JPMorgan: Still Too Big, Smart, Capitalized To Fail
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Life goes on for JPMorgan Chase (NYSE: JPM). Any enterprise as large, with as many employees, and as many assets spread over six continents, is going to have issues. The huge trading losses stemming from the London Trading Desk have been so salient and dominating that some small but important issues have been overlooked in recent weeks. I will cure that today.
First, a word about the trading loss, originally estimated at $2 billion, but now according to some commentators reaching as much as $9 billion. I suspect the sum amount will be in the $3 billion to $5 billion range, but whatever the amount, JPMorgan can handle it without any sense of stress for the overall health of the bank. It carried at the end of the first quarter of 2012 some $56 billion in cash, plus another $300 billion in short term cash equivalents. I don't think it will miss what at worst will be 14% of the cash hoard. The real problem here is the trust the public will continue to have in CEO Jamie Dimon, who spent much of the last five years reminding us he really is the smartest banker on the planet.
Dimon's mid-April, 38-page letter to shareholders seems quite hollow today. An entire chapter was devoted to the virtue of the share buyback program. JPMorgan has announced it is no longer buying back shares, so that part of the letter is moot. Much of the rest of the letter portrayed JPMorgan as a humble and benevolent public servant. Well, let's see whether that is true.
Reuters reports that JPMorgan is being scrutinized for its potential role in price manipulation of energy supplies in the California and the Midwest. At issue is whether in 2010 and 2011 JPMorgan failed its duty to be honest and forthright to the Federal Energy Regulatory Commission (FERC) and regional energy coordinators. At issue in particular is whether certain documents that the FERC wishes to uncover are otherwise privileged documents. This issue is entwined with the larger issue of banks like JPMorgan becoming active bettors in the world of physical commodities. On the books of certain major banks, including Goldman Sachs (NYSE: GS) and Morgan Stanley (MS) in particular, are assets such as pipelines, oil storage units, and refinery interests. There is some dispute over whether the Volcker Rule of the Dodd Frank financial reform package would govern these non-typical banking assets.
In statements reminiscent of Greg Smith's not so stunning criticism of Goldman Sachs for its change of culture putting profit above all else and, too often, its own interest ahead of clients, several former employees of JPMorgan have come forward, stating that the bank ignored its fiduciary responsibilities to its clients and often favored its own position at the expense of its clients'. This all stemmed from JPMorgan's expansion of its mutual fund business the past few years. The funds are typically more expensive than anything offered by companies like Vanguard or Janus (JNS), and typically underperformed their market segment. Yet despite all this, “financial counselors” were strongly encouraged to sell shares of JPMorgan funds. In 2011, the bank lost an arbitration proceeding, forcing it to pay $373 million to American Century for favoring its own products despite an earlier agreement to sell offerings from American Century.
With the Federal Reserve's ill-conceived extension of the “twist” program, JPMorgan will, along with all other banks, struggle against a flattening yield curve. This actually will harm JPMorgan less than most banks, as the bulk of its assets are not really used for banking activities in the traditional sense. Many banks still think profits are a matter of low credit costs, effective underwriting, reasonable interest rates, and effective expense control. That seems to work for companies like BB&T (NYSE: BBT), U.S. Bancorp (NYSE: USB), and Fifth Third (NASDAQ: FITB). What all three of these large regional banks have in common is a recent history of earning a return on assets in excess of 1%, a level JPMorgan has not reached in at least fifteen years. Less than one third of JPMorgan's assets are in the form of loans. For many regional banks, that number is at least double JPMorgan's percentage. In fact, JPMorgan is less exposed to yield curve expansion and contraction than any of the 50 largest commercial banks in the United States.
Smaller regional banks like BB&T, U.S. Bancorp and Fifth Third also do not have the international investment banking exposure that continues to get JPMorgan into trouble. The latest is still developing, and has to do with the LIBOR probe going on in Great Britain. Thus far only British banks have been implicated, but I would not be one bit surprised to see JPMorgan's investment banking unit to have been involved as well.
All of JPMorgan has come under increased review and scrutiny since notice of the trading loss in April. The current flavor of the month is the bank's risk models, and in particular, its Value-at-Risk daily assessment, which was changed to raise the risk profile of the bank just prior to the trading debacle. The SEC is concerned whether the bank adequately informed the investing public of the increased VAR.
Most recently, JPMorgan was among a group of nine “banks," each with non-banking assets of at least $250 billion, which submitted their “living wills” to the Federal Deposit Insurance Corporation, which in turn released details to the public. This was part of the Dodd Frank banking reform measure that required banks to report how they would best be wound down in an orderly fashion in the event of a financial crisis, without resorting to taxpayer bailouts. Eventually, all banks with assets of $50 billion or more will have to file such a resolution plan.
JPMorgan's 33 page plan spent over 80% of its content explaining why JPMorgan is too big, smart, and well, capitalized to fail. But if it did, and selling assets and seeking recapitalization did not work, management believes bankruptcy court, as a last resort, would insulate the taxpayers from giving additional largess. Well, wasn't the 2008 largess to avoid the difficulty of large banks going into bankruptcy? What changed in the last four years? Or perhaps, things have not changed at all.
What is clear at this point in time is that JPMorgan is a “thrill a minute” kind of company, and not typically in a good way. Its second quarter report will be released July 13th, and I will be reading every word of it.
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