JPMorgan Chase’s Wild Ride

Investing Daily Article of the Week

by Brian O’Connell

What’s to like about a “too big to jail” bank that just announced it has paid a whopping $9.15 billion in pre-tax legal expenses, up from $684 million just a year ago?

Oh, and its third-quarter numbers came in under the red side of the ledger, and it follows a conga line of publicly traded companies that have told Wall Street not to expect them to meet third-quarter performance expectations.

The bank in question is JPMorgan Chase & Co (NYSE: JPM) and it’s making big news this week, as the specter of the federal government shutdown has haunted big banks and financial stocks have been wobbling a bit.

In addition, 20 percent of US companies in the S&P 500 say they expect to underperform this quarter (that last piece of news coming from John Butters, a senior analyst at FactSet, an investment analytics firm).

JPMorgan’s Q3 numbers were announced early on Friday, October 11, and the stock bounced around more than a Tim Wakefield knuckleball as investors tried to discern the meaning of a $9 billion legal cost hit, solid financials (once you dig deep), and a general consensus among analysts that JPM was still a stock to take to the bank.

First, here are the numbers, straight from JPMorgan’s financial statements released on October 12:

JPMorgan Chase & Co. today reported net loss of $0.4 billion for the third quarter of 2013, compared with net income of $5.7 billion in the third quarter of 2012. Earnings per share were (negative) $0.17, compared with $1.40 in the third quarter of 2012. Revenue for the quarter was $23.9 billion, compared with $25.9 billion in the prior year. The firm’s return on tangible common equity for the third quarter of 2013 was (negative) 2 percent, compared with 16 percent in the prior year.

Third-quarter results included legal expense in corporate of $9.2 billion ($7.2 billion after-tax), and a benefit from reserve releases of $1.6 billion ($992 million after-tax). Excluding these items, third-quarter net income would have been $5.8 billion, or $1.42 per share.

Clearly, JPM executives are blaming the legal woes for the bank’s off-beat earnings statement.

Send Lawyers, Guns & Money

Chief executive officer Jamie Dimon, who saw the first quarterly loss under his stewardship at Morgan, points the icy finger of guilt at Washington, DC and what he sees as an onerous regulatory and oversight environment.

Dimon said in an October 11 mea-culpa-like statement that –

“While we had strong underlying performance across the businesses, unfortunately, the quarter was marred by large legal expense. We continuously evaluate our legal reserves, but in this highly charged and unpredictable environment, with escalating demands and penalties from multiple government agencies, we thought it was prudent to significantly strengthen them.”

The beleaguered CEO says the ongoing legal morass over the bank’s purchase of Bear Stearns and Washington Mutual, and the resulting mortgage headaches that came with those transactions — a situation Dimon calls “extraordinary” — have hurt the bank. Dimon is reportedly none too happy over the government’s aggressive investigation of those deals, especially the Bears Stearns buyout, which came at the behest of the US government back in 2008.

He also offers a heads-up to investors about the banking giant’s legal costs going forward.

He adds –

“While we expect our litigation costs should abate and normalize over time, they may continue to be volatile over the next several quarters.”

But once you get past the legal wrangling, and the sticker shock of that $9 billion tax bill, JPMorgan actually has a lot going for it.

As Dimon points out, most of the third quarter was actually positive, and maybe that’s what traders were looking at as the stock rose 2.6 percent in the first hours after the quarterly release.

Here’s a rundown of some of the good news Dimon brought to the table from the bank’s Q3 numbers:

1. JPMorgan Chase held tight to its #1 rank in global investment banking fees. In addition, JPM ranked #1 in global debt, equity and syndicated loans.
2. Equity markets revenue was up 20 percent, driven by broad-based strength across products.
3. For the second consecutive year, JPM led the nation in deposit growth, up 10 percent from the prior year, more than twice the industry average.
4. Credit card sales volume was a record $107.0 billion, up 11 percent, and general purpose credit card sales volume growth has outperformed the industry for 22 consecutive quarters.
5. JPM’s Asset management continued to post strong performance, with $19 billion of net long-term client flows, the 18th consecutive quarter of positive net long-term client flows.

Year-to-date, JPM’s stock price has been up about 17 percent, and the smart money says that, despite the mammoth legal costs incurred by the bank, the stock should continue its upward momentum.

Yes, those toxic mortgages stemming from the Bear Stearns and Washington Mutual debacles continue to be a drain on the bottom line. Any news of a monster settlement would almost certainly slow JPM’s stock price progression, especially in relation to its industry rivals.

That said, let’s not ignore the data outlined above, and also the bank’s top-notch performance in the retail and investment banking markets.

And let’s not ignore a robust trading portfolio that, as Zacks Investment Research points out, is not interest-rate sensitive.

Zacks says in a recent research note –

“Persistent low interest rate environment will continue to enhance trading activities, which should strongly support the top line going forward.”

If you can get past the $9 billion hit, then JPMorgan Chase’s Q3 numbers look fairly strong, and should help trigger an upswing not only in its own share price, but those of key competitors such as Goldman Sachs (NYSE: GS) and Citigroup (NYSE: C).

So look for a further 20 percent climb in JPM, even as it remains an investment banking lawyer’s best friend.

For now, that is.