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Settlement Unshackles JPMorgan's Stock (Update 1)

Updated from 9:23 a.m. ET with comments from Credit Suisse analyst Moshe Orenbuch and CLSA analyst Mike Mayo.

NEW YORK (TheStreet) -- A total fourth-quarter litigation tab of $17.5 billion is a tough pill to swallow, but JPMorgan Chase's (JPM - Get Report) aggressive move to settle the bulk of its mortgage mess sets the stage for a significant rise in the company's stock.

After weeks of leaks and word of difficult negotiations over the precise wording of the bank's admission that investors purchasing residential mortgage backed securities (RMBS) from JPMorgan Chase, Bear Stearns and Washington Mutual were misled about the quality of underlying loans, the bank finally entered into a $13 billion settlement with multiple government authorities on Tuesday.

JPMorgan acquired Bear Stearns in March 2008, when the investment bank was facing bankruptcy as its liquidity dried up.  Washington Mutual failed in September 2008, after which the nation's largest savings and loan institution was sold by the Federal Deposit Insurance Corp. to JPMorgan.

New York State Attorney General Eric Schneiderman, who heads President Obama's Residential Mortgage-Backed Securities Working Group announced the settlement between the bank, the Department of Justice, federal regulators and states' attorneys general.  This includes the previously announced $5.1 billion settlement with the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac

The settlement deal includes cash payments of $9 billion and another $4 billion in assistance to distressed homeowners.

Some investors and analysts have called the government's efforts to skewer JPMorgan over its mortgage sales practices a government shakedown.  But the RMBS working group continues to investigate other banks over their mortgage sales practices leading into the credit crisis of 2008.  Then again, Scheiderman said on Tuesday that some of New York's $1 billion portion of the settlement would be "directed to provide additional legal services and housing counseling for those affected by Superstorm Sandy."

Helping people affected by the storm is, of course, a laudable goal.  But it has nothing to do with JPMorgan's RMBS sales before 2009.

The bank's Tuesday settlement was preceded last Friday by a $4.5 billion RMBS settlement with a group of institutional investors, also covering sales by Bear Stearns and Washington Mutual.

JPMorgan reported having $23 billion in litigation reserves as of Sept. 30 and said on Tuesday it was "fully reserved for this settlement."  The company's third-quarter earnings were erased by a $9.15 billion provision for litigation reserves, in anticipation of the fourth-quarter settlements. 

JPMorgan CEO James Dimon during the company's conference call on Tuesday said the $4 billion portion of the settlement allocated to homeowner relief would not be drawn from litigation reserves, but would be reflected in the firm's operating expenses.

JPMorgan CFO Marianne Lake during the call said the $13 billion settlement "does not resolve claims on trusts issued by Washington Mutual. We continue to believe that WaMu repurchase liabilities remains with the FDIC, and litigation on this matter is continuing."  While resolving the possible Washington Mutual exposure will continue to worry investors, a subsequent settlement would pale compared to the one on Tuesday.  Morgan Stanley analyst Betsy Graseck in a client note on Monday wrote "We assume that risk remains with the FDIC receivership. If we're wrong, our bear case assumes a $3.3b payout."

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