JPMorgan Chase & Co., Q3 2008 Earnings Call, Oct-15-2008 - NYSE:JPM

NYSE:JPM

Michael Cavanagh, the Chief Financial Officer of JPMorgan Chase & Co., provided extensive commentary during the Q3 2008 earnings call. Below is a detailed summary of his remarks:

Opening Remarks

• Washington Mutual Transaction Impact: Cavanagh began by discussing the impact of the Washington Mutual (WaMu) transaction that closed during the quarter. He noted that the numbers provided were preliminary and subject to refinement.
• Firm-Wide Net Income: Reported firm-wide net income, including WaMu impact, was $527 million or $0.11 per share.
• WaMu Merger Items: Included a conforming loan loss reserve adjustment of $1.221 billion and an extraordinary gain of $581 million, resulting in a negative impact of about $0.18 per share.
• Future Merger-Related Items: Expected ongoing merger-related costs to be booked in the corporate segment, estimating approximately $100 million after-tax in Q4 2008 and up to $500 million over the next few years.
• Purchase Accounting Refinements: Any refinements to purchase accounting would run through the P&L and be counted in the merger-related items line.
• WaMu Operating Results: Beginning in Q4 2008, the ongoing operating results of WaMu would be included in the relevant business segments.
• Earnings Impact: Comfortable with the expectation of an incremental $0.50 EPS for 2009 from the WaMu acquisition, with a pro rata portion of $0.10 to $0.12 in Q4 2008.

Firm-Wide Results

• Deferred Tax Liability Benefit: After-tax benefit of $927 million, spread across business units, primarily in the investment bank.
• Credit Reserves: Increased credit reserves through the P&L by $1.3 billion, bringing the total to $15.3 billion.
• Tier 1 Capital: Maintained strong Tier 1 capital of $112 billion or 8.9% Tier 1 ratio, bolstered by a $11.5 billion common equity raise.

Investment Bank Results

• Net Income: $882 million on pre-tax income of $16 million, driven by the deferred tax liability benefit.
• Investment Banking Fees: $1.6 billion in revenues, up 20% year-over-year, and leading market share.
• Fixed Income Markets: Total revenues of $815 million, including write-downs of $2.6 billion on mortgage positions and $1 billion on leverage lending.
• Equity Markets: Revenues of $1.650 billion, up year-over-year, driven by strong client and trading revenue.
• Credit Costs: $234 million, primarily additions to loan loss allowance, with only $13 million in actual charge-offs.
• End of Period Equity: $33 billion, reflecting a refined capital allocation methodology.

Retail Results

• Branch Statistics: Growth in checking accounts, branches, and ATMs.
• Average Deposits: Up 2% year-over-year.
• Mortgage Originations: Down, with most originations conforming to government guarantee standards.
• Home Equity Originations: Down 77% year-over-year.
• Revenue: $4.9 billion, up 16% year-over-year.
• Net Income: $247 million, down from the previous year, driven by higher credit costs.
• Credit Costs: $1.678 billion, including $450 million of additions to loan loss reserves.
• Capital Allocation: Increased from $17 billion to $25 billion, taking into account the WaMu acquisition.

Major Residential Mortgage Portfolios

• Home Equity: Net charge-offs of $663 million, up from the previous quarter. Outlook for quarterly loss to trend as high as $725 million to $800 million.
• Subprime: Net charge-offs of $273 million, with an outlook of as high as $375 million to $425 million.
• Prime Mortgage: Charge-offs of $177 million, trending as high as $300 million by early 2009. Noted that 50% of losses come from 2006-2007 vintages.

Card Business

• Profits: $292 million, down substantially from the previous year.
• Credit Costs: $2.2 billion, up significantly from the prior year.
• Charge-off Rate: 5%, in line with expectations.
• Outstandings Growth: 6% year-over-year to $158 billion.
• Charge Volume Growth: 5%.

Commercial Bank

• Profits: $312 million, up 21% from the previous year.
• Record Revenue: $1.125 billion, up 11% year-over-year.
• Loan Growth: 18% year-over-year.
• Deposit Growth: 13% year-over-year.
• Credit Costs: $126 million, with a 22 basis point net charge-off rate.

Treasury and Security Services

• Profits: $406 million, up from the previous year.
• Record Revenue: $897 million in treasury services.
• Liability Balances: $260 billion.

Asset Management

• Net Income: $351 million, down from the previous year.
• Assets Under Management: Down $133 billion due to market declines.
• Inflows: $123 billion over the past year, $46 billion in the quarter.

Corporate Segment

• Private Equity: After-tax losses of $164 million.
• Corporate: After-tax costs of $1.64 billion, including write-downs of Fannie Mae and Freddie Mac securities ($642 million after-tax), auction rate securities settlement ($248 million after-tax), and prime loan costs ($234 million after-tax).
• Merger-Related Items: After-tax costs of $735 million, including the WaMu conforming loan loss reserve adjustment and Bear Stearns merger-related costs.

Capital

• Tier 1 Capital Ratio: 8.9% for the quarter, including the WaMu balance sheet and the $11.5 billion common equity raise.
• Capital Allocation: Ensured proper capital allocation across businesses considering Basel II implementation and off-balance sheet accounting rules.

