JP Morgan’s Q3 net revenue declined 11% y/y (-5% q/q) to $24.8bn as investment banking revenue declined 18% y/y (-9% q/q) to $12.6bn from $13.9bn in the previous year and net interest income declined 2% y/y (-2% q/q, off of a combination of ZIRP victimization and a rapidly shrinking asset base and loan book) to $12.5bn versus $12.7bn in the previous year. Non-interest expense increased 7% y/y (-2% q/q) to $14.4bn as compensation expenses to net revenues remained broadly flat (28% vs 27.5%) while non-compensation expenses to net revenues jumped to 33% vs 23% in the corresponding period last year. As a result of “Fraudclosure” we expect this number to skyrocket next quarter. Overall, the efficiency ratio (total expenses-to-net revenues) increased to 60% vs 51% and we expect this ratio to spike next quarter as well as the banking business becomes even more expensive.
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However, despite a decline in net revenue and increase in non-interest expenses (both of which appear to be part of an obvious trend), profit before taxes was up 22% y/y as provisions for credit losses were slashed by 60%. JPM decreased its provision for credit losses despite no evidence of a substantial, sustainable improvement in credit metrics (please reference As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves). Provisions have lagged charge-offs for two consecutive quarters in a row.
As a result, banks allowances for loan losses have decreased to 4.9% in Q3 from 5.1% in Q2 and 4.7% in previous year. Although under provisioning has helped the bank to mask its dearth in profits it has also materially undermined its ability to absorb losses if economic conditions worsen. The Eyles test, a measure of banks ability to absorb losses, has consequently worsened to 1.9% in Q3 from 3.7% in Q2 and 5.9% in Q3 09.
JPM also increased its mortgage repurchase reserves increased $1.0 billion pretax in anticipation of pressures from GSE’s for repurchase of troubled mortgages and made a provision of $1.3bn for litigation reserves. I explicitly outlined this risk this time last year (Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results) and reiterated it days before JPM’s earnings release (The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!) wherein I told BoomBustBlog readers to carefully follow the “warranties and representations” numbers, which is nearly guaranteed to spike – and spiked it has.
I would like to note that I don’t recall anyone making a big deal about this topic when it first reared its head last year, although the trend was quite obvious. Now, it is one of the biggest issues of discussion in the earnings call Q&A. Was it potentially my advice on watching the spike in the repurchase requests? I do hope somebody was paying attention!
If you haven’t noticed, despite the fact JPM is pulling provisions to, IMO, pad accounting earnings ahead of what I feel to be a tsunami of macro and fundamental issues, they are at the same time going to the capital markets for a re-up, and willing to pay a premium to do so…
So, the question is, "Was JPM management correct in releasing reserves ahead of what appeared to be improving credit metrics?". After all, said reserve releases do wonders for the bottom line, at least from an accounting perspective which is what most investors pay attention to. Well, now with the benefit of hindsight, we have a preliminary answer to that question - that is assuming the collapse in housing prices were the cause for drop in the first place. After all, the more houses underwater, the riskier these mortgages are, right? Let's peruse As Clearly Forecasted On BoomBustBlog, Housing Prices Commence Their Downward Price Movement In Search Of Equilibrium Scraping Depression Levels Tuesday, December 28th, 2010
Anyone who regularly follows me knows that I have been adamant in disagreeing with any who actually assert that the US has entered a housing recovery. The bubble was blown too wide, supply is too rampant, with demand too soft and credit tighter than frog ass. Today, the Case Shiller numbers have come out, and after a few months of showing price increases, have come around full tilt to reveal the truth!
U.S. single-family home prices fell for a fourth straight month in October pressured by a supply glut, home foreclosures and high unemployment, data from a closely watched survey showed Tuesday. AP The Standard & Poor's/Case-Shiller composite index of 20 metropolitan areas declined 1.0 percent in October from September on a seasonally adjusted basis, a much steeper drop than the 0.6 percent fall expected by economists. The decline built on a revised decrease of 1.0 percent in September and took prices down 0.8 percent from year-ago levels. It was the first year-on-year drop in the index since January. The housing market has been struggling since home buyer tax credits expired earlier this year. To take advantage of the tax credits, buyers had to sign purchase contracts by April 30.
