Investment Banking Division Grabs The Spotlight In JPMorgan’s Strong All-Around Quarter
JPMorgan Chase (NYSE:JPM) kicked off the earnings season among banks by beating investor expectations for its first quarter results late last week – raising the bar for other banks to follow over coming weeks. [1] The largest U.S. bank made the most of its diversified business model, seasonal trends in the banking industry and the existing economic conditions to report the highest quarterly revenues in more than four years. This was driven largely by the spurt in debt trading revenues seen over recent quarter, while underwriting fees and equity trading revenues remained seasonally elevated. While the bank’s commercial banking revenues crossed the $2 billion mark for the first time ever, strong inflows for its asset management arm from the ongoing push in ETFs also helped boost the top line. Notably, JPMorgan’s consumer banking division also did quite well taking into consideration the fact that the first quarter is a seasonally slow period for traditional loans-and-deposits services. In fact, gains from improved interest margins, coupled with strong loan growth, largely mitigated the impact of weak mortgage banking revenues. The strong revenue growth came at the cost of an increase in compensation expenses, though, and higher performance-linked pay and bonuses for full-year 2016 did not let the bottom line reflect these gains. The earnings figure was also hurt by a sharp increase in provisions from $864 million in Q4 2016 to $1.3 billion this time around.
All things considered, JPMorgan remains well positioned to grow profitably in the long run thanks to its market-leading position in every major banking service its diversified business model offers. With the outlook for the U.S. economy remaining positive, and with the Fed following through on its rate hike plan, the bank should see considerable growth in profits over coming years. At the same time, the bank’s common equity tier 1 (CET1) capital ratio figure of 12.4% is comfortably above its 11% target. This should allow the bank to hand out more cash to investors through dividends and share repurchases over 2017-18.
Taking this into account, we revised our price estimate for JPMorgan’s stock upwards from $82 to $85. The new price estimate is slightly ahead of the current market price.
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The table above summarizes the factors that aided JPMorgan’s pre-tax profit figure for Q1 2017 compared to the figures in Q1 2016 and Q4 2016. Trading & Investment Banking revenues jumped considerably y-o-y as well as q-o-q. Although consumer banking revenues fell compared to both quarters, the decline was primarily due to lower mortgage banking fees coupled with high new account origination costs for the card divisions (this impacts the top line as JPMorgan treats it as a contra-revenue).
As we mentioned earlier, the revenue jump was accompanied by an increase in compensation expenses. The increase was largely proportional, though, with revenues increasing by 6% compared to an increase of 7% for compensation costs (compared to the year-ago period). Although loan provisions increased substantially compared to the previous quarter, this was in part due to JPMorgan’s decision to write down its student loan portfolio. Notably, JPMorgan released some of its loan reserves for its corporate & investment banking (CIB) as well as commercial banking divisions due to a recovery in oil prices compared to the lows seen in the first quarter of 2016.
Strong Trading Revenues Complement Best First Quarter Advisory & Underwriting Fees In History
As has been seen for the most of 2016, the single biggest profit driver for JPMorgan yet again in Q1 2017 was its FICC (fixed income, currency and commodities) trading desk. FICC trading revenues for the quarter were $4.2 billion – making it the second best quarterly performance in the last four years (after Q3 2016). Also, the equity market rally coupled with seasonally higher equity trading activity let JPMorgan report equity trading revenues in excess of $1.6 billion for just the 5th time in its history.
The table below details the changes in JPMorgan’s investment banking revenues for Q1 2017 compared to Q1 2016 and Q4 2016.
Notably, the bank made more from each of its investment banking units this time around compared to both quarters, as debt and equity market conditions were particularly strong globally for the period. With M&A activity remaining subdued for a second consecutive quarter, M&A advisory fees was the only revenues stream to fall compared to both quarters here.
Commercial Banking, Asset Management Divisions Also Ring The Cash Register
JPMorgan’s commercial banking arm saw its total loan portfolio swell 3% from the figure at the end of 2016 – a trend which is in sharp contrast to the 1% reduction in commercial and industrial loans across U.S. banks according to data compiled by the Federal Reserve. The record-high loan portfolio of $195 billion, coupled with improved net interest margins, helped total revenues for this division increase to an all-time high of over $2 billion for Q1.
The bank’s asset and wealth management also reported revenues that remained level at the record $3.1 billion figure seen in the previous quarter, as improvements in market valuation coupled with inflows into its liquidity as well as long-term fund offerings helped its asset base grow to a record $1.84 trillion at the end of Q1 2017. Notably, revenues from the asset management unit remained under pressure – a trend seen across the industry over recent quarters from the rising popularity of low-cost ETFs and passively-managed funds. JPMorgan’s wealth management unit more than made up for the revenue shortfall thanks to handsome growth in private banking client assets.
Net Interest Margins Are Moving In The Right Direction
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 benefits of the Fed’s rate hike in late December and again in March have begun to reflect across JPMorgan’s businesses, with the bank’s sizable custody banking division gaining the most from higher interest rates. This, coupled with a notable increase in the bank’s interest-earnings assets, resulted in net interest revenues crossing the $12-billion mark for the first time since Q4 2011. JPMorgan’s NIM figure for the quarter increased from 2.3% in Q1 2016 and 2.22% in Q4 2016 to 2.33% in Q1 2017.
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 Q1 2017. The increase in interest earning assets drove an increase compared to both Q4 2016 and Q1 2016. You can see how a change in JPMorgan’s net interest yield on consumer loans affects our estimate for its share price by modifying the chart below.
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- 1Q17 Earnings Press Release, JPMorgan Earnings Release, Apr 13 2017 [↩]