Dimon Beset by Bad Loans as JPMorgan Pushes Overseas

Jamie Dimon, CEO of JP Morgan Chase & Co.
Jamie Dimon, chief executive officer of JP Morgan Chase & Co. Photographer: Tim Boyle/Bloomberg

Jamie Dimon wanted Washington Mutual Inc. and he wanted it bad.

The JPMorgan Chase & Co. chief executive officer was determined to expand on the West Coast, and Seattle-based WaMu, as it was called, was a prime target. Dimon had a team of auditors poring over WaMu’s books in March 2008, at the same moment the Treasury Department was pressing him to acquire struggling investment bank Bear Stearns Cos.

While he initially couldn’t make a deal for the Seattle lender, JPMorgan did buy WaMu in September 2008 after it was seized by the Federal Deposit Insurance Corp., which meant the assets came at a bargain price of $1.9 billion, Bloomberg Markets magazine reports in its December issue.

The 2,200 WaMu branches in California, Washington and 12 other states gave JPMorgan’s consumer bank, Chase, a total of 5,410 branches -- the second-biggest network in the nation. And it moved Chase to first from third in deposits, with $905 billion after the deal closed.

Dimon, 54, got what he wanted -- and a lot that he didn’t want. JPMorgan is now saddled with $74.8 billion in nonperforming home loans inherited from WaMu, a third of the $230.7 billion in mortgages on its books.

The WaMu losses are just one of the afflictions besetting the man who, in the midst of the recession two years ago, was dubbed the world’s most powerful financial executive by the New York Times and labeled President Barack Obama’s “favorite banker.”

King Jamie

New York magazine called him “Good King Jamie,” while a biography of Dimon by author Duff McDonald is entitled Last Man Standing (Simon & Schuster, 2009).

Back in 2008, Douglas Ciocca, managing director of St. Louis-based asset manager Renaissance Financial Corp., compared Dimon with J. Pierpont Morgan himself, who helped rescue the financial system in the crash of 1907.

“He’s been a voice of reason throughout the industry pretty much throughout the financial crisis,” Ciocca said.

A lot has gone wrong for Dimon since those halcyon days. Both the WaMu mortgages and JPMorgan’s own home-equity loans are spilling red ink. Dimon’s commodities-trading team, led by Blythe Masters, has suffered a big setback. Dimon complains that hundreds of millions of dollars in profits will be lost to the Obama administration’s new financial regulations, which he fought unsuccessfully to derail.

Basel Costs

Still more potential profits will be lost to the new Basel rules, which will increase capital requirements for banks worldwide beginning in 2013. The Basel Committee on Banking Supervision pushed back the date the capital rules would take effect because of the fragility of most of the big banks in the U.S. and Europe.

In consumer banking -- JPMorgan’s biggest revenue source -- the bank is pushing against a regulation limiting it to 10 percent of national deposits. With more than $2 trillion in total assets, JPMorgan is now the second-biggest U.S. financial institution by assets, after Bank of America Corp.

It’s the biggest U.S. credit card company, with $137.4 billion in outstanding loans, followed by Bank of America and Citigroup Inc.

The latest bad news is that the Securities and Exchange Commission is investigating whether JPMorgan failed to tell investors that an Evanston, Illinois-based hedge fund called Magnetar Capital helped select subprime mortgages for a collateralized debt obligation, or CDO, that the bank created, a person familiar with the matter said yesterday.

‘Cooperating Fully’

Magnetar later bet against the security, the person said. JPMorgan spokeswoman Kristin Lemkau said the company, “like other firms, has received inquiries from the SEC related to collateralized debt obligations. We are cooperating fully with these inquiries.”

The bank’s shares dropped as much as 1.4 percent after the investigative Web site ProPublica disclosed the probe yesterday, closing down 21 cents, at $37.42. They fell 46 cents or 1.2 percent more today to a close of $36.96.

