Recommendation to Purchase Stock: Buy Report
JPMorgan & Chase
(NYSE: JPM)
FIN 573: Fall 2010
Erin Miner
12/6/2010
JPMorgan Chase & Co.
Table of Contents
Executive Summary 2
Introduction 3
Buy Recommendation 3
Macroeconomic Review 4
Industry Analysis 5
Demand Analysis 6
Interest Rate Environment 7
Noninterest Expenses 7
Review of the Company and its Business 7
Acquiring Bear Stearns 8
Acquiring Washington Mutual 8
Operations 8
Investment Bank 9
Retail Financial Services 10
Commercial Banking 10
Card Services 11
Treasury & Securities Services 12
Asset Management 12
Corporate/Private Equity 13
Management Team 13
SWOT Analysis 14
Investment Opinion 14
Financial Analysis 15
Financial Projections 15
Valuation 17
Works Cited 19
1
JPMorgan Chase & Co.
EXECUTIVE SUMMARY
JPMorgan Chase & Co. (NYSE: JPM) is one of the world’s largest financial institutions with
over $2 trillion in assets. JPM is headquartered in New York and has grown substantially in the
past ten years as a result of multiple significant acquisitions and mergers. Most recently, JPM
purchased the assets of troubled investment broker Bear Stearns and retail banking institution
Washington Mutual, both in 2008. Most financial institutions lost substantial share value
throughout 2007 and 2008 due to the struggling residential housing market and overall economic
conditions. However as the economy recovers and the financial industry emerges after some
consolidation and the failure of over 300 domestic institutions, some banks will be better
positioned to realize a faster return to revenue and profit growth. JPMorgan well-positioned to
be one of the industry’s top financial performers and will return to its higher dividend payouts,
rewarding shareholders for their patience and sharing in this success.
JPM provides retail, commercial and investment banking, and asset and security management
services primarily in the United States and increasingly throughout the world. Its operations are
divided into six distinct business segments: investment banking, retail banking, card services,
asset management, commercial banking, and treasury & securities services. A seventh segment,
corporate & private equity, manages JPM’s own portfolios and other activities. JPMorgan
provides banking and other financial services to a wide variety of clients including individuals,
small and large businesses, governments, non-profit organizations, and global corporations. Its
investment banking group expanded with the acquisition of Bear Stearns in 2008, adding new
employees and client portfolios to the group’s operations. The retail financial services segment
grew significantly with the 2008 acquisition of Washington Mutual, adding many branches to its
operations in the previously-unoccupied states of California, Oregon, Washington, Florida and
Georgia. Now that operations are fully-integrated, JPMorgan has focused on efficiently
managing its substantial domestic and global footprint.
JPMorgan is better positioned than many of its competitors for a number of reasons. First, its
revenues and subsequent profitability is well diversified in its seven business segments helping
to insulate the company’s overall performance from low returns in specific activities. Secondly,
JPM acquired excellent growth prospects in its purchases of Bear Stearns and Washington
Mutual, with opportunities for growth particularly in its investment and commercial banking
segments. Third, the company continues to be operated by a strong team of seasoned executives
who exercise aggressive management techniques and are well-respected by both industry peers
and government administration. Finally, JPM’s substantial investments and growth plans in off-
shore markets will continue to increase penetration and thus become a larger part of the
company’s profitability. This growth enables JPMorgan to further diversify its revenue streams
from the U.S. economy and allow the company to realize strong returns in emerging markets.
These factors will yield consistent growth, better profitability, and higher shareholder returns.
Recommendation
Based on my forecast of JPMorgan’s financial performance, I have determined that the stock
should be valued at $50.16 per share and is thus undervalued by approximately 25%. Therefore,
I recommend that 140 shares of JPM stock be purchased at its current price of $40.62 per share.
2
JPMorgan Chase & Co.
INTRODUCTION
JPMorgan Chase & Co. (NYSE: JPM) is one of the nation’s largest banking institutions,
providing comprehensive banking and financial services to a diverse client base throughout the
world. JPM maintains over $2 trillion in assets and achieved over $100 billion in revenue during
2009. Headquartered in Manhattan, JPMorgan maintains operations in over 60 countries,
managing assets of over $2 trillion (Datamonitor). Its activities are segmented into six groups,
defined primarily by their target client base: Investment Banking, Retail Financial Services,
Card Services, Commercial Banking, Treasury & Security Services, Asset Management, and
Corporate/Private Equity.
Though it continues to go through phases of growth and expansion, JPM is most accurately
described as a mature company. During the past five years, JPM reached its peak performance in
2007 with over $1.5 trillion in assets and over $71 billion in net revenue. Recently, JPM’s
operations have seen substantial growth due primarily to the acquisition of struggling firms Bear
Stearns and Washington Mutual in 2008. These mergers have realized growth of 50% and 25%
in revenues and assets respectively for the firm (JPMorgan Chase & Co.). Having purchased the
operations of both firms at a significant discount, JPM is well-positioned to grow its market
share by utilizing these new client portfolios and network of branches.
