JPMorgan Chase's Financial Results: Uglier Than They Look
Accounting will bore you to death -- and save your hide, as JPMorgan Chase's (JPM) latest financial results attest. The company's $1.1 billion in profits for the quarter come in part from a $1.9 billion "debt valuation adjustment," a bit of financial gimcrackery that banks use to dress up their earnings.
Under a 2007 change in federal accounting guidelines, banks may record the value of their bonds according to their current market value. At banks like JPMorgan, the value of that debt has fallen in recent months because investors are buying credit protection to offset the firms' exposure to financial losses in Europe. As a result, JPMorgan is allowed to "mark" that decline in its books as a gain. Why? Because in principle a bank could realize a profit by repurchasing that debt at the lower price.
JPMorgan isn't being deceptive -- it's simply playing by the rules laid down by the ever-lenient Financial Accounting Standards Board (although it's worth noting that Wall Street lobbyists have demanded such leniency over the years). And those cut both ways. The bank also reported a $691 million loss related to a lower valuation of its derivatives holdings. But the bigger problem is that DVA lets banks misrepresent -- oops, "manage" -- their financial results. Writes banking analyst Chris Whalen of Institutional Risk Analytics:
This is basically a gift from the FASB and University of Chicago by way of fair-value accounting to defraud investors. Ridiculous. For JPM and other large banks, DVA will make earnings look better than the "economic reality" fair-value accounting is supposed to measure.Investment banking hits the skids
Certainly JPMorgan needs the help. Net income for the quarter fell 22 percent sequentially, to $4.3 billion, or $1.02 per share, and is down 4 percent from the year-ago period. Subtract the DVA gains, along with things like the money the banking giant is setting aside to cover the cost of litigation, and JPMorgan's EPS for the third quarter drops to $0.82.
JPMorgan is feeling the effects of the slowing U.S. economy across its businesses. Overall, sales fell 11 percent from the last quarter and are essentially flat compared with a year ago. Worryingly, earnings declined from the prior quarter in all but one of its six divisions.
Investment banking was hit particularly hard, with fees for trading, securities underwriting, and advising on mergers and acquisitions tumbling 46 percent from the prior quarter. The division offers a perfect example of how DVA can gussy up a bank's results. JPMorgan reported net income of $1.6 billion from investment banking, but fully $1.2 billion of that profit was from the DVA gain. Presto!
Haunted by the past
The one bright spot at JPMorgan: retail banking. Earnings from mortgage loans, deposit fees and other bread-and-butter banking services more than tripled from the prior quarter to $1.2 billion.
Yet clouds loom even there. JPMorgan earmarked $1 billion to cover the cost of mortgage-related lawsuits. Notably, the company also raised the reserves it allocates to soak up credit losses. Since the housing crash, big banks have been using these "provisions" to boost earnings. But that will be harder to do if provisions remain elevated over the next few quarters.
In a conference call, JPMorgan CEO Jamie Dimon described the company's performance as "reasonable." That's a relative term, of course. The company is undeniably in better shape than other big banks, especially compared to industry weakling Bank of America (BAC). Yet like its peers, JPMorgan continues to be dogged by the anemic economy and Wall Street's reckless lending during the housing boom. As Whalen notes, more than half of the company's profits stem from cost cuts and from the company paring back on employee compensation.
In short, bookkeeping stunts can't disguise the serious growth hurdles facing JPMorgan and the entire banking industry.
Image from Flickr user World Economic Forum
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