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Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!
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. 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.
Net revenues, net profits, and earnings per share are totally
oblivious to what took to generate them. As a result, anyone who adheres
solely to these metrics is probably oblivious as well to what it takes
to generate these measures. It’s really simple, put more money into the
machine to get more money out – damn the risks taken, or the cost of the
monies used. This has been the bane of Wall Street for well over a
decade, is the direct and sole reason for this current crisis, and is
the reason why bonuses based upon revenue generation alone engender
systemic risk. Just sell more, do more, to get a bigger bonus. It
doesn’t matter what you sell or who you sell it to, as long as it blows
up AFTER the bonus is paid. This short term-ism is now so deeply
ingrained within the investor psyche as to allow companies’ to rampantly
destroy economic shareholder value with the abject blessing of the
shareholders, with cheer leading by the analysts – as long as those
accounting earnings per share keep rolling in higher and higher!
Ignoring the cost of capital inflates returns by default, because
those returns were never costed in the first place. The problem is,
ignoring something does not make it go away. Capital does have a cost
whether you acknowledge it or not, and if you ignore that cost you may
skate for awhile but eventually it will come back to reassert itself,
and often with a vengeance towards the wayward investor. On that note,
here is JPM’s return on average equity – and here’s JPM’s return on
average equity less the cost of said equity. It’s negative, very, very
negative!!!
FACT TWO: ZIRP is Literally Starving JP Morgan
Even as the Fed tries to reduce the cost of debt capital to damn near
zero, bad things are still happening to those this exercise was meant
to save. Why??? Because the responsible world wants capital to have a
cost, for if it does, it enforces discipline upon those who use it –
whether they acknowledge that cost or not (here’s to you Wall Street).
In regards to JP Morgan and despite zero interest rate policy (ZIRP),
fed funds as a proportion of interest bearing assets have increased due
to lower risk appetite. The proportion of fed funds to interest bearing
assets have increased to 12% as of end September 2010 from 7.7% as of
end March 2009 while proportion of loans have declined to 35.8% from
38.9% in the corresponding period. Lower interest rates together with a
higher proportion of lower interest bearing assets have taken a toll on
banks spreads and net interest margin.
ZIRP, low demand, plus the slow investment banking environment is
what forced a disgorging of reserves and provisions by management. In a
catch 22, ZIRP is not so slowly starving the patient it was intended to
save. This is analogous to the use of chemotherapy in treating cancer.
The treatment needs to eradicate the disease in confined period of time
or the patience is at risk at succumbing to the treatment, itself.
FACT THREE: The JP Morgan Foreclosure Pipeline is Not Only
Packed Tight, It Is Progressively Getting Much Worse As The Time To
Foreclosure Extends AND the Delinquency Rate Continues to Climb At The
Same Time That Real Economic Housing Sales Value Is At An All Time Low
As Well – and Getting Worse!!!
Future Losses Are Mounting at an Incredible Pace Yet JPM is reducing provisions due to improving credit metrics. See JP
Morgan’s 3rd Quarter Earnigns Analysis and a Chronological Reminder of
Just How Wrong Brand Name Banks, Analysts, CEOs & Pundits Can Be
When They Say XYZ Bank Can Never Go Out of Business!!! and 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
JP Morgan’s average delinquency at foreclosure is 448 days (with
Florida and New York having a record 678 days and 792 days of
delinquency at foreclosure). Average delinquency for the industry is
about 478 days and is increasing consistently since the start of the
crisis. During 2009 the average days from delinquent to foreclosure
process was 223 days while as of August 2010 average days from
delinquent to foreclosure process is 478 days. A very important, yet
often under appreciated fact is that although serious delinquencies are
still climbing, the lengthening of foreclosure process has resulted in
these loans still being classified as delinquent. The difference between
delinquency rates and foreclosure rates has increased to 5.3% (9.8%
delinquency rate vs 4.6% foreclosure rate) in August 2010 from 3.6% in
March 2002 (5.1% delinquency rate vs 1.5% foreclosure rate). As the
difference between delinquencies and foreclosure rates normalizes, and
shadow inventory overhang moves to further depress real estate prices,
real estate related write-downs could further balloon. So, you see, the
marginal improvements in credit metrics that JP Morgan’s management has
used to justify the releasing of provisions (which also just so happened
to have padded a weak quarter of accounting earnings) is really kicking
the can of reckoning down the road…
Add to this the difficulty in getting rid of the properties once they
are foreclosed upon and you will find that the big banks such as JP
Morgan (or after looking at these numbers, particularly JPM (although I
suspect BAC and certain others are worse off) will become the nations
largest distressed residential housing REITs!!!
