JP Morgan Chase, Wall Street Enigma, Sees Earnings Upside

J.P. Morgan Chase & Co. (NYSE: JPM), the granddaddy of Wall Street financiers that came into 2012 with bragging rights as the biggest U.S. bank by assets, is expected Friday to a healthy first-quarter profit as reduced interest costs offset declining revenue from traditional sources.

Regulatory requirements and litigation mean those sources are generating less than they used to. Trading revenue, for example, partly recovered during the recently ended quarter but remains fragile. Even the near-zero interest rate regime, begun three years ago to help Wall Street, has caused loans made by big banks to yield less and less with each passing month.

That has prompted analysts such as JMP Securities' David Trone to "expect traditional banking revenue to continue to drift downward."

A consensus forecast of banking analysts polled by Thomson Reuters has J.P. Morgan reporting $24.6 billion in managed revenue for the first quarter, which would be 4.6 percent less than the $25.8 billion posted for the same period of 2011.

The lower revenue will hurt the bank's bottom line: The analysts' consensus is that J.P. Morgan will report net income of $1.15 a share, down from $1.28 a share a year ago. But because the bank navigated fallout from the euro zone debt crisis better than its rivals during the fourth quarter, the earnings hit isn't likely to be catastrophic. In addition, some of the very factors that depressed revenue have enabled J.P. Morgan to provide offsetting reductions in its borrowing costs.

"Overall, we expect JPM to set a high bar for the industry this quarter by reporting strong results driven by improved trading, strong mortgage banking, and continued loan growth in its commercial book," Frederick Cannon of specialist investment bank Keefe, Bruyette and Woods wrote in a note to clients. His analysis assumed a return on tangible common equity, a common measure of bank profitability, near 15 percent -- "well above universal bank peers."

The bank is scheduled to report first-quarter earnings Friday at 7 a.m. EDT, followed by a conference call at 8:30 a.m.

'Fortress' Balance Sheet

That Wall Street expects J.P. Morgan to outperform its peers shouldn't come as a surprise. Besides being the biggest, J.P. Morgan is arguably among the three or four most stable big banks -- joined by Wells Fargo & Co. (NYSE: WFC), U.S. Bancorp (NYSE: USB) and PNC Financial Services Group Inc. (NYSE: PNC).

Morgan's management has frequently bragged about its "fortress balance sheet," and CEO Jamie Dimon is an unapologetic defender of Wall Street. His public statements often rebut critics who argue bankers are at the heart of the financial industry's problems, with Dimon instead castigating politicians and regulators. The bank also has the best credit rating among elite peers Bank of America Inc. (NYSE: BAC) Citigroup Inc. (NYSE: C) Morgan Stanley (NYSE: MS) and Goldman Sachs Group Inc. (NYSE: GS).

But beyond a chip on its shoulder and a CEO more than happy to carry it, the bank has advantages over its rivals that contribute to sizable profits.

Brennan Hawken, an analyst at UBS, noted in early April that J.P. Morgan handily leads competitors in mergers and acquisitions, garnering 24.8 percent of the total market. That will position the firm to take advantage of an incipient rebound in M&A activity, which analysts believe will rise by double-digit percentages this year.

"JPM remains the best positioned firm in our coverage, and has grown significant market share in its FICC (non-equity trading) operations over recent years. JPM received a strong vote of confidence in the Fed's stress test, and JPM's proven ability to execute gives us confidence," Hawken wrote in a note to clients.

About those stress tests that the Fed assessed in March: J.P. Morgan passed them with flying colors, and once it learned of its success announced higher dividends and the initiation of a stock buyback program. Shares promptly soared.

Other Upsides

There are other, less-obvious upsides that could be reflected in the first-quarter earnings.

Trading activity, which was abysmal during last year's fourth quarter, recovered somewhat during the beginning of 2012. Analysts expect increases in fixed-income trading revenue exceeding 50 percent when compared to last quarter, with more likely upside than downside.

"We think JPM and Goldman have retained their edge in committing capital for clients throughout the cycle and as client interest in credit and mortgage assets picked up in 1Q12, these firms likely reaped the rewards and should generate healthy returns," Glenn Schorr, an analyst at Nomura Securities, wrote in a recent note to clients.

It is also possible the bank has improved cost management, an issue most analysts agree the institution has plenty of room to work on, not having slimmed down as much as competitors such as Bank of America and Goldman Sachs in recent quarters.

An even more intriguing prospect, which wouldn't affect first-quarter revenues but would heavily weigh on earnings, is the possibility the bank was able to hedge more effectively against expected amortization from dollar-value averaging, or DVA.

DVA is an accounting method that requires banks to record a paper loss when the market judges its bonds to be on a stronger footing, as is the case with J.P. Morgan bonds of late, so any hedge that moves against that loss helps the bottom line. In recent days, both the Wall Street Journal and Bloomberg News noted that a J.P. Morgan trading office in London has been setting up some heavy positions in the credit-derivatives swap market, which could be used to set up such a hedge.

But Will It Boost The Stock?

There are no promises any of these upsides will emerge Friday, but analysts agree they are possibilities. Even a stellar first-quarter report may not do much for shareholders. The bank's stock is already up 29.2 percent for the year, and seems to have hit a technical ceiling just shy of $46 in March.

At those prices, even J.P. Morgan isn't buying J.P. Morgan -- Dimon recently said the company wouldn't seek to promote the announced stock buyback program if shares exceeded $45, effectively making that a strong psychological benchmark for the market. At midday Thursday, the shares were up 43 cents to $44.44.

Hence the enigma that is J.P. Morgan Chase as it prepares to disclose its first-quarter performance: a bank expected to have less revenue but still-healthy profits, one that, despite having more upside than downside relative to analysts' projections, has only slim upside on the tape.