JP Morgan Chase: In Danger of Plummeting From Bad Publicity
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A cash settlement is in order. It was recently announced that JP Morgan Chase (NYSE: JPM) has agreed to pay a $20 million fine to settle a legal battle with federal regulators. The civil suit that JP Morgan is settling out of is over whether or not it illegally handled customer funds that were deposited by the failed Lehman Brothers Holdings Company. According to the Commodity Futures Trading Commission (CFTC), JP Morgan extended too much credit to Lehman Brothers. This occurred because when JP Morgan calculated Lehman Brothers’ equity, it included customer funds in the calculation.
JP Morgan now has less uncertainty surrounding it. From an investment perspective, its earnings multiple can expand because the uncertainty "discount" related to the settlement is now reduced.
The recent collapse of MF Global Holdings, along with others, started a whole new rush of customer claims regarding money being frozen or lost after it was improperly used by these companies. Lehman Brothers had more than $1 billion of costumer funds deposited with JP Morgan at times, money that, according to the CFTC, was being misused and miscalculated to give Lehman Brothers more equity. The CFTC is being quite clear that it is not going to let this sort of thing slide anymore. Despite JP Morgan’s claims that the errors were unintentional and the damage that was caused was minimal, it appears that they are being made an example by the CFTC.
According to Mary Sedarat, a spokeswoman for JPMorgan, the withholding of the costumer funds immediately following the crash of Lehman Brothers can be attributed to “the chaos of the week, which led to delays in back-office procedures.” The CFTC maintains that federal laws impose restrictions on the handling of costumer funds and that these restrictions are critical. In the end, taking the hit of the $20 million fine is definitely better for JP Morgan than trying to fight the federal government. It can only handle so much bad publicity.
JP Morgan is in other fights with the federal government at the same time. One of its traders, Bruno Iksil, has placed numerous out sized bets and is drawing attention to the debate over whether banks are taking excessive risks with federally insured and subsidized money. Iksil works in London in the chief investment office of JP Morgan. The firm says that these bets are all just hedging risks and examples of investing extra cash. Other experts believe that the trades are large enough to be seen as prop bets, or wagers made with the bank’s own money. Iksil’s risky trading has earned him the nickname “Voldemort” after the “Harry Potter” villain. One trader said, “Iksil also has been dubbed the London whale.” Iksil is somewhat mysterious, but he is thought to be in his late 30s. Last year, he bet against a group of hedge-fund traders who thought that a cluster of companies in one of the indexes wouldn’t default before contracts expired in December.
When Bloomberg News reported theses trades on April 5th, it set off an Easter-holiday weekend policy debate in the United States about the implementation of the Volcker rule. This is the part of the Dodd-Frank Act that sets limits on risk-taking by government-backed banks. This is a controversial law and it has many worried that it will unfairly hinder American companies, compared to foreign companies. The people who are in support of this law, however, are using this as an opportunity to point out the great importance of the new regulations and they are using JP Morgan as just one example of the things that the law is trying to prevent.
Two competitors of JP Morgan, Bank of America and Citigroup, recently climbed back into bull market territory. Both companies saw 6-month high prices per share in March. These two companies are considered by analysts to be quite good buys at the moment. However, the long-term growth could result in many shareholders selling stock and there is always a possibility that things will turn downhill soon.
JP Morgan is looking at similarly high prices currently. Its 52-week low is around $27.85 per share and its 52-week high is around $47.37 per share. It is currently hovering around $43 per share and, despite some recent minor blows that it has taken, and all the bad press that its legal troubles are causing, it looks like it will keep moving in the right direction.
It was recently announced that JP Morgan is planning to buy 7% stake in the Internet company Conduit Ltd. for $100 million from Yozma Venture Capital. This is hopefully a good investment for JP Morgan. I expect it to be fruitful. This is just one of many recent transactions made by JP Morgan as the company continues to keep busy. Also its analysts are initiating coverage of several new companies. One of these companies is TIVO, which received a starting rating of “neutral” and a price target of $12.50 per share. Another company that JP Morgan is now covering is McDermott International, which also started with a “neutral” rating and a $14.50 price per share target.
Unfortunately, that is where the good news stops and we return to the courts. There is one more important lawsuit to mention. This is a fraud suit that was filed against JP Morgan by the German lender Bayerische Landesbank. It is over nearly $2.1 billion in residential mortgage-backed securities. On November 21, 2011 the Munich-based bank sued JP Morgan in the New York State Supreme Court in Manhattan. The accusation was that JP Morgan had concealed the truth about the quality of the loans that were underlying the securities. Recently the suit was moved to federal court. The U.S. District Court in Manhattan will hear it. Unfortunately, this is a tough pickle for JP Morgan to get itself out of. Indeed, JP is likely to settle with Bayerische rather than face a potentially large financial liability from the courts if they weigh in favor of Bayerische. The company could be looking at a settlement approximately one tenth of the $2.1 billion in alleged losses, or $210 million.
I wish that I had better news to end on, but this is the most imminent threat to the company and makes me somewhat concerned about JP Morgan’s future, because the bad publicity just never seems to end. If you’ve stomached JP Morgan for this long, chances are you’re not concerned with its string of bad publicity. Just be aware, the end doesn’t seem anywhere in sight. Thus, although JP Morgan stock is a less uncertain investment than it was recently, litigation risk is still present. Investors should continue discounting the stock, albeit by a lesser amount than before the recent settlement.
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