JPMorgan Swallows its Medicine, And Other (TBTF) Bank Musings


Following the news of JPMorgan Chase’s (NYSE: JPM) landmark $13 billion settlement with the U.S. government over civil charges related to the financial crisis of 2008, investors should take a moment to asses the current state the nation’s largest banking institutions.

JPMorgan, for its part, was well aware of the likelihood of future liabilities stemming from their shotgun acquisitions of Washington Mutual and Bear Stearns in late 2008. CEO Jamie Dimon and his crew have set aside nearly $30 billion in reserve assets over the past few years, so the settlement amount – while nominally gargantuan – will not cause permanent damage to the nation’s largest banking firm. In fact, since the details of the settlement were announced, JPM shares are actually up over 5%, easily outperforming the S&P 500’s .29% return.

Investors always prefer the known over the unknown, even when the news is bad. The markets’ benevolent reaction to the settlement could be a strong indicator of the medium-term future of not only JPMorgan, but its peers as well. By some of the most important metrics for banking stocks – Price/Book, Price/Cash Flow, Return on Equity and Net Margin – the“Big Four” U.S. banking group including Wells Fargo (NYSE: WFC), Citigroup (NYSE: C), and Bank of America (NYSE: BAC) all look historically undervalued.

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Banking Stocks: JP Morgan (NYSE:JPM) Price to Book relative to peers C, BAC, WFC, USBBanking Stocks: JPMorgan (NYSE:JPM) Price to FCF relative to peers C, BAC, WFC, USB


Banking Stocks: ROE and Net Margin for JPM, WFC, C, USB, BAC

JPMorgan And Banking Sector Review

Investors in these four behemoths find the banking sector at an important crossroads. It’s more than fair that this group had severely underperformed the broad market rally from the lows in early 2009. These were the companies utterly exposed to all those toxic assets, the ones most vulnerable to penalties and litigation down the road.

But as investors have seemingly become comfortable with the idea of a real -albeit modest – economic recovery, the financial sector has improved in line with the markets year-to-date, up 26% to the S&P 500’s gain of 25%. The more narrowly focused KBW Banking Index (^BKX) is up nearly 30% YTD. Historically, this group is highly leveraged to economic growth, as it leads to growth in deposits, investment income gains, and higher financial services fees.

Banking Stocks Peer Review

JPMorgan and its peers have all been designated as “too big to fail” by the government, and thanks to (nearly) free money from the Federal Reserve over the past four years, these four giants have been booking strong gross profits; which has been the key in allowing them to shore up their reserves (see chart below) and repair capital ratios.

Banking Stocks: JPM, BAC, C, WFC and USB Management of Reserves

Bank of America (NYSE: BAC) shares have been the strongest performers in the past year, up 70%. Net income has doubled year-over-year, and management is in the midst of a $5 billion share repurchaseplan. Billions more could be added to the plan in 2014, along with increased bottom-line benefits from a $9.2 billion cost-cutting effort. There is still the overhang of the Countrywide deal lingering around B of A, as evidenced by a peer-low 0.7 Price/Book, and reserves that have been building in anticipation of future litigation liabilities (see graph above).

Third-largest bank Citigroup (NYSE: C) has a lower Price/Book than its peers and Price/FCF, a sign of overall investor hesitation around the fact that Citigroup lags the peer group in deposit growth and net margin. However, it could give the stock leverage to outperform the group if the most optimistic GDP and unemployment forecasts play out in 2014.

Banking Stocks: Earnings Leverage Citibank(C) peers WFC, JPM, BAC, USB


Wells Fargo & Company (NYSE: WFC) shares sport an above-average net margin and return on equity, but with a price/book higher than the peer average, shares may have less of a floor underneath them should broad economic prospects decline in 2014.

Banking Stocks: Net Margin Wells Fargo (NYSE:WFC)Banking Stocks: ROE for Wells Fargo (WFC)








Wells Fargo shares have slightly outperformed the S&P 500 year-to-date, and the company is generally deemed to have the strongest overall balance sheet of the group. Also, Wells Fargo pays a solid dividend rate of 2.7%, in step with JPMorgan’s 2.6% (Citigroup and Bank of America both have dividend rates below .25%).

Parting Thoughts on the Banking Sector

Given that all four banks have access to the same “wind-aiding” from the Federal Reserve for the foreseeable future, I would anticipate that the group meets or beats market returns in the coming year, provided that the broad economy stays in some form of recovery.

The Federal Reserve – and likely new leader Janet Yellen – has committed to keeping the currentquantitative easing cycle intact until the unemployment rate drops below 6.5%. The earliest this could conceivably happen is next spring, but regardless of when the QE programs do phase out, these companies will all have the capital footing to fund growth drivers and perform well in what would be a burgeoning, rising-interest rate economy.

The faster future settlements come down the pike, the sooner shares of all these companies can be free to rise on their own merits – good news to investors who realize that industry-wide valuations are quite low by historical standards. If the economy really takes off, Citigroup and Bank of America should have more upside, but JPMorgan and Wells Fargo could outperform in more diverse economic backdrops.

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