Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the U.S.? 22 comments
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JPM derivative and off balance sheet lending commitments and guarantees exposure
As we step through the various exposures that this most esteemed bank has, keep in mind that as of June 30, 2009 JPM's common shareholder's equity and tangible common equity stood at $147 bn and $79 bn, respectively. You tell me if the risk inherent in our banking system has been mitigated, please!
Off balance sheet lending commitments and guarantees
As of June 30, 2009, JPM had exposure of $85 billion (or 108% of its tangible equity) towards off balance sheet lending commitments and guarantees. The contractual amount of the off balance sheet lending commitments and guarantees represents the maximum possible credit risk should the counterparty draw upon the commitment or JPM be required to fulfill its obligation under the guarantee, and the counterparty subsequently fail to perform according to the terms of the contract.
click all graphics to enlarge
Derivative exposure
As of June 30, 2009, the total notional amount of derivative contracts outstanding as of June 30, 2009 was about $80 trillion (or 101,846% of its tangible equity). I hear a lot of you smart guys and gals out their saying, "But hold on a minute there, big fella! Notional amount quotes are misleading. It is the net exposure that truly determines economic risk." Okay, smart guys and gals. I guess I can buy that, at least in part. The only issue is that there is no free lunch. Let's move on to see how this can play out. Let's ascertain the fair market value of JPM's derivative exposure.
Gross fair value (before FIN 39) of the derivative receivables and derivative payables was $1,798 billion (or 2,276% of its tangible equity) and $1,749 billion (or 2,214% of its tangible equity), respectively. The, fair value of JPM's derivative receivables (after FIN 39) was $84 billion (or 106% of its tangible equity) while the fair value of JPM's derivative payables (after FIN 39) was $58 billion (or 73% of its tangible equity). FIN 39 allows netting of derivative receivables and derivative payables and the related cash collateral received and paid when a legally enforceable master netting agreement exists between JPM and a derivative counterparty.
How does JPM swap out $1.8 trillion dollars of fair value market exposure to the much smaller $84 billion (which is still more than 100% leveraged at 106% of its tangible equity) net amount? What magic has the financial engineering wizards that have created the original FrankenFinance monsters (see Welcome to the World of Dr. FrankenFinance! for more on this scary alchemical mischief) used to accomplish such a feat? By netting the risk out, of course! Hey!!! Doesn't that mean that JPM has swapped one form of risk for another? If one were to consider the $1.8 trillion amount to be invalid due to the claim that JPM has offsetting agreements with other entities, then JPM is reliant on the solvency, liquidity, and management of said "other entities". Thus, JPM has swapped a more than $1.7 trillion of market risk for roughly more than $1.7 trillion of counterparty risk. I think it is quite misleading to simply pretend the credit and/or market risk just,,,, well,,,,, disappears. Ask Lehman Brothers', AIG's or Bear Stearns' counterparties if that market risk (which was allegedly netted out) simply disappeared - or was it just transformed into another form of risk? I think Goldman Sachs knows above all, if it wasn't for strong government connections, about $13 billion of "netted" market risk would have shown up on the books as a loss due to counterparty failure. Luckily, they manage their "political risk" quite well through the strategic purchase of key government (ahem) opinions, at least thus far...
So, if JPM has more than $1.7 trillion of counterparty risk (or 2,152% of its tangible equity) that is NEVER mentioned in the mainststrem or popular financial media, exactly what are the chances of that counterparty risk being tested? Let's stroll through the credit quality of their derivatives and offbalance sheet portfolio from a bird's eye view.
About 23% of the derivative receivables (in terms of fair value after FIN 39) were below investment grade (less than BBB or equivalent) while 12% were rated BBB or equivalent.
