Increasing JPMorgan Fair Value to $153 After Q1 Earnings And Investor Day

Strategist

Eric Compton

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JPMorgan Chase is arguably the most dominant bank in the United States. With leading investment bank, commercial bank, credit card, retail bank, and asset and wealth management franchises, JPMorgan is truly a force to be reckoned with. The bank's combination of scale, diversification, and sound risk management seems like a simple path to competitive advantage, but few other firms have been able to execute a similar strategy. Even the best-managed banks are not immune to the occasional stumble, but JPMorgan has managed to seemingly put all the pieces together in a more cohesive and less error prone way than peers. With the importance of scale and technology only increasing for the banks, we think it will be hard for competitors to catch up.

JPMorgan benefits from an unrivaled combination of scale and scope within the United States, which has only become more important during the recent banking industry turmoil, but management is not resting. JPMorgan has gone through several iterations of investments to generate share gains, and started its next cycle of expansion in 2022, with investments set to continue in 2023. While this is causing pressure on expenses today, we expect the bank will take incremental share across its different business lines for years to come, and open up new avenues for growth. 

For example, the bank has invested in Brazil and in the U.K., where the plan is to build out full banking services with a focus on digital platforms. JPMorgan is also hiring more financial advisors and bankers, and has made investments in its consumer ecosystem by acquiring a travel agency, a restaurant review platform, and a travel loyalty rewards tech platform. Over time we think these programs will help acquire more customers, but calculating the exact payoff is difficult, and it will take years of work, regardless. 

We think the bank's acquisition of First Republic will be mildly accretive based on the balance sheet alone, with any incremental wealth management gains only improving the math.

Being so large does have its downsides as well, including increased complexity, difficulty managing so many businesses, and higher capital requirements.

Business Strategy & Outlook

We believe JPMorgan Chase possesses a Wide Morningstar Economic Moat Rating based on cost advantages and switching costs that are consistent with our bank moat framework. JPMorgan is the largest U.S. money center bank by assets and tends to have leading share and operations in almost all of the areas it competes. JPMorgan has one of the leading investment banks in the world, is one of the largest U.S. issuers of credit and debit cards, is one of the top U.S.-based merchant acquirers, has one of the largest global trading desks, is one of the larger global custodians, has one of the larger commercial banking franchises across business sizes, has a leading consumer franchise with products across over 60 million U.S. households, and is also one of the largest asset managers in the world with assets under management of nearly $3 trillion. Even accounting for the bank’s higher capital requirements compared with peers, we have a high degree of confidence the bank will consistently earn returns that exceed its 9.5% cost of equity through the cycle. The increasing importance of scale and scope along with changes in technology should help maintain the bank's wide moat for some time.

We argue that bank moats are derived primarily from two sources: cost advantages and switching costs. We see cost advantages as stemming from three primary factors: a low-cost deposit base, excellent operating efficiency, and conservative underwriting, with regulatory costs being a final factor that must also be considered. Within the operating efficiency bucket, we also see room for economies of scope leading to a cost advantage via lower relative customer acquisition costs. This factor applies primarily to the banks with the largest distributional scale and the largest breadth of products, JPMorgan being the quintessential example.

JPMorgan fared better than many of its peers during the financial crisis, with lower collateralized debt obligation, or CDO, exposure and lower overall credit costs. The bank’s largest exposures came via the firms it ultimately acquired as part of the crisis fallout, namely Bear Sterns and Washington Mutual. Both firms were key reasons for multiple legal settlements and charges, reaching as high as $13 billion in 2013. Even so, the bank remained profitable in all years and only dipped below its cost of equity on a tangible return basis in a single year. Overall, we are encouraged by the bank’s history of above average underwriting and risk taking ability and believe the culture has likely remained or even improved following all of the reform that has taken place in the industry since the crisis. 

JPMorgan’s operating efficiency has generally been close with peers. The bank has some segments that weigh on the efficiency ratio due to the structural characteristics of those individual business lines, such as asset management, investment banking, or home lending. However, despite this, and despite some potential for diseconomies of scale at the far end of the bank size spectrum, the banking behemoth that is JPMorgan has still managed to keep operating efficiency roughly in line with its peers. Given the new phase of banking we are now entering, where technological changes are occurring faster and are more impactful than ever before and can be deployed across singular, integrated platforms, we see only more advantages for the largest banks when it comes to operating efficiency in the future. With JPMorgan’s tech budget of over $10 billion per year, the bank may not drop to the lowest overall efficiency ratio among peers, but it will be able to maintain higher levels of investment at similar efficiency levels. Further, with the bank’s solid mix of fee income, JPMorgan is better insulated in low rate environments. 

JPMorgan’s overall deposit market share is attractive, with one of the highest weighted average market shares among our coverage. JPMorgan is the top depositee in all three of its largest MSA’s, and the bank is dominant in some of the toughest markets, including the New York-Newark-Jersey City MSA, where the bank has top deposit share. On a cost-advantage basis, we view the bank’s deposit base as having a likely chance of being advantaged in the future.

