Why J.P. Morgan's Consumer & Business Banking Unit Can Justify a Higher Market Valuation

Source: Company

J.P. Morgan (NYSE: JPM  ) is definitely going in the right direction.

The country's largest bank has released its second quarter earnings yesterday which indicated a solid Consumer & Community Banking segment with strong deposit growth, an increase in client assets and high business banking loan originations.

And investors clearly liked J.P. Morgan's results: Shares closed nearly 4% higher in yesterday's trading session.

Going forward, J.P. Morgan has huge potential to turn its Consumer & Community Banking business segment into a true loan and mortgage machine, which could be instrumental in justifying a higher market valuation for J.P. Morgan.

Jamie Dimon put J.P. Morgan on the right track
J.P. Morgan's chief executive officer Jamie Dimon has done a great job in steering the company through the financial crisis and its aftermath.

Source: Wikimedia Commons, Jamie Dimon

Though the bank had its fair share of problems, ranging from a large trading scandal to settlements with regulators over mortgages, the bank has a lot going for itself, especially on the deposit and lending side of the banking business which has been accentuated by Jamie Dimon.

In the second quarter 2014, J.P. Morgan added to its reputation as a deposit-attracting banking franchise: The bank increased its average total deposits in Consumer & Business Banking by 9% from $432.8 billion in the year ago quarter to $471.6 billion in Q2 2014. Client investment assets also increased sharply by 19% year-over-yearto $205.2 billion.

J.P. Morgan achieved a return on equity of 11% in the second quarter and results were largely driven by J.P. Morgan's push for increased loan originations. 

Lending, lending, lending
The key take-away of J.P. Morgan's second quarter results was its performance in its loan origination business.

Business banking loan originations skyrocketed a whopping 46% to $1.9 billion compared against just $1.3 billion in the second quarter of fiscal 2013. Auto loan originations increased 4% year-over-year to $7.1 billion.

Generally speaking, higher loan demand signals, that the economy is doing well and businesses look with confidence into the future. In fact, loan demand is probably the most convincing indicator, that points toward prospective capital expenditures and increasing hiring by U.S. corporations.

Considering that we are still in the very early stages of the interest rate cycle, companies across the country should see meaningful potential to grow their top and bottom lines over the next couple of years.

Short-term challenges
Mortgage originations, on the other hand, have been performing rather weakly, but this is not necessarily an issue only affecting J.P. Morgan. Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) also suffered from a decline in mortgage originations in recent quarters. Many consumers have already taken advantage of low interest rates and refinanced their older, higher-cost mortgages in the past leading to a decline in mortgage demand over much of 2013.

With a broad-based recovery in the U.S. housing market, mortgage originations, however, could become a key earnings driver for J.P. Morgan once again.

Improving credit quality trends
In addition to a well-performing loan and deposit business, which has the potential to turbocharge J.P. Morgan's earnings in the future, the bank also benefits from gradually improving delinquency trends.

From home equity to credit cards, delinquencies are down sharply which alleviates pressure on J.P. Morgan's earnings, but also gives the bank room to step up its loan game  -- with more stringent underwriting standards this time around.

Source: J.P. Morgan Second Quarter Earnings Release Presentation, July 15, 2014

Valuation
J.P. Morgan's second quarter results highlighted once more, that the bank is solidly boosting its book value: Its tangible book value per share grew 3% sequentially and 8% year-over-year to $43.17 per share.

And this achievement comes despite a $13 billion penalty at the end of last year over J.P. Morgan's role in overstating the quality of mortgages.

Investors surely appreciate J.P. Morgan's book value growth. One has to look no further than to J.P. Morgan's book valuation to see, that investors are generally more optimistic about J.P. Morgan's earnings and book value growth prospects as opposed to the outlooks for Bank of America or Citigroup.

With a 51% premium to tangible book value, investors believe J.P. Morgan is better positioned to capitalize on growth opportunities compared to both Citigroup and Bank of America which will have to deal with their own mortgage settlement mess in the short-term first.

The Foolish Bottom Line
J.P. Morgan has delivered a solid quarter that was driven by loan and deposit growth, rather than by surprises on the investment banking side of the business.

Though revenue and mortgage origination challenges persist for the time being, J.P. Morgan's strong loan growth also indicates, that the U.S. economy is doing increasingly well, which in turn should fuel J.P. Morgan's earnings growth in its vital Consumer & Business Banking unit going forward. Further tailwinds for J.P. Morgan's valuation are ahead.

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