JPMorgan Chase & Co. — 3Q10 Form 10-Q Summary
Business context and reporting period
JPMorgan Chase & Co. reported unaudited results for the three and nine months ended September 30, 2010. The firm operated through Investment Bank, Retail Financial Services, Card Services, Commercial Banking, Treasury & Securities Services, Asset Management and Corporate/Private Equity. At quarter-end, the firm reported $2.1 trillion of assets, $173.8 billion of stockholders’ equity and approximately 236,810 employees.
Key financial metrics
| Metric | 3Q10 | 3Q09 | 9M10 | 9M09 |
|---|---|---|---|---|
| Total net revenue | $23.8 billion | $26.6 billion | $76.6 billion | $77.3 billion |
| Net income | $4.4 billion | $3.6 billion | $12.5 billion | $8.5 billion |
| Diluted EPS | $1.01 | $0.82 | $2.84 | $1.51 |
| Provision for credit losses | $3.2 billion | $8.1 billion | $13.6 billion | $24.7 billion |
| Noninterest expense | $14.4 billion | $13.5 billion | $45.2 billion | $40.3 billion |
| ROE | 10% | 9% | 10% | 6% |
| Overhead ratio | 60% | 51% | 59% | 52% |
Third-quarter net income increased 23%, while nine-month net income increased 48%. The improvement was primarily driven by sharply lower credit-loss provisions, partially offset by lower revenue and higher expenses. The effective tax rate was 28.8% in the quarter and 29.7% year to date.
Net interest income was $12.5 billion in the quarter and $38.9 billion year to date. The fully taxable-equivalent net yield on interest-earning assets was 3.01% in the quarter, down from 3.10% in the prior-year quarter, and 3.13% year to date, down from 3.15%.
Net cash used in operating activities was $5.6 billion for the first nine months of 2010, compared with $110.9 billion of cash provided in the prior-year period. Investing activities provided $20.7 billion, while financing activities used $17.8 billion. Cash and due from banks was $24.0 billion at September 30, 2010.
Period-end loans were $690.5 billion, deposits were $903.1 billion, long-term debt was $255.6 billion, and common stockholders’ equity was $166.0 billion. The deposits-to-loans ratio was 131%. The firm reported a $273 billion Global Liquidity Reserve, consisting of $171 billion of central-bank cash and highly liquid securities and $102 billion of other borrowing capacity.
Capital remained strong: the Tier 1 capital ratio was 11.9%, the total capital ratio was 15.4%, the Tier 1 leverage ratio was 7.1%, and the Tier 1 common ratio was 9.5%. The firm and its banking subsidiaries were reported as well-capitalized.
Material changes versus prior comparable periods
- Revenue declined 11% in the quarter and 1% year to date. The quarterly decline reflected lower principal-transactions revenue, particularly weaker fixed-income and credit trading results. Year-to-date revenue also reflected lower mortgage fees and credit-card revenue, partly offset by higher private-equity and securities gains.
- The provision for credit losses declined 60% in the quarter and 45% year to date. Consumer and wholesale credit trends improved, and Card Services reduced its allowance by $1.5 billion in the quarter and $4.0 billion year to date.
- Noninterest expense increased 7% in the quarter and 12% year to date, primarily because litigation expense was $1.5 billion in the quarter and $5.2 billion year to date, compared with $246 million and a net benefit, respectively, in the prior-year periods.
- The firm adopted new VIE consolidation guidance on January 1, 2010. This added $87.7 billion of assets and $92.2 billion of liabilities, reduced equity by $4.5 billion and reduced the Tier 1 capital ratio by 34 basis points. The change also added approximately $84.7 billion of credit-card loans to the balance sheet and materially affects period-over-period classification comparisons.
- Mortgage repurchase losses increased materially. The firm recorded a $1.0 billion increase in the repurchase reserve in the quarter and $1.6 billion year to date. The total repurchase liability reached $3.3 billion, versus $1.7 billion at December 31, 2009.
- The firm repurchased 57 million common shares for $2.2 billion during the quarter and 60 million shares for $2.3 billion year to date. Remaining common-stock authorization was approximately $3.9 billion at quarter-end.
Guidance, outlook, risks and unusual items
- Management expected Retail Banking revenue to remain stable over the next several quarters, but estimated that overdraft and nonsufficient-funds fee changes would reduce annualized Retail Banking net income by approximately $700 million.
- Management estimated realized mortgage repurchase losses could total approximately $1.2 billion in 2011. It also anticipated continued elevated servicing, default and foreclosed-asset costs.
- Management expected Card Services outstandings to decline approximately 15% from 2009 levels to about $123 billion by year-end 2010 and estimated that the CARD Act could reduce annualized Card Services net income by approximately $750 million. Full run-rate effects were expected in the fourth quarter of 2010.
- Real Estate Portfolios remained loss-making, with a third-quarter net loss of $148 million and a nine-month net loss of $1.7 billion. Management indicated that quarterly net charge-offs could remain approximately $1.0 billion for home equity, $400 million for prime mortgage and $400 million for subprime mortgage over the next several quarters. Reserves could increase by approximately $3.0 billion over two years if delinquency and loss-severity improvements do not occur as projected.
- The firm temporarily suspended certain foreclosure judgments, sales and evictions while reviewing affidavit and foreclosure procedures. State and federal investigations were ongoing, and additional legal, servicing and property-maintenance costs were expected, although the ultimate impact was not estimable.
- Management expected modest downward pressure on fourth-quarter net interest margin. It also stated that earnings in Investment Banking, Treasury & Securities Services and Asset Management would remain sensitive to market levels, volumes, volatility and client flows.
- Basel III proposals could reduce the firm’s Tier 1 common ratio by approximately 100 to 200 basis points under management’s then-current estimates, although the firm expected to comply with the proposed standards when effective.
Most important facts for an investor to verify
- Whether the significant earnings improvement is sustainable after the benefit from lower credit provisions and allowance releases diminishes.
- Future mortgage repurchase demands, litigation reserves and foreclosure-related costs, including the sensitivity of the repurchase liability to adverse assumptions.
- Credit performance in mortgage, home-equity, purchased-credit-impaired and credit-card portfolios, including delinquency and charge-off trends.
- The comparability of reported 2010 results with 2009 results after VIE consolidation and the distinction between reported GAAP and managed-basis metrics.
- The effect of the CARD Act, overdraft-fee legislation, Dodd-Frank implementation and future capital and liquidity rules on revenue, expenses and capital deployment.
- Cash-flow volatility, reliance on secured funding and repurchase agreements, and the potential liquidity impact of credit-rating downgrades or derivative collateral requirements.
- The outcome of material litigation and regulatory proceedings, including mortgage-backed securities, foreclosure, Washington Mutual, Lehman Brothers, municipal derivatives and securities-lending matters.