JPMorgan (JPM) reported second-quarter earnings this morning and the magic number is $4.4 billion. That's how much the Whale cost the firm in the second quarter. The firm went through quite a bit of effort in its press release to make it clear that it is serious about never repeating the CIO desk's "whale of a mistake." The firm notes that it
- Significantly reduced total synthetic credit risk in CIO
- Substantially all remaining synthetic credit positions transferred to the Investment Bank
- CIO synthetic credit group closed down
That's all fine and good except that the CIO synthetic division was the most profitable group at the firm. Having said that, investors should of course be aware that the firm most certainly did not "earn" $1.21 per share in the quarter by any reasonable interpretation of the word "earn."
First, you have to strip out 16 cents per share from "securities gains in the firm's CIOs investment securities portfolio." These are the good assets the firm sold off so the Whale loss wouldn't exceed $5 billion. As I noted in a previous article, selling these performing assets deprives shareholders of any future revenue they may have generated. Additionally, it is difficult to see how including them in "earnings" adds anything to investors' understanding of the firm's financial position as they were already on the books as paper profits anyway, so selling them was a blatant attempt to juice the number everyone sees on the press release.
Next, the firm "earned" 33 cents per share by reducing loan loss reserves for mortgages and credit cards. These reductions are, of course, entirely derived by the firm's own models and are thus far from objective:
These reductions in reserves are based on the same methodologies we have used in the past - the good news is that these reductions reflected meaningful improvements in delinquencies and estimated losses in these portfolios.
Then of course, there are the dubious DVA "gains," which I alluded to in a previous article. The benefit to earnings was 12 cents here. I can't stress enough how nice it is that the firm gets to add 12 cents to earnings because its CDS spread blew out during the quarter.
Stripping out these items, (which, I would imagine, wouldn't count as "earnings" in the way most reasonable people would define earnings) the firm earned 60 cents per share in the second quarter. Considering this, and considering the uncertain outlook occasioned by the ongoing LIBOR and power market manipulation probes, JPMorgan is far from a safe bet. Investors should use Friday's post-earnings rally as an opportunity to either buy cheap put options on JPMorgan or short the stock.