JPMorgan on profit drop: Be relieved we aren't taking big risks

JPMorgan Chase & Co executives had a clear message for shareholders after reporting declining first-quarter earnings: don't worry, be happy that the bank isn't chasing short-term gains by making irrational lending decisions.

The first quarter was a tough one for JPMorgan. Profit fell 19 percent, revenue fell 8 percent, and the bank set aside 38 percent more money to cover loan losses.

But the important thing is that the bank is not lowering its lending standards, Chief Executive Jamie Dimon told reporters.

"We feel really good about the risks we're taking ... for the future of the company," Dimon said on a conference call.

The bank will not be too aggressive in areas where it says it believes other lenders have taken leave of their senses, such as business lending, Chief Financial Officer Marianne Lake told analysts on a separate call.

"We'll do every rational and sensible deal we can do but we aren't going to chase growth at the expense of discipline," Lake said.

Some investors say they appreciate the bank's strategy. Analyst Mike Scanlon at John Hancock Asset Management said Dimon seems to be making the kind of cautious lending decisions that long-term investors should want.

"They gave up revenue instead of chasing every dollar of business," Scanlon said.

Before the financial crisis, Charles "Chuck" Prince, then chief executive of Citigroup, infamously said that his bank had no choice but to make aggressive loans to private equity funds because its rivals were. "As long as the music is playing, you've got to get up and dance," he told the Financial Times.

A senior executive at JPMorgan, who was not authorized to speak on the record, said on Friday, "Jamie is not going to dance."

By backing away when others lend more aggressively, JPMorgan is acting like it did before the credit crisis, Scanlon added. John Hancock Asset Management owns about 1 million shares of JPMorgan.

Dimon's recent tangles with regulators over a range of issues, including the loss of more than $6 billion in the London Whale derivatives scandal, may be making the bank more inclined to play it safe when it comes to all kinds of risk, said analyst Gerard Cassidy of RBC Capital Markets.

"All of this is coming together to make a conservative bank that in the long-run is going to work very well for shareholders, but over the near-term is going to come up short at times, like they did this quarter," said Cassidy.

JPMorgan has one of the highest valuations among the major commercial and investment banks, as measured by share price to tangible common book value, which is due in part to its tendency to know when to scale down credit risk, Cassidy added.

Wells Fargo & Co, the fourth-largest U.S. bank by assets, agrees that competition is heating up now.

"You tend to see competitors be a little more aggressive, price things more aggressively to generate revenue," said Tim Sloan, chief financial officer at Wells Fargo.

Wells Fargo said on Friday that it managed to boost its lending book in the first quarter, but much of its 14 percent net profit increase in the period came from one-time gains.

LAGGING RIVALS

For JPMorgan, remaining disciplined is painful.

The bank's mortgage lending and bond trading businesses logged steep profit declines, and the bank's profits also fell in many other key businesses, including corporate lending and debt underwriting.

"It was not an exciting set of numbers," said Andrew Kohl, an associate portfolio manager at Alpine Financial Services Fund, which owns JPMorgan shares.

The results and company commentary prompted analyst Chris Kotowski of Oppenheimer to cut his JPMorgan earnings estimates. He reduced his 2014 estimate to $5.64 a share from $6.13, and his 2015 estimate to $6.00 a share from $6.45.

Total loans on JPMorgan's books grew less than 1 percent in the first quarter compared with the year-earlier period, and the average rates it earned on its $730 billion of loans fell to 4.49 percent, from 4.78 percent.

One headwind for loan growth at JPMorgan is the impact of old Washington Mutual assets that the bank is not replacing when they mature. JPMorgan bought Washington Mutual at the height of the financial crisis after it failed.

But the bank is consciously trying to limit its new business in areas where profitability is shrinking. For example, JPMorgan made just $17 billion mortgages in the first quarter, down from $52.7 billion in the same quarter last year. That nearly 70 percent drop is steeper than the 57 percent decline that the Mortgage Bankers Association expects for the industry in the first quarter, mainly as a result of the reduced appeal of refinancing because of higher interest rates.

Speaking to investors in February, JPMorgan's Consumer and Community Banking CEO Gordon Smith said that there is a lot of competition in mortgage lending now as volume shrinks, and the bank is trying to determine how much business it wants there.

JPMorgan's total loan growth lags the overall market, Federal Reserve data show. Loans across the U.S. banking system rose about 3.5 percent from the final week of March 2013 to the last week of March 2014.

Overall volume of loans to companies has been growing fast, Fed data show: commercial and industrial loans on banks' books were 7.8 percent higher at the end of March from a year earlier.

In the riskiest part of that market, namely junk-rated loans to companies, quality has weakened, and deals are put together in a way that reduces protection to investors.

In loans to companies, JPMorgan is increasingly seeing competition from private equity firms and other lenders outside of the banking sector.

About $1 billion of loans that JPMorgan made to companies with weak credit quality have been refinanced by non-banks, Doug Petno, chief of the bank's commercial banking, said in February.

Wells Fargo's Sloan said he has seen increasing competition from non-banks as well, but added that Wells Fargo's ability to sell a wide range of products to customers has prevented it from losing too many clients.

In the first quarter, companies took out $8.6 billion of second-lien loans, which are riskier as they provide lower recoveries to lenders in a default. That is the fifth-highest level on record and a 25 percent increase over each of the past two quarters, Thomson Reuters LPC data show.

(Reporting by David Henry in New York, Additional reporting by Lauren Tara LaCapra, Peter Rudegeair and Michelle Sierra in New York; Writing by Dan Wilchins; Edited by Martin Howell)