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Morningstar | JPMorgan Finishes 2018 With Tougher Trading Environment, Hits 17% ROTE for Full Year

Narrow-moat JPMorgan Chase reported decent fourth-quarter results, with net income on a reported basis of $7.1 billion, or $1.98 per diluted share. Results did drop off a bit in the quarter, which was partially expected given some of the drop-off in market-sensitive revenue we have seen at peers, but full-year return on tangible common equity was 17%, and EPS growth was over 40%. This level of ROTE is already on par with management’s long-term goal for the bank, which signals to us that JPMorgan is and has been firing on all cylinders. We believe the bank is already operating at full capacity and do not expect much improvement from here. We do not expect to be making any material changes to our current fair value estimate based on our initial reaction to earnings, but may alter it slightly as we more fully incorporate the results into our model.

If there was one area for potential disappointment, it was the adjusted overhead ratio, which stayed flat year over year for the bank. However, given the massive investments the bank is able to support while also maintaining relative efficiency and returns on equity, we don’t view this negatively. We believe the largest banks, with JPMorgan currently operating as one of the best, are gaining scale advantages by being able to support greater investment for long-term competitive advantages while also maintaining returns and operating efficiency. Therefore, to look only at quarter-to-quarter efficiency ratios would be myopic, in our view.

JPMorgan continued to increase loans at a decent clip, up 6% year over year, but segment-specific loan growth within commercial banking was not the strongest. Average commercial banking loans were up 2% year over year. We appreciated management’s comments regarding the nuances surrounding different loan portfolios. Specifically, the bank is pulling back within CRE, particularly construction, as competition remains stiff, while the stronger growth is more concentrated within cards and some of the new markets where the bank is trying to grow its commercial operations. On that same note, credit costs remained range-bound and generally below normal for JPMorgan, with charge-offs on almost all portfolios coming in below historical norms.

The bank continued to increase debit and credit card sales volumes, up 8.4% year over year, and merchant processing volumes were up 17% year over year. The bank’s card services net revenue rate also continued to improve, with a full-year rate of 11.27% compared with 10.57% last year. JPMorgan maintained its top spot for I-banking fees for 2018, even gaining share in most markets. Finally, for wealth and asset management, we believe the bank did an admirable job given the current pressures in the market. The bank did experience net outflows within equity and multi-asset/alternatives, but the net inflows into liquidity and fixed income products led to net positive organic flows for the quarter. Further, the bank had net positive organic flows for all asset types for full-year results, demonstrating the diversity and strength of the franchise.

We currently see JPMorgan largely maintaining these types of returns, as continuing investment expenses and a normalization of the credit environment are partially offset by efficiency gains, releasing excess capital, and overall growth. The bank may underperform these measures for certain periods of time during economic stress, but on average we believe the bank has hit a fairly sustainable level of return.