FACT FOUR: JP Morgan’s Derivatives Portfolio Is STILL VASTLY
Inferior To That of Bear Stearns AND Lehman Brothers Just Before They
Collapsed!!!
The oft used chart below was created in the 4th quarter of last year.
Click graph to enlarge
Here is an update as of Q2 2010 regarding JPM’s net derivative exposure…
As you can see, the AAA holdings have been trending down significantly, replaced by materially lower rated assets.
Cute graphics above, eh? 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 36.9% 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??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman (“Is Lehman really a lemming in disguise?“:
On February 20th, 2008) months before their collapse by taking a
close, unbiased look at their balance sheet. Both of these companies
were rated investment grade at the time, just like “you know who”.
Now, I am not saying JPM is about to collapse, since it is one of the
anointed ones chosen by the government and guaranteed not to fail –
unlike Bear Stearns and Lehman Brothers, and it is (after all)
investment grade rated – and we all know how prescient those rating
have been. Then again, who would you put your faith in, the big ratings
agencies or your favorite blogger? Hey, if it acts like a duck, walks
like a duck, and quacks like a duck, is it a Swan??? I’ll leave the
rest up for my readers to decide. On that note, for those that don't remember the sequence of events, here is refresher: A Chronological Reminder of Just How Wrong Brand Name Banks, Analysts,
CEOs & Pundits Can Be When They Say XYZ Bank Can Never Go Out of
Business!!!
- advertisements -
I still want to hear what Warren Buffet has to say about Wells Fargo's behavior throughout all of this. The innocent Grandpa with the cherry coke in his hand play-act theatre is getting awfully old.
Marc45. Your intent is clear. In this case, many will agree that it's OK to be far from this Maddening Crowd. Unjunked for you times two.
Reggie, it's all only "notional". The real loss, once you net/net and then multiply the result by 7 is only about 3-6 trillion :)
Keep it up, Reggie. But realize that few will give you credit even when JPM vaporizes.
My next banking post will be on the fantasy game known as netting. Netting only offsets risk if the counterparty you are netting against has the ability to pay up in case of an event. If that party is using you to fund his hedges, and you are him to fund your hedges, and the other 4 guys in the room are doing the same with each other and you, then where is the capital going to come from to fund the actual loss? All that was done was to pass the risk along a circle of 5 banks, and that risk actually landed squarely back in our lap, disquised as netted derivative exposure, commonly known in Brooklyn as Bullshit!
Provided the event is big enough and common to all players involved (ex. MBS/real estate related, hint, wink) you will see a correlation of 1.0 and a massive run for the exits. Everybody will just look to the next bank, who will look to the next bank, etc.
You mean large banks' swap desks and hedge funds should have proper amount of capital to fund their investments, instead of expecting retail bank depositors and taxpayers to fund their losses??? That's downrit Uneeeeemurican. You Stalinist commie you!!!! And I did done know you is a Stalinist commie because I had a vision about you when I was listnin to Glenn Beck today at the usual time I'm taking my meds. Oh!!! I just remembered somethin.....
"Jamie Dimon seems to be one of the best bank CEOs..."
Really? JPM is sitting on the biggest derivative powder keg and Jimmy is "one of the best."
Achieving top-of-the-heap, TBTF status may be clever in a sick way, for awhile, but it has nothing to do with "best."
A $5000 suit and girlie loafers does not equal smart. Try compensation scheme sans soul.
Evil is often well-dressed and pampered...
I know it sounds cute but to infer that if the bank (who loaned you the money in the first place) didn't cross every T and dot every i, shouldn't get paid back is advocating anarchy. Anarchy sounds like fun at first but you wouldn't want to live in it.
I'm tired of hearing about people who haven't paid their mortgage in over a year and are totally ok with squating in a bank owned house. It just furthers the general impression that Americans are selfish and short-sighted. In essence, we are the problem, not just a few "bad" banks.
"cross t's and dot i's" - the meme of banker trolls.
What they did was break laws. What they did was TREASON. My fear is that if justice is not done, Citizens ("consumers" to you), will take the law into their own hands.
