Marshall Auerback here.  I wanted to add a few thoughts to the discussion about recent events in U.S. banking.  Below is the Federal Reserve press release on the Bank of America bailout.  Here are the most important words from the release:

where the debt is supported by collateral and the issuance supports new consumer lending.

The carrot and stick in the paragraph in red above and below is something brand new and out of the box.  It is surprising that it came on Bush’s watch but it has Obama’s fingers all over it. This is a big new push by the government and it has Barney Frank and Shelia Bair’s names all over it.

• We, the US government want to make consumer loans, you the bank want a nice interest spread, say 12% plus.
• The US will guarantee your loans that are presently going for only 200bp over governments 94.5% fro 10 years) and you can go and make credit card loans at 16% and make a 1200 bp profit margin.
• Then JPM just puts up the credit card loans as collateral as per the new government request.

Bottom line:  The U.S. government is now making credit card loans and letting JPM make a 1200 bp profit margin, if not more.

Talk about restoring the banks’ balance sheets through a positive yield curve. They will backstop bond issuance from every firm that qualifies as a bank from GS to BAC, etc. for ten years if they agree to make consumer loans.

Do you realize that money is fungible and thus JPM for instance could go and get 10 year loans at FDIC rates, probably at several hundred basis points below prevailing market rates.

And all JPM has to do is to show the government that it made new consumer loans for the amount of the new government guarantees. That shouldn’t be too hard as the money is fungible so JPM says that every new consumer loan that it makes in the normal course of its business will be from those new loans.

GS sold 3 year bonds at 2% over US govt 5 year for 3.25% in December.

Can you imagine, here was a firm that was collapsing in market confidence just 3 months ago that is now able to sell 10 year paper at 200 bp over 2.5% treasuries?

Here is an idea.

Let’s start a bank, borrow for ten years at 4.5%, use part of the money to buy gold, use part of the funds to buy government guaranteed mortgage bonds of equal or lesser maturities and use the positive yield spread between the cost of funds and the yield on the mortgage bonds to pay the interest on the portion of the funds used to buy the gold.

So at the end of the day you have gold that is funded by government guaranteed debt, the carrying cost of which is paid for by buying US government guaranteed debt (mortgage backed bonds) and use the positive carry to fund your gold purchases.

All you need to do is start a bank, fund it with 8% tier 1 capital and you are off to the races.

And you want to know why gold will trade at 5-10X in 5-10 years, you are looking at the reason in the paragraphs below.

What are we waiting for?

Federal Reserve Board of Governors, Joint Press Release
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
U.S. Department of the Treasury

For immediate release, January 16, 2009 (note the items in red)

Treasury, Federal Reserve, and the FDIC Provide Assistance to Bank of AmericaThe U.S. government entered into an agreement today with Bank of America to provide a package of guarantees, liquidity access, and capital as part of its commitment to support financial market stability.

Treasury and the Federal Deposit Insurance Corporation will provide protection against the possibility of unusually large losses on an asset pool of approximately $118 billion of loans, securities backed by residential and commercial real estate loans, and other such assets, all of which have been marked to current market value. The large majority of these assets were assumed by Bank of America as a result of its acquisition of Merrill Lynch. The assets will remain on Bank of America’s balance sheet. As a fee for this arrangement, Bank of America will issue preferred shares to the Treasury and FDIC. In addition and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.

In addition, Treasury will invest $20 billion in Bank of America from the Troubled Asset Relief Program in exchange for preferred stock with an 8 percent dividend to the Treasury. Bank of America will comply with enhanced executive compensation restrictions and implement a mortgage loan modification program.

Treasury exercised this funding authority under the Emergency Economic Stabilization Act’s Troubled Asset Relief Program (TARP). The investment was made under the Targeted Investment Program. The objective of this program is to foster financial market stability and thereby to strengthen the economy and protect American jobs, savings, and retirement security.

Separately, the FDIC board announced that it will soon propose rule changes to its Temporary Liquidity Guarantee Program to extend the maturity of the guarantee from three to up to 10 years where the debt is supported by collateral and the issuance supports new consumer lending.

With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy. As was stated in November when the first transaction under the cTargeted Investment Program was announced, the U.S. government will continue to use all of our resources to preserve the strength of our banking institutions and promote the process of repair and recovery and to manage risks.