"The (housing) double dip is almost here [there was no double dip, just a result of .GOV bubble blowing] , as six cities set new lows for the period since 2006 peaks. There is no good news in October's report,'' said David Blitzer, chairman of the index committee at S&P.
Eighteen of the 20 cities showed weaker year-on-year readings in October and all 20 cities showed monthly price declines.
Unadjusted for seasonal impact [in other words, closer to the truth], the 20-city index fell 1.3 percent in October after a 0.8 percent decline in September.
To begin with, the Case Shiller index is highly flawed in tracking true price movement in a downturn such as this since said downturn is being led mostly by elements that the CS index purposefully omits. This means that those price drops that are being shown by the Case Shiller index are actually highly optimistic and seen through spit shined rose-colored glasses. The reality is a tad bit uglier. See The Truth Goes Viral, Pt 1: Housing Prices, Economic Sales and the State of Depression as well as Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!
I discussed my thoughts on the Case Shiller index (a complex statistical construct that excludes many of the factors currently dragging on the housing market) being quoted in the mainstream media as if it was the S&P 500, its shortcomings, the true state of housing sales value in America and what's in store for the near future. [youtube MutLxFck9Ec]
Several times last year I stated that most of the big banks were being much too optimistic in their forecasts and releasing of credit loss provisions - see As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves. You see, the mortgages currently on the books are worth even less as the collateral continues to depreciate, and it is exacerbated by the robo-signing problems.
I commented on what I perceived to be JPM management's overt optimism on CNBC as well. Well, in hindsight, was a brother correct? Now, back to that Bloomberg article...
Litigation “ain’t going away,” Chief Executive Officer Jamie Dimon told analysts on an Oct. 13 conference call. “It’s becoming a cost of doing business.”
At least JPMorgan’s shareholders are more likely to be informed about legal expenses than some other bank investors. The bank, which used the word “litigation” about 50 times in its latest 10-Q filing with the Securities and Exchange Commission, discloses more about lawsuits’ effect on results than Citigroup or Wells Fargo, and has been taking larger reserves than some rivals, according to company filings.
You know, the interesting part of this is that JP Morgan’s Analysts Agree with BoomBustBlog Research on the State of JPM (a Year Too Late) but Contradict CEO Jamie Dimon’s Conference Call Statements Monday, October 18th, 2010
As I sit in the car, surrounded by thick NYC traffic, on my way to the highly anticipated CNBC interview (the Squawk on the Street show) on JP Morgan, banks, real estate and related issues, guess what I happen to drive by… MORE construction – causing me to ponder what additional damage will be done to banks that backed these deals. Then, less than an hour later I read from CNBC and Bloomberg that JP Morgan’s analysts predict that forced repurchases of soured U.S. mortgages may be the “biggest issue facing banks”. Bloomberg goes on to state:
Future losses from repurchases of home loans whose quality failed to meet sellers’ promises will likely total $55 billion to $120 billion, or potentially $10 billion to $25 billion for the next five years, the New York-based mortgage-bond analysts led by John Sim and Ed Reardon wrote in a Oct. 15 report.
I immediately blurt out, “Now hold the hell on a minuted!!!” That report of the 15th sounds an awful lot like the article I published on the 12th, “The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!” (Hey, no peeking, no copying, fellas!) which, among many other things, reiterated what I said in the 4th quarter of LAST YEAR!!!.
To be fair, the JP Morgan report is very similar to mine in content, scope and gist – JUST A YEAR OR SO TOO LATE! I quote (again) “Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results”...
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!
With that being said, I actually do believe that JPM is in better shape than many of its peers. I don't know if that's a good thing, though.