Still a Smart Long-Term Investment
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JPMorgan Chase (NYSE: JPM) was one of the few banks that came out of the financial crisis of 2008 with its reputation and credibility intact. Its CEO Jamie Dimon was regarded as one of the best bankers in the world until the derivatives scandal surfaced around two months ago. The losses from the derivatives scandal, of which Dimon was dismissive in the beginning, look as if they could touch $7 billion. If this were not enough, JPMorgan has now been dragged into the Libor rate rigging scandal and has been hit by a large number of subpoenas with requests for more information from regulators in the U.S., the UK, Canada and Switzerland.
Libor stands for London Interbank Borrowing Rate, a short-term rate that is a benchmark for the pricing of many financial instruments and determines the cost of borrowing for companies and borrowers globally as well as around $350 trillion in credit derivatives. Despite its status as a benchmark, it appears to have been systematically manipulated for years in what may become the biggest financial scandal in history. JPMorgan has been identified as one of the 16 U.S. banks being investigated, and Bank of America (NYSE: BAC) and Citigroup (NYSE: C) have confirmed receiving similar subpoenas. However, Bank of America and Citigroup noted fewer regulatory agencies than JPMorgan. Morgan Stanley (NYSE: MS) is also being investigated. Currently, four former and current Morgan Stanley employees are being investigated. Barclays (BCS) has admitted complicity and agreed to pay $450 million in fines. JPMorgan has already stated that it is starting to see a large and growing number of lawsuits arising out of this mess. The bank has spent in excess of $3 billion this year on litigation alone.
As if this were not enough, JPMorgan has restated its earnings for the first quarter to show a lower profit after discovering that its traders involved in the derivatives mess had overstated the value of some derivatives to minimize the effect of almost $6 billion in losses from the deals which have come to light following investigation. The restated numbers show a profit of $4.92 billion for the first quarter against the original figure of $5.38 billion. EPS has been reduced to $1.19 per share against the earlier figure of $1.31 per share. The Federal Reserve and the Office of the Comptroller of the Currency have instructed the bank to restate one measure of capital strength and this has been restated downwards for the first two quarters of this year to reflect the risk from the trading losses. The bank has admitted to a "material weakness" in its internal controls and says that it is taking further steps to resolve the problem and that a comprehensive review is being carried out.
Despite these developments, JPMorgan reported a solid performance in the second quarter and, along with Goldman Sachs (NYSE: GS) appears to be one of the strongest players in the banking industry. Investment banking profits rose more than 300% to $1.5 billion on higher underwriting fees and gains in its bonds business though some analysts felt that this was a spike that was not sustainable. Both Goldman Sachs and JPMorgan have definitely benefited from the smaller playing field in investment banking. However, at the same time, JPMorgan reported higher losses from credit cards and consumer lending and has set aside $9.7 billion for credit losses for the quarter up from $4.29 billion on a year-on-year basis. It is also setting aside an additional $2 billion for future losses making its total loan-loss reserves to more than $30 billion. JPMorgan's credit card services division showed a $672 million loss for the quarter, compared with a year-earlier profit of $250 million. All credit card issuers have been affected by delinquencies as well as lower levels of consumer spending. It is not clear how the recent credit card consumer protection legislation will affect the performance of the credit card business. JPMorgan repaid $25 billion in loans it received from the government as part of the Troubled Asset Relief Program.
Despite the depressed investment banking climate, retail financial services will continue to be a major source of profitable revenue generation and, with the gradual improvement in the economic climate in the US, delinquencies are showing a downward trend and will need more time to stabilize. Meanwhile, if and when the US economy recovers substantially, JPMorgan is ideally placed to take advantage and, of course, any improvement in investment banking will further strengthen the bottom line. In my opinion, bank bashing and JPMorgan bashing have already been overdone and investors are being influenced without considering that many of these losses are non-recurring in nature and already behind us. It is now time to recognize that banking is an important industry and it is now necessary to re-evaluate the parameters for considering further investments in the industry.
JPMorgan has a strong balance sheet with high tier capital ratios, and has the capability to deal with any losses arising out of its current problems. The core business is solid and has performed well, even during the worst of the 2008 crisis. I believe the impact of the current problems have been exaggerated and there is plenty of upside potential as well as a dividend yield above 3%. I think that the current problems have created a window of opportunity in terms of buying the stock cheap, and I recommend investors consider taking advantage of this rare buying opportunity and add to your long-term investment portfolio.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