Term sheet (77 KB PDF)

2009 Banking and Consumer Regulatory Policy

Related posts:

• Press Release: Public Private Partnership Investment Program
• FDIC Chairman Sheila C. Bair Statement on the Legacy Loans Program
• TALF’s first recipient will be Nissan Motors of Japan
• Countrywide is the real problem at Bank of America
• Treasury Considers Plan to Halt Home Price Slide

JPMorgan Chase moved up its earnings announcement to today in order to surprise the market with better than expected earnings.  The company reported full-year income of $5.6 billion and 4th-quarter income of $702 million or $0.07 a share, beating consensus estimates of $0.01 a share.  You should note, these numbers do not include the estimated $31.2 billion of writedowns (later increased to $32.5 billion) associated with the Washington Mutual transaction. But, folks, for banks, this is as good as it gets.

Before I get to the heart of things, I do want to caution that WaMu recorded tens of billions in writedowns to their asset base in being acquired by JPMorgan Chase.  Those are not reflected in these results (as they were apparently taken by Washington Mutual just before the acquisition). During the WaMu takeover announcement on September 25th, the JPMorgan Chase management were very specific in detailing the extremely cautious estimates they made in writing down WaMu assets.  What we are now seeing is probably only JPMorgan Chase credit exposure. (UPDATE:  Deal Book has a good piece on the Bear Stearns and WaMu exposure.  The long and short is Bear probably cost JPMorgan this quarter, whereas WaMu may oly cost them down the line.  See story here.)

As to the earnings, they are very good, considering the environment we are in.  Here are the highlights:

• $4.1 billion (pretax) increase to loan loss reserves, resulting in coverage ratios of 4.24%¹ for consumer businesses and 2.64% for wholesale businesses
• $2.9 billion (pretax) net markdowns due to leveraged lending exposures and mortgage-related positions in the Investment Bank
• $1.1 billion (after tax) benefit from merger-related items
• $854 million (after tax) benefit from MSR risk management results
• $680 million (after tax) private equity write-downs
• $627 million (after tax) gain due to dissolution of Paymentech joint venture

JPMorgan’s Tier 1 capital ratio came in at 10.8% and their total capital ratio came in at 14.7%. Their leverage was 16 times ($134 billion of capital on $2.1 trillion of assets).  You should note here that JPMorgan’s 3rd Quarter 10-Q shows assets of $2.25 trillion on equity of $137.7 billion, so we have witnessed a mild deleveraging and asset shedding here.

In the areas of greatest stress: leveraged loans and credit cards, there was considerable weakness. Their investment banking division lost $2.36 billion. That compares to a profit of $124 million last year. In credit cards, they lost $371 million. That compares to a profit of $609 million last year. Both of these numbers are tolerable – although I would expect them to worsen over 2009.

Otherwise, divisions made money across the board: Commercial Banking, Treasury and Security Services, Asset Management, and Private Equity (due to an extraordinary gain).

The bottom line: this is a very good report. However, going forward, I would expect greater credit card, leveraged loan and private equity losses. In comparison to other firms announcing later, one should expect JPMorgan’s earnings report to be the gold standard.

Sources
JPMorgan Chase Acquires the Deposits, Assets and Certain Liabilities of Washington Mutual’s Banking Operations – JPMorgan Chase Website
JPMorgan Chase Reports Full-Year 2008 Net Income of $5.6 Billion, or $1.37 per Share, on Revenue of $67.3 Billion; Fourth-Quarter 2008 Net Income of $702 Million, or $0.07 per Share – JPMorgan Chase Website
JPMorgan Profit Drops 76 Percent on $2.9 Billion of Writedowns – Bloomberg.com
JPMorgan Chase 2008 3rd Quarter 10-Q – filed 7 Nov 2008

Related posts:

• JPMorgan has record revenue and $2.7 billion in profit
• Goldman crushes earnings estimates
• JPMorgan Chase: Large exposure to real economy downturn
• Prime looks terrible
• $35 billion in missing writedowns

It’s interesting to hear a chief executive of a major Wall Street firm speak openly and on the record about the economy. So, it’s refreshing to watch this video and see Jamie Dimon’s take on a number of economic issues including house prices, infrastructure spending and tax cuts.

A few days ago, I showed you a video from a long session he did with Erin Burnett of CNBC at the Yale CEO Summit. This is another segment of that session. On the whole, he sounds very reasonable. Take a look.

Jamie Dimon on the Economy

Related posts:

• Jamie Dimon: November was terrible, December is terrible
• Jamie Dimon: ‘we don’t need’ your money
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”
• Roubini: Even 2010 will feel like a recession
• Jamie Dimon makes the best case for not breaking up banks

JPMorgan Chase’s CEO Jamie Dimon tells it like it is. When asked by CNBC’s Erin Burnett’s how business is going, Dimon replied “terrible.” Here’s how Reuters describes his comments:

“November itself has been a terrible trading month … (and) December so far is pretty terrible,” Jamie Dimon told CNBC. “It will be a tough quarter.”

