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JPM Beats but Credit Is Red Flag (Update 3)

  • JPMorgan Chase reports third-quarter EPS of $1.40, soundly beating the consensus estimate of $1.24.
  • Net revenue also beats, at $25.1 billion.
  • Significant decline in credit quality, as nonperforming assets grow by 10%
  • CIO "effectively closed out the index credit derivative positions."

Updated with detailed information on JPMorgan's net interest margin, credit quality information, including comments from CFO Douglas Braunstein, CIO Update, and conference call comments from CEO James Dimon. Also updated to include comments from Stifel Nicolaus analyst Christopher Mutascio, and from KBW, tying JPM's strong mortgage results to expectations for Bank of America.

NEW YORK ( TheStreet) -- JPMorgan Chase (JPM - Get Report) on Friday announced a very strong third-quarter bottom line, but also a significant increase in problem loans.

The company reported third-quarter earnings of $5.7 billion, or $1.40 a share, beating the consensus estimate of $1.24, among analysts polled by Thomson Reuters.

In comparison, JPMorgan earned $5.0 billion, or $1.21 a share, during the second quarter, despite booking a $4.4 billion trading loss, from the hedging activity of the company's Chief Investment Office (CIO). During the third quarter of 2011, the company earned $4.3 billion, or $1.02 a share.

Third-quarter revenue totaled $25.1 billion, beating the consensus estimate of $24.5 billion, and increasing from $22.9 billion the previous quarter, and $24.4 billion a year earlier.

The company reported a third-quarter return on assets (ROA) of 1.01%, improving from 0.88% in the second quarter, and 0.76% during the third quarter of 2011. JPMorgan's third-quarter return on tangible common equity (ROTCE) was 16%, increasing from 15% the previous quarter, and 13% a year earlier.

The company estimated a Basel III Tier 1 common equity ratio of 8.4% as of Sept. 30, increasing from 7.9% the previous quarter.

The company said that "during the third quarter, the CIO effectively closed out the index credit derivative positions that were retained following the transfer of the synthetic credit portfolio to the IB on July 2, 2012." The CIO results included $449 million of losses on this portfolio reflecting credit spread tightening during the quarter," and "net revenue also included securities gains of $459 million from sales of available-for-sale investment securities." Net interest income within CIO "was negative, reflecting the impact of lower portfolio yields and higher deposit balances across the Firm."

When asked about the CIO losses during a conference call with reporters, Dimon said "synthetic credit is a sideshow."

One of the reasons JPMorgan Chase had such a good bottom line during the second quarter was that the company released $2.1 billion in loan loss reserves. A reserve release takes place when a bank's provision for loan loss reserves -- the amount set aside each quarter to cover expected loan losses -- is less than the amount of problem loan balances charged off. Most large banks have seen a significant earnings boost over the past two years through reserve releases, as the economy and credit quality have improved, but analysts expect this trend to subside.
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