Many investors might have been pessimistic coming into this latest batch of bank earnings reports, but the first few were by and large pretty positive. JPMorgan Chase (JPM 1.44%), the largest bank in the U.S. by assets, reported earnings results for the third quarter that beat analyst estimates. The bank also reported a clean bill of health when it comes to credit quality, although things could still deteriorate in the future.
While activity in some business segments like investment banking remains depressed, other business lines are robust, which recently enabled JPMorgan to raise its revenue projections for the full year of 2022 and for 2023 as well.
Net interest income should keep surging
Companies provide revenue guidance to help investors and analysts model that company's projected earnings. Investors and analysts then use earnings and growth forecasts to arrive at a valuation for a company, which plays a big part in determining the actual stock price and future stock price. So, when revenue is revised higher it can often translate into better earnings, a higher valuation, and therefore a higher stock price.
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While large banks like JPMorgan Chase are now involved in many types of financial services, including investment banking, trading, investment management, and payments, lending remains one of the most traditional and core parts of their business.
The revenue from lending is referred to as net interest income (NII), which is the profit banks make on loans after they cover the cost to fund those assets. Banks also now invest a lot of their deposits into bonds, which also generate interest income. NII made up nearly 54% of JPMorgan's total revenue in the third quarter.
This makes banks heavily influenced by interest rates because many of their bonds and loans will see their associated yields move up as the Federal Reserve raises its benchmark overnight lending rate, the federal funds rate. So, if a bank can develop a stable and lower-cost deposit base it can see its margins widen in a rising-rate environment. JPMorgan is certainly one bank that benefits from higher interest rates, and the federal funds rate has ascended very quickly from practically zero at the start of the year to now inside a range of 3% to 3.25%. The federal funds rate could very well end the year even higher.
JPMorgan reported NII of $16.9 billion in Q3, excluding NII from its markets business, which can be volatile and hard to predict and which management now excludes from core NII. The $16.9 billion number rose by $3.2 billion from the second quarter of the year. Now, the bank is projecting NII excluding markets of $19 billion in the fourth quarter, which would give the bank roughly $61.5 billion of NII for the full year of 2022. JPMorgan Chase in the second quarter had only guided for full-year NII of roughly $58 billion excluding markets.
Moreover, if you annualized the $19 billion run rate in Q4, you could conclude that JPMorgan Chase would be on pace to earn a whopping $76 billion of NII excluding markets in 2023.
CEO Jamie Dimon on the bank's recent earnings call cautioned analysts that right now management does not think 2023 NII will necessarily come in that high because there could be some deposits leaving the bank and deposit costs may rise as well, which will cut into loan and bond profits. He told analysts that an NII number like $74 billion is probably more realistic. Still, $74 billion in NII would be more than 20% higher over projected 2022 levels.
Some things to keep in mind about JPMorgan Chase
This new guidance is welcome news for JPMorgan investors during what has been a difficult year thus far in 2022. But it is just guidance, and we are currently facing a difficult and uncertain economic outlook, so things could change quickly.
If there is a severe recession next year, loan growth might soften more than anticipated. Deposit costs could also soar. If there is a severe recession the Fed may even need to pivot and lower interest rates, which might cut into NII as well. Additionally, higher revenue doesn't always mean better earnings. Rising interest rates could lead to higher loan losses at banks, which also cut into profits.
But I still find this new guidance quite encouraging because management understands these risks better than anyone, so the guidance it is providing is likely pretty conservative because management always likes to hit its estimates if it can.
