Why Deutsche Bank Prefers Bank of America over J.P. Morgan

In a report last week, Deutsche Bank (DBK) analyst Matt O’Connor discussed why he prefers Bank of America (BAC) to JPMorgan Chase (JPM). Deutsche Bank was bullish on JPM until now, but after its outperformance during the year, it believes Bank of America has more upside potential. JPM shares have gained 1.5% year-to-date, while BAC is down ~12%.

The investment bank believes Bank of America is a better bet due to attractive valuations, better cost-cutting potential, and lower consumer credit risk as compared to J.P. Morgan. A Deutsche Bank report mentioned, “The company’s (Bank of America) strengths can be seen in multiple areas, such as its expanding profit margins and notable return on equity. We feel its strengths outweigh the fact that the company has had sub par growth in net income.”

Bank of America aims to cut down its operating costs to $53 billion by 2018, $3 billion–$4 billion below Deutsche Bank analysts’ expectations. In 2015, the bank reported operating costs of $75 billion. While J.P. Morgan also has a significant cost-cutting program, it believes Bank of America is more aggressive.

While Bank of America and J.P. Morgan both have substantial credit card, auto, and multi-family loan portfolios, Deutsche Bank believes Bank of America is at lower credit risk given its higher FICO costumers. The FICO score is a measure of consumer credit risk in the United States (XLF) (VFH). Bank of America has a small multi-family loan portfolio while the category forms ~7% of J.P. Morgan’s loans. Auto loans form ~5% of Bank of America’s loan portfolio and 14% of J.P. Morgan’s loan portfolio. Credit quality concerns have been bothering banks especially in the context of credit card, auto, and multi-family concerns.

Bank of America trades at a significant discount to J.P. Morgan on forward earnings estimates as well as its book value. This is primarily because J.P. Morgan has been more profitable in recent years. However, if Bank of America can successfully execute its cost-cutting targets, analysts believe this valuation gap could narrow.

In this series, we’ll compare Bank of America and J.P. Morgan on the basis of their 2Q earnings, profitability, cost-cutting initiatives, and interest rate sensitivities. We’ll also discuss their consumer banking businesses and relative performance of their trading and investment banking segments. Lastly, we’ll look at their dividend payouts, valuations, and analyst ratings. First, let’s look at how they performed in the second quarter.