J.P. Morgan Chase (JPM), America’s biggest bank, admitted last week it lost $2 billion on a derivatives trade that its chief executive, James Dimon, called “flawed” and “poorly reviewed.” Its shares have tumbled in response.
And that presents an opportunity for the bank to make its money back and then some.
J.P. Morgan’s appetite for complex credit bets is matched by an appetite for its own shares. In March, when the company announced a dividend increase, it also authorized a $15 billion stock repurchase program, with $12 billion of the funds earmarked for this year. Companies buy back shares in an effort to make remaining shares more valuable, thereby putting their surplus cash to use for investors.
Whatever J.P. Morgan loses on its soured trade — the bank warns it may lose an additional $1 billion before unwinding the positions — it also stands to save plenty by carrying out its share repurchases at a lower price. It could take the bank one quarter, maybe two, to make its money back in savings, reckons Marty Mosby, an analyst with Guggenheim Securities.
Consider: The $2 billion trade loss is offset by gains on other trades, resulting in a $1 billion net loss so far. J.P. Morgan will be able to use this loss to offset other profits for tax purposes, effectively making it a $650 million loss after taxes.
Mr. Mosby expects JP Morgan to repurchase 60 million shares this quarter. He notes that the stock price has fallen by $10 to $36 and change since the end of the first quarter. (The Wall Street Journal first reported on the massive derivatives trade on April 5.) The discount may thus save the bank $600 million on its repurchases — nearly enough to offset that $650 million after-tax loss.
If the stock price stays at its current level for the rest of the year, J.P. Morgan could save much more than it lost.
Of course, whether that savings on share repurchases ultimately proves a good deal for investors depends on JP Morgan’s stock price recovering in future years. As the surprise trade loss illustrates, Wall Street’s earnings estimates for complex banks should be viewed cautiously. But the estimates bode well for J.P. Morgan shares.
A $1 billion net trading loss during the second quarter would reduce earnings by around 17 cents per share. Analysts over the past week have already lowered their full-year consensus estimate by 27 cents. Nonetheless, J.P. Morgan’s earnings are expected to rise to $4.71 per share this year from $4.48 last year. Early forecasts for next year call for earnings of $5.55 a share.
If those estimates prove anything near accurate, and if the stock price responds to future earnings growth — two big ifs — J.P. Morgan’s massive loss may turn into an even larger gain by this time next year.