Reggie Middleton with Max Keiser on the Keiser Report and RTT Television
Go to 12:20 in the video to see the portion with Reggie Middleton
The topics in this interview stem from the post Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!
On the difference between accounting earnings and economic earnings...
... accountants have not been – and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit. Hence we hear much about easily manipulable and manageable accounting earnings, revenues, operating margins, earnings per share, etc. These measures are highly flawed in a variety of ways, with the primary flaw being that they do not account for the efforts both required and undertaken to achieve them. Basically, they measure JUST HALF (and coincidentally, the positive half may I add) of the risk/reward equation that should be at the root of every investors move. Long story short, they do not account for, nor do they EVEN RESPECT, the cost of capital. This concept ties in closely with Chairman Bernanke’s current course of action as well as the ZIRP discussion later on this missive demonstrates (capital offered at zero cost causes reckless abandonment of risk management principles which eventually causes crashes – yes, more crashes). Acknowledgment of the cost of capital enforces a certain discipline on both corporate management and investors/traders. Without respect for such, it is much too easy to create and portray a scenario that is all too rosy, since we are only looking at rewards but never bother to glance at the risks taken to achieve said rewards. I reviewed this concept in detail as it relates to bonuses and compensation on Wall Street in The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma.
"Goldman, unlike the rest of the street and practically the rest of the I banking world, is ratcheting up off balance sheet risk!!! Is BoomBustBlog the only one inquiring as to WHY??? We have a few reasons in mind... And to think, many thought the Enronesque days of off balance sheet "hide the sausage" games have come to an end..." Go through your sell side analyst's quarterly update and if you don't find these tidbits of information thoroughly explained, but instead see a Goldman fan boy(girl) cheering section, come back and subscribe to BoomBustblog. At the very least, we tell it like it is!
My opinion and updated valuation for Goldman and its 3rd quarter performance is available for download to all paying subscribers: GS 3rd Quarter 2010 Update. While I can't spill the beans on the entire contents of the subscription document, there are a few issues (as usual) and observations that I would like to make public.
To begin with, I must commend Goldman's management. They do a helluva job massaging numbers and attempting to right their ship, particularly in relation to some other banks. Anecdotally, I'm aware of their losing some talent on the equities side but I am sure they have no problem replacing it. There is also the issue of their subprime servicing unit, Litton Loans, which I am sure will bring them nothing but heartache in the near to medium term, but at least that aspect of the business has been recognized by the sell side, if not under appreciated in terms of potential risk. Despite its small size in relation to Goldman's aggregate operations, it carries with it material reputation risk as well as the prospects for significant litigation and more.
Now, on to the aspects which the sell side decided not to cover - or somehow overlooked. Goldman was applauded for having strong accounting earnings. In Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!, I warned of the danger at looking at accounting earnings as if they were actually a legitimate barometer of a companies actual economic value. If that were the case, wouldn't accountants be the best investors in the world? I will delve into the folly of relying strictly on accounting earnings later on this missive as well, particularly in regards to a company with management as crafty and capable as Goldman - but before I do let's realize that even those accounting earnings were down significantly from previous periods...
I have received a lot of feedback concerning my article posted yesterday, A Step by Step Guide to Exactly How Much Derivatives Risk Each of the 5 Big Banks Actually
Pick up your own "Fiery Swords of Truth" and aggressively seek out the facts. Don't be afraid to ask questions under the pretense you don't understand. Chances are, if it is so complex that you can't understand it, it is either wrong or many other people, including the creators and proponents, don't understand it either!!!
Have, and How It Could All Go Boom! (a must read precursor to this piece) in which I picked up the fiery sword of Truth and attacked all misinformation within reach. A decent amount of derivatives traders, salesman and financial engineers chimed in. Of course, being the simpleton that I am, I am at a loss how anybody can argue that the hedging and netting system actually works with the utter failure of the monolines, Lehman (wherein contracts were unwound and rewritten, but why would they have to be if everybody was netted???) and Bear Stearns (where the government had to step in to be the counterparty of last result), all of which allegedly netted out much of their risk - RIIGHHHT??? Nonetheless, I will go through some of the responses I received via email, all of which were cogent, intelligent and polite - but most of which took a swing at my thesis. Okay, I'm swinging back - and I'm swinging back with the "Fiery Sword of Truth" as well!
