Although JPMorgan Chase (JPM 0.06%) is by far the largest bank in the U.S., even it wasn't immune from the fallout that resulted from last month's collapses of Silicon Valley Bank and Signature Bank, the second- and third-largest bank failures in U.S. history, respectively.
The company began March trading at $142.10 but ended it down 9% to $129.30. Considering that many in the market consider JPMorgan the safest bank stock, does that pullback make this an excellent time to buy shares, or are there reasons to remain cautious?
It is too big to fail
The U.S. government enacted the Dodd-Frank Act in 2010 to prevent banks from taking the same type of ill-considered risks that led to the Great Recession and required taxpayer-funded bailouts. Under the original Dodd-Frank rules, financial institutions holding $50 billion or more in assets were deemed "systemically important." And the law required all "systemically important financial institutions" (SIFIs) to maintain enough liquid assets to pay all depositors wanting their money back during times of stress. The act also required that the banks submit to annual stress tests by the Federal Reserve to gauge their ability to withstand a financial crisis.
Unfortunately, the Trump administration rolled back parts of Dodd-Frank, and boosted the SIFI demarcation line from $50 billion to $250 billion. Ironically, SVB Financial was one of the banks that lobbied for the relaxation of the Dodd-Frank regulations.
Signature Bank had assets of $110.4 billion on the books when it failed, while SVB Financial had total assets of $211.8 billion when it failed -- both under the current $250 billion SIFI designation, but well above the original $50 billion threshold. Adding salt to the wound, had SVB remained under the original Dodd-Frank regulations, it might have survived. Although the federal government wound up backstopping the depositors at both failed banks, ensuring their customers kept access to all their funds, their shareholders lost their entire investments.
In comparison, JPMorgan holds $3.66 trillion in assets -- well above the new SIFI threshold. Consequently, it is unlikely the bank would be allowed to take the sorts of ill-considered risks that SVB did, because government regulators are watching JPMorgan too closely. For instance, after its June 2022 stress test, the Federal Reserve raised the requirements of how much loss-absorbing capital JPMorgan must hold. To meet those requirements, the company needed to pause its stock buyback program in the second half of 2022. Thanks to that more intense regulatory oversight, it can't squander money and had to cut back on what would be viewed as a shareholder-friendly program to maintain enough capital for a crisis.
The good news, however, is that it only took a short period for the bank to ramp up its capital reserves to its target Common Equity Tier 1 capital (CET1) of 13% (a level above the Federal Reserve's requirement of 12%). CET1 consists of assets the bank has available to use rapidly to cover unexpected losses. Additionally, JPMorgan hit its CET1 target a quarter earlier than it initially anticipated. And now that the bank is better cushioned in case a financial crisis occurs, when it releases its first-quarter 2023 earnings results on April 14, it should show that it has resumed share buybacks -- an excellent development for shareholders.
Last, as the fifth-largest bank in the world by total assets, it is literally too big to fail, even though no one in the federal government wants to admit that fact. If JPMorgan came close to collapsing, Washington would likely bail it out rather than risk the damage to the global financial system that would result from its collapse. As a result, while its stock price might fall off a cliff during an existential crisis, JPMorgan shareholders would be unlikely to take a total loss, unlike SVB and Signature's shareholders.
Should you buy it?
Although JPMorgan beat analysts' estimates for revenue and earnings in the fourth quarter, a better way to value the stock is by measuring its profitability with a metric called return on average tangible common shareholders' equity (ROTCE), which measures a company's return versus its book value minus the intangibles, goodwill, and preferred equity. Keefe Bruyette & Woods managing director Jeffrey Wishner studied the factors influencing bank stock prices in 2015. He found that banks that produced ROTCEs north of 10% had higher valuations than those that came under that level. In Q4 2022, JPMorgan's ROTCE was 18% -- an outstanding return. Not all of its competitors have fared as well. For instance, Wells Fargo (WFC -0.03%) was in the doldrums with an ROTCE of 7.6%.
Another valuable profitability measure worth considering is the efficiency ratio, which weighs administrative and support personnel expenses against revenue. When the efficiency ratio decreases, it indicates a bank's back office costs are falling or its revenues are increasing -- and vice-versa, should the ratio increase. Most analysts consider a bank efficiency ratio of 50% or below to be ideal. JPMorgan's efficiency ratio was close at 55% in Q4 2022, lower than all of its large bank peers. There is a reason many consider it the best-managed large U.S. bank.
The cherry on top of the investment thesis here is JPMorgan's steady dividend, which pays investors a yield of 3.1% at the current share price while they wait for the market to rebound.
Although it has excellent fundamentals, investors' lingering fear and uncertainty about the macroeconomic environment have the bank trading below what it is worth. Currently, its price-to-tangible-book-value ratio is below its five-year median -- a signal that the market may be undervaluing the stock.
JPM Price to Tangible Book Value data by YCharts.
If you are a buy-and-hold value investor looking for a solid bank stock that offers an attractive dividend, now would be an excellent time to buy this safe-haven stock.
