Dow Jones Industrial Average component JPMorgan Chase & Co. (JPM - Free JPMorgan Stock Report) is one of the largest banks in the world, with operations in more than 50 nations. The New York City-based company is the product of mergers of more than 1,000 institutions during the past 200-plus years. Although the company didn’t sidestep the credit quality and other issues that have depressed bank results in the last few years, it has performed relatively better than most of its peers in the industry.
JPMorgan Chase & Co. traces its earliest roots to The Bank of The Manhattan Co., founded in 1799 by then U.S. Senator Aaron Burr. Following a yellow fever epidemic, he established a fresh water supplier, The Manhattan Company, and used a provision in the water company’s charter to set up a bank. Much later, in 1877, John Thompson, a Wall Street publisher, established Chase National Bank, named after Salmon P. Chase, who was Treasury Secretary under President Lincoln. That company acquired a number of banks through the years, including, in 1930, one with extensive overseas operations, The Equitable Trust Co. of New York. A large portion of Equitable’s stock was owned by members of the Rockefeller family, and following World War II, David Rockefeller rose through Chase’s management ranks to become Chief Executive Officer. In 1955, Chase National merged with The Bank of The Manhattan Co. to form The Chase Manhattan Bank.
Other predecessors of JPMorgan Chase started life as part of manufacturing concerns. New York Manufacturing Co., which built cotton-processing equipment, established a bank in 1817 that eventually became Manufacturers Hanover Trust Co. And in 1824, the New York Chemical Manufacturing Co., a producer of chemicals, medicines, and paints, set up The Chemical Bank. The company eventually shed the chemicals operations and renamed itself Chemical Banking Corporation. It made a number of notable purchases over the years, including Texas Commerce Bank in 1987, Manufacturers Hanover Corporation in 1991, and The Chase Manhattan Co. in 1996, when it adopted The Chase Manhattan name.
Another namesake predecessor was formed in 1871, when J. Pierpont Morgan and Anthony Drexel founded Drexel, Morgan & Co. The bank became known for reorganizing financially-weak railroads and financing the mergers that formed major industrial corporations, like General Electric Co. (GE - Free General Electric Stock Report). In 1904, it helped raise funds for the purchase of the land rights needed to build the Panama Canal. Following the 1929 stock market crash, the company spun off its investment banking business, which became Morgan Stanley (MS). After merging with Guaranty Trust Co. (inventor of the American Depositary Receipt) in 1959, the company renamed itself Morgan Guaranty Trust Co. In 2000, it merged with The Chase Manhattan Corp., calling itself J.P. Morgan Chase & Co.
Meanwhile, midwestern banks, some with roots in the early nineteenth century, were also joining forces. In 1995, First Chicago Corp. merged with Detroit-based NBD Bancorp, with the combined company called First Chicago NBD. That company and Banc One Corp. joined forces in 1998, to form Bank One Corp. Finally, in 2004, J.P. Morgan Chase & Co. merged with Bank One, to form JPMorgan Chase & Co., with Bank One’s Chairman, James Dimon, assuming the title of President and Chief Operating Officer at the time of the merger. He was named Chairman of the Board in 2007.
JPMorgan Chase & Co. divides its operations into five main business groups. The first two account for the lion’s share of revenues, but their profits have been subject to dramatic swings in recent years. When depression era rules separating banking from investment banking began to crumble in the 1980s, many large banks rebuilt their investment banking operations via acquisitions and by obtaining permission from regulators to engage in specific investment banking activities. JPMorgan Chase’s Consumer & Community Banking segment rakes in a majority of the equity's net income, with the Corporate & Investment Banking division, which engages in debt and equity underwriting, trading, advisory, corporate lending, and principal investing activities, coming in a close second.
Profits in the remaining three smaller business groups aren’t as volatile as the preceding two, but together they account for only a third or so of JPMorgan Chase’s bottom line. Commercial Banking lends to midsized firms, large companies, and municipalities, and includes commercial real estate lending. And the Asset Management division provides investment management and private banking services.
