JPMorgan shows juice is in reserves, not earnings

July 15, 2010

Don’t count on a rebound in earnings to boost U.S. bank stocks. That’s the message to glean from JPMorgan’s second-quarter results. Granted, the bank’s performance was hardly disastrous, especially considering the slowdown across the industry in trading in May and June. But almost a third of the bank’s profit came from a $1.5 billion gain on releasing loan-loss reserves.

By itself, that’s another encouraging sign that the wounds inflicted by the financial and economic crisis are healing. There are others: JPMorgan’s credit card business made money for the first time in a while, thanks to lower charge-offs. And the bank has revised downwards estimated losses on problem mortgage loans.

But business was sluggish. Credit card revenue actually fell 4 percent from the first quarter, while both asset management and commercial banking were flat. The investment bank, meanwhile, suffered from a marked slowdown in client flow that reduced overall revenue by 24 percent and fixed-income trading revenue by more than a third.

Tellingly, the bank made the point that spreads have returned to pre-crisis levels and that competition was well and truly back — implying that the bumper performance of trading desks across Wall Street for the past few quarters may finally be on the wane.

All in, the bank’s earnings before provisions actually fell 9 percent from the first quarter. That’s where the loan loss reserves prove so handy. Had these stayed at the same rate as the first three months of the year, JPMorgan’s annualized return on equity for the quarter would have been far more anemic than the reported 12 percent. The bank isn’t, though, trying to fudge the numbers: boss Jamie Dimon made it clear that he doesn’t consider the gain from releasing reserves a bonus: “It’s just ink on paper. It means nothing.”

That’s still good news for shareholders, assuming the economy continues to improve ever so slowly. Even if pre-tax, pre-provision earnings don’t grow, JPMorgan’s stock could more than double if provisions for loan losses fall by three-quarters over the next few quarters. It’s a similar story for the likes of Bank of America and Citigroup.  That should give shareholders a good deal of comfort.

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