Wednesday, May 16, 2012

Are We Overstating the Problems At JP Morgan Chase?

When you take the topline figure that JP Morgan Chase lost $2 billion on a bad hedge position that presented undue risk to the bank, that looks like tremendously bad news. Even the Justice Department is opening investigations into the circumstances behind the loss. The investigation centers on whether the bank was hedging risk or seeking to profit from risky trades (and semantics is what this is all about - there's no hard and fast rule to work with here).

Yet, the bank is still expected to make $4 billion for the quarter.

Let that bit sink in
The overall health of the bank remains strong, even with the additional losses, and JPMorgan has been able to increase its stock dividend faster than its rivals because of stronger earnings and a more solid capital buffer.

Still, the huge trading losses rocked Wall Street and reignited the debate over how tightly giant financial institutions should be regulated. Bank analysts say that while the bank’s stability is not threatened, if the losses continue to mount, the outlook for the bank’s dividend will grow uncertain.

The bank’s leadership has discussed the impact of the losses on future earnings, although a dividend cut remains highly unlikely for now. In March, the company raised the quarterly dividend by 5 cents, to 30 cents, which will cost the bank about $190 million more this quarter.

A spokeswoman for the bank said a dividend cut has not been discussed internally.

At the bank’s annual meeting in Tampa, Fla., on Tuesday, Mr. Dimon did not definitively rule out cutting the dividend, although he said that he “hoped” it would not be cut.

John Lackey, a shareholder from Richmond, Va., who attended the meeting precisely to ask about the dividend, was not reassured. “That wasn’t a very clear answer,” he said of Mr. Dimon’s response. “I expect that shareholders are going to suffer because of this.”

Analysts expect the bank to earn $4 billion in the second quarter, factoring in the original estimated loss of $2 billion. Even if the additional trading losses were to double, the bank could still earn a profit of $2 billion.

And many analysts and investors remain optimistic about the bank’s long-term prospects.
There are serious concerns as to how and why the bank was able to establish this hedge position and took on more risk than it might otherwise should have.

Yet, the loss - and the resulting hit on the share price - might actually benefit Chase shareholders in the long term because of the decision in March to expand the company's stock buyback program:
The bank is authorized to buy back up to $12 billion in 2012 and another $3 billion through the end of the first quarter of 2013. It expects to buy back at least the same amount of shares it issues for employee stock-based incentive awards.

Dimon said the company intends to repurchase equity only when it is generating more capital than it needs to fund organic growth and when it thinks the investment will provide “excellent value” to existing shareholders.

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