Here's the first one:
Hi reggie, love the independance of the blog. Couldnt help but wonder though, as to if the big 5 were really cross exposed to that degree. Surely hedge funds, private banks, real world commodity producers etc are other swap counter parties that you fail to include in your calculations. 1.7 trillion of unlevered hedge fund assets arent included anywhere for a start. How about other smaller banks too, that dont show up in the comparison, maybe there is more diversification than you think.
Over the three years since I have been publishing BoomBustBlog, I have amassed what many consider a remarkable track record, having called nearly every major market crash and large financial/real estate/bank collapse over said time period. Believe it or not, many have even went so far as to call me "intelligent". While I would love to bask in the light of potential admiration, let me assure you, although I am in no way lacking in confidence or ability, I am also quite average in the intelligence arena. While not being any more intelligent than the average man, I do have an uncanny knack for seeking out that rarest of rare concepts these days - the TRUTH! This increasingly uncommon ability (to both speak and seek the truth) has served me quite well in both my investing pursuits as well as in the personal aspects of life. Let's delve into how I translate this personal talent into a product that I distribute from my BoomBustBlog, and then into the facts in regards to the current state of concentrated risk in today's US banking system - to wit, the systemic risk of derivatives concentration.
The full 3rd quarter forensic analysis and valuation update for JP Morgan is now available for all subscribers: JPM 3Q 2010 Forensic Update. The download is a much more detailed version of the (not so) quick overview I posted the day after earnings that reveals some very interesting points. All in all, the JPM quarter was quite bad, considerably worse than the media appears to be making it out to be. I have taken the liberty to include some of the highlights of interest in this blog post. While the hardcore actionable stuff is reserved for clients, I feel there are a few topics of discussion that demand public attention. I would like anybody who reads this to go to their local broker (or prime broker) and get a copy of their JP Morgan quarterly research opinion and update - regardless of the source(s). If the four issues that I have discussed in this blog post are NOT PRESENT in your (prime) broker's report(s), I respectfully request that you do yourself a favor - subscribe to BoomBustBlog.com and download the report linked above, which includes valuation as well. I will be offering an extra download for professional and institutional subscribers interested in granular, detailed loan, charge-off and derivative holdings in the near future.
FACT ONE: First and Foremost, JP Morgan has been DESTROYING Shareholder Value for TWO Years Running, and I Don't See It Getting Much Better Any Time Soon! That Two Years Is Exclusive Of The Devastating 2008 Market Crash!
Getting back to the issue of Wall Street's sell side analysis, the biggest problem I have with them (outside of rampant conflicts of interest, which is probably not the fault of the individual analysts) is the abject reliance on accounting figures to measure and value an economic entity such as a business as an ongoing concern. Let' be frank here, accountants, albeit probably quite smart, don't necessarily make the world's best investors. As a matter of fact, practically every accountant I know comes to me for my investment opinion and I make a horrible accountant. Try and try as I might, I can only think of one accountant that has ever excelled at investing over time (not to disparage accountants, of course, with all respect due). Granted, this man is probably a damn genius, and he knows how to identify quality when he sees it - having created Canada's largest independent brokerage and independently its premier asset management firm with ~$6 billion under management - including the innovative physical gold trust. He has said, and I quote from Crain’s New York:
“His work is so detailed, so accurate, it’s among the best in the world,” says Eric Sprott, CEO of Sprott Asset Management, a Toronto firm that manages about $5 billion and subscribes to Mr. Middleton’s research.
Yeah, I know that was cheesy, but I couldn't help myself :-) . Back to the matter at hand, accountants have not been - and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit.
Here's a little cross pollination to attract bears from all over. Karl Deninger, the editor of the Market Ticker, invited me over for a half hour chat on his Blog Talk Radio show to discuss things such as foreclosure fraud, banks, derivative risk and the markets. You can access the original airing podcast on Karl's site. I have taken the liberty to append some graphics to the background to add some information to the discussion (see below). Enjoy!
Part One (the impatient may want to skip ahead about 1:32 to get the actual start of the discussion. I highly recommend you choose the 720p HD setting and expand to full screen in order to read the graphics in full fidelity.
