DBRS Confirms JPMorgan Chase & Co. at A (high), Trend Remains Stable

DBRS, Inc. (DBRS) has today confirmed all ratings for JPMorgan Chase & Co. (JPMorgan or the Company) and related entities, including JPMorgan’s Issuer & Senior Debt rating of A (high) and its Short-Term rating of R-1 (middle). The trend for the Company’s ratings remains Stable. The ratings action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

JPMorgan’s ratings reflect its powerful universal banking franchise, the resilient earnings generation of its diverse businesses and its solid financial profile. Highlighting these strengths, JPMorgan has been able to consistently outperform most peers in the currently still-stressed environment, despite certain business lines remaining under pressure. From DBRS’s perspective, the Company is well-positioned given its resilient and substantial earnings power, coupled with sound funding, ample liquidity and solid capital levels. This affords it greater flexibility, relative to many banks, to manage through the current environment characterized by low rates, higher compliance and regulatory costs and subdued client activity.

That said, events in the Chief Investment Office (CIO), which resulted in a revision of the rating trend to Stable from Positive in May 2012, raise concerns about the Company’s risk management, which has always been an underpinning of JPMorgan’s ratings. In DBRS’s view, sound risk management was a key factor contributing to the Company’s generating more stable results throughout the crisis when compared to many peers. The CIO losses raised serious questions about the ability of the Company to monitor and manage the risks across its large and complex franchise. In addition, management’s shift in tone in a relatively short time span about the potential risks surrounding the CIO’s synthetic credit exposures suggested a lack of understanding and organizational communication about the nature of some trades that it had on its books. Importantly, however, JPMorgan’s strong earnings generation capacity meant the financial impact of the trading losses was readily absorbable. Though risks remain, the range of potential losses on the synthetic credit portfolio has likely declined from the $800 million to $1.6 billion range provided in July.

The cornerstone of JPMorgan’s U.S. banking franchise is its strong, super-regional branch banking business that has been virtually national in scope following the Washington Mutual acquisition. This franchise is enhanced by the Company’s leading credit card business and other nationwide lending businesses, as well as its solid commercial banking franchise. The earnings of the U.S. banking franchise have benefited from reserve releases in recent periods (especially in Cards), but remain constrained by the difficult rate environment and the cost of new regulation. This franchise also includes a top-tier mortgage banking and production business, which despite record production volumes continues to face headwinds related to mortgage repurchases and foreclosure and securitization-related litigation. Still-high levels of delinquencies, costs related to the National Mortgage Settlement, and regulatory consent orders are continuing to elevate expenses in the business. As these pressures abate, earnings will improve, though DBRS notes that this will be somewhat offset by loan runoff in JPMorgan’s Real Estate portfolios.

DBRS views JPMorgan’s global investment banking business as another key foundation of the Company’s franchise which enables the Company to benefit from the expanding globalization of capital markets, though some areas are currently experiencing a downturn. The Company has leading positions in many capital markets businesses globally, with particular strength in fixed income. Fixed income markets, excluding CVA/DVA, generated $12.2 billion, or 59% of IB revenues in 9M12, reflecting a stronger performance than most peers. Highlighting the Company’s strong positions in the highly visible advisory and underwriting businesses, IB generated $4.0 billion in revenues from investment-banking fees and has maintained strong positions in various league table rankings.

JPMorgan’s risk profile also benefits from its extensive global fee-based businesses that include its successful asset management businesses, including a substantial private bank, as well as a range of treasury and securities services businesses. These less credit-sensitive businesses have remained solid contributors, and like JPMorgan’s U.S. Banking and IB franchises, these businesses also have top-tier market positions. DBRS views these businesses positively from a ratings perspective because they provide revenues from their own customer base and generate substantial revenues by providing both domestic and international services that deepen the Company’s customer relationships across much of its franchise as well as strengthening its global reach.

The ratings also reflect JPMorgan’s strong financial profile. The Company’s solid funding and liquidity profile is anchored by its $1.1 trillion deposit base, which is the largest among U.S. banks. Wholesale funding reliance is elevated, but this reflects the Company’s business mix and is appropriately diversified across sources and maturities, in DBRS’s view.

Capital levels remain solid and compare favorably to peers. At the end of 3Q12, JPMorgan reported a Tier 1 Common ratio of 10.4% and a Tier 1 ratio of 11.9%. JPMorgan’s current capital levels provide ample loss absorption capacity, and DBRS sees the Company as well-positioned to address coming Basel III requirements, including any additional buffer for Global Systemically Important Banks (GSIB). DBRS notes that in November 2012, JPMorgan was one of the four banks that the Financial Stability Board proposed would be subject to the GSIB buffer of 2.5%. At September 30, 2012, JPMorgan reported an estimated Basel III Tier 1 Common ratio of 8.4%. With strong earnings enabling organic capital generation and management’s commitment to solid capital ratios, DBRS expects JPMorgan’s capitalization will remain sound.

Still, challenges remain. The Company faces considerable uncertainty in its mortgage banking operations related to repurchases, though DBRS sees the Company as well reserved in this regard. In addition, litigation risks are material. Providing a measure of comfort is that from the beginning of 2010 through the end of 3Q12, JPMorgan has added some $12.7 billion to litigation reserves primarily for mortgage-related matters. The ongoing LIBOR investigation also remains an overhang and unknown for the industry.

In DBRS’s view, generating appreciable organic revenue growth will be a challenge for the industry in a difficult operating environment, making cost control a critical focus. Also, macroeconomic concerns increase the potential for higher credit costs, especially in JPMorgan’s $181.5 billion real estate portfolios (including credit impaired balances), where a slowdown in housing or labor markets could pressure performance. Resolution of the fiscal cliff would diminish these risks in DBRS’s opinion, especially given the current recovery in housing markets. Additionally, DBRS recognizes that JPMorgan has maintained significant reserves for these portfolios.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the Federal Reserve, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: William Schwartz
Rating Committee Chair: Roger Lister
Initial Rating Date: 22 June 2001
Most Recent Rating Update: 15 May 2012

For additional information on this rating, please refer to the linking document under Related Research.