Dimon said he was referring to the trading, loans and mortgage segments of the largest U.S. bank.

Looking ahead, the CEO said U.S. housing prices — which spawned the current credit crisis — could fall another 20 percent. He said that, “if we’re lucky,” the market could start to recover after two more quarters.

You’ll notice he cites the sectors of the economy which I have been warning will contribute to massive additional writedowns in the financial services sector. JPMorgan Chase is particularly exposed here. Watch the video to see exactly what he says:

There are two other related CNBC videos here and here.

Sources
JPMorgan CEO warns of “terrible” fourth quarter – Reuters
JPMorgan’s Q4 Outlook – CNBC
JPMorgan Chase Is Having A ‘Terrible’ Quarter: Dimon – CNBC

Related posts:

• Jamie Dimon on the economy
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”
• Prime looks terrible
• Jamie Dimon: ‘we don’t need’ your money
• A brief note on upcoming bank earnings announcements

The financial services sector has been the hardest hit sector in the credit crisis so far.  Banks with large exposures to mortgage-backed securities like Citigroup, UBS and Merrill Lynch have suffered the most. This is largely because the crisis has been in asset prices — chiefly home prices.  However, as credit has become severely restricted, the credit crisis has become a global recession and that means the real economy will be impacted.  This spells trouble for JPMorgan Chase.

As the global economy slips into recession, the categories of credits that will sour in the U.S. will expand to include:

• Residential Property (like Alt-A, Payment Option, Negative Amortisation Mortgages)
• Commercial Property (Commercial Real Estate and Construction Loans)
• Leveraged Loans and High Yield Bonds (from Private Equity LBOs)
• Credit Card Receivables and Asset Backed Securities
• Auto Loan Receivables and Securitised Auto Loan Bonds

And JPMorgan Chase is more exposed in many of these categories in addition to being one of the largest players in credit default swaps and other derivative instruments.  Below is a good article from yesterday’s Financial Times which highlights this fact.  While I greatly respect the managerial acumen of Jamie Dimon, JPMorgan Chase’s CEO who came to the bank via Bank One after losing out in a Citigroup power struggle, I do expect the company to be hit hard by writedowns in the coming quarters. JPMorgan Chase is no Citigroup but it is going to take a beating nonetheless.

“As the credit crisis ripples through the real economy, perceptions about strength and risk management will change,” says Charles Peabody of Portales Partners, a research boutique. Mr Peabody predicts that losses from commercial loans can increase up to six-fold. He says he is especially concerned about JPMorgan Chase, so far the symbol of prudence. JPMorgan has a far bigger book of corporate loans than Citi, far bigger exposure to the commercial real estate market and it is at continuing risk from its exposure to leveraged buy-out deals. Indeed, according to the calculations of Mr Peabody, those exposures amount to some $288bn.

The buy-out loans include such troubled deals as the $6bn JPMorgan put up to help Cerberus finance its purchase of ailing Chrysler.

The bank has already marked down its $12.9bn leveraged loan book almost 30 per cent to $9bn, but investors in private equity deals say they expect there are far more drastic markdowns to come.

Most of the corporate targets of recent buy-outs have so much debt and carry such low ratings that defaults on such private equity-owned companies are expected to reach record highs and recoveries record lows. All that means is that companies owned by private equity, whether retailers or semiconductor companies or media firms will be the first hit – not the only ones.

JPMorgan’s management and its risk management are far more impressive than any of its peers among the commercial banks. It has been conservative and is becoming more so. So far, its charge-offs have been modest and a spokesman says that the level remains low even by historical standards.

Still, in anticipation of harder times, the bank has been adding to reserves, which now stand at 3.85 per cent just for the non-retail loans made out of the investment bank. In addition, JPMorgan has extensive hedges to help safeguard its exposures. Still, precisely because JPMorgan is so big, it cannot escape unscathed, as CEO Jamie Dimon frequently warns. Moreover, one of the lessons of the past two years is that sometimes hedging activity, instead of reducing risk, actually amplifies it. For example, JPMorgan is one of the biggest dealers in the credit default swap market. As a massive lender, appropriately, it has bought more protection against declining creditworthiness and defaults than it has sold. Still, the total gross face value of its credit derivatives book is $9,200bn. That means JPMorgan is on one side or another of one out of every six contracts in the opaque market. It has counterparty risk on the contracts it has bought, even with collateral and faces losses on the contracts it has sold.

