July 18, 2007 / 2:12 PM / in 10 years

JPMorgan profit hurt by home equity loans

NEW YORK (Reuters) - JPMorgan Chase & Co. (JPM.N) said on Wednesday it tripled the amount set aside for loan losses as even borrowers with good credit defaulted on home equity loans, hurting the bank’s quarterly profit.

The JPMorgan Chase headquarters in a file photo. JPMorgan Chase said on Wednesday it tripled the amount set aside for loan losses as even borrowers with good credit defaulted on home equity loans, hurting the bank's quarterly profit. REUTERS/Peter Morgan

The negative trend provides a new worry for investors. Until now, most of the angst has been focused on subprime lending, or loans to people with weak credit.

JPMorgan’s stock, a Dow 30 component, sank $1.75 or 3.5 percent to $48.17 in early afternoon trade and was one of the biggest losers in the Dow Jones industrial average. The index was off about 1 percent.

JPMorgan Chief Financial Officer Mike Cavanagh said losses on home equity loans to prime borrowers, or those with good credit, will steepen, partly because U.S. housing prices have flattened or fallen in some areas.

The No. 3 U.S. bank said second-quarter net income was $4.2 billion, or $1.20 a share, compared with $3.5 billion, or 99 cents a share, a year earlier. That beat analysts’ average estimate of $1.08 a share, helped by a sharp rise in investment banking revenue and big gains from private equity deals.

But the bank set aside $1.53 billion for loan losses, up from $493 million a year earlier. About a one-third of the increase resulted from higher loss estimates on home equity loans in which borrowers had little equity in houses with falling values.

Deutsche Bank analyst Mike Mayo estimated that the extra money set aside for loan losses reduced JPMorgan’s earnings by about $350 million, or 10 cents a share.

“It’s definitely a change in trend that we’re reacting to,” Cavanagh told reporters on a conference call.

The bank bolstered its reserve for loan losses to make the transition from a benign credit environment to one that is expected to get worse, the executives said.

“The loan loss reserve increase has investors spooked,” said Kenneth Crawford, a portfolio manager at Argent Capital, which owns about $12 million in JPMorgan stock. “Credit quality is decreasing and it’s a moving target.”

WEAK SPOTS

JPMorgan said regional banking and auto finance were weak spots in the quarter, with profit in those areas declining.

The bank’s retail finance division set aside $587 million, part of the overall loan loss reserve number, up from $100 million a year earlier, to reflect weak housing prices and the resulting increase in losses on home equity loans.

Cavanagh said the bank had problems with home equity loans started by independent mortgage brokers. The bank has since tightened underwriting standards and raised prices to reflect elevated risk.

    JPMorgan’s overall net revenue rose 25 percent to $18.9 billion, higher than the $17.5 billion expected by analysts.

    Investment banking continued to be a bright spot as JPMorgan raked in fees from merger and acquisition advice. Investment banking revenue surged 34 percent to $5.8 billion, from $4.3 billion a year earlier. The first quarter was better, though, at $6.3 billion.

    “The take-away message from JPMorgan’s results is that even better operators are going to catch some flak from weak spots in the mortgage and leveraged lending markets,” analysts at independent research firm CreditSights said.

    JPMorgan Chairman Jamie Dimon slammed loaning cash upfront on leveraged buyout deals, calling it a terrible idea. But JPMorgan and other big banks make these loans to keep prized private equity clients happy, despite a big potential downside.

    “I think equity bridges are a terrible idea,” Dimon said during the conference call. “...I don’t think they’re good for the private equity guys, so I hope they go the way of the dinosaur because they’re basically a one-sided put on our balance sheet.”

    Meanwhile, the bank’s retail financial services division, which includes home loans, credit cards and auto financing, reported $785 million in net income, down 10 percent.

    JPMorgan’s asset management business saw profit soar 44 percent to $493 million as the unit took in more money from clients. The unit now has $1.1 trillion under management.

    Reporting by Tim McLaughlin

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