Highlights From JPM's Q3 Conference Call: Tops Estimates, But Significant Items; Dimon Comments on Outlook

JPMorgan Chase & Co. (NYSE: JPM) reported Q3 EPS of $1.02, $0.06 better than the analyst estimate of $0.96. Revenue for the quarter came in at $24.4 billion versus the consensus estimate of $23.73 billion. Shares are down 5.27% heading into the close.

Highlights From JPM's Q3 Conference Call:

• (Douglas L. Braunstein) We generated $4.3 billion in net income, $1.02 a share on revenues of $24.4 billion. There are a number of significant items for the quarter.
  
• You'll see we ended the quarter Basel I and Basel III ratios of 9.9% and 7.7% respectively, and that's after the impact of repurchasing $4.4 billion of JPM shares and warrants in the quarter, and that completes our previously approved repurchase authority of $8 billion.
  
• It's worth noting a number of items this quarter:
  
• For Credit, you see our loan loss coverage ratio of 3.74% on total loans. Firm-wide reserves remained essentially unchanged quarter-on-quarter. From a loan growth standpoint, we saw loans grow across the company $7 billion, and that's despite the runoff we see in our home lending portfolio.
  
• We had meaningful year-to-date growth year-over-year in our Small Business originations, up 71%; Middle Market balance is up 18%; Trade Finance, up 70% year-over-year; just some examples of some of the strength in various categories.
  
• We also experienced significant deposit growth, $44 billion quarter-on-quarter, total deposits up $1.1 billion and deposit growth year-over-year up 21%.
  
• On an absolute basis it was our weakest IBC quarter since the third quarter of 2005. Having said that, we did maintain our number-one market share in terms of fees and we also had very positive lead-table results.
  
• Markets and CPG results, $1.9 billion in DVA and that largely resulted from the firm's credit spreads widening this quarter. They actually more than doubled in the quarter. Now if these spreads reserve themselves we'd ultimately book losses. Neither the gains nor the losses relate to the underlying operations of the company. So if you remove $900 million in DVA that's associated with structured notes, fixed income revenue would be $2.8 billion, down 34% quarter-on-quarter.
  
• Equities revenue of $1 billion, down 9% quarter-on-quarter. That's driven largely by the volatility I talked about, lower volumes in continued de-leveraging of our prime service customers. $578 million you see in the credit portfolio, remember three parts here: NII and fees for retained loans, we had $1 billion DVA gain in the credit portfolio and that was largely offset by a $700 million CVA loss after hedging. And that's again, as credit spreads widen for our counter parties, CVA increases as well.
  
• Expenses in the quarter, of $3.8 billion, that's down 12% quarter-on-quarter, up 3% year-on-year. And you see the comp-to-revenue ratio of 29%. We continue to expect to remain full year in the range of 35% to 40% comp-to-revenue ratio.
  
• Consumer and Business Banking business, that's the retail branch in Business Banking business, reported $1 billion in net income. That's up 22% year-on-year. Revenues are up 6% year-on-year and if you want to focus on the highlights, deposit growth up 7%; business banking loan growth up 28% year-on-year.
  
• Actually, the pipeline there remains very solid and all of that in revenues was offset by lower deposit spreads we saw year-on-year. Expenses in the quarter up 2% year-on-year and that really is the continuing investment spend. We opened 60 branches, 123 Chase private-client branches this quarter and we're going to continue that investment.
  
• And then the final comment is the impact of Durbin, which as you know took effect October 1. We continue to expect revenues on an annualized basis from Durbin to be $1 billion plus or minus. We expect $300 million in the fourth quarter versus the third quarter run rate and that's an elevated amount due to the timing of when we ended some of our debit reward programs.
  
• Mortgage Production and Servicing. You see net income of $200 million. That's compares to $25 million the prior year.
  
• Production revenues, we broke into production and servicing. So if you go to the top production revenues, excluding repurchases, we're $1.3 billion. It's down year-over-year but up quarter-on-quarter largely on the back of $37 billion of originations and improved margins sequentially. Repurchase losses in the quarter you see $314 million. That was below our expected run rate, but we do expect losses to remain at $350 million plus or minus a quarter.
  
