Some Holes in J.P. Morgan's Story - TheStreet

Some Holes in J.P. Morgan's Story

Earnings soar over last year, but sequentially the comparison pales.
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Updated from 8:31 a.m. EDT

J.P. Morgan Chase

(JPM) - Get Report

, the nation's second-largest bank, reported sharply higher third-quarter profits on Wednesday, but revenue fell from the second quarter.

The New York-based lender earned $1.63 billion, or 78 cents a share, compared with $40 million, or 1 cent a share, a year ago. The earnings beat the Thomson First Call estimate by 2 cents.

The company posted strong year-over-year revenue gains in investment banking, trading and, for a change, private equity -- an area that has been bleeding red ink for more than a year. J.P. Morgan also made a deep reduction in the amount of money set aside for bad loans, a problem that plagued it for much of the economic downturn.

In all, total net revenue in the third quarter rose 47% from a year ago to $7.5 billion. But revenue was down 12% from the second quarter's $8.6 billion.

The sequential revenue slip led some on Wall Street to question the strength of the bank's performance, despite the impressive year-over-year profit gain.

"I'm not buying them today," said Tim Ghriskey, president of Ghriskey Capital Management, a Connecticut hedge fund, who has no position in the bank's stock. "Just don't go by the headline because it doesn't always tell the whole story. I would just be very careful with this company."

The shares were recently down $1.30, or 3.5%, to $35.37. The shares have been trading near their 52-week high of $38.26, after trading as low as $16 a year ago.

The third quarter of last year may have been the bleakest period for J.P. Morgan, as many skeptics on Wall Street openly doubted whether it could survive the aftermath of its involvement in the Enron scandal and its wave of bad loans.

But the company has rebounded this year as it managed to whittle down the dollar value of bad loans and produce solid profits. The skeptics are becoming fewer in number. The bank's management has pointed to the rebound as proof that the three-year-old merger of Chase Manhattan Bank and J.P. Morgan Chase was a success.

"Our results for the quarter and the first nine months of 2003 show the substantial progress we have made this year," said J.P. Morgan Chase Chairman and Chief Executive William Harrison Jr., in a press release.

The weakest division at J.P. Morgan was its Chase Financial Services division, which includes its retail bank and big home-lending operations. Operating revenue fell 9% from a year ago to $3.3 billion. Its home-lending operation had revenue of $662 million, down 32% from last year.

The bank blamed the slump on an "extremely volatile quarter" for interest rates, which affected the hedging operation for its mortgage servicing rights portfolio, and "losses from the hedging of pipeline and warehouse loans." In the quarter, the bank's hedges generated a loss of $6 million, compared with hedging gains of $263 million a year ago.

The third-quarter numbers also fall far short of the bank's performance in the second quarter in almost every category. Its third-quarter earnings declined 11% from the second quarter's $1.83 billion.

On a sequential basis, the bank took a major hit in trading revenue, which fell 46% to $829 million. The decline no doubt reflects the summer tumult in the bond market. In the second quarter of this year, J.P. Morgan has feasted on big gains in bond trading revenue.

Compared to the second quarter, investment banking fees fell 17% to $649 million and securities gains were off 79% to $164 million.

Of course, the third quarter is traditionally a slow one on Wall Street. Other big banks, such as

Citigroup

(C) - Get Report

, have posted only modest revenue gains from the second quarter.

So the revenue declines at J.P. Morgan may prove to be nothing more than a blip on the radar screen. Still, it's noteworthy that J.P. Morgan is one of a handful of big banks that has not raised its dividend this year.

And the poor quarter-to-quarter performance could prompt some analysts to begin reducing earnings estimates for next year. The current First Call estimate has the bank earning $3.05 a share in 2004, 2 cents more than this year's projected earnings.

"The estimates for next year are too high,'' said Reilly Tierney, a brokerage analyst with Fox, Pitt-Kelton, who has owned shares of J.P. Morgan since it was trading in the $20-a-share range. "This company's peak earnings are behind them.''

Reilly called the hedging losses in the bank's mortgage operation a "big screw-up'' and said the fixed-income trading division performed worse than he had expected.

Still, there is much to cheer about in the third-quarter report, especially when it comes to the matter of bad corporate loans. Commercial loan net charge-offs were $259 million, compared to $834 million a year ago. Total nonperforming assets --loans and other credits that are overdue -- were $3.68 billion at the end of the quarter, down 34% from a year ago.

The bank's allowance for credit losses at quarter's end was $5.08 billion, down from $5.84 billion a year ago.