Look up "control fraud, marc45. Look up Fascism too.
The "bank" didn't loan any money, the mortgage originator marketed a security note the homebuyer issued. The financial institutions INSERTED themselves between the buyer and the true lender (MBS investor), and they fucked the parties on each end of the transaction that had the legitimate interest in the transaction (J6P homebuyer and J6P pension/retirement fund investor).
So, go fuck yourself bankster apologist puke.
Bullshit. Banks sent a clear message they didn't care about the quality of loans...they just wanted volume. Originators sold the story that real estate prices never went down. Most borrowers were duped and were not greedy speculators. The crime was commited by the banks that control Washington D.C. America is dangerously close to becoming a Predator nation rather than the Light on the Hill our Founders meant it to be.
Reggie is right on. The Man!
i would love to see jpm plowed under but not as badly as boa....
there is one good point (i am not counting) in this article: "and is the reason why bonuses based upon revenue generation alone engender systemic risk."
i am amazed at how pervasive sales based bonuses are....it's as though managers are total fucktards seeking to grow revenue even when it costs losses....it is total nonsense.
but the net economic value of most enterprises is 0 as one interesting graph posted on zh showed.
of course zirp is the most destructive economic force on the planet - just another brand of economic terrorism spread by the banksters....
Shameless and relentless self-promotion, backed by facts. Lookout Wall Street analysts. Ain't no stoppin Reggie! My man.
Is that an open can of "whoop ass" you posted Reg?
And remember kids, JP Morgan is a member/owner of the Federal Reserve... plus they are in charge of SNAP (food stamps). So one of the retail arms of the Federal Reserve, JP Morgan, is in deep shit.
Great work Reggie did you cover your short from $22 per share on JPM yet.
The derivatives charts are staggering! Get back on CNBC and bring your charts this time Reggie.
Great stuff but consider running spell check - at least three words were crucified in both the charts and the body. I don't want people to think "well, if he cannot spell, then how can I be sure his facts are correct"...
The fact of the matter is that the calcs are done by analysts and cross checked by me for quality and accuracy for a subscription service and my own account. The free blog posts are hastily thrown together at 3 am before I start my day - part and parcel of my not getting compensated for them is that they have to come second to the stuff that can pay bills. Spelling errors are nearly guaranteed...
As for my facts, it would be foolish to accept anybody's word as gospel. This is food for thought. If it piques your (or anybody else's) interests my suggestion is either subscribe for the real deal or pursue the ideas on your own to verify - preferably both.
The reason why my analysis is so different from the street's is that I start from a clean slate and take nothing for granted nor anybody's word for anything.
You don't need to defend yourself Mr. Middleton. Thanks for being brave and generous.
Agreed - but I would fix the notional derivatives chart where it says JPM outstrips ROW by $21 billion. That chart needs to be passed around.
Are you taking into account the effect that seeing Jamie Dimon dragged out in handcuffs will have on the stock price? Imagine the stories he could tell.
"I read Reggie's BoomBustBlog and I'm not gonna take it anymore!"
Reggie, your work is awesome. This is like watching a train wreck in slow motion, and it is going to end badly. Yours, Maverick
Well done, Reggie, and all BEFORE the recent set of disasters. What a bad joke of a company.
Ring ring..
Hello this is Timmy, how may I help you?
Hi Timmy, this is Benny and the Doves, we have a um problem.
Crap, how much do you need this time?
lets get together and finish this process...
get ahold of your bank, and tell 'emm, show me the note....
no note, no more pay
that oughta bottom the housing market in a month, as another couple million people stop paying on their mortgage
i'm willing to bet they couldnt come up with even half of the notes on all these properties
A lottery ticket is worth more than JPM WFC BAC intentionally packed with acquired toxicity
THAT WAS GREAT, REGGIE! I've been waiting for you to lay out the particulars on your position regarding JPM.
Those are not the particulars, that's just the stuff that I was giving away for free. The general overview. I'm bearish on many (if not most0 banks in general. Jamie Dimon seems to be one of the best bank CEOs, operators and negotiators out there, and you see what I think of JPM's situation.
Reggie, I think your notional derivate exposure chart should say JPM is $21 Trillion larger than the whole world, not $21 Billion
LOL, I caught that Reggie--but you gave away more than previously . . . yet certainly not too much!
That you pick on Jamie's Joint is what makes it interesting.
Thanks.