JPM - JPMorgan Chase: Winning On All Fronts

2023-05-03 14:09:32 ET

Summary

• JPMorgan Chase & Co. has seen strong first quarter results, even as the banking sector was in turmoil.
• The bank has seen modest deposit inflows, despite its status as "too-big-to-fail."
• JPMorgan Chase & Co. now emerges as the winner for the First Republic Bank scramble.

By Mid-March, I had concluded that JPMorgan Chase & Co. ( JPM ) was solid as a rock, being a real stronghold at a time of uncertainty. I pointed out it was very well capitalized, and it saw near-term deposit inflows, making it a beneficiary of the uncertainty in the (regional) banking sector. As it turned out, deposit inflows in the fourth quarter were modest, yet the strong balance sheet allowed the bank to play a key role in further consolidation.

A Quick Recap

Amidst the uncertainty in the (regional) banking sector in March, shares of JPMorgan Chase & Co. shed about $10 in a week, marking a big pullback. However, contrary to smaller peers, JPM ended the disastrous week on a positive note. This came as investors were distinguishing between smaller banks and larger banks, with the larger banks being better capitalized, more regulated, and thus making them a beneficiary as depositors moved their deposits to the bigger banks (with the implicit government backing).

The issue is that there were two problems for banks, which in one way or another impacted all banks in the same way, although the degree depends heavily on the strategy and investment/lending choices being made.

The first was that banks were rich on deposits after government handouts placed a lot of cash with consumers and smaller businesses. As the Fed started on its historically aggressive rate hiking cycle, banks were slow to raise their deposit rates as they were rich on deposits to start with, and the Fed has operated aggressively ever since. With the gap between risk-free alternatives rising, depositors were moving money, and hence banks might see pressure on net interest margins.

The other immediate risk was that of the impact of these higher rates on the asset side of the balance sheet of the bank, related to loans as well as held-to-maturity and available-for-sale securities which are immediately impacted. With some duration risks, these assets lost quite some value, no issue as long as depositors do not flee which otherwise might create a hole in the capital of the bank when it is forced to sell these assets (instead of holding them until maturity).

A Look At JPMorgan

JPMorgan has seen a decent 2022, a year in which revenues rose by 6% to $128 billion, although that higher rates triggered an acceleration in fourth quarter revenue growth with revenues up 18% to $35 billion.

The bank posted a $37 billion profit, which was down $10 billion from the year before. That does not tell much, as credit loan loss provisions came in at $6 billion after they were negative $9 billion in 2021, following huge reserves made in 2020 which not have been written down.

The balance sheet was down 2% to a staggering $3.7 billion, financed by about $2.3 trillion in deposits, actually down 5% on the year before despite the fact that the bank paid interest-bearing deposits a fairly competitive rate of 1.4% on the fourth quarter of 2022. With that I mean relative competitive rate to other banks, as it trails risk-free alternatives by a huge margin.

While JPMorgan Chase & Co. likely saw some losses on $631 billion investment securities either held available-for-sale or held-to-maturity, realistic losses would likely be very manageable given a $300 billion shareholder equity position, but moreover not applicable as the bank actually saw deposit inflows following the fears emerging in the space.

While the bank is a rock-solid operator which might benefit from the turmoil in the near term by attracting depositors or even by acquiring bank (assets), the issue is that JPM likely would be hurt by higher deposit rates as well, making me a bit cautious to be involved with the shares, as I generally shy away from investment into financial institutions.

What Happened? - Earnings

Since the cautious stance at $130 by mid-March, JPM shares hovered in the mid-120s as uncertainty was prevailing in the banking sector. Shares then rose to the $140 mark on the back of strong quarterly results and the acquisition of First Republic Bank ( FRC ) as well.

In mid-April, the bank posted a solid set of first quarter results. Reported revenues rose by a quarter to $38.3 billion as net earnings rose by as much as 52% to $12.6 billion, translating into handsome earnings of $4.10 per share. Home lending revenues fell amidst the correction in the housing market, but this is really a small division for the bank. This was offset by a strong performance of the bank and wealth management activities.

If we look at the deposit base, a $2.37 trillion deposit base is up 2% on a sequential basis, but down 5% on an annual basis, marking pretty stable developments here, despite the deposit inflows taken from other banks. This comes as consumers at large have withdrawn deposits from the sector, investing money elsewhere, or simply needing it for their consumption. The bank paid more than 1.8% on these interest bearing deposits, rapidly getting more competitive here.

The First Republic Bank Deal

On the first day of May, JPMorgan emerged as the winner in the bidding race for First Republic Bank. The company acquired a total of $203 billion in loans and securities, assuming $92 billion in deposits, which includes $30 billion of large bank deposits which will be repaid. The bank will pay $10.6 billion to the FDIC, but will not assume any of its debt or equity, of course.

In return for the acquisition, the company will enter into a FDIC loss-sharing agreement on single-family residential mortgage loans as well as provide $50 billion in five-year, fixed-rate financing. The bank conservatively estimates about half a billion dollars in accretion, likely to please its investors, as this deal is really about bringing stability back to the banking sector. The conference call on the deal revealed that the company is downplaying the earnings power of the deal, to avoid scrutiny here as well.

And Now?

The reality is that the deal for First Republic might be a multi-billion home run, as JPMorgan is acquiring $203 billion in loans and securities, while assuming just $122 billion in liabilities, although this comes ahead of the $50 billion FDIC loan and the acquisition price.

Hence, this seems to be a steal in disguise. JPMorgan Chase & Co. is really trying to downplay its interest in buying First Republic as only doing it for the sector and nation. This might certainly be true, but JPM is likely getting a great deal itself in the meantime as well.

Hence, I remain upbeat on JPMorgan Chase & Co. after a strong first quarter and nice bolt-on deal. However, the reality is that higher funding costs likely will weigh on the sector and idiosyncratic risks remain elevated in the sector. That said, JPMorgan Chase & Co. has been a true long-term winner, and is probably remaining very much a long-term winner in this industry.

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