|The $13 billion: It can handle it.|
Will it crush the bank's growth plans and business opportunities in the periods to come? Will it strangle a banking empire and cause it to retreat into a shadow of its post-crisis self?
Announced in business headlines everywhere, the $13 billion is the total amount in the bank's settlement with the U.S. Department of Justice, all related to the bank's mortgage-securitization business in the 2000's and the businesses it inherited from its acquisitions of Bear Stearns and Washington Mutual.
The government claims JPMorgan and affiliates improperly and unfairly structured mortgage securities, leading to billions in losses to investors who had purchased the securities. The settlement puts an end to one chapter in the bank's efforts escape the mortgage nightmare of that decade.
For a financial institution with market value and book value in the hundreds of billions and with billion-dollar earnings announced every quarter, is $13 billion a lot? Let's decide.
Of the $13 billion, about $7 billion is tax-deductible. Hence, the bank will have a benefit on its tax books (reduction in tax liability, e.g.) of some kind for about $2-3 billion, effectively reducing the "pain" of the settlement by that amount.
Of the $13 billion, about $4 billion is slated for mortgage relief for homeowners. Banks and investors who hold those loans or hold securities backed by those loans have likely written them down, charged them off, or set aside significant reserves. If JPMorgan continued to hold some of those loans and securities on its books, the settlement amount captures assets that the bank had previously written off or planned to write off. In effect, the settlement number acknowledges and accounts for write-offs the bank already took (related to mortgage securitization).
In 2012, the bank (consolidated) reported $21 billion in earnings. It operates at a pace of generating about $6-7 billion each quarter (or about $24-28 billion/year). Hence, a gross $13 billion settlement doesn't result in fiscal-year losses (comprising about half of expected annual income). The bank will continue to be profitable, expecting to report profits above $15 billion in 2013 and above $25 billion in 2014.
Even more, the bank indicated it has already set aside reserves (and adjusted financial statements) to account for the entire $13 billion--including about $9 billion in legal reserves (including write-offs and loss provisions) in the third quarter in anticipation of various legal settlements.
JPMorgan's equity base exceeds $206 billion, an amount that has already netted out much, if not all, of the $13 billion. A $13 billion settlement comprises less than 7% of equity, if it had not already made equity adjustments for such charges. As massive as the number appears in headlines, $13 billion won't put the institution in financial peril.
Has the bank's market value (share value) suffered because of the settlement? In recent weeks, as the public heard rumors and eventually learned about a finalized settlement, the bank's share price didn't plummet and even flirted with record levels. That's because the market, whether it's partly or fully efficient (depending on which finance theorist you believe), had already accounted for all possible losses related to the settlement.
Equity markets, too, like companies that flush out losses and start anew. Markets like companies that erase vast amounts of uncertainty (especially related to lingering legal issues). Markets appreciate and value companies when they clean the slate and eradicate such hangover.
Then there are regulators, who have applied an increasing burden of capital and liquidity requirements to big banks. Does the $13 billion jeopardize regulatory compliance? Not really. The bank had already begun to retain, boost and increase capital to comply not only with capital requirements of today, but the progressively increasing requirements over the next few years. Its regulatory ratios were in good shape.
New regulation has certainly annoyed JPMorgan (and its peers) and has stifled business activity in certain segments (trading, the best example). The bank continues to grapple with new rules regarding trading, leverage and liquidity. But the settlement hardly influences the scenarios the bank confronts on these fronts.
Still, $13 billion is still a mind-boggling total, so it has to hurt somewhere, if capital ratios, earnings, balance sheet, and stock price have not felt pain. Moody's, the ratings agency, in November downgraded the holding company a notch, but the downgrade had little to do with settlement figures, more to do with systemic issues and how Moody's suspects big banks can manage through crisis scenarios.
Some "hurt” or injury should exist, contends the Justice Department, which wants the bank to comprehend the impact of its past actions. The bank has weathered public embarrassment, glaring headlines and threats to gilded reputation, but all that could be short-lived, as regulators and the media move on to the next big issue plaguing financial institutions.
For now, the "pain" of the settlement is not financial. Could there could be a cumulative, damaging effect from having to ward off the slings and arrows of many legal issues at once? They include (a) the time commitment and distractions involved in legal wrangling and legal negotiation, (b) the possibility, even if remote, of criminal charges arising from any of the past activities, and (c) other legal issues (including any related to last year's "Whale trading" derivatives losses that exceeded $6 billion.
Don't forget, too, the expected "pain" of explaining to senior managers, deal-doers, and business leaders how inappropriate it might be in 2013 to pay eye-popping bonuses in the wake of a $13 billion shakedown, an internal corporate message that always results in the risk of losing talent.
And $13 billion is an amount of missed opportunities--new investments in business expansion, product growth and new technology that the bank could have made, but didn't. The bank, nonetheless, would counter that it has ample resources, people and capital (from retained earnings) to make all the investments it needs in the post-crisis era.
At JPMorgan, the "pain" will be bearable. CEO Jamie Dimon will sleep at night. The $13 billion was, well, not too much money.