Amid high inflation and worries over a more severe recession, bank stocks have not fared well this year. As the largest bank by assets in the U.S., JPMorgan Chase (JPM 1.92%) has not been spared. Its stock has been down more than 29% this year, trading at some of the lowest levels seen since the end of 2020. With the Federal Reserve still aggressively raising interest rates and a lot of economic uncertainty still in the environment, is JPMorgan Chase stock a buy? Let's investigate.
Rising rates should boost revenue
Although rapidly rising interest rates have created a lot of market volatility, banks have been waiting for a real rising-interest-rate environment since the Great Recession. They got a taste between 2015 and 2019, but it was gradual, and the Fed had to drop rates to zero once the pandemic started.
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Now the Fed is raising rates incredibly quickly. Since March, the Fed has already raised the federal funds rate inside a range of 2.25% to 2.50%, which is the peak of where rates got to in 2019 after almost four years of a rising-rate environment. JPMorgan Chase should benefit greatly as more of its interest-earning assets, such as loans, reprice higher and faster than its interest-earning liabilities, such as deposits, benefiting net interest income (NII). The bank saw NII grow by $1.3 billion in the second quarter, and the bank did a little more than $29 billion of NII through the first six months of the year. Management now thinks the bank will generate $58 billion of NII in 2022, meaning investors can expect another $29 billion of NII in the back half of the year.
Rising rates could certainly increase loan delinquencies and charge-offs (debt unlikely to be collected and a good indicator of loan losses), but we just saw JPMorgan raise its allowance for credit losses to more than $34 billion in 2020 when economic uncertainty was at an all-time high, which equates to 3.27% of the bank's total loan book. Despite the huge provision increase, JPMorgan still generated more than $29 billion in profits in 2020.
Catching tailwinds into 2023 and beyond
JPMorgan has seen some of its key businesses fall off this year, such as investment banking. The volatile markets and plunging equity valuations have brought initial public offerings to a halt this year, as well as other issuances. Investment banking fees in Q2 fell 54% year over year. While trading revenues have fared much better and helped support JPMorgan's corporate and investment bank during these volatile market conditions, investment banking can hopefully start to bounce back in 2023.
Another headwind has come in the form of regulatory capital, with JPMorgan facing some of the most cumbersome regulatory capital requirements in the entire industry. Currently, the bank has to maintain an 11.2% common equity tier 1 (CET1) capital ratio, which looks at a bank's core capital expressed as a percentage of risk-weighted assets such as loans. Its CET1 ratio at the end of Q2 was 12.2%. But with regulatory capital rules constantly changing and seemingly always not in JPMorgan's favor, the bank expects its required CET1 ratio to rise by 12.5% in 2023 and then perhaps beyond 13% in 2024.
Having to build all this capital is going to weigh on capital distributions to shareholders and make dividends and share repurchases more modest in the near term than they normally would be. But JPMorgan has never failed to rise to a regulatory capital challenge and can build capital very quickly. I am confident the bank will find a way to build excess capital to eventually return to shareholders at more normal levels.
Is JPMorgan Chase stock a buy?
Right now, JPMorgan Chase trades at roughly 173% of its tangible book value, or net worth, which is quite modest compared to what its valuation has been since 2017. And this is while the bank is about to enjoy the largest rising-rate environment since the Great Recession. The same can be said when you look at the bank on an earnings basis. Yes, there could be a severe recession, investment banking fees are way down, and the bank is being challenged by new regulatory capital requirements.
But we just saw JPMorgan Chase do very well during an unprecedented pandemic, and NII is starting to surge. The other headwinds are out of the bank's control, and the business is really quite healthy. At these valuations, I think JPMorgan is a good long-term buy and hold.