The map at left displays JPM’s
branch and office footprint in the
United States, which is by far its
largest market and represents the
highest concentration of its revenue
streams. With these merged
operations now fully-integrated, JPM
has expanded into five new states
with the potential for growth in
significant domestic markets
including California, Florida, and
Washington. The firm is also focusing substantial resources on expansion of its international
operations, particularly in emerging markets including Brazil, India, and China. JPM has already
suffered through $51 billion in bad loans, but has yet to report an unprofitable quarter
(Lowenstein). Despite the continued impact of the economic downturn on the financial sector,
and risk associated with potential future legislation on banks and financial firms, JPMorgan
Chase is well positioned to show above-average performance during the next five to six years. I
recommend buying JPM shares due to the likelihood of growth in performance and profitability,
and the likely return to its historically higher level of dividend payout per share.
Buy Recommendation
Under the following analysis, I have determined that JPM shares are currently undervalued by
approximately 25%. My forecasted stock performance has determined a value of $50.16 per
share, and therefore I recommend that our portfolio purchase 140 shares of JPM stock at its
current price of $40.62 per share.
3
MACROECONOMIC REVIEW
The U.S. economy has seen a significant contraction during the last three years, bottoming out in
March 2009 after losing 60% of index value. As residential housing values dropped and
homeowners began to default on their mortgages, bank loan balances had to be risk rated
appropriately, thus resulting in a series of write-downs and additional loss provisioning during
2008 and into 2009. The FDIC conducted a number of stress tests on the industry, determining
that minimum capital levels should be increased from 6% to 8% for FDIC compliance. Through
further degradation in asset quality and increased capital requirements, many financial
institutions large and small were strapped for cash. Though initially designed to increase bank
lending, the TARP program allowed many banks to obtain the liquidity needed to stabilize
balance sheets and re-capitalize. In the effort to stimulate growth and encourage bank lending,
the Fed funds rate has been held at 0% for over a year. Despite this virtually nonexistent cost of
funds, many strong banks are holding onto their high capital rates and liquidity, providing them
with a sound balance sheet to insure against the impact of a prolonged economic recovery.
Paired with higher underwriting standards and continued sluggish GDP growth, loan growth is
simply lower than the industry and current administration’s expectations. With credit still
difficult for small or struggling businesses to obtain, high unemployment rates and low consumer
confidence continue to slow recovery.
The U.S. stock market has recovered much of the losses seen in early 2009, but is far from
returning to its 2007 peak levels. Early growth in 2010 leveled off by the summer, and the
market has seen relative stagnancy during the past few months.
In addition to these economic influences, a number of recent outside developments have
impacted the high volatility of stock prices. In September 2010, inconsistency in foreclosure
filings led to the discovery that many such legal documents were improperly or fraudulently
completed. In October, former investors in mortgage-backed securities began filing lawsuits
against a number of large banking institutions, seeking to unload their now troubled residential
mortgage assets back onto the banks that sold them. With the acquisition of institutions such as
Wachovia, Countrywide, and Washington Mutual, purchasing banks Wells Fargo, Bank of
America, and JPMorgan Chase are now exposed to the thread of these ―put-backs‖. The
primary environmental factors in the U.S.-based financial industry are summarized as follows:
Technological
Increasing demand for mobile access to financial services products and banking for
individuals and companies.
Advances in security features have helped clients to avoid fraud, but offenders continue to
find new ways to breach security.
Demographic
U.S. population growth is expected to continue slowing in its growth rate, as it has for the
past ten years.
The sluggish economy has further slowed population growth over the past 3 years.
Economic
The lingering domestic unemployment rate remains high at 10% despite other signs of
economic recovery.
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Consumer confidence remains low, particularly in regards to large financial institutions.
Borrowing interest rates are at nearly all-time lows, but new loan origination remains low
due to tight underwriting practices and aversion to new debt.
Socio/Cultural
Society remains frustrated with large banks and bonuses, and the TARP action was one of
the most debated decisions in the fall 2010 elections.
There is a slight consumer trend in moving towards smaller community banks, but this is
limited by fears of deposit safety and security.
Governmental
The recent Frank-Dodd Act limits fee income on both debit card transactions and credit card
accounts, driving larger card issuers to determine other means to replace lost fee and interest
income.
The Federal Reserve is likely to increase interest rates in 2011, and the FDIC is likely to
further increase deposit insurance rates in light of continued bank closures.
Global
European debt markets continue to show instability, placing additional uncertainty and fear
in all financial markets.
Basel III minimum capital requirements will be implemented in 2012, yet the committee has
not yet defined the various levels of capital required.
Continued growth in emerging markets in China, Brazil, and India present strong growth
opportunities for international growth to large institutions.
INDUSTRY ANALYSIS
The banking and finance industry has been in a mature life cycle phase for decades. Its trends
mirror the performance of the U.S. economy closely, following unemployment rates and GDP
growth. This is a well-established industry in the U.S. economy, with all competitors vying to
increase market share.