Source
Economy bears brunt of the biggest banks’ miscalculations – Financial Times

Related posts:

• JPMorgan: Beats expectations despite writedowns
• JPMorgan has record revenue and $2.7 billion in profit
• Commercial real estate is next
• The U.S. banking crisis: where are we?
• Moody’s anticipates huge increase in leveraged loan defaults

I love Jamie Dimon, JPMorgan Chase’s CEO. He really tells it like it is. At last quarter’s earnings call, he called a spade a spade and said “prime looks terrible” in reference to prime mortgage loans.

This quarter his quote is even more to the point:

“If You Are Not Fearful, You Are Crazy.”
-Deal Book

Words of wisdom.

Related posts:

• Quote of the day: Willem Buiter – Tits on a bull
• Quote of the day: “Jamie is always hanging around the hoop”
• Quote of the day: Warren Buffett
• Jamie Dimon makes the best case for not breaking up banks
• Jamie Dimon on the economy

According to the Times of London, that’s what Lehman’s creditors seem to suggest in Lehman’s bankruptcy filings. Apparently, JP Morgan cut Lehman off the night before it filed for bankruptcy and creditors are blaming this action for Lehman Brothers failure.

RUUUBBISH! I don’t buy it one bit — Lehman was bankrupt all on its own. But, as I have often said, “there are going to be a lot of lawsuits because of this financial mess.” Stay tuned.

JP Morgan has been accused by its Wall Street rivals of dealing the final hammer blow that forced Lehman Brothers into collapse in a sensational claim that threatens to spark a colossal legal battle.

The giant American bank is alleged to have frozen $17 billion (£9.6 billion) of cash and securities belonging to Lehman on the Friday night before its failure.

According to Lehman’s biggest creditors, this was what precipitated the liquidity crisis that embroiled the firm, forcing it into Chapter 11 bankruptcy protection on the morning of Monday, September 15.

The allegations have been raised in a filing at the bankruptcy court in New York, lodged late last week. Lehman’s biggest creditors include almost every big firm on Wall Street, most of Europe’s heavyweight banks and insurance companies as well as a slew of Japanese and Chinese institutions that are owed several hundred billion dollars.

The funding lines provided to Lehman to finance its everyday operations amount to $188 billion, according to court filings.

The creditors are now demanding that JP Morgan open up its books to the bankruptcy court to allow the transactions to be assessed.

“The creditors’ committee understands that LBHI [Lehman Brothers Holding Inc] had at least $17 billion in excess assets which were held at JPMC [JP Morgan Chase] on the Friday going into the weekend before its bankruptcy filing,” the documents said.

“The creditors’ committee further understands that, on September 12, 2008, JPMC refused to allow LBHI access to its excess assets and instead ‘froze’ LBHI’s account. In freezing LBHI’s assets, JPMC was purportedly holding all of LBHI’s assets as a potential offset against any claims JPMC may have had against LBHI.”

The filing goes on to claim that “as a result of JPMC’s actions, LBHI suffered an immediate liquidity crisis, that could have been averted by any number of events, none of which transpired”.

Lehman’s collapse is fast emerging as the single biggest event of the credit crunch, sparking a number of unexpected effects.

The unravelling of the firm’s prime brokerage operations has already forced a number of hedge funds out of business.

Olivant, the investment group run by former Abbey boss Luqman Arnold, revealed last week that its 2.8% stake in UBS was held through an account at Lehman in London which the firm’s administrators are refusing to release.

Previous court documents have suggested that JP Morgan was owed $23 billion by Lehman in secured loans.

JP Morgan said: “These assertions raised by the creditors’ panel are unfounded conjecture. We will address them at the appropriate time in bankruptcy court.”

In London, Price Waterhouse Coopers, the administrators to Lehman Brothers in Europe, is wrangling with more than 60 stock exchanges and clearing houses around the world to recoup up to $3 billion Continued on page 2

Continued from page 1 that it says is owed to the defunct bank.

LCH Clearnet, the clearing house, has returned £217m to PWC in recent weeks and Eurex is also thought to have returned some funds.

The cash was held as margin – money that exchanges require in case a company goes bust.

LCH is one of the largest holders of these reserves, reflecting Lehman’s standing as the biggest trader on the London Stock Exchange.

An LCH spokeswoman said: “We have already given the administrators £217m of the margin we held for Lehman and it would be imprudent of us to return all the remaining margin until this has been completed.”

Tony Lomas, the lead administrator at PWC, said “constructive discussions” were continuing with other exchanges.

The art on the 30th and 31st floors of Lehman’s Canary Wharf headquarters in east London has been removed after appraisers valued it and is being stored in a “safe place”, Lomas said.

It will “be dealt with on another day when we have resolved more pressing matters”, he added. The works, which include oil paintings and bronze sculptures, are understood to be worth millions of pounds.

See my posts labeled “law and jurisprudence” to follow some of the other legal wrangling.