While chatting with Herb Greenberg before my interview at CNBC on the banks, he asked me why I was short the banks, JPM in particular (JP Morgan’s 3rd Q & Just How XYZ Bank Can Never Go Out of Business!!!). I told him that I believe they are overly optimistic about the reserve thingy (Big Banks Will Pay for Optimism), the mortgage put back cosequences (JP Morgan’s Analysts Agree with BoomBustBlog Research, Contradict CEO Jamie Dimon’s Conference Call and The Putback Parade Cometh: Pimco, New York Fed Said to Seek Bank of America Repurchase of Mortgages) and real estate in general. I also said that in the scheme of things, Jamie Dimon appears to be, by far, the most effective manager of the big banks, and JPM seems to be the best run of the big banks. He negotiated a literal coup with Bear Stearns purchase, getting the billion dollar head quarters for free, the company for $10 per share and government backing for the legacy assets. He made a mistake with WaMu by not demanding a deeper discount. I know it seems like 28% or so off seems like a good deal, but it was not - and I clearly stated it several times (Is JP Morgan Taking Realistic Marks On Its WaMu Portfolio Purchase? Doubtful!). I just want to make this clear. There is nothing personal here, at least in terms of investments and financial analysis. The stream of events are of such grave consequence that this goes beyond mere finance, though. Why? This country has been "Bamboozled by the Banking Industry", but the "Chickens Are Coming Home to Roost". Let me explain...
Throughout most of 2009, while 10%+ of unemployed middle America stopped paying their mortgages, busy standing in line for shiny fat margin iThingies while in rabid debate about how many pieces of tail Tiger Woods may or may have not hit (yes, that story got 2160 tweets and 375 comments on how well endowed "the Tiger" is - would you dare to bet that this article on a potential depression will get even one third of that?) the greatest mass fraud of this lifetime against said persons was underway.
This should be played 720 HD full screen mode
Mr. and Mrs Middle America, you've been Had, you've been Took, Bamboozled, Hoodwinked, led Astray, run Amok (yes, YOU have, see You’ve Been Bamboozled, Hoodwinked and Lied To! Here’s the Proof. What Are You Going to Do About It? and click your rung in the socio-economic ladder, ex. your "social class"). From rating agency subprime madness to stress tests designed not to apply any stress to robo-signing and beyond (Mortgage Putbacks, the Harbinger of the Collapse that Will Dwarf 2008!) the financial and political elite appear to be running a real time experiment to demonstrate how numb they can prove the mainstream populace to really be? Will the experiment fail this time around? After all, things are different with the Web, and independent thought rocketed around the world in the form of blogs. We shall see what becomes of this real time socio-economic lab session, we shall see!
A few have been emailing me looking for a bio. I believe my track record should speak louder than any paragraph or two about my prior occupation(s). Credibility should come from accomplishment, not pedigree, no? Click here to find out who I am what I have done. Be sure to scroll all the way down to the bottom of the page.
- the updated JP Morgan forensic valuation (yes, what I think it is actually worth) for subscribers (there's a surprise or two in here that I'll reveal to the public)
- the Goldman Sachs forensic valuation update
- and my proprietary research on the foreclosure backlog this one will be a doozy)!
The Truth goes Viral!
Summary: As the putback parade gets going, the question is not whether the banks can afford to buy back the mortgages. The question is "Can the Banks Afford the Instantaneous and Guaranteed HIT to CAPITAL?" What investors will lend money to see it instantly evaporate, and how much will they charge for those evaporation services? TARP 3.0 coming to a door step near you!!!
As clearly articulated in detail in 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!, entities are looking to stem losses by putting it to the originating banks and/or servicers. From Bloomberg: Pimco, New York Fed Said to Seek Bank of America Repurchase of Mortgages
Oct. 19 (Bloomberg) -- Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit, people familiar with the matter said. The bondholders wrote a letter to Bank of America and Bank of New York Mellon Corp., the debt’s trustee, citing alleged failures by Countrywide to service the loans properly, their lawyer said yesterday in a statement that didn’t name the firms.
Investors are stepping up efforts to recoup losses on mortgage bonds, which plummeted in value amid the worst slump in home prices since the 1930s. Last month, BNY Mellon declined to investigate mortgage files in response to a demand from the bondholder group, which has since expanded. Countrywide’s servicing failures, including insufficient record keeping, may open the door for investors to seek repurchases by bypassing the trustee, said Kathy Patrick, their lawyer at Gibbs & Bruns LLP. “We now are in a position where we have to start a clock ticking,” Patrick, who is based in Houston, said today in a telephone interview.
