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JPM AT A GLANCE

P/E ► 28.6 AVG EV/EBITDA ► 18.0 AVG ROA ► 1.3% AVG ROE ► 4.6% AVG Debt to Equity ► 11.6 AVG Current Ratio ► 0   Interest Coverage Ratio ► 1.98 AVG

 

 

 

 

 

 

JPMorgan Chase & Co. (NYSE: JPM) is one of the largest financial institutions in the United States. Its main services include the provision of credit cards and loans and other financial services to both commercial and individual customers in addition to the underwriting of new debt and equity issuance through its investment banking division. Together, these three businesses comprised almost 75% of JPMorgan Chase's $71.3B in 2007 revenue. The firm has a significant amount of international exposure, with operations in over 50 countries and clients in every major financial market in the world.

Despite having sold $25B in preferred stock to the US Government through the Troubled Assets Relief Program (TARP) in October 2008, JPMorgan Chase's performance has been relatively strong thus far.^[1] To avoid government interference and increased oversight, it was one of the first financial institutions to repay its TARP funds. It reported record revenues and positive earnings in 2Q2009, despite having incurred more than $25b for repaying its TARP funds, which included more than $800m in dividends for preferred stock. In addition, it reported a Tier 1 Capital Ratio of 9.7%, well above the 4% minimum outlined by the Fed to be considered adequately capitalized.^[2]

In March 2008, JPMorgan announced that it would acquire Bear Stearns Companies (BSC). The deal was approved by Bear shareholders making the acquisition official and ending Bear's 85 years as an independent firm.^[3] Additionally, in September 2008, JPMorgan acquired Washington Mutual (WM) after WaMu suffered a run on the bank and saw its liquidity effectively disappear.

Business Overview

2008 Net Revenue and Net Income by Line of Business, in millions USD^[4]

Investment Banking (16.8% of 2008 revenue; -21.0% of 2008 net income)

Investment banking is JPMorgan Chase's chief operation. The investment bank is employed by clients running the gamut from large corporations to governments to financial institutions. JPMorgan offers a wide range of financial services, including risk management, corporate advising, trading and market-making (enabling transactions between buyers and sellers of cash securities and derivatives), capital raising in equity and debt markets, and research. The investment bank is also responsible for investing and trading with the firm's own capital.

Both net revenue and net income declined in this segment with net income going negative. The losses were driven by writedowns of $5.9B in mortgage-related activities and $4.7B in leveraged lending commitments. These writedowns were mostly caused by subprime-related holdings and overall unfavorable global credit conditions. The acquisition and consolidation of Bear Stearns in May of 2008 also added to the poor performance of JPM's Investment Banking Segment. The segment did see record highs in returns on rates and currencies, credit trading, commodities and emerging markets.^[5]

Retail Financial Services (32.3% of 2008 revenue; 15.7% of 2008 net income)

JPMorgan Chase's retail bank accounted for 32.3% of the firm's earnings in 2008. Chase has the third-largest deposit base in the U.S., and has the largest market share in large cities like Chicago and New York, with the acquisition of Bank of New York's operations. The firm also operates the third-largest ATM network in the United States and the nation's fourth-largest branch network. The segment acquired Washington Mutual for $1.9B from the Federal Deposit Insurance Corporation (FDIC) on Spetember 25, 2008.

The division's net income fell substantially to $880 million in 2008 from $2,925 in 2007. Although Net interest Income rose due to the acquisition of Washington Mutual (WM), a large provision for loan loss offset these gains. JPMorgan had to set aside more money to cover losses in both subprime mortgages and prime mortgages. The segment's loan loss provision also increased due to a rise in predicted losses in auto, student, and business loans.^[6]

Credit Card Services (22.6% of 2008 revenue; 13.9% of 2008 net income)

