Analysis: JPM

Tuesday morning, before the opening bell, JPMorgan Chase (JPM)  reported a top and bottom-line beat with its second-quarter 2019 results. On the top line, managed revenues of $29.566 billion (+4% YoY), beat expectations of $28.835 billion and on the bottom line, diluted earnings per share of $2.82 (+23% YoY), exceeded estimates of $2.50 per share.

Looking to several key bank-wide metrics, the bank's interest-rate spread contracted sequentially to 2.17%, while the all-important net yield on interest-earnings assets (net interest margin or "NIM") was a tad short versus expectations coming in at 2.49% (-8bps sequentially) versus a 2.51% consensus. While this line item is somewhat disappointing, it does not come as surprise given the flatter yield curve seen throughout the second quarter, and while it may be causing some pressure this morning, it will likely ultimately be forgiven as current Fed commentary and guidance aided in steepening the curve.

On a managed basis (which makes for an apples-to-apples compare versus estimates), JP Morgan reported an overhead (or "efficiency") ratio (operating expenses/revenue) of 55% was better than the 56.6% ratio expected by analysts (recall, on this front, lower is better as it essentially indicates the cost of revenue.

At an impressive 20%, return on tangible common equity (ROTCE) increased from the 19% rate of return seen in the first quarter and the 17% seen in the year ago period. The result also exceeded the 17.2% consensus. As a reminder, this is a key metric that has helped the stock justify its premium price to book multiple.

Meanwhile, the bank's common equity tier 1 (CET1) ratio, which compares core equity capital to total risk-weighted assets and is a measure of financial strength, came in at 12.2%, a slight miss versus expectations of 12.4%, however remains well above the Fed's required 4.5% minimum and indicative of a strong financial position that provides room for additional business investments, shareholder returns and a solid buffer against an economic downturn. Bottom line, the takeaway here is simply that the balance sheet remains a fortress and the bank has plenty of capacity for additional shareholder returns.

Additionally, the bank's tangible book value per share (TBVPS), which is a measure of book value less goodwill and other intangible assets, came in at $59.42 (+8% YoY), above expectations of $58.11 and up from $55.14 in the same period last year.

On the capital return front, JP Morgan returned a total of $7.5 billion to shareholders, with $5.0 billion coming in the form of share buybacks and the remainder via a common dividend of $0.80 per share.

Lastly, regarding management's updated outlook, this was likely a source of pressure for shares on the initial release (though shares have since reversed course) as management reduced their FY2019 net interest income outlook from the $58B+ forecast provided in the first quarter to $57.5B+/- and increased their expected net charge-offs (loans management does not expect to be repaid) from "<$5.5B" to "~$5.5B."

As for capital returns, speaking to our commentary above regarding the CET1 ratio, management noted on the conference call, "We are pleased to have significant flexibility with repurchase capacity of up to 29.4 billion over the next four-quarters and the board announced its intentions to increase the common dividend to $0.90 per-share effective in the third quarter."

Consumer & Community Banking

Within the Consumer & Community Banking division, revenues of $13.833 billion (+11% YoY) outpaced expectations of $13.729 billion, leading to segment income of $4.174 billion. Digging deeper, average loans declined 2% YoY as Home Lending loans fell 7% (impacted by loan sales) while credit card loans advanced 8% and business banking loans ticked up 2% from the same time last year. Also driving the top line was a 3% YoY increase in average deposits, a 16% YoY increase in client investment assets and an 11% YoY advance in credit card sales. Active mobile customers also increased, advancing 12% from the same period last year as the bank continues to invest in its digital efforts.

However, slightly offsetting the rise in revenue, expenses increased 4% YoY on the back of business investments, and higher auto lease depreciation that was only partially offset by expense efficiencies and lower FDIC charges.

Breaking the top line down further, JP Morgan generated revenues $6.797 billion (+11% YoY) within Consumer & Business Banking "predominantly driven by higher net interest income as a result of higher deposit margins and balance growth".

Within Home Lending the bank generated $1.118 billion (-17% YoY) "driven by mortgage servicing rights (MSR) adjustments, reflecting updates to model inputs. Excluding this adjustment, revenue would have been up 4%, driven by higher net production revenue, largely offset by lower net interest income due to the impact of spread compression and lower balances."

As for Card, Merchant Services & Auto operations, revenues revenue came in at $5.918 billion (+18% YoY) "including the impact of a rewards liability adjustment of approximately $330 million in the prior year. Excluding this adjustment, revenue would have been up 11%, driven by higher Card net interest income on loan growth and margin expansion, and higher auto lease volumes."

