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Tuesday, 19 January 2010 04:00

Reggie Middleton on JP Morgan's "Blowout" Q4-09 Results

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My reveiw and opinion of JP Morgan's Q4 2009 is ready for download JPM 4Q09 review 2010-01-19 01:48:27 1.16 Mb. I have made it available to all readers, but I sugguest that paying subscribers follow the appropriate links to see how appropo the assumptions regarding revenue and loss trends were in the forensic analysis. I have excerpted some of the review below:

Right off the bat, let's get something straight. The tax rate for JPM in 4Q09 was impacted by one-time items and some tax deductions. The tax rate was 15.4% against the normalized tax rate of 35%. Thus, JPM saved nearly $758 million (25.7% of the net income available to common stockholders) or $0.19 per common share in 4Q09 owing to lower tax rate. So when you see headlines in the media touting, "JPMorgan Earnings Blow Past Expectations, Revenue Looks Light ...", "JPMorgan Earnings May Have Tripled on Investment-Banking Fees‎", and "J.P. Morgan Earnings: A Beat! - MarketBeat - WSJ", view them with a jaundiced eye.

When the markets rejoiced the strong revenues of investment banks in 3Q09 on the back of extraordinary trading revenues, Boombustblog anticipated well in advance the highly fluctuating nature of this source of income and raised concerns about its sustainability (subscribers, see "The JP Morgan Full Forensic Report is ready for download! ", non-subscribers should reference Reggie Middleton on JP Morgan's Q309 results). If anything, I was "TOO" optimistic in my assumptions and forecasts regarding revenue drivers and loss rates. JPM's 4Q09 results have reinforced Boombustblog's apprehensions that the trading revenues which soared high in 3Q09 on the back of increased volumes and record high spreads would normalize and suffer sharp compression in the coming quarters. The revenues from principal transactions which largely comprise trading income as well as gains and losses on fair valuation of investments fell to just $0.8 billion in 4Q09 from $3.8 billion in 3Q09. The obvious reason was the drop in volumes and tightening of spreads, which I clearly warned my subscribers about last year. Revenues from principal transactions accounted for just 3.6% of the total net revenues against 14.5%, the previous quarter.

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Credit conditions continue to remain tough as the delinquency rates continue to climb and NPAs remain at elevated levels. The 30 day+ delinquency rates for the consumer lending rose to 5.93% in 4Q09 from 5.85% in 3Q09 and 4.21% in 4Q08. The 30 days+ delinquency rates for credit card touched 6.28% in 4Q09 against 5.99% in 3Q09 and 4.97% in 4Q08.

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Non performing loans increased to 2.77% of total loans at the end of 4Q09 from 2.72% of total loans at the end of 2Q09.

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Loan portfolio continues to shrink and net interest margin continues to contract.

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As clearly foretold last year, JP Morgan is significantly understating the potential for losses on its WaMu portfolio acquisition

We looked into acquired portfolio of Wamu and as analyzed in the forensic report, owing to continuous deterioration in the credit quality, the acquisition is proving to be a bad deal for JPM. Exactly one year ago, I accused JP Morgan of taking unrealistic marks on the WaMu portfolio, see Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful!. It appears as if I was right on the mark, despite management proclaiming that the loss trend on those loans are going as expected. If that was the case, why is the discount and loss buffer already eaten through to provide material net losses - just one year after the purchase??? The Alt-A/Option ARM/HELOC pain has yet to really hit, and JPM is already in the red by about 5% on this deal and they bought it at a 25% discount! I suggest all readers reference the loss trends in the Alt-A market as of December (A Fundamantal Investor's Peek into the Alt-A Market) and paying subscribers should download the worksheet behind the data to get a granular view of what is going on. We are already at a charge-off rate of near 30%, which will not be reflected in JPM's numbers until next quarter, and I have reason to believe that the WaMu loans will perform worse than average.

As per the last forensic report at the end of 2Q09, the implied discount rate for purchased credit impaired loans stood at 22.9% while delinquency rate was 23.4%, thus a negative buffer of 0.5%. In 3Q09, this negative buffer has further worsened to 2.6%, due to an increase in delinquency rate to 25.6% reflecting continuous deterioration in the acquired portfolio. Moreover, for 4Q09 the delinquency rate has increased further to 27.8% and though the company has not reported the outstanding balance and carrying value numbers we believe that the buffer for 4Q09 will decline further.

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In light of expected loan losses from the acquired portfolio, JPM is adding to the allowance for loan losses. In 4Q09, JPM added nearly $491 million to allowance for loan losses to cover the estimated deterioration in the Washington Mutual purchased credit-impaired portfolio; this is compared with no addition in the same quarter last year and nearly $1.1 billion addition in 3Q09.

Warranties of representation, and forced repurchase of loans

JP Morgan has increased its reserves with regards to repurchase of sold securities but the information surround these actions are very limited as the company does not separately report the repurchase reserves created to meet contingencies. However, the Company's income from mortgage servicing was severely impacted by increase in repurchase reserves. Mortgage production revenue was negative $192 million against negative $70 million in 3Q09 and positive $62 million in 4Q08.

Counterparties who are accruing losses from bad loans, (ex. monoline insurers such as Ambac and MBIA, see A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton circa November 2007,) are stepping up their aggression in pushing loans that appear to breach certain warranties or smack of fraud. I expect this activity to pick up significantly, and those banks that made significant use of brokers and third parties to place mortgages will be at material risk - much more so than the primarily direct writers. I'll give you two guesses at which two banks are suspect. If you need a hint, take a look at who is increasing reserves for repurchases! JP Morgan and their not so profitable acquisition, WaMu!

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As I said, losses should be ramping up on the mortgage sector. Notice the trend of housing prices after the onset of government bubble blowing: If Anybody Bothered to Take a Close Look at the Latest Housing Numbers...

PNC Bank and Wells Fargo are in very similar situations regarding acquiring stinky loan portfolios. I suggest subscribers review the latest forensic reports on each company to refresh as the companies report Q4 2009 earnings. Unlike JPM, these banks do not have the investment banking and trading fees of significance (albeit decreasing significance) to fall back on as a cushion to consumer and mortgage credit losses.

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JComments

ReggieMiddleton: @Digikelly @pdacosta @hmtreasury @ReutersJamie many thanks, original article is here, much more to the conversation http://t.co/wCr1I59MNY

about a day ago from HootSuite

ReggieMiddleton: @islesail it matters much less for the states... the US had its own printing press, Scotland, Cyprus and Iceland do not.

about a day ago from HootSuite

ReggieMiddleton: @BrettBina the answer to that question is contained in the subscription documents towards the end if the article.

about a day ago from HootSuite

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