There is one large bank that analysts don't seem too impressed with, but it's possible they are underestimating the potential growth of this franchise. JPMorgan Chase (NYSE: JPM), is performing better than some of its peers, and improvement in one division may be the key to the bank's future.
Less problem assets = better performance?
The biggest banks have gotten a bad rap over the last several years, but you can still identify strong institutions based on the simplest measures. Banks need their borrowers to pay on time, and this has been made even more apparent because of the troubles of the Great Recession.
One of the key measures in determining the strength of a bank's loan portfolio is its percentage of nonperforming assets compared to total assets. With JPMorgan Chase facing competition from the likes of Citigroup (NYSE: C), Bank of America (NYSE: BAC), and Wells Fargo (NYSE: WFC), even a small difference in performance can be significant. When billions of dollars are at stake, a difference of a tenth of a percentage point in nonperforming assets can mean millions in lost earnings.
If you look at each of these banks' nonperforming asset percentage, JPMorgan's number almost jumps off the page. The bank's percentage of nonperformers in the last quarter was just 1.5%, compared to at least 2.3% at both Bank of America and Wells Fargo. Where Citigroup is concerned, the number is a little convoluted since the "good bank" has a non-performer percentage of 0.9%, but 3.6% of Citi Holdings assets are nonperforming.
With a lower level of nonperforming assets, JPMorgan doesn't have to spend as much money or time dealing with problem loans. In addition, the bank can theoretically set aside less money for problems in the future if this positive trend continues.
Strong deposit growth = lower funding costs
A second way to gauge the strength of a financial institution is by the bank's ability to attract deposits. There's no more sure way for a bank to improve its earnings and net interest margin than to attract deposits so that it can avoid borrowing to fund its lending commitments.
JPMorgan Chase reported a nearly 8% increase in total average deposits from July of 2012 to July of 2013. To say this was a strong performance is an understatement. Of its large peer banks, Wells Fargo came close with a 6% core deposit increase during this same timeframe. By contrast, Bank of America and Citigroup were only able to grow deposits by about half the rate of JPMorgan Chase.
If the bank can maintain this level of deposit growth, it should be able to avoid borrowing to fund its loans. In addition, the bank may see its net interest margin expand. Finally, more deposits means more opportunities to cross-sell other products and services. This greater deposit growth could help add to the bank's fee income as well.
This big bank needs small customers
Many investors might think the future of these big banks is to cater to large businesses, but JPMorgan Chase actually needs to cater more to its consumer clients. Looking at the bank's consumer loan growth (or lack thereof), some opportunities are clearly being missed.
In the quarter ended July 2013, JPMorgan Chase reported overall loans were flat, and the primary culprit was a 4% decline year over year in consumer loans. JPMorgan Chase's lack of loan growth could be partially attributed to loans being paid down. However, in looking at the bank's peers, it seems clear that JPMorgan Chase is losing loans to its competition.
Wells Fargo and Citigroup both reported overall loan growth of at least 3% year over year. Bank of America is still in rebuilding mode, so its total annual loan decline of 6% is less comparable to JPMorgan Chase's results. Smaller competitors like BB&T, PNC, and U.S. Bancorp each reported annual loan growth of at least 4.5%.
With several of JPMorgan Chase's competitors generating overall loan growth, it's possible the bank needs to be more proactive in generating consumer loans. However, lack of loan growth isn't always a bad thing -- especially if its because the risk-reward trade-off is not attractive. If the bank can focus on turning its retail lending around, the combination of strong deposit growth and better loan growth could be a powerful combination to push earnings higher.
Long-term opportunity from short-term issues
The average analyst expects just 6% EPS growth from JPMorgan Chase over the next few years. Though the bank is growing deposits and handling its nonperformers well, the bank's greatest opportunity lies with its consumer loans.
If its consumer loan portfolio continues to run off, earnings growth may be muted. However, if JPMorgan Chase can drum up more loans, the bank could surprise with stronger earnings growth. With a competitive yield of just under 3%, long-term investors are being paid to wait for this strong institution to address one of its few weaknesses.
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