Source
JP Morgan ‘brought down’ Lehman Brothers – Times Online

Related posts:

• Dick Fuld feels horrible about Lehman collapse
• Law firm confirms the disaster at Lehman
• Lehman has filed for bankruptcy
• Barclays gets “core Lehman” assets
• Creditors paid in full? No – try 6 cents on the dollar

JP Morgan Chase has taken over the deposit taking subsidiary of Washington Mutual. The transaction is effective immediately, meaning it has closed. This is the biggest deal in FDIC activity yet.

Note: I originally heard this story just before 9PM ET and Yves Smith at naked capitalism has her take on the news.

Obviously, this is a bankruptcy as much as a takeover by JP Morgan. Will it be seen as such by the Credit Default Swaps market? JP Morgan Chase is only buying the deposit-taking subsidiary. I imagine the Credit Default Swap exposure is for the holding company, which is now effectively bankrupt. This is a very important point because my understanding is that all litigation – including class-action lawsuits – should rest with the Washington Mutual holding company were the common shares and subordinated preference shares sit. The only residual litigation risk that JP Morgan is taking on comes from individual lawsuits that mortgage customers might file.

I learned from the JP Morgan Conference Call at 9:15 PM ET that Washington Mutual went into a competitive bidding forced sale at the behest of the FDIC because they were on the verge of collapse. Remember they had an agreement with the Office of Thrift Supervision for close scrutiny.

I had asked last month what the FDIC would do if WaMu went bankrupt in my post, “What if a large U.S. regional bank goes to the wall?“. Now we know. They will not assume the huge losses here. This is the best case scenario because the FDIC does not have to fund the $31 billion in writedowns that this deal has created. Nor could they (see post) as JPM was forced to write down $31 billion of WaMu’s assets (I assume because of FAS 157).

This deal leaves us with three enormous banks dominating the U.S. banking landscape in JP Morgan Chase, Bank of America, and Citigroup. This is a much better deal than the BAC – Merrill deal. Jamie Dimon is obviously a much better deal maker than Ken Lewis. Let’s see how the market responds tomorrow.

Here is CNBC on the deal.

Synopsis of JP Morgan conference call

• The deal is immediately accretive and the accretion will grow over time.
• JPM has not built in lots of revenue growth or synergies.
• JPM is offering $8 billion of common stock to maintain balance sheet and capital ratios at reasonable levels.
• This is the most important part: they are buying the bank, not the holding company. That means they are not buying unsecured preferred debt (ouch).
• Their competitive bid was for $1.9 billion, an incredibly low sum for hundreds of billions in assets and is reflective of the massive writedowns they have to take.
• The transaction closes immediately. They already own the business. That’s how deals function in crisis!
• JPM says the love the branch business. It helps consumer business and small business as well as private clients. (Of course they love the deposit-taking business, it means they are less vulnerable to the inter-bank market.)
• After the deal JPM will have 5400 branches and $900 billion in deposits, increasing number of deposits from retail.
• They pick up the entire West Coast and get 250 branches in Florida. They believe this makes the deal a “unique opportunity.”
• The deal also makes JPM even stronger in their home markets, as Washington Mutual expanded into the Tri-State area with its 2001 acquisition of Dime Bancorp.
• This deal has been in the works for a while because they have a detailed presentation which I have linked to at the bottom of this post.
• Mortgages: $1.4 trillion in combined mortgages – that’s huge.
• There are not huge synergies assumed into the deal to make the numbers here. JPM will close less than 10% of their combined branches and look to relocate displaced workers.
• They will exit all non-branch based retail lending.
• They will rebrand branches, so the Washington Mutual name is history.
• They are marking down assets on WaMu’s loan portfolios by $31 BILLION. That’s huge. (See page 17 of the presentation below). Again, JPM is taking a huge $31 BLLION writedown on assuming WaMu’s liabilities. WOW!
• They have really been doing their due diligence and have poured over WaMus docs.
• They are also making some pretty dire assumptions in this deal regarding downside in house prices and unemployment. (see page 16).
• Tier 1 capital ratio goes down from 9.2 to 8.3%. That’s why they are raising capital.
• These guys are good. JP Morgan is cleaning up here. These numbers sound great.

Conference Call Q&A

• Slides 18 and 19’s pro forma numbers include the $8 billion share sale.
• Litigation exposure: JPM is NOT taking over the holding company so any liability related to the assets themselves moves to JPM. But the other liabilities remain with the holding company, which is effectively bankrupt.

The FDIC press release

JPMorgan Chase acquired the banking operations of Washington Mutual Bank in a transaction facilitated by the Federal Deposit Insurance Corporation. All depositors are fully protected and there will be no cost to the Deposit Insurance Fund.

