In Berkshire Hathaway's (BRK.B)/(BRK.A) annual letter last month, Warren Buffett encourages followers to read Jamie Dimon's annual missives. The J.P. Morgan (JPM) chief released the 2011 version on Wednesday, along with the firm's annual report. True to form, the 38 page letter contains some gems. Here are 11 takeaways from Dimon's letter:
1. J.P. Morgan's static earnings should be 25% higher in a more normalized environment. Mortgage-related losses and costs are preventing that, but those issues won't be with us forever.
2. The firm has been making up for its less than stellar performance dealing with military-related matters by making a military veteran hiring push. Dimon brags about hiring 3,000 veterans over the past few months. On an anecdotal level, I met a fellow Army Reserve Judge Advocate this past week who was recently hired to work in J.P. Morgan's compliance department. He felt his military experience was instrumental in getting an interview.
3. The firm has maintained its exposure to Europe. "These exposures are primarily loans to businesses and sovereign nations, as well as some market making." The goal seems to be to maintain the relationships in order to show customers they stuck with them when times were tough.
4. Dimon believes there is not a lot of waste to cut. Compare this to Brian Moynihan's New cost-cutting initiative at Bank of America (BAC). Moynihan has a lot to clean up. Dimon believes J.P. Morgan is much more efficient, and has been efficient in the past, so there's not much there to cut.
5. Big businesses aren't all bad. Dimon may be one of the few Wall St. figures who has the credibility to defend big businesses. He says large and small businesses need to work together, and we shouldn't separate the two when promoting public policies. It doesn't hurt that J.P. Morgan calls most of those big businesses customers.
6. If regulations are severely crimping J.P. Morgan, they must be disproportionately hurting banks less well-run. Dimon claims compliance costs are huge, requiring tens of thousands of workers and $3 billion of costs for the estimated 14,000 new regulatory requirements. The cost of credit will, and already has, significantly risen. That's not good for the economy.
7. More harmful is the confusion and complexity created by the new regulations. Page 20 provides a chart showing what regulator has what role. Some are inconsistent with each other. Hundreds are uncoordinated. This is not effective regulation. It encourages political turf wars and regulatory grandstanding as opposed to the goal of protecting consumers and promoting sound and effective markets. As Dimon has said on more than one occasion, "No one has considered the cumulative effect of all these changes taking place all at once." Overlay international standards on top of U.S. rules and it can be maddening.
8. J.P. Morgan has spent and lost tens of billions of dollars modifying and charging off mortgages and home equity loans. Ultimately, Dimon expects $27 billion of foreclosures and charge-offs on first mortgages alone.
9. Despite the previous paragraph, Dimon's next headline is this: "Housing is getting better - there, I said it." Over the last four years, household formation has only been half of the historical average. That can't last forever, and Dimon feels that there is significant pent-up demand. Furthermore, inventory is low, currently at a six month supply. There is still shadow inventory, but much of that may be bought up by investors and it could move quickly. With the economy improving, thus creating more jobs, household creation will begin to return to the historical average and prices will follow, perhaps quickly. This is why Warren Buffett has said that if he could, he'd buy up millions of single family homes.
10. J.P. Morgan doesn't disagree with the intent behind the Volcker Rule, but the implementation is the key. Dimon is concerned it will be written in a way that will make U.S. banks uncompetitive with foreign banks and that costs for costumers will increase.
11. How should investors look at J.P. Morgan's stock price? Dimon urges investors to look at tangible book value ($33.69 at the end of 2011), which he calls a "very conservative measure of shareholder value." J.P. Morgan would love to buy back shares around tangible book. Unfortunately, after this year's run-up in share prices, J.P. Morgan no longer trades around tangible book. At today's prices, Dimon indicates that the firm will only buy back shares to offset employee compensation. The takeaway is if he isn't willing to buy back shares at this multiple, perhaps you shouldn't be willing to pay this price either.
Consider the competition: Morgan Stanley (MS), Goldman Sachs (GS), and Bank of America all trade for less than tangible book, some significantly less. J.P. Morgan is surely the best of that bunch, but they're trading at a significant premium right now. Investors may want to be careful.