April 2, 2009 Following are our notes to the letter written by Jamie Dimon, CEO of JP Morgan. It is an excellent letter.
April 1, 2009 (Ron) (27.50) Notes to 2008 Shareholder Letter
“With great hesitation, I would like to point out that mistakes also were made by the regulatory system. That said, I do not blame the regulators for what happened. In each and every circumstance, the responsibility for a company’s actions rests with us, the CEO and the company’s management. Just because regulators let you do something, it does not mean you should do it. But regulators have a responsibility, too. And if we are ever to get this right, it is important to examine what the regulators could have done better. In many instances, good regulation could have prevented some of the problems. And had some of these problems not happened, perhaps things would not have gotten this bad.”
1. They were determined to be prepared for downturn. Yet, they claim what transpired was unprecedented and inconceivable.
2. Financial results marred by increasing credit costs for consumer and mortgage loans, as well as Investment Bank Write-Downs of > $10B, mostly from leveraged lending and mortgage exposure.
3. “Fortress balance sheet.”
4. Tier 1 ratio even without $25B TARP would have been 8.9%.
5. “Although we did not anticipate all of the extraordinary events of the year, our strong balance sheet, general conservatism and constant focus on risk management served us well and enabled us to weather this terrible environment.”
6. “We also know that the investment banking business, in many ways, will never be the same. Leverage will be lower, and certain structured financial products will likely cease to exist. But the fundamental business will remain the same: advising corporations and investors, raising capital, executing trades, providing research, making markets, and giving our clients the best ideas and the financing to make those plans a reality.”
7. Current charge-off expectations could range from $1.8B to $2.4B. This is an annualized loss rate of 3.5% to 5%. Dimon calls that rate “extremely high.” If I recall properly,
long time historic rates are in the 1% range.
8. Believes JPM has corrected underwriting lending mistakes of the past, and are now lending in a more “old-fashioned” manner. Claims a max of 80% LTV with full documentation.
9. 30% of legacy mortgage loans were originated through the broken and now terminated broker channel.
10. Expects branch based Retail Banking to generate 30% ROE’s over time. Consumer Lending expectations at 15% to 20%.
11. Largest credit card issuer in nation, since the WAMU acquisition.
12. Expects CC losses to track unemployment rate. Looking closely at risk management. Reducing the riskier lines of credit. Increasing reserves to $8B and intensifying credit collection efforts. Expects to lose money in this division in 2009. The reason the losses are expected to track the unemployment rate is because of accompanied housing price decline. Previously losses would be in area of ~78% of unemployment rate.
13. Commercial Banking will have a tough year in 2009. Expects industry problems in Commercial Construction. Yet claims to have “limited exposure and strong reserves.”
14. Expects Treasury and Securities Services (TSS), to continue to grow and be an important part of their future. ROE in 2008 was 47%.
15. Asset Management Business has been weak, expects weakness in 2009, but remains patient and expects 20% ROE over time.
16. “One important and critical point to highlight is that each of our businesses now ranks as one of the top three players in its respective industry. As ever, our goal is
to be the best, not necessarily the biggest. That said, we know that size matters in businesses where economies of scale – in areas such as systems, operations,
innovation, branding and risk diversification – can be critical to success. The only reason to get bigger and gain economies of scale is when doing so enables you
to do a better job for your clients; i.e., by giving them more, better and faster at a lower cost. Ultimately, this is also the only real reason to do a merger – the
client gets something better.”
17. Managed Net Revenue By Line of Business
|Retail Financial Services||$23,520||32%|
|Asset Management||$ 7,584||10%|
|Commercial Banking||$ 4,777||7%|
Bear Stearns Purchase
18. Integration and cost integration of Bear Stearns has been completed. By normal terms, Dimon considered the price low. Because conditions were not normal, they had to build in a risk price and a “huge margin of error.” “We were not buying a house, we were buying a house on fire.” All of Bears equity was used up in the integration. This ran through the income statement in the 2nd half of 2008. JPM had hoped for retained equity, but that did not occur. Yet, Dimon wrote, “”Despite these additional costs, we still believe that Bear Stearns has added significantly to our franchise. In particular, it completed our franchise in two areas where we were weak, Prime Brokerage and Commodities, and it enhanced our broader equity and fixed income businesses. Ultimately, we expect the businesses we acquired to add approximately $1 billion of annual earnings to the company.”
19. JPM was only bank prepared to act on the FDIC takeover. Acquired 2200 branches, 5500 ATM’s and 12.6M checking accounts. Also savings accounts, credit cards and mortgages. They did not buy any other assets, nor assume any unsecured or subordinated debt. This will add $2B (or $0.50 per share) of earnings in 2009, and more thereafter.
