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January 22, 2009

JP Morgan, When I Say Insolvent, I Really Mean Insolvent
by Reggie Middleton

Do you remember what I said on January 6 (Amid the rally, I look at the Doo Doo 32 and their receipt of the TARP)? Well, believe it or not, Mr. Market along with members of the Bush Administration and certain CEOs are allowing members of BoomBustBlog to actually get paid from the same set of research for a 5th time in less than a year. This has got to be a record! I am of the mindset that this type of behavior will not continue for much longer, for I get the feeling that Barack and crew are a bit more serious about putting the bank issues to bed than the previous administration. Be that as it may, until they get their machinations firmly entrenched, and as long as banks are shuffling taxpayer money out the door in the form of dividends ala ponzi scheme et Madoff, my subscribers have the opportunity to profit immensely.

I have said it before, and I'll say it again - JP Morgan is insolvent! Anybody from JPM who wants to correct can simply email me via the contact form at the top of my site to show me where I'm wrong. I am always willing to admit that I am wrong when I actually am. I don't think this is one of those times. Keep in mind that throughout this entire credit debacle, I haven't been wrong about a bank or insurer yet. I have called all 32 of the Doo Doo 32, Bear Stearns, Lehman, GGP, MBIA, Ambac. Simply search my blog for the articles, for most of these companies have fallen in share price more than 98% (with the Doo Doo 32 being an exception since that was more of a macro call).

Despite heavy government subsidies (in my opinion, JPM is the beneficial recipient of over $100 billion of government aid and other capital, between the Bear Stearns subsides, backstops and guarantees, WaMu seller's concessions and TARP) I am still confident in declaring JPM insolvent. They have pre-announced earnings to coincide with the feel good aura of the Obama inauguration - good move, but it didn't work. I can still count even if I do feel good. JPM incurred an operating loss, masked by accounting shenanigans (these things don't fool me, I can count) and one time asset sales. Basically, the JPM dividend is being funded by tax payer monies (TARP) and asset sales, hidden by accountants who may been smoking some of those creativity tea leaves I hear they sell in Jamaica, you know that dark green Sensimilia! I've decided to divulge a bit of the top secret subscriber research to the public through an open post available to all. I've done this as to illustrate to those who are not part of our closed community the travesty and trouble that is what appears to be the MSMs (mainstream media) most respected and well run bank. The real juicy stuff (valuations and a sample trade optimized for risk/reward) will be available for download to retail and pro subscribers, accordingly.

Here is some JPM accountant's Sensimilia inspired food for thought:

• While the banking world is bustin' their ass to delever, JPM is currently sporting a ~30x leverage ratio.
• In 4Q2008 derivatives increased substantially to $163 bn from $118 bn in 3Q2008 and $77 bn in 4Q2007. Much of the increase in 3Q2008 was due to acquisition of Bear Sterns. As of September 2008 JPM has a $118 bn worth of derivatives on its balance sheet while the notional value of these derivatives is $84.3 bn.
• As a reminder, JPM is the WORLD's largest credit derivative counterparty. With that note in mind, realize that JPM's trading VaR is up 50% while its increase in derivatives receivables are up nearly 40%. This all occuring as JPM is trying to delever by shedding assets,
• According to September 2008 filings although bank had sold credit derivatives of $4.5 bn and purchased credit derivatives of $4.6 bn (net is nearly 0) the bank has recorded a fair value of $28.5 bn (as of Sep' 08) against notional amount of $9.2 bn.
• JPM's level 3 assets have increased significantly due to purchase of Bear Sterns, reaching 17.5% of total assets at fair value from 11.2% as of December 2007.
• As of Q3 08, JPM sported an adjusted leverage of 32x! That is just what we could find on balance sheet. You know there has to me some stuff off balance sheet somewhere that is hidden from me. And to think, some people thought Bear Stearns and Lehman were highly leveraged... Oh yeah, that's right! JPM bought Bear Stearns and Lehman went bankrupt. Hmmmm!

Despite all of this, JPM actually rallied 40% up after the bank rout the other day and continued to drift up after hours. Cool, the kids gotta eat! You see, the counter-argument to the JPM short is that it the government has set up juicy wide spreads in certain trades that will allow banks such as JPM to earn their way out of insolvency. Well, this will work for solvent banks, but the very insolvent one's are just about out of time. The trades entail borrowing low and lending high, but who will you lend to? Think about it. If you are a very strong credit risk right now, you are probably not in the market to borrow money unless you have a relatively risky deal you are trying to finance. Of course, there are a lot of other entities and persons who are in the market for loans right now, but those are the one's that should have never been lent to in the first place and are definitely not the ones you want to lend to now. Adverse selection via Taxpayer subsidy! That's what I call it. The insolvent banks are between a rock and a hard place.