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":
I included this sidebar for those of you who have not followed me in the past. You can save some time and just review Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?, but this is probably a lot more entertaining! I took the time to pour through my blog's archives, and...
Hey, Big Wall Street Bank Execs Always Tell the Truth When They're in Trouble, RIIIIGHT????
Here's more of Alan Schwartz lying on TV in March of 2008
Meredith Whitney downgraded Bear Stearns today Friday, March 14th, 2008: "Yep, she did it. The ratings agencies are considering a downgrade. I thought it was a joke when I first heard it. Let's just imagine that I used these wise sources as an info source to make my money! The ratings agencies and sell sides are jokes that I can no longer laugh at."
It's a good thing no one listened to that damn blogger who has the gall to charge money for his research and opinion. We had to listen to him bitch and moan for 2 months before... Is this the Breaking of the Bear? (January 2008)"
Bear Stearns is in Real trouble
Bear Stearns will soon be, if not already, in a fight for its life... the biggest issues don’t seem all that prevalent in the media though. Bear Stearns is in a real financial bind due to the assets that it specialized in, and it is not in it by itself, either. For some reason, the Street consistently underestimates the severity of this real estate crash. If you look throughout my blog, it appears as if I have an outstanding track record. I would love to take the credit as superior intelligence, but the reality of the matter is that I just respect the severity of the current housing downturn – something that it appears many analysts, pundits, speculators, and investors have yet to do with aplomb. With a primary value driver linked to the biggest drag on the US economy for the last century or so, Bear Stearn’s excessive reliance on highly “modeled” and real asset/mortgage backed products in its portfolio may potentially be its undoing. This is exacerbated significantly by leverage, lack of transparency, and products that are relatively illiquid, even when the mortgage days were good."
Notice how the worse case scenario is economic insolvency - as in less than ZERO!
Book Value, Schmook Value – How Marking to Market Will Break the Bear’s Back
... I can say that when I do watch it I hear a lot of perma-bulls stating that this and that stock is cheap because it is trading at or below its book value. They then go on to quote the historical significance of this event, yada, yada, yada. This is then picked up by a bunch of other individual investors, media pundits and other “professionals,” and it appears that rampant buying ensues. I don’t know how much of it is momentum trading versus actual investors really believing they are buying on the fundamentals, but the buying pressure is certainly there. They then lose their money as the stock they thought was cheap, actually gets a lot cheaper, bringing their investment down the crapper with it. What happened in this scenario? These investors bought accounting numbers instead of true economic book value. Anything outside of simple widget manufacturers are bound to have some twists and turns to ascertain actual book value, actual marketable book value that is. This is what the investor is interested in, the ECONOMIC market value of book, not what the accounting ledger says. After all, you are paying economic dollars to buy this book value in the market, so you want to be able to ascertain marketable book value, I hope it sounds simplistic, because the premise behind it is quite simple – How much is this stuff really worth?. The implementation may be a different matter, though. I set out to ascertain the true book value of Bear Stearns, and the following is the path that I took.
Then he had the nerve to come back with Bear Stearn’s Bear Market – revisited Friday, February 22nd, 2008
So, who was right?
The Bust that Broke the Bear’s Back? Monday, March 10th, 2008: My ruminations on Bear Stearns look to come into their own…
It looks as if the prudent should start debating the ability of Bear Stearns to remain a going concern Thursday, March 13th, 2008
Despite the Federal Reserve’s efforts Wall Street fears a big US bank is in trouble Thursday, March 13th, 2008: While I can't know for sure which IB it may be, my studies tell me it is either the Bear with the Broken Back or the Riskiest Bank on the Street, and that's where I'm concentrating my bets…
From the London Business Times: Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump $280 billion (£140 billion) into global markets was seen as a sure sign that at least one financial institution was struggling to survive. The name on most people's lips was Bear Stearns. [Hey, it pays to read the boombustblog.com. ...] “The only reason the Fed would do this is if they knew one or more of their primary dealers actually wasn't flush with cash and needed funds in a hurry,” Simon Maughan, an analyst with MF Global in London, said. Bear Stearn's new CEO states unequivocally that his balance sheet hasn't changed since November and that they have $17 billion of cushion. [He did not outright say that they were in good shape though. My concern was looking forward. They are a significant counterparty risk (along with Morgan Stanley) and they have significant illiquid level 2 and 3 assets as a percentage of tangible equity. In addition, 17 billion is not much considering the leverage and amount of illiquid assets held by this bank.]
