Yesterday, after the close, JPMorgan (NYSE: JPM) filed its 10-Q and disclosed ~$2 billion in losses in its CIO unit’s synthetic credit portfolio. These losses were partially offset by ~$1 billion realized gains from the sales in CIO’s AFS portfolio. The corporate/Private Equity segment, which was expected to post net income of $200 million in 2Q12 according to prior guidance, will now post a loss of $800 million. This equates to $0.17 in per share terms.
While the company’s near-term results will be adversely impacted by this poorly executed hedging strategy, the situation is manageable and it doesn’t pose any major fundamental risk to the company. JPMorgan highlighted that its AFS portfolio currently has an unrealized gain of ~$7 billion-plus, which could be used to offset any future losses. Although, the loss reduces JPMorgan’s Basel III T1C ratio by ~20 bps, it does not impact JPMorgan’s Basel I Tier 1 common capital ratio (10.4% at Q1). JPMorgan confirmed that it will go ahead with its capital plans and I expect share buybacks to offset some of the EPS effect of losses. According to consensus estimates, JPMorgan is expected to post ~$19 billion in profits this year and I believe current losses are relatively small as compared to it.
JPMorgan’s stock has corrected over 6% in after-hours trading. To some extent this was expected. JPMorgan is considered relatively a safer bank and it is trading at a premium to its TBV, while many of its peers like Citigroup, Bank of America, Morgan Stanley, etc. are trading at significant discount to their book values. So, such a loss from JPMorgan was embarrassing and has hurt its credibility. However, I believe the 6-7% correction is quite excessive and the current decline provides a buying opportunity in the stock given improving macros, JPMorgan’s strong capital position, and management’s commitment to return cash to the shareholders through buybacks and dividends.
From the industry perspective, this loss is likely to serve as a fodder for the Washington DC crowd and will reignite the debate on Volcker’s rule. This may pose a headline risk to other banking stocks and they might also see some pressure in the near term. However, I believe any decline in the US banking sector should be used as a buying opportunity. Investors who are still skeptical about JPMorgan’s prospects may consider buying other well run, less risky banks like Wells Fargo, which offers an attractive risk reward profile.
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