DBRS: JPM 4Q Earnings Remain Pressured by Legal Expenses Despite Solid Underlying Returns

Summary:
• JPM’s returns continue to be hampered by legal expenses, with a $1.1 billion pre-tax charge in 4Q14 largely related to foreign exchange investigation
• Underlying returns demonstrate positive momentum across all businesses
• DBRS rates JPMorgan Chase & Co. Issuer & Senior debt at A (high) with a Stable trend

DBRS Inc. (DBRS) views JPMorgan Chase & Co.’s (JPM or the Company) 4Q14 underlying results as solid, despite continued elevated legal charges that weighed on overall results. Importantly, JPM continues to deliver solid returns through the cycle, supported by the breadth and depth of its global franchise, despite very elevated levels of capital. Net revenues of $22.5 billion showed some weakness with marginally declining trends in its consumer and commercial banking businesses, partially offset by some positive momentum in the Corporate & Investment Bank (CIB) and continued stability in asset management.

Expense controls remain important, with declining levels of compensation helping to offset regulatory spend and franchise investment. The relatively low 2014 comp/net revenues ratio of 30% in the CIB is an important contributor to overall expense controls as the CIB accounts for approximately one-third of the Company’s compensation expense. The Company also continues to demonstrate positive trends in credit performance, despite lower levels of reserve releases in the quarter that drove higher provisioning levels, also contributing to bottom line returns. Overall credit costs remain low with provisions for credit losses of $840 million, or just 10% of DBRS-calculated adjusted income before provisions and taxes.

Litigation charges continue to hamper overall returns, with declining trends in ROE over the past two quarters that included sizable additions to legal reserves ($1 billion in 3Q14, $1.1 billion in 4Q14). DBRS views litigation expenses as likely remaining a headwind over the intermediate term. While DBRS views JPM as having a strong ability to generate capital through retained earnings, continued one-off expenses of this size certainly constrain performance.

Regulatory requirements continue to be a focus, as the updated list of G-SIB capital buffers was announced in November 2014. Despite business simplification efforts, JPM buffer requirement remains at 2.5% over the regulatory minimum; currently, this is the highest populated buffer tier. With a Basel 3 CET1 minimum requirement of 4.5%, plus the 2.5% G-SIB requirement and a 2.5% capital conservation buffer, the Company is required to reach a fully-loaded CET1 ratio of 9.5% by January 1, 2019. While JPM’s CET1 ratio of 10.1% currently exceeds the requirement well in advance of the 2019 deadline, DBRS notes that JPM has to generate more net income to achieve the same hurdle rate for return on capital than most global peers given the elevated buffer requirement. As rules are adjusted and finalized, JPM’s requirement could increase further. DBRS views JPM as having the ability to adjust by generating capital organically but returns on capital have the potential to become a greater challenge and competitive disadvantage

DBRS rates JPMorgan Chase & Co. Issuer & Senior debt at A (high) with a Stable trend.

Note:
All figures are in U.S. Dollars unless otherwise noted.