[Vision2020] Trust Accountants & CEOs

[Art Deco]

How Jamie Dimon hid the $6 billion loss By Stephen Gandel, senior
editor<http://finance.fortune.cnn.com/author/stephengandelfortune/>
July
13, 2012: 1:08 PM ET A mixture of accounting moves and rosy assumptions
appear to have masked JPMorgan's London Whale.
[image: Jamie Dimon]<http://fortunewallstreet.files.wordpress.com/2011/02/jamie_dimon_wef.jpg>

Whale Killer and CEO Jamie Dimon

FORTUNE -- Here is perhaps the most amazing thing about JPMorgan Chase's (
JPM <http://money.cnn.com/quote/quote.html?symb=JPM>) $5.8 billion trading
loss: Take a look at the firm's overall results, and it's like the London
Whale's misstep, one of the largest flubs in the history of Wall Street,
never happened.

Back in mid-April, about two weeks before talk of the trading losses
emerged, JPMorgan was expected to earn $1.21 a share in its second quarter.
On Friday, JPMorgan reported that it had, Whale and all, earned
exactly that<http://money.cnn.com/2012/07/13/investing/jpmorgan-earnings/index.htm?iid=HP_LN>
.

How the bank appears to have offset the huge trading loss is a prime
example of how complex and malleable bank profits actually are, and how
much they should be believed. JPMorgan's quarter should give fodder for
accountants to talk about for some time.

MORE: Who will take JPMorgan to
task?<http://management.fortune.cnn.com/2012/07/12/jp-morgan-jamie-dimon-2/?iid=SF_TS_Lead>

"Yes, I have seen these results, but I have also seen how the sausage is
made and I am worried that I might get food poisoning in the future," Mike
Mayo of Credit Agricole Securities  and author of the book *Exile on Wall
Street* told Dimon in a meeting with analysts following the bank's earnings
release.

Sure some of JPMorgan's businesses were strong. Profits in its mortgage
operations, helped by falling interest rates, rose by nearly $1.3 billion.
But a good deal of JPMorgan's earnings came from some shifting of losses
and an assumption that things for the bank, and the economy in general, are
about to get a good deal better. That assumption might prove right, but it
could also add to losses in the future.

So how do you make a nearly $6 billion loss go away? First stop taxes. The
bank said that the London Whale's blunder cost the bank $4.4 billion in the
second quarter alone. But that's before taxes. After it pays taxes, though,
JPMorgan says the loss will shrink to just over $2.7 billion, which means
the bank plans to take a $1.7 billion write off from Uncle Sam. Like any
loss, banks are allowed to use trading blunders to offset taxable profits
elsewhere in the bank. The question is the rate. At $1.7 billion, JPMorgan
is writing off roughly 38% of the loss. That's not that out of line with
the U.S. corporate tax rate, but it's a far larger percentage of profits
than most companies actually pay. Nonetheless, on taxes alone, the bank was
able to shrink the London Whale's wake to $4.1 billion.

MORE: How JPMorgan made its multi-billion dollar
blunder<http://finance.fortune.cnn.com/2012/05/15/jpmorgan-london-whale-blunder/>

We haven't left the firm's vaunted chief investment office yet. CEO Jamie
Dimon has long said the portfolio is safe and that if he were to liquidate
it today he could produce an $8 billion gain for the bank. In the second
quarter, he dipped into some of that. London Whale aside, the CIO took a
$630 million gain. Now we're down to $3.5 billion.

Next stop loan losses. Banks have to put money away for loans they believe
are going to go bad. But banks can lower their expenses by putting away
less money for future loan losses. In the second quarter, the bank put away
just over $200 million for future loan losses. That was not only the lowest
amount the bank had set aside in any three month period since the start of
the financial crisis, it was the lowest by far. A year ago, the loan loss
provision was $1.8 billion.

What's more, not only did the bank put away less money for future loans, it
also pulled back money it had put away in the past. And any money you take
out of your loan loss reserves the accountants let you send right to your
bottom line. It appears $1.3 billion, or about 28% of the company's total
second quarter profit, came from this move, which is again only real
earnings to accountants.

MORE: Wall Street's latest sucker: Your
hometown<http://finance.fortune.cnn.com/2012/07/11/libor-sucker-hometowns/?iid=SF_TS_Lead>

Of course, some of this move may be justified. The bank's loan portfolio
does appear to have improved - fewer new people are telling the bank they
can't pay their loans. The question is, once again, how much. For example,
in the bank's retail business alone, JPMorgan still has $8 billion in loans
in which people have stopped paying. That's only down by 4% from a year
ago. And CFO Doug Branstein told analysts not to expect any more reduction
in reserves from credit cards, which means they probably took all the
earnings juice they could get out of that business this quarter.

Put them together, and JPMorgan appears to have gotten a $2.9 billion boost
from changes it made to its loss provisions. Impressive. Just $600 million
of the Whale to go.

Now we get to the more esoteric moves. Mortgage servicing rights - the
obligation that a bank takes on to collect payments and pass those along on
the loans it sells to investors - are one of those assets that accountants
call intangible. Banks hold those rights on their balance sheets as if they
are worth something, but it's really an obligation, and no bank could
actually sell it, at least not for much. Nonetheless, JPMorgan said in the
second quarter, due to improved risk management - never mind the whole
robo-signing thing - the value of its mortgage servicing rights jumped by
$233 million, nearly 10 times the benefit the bank got from the same
accounting maneuver a year ago. And we're down to $400 million.

Finally, the bank pulled another classic loss hiding move: Say it happened
sometime else. Just before the bank released its earnings, it announced
that it was restating its first quarter earnings. JPMorgan now claims more
of the London Whale's trading losses happened in the first quarter, $459
million to be exact - or just slightly more than what Dimon needed to fill
the gap - than it earlier thought.

And, voila, with that, the London Whale disappeared from sight, or at least
from the horizon of JPMorgan's bottom line.

"I think they did as much manipulation as they could have to hide the
loss," says Christopher Whalen, who follows bank stocks for Tangent Capital
Partners. "Some businesses were strong, but I don't think they would have
tried so hard to boost earnings if the London Whale didn't exist."


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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