JPMorgan Chase: Stretching Out Its Lead In A Tough Bank Stock Environment

Summary:

• JPMorgan Chase has handily outperformed its peers in the banking sector, with 10% to 30% outperformance on a year-to-date basis on the back of much stronger-than-expected earnings leverage.
• The bank’s balance sheet positioning and asset sensitivity have allowed it to benefit from higher interest rates and maintain strong net interest margins.
• JPMorgan’s operating leverage, loan growth, and fee-generating businesses have contributed to its profitability and efficiency ratios, further setting it apart from its competitors.
• JPMorgan is not the cheapest high-quality bank, but it does look well-positioned for the current environment and still offers enough upside to be worth consideration.

Regular readers know that I make no secret of my admiration for JPMorgan Chase (NYSE:JPM) and its management team, nor the fact that I think this is one of the best-run banks (and overall companies) in the world.

It’s not hard to maintain that position when the company continues to execute well relative to its peers and targets/guidance, and when that execution is rewarded by the market. Looking at the performance of JPMorgan relative to its “Four Horsemen” peers (Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC)) and the larger bank group in general, JPMorgan stands out with a 10% to 30% outperformance on a year-to-date basis. The outperformance on a one-year basis is even more glaring, with JPMorgan shares up more than 35% and the next-best performer in the KBW Nasdaq Bank Index coming in at +7% (Bank of New York Mellon (BK)).

While I do think that “flight to quality” and the perception of JPMorgan as the best-run bank in the business have helped during this period of exceptionally weak sentiment, there are also fundamental factors at play, and I believe these can continue to drive better results into 2024. All of that said, this outperformance does come at a price – while I still think JPMorgan offers some upside for investors, there are definitely names with more upside potential for the eventual turn in business and sentiment.

Sensitivity Is Still A Tailwind

While it may be generally true that banks perform better when rates are coming down, the reality of bank performance relative to rates is more complicated than “higher rates bad, lower rates good” and there are a lot of bank-specific factors to consider.

Take the case of net interest margin, deposit betas, and asset betas. As rates have shot up rapidly, deposit betas have become one of the hottest topics in the banking sector, with banks with lower betas (that is, lower increases in deposit costs relative to increases in benchmark rates) generally more in favor. Superficially, that’s bad for JPMorgan, as the bank’s cumulative interest-bearing deposit beta is already 45% (versus 57% at Citi, 36% at Bank of America, and 32% at Wells Fargo).

The ”but” is that deposit beta isn’t the only thing that matters. First, while JPMorgan has seen its deposit beta accelerate sooner in the cycle, and probably will have a higher peak beta than many peers, don’t forget that there can be some “rubber band” effects here and some of these laggards may yet see their betas shoot up in the later stages of the cycle. Moreover, higher-cost deposits aren’t always the worst thing – paying up to keep deposits can still be cheaper than turning to other sources of financing (Bank of America, for instance, has been quite active in short-term borrowings).

There’s also another part of the equation that matters, asset sensitivity, and this is where JPMorgan has been shining. Not only has JPMorgan been doing relatively well with loan growth and credit quality, it has structured its balance sheet in such a way that it is garnering more benefit from these higher rates. That shows up in metrics like net interest margin, where JPMorgan’s 2.62% in Q2’23 compares well to Citi (2.06%) and Bank of America (2.48%), while lagging Wells Fargo (3.09%).

Given this balance sheet positioning, JPMorgan will likely see less pressure on its NIM than other banks in the next couple of quarters (I expect NIMs below sell-side estimates to be a theme for the coming third quarter reports) and less pressure on net interest income. Indeed, JPMorgan has delivered some of the strongest beat-and-raise performances this year, with the company’s net interest income now about 18% above initial targets.

Better still, this balance sheet positioning can also allow the company to start moving in a way that will better-position the company for ongoing success. While management believes they’re significantly over-earning today (a ROTCE of 23% versus a 17% full-cycle target), JPMorgan has the luxury of gradually repositioning its asset sensitivities/exposures in a way that will allow for better earnings performance when rates fall, but without hammering near-term profitability.

