JPMorgan Still Cheap, But Never Easy

By Stephen D. Simpson, CFA | October 11, 2012 AAA

By and large, it looks like investors continue to prefer the regional banks to the money center banks such as JPMorgan (NYSE:JPM), Citi (NYSE:C) and Bank Of America (NYSE:BAC). To a certain extent, this makes sense - the regional banks are simpler to understand, less volatile (due in part to less reliance on trading and investment banking), and less of a soft target for litigation. That said, while JPMorgan's trading losses earlier this year highlight the fact that no bank with a prop desk is ever completely safe, today's valuation seems to undervalue not only the company's balance sheet and array of businesses, but the quality of its management and growth opportunities.

Credit Card Comparison: Find the credit card that is just right for you

A Strong Core, Driven By I-Banking and Cards
Once again, JPMorgan delivered a strong headline result (with revenue up 13% sequentially) and a strong core/adjusted EPS number. Much of the strength was centered in investment banking and cards, though consumer and commercial banking were pretty solid as well.

Revenue grew, despite an as-expected slowdown in net interest income. NII fell 2% sequentially, with core net interest margin down nine basis points (to 2.92%) and reported NIM down 4bp to 2.43%. As has been the case for some time now, JPMorgan is struggling to overcome faster mortgage prepays, as its reinvestment options are so limited (with a securities yield just over 2.1%).

Fees were up 28%, helped by ongoing strength in the mortgage business. JPMorgan saw some further increases in non-interest expense, but the efficiency ratio slipped below 60%. Credit quality is also pretty good, as provisions were about $1 billion higher than net charge-offs. While the reported non-performing asset ratio did increase sequentially (from 1.5 to 1.69), much of this was due to changes in how that number has to be calculated/reported.

SEE: Analyzing A Bank's Financial Statements

Underlying Trends Still a Little Mixed
JPMorgan's core banking and card performance looks solid, but not spotless. The company continues to attract deposits (checking accounts up 1% quarter-over-quarter, average deposits up 1% quarter-over-quarter), and the bank is seeing good growth in commercial/business lending. Mortgage originations are also strong (up 8%), but retail channel originations fell 2% and the company's overall loan balance was still down. At a very simplistic level, JPMorgan is still working on getting the basic banking business back to a healthy operating state.

On the card side, I'm still slightly concerned. The Card business saw 4% sequential growth and bad debt has improved, but underlying spending looks soft. If that's an industry-wide trend, it won't do any favors for American Express (NYSE:AXP), Capital One (NYSE:COF) or U.S. Bancorp (NYSE:USB), as there's only so much additional benefit to be had from lower bad debt expense.

The better-than-expected performance in trading was welcome, and it will be interesting to see if Goldman Sachs (NYSE:GS), Citi and B of A can match that sort of performance. JPMorgan has been an outperformer here for a while, so those reports should be interesting. Elsewhere, those ongoing strong trends in commercial lending ought to be good news for U.S. Bancorp, BB&T (NYSE:BBT) and other smaller banks, such as M&T Bank (NYSE:MTB).

SEE: The Banking Industry in 2012

The Bottom Line
It's always something with these large banks, and recent litigation tied to Bear Stearns is no exception. JPMorgan CEO Dimon commented sharply on the dichotomy between how the government has treated banks like JPMorgan (which bought Bear Stearns largely at the government's request) and how the government pretty much absolved GM in that bailout. I don't expect anybody to feel particularly sympathetic to the big banks, but it's worth noting that the litigation noise is far from over.

I continue to like JPMorgan, and I believe the bank is doing relatively well in what remains a very challenging environment for the industry. Assuming that JPMorgan can regain a return on equity in the 11 to 12% range by 2017, these shares ought to trade in the $50s. With a solid dividend, prospects for share buybacks in 2013 and overall undervaluation, I think these shares remain a good buy.

At the time of writing, Stephen D. Simpson owned shares of JPMorgan and BB&T for over five years.

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