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Reversing its trend of beating earnings estimates for the past six quarters, JPMorgan Chase & Company came out with a loss in the third quarter. As expected, the banking giant surrendered its strong earnings run to deal with the legal issues against it and reported a loss of 17 cents per share, widely missing the Zacks Consensus Estimate of an earnings of $1.28 and deteriorating from the year-ago earnings of $1.40.

Our proven model predicted that JPMorgan may not have beaten earnings as it did not have the right combination of two key ingredients – the Earnings ESP and Zacks Rank. While it had a Zacks Rank #3 (Hold), the Earnings ESP was negative.  

Massive legal expense has primarily dampened the banking giant’s results in the quarter. But fundamental pressure from a low interest rate and sluggish loan growth were well evaded by the company thanks to solid performance by its client franchises.   

Results for the quarter included $7.2 billion or $1.85 per share after-tax legal expense in Corporate (including reserves for litigation and regulatory proceedings) and a $992 million or 26 cents per share after-tax benefit from reserve releases. Excluding these items, JPMorgan would have earned $5.8 billion, or $1.42 per share, surpassing of the Zacks Consensus Estimate.  
 
Substantially higher-than-expected non-interest expenses and reduced revenues more than offset the benefit from provision. However, the company witnessed remarkable transactions and gained market share during the quarter. Broad-based strength across products helped Equity Markets revenue grow 20%. Also, improvement in Consumer deposits and Credit Card sales volumes continued.  

Most noticeably, though the Corporate & Investment Bank segment earned 21% lower than the prior quarter, it maintained its #1 rank in Global Investment Banking fees. It also ranked #1 in global debt, equity and syndicated loans. All the other segments also showed decent improvement but for Corporate/Private Equity which reported a significant loss.
    
Quarter in Detail

Managed net revenue of $23.9 billion in the quarter was down 8% from the year-ago quarter. The figure also compared unfavorably with the Zacks Consensus Estimate of $24.2 billion.

Managed non-interest revenue decreased 12% from the year-ago quarter to $12.9 billion. Also, net interest income fell 2% year over year to $11.0 billion, primarily reflecting the impact of lower loan yields due to competitive pressure and replacement of higher yielding loans with lower yielding loans. Non-interest expense was $23.6 billion, up 54% from the year-ago quarter. Higher litigation reserves were primarily responsible for this rise.

The company recorded a benefit of $543 million from managed provision for credit losses, compared with a loss of $1.8 billion in the year-ago quarter. Total consumer provision for credit losses was a benefit of $273 million versus an expense of $1.9 billion in the year-ago quarter. This reflects improved delinquency trends and lower estimated losses in the mortgage and credit card portfolios.

Credit Quality

JPMorgan’s credit quality improved during the quarter. As of Sep 30, 2013, nonperforming assets were $10.2 billion, down 18% from $12.5 billion a year ago. Consumer net charge-offs decreased 54% year over year to $1.3 billion. As a result, the consumer net charge-off rate improved to 1.47% from 3.10% a year ago.

Capital Position

JPMorgan maintained a strong capital position with Basel I Tier 1 common ratio of 10.5% as of Sep 30, 2013. The estimated Basel III Tier 1 common ratio was 9.3% as of the same date.

Book value per common share was $52.01 as of Sep 30, 2013 compared with $52.48 as of Jun 30, 2013 and $50.17 as of Sep 30, 2012. Tangible book value per common share came in at $39.51 as of Sep 30, 2013 compared with $39.97 as of Jun 30, 2013 and $37.53 as of Sep 30, 2012.

The company resubmitted its capital plan to the Federal Reserve during the quarter and expects to receive feedback by the year end. The capital plan was required to address the weakness recognized in the bank’s planning process.  

In Our View

The banking behemoth is working hard to offset the imminent pressure from the settlement of criminal and civil charges over allegations involving bad mortgages. However, in the near term, the potentially huge settlement would certainly weaken its footing in the industry.

Pressure on interest margin and the impacts of a stringent regulatory environment might also mar its results to some extent going forward. However, rapidly improving retail and investment banking performances, and continued improvement in credit trends are expected to support the bottom line.

Moreover, trading revenue has been showing strength due to the popularity of financial instruments that are not interest rate sensitive. Persistent low interest rate environment will continue to enhance trading activities, which should strongly support the top line going forward.

Among the banking big shots, JPMorgan, with exposure in almost all banking businesses, has kicked off the third quarter earnings with Wells Fargo & Company . Therefore, the release is going to be a significant indicator of performance by the key banking sector. However, JPMorgan’s damage due to huge legal expense is not a signal for most of the industry players.  
 
Among other Wall Street big shots, Citigroup, Inc. is scheduled to release its third quarter results on Oct 15 and Bank of America Corp. will report on Oct 16.

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