In addition, and as the article below illustrates, banks are using TARP to do the same thing that Madoff allegedly did. They are placating investors in an unprofitable business (remember JPM had an operating loss this quarter) by taking the capital received from new investors (the US tax payer) and paying off older investors (shareholders through dividends and bond holders through interest). The technical finance term for this is called, PONZI scheme. To see the Ponzi scheme in detail, as well as valuations, download the subscription material. For the first time, I will also include sample trades with an optimized risk/return profile based upon the findings of the report for professional level subscribers and above. The samples include a vertical ratio spread vs straight shorting of stock vs long only put purchases. Keep in mind that there is no need to get fancy with solid research. As both my long time subscribers and the 2008 Blog Research Performance attest, all you really have to do is buy a simple position and hold in the case of a company that is bankruptcy (or receivership) bound. Alas, since subscribers have been clamoring for trade info, I will occasionally remit such. I want to make it clear that these sample trades do not necessarily reflect what I do in my own proprietary account (which is I call it "proprietary") but are feasible assuming a relatively strong background in options and stock trading.

JP Morgan Q408 quarterly valuation opinion - Retail 2009-01-22 08:49:26 79.24 Kb

JP Morgan Q408 Quarterly opinion with sample trades - Professional & Institutional 2009-01-22 08:48:02 211.69 Kb

Subscription plans and pricing

Even on an unadjusted, accountant polluted basis, the economic value of non-performing assets just about wipes out shareholder's equity.

When adjusting for intangibles, JPM's equity holders are underwater 1.4x over!

The Eyles test shows JPM's current reserve for loan losses shortfall as % of tangible shareholders' equity (non-accrual loans on an economic basis). No matter which way you look at it (as long as you REALLY look at it) the common shareholder's of JPM are done for. Maybe this is why they are still paying a dividend. "Get as much (taxpayer) money out of the door as possible before the one of those damn bloggers start spewing the truth and the feces hits the fan blades"!

Yeah, you think the subprime category is eating heavily into equity, wait until the Option ARMs start to recast AND guys like me make it known the accounting BS that JPM is trying to pull in order to hide the fact that WaMu's purchase is killing it!

Bloomberg: Kill JPMorgan's Dividend, Save America's Banks: Jonathan Weil

Memo to JPMorgan Chase & Co.: Your dividend needs to go.

For all the complaints that U.S. banks aren't lending enough money, the bigger problem may be they're giving too much away. Here we are amid the greatest banking crisis in 80 years, and some of the biggest, purportedly shrewdest banks keep acting as though they can spend their way into solvency by plying shareholders with outsized quarterly checks.

The latest numbers from JPMorgan say it all. Last week, the nation's largest bank by market value reported $702 million of net income for the fourth quarter. That was about half as much as the $1.4 billion it paid in dividends to common shareholders. The company barely earned its dividend for the year, too, when net income and common dividends each were about $5.6 billion.

JPMorgan's chief executive officer, Jamie Dimon, says the dividend is sustainable. "This company has enormous earnings power," he said on the company's Jan. 15 earnings conference call. "We feel an obligation to pay the dividend. So we feel pretty good about it, and so we're not that concerned about it."

That's hardly convincing. JPMorgan would have reported net losses the last two quarters were it not for $1.9 billion of nonrecurring gains from accounting adjustments, related to the company's purchase last September of the banking units of the failed thrift Washington Mutual Inc.

...

JPMorgan already has received $25 billion of government bailout cash. It would pay almost a fourth that much in common dividends this year. That doesn't include the interest the bank separately must pay to the U.S. Treasury on its preferred stock.

After Bernard Madoff's Ponzi scheme, it should be out of fashion for financial companies to pay returns to old investors with money raised from new investors. Put aside the unseemliness of paying dividends with taxpayer bailout cash, though. The best reason for JPMorgan to slash its dividend is self-preservation.

...Dimon, who also is JPMorgan's chairman, already may have waited too long to hack the bank's dividend. That's no excuse for further delay. JPMorgan's bosses should start showing they're prepared for the worst. The longer they dither, the greater the risk for us all.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

Visit his blog Boom Bust Blog.

Copyright © 2007-2009 Reggie Middleton

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