Competitive Rivalry – Very High
There is strong competition between both small and large institutions for nearly every
client type and market segment
Industry participants strive to increase product and service differentiation to attract new
and existing clients
Competitors often practice aggressive pricing strategies, leading some to differentiate on
level of service quality and convenience
Power of Suppliers – High
Federal Reserve sets borrowing rates which may or may not be the most competitive
resource for bank funds
Depositors also act as suppliers for borrowing funds, with many large depositors
demanding significant interest rate returns in order to maintain their relationships
Threat of New Entrants – Moderately Low
This increasingly regulated industry has substantial governmental hurdles to entry,
particularly in the post-9/11 financial environment
It is expensive to operate financial institutions due to reporting requirements, high
employee costs, and the complex infrastructure needed to be competitive
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The expansion of existing global or domestic participants into new markets poses more of
a threat than new industry entrants
Power of Consumers – High
Large, strong borrowers and depositors can choose their institutions based on pricing,
desired service level, and convenience
Significant government depositors often must utilize the best pricing/return for their
relationship, as stipulated by regulations
Threat of Substitutes – Very Low
Most consumers and corporations must have a banking relationship
There are very few true substitutes for banking and financial service providers
On the heels of this tumultuous recent three-year history, U.S.-based financial institutions are
likely to experience continued change in their operations. If the FDIC chooses to further
increase its insurance rates on deposits, these costs will be passed along by banks to its clients,
likely in the form of lower interest rates on deposits. As legislation changes the balance sheet
requirements for banks, they will likely be limited to a lower leverage rate than in prior years.
This lowers profitability for lending institutions, which will also likely be passed along in cost to
the client. Banks will seek to replace these lost revenues through other sources of income, most
likely through higher service fees and interest rates. For more granular clients such as
individuals and small companies, these changes will simply become the cost of maintaining a
stable banking relationship. For larger companies, government entities, and nonprofit groups,
any changes will likely continue to complicate their banking relationships.
Demand Analysis
For the banking and finance industry, demand is driven by growth in the economies in which the
institution operates. This is a result of such fundamental factors as population growth,
unemployment rates, and GDP growth. Financial institutions flourish when companies and
individuals are actively borrowing, and money is moving through the various stages of the
economy. During 2008 – 2009, the U.S. economy contracted substantially as new home starts
and other construction virtually halted, and residential home sales slumped. This year, the
economy has begun to show signs of slow growth, as GDP is currently on track to yield 2%
growth during 2010. Unemployment rates continue to hover at 9-10% across the country.
According to the U.S. Census, population growth has slowed its pace over the past ten years, and
is expected to continue slowing its growth through 2050. This trend signals that banking and
financial institutions will see fewer opportunities for continued growth in the domestic market.
For those institutions with an international presence, opportunities for continued growth are
vastly different. Western Europe’s highly saturated banking environment was once a strong area
of growth for financial firms, but its uncertain regulatory environment and struggling
governments has made this a less stable area for continued growth. Many institutions are
focusing on growth in emerging markets, particularly the BRIC countries. As presented below,
their substantial GDP growth during the past two years has yielded attractive opportunities for
international institutions.
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REAL Q-O-Q GDP GROWTH
Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010
Brazil 1.5% 2.2% 2.3% 2.7% 1.2% TBD
Russia -10.8% -7.7% -3.8% 3.1% 5.2% TBD
India 6.0% 8.6% 6.5% 8.6% 8.8% TBD
China 7.9% 9.1% 10.7% 11.9% 10.3% 9.6%
(Trading Economics)
As such GDP growth yields stronger commercial businesses and wealthier residents, financial
institutions can expand market share with loan, deposit, and investment products. Due to the
excellent opportunities in these emerging markets and elsewhere, larger financial firms are likely
to look to international operations for higher growth potential than their domestic markets.
Interest Rate Environment
For financial firms that originate loans and maintain deposits, profitability is largely driven by
maintaining a stable and lucrative interest margin. Financial institutions must charge high
enough interest rates on their outstanding loans to cover their interest payments on deposit
accounts, as well as operating expenses (noninterest expenses).
Prior to the economic downturn,
Fed Funds Rate
borrowing costs from the Federal
6.00% Reserve topped 5%, driving banks to
4.00% attract commercial and consumer
2.00%
deposits at a lower cost of funds
(Trading Economics). The Fed’s
0.00% current effective lending rate of 0.0%
2005 2006 2007 2008 2009 has driven banks to dramatically lower
their yield on deposits, choosing rather
to borrow overnight funds as needed. This has in turn pressured interest rates for good
borrowers, driving most institutions to offer very competitive short and long-term interest rates
on loans. As institutions increase their assets with fixed-rate mortgage and commercial loans,
often with 10 – 30 year maturities, future interest margins will likely see more compression when
the interest rate environment begins to increase to more historically-consistent levels.
