Given the recent media frenzy, you can be forgiven for thinking JPMorgan is nothing other than a prop-hedge – or prop-flow – desk, dubbed the chief investment office (CIO), serving as a genetically designed advert for the Volcker rule. But believe it or not, JPMorgan boasts other divisions. And as we have reported, brokers are still bullish on the stock, citing solid earnings capacity and the depressed valuation of the US financial sector, more generally.
On Wednesday, analysts at Nomura – which has a buy recommendation on the stock with a target price of $50-a-piece, a 39.7% upside to Monday’s closing price – lavished much ink on the bank’s margin growth story. After a meeting with Mike Cavanagh, the CEO of the bank’s Treasury and Security Services (TSS), the analysts touted the newfound importance of this division:
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“While the same revenue headwinds remain in the near term (but are in the run rate), we think the TSS businesses are an important component of the overall company portfolio, with a majority of growth coming from deeper penetration of existing clients and leveraging the rest of the JPM franchise, including the investment bank, commercial bank, asset management... Importantly, returns are decent now and should improve, as the TSS businesses are capital efficient on a Basel III basis, have scale benefits and high barriers, have pretty steady revenues and earnings, and have solid secular growth trends. Putting it altogether, TSS has competitive profitability now with high-teens ROE (better than the trust banks) and mid 20’s pretax margin (about in line), with a pretty straightforward path towards a 25% ROE and a 35% margin over the next several years.” |
The TSS division has outperformed by a large margin during the past year, even amid weak economic activity. In 2011, the unit’s revenues grew by 12%, liability balances by 23%, assets under custody by 14% and trade finance loans by 73%. As we have reported, this division is reaping the upside of strengthening links with its emerging markets, prime brokerage and the global corporate bank – a partnership between the investment bank and treasury services – which serves as fully integrated revenue-sharing businesses.
What’s more, the bank has invested in infrastructure to cut costs and ramped up its client-servicing capabilities in the Asia-Pacific region, with revenues growing 26% year-on-year in 2011.
Still, the TSS unit is expected to represent a modest 7% of JPMorgan’s projected $21 billion net income in 2013. But its strategic importance is expected to rise, reckon Nomura analysts. “The TSS game plan will lead to a better growth story over the next three-to-five years as JPM captures a greater share of wallet and operates more efficiently.”
Just a 100-basis-point rate hike in the one-month rate could add $350 million to its annual net-interest income. But growing the corporate cash-management business will prove a structural boon for TSS earnings – though only time will tell if this will pay off, the analysts say:
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“The company is adding corporate bankers aggressively to capture more business, especially in corporate cash management. While the company would like to accelerate the growth, there is only so much bandwidth available to get things done, as developing client relationships, leveraging existing JPM relationships and winning new business takes time. Brand and counterparty strength have also been a clear competitive advantage in seeking new business in these markets.” |
While international growth and interest-rate hikes are key to the unit’s revenue growth prospects, the introduction of the Volcker rule might prove a tail risk for its trust services, the bank concludes:
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“The trust banks have some downside if the rule was passed in its current form. In their Association of Global Custodians (which includes JPM) comment letter, as well as letters from BK, NTRS and STT, the trust banks argue that the rule could substantially limit their ability to provide certain services to their covered fund clients or asset management affiliates (eg, Bank of New York Mellon, State Street and SSGA). If that is the case, the trust banks say they would have to discontinue certain custody services and restructure their asset management and custody businesses (fyi, we don’t believe this should or will ultimately happen, but it is a risk worth noting).” |
Source: Nomura