JPMorgan Moving Past Beached Whale: Analyst

NEW YORK ( TheStreet) -- Maybe the "London Whale" was a blessing in disguise for investors.

JPMorgan Chase has bounced back in a big way from the hedge trading losses in the firm's Chief Investment Office (CIO) first announced by CEO James Dimon in May, and the shares are still cheaply priced to book value and forward earnings.

And unlike other "cheapies," including Bank of America ( BAC) and Citigroup ( C), which may well be excellent buys for long-term investors based on low valuations and "normalized earnings" potential, JPMorgan Chase is already bringing home the earnings bacon.

JPM on Friday reported third-quarter earnings of $5.7 billion, or $1.40 a share, increasing from earnings of 5.0 billion, or $1.21 a share, during the second quarter, when the company booked $4.4 billion in losses from the CIO hedge trading debacle. In Sept. 2011, the company earned $4.3 billion, or $1.02 a share.

Here's a very quick snapshot of earnings performance and price valuations for the "big four" U.S. banks:
  • JPMorgan's third-quarter operating return on average assets (ROA) was 0.99% and its return on average tangible common equity (ROE) was 17.20%, according to Thomson Reuters Bank Insight. For the 12-month period ended Sept. 30, the company's ROA was 0.84%, and its ROE was 14.56%. The shares closed at $41.62 Friday, trading for 1.2 times tangible book value, according to Thomson Reuters Bank Insight, and for eight times the consensus 2013 earnings estimate of $5.21 a share, among analysts polled by Thomson Reuters.
  • For Wells Fargo (WFC), the third-quarter ROA was 1.46% and its ROE was 16.69%. The company has set the earnings "gold standard" for the big four, with an ROA of 1.36% and an ROE of 15.14%, for the 12-month period ended Sept. 30. The shares closed at $34.25 Friday, and traded for 1.5 times tangible book value, and for 9.4 times the consensus 2013 EPS estimate of $3.64.
  • Citigroup announced its third-quarter earnings this morning, reporting an operating return on assets of 1.40% and a return on average common equity of 8.4%, excluding debit valuation adjustments (DVA), a tax benefit, and a $4.7 billion pre-tax loss on the company's sale of a 14% stake in the Morgan Stanley Smith Barney joint venture, and the write-down of its remaining stake in the joint venture. With these items included, the company's return on common equity was 1%. Leaving the messy third quarter aside, the company's ROA for the 12-month period ended June 30 was 0.55%, while its ROE was 7.22%. Citi's shares closed at $34.75 Friday, trading for 0.7 times their reported June 30 tangible book value of $52.70, and for 7.6 times the consensus 2013 EPS estimate of $4.55.
  • Bank of America will announce its third-quarter results on Wednesday. For the 12-month period ended June 30, the company's ROA was 0.52% and its ROE was 7.46%. The shares closed at` $9.12 Friday, trading for 0.7 times tangible book value, and for 10 times the consensus 2013 EPS estimate of 91 cents.

So JPMorgan Chase trades at a similar valuation to forward earnings as Citigroup, despite having a much stronger recent earnings track record. Wells Fargo has an even better earnings track record, which is reflected in a higher forward P/E than JPMorgan, as well as a higher price-to-book ratio. Bank of America's shares trade at a similar discount to book value as Citi, even though the company faces greater headline risk over its legacy mortgage mess.

Oppenheimer analyst Chris Kotowski said late on Friday that JPMorgan's stock was "we extraordinarily cheap at less than 7X" his 2013 earnings estimate of six dollars a share. The analyst said that the company had an "excellent" third-quarter, "even though credit and environmental costs remain high and the trading environment is still far from robust and seasonally low in 3Q."

With JPMorgan being forced to get its risk management house in order, which in hindsight, plays nicely in light of the continued focus of regulators on systemic risk, as they implement the new rules required by the Dodd-Frank bank reform legislation, the stage is set for the company to resume significant share buybacks next year. Dimon said during the earnings conference call on Friday that an early resumption of the stock repurchases during the first quarter would be "immaterial," it is likely to be very much a material event, after the Federal Reserve completes its next round of annual stress tests.

While Kotowski is way in front of the consensus with his EPS estimate for 2013, he said that earnings of six dollars a share "would be equivalent to a 15% ROTE, which is what the company has earned YTD in 2012, despite $6B+ in "whale" losses. In 3Q12, which we should stress again is seasonally slow in terms of trading revenues, ROTE was 16%. That doesn't seem crazy to us."

One hiccup for JPMorgan -- and for Wells Fargo, for that matter -- was an increase in nonaccrual loans and net charge-offs, because of new guidance from the Office of the Comptroller of the Currency, requiring banks to write-down consumer loans with borrowers current on payments or less than 60 days past due, to their collateral value, if the loans had been restructured because of bankruptcy.

The OCC has also required banks to place performing junior-lien mortgage loans, that are subordinate to nonperforming first-lien loans, into nonaccrual status. This requirement makes sense. After all, a performing second-lien loan, where the first-lien loan is in nonaccrual, is a fairly flakey piece of paper, since there's likely to be no collateral left for the second lien holder, in the event of a foreclosure.

But this regulatory change is a "sideshow" for JPMorgan -- to steal a phrase used by Dimon when discussing synthetic credit during Friday's conference call with reporters -- since it is now done, and the company is strongly reserved for loan losses. JPMorgan Chase's allowance for loan and lease losses covered 2.61% of total loans as of September 30, while the company's annualized ratio of net charge-offs to average retained loans -- elevated because of the required write-downs -- was 1.53%.

With the London Whale behind it, Kotwoski said "the swelling and throbbing is beginning to subside," and that he thinks "it highly likely that investors will now start to focus on the fact that JPM is a well-managed, well capitalized, highly profitable and diverse financial institution and that the stock is way too cheap at less than 7X our estimate, and even the 8X consensus," which he thinks will "come up."

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.