Analysts Differ on JPMorgan's 2014 Litigation Risk

NEW YORK (TheStreet) -- JPMorgan Chase (JPM) reported a decent fourth quarter, all things considered, but analysts disagree on whether or not investors can expect relatively "clean" results during 2014.

The nation's largest bank on Tuesday reported fourth-quarter earnings of $5.3 billion, or $1.30 a share, on revenue of $24.1 billion. That was down from $5.7 billion, or $1.39 a share, on revenue of $24.4 billion, during the fourth quarter of 2012.

JPMorgan's results for the most recent quarter included $1.1 billion in after-tax litigation charges, without which fourth-quarter EPS would have come in at $1.40, and the company's return on average tangible common equity (ROTCE) would have been 15%, matching its year-earlier performance.

For all of 2013, JPMorgan earned $17.9 billion, or $4.35 a share, on revenue of $99.8 billion, down from record earnings of $21.3 billion, or $5.20 a share, on revenue of $99.9 billion during 2012. Earnings were down for 2013 mainly because of a third-quarter net loss of $387 million, springing from $9.15 billion in provisions for litigation reserves. This sets the company up to absorb the $17.5 billion in residential mortgage-backed securities settlements it entered into during the fourth quarter with government authorities and investors, as well as the bulk of its $2.6 billion in settlements with the Department of Justice and regulators for its role in the Bernie Madoff Ponzi scheme. The Madoff settlements still resulted in a reduction in fourth-quarter after-tax earnings of $850 million.

Looking ahead, JPMorgan still faces numerous lawsuits for investors, as well as a continuing investigation of the LIBOR rate-rigging scandal by U.S. regulators and multiple investigations of alleged rigging of foreign exchange trading by global banks.

Leaving aside the litigation risk, JPMorgan in its outlook said it expects its mortgage production unit to continue posting pre-tax losses, at least during the first quarter.

JPMorgan's stock has been very strong over the past two years, although the gains have pretty much been in line with the KBW Bank Index (I:BKX).  The stock continues to be among the cheapest of all U.S. bank stocks, on a forward price-to-earnings basis. The shares closed at $57.74 Tuesday and traded for 9.1 times the consensus 2015 EPS estimate of $6.35, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $5.97, which would be well above the record earnings for 2012.  A declining share count from stock buybacks plays a major role in the expected earnings increase.  JPMorgan repurchased $4.789 billion worth of shares during 2013, with its weighted average share count declining by 1%.

There's no question that sell-side analysts are overwhelmingly positive on JPMorgan's prospects, with 26 out of 34 analysts polled by Thomson Reuters rating the stock a "buy," with seven neutral ratings and just one "underperform" rating.

Here are two opposing views:

Jefferies analyst Ken Usdin on Tuesday reiterated his "buy" rating for JPMorgan, with a price target of $66, while maintaining his 2014 EPS estimate of $5.95 and his 2015 EPS estimate of $6.30. 

"In our model, a more upbeat I-banking and trading outlook offsets a slightly higher starting point for expenses (ex. $0.8B of legal costs). JPM remains the cheapest of the universals on '15 EPS, and we believe it can regain multiple as legal/environmental issues subside, earnings become cleaner, and core business results continue to outperform," Usdin wrote in a note to clients.

Excluding legal expenses, Usdin expects JPMorgan's operating expenses to decline to $59 billion in 2014 from $60 billion in 2013.

Following the next round of Federal Reserve stress tests for the nation's largest financial firms and subsequent of capital plans in March, Usdin expects JPMorgan to receive regulatory approval to raise its quarterly dividend on common shares by four cents to 42 cents, and to be approved for up to $5 billion in share buybacks through the first quarter of 2015.

FBR analyst Paul Miller on Wednesday reiterated his "market perform" rating for JPMorgan, with a price target of $55.00.

"While the core profitability of key businesses remains strong, ongoing litigation expenses, higher regulatory costs, and a weak macro economic backdrop limited the company's ability to grow earnings and book value at a meaningful rate over the course of the year. We expect more of the same in 2014, as loan growth expectations remain tepid, margins hold steady, and one-time expenses continue
to weigh on earnings," Miller wrote in a client note.

The limited earnings growth potential over the near term, along with the possibility of continued earnings volatility from litigation charges, "warrants a modest discount" for JPMorgan's stock against "more benign regional peers," Miller added.  He estimates the bank will earn $6.10 a share this year, with EPS rising to $6.30 during 2015. 

While conceding that JPMorgan's size exposes the company to "greater headline risk than smaller, regional peers," Miller wrote that "investor fatigue is a possibility if these [litigation] losses continue to extend out."

JPMorgan's shares were down 0.3% in premarket trading Wednesday, to $57.59.

The following chart shows the performance of JPMorgan's stock against the KBW Bank Index and the S&P 500 since the end of 2011:

JPM Chart data by YCharts


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

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.

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