J.P Morgan, the New York-based investment bank, reported third quarter earnings of $1.02 per share on $24.37 billion in revenues. Wall Street expected earnings of 96 cents per share on $23.73 billion in revenues.
J.P. Morgan said the third quarter credit card net charge-off rate was 4.34%, and that given the macro environment in Europe, it considers its earnings “very favourable.” It said that 85% of its exposure to the European Union is in Italy and Spain.
“The Firm reported third-quarter net income of $4.3 billion, representing a 13% return on tangible common equity. It is notable that these results included several significant items(*), including a $542 million pretax loss in Private Equity, $1.0 billion pretax of additional litigation expense in Corporate and a $1.9billion pretax DVA gain. The DVA gain reflects an adjustment for the widening of the Firm’s credit spreads which could reverse in future periods and does not relate to the underlying operations of the company. All things considered, we believe the Firm’s returns were reasonable given the current environment.”
At first glance, that is an earnings beat, so why are shares down 5% as of the time of this article?
The devil is always in the details.
Breaking down the report, you see that J.P. Morgan did not take any money from from its loan loss reverses to help it beat earnings, but the company did have something called a debit valuation adjustment, or DVA.
A DVA is essentially a bank being allowed to book a profit when the value of its bonds fall from par. This is a rule from the Financial Accounting Standards Board in 2007, and is known as Standard 159. J.P. Morgan booked $1.2 billion in DVA this quarter. So when you break down the quarter, it was not as strong as is made to believe at first blush.
Despite the negativity from the DVA, the quarter was solid, but nothing spectacular. The earnings release was nothing really to worry about, but the commentary from CEO Jamie Dimon and the banks stance towards President Obama are the real diamonds this morning. Dimon was particularly negative on the Volcker Rule with some of his comments, further lending credence to his unhappiness with the Obama administration.
Dimon, who has long been known as one of, if not the leading Democrat on Wall Street, has recently changed his stance on some of President Obama’s policies, as well as the international capital requirements for Basel III. Things have gotten so bad with Obama and Dimon, that Dimon met with Republican presidential candidate Mitt Romney.
During the conference call, Dimon said that the Volcker rule could “strangle” U.S. banks if the market making provision in the rule are too restrictive. Strangle is a very harsh word, especially coming from one of the most powerful players on Wall Street.
With Dimon seemingly turning on Obama, he has now essentially lost the last person on Wall Street who was standing up for him. It seems as if the Obama administration is trying to make it increasingly hard for banks to turn a profit with all of its rules and regulations, including Dodd-Frank. That regulatory uncertainty and pressure on earnings has caused the earnings multiple to compress to just six times 2012 earnings, and forced the dividend to currently yield well above 3%. A strong dividend is good for a bank, but a low earnings multiple is not.
Until the regulatory issues get cleared up on Wall Street, J.P. Morgan and other banks may expect to see “so-so” earnings for the foreseeable future.
That is, unless Wall Street has its way.
Traders who believe that regulatory issues will get cleaned up sooner rather than later might want to consider the following trades:
- The major investment banks are trading at depressed multiples. If Washington eases up a bit on the banks, that means names like Citigroup, Bank of America and Goldman Sachs could see multiple expansion.
- Wells Fargo could also be a major beneficiary, especially if housing turns around, as Wells Fargo is one of the major mortgage owners in the country.
Traders who believe that Washington will continue to step down on the banks’ collective throats may consider alternate positions:
- If Europe does not improve and Washington wants to pressure the banks, credit default swaps on the banks will continue to grow. Traders may consider shorting as CDS spreads continue to blow out.
By Jonathan Chen
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