Credit derivative positions
JPM's credit derivative positions include positions in the dealer client business as well as positions entered for credit portfolio management. The total notional amount of the credit derivative positions as of June 30, 2009 was $6.8 trillion
Within the dealer/client business, JPM utilizes credit derivatives by buying and selling credit protection, predominantly on corporate debt obligations, in response to client demand for credit risk protection on the underlying reference instruments. Protection may be bought or sold by the Firm on single reference debt instruments ("single-name" credit derivatives), portfolios of referenced instruments ("portfolio" credit derivatives) or quoted indices ("indexed" credit derivatives). The risk positions are largely matched as the Firm's exposure to a given reference entity under a contract to sell protection to a counterparty may be offset partially, or entirely, with a contract to purchase protection from another counterparty on the same underlying instrument. Any residual default exposure and spread risk is actively managed by the Firm's various trading desks. After netting the notional amount of purchased credit derivatives where the underlying reference instrument is identical to the reference instrument on which the Firm has sold credit protection, JPM has net protection purchased of $82 billion along with other protection purchased of $77 billion.
So that's it. They are square, then. Of course unless the sellers of their protection default. If they do, then it may very well cause a daisy chain reaction that could get very ugly (see Counterparty risk analyses - counter-party failure will open up another Pandora's box). If you thought Lehman caused problems, compare Lehman's counterparty exposure to JPM's. Of course, JPM is one of the government's favored sons, clearly articulated as being "too big to fail". I posit this though - imagine Tim Geithner going back to congress saying, "I know my predecessor extorted $780 billion out of you by threatening the collapse of the entire financial system, and I know Bernanke has been handing out barely collateralized loans by the hundreds of billions like a pervert in a porn shop without security, but JPM is just too big to fail and they have $1.7 trillion plus of exposure that looks to be about blown up - chain reaction style - and they only have $79 billion of tangible capital to make good on it. How much TARP did you say was left again???"
Looking at the credit quality of the reference entity under the protection sold by JPM, about 34% of the credit sold (before the benefit of legally enforceable master netting agreements and cash collateral) was below investment grade as of June, 2009.
Gains and losses on derivative exposure
In 2Q09, JPM recorded net gains on derivatives of $16 million in earnings after recording $6 billion of gains from trading activities offset by losses of $4.6 billion on risk management activities and by losses of $1.4 billion on fair value hedges. Risk management activities include fair valuation of the derivatives used to mitigate or transform the risk of market exposures arising from banking activities other than trading activities. Now, you tell me... With the advent of FASB caving in to politicians and Wall Street special interests and allowing financial entities to basically rewrite the profit and loss statements of non-marketable (actually there is no such thing, let's call it "assets whose market price management does not like the sound of") assets, what are the chances that JP Morgan fudged the results just a little bit, in order to eke out that $16 million gain, which is actually about a 0.267% profit margin!
Exposure to unconsolidated VIE
As of June 30, 2009, maximum exposure to loss from unconsolidated VIE included $32.3 billion under arrangements with multi seller conduits, $7.9 billion from nonconsolidated municipal bond vehicles, $27.2 and $6.0 billion through derivatives (the exposure varies over time with changes in the fair value of the derivatives) executed with the VIEs. This exposure to off balance sheet loss is basically all of JPM's tangible equity - nearly all of it, and this is just the off balance sheet VIE stuff!
I will be offering a full blown forensic analysis and valuation to subscribers since I have always believed JPM to be insolvent (if one were to mark all assets to market and take the appropriate capital charges for the risk that it has undertaken) but never really took the time to find out if my hunch was correct. I will try to get it out in the next week, and we shall see if my hunch concerning this bank is truly on point or not.
Disclaimer: Short JPM
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Thanks for the excellent analysis--How does Goldman compare?
You have it exactly right. But what is even more scary is that JPM doesn't understand it. All conglomerate banks are being managed on a wink and a nod basis internally, with fancy headfakes and footwork shown for outside consumption. Bottoms up analysis, such as Reggie does, often shows as much about what we don't know as the opposite. That doesn't sell newspapers or get TV viewers. But it does help in the investment process.
Reggie - - -
Good work.
I think no one but Reggie really understands how bad the problem is. The media is, generally speaking, choosing to drink the kool-aid, in stead of face the horrible world without the benefit of kool-aid.