Chase Card Services, JPMorgan's brand for its credit card services business, is the second-largest domestic issuer of Mastercard (MA) and Visa (V) cards, with a total of 168 million of its cards in circulation. Chase manages more than $190 billion in loans for customers ranging from individual consumers to small businesses. The business has grown naturally and through the acquisition of Washington Mutual's credit card operations. Chase Card Services has recently focused on expanding its network of private-label cards, which are cards issued by a specific retailer and are accepted only by the issuing retailer. Chase's current partners include BP (BP), Circuit City (CC), and Kohl's (KSS). Chase also issues cards jointly with various organizations, including Walt Disney Company (DIS), AARP, Marriott (MAR), Sony (SNE), and Amazon.com (AMZN). Private-label cards, while they offer better growth opportunities than traditional bank-issued cards, typically experience higher rates of delinquency, which adds additional risk to Chase's private-label expansion.

Credit Card services accounted for 22.6% of 2008 revenue. Net income declined by 73% from the previous year due to a higher provision for credit losses. The worsening economic condition has increased the likelihood of charge-offs and a higher delinquency rate.^[7]

Asset Management (10.4% of 2008 revenue; 24.2% of 2008 net income)

JPMorgan's asset management division provides retail investors, institutions, and high-net-worth individuals worldwide with investment and wealth management. The division's products and services include management of equities, hedge funds, real estate, fixed income, and private equity investments, as well as trust and estate services for its high-net-worth clients. Asset Management is the leader in asset management with over $1.5 trillion in investment and wealth management. In 2008, the segment's net profit and net revenue both fell. This was caused by lower performance fees from a weaker market overall. As whole, the weakening credit market hurt the segment's performance.^[8]

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Treasury & Securities Services (11.2% of 2008 revenue; 31.5% of 2008 net income)

Treasury Services provides cash management, trading, and other services to corporations, financial institutions, and government entities. Securities Services holds, values, and clears securities, cash, and alternative investments for investors and broker-dealers, essentially facilitating transactions on stock markets across the world. In 2008, this division made record profits of $1.8B and a record net revenue of $8.1B on record net revenue of $6.9 billion. Increased usage of its products and services by clients, growth in the volume of electronic transactions, and larger loan balances all contributed to the segment's performance in 2008.^[9]

Commercial Banking (6.6% of 2008 revenue; 23.7% of 2008 net income)

Commercial banking is a small but strong component of Chase's business, serving over 26,000 clients across the U.S. This division provides a range of banking services to corporations, government agencies, non-profits, and other financial institutions. Comprising only 6.6% of the firm's income, the commercial bank has earned record profits in both 2008 and 2007. The segment added $44.5B in loans from the acquisition of Washington Mutual and $2.3B in loans and $1.2B in deposits from the acquisition of The Bank of New York. The segment's share of net income has risen in recent years as the other segments have performed poorly while Commercial Banking has maintained growth.^[10]

2007-2008 Net Income Comparison by Line of Business, in millions USD^[11]

Trends and Forces

Repayment of TARP

$25 Billion Bailout and Repayment

In June 2009, JP Morgan announced that it had received permission to repay the $25b in TARP funds it had received from the government. It was one of the first financial institutions allowed to repay TARP funds because of its strong financial position, as well as its fulfillment of the conditions outlined by the Fed. This includes the passing grade that JPM got on the Stress Test in May.

The repayment of the TARP funds has cost JPM more than the $25b loan. It incurred a near $800m payment to the U.S. Treasury in dividends on the preferred stock it purchased, a non-cash $1.1b charge against its second quarter results, and a future payment to repurchase a 10 year warrant.^[14][15] Although JPM incurred a $1.1b charge in 2Q 2009, it still reported positive earnings of $2.7b and record revenues of $27.7b.^[2] In addition, it reported a Tier 1 Capital Ratio of 9.7%, which is well above the 4% minimum to be "adequately capitalized."^[2] The Fed used the Tier 1 Capital Ratio as a measure for the Stress Test it conducted in February 2009.

