uploads///ROE JPM

J.P. Morgan’s Profitability Is Driven by Expense Control Mechanisms

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Oct. 12 2015, Updated 10:08 a.m. ET

Analyzing profitability ratios

In this part of the series, we’ll take a look at the profitability ratios of J.P. Morgan (JPM) and compare them to Wall Street estimates.

A key element gripping the US banking sector is the prevalent near-zero interest rate environment that is dragging on bank earnings. The bank’s valuations derive from the returns they can generate on assets and shareholders equity. These are key measures of banks’ profitability.

For 3Q15, Wall Street analysts expect J.P. Morgan to post a return on equity, or ROE, of 10.6%, and a return on assets, or ROA, of 0.99x. During the last quarter, the ROE for the bank was 11% while its ROA was 1x. During the third quarter of 2014, J.P. Morgan reported an ROE of 10%.

ROA was reported to be 1x for 2Q15 and 0.9x for 3Q14.

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Reasons for improving profitability ratios

These ratios have been improving for the bank due to its ability to trim overhead expenses. J.P. Morgan’s second-quarter profits increased by 10% despite a 6% dip in its top-line revenues. This was mainly due to the bank’s continued efforts to trim operating expenses. J.P. Morgan reported $14.2 billion in operating expenses this quarter, much lower than consensus estimates of $14.7 billion. While its return on equity remained constant in 2Q15, at 11%, its overhead ratio declined to 59% from 61% a year ago.

However, peers like Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) have been criticized for their expense control mechanisms. These banks are ~48% of the portfolio investment of the Financial Select Sector SPDR ETF (XLF).

In the next part of this series, we’ll focus on the bank’s ability to cut down on overhead expenses.

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