Dimon has ambitious plans for overseas expansion, yet is hemmed in by banks with big international franchises, especially in the so-called BRICs: Brazil, Russia, India and China. Just a quarter of JPMorgan’s total revenue comes from outside the U.S., compared with more than half for Citigroup, says Anthony Polini, an analyst at investment bank Raymond James Financial Inc. International business, however, accounted for 61.6 percent of JPMorgan’s net income in 2009.

Overseas Expansion

Dimon is likely to expand overseas through acquisitions, Polini says -- the New York banker’s approach since he linked up right out of Harvard Business School in 1982 with Sanford Weill and helped Weill build the financial conglomerate that became Citigroup.

Yet Dimon has made only one major acquisition since WaMu. He’s been too busy putting out fires. In addition to the WaMu losses, Dimon has to deal with $113 billion in risky subprime, home-equity and adjustable-rate loans that JPMorgan originated.

In October, the bank halted foreclosures on thousands of homes when lawyers for homeowners said that JPMorgan, Bank of America, Ally Financial Inc. and other big banks had been “robo-signing” foreclosure documents without verifying their accuracy. JPMorgan temporarily stopped foreclosures in the 23 states where they are processed through the courts, later expanding the number to 41.

Bank of America, the nation’s biggest mortgage holder, stopped selling off homes in all 50 states before reversing course.

Regulation Blues

Meanwhile, Dimon’s standing in Washington has declined since he lobbied against parts of Obama’s financial regulation law, which imposes new capital requirements on banks, forbids proprietary trading and imposes new regulations on the trading of derivatives, of which JPMorgan is the U.S.’s biggest dealer.

Dimon wasn’t included in the photo op when the bill was signed, and he was absent from a May White House state dinner attended by American Express Co. CEO Kenneth I. Chenault, Morgan Stanley’s James Gorman and Bank of America’s Brian T. Moynihan, among other Wall Street leaders.

When a shareholder asked Dimon during JPMorgan’s annual meeting in May whether he was still Obama’s favorite banker, he replied, “I heard he has a new one.”

Dimon, a Queens, New York, native, is well-known for his refusal to mince words. When he dresses down subordinates, politicians or the media, he uses profanity liberally, according to people who have heard him. In June, students at Syracuse University protested when he was invited to give the school’s commencement address.

Lap Dogs and Sycophants

He went ahead with the speech and congratulated them for speaking their minds.

“Throughout my life and throughout this crisis, I’ve seen many people embarrass themselves by failing to stand up, being mealy-mouthed and acting like lemmings by simply going along with the pack,” he told the graduates. “Along the way, you’re going to face a lot of pressure -- pressure to go along, to get along, to toe the line. Have the fortitude to do the right thing, not the easy thing. Don’t be somebody’s lap dog or sycophant.”

JPMorgan declined to make Dimon available for this story.

Dimon anticipated that his crown was likely to be knocked askew. In 2009, he told attendees at a meeting, “I know exactly what the headline will say when I make a mistake: ‘Dimon Loses Luster,’” according to two people who heard the comments.

Best Big Bank

Yet Dimon’s bank is still the brightest star in a dim firmament. While JPMorgan’s stock lost 14.4 percent in the three years through today, investors did far worse buying the shares of its competitors. Citigroup shares were down 89 percent in the same three years, while Bank of America’s return was minus 74.7 percent and Wells Fargo & Co.’s stock fell 19.6 percent.

“Revenue headwinds such as slow loan growth, slim profit margins and higher regulatory costs should continue to hammer bank revenue not only next year but for the decade,” says Mike Mayo, an analyst at Credit Agricole Securities USA Inc. in New York. “We think 2011 will be indicative of a year in a decade for banks that has the worst revenue growth since the Depression.”

The debacle in the housing market is still the biggest headache for U.S. banks. Payments on some 8 million U.S. mortgages were delinquent in late September, and almost 7 million of those may end up in foreclosure, says Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP.

11.5 Million Seizures

Those projections exclude the 200,000 additional borrowers that become delinquent each month for the first time, she says.

In total, Goodman estimates that 11.5 million homes could be repossessed by banks during the next five years.

