JPMorgan May Be Eroding Shareholder Value With Asset Sales

| About: JPMorgan Chase (JPM)
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I have published two articles over the past few weeks advising investors to either steer clear of JPMorgan (NYSE:JPM) shares or bet against the stock via short sales or put options. The first article cited the possibility that losses on the firm's disastrous derivatives trade could far exceed the firm's initial estimates and the second article noted that should a large portion of the derivatives in question be reclassified as 'Level 3' assets for the purpose of inflating the current quarter's earnings, investors could be mislead into thinking the firm's finances are in better shape than they are.

On Tuesday, several news outlets reported that the firm sold $25 billion in profitable assets in an attempt to offset the losses from the bad derivatives bet. This is indeed the first example of the firm manipulating earnings at the expense of shareholder value. According to Reuters, the sale of the securities will add 16 cents (roughly 25%) to the firm's quarterly earnings, but will cost the bank dearly in terms of taxes and the loss of future revenue--the tax bill is around $380 million and the yield on the securities sold averaged around 3.25%. Additionally, the sale adds no real value: the gains from the securities were already on the books in the form of paper profits, they have merely been moved to the income statement.

CEO Jamie Dimon has said that the firm's CIO office (the division responsible for the trade that imploded) has other profitable assets--around $7 billion in unrealized gains sit on the CIO's books--it can sell if it needs to, implying that should the losses from the bad part of the unit's portfolio continue to mount, the firm will continue to sell off good securities. This is not a good thing; selling performing assets in order to save face at the expense of long-term earnings potential is a less-than-desirable scenario at best and a very bad decision at worst.

While Dimon has indicated that he will be judicious regarding the sale of good assets due to the considerable tax ramifications, the firm's decision to sell $1 billion worth of the assets seems to indicate otherwise. Indeed, the firm would probably be better-off simply taking its medicine this quarter in the form of depressed earnings (analysts have already lowered their EPS estimates by around 20% anyway, so it's not as if no one is expecting this), rather than foregoing future earnings to cover up something everyone already knows about.

Especially frightening is the following justification for the sales mentioned in the Reuters article:

The financial industry has gone through periods in the past when banks cashed out good assets to cushion losses, said former SEC Chief Accountant Turner. It happened during the U.S. savings and loan crisis in the 1980s, abated during a period of tougher regulatory scrutiny and fewer losses, and then came back during the latest financial crisis.

So the current predicament JPMorgan faces is being compared with the savings and loan crisis and the financial crisis of 2008-2009--hardly the "tempest in a teapot" event Jamie Dimon described when news of the losses first surfaced.

As I have mentioned before, the fact that JPM suspended the buyback program indicates the seriousness of the situation: JPM would likely be buying its own stock here were it allowed to. It seems likely however that regulators instructed JPM to cease buying back the stock given the contradictory nature of Dimon's comments on the matter: he recently intimated that suspending the buybacks was a means of preparing the bank to meet new international capital guidelines, not a response to the trading loss. However, Mr. Dimon previously "said buying back stock helps the company meet regulatory requirements quicker." Those two notions cannot coexist--they are blatantly contradictory. According to Zero Hedge's interpretation of the Fed's stress test results for JP Morgan, the

permissive gating conditions, which if met, would still enable JP Morgan to...buyback [shares]... [say that] $31.5 billion is how much pain JPM is allowed, in the NY Fed's view, to suffer before losses and dividends/buyback would jeopardize the capital structure, and the buyback process should be halted.

Coming full circle with the argument then, the question becomes: if losses ballooned to $10, $20, or $30 billion on the trade, how many good assets would the firm be forced to sell off the cover those losses, and what would the attendant impact on shareholder value be and what would the tax bill be once gains on the assets are locked-in? These are questions that need to be answered before anyone buys these shares. Short JPM or buy puts until Dimon gives investors some answers other than to say that the trades will be "something we don't have to talk about by the end of the year."

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in JPM over the next 72 hours.