Deutsche Bank Rats Out, Then Cuts JPMorgan

NEW YORK ( TheStreet) -- Two weeks after Reuters reported that Deutsche Bank had applied to be a prosecution witness in the Libor scandal investigation, Deutsche Bank analyst Matt O'Connor on Sunday lowered his rating for JPMorgan Chase ( JPM), in part because of the Libor scandal investigation.

Among the "regulatory/legal" matters cited by O'Connor in justifying his downgrade of JPMorgan's shares from a "Buy" rating to a "Hold" rating, were "LIBOR, VAR Value at Risk model changes, and CIO loss disclosures," which refer to the hedge trading activity by JPMorgan's Chief Investment Office, which led to $4.4 billion in trading losses, during an otherwise decent second quarter.

Reuters reported on July 15 that Deutsche Bank could "escape with a lighter penalty than other banks in Europe if investigators impose fines in the wake of an interest rate-rigging scandal," since the bank had applied to cooperate with authorities in their investigation under the leniency programs of the European Union and in Switzerland," according to unnamed sources.

JPMorgan's shares were down over 2% in early afternoon trading, to $36.08.

The company on Friday announced the realignment of its wholesale businesses and several changes in the company's top management, including the promotion of current CIO head Mat Zames and Frank Bisignano -- currently in charge of the company's mortgage operations -- to co-chief operating officer positions, beginning in early 2013.

Following a meeting with JPMorgan Chase CFO Douglas Braunstein on Friday, O'Connor said that the company had "delayed some reinvestment of its CIO securities available-for-sale portfolio, which was down to $323b in 2Q (vs. $350b fully invested), while it determines the reinvestment strategy." The analyst also said that JPMorgan's management "reiterated that 2H12 expenses will be higher than expense guidance from Investor Day," by between $1.5 billion and $2 billion.

O'Connor also said that JPMorgan would not comment further on the Libor investigation, beyond CEO James Dimon's comments on July 13 that "it's going to take a while, and not all companies are in the same position," which to the analyst suggests "that JPM thought its LIBOR related risks were less than some others."

The analyst added that JPMorgan still believed that additional mortgage putback charges related to repurchase claims by Fannie Mae and Freddie Mac "are unlikely," and that JPM "again reiterated its commitment to the Universal Bank model."

O'Connor said that his 2013 earnings estimate of $5.00 a share for JPMorgan "is now 10% lower than pre-CIO trading losses," reflecting "the elimination of earnings related to macro hedges, some de-risking of the securities book, modest market share losses in the core trading business and less share buybacks," which "are partially offset by tighter cost controls, higher mortgage and lower loan loss reserves."

Dimon said during JPMorgan Chase's second-quarter conference call that "hopefully, if all goes well, we can start buying back stock early in the fourth quarter," resuming the share buyback program that was suspended in May after the CIO hedge trading losses were first disclosed.

O'Connor said that Deutsche Bank has become "increasingly concerned" that "EPS expectations may be too high," and that "capital deployment may disappoint," since Federal Reserve "approval for meaningful buybacks in 4Q12/1Q13 is unlikely."

Deutsche Bank's price target for JPMorgan Chase is $40.00.

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.