Profits are also being squeezed by the Federal Reserve’s policy of keeping interest rates persistently low, which had helped boost bank earnings during the worst of the credit crisis, says Matthew O’Connor, an analyst at Deutsche Bank AG in New York. The Fed’s near-zero target rate for interbank overnight lending is compressing banks’ net interest margins, the difference between what they pay to borrow money and what they get for loans and securities.

“It’s a massive issue,” O’Connor says. “As you look out over the next few quarters, it’s a potentially very dire situation for the overall industry.”

JPMorgan’s results for the third quarter confirmed O’Connor’s pessimism. Margins fell by 31 basis points to 3.01 percent at JPMorgan from March 31 to Sept. 30. (A basis point is 0.01 percentage point.) Combined with lower lending volumes, the reduced margins translated to a decrease in net interest income of $1.2 billion.

Revenue Drops

While third-quarter profit rose 23 percent from 2009 to $4.42 billion, the company generated 11 percent less revenue, at $23.8 billion. The profit included $1.5 billion the bank took out of its reserves against bad credit card loans.

“Investors are still trying to figure out where revenue is going to come from when they stop being able to release reserves,” says Jason Tyler, a senior vice president at Ariel Investments LLC in Chicago. “That’s not clear yet.”

There may be more bad news hidden in JPMorgan’s books. The bank set aside $30 billion against bad WaMu loans when it acquired the thrift in 2008. Dimon predicted that number could rise by $24 billion if unemployment hit 8 percent.

Unemployment was 9.6 percent in October, yet JPMorgan had only upped its reserves by an additional $3 billion.

“WaMu was a top-to-bottom subprime lender,” says Paul Miller, a bank analyst at FBR Capital Markets Corp. in Arlington, Virginia. And its branch network outside California is not worth much, he says. “They were very expensive branches, not well placed.”

‘Performing Better’

The company told analysts last month that the WaMu mortgage portfolio could cost $3 billion more if losses continued at current rates. “The portfolio is performing better than expected in this type of environment,” says Joe Evangelisti, a JPMorgan spokesman.

Dimon says he doesn’t expect profits to be dented much by the foreclosure scandal.

“It will cost us some money to go back and make sure it’s done right,” he told analysts on the Oct. 13 earnings conference call. “It will delay some foreclosures. But the whole mortgage issue costs us so much money now, to me it will be incremental.”

He said that no one had been evicted who shouldn’t have been. JPMorgan is the third-largest mortgage servicer in the U.S., with 13 percent of the market as of June 30, according to industry newsletter Inside Mortgage Finance.

50-State Probe

On the same day Dimon made his statement, attorneys general in all 50 states announced a joint investigation into whether banks and loan servicers used false documents and signatures to foreclose on hundreds of thousands of homeowners.

In September, lawyers for defaulting borrowers disclosed that a mortgage executive at Chase Home Finance in Florida said in a May 17 deposition that she was among eight managers who together signed about 18,000 affidavits a month attesting to facts in foreclosure cases without personally checking loan records.

JPMorgan said on Oct. 13 that it was reviewing the documents for 115,000 loans. Nancy Bush, an analyst at Annandale, New Jersey-based NAB Research LLC, says JPMorgan can’t rid itself of the foreclosure mess so easily.

“Dimon was putting a happy face on this issue,” she says. “He’ll review 115,000 foreclosures now in process. But what about the rest that have already occurred?”

‘Long-Term Problem’

Brian Battle, vice president of trading at Performance Trust Capital Partners LLC in Chicago, says the bank’s foreclosure flaws are just becoming apparent.

“That can be a big long-term problem, very expensive,” he says. “The whole can of worms is wide open.”

Even as Dimon swims through a sea of trouble, he can brag that JPMorgan remains the strongest big bank in the nation. It’s the only major bank to have turned a profit in every quarter since the crisis erupted in late 2007. Per-share earnings have grown 14-fold since hitting a six-year low of 7 cents in the fourth quarter of 2008. They were $1.01 in the third quarter.

The bank has generated $29.9 billion in net income since taking over Bears Stearns in March 2008 -- an acquisition that has been a huge boon to JPMorgan’s investment banking franchise.

