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Summary

  • JPM recently sold its physical commodity business to Mercuria Energy Group for $3.5 billion.
  • Unsteady commodity market, rising legal expenses, high debt makes it a right choice.
  • JPM leads GS, MS and other US banks in commodity income.

Recently, the Fed has been getting stricter about how the US banks are involved in the physical commodity business. In January this year, the Fed released an advance notice of proposed rule-making (ANPR) discussing the risks associated with banks' physical trading activities and potential regulatory changes that could mitigate those risks.

"Physical commodities activities can pose unique risks to financial holding companies," said the Fed's director of banking supervision and regulation Michael Gibson before a U.S. Senate subcommittee in January.

This is the reason why Morgan Stanley (MS) has agreed to sell its stake in Heidmar, as well as the rest of its global oil merchant unit, to the Russian state-owned oil producer Rosneft (OTC:RNFTF). (The deal is to complete in the second half this year.)

And this is why JPMorgan Chase (JPM) announced today that it will sell its physical commodities unit to Switzerland-based Mercuria Energy Group, ridding itself of a source of controversy and potential legal implications from the Fed regulations and Dodd Frank-Volcker Rule, bringing in $3.5 billion in cash for the company.

Right Step for JP Morgan Chase at the Moment

Now, there are a few reasons why JP Morgan Chase might have made just the right deal at the right time.

Rising Legal Expenses - First with the $13 billion settlement with Justice Department in November last year, $2.6 billion charge in the Bernie Madoff case in January this year, followed by the $400 million fine to Syncora Guarantee, legal woes for JP Morgan Chase is a never-ending issue as it seems. This year, JP Morgan is estimated to spend up to $5 billion in legal fees over and above current reserves, down from an estimate of $6.1 billion a year ago. In that case, an extra $3.5 billion in the coffer will prove to be helpful in these cases.

Falling Commodity Fair Value - Looking through the financial statements, it is pretty clear that fair value of physical commodities have dropped to $16.2 billion in 2012 from $26 billion in 2011. Now, since the trading assets have risen by around $7 billion in one year since 2011, it can be said that leaving the physical commodities business was long in the pipeline for JP Morgan Chase. Even being the top revenue gainer from the commodity business among US banks, followed closely by Goldman Sachs (GS) , JP Morgan Chase apparently made the right choice. Commodities revenue at the 10 largest US banks declined 18% last year to $4.5 billion because of lack of confidence among clients and low volatility, according to a report by the London-based analytics company, Coalition.

High Current Portion of Long-Term Debt - The current portion of the long-term debt of JP Morgan Chase presently stands at a massive $57.85 billion, which is far higher than $2.14 billion of Morgan Stanley and even higher than $44.7 billion of Goldman Sachs. It is wise of JP Morgan Chase to shed off the extra fat and get trimmer and more efficient if they want to operate in the future.

Alpha Bottom-line

Going by the current Fed's concern with physical commodity business by financial holding companies, the serious financial disposition of the too-large-to-fail US banks and the unsteady commodities market, I would say JP Morgan Chase has taken the right decision at the right time.

Please weigh in with your comments as well.

Disclaimer: This article includes my own personal opinion. Please consult your financial adviser before taking your investing move.

Source: JPMorgan Shedding Its Fat