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JPMorgan (NYSE: JPM) Talks $11 Billion Settlement; Q3 Earnings at Risk – Money Morning

This is a syndicated repost courtesy of Money Morning. To view original, click here. Reposted with permission.

JP MorganChase & Co. (NYSE: JPM) finds itself in front of regulators yet again for misdeeds.

Chief Executive Officer (CEO) James Dimon was in Washington yesterday (Thursday) attempting to broker a settlement over the bank’s sale of substandard mortgages.

Dimon met with U.S. Attorney General Eric Holder about a possible $11 billion settlement in attempts to end criminal and civil charges over JPM’s questionable mortgage practices. The U.S. Justice Department said earlier in the week it could file a lawsuit over one of the bank’s pending mortgage cases.

An $11 billion settlement would be the highest deal struck by the Justice Department with a single company, reported The Wall Street Journal.

JPM and federal and state authorities have discussed the bank paying as much as $7 billion in cash and $4 billion in consumer relief. Monday, JPM offered a $3 billion settlement, which Holder swiftly rejected.

“I don’t really want to get into the nature of the conversations, the discussion that we had,” Holder told the Washington Post. But it “is a priority for this Justice Department to hold accountable people who would manipulate companies, who would manipulate our financial markets for their own customer’s benefit of for the benefit of the companies.”

The meeting between Dimon, CEO of the nation’s largest bank, and Holder, the highest ranking U.S. law enforcement official, highlights the ongoing quest to pin down responsibility for the 2008 financial crisis. Investigations into misconduct involving mortgage securities, a move that crippled the housing market and crushed global markets, continue some five years later.

And JPM has never been far from the spotlight.

As The Journal wrote, “Trying to keep an accurate tally of the government investigations of J.P. Morgan has become a full-time job.”

This week alone, The Journal counted seven ongoing Justice Department investigations, plus several inquires at other agencies.

JPM a Regulator Target

Able to avoid the worst losses in the financial crisis, and emerging in much better shape than the bulk of its peers, JPMorgan has found itself in the spotlight since May 2012, when it lost more than $6.2 billion on derivative bets gone bad in the “London Whale Trade.”

Investigations revealed an extreme lack of trader oversight. On top of the losses, JPM paid $920 million in fines.

Then there were examinations into the bank’s “illegal credit card practices.” In mid-September, the Consumer Financial Protection Bureau reported JPM made $309 million in restitution to credit card customers for the sale of problematic credit card protection promises.

Regulators are also bringing charges against JPM for violations of Bear Sterns and Washington Mutual, since the bank inherited risky mortgages from the firms. The irony here is that JPM rescued both during the financial meltdown at the request of regulators.

In May, investors pressed for Dimon to be stripped of his chairman title in order to separate the positions of CEO and chairman so that shareholders could be better represented. But the outspoken leader, hinting he would quit under such a scenario, was able to hang on to both titles.

Investors too have hung on through it all. The seemingly Teflon JPM shares are up nearly 20% year to date.

While a settlement is preferable to a long, costly court battle, Dimon is likely to fight an $11 billion payment.

“The bigger question is will JP admit fault as it just did in the London Whale case?” Anthony Sabino, a professor at St. John University’s Peter J. Tobin College of Business, told Forbes. “Given the possible size of the settlement here, it might dig in and refuse to make any admission that would undoubtedly be used in subsequent litigation with aggrieved shareholders and others.”

JPM Earnings Could Take a Hit

Over the last three calendar years, litigation expenses have cost the bank more than $18 billion, according to the company’s annual report.

Moreover, recent reports suggest JPM’s Q3 2013 earnings could be completely wiped out amid an $11 billion settlement. Some rumors put a settlement as high as $20 billion.

Third-quarter losses are not merely rumors.

Chief Financial Officer Marianne Lake said at a conference on Sept. 9 the bank was expecting net losses in its mortgage origination business during the second half of 2013. Lake added that a “crescendo” of regulatory scrutiny would add to mushrooming litigation expenses “which will more than offset the $1.5 billion or so of consumer reserve releases.”

Thursday, in his third-quarter earnings preview for large-cap U.S. banks, Oppenheimer’s Chris Kotowski slashed Q3 earnings estimates for JPM by more than 50%. Kotowski now expects earnings per share of $0.70, down from $1.42, when the company releases third-quarter numbers on Oct. 11.
Revenue is projected to be flat to down 5% year over year.

JPM’s attractive $0.38 per share dividend (2.94% yield) looks safe if the settlement hits around $5 billion.

“We obviously have no idea what it [the global legal settlement] will be, but in putting a $5B assumption into our estimate, we want to point out that even this amount would leave JPM with earnings comfortable above its dividend,” Kotowski wrote.

However, an $11 billon Q3 settlement, based on Kotowski’s calculations, would obliterate the bank’s third-quarter results.

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