And what happens after the fact? Yes, I can turn bullish as well...
Joe Lewis on the Bear Stearns buyout Monday, March 17th, 2008: The problem with the deal is that it is too low, and too favorable for Morgan. It is literally guaranteed to drive angst from the other side. Whenever you do a deal, you always make sure the other side gets to walk away with something. If you don’t you always risk the deal falling though unnecessarily. $2 is a slap in the face to employees who have lost a life savings and have the power to block the deal. At the very least, by the building at market price and get the company for free!
BSC calls are almost free and the JP Morgan Deal is not signed in stone Monday, March 17th, 2008
This is going to be an exciting, and scary morning Monday, March 17th, 2008
As I anticipated, Bear Stearns is not a done deal Tuesday, March 18th, 2008
Reggie Turns Bearish on Lehman in February, before anyone had a clue!!!
Like I said above, it's not as if upper management of these Wall Street banks would ever mislead us, RIGHT????
Even if the big Wall Street banks would lie to us, we have expert analysts at hot shot, white shoe firms such as Goldman Sachs, who of course not only are "Doing God's Work" but also happen to be the smartest of the smart and the "bestest" of the best, RIIIGHT!!!??? Below we have both Erin from Lehman AND Goldman lying on TV in a single screen shot. Ain't a picture worth a thousand words???
We even had the inscrutable Meredith Whitney say "To suggest that Lehman Brothers is going out of business is a real stretch!" (She OBVIOUSLY DOESN'T READ THE BOOMBUST) as well as Erin Callan, the CFO of this big Wall Street bank on TV lying interviewing again...
But that damn blogger guy Reggie Middleton put his "put parade"short combo on Lehman right about that time, and had all of these additional negative things to say...
Lehman stock, rumors and anti-rumors that support the rumors Friday, March 28th, 2008
It appears that I should have dug deeper into Lehman! May 2008: I never got a chance to perform a full forensic analysis of Lehman, but did put a fair size short on them a few months back due to their “smoke and mirrors” PR (oops), I mean financial reporting. There were just too many inconsistencies, and too much exposure. I was familiar with the game that some I banks play, for I did get a chance to do a deep dive on Morgan Stanley, and did not like what I found. As usual, I am significantly short those companies that I issue negative reports on, MS and LEH included. I urge all who have an economic interest in these companies to read through the PDF’s below and my MS updated report linked later on in this post. In January, it was worth reviewing “Is this the Breaking of the Bear?”, for just two months later we all know what happened. I came across this speech by David Eihorn and he has clearly delineated not only all of the financial shenanigans that I mentioned in my blog, but a few more as well. Very well articulated and researched.
So, who was right? The Ivy league, ivory tower boys doing God's work or that blogger with the smart ass mouth from Brooklyn?
Please click the graph to enlarge to print quality size.
Learn more about BoomBustBlog here: Who is Reggie Middleton!!!
Note: I will be on CNBC's Squawk on the Street Monday Morning, Oct 18th to discuss my (probably controversial) opinions on banking, technology and real estate. It should be interesting for I believe I am a very "different" type of pundit. Be sure to tune in and write CNBC with your opinions and comments
This is my opinion and analysis of JP Morgan's 3rd quarter 2010 operating results. I have included the hefty sidebar to the right to give my readers and subscribers historical perspective into the possibility of management being,,, ah,, well, optimistic at times when confronting investors and the public about what I see as potentially devastating macro and/or fundamental developments. I also included the sidebar to illustrate and remind all that just because certain big, brand name pundits, Wall Street banks and analysts may claim the coast is clear and all is just fine, it may not necessarily be the case - particularly when your favorite, most handsome and humble blogger claims otherwise. Please take careful note of the dates next to each entry and video. The time line aids significantly in giving the reader perspective. For those who are new to BoomBustBlog or are not familiar with me and my work, please visit Who is Reggie Middleton!!! before you move on.