When JPMorgan acquired Bear Stearns and WaMu, Dimon “had the strongest balance sheet in the industry,” says Robert Willumstad, a former Citigroup chief operating officer who has known Dimon since they both worked at Baltimore-based Commercial Credit Co. in the 1980s. “That’s the exact position you want to be in: You want to be the strongest player in the marketplace when the government turns to you and says: ‘We’ve got a problem. Can you take it off our hands?’”

Efficient Integrator

Dimon’s surpassing skill is his ability to hold down costs, efficiently integrate new acquisitions and minimize risk, Willumstad says. During his four years as CEO of Chicago-based Bank One Corp., from 2000 to 2004, Dimon engineered a dramatic turnaround that took the bank from a $511 million loss in 2000 to a $3.5 billion profit in 2003.

When Bank One merged with JPMorgan in 2004 in a $58 billion deal, CEO William Harrison named Dimon president and chief operating officer. Dimon overhauled management, shuttered lagging businesses and instituted monthly management reviews in local branches.

Dimon was named JPMorgan CEO on Dec. 31, 2005. He largely avoided investing in the subprime housing loans that crippled Bear Stearns and Merrill Lynch & Co. -- at least until he bought WaMu. Since 2006, JPMorgan has generated $59.7 billion in profit at a compounded annual growth rate of 22 percent.

Fees Double

Investment-banking fees, including those from trading and extending credit lines to clients, were $20 billion during the first nine months of 2010, up from $9.4 billion for the same period in 2004.

Dimon honed his cost-cutting skills while managing the serial acquisitions that he and Weill used to build Citigroup. The two men worked together for 16 years, starting at American Express. The list of institutions Weill and Dimon then took control of reads like a history of modern finance: Travelers Group Inc., Shearson, Smith Barney, Salomon Brothers, Citicorp and Primerica, to name the largest.

By the time Dimon was fired from Citigroup in November 1998 by Weill and his co-CEO John Reed, Dimon and Weill had created a banking, trading and insurance behemoth of unprecedented size and scope.

No Fools Invited

In his various jobs under Weill, “Dimon didn’t suffer fools,” says former Nasdaq Stock Market Inc. CEO Frank Zarb, now chairman of consulting firm Promontory Financial Group LLC in Washington. Zarb, 75, met Dimon in 1987 at Commercial Credit, and they have remained close ever since. “He was young but struck me as really smart and he called them like he saw them,” Zarb says. Some called the young banker brash, Zarb adds. “I call it intellectually honest,” he says.

At JPMorgan, Dimon hasn’t deviated from the management practices that have brought him this far. JPMorgan’s acquisition of Bear Stearns, the fifth-largest U.S. securities firm at the time, has gone far smoother than that of WaMu.

The bank ended up paying roughly $1.5 billion in stock to close the deal. The Federal Reserve Bank of New York agreed to take $30 billion of the struggling investment bank’s mortgage-backed securities, collateralized debt obligations and other illiquid assets. JPMorgan assumed the first $1 billion in losses.

JPMorgan got billions of dollars in new investment-banking revenue and a prime-brokerage business serving hedge-fund clients out of the deal. The acquisition boosted 2008 second-quarter profits by $500 million.

Faltering Economy

JPMorgan’s investment bank carried the bank’s earnings through 2008 and 2009. Fees and trading revenue began to falter in 2010 due to the persistently weak economy and high unemployment.

Dimon’s commodities division, run by Masters, was rocked in the second quarter by an undisclosed loss in its coal investments, when trader Chan Bhima took a position in the fuel just before prices plunged. Masters sought to reassure her team in an internal conference call on July 22, after what she called “extremely difficult” dismissals, defections and a 2010 first half in which some results were as much as 20 percent below expectations.

“Don’t panic,” Masters said in the 35-minute call, a recording of which was obtained by Bloomberg News. “No one’s going to get screwed. We’re not going to do crazy things on compensation at the end of the year.”

