JPMorgan Chase & Co.'s blow-out first quarter earnings strongly suggest the credit crisis is finally ending. But for many banks, especially those without investment banking operations, they still leave unanswered the question of where banks will make money in the future.
The New York banking giant reported profits of $3.3 billion, smashing expectations, largely on the strength of its powerhouse investment bank.
It also delivered surprisingly bullish news on the credit front, becoming the first major lender to effectively draw down its reserves since the recession started, a move that added about $900 million to the bottom line. While loan losses rose, the bank set aside less money to cover bad loans, as loans past-due at least 30 days fell in its home equity, prime mortgage and credit card books.
The results emboldened the bank's notoriously conservative chief executive, Jamie Dimon. "There is clear and broad-based improvement in the economic factors in the United States and around the world," Dimon said in a conference call with reporters on Wednesday. "I think the chance of a double-dip (recession) is rapidly going away."
Market watchers welcomed that optimism as a sign the banking industry's biggest source of pain — consumer loan losses — may be reaching an inflection point.
"They're not building their reserves further — I guess they don't project higher losses in the future," Matthew Albrecht, a banking analyst with Standard & Poor's, said. "I didn't expect that."
But other numbers in JPMorgan Chase's earnings report could have ominous implications for large and regional banks that lack muscular capital-markets operations.
The credit-quality picture looks brighter, sure, but that shines a light on other fundamental problems plaguing banks, said Keith B. Davis, an analyst with Farr Miller & Washington.
With loan books shrinking, it isn't clear how banks are going to grow on the other side of the recession, he said, through the fundamental business of taking deposits and lending them out at attractive rates.
"The biggest concerns are going to shift from credit to where the revenue is going to come from," Davis said. "Longer term, if they are not going to aggressively grow their loan portfolio and net interest margin starts to shrink, it is going to be very difficult for them to grow their revenue."
While JPMorgan Chase is printing money in its investment bank — reporting net income of nearly $2.5 billion there on stellar fixed-income revenue — capital-markets activity is notoriously fickle and unsustainable, Davis said.
JPMorgan Chase's bread-and-butter banking businesses are still anemic. Its credit card and retail financial services units continue to bleed money as losses remain elevated. Housing, commercial and credit card loans are running off its books faster than they can be replaced with healthier new ones. In commercial banking, profits rose as loan losses eased. But revenue was flat and net interest income declined as its middle-market, commercial-term and real estate loan books shrank.
The company also reported a new expense that could plague other banks, setting aside $2.3 billion to cover what it described in a press release as legal fees involving "mortgage-related matters." Market watchers said they wouldn't be surprised if other big banks started to report higher expenses as they face more lawsuits from people who took out loans they couldn't afford. Banks have also been forced to repurchase more troubled credits they may have sold to government-sponsored entities.
"I would expect Bank of America or Wells Fargo to have higher litigation expenses — I'm not sure they are going to be comparable to JPMorgan's," Anthony Polini, an analyst with Raymond James & Associates, said. "Those expenses have to go up when looking at loan modifications. …The whole cleanup process involves a lot of litigation."
Still, Polini said that JPMorgan Chase's showing in the quarter was more positive than negative, particularly given the surprising reserve release and improving delinquency trends.
The company's overall reserves rose due to an accounting adjustment. But its charge-offs exceeded provisions by roughly $900 million, which is an important development because it indicates that the company feels that it has enough allowances to more than cover its pending loan losses.
Last quarter, provisions exceeded charge-offs by about $1.1 billion; a year earlier, by $4.2 billion.
"We can't really point to sustainability for sure … you are starting to see some actual trends downward in these early-bucket delinquencies," Mike Cavanagh, the company's chief financial officer, told reporters.