As for those who may consider it blasphemous to mention the enshrined, the exalted JP Morgan and Bear Stearns or Lehman in the same sentence - I query "Who bought Bear Stearns?". Whatever Bear had, JPM now has - of course along with some very convenient government guarantees. But, then again...
Click any graphic below to expand... (there is a typo in the graphic below, it should read "t"rillion, not "b"billion)
Excerpted from An Independent Look into JP Morgan (subscription content free preview!):
Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we???
Now, on to JP Morgan's 3rd quarter 2010 results...
In a Nutshell, JPM's quarterly results were downright horrible - as we expected and warned of in our previous quarterly analyses (see notes at bottom of page)...
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.
Click to enlarge...
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...
BN *JPMORGAN $1.25 BLN 30-YR DEBT MAY PAY 165 BASIS-POINT SPREAD
BN *JPMORGAN $2.75 BLN 10-YR DEBT MAY PAY 180 BASIS-POINT SPREAD
I suggest readers brush up on reading between the lines... I will be factoring a lot of this into the updated valuation for JPM for my subscribers next week.
As quoted from “Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results” almost a year ago:
“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!
Now, let’s fast forward to the Q3 2010 conference call:
On outlook, what we said is for 2010 I think our outlook was plus or minus $1.2 billion of expense. Obviously you'll take a look at our third quarter numbers are a little higher. And so we're likely to come in at the high end of that range. For 2011 what we've said is $1 billion of realized repurchase losses. And what we've done is we've taken, based on what we know, we've gone back and increased our reserves by $1 billion based on the higher file requests as well as higher settlement demands. And where we are today we believe we're adequately reserved based on what we know and we'll go back periodically and review that.
Reggie Middleton (not invited nor present at the conference call, but throwing his 22 cents (2 cents levered 11x) in anyway: But why are you raising these reserves "based on the higher file requests as well as higher settlement demands" now when it was obvious this was coming down the pike anyway? Hey, I called it in Q4 of last year, and I have much, much less access to info than you guys. It seriously looks as if you were more interested in padding the quarter than in preparing for this issue - although I could always be wrong. Is next quarter gonna be an "unexpected jump" in "higher file requests as well as higher settlement demands" as well or are you guys gonna come clean and realize that the insurers, investors and borrowers are officially lawyered up and comin' after 'ya? Again, if you haven't read it, peruse 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! in its entirety!
Oh well, back to the people who were invited, welcome, and present at the conference call...
Matt O’Connor – Deutsche Bank
I realize you guys don't want to talk in too much detail on the litigation reserve, but just conceptually, you've taken a little bit greater than $4 billion reserves for litigation so far this year and I guess a lot of us are just having a hard time understanding what it might be for and are you getting ahead of it or are still trying to catch up and -
You know our society, right? You know how many lawsuits go on, and class action suits, and stock drop suits, and [unintelligible] suits and WaMu suits and Morgan suits and it ain't going away. It's becoming a cost of doing business.
…In repurchase reserves and litigation, it's unclear exactly how or where it's going to show up, but we do think there will be some of that. And when we make the statement that some of these costs may go on for a while it relates also to that. That while we're burning through the vintages or the GSEs there are other vintages where there may have been more of a time lag than that. And I think it's also important to note that they're fundamentally different, because a lot of the private label stuff didn't have the same rules, requirements, disclosures. So they're all different, but loan by loan it's going to have some of the same characteristics that people are right. You're going to have to make them [unintelligible]. Hopefully if they're going to sue just to win they're making a huge mistake.
Right, but you're already contemplating some of those issues in your current reserving?
To the extent we can, you know? Reserves are - you can't guess and put up numbers, but to the extent we can. I think the question is, between the reserves we have is how long losses relating to repurchase, whether it's GSE or private label, and whether it shows up on the litigation or repurchase, how long they go on for. We don't expect it to be a blowup kind of number. We expect it will be they'll just drag out these losses as these things play themselves out.
Nancy Bush - NAB Research
Two questions. The first related to the foreclosure issues, and whether there are going to be any extraordinary expenses associated with that. And is the level of expense in that whole activity now going to be higher going forward?
I think I already mentioned that the way I look at it we're bearing $5 billion of charge-offs a year, $1 billion in repurchase reserves a year, a lot of re-owned foreclosure, which I forget off hand, but it's big numbers. Those numbers may bounce up and down and probably will go up a little bit because of this, but I'm not sure they're going to materially change because of this. And there will be litigation, I put to the side, I don't know how it's all going to be sorted out.
