Look Beyond the Trading Loss for the Real News in JPM's 2Q Report

It's about more than JPMorgan Chase's trading losses in London.

When JPMorgan Chase (JPM) reports second-quarter results on Friday, analysts will surely give Chief Executive Jamie Dimon the third degree about the financial impact of trades that resulted in losses of at least $2 billion.

But what the largest U.S. bank has to say about its bread-and-butter banking businesses will be watched closely by many industry insiders for clues to the direction all banks are headed. Wells Fargo (WFC) is scheduled to report about an hour after JPMorgan Chase.

Whether it's how the persistently low interest-rate environment is hammering net interest margins, or the toll regulatory and other costs have taken, what JPMorgan Chase has to say will offer plenty of foreshadowing for the narrative of banks' second-quarter earnings reports.

"They're going to have pressure on the margin side, and everyone is going to see it," Macquarie Securities analyst Tom Alonso says.

Banks showed a modicum of momentum in the first quarter, but the outlook is expected to get murkier after the second-quarter reports, analyst Meredith Whitney says.

"Some things in banking, like mortgage banking, expense reductions, and reserve releases continue to work, [but] they are more marginal and likely fleeting," Whitney wrote in a June 27 research report. "Larger contributing factors like strong loan growth (and pricing), capital markets results and aggressive capital management, all traditional catalysts for bank stock investing, remain in the doldrums."

To be certain, the trading losses that occurred in London are believed to have hurt Chase's bottom line. Whitney cut her second-quarter earnings-per-share estimate for JPMorgan Chase by 22 cents because of the charge associated with the losses, while Alonso trimmed his estimate by 56 cents. JPMorgan Chase will provide a detailed update on the size of the losses.

Alonso believes JPMorgan Chase will be able to compensate for the trading loss by taking securities gains through its fixed-income portfolio.

"They're going to take more gains, because it behooves them from a capital perspective," Alonso says.

Some other analysts think JPMorgan Chase is making headway on limiting damage from the losses. Guggenheim Partners analyst Marty Mosby noted that, during his June 13 appearance before the Senate Banking Committee, Dimon said the company would provide more details on the fallout from the losses when it releases earnings, suggesting the company has been able to mitigate some of those losses.

Raymond James analyst Anthony Polini believes the trading losses, while nevertheless likely to be a focus of questions during JPMorgan Chase's earnings report, have already started to fade as an issue "as subsequent losses are offset by securities gains and the vast majority of its position is unwound." JPMorgan Chase is also likely to resume buying back stock soon after it has dealt with the trading losses, Polini says.

Dimon also defended the bank's trading operations, saying that despite the breakdown in risk management, JPMorgan Chase will continue to provide complex financial services because its customers demand them.

"They buy [these complex financial services] because they need them," Dimon said during the Senate hearing. "They don't buy them because we want them to buy them."

Further, Mosby says, JPMorgan Chase established new risk procedures during the second quarter to prevent similar losses, and it's likely that negative effects stemming from the failed London trades will dissipate in the third quarter.

But higher costs in other areas may continue to plague the company, either from regulatory requirements like submitting a so-called living will on how the bank would be unwound safely, or from legal costs stemming from the multistate mortgage servicing settlement.

Like other banking companies, noninterest income has fallen at JPMorgan Chase because of new regulations that cut debit interchange fees. But, unlike many other banks, the company has been unable to recoup those losses through some fee hikes; rather, JPMorgan Chase has stopped charging some overdraft fees to retail customers as it tries to settle a class-action lawsuit on its overdraft program.

But JPMorgan Chase has found profits from higher mortgage banking revenue, partly fueled by a higher rate of re-financings through the federal government's Home Affordable Refinance Program, and from the continued lowering of provisions against bad debt.

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