Analysts Give JPMorgan a Pass on Unknown Legal Expenses

NEW YORK ( TheStreet) -- Analysts remain stubbornly bullish on JPMorgan Chase ( JPM) despite the bank's mounting legal bills.

CFO Marianne Lake on Monday said during an investor presentation that the bank's legal expenses in the third quarter could top $1.5 billion following a "crescendo of activity" in the past few weeks, erasing the benefit from loan loss reserves.

The bank's mortgage origination business could see a loss in the third and fourth quarter. And markets revenue in the third quarter could be flat to down 5% from a strong third quarter of 2012.

Analysts on Tuesday took down their earnings estimates for the bank following the fresh guidance, but many reiterated their "buy" ratings citing attractive valuations.

KBW analyst Chris Mutascio lowered his third quarter earnings estimate to $1.12 a share from $1.45, to factor in the higher legal expenses of $1.67 billion. KBW's full year 2013 estimate was lowered to $5.70 from $6.11. "We think it is prudent to carry forward some legal reserve builds despite the projected sizable build up we expect in 3Q13. Until the recent litigation actions are settled or we get more information from management, we think it is prudent to increase litigation costs over the next several quarters," Mutascio wrote in a report.

Still, he maintains an "outperform" rating on the stock. "In an environment where investors are willing to potentially wait years for short-term interest rates to rise and net interest margin to expand while bidding up 'asset-sensitive' bank stocks in anticipation, we are willing to buy the shares of JPM at a significantly discounted valuation knowing legal costs will eventually fall. Despite our earnings revisions, JPM shares still trade at just 8.9x our 2014 EPS estimate of $5.95. Our $63 target price represents just 10.6x our 2014 EPS estimate (we have yet to publish 2015 EPS estimates) and 19% potential upside potential -- not including a dividend yield of nearly 3.0%," he wrote.

Atlantic Equities analyst Richard Staite also lowered estimates on a "noisy" quarter but retained his positive outlook. "We think the shares are attractively valued on a 2014 PE of 8.6x with the main catalyst to a re-rating being a reduction in the litigation overhang," he wrote in a note to clients.

RBC Capital analyst Gerard Cassidy increased his estimate of legal expenses to $1.6 billion from $500 million but made no changes to his earnings estimate.

That's because the analyst does not consider legal expenses to be a core earnings item. Analysts tend to exclude items that tend to be non-recurring or unsustainable from their earnings estimates but they do not always agree on what is core and what is non-core.

Charles Peabody of Portales Partners in contrast seems a lot more concerned about the litigation risk at JPMorgan.

The bank since 2007 has likely accumulated $22 billion in legal expenses, almost the equivalent of a full year of profits, according to Peabody.

This year litigation costs could be as high as $5 billion for JPMorgan, according to Peabody, if the company settles the mortgage-backed securities lawsuit from the Federal Housing Finance Agency and enters into multiple settlements over the "London Whale" hedge trading debacle with the Securities and Exchange Commission, the Department of Justice and UK authorities.

Peabody is also concerned the SEC might try to extract an "admission of guilt" from JPMorgan over the London derivative trades.

"Regulators and administration want to remove the benefits of being big," he said in an interview with Bloomberg News. "Now if you are too big to manage they are going to raise the cost of litigation for being too big to manage."

-- Written by Shanthi Bharatwaj in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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