Great report again, Reggie. The more we see, the more we cringe at our capacity to demolish a good thing. If deflation is the creative destruction phase, then inflation (expansion) must be the destructive creation phase.
Not that this means much, but you now have another follower. Hoping a few of my followers read your keen insights.
On Sep 05 04:08 PM Mayascribe wrote:
> Reggie: Impressive piece of journalism, in how you unraveled the
> spaghetti trail of JPM's debt.
>
> Not that this means much, but you now have another follower. Hoping
> a few of my followers read your keen insights.
Hell, Statistical Tables are used to determine life expectency. The Law of Large Numbers combined with life expectancy provides a steady stream of Income which allows these Insurers to continue.
I would argue that None of them would be able to survive, if just 10% of their Insureds would die tommorow. The Business model is Not set up that way.
I'm sorry, picking and choosing which Liabilities can Implode does not mean they Will implode. Saying This will happen if the right circumstances arise, does not mean they will Ever arise.
I can say that Tommorow Buffett will come to his senses and give me $1 Billion. Its Possible but it sure as hell isn't probable.
So, I'll say this, even at these prices: JPM is a rip roaring undervalued stock.
I really don't understand happened to the difference between Short term liabilities and Long term liabilities and How the two are treated differently. Sure, "Mark to Market" exists but just like in the Longevity Tables, the presumption is that everybody is expected to live a certain amount of time, not die tommorow.
I'm not in the least bit concerned about the preferred and common shares. I accept that there will be pullbacks while Wells unwinds it's debt, and likely does another secondary. Currently, Wells and JP Morgan are insanely cheap, if you believe that forty months from now they will be still be surviving entities. My broker has Wells as a $60 to $70 stock 4 years from now, and paying a decent dicvidend again.
What this superlative "snapshot" article does for me is let's me learn about how much debt is still out there in the banks, even the "can not fail" category of banks.
Bottom line, this country needs banks. Banks have to go the route-- should behave as if the Glass-Steagle Act was never repealed.
the english lord who said, 'control the courts and the money, leave the rest to the rabble' figured out EXACTLY where we were headed
There are something in the area of $650 Trillion worth of "who the Hell knows what" still floating around electronically somewhere. That's down from $750 Trillion last year. (this is just an example)
You can acknowledge its existence, Try to allocate it country by country, Institution by Institution and destroy the Financial System Now or you can allow it to run its course for however long it may take.
If you sign a 30 year Contract for a Home Loan, the Bank expects you to repay it over 30 years. My vested principal will not start accumulating for years. The Value of the home may fluctuate over the intervening decades, but my payments will remain the same. The Lenght of the Loan will remain the same.
As far as I'm concerned, Mark to Market is being incorrectly applied. Whether the original loans were Sub-prime, Alt-A, Jumbo, whatever, each were issued for a specific time frame. The Fact that they were packaged, repackaged, leveraged and releveraged means little. None of the Mortgages were ever designed to be called the next day, No one would ever agree to a Mortgage with that parameter in the contract.
But here we are, trying to put a current Market Price on Loans which were issued years ago with specific expiration dates in mind and treating all of them as if they were due tomorrow for the purpose of valuation, packaging and leveraging aside.
Since when does my $100k loan for 30 yrs turn into something else when its packaged?
Your example of mark to market analogy is inaccurate. Here is a more accurate analogy.
I borrow a million dollars from you, secured by 1.4 million in property to make sure that I get paid back. The property is then devalued by 50%, meaning the max I can reclaim in a worst case scenario is $700k. This means that you have to hope I don't default.
Then the payment patterns of everyone that has a loan like me start to deteriorate, wherein at least 10% of the people who have the loans default, despite the fact that you made the loan under the pretense that only .05% would default, and that is how the loan was originally valued.
The straw that breaks the camels back is that all of the people who bought these loans stopped buying them because of the factors above.
Now, how much is the loan worth now? Can yu honestly allege that it should be valued as much as it was when you made the loan? If it can be reasonably assured that credit levels and RE asset price levels will not return to the level that they were when you made the loan, there is absolutely no practical reason NOT to mark this loan to market and bring its value down to where it actually is, and not to where it was, or where you hope it would be.