Noninterest Expenses
Financial firms also report substantial noninterest expenses related to running their physical
offices and infrastructures. Employee pay and benefits are the largest component of noninterest
expenses, often called ―the Burden‖ by financial firms. Risking costs of employee benefits such
as healthcare and insurance coverage are likely the largest threat to maintaining noninterest
expense margins. In order to merit increasing a firm’s workforce, the company should
demonstrate adequate growth potential in the new market or enough demand in the existing
market to merit additional support staff.
REVIEW OF THE COMPANY & ITS BUSINESS
Its name is derived from its two oldest components, Chase Manhattan Bank and J.P. Morgan &
Company. Chase Manhattan was originally formed in 1799 as the Bank of the Manhattan
7
Company, and later became one the most prestigious banking institutions under the helm of
David Rockefeller. As the world’s first billion-dollar company, J.P. Morgan was formed in 1895
and became the most important institution in American finance. Under the Glass-Steagall Act,
the company was forced to separate its investment banking and commercial banking operations,
and thus spun off its investments arm into the future Morgan Stanley. Two significant
acquisitions have impacted JPMorgan’s operations during the past three years.
Acquiring Bear Stearns
In 2008, JPMorgan acquired two troubled institutions: Bear Stearns and Washington Mutual.
Both purchases were made in quick weekend deals with the federal government, who had taken
action to relieve both institutions of some of their large debts. Bear Stearns was previously a
successful investment banking firm, providing trading services and portfolio management to a
large network of wealthy individual and corporate clients. Bear Stearns’ assets were sold to
JPMorgan for approximately $10 per share, much to the anger of its prior shareholders. With
this acquisition, JPMorgan purchased an extensive portfolio of domestic and international clients
and the company’s well-established management methods. Likely the most valuable assets
purchased in this acquisition were Bear Stearns’ unique portfolio management software and its
practices for attracting and developing client relationships. JPM also gained access to a large
group of talented employees and advanced investment banking infrastructure.
Acquiring Washington Mutual
JPMorgan purchased many of WaMu’s assets through FDIC receivership, and was able to leave
much of the company’s substantial debts with the federal government. This purchase provided
JPM with a large network of retail service branches focused in the Pacific Northwest, as well as
California, Florida and Georgia. JPMorgan aggressively wrote-down values of these bank loans
purchased and completed a large-scale consolidation of WaMu’s prior operations (JPMorgan
Chase & Co.). After this acquisition, JPMorgan was pressured to take advantage of TARP funds
to help secure its capital position, but gained operations in a number of large domestic markets.
In recent months, resolution of WaMu’s non-performing mortgages has proven challenging for
JPMorgan. The high number of NPA mortgages and potential ―put-back‖ litigation continues to
be a hindrance to the company’s drive to move forward from the economic downturn (Kopecki).
In spite of these challenges, CEO Jamie Dimon continues to support the opportunities provided
by the acquisition of these two substantial companies (Kim, Putbacks Could Cost Top Banks $43
Billion).
OPERATIONS
JPMorgan’s operations are divided into six distinct lines of business, designed to focus on groups
of customers based on their banking and investment needs. The final category,
Corporate/Private Equity, summarizes the
performance of JPM’s internal treasury, Revenue Sources
investment office, and other corporate Investment Banking
activities, which includes centrally-managed 9%
6%
Retail Financial Svs
22%
expenses and discontinued operations. As of 8%
Card Services
rd
the 3 quarter of 2010, JPMorgan’s revenues 6%
Commercial Banking
Treasury & Securities
were derived as follows from their six
18% 31% Asset Management
Corporate/Private Equity
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business segments, and Corporate/Private Equity (JPMorgan Chase & Co.):
JPMorgan’s operations and revenue streams are concentrated primarily in Investment Banking,
Retail Financial Services, and Card Services. Over the past two years, Commercial Banking and
Treasury & Securities Services have seen the most revenue growth and have helped to buoy
profitability during a challenging time for JPM’s Retail and Investment Banking business
segments.
As displayed above, JPM’s revenue streams are relatively diversified in each of its business
segments, allowing the company to rely less on its principal activities in Retail Financial
Services and Investment Banking. The chart below exhibits resulting net income attributed to
each business segment, also based on company performance during the 3rd quarter 2010. Though
revenue is highly concentrated in Retail
Financial Services, JPM’s profitability was
Net Income Sources driven largely through the Commercial
Investment Banking
Banking segment. This display isolates
16% 17%
the relative profitability of each business
Retail Financial Svs
segment, showing the importance of its
Card Services
14%
9% activities in Commercial Banking, Asset
Commercial Banking
Management, and Corporate and Private
12% Treasury & Securities
10% Equity. The following provides further
22%
Asset Management explanation of each of the six business
Corporate/Private Equity segments, as well as Corporate and Private
Equity.
Investment Bank
This segment focuses primarily on corporate finance needs for their 5,000 institutional clients
throughout the world. Approximately 20% of these clients are governmental entities, hospitals,
schools, and non-profits. The remaining 80% are mostly corporations and financial institutions.
The Investment Bank segment helps these clients to manage their balance sheets and plan for
future changes or growth. Its profitability is driven by collection of transaction-based and
service fee income, as well as investment margins made between trading activities, relative to the
cost of the assets traded and compensation expenses for its employees.
