts Help JPMorgan Serve Up Strong Q2 Results
JPMorgan Chase (NYSE:JPM) kicked off the second quarter earnings season among banks on Thursday, July 14 on a strong note. [1] A notable improvement in trading revenues for the period, coupled with a continued reduction in operating costs, helped boost the bottom line at the country’s largest bank. Notably, JPMorgan’s results highlight a strong underlying business model – something we believe will help the bank weather the period of global economic uncertainty that will likely prevail over the next few quarters from Britain’s decision to exit the EU. Taking this into account, along with the bank’s decision to return as much as $17 billion to shareholders over the next four quarters, we have revised our price estimate for JPMorgan’s stock upwards from $70 to $72. The new price target is about 10% ahead of the current market price.
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Several Things Worked In JPMorgan’s Favor In Q2
The table above summarizes the factors that aided JPMorgan’s pre-tax profit figure for Q2 2016 compared to the figures in Q2 2015 and Q1 2016. The sharp improvement in Trading & Investment Banking revenues year-on-year as well as quarter-on-quarter is evident here. While these revenues were unusually low in Q1 2016 due to weak trading activity as well as poor underwriting volumes, things were more upbeat this time around – especially on the securities trading front. JPMorgan’s FICC (fixed income, currency and commodities) trading desk brought in almost $4 billion in revenues in Q2 2015 and the equity trading desk added another $1.6 billion for total trading revenues of just under $5.6 billion – well above the $4.5 billion figure a year ago. This jump can be attributed to the increase in trading activity across asset classes worldwide on the U.K.’s unanticipated decision to exit the E.U.
The increased revenues were not accompanied by a corresponding increase in costs, though, as JPMorgan’s efforts to cut down on costs shaved off nearly $1 billion in non-compensation operating expenses compared to Q2 2015. Also, with oil prices recovering from their decade-low levels seen in Q1, JPMorgan reported net credit recoveries of $25 million for its commercial banking division in Q2 as opposed to the $304 million in loan provisions set aside to cover losses on its energy loan portfolio in Q1. That said, there was a notable increase in loan reserves for the bank’s consumer lending operations in Q2 2016 ($1.2 billion) compared to Q1 2016 ($1.05 billion) and Q2 2015 ($702 million). The bank attributed this largely to higher loan losses on its card balances.
Headwinds From Shrinking Interest Margins Continue To Weigh On Results
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 again to 2.25% in Q2 2016. Fortunately, this did not have a very drastic impact on net interest revenues this quarter due to a sizable increase in interest-earning assets q-on-q.
The table below summarizes how changes in NIM and the interest-earning asset base have affected JPMorgan’s net interest revenues in Q2 2016:
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 second half of 2016, with improvements only expected 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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- 2Q16 Earnings Press Release, JPMorgan Earnings Releases, Jul 14 2016 [↩]