Museum shop

5 important things Jamie Dimon said on JPMorgan Chase second quarter earnings call

It was a remarkable second trimester for JPMorgan Chase (NYSE: JPM), which managed to turn around a profit of around $ 4.7 billion after setting aside nearly $ 10.5 billion to cover potential future loan losses. This $ 10.5 billion quarterly credit allowance is higher than any quarterly allowance the bank took during the Great Recession, and possibly the largest on record. The provision was offset by a record total revenue of $ 33.8 billion for the company. The main driver of this figure was $ 16.4 billion in revenue generated by the investment banking and investment banking division of JPMorgan, of which $ 9.7 billion came from trading revenues from fixed income markets and actions.

Despite the company’s excellent results in a very difficult quarter, the coronavirus pandemic is far from over and JPMorgan Chase CEO Jamie Dimon has acknowledged that there is still a lot of uncertainty going the front. Here’s what else Dimon had to say about JPMorgan’s earnings and the economy when calling the bank’s second quarter results.

Image source: Getty Images.

1. The recession won’t hit banks right away

Perhaps the strangest part of the coronavirus pandemic for banks is that real losses don’t materialize as they normally do in a recession. Typically, after a bank reports a high quarterly credit allowance, as JPMorgan did in the first quarter, you will start to see some losses register in the following quarter. But JPMorgan announced net write-offs (debts unlikely to be collected) of about $ 1.6 billion in the second quarter, up slightly from previous quarters. This could be explained by the fact that the government is intervening in unprecedented ways with the Paycheck Protection Program and the $ 1,200 stimulus checks. Many banks are also using a new accounting system that allows them to predict loan losses much sooner than they actually materialize.

But what’s even stranger about all of this is that there is very little evidence of new credit problems. While non-performing loans – those on which a borrower has not made a payment for more than 90 days – increased by a few billion dollars from the first quarter, JPMorgan CFO Jennifer Piepszak said at the time. of the results call this was largely from a customer and is not a good representation of overall credit trends. In addition, the over 30-day delinquency rate declined between the first and second quarters of the year in the mortgage, auto and credit card categories, suggesting that fewer borrowers are defaulting. payments or that some borrowers have regained a better financial situation. in the past three months. It doesn’t make much sense given the economic conditions.

“In a normal recession unemployment rises, delinquencies rise, accrued liabilities rise, house prices fall. None of that is true here,” Dimon said. He added that “you will see the effect of this recession; you just won’t see it right away because of all the stimulus,” and the fact that many unemployed people are making more money now than they are. ‘they were not working. .

2. Economic conditions will be murky

Several months ago, many experts and economists predicted that the second quarter could be the worst of the entire pandemic, with three full months of the virus, including a period in which many states have implemented orders. shelters on site. But Dimon told analysts when announcing the bank’s results to expect a “much darker economic environment” than that which materialized in May and June.

“You have to be prepared; you’re going to have a lot of ins and outs. You are going to have people who will be afraid of COVID; they will be afraid of the economy, of small businesses, of bankruptcies, of emerging markets. It’s going to be murky, “he said. Dimon added that he doesn’t think anyone knows how bad things could turn out, or if there will be another increase in coronavirus cases – or a Another big economic shutdown – in the fall He said the bank was preparing for the worst, but “we just don’t know” the likelihood of a worst-case scenario happening.

3. JPMorgan’s dividend is sustainable

Dimon went on to stress that he believes the current dividend of $ 0.90 per common share is “completely sustainable” and a “completely miniscule” quarterly charge. He also appeared to suggest that the bank could take a few more quarters of heavy losses while maintaining the dividend, specifically saying the bank could “bear an additional $ 20 billion in loan loss reserves.” This makes some sense because at the end of the second quarter, the bank’s total allowance for loan losses was $ 34.3 billion.

In its annual stress tests, the Federal Reserve predicted that in a very unfavorable scenario where gross domestic product (GDP) declines 8.5% over the next few quarters and unemployment peaks at 10%, the bank would record provisions. total credit of nearly $ 58 billion.

Dimon acknowledged that if the economy entered an extremely adverse scenario, the bank’s board “should and would consider” reducing the dividend. “The reason they would consider reducing it is because once you go into unemployment at 14% or 15% you don’t know the future. So now you’re going to have to look at another case. extremely unfavorable, which will be 20% unemployment and therefore you protect yourself from it, and cutting the dividend is cheap equity. “

On the flip side, Dimon said that if a less severe “base case” scenario eventually materializes and the loan losses are not as severe as initially expected, the bank would ultimately have too much capital. available and would therefore ideally wish to carry out share buybacks, which all the major banks suspended earlier this year. “We don’t expect that this year, but I wouldn’t rule it out completely in Q4,” Dimon said.

4. Trading income will normalize

Part of the reason JPMorgan Chase was able to generate profit in the quarter was due to extremely high trading revenues. Transactions in the fixed income market generated revenues of $ 7.3 billion, levels 99% higher than in the second quarter of 2019. The bank made an additional $ 2.4 billion from transactions in the stock markets and generated total market and securities trading revenues of $ 11.3 billion. But Dimon expects revenues for the company’s investment banking division to normalize soon. During the company’s earnings call, he also asked analysts to cut trading revenue in half. Even at this level, trading revenues would still be significantly higher than they were in recent quarters.

5. Credit reserves may have reached their peak

With the first and second quarters of the year now on the books, JPMorgan has set aside $ 19 billion to cover potential loan losses. As bad as it is, it can actually be the worst from a quarterly provisions standpoint. Earlier this year, many banks such as JPMorgan started using a new accounting system called the Current Expected Credit Loss Methodology (CECL). Essentially, the system requires banks to project future loan losses as soon as those loans are issued and recorded on their balance sheet. The idea is to give banks a better idea of ​​what future loan losses look like as early as possible.

Dimon and Piepszak both said that if the assumptions underlying their modeling, such as GDP and unemployment, hold up, they do not expect a significant increase in credit reserves in the coming quarters. . Part of the reason is how CECL asks banks to forecast loan losses. With such uncertainty ahead, things could certainly change, but it’s still a good test for CECL to see if the new – and controversial – accounting methodology works as expected.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.