• Real Estate portfolios. A loss of $70 million on lower revenues of $1.2 billion. That is a function of the decline in NII and that's a function of our portfolio runoff. We talked about that. $27 billion loan declines year-over-year. $6 billion quarter on quarter. The expenses are also down 7% year-on-year and you'll see the note. That's due to a temporary delay in foreclosure activity. We do expect FEE expense to increase $20 to $30 million per quarter as that activity resumes.
  
• Mortgage Banking portfolio is just a little deeper dive on credit. You see circled net charge-offs for the quarter of $900 million. And that's a modest decline versus the prior quarter. But delinquency trends really flattened at the end of the third quarter.
  
• Given that flattening and the ongoing uncertainty in the environment relative to HPI and other items, you'll see we made no changes in our allowances, either for our non-credit impaired portfolio which remains at $9.7 billion, or our PCI.
  
• You'll also see our guidance remains unchanged at $1.2 billion plus or minus but it's fair to say that if the current environment remains stable, those losses could clearly be modestly better next quarter. And then just a quick update on sensitivity for the portfolio. So if you had a 10% decline in housing prices from today, for the NCI portfolio that would imply a modeled loss of $700 million over the next year. For PCI, given that's a life of loan, it could add $1.5 billion to existing reserves.
  
• Card Services and Auto. This now reflects the combination of auto and student lending that we transferred from RFS and you'll see in the supplement the restatement of all of that information. Circled net income of $850 million. That's on revenues of $4.8 billion. Credit costs in the quarter were again the story $1.3 billion. That included a $500 million reserve release in card that was offset by $130 million build in student lending. At the end of the quarter, total allowances for card are $7.5 billion.
  
• 4.34% charge-off rate in the Chase portfolio. That's an improvement of almost 100 basis points over the last quarter. We also think net charge-offs could modestly improve again next quarter from the current quarter. But after that, you shouldn't expect much additional improvement.
  
• Sales volume you see is up 10% in the portfolio year-over-year, 2% quarter on quarter. Outstandings while they declined 6% year-over-year actually leveled off quarter on quarter and that's a positive trend. I will caution the payment rates for the portfolio still remain very high. And if you add all that up on card, pre-tax pre-reserve is up almost $1 billion year-over-year. $700 million for this quarter and that includes significant growth in our marketing expenses that you see running through the expense line this quarter.
  
• Auto. The performance of auto again was solid this quarter. We had almost $6 billion of originations and we do believe we're going to continue to grow and invest and manage this business for what are very attractive returns.
  
• On the loan balance side, you see $107 billion circled. That's up $5 billion quarter on quarter, $9 billion year-on-year. It's our fifth consecutive quarter of loan growth. Middle-market balances, which I said were up 18%. That's our sixth consecutive quarter of loan growth in the middle market.
  
• Expenses were up slightly this quarter. That reflects the build out of our WaMu footprint states. Just as a measure of performance, loan balances and liability balances are each at about $2 billion, up almost 100% year-on-year, respectively. And then you see credit trends continue to be favorable, declining net charge-offs this quarter and declining non-accrual loans.
  
• Asset Management. This is a business that was clearly also affected by volatile markets this quarter. You see circled net income of $385 million. That's down 8% year-on-year, 12% quarter on quarter. Revenues of $2.3 billion, while up 7% year-on-year are down 9% quarter on quarter related to those market conditions. And again this is a business that we'd expect to see continued pressure on revenue in the fourth quarter if the current market conditions persist. Long-term flows here also slowed materially this quarter.
  
• Corporate. There was a loss of $300 million. It was a function of three things. The challenging trading environment impacted our mark-to-market positions and that was partially offset by higher security gains. We had lower NII, and that's really result of the repositioning of the portfolio.
  
• We've talked about that for a number of quarters, but the security gains we took last quarter lowered NII this quarter. And then we also took $1 billion in litigation expense predominantly related to mortgage matters, and you see that in Corporate for the quarter.
  
• (James Dimon - Mostly reiteration and company guidance) We have great franchises. Doug mentioned some really astounding numbers: small business loans up 71%, middle market loans up 18%, trade finance up 71%, deposits retail up 7%, deposits commercial bank up something like 30% to 40%. I would include TS&S because some of that may be a little applied to quality, but up $100 billion.
  
• I would include TS&S because some of that may be a little applied to quality, but up $100 billion. Unbelievable liquidity, and so we feel very good about all the things.
  
