Chillin' out till it needs to be funded
Though JP Morgan would degrade earnings for Q2 by a minimum of $800 mln from yesterday’s announcement, the damage could be more severe for the bank’s decision to hold on to unrealised gains in the CIO portfolio of securities of $ 8 bln. It has till now sold off positions for a gain of $1 bln to bring the net damage from Bruno Iskil’s trades to $800 mln. The CDX series traded not being the detail of importance, Dimon is also unlikely to face a major burn from this event as the bank gets downgraded two notches for another $1.7 bln in collateral and stretches the earnings dollar. The current estimate for JP Morgan’s Q2 earnings and of 2012 as a whole is a $1.25 and $5.03 respectively This EPS estimate probably does not factor in the effect of buybacks fully and assuming buybacks are continued after the picture stabilises it would still not use too much of it in such a piquant situation as that may be a waste of the allocated $12. 5 bln. Q2 results would still be $92 cents for the bank.
Nevertheless even if a further $3 bln is bought back, the bank would still be able to report $0.38 for every $1 bln in profit it makes apart from the CVA profits it makes on paper as the bank’s own CDS spreads are now ruling at 125 bps from 110 bps on Thursday morning. That means the bank will hardly lose $1 in EPS for the year if it does and though the mortgage portfolio is not growing and retail is challenged the damage to the bank’s equity is unlikely to affect future customer flows or investment banking mandates. Government pressure might keep them busy for sure but the Financial ramifications seem limited. The bank can well rerate earnings a few steps later but it would wait for the storm to roll over as analysts wait for details on how the CDS positions will be novated or settled with various counterparties it was sold to.
As mentioned elsewhere ( zH , zerohedge, azizonomics) the Bruno Iskil strategy relied on high probability low pay off scenarios and were unlikely to cover losses of the portfolio hedged and the London whale is unlikely to have burnt Rome in a day. The stock is down 8%, Barney Frank’s been on the networks and Jamie Dimon in so many words admitted to “egg on our face” That does not stop the bank from making another $17 bln in profit this year and even if it makes $15 bln in profits or $12 bln before CVA it would hardly miss a beat if regulators and Too Big to Fail shouts can just get the remaining job done and not add any regulatory costs targeting JP Morgan like Goldman Sachs was targeted earlier in 2009.
As the Q2 loss in Corporate / PE is likely to be $800 mln plus legal losses any repositioning of the strategy must involve more accounting ‘jugllery’ as CDS accounting always does apparently including a delightful ( for other banks) proportion that may be accounted as Level 3 CDS which is held to perpetuity. The “credit market distorting” trades were as bad as a $100 bln exposure on one side of the dominoes, a single transaction capable of theoretically shutting out the entire sector. It has added $90 bln in sold CDS positions in Q1 when it was carrying the $8 bln in gains in the AFS Corporate portfolio
The MTM losses could also reduce technically as the situation in Europe improves and buyers no longer need the insurance on their bottomline leaving JP Morgan;s speculative bets to close out with the current exposure. It just might happen! Furthermore it is an illiquid market and like the whale’s actions any actions by the counterparties that jeopardise the market will be equally questionable.