If mark to market was consistently used, the US would not have had to lend AIG nearl $200 billion, because the market would have imploded the company way before that.
Of course, none of this has to do with the counterparty risk that is the topic of the article.
One of the problems is that identifying the next Great Depression (and its causes) is "above my pay grade" for most of the media.
On Sep 05 03:21 PM Michael Clark wrote:
> I meant to add one last comment: the media is afraid of looking at
> the truth. They are afraid that by looking they will be forced to
> confront the demon -- that is, the mortality of the expansion, the
> mortality of the good life we have...I won't say created...borrowed.
What part of my simplistic approach is wrong?
This Loan and millions like it were Packaged, sold, leveraged, repackaged and resold. But all of them started out the same way, with Different categories of Buyers (sub-prime, prime, etc) but all with specific Loan amounts and specific times for repayment.
This was the Beginning, I saw my loan move from one company to another and another, etc. Nothing changed except where the payments were sent.
Now, if Millions default and Property Values are Marked to present Value, During a Depression in same, then you have Insolvency across the board. I have no arguement on that whatsoever.
However, if the Mark to Market provision is allowed to be stretched over a few more years, then it won't be a Problem. I do not believe anyone on this forum believes that Inflation will be low next year or the year after.
As far as AIG is concerned, its problems occurred because because the Worldwide Financial System froze. It was illiquid and needed immediate Cash. $1.7 Trillion in Illiquid assets frozen in limbo. They will pay it all back eventually. The Insurance aspect wasn't the problem. The illiquidity was created because of Mark to Market of Its Noninsurance assets.
Aig has Insurance subsidiaries in every State, None of them has gone Bankrupt nor was likely to even then. Had the Parent gone Bankrupt, they would still have functioned normally. The Assets of each insurance company are valued at Mark to Market by every single State, have been for decades and the States lowered their asset requirements during the Crisis.
I'm a big believer that The USA will succeed in averting the Potential worst case Mark to Market scenario by Infating the Hell out of everything.
You are right, life insurance pays off based upon mortality tables, and if there is an event that kills many people at once, the insurers will be in the red. But the insurers are supposed to have reinsurance agreements in place to fund such an event, and each insurer and reinsurer is supposed to have sufficient reserves. In the case of the banks, the insurance contracts and protections are actually empty promises. They can't pay for the real defaults, much less what is yet to come. Therefore, JPM is not a screaming buy, anymore than Fannie, Freddie, AIG, Lehman were screaming buys. JPM is functionally bankrupt. So is BAC, Wells Fargo, etc. They are operating on the largesse of the U.S. taxpayer, and lying to us with the express permission of the agencies put in place to protect us.
On Sep 05 11:54 PM one eye wrote:
> Once upon a time, it was what is good for "GM" is good for the rest
> of the country.
>
> There are something in the area of $650 Trillion worth of "who the
> Hell knows what" still floating around electronically somewhere.
> That's down from $750 Trillion last year. (this is just an example)
>
>
> You can acknowledge its existence, Try to allocate it country by
> country, Institution by Institution and destroy the Financial System
> Now or you can allow it to run its course for however long it may
> take.
>
> If you sign a 30 year Contract for a Home Loan, the Bank expects
> you to repay it over 30 years. My vested principal will not start
> accumulating for years. The Value of the home may fluctuate over
> the intervening decades, but my payments will remain the same. The
> Lenght of the Loan will remain the same.
>
> As far as I'm concerned, Mark to Market is being incorrectly applied.
> Whether the original loans were Sub-prime, Alt-A, Jumbo, whatever,
> each were issued for a specific time frame. The Fact that they were
> packaged, repackaged, leveraged and releveraged means little. None
> of the Mortgages were ever designed to be called the next day, No
> one would ever agree to a Mortgage with that parameter in the contract.
>
>
> But here we are, trying to put a current Market Price on Loans which
> were issued years ago with specific expiration dates in mind and
> treating all of them as if they were due tomorrow for the purpose
> of valuation, packaging and leveraging aside.