JPM Passes Stress Test

In February, Secretary of Treasury Timothy Geithner announced that banks with more than $100 billion in assets will be required to participate in a "stress test" -- a series of financial assessments to determine the health of the bank and if the bank needs additional capital.^[16] JP Morgan passed the Stress Test and was not required to raise additional capital. However, ten of its competitors had to raise approximately $175b in capital^[17]

The Fed's criteria for the Stress Test included measures such as, GDP, unemployment rates, and housing prices. These measures were used to simulate two economic scenarios: one similar to what has been predicted and one that is worse-than-expected. To measure how the bank could withstand such scenarios, the banks were asked to report estimated numbers, such as the amount of write downs and the bank's loan loss provision. Write downs occur when the bank's assets are overvalued compared to market value, so a high write-down number brings uncertainty in the true value of a bank's balance sheets. As "bad loans" were a key driver of the crisis, a bank's loan loss provision (LLP) provides information as to how many "bad loans" the bank has. In short, including write-downs and LLP helps to measure how much public shareholders would receive if the bank were nearing bankruptcy and had to sell most of its portfolio for cash (liquidation).

Acquisitions and Divestitures allow JPM to remain flexible

A few recent acquisitions and divestitures include:

• September 2009: it was announced that the Royal Bank of Canada, Canada's largest bank, will acquire JPM's investment adviser servicing business. This department of JP Morgan is third-party registered. The transaction is expected to be complete in 2010.^[18]
• September 2009: JPM and Cazenove agree to enter into a joint venture for investment banking services in London^[18]
• June 2009: JPM completes its acquisition of the hedgefund Highbridge Capital Management.^[18]

Bear Stearns Buyout and Washington Mutual

In March of 2008, JPMorgan announced its intention to acquire troubled investment bank Bear Stearns Companies (BSC) for $2.32 per share, significantly less than its closing price of around $30 on the previous trading day. This sent Bear Stearns shareholders into an uproar, which eventually led JP Morgan to raise its offer to about $10 per share, more than four times the original bid. The takeover was approved by shareholders on May 29, 2008. JP Morgan hopes to take advantage of Bear's name and customer relationships to augment its existing investment banking operations. Bear's private equity unit will be spun off, however, as an independent company. JP Morgan will retain a $1 billion stake in Bear Stearns Merchant Banking, which manages about $5 billion.^[19]

JP Morgan also acquired Washington Mutual on September 25, 2008 for $1.9B. This purchase includes $307B in assets and $188B in deposits ^[20] JP Morgan will have to work to integrate the two companies together - WaMu is the largest bank, in terms of assets, in history to fail. JP Morgan announced that it plans to lay off 9,500 employees, nearly 1/4th during the transition process. ^[21] JP Morgan is also at much higher risk because the $307B assets are troubled, and could negatively effect JP Morgan and its balance sheet.

Downturn in US Economic Cycle

US Global gross domestic product fell between .3% - .5% in the Third Quarter 2008 and fell by 6.1% in the Fourth Quarter.^[22] The CBO is predicting that there will be a 1.5% decrease in GDP in 2009.^[23] As the US economy continues to shrink, JPM and all other firms will continue to face pressure as investments become less profitable and consumer spending falls.

Interest Rates

In late 2007 and early 2008, the Fed implemented a series of interest rate cuts, reducing the rate from 5.25% in September of 2007 to 2% in July 2008 and 0.5% in July 2009.^[24][25] These measures were largely aimed at stimulating economic activity in the face of a potential recession caused by fallout in the subprime lending industry. JPMorgan will benefit from these cuts if they have the desired effect of stimulating consumer spending and encouraging businesses to expand. It will also make it a lot easier for JPM to get credit at low interest rates which will improve its ability to provide loans.

Effects of housing market slowdown

With the slowdown the housing market from 2007 and into 2008 and 2009, JPMorgan's mortgage lending business is being hit by the slow growth and decreases, in residential real estate prices. The economy as a whole is experiencing the "home equity effect", where homeowners perceive their house values to be lower than they anticipated, and therefore perceive themselves to be relatively less wealthy. As a result, consumers spend and consume less, which has negative repercussions for many of JPM's businesses. The number of total housing starts has fallen by 63% of their peak levels during the end of the housing boom.^[26] During the last 3 months of 2008, the nation's banks recorded a total of $26.2B in losses and faced a weighted average of 94% fall in profits.^[27] JPMorgan's Investment Bank and Asset Management segments has specifically taken setbacks due to higher loan loss provisions from mortgages.