“For all depositors and other customers of Washington Mutual Bank, this is simply a combination of two banks,” said FDIC Chairman Sheila C. Bair. “For bank customers, it will be a seamless transition. There will be no interruption in services and bank customers should expect business as usual come Friday morning.”

JPMorgan Chase acquired the assets, assumed the qualified financial contracts and made a payment of $1.9 billion. Claims by equity, subordinated and senior debt holders were not acquired.

“WaMu’s balance sheet and the payment paid by JPMorgan Chase allowed a transaction in which neither the uninsured depositors nor the insurance fund absorbed any losses,” Bair said.

Washington Mutual Bank also has a subsidiary, Washington Mutual FSB, Park City, Utah. They have combined assets of $307 billion and total deposits of $188 billion.

Thursday evening, Washington Mutual was closed by the Office of Thrift Supervision and the FDIC named receiver. WaMu customers with questions should call their normal banking representative, service center, 1-800-788-7000 or visit www.WaMU.com. The FDIC’s consumer hotline is 1-877-ASK-FDIC (1-877-275-3342) or visit www.fdic.gov.

JP Morgan press release

JPMORGAN CHASE ACQUIRES THE DEPOSITS, ASSETS AND CERTAIN LIABILITIES OF WASHINGTON MUTUAL’S BANKING OPERATIONS
Highly attractive, strategic transaction significantly strengthens consumer franchise.
Deal expected to be accretive to earnings immediately. Adds large, stable deposit base and recurring earnings stream to company.
Company intends to raise additional capital in conjunction with this transaction to maintain strong capital position.
• Acquisition creates largest U.S. depository institution, with over $900 billion of customer deposits
• Expansion into attractive California, Florida and Washington State markets creates nation’s second-largest branch network; also strengthens existing presence in New York, Texas, Illinois, Arizona, New Jersey, Colorado, Connecticut and Utah
• Larger branch footprint will allow company to further extend and grow commercial banking, business banking, credit card, consumer lending and wealth management efforts

Here is what Bloomberg says:

JPMorgan Chase May Acquire Washington Mutual After FDIC Seizure
Washington Mutual Inc. may be seized by regulators later today and parts sold to JPMorgan Chase & Co. in what will rank among the biggest banking failures in U.S. history.

The Federal Deposit Insurance Corp. plans to take control of Seattle-based WaMu, the biggest U.S. savings and loan, according to the CNBC television network, and New York-based JPMorgan will buy deposits and branches, the Wall Street Journal said, without citing any sources. The FDIC insurance fund is not expected to contribute any money, the Journal said.

WaMu’s fate played out as Congress tried to reach an accord that will ease the global credit crunch, which has already driven Lehman Brothers Holdings Inc. and IndyMac Bancorp out of business, and Bear Stearns Cos. and Merrill Lynch & Co. into hastily arranged rescues. As many as five banks had considered bids for WaMu without making an offer, balking in part because the lender faced as much as $19 billion in mortgage loan losses.

Resolving WaMu’s situation “is a positive,” said Patrick Becker Jr., who oversees $2 billion as chief investment officer at Becker Capital Management in Portland, Oregon. “That’s been a big cloud over the market and financial shares.” His firm does not own JPMorgan or WaMu shares.

WaMu and JPMorgan officials didn’t return calls seeking comment.

Five banks that were considering bids, including JPMorgan Chase, have failed to make an offer in the week since WaMu put itself up for sale. WaMu also approached Carlyle Group and Blackstone Group LP, two people briefed on the matter said.

Deal Pressure

WaMu came under increasing pressure to strike a deal as its stock sagged and ratings companies pummeled its debt. Standard & Poor’s yesterday cut WaMu’s rating for the second time in nine days, dropping it to CCC from BB-. WaMu’s regulator, the Office of Thrift Supervision, and the Federal Deposit Insurance Corp., which guarantees customer deposits, have declined to comment.

WaMu fell 57 cents, or 25 percent, to $1.69 at 4 p.m. in New York Stock Exchange composite trading. The stock skidded about 88 percent this year, the biggest decline in the 24- company KBW Bank Index. WaMu is the only junk-rated company in the index.

A record 392 million WaMu shares changed hands today, more than twice the daily average this month and seven times the average over the past year, Bloomberg data show.
-JPMorgan Buys WaMu’s Deposits as Thrift Is Seized, Bloomberg

Sources
JP Morgan Press Release
JP Morgan Conference Call Presentation
Office of Thrift Supervision fact sheet

Related FDIC Posts
FDIC list of problem banks
Does the FDIC have enough money?

