Is the worst over for JPMorgan Chase?

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When the coronavirus pandemic hit the economy in March, it created a situation very few people could have imagined in January or February. The pandemic forced all banks to set aside huge sums of money to prepare for future loan losses as tens of millions of people were suddenly out of work, while many companies faced a scenario. apocalyptic.

As the largest bank in the country, JPMorgan Chase (NYSE: JPM)set aside nearly $ 19 billion in the first half of the year to cover potential future loan losses due to its far reaching reach in the U.S. economy and exposure to the many industries and industries in which she operates. That’s more than any other bank in the country.

Although the first quarters of the year were difficult, I am cautiously optimistic that the worst is over for JPMorgan. Here’s why.

Image source: JPMorgan Chase.

Huge provisions and forward-looking accounting

This year, most banks are operating under the current new accounting policy for expected credit losses (CECL). Before this policy, banks only wrote down a loan when something happened that made them believe that the borrower’s ability to repay it had deteriorated.

The CECL asks banks to be more forward looking by setting aside liquidity for potential losses over the life of a loan as soon as it is created and recorded on the balance sheet. The CECL is new and somewhat controversial, but ideally it should get banks to think more holistically about their entire portfolio losses, and earlier in the process.

JPMorgan’s nearly $ 19 billion credit provision in the first half of the year is the highest provision JPMorgan has taken in a six-month period. Collectively, the Bank has now set aside more than $ 34 billion to cover future losses, enough to cover losses of 3.32% of its total loan portfolio.

“And given that CECL covers the life of the loans, if our assumptions hold true, we would not expect any significant additional reserve building in the future,” said Jennifer Piepszak, CFO of JPMorgan Chase, during from the company’s recent earnings conference call. Getting the assumptions right is always a big ‘if’, but it seems the bank is thinking conservatively.

JPMorgan said in July that its baseline scenario assumed that U.S. real GDP would contract 6.2% cumulatively between the end of the second quarter and the end of the year, and that it would still be down 3%. at the end of 2021. The bank’s baseline scenario also assumes unemployment ends the year at almost 11% and still stands at 7.7% at the end of 2021.

Unemployment in July fell to 10.2%, and Piepszak said the bank is actually reserving a worse-than-baseline scenario. She also said the bank took loan deferrals into account when reserving losses, so it seems pretty well prepared.

Another important consideration is that the bank managed to remain profitable, despite the fact that the huge provisions it took in the first half of the year directly reduced profits. JPMorgan made nearly $ 2.9 billion in first quarter profit and nearly $ 4.7 billion in the second quarter .

No certainty

While I certainly think the bank provisioned prudently and performed extremely well under the circumstances, it would be remiss of me to say that there is no risk. If there’s one thing the coronavirus pandemic has taught us, it’s never say never.

CECL is still new, and if there are more state lockdowns in the future or another significant spike in coronavirus cases in the fall that results in much lower spending activity, JPMorgan may have to build up again. reserves significantly. However, given how quickly the virus struck in March and how unprepared the United States was to deal with it, I don’t think another lockdown or spike in cases would force the bank to build up reserves as substantially as in the first half of the year. of the year. Plus, with the rapid adoption of digital and remote trends over the past few months, I think the world is better prepared for another period of lockdown than it was earlier this year.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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