In this article series, we’ve been analyzing JPMorgan Chase & Co.’s (JPM) Q3 earnings reported by first breaking out the areas that drove revenue and led to an EPS beat for the quarter. In my first article, we analyzed revenue, loan growth, and net interest income.
In this article, we’ll do a deep dive into one of the often overlooked but important divisions of JPMorgan, Consumer Banking. We’ll also look into how the bank has positioned itself for year-end and into 2018.
We typically think of JPMorgan Chase & Co. as an investment bank which happens to lend from time to time to consumers and businesses.
However, the growth story that’s taking place in the Consumer Bank should set JPMorgan up very well for Q4 and going into 2018.
Key Divisions Impacting Earnings:
The consumer division can give us enormous insight into the growth of JPMorgan and also for the economy as a whole. With mortgages, credit cards, and auto loans, the consumer banking division of a large bank like JPM is essentially an economic indicator in itself. In particular, I wanted to see the numbers for mortgage originations since it can give us a good sense of the health of the housing sector.
- Revenue of $12 billion was up 6% year on year. Consumer and business banking revenue was up 15% on higher NII.
- Average loans for the division were only up 2%, but the bank’s core loans were up 8% year on year. Credit card and auto loans and leases were each up 7%.
- Mortgage loans were up 12%; however, revenue was down y/y.
“Mortgage revenue was down 17% on loan spread and compressed margins.” – Press release.
Despite new mortgage loans being up 12%, revenue was down. This makes sense given how low 10-year yield was in Q3. Remember this the next time someone tells you that low or high yields don’t impact banks like JPMorgan. A 17% drop in revenue for a bank of this size is significant. However, the 17% drop was the yearly number. The good news for shareholders lies in the quarterly growth numbers as outlined below.
Below are the Consumer Banking financials:
- Mortgage revenue was up $132 million from Q2 to Q3 (in green in the top-left portion). Although not a significant jump, it tells a different story than the 17% decline year on year.
- New mortgage loans grew in Q3 from Q2 by roughly $4B or 1.7% (bottom right portion highlighted in green).
- I thought mortgages would perform better during housing season. Although for investors, the results are not a huge factor since mortgage lending isn’t one of JPM’s core businesses.
- Credit card and auto loan revenue (top left, highlighted in green) both grew from Q2 to Q3 and on an annual basis. Also, both products grew by over $300M.
- Credit card loans jumped 7% compared to last year and rose 2% since Q2 (highlighted blue region at the bottom right).
- Credit cards and auto loans should do well in growing economy as consumer spending typically increases. So it’s not surprising JPM saw 7% growth for both products. I believe both cards and auto loans will be steady drivers of income for JPM if the economy performs well in 2018.
- Again, focusing on the year-over-year numbers can sometimes hide the growth story from quarter-to-quarter. In short, every major credit product in the Consumer division saw growth both in revenue and in new loans in Q3 for JPMorgan.
From JPMorgan Q3 earnings presentation.
Takeaways and thoughts:
- Loan loss provision and credit costs were higher by $1.5B in Q3. According to Ms. Lake, “credit costs of $1.5 billion were up about $200 million year-on-year driven by higher net charge-offs in card.”
- Also, the bank built up $300 million in card reserves which helped in Q3 as Ms. Lake mentioned the reserves which “allowed us to absorb the expected impact of the hurricanes into our current reserves.”
- The extra reserves could be due to an expected rise in default rates by JPM’s executive management. Management could be simply exercising caution given the growth rates in credit card products this year. As the bank increases its lending and card issuance, it’s likely their default rates will rise since they have more credit card clients.
- Although I’m not concerned today, if we continue to see a pattern into Q4 and Q1 of next year of rising reserves and loan loss provisions, it might be a sign of poor credit quality on the books at JPMorgan. In my opinion, I believe management is simply being cautious and the loan loss and credit reserve increases will not become a concern.
- I found it interesting that the CFO commented on the state of the auto industry as it relates to lending from JPMorgan. The auto market “has plateaued at current levels with inventory, incentives, used car prices and SAW all having stabilized over the last few months.” Auto loan growth will be something to monitor in the coming quarters to determine if there’s a drop-off in new loans. In my opinion, I believe economic growth both in the U.S. and in China will bolster the auto industry in 2018. As a result, I’m more optimistic about auto lending growth than Ms. Lake.
- Going forward, JPMorgan is likely to see a reduction in mortgage lending in Q4 because of the holidays and the start of winter. If auto lending declines as well, look for credit cards to carry Q4 for the Consumer Banking division.
- However, I believe Q3’s credit product growth should bolster net income going forward. As I stated earlier, we don’t think of JPMorgan as a consumer bank, but I believe the division has been and will continue to be a key contributor in the next few quarters.
- If you follow my articles on Seeking Alpha, you know that I believe that economic growth will continue to rise, taking Treasury yields higher. Also, the Fed hiking interest rates and tapering the central bank’s balance sheet should be positive for bank earnings and bank stocks.
- JPMorgan’s Consumer Banking division should perform well against the fundamental economic and monetary backdrop. The reason for my optimism lies in the fact that auto loans, credit cards and, to some extent, mortgages are variable-rate credit products. As a result, when yields rise, so do the margins on these products and JPMorgan’s stock should rise as well.
Good luck out there.
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