>
> Since when does my $100k loan for 30 yrs turn into something else
> when its packaged?
>
>
>
>
>
>
>
The Losses would be Horrific in the Headlines But I would be looking for Bargains, if I wasn't buried beneath the rubble.
OG: Claims aren't loses, all sort of steps are taken first, and if need be wind up in Court or Arbitration, the entire process can take years to go between Making a Claim and receiving anything at all.
Earthquake, tremendous loss of life, Life Insurance, you can't collect, have to find and identify the bodies, have to determine the Cause of death, is there 3rd party involvement...a poorly constructed building?...Just look at Katrina. Claims are still being settled.
Claims are not losses, they are just the claimed amts. As a matter of fact, All Insurers have spreadsheets devoted to Claim amounts, settlement amounts during the 1st year, 2nd year going out to 5 years, and a cummulative thereafter, all statistically derived from History. These are also filed with the State Insurance departments.
All you have to do is spread the losses far enough into the Future.
The Changes made in "Mark to Market" accounting not only allow for Shoving the Most Toxic back into the Fantasy Tier but keeping them there Indefinitely.
They are all screwed if everything is viewed and priced at the same time. By simply allowing them to continue to hide and give them time to spread everything over years while deleveraging will alleviate most of the current "Junk". Hits will still be Taken, but the System will survive.
Freya worked at an Insurance Company for 15 yrs, then with a State Insurance Dept. for another 25, she was laid off because they didn't have any Bankruptcies to handle, ANY, not in any category and the Department did not expect any for the foreseeable future.
It's all about money; remember REGULATION FD? The SEC doesn't follow what regulations it establishes, that is why there were so many fraud cases in the past 10 years.
the logic of your argument doesn't explain what happened to:
- AIG (significantly under reserved for the risk that it assumed),
- Countrywide (significantly under reserved for the risk that it assumed),
- MBIA (significantly under reserved for the risk that it assumed),
- Ambac (significantly under reserved for the risk that it assumed)
- FSA (significantly under reserved for the risk that it assumed)
- Fannie (significantly under reserved for the risk that it assumed)
- Lehman (significantly under reserved for the risk that it assumed, and significant liqudity issues)
- Freddie (significantly under reserved for the risk that it assumed)
- Indymac (significantly under reserved for the risk that it assumed)
- WaMu (significantly under reserved for the risk that it assumed)
- Wachovia (significantly under reserved for the risk that it assumed)
- National City (significantly under reserved for the risk that it assumed)
- XL Capital (significantly under reserved for the risk that it assumed)
Bear Stearns (significantly under reserved for the risk that it assumed)
---- this list can go on for quite some time and only covers a and and a half year period. Recent history has thrown us a boatload of uncontravertible evidence that shows that assets and guarantees written with leverage at the top or near the top of a bursting bubble simply cannot survive and will be called upon. Any institution that does not have both the capital and the liquidity to deal with this call will be eliminated.
One cannot expect the losses to cease simply because the entity in question refuses to recognize the loss. All that does is keep investors and potentially regulators (who are now in cahoots, apparently) in the dark until the company eventually approaches collpase.
The difference between your cat and life loss analogy and what is happening here is that the claims of loss are highly levered, the settlement process is significanly quickened (through products such as CDS), and the state govt. reserving process which insures at least a modicum of practical protection, simply does not exist.
These are all companies that I have discussed in my blog, most of which I have warned about months before their collapse and quite profitably shorted from atmospheric heights down to zero or close to it. I did not have a crystal ball, only a spreadsheet and some unbiased, unshaded analysis. Do a search for these companies on my site, and sort by date (oldest post first) and you will see the bread crumb trail.
My team is just finishing up the JPM analysis, and not only did they create last quarters accounting profit out of a solid economic loss, they are steeped in economic risks that they are not only under reserved for, but in the biggest case, not reserved (at least as can be determined from public filings) at all. This is with $80+ trillion of derivatives on the balance sheet and only $79 billion of tangible equity of which to cushion against losses.
Now, that is what I call leverage.