Related posts on FAS 157
Paulson’s Economic Patriot Act is about marking to market
Regionals options suffer due to accounting rules
What is a credit writedown?
The regionals versus money center banks
De-leveraging redux

Other articles
FDIC to Seize WaMu and Sell Deposits to JPMorgan – CNBC

Related posts:

• Five banks seized in FDIC Friday night special
• Capital One buys Chevy Chase Bank: Another bailout freebie
• WaMu on the brink of disaster: has agreement with regulators
• JPMorgan: Beats expectations despite writedowns
• AIG down; Lehman and WaMu looking to be sold

Not every financial services sector company is a basket case destined for bankruptcy. There are many well-run lower risk organizations in the bunch. Moreover, let’s not blame the banking model for individual companies’ woes. The Economist had a good article this weekend highlighting the fact that it is not the universal banking model which is to blame f0r large writedowns at the likes of UBS and Citigroup.

Yet, tempting as it is to believe that changing business models would solve UBS’s problems, or those of the wider industry, the evidence of the credit crisis suggests otherwise. No single model has emerged from the turmoil either wholly vindicated or entirely discredited. Credit Suisse shares a city square in Zurich and a business strategy with UBS, but has come through the past 12 months in much better shape and continues to attract money into its wealth-management division. Citigroup’s version of the universal-banking model is one where it walks into every punch going; Britain’s HSBC has been more successful in blunting the impact of its American misadventures through decent earnings in emerging markets. Of the Wall Street investment banks, Goldman Sachs has survived with its reputation enhanced. Bear Stearns did not survive at all. Pure retail banks can blow up too: Northern Rock, which was nationalised by the British government after a humiliating run on it, had a simple enough product line.-No size fits all, Economist, 14 Aug 2008

While it is not a sure bet that Credit Suisse, Goldman and HSBC will continue to outperform their peers, it should be obvious that there are extreme differences in the risk profiles of different financial institutions n the same line of business.

Enormous losses were not a given for financial services companies. Those organizations with the greatest losses are the ones who took the largest risk. Their risk play has not paid off and they are reaping the consequences. Losses in the financial services sector are a direct result of individual institutions succumbing to the pressure for sustained profits in a low-return environment and making large bets on riskier assets just when the housing bubble burst. Other companies in the same sectors avoided these risks.

This got me to thinking about relative value plays in the financials. In that vein, let me suggest some financial institution relative value plays:

1. Large U.S. Banks: Wells Fargo over Citigroup
2. Large U.S. Banks: U.S. Bancorp over JP Morgan Chase
3. Large U.S. Banks: Bank of New York Mellon over Bank of America
4. Large U.S. Regional Banks: SunTrust over Wachovia
5. Large U.S. Regional Banks: M&T Bank over Washington Mutual
6. Britain: Lloyds over HBOS
7. Switzerland: Credit Suisse over UBS
8. Canada: Scotiabank over CIBC
9. Germany: Commerzbank over Deutsche Bank
10. Investment Banking: Goldman Sachs over Merrill Lynch
11. Property and Casualty Insurance: Berkshire Hathaway over AIG

Why would you own the list of second names when you can own the first? Bottom-fishing is the only plausible reason I can come up with. But, in this credit crisis so far, bottom fishers have not done well. Expect more of the same going forward.

Related posts:

• Citigroup: the financial supermarket is dead
• Banks: are mergers in the offing?
• British banks are underestimating losses
• Global Bank write-offs and failures
• A brief note on upcoming bank earnings announcements

Just because the financials are in for a few further rounds of pain doesn’t mean that quality financial institutions in the U.S. don’t exist. There is a stark difference in the level of risk some institutions took during the heydays of the housing and credit bubble.

For example, take yesterday. Dour Jamie Dimon reported results that were better than expected and demonstrated that JP Morgan Chase was not nearly as exposed to the mortgage sector as some of its competitors. Yet, he remained cautious about the future, warning us about the uptick in prime mortgage charge-offs in addition to the already known subprime mess and the well-anticipated Alt-A storm to come. Yes, JP Morgan Chase is a major player in the derivatives market and still has significant exposure to yet more charge-offs, but this is an institution which will survive.

On Tuesday, U.S. Bancorp presented its results. They were ugly just like everyone else’s, with profits off 18%. However, they still made a significant profit and they demonstrated that future charge-offs are likely to be less at U.S. Bancorp than the regional banks that are getting annihilated.

U.S. Bancorp’s second-quarter earnings fell 18 percent, missing analysts’ expectations, as the company more than tripled its provision for credit losses but offered assurances that its credit problems would continue to be manageable. Shares fell nearly 3 percent.

