JPMorgan Chase & Co Chief Executive Jamie Dimon has given investors plenty to worry about throughout the year, but they have shrugged off his cautionary remarks and embraced his couched reassurances.
It might be time to reconsider Dimon's cautionary side after Merrill Lynch & Co Inc unveiled a $5.5 billion credit implosion last week. Merrill's shocker -- a money-losing third quarter -- once again demonstrates how Wall Street firms and analysts have woefully underestimated exposure to risky subprime mortgages, leveraged loans and collateralized-debt obligations.
Some analysts expect JPMorgan to take at least a few billion dollars in write-downs when it reports third-quarter results next week. But those estimates came before Friday's bad news from Merrill, once seen by some as the least exposed to the vagaries of the fixed-income market.
Last week, for example, Deutsche Bank analyst Mike Mayo predicted JPMorgan should have about $2 billion in leveraged loan write-downs before fees and hedges. JPMorgan, which declined to comment for this story, also has exposure to the subprime and CDO markets.
Analysts at CreditSights, an independent fixed-income research firm, said most large U.S. banks, when they reported second-quarter results in July, also expected a solid second half. Not anymore.
Most expectations for a solid second half have been thrown out the window by the mortgage meltdown, which turned into a full-blown credit crunch, and possibly the first steps toward any economic slowdown or recession, CreditSights analysts said last week.
In March, Dimon labeled the subprime mortgage lending business as possibly ugly in his annual letter to shareholders. But in the second quarter, it was home-equity loans to people with solid credit that hurt the bank's profits.
JPMorgan set aside $1.53 billion for loan losses, up from $493 million a year earlier. About one-third of the increase resulted from higher loss estimates on home-equity loans.
Meanwhile, JPMorgan's Chase Home Finance originated $3.3 billion in subprime loans in the second quarter, No. 6 among U.S. lenders, and 15 percent more than the year-earlier period, according to National Mortgage News.
JPMorgan shares are down 2 percent this year. But that is still better than the 14 percent decline in Citigroup shares and Merrill's 20 percent drop. The Dow Jones Titans Bank Index is off 1.6 percent this year.
But JPMorgan may have to set aside more for mortgage-related losses as the U.S. housing market continues to slump. Mayo said in his September 30 note that he expects continued reserve building at the bank, but at a slower pace than previous quarters.
During a July conference call, Dimon conceded JPMorgan was involved in a couple of hung leveraged buyout deals and exposed to leveraged loans without covenants. The credit markets have deteriorated even more since then.
There's nothing that's on our balance sheet we're particularly concerned about, but if you see this continue you will see the street taking on a lot of bridge loans and more aggressive pricing of those things, Dimon said on the July conference call.
To reassure analysts and investors, Dimon also said that JPMorgan underwrites every loan as if it might end up owning it. He threw in a bit of caution, too.
On the loan side ... I am less comfortable because I can't predict the outcome of the market, Dimon said in July. But like I said, the way we look at it -- and obviously we don't expect to happen -- is if all of it ended up on our balance sheet, we'd be OK. We might have to take some markdowns and take some reserves, but we already have a lot of loan loss reserves.