What JPMorgan Shareholders Really Care About

NEW YORK (TheStreet) -- When JPMorgan Chase (JPM) reports fourth-quarter earnings Tuesday, the immediate headlines would likely focus on whether or not the bank beat estimates, whether its legal costs, which wiped out profits in the third quarter, continued to climb and what the bank's outlook is for 2014 amid a more complex regulatory climate.

But the most relevant question for long-term shareholders is whether the bank can continue to deliver a high return on capital. That's what makes the large legal tab and the volatile earnings stream from trading operations bearable for shareholders.

A higher capital burden and regulatory compliance costs has made it more difficult for banks to deliver returns in the high teens. Five years past the crisis, this question remains largely unanswered and, unfortunately, the fourth-quarter results are unlikely to reveal anything new.

Shareholders might have to wait for the bank's investor day in February, when it sets forth its strategy and targets for the year.

Analysts expect JPMorgan to report fourth-quarter earnings per share of $1.35 on revenues of $23.685 billion, according to estimates from Thomson Reuters.

The fourth quarter is expected to be relatively clean, with the bank having already made a large reserve build in the previous quarter.

JPMorgan reported an unexpected loss in the third quarter, the first loss since Jamie Dimon took over as CEO in 2006, after it took a $7.2 billion post-tax legal charge to meet escalating demands and penalties from multiple government agencies.

In the fourth quarter, the bank announced a number of legal settlements, including a $13 billion settlement with the Department of Justice over mortgage-backed securities sold by the bank and its Bear Stearns and Washington Mutual units before the crisis. The bank also paid $4.5 billion to settle suits from private label investors.

It also recently announced a $1.7 billion settlement over claims that it failed to alert authorities about suspicious activity Bernard Madoff, even though it cut back on its own exposure to the $65 billion Ponzi scheme. The bank said it would take a $850 million charge in relation to the Madoff settlement in its fourth quarter.

Other aspects of the business are expected to be more of the same. Sluggish loan growth, weak fixed income trading revenue offset by stronger investment banking fees, a sharp drop off in mortgage banking income (this has been priced in) and continued reserve releases on the back of improving credit quality.

Analysts expect legal expenses to remain elevated for some time. Dimon has warned that about $2 billion in regulatory and compliance costs are not going away for a while, but has said the bank will strive for efficiency in its normal operations.

Shareholders appear to be nonchalant about JPMorgan's mounting legal tab. Shares of JPMorgan are up over 30% in the past year.

This performance might be puzzling for the average person on Main Street. Why do shareholders continue to give the bank a pass even as its legal tab grows and lawsuits continue to pile up against the bank?

For one thing, shareholders want the bank to settle lawsuits quickly so that it can move on and focus on regular business. Dimon told investors in a recent financial conference organized by Goldman Sachs that a legal fight against the Justice Department and regulators would mean years in court and would hurt the health and morale of the company. So he was willing to pay a premium to settle.

Secondly, the narrative about the bank's legal battles has for the most part been favorable, with JPMorgan being seen as an unfair target. Take the $13 billion settlement for example. Many believe that the bank was unfairly made to pay for wrongdoings committed by Bear Stearns and Washington Mutual, which JPMorgan rescued in the height of the financial crisis in 2008.

It would be interesting to see how shareholders view transgressions that may have taken place after the crisis. The bank faces allegations that it hired relatives of top officials in Hong Kong to gain business, a violation of anti-bribery rules. Several banks including JPMorgan are also a target of an investigation surrounding currency manipulation.

Then there is the fact that the settlements, despite the large numbers that make the headlines, are not really all that damaging to the bank. A good portion of those fines tend to be tax deductible. And critics argue that a substantial portion of the settlement is targeted toward providing relief to consumers, which is often in the bank's economic interest to do so.

And finally, there is the fact that analysts still profess unwavering love for JPMorgan. The stock still is featured among the top picks for the year for many analysts. KBW's Chris Mutascio believes the bank's legal hurdles are temporary and that the bank's valuations by almost every measure are still relatively attractive compared to peers.

The valuations are attractive given that JPMorgan delivers an impressive return on tangible common equity of 16%. But Dimon said at the Goldman Sachs Financial Services Conference that that higher regulatory capital and regulatory compliance costs could put pressure on that return.

The CEO expects the industry to re-price several products to earn an acceptable return and the bank would likely exit more unprofitable businesses. Still, in the transition, shareholders might have to contend with lower returns than they have been accustomed to from the bank.

Shareholders might be willing to turn a blind eye to mounting legal costs so long as the bank keeps raking in profits. They might not be so loyal if they see their returns diminish.

-- Written by Shanthi Bharatwaj in New York

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

If you liked this article you might like

Dow, S&P 500 and Nasdaq Rebound as Oracle and Facebook Tumble

Dow, S&P 500 and Nasdaq Rebound as Oracle and Facebook Tumble

JPMorgan Is a Can't Miss Investment

JPMorgan Is a Can't Miss Investment

Here Are the Biggest Losers Monday From Each Major Index

Here Are the Biggest Losers Monday From Each Major Index

8 Great Ideas for Income Seekers, Including an MLP With a Twist

8 Great Ideas for Income Seekers, Including an MLP With a Twist

Unilever's Move Counters Takeover Buzz; Adobe Sales Are High in the Cloud--ICYMI