Strong Retail Banking Performance Helps JPMorgan Overcome Subpar Securities Trading

The earnings season among banks started on a largely positive note, as JPMorgan Chase (NYSE:JPM) comfortably beat investor expectations on the back of robust loan growth. While the largest U.S. bank saw its earnings receive a one-time boost of $406 million from a legal settlement, its diversified business model benefited from a sizable increase in revenues for its consumer banking, commercial banking and asset & wealth management (AWM) divisions. In fact, the commercial banking division churned out record revenues and profits, as the bank’s commercial loan portfolio grew to almost $200 billion while  loan losses fell. The AWM business also saw profits reach a new high on the back of record assets under management (AUM). Moreover, JPMorgan witnessed sharp growth in its cards and payments business – something that helped card fees recover from the lows seen over the last two quarters.

JPMorgan faced some headwinds over the quarter, though. Weak debt trading activity for the quarter led to a marked reduction in FICC trading revenues compared to Q2 2016 as well as Q1 2017. While continued slowdown in the mortgage industry depressed mortgage banking revenues, the industry-wide trend of higher card charge-off rates also led to an increase in consumer loan provisions for the period. At the same time, an increase in the cost of funding led to a lower-than-expected improvement in net interest margins (NIM) for Q2 and is expected to weigh on interest revenues for the rest of the year too.

That said, JPMorgan’s market leading position across banking services will continue to drive the bank’s profits in the long run. The outlook for the U.S. economy remaining positive, and the Fed remains committed to its rate hike plan – factors that will directly aid JPMorgan going forward. Additionally, the bank recently announced plans to return a record $27 billion to shareholders through dividends and share repurchases. Taking all these factors into account, we have revised our price estimate for JPMorgan’s stock upwards from $85 to $95. 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 Q2 2017 compared to the figures in Q2 2016 and Q1 2017. Trading & Investment Banking fell sharply y-o-y as well as q-o-q – something that can be attributed almost completely to weak debt trading revenues for the quarter. Consumer banking revenues were largely level compared to the year-ago period, although the figure improved considerably from the previous quarter thanks to a jump in card fees coupled with higher interest revenues. The gains from all other divisions include the one-time cash gain from a legal settlement, in addition to a healthy increase in revenues for both commercial banking as well as AWM.

JPMorgan did well on the cost front too, as compensation expenses fell compared to both quarters – something that can be attributed largely to lower performance-related payouts for the investment banking arm. The notable increase in other operating expenses compared to Q2 2016 is primarily due to a net legal benefit that accrued last year (separate from the one-time legal gain that increased revenues this quarter). While loan provisions were lower than the comparable quarters, there is a clear increase in consumer banking provisions – more than mitigated by a release in loan reserves for the bank’s corporate & investment banking (CIB) as well as commercial banking divisions.

Debt Trading Revenues Tanked, But That Was Largely Expected

After having an exceptionally strong run since Q2 2016, JPMorgan’s FICC (fixed income, currency and commodities) trading desk stumbled in Q2 2017, with revenues falling from $4 billion in Q2 2016 and $4.2 billion in Q1 2017 to just $3.2 billion in Q2 2017. The decline was largely expected though, as all major investment banks had warned of a sizable reduction in Q2 FICC trading revenues in late May, as low volatility in debt markets globally had depressed the demand for debt trading services. Equity trading revenues remained largely at $1.6 billion, though.

The table below details the changes in JPMorgan’s investment banking revenues for Q2 2017 compared to Q2 2016 and Q1 2017.

JPMorgan’s advisory and underwriting fees were largely upbeat for the quarter, with strong debt and equity market origination activity helping the bank’s total fees. Although M&A advisory fees increased compared to Q2 2016, these fees were below average as M&A activity remained subdued for a third consecutive quarter.

Net Interest Revenues Are Growing, But At A Slower-Than-Expected Pace

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 hikes 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 increasing to over $12.2 billion for the first time since 2010.

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 Q2 2017. Notably, the bank reduced its guidance for expected increase in interest revenues for full-year 2017 compared to 2016 from $4.5 billion to $4 billion due to higher funding costs. It should be noted that the interest rate environment is currently in a state of flux, which is leading to erratic net interest margin movements for the banks. In the long run, once the Fed’s rate hike process is completed, interest rates should normalize – leading to sizable gains for all banks.

You can see how a change in JPMorgan’s net interest yield on commercial loans affects our estimate for its share price by modifying the chart below.

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