I’ve never been bearish on JPMorgan Chase (NYSE: JPM) long-term, but in the past few months, I’ve been worried about the kinds of problems the bank might run into in the short term. After all, America’s largest bank is a leading lender to the struggling oil industry and has a massive credit card division, which can see losses rack up quickly in a recession. I’ve also expressed concerns about JPMorgan being able to maintain its current dividend if economic conditions continue to deteriorate.
But after the bank reported a profit of nearly $4.7 billion in the second quarter, while setting aside billions to cover loan losses, there is no doubt in my mind that JPMorgan is a tremendous bank stock to have right now, and probably pretty cheap in the long term at less than $100 per share. Bank of America (NYSE: BAC) is certainly not a bad stock and has fared pretty well during the coronavirus pandemic as far as a bank is concerned, but what JPMorgan did in the second quarter was very special in my opinion. Here’s why.
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A remarkable second quarter
On paper, JPMorgan and Bank of America performed fairly similarly in the second quarter. JPMorgan reported net income of nearly $4.7 billion in the second quarter, down 51% from the second quarter of 2019 , while Bank of America reported net income of about $3.5 billion, down 52% from the second quarter of 2019 . Both stock prices are down by similar levels since the pandemic really hit the markets in late February.
But JPMorgan generated $4.7 billion in profits while setting aside roughly $10.5 billion to cover potential loan losses . Not only is this probably the biggest quarterly provision that JPMorgan has ever taken, including higher than any provision during the Great Recession, it’s more than double the $5.1 billion provision Bank of America took in the quarter .
JPMorgan’s CEO Jamie Dimon has always talked about building a “fortress balance sheet,” and this quarter we really saw that in action. While the bank’s consumer and community banking, commercial, and corporate banking divisions posted losses in the quarter, the asset management and corporate and investment bank divisions rode gains that made the company profitable overall. Specifically, the investment bank performed phenomenally in the quarter, posting $16.4 billion in revenue, driven by fixed-income market trading revenue of $7.3 billion for an overall profit of nearly $5.5 billion . This is exactly how the “fortress balance sheet” is supposed to work — when markets are volatile, the investment bank picks up the slack, and when they are stable, the consumer bank does more of the heavy lifting.
The other thing to consider is that JPMorgan has now built in about $19 billion of cash just to cover loan losses over the past two quarters. Even though those losses haven’t materialized yet, the bank has already taken a lot of the pain to account for them. If things do not get as bad as the bank is projecting, it could be able to take some of the money out of the provision bucket down the line.
I have been concerned about JPMorgan being able to maintain its current dividend down the line if economic conditions continue to deteriorate at a worse clip than they are now. The problem is that because it’s the largest bank in the country, JPMorgan continues to have a higher regulatory burden even when it appears to be performing well.
For instance, following the Federal Reserve’s stress test results, JPMorgan announced that it would have to maintain a higher common equity tier 1 (CET1) capital ratio, a metric closely watched by regulators that measures a bank’s core capital as a percentage of its risk-weighted assets. Its regulatory minimum will likely increase from a 10.5% CET1 ratio to 11.3% in October, while Bank of America’s minimum CET1 ratio will remain at 9.5% . If the CET1 ratio falls below a bank’s required minimum, that bank is limited to paying out capital distributions equivalent to 60% of eligible retained income, which makes a dividend cut more of a serious consideration.
With JPMorgan’s CET1 ratio at 12.4% at the end of the second quarter , it only has 1.1% to fall until it brushes up against that minimum. Meanwhile, Bank of America’s current CET1 ended the second quarter at 11.6% , leaving it with more than 2% to fall before brushing up against its regulatory minimum.
For this reason, I do see Bank of America’s dividend being much safer right now, but I still think JPMorgan is in solid shape. First of all, the bank still might be able to pay its dividend if its CET1 ratio fell slightly below 11.3%, and second, there’s no indication that ratio will get that low again. Last quarter, its CET1 ratio fell to 11.5%, but that was after business customers at the bank drew down an unprecedented $50 billion in revolving lines of credit, significantly increasing the bank’s risk-weighted assets and therefore dropping its CET1 ratio .
Again, I want to reiterate that Bank of America is not a bad stock to own long-term, but I was really impressed with JPMorgan’s ability to generate $4.7 billion in profit, while setting aside so much cash to cover potential loan losses. As it did in the Great Recession, the bank continues to perform well in times of stress. While the dividend may be at more risk than Bank of America’s, even if there was a cut, it would likely only be temporary, and I still think JPMorgan is in position to maintain its current dividend level.
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