JP Morgan Chase 2014 Annual Report Download - page 21

1919
II. BUILT FOR THE LONG TERM
A very good current example of how we
view investing and long-term decision
making is how we are dealing with the
squeeze on our net interest margins (NIM)
due to extremely low interest rates. The best
example of this is in our consumer business,
where NIM has gone from 2.95% to 2.20%
(from 2009 to 2014). This spread reduction
has reduced our net interest income by $2.5
billion, from $10 billion to $7.5 billion – or
if you look at it per account, from $240 to
$180. Since we strongly believe this is a
temporary phenomenon and we did not
want to take more risk to increase our NIM
(which we easily could have done), we
continued to open new accounts. Over those
years, we added 4.5 million accounts – and,
in fact, very good sizable accounts. This has
reduced our operating margins from 36%
to 32%, but we don’t care. When normal
interest rates return, we believe this will add
$3 billion to revenue and improve our oper-
ating margin to more than 40%.
Our long-term view means that we do not
manage to temporary P/E ratios — the tail
should not wag the dog
Price/earnings (P/E) ratios, like stock prices,
are temporary and volatile and should not
be used to run and build a business. We
have built one great franchise, our way,
which has been quite successful for some
time. As long as the business being built is a
real franchise and can stand the test of time,
one should not overreact to Mr. Market.
This does not mean we should not listen to
what investors are saying – it just means
we should not overreact to their comments
– particularly if their views reflect tempo-
rary factors. While the stock market over a
long period of time is the ultimate judge of
performance, it is not a particularly good
judge over a short period of time. A more
consistent measure of value is our tangible
book value, which has had healthy growth
over time. Because of our conservative
accounting, tangible book value is a very
good measure of the growth of the value
of our company. In fact, when Mr. Market
gets very moody and depressed, we think it
might be a good time to buy back stock.
I often have received bad advice about what
we should do to earn a higher P/E ratio.
Before the crisis, I was told that we were
too conservatively financed and that more
leverage would help our earnings. Outsiders
said that one of our weaknesses in fixed
income trading was that we didn’t do enough
collateralized debt obligations and structured
investment vehicles. And others said that we
couldn’t aord to invest in initiatives like our
own branded credit cards and the buildout
of our Chase Private Client franchise during
the crisis. Examples like these are exactly the
reasons why one should not follow the herd.
While we acknowledge that our P/E ratio is
lower than many of our competitors’ ratio,
one must ask why. I believe our stock price
has been hurt by higher legal and regulatory
costs and continues to be depressed due to
future uncertainty regarding both.
We still face legal uncertainty though we are
determined to reduce it over time. Though
we still face legal uncertainty (particularly
around foreign exchange trading), we are
determined to reduce it and believe it will
diminish over time. I should point out that
while we certainly have made our share of
costly mistakes, a large portion of our legal
expense over the last few years has come
from issues that we acquired with Bear
Stearns and WaMu. These problems were far
in excess of our expectations. Virtually 70%
of all our mortgage legal costs, which have
been extraordinary (they now total close to
$19 billion), resulted from those two acquisi-
tions. In the Bear Stearns case, we did not
anticipate that we would have to pay the
penalties we ultimately were required to pay.
And in the WaMu case, we thought we had
robust indemnities from the Federal Deposit
Insurance Corporation and the WaMu receiv-
ership, but as part of our negotiations with
the Department of Justice that led to our big
mortgage settlement, we had to give those
up. In case you were wondering: No, we
would not do something like Bear Stearns