Analysis: JPMorgan dips into cookie jar to offset "London Whale" losses

NEW YORK (Reuters) - JPMorgan Chase & Co has sold an estimated $25 billion of profitable securities in an effort to prop up earnings after suffering trading losses tied to the bank's now-infamous "London Whale," compounding the cost of those trades.

CEO Jamie Dimon earlier this month said the bank sold corporate bonds and other securities, pocketing $1 billion in gains that will help offset more than $2 billion in losses. As a result, the bank will not have to report as big an earnings hit for the second quarter.

The sales of profitable securities from elsewhere in the bank's investment portfolio will increase its costs by triggering taxes on the gains and by eliminating future earnings from the securities.

Gains from the sales could provide about 16 cents a share of earnings, about one-fifth of the bank's second-quarter profit, analysts said. But rather than creating new value for investors, the transactions merely shift gains in securities from one part of the company's financial statements to another.

"They really made two stupid decisions," said Lynn Turner, a consultant and former chief accountant of the Securities and Exchange Commission. The first was taking risks with derivatives that they did not understand, Turner said.

"The second is selling assets with high income that they can't replace," Turner added. In a low interest-rate environment, the bank will struggle to generate as much income with the cash it received from selling the securities, he said.

Dimon first disclosed the sales on May 10 when he announced the derivatives losses generated from the bank's London office and trader Bruno Iksil -- dubbed the "London Whale" in credit markets due to the size of the trading positions he took. Dimon noted that the bank has another $8 billion of profit it could gain by selling an array of debt securities.

It remains unclear exactly when the bank sold the securities, and the bank has not detailed the value of securities it sold. Given the drawbacks of the sales, it also is unclear how many more the bank will sell to bolster second-quarter profits. To be sure, the bank may have additional reasons for making the sales, and the sales do not violate laws nor are they likely to hurt the bank's stability.

A JPMorgan spokeswoman declined to comment beyond the company's public statements.

$380 MILLION TAX BILL

However, based on disclosures that show the bank has historically realized less than a 4 percent gain from selling these kinds of securities, JPMorgan would have to sell $25 billion in securities to generate $1 billion in gains, according to a Reuters analysis of the bank's practices.

Taxes on the gains, if calculated at the 38 percent tax rate that JPMorgan uses to illustrate its business to analysts, would mean a $380 million cost to realize the gains. That would leave a net gain to earnings of $620 million, or 16 cents a share.

Before the sale, the gains would have existed on the bank's books as so-called paper profits, and would have been included on its balance sheet. But when the bank sold and realized the gains, they moved to its income statement as profit.

Paul Miller, an analyst at FBR Capital Markets, said the bank should skip the asset sales and "just take the pain" of reporting lower profits.

Dimon, too, has said he is reluctant to cash in good investments. He highlighted the tax issues in selling these securities when he spoke to analysts May 10.

"We can take some of those gains and we can take them to offset this loss," he said. "But usually it's tax inefficient, so we're very careful about taking gains."

Yet the bank is under pressure to show strong profits. Its stock has fallen 18 percent since the day before it disclosed the losses. It closed Friday at $33.50.

The bank currently is expected to report earnings of 90 cents a share for the second quarter, according to analysts surveyed by Thomson Reuters I/B/E/S. That compares with $1.24 a share before the derivatives debacle was disclosed and $1.27 a share that the bank reported a year earlier.

LOSSES COULD INCREASE

Dimon has not said who at the bank decided to sell the securities. Nor has he said if the decision was made before he knew that the derivatives losses could top $3 billion and before he told analysts on April 13 that reports of trouble with derivatives trades were a "tempest in a teapot."

Meanwhile, the bank's losses could grow, which could increase pressure on the bank to continue securities sales. Some analysts have said the total losses could exceed $5 billion, since the credit derivative markets in which the trades were made are thinly traded and current prices are not favorable to JPMorgan.

The pool from which the securities were sold included, as of March 31, corporate debt securities with an average yield of 3.15 percent and mortgage-backed securities yielding 3.41 percent, according to a company filing. Using the cash to buy back similar securities would not produce yields as high, analysts said.

The financial industry has gone through periods in the past when banks cashed out good assets to cushion losses, said former SEC Chief Accountant Turner. It happened during the U.S. savings and loan crisis in the 1980s, abated during a period of tougher regulatory scrutiny and fewer losses, and then came back during the latest financial crisis.

But the costs are significant. In statements about the latest losses, Dimon has been careful to emphasize the disadvantage of paying more taxes, said Chris Kotowski, an analyst at Oppenheimer & Co.

"I think he was trying to tell you, 'Don't expect us to offset all of these losses,'" Kotowski said.

(Reporting by David Henry in New York; Editing by Dan Wilchins, Edward Tobin, Alwyn Scott, Maureen Bavdek)

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