JPMorgan Risk/Reward Balanced

We have reiterated our long-term Neutral recommendation on JPMorgan Chase & Co. (JPM - Analyst Report), based on strong fundamentals and steady performance by its business segments. Further, despite reporting a significant trading loss in the second quarter of 2012, the company substantially outpaced the Zacks Consensus Estimate.

Results primarily benefited from lower operating expenses and slowdown in provision for credit losses, which were partly offset by lower top line.

JPMorgan also 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 second quarter results, which improved due to buoyancy in the capital markets.

Further, we believe that the main reason behind JPMorgan’s robust 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.

The company will also be able to take advantage of its strong deposit base once interest rates rise. Despite the overall sluggish economic environment, the company’s total deposits surged 6% from the prior-year period to $1.12 trillion in the first half of 2012.

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), 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, paving the way to 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 JPMorgan’s risk management capabilities. Though the company announced a number of measures to control future losses, we believe it will take time to fully recover from the financial impact of the losses already incurred.

In addition, JPMorgan’s top-line growth is expected to be sluggish in the upcoming quarters owing to weak trading revenue and net interest margin (NIM) contraction. Also, the pressure on NIM could put its traditional banking businesses at stake. Moreover, with the thrust of new banking regulations, there will be a pressure on fees, and loan growth is likely to remain feeble.

Currently, JPMorgan retains a Zacks #3 Rank, which translates into a short-term Hold rating.