Bernstein Research analysts John E McDonald, Ian Weber and Steven Wald take a close look at the potential claims against JPMorgan Chase & Co (NYSE:JPM) for mortgage backed securities (MBS) and GSE issuances issued by WMI Holdings Corp (OTCMKTS:WAMUQ).
JPMorgan Chase & Co (NYSE:JPM) acquired WMI Holdings Corp (OTCMKTS:WAMUQ) in 2008 from the FIDC. Deutsche Bank National Trust has sued JPM and FIDC jointly for claims arising from MBS issuances made by WAMU during the financial crisis.
Representations and Warranties at the core of the dispute
Who holds the can for the Representations and Warranties WMI Holdings Corp (OTCMKTS:WAMUQ) made in its MBS documents?
According to JPMorgan Chase & Co (NYSE:JPM), it agreed to discharge the “liabilities of the Failed Bank which are reflected on the Books and Records of the Failed bank as of Bank Closing.” By this reading, JPM has no liabilities relating to WAMU’s pre-failure mortgages.
On the other hand, the FIDC takes the defense that a section of its agreement with JPMorgan Chase & Co (NYSE:JPM) states “Assuming Bank specifically assumes all mortgage servicing rights and obligations of the Failed Bank.” By this view the liability falls squarely on JPM’s shoulders.
Whatever the eventual outcome of this dispute in the courts, the analysts attempt to quantify a worst case scenario for JPMorgan Chase & Co (NYSE:JPM), review its reserves for legal liabilities and thereby assess the impact on JPM’s stock valuation for 2014 and 2015.
Worst case scenario, JPMorgan’s reserves and hoping for the best!
Assuming JPMorgan Chase & Co (NYSE:JPM) is held liable for both WMI Holdings Corp (OTCMKTS:WAMUQ)’s private label MBS and GSE issuances, the analysts estimate its liability at about $5-$6B based on similar settlements (MBS ~$4B and GSE ~$1.5B).
With reserve additions after 2009 estimated at $21B this could be the reserve for all litigation including WAMU-related. The analysts suspect JPM “is hoping for the best, but planning for the worst,” and that WMI Holdings Corp (OTCMKTS:WAMUQ) related liabilities are already provided for.
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However, if JPMorgan Chase & Co (NYSE:JPM) is ultimately held not liable, they think this could positively impact 2014 and 2015 estimates by 7 percent-8 percent.
Bernstein Research says there is good value in JPMorgan Chase & Co (NYSE:JPM) shares given that the bank has the lowest P/E across the bank sector, and its optionality to higher interest rates as well as a “fading” of outsized crises costs could be positive on earnings in the future. Their current rating on the bank is Outperform.