Memorandum
Real Client Management Portfolio
Holding: JPMorgan Chase & Co.
Prepared by: Piotr Chorzewski, December 2, 2004
Micro-economic environment
Commercial banking industry remained highly profitable in 2003-2004. Banks’ profits and balance sheets were shaped the financial and economic condition that prevailed during the last two years. Perhaps the most important monetary police remained highly accommodative. In mid 2003 the Federal Reserve reduced the intended federal fund that already had quite low level. Within the first nine months of 2004 the Federal Reserve Board raised twice by 25 basis points the interest rate to 2.75%.
During the first quarter of 2004 assets at reporting bank holding companies rose $325 billion (or 3.7 percent) in the first quarter of 2004 as the "fifty large" bank holding companies acquired investment securities as part of broader efforts to adjust interest rate sensitivity. Nonperforming assets and net charge-offs continued their sustained decline. Net income of reporting bank holding companies, which rose to nearly $30 billion for the quarter, was supported by stronger net interest income, lower provisions for loan losses, and significant gains associated with the sale of investment securities previously held in portfolio. More than one-third of the quarterly increase in the net income was provided by "all other" bank holding companies as provisions for loan losses declined dramatically, in part because of seasonal influences. Earnings of these institutions had declined in the previous two quarters.
Non-interest revenue of banks remained very volatile during first three quarters of 2004. During the second and the third quarter of this year most of big investment banks experienced significant decline in their trading revenue in comparison to 2003.
All bank holding companies attached great importance to control their expenses and by this improve their performance.
During the last few months further consolidation of the industry could be observed. With the announcements of several large mergers in 2004, the whole banking industry seems to be far beyond from its slow down which occurred at the beginning of this decade.
JPMorgan Chase & Co.
During 2004 the company has mainly focused on its merger with Bank One. The merger, which was materialised on June 30th, is a significant turning point for JPMorgan. Acquiring Bank One ; JPMorgan has entered a completely new market segment, in which it was present before; retail banking.
According to the official statements of both companies there are several benefits from the merger for both sides e.g.
- More balanced business mix and greater geographic diversification
- Enhanced opportunities for wholesale and other financial services business
- Financial synergies. The company estimates 3bilion saves (pre-tax)
- Enhance positions in retail financial services. On a pro forma basis, the combined company became rank second in the United States in terms of total assets as of September 30, 2003, fourth in terms of number of branches as of June 30, 2003 and have the highest market share position in some of the most important U.S. banking markets, including New York, Chicago, Houston and Dallas.
Although there are many official reasons and benefits from the merger, it seems to be quite obvious that for JPMorgan the true reason to merge with Bank One was to hedge its volatile income which for the most part came from investment bank services. Secondly the merged company has become second largest bank in the US and one of the biggest in the world.
Recent results and future perspectives
3Q 2004 was the first quarter when the merged company presented its results. Unfortunately, this was a disappointing quarter. The trading revenue dropped over 50%, which was much bigger decrease than the one experienced by other banks in the same period. Other business lines, such as commercial banking, card services, assets and wealth management, treasury and securities services were consistent with expectations. Although the company has reported merger savings of $140mln, the overall expenses in the 3Q were higher that it had been anticipated.
At the end of the 3Q the company was quite enthusiastic about the merger progress. They merged their card systems, defined a common HR policies-ownership and compensations for the merged company.
The 3Q results had obviously impact on the stock price, which dropped about 6.5%.
Future perspective
Obviously JPMorgan Chase & Co. is in an important point. Analysing historical financial performance of the pre-merger companies and the results of the third quarter few conclusions can be drown.
Firstly, It is reasonably say that market is very optimistic about the company as well as about whole investment banking industry. JPMorgan has quite low revenue growth rate around 0.6% (industry average 6.5%). In the same time the PEG ratio is quite high 1.12. It means the investors pay more that a dollar for each dollar of growth.
There are positive sights. From 2002 to 2003 the JPMorgan company has significantly to reduce significantly its costs to improve profitability and by this the earning per share. Bank One maintained its expenses on similar level. It may suggest that as a merged entity both companies will further reduce their expenses. Compensation, Technology and Marketing are the biggest part of the overall expenses. It has to be closely monitored how the merged company is able to reduce these expenses.
Secondly, interest income is very important part of the overall revenue of the company. There are two ways of increasing the revenue, i.e.:
- to increase the interest income spread (difference between return on assets and cost of founds)
- to increase the level of assets of total loans and investments
Both JPMorgan and Bank One were able to increase the interest income spread over last four years. It is hard to say if the merged company will be able to continue this growth. The size of the interest income spread has to be carefully watched during next few quarters.
Last but not least, it is important how the company will be able to leverage synergy from the merger. The merger should create opportunities for incremental revenues from, among other things, cross-marketing of an expanded range of products and services.
Conclusions
As it is shown above there are positive as well as less optimistic signs about future of the company. Additionally there is very short record of financial data for the merged company, so it is very difficult to make judgement about performance of the combined entity. Although the most recent results (3Q 2004) are not very encouraging, tTaking into account favourable macro-economic environment and into account the factorsavailable data such as favourable macro-economical environment and opportunities for the company which come from the merger it is recommended to hold the position of the 924 shares.
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