In the December edition of Value Investor Insight, Soma Asset Management's Igor Lotsvin described how his portfolio is positioned for 2009. Key excerpts - explaining his bear case for JPMorgan Chase (NYSE:JPM) - follow:
Describe the bearish case for one of your highest-conviction shorts, JPMorgan Chase [JPM].
IL: People want to believe that certain companies because they’re the high-quality players will ride out the credit crisis without that much pain. JPMorgan deserves credit for being much better positioned than others, but that doesn’t mean its pain from loan losses is going to be any less real.
As much respect as we have for [JPMorgan CEO] Jamie Dimon, we were frankly shocked at the purchase of Bear Stearns in March and expect it to be the biggest mistake of his career. We’ve worked on acquisition due diligence and can tell you there’s absolutely no way the decision over two days to buy Bear Stearns was much more than a gut trading call on Dimon’s part that Bear’s assets were fundamentally solid and that the government’s willingness to cover $29 billion in asset writeoffs had him covered. We just think that’s going to turn out to be fundamentally and disastrously wrong.
IL: As of the end of the third quarter, JPMorgan had $2.2 trillion in liabilities on its balance sheet, against which it has a market cap of around $116 billion. As we go through the various components of the loan portfolio and make assumptions about the level of writeoffs, big chunks of that equity value get eaten up quickly.
For example, the company has a credit card loan portfolio of $150 billion, on which we think loss writeoffs could go as high as 13-14%. They point out that losses on credit cards peaked at 8% in 2002, but we think this recession will be much worse. Consumers are more leveraged than they’ve ever been, unemployment rates will almost certainly go higher than they’ve been in decades, and there are no other sources of liquidity, like savings, for people to pay off their credit cards. There’s another $100 billion in home equity lines of credit, on which we think losses could reach 15-17%. They have $15 billion in subprime mortgages, on which losses could be 50%. They have $50 billion in prime mortgages, with losses on that likely to be 10-15%.
In all, we think there’s a reasonable chance that JPMorgan is facing $50 billion in losses on existing loans over the next year, which would cut its book value to the high-teens per share, from the current level of $35.
We assume you’d expect the share price, currently $31, to follow suit.
IL: The shares already trade below book value, which is highly unlikely to change if the company experiences the loan losses we expect. If we’re right, we’d expect to see the share price fall at least to $15.
What are the biggest risks to your thesis?
IL: The key here – and this is true of a lot of our shorts – is how soon the housing market starts to rebound. If that happens much sooner than we expect, there’s a good chance we’ll be wrong about how bad the loan losses get.
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