Growth potential
The portfolios acquired from Bear Stearns have yielded some excellent potential client
segments for future growth, particularly through the combined JPM and Bear Stearns
large investor client groups.
JPM will continue to implement and expand Bear Stearns’ Prime Services business group
in European and Asian markets.
JPM has invested nearly $1 billion in technology advancement to create innovative
business solutions to provide shorter execution timelines and enhanced convenience,
which is expected to enhance customer benefit and attract new clients.
New IB offices are being opened further into India, China, and Brazil helping to attract
clients and facilitate investment in these growth markets. In the past five years, JPM has
increased their India corporate portfolio by 400% (Jucca).
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Risks
Competition is becoming increasingly intense as other global banks vie for these high-
return clients in emerging economies.
As big-budget institutions continue to invest in emerging economies, attracting talented
local employees will likely become more expensive.
Retail Financial Services
This business segment includes Chase’s over 5,100 branches and 61,000 employees across 23
states. Their operations serve 30 million small business and consumer clients with common
financial and banking products. Core activities include checking and savings accounts, and
business, home, auto, and student loans. This is by far the most visible part of JPMorgan’s
activities and is what most current and potential clients are familiar with. These operations were
substantially increased with the acquisition of Washington Mutual, adding five new states to
JPMorgan’s operations: Washington, Oregon, California, Florida and Georgia. Profitability in
this sector is driven by interest and fee income, relative to interest expense and operating
overhead. In the past two years, this sector has driven down JPM’s overall performance due to
write-downs in the consumer residential portfolio. This business segment is most likely to
remain concentrated in the United States with relatively little expansion into other international
markets. Through electronic and mobile banking technology, JPM will likely see most of its
increased market penetration in existing branch offices.
Growth Potential
JPM purchased a highly granular group of individual clients from WaMu, and it can
provide a wider array of services and improved mobile access to those clients that are less
price-sensitive.
JPM will increasingly offer its wider array of services to this new client base, including
investing and portfolio management.
It maintains partnerships with auto dealers to provide competitively-priced auto loans,
and became largest auto lender in the U.S. in 2009 (JPMorgan Chase & Co.).
JPM can expand its commercial clients in these retail service branches, particularly in
large California and Florida markets, which were not previously a target segment of
WaMu’s business.
Risks
The company is likely to see continued net losses in this segment due to write-downs of
consumer loans and mortgages.
The Frank-Dodd Act limits overdraft fees on consumer accounts and has resulted in a
decrease in noninterest income, thus these fees should be replaced through other means.
JPM is exposed to potential litigation from mortgage ―put-backs‖ from angry investors,
with related losses most recently forecasted at $10-15 billion (Kim, Putbacks Could Cost
Top Banks $43 Billion).
Card Services
The Card Services group comprises both the company’s credit card account operations and
merchant processing activities. JPM’s maintains credit accounts for millions of customers across
the world. Profitability for credit card operations is driven by collection of finance charges and
fee income relative to write-offs for bad credit and fraud. This business segment has become an
10
increasingly strong source of non-interest income over the last decade, but in the past two years
has been a substantial source of headaches and write-offs for most large institutions. Chase
Paymentech is the largest U.S. merchant services company, providing credit and debit card
processing for governments, retail, and nonprofit groups all over the world. Merchant services
profitability is driven by the collection of transactional fee income relative to carrier charges and
write-offs for bad debt (Visa, MasterCard, etc.).
Growth Potential
JPM has invested in mobile account management technology to allow business and
individual card clients to improve their payment options and rewards programs.
It has introduced new products to attract new clients and gain more business of those
existing, such as Chase Sapphire rewards card for the affluent.
JPM’s existing strong franchises maintain strong market share, attracting new clients with
enhanced convenience and brand recognition of steady institutional strength.
Risks
This segment is most likely to see continued negative profits due to write-downs and
lesser fee income through the end of 2011, but its performance will improve as the U.S.
economy does.
Historically reliable fee income from debit card transactions and credit card accounts will
be limited in the future due to the Frank-Dodd Act.
Card issuers have actively reduced credit limits and adopted higher underwriting
standards, and cardholders are utilizing credit cards less in the current economic
environment.
Commercial Banking
This business segment focuses on providing products and services to commercial business clients
and real estate investors, with over 55,000 clients across the world. A portion of this business
segment also focuses on local non-profit and government entities. This segment provides
financing and ongoing deposit products for operations, expansion, acquisition, and commercial
real estate development. This segment has become an increasingly profitable area of operations
for JPM, as loan interest rates are less regulated and of higher yield than that of its Retail
segment. Profitability is driven by the collection of loan repayment and fees on products and
services, relative to nonperforming loans and interest yield on deposits. Financial institutions are
not permitted to pay interest rates on commercial demand deposit (i.e. checking) accounts, thus
these deposits are held at banks for a lower cost of funds than those of individual personal
accounts.
Growth Potential
JPM is now exposed to new domestic regions including the Pacific Northwest and
California, providing vast potential for new commercial clients.