Commodities Firings

The company let go about 10 percent of the commodities front-office staff in the third quarter. JPMorgan also shuttered its commodities proprietary trading desk, affecting roughly 20 traders, most of them in London. They had to reapply for jobs elsewhere in the company.

The company said it cut the desk to comply with the Dodd-Frank law, which limits banks’ ability to trade for their own account. Other proprietary traders are being moved to JPMorgan’s asset management division, where they will trade for clients.

Dimon doesn’t want to hear excuses for his executives’ failures. He has a sign in his office in big bold type that reads “No Whiners.”

“It’s a looking-forward mentality: Don’t whine about it; just get it done,” says Ron Seiffert, whom Dimon hired from Huntington Bancshares Inc. to run Bank One’s small-business lending in 2002.

Seiffert is now vice president of Ohio Dominican University.

Doubling Down

Seiffert says Dimon displayed his philosophy when United Airlines filed for Chapter 11 bankruptcy protection in 2002, after being weakened by the 9/11 terrorist attacks. Bank One was one of the airline’s biggest creditors. Instead of scaling back his exposure, Dimon decided to extend even more credit to the airline.

It was a risky bet that eventually paid off, Seiffert says. “He said: ‘We made this decision. If we made the wrong decision, I’ll go home, I’ll have a couple of martinis, I’ll wake up the next day and we’ll come back,’” Seiffert says.

Dimon doesn’t always play the role of F-word-slinging tough guy. Executives, including junior managers, whose work catches his attention might get invited to sip wine in his office after markets close on Friday afternoon, current and former employees say. It’s a tradition begun under Weill, when Dimon was his chief of staff at American Express.

Executive Shakeups

Dimon has been both the victim and author of executive suite shakeups. After Harrison left the bank in 2006, Dimon replaced many of his top staff with former colleagues from Bank One and Citigroup. The most recent executive shuffle took place in September 2009, when Bill Winters, now 48, a co-CEO of JPMorgan’s investment bank, was fired and Dimon named James “Jes” Staley CEO of the unit.

Steven Black, the other investment bank co-CEO, was moved up to vice chairman; he has no operational departments reporting to him, people familiar with the matter say. Black and Winters declined to comment for this story.

Staley, 53, joined JPMorgan in 1979. He started out in investment banking on the Brazil desk, later running JPMorgan’s equity and capital markets group as well as its asset management division.

Dimon’s brain trust -- the people he gathers around him in times of crisis -- are a mix of new and old bankers, people familiar with his decision making say. Dimon said in March that he planned to rotate senior executives with an eye toward picking a successor. He’s been grooming a handful of long-time loyalists for the spot for years.

Brain Trust

Among them, besides Staley, are Heidi Miller, who was promoted in June to head of international operations after having started as Dimon’s assistant at Travelers Group in 1992; Charlie Scharf, head of retail services, who first worked with Dimon at Commercial Credit; Mike Cavanagh, head of treasury and security services, who was hired by Dimon at Salomon Smith Barney in 1993 and then again at Bank One in 2000; and Jay Mandelbaum, whom Dimon hired away from consulting firm McKinsey & Co. in the mid-1990s and who now runs JPMorgan’s strategy and business development division.

Dimon has also grown close to Stephen Cutler, the enforcement chief of the Securities and Exchange Commission under President George W. Bush who joined JPMorgan as general counsel in 2007.

One of the inner circle’s challenges is to deal with the raft of financial regulations passed by the Obama administration in July. Dimon told investors on Sept. 14 that the bank will lose about $750 million in profits just as a result of new restrictions on the fees and interest it can charge on credit cards.

Derivatives Hit

“No bank has more to lose with the new financial service rules than JPMorgan,” says Joshua Rosner, a bank analyst at independent research firm Graham Fisher & Co. in New York.

JPMorgan is especially vulnerable because it’s the U.S.’s biggest creator and trader of derivatives, securities whose value is derived from the price of stocks, bonds or commodities, Rosner says. The notional value of the bank’s outstanding derivatives contracts -- that is, the value of the securities underlying them -- was $75.6 trillion as of June 30, according to the Office of the Comptroller of the Currency.

