Although not surprising, two of the United States’ largest banks, JP Morgan (click ticker for report: ) and Wells Fargo (click ticker for report: ) kicked off the first quarter with terrific earnings. JP Morgan exceeded earnings expectations, generating a record $1.59 per share in earnings on revenue of $25.8 billion. Wells Fargo’s results weren’t too shabby either, boasting record earnings per share of $0.93 on revenue of $21.3 billion.
JP Morgan
Much of JP Morgan’s quarter was driven by strong performance from the mortgage business, which earned a return on equity of 14% (image source: JPM Q1 2013 presentation). Originations grew 37% year-over-year and 3% sequentially to $52.7 billion. Net interest margins on mortgages continue to compress, and CFO Marianne Lake anticipates this will continue, saying on the conference call:
“…it’s [net interest margin] tough to predict but maybe the thing is, look at is if you take off pretax spread right now of 100 basis points that compares to a longer term sort of average run rate of 65 basis points before the crisis.”
The Corporate & Investment Bank segment remains challenged, though profitability improved as the firm focused on controlling costs. The segment earned investment banking fees of $1.4 billion, up 4% year-over-year, and ranked first in global investment banking fees. Compensation as a percentage of revenue fell 600 basis points year-over-year to 33%, while total expenses declined 2% compared to the prior year.
We were pleasantly surprised by the results of JP Morgan’s heavy push into Asset Management. Net income soared 26% year-over-year to $487 million, on revenue increasing 12% year-over-year to $2.7 billion. Asset inflows totaled $28 billion, and the firm now manages $1.5 trillion in assets. Clearly performance was aided from strong equity market performance, but we believe the company’s push into asset management will be incredibly profitable because the firm offers a full-service package that could help retain assets.
Wells Fargo
As for Wells Fargo, the company made headlines when it announced the opening of its first ever 1,000 square foot branch. The move could provide the company with the flexibility to expand its ATM base at a much lower cost than the traditional 3,000-4,000 square foot office. This could be a prelude to Wells Fargo expanding its presence in smaller markets.
As for its financial performance, Wells Fargo increased its return on equity 145 basis points year-over-year to 13.59%. Net loan charge-offs declined materially to 0.72% of average total loans compared to 1.25% during the same period last year. Loan performance continues to improve, but we do not see charge-offs falling below 0.70% (though we reiterate that Wells Fargo is one of the highest quality lenders amongst the large banks).
Net interest margins compressed yet again, falling to 3.48% from 3.91% a year ago, but just 8 basis points lower than the previous quarter.
Mortgage originations (shown above; source: WFC Q1 2013 presentation) fell sequentially though remained robust at a whopping $109 billion. Wells Fargo remains far and away the country’s largest mortgage originator, though recent results show that competition may be intensifying. CEO John Stumpf suggested the business could decline, saying:
“So I think we’re very bullish on the [mortgage] business. That said, our expectation is that it’s probably likely that revenues and margins will come down a little bit. All that said, to the extent that it comes down further than we think, we’ll adjust cost as or team has done through various cycles on a number of occasions.”
The asset management business performed strongly during the quarter, driven by market performance and fund inflows. Assets under management were 7% higher than the year prior at $1.5 trillion, driving a 14% increase in net income. We believe inflows could remain strong if the Dow and S&P continue hitting new all-time highs, increasing general interest in the broader stock market.
Although neither is owned individually in our actively managed portfolios, we include the Financial Services Select SPDR ETF (XLF) and the SPDR S&P Bank ETF (KBE) in the portfolio of our Best Ideas Newsletter, and we remain optimistic about return prospects in the industry. Still, the balance sheet risk of owning an individual bank stock is too large for us to stomach.