DBRS Comments on 3Q13 Earnings of JPMorgan – Senior at A (high), Trend Remains Stable

DBRS, Inc. (DBRS) has today commented that its ratings for JPMorgan Chase & Co. (JPMorgan or the Company), including its A (high) Issuer & Senior Debt rating, are unchanged following the release of the Company’s 3Q13 results. For the quarter, JPMorgan reported an earnings loss of $380 million, compared to earnings of $6.5 billion in 2Q13 and $5.7 billion in 3Q12.

The quarter’s financial results were dominated by $9.2 billion in litigation expenses, which included a number of legal cases and settlements. JPMorgan also disclosed a remaining $23 billion litigation reserve after the 3Q13 payouts in addition to its $2.2 billion mortgage repurchase reserve. While the scale of the litigation expense was well beyond DBRS expectations, it represents approximately one quarter of adjusted income before provisions and taxes (IBPT), which is absorbable. DBRS analysis will be focused on the medium and longer-term impact of ongoing litigation on the Company’s transactional and customer businesses. JPMorgan’s ratings would likely be pressured if it were unable to settle its legal liabilities reasonably and move out of the legal and media cycle, which could impair its reputation and ability to transact business over time. The ratings would remain stable, however, if the Company is able to navigate this difficult period successfully without impairing its business fundamentals and franchise strength.

In general, DBRS sees JPMorgan’s quarterly financial performance as mixed (outside of the litigation expense), reflecting a difficult environment for growing revenue including lower investment banking and mortgage revenues. Nonetheless, the Company delivered continued positive trends in credit performance (resulting in a large reserve release in mortgage), strong customer deposit and asset inflows, and grew credit and merchant processing volume by double-digits. Additionally, balance sheet improvements included higher capital ratios and liquidity levels. The third quarter results included a DVA loss to revenues of $397 million, compared to 2Q13’s DVA gain of $355 million and 3Q12’s loss of $211 million. Excluding DVA, as well as adjusting for the litigation expense and securities gains, DBRS-calculated IBPT was $8.4 billion, down 11% from both 2Q13 and 3Q12. DBRS also notes that 3Q13 benefited from a $1.6 billion reserve release in consumer banking, which strengthened net income by $992 million.

Adjusted revenues in the quarter were $23.5 billion, down 5.0% from 2Q13, and down 2.2% from 3Q12. The 65% YoY and 54% QoQ declines in mortgage revenues were the primary drivers for the revenue declines followed by moderate weakness in fixed income markets. The QoQ firm-wide net interest margin (NIM) declined two basis points (bps) to 2.18% while the core NIM was stable at 2.60%, as spread pressure slowed. The Company guided to a relatively stable margin and net interest income in 4Q13. Meanwhile, expenses at $23.6 billion for 3Q13 were dominated by the $9.3 billion legal expense. Positively, compensation expense, the largest expense component (ex-legal) at $7.3 billion, was down 9% QoQ and 2% YoY, while most other expense line items were flat. Although the legal expense was outsized, general expense is expected to be permanently elevated as JPMorgan has stated that its control agenda is priority number one with 5,000 people added firm-wide and an additional $1 billion spent on controls this year.

Consumer & Community Banking (CCB), which includes Consumer & Business Banking (CBB), Mortgage Banking, and Card, Merchant Services & Auto (CSA) reported 3Q13 net revenues of $11.1 billion, down 7.8% from 2Q13 and were off 12.9% compared to 3Q12. As anticipated, mortgage fees fell precipitously to $839 million, down $980 million QoQ and $1.5 billion YoY. In 3Q13, mortgage origination volume declined 17.3%, while applications fell 37.8% and margins narrowed. Positively, purchase originations of $20.0 billion grew 15% QoQ. While CCB average loans fell 1.5% in the quarter, deposits grew 0.7%, accounts grew 1.4%, and client assets rose 4.1%. Meanwhile, CSA’s revenues declined a modest 0.8% QoQ, as spreads compressed despite strong sales volume. Positively, CSA benefited from a $351 million reserve release and expects to release another $150 million in 4Q13. DBRS notes that Commercial Banking results were up with strong CRE and multifamily growth, and strong credit metrics, yet corporate lending demand remained weak. Lastly, Asset Management had another strong quarter with $19 billion of net long-term product inflows and good investment performance, but expenses rose almost 6% QoQ, impacting earnings.

In the Corporate and Investment Bank (excluding the impact of $397 million DVA loss), net revenues were down 9.8% QoQ to $8.6 billion, but were up a slight 0.2% YoY, as principal transaction, asset management and investment banking fees softened. Significant declines in fixed income (which includes the CIO synthetic credit portfolio and whose VAR ticked up), equity and debt underwriting were only slightly offset by improved advisory fees.

As noted, credit quality continued to improve in the quarter with non-performing assets (NPAs) and charge-offs (COs) declining QoQ, supporting a $1.9 billion reduction in the allowance for credit losses. JPMorgan also reported improvement in PCI loans based on HPI gains. The Company’s wholesale portfolios reported another good quarter with only $26 million in net charge-offs and nonaccrual balances fell even lower to only 0.32% of total wholesale loans. Consumer credit also improved with a 5.8% decline in NPAs and a 10% decline in NCOs mostly in credit card loans. As such, JPMorgan’s reserves remain adequate in DBRS’s view, covering 1.89% of total loans and 149% of nonaccrual loans (excluding credit card) at 3Q13.

With regard to mortgage repurchases, JPMorgan realized total repurchase losses of $135 million in 3Q13 and the repurchase liability declined $294 million QoQ to $2.2 billion. Notably, new repurchase demands of $2.0 billion were up 74% QoQ and were 11% above 3Q12 levels. DBRS is mindful that the Company continues to negotiate the terms of a large multi-party (including federal and states) settlement with the Justice Department related to mortgages that would likely require a large payment. In 3Q13, JPMorgan recorded the range of possible losses beyond litigation reserves at $5.7 billion.

In DBRS’s view, JPMorgan’s sound funding and liquidity profile coupled with solid capital levels afford it greater flexibility, relative to many banks, to cope with challenging market conditions and manage through the continually evolving regulatory environment. The Company continues to gather substantial levels of deposits (up 6.5% QoQ and 12% YoY at $1.3 trillion) and liquidity levels remain very high, as evidenced by the “High Quality Liquid Asset” (HQLA) figure of $538 billion at 3Q13, an increase of 18.5% sequentially. JPMorgan also estimated its 2Q13 LCR ratio to be 118% with 3Q13 not far off that level and well above the Basel proposed 100% future requirement. With respect to capital, JPMorgan maintains a comfortable cushion and ample loss absorption capacity. The Company reported an estimated Basel I Tier 1 common ratio of 10.5% at quarter end, factoring in Basel 2.5. The estimated Basel III Tier 1 Common ratio was 9.3% at quarter end with a 9.5% year-end 2013 target and a 10.5% longer term target providing an additional buffer. DBRS notes that the estimated capital level occurred in a quarter where JPMorgan repurchased $0.7 billion of stock and paid approximately $1.4 billion in dividends. JPMorgan also disclosed its supplementary leverage ratio of 4.7% at 3Q12 compared to the proposed 5% requirement for the largest bank holding companies and 4.3% at the bank subsidiary compared to the 6% banking subsidiary requirement to be considered “well capitalized” that is phasing in to be fully effective on January 1, 2018.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]