JPMorgan Outlook Worsens Fears About Mortgages
Forget the huge boost in trading income. Set aside (for now) the legion of questions about new capital requirements.
The real news in JPMorgan Chase's second-quarter report was the weak outlook that it provided for traditional banking. Rising rates could cut the mortgage business by at least a third the rest of the year, and commercial loan growth was anemic. Credit cards offered a bright spot.
Above all, its results cast doubt on predictions that industrywide mortgage volume was going to fall by 20% this year compared with 2012, says Christopher Whalen, managing director and head of investment banking at Carrington Investment Services in Greenwich, Conn.
"JPMorgan numbers suggest that interest rates could account for an additional 10% to 20% drop in volumes," on top of the expected decline in refinance volumes, Whalen says.
The headline numbers for JPMorgan were strong, as they often are.
Much of the 31% increase in JPMorgan's quarterly earnings, to $6.5 billion, came from investment banking. Net income from corporate and investment banking rose 19% to $2.8 billion, from a year earlier. That included a 38% rise in investment banking fees, a 50% rise in debt underwriting fees and an 83% increase in equity underwriting fees.
"Their capital markets business continues to do so well during a period of unprecedented volatility," says Nancy Bush, a banking industry analyst with NAB Research. "Clients continue to come to them for their trading ability."
Meanwhile, analysts incessantly questioned Jamie Dimon, chairman and chief executive, about the potential effect on the company's capital position from proposed Basel III rules. Dimon responded that JPMorgan "intends to be in compliance" when required to do so but internal details are still being worked out.
However, it all came back to mortgages.
For the second quarter, net income from mortgage banking at JPMorgan fell 15% to $1.1 billion, from $1.3 billion a year earlier.
The effect of rising rates on its mortgage business could be huge, Marianne Lake, chief financial officer, said. JPMorgan's mortgage production, both refinancings and new purchase mortgages, "could be reduced by an estimated 30% to 40%" in the second half of 2013, Lake said.
JPMorgan is looking at a potential "dramatic reduction in profits," Dimon said. "This would be a significant event if mortgage rates stay where they are."
Ten-year Treasury yields rose from 1.63% on May 2 to 2.74% on July 5, the highest yield since August 2011. The 10-year Treasury yield stood at 2.58% in late Friday morning trading.
Dimon said that it's difficult to make broad comments about the impact of interest rates on the bank overall. Higher rates were one contributing factor to market volatility, and heightened volatility helped trading results.
"Higher rates hurt mortgages but, again, they can help other areas, so it's a whole potpourri," Dimon said. "It's impossible to separate it out."
Commercial lending fell 8% to $621 million, from $673 million a year earlier, with Lake characterizing the drop as a result of continued pessimism among borrowers.
"Corporate America is very liquid right now and has access to the capital markets, and that obviously affects demand," Lake said. "Our customers are still very cautious and also still very liquid. We need confidence to pick up."
Average loans in credit cards fell 2% to $122.9 billion, from a year earlier. But Lake predicted an increase in card business later this year.
"We saw a stabilization…at the end of the second quarter after 15 quarters of net run-off," Lake said during the call. "We feel we've reached an inflection point and expect some modest growth from here."
JPMorgan's second-quarter results also included $600 million in new expenses for litigation, although Dimon declined to provide details on the source of the litigation cost.
Federal regulators signed off this week on Basel III rules on capital ratios, which include new risk-based capital requirements. JPMorgan executives were asked numerous questions by analysts about the proposed rules; including one question from Whalen whether the U.S. should withdraw from the Basel process.
Dimon said the company has "always believed in high capital, high liquidity, good regulation and things like that and finishing it." But he did express frustration with the process.
"One of the things that Basel" was supposed to do was "harmonize global rules," Dimon said. "This is clearly no longer harmonization. I don't think there's any industry out there to be comfortable with something like that in the long run, because in the long run that has a lot of effects that you can determine, quarter by quarter."
Some analysts and investors are also becoming frustrated with the lack of clarity on the Basel III rules, as well as new proposals to break up JPMorgan and other large banks.
"Everything is so squarely aimed at Chase," Bush says. "If you had to look at what [Sen. Elizabeth] Warren did yesterday with Glass-Steagall, I characterize that as the 'Get Jamie Dimon Act.'"