JPMorgan earnings won't be business as usual

JPMorgan kicks off earnings season Friday but investors will be looking beyond results for news of a possible legal settlement.

By Staff Oct 10, 2013 9:29AM

People pass a sign for JPMorgan Chase & Co. at headquarters in Manhattan in New York City (© Spencer Platt/Getty Images)By Shanthi logo


JPMorgan Chase (JPM) will be the first Dow ($INDU) component and the first bank to report third-quarter results on Friday, formally kicking off earnings season.


As the nation's largest bank, it usually sets the bar for its competitors. And management views on the economy, housing and all other macroeconomic concerns such as the impact of the current government shutdown would normally have the market's attention.


Not so much this time. Investors instead will be on the lookout for how the bank is handling its mounting legal tab and a raft of new regulations and enforcement actions.


According to consensus estimates polled by Thomsom Reuters as of Wednesday night, JPMorgan is expected to report a third-quarter profit of $4.8 billion or $1.20 per share, down from $6.1 billion or $1.60 per share in the previous quarter and from $5.3 billion or $1.40 per share a year earlier.


But the big news would be the bank announcing an expected settlement with the Department of Justice and other regulators over the sale of faulty mortgage-backed securities in the run up to the crisis.


Press reports suggest the settlement could be as high as $11 billion, though at least $4 billion of that could be in the form of consumer relief.


While the tab is high, most analysts believe that such a settlement would broadly put to rest concerns about the bank's legal woes.


JPMorgan, which sailed through the financial crisis, has hit a rough patch in the past year or so, after a set of disastrous derivative trades in 2012 exposed a lapse in risk management and controls at the bank.


Since then the bank has been a target of a number of investigations and enforcement actions on a variety of charges that ranges from the "London Whale," to claims of faulty mortgage-backed securities sold in the run-up to the crisis and charges of bribery relating to its hiring practices in Hong Kong.


The bank said in its second quarter 10-Q that the reasonably possible legal losses in excess of reserves it has already set aside could total $6.8 billion.


In an investor presentation in September, CFO Marianne Lake said legal reserves in the third quarter would likely more than offset loan loss reserve releases of approximately $1.5 billion.


Since then, the bank has already entered into a $920 million settlement with four regulators over its "London Whale" losses and into a $369 million settlement related to credit card practices.


It remains to be seen if the bank sets aside even more reserves for the expected settlement.


But a universal residential mortgage-backed securities (RMBS) settlement is still the "big nut" according to KBW analyst Chris Mutascio. "If you look at the major legal costs for banks since the crisis -- litigation, putback claims . . . it is all related to mortgages," he pointed out, in telephone interview. There could still be other lawsuits after the mortgage settlement related to bribery or manipulation of energy prices or derivatives, but they are not going to be anywhere near the size of the RMBS claims, he said.


With the bulk of the legal troubles behind the bank, investors could finally start refocusing on the fundamentals. When they do, argues Mutascio, they are likely to find an extremely attractively valued bank that is still capable of delivering return on equity in the low teens, despite having to build significantly more capital.


Plus, while shareholders have to endure large legal losses, Mutascio notes that the $7 billion reported cash settlement, when adjusted for reserves already set aside and for tax, could pose only a modest hit to tangible book value of about 2 percent.


Of course, if the bank fails to reach a settlement by Friday, then questions will abound during the analyst conference call about the bank's legal problems. But it is quite likely that the bank would avoid commenting on the issue given ongoing negotiations. So there are likely to be more questions than answers.


Still, investors would like to know what has changed within the bank given its recent troubles.


The bank has said it is making compliance its number one priority and plans to spend $4 billion and hire 5,000 employees to fix its compliance problems.


JPMorgan is also exiting businesses it views as unprofitable in a new regulatory environment such as student lending and the physical commodities business. The bank is also evaluating its relationships with commercial lending clients such as pawn shops, payday lenders, check cashers and car dealerships, relationships that could expose the bank to more reputational damage and legal liability.


Shareholders have so far shrugged off JPMorgan's legal problems. Shares are still up 15 percent year-to-date, underperforming its peers Wells Fargo (WFC) and Bank of America (BAC) by a slight margin.


That's testimony to the health of JPMorgan, which still remains among the best capitalized banks. "No one believes that JPMorgan is insolvent or cannot afford its legal bills," says Mutascio.


But Rafferty Capital Markets analyst Richard Bove worries that JPMorgan's troubles are more long lasting.


"The predominant view is that once the bank makes a large settlement with the government all business activity returns to normal and the bank earns at least $20 billion net," Bove wrote in a recent report. "While I have not adjusted my earnings estimates as yet, I do not share this view. I believe that the short-term and secular earnings of the company have been negatively impacted by the changes being forced upon the company."


There are also concerns about Dimon's future role in the company, as critics call for his exit. Supporters worry that the chairman and CEO might leave the company, tired from the constant attacks.


"It would be a bit of a shame," said Mutascio. "Maybe Dimon wasn't as great as people thought he was, but he is not as bad as people make him out to be today."


He believes the chances of Dimon leaving are low.


Outside of the legal problems, the results have been pretty well telegraphed and the market should expect few surprises.


But the results are likely to be disappointing, with almost every avenue for growth suffering. Based on management guidance and analyst estimates, loan growth is likely to have been tepid, margins probably flat to lower, fixed income trading is expected to be sharply lower and the mortgage business is expected to post a loss.


So ironically the announcement of a multi-billion dollar legal settlement might actually be good news and give investors something else to focus on.


More from

Oct 10, 2013 10:53AM

This could be a great day.....Markets up nicely.


Ex-Repub....Had a couple dividends come in this a.m....They even "increased" payouts by 8.5%..

We get dividends every week of the Quarter, except 2....Pays to diversify...I know you like Divs.

Now I have enough to go to a Casino tonight, Thursday is Miss Lilly's "lucky night."


Too chilly and damp to play Golf this morning, so I have to finish up some tomato sauce for winter.

Ahhh, life is good; Even when we have a screwed up Government.

Oct 10, 2013 10:00AM

I would guess that we would have a 150+ upside day, judging somewhat on the overnights and original futures...

The "glitch" in the jobless claims is the only thing muddling up possible good news.

Oct 10, 2013 9:54AM

Jimmy Boy or Bobo, has got his staff putting out the Articles this morning....

Hope you guys don't get the shakes and quivers, without your Kramer hit.

Oct 10, 2013 2:28PM

From Sam Pekinpah's excellent movie, "The Ballad of Cable Hogue", with Cable (Jason Robards) talking to the local town banker, Cushing:


Cable: I always thought you bankers stole for the rich. I didn't know you'd talk to shirttail trash like me.

Cushing: We don't steal.

Cable: Well, lend, borrow, invest and mortgage and repossess. What the hell else do you call it?


.....................need I say more!

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