Corporate & Investment Banking

Moving on to Corporate & Investment Banking, revenue of $9.641 billion (-3% YoY) was a beat against the $9.359 billion consensus and resulted in net income of $2.935 billion (-8% YoY).

Breaking top-line revenue down further, Total Banking revenue came in at $3.248 billion (-6% YoY) while net revenues from Total Markets & Investor Services came in at $6.393 billion (-1% YoY).

Within Total Banking, Investment Banking revenue came in at $1.776 billion (-9% YoY) "reflecting lower fees across products." As for Treasury Services, revenue contracted to $1.135 billion (+-3% YoY), "predominantly driven by deposit margin compression, largely offset by growth in balances and fees." Lending revenue on the other hand, advanced to $337 million (+5% YoY) "predominantly driven by higher net interest income reflecting growth in loan balances." It is also worth noting that the firm maintained its #1 rank in Global IB fees year-to-date. Additionally, regarding the poor YoY performance at Investment Banking, management reminded investors on the call that "performance was particularly strong last year which featured record or near-record revenues in overall IB fees and Equity Markets," adding that "Advisory, debt underwriting and equity underwriting fees were down 16%, 13% and 11% respectively reflecting lower levels of deal activity as well as a 10-year record share in equity underwriting in the prior-year."

As for Total Markets & Investor Services, within the segment, Fixed Income Markets revenue came in at $3.69 billion (-3% YoY) reflecting "relative weakness in EMEA across products, largely offset by increased client activity in North America Rates and agency mortgage trading due to the changing rate environment." Equity Markets revenue was $1.7 billion (-12% YoY) "predominantly driven by lower client activity in derivatives as well as a strong prior year comparison." Lastly, Securities Services revenue of $1.045 billion (-5% YoY) "driven by deposit margin compression and the impact of a business exit, partially offset by increased client activity."

Commercial Banking

Commercial Banking revenues of $2.211 billion (-5% YoY) missed expectations of $2.332 billion, leading to $996 million in net income. The annual decline in sales was "predominantly driven by lower investment banking revenue, compared to a strong prior year, and lower net interest income on lower deposit balances." On the call, management also note that "Global IB revenue of $1.4 billion was up 4% year-to-date on strong syndicated lending and M&A advisory activity and we continue to move solidly toward our long-term $3 billion target."

Asset & Wealth Management

Within Asset & Wealth Management, revenues of $3.559 billion was roughly flat YoY "as the impact of higher average market levels was offset by lower investment valuation gains." This was a slight miss versus expectations of $3.57 billion and resulted in net income of $719 million. Additionally, during the conference call, management noted "we saw record net long-term inflows of $36 billion driven by Fixed Income." Moreover, the firm ended the quarter with Assets Under Management (AUM) of $2.2 trillion (+7% YoY) and client assets of $3.0 trillion.

Dimon's Economic View

In support of solid print, CEO Jamie Dimon provided a positive view on the U.S. economy in the company's press release, which should serve to ease concerns of an imminent recession stating, "We continue to see positive momentum with the U.S. consumer - healthy confidence levels, solid job creation and rising wages - which are reflected in our Consumer & Community Banking results. Double-digit growth in credit card sales and merchant processing volumes reflected healthy consumer spending and drove 8% growth in credit card loans, while mortgage and auto originations showed solid improvement, and we continued to attract new deposits, up 3%. Client investment assets were up 16%, driven by both physical and digital channels, including You Invest." That said, Dimon did somewhat caveat his positive view of the consumer, noting "In the Corporate & Investment Bank, Markets performance was relatively steady on slightly lower client volume, probably due to slightly higher global macroeconomic and geopolitical uncertainties. Treasury Services and Securities Services demonstrated good organic growth despite headwinds from rates."

Bottom Line

All in, while this was not the cleanest quarter from JPMorgan, as there are few misses here and there on the underlying line items, it was nonetheless a solid print from a difficult quarter. We believe the bank's robust balance sheet, better than expected tangible book value and best-in-class return on tangible common equity are all causing investors to forgive the net interest margin miss, which again, was expected to see a contraction due to the flatter yield curve seen in the second quarter. Additionally, while the FY2019 net interest income guidance cut is disappointing, we would note that this guidance is based on "lower rates and up to three rate cuts this year," the point being that the expectations baked into this guidance cut are relatively conservative and as a result, there could be upside should we see less than three Fed rate cuts by the end of the year. Bottom line, despite the noise, we continue to view JPMorgan as an industry leader. However, given the run shares saw ahead of the quarter and underlying misses on select line items, we maintain our Two rating.

Members interested in reviewing the earnings material may do so, here.