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5 Key Takeaways from JPMorgan Chase's Q2 Earnings

JPMorgan Chase (NYSE: JPM), America's largest bank by assets, kicked off earnings season for the second quarter of the year, generating $3.78 diluted earnings per share (EPS) on total revenue of nearly $30.5 billion. Both EPS and revenue beat analysts' expectations, although JPMorgan also released another $3 billion of reserves previously stored away for loan losses back into earnings, which provided a $0.75 benefit to EPS. Here are five takeaways from JPMorgan's earnings results.

1. The economic recovery is well underway

The economic recovery that so many experts and economists have talked about is officially underway. Combined spending on debit and credit cards at the bank, which has $3.68 trillion assets, jumped 45% in the second quarter of this year from the second quarter of 2020, and is up 22% from the second quarter in 2019.

Travel and entertainment (T&E) spend, perhaps the hardest-hit sector during the pandemic, was flat in the second quarter compared to the second quarter of 2019, and really rebounded in June. In April, T&E spend was down 11% compared to April of 2019, but in June T&E spend was up 13% from June 2019. CEO Jamie Dimon said, "You may have growth in the second half this year as strong as it's ever been in the United States of America."

Image source: JPMorgan Chase.

2. Loans grew barely, while NII slipped

Investors and analysts have been closely searching for the first signs of real loan growth. But while the economy is seeing a clear recovery, it hasn't translated to the type of loan growth or net interest income (NII) that banks would have hoped for. The good news is that average loan balances grew 1% from the previous quarter, but the profits made on those loans through NII fell 8% year over year, as consumers continue to pay down their loans at a high rate given the build up of cash from savings and stimulus during the pandemic.

There were some bright spots, however. Credit card loan balances jumped 7% from the previous quarter. Total mortgage and auto originations are up 64% and 61%, respectively, from the second quarter of 2020. However, total consumer loan balances are down 2% year over year because of all the prepayments. Commercial loan balances are still down 9% year over year, driven in part by lower utilization of revolving lines of credit.

As was previously disclosed in June, JPMorgan has cut its NII guidance for the year from $55 billion to $52.5 billion, largely because the bank has chosen to stockpile cash instead of investing in the bond market. The decision looks like a good move, as the yield on one popular security that banks invest in, the 10-year Treasury bond, has fallen a good amount in the quarter.

JPMorgan CFO Jeremy Barnum noted that while the $52.5 billion is JPMorgan's "central case," there is "elevated uncertainty" around the number because of the stimulus money consumers still have and the volatility in the market. He also said he expects the growing spend in debit and credit to eventually translate into credit card loan growth, but it may not be until 2022.

3. Normalizing corporate and investment bank revenues

Everyone has been waiting for JPMorgan's red-hot corporate and investment banking (CIB) division to cool off after posting phenomenal profits during the pandemic, and some areas did begin slow. Fixed income markets revenue fell 29% from the first quarter and 44% from the second quarter of 2020, while equity markets revenue dropped 18% from the first quarter, although it's still up 13% year over year.

Investment banking, however, had a record quarter with revenue up 20% from the previous quarter and slightly up year over year, primarily driven by the bank's advisory business and debt underwriting. Overall, revenue in the CIB division came in at $13.2 billion for the quarter, down 10% from the prior quarter and 19% year over year. Barnum said the bank expects revenue in the division to continue to normalize, although the timing is hard to predict.

4. Credit quality better than expected

Hardly anyone has been talking about credit quality over the past few months because it has been so unbelievably good this year. Between the end of 2019 and the end of the third quarter of 2020, JPMorgan grew its total allowance for credit losses by more than $19 billion. Considering a pandemic shut down massive portions of the economy for weeks and months at a time, it made sense with billions of losses expected.

But thanks to trillions of dollars infused into the economy through stimulus from the federal government, intervention from the Federal Reserve, and the effective deployment of several COVID-19 vaccines, loan losses largely didn't materialize.

JPMorgan reported net charge-offs (debt unlikely to be collected and a good indicator of potential losses) of $732 million, which is near historical lows. The bank also provided guidance that said net charge-offs in its credit card segment are expected to be less than 2.5% of total credit card loans for the full year, which is very low.

Superb credit is also the reason the bank has released more than $11 billion from reserves previously stored away for potential loan losses back into earnings, largely as profits. Barnum noted that these low levels of charge-offs do help offset the lack of loan growth and headwinds to NII.

5. A new binding capital ratio ... for now

Banks are subject to many different capital requirements and ratios. Most banks are typically bound by one in particular, called the common equity tier 1 (CET1) capital ratio, which is a measure of a bank's core capital expressed as a percentage of its risk-weighted assets such as loans. But during the pandemic, deposits flooded into the banking system, ballooning lots of bank balance sheets including JPMorgan's.

As a result, the bank started to run up against another regulatory capital constraint called the supplementary leverage ratio (SLR), which is a measure of a bank's tier 1 capital expressed as a percentage of total assets and off balance sheet items. Large banks must maintain an SLR of at least 5%. During the pandemic, the Federal Reserve applied an exclusion so banks didn't have to worry as much about the SLR, but that exclusion expired earlier this year.

Now, the SLR is JPMorgan's binding regulatory capital ratio, and JPMorgan ended the quarter at 5.4%, not leaving a huge cushion. Dimon has long been frustrated with regulatory requirements like the SLR because it is not always risk-based. JPMorgan's balance sheet grew as much as it did because of the influx of deposits, but loans actually declined while those deposits were coming in, so while the bank got bigger, it didn't really get any riskier.

JPMorgan will have to closely manage the SLR by either turning away deposits from corporate customers, or raising capital through preferred and common stock raises. Regulators may eventually change how the SLR works, so it likely won't be binding forever, but near term it will likely lead to JPMorgan holding more capital than it would like to, or need to, if the CET1 ratio was the binding regulatory constraint.

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