Keeping a Balanced View on JPMorgan

We are retaining our long-term ‘Neutral’ recommendation on JPMorgan Chase & Co. ( JPM - Analyst Report ) despite the announcement of a huge mark-to-market trading loss for the first six weeks of the second quarter. The affirmation reflects the company’s strong fundamentals and better-than-expected first-quarter results.

JPMorgan’s first quarter earnings significantly outpaced the Zacks Consensus Estimate primarily due to higher revenue and slowdown in provision for credit losses, which were partly offset by higher operating expense. Further, improved credit quality and a strong capital position were the other positives.

JPMorgan benefited from the gradually improving macro-economic elements. Though there are increasing concerns related to the stability of the European economy, better equity-centric activities in the U.S. are expected to support its results in the upcoming quarters. This was reflected in the first-quarter results, which improved due to buoyancy in the debt and equity markets.

Additionally, the primary strength of JPMorgan’s earnings stability amidst the ongoing economic recovery lies in its business diversification. The spread of its portfolio may prove to be as much of a positive during the recovery as it was during the downturn. Also, the company would be able to take advantage of its strong and stable deposit base once interest rates rise.

Moreover, though the Federal Reserve’s requirement of maintaining higher capital cushions is expected to significantly impact the lending ability of major banks like Bank of America Corporation ( BAC - Analyst Report ) and Morgan Stanley ( MS - Analyst Report ) , JPMorgan is expected to comfortably deal with the challenge as it is in a relatively good shape from a capital perspective due to its earnings power. We expect the company to continue building capital over the next couple of years, resulting in a better financial position.

On the flip side, the announcement of a significant trading loss related to a hedging strategy that backfired has raised doubts regarding the company’s risk management abilities. Since the announcement of the trading loss, JPMorgan has been facing the wrath of the investors, employees and regulators alike. Moreover, Fitch Ratings and Standards & Poor’s (S&P) pessimistically revised the assessments for the company. We believe that the company runs the risk of further hedge-related losses over the quarter, which would substantially dampen its overall financial results.

Further, following the trading loss, JPMorgan suspended its share repurchase program for the time being in order to achieve its targeted Basel III capital requirements. The company intends to re-start the program once it rebuilds the capital it lost as a result of the trading loss. Though we believe that JPMorgan will be able to withstand this huge loss and soon revive its share repurchase program, the announcement has dented investors’ confidence in the stock.

Currently, JPMorgan retains a Zacks #4 Rank, which translates into a short-term Sell rating.