JP Morgan (JPM) reported strong first-quarter results Friday that revealed a strengthening balance sheet and positive credit trends in its consumer real estate and credit card portfolios. The firm’s net income fell $172 million (3%) from the same period a year ago, though earnings per share advanced modestly, to $1.31 (consensus expectations were at $1.18 per share). Though we expect the earnings environment to continue to be challenging for banks, we do expect the group as a whole to fetch better valuations in the years ahead as the outsize risk premium associated with ongoing concerns about the domestic housing market and European sovereign debt ease. We continue to hold small, diversified financial positions in the portfolio of our Best Ideas Newsletter, namely the Financial Select Sector SPDR (XLF) and the SPDR S&P Bank ETF (KBE).
First, let’s start with the bad. JP Morgan’s investment bank division was the weakest performer across all of its business segments. Its investment bank witnessed a revenue decline of 11% and a net income drop of roughly 30% in the period. Though we’d like to see better results from the division, we’re less concerned about i-banking revenue, as it relates to a gauge on the health of the domestic consumer. Plus, we expect i-banking performance to improve in coming periods and have no qualms with the firm’s number 1 ranking in global investment banking fees in the first quarter. The company’s asset management arm was another weak performer in the quarter due primarily to lower performance fees, with net income falling 17% from the same period a year ago. And its card services and auto business saw net income tumble 23% from the same period last year.
Though a few segments were weak, importantly, underlying credit measures continue to improve. Specifically, we were very happy with the performance in its retail financial services segment (RFS), with net income coming in at $1.75 billion versus nearly a $400 million loss in the same period a year ago. The biggest driver behind the improved performance was better delinquency trends, resulting in lower net charge-offs and a $1 billion reduction of the allowances for loan losses. JP Morgan’s consumer and banking division also witnessed lower credit loss provisions (a 2.19% net charge off rate versus a 2.86% net charge off rate in the same period a year ago), and its mortgage production and servicing segment experienced improvement, with net income in the division coming in at $461 million versus a $1.1 billion loss in the same period a year ago. These are extremely positive data points as it relates to the health of consumer lending.
Further, the firm’s real estate portfolios turned the corner thanks to improving credit quality, with the segment bringing in $518 million in net income in the period compared with a loss of $162 million. We liked the direction of charge-off rates in this division as well: Home equity net charge-offs were $542 million (2.85% net charge-off rate), compared with $720 million (3.36% net charge-off rate) in the prior year. Subprime mortgage net charge-offs were $130 million (5.51% net charge-off rate), compared with $186 million (6.80% net charge-off rate). Prime mortgage, including option ARMs, net charge-offs were $131 million (1.21% net charge-off rate), compared with $161 million (1.32% net charge-off rate). Credit trends in its card services and auto segment also showed improvement. The Credit Card net charge-off rate was 4.37%, down from 6.81% in the prior year; and the 30+ day delinquency rate was 2.55%, down from 3.55% in the prior year and 2.81% in the prior quarter. The Auto net charge-off rate was 0.28%, down from 0.40% in the prior year and 0.37% in the prior quarter. Its commercial banking division also saw improvement in the top and bottom line and lower net charge-offs.
All things considered, we view JP Morgan’s first-quarter report as another data point that consumer credit continues to improve. The company’s capital position at the end of the period–Basel III Tier I common ratio of 8.4%–also speaks to the ongoing focus of domestic banks on maintaining significant capital strength. We remain comfortable with the comparatively small financials exposure in the portfolio of our Best Ideas Newsletter (banking stocks remain absent from our Dividend Growth porfolio).