• We have no major layout programs. Obviously the Investment Bank will be trimming its sales a little bit, getting tight, and there are some benefits of getting from rolling in some new productive systems. So we expect to see the head count going down but no major layoff programs.
  
• Asset Management obviously dependent on market levels, but we continue to build the business and even this quarter had net inflow. We don't know about other people yet, but I think that's probably pretty good.
  
• Consumer Business Banking, Doug's already mentioned Durbin. This 600 million is the same as the other billion you saw. This is just after tax. This is the actual revenue effect minus what we've already done but not including what we might do.
  
• Commercial Banking and Treasury, Security Services, their margins have been low kind of as long as rates stay low. So they're kind of positioned to benefit from raising rates only if that happens. Quarterly net income, Doug already mentioned, as a private equity if things stay like this you shouldn't expect any profit this quarter. And then just to point out we haven't really spoken on this before, part of private equity is mark-to-market, part of it is mark-to-model, which means mark to PEs and stuff, so that you can think of it several billion dollars are in effect mark-to-market pretty much.
  
• We are going to spend a lot of time literally in the next six to nine months till we build our budgets dealing with regulatory issues. So what we want to do is build in at the product level, legal level, liquidity, capital, GSIFI, whatever we have to deal with so we can properly price and manage our businesses going forward. I do think they will have effects on a whole bunch of areas, and we haven't calculated yet now but if I had a guess it's going to add $0.5 a billion dollars overhead over time as we put all these systems of reporting in. I want to point out that I think some of that's a waste of money, but that's life. We simply have to do it.
  
• (Q&A) Jamie, I was hoping you can just flush out some of the buy-back and capital commentary you made. You mentioned confusion. You obviously exhausted the buy-back that you said for this year. I mean is there ability for you to do more now or are you going to wait and wait until early next year or do you have to wait beyond that? (A) I think the way the Fed is set up is you can
  > request. And as we go through our budget start to decide what to do, but we used what we already had permission for. And like I said, we have a lot of capital generation. The only question is when and how you use it and how quickly you want to get up to the higher Basel III numbers and do you want to get up there just by retained capital and waiting for mitigation as things like that. So we'll get back to you on that. There's a lot of issues around that. (A) James Dimon: I guess on last quarter's earnings call, it seemed like you were going to kind of ease into the new capital requirements and kind of continue with the buy-back and now it seems like a change in tone. Just curious if there was anything in particular driving that? (A) Douglas L. Braunstein: Yeah, I think - you are picking up a real change in tone. I think the fact is we don't know what the rest of the world's going to do. It's a little confusing about it and I think the regulators need to give, not just JPMorgan but the banking industry a little bit more guidance. Do they really mean you can leg if it's over seven years? Or do they really mean they want you to do it right away? We can probably do it very quickly if we wanted to. I'm not sure it's the right thing to insist on.
  
• And then just turning to Volker we got more guidance late last week and this week. I guess your initial interpretation of what they put out, the overall impact either in dollars or just direction in terms of your businesses? (A) Yeah, so let me give you the most important thing. The United States has the best, deepest, widest, most competitive capital markets in the world, which give you, the investor, the ability to buy and sell large amounts at very cheap prices. That's a good thing. I wish Paul Volker understood that. Okay? Now, we understand why Volker tried to pry that trade and it was fine. These are - I haven't read them all yet, like 178 rules or 48 in compliance around what's proper market making. We have to be in a position to proper market making for our clients. Most of our business is market making. And so there's going be commentary. I think the commentary's going to come from the public, which includes you. I hope all of you understand how important it is not just for your own business, but for the future of the United States. And we hope at the end of the day we'll be able to make markets freely. If American companies are put at a huge disadvantage, the foreign companies - we were told everyone was going to adopt this, which we know is not true. That would be an even bigger deal. So to me we got to keep all these things in mind and make sure it ends up in the right place and we'll be giving our comments to regulators and I assume a lot of you will too at one point.
  
• Any chance to kind of put a stab in terms of dollars or range in terms of what the impact would be kind of go forward to be implemented today? (A) It's impossible to tell. These are just comments and rules and requirements and it cuts across all of our parts of our company. So they seem to be more prescriptive. I would have been - I would have preferred to keep it simple. High capital, high - remember, they already doubled and tripled capital liquidity on trading. And proper reporting and disclosure but this is a little bit more prescriptive. It may make it a little harder. Let's let it work through the process before we have too many comments about it.

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