Big misbehaving banks in America haven’t been popular these days. The “Big Four” – Bank of America (BAC: Charts, News, Offers), JPMorgan (JPM: Charts, News, Offers), Citigroup (C: Charts, News, Offers) and Wells Fargo (WFC: Charts, News, Offers) – sucked up billions of taxpayer dollars, and in return started charging their customers with excess fees and pushing upon them unwanted financial products. Last week, JPMorgan gave investors another reason to despise big banks – by masking terrible earnings with deceptive accounting. Investors and analysts were not amused by the bank’s antics, and shares initially crashed 6% but made small recovery on Friday due to a market-wide rally. JPMorgan, the second largest bank in America, reported earnings of $1.02 per share, or $4.3 billion, a slight drop from the $4.42 billion, or $1.01 per share, it earned last year. Analysts were expecting 92 cents per share.
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At first glance, JPMorgan beat earnings expectations by a wide margin. However, after sorting through the company’s cluttered earnings report, it became apparent that JPMorgan had used an accounting trick known as debit value adjustment, or DVA, to pad its earnings. DVAs are caused by the bank’s widening credit spreads, which is a theoretical profit which would be realized if the bank were to buy back its own debt at a discount. In short, it’s nothing but theoretical earnings on a theoretical sale, which is nothing but an artificial boost that does not relate to the company’s fundamental financial health. Even CEO Jamie Dimon stated clearly, “The DVA gain reflects an adjustment for the widening of the firm’s credit spreads which could reverse in future periods and does not relate to the underlying operations of the company.” After removing the DVA adjustment, JPMorgan’s earnings actually came in at 73 cents per share, missing estimates by 19 cents.
Other big banks are expected to use similar accounting parlor tricks to pad their earnings during the earnings season. These shifty moves are not new to the banking industry. In 2008, big banks lobbied and forced Congress to change accounting methods from “Mark-to-Market” (which pins its revenue and earnings to directly available capital) to “Mark-to-Model” (which pins its revenue and earnings to “possible” future capital). “Mark-to-Model” has been widely ridiculed as “Mark-to-Make Believe” and continues to discourage investors, rightfully so, from investing in banking institutions. Financial blogger Barry Ritholtz commented, “Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell.”
JPMorgan, along with the other three members of the “Big Four”, have all underperformed the S&P for the year. Like its peers, JPMorgan faces the dreaded squeeze on net interest margins – the difference between their interest earnings on outgoing loans and interest payments on incoming deposits and financial products. JPMorgan’s investment bank reduced 4% of its staff in the third quarter, and is likely to reduce its workforce further in the fourth. Investment banks have suffered globally due to American and European inaction in the face of a spreading debt crisis, which has pummeled world markets. JPMorgan investors are likely going to have a long-term view of the markets, as the near-term picture is dire. The bank, while better off than its much maligned peer Bank of America, has been targeted by the “Occupy Wall Street” movement as a symbol of corporate greed and excess, and protesters have encouraged JPMorgan customers to close their accounts and deposit their money in smaller banks and credit unions. With a tiny forward P/E of 6.1 and a PEG ratio of 0.76, value investors may find an opportunity to build a small position in hopes of a financial recovery, but in these gloomy markets, momentum stocks have outperformed value stocks considerably.
Other News About JPM
Wall Street Protest Rallies at JPMorgan Branch to Close Accounts
Protests target JPMorgan in an effort to reduce the bank’s size.
JPMorgan’s Earnings Decline on Investment-Banking Slump
JPMorgan’s earnings plunge due to a gloomy macro environment.
Other Stocks in the News
UBS chief: Missteps must “never happen again”
UBS says “never again,” but does anyone buy it?
Kodak to license laser projection patents to Imax
Kodak treads water with its patents once more.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