Growth in the higher-return commercial segment will help to drive profit growth, due to
condensed operations and higher yields and fees on products and services.
Commercial loans are likely to see improved asset quality beginning in mid-2010,
particularly under increased underwriting standards and some improvements in U.S.
economy.
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Risk
Competition is high among institutions for good quality commercial clients, driving down
interest rate and fee pricing.
JPM is likely to see continued credit quality degradation in some segments, especially if
U.S. economy continues its slow progress of improvement.
Treasury & Securities Services
The TSS segment works to help clients mitigate inflation rates through return on capital and
interest margins. Its primary activities include corporate cash management, corporate card
services, and trade services to both large corporate clients and governmental entities. This
segment represents JPM’s largest corporate and government clients, including the distribution of
U.S. unemployment benefits and the Federal Reserve’s purchase of mortgage-backed securities.
The TSS group recognizes small margins on its activities, but transaction volume and growth in
its client base has yielded increased revenue from this group, making it an important area of
growth for JPM.
Growth Potential
New international branches in China and northern Europe to follow new and existing
clients, gaining more of their business and exposure to potential new clients
Expansion of services in Asia, South America, Australia and the Middle East, where
JPM’s comprehensive product and service offerings can compete strongly
Continued aggressive expansion of new Global Corporate Bank franchise, providing
foreign exchange risk management to a potential 30% increase in TSS clients
Continued growth in international electronic transactions, a competitive advantage for
JPM’s significant global footprint
Substantial potential for fee income in foreign exchange risk management for clients, as
historically strong global currencies remain volatile, impacting costs of trade
Risks
Continued weak U.S. market growth impacts investment performance
Low interest rates likely to continue compression in interest margins
Potential for relatively low transaction volume in securities lending due to continued
market risk aversion
Asset Management
The Asset Management group of JPM includes two primary businesses: Investment
Management and Private Banking. The IM group provides institutions and retail investors with
their portfolio management, as well as 401K services for mid- to large-sized U.S. employers.
This segment has seen growth particularly in its pension-management activities, as many risk-
adverse employers requested increased monitoring and management generating fee income and
increasing JPM’s client base. The Private client group provides a wide range of wealth
management products and services to some of the world’s wealthiest individuals and families.
Private Banking has seen both a contraction in its asset base as some client holdings declined in
value, as well as increases due to existing and new clients’ transfer of more assets to JPM’s
services.
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Growth Potential
Planned expansion of Private Banking group,
Increased focus on off-shore expansion, particularly targeting ultra-high net worth
individuals in Russia and Switzerland (Jucca)
Expansion of IM activities in China, particularly through a joint venture with Chinese
firm First Capital Securities
Risks
Volatile investment environment may yield mixed results in client portfolio management
High level of competition in new markets, particularly through UBS and Goldman Sachs’
established presence in China (Chan)
Corporate/Private Equity
This group comprises three segments: Private Equity, unallocated corporate expenses, and
JPM’s own corporate investment portfolio, which includes merger-related items and activities.
By managing its own corporate cash holdings invested in various portfolios, JPM has helped to
increase net income through returns on the U.S. and global markets. This is not one of JPM’s
primary operating activities, but helps to manage interest rate exposure. This is a small segment
of JPM’s revenue streams, and has continued to contract within the past two years.
Management Team
In its early years, JPMorgan expanded significantly under the management of financial legend
John Pierpont Morgan. He was described as a stubborn, aggressive leader who spoke candidly to
clients and exercised cold rationale (A&E Television Networks). JPMorgan CEO Jamie Dimon
has been likened to the historic financial figure with their similar approach to management.
Dimon took helm of the company in 2004 long before the residential mortgage bust and before
Americans lost their trust in big banks. He spent his first weeks examining the fine print of the
company’s financial performance and assets, working to understand its complex trading
activities and estimate its potential exposure (Lowenstein). He immediately began allocating
more capital and became a strong advocate for a ―fortress balance sheet‖ (Kim). In spite of these
efforts to plan for a potential catastrophe, the company was still exposed yet out-performed many
of its competitors. In 2008, Dimon was one of the few executives making aggressive bids and
subsequent contracts to acquire troubled financial firms. This allowed JPM to purchase the
assets of both Bear Stearns and Washington Mutual and leave much of their substantial debts
with the U.S. government (Lowenstein). After acquisition, Dimon wrote-down the value of
these assets on the company’s balance sheets, and accordingly provisioned loan loss funds, and
demanded dramatic consolidation of operations. These actions have helped to lessen JPM’s
operating expenses and prevent further write-down of its assets.
In addition, JPM’s board of directors includes leaders in a number of diverse industries including
oil production, restaurants, health care, real estate, and manufacturing. These leaders can
provide insight into their respective industry challenges and future environments, helping JPM to
plan for its clients’ futures. JPM has consistently released potential loss estimates before its
competitors, helping the market to better understand its position (Kim). Close interaction with
the presidential administration has allowed Dimon to voice opinions on past measures and future
regulations, providing enviable insight into future industry challenges. Dimon recently
reorganized his executive team, reassigning his top three operating managers to different areas of
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the bank in order to diversify their experience and help to build innovative thinking
(Lowenstein). JPM’s skilled management team continues to position the company for long-term
success.