JPMorgan Chase & Co. also reports the results of a Corporate/Private Equity division which, in addition to the results of a private equity investment operation and of managing the investment securities portfolio, includes unallocated corporate expenses. The bottom-line contribution from this segment has also been subject to dramatic swings from year to year.
Relative Strength In A Beleaguered Industry
JPMorgan Chase & Co. certainly hasn’t sailed through the past few difficult years unscathed. Like other banks, it has had to contend with the deterioration in credit quality, the impact of soft economic activity and tighter regulations on revenue growth, and the mortgage mess (mortgage loan losses, litigation, investor demands that the bank buy back sour mortgage loans, and pressure to modify delinquent mortgages). It also had to absorb losses related to its acquisition of brokerage firm Bear Stearns and contend with high mortgage loan losses at Washington Mutual. (The two ailing firms were acquired in May and September, 2008.) But the company appears to have come through the storm in better shape than many other banks.
Prior to the 2004 merger, Chairman James Dimon had effected a dramatic turnaround at Bank One, which lost about $500 million in 2000 but earned $3.5 billion three short years later. On taking the helm at JPMorgan Chase & Co. (which wasn’t in dire shape like Bank One, but had plenty of room for improvement), he reduced expenses and scaled back some risky activities. In 2005, prior to the 2008 recession and before the housing crisis erupted, the company limited the amount of subprime credit issued by its card and consumer banking operations, and it decided not to offer certain high-risk mortgage products that eventually resulted in huge losses at other banks. Absent those credit decisions and other conservative moves, the company’s consumer and mortgage loan losses since 2005, albeit high, might have been significantly greater.
The company also focused on maintaining a strong balance sheet and healthy loan loss reserve and equity capital levels, which help banks muddle through in tough times. Although JPMorgan Chase & Co., like most large banks, accepted bank bailout funds ($25 billion) from the government in late 2008 (which it repaid just eight months later), the company has indicated that its core equity capital ratios would have been decent without the infusion.
JPMorgan Chase also got out of businesses that didn’t suit it, like lending for manufactured housing and recreational vehicles, and focused on building up other operations, including energy trading and retail banking (adding bank branches and retail loan officers). Its diverse business mix also helped it offset a steep loss in the credit card business with strength in its other operations in 2009.
Over the coming five years, we look for JPMorgan Chase to introduce new products and services at the branches acquired from Washington Mutual. The deal significantly expanded its branch network in rapidly growing markets, like California, and JPMorgan should be able to raise the profitability of those operations. The company also intends to expand its mid-size commercial banking and credit card activities in the former Washington Mutual markets. In the Investment Banking business, JPMorgan plans to build out its commodities platform (significantly enhanced by the addition of Bear Stearns) and expand its international operations. Note that, although these and other expansion initiatives should aid earnings growth, the bottom line probably will get its biggest boost as credit costs, litigation expense, and the costs of restructuring and buying back sour mortgage loans ease over the next several years. Resolutions of these problems also should free up equity capital that can be used to support the growth initiatives.
Progress probably won’t be smooth. JPMorgan already appears to have lost some investment banking market share as formerly ailing competitors have started to bounce back. Also, the uneven economic recovery and regulatory reform rule changes probably will continue to restrain revenue growth in the near term. Even so, we look for earnings to advance at a mid-teens rate to 2015-2017, and believe the stock has long-term appeal for patient investors, though it may be too volatile for conservative investors.
Like many other banks, JPMorgan Chase slashed the dividend on its common stock in early 2009. The move freed up equity capital and probably facilitated the company’s early repayment of the preferred stock sold to the government. The company received permission from regulators to partially restore the payout in early 2011 and is targeting an eventual payout ratio of 35%, but it may take time for the dividend to climb back to pre-recession levels.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.