Assisted by Stephanie, analyst at BAD BEAT Investing
Those who follow our exclusive chat room often know that we said finances would come under pressure, but there was only one that we wholeheartedly supported, while everyone else was negative. This was of course the best JPMorgan Chase (JPM). We are often asked about banks and hundreds of other stocks a week in our group. We were clear – stay away from the other banks for a short time, but think about JPM. On the other hand, we have very low rates. We also face strong risks from lending, deferral of mortgages, and direct defaults affecting the sector. But we feel the name was a good $ 80-85 buy. This market gave you several entry opportunities. While real economic data weighs, the company has really had a heroic quarter and shown why it is dominant. But it wasn̵
JPMorgan had an enormous quarter when it came to headlines versus historical performance, but it was heroic in relation to expectations. Nobody really knew where it was going to go. Overall, the headlines reflected the pain of the COVID 19 crisis, which has led to reduced demand and a change in banking activity from the norm, but has exceeded expectations. Of course, after a nearly 50% drop in stock from top to bottom, we can see that the market is priced in disaster. Q2 was better than expected, but Q3 could see that the pain persisted at least surgically. Managed sales were $ 32.9 billion, 15% higher than the previous year. This was almost $ 3 billion above our $ 30 billion expectations. This continues a pattern of strong sales growth in the second quarter of recent years:
Source: SEC filings, Graphics by BAD BEAT Investing
What a result. We had obviously lowered our expectations for the year. The same thing happened with analysts. The competition fought. But JPM did a home run. The income was breathtaking. However, it wasn’t just sunshine and roses here. Operating expenses increased 4% year over year, while credit loss provisions were cruel at $ 10.5 billion compared to an average of $ 1.5 billion in the last three quarters of 2019. They also increased from $ 8.2 billion in the first quarter of 2020. This offset the massive sales, and EPS declined from the second quarter of the previous year:
Source: SEC Filings, graphics by BAD BEAT Investing
In the second quarter of last year, the company posted earnings per share of $ 2.83, or $ 9.6 billion in total. This quarter’s earnings exceeded our expectations for $ 1.10 by $ 0.28, and we expected sales of $ 30 billion and not nearly as much credit losses. Let’s dive a little bit into the key income metrics.
Interest-free and interest-free income
So those who follow our work know that when we look at a bank, we like to look at both important classifications of income. They are often dichotomous, with growth in one area and contraction in another.
However, JPMorgan’s performance reflected such a dichotomy in these metrics. Over the years, the trend for both measures has been higher. In the current quarter, noninterest income increased 33% to $ 19.1 billion. This was the result of a lot of customer trading activities.
The interest surplus had been growing for years, but now we see the impact of interest rates. In this quarter, net interest income remained unchanged from the previous year. The pace of growth has slowed due to interest rates. It dropped 13% to $ 13.8 billion, which wasn’t as bad as we thought. The impact of rate cuts was not as we thought. We have to point out that assets under management rose to $ 2.5 trillion year-on-year and rose 12% year-over-year. There was a huge trade. As assets under management continue to grow, it is important to consider movements in the company’s risk provisioning. And the supplies were stunning.
Credit growth continues along with loan loss provisions
The loan portfolio continued to grow compared to the previous year as the total number of loans increased by 2% compared to the previous year. As credit grows, we have to consider possible credit losses and believe me, those losses were huge.
Loan loss provisions increased dramatically over the previous year, but even before COVID-19, things were volatile and provisions increased over time. But what we saw here was crazy. We are cautious about expanding provisions as this may mean that the company is providing risky loans or that borrowers may not be able to pay. In this case it is the latter – since unemployment is increasing and small companies have no income, companies are closed. The results are bearish for the economy and consumer health, but the bank will do well in the medium term.
We usually take this as a measure of credit security. Please note that this does not lead to losses. We just want to point out how much is set aside.
A large part of the reserves are in the consumer portfolios, in which a large part of the new credit activities are running. The company has entered this crisis in a position of strength and continues to have good capital resources and high liquidity with total liquidity resources of over $ 1 trillion.
While some lending criteria are tightened, the company’s underlying results in the second quarter were extremely good. However, given the likelihood of a fairly severe recession, it was necessary to build up credit reserves, resulting in total credit costs of $ 10.5 billion for the quarter. The determination was intentional, but far exceeded our expectations. We thought they would be roughly flat from the first quarter of 2020.
Highly efficient bank
A measure that has not improved in recent years is the efficiency rate, but that doesn’t matter either, as the bank is highly efficient.
The efficiency rate takes into account the costs that are used to generate a dollar of sales. This metric has long been attractive to JPM. Overall, JPMorgan Chase found the efficiency rate to remain solid, and this quarter, at 51%, was the best result we have ever seen for this metric for JPM. Of course, lower is better. We generally followed a textbook goal of around 50% for this critical indicator. JPMorgan’s efficiency of 51% shows another reason why it is the best.
There is no doubt that JPMorgan Chase has had strong results here. The company spent the quarter positioning itself for a recession and playing defense. Credit and wealth management has received an enormous boost. In addition to the virus, complex geopolitical problems remain and global growth is now a major concern. However, this virus problem will not last. There will still be a couple of quarters of the pain, and most of the economic problems will continue until the end of the year.
The company continues to have a fortress-like balance sheet and will be able to defend itself in the coming quarters. We always believe that the ups and downs of the stock don’t matter in the long run, and you should try to buy a quality company at a fair price. We have a high quality company here that has a discount, even if EPS wears it on the chin for a few quarters. It’s a winner in the long run. You should scale declines. If you don’t buy everything at once, the market will inevitably lead you to better prices.
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Disclosure: I am / we are long JPM. I wrote this article myself and it expresses my own opinion. I don’t get any compensation (except from Seeking Alpha). I have no business relationship with a company whose shares are mentioned in this article.