Heard on the Street
J.P. Morgan's Earnings Show Few Signs of Market Thaw
Concerns About Slumping Markets Ring True
By John Carney
April 11, 2014 2:13 p.m. ET
As the year began, investors had reason to be hopeful. It appeared as if economic growth and rising rates would spur expanded lending, increased trading revenue and improving net interest margins. Although the great wave of mortgage refinancing had crested, it was possible that housing purchase activity might take up a bit of the slack.
Market conditions, however, quickly began to grind against those hopes. Several indicators showed lending and trading activity stalled as interest rates hit an unanticipated lull. And the decline in profits and revenue shown in J.P. Morgan's first-quarter performance, often considered a bellwether for the banking sector, confirmed suspicions that big banks were largely adrift in early 2014.
Yet as disappointing as J.P. Morgan's results were—revenue was down 8% compared with a year earlier, while earnings per share were 19% lower—they didn't point to any serious stumbles on the bank's part. The sharp declines from a year ago in mortgage lending and in fixed income, currency and commodities trading revenue, and the less sharp decline in stock markets revenue, seemed to reflect broad market conditions.
At worst, the results indicate that J.P. Morgan will struggle to increase revenue so long as trading and lending remain subdued.
More reassuring actually may be J.P. Morgan's calm reaction. Finance chief Marianne Lake said the bank had no plans to rethink its strategy or head count because of the quarter. That should mean the bank will be well-positioned when markets activity eventually picks up. Nor did the bank err in the opposite direction by lowering its lending standards or taking excessive market risk to juice performance.
This conservatism, however, may have kept J.P. Morgan from benefiting from one area that did see year-over-year growth in the first three months. Commercial and industrial loans rose more than 9.7% for U.S. banks overall, according to Federal Reserve data. At J.P. Morgan, this category of loans didn't increase at all.
That was in contrast to Wells Fargo, whose first-quarter report showed business lending up 7% versus a year earlier. That was accompanied by growth in lending for residential mortgages, auto loans and credit cards. Granted, Wells's 14%, year-over-year increase in earnings per share was helped by a tax benefit, big gains on the sale of equity investments and a lower provision expense.
No matter, investors cheered the fact that Wells showed loan growth, the elixir that has proved elusive for so many banks. And such growth helps underpin the valuation premium it receives to J.P. Morgan; Wells trades a third higher based on price/tangible book value.
That premium is also an indicator of how little credit investors are willing to give banks for their trading business these days. And when J.P. Morgan CEO James Dimon proclaims that revenue from that business is mostly impossible to predict, it somewhat justifies the valuation gap.
The dearth of fixed-income underwriting and trading reported by J.P. Morgan doesn't bode well for Bank of America or Goldman Sachs Group. Both banks are set to report earnings next week, and both derive substantial revenue from fixed-income trading, about one-third of which is typically made in the first quarter. At Goldman Sachs, fixed-income trading generated more than a quarter of its 2013 revenue. At Bank of America it was 10%.
Unfortunately for investors, despite some early signs of returning loan growth, the trading and mortgage lending lull appears to have continued into early April, raising the prospect that the second quarter could be challenging as well.
It might not necessarily be a calm before a storm, despite recent stock market upheaval. But banks like J.P. Morgan are in need of some excitement.
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