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Headwinds Won't Rattle JPMorgan

Market volatility and the commodity meltdown are manageable for the banking giant, says Morningstar's Jim Sinegal.

Narrow-moat

Through reductions in nonoperating deposits, level 3 assets, and OTC derivative notional balances, the company believes it will qualify for lower regulatory capital buffers, reducing a potential disadvantage to peers able to operate in similar business lines with lower capital levels. We expected JPMorgan to take action on this front, and model the company operating near current capital levels (Basel III Tier 1 capital of 11.6%) over the next five years--should the company need to operate with a larger buffer, we'd reduce our fair value estimate.

Worries in the capital markets detracted from performance in multiple areas, and the near term may continue to be difficult, but we expect volatility in trading, investment banking, and asset management revenue and will not alter our fair value as a result. The company saw net outflows in asset management, a 34% decline in principal transactions from the third quarter, and a slight decline in investment banking fees.

Management believes the firm can reduce expenses in consumer banking by another $1 billion annually, and another $1.5 billion in the corporate and investment bank, with a portion of these savings to be "reinvested" rather than passed on fully to the bottom line. Our valuation incorporates total noninterest expenses falling by approximately $900 million in 2016 and growing by approximately 2.5% annually thereafter.

Not surprisingly, the energy and materials sectors are resulting in growing credit expenses including a $1.04 billion provision for credit losses in the quarter. Overall, though, we are positive on the medium-term outlook for credit. A low unemployment rate, the aging of the millennial population, and easing mortgage credit should be quite positive for the overall U.S. economy.

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