The Real Impact of JPMorgan Chase Halting Its Share Buybacks

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JPMorganAs a result of the bank's recent $2 billion (and counting) trading loss, JPMorgan Chase (JPM) announced Monday it would be suspending its $15 billion share-buyback program. This is yet another blow to the bank's investors, who have already seen $30 billion in equity wiped out from the trade gone wrong.

Here's a primer on the costly trades, what the buyback program was about, and what its cancellation means for investors.

Details surrounding the trades continue to emerge, but here's the story so far: A trader working in the bank's London office, Bruno Iksil, placed a huge bet in the derivatives market. Derivatives, if you recall, caused much of the chaos we experienced in the 2008 financial meltdown.

Credit default swaps are a type of derivative, and were part of Iksil's bet -- a bet so big it "moved the market," i.e., interfered with other traders' positions. These traders -- mostly hedge-fund managers -- dubbed Iksil "the London Whale" for his outsize positions.

Eventually, they began counter-betting against Iksil. JPMorgan CEO Jamie Dimon initially wrote off the complaints as "a tempest in a teapot," but as losses began to mount, he finally had to speak up.

He initially reported losses to be $2 billion, with the possibility of them reaching $3 billion. Analysts for rival Morgan-Stanley (MS) are now estimating they could go as high as $5 billion.

The problem is, the positions the bank have taken are enormous, very complicated, and will take time to unwind -- which is why no one knows exactly how big the losses will be.


"Obviously, We're Not Going to Make as Much Money"

Per Dimon himself, the trading losses are the reason why JPMorgan is halting the share buyback program. "Obviously, we're not going to make as much money," he said in a statement.

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After the bank passed its most recent "stress test" (a test of a bank's balance sheet in a simulated economic nightmare scenario administered by the Federal Reserve), it was one of 15 banks allowed to increase its dividend and buy back shares.

Buying back shares is very popular among shareholders. Like any other commodity, the fewer shares that are out there the more each individual share is worth. But while buybacks are nice, their suspension will have no immediate effect on shareholders.

More importantly in all this are these two points:

1. JPMorgan's shareholder dividend is safe; Dimon said so himself as part of the share-buyback announcement.

2. JPMorgan Chase itself is in no imminent danger of collapse.

With total assets of $3.4 trillion, JPMorgan Chase is currently the biggest bank in the United States. Over the past 12 months alone, it's made $90.49 billion in revenue and $17.45 billion in profit. So even a $5 billion write-off would not affect the bank's overall solvency; the losses on this trade would have to multiply dramatically for that to be the case.
This too shall pass

By halting the share buyback program, Dimon is being prudent and tactful. Even with JPMorgan Chase's seemingly limitless assets, it's wise to preserve capital until all the trades are unwound and there's a full accounting of the damage done.

The Real Impact of JPMorgan Chase Halting Its Share Buybacks

With 10,000 lawsuits against them, you knew they'd be on the list somewhere. JPMorgan estimates it faces up to $3.315 billion in litigation after taxes, beyond what it has already paid out or reserved against. That adds up to 8.8% of the $37.612 billion JPMorgan is expected to earn in 2012-2013.

In 2011, JPMorgan's noninterest expense included $3.2 billion of litigation expense, mostly for mortgage-related matters, compared with $5.7 billion of litigation expense in 2010, according to Nomura's report

Citigroup estimates it is on the hook for up to $2.6 billion in litigation after taxes, beyond what it has already paid out or reserved against. That adds up to 9.9% of the $26.364 billion Citigroup is expected to earn in 2012-2013.

Citigroup faces a variety of regulatory inquiries and class action lawsuits related to its mortgage origination practices. The private lawsuits will not be included in a National Mortgage Settlement, reached last month with 49 state attorneys general and the federal government. Bank of America (BAC), JPMorgan, Wells Fargo (WFC) and Ally Financial, the former GMAC, were also part of the settlement.

Bank of America estimates it faces up to $2.34 billion in litigation expenses after taxes, beyond what it has already paid out or reserved against. That would equate to 10.9% of the $21.455 billion the bank is expected to earn in 2012-2013. The bank faces lawsuits related to mortgage originations and servicing, as well as for alleged failure to disclose its knowledge of ballooning losses at Merrill Lynch ahead of its eventual acquisition of that company.

The $2.34 billion figure, however applies only to "those matters where an estimate is possible," according to the bank's annual 10-K filing with the Securities and Exchange Commission.

Regions Financial estimates it faces up to $221 million in additional litigation costs after taxes, or 12.9% of estimated $1.707 billion in 2012-2013 earnings.

Regions is also on the hook for any litigation related to its Morgan Keegan brokerage unit, which it agreed to sell to Raymond James Financial (RJF) on Jan. 11.

Synovus faces just $39 million in potential litigation costs after taxes, above what it has written down or reserved against. However, that equates to 14.5% of the bank's estimated $270 million in 2012-2013 earnings.

As is the case with Bank of America, however, Synovus's estimates relate only to "those legal matters where [the company] is able to estimate a range of reasonably possible losses," according to its 10-K.

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JPMorgan came through the 2008 financial crisis with its reputation more intact than any of the other big banks -- primarily because of its ability to manage risk, much of which is attributed to Dimon himself. But the bank, by its own admission, made a big mistake here -- managing its risk in this situation very poorly, indeed. As such, it's paying the price: not just through damage to its balance sheet, but through damage to its reputation as well.

Unless there's some startling revelation, however, this too shall pass, and JPMorgan will get back into its groove relatively quickly.

Motley Fool contributor John Grgurich owns no shares of any of the companies mentioned in this column. The Motley Fool owns shares of JPMorgan Chase.

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