SWOT ANALYSIS
During the past three challenging economic years, JPMorgan Chase has developed a unique
position within the financial industry. Like most large institutions, JPM has made significant
changes to its balance sheet and operating practices. The company has downsized staff, built
capital, and taken a more proactive approach to recognizing potential credit weaknesses and
exposure. Its future growth and success will be impacted largely by the factors listed below in
summary:
•Maintains strong franchise performance and brands across various business segments
•Excellent liquidity and capital position, declining provisions and NPAs relative to assets
Strengths •Strong growth potential in new domestic and international markets
•Continued credit losses impact profitability, slow to improve asset quality in both retail
and commercial banking groups
Weaknesses •High dependence on health of U.S. economy due to concentrated domestic operations
•Growth in U.S. credit card market, strong credit card brand and market share
•Exposure to new domestic markets for commercial banking and other services
Opportunities
•Continue to acquire growing international businesses in emerging markets
•Likelihood of increases in regulatory oversight, increasing cost for FDIC insurance
•Potential for "put-backs" from WaMu's mortgages, continued negative publicity
Threats •Prolonged economic uncertainty in main global markets of U.S. and Europe
INVESTMENT OPINION
Based on the analysis presented above, JPMorgan is better positioned than many of its
competitors for these primary reasons:
Its revenues and subsequent profitability is well diversified in its seven business segments
helping to insulate the company’s overall performance from low returns in specific
activities.
JPM acquired excellent growth prospects in its purchases of Bear Stearns and
Washington Mutual, with opportunities for growth particularly in its investment and
commercial banking segments.
The company continues to be operated by a strong team of seasoned executives who
exercise aggressive management techniques and are well-respected by both industry
peers and government administration.
JPM’s substantial investments and growth plans in off-shore markets will continue to
increase penetration and thus become a larger part of the company’s profitability. This
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growth enables JPMorgan to further diversify its revenue streams from the U.S. economy
and allow the company to realize strong returns in emerging markets.
FINANCIAL ANALYSIS
Like virtually all financial institutions headquartered in the United States, JPMorgan’s
performance over the past five years has been largely impacted by the struggling economy. Prior
to the collapse of the housing market, many prominent financial firms were posting their largest
gains and record profits, driving up share prices throughout the industry. Over the past three
years, all bank stocks have been impacted by the financial industry’s consumer discontent, high
asset write-downs, and overall dismal profitability.
The chart below exhibits JPMorgan’s five-year historical revenue and expense drivers, relative to
actual net income recognized through 2009 (JPMorgan Chase & Co.). The poorest year in
company performance was during 2008, when noninterest income and resulting net income were
at their lowest point. The 2008 year also included the mergers of Washington Mutual and Bear
Stearns which involved significant outside costs and expansion of operating expenses. With a
return to its historical level of noninterest income and lesser required allocations to loan loss
provision, the company shows a return to higher net income during 2009. For additional detail
on these historical figures, please consult the Income Statement provided in Exhibit A.
Historical Profitability Drivers
$80,000
$70,000
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$-
2005 2006 2007 2008 2009
Interest Income Interest Expense Noninterest Revenue
Noninterest Expense Net Income
The attached balance sheet, Exhibit B, shows 2005 – 2009 growth in the company’s asset mix
over the past five years, as well as its funding sources for growth.
FINANCIAL PROJECTIONS
In order to forecast JPMorgan’s financial performance over the next eight years, the following
assumptions have been made based on historical trends, recent developments, and the anticipated
economic environment:
Assumptions
Interest Income:
Interest income will likely grow in 2011 as the Federal Reserve begins to slowly increase
borrowing rates, driving up income from variable interest rates and new loans.
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This interest rate growth trend will continue into 2012 and 2013, as the Federal Reserve
drives more economic growth.
Additional interest income growth will be driven by new clients, particularly in
commercial banking and asset management activities in off-shore and newly-acquired
domestic markets.
Fixed-rate loans originated during this low interest rate environment will limit interest
income, as bank borrowing rates increase and net interest margin is tightened (Cassidy
and Civiello).
Interest Expense
These future interest rate increases will also drive higher deposit rates and higher deposit
balances.
Other resources for funds are likely to increase, including rates on interbank long-term
debt and overnight lending.
Noninterest Income
Trading activity and volume will continue its growth into 2011, yielding higher service
levels and transaction fees.
JPM is likely to discontinue ―free checking‖ accounts, thus the retail banking services
sector will see an increase in noninterest income
Noninterest Expense
Expansion of off-shore operations and a return to higher domestic wages will increase
compensation expenses (Graseck, Pate and Cyprys).
Opening of new international branches will result in some modest increases in other
operating costs.
Continued write-downs in its mortgage portfolios, retail banking loans, and credit card
losses will drive higher other expenses into 2011, potentially 2012.