Overall, we believe the bank’s key advantage comes from its scale in certain fixed cost, fixed platform businesses, as well as, the breadth of products it can offer to clients. This contributes to economies of scale and economies of scope and creates switching costs for customers as they use the bank for more and more products. The bank is one of the top issuers of credit and debit cards, where many of the costs of running a payments platform are fixed and high in nature, leading to the need for scale. This has been borne out in the industry where much consolidation and concentration within the top performers has occurred. The same has occurred within the mortgage industry and is occurring for other consumer based, mass market products. JPMorgan has one of the largest FICC trading platforms, where incremental returns from additional volume are maximal as the bank is able to spread the fixed costs of trading operations over an enormous base of transactions, which helps the bank compete effectively in a very competitive space. Further, we view scale and historical performance as increasingly important in the asset management space, and JPMorgan has both. The company's asset management operations possess a sound brand, with a majority of the bank’s mutual fund assets being ranked 4 or 5 stars by Morningstar and performing in the top two quartiles. Additionally, the bank competes at scale, with roughly $3 trillion in assets under management and over $4 trillion in total client assets, making the bank one of the largest global asset managers. JPMorgan is also one of the top investment banks in the world, and while many of the costs are variable (most notably banker compensation), the bank has built up a strong reputation, a massive securities distribution platform, attracts top talent, and has a global reach which only the best can compete with. This leads us to view this segment as a positive contributor to JPMorgan’s moat as well. 

While all of these segments are strong on their own, we believe there are advantages to combining them all under one banking roof. On the consumer side, JPMorgan is able to cross-sell multiple products, providing advantaged pricing to key customer segments (such as through its Sapphire banking program), and spread the overall costs of customer acquisition across more revenue streams. For a business where switching costs are important, having the product depth and reach that makes it more likely for new customers to try your services first also plays a key role. On the commercial side, similar dynamics apply, and the bank is able to offer a complete package with global scale that few can compete with, while sending out armies of bankers to both existing and new markets in an effort to win new business. Finally, the largest banks will be able to spend the most on technology going forward, better optimizing operations, and creating unique data on the largest client bases. While there are some disadvantages to being so big, including dealing with legacy technology and the increased pain of implementing change, we believe the bank’s ability for higher investment in tech platforms that can scale, as well as its access to customer data on millions of households, will ultimately matter more and should bolster the bank’s advantages over the longer run.

From a systemic standpoint, we believe the U.S. banking system has improved over the last decade, as capital levels supporting the banking system are at all time highs. Further, regulation has become considerably stronger in the past several years. The U.S. banking market is quite fragmented, and JPMorgan must compete with a variety of regional and community banks as well as large money center institutions, although this fragmentation has gradually decreased since the 1990s. While we do view the banking sector as intensely competitive, we note that the largest banks by asset size have generally been able to earn higher returns on equity for the last several decades, and still do so today. Our outlook is generally positive from a macroeconomic and political standpoint for the U.S. banking system, as the U.S. is still the world's leading democracy, has increased GDP at a steady pace for years, and maintains the world's reserve currency, all of which contribute to banking stability.

JPMorgan is large enough to be considered a global systemically important bank and also has the highest GSIB surcharge, at 4%, which supports the view that JPMorgan faces some of the highest regulatory requirements and costs. The bank is also large enough to be subject to the Federal Reserve's annual stress tests, as well as a host of other regulatory requirements (LCR, SLR, and so on), and we don’t see any massive regulatory relief coming for the large money center banks. The stringent capital requirements that the largest banks are held to give us some reassurance that these banks will be able to weather the next economic downturn.

Wide

Economic Moat

JPMorgan Chase & Co

JPMorgan Chase Bank, N.A., doing business as Chase Bank, is a national bank headquartered in Manhattan, New York City, that constitutes the consumer and commercial banking subsidiary of the U.S. multinational banking and financial services holding company, JPMorgan Chase & Co. The bank was known as Chase Manhattan Bank until it merged with J.P. Morgan & Co. in 2000. Chase Manhattan Bank was formed by the merger of the Chase National Bank and The Manhattan Company in 1955. The bank has been headquartered in Columbus, Ohio since its merger with Bank One Corporation in 2004. The bank acquired the deposits and most assets of Washington Mutual.

Chase Manhattan Bank

Bank One Corporation was the sixth-largest bank in the United States. It traded on the New York Stock Exchange under the stock symbol ONE. The company merged with JPMorgan Chase & Co. on July 1, 2004. The company had its headquarters in the Bank One Plaza (now the Chase Tower) in the Chicago Loop in Chicago, Illinois, now the headquarters of Chase's retail banking division.

Bank One Corp

JPMorgan Chase & Co. is a financial holding company, which provides financial and investment banking services. It offers a range of investment banking products and services in all capital markets, including advising on corporate strategy and structure; capital raising in equity and debt markets; sophisticated risk management; market making in cash securities and derivative instruments; and prime brokerage and research. It operates its business through the following segments: Consumer and Community Banking; Corporate and Investment Bank; Commercial Banking; and Asset and Wealth Management. The Consumer and Community Banking segment serves consumers and businesses through personal service at bank branches and through automated teller machine, online, mobile, and telephone banking. The Corporate and Investment Bank segment offers a suite of investment banking, market-making, prime brokerage, and treasury and securities products and services to a global client base of corporations, investors, financial institutions, government and municipal entities. The Commercial Banking segment delivers services to U.S. and its multinational clients, including corporations, municipalities, financial institutions, and non profit entities. It also provides financing to real estate investors and owners as well as financial solutions, including lending, treasury services, investment banking, and asset management. The Asset and Wealth Management segment provides asset and wealth management services. It offers investment management across all major asset services, including equities, fixed income, alternatives, and money market funds. The company was founded in 1968 and is headquartered in New York, NY.

Earnings data Q3 2023

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