Over the past couple of weeks, market action has been driven by macro forces. This is normal seasonality as investors await the Q1 earnings report cards.
We are finally getting those corporate earnings. This allows us to see how the macro issues are impacting individual companies. Investors will be able to parse through winners and losers in a volatile environment.
J.P. Morgan (JPM) is always one of the earliest reports for the markets. The bank bell weather provides us a wealth of information about the economy. Its insight into potential winners and losers is invaluable.
What did JPM Tell Us?
JPM reported a steady round of results but actions around its balance sheet reserves is what is capturing market attention.
J.P. Morgan missed earnings expectations by 7 cents per share. This was its first bottom line miss in eight quarters. The overall net income fell 42% from the prior year period. This shortfall may surprise investors as we have been told that rising rates are supposed to boost bank profitability.
The primary reason for the miss was actions JPM took to protect against risk. Investors need to understand JPM’s decision and what it means for broader markets.
Banks hold reserves on their balance sheet to protect against downside risk. Risk assessments are made based on Assets Under management and volatility in the markets that could impact the value of these assets.
When things are good, banks release reserves which boosts bottom line performance. For instance, in the first quarter of 2021, JPM released $4 billion of reserves as fears around the pandemic eased. It did not need to tie up cash as it had ample reserves on hand to protect against asset declines. When the environment shifts and economic sentiment softens, banks build these reserves to protect against potential asset write downs.
In the first quarter, JPM announced a $1.5 billion provision for credit losses. This included a reserve build of $902 million driven by the increased probability of downside risk due to high inflation and the war in Ukraine. The bank took a $562 million charge for accounting purposes related to its Russian-associated exposure, wider spread volatility, and commodity trades. There was also $582 million of net charge-offs.
Basically, JPM is concerned about the volatility in markets. It wanted to increase the amount of cash it holds to protect against declines. As JPM said on its call, “it reflects the increasing probability- from very low to slightly higher- of a Volcker-style, Fed-induced recession in response to the current inflationary environment”.
J.P. Morgan said it remained optimistic about the economy. However, it did put in the caveat ‘for the short term’. The bank sees significant geopolitical and economic challenges ahead due to high inflation, supply chain issues and the war in Ukraine.
What did the results tell us?
Investors should take note of this cautious outlook from such an important global player. Caution is prudent but it should be noted that overall results, while comparatively weaker from recent quarters, did not flash a recession warning.
Revenues fell 5% from the prior year period to $30.7 billion. This marked a slow down in activity in a couple of areas. Average Loans increased 5%, a slight deceleration from the 6% increase in Q4. This reflects continued demand in the economy.
The Consumer & Community Bank (CBB), the traditional lending segment saw income fell 57% reflecting the reserve build/release. Net revenues declined 2% in CBB. Home Lending was down 20% y/y on lower production revenue from both lower margins and volumes. Originations declined 37% with the rise in rates. Mortgage loans fell 3% as a result.
Card and Auto revenue fell 8% primarily on strong new card account originations leading to higher acquisition costs. This reflects the competitive dynamic for credit cards. Combined credit and debit spend increased 21% reflecting strong consumer spending. The bank saw a robust reacceleration in Travel & Entertainment spend. Auto originations fell 25% due to a lack of vehicle supply.
This will flash warnings around homebuilders and auto stocks. It is not terribly surprising, but it will keep expectations low ahead of earnings. This low bar could end up being a positive, at least for short term bulls. Consumer spending habits will ease some worries around retail names. T&E names should see improved sentiment. The T&E spend was also boosted by a strong performance by Delta (DAL).
Markets and Security services were a drag as they fell 8% from the prior year period. Investment Banking fees fell 31% from the prior year period due to lower equity and debt underwriting activity. Clients pulled back on activity in a volatile environment.
Trading performance was better than feared. Fixed Income revenue declined 1% y/y driven by a lower performance in Securitized Products. Equity Market revenue fell 7%. This should provide a boost to Goldman Sachs (GS) and Morgan Stanley (MS).
Net Interest Income increased 7% from the prior year period. The bank continued to forecast NII of $53 billion for FY22. It suggested that there was potential upside as rates increase. Net Interest Margin improved 4 basis points to 1.67%.
Investors continue to watch the elevated spend by banks. Institutions need to increase technology prowess as they face continued challenges from technology companies. Noninterest expense was $19.2 billion, up 2% from the prior year, and in line with expectations. The rise was predominantly driven by investments and structural expenses, largely offset by lower-volume and revenue-related expenses. JPM reiterated that it expects expenses to be $77 billion in 2022.
Conclusion
Overall, the results were solid but the reserve build and cautious commentary around the economic outlook should be respected.
As for J.P. Morgan shares, they are under selling pressure. Shares fell 3.5% to the $126 area. This is setting up for a test of key long-term trend support. The stock has fallen 28% since October and 25% since posting Q4 results in January. There is a lot of negative news priced into shares.
If you are a long-term investor, this is a great area to add a position. Its banking business continues to hold steady and the upside potential in NII is enticing. It has ample support at these levels which should limit downside risk.
There is the global exposure which could be concerning. If that is an issue, then you may want to pivot to some of the bigger regionals are perhaps the Regional Bank ETF (KRE) to avoid near-term volatility.
