Wednesday, 27 April 2011 09:17

There's Something Fishy at the House of Morgan

I invite all to peruse the mainstream financial media and sell side Wall Street's take on JP Morgan's Q1 earnings before reading through my take. Pray thee tell me, why is there such a distinct difference? Below are excerpts from the our review of JP Morgan's Q1 results, available to paying subscribers (including valuation and scenario analysis): File Icon JPM Q1 2011 Review & Analysis.

Here we go...

There's Something Fishy at the House of Morgan

JPMorgan’s Q1 net revenue declined 9% y-o-y ad 3% q-o-q to $25.2bn as non-interest revenues declined 5% y-o-y (down 5% q-o-q) to $13.3bn while net interest income declined 13% y-o-y and (-2% q-o-q) to $12.5bn. However, despite decline in net revenues, noninterest expenses were flat at $16bn. Non-interest expenses as proportion of revenues went was 63% in Q1 2011 compared with 58% a year ago and 61% in Q4 2010. However, due to substantial decline in provision for credit losses which were slashed 83% y-o-y (63% q-o-q) to $1.2bn from $7.0bn, PBT was up 78% y-o-y (15% q-o-q).

Lower reserve for loan losses and consequent decline in Eyles test (an efficacy of ability to absorb credit losses) coupled with higher expected wave of foreclosures which is masked by lengthening foreclosure period and overhang of shadow inventory, advocate a cautionary outlook for banking and financial institutions. As a result of consecutive under-provisioning since the start of 2010, JP Morgan’s Eyles test have turned negative and is the worst since at least the last 17 quarters. The estimated loan losses after exhausting entire loan loss reserves could still eat upto 8% of tangible equity.

Non-interest revenues

 

Non-interest revenue declined 5% y-o-y (down 5% q-o-q) to $13.3bn from $14.0bn in the previous year. Investment banking fees were up 23% y-o-y as debt underwriting fees and advisory fees were up 29% y-o-y and 44% y-o-y, respectively partially offset by 8% decline in equity underwriting fees. Principal transactions revenues were up 4% y-o-y to $4.8bn, the highest at least since last 17 quarters. Asset management revenues were up 10% y-o-y $3.6bn. The bank reported a loss of $0.5bn on mortgage fees and related income compared with gain of 0.7bn in the corresponding quarter last year while securities gains for Q1 2011 declined to $102m from $610m in Q1 2010. Credit card income was up 6% y-o-y to $1.4bm while other income increased 40% y-o-y to $574m.

I have warned of this event. JP Morgan (as well as Bank of America) is literally a litigation sinkhole. See JP Morgan Purposely Downplayed Litigation Risk That Spiked 5,000% Last Year & Is Still Severely Under Reserved By Over $4 Billion!!! Shareholder Lawyers Should Be Scrambling Now Wednesday, March 2nd, 2011.

Traditional banking revenues: manifest destiny as forwarned - Weakening Revenue Streams in US Banks Will Make Them More Susceptible To Contingent Risks

Net interest income declined 13% y-o-y (-2% q-o-q) to $11.9bn versus $13.7bn in the previous year as interest income fell 7% to $15.6bn while at the same time interest expenses increased 19%. Interest income declined as a result of steep decline in yield on interest bearing assets despite a 2% y-o-y and 4% sequentially increase in interest bearing assets. Low interest rates and lower proportion of high yield assets have caused a strain on yield on interest bearing assets. The proportion of loans to interest bearing assets (high yield assets) have declined to 34% in Q1 2011 from 36% in Q1 2O10 and 39% in Q1 2O09 while at the same time proportion of Feb Funds rate (low yield assets) to interest bearing assets have increased.  Yield on interest bearing assets which is in a downward trajectory declined to 3.06% in Q1 2011 versus 3.35% in Q1 2010.

Interest expense increased to 19% as interest bearing liabilities increased 2% y-o-y while at the same time yield on interest bearing liabilities increased to 0.81% from 0.69%. Overall, the bank’s net interest margin declined to 3.1% in Q1 2011, the lowest since 2007 as low interest rate environment coupled with low risk appetite have taken a toll on banks net interest margin.

Again, I have warned of this occurrence as well. See my interview with Max Keiser where I explained how the Fed's ZIRP policy is literally starving the banks it was designed to save. Go to 12:18 in the video and listen to what was a highly contrarian perspective last year, but proven fact this year!

Provisions and charge-offs: I have been warning about the over-exuberant release of provisions to pad accounting earnings since late 2009!

 

Declines in provision was one of the major contributors to bottom line. JPMorgan reduced its provision for loan losses to $1.2bn (0.7% of loans) in Q1 2011 from $7.0bn (4.2% of loans) in Q1 2010 and from $3.0bn (1.8% of loans) in Q4 2010 while charge-offs declined to $3.7bn (2.2% of loans) in Q1 2011 from $7.9bn (4.4% of loans) in Q1 2010 and from $5.1bn (2.9% of loans) in Q4 2010. Although banks delinquency and charge-off rate has declined, the extent of decline in provisions is unwarranted compared to decline in charge-off rates. As a result of higher decline in provisions compared to charge-offs, total reserve for loan losses have decreased to 4.3% in Q1 from 5.3% in Q1 2010 and 4.7% in Q4 2010. At the end of Q1 the banks allowances to loan losses is lowest since 2009.

Although the reduction in provisions has helped the banks to improve its profitability it has seriously undermined the banks’ ability to absorb losses, if economic conditions worsen. As a result of under provisioning for the past five quarters, the banks Eyles test, a measure of banks’ ability to absorb losses, has turned to a negative 7.7% in Q1 2011 compared with +6.4% in Q1 2010. A negative Eyles test has serious implications to shareholders – the losses from banks could not only drain entire allowances for loan losses which are inadequate but can also wipe off c7.7% of shareholder’s equity capital. The negative value of 7.7% for JPM’s Eyles is the lowest in this downturn.

 

 

For those of you who believe the housing market has put in a bottom, JPM may be the company to believe in. For those a bit more grounded in reality, realize...

For those who still do not believe that the Fed's ZIRP is starving the banks, I strongly suggest reading Did Bernanke Permanently Cripple the Butterfly That Is US Housing? The Answer Is More Obvious Than Many Want To Believe Monday, March 28th, 2011, as excerpted:

Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!, Bernanke et. al. have snipped the chrysalis of the US markets and economy one too many times. He has interrupted the circle of life...

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the “Peak” phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality…

The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference File Icon The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. All four corners of the globe are currently “hobbling along on one leg”, under the pretense of a “global recovery”.

Reminisce while traipsing through our real estate analysis and research:

  1. On Employment and Real Estate Recovery Monday, April 25th, 2011
  2. A First In The History Of Mainstream Media? NAR Is Identified As A Joke! Tuesday, March 29th, 2011
  3. The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance Friday, March 11th, 2011
  4. Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate Friday, February 25th, 2011
  5. Further Proof Of The Worsening Of The Real Estate Depression Thursday, February 24th, 2011
  6. In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse Wednesday, February 23rd, 2011
  7. When Will the Mainstream Media Be Ready To Call The NAR The Sham That It Really Is? Tuesday, February 22nd, 2011
Last modified on Wednesday, 10 August 2011 07:51