What Does JP Morgan’s Trading Loss Mean for Investors?

The answer is, not much. On the surface, there has been much hoopla around the $2 billion trading loss that JP Morgan (NYSE: JPM) suffered. Yesterday it was announced that Ina Drew was now the ex-Chief Investment Officer of JPM. Dealbook reported that two of “Drew’s lieutenants, Achilles Macris and Javier Martin-Artajo, are also expected to resign” and that the company would “form a team of senior executives to investigate and respond to the recent losses.” Our take is that if you take a step back and evaluate JPM as a whole, the couple billion-dollar loss will be easily absorbed.

JPMorgan Chase & Co (NYSE:JPM)

The lowdown on the trade is that in order to hedge corporate credit risk, JPM had re-hedged synthetic credit exposure. Now, the re-hedge is not working and the trade is losing money…and a lot of it. We expect that the losses will not be limited to $2 billion, given that as the re-hedge position is unwound, additional losses will accrue. However, let’s take a look at the company’s capitalization stats: total assets of $2.3 trillion and shareholders equity of $190 billion, 2011 revenues of $97 billion, and 2011 net income of $19 billion. That $2.3 billion (media has been rounding) amounts to ~1% of the firm’s total net worth, which isn’t worth going crazy over.

The loss was booked in the corporate & private equity division. According to CEO, Jamie Dimon, the $2.3 billion loss will be partially offset by a $1 billion gain from sale of securities, so that results in a $800 million Q2 loss for the division. In 2009 the division’s net revenue amounted to $6.6 billion, in 2010 it brought in $7.4 billion, and last year it generated $4.1 billion. The division has been around since 2006, and we’ve dug up to those numbers to show that the loss is manageable even on a division-level; we don’t see any spill-over losses. So, when that $800 million loss is put into perspective, it seems to lessen the sting. Besides, as an astute investor pointed out to us, the street doesn’t focus on the corporate and private equity division’s performance as a major earnings or expectations driver. For example, in Q1, the street didn’t bat an eyelash when the division reported that it had benefitted to the tune of $1 billion from a bankruptcy settlement. That certainly didn’t’ get a front page headline.

Additionally, from a more macro standpoint, JPM has a number of opportunities we think it will be able to capitalize on. Analysts have been increasing earnings estimates due to the company taking market share in Europe and returning capital to shareholders, among other factors. There are many bright spots in the business including decreasing mortgage foreclosure costs, a healthy investment banking department is doing quite well in gaining market share, the card business is showing stabilization in NIM, and growth in commercial and industrial loans.

Once again, the media has blown this way out of proportion and has conveniently left out any relevant context. We don’t want to discount the size of the loss. After all, $2 billion is a large chunk of change, but we seek to remind investors that JPM remains among the best capitalized banks out there, and that the firm is taking measures to investigate and prevent future similar incidents. Near-term volatility is likely as investors digest this news and information from the forthcoming conference call. Now, if JPM’s credit ratings are negatively impacted or if litigation arises from this event, we think it would be appropriate to reevaluate the situation. Meanwhile, we will be interested in tracking what changes Eric Halet, Paul Ruddock, Martin Hughes, and Christopher Grisanti make to their holdings of the stock.

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