JP Morgan Earnings? Nothing Is But What Is Not...

My apologies to Shakespeare there...I have not done this type of analysis for quite some time for many reasons, largely time-related.  But this is the kind of "forensic accounting" that I truly enjoy.  The accounting standards used by public companies today have become a complete joke, and what standards remain go unenforced by the FASB/SEC/NASDAQ/FED etc.  When I saw JPM's earnings headlines this morning, my doubt about the "quality" of those earnings was triggered to the point at which I felt motivated to do a cursory examination of JPM's 8-K (preliminary 10-Q) filing.  I literally spent about 40 mins. just going thru the credit section located in the bowels of the 8-K, since this was the source of most of JPM's earnings boost.  I would like to qualify my work by saying that I would literally need all day to go thru this report plus the footnotes of the latest 10K in order to figure out exactly where JPM is exploiting the grey areas of FASB and pushing the envelope with accounting assumptions (like loan charge-off standards, deliquency period standards, interest rate assumptions, etc).  There is also a lot of information behind these numbers that would never be revealed to the public, so we have to make some assumptions about what is being manipulated on the "inside" books.  There is absolutely no doubt in my mind that there is serious manipulation of accounting standards and exploitation of the fact that these standards are rarely enforced, especially on a big, too-big-to-fail bank.

Why is this important and why does the whole earnings circus on Wall Street piss me off?  Because most investment money managers (big fund managers, etc),  financial advisors, stockbrokers and media morons look only at the headlines reported and assume that a company like JPM is telling the truth and they grab onto the headline information and spread it as gospel.  99% of all money managers and financial advisors, even the ones with fancy initials of accolade after their names, do not understand how to thoroughly dissect an SEC financial filing.  That skill is not required for them to be licensed to lose your money and take a lot fees in the process.  To be sure, some Wall Street analysts will go thru JPM's numbers like I just did and put together an analytic report that might highlight some red flags, but 99% of them will reiterate a "buy" recommendation and the portfolio managers, financial advisors and stockbrokers will grab onto those reports without reading them and justify loading up on JPM stock.  The whole circus is really a complete tragedy that will not end well in the long run.

So with that as a preface, let's jump into a "drive-by" look at what JPM reported and see if it makes sense and if the quality of earnings is solid or fraudulent.  Everything will be compared on a 1st quarter 2011 vs. 1st quarter 2010 basis.  Total revenues declined by 8.7%.  Not sure I would call that positive.  Net income, however, surged to $5.6 billion this quarter from $3.3 billion in 2010.  Well, when you are looking at a trillion dollar balance sheet, it only takes a small "adjustment" of bad loan assumptions to generate a couple billion in accounting income.  I am sure many of the assets JPM holds because they can't unload them - i.e. the toxic assets - were marked up in price to generate even more "paper income."  The disclosure on that latter source of "income" in the 8-K is very poor.   So how the hell did they report a huge jump in net income which was in excess of consensus expectations?

For purposes of this exercise I am just evaluating the credit statistics at a macro level.  My work is not precise but it's for sure within the bounds of "horseshoes and handgrenades."  To begin with, the "provision for credit losses" was $7 billion in Q1 2010 vs. only $1.2 billion this quarter.  Is this reasonable?  To be sure, if the 2010 number was large relative to the actual amount of losses experienced, it makes a lot of sense to reduce the provision recorded this year. "Provision" means an "estimate" of "potential" losses.  You can imagine that there's a lot of "wiggle" room in the assumptions made to calculate this "estimate," especially if Jamie Dimon leans heavily on his lieutenants to come up with some accounting earnings so they can beat the street and justify Dimon's HUGE bonus this year.  Let's just say that IF they had used a more reasonable 50% of the provision taken last year, it would have created a $3.5 billion accounting provision and that would have produced, roughly, only $3.3 billion of net income this year, which would have been a huge earnings miss.  I think it's safe to assume that if they "over reserved" for losses last year, they "under reserved" this year.  To be frank, if the Fed were not buying up toxic assets and if the Government were not guaranteeing a lot of bank assets, these provisions would much higher.  Especially given that we know for sure that deliquency and default rates on mortgages are still climbing.  Roughly 30% of JPM's assets are home-related loans (primary mortgages, home equity loans, home equity secured non-credit card loans, etc).  It's up to you to decide if JPM is being honest here, but I will unequivocally state that they did not take a high enough provision against credit losses by a couple multiples. 

Here's another interesting source of earnings management that I found.  They have mortgage repurchase liability on a lot of the mortgages they underwrote and then sold off to mortgage trusts.  That liability increased in 2011 to $3.3 billion from $2.3 billion last year.  This despite the mortgage foreclosure moratorium we have had.  That statistic alone justifies my statement in last sentence of the previous paragraph.  HOWEVER, despite an increase in this liability, the provision against this liability, i.e. the amount JPM has reserved for GAAP accounting purposes, was only $420 million vs. $1.4 billion last year.  That's a whopping $1.04 billion dollar swing in the expense line (lowering expenses by that much) and thus boosted net income by a little less than that, adjusting for taxes.  That number is about 26 cents of the 29 cents of earnings generated from lower write-offs referenced in the headline earnings summary (see any press release).   As you can see, it takes a very small change in bad-loan write-off assumptions to generate a big increase in GAAP-reported accounting earnings. 

One more little statistic that will never be reported in the press or analyzed by your financial advisor or retirement fund money manager is the percentage of non-performing loans as a percent of the total amount of outstanding loans plus deriviatives.  This is a HUGE area of earnings manipulation because it's data that gets buried in the bowels of financial filings and Wall Street analyst reports.  This number for JPM is absurdly low, as I'm sure it is for all banks.  But we know that JPM has an inordinate market share of entire derivatives market, and thus should probably be using higher assumptions for non-performing loans. Ha ha haaa.  For this year, JPM is reporting $15 billion in non-performing assets vs. total loans outstanding of $685 billion.  This would be 2% of total loans.  They are reporting a total balance sheet of $1.2 trillion, which includes loans plus derivatives.  So it's total reported non-performing loans represents only 1.3% of the entire balance sheet.

Does this make sense?  You tell me.  I find that number to be retarded, especially given the highly volatile nature of derivatives.  But let's say they are only light .5%.  Again, that is retarded.  But if they became only .5% less retarded and .5% more honest, that would create a $6 billion charge against earnings on a $1.2 trillion portfolio.  If this was their only mea culpa to the accounting gods - and none of the above mentioned areas of manipulation were adjusted toward the truth - they would have reported, roughly, a small loss for the quarter.  Imagine how big shareholders would howl in that case given the recently reported massive bonus Jamie Dimon awarded himself.  And believe me, I've been involved in quarter end games with trading desk assets in which we hid positions and had some positions marked way too high in order to increase the size of our bonus pool.  This was just on one small desk in the 1990's.  Imagine how large that fraud is across a big $1.2 trillion bank.

I could go on forever with this analysis but I would have to spend a week going thru JPM's public disclosures to ferret out some part of the golden truth.  Rest assured that what is disclosed publicly and can be put together with some forensic accounting is still based on "massaged fraud."  I would bet my last nickel that JPM is technically insolvent and that a very large percentage of its balance sheet is worth less than 50% on the dollar. 

Here is the link to the latest 8-K if anyone wants to peruse it for themselves Fraud-K  Since I don't get paid to do this work, I have to get back to doing what I do get paid for.  Ciao.