The FDIC is likely to increase deposit insurance rates, driving up carrying costs of JPM’s
deposits.
Other Factors
Loss provisioning will continue its expected decline during 2010, leveling off to a
slightly higher than historical rate due to the likelihood of increased regulatory
requirements.
The litigation from ―put-backs‖ will likely result in some loss recognition, but may be
somewhat legally limited since JPM purchased the WaMu assets through receivership
(Kotowski, Chung and Chittenden).
Some expected tax savings will be recognized in 2010 and 2011 due to continued
foreclosure write-downs and litigation expenses.
Tax rates will return to their historical level of approximately 33% by 2012.
Valuation
The attached Exhibit C shows the forecasted performance for JPMorgan, including historical
performance of 2005 through 2009 continuing into 2018. The forecasted Income Statement
includes anticipated cash flows to shareholders, arriving at a determined true value of a JPM
share. The graph displayed below exhibits these forecasted revenues and resulting net income
based on various growth rates in both income and expenses for each year. Revenue is expected
to see a slow increase over the next two years through 2012, gaining momentum into 2013 as the
U.S. economy returns to higher activity and employment levels. Through its growth strategy and
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efforts executed during these slower
$300,000 years, JPMorgan positions itself for
$250,000
strong growth into 2014 through 2017.
For additional detail, see Exhibit C
$200,000
Valuation.
$150,000
$100,000
The dividend payout rate will
$50,000 increase in 2011 based on JPM’s
$- application to resume a higher level of
dividend payments.
Dividends will increase in
Net Income (Millions) Total Revenues (Millions) 2012 and thereafter due to a higher
EPS and higher payout rates, helping
to attract and retain shareholders.
Going-forward, the dividend payout rate will be likely be lower than that prior to the
economic downturn. It is
assumed at 32% to help $12.00
maintain the likely higher $10.00
regulatory capital rates. $8.00
$6.00
$4.00
The graph at right exhibits these $2.00
forecasted EPS and dividends for $-
JPM shares, reflecting the above-
mentioned assumptions. For
further detail into the individual
Earnings per Share Dividend per Share (FCFE)
cash flows calculated for JPM’s
shares, please reference attached
Exhibit C.
Based on these individual cash flows, the determined intrinsic value of each JPM share is $50.16.
This suggests that the stock is currently undervalued by approximately 25%, at its current price
of $40.62 as of 11/15/2010. Two other valuations were completed based on a best and a worst
case forecast of JPM’s earnings over the same timeframe. These determined intrinsic values
were as follows, with further detail provided in Exhibits E and F:
Best Case $ 57.56
Most Likely $ 50.16
Worst Case $ 46.11
Current Price $ 40.62 11/15/2010
Each of the three scenarios determined that JPM is undervalued, with the worst case scenario
predicting an approximate 14% higher intrinsic value. The best case scenario arrives at a 40%
higher value to JPM’s shares. Therefore I recommend buying 140 JPM shares at their
current price of $40.62 per share as it is undervalued by 25%.
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Works Cited
A&E Television Networks. John Pierpont Morgan. 2010. 30 October 2010
.
Cassidy, Gerald and Jake of RBC Capital Markets Civiello. "JPMorgan Chase & Co. 3Q10
Results Were a Mixed Bag." 14 October 2010. Investext. 2 November 2010
.
Chan, Cathy. "JPMorgan Forms China Investment Bank Venture With First Capital." 9 June
2010. Bloomberg. 4 November 2010 .
Datamonitor. JP Morgan Chase & Co. Company Profile. New York: Datamonitor, 2010.
Graseck, Betsy, et al. "J.P. Morgan Chase & Co. Catching Up with the Boss." 20 July 2010.
Investext. 2 November 2010 .
JPMorgan Chase & Co. Annual Report 2009. 10-K. New York, NY: JP Morgan Chase & Co.,
2009.
—. Third Quarter Earnings Release. 10Q. New York, NY: JP Morgan Chase & Co., 2010.
Jucca, Lisa. "JP Morgan Targets Swiss, Russa, EMEA Growth." 5 October 2010. Reuters. 29
October 2010 .
Kim, Jim. "Jamie Dimon: Press Shifts Slightly." 7 November 2010. FierceFinance. 11 November
2010 .
—. "Putbacks Could Cost Top Banks $43 Billion." 4 November 2010. FierceFinance. 5
November 2010 .
Kopecki, Dawn. Dimon Beset by Bad WaMu Loans. 2 November 2010. 10 November 2010
.
Kotowski, Chris, Kaimon Chung and Benjamin of Oppenheimer Funds Chittenden. "JPMorgan
Chase & Co. 3Q10 on Target; Continue to Recommend." 13 October 2010. Investext. 2
November 2010 .
Lowenstein, Roger. "Jamie Dimon: America's Least-Hated Banker." The New York Times
Magazine 1 December 2010: MM34-MM42.
Trading Economics. Trading Economics. 30 September 2010. 8 November 2010
.
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