20. Expected cost savings of $1.5B, but now expects $2.B
21. Unlike Bear deal, they came out with around $4B in “good common equity.” The WAMU deal occurred on 9/25/08. JPM projected 10% forward decline in home prices. If home prices go down 20%, all other things being equal, could cost another $5B to $10B. Even if that occurred, JPM expects WAMU to have been a great deal.
22. I will forever remember this quote:
“In 2008, Bear Stearns collapsed; Lehman Brothers declared bankruptcy; Fannie Mae and Freddie Mac were placed into government conservatorship; the government assumed majority ownership of AIG; Merrill Lynch sold itself to Bank of America; Wells Fargo took over a struggling Wachovia; IndyMac and WaMu went into receivership by the Federal Deposit Insurance Corporation; Countrywide and the U.S. mortgage business virtually collapsed; the two remaining major investment banks, Goldman Sachs and Morgan Stanley, became bank holding companies; around the globe, French, British, Swiss and German banks were rescued by their governments; and the world entered the sharpest, most globalized downturn since the Great Depression.
As for JPMorgan Chase, we had large credit and operational exposures in virtually every situation mentioned above, affecting nearly every line of business. Our firm’s management teams, credit officers, risk officers, and legal, finance, audit and compliance teams worked tirelessly to protect the company. We believe it is a considerable sign of strength that we could manage through such extraordinary problems with minimal losses to the company.”
23. JPM emphasized they stayed away from sponsoring SIV’s, didn’t write Option Arms, cut back on sub prime mortgages early in the crisis, avoided structured finance (i.e. CDO’s), did not unduly leverage capital, maintained high level of liquidity, avoided short term funding of illiquid assets and does not rely on wholesale funding. “Simply put, we still follow the financial commandment: Do not borrow short to invest long.”
24. Did not ask for TARP infusion of $25B, but felt it was the right thing to do. Calls our leaders “bold and brave.” Had a wonderful quote from Teddy Roosevelt. “It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”
25. Thinks regulatory system is poorly organized and archaic.
26. Thinks Basel II allows for too much leverage.
27. “Derivatives have become an essential and widely used risk management tool.”
28. “As such, derivatives are a large business for JPMorgan Chase and for firms around the world. It is important to note that derivatives in and of themselves did not cause this crisis. In fact, derivatives have performed fairly well in this crisis environment. However, it is clear that derivatives, at least in financial reporting, are hard to understand, lack transparency and did contribute somewhat to the crisis. At JPMorgan Chase, we believe derivatives, when used properly, play an important role in managing risk, and we are trying to address the concerns about derivatives.”
29. “Some of the concerns about derivatives have to do with the large notional amounts. But those figures are reference measurements and do not reflect actual counterparty credit risk. Actual risk is the mark to- market value of the contract after taking into account netting of risk across all transactions with a counterparty, collateral and hedging. Actual risk projections also take into account the potential future exposure coming from market moves.”
30. “Our counterparty exposures net of collateral and hedges are $133 billion, and the company manages those exposures name by name – like a hawk. The figure is large, but we get paid to take the risks, we reserve and account for them conservatively, and we manage them in conjunction with all of our other credit exposures.”
31. JPM supports the development of clearing houses for derivatives. They think this will reduce counterparty and systematic risk.
32. Claims AIG’s fall was due to poor risk management and not use of derivatives. AIG did not give proper collateral and took concentrated risks through CDS.
33. “With proper management, systemic risks created by derivatives can be dramatically reduced without compromising the ability of companies to use them in managing their exposures.”
Fortress Balance Sheet
34. Focused on keeping fortress balance sheet intact. Recognizes obligation to pay dividends as well. “extraordinary times require extraordinary measures.” Discusses need for abundance of caution in this uncertain environment. Fortress balance sheet will give ability to seize opportunities.
35. Expects to pay out via dividends 30% – 40% of normalized earnings.
36. Expects to be able to withstand worse than expected economic scenarios, including Government stress test of 10.4% unemployment and 48% peak to trough house price declines.
37. “We believe we have a deep responsibility to you, our shareholders, and to our creditors, our clients and all our employees. We work incredibly hard to uphold all our obligations every day.”
38. “We employ 225,000 people worldwide in 48 U.S. states and more than 60 countries. Our 5,000 branches serve customers in 23 states. We provide health care coverage for 400,000 people. On average, we pay more than $10 billion a year in taxes to the U.S. government, as well as to state and local jurisdictions.”
Ron Redfield John O’Shaughnessy
908 276 7226