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What Would Jamie Do? A Look at JPMorgan Earnings
July 12, 2012 12:46 PM
Friday morning at 7:00 a.m. EDT,
) will report its earnings from the second quarter. Analysts are expecting a gain of $0.76 per share and revenues of $21.70 billion.
What everyone is most worried about is how big the losses from the Chief Investment Office may wind up being. On May 10, CEO Jamie Dimon announced that the firm had lost more than $2 billion of mark-to-market losses in its synthetic credit derivatives trading. These were linked to trading in an older-dated North American Investment Grade Credit Default Swap Index, IG9, set to expire in June of 2017. The loss alone in that index was originally reported to be $800 million, with further losses in more recent and liquid indexes bringing the total to $2 billion.
Because the index was “off the run” or something that was not actively traded, it would not be easy to unwind the trade and the bank would have to pay a “penalty” to get out of the position. The issue isn’t that it lost money in the hedge -- a hedge is supposed to lose money -- but rather that the position grew so large and so out of control that it violated major risk management controls.
More recent news reports, including an article from the
Wall Street Journal
, suggested that the losses may have climbed all the way to $5 billion. This
article from Zerohedge
does an excellent job of laying out the net notional moves (in the CDS market, buying $10 million of a company’s CDS and selling $10 million on the same company would equal $20 million in gross notional, but zero net notional) within the indexes and tranches that the CIO office traded and hedged in.
However, there are a number of factors that may deaden the loss from the potential trading error. The CIO office is sitting on a $360 billion AFS portfolio that has between $7.5 billion and $8 billion of unrealized gains. The one flaw in this strategy is that the bank would be selling something that has the potential to move higher and forego future gains. This would be “selling when it had to” rather than “selling when it can."
Another profit that JPMorgan will likely take is through the value of its debt instruments. At the end of the second quarter, JPMorgan five-year CDS had widened by 44 bps. This would imply a debt-value adjustment (or DVA) gain of $679 million. Over the same time frame, its most recent five-year note fell $0.35, and its yield gained 4 bps, so the fixed income gain might not be as large. This should give the company’s earnings a tailwind as credit spreads have widened, compared to the first quarter when its earnings saw headwinds to a loss of $907 million after credit spreads had tightened dramatically. In the first quarter, the DVA loss was broken down as a loss of $352 million in Fixed Income, $130 million in Equity, and $425 million through the Credit Portfolio.
Lastly, will the departures of executives from the CIO office result in clawbacks of bonuses or stock options? Over the past two years the head of the office, Ina Drew, has received $29 million in compensation according to regulatory filings. This is one thing that's been rumored and should be watched.
One bright spot from JPMorgan may be through its credit card business. Credit card delinquencies have seen the lowest rate in over 18 years at 1.78% last month. JPMorgan’s credit spending and lending business is one of the top five in the United States and should bolster earnings. According to Fitch, credit card net losses should
average below 4% this year, compared to loss rates of greater than 6.7% from 2007 to 2011.
So does this mean JPMorgan will report a disastrous quarter? Likely not. The firm is still profitable and investors will be more worried about how such trading or hedging got out of control and whether the London CIO unit is actually a “prop” trading hedge fund inside of an investment bank.
To assuage investors, Jamie Dimon will hold a face-to-face two-hour meeting with analysts to describe what has gone on recently. In his testimony to Congress, Dimon said that the “buck stops with me.” What types of constraints will he take, as he is ultimately the commander-in-chief of JPMorgan? How can he convince shareholders that this type of mistake won’t happen again? And lastly, how can he convince shareholders to keep their faith with his own abilities as CEO?
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