… I think the way you should look at this topic is that we're bearing today $7 billion of charge-offs, foreclosure, repurchase costs - this affects reserves. That $7 billion will go up or down based upon the economy and stuff like this. I'm not sure stuff like this is going to dramatically change that number. It may extend it a little bit longer and stuff like that but - and remember we have in total, between repurchase reserves and the $11 billion, we have $14 billion of reserves for repurchases or loan losses. And look, the mortgage thing is - we're halfway through all this. We think we should continue and get done and make sure we do the right things for the consumers, the investors, and the country. And so obviously it will increase our costs a little bit and maybe we'll have to pay penalties eventually to some of the AGs, but we really think we should just continue.
…And the big one is the $200 billion runoff of stuff, a lot of which was acquired from WaMu. That will be running off for years.
I will be releasing the balance of this review to subscribers, including an updated valuation, more on the (by now probably fully disintegrated) discount on the WaMu purchase and any other issues we uncover.
As a matter of fact, the quarter ended before the “robo signing” scandal really started making waves, thus the numbers reported are only the tip of the iceberg. We contend that the “robo-signing’ subject will actually open the door to a much more critical issue for the banks (refer to our upcoming Foreclosure Crisis subscriber research for details) as RMBS securities tied to residential mortgages will experience higher loss due to longer liquidation time lines, negative ratings and potential losses arising from the repurchase of loans from GSE’s due to mortgages not meeting the investor underwriting standards – or put more directly, fraud during the underwriting process will come to the forefront and cause many an investor to attempt to disgorge these loans and derivative loan products. With GSE’s already vying for more repurchases of troubled securities, the outrage caused from falsified documents would further escalate the repurchase demands. When combined with the issues of foreclosures, weakening pricing, and legal issues with foreclosures which materially exacerbate the economic sales and pricing situation, combined with the deluge of repurchase demands, the banks will be facing one of the toughest periods of this century.
Let's not forget about CRE!
JP Morgan's (like many other banks) real estate related issues are woefully underestimated, yet JP Morgan can get away with under-provisioning without being punished by the markets. Hmmm!!! How long will that last?
Even visitors from Amsterdam, never having been here (area in the video below) before, can see there is something fundamentally wrong with the mortgage landscape (still) in many parts of the US. The clincher, "But how do all of these people [developers] get all of this money to put up all of these [empty] buildings? [as they are still building new buildings around the empty buildings that they cannot sell or rent!]" I reply, "Those people over there! The banks!" As I point to the local JP Morgan Chase branch in downtown Brooklyn.
For all of you CRE bulls, that clip is the same area photo-toured more than one year ago - tell me if the situation has changed in accordance with the 100%+ spike in REIT and bank share prices - “Who are ya gonna believe, the pundits or your lying eyes?”. Download my free research on the topic - CRE 2010 Overview 2009-12-15 02:39:04 2.72 Mb. Tuesday, December 15th, 2009, then subscribe to get the juicy stuff.
The clip above is from the October 4, 2010 VPRO Backlight (Dutch public television) featuring the issues facing JP Morgan, as well as the European banking sector. This special was very well done and I look forward to the US public television stations doing similar investigative work. See the entire video (43 minutes) on the VPRO site (in Italian, Dutch and some English with Dutch Subtitles).
Teaser to our upcoming foreclosure research
More Reggie Middleton on JP Morgan
Subscribers should also review our forensic valuation reports, which have (thus far) proven to be right on the money in terms of JP Morgan:
Those that don’t subscribe still have a lot of BoomBustBlog JPM opinion and analysis to chew on, including a free, condensed (but still about 15 pages) version of the forensic analysis above. You can find it below this pretty graphic from “An Unbiased Review of JP Morgan’s Q1 2010 Results Yields Less Roses Than the Maintream Media Presents“…
- An Independent Look into JP Morgan (subscription content free preview!)
- If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 – JP Morgan
- Is JP Morgan Taking Realistic Marks On Its WaMu Portfolio Purchase? Doubtful!
- Anecdotal observations from the JP Morgan Q2-09 conference call
- Reggie Middleton on JP Morgan’s Q309 results
- Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results