JPMorgan Hit By Declining Earnings

As the Dow (^DJI) opened only modestly lower to start yesterday’s trading session, J.P. Morgan (JPM) surprised analysts when they reported positive earnings of $527 million, or $0.11 a share. Even though it represented an 84% drop from last year’s earnings of $3.37 billion, or $0.97 a share, the average consensus estimates from analysts were expecting a loss of $0.21 on revenue of $16 billion. Included in the earnings were $3.6 billion in write-downs from mortgage investments and leveraged lending exposures.  Revenues also declined 8.5% to $14.74 billion.  Also, JPM faced a few large one-time items including $927 million gain from lower deferred tax liabilities and a $642 million loss on Fannie Mae (FNM) and Freddie Mac (FRE) preferred stock. They also realized a $248 million after-tax charge related to auction rate securities.

Their big move during the quarter was the acquisition of Washington Mutual’s banking operations on September 25^th, providing an additional 5,400 consumer branches. In the process, they reported a $640 million loss from the acquisition due in part to a $1.2 billion loss to conform loan loss reserves and a gain of $581 million related to the acquisition.

JPM’s Investment Banking kept them afloat over the last quarter with net income increasing $586 million to $882 from last the prior year due primarily to lower deferred tax liabilities. These lower deferred tax liabilities however, were offset by increased non-interest expense of $3.8 billion, an increase of $1.4 billion, or 60%, from the prior year. Net revenue was $4.0 billion, an increase of $1.1 billion, or 37%. This was helped by a 20% increase in investment banking fees and record revenue of $1.7 billion in Equity Markets resulting from strong trading results and client revenue. Commercial Banking and Treasury and Security Services also posted gains from a year ago with CB’s net income up 21% or $54 million and TSS net income higher by 13% or $46 million. JPM’s Investment Banking kept them afloat over the last quarter with net income increasing $586 million to $882 from last the prior year due primarily to lower deferred tax liabilities. These lower deferred tax liabilities however, were offset by increased non-interest expense of $3.8 billion, an increase of $1.4 billion, or 60%, from the prior year.

Net revenue was $4.0 billion, an increase of $1.1 billion, or 37%. This was helped by a 20% increase in investment banking fees and record revenue of $1.7 billion in Equity Markets resulting from strong trading results and client revenue. Commercial Banking and Treasury and Security Services also posted gains from a year ago with CB’s net income up 21% or $54 million and TSS net income higher by 13% or $46 million.

More Bad News

The biggest drag on JPM’s bottom line was in their Retail Financial Services business where they saw Net income decrease $392 million to $247 million, a decrease of 61%. They did see moderate revenue growth of $4.9 billion, an increase of $674 million, but faced large credit losses of $1.7 billion from high loan-to-value home equity and mortgage loans. Net income was also hurt by non-interest expense of $2.8 billion, an increase of $303 million, or 12% from the third quarter last year.

Higher provisions for credit losses and lower net revenues also hurt the Card Services and Asset Management divisions during the quarter. CS declined $494 million, or 63%, to $292 million while AM saw a 33% drop of $170 million to $351 million.

Looking Forward

J.P. Morgan’s CEO, Jamie Dimon, gave a grim outlook on the banking sector, but re-affirmed his company’s strength: “Given the uncertainty in the capital markets, housing sector and economy overall, it is reasonable to expect reduced earnings for our firm over the next few quarters. However, with a total loan loss allowance of $19 billion (including Washington Mutual) and an 8.9% Tier 1 capital ratio, we feel well-positioned to handle the turbulent environment and, most importantly, to continue to invest in our businesses and serve our clients well.”

JPM showed reaffirmed its strength this morning with great numbers, but going forward this year it has remained to be seen when the bottom of the credit crisis will hit and what that will mean for banks.

CEO Jamie Dimon feels confident in the benefits of acquiring WaMu in saying: “We expect the Washington Mutual transaction to create long-term value for shareholders while also being immediately accretive, adding 50 cents per share to earnings in 2009.”

The acquisition definitely adds to JPM’s core business and we have seen that some of the costs were large. But as they continue to integrate WaMu, and with a $25 billion cash injection from the U.S. government’s financial rescue package on the way, JPM should be well positioned to weather the rest of this year well and help lead the beaten down financials through a recovery next year.

Disclosure: The mutual fund the author is associated with is long JPM.

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