Washington Mutual Integration

• Stabilizing Deposit Base: Positive net inflows on seven out of the past nine days.
• Loan Balances and Reserves: Detailed the loan balances and reserves associated with the WaMu acquisition.

Outlook

• Higher Credit Costs: Expectation of higher credit costs across businesses, with worsening economic conditions likely leading to continued additions to loan loss reserves.
• Card Business: Losses expected in the 5% range in Q4 2008, with a reasonable expectation of 6% at the beginning of 2009 growing to 7% by the end of the year, depending on the economy.
• Asset Management and TSS: Subject to market conditions.
• Corporate: $50 million to $100 million negative outlook.
• Washington Mutual: Incremental $0.50 EPS for 2009, with a pro rata piece in Q4 2008.

Closing Remarks

• Paymentech Gains: Expected after-tax gain of $800 million from the dissolution of the merchant services business with First Data, assuming it goes through in early November.

James Dimon provided several comments and insights during the JPMorgan Chase & Co. Q3 2008 Earnings Call. Here is a detailed summary of his remarks:

General Comments

• Preparation for a Bad Environment: JPMorgan is preparing for a challenging economic environment. While the bank's non-performing loans, delinquencies, and credit card metrics are not in bad shape, the bank is bracing for increasing loan loss reserves given the rise in unemployment and uncertainty.

• Trading Results and Charge-offs: Trading results may be tough going forward, and charge-offs are expected to increase. The bank anticipates adding to its loan loss reserves over the next few quarters.

• Strong Balance Sheet: JPMorgan enters this environment with a strong balance sheet, including an 8.9% Tier 1 capital ratio before any government assistance, and robust loan loss reserves, which are among the strongest in the industry.

• Real Growth: Despite the challenging environment, JPMorgan has experienced real growth in market share and raw growth in areas such as deposits and loans.

• Investment Banking Performance: The investment banking division performed well, managing through volatile markets in September. The bank is proud of its employees' accomplishments during the period.

• Government Assistance Package: JPMorgan viewed the government's assistance package as a positive step for the system. The bank decided not to act in a parochial manner and supported the package, despite potential asymmetric benefits for competitors. The bank received $25 billion of capital and hopes to use it effectively for shareholders while continuing to serve clients.

• Client Focus: Despite challenges in certain lending categories (e.g., home equity, auto), JPMorgan strives to stay in business for clients, with commercial loans up 18% and investment banking loans significantly increasing.

Specific Business Areas

• Bear Stearns Integration: The Bear Stearns business is performing as expected, with some improvements in P&L but not yet reaching the targeted incremental profits for 2009.

• Credit Card Business:

  • The credit card margin was up quarter-over-quarter, but the prime LIBOR spread could cost the bank $100 million per month if sustained.
  • Spend numbers dropped, with consumer-side spend running at 3%-5% weekly, compared to VISA numbers around zero.
  • Payment rates decreased slightly, and losses are trending upward as expected.

• Government Capital Deployment:

  • The government's non-voting preferred stake implies no direct involvement in JPMorgan's business operations.
  • JPMorgan plans to use the capital to facilitate clients and make loans, aligning with the government's intention.

• TARP Asset Sale Facility: JPMorgan does not plan to use the TARP asset sale facility for reducing mortgage exposures, given the bank's reduced exposure and the potential benefits of the TARP facility for market stability.

Other Topics

• Lehman Bankruptcy Risks: JPMorgan believes it will manage risks related to Lehman's bankruptcy well, with some open issues remaining.

• Card Business Legislation:

  • JPMorgan has already eliminated practices such as double-cycle billing and off-us pricing, which could mitigate the impact of potential legislative changes.
  • Proposed legislation could lead to significant changes, but competitive dynamics would adjust pricing and lending practices over time.

• Deposit Market Share: JPMorgan is likely gaining market share in wholesale deposits, particularly in Treasury Services and Private Banking, but not in retail deposits.

• Prime LIBOR Inversion: The inversion negatively impacts the credit card business but benefits some other areas of the bank.

• Mortgage Origination Changes: Mortgage origination volumes have declined due to stricter underwriting standards and lower loan-to-value ratios, especially in states like California, Nevada, and Florida.

• Credit Pullback Impact: While credit pullback could exacerbate credit deterioration, the bank does not have specific examples to illustrate this effect.

• Investment Banking Outlook: The bank advises caution regarding investment banking results, given the ongoing economic crisis. It expects trading results to be tough and does not anticipate significant earnings from this area.

• TARP and Market Stabilization: The Troubled Asset Relief Program (TARP) has had a slight stabilizing effect on pricing in the mortgage market, particularly in Alt-A and CMBS sectors. However, agency MBS spreads remain high.

• Treasury Program and Capital Raising:

  • The Treasury program's details suggest that it aims to normalize capital raising processes over time.
  • JPMorgan believes that the program will not make capital raising more expensive for the banking industry in the long term.
  • The program may help weaker banks more than stronger ones, but its intent is not to prop up failing institutions.

These comments provide insight into JPMorgan's strategic approach, operational performance, and response to the evolving economic landscape during the 2008 financial crisis.