Chief Executive Richard Davis said the Minneapolis-based bank expects to see net charge-offs from bad debt increase in the coming quarter and didn’t expect to buy back stock for the rest of the year

However Davis also told analysts on a conference call that would continue to protect the company’s dividend. ”No bank will protect it harder and hang onto it more than this one,” Davis said.

Davis said it was a ”buyer’s market” for acquisitions in the banking sector, though he added: ”We are not shopping, but we’re listening.”

U.S. Bancorp’s earned $950 million, or 53 cents per share, down from $1.16 billion, or 65 cents per share, during the same period last year. The latest results include 11 cents in net securities losses, reflecting writedowns of structured investment securities and the credit-loss provision.

-New York Times, 15 Jul 2008

When all is said and done the likes of U.S. Bancorp and JP Morgan will come out of this crisis in a favorable position and be poised to benefit at the expense of weakened and over-leveraged competitors. Bank of New York Mellon is another institution to like. Wells Fargo is another (although I did not like their dividend increase in the least. It may have been a signal, but capital is scarce now and Wells Fargo is already yielding 6%+.)

Would I buy shares in these companies now? No, we have a long way to go before the financial services sector hits bottom. But, when it is time to buy and capitulation has set in, at least we know know how to separate the wheat from the chaff and who to buy. In the meantime, look at rallies like those in financials the past few days as short-covering rallies, dead cat bounces, suckers’ rallies or whatever you want to call them.

For now it is still buyer beware.

Related posts:

• Wells sells $600 million in distressed assets at 35 cents on dollar
• Regional banks are suffering
• AMEX credit card trouble deepens bank worries
• Wells Fargo to buy Wachovia
• Writedown news: 23 Sep 2008

“Prime looks terrible.” Those are the words of Jaime Dimon, CEO of JP Morgan Chase regarding the future of prime mortgage loans. Wall Street analysts were ecstatic at the largely positive news in JP Morgan’s earnings report even though earnings were down by more than half compared to a year ago. Yet, Dimon attempted to lower enthusiasm by pointing out the high hurdles to clear in coming months.

JPMorgan has weathered the subprime downturn better than many of its peers. But on Thursday, it said it charged off 5 percent of its subprime mortgages in the latest quarter, resulting in a hit to earnings of nearly $200 million.

And the mortgage contagion may be spreading from subprime to prime mortgages, which were given to people with the best credit histories.

“Prime looks terrible, and we’re sorry,” Mr. Dimon said on Thursday’s conference call with investors. “We can say it eight times. It looks terrible.”

Around three-quarters of the firm’s prime mortgages are “Alt-A” and “jumbo” mortgages. Alt-A mortgages were written to people with relatively strong credit histories, but whose income was not verified. Jumbo mortgages were written for those borrowing more that $417,000.

Prime mortgages are supposed to have a very low chance of defaulting. For example, in the second quarter of 2007, the firm wrote off just 0.05 percent of its prime mortgages, for a charge of $4 million. That rose to 0.91 percent in the latest quarter, amounting to a $104 million charge-off.

A tripling of the losses stemming from its prime mortgages would mean a $300 million loss. It would force the firm to increase its reserve pool, belting down even more capital to soak up the markdowns.

As it is, JPMorgan had to beef up its reserve pool for bad loans by $430 million in the second quarter. This ties up the bank’s capital, making it harder to invest in other things such as loans to consumers — or increase dividends to shareholders.
-New York Times, 17 Jul 2008

An increase in writedowns in higher classes seems inevitable. On Tuesday, I said

There are three obvious places to look:

1. Other mortgage areas beyond subprime that have been ‘tainted’ by the subprime mess and that are showing signs of distress.
2. Other credit classes that exhibited the same levels of euphoria during the upswing
3. Other unrelated credit classes that might be affected by a negative feedback loop that credit contraction has on the real economy.

As far as Mortgage classes go, Alt-A is the class to watch now. This class between sub-prime and prime is now exhibiting many of the hallmarks of distress previously seen in sub-prime before it cratered. (See my posts under the label Alt-A for more). IndyMac, now bankrupt, was a major provider of mortgages in this sector. In April, Moody’s began downgrading Alt-A Residential Mortgage-Backed Security (RMBS) bonds.
- Financials: catching a falling knife

Therefore, at a minimum, we should be expecting Alt-A performance to worsen significantly in the coming months. Dimon is signaling further that even Prime mortgages will see significant deterioration. The pain in financials is far from over.

See Credit Crisis Timeline for a complete list of writedowns by institution.

Related posts:

• Prime Foreclosures greater than subprime
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”
• Mortgage distress shifts to prime borrowers
• Jamie Dimon: November was terrible, December is terrible
• Subprime good, prime bad