Competitors

Global M&A Market Share for the first nine months of 2007^[28]

JP Morgan Chase & Co. ranked third among the large US money center banks in terms of assets and second in terms of net revenue for the year 2007.

J.P. Morgan has the lowest NIM

Chase Card Services, a part of JPMorgan Chase, surpassed Bank of America as the top issuer of Visa and Mastercard in 2006 and has maintained its dominance since then.

JPMorgan is ranked third in its market share of total deposits in the US behind Bank of America and Wells Fargo. WFC surpassed JPMorgan after it acquired Wachovia (WB) in December of 2008.

References

1. ↑ Bloomberg Press "Citigroup, JPMorgan Chiefs Summoned to Discuss TARP" 2 Feb 2009
2. ↑ ^{2.0 2.1 2.2} JPMorgan Chase Reports Second-Quarter 2009 Net Income of $2.7 Billion, or $0.28 per share," July 16, 2009
3. ↑ Bear's Final Moment: An Apology and No Lack of Ire - WSJ.com
4. ↑ - page 2, 10
5. ↑ JPM 10-K 2008 "Investment Bank" pp. 42-43
6. ↑ JPM 10-K 2008 "Retail Financial Services" pp. 45
7. ↑ JPM 10-K 2008 "Credit Card Services" pp. 51
8. ↑ JPM 10-K 2008 "Asset Management" pp. 58
9. ↑ JPM 10-K 2008 "Treasury & Securities Services" pp. 56
10. ↑ JPM 10-K 2008 "Commercial Bank" pp. 54
11. ↑ JPMorgan Chase & Co. Annual Report 2008 - page 2
12. ↑ JPMorgan Chase & Co (JPM.N) Financial Statements | Stocks | Reuters.com
13. ↑ JPM 10-K 2008 "Selected Financial Data" pp.38
14. ↑ Reuters, "Key Developments For JPMorgan Chase & Co"
15. ↑ Bank Investment Consultant, "Early Tarp Repayment to Cost JPMorgan Chase $1.1B," Matthew Monks, American Banker, 06/22/09
16. ↑ Board of Governors of the Federal Reserve System, "The Supervisory Capital Assessment Program:Design and Implementation," 04/24/09
17. ↑ MSNBC "Ten of the largest U.S. banks need $75 billion," 05/08/2009
18. ↑ ^{18.0 18.1 18.2} Reuters, "Key Developments For JPMorgan Chase & Co"
19. ↑ JP Morgan Spinning Off Bear Stearns Private Equity Unit
20. ↑ CNN Money: "JPMorgan buys WaMu" 26 Sept 2008
21. ↑ Business Week: "JPMorgan cutting 9,200 jobs at Washington Mutual" 1 Dec 2008
22. ↑ About.com The US Economy "GDP Current Statistics"
23. ↑ Forbes Business "US ECON: CBO's 2009 Outlook Worsens, Sees 1.5% GDP Drop" 20 March 2009
24. ↑ Federal Reserve Board "Open Market Operations" 16 Dec 2008
25. ↑ Bloomberg.com, US Rates and Funds
26. ↑ Housing Economics "Housing Starts State & Metro Forecasts for 2008-2009"
27. ↑ Star Tribune "FDIC says US banks posted $26.2 billion loss at end of 2008, first quarterly loss since 1990" 26 Feb 2009
28. ↑ WSJ.com - M&A Bubble Bursts
29. ↑ Herald Tribune "Bank of America claims top spot in assets" 15 June 2009
30. ↑ CreditCards.com "Credit card statistics, industry facts, debt statistics" 20 March 2009
31. ↑ FDIC Quarterly 2008, Volume 2, No. 4 "Highlights from the 2008 Summary of Deposits Data"
32. ↑ FDIC "Summary of Deposits" June 2008