The earnings season has kicked off within the US financial sector as JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC) became the first money center banks to report their second quarter performances. Let’s review their performances in comparison to what analysts were expecting amid rising interest rates.
A look at the macro indicators during 2Q
The second quarter was marked with turbulence in both mortgage and interest rates. This was largely due to the speculations related to the Fed’s exit from both Agency MBS and Treasury markets. These speculations also resulted in a rising interest rate environment. Since, interest income forms a large part of banks total revenues, higher rates should have a significant impact on the top-line. Besides, the book values of these banks should have experienced a decline.
What analysts were expecting
Credit Suisse believed that JPMorgan Chase & Co. (NYSE:JPM) was among the banks that were best positioned to benefit from the current higher interest rate environment. It was positioned to grow both its revenue and book value. Credit Suisse expected as much as 1.1% growth in its book value despite the prevailing rising rates due to the lowest durations on its available-for-sale securities, while its own CEO said investors should expect as much as $2 billion in addition revenues if the yield on 10-year Treasury increases by 100 bps.
What JPM reported
At first glimpse, it seems like JPMorgan Chase & Co. (NYSE:JPM) produced impressive second quarter results. That’s because it was able to beat its earnings per share (EPS) and revenue estimates for the second quarter. However, despite the beat, its shares fell after the earnings announcement.
All that glitters is not gold
A deeper look into JPMorgan’s results reveals that all that glitters is not gold. JPMorgan Chase & Co. (NYSE:JPM) was $0.16 per share ahead of its estimated EPS when it reported its $1.60 per common share in EPS for the second quarter, while revenue of $25.2 billion was $360 million ahead of the consensus estimate. The bottom-line was given a real boost of $0.24 per share by a reduction in the loan loss reserve in the bank’s credit cards and real estate portfolios, as net charge-off in these portfolios nearly reached historical lows. This was partially offset by a $0.09 per share increase in litigation reserves.
The disappointing part comes in now. Since interest rates have increased so much over the past quarter, I believe that a quarter-over-quarter analysis makes more sense rather than a year-over-year analysis.
The top-line for the second quarter edged up 0.4 bps or $110 million over the linked quarter. This is in sharp contrast to the $2 billion additional revenue expected by the bank’s CEO. A similar disappointment trickled down to the bank’s bottom-line, which plunged 0.5 bps over the same time period. Even though the sequential changes are minute in nature, they are in sharp contrast to what was expected. Net interest margin, a key matrix of revenue at JPMorgan Chase & Co. (NYSE:JPM), was down a significant 31 bps over the prior year, which resulted in net interest income down 1% over the prior year. Clearly, the bank did not benefit from the rising interest rate environment as far as its net interest margin and net interest income is concerned. The second largest home lender also reported a 7% sequential decline in mortgage originations during the second quarter.
However, JPMorgan was able to report some growth in its tangible book value, which was in line with the expectations of Credit Suisse analysts. The tangible book value surged 1.2% over the prior quarter despite higher rates.
What to expect in the future?
For both JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC), the future could be harsh as interest rates continue their upwards journey amid a sluggish US loan growth environment. Since both JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo hold top positions as home lenders in the US, they are poised to face declining profits in their mortgage banking units.
Bloomberg reports JPMorgan acknowledged that the situation is becoming difficult as bond markets continue to suffer, and the only way out for JPMorgan is accelerated cost-cutting. JPMorgan’s CFO goes a step further and explains that the bank’s mortgage lending volumes could be cut by 30 – 40%, while the demand for most of the loans in the US is hardly surging.
These macroeconomic conditions combined with more and more stringent capital regulations will lead JPMorgan Chase & Co. (NYSE:JPM) to a tougher second half of the current year.
Better NIM and mortgage banking results
In my opinion, Wells Fargo & Co (NYSE:WFC) posted better-than-expected overall results due to better mortgage banking unit’s results and a relatively stable net interest margin. The bank reported EPS of $0.98, $0.04 per share ahead of the consensus mean estimate, while the revenue for the second quarter came in at $21.38 billion, beating estimates by $170 million.
Mortgage originations surged 3%, while the net interest rate margin plunged only 2 bps over the prior quarter. However, mortgage applications decreased 15% over the same time period, which means the future of mortgage banking at Wells Fargo will be weaker.
In another positive development, Wells Fargo & Co (NYSE:WFC) reported a flat book value compared to the prior quarter. This is in contrast to the highest book value erosion estimated by Credit Suisse and points towards some fixed income portfolio re-balancing and better strategic decision making at the bank.
Competition
I introduce U.S. Bancorp (NYSE:USB) as competition for JPMorgan. That’s because it is the third largest home lender after Wells Fargo & Co (NYSE:WFC) and JPMorgan and has the same diversified business model as the aforementioned banks. According to Yahoo Finance, U.S. Bancorp (NYSE:USB) is expected to report its second quarter results on July 17, 2013.
Credit Suisse expects U.S. Bancorp (NYSE:USB) to report 3% sequential higher revenues, on higher fee-based income as a result of healthy trends in corporate payments and merchant processing. The bank will not experience any significant improvement in its net interest margin, while its credit quality is largely expected to improve. The bank’s mortgage banking results should be better on higher mortgage production. The bank’s management has already acknowledged better mortgage production this quarter, compared to the prior quarter.
Conclusion
While both JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC) produced better-than-expected EPS for the second quarter, only JPMorgan Chase disappointed its investors and analysts by reporting lower-than-expected revenue and a poor mortgage banking performance. It is clear that JPMorgan was not able to expand its interest income and utilize higher interest rates, while in contrast to expectations, Wells Fargo & Co (NYSE:WFC)’s fixed income portfolio’s possible re-balancing resulted in a relatively flat book value. So, in my opinion Wells Fargo has a better future.
Adnan Khan has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC).
The article JPMorgan: All That Glitters Is Not Gold originally appeared on Fool.com.
Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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