Section I: Management Presentation
Please standby. We are about to begin. Good morning ladies and gentlemen. Welcome to JPMorgan Chase’s third quarter 2013 earnings call. This call is being recorded. Your line will be muted for the duration of this call. We will now go live to the presentation. Please standby.
At this time, I would like to turn the call over to JPMorgan Chase’s Chairman and CEO, Jamie Dimon, and Chief Financial Officer, Marianne Lake. Ms. Lake, please go ahead.
Marianne Lake – CFO, JPMorgan Chase & Co
Thank you. Good morning everyone. I’m going to take you through the earnings presentation, which is available on our website. Please refer to the disclaimer regarding forward-looking statements at the back of the presentation.
The firm made a net loss of $380 million for the third quarter, on the back of very significant litigation expenses. So I want to take you first to page two. We’ve added this page for this quarter only, as we want to be as transparent with you as we can be and give you as complete a picture as possible of our litigation reserves and the current perspective on the evolution of our reasonably possible range of losses to litigation. And as you know, as transparent as we would like to be, we are necessarily constrained in what we can actually say.
Having said that, on page two, I’ll start by saying that we appreciate that the litigation expense of $9.2 billion is much more significant than you’ve been expecting. It’s much more significant than we expected until very recently. The reality is that over the last few weeks, the environment has become highly charged and very volatile. Things have been very fluid, and the situation escalated to the point where we’re facing very large premiums and penalties, the level of which has gone far beyond what we reasonably expected. However, those are the facts we’re dealing with today in our reserving actions this quarter and are trying as far as possible to put these issues behind us.
So let me quickly take you through the table on the top of page two, which is a roll-forward of our reserves. We started 2010 with $3 billion in reserves, added around $28 billion through the third quarter, including the actions this period, and have settled a little less than $8 billion across matters, which leave us with $23 billion approximately of ending reserves, which relate to a broad range of matters and includes a significant reserve for mortgage-related matters, including both securities and repurchase litigation exposure. Remember, our GSE repurchase reserves of over $2 billion are separate from this.
The balance at quarter end reflects the $9.2 billion we’re expensing this quarter. This expense also covers a range of matters, including but not limited to mortgage-backed securities. And the impact from their income you can see is high, as it’s being affected by a portion of the expense estimated to relate to enforcement penalties, which would not be tax deductible.
Again, these estimates relate to a number of cases, including among other things, mortgage, as well as the recently announced CIO settlements. We do expect litigation expenses to normalize over time to much lower levels, but they may be somewhat lumpy quarter over quarter.
Finally, on this page we’ve included a table which shows a revised range of reasonably possible losses. And those are losses that would be in addition to our reserves, and remember, it’s pre-tax. It’s very important to emphasize that when estimating this range, it’s difficult, and there are significant inherent uncertainties and judgments required.
As you can see, this was estimated at $6.8 billion last quarter, and while the range has gone down versus last quarter, it’s only gone down modestly in comparison to reserve adds. Think of it simply as if the estimate of what was reasonably possible back in the second quarter reflected our best assessment of the environment we were in and our best judgment at that time. But as I said, we didn’t — even a few weeks ago — reasonably expect things to have escalated to where they are now. So we have therefore revised our range to better reflect the reality of this current environment, with a range of up to $5.7 billion.
Now before we go back to page one, just a final comment, as we said in the press release, the board and senior management continues to seek fair and reasonable settlement with the government on mortgage-related issues, but at this time, we are unable to report on any specifics.
So just flipping back to page one and just to finish off the front page, the other significant item we’ve highlighted on the page is the combined $1.6 billion of loan loss reserve releases for the consumer businesses. And if you add the two significant items in the table, which we don’t consider to be core to our earnings, they total a loss of $6.2 billion and $1.59 of EPS in the negative. If you adjust our results for these two non-core items, we would have earned $5.8 billion and an EPS of $1.42 with a return on tangible common equity of 15%. And that’s not to discount the items, but rather to show the strength of our underlying performance.
The businesses showed double-digit growth in key drivers, as well as market share gains in consumer and CIB, in banking and market. For the second consecutive year, we led the nation in deposit growth, up 10%. Credit card sales volumes were up 11%, and we maintained our number one IDC ranking with 130 basis points increase in market share and asset management saw $19 billion of long-term net inflows, the 18th consecutive quarter.
So turning with that to page four, and the details of our balance sheet and capital. First, after allowing for dividends and repurchases, our capital declined in the quarter by approximately $2 billion. As a result, our Basel III Tier 1 common ratio remained flat at 9.3% quarter over quarter with the decline in capital being offset by lower risk-weighted assets, primarily driven by legacy portfolio run-off. We’re targeting 9.5% by the end of this year, and still aiming to run at about a 50 to 100 basis point buffer above this level over time. And our 2014 CCAR submission will take both these targets into consideration as well as maintaining the flexibility to increase dividends and to repurchase shares. And just to note, our Basel III ratio under the advanced approach is currently lower than under the standardized approach.