Operating Leverage, Loan Growth, And Fee-Generating Businesses Stepping Up

JPMorgan’s net interest margins and asset sensitivity aren’t the only positives that matter. Indeed, the company is generating profitability numbers (efficiency ratio, returns on tangible common equity, et al.) well above many of its peers due to a combination of positive drivers.

Operating leverage has come to the fore recently as a positive driver. While JPMorgan had taken a hit in prior years for aggressive operating spending aimed at reinvesting in the business (particularly digital capabilities), the benefits of past spending are coming through. JPMorgan is on track for strong positive operating leverage in 2023 (up 10% or so) versus single-digit growth at Bank of America, a slight decline at Citi, and high single-digit growth at Wells Fargo. The effect likely won’t be so profound in 2024 (flat to up slightly), but I still expect JPMorgan to outperform by 100bp-200bp here as well.

It’s also worth, I think, taking a look at efficiency ratios. For Q2’23 JPMorgan posted an impressive 50.3% (lower is better), while Bank of America came in at 61.3%, Wells Fargo at 63%, and Citi at 64.6%. Looking ahead, while I do think Citi and Wells Fargo can continue to improve, I expect ongoing superior execution at JPMorgan and a low/mid-50% efficiency ratio that not many banks will achieve (only Regions (RF) is likely to be close in the near term).

In addition to leveraging above-average asset sensitivity to generate better NIM, JPMorgan has also been performing well in its lending. The company has maintained one of the strongest card lending franchises in the sector (at a time when card lending is one of the few growing categories) and the company’s efforts to improve its middle-market lending have likewise started paying off. That has lead to stronger loan growth relative to Citi and Wells Fargo for multiple quarters now, and taking the lead from Bank of America last quarter – looking ahead, I think that JPMorgan’s funding, credit, and lending operations positions will allow for mid-single-digit loan growth in FY’24 (after double-digit growth in FY’23), not only better than its peers but also boosting the benefit of the better asset sensitivity profile.

Last and not least is fee-based income opportunities. Wells Fargo has been building up its trading operations, and that should be an important source of future non-interest income, but JPMorgan has continued to do well in both investment banking and trading. What’s more, the investments that the company has made into areas like payments have given the company a strong skew of non-interest income (46% of revenue) in its revenue mix. I do see some risk that the economy slows further in 2024, which will impact areas like payments, but this is nevertheless an invaluable source of income.

The Outlook

There are certainly reasons to be concerned about banks now. Lending has continued to slow, with recent Fed data indicating that loan growth has declined from around 8% early in the year to just above 1%, with business (C&I) lending now basically flat. Rates (and deposit costs) are likely still heading higher, and it generally takes a quarter or two for deposit costs to peak once the Fed stops raising rates. Current market expectations are for one more hike, then cuts in 2024, but many have noted the risk of even higher rates (including JPMorgan’s CEO), and expense-driven operating leverage will be harder to come by as many banks have already undertaken meaningful cost-reduction efforts.

Still, I continue to expect above-peer performance from JPMorgan, and the acquisition earlier this year of First Republic only helps the long-term story (including accelerating the build-out of its lucrative private banking operations). With stronger than expected results this year, my near-term core earnings growth rate is still around 5%, and I expect long-term growth in the 4%-5% range. Threats like increased capital ratios remain, but I believe are well-understood by the market now, and management has been planning for higher capital ratios for some time now.

Between discounted long-term core earnings and near-term approaches like ROTCE-driven P/TBV and P/E, I believe JPMorgan shares should trade in the mid-$150’s to $160. Assumptions used here include a 16.6% ROTCE in 2024 (and a resulting 2x multiple on TBVPS) and a 9.9x multiple on 2023 EPS – lower than the average, but arguably appropriate given sentiment today.

The Bottom Line

JPMorgan isn’t the cheapest bank stock out there, but I wouldn’t expect that for one of the best and most reliable names in the business. I certainly understand why investors may prefer to go with names like Bank of America and Wells Fargo given greater upside potential, but for investors who prefer one-decision stocks they can stick with through thick and thin (or at least until there’s a change in the CEO position), I still think JPMorgan qualifies and offers enough upside to be worth consideration.

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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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