JPMorgan Continuing To Leverage Its Unique Strengths
Contributor since 2011 / 19025 Followers
Summary:
- JPMorgan Chase is well-positioned amid a slowing US economy and liquidity crisis due to its scale and market leadership in most businesses where it competes.
- Second quarter results could offer upside from pretty attractive net interest margin on healthy loan spreads, but opex could trend a little higher than Street expectations.
- JPMorgan should benefit from widening loan spreads as smaller banks pull back on lending and has potential for organic growth through branch expansion, small business lending, and tech-driven services.
- Despite potential regulatory changes and macroeconomic challenges, JPMorgan’s balanced approach and ability to switch between offense and defense make it a worthy consideration for investment below the mid-$150s.
winhorse
Bank stocks are clearly out of favor, and not without some valid reasons given the shape of the yield curve, the slowing of the U.S. economy, and the recent liquidity crisis, but JPMorgan Chase (NYSE:JPM) continues to show the virtues of its well-run, almost-impossible-to-replicate operations. Through a combination of excellence in virtually all of its addressed markets (including leading share in most businesses where it competes) and scale, JPMorgan is a rare bank that can switch from offense to defense with minimal disruption.
Loan demand is slowing across the banking sector and funding costs are rising, but JPMorgan is well-positioned in terms of liquidity and capital and should be a net winner as loan spreads widen with smaller banks pulling back to preserve/improve liquidity. At the same time, branch-based expansion, small business lending growth, and technology-driven payments and advisory services all leave room for organic growth. JPMorgan is by no means the cheapest bank now, and has benefited from some flight-to-safety investment flows, but the shares still offer enough upside to be worth serious consideration.
No Stress From The Stress Test, But Capital And Rule Changes Are Still On The Way
As I expected, the largest banks in the U.S. came out of the annual Fed stress test process relatively unscathed, and JPMorgan’s prior moves to build up capital served it well on balance. Helped in part by its diverse business lines (and relatively more moderate consumer lending exposure), JPMorgan actually saw the lowest decline in its required capital (as measured in minimum CET1 ratio), with a 109bp drop from 12.5% to 11.4%. Bank of America (BAC) saw a 90bp drop and Goldman Sachs (GS) saw an 83bp drop, while M&T (MTB) saw a somewhat surprising (to me, at least) drop of almost 70bp, though M&T has also seen one of the largest increases relative to 2020 (management has building up capital in anticipation of higher requirements.
With this positive outcome, management is free to return more capital to shareholders and a 5% dividend increase is coming in the third quarter.
The Fed stress test was a benign-to-positive development for JPMorgan, but there are still future developments to monitor. The Fed will likely come out with its Basel IV (also called Basel III “endgame”) recommendations, and as I previewed in that earlier piece, this process is likely to result in higher capital requirements for the industry – perhaps something on the order of 20%. To that end, I think JPMorgan is taking the right approach in its somewhat conservative guidance with respect to capital and capital returns to shareholders – I do see a moderate risk that some banks could “whipsaw” investors; increasing dividends in the near term only to see Basel IV requirements lead to a round of capital-building.
The industry is also still waiting to see what changes to rules and regulations come in the wake of the high-profile failures of Silicon Valley Bank, Signature, and First Republic (acquired by JPMorgan) and the panic created by duration mismanagement and liquidity squeezes at many regional banks. Given JPMorgan’s funding and capital position, I see little risk to the bank and I expect banks like JPMorgan and Bank of America to be net beneficiaries to rules changes that could ultimately force smaller banks to take a more conservative approach to loan growth, though this benefit is likely to be offset by higher charges/fees to further strengthen the FDIC.
Q2 Should Be Another Healthy Quarter, At Least Relatively Speaking
Looking ahead to second quarter earnings, I don’t see much to concern JPMorgan investors as most of the major macro trends have continued to develop as management has expected and incorporated into investments. That said, I do still see some areas where JPMorgan could offer upside relative to current average sell-side estimates.
Deposit costs continue to rise across the sector as banks have to pay more to keep deposits (let alone attract new deposits), but large banks like JPMorgan, Bank of America, Citigroup (C), PNC (PNC) and Wells Fargo (WFC) have benefited from a “flight to safety” that has seen large uninsured deposits flow from smaller regional banks into these large institutions. At the same time, many of these same regional banks are having to (or choosing to) slow lending to improve their liquidity. With that, loan spreads are still pretty attractive and I see an opportunity for JPMorgan to deliver some upside on net interest margin even with modest earning asset growth.
I do see more risk on the non-interest income side. Peers have been guiding down recently for trading income, and I would expect JPMorgan to see some of those same pressures. Some analysts have already started adjusting their estimates lower and I believe we could see some further downward revisions over the next week or so as analysts publish their Q2 preview reports. I don’t believe there’s anything fundamentally wrong here beyond just an overall decline in volumes; JPMorgan’s market share in trading is still quite good (even with Bank of America stepping up recently), and likewise in investment banking.
Expenses are always a tricky line-item to estimate for the largest banks, and JPMorgan is no exception. That process is complicated by the need to integrate the First Republic acquisition, though the late May Investor Day did give analysts a chance to adjust their estimates and management here usually gives conservative guidance. Still, I do see a risk of somewhat higher initial post-merger expenses, and JPMorgan is still in the process of investing in the business (particularly in branch-based banking and small business banking, as well as digital and payments tech).
All told, I think JPMorgan will beat on pre-provision operating income due to better-than-expected net interest income, but I do still see a weak sequential reported number as a likely outcome. I also expect management to be restrained on its buyback activity as it awaits the Fed’s initial proposals on Basel IV.
Built To Win
I don’t see the near-term challenges for the banking sector getting any easier in the short term. Loan activity continues to slow, with recent Fed H.8 data still showing year-over-year growth in almost every lending category, but slower growth relative to the first quarter (up around 8% year over year for the quarter, with the most recent weekly figure up 6% year over year).
Looking further, C&I lending is down sequentially versus the first quarter and appears to be losing further momentum. That’s a risk for JPMorgan, as well as other meaningful C&I lenders like PNC, and commercial real estate lending has likewise continued to slow. CRE lending isn’t all that significant for JPMorgan, but it’s worth watching for banks like Synovus (SNV), M&T, and Citizens (CFG). Card lending is also slowing, but at a much more modest rate and double-digit year-over-year growth bodes well for leading card lenders like JPMorgan and Citi.
On the funding side, deposits continue to flow away from banks. Core deposits are on pace to decline about 8% from the prior year, forcing banks to turn to higher-cost time deposits (CDs, mostly). JPMorgan outperformed the sector in the first quarter in terms of deposit-gathering, and I expect that to continue, but I do expect even JPMorgan to see some deposit erosion (in organic terms, at least) as depositors chase higher rates elsewhere. As I mentioned above, while deposit costs are going to pressure NIM in the short term, reduced lending capacity among smaller banks is a net positive for loan spreads and I expect JPMorgan to benefit over the longer term.
“Longer term” are keywords where JPMorgan is concerned, as I believe JPMorgan has the infrastructure in place to continue to outperform. The bank continues to benefit from organic branch initiatives launched in prior years and it takes time for those branches to mature – as they do, this is a “coiled spring” for future revenue growth and profit leverage.
JPMorgan is also relatively early in a process of actively growing its small business lending operations. Large banks aren’t typically considered great options for small business borrowers, but JPMorgan is actively looking to change this with technology investments and cultural adjustments that should allow for quicker lending decisions and more competitive offerings.
The Outlook
Given the opportunities to leverage growth in under-penetrated retail and small business markets, as well as opportunities in areas like middle-market lending and payments, I expect JPMorgan to generate long-term core earnings growth in the mid-single-digits (around 5%). I’m expecting that 2023 earnings growth will be comfortably above that trend before a below-trend year in FY’24, and we still need to see what the post-Basel IV capital requirements will look like.
Between discounted core earnings, forward P/E, and ROTCE-driven P/TBV, I believe that JPMorgan is undervalued below the mid-$150’s.
The Bottom Line
There are banks that offer considerably more upside than JPMorgan today, but on a risk-adjusted basis, I still think JPMorgan offers worthwhile upside. Few banks can switch as easily between offense and defense as JPMorgan, and likewise few banks are as competitive in so many markets as JPMorgan. Given significant unknowns on the regulatory front and ongoing challenges in the macro environment, I think the balanced approach is a good one and this remains a bank worthy of consideration as a core investment.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of JPM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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