An update then on leverage. The firm-wide supplementary leverage ratio under U.S. rules remains at 4.7% this quarter, and similarly the bank leverage ratio remains at 4.3%. And as you know, comment letters were provided recently relating to both the U.S. NPR as well as Basel proposals, which included requests for revised treatment for certain assets and exposures. And we don’t know what the outcome of the final rules will be, but it’s possible there will be some things that improve those numbers.
Finally, we remain compliant with LCR this quarter, and have HQLA of over $530 billion, with around $350 billion in cash at central banks. And as you know, we resubmitted our CCAR at the end of September and expect to receive feedback from the Fed in early December.
So now let’s turn to business performance. And while the environment has been and continues to be very challenging, remember that there are more than 250,000 people in this company focused day-in and day-out on serving our customers and communities.
So with that, on page five, I’ll start with consumer and community banking. The combined consumer businesses generated $2.7 billion of net income for the quarter on $11 billion of revenue and with an ROE of 23%. As expected, we’ve seen a sharp drop in mortgage banking origination volumes and margins that impacted non-interest revenue in the quarter. But taking a look at the franchise, we ended the quarter with over 5,600 branches, over 19,000 ATMs, and 1,900 Chase Private Client locations. And we continue to see really strong growth in the underlying drivers for the consumer businesses.
Average deposits were up $40 billion year on year, an increase of 10%. And for the second year in a row, we led the FDIC survey with the highest deposit growth and a growth rate more than twice the industry average. With that strength being broad-based across markets, we’re number one in our three largest markets, and we gained share in 20 of the 25 largest markets.
Our active mobile customer base grew by 30% year on year. We had record credit card sales volume of $107 billion, up 11% year on year and outperforming the industry for the fifth consecutive year. This quarter also had record client investment assets of $179 billion, up 16% year on year, reflecting a strong positive momentum of the Chase Private Client initiative as well as overall higher market levels.
And to close, a moment on expenses, which were down $89 million year on year, primarily due to lower mortgage banking expenses. And across CCB, we will have reduced head count by over 15,000 for the full year of 2013.
Turning to page six, consumer and business banking. We generated net income of $762 million and an ROE of 27%, on net revenue of $4.4 billion, up 2% year on year and 3% quarter on quarter. Net interest income is up 3% quarter on quarter, driven by the strong growth in deposits I mentioned, partially offset by spread compression. But for the first time in about three years, the deposit margin has not declined quarter over quarter, meaning that rate compression is being offset by higher reinvestment rates. And at current market rates, we would expect, all other things being equal, for our deposit margins to be relatively stable in the medium term.
On the non-interest revenue side, we continue to see strong growth in both debit and investment revenue. Expenses are up year on year, reflecting the investments we’ve made in the business, including Chase Private Client as well as costs related to strengthening control and compliance.
And a minute on business banking. You can see loan balances stayed flat quarter over quarter, up 2% versus last year, and production levels have stabilized at around these levels with a healthy pipeline in that context.
Turning to page seven, and the mortgage bank. Overall mortgage banking net income was around $700 million with an ROE of 14%. And the short story here is significantly lower production income, offsetting higher reserve releases. But if you start at the top with production pre-tax, we guided you that production pre-tax margins would be slightly negative in each of the third and fourth quarters. And excluding repurchases, you can see that’s the case for the third quarter with a net loss of $85 million, or a net negative 21 basis points of pre-tax margins.
As you see, revenues are down over 50% quarter on quarter. This reflects both a reduction in LOCs (Letters of Credit) and the impact of a mix change together driving 120 basis points of revenue margin compression in the quarter. While LOCs are down 40%, quarter on quarter closed loan volumes were down 17%, reflecting a pull through of the second quarter pipeline. And although you do see that our expenses are down some, around 7%, this reflects primarily the transaction level variable costs. We have taken appropriate actions this quarter to adjust capacity, which will fully hit our run rate in exit Q4. On the positive side, our purchase volumes continue to increase and purchase mix was nearly 50% of loans this quarter, up from 35% last quarter.
Moving on to servicing, a loss of $226 million pre-tax, excluding MSR risk management. Lower revenues were down due to a couple of items, including the exit of lender-placed reinsurance. On an adjusted basis, the servicing revenue would have been up slightly, reflecting the impact of higher rates. Also, servicing expenses were $858 million for the quarter, including approximately $200 million of foreclosure-related matters. If you adjust for this, our core expenses would have been around $650 million, on track for the approximately $600 million in the fourth quarter as we guided at investor day.
Finally, you see the MSR showed a modest loss this quarter of $180 million, which includes a negative $120 million due to further HPI improvements, which is also driving higher reserve releases in the real estate portfolios.
So, on to the real estate portfolio. Pre-tax income of $1.5 billion includes net charge-offs of a little over $200 million with charge-offs expected at around that same level next quarter. As expected, a continued reduction in delinquencies, but importantly improvement in HPI, drove severity down in both NCI and PCI portfolios, which led us to release a combined $1.25 billion of reserves this quarter.