A JPMorgan team led by Masters was among the first sellers of the most controversial form of derivative, the credit-default swap, which provides insurance against a security’s default.

$1 Billion Lost

The Dodd-Frank Act requires banks to move derivatives trading to separately capitalized subsidiaries, which Dimon is in the process of doing at what he says is a cost of $1 billion in lost revenue. Standard derivatives must be traded on exchanges, rather than over the counter.

“It’s an operational nightmare,” Dimon said on a July conference call with analysts, of the bill’s restrictions on derivatives trading. “In my opinion, it’s highly ill-conceived, doesn’t reduce risk at all.”

Dimon says he is looking for ways to pass on all of the extra regulatory costs to consumers and corporate clients. Fewer borrowers will get loans and credit cards, he says. He estimates that the passing on of costs will reduce the bank’s retail customer base by about 5 percent.

“We are going to earn it all back, whatever the number is,” Dimon told investors at a Sept. 14 conference hosted by Barclays Capital in New York.

The bank hopes to replace some of its lost profits by expanding overseas, particularly in the booming BRIC countries.

Throwing BRICs

“These emerging markets, primarily in Latin America and Asia, offer much better economic prospects than the U.S. or Western Europe,” Raymond James’s Polini says. “JPMorgan is ramping up to go head-to-head with Citigroup.”

Miller says JPMorgan needs to expand internationally because that’s where its corporate customers are.

“Multinationals operate in sometimes more countries than we do,” Miller said at the time she took her new job. “We increasingly see our clients look to us to provide services and solutions throughout the world. We want to make sure we can do it for them seamlessly.”

Investment bank head Staley laid out ambitious plans in February to double the bank’s market share in Asia in the next few years. U.S. banks, however, could have a difficult time widening their footprint there, Peter Sands, CEO of London-based Standard Chartered Plc, told Bloomberg News in October.

Global Blockade

Standard Chartered gets 90 percent of its revenue from Asia, Africa and the Middle East, and he says both international banks like his and local competitors could block new foreign intrusions.

“The best of the competition probably comes from the best of the local banks in most of our markets rather than from the international class,” he says.

One sector where JPMorgan already has global stature is commodities. Under Masters, JPMorgan has acquired a half dozen international concerns, including UBS AG’s global agriculture and Canadian commodities divisions in 2009. Buying Bear Stearns gave the bank a business trading natural gas, coal and weather contracts.

Last year, the company completed a $1.7 billion deal to buy parts of commodities trader RBS Sempra, a joint venture between Royal Bank of Scotland Group Plc and Sempra Energy. And in March 2008, the bank made itself a big player in European carbon trading when it bought Oxford, England-based ClimateCare, which sponsors projects that help reduce carbon emissions.

Commodities Leader

“What we have pulled off over the last three years is unbelievable,” Masters said during the July internal call. “We now, post-merger and post-all the other work we’ve done over the last few years, have a phenomenal physical capability that’s global, that involves storage, transportation across the world.”

Dimon, like his counterparts at other banks, is waiting impatiently for the housing crisis to ease so the bank can rid itself of its huge portfolio of bad loans. In addition to the WaMu writedowns, the bank faces an avalanche of litigation over allegedly predatory and fraudulent WaMu mortgages and has set aside a total of $3.5 billion in reserves to cover the cost of mounting lawsuits.

Dimon blames the continuing home-loan losses on house prices that keep falling, unemployment that remains high and an economy that’s recovering at a snail’s pace. He predicted in April 2008 that home prices would fall by a maximum of 9 percent over the rest of that year; they fell by 16.5 percent.

Hiking Reserves

Meanwhile, the company set aside $34.5 billion in reserves against potential losses on its mortgage, credit card and auto loans in 2009, up from $20.4 billion the year before.

“It is just going to take a little bit of time before the mortgage losses are run off and things normalize,” Dimon told investors in September. That means Dimon has more time to mull the question of whether buying Washington Mutual was that rarest of events in his professional life: a bad deal.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE