Risk, Reward Balance JPMorgan

We have reiterated our long-term Neutral recommendation on JPMorgan Chase & Co. ( JPM - Analyst Report ) , based on strong fundamentals and steady performance by all its business segments. Further, maintaining its track record of delivering positive earnings surprises, JPMorgan substantially outpaced the Zacks Consensus Estimate in the third quarter. Results largely benefited from improved revenue and lower provision for credit losses, marginally offset by still high operating expenses.

JPMorgan is an attractive option for investors seeking both growth and income due to its capital deployment activities. After reviewing the company’s capital plan, in November 2012, the Federal Reserve allowed the company to resume its share repurchase program in the first quarter of 2013.

The need to resubmit the capital plan arose due to the huge trading loss in its chief investment office (CIO) division in May, following which, the company temporarily suspended its share repurchase program. Moreover, earlier in March, following the release of the Fed’s stress test results, JPMorgan received approval to hike its quarterly dividend by 20% to $0.30 per share. Since then, the company has maintained the same dividend level.

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 4% from the prior-year period to $1.14 trillion in the first nine months 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 - 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, paving the way for a better financial standing.

On the flip side, 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. Despite an expected interest expense savings as a result of redemption of trust preferred securities this year and the next, management anticipates the downward pressure on NIM to continue.

Further, JPMorgan’s profitability is expected to be negatively impacted by the financial reform law due to increased costs and fee restrictions. Additionally, in November 2012, the Financial Stability Board indicated that the company would be required to hold an additional 2.5% of Tier 1 common equity as a Globally Systemically Important Institution (SIFI) under the Basel Committee’s methodology. In the mid-term, stricter capital requirement is expected to restrict JPMorgan’s flexibility with respect to its business investments to an extent.

Currently, JPMorgan retains a Zacks #2 Rank, which translates into a short-term Buy rating.