JPMorgan (JPM) last week became the first bank to report its earnings for Q409. Once again, the bank’s $3.3bn net profit roundly beat expectations, while it pocketed a handsome $11.7bn for 2009 as a whole. The level of profitability came as no surprise, given that JPM is now widely recognised as the strongest universal bank in the US. Of greater interest were the latest trends that its results suggest may now be emerging.

It has been widely observed that the enormous profits generated by investment banking activities in Q209 and Q309 would fall back as markets normalised. JPM’s results give the first tangible indications that this process is under way: net revenues generated by JPM’s investment bank in Q409 fell by 34% QoQ to $4.9bn. This was particularly due to “lower overall volumes and tighter spreads” in the Fixed Income business (where revenues fell 45% QoQ), which had been the source for the majority of the extraordinary recent profits. A 34% quarterly drop in revenues is too large to be ascribed simply to the seasonal effects of the Christmas break, although this will doubtless have contributed to their reduction. It is more likely that a fundamental shift in the market has occurred, and that investment banking profits will decline to more usual levels over the coming quarters.

But there was good news to counter the bad: credit losses, which damaged all major banks in 2009, could well be on the wane. At JPM, they fell back by 9% QoQ in Q409 to $8.9bn. Might this be a sign that they will now begin the long journey back to more normal levels? Admittedly it will take more than one data point to give investors confidence that this is the case –JPM’s credit losses also fell in Q209 before rising again in Q3. But at that stage the US had not come out of recession. This time around, by contrast, the US economy has returned to growth and unemployment growth is slowing. The stage therefore seems set for banks to begin reducing their provisions. However, the likelihood of an anaemic economic recovery and persisting high unemployment means that the progress on this front will probably be slow. Nevertheless, we believe that banks are now past the peak of the provisioning cycle.

Finally, the strength of JPM’s results also serves as a reminder that President Obama’s recent proposal for a Financial Crisis Responsibility Fee would not be overly problematic for the affected lenders if it becomes law. The levy would aim to cover projected losses from the TARP by raising $90bn over the next ten years from US banks with more than $50bn of assets. Subsidiaries of foreign lenders would not be exempt. Banks would face an annual charge of 15bps of covered liabilities (defined as total assets minus Tier 1 capital and deposits). Investment banks, being entirely wholesale funded, would be hardest hit. But how great might the impact on other banks be? JPM’s charge, based on its balance sheet at end-2009, would be around $1.4bn, or 12.3% of its 2009 net profits. That is clearly significant. However, the proposed tax is highly likely to be offset by sharply falling credit costs over the next decade. In 2009, JPM’s credit costs were $38.5bn, compared to just $3.3bn in 2006. JPM, therefore, could potentially offset the annual $1.4bn tax with up to $35bn of gains from reduced credit losses in the coming years. Such a cost saving would have given JPM net profits of around $47bn in 2009. And, as discussed above, all banks are likely to see their credit costs fall as the economy improves. JPM’s results therefore indicate that, despite the proposed levy and falling revenues from investment banking, bank profitability looks set to improve in the coming years as the crisis and concomitant provisioning requirements abate.

Nick Smallwood, Credit Analyst

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