JPMorgan's Reserve `Bleeds' Distort Record $16.7 Billion Earnings Estimate
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JPMorgan Chase & Co., the second- biggest U.S. bank by assets, will probably report record earnings of about $16.7 billion for last year boosted by a reduction in reserves for future losses.
Fourth-quarter results, which the New York-based company plans to announce tomorrow, are likely to show a profit of $4.2 billion, or $1 per share, based on the average estimate of analysts surveyed by Bloomberg. About 40 percent of earnings for the first nine months came from money taken from loss reserves as U.S. banks dip into their funds, at least temporarily, and mask a revenue squeeze.
“Don’t pay attention to the bottom line EPS numbers,” said Chris Kotowski, managing director of research at Oppenheimer & Co. in New York. “Reserve accounting distorts what’s reported as earnings. It’s not like it’s just JPMorgan. It’s the entire industry.”
Reserves are typically released back into earnings if the losses they were meant to cover don’t materialize or if the company’s outlook improves. Such reserve “bleeds” will also boost 2011 results, especially if the economy continues to rebound, Betsy Graseck, a bank analyst at Morgan Stanley, said in a Dec. 1 research report.
Citigroup Inc. may benefit the most from releasing reserves in 2012, according to Graseck, who estimated a 19 percent boost to per-share profits for the New York-based bank based on historical reserve practices.
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Among the largest U.S. lenders, JPMorgan, Bank of America Corp. and Wells Fargo & Co. stand to derive 4 percent, 10 percent and 5 percent of their 2012 earnings from reserve releases alone, Graseck said.
“If the economy accelerates, the reserve bleed could punch EPS even higher in 2011 and 2012,” Graseck said.
Banks “got dinged when they were building reserves, so when you release reserves it goes directly to the capital account,” said bank analyst Jason Goldberg of Barclays Capital in New York. “It is real capital even if it’s not considered real earnings.”
Reserves hurt bank earnings while they’re being built up. JPMorgan said it added about $5.2 billion to its litigation reserves during the first three quarters last year. Reserve accounting will probably continue to distort earnings over the next year or two, analysts said.
The banking industry is still struggling with escalating foreclosures, increasing litigation costs and anemic loan growth, which are all eating into revenue. JPMorgan’s revenue, which slumped 11 percent in the third quarter, remained weak in the fourth quarter, Goldberg said.
Profit margins at JPMorgan, the first of the largest U.S. banks to report earnings, narrowed in the third quarter as revenue from investment banking and card services tumbled from a year earlier and non-interest expenses rose 7 percent.
“While they benefit from reserve releases, you’re still facing the detriment of elevated loan-loss provisioning, some more subdued loan growth, the impact of prolonged low interest rates and elevated mortgage repurchase costs,” Goldberg said.
Investors should expect some “bumpiness or lumpiness” in trading results in the fourth quarter, although it should be better than the previous three months, Kotowski said. Fixed- income revenue was $3.1 billion in the third quarter, compared with $5 billion a year earlier and $3.6 billion in the second quarter.
Kotowski is among analysts who have raised their price targets and earnings estimates on JPMorgan and other banks in the past month amid signs that the improving economy may benefit bank stocks.
“It’s more important to focus on the fundamentals rather than the noise,” Kotowski said. “JPMorgan’s core earnings power is quite stable and robust.” He said that pre-provision earnings, which back out all reserving, were running at an annual rate of $47 billion during the first nine months last year, compared with $48 billion for all of 2009.
Credit card charge-offs dropped from 8.35 percent in the third quarter to 7.51 percent in October and November, which is a “broadly positive indication,” Kotowski said.
Loan growth is shrinking at a slower pace. Loan volumes dropped 0.5 percent from September to December, which is an improvement from a 1.1 percent decrease the quarter before and a 4.4 percent quarterly drop at its worst pace in late 2009, Kotowski said, citing Federal Reserve data.
“Credit quality is steadily getting better,” Kotowski said. “Loans are still shrinking but a lot less than they were and they show every sign of turning around in the next two quarters.”
Mike Mayo, an analyst at Credit Agricole, increased his earnings estimate for JPMorgan from 97 cents to 99 cents a share on Jan. 7 due to the better economic outlook. Matt O’Connor, an analyst at Deutsche Bank AG in New York, upped his estimates on the expectation that banks will use excess reserves to raise dividends or buy back stock.
JPMorgan investors may see their quarterly dividend, which was cut to 5 cents in 2009, rise in the second quarter, Chief Executive Officer Jamie Dimon said in a Jan. 11 interview on CNBC television.
“We’re waiting for guidance from regulators about on what basis are they going to let firms pay dividends, buy back stock or do other things,” Dimon, 54, said from the company’s annual health-care conference in San Francisco.
The board hasn’t decided on a specific increase, with the bank hoping eventually to pay 30 percent to 35 percent of normalized earnings, Dimon said.
Dimon said in October that he was “reasonably hopeful” the firm will be able to raise the payment in 2011’s first quarter and that regulators were open to the idea. JPMorgan has been buying back its own stock in the meantime, repurchasing $2.6 billion of shares through the third quarter.
The KBW Bank Index of 24 stocks has dropped 56 percent since its February 2007 peak after the U.S. housing bubble burst and left banks grappling with the worst economy since the Great Depression. Investors in JPMorgan, the only major Wall Street firm to post profits in every quarter throughout the recession, lost 14 percent during the same period.
Citigroup, the third-biggest U.S. bank behind JPMorgan and Bank of America, may report fourth-quarter earnings of $2.2 billion when it releases results on Jan. 18, the survey of analysts shows. Charlotte, North Carolina-based Bank of America may report a profit of $2.5 billion on Jan. 21.
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