JPMORGAN CHASE & CO quarterly report, Q2 FY2012

JPMorgan Chase & Co. 2012 Q2 Form 10-Q Summary

Business context and reporting period

JPMorgan Chase & Co. is a global financial-services firm with investment banking, consumer and small-business banking, commercial banking, transaction processing, asset management and private-equity operations. This unaudited Form 10-Q covers the three and six months ended June 30, 2012, with comparisons primarily to the corresponding 2011 periods. The Firm reported approximately $2.3 trillion of assets and $191.6 billion of stockholders’ equity at June 30, 2012.

Key financial metrics

Metric	Q2 2012	Q2 2011	Change
Total net revenue	$22.2 billion	$26.8 billion	Down 17%
Net income	$5.0 billion	$5.4 billion	Down 9%
Diluted EPS	$1.21	$1.27	Down 5%
Noninterest expense	$15.0 billion	$16.8 billion	Down 11%
Provision for credit losses	$214 million	$1.8 billion	Down 88%
Return on common equity	11%	12%	Down 1 point

For the first six months, net revenue was $48.2 billion, down 7%; net income was $9.9 billion, down 10%; and diluted EPS was $2.41, down 5% from the prior-year period. The effective tax rate was 29.1% for the quarter and 29.3% year to date.

Net interest income was $11.1 billion in Q2, down 6%, reflecting low interest rates, lower trading-asset balances, mortgage-backed-securities financing costs and runoff of higher-yielding loans. The net yield on interest-earning assets was 2.47%, down 25 basis points.
Mortgage fees and related income increased to $2.3 billion, up 105%, supported by higher origination volumes, wider production margins and refinancing activity.
Investment banking fees declined 35% to $1.3 billion, reflecting lower industry-wide volumes.
Principal transactions revenue was a loss of $427 million, compared with revenue of $3.1 billion in the prior-year quarter, primarily because of Chief Investment Office synthetic-credit-portfolio losses.
Net cash provided by operating activities was $46.2 billion for the first six months, compared with $58.7 billion in 2011. Investing activities used $66.0 billion, while financing activities provided $4.9 billion.
Period-end assets were $2.290 trillion, loans were $727.6 billion, deposits were $1.116 trillion and long-term debt was $239.5 billion. Common stockholders’ equity was $183.8 billion.
The deposits-to-loans ratio was 153%. Management described liquidity as strong; the Global Liquidity Reserve was approximately $414 billion.
Basel I Tier 1 common capital was $130.1 billion, or 9.9%; Tier 1 capital was 11.3%; total capital was 14.0%; and the Tier 1 leverage ratio was 6.7%. Management estimated the Basel III Tier 1 common ratio at approximately 7.9% after estimated Basel 2.5 and Basel III impacts.
Credit trends improved. Net charge-offs were $2.3 billion in Q2, versus $3.1 billion in the prior year, and nonperforming assets were $11.4 billion, down from $13.4 billion. The allowance for credit losses was $24.6 billion, down from $28.3 billion at December 31, 2011.

Material changes versus prior comparable periods

The largest adverse change was the synthetic credit portfolio held by CIO, which generated pretax losses of $4.4 billion in Q2 and $5.8 billion for the first half.
Consumer credit performance improved, allowing a $2.1 billion Q2 reduction in the allowance for loan losses, primarily in residential real estate and credit cards. This materially reduced the credit-loss provision.
Retail Financial Services benefited from mortgage growth and lower credit costs; Q2 net income rose to $2.3 billion from $383 million. Mortgage Production and Servicing reported net income of $604 million versus a $649 million prior-year loss.
Commercial Banking and Treasury & Securities Services reported higher Q2 net income, while Investment Banking and Asset Management reported lower net income.
Corporate/Private Equity reported a $1.8 billion Q2 net loss versus $502 million of net income, driven chiefly by CIO losses.
Noninterest expense declined in Q2 partly because the prior-year period included approximately $2.3 billion of litigation expense, predominantly mortgage-related. First-half noninterest expense nevertheless increased 1% to $33.3 billion.
The common dividend increased from $0.25 to $0.30 per share. The Firm repurchased approximately $1.4 billion of common stock and warrants during Q2 but made no repurchases after May 17, 2012.

Guidance, outlook, risks and unusual items

Management expected Consumer & Business Banking deposit-spread compression to reduce 2012 net income by approximately $400 million and the Durbin Amendment to reduce annualized RFS net income by approximately $600 million.
Mortgage production margins were not expected to remain at Q2 levels. Elevated foreclosure, servicing, default and mortgage-repurchase costs were expected to continue, although management believed the existing mortgage repurchase liability was sufficient for probable GSE-related losses.
Management expected residential real-estate quarterly net charge-offs below $750 million and portfolio runoff of approximately 10% to 12% in 2012. Card charge-off rates could decline to approximately 3.75% in Q3, but further allowance reductions could be near an end.
Treasury and CIO was expected to incur quarterly net losses of approximately $200 million, with variability of approximately $200 million in either direction. The Firm expected a pretax gain of approximately $900 million from the July 2012 redemption of approximately $9 billion of trust-preferred securities and lower future interest expense, subject to funding costs.
The Firm transferred substantially all of the synthetic credit portfolio to the Investment Bank on July 2, 2012, retaining approximately $11 billion of notional positions as of July 13. Stress testing indicated potential additional losses of approximately $800 million to $1.7 billion under extreme scenarios.
The filing restated first-quarter 2012 financial statements, reducing previously reported first-quarter net income by $459 million. The restatement did not affect Q2 or first-half 2012 reported financial statements, but management identified a material weakness in internal control over financial reporting at March 31, 2012. Remediation was substantially implemented by June 30 but remained subject to testing.
Moody’s downgraded the Firm’s long-term senior debt ratings in June 2012 and maintained a negative outlook; Fitch also downgraded the Firm and S&P revised its outlook to negative. Management stated that the actions had not materially impaired funding, but further downgrades could increase funding costs, collateral requirements and liquidity pressure.
The mortgage repurchase liability was $3.3 billion. The filing estimated reasonably possible additional losses of up to approximately $1.7 billion beyond the recorded liability. Aggregate reasonably possible legal losses in excess of established reserves were estimated at up to approximately $5.3 billion.
Subsequent events included a proposed credit-card interchange settlement with a total cash payment of $6.05 billion, of which the Firm’s share was approximately 20%, subject to court approval, and a planned reorganization of business segments into Consumer & Community Banking and Corporate & Investment Bank.

Most important facts for investors to verify

Reconcile the reported Q2 and first-half earnings with the $4.4 billion CIO synthetic-credit loss, $1.0 billion securities gain, $2.1 billion allowance release, DVA gains and Bear Stearns-related recovery.
Review the restated March 31, 2012 financial statements and the status and testing results of remediation of the material internal-control weakness.
Monitor subsequent CIO portfolio losses, remaining notionals, valuation methodology and the potential $800 million to $1.7 billion stress-loss range.
Assess whether consumer credit improvement and allowance releases are sustainable, particularly in residential real estate, PCI loans, home equity and credit cards.
Evaluate mortgage servicing, foreclosure, repurchase and legal exposures, including the $3.3 billion repurchase liability and up to $5.3 billion of reasonably possible litigation losses above reserves.
Verify the effect of Basel 2.5, Basel III, revised risk-weighted assets, the July 2012 trust-preferred redemption and the pending capital-plan resubmission on capital ratios and share repurchases.
Track rating-agency actions, derivative downgrade triggers, collateral requirements, off-balance-sheet commitments and the proposed interchange settlement.