It is well known that JPMorgan Chase & Co. (JPM) has suffered a trading loss of at least $2 billion, and potentially far higher, due to authorized hedge trades out of the bank's London Trading Office that soured. Early on in the crisis, CEO Dimon stated that there would be trading gains to offset part of those trading losses so that the $2 billion plus would not be a direct hit to earnings.
There are two ways for investors to assess the impact. My own worst-case scenario is $3.5-$4.0 billion of overall exposure due from the disclosed hedge losses along with costs of unwinding the position, and inevitable fines from regulatory bodies that face public pressure to show who is in charge. JPMorgan should be in a position to earn $4.5-$5.2 billion in operating profits per quarter this year, so even in a worst case, profits would not be wiped out in any quarter, and a loss this size is will make no real dents in the bank's long-term capitalization.
The best-known handling in corporate crisis management undoubtedly occurred 30 years ago, when Johnson & Johnson (JNJ) wrote the blueprint for dealing quickly, openly, and decisively with any product-related crises. It is amazing to me that after 30 years, some have forgotten, or perhaps never learned from how Johnson & Johnson recovered rapidly from the tainting of its Tylenol that led directly to the deaths of seven people in the Chicago area. Despite all evidence thus far to the contrary, let's hope Jamie Dimon and JPMorgan did learn lessons from 1982.
First and foremost, investors still need a clear explanation from JPMorgan. It should not take exhaustive work by the SEC, or by plaintiffs' lawyers in the civil suits that have been filed against JPMorgan to learn and understand what happened. Jamie Dimon should stand at a podium and explain to all exactly what happened and how we can be assured this will not happen again.
Next, of course, is the time-honored "kitchen sink" approach to managing the costs of the crisis. Force all costs into the second quarter of this year if at all possible, as everyone already knows this second quarter of 2012 will not be very profitable. Yet the longer this all plays out and the more quarters over which costs are incurred, the longer this sorry incident will be on investors' minds.
Yet, on the very day that the "London Whale" trading loss was disclosed, the chance for a one-quarter economic impact to JPMorgan had been lost. To assuage the investing community, Dimon stated that JPMorgan had nearly $1 billion in trading gains to offset the trading loss. It turns out that the big bank had sold some $25 billion in bonds and other securities to generate that $1 billion in pretax gains. The opportunity cost of redeeming such a large chunk of its securities portfolio has an incalculable opportunity cost. But what is calculable is that for many, many quarters to come, earnings have been marginally reduced.
To my way of thinking, I would be more comfortable investing in JPMorgan if I believed the company could put the past behind it quickly. Thus far, it seems that JPMorgan has chased quarterly profits at the expense of its longer-term profitability, and that is precisely what I do not want to see as a value investor. There is some time left for JPMorgan to manage this entire scenario in a way that it can benefit itself and the entire banking community. Let's hope that long-term viability, rather than a quarterly earnings statement, is JPMorgan Management's goal. I am not holding my breath.
For investors with steely risk tolerance, JP Morgan is 30% cheaper than it was 12 weeks ago.
If you like the idea of a big bank, and would appreciate some sense of safety and predictability, look to BMO Financial Group (BMO). The large Canadian banks, which include The Bank of Nova Scotia (BNS), Royal Bank of Canada (RY), and Toronto Dominion Bank (TD), all largely avoided the banking crisis last decade that devastated so many domestic banks. They are all high among the world's fifty safest banks, pay quality dividends, and have steady, but not great, growth potential.
Bank of Montreal stands out because, of all things, it has substantial American assets. In 1984, it bought Harris Bank, at that time a large, Chicago-based bank. It added Milwaukee-based Marshall and Ilsley, and folded it into its Harris Bank franchise. Bank of Montreal is now so entrenched in the United States, and the Midwest in particular, that it recently acquired long-term naming rights for the NBA Milwaukee Bucks basketball arena.
Prior to being acquired by Bank of Montreal, Marshall and Ilsley had been beaten down by the banking crisis and recession about as badly as any large bank in the country. The turnaround in the Midwest economy is apparent, lifting the balance sheets and income statements of windsocks like Comerica Inc. (CMA), Fifth Third Bancorp (FITB), and Pnc Financial Services Group,The (PNC).
This lifting tide has also aided the Midwest business of Bank of Montreal, helping to drive up its efficiencies and profitability. Now that the American assets are no longer an albatross around Bank of Montreal's neck, yearly and quarterly comparisons for the bank should look quite attractive, with profit growth outstripping its peers.
Analysts on average are looking at fiscal 2012 earnings of $5.53 per share, but I look for earnings close to $6 per share. I also expect 2013 earnings of near $7 per share. A longer-term growth rate of 8%-10%, along with rising dividends is in store for shareholders. This is a winning stock for growth and income investors who crave safety, and a refreshing departure from the short-termism ever-present at JPMorgan.