JPM: Earnings Power and Buyback Capacity Under-Estimated
With declining Treasury rates over the last few months and a first-quarter earnings miss, consensus 2015 EPS for JPM has fallen to just above $6.00 from $6.35 in March. This is overdone, and we expect the bank to beat comfortably in 2015 as rising net interest margins lever over expense-saves particularly in the branch network. Our EPS estimate for 2015 is $6.30 including in-line legal expenses at an average run-rate of $500mm/quarter (so representing ~30 cents on full-year EPS). We differ from consensus in two main areas:
- Net Interest Margin: Management has guided for the NIM to be “stable to slightly positive” in 2015 while the forward markets, notwithstanding recent declines, are indicating a more meaningful up-move: 6-month Libor to 1.5% by mid-2015 (vs. 0.3% today) and 3-year swaps up even more, so that the curve steepens, to 2.4% (vs. 0.9% today). In the past, banks have captured ~one half of the increase in short rates through their deposit franchises and, while new liquidity regulations could blunt this somewhat, JPM has already adjusted. We are modeling a core (i.e. excluding markets-related activities), managed (i.e. taxable-equivalent) net interest margin of 2.4% in 2015 vs. 2.2% today and believe the risk is more to the upside than downside.
- Core Expenses (i.e. excluding litigation): Management has guided core expenses to “below $59bn” for 2014 with the first-quarter report annualizing at $58.4bn. Given this is seasonally comp-heavy and that JPM continues to capture efficiencies (with more detailed information expected in the Q2 report), we expect the full-year number to be closer to $57bn. Furthermore, as discussed in our note of April 23rd titled “Mobile Banking will Increase Scale Economies”, there is a secular decline in the cost-to-serve of retail customers as they migrate to mobile and online channels with JPM expected to cut branch staff by 20% over the next two years.
Finally, JPM is in a position to increase its stock buyback in 2015 to at least $10bn (or ~5% of current market cap of $202bn). This will not create additional accounting leverage even assuming a $5bn adverse impact to equity from other comprehensive income (as rising rates lead to negative securities marks). Given JPM will reach its 10% target for the Basel 3 CET1 ratio by year-end and will move the firm SLR above the current 5.1%, we do not believe regulatory capital or the CCAR process will prevent the modeled 70% payout in 2015.