The Deal: Asset Sales May Help JPMorgan Image Makeover

NEW YORK ( The Deal) -- Pressure by the Federal Reserve is driving JPMorgan Chase ( JPM) to sell its physical commodities operation; however the sale could also improve the tarnished image of the too-big-to-fail-bank that was once the darling of Wall Street, analysts said.

The company said in July that it will explore "a sale, spinoff or strategic" partnership for its commodities unit, which includes the storing of metals products including steel and aluminum, a process that has attracted several interested suitors, according to analysts following the bank.

However, analysts contend that the auction of the commodity assets comes as regulators have put increased pressure on JPMorgan and the other big U.S. banks to sell their non-core businesses. As part of that pressure, the Federal Reserve in July said it is reviewing a 2003 determination that "certain commodity activities are complementary to financial activities and as a result are permitted for banks."

This is a message that Fed has found "some stuff going on" at the big bank's commodity units and wants it to stop, which can be accomplished by selling off the unit, said Nancy Bush, managing member at NAB Research.

However, the sale could also help improve the public image of the too-big-to-fail bank by sending a message to the world that it is trying to become more manageable and less of a complex institution, even though the unit is tiny and the divestiture won't go far to reducing its size and complexity.

"There is no negative news associated with this sale. It's a good thing for their reputation because they look like they are getting smaller and more manageable," said one analyst.

A sale of the unit would actually result in a sliver of positive news for a bank whose name has been dragged through the mud of late -- with more bad news expected in the days and months to come. The bank in 2012 experienced a $6.2 billion credit derivatives trading loss known as the "London Whale" incident, for which regulators last month fined it roughly $1 billion over "deficiencies" in oversight, management and internal controls. JPMorgan will likely soon pay a staggering $11 billion or more to settle a hodgepodge of other issues facing the bank, but the deal is not expected to resolve all the lawsuits pending before the overly interconnected institution.

The bank is reportedly close to settling with federal and state regulators over its subprime mortgage practices and those it inherited during the height of the crisis when it acquired Washington Mutual.

The Department of Justice did not respond to requests for comment on the status of settlement negotiations, while a JPMorgan spokesman declined comment.

However, it will not be the blanket pardon JPMorgan's embattled chief executive Jamie Dimon is hoping for, insisted Columbia Law School Professor John Coffee. Dimon himself could be under increased pressure by JPMorgan's board to step down, as fines pile up.

There are a number of criminal or other types of investigations still outstanding that are not likely to be included in the settlement under discussion, Coffee said. New York federal prosecutors are investigating whether JPMorgan employed "manipulative schemes" at power plants. The bank is also being targeted for alleged nepotism in the hiring of friends and family of Chinese ministers. There are also criminal charges being pursed against two former JPMorgan employees over the London Whale incident. The ex-employees have asserted their innocence. JPMorgan hasn't been accused of wrongdoing in its hiring practices and has said in the past that addressing regulators' concerns is a priority.

"You will see a conclusion to subprime mortgage problems for JPMorgan," said Coffee. "But it becomes unholy to bring in energy manipulation and individual criminal charges related to the London Whale."

A mortgage fraud settlement -- even a multi-billion-dollar fine -- itself won't put JPMorgan in a position where it must sell assets to raise capital. The bank has a strong capital buffer of at least $148 billion in common capital set aside to meet a global agreement on bank buffers.

It also likely has a significant litigation reserve, which it hasn't fully disclosed. That number, if known publicly, could become a "starting point" for negotiations with the government, observers said.

However, the bank in its filing reporting its second quarter results estimated that the cost of litigation could exceed its reserves by up to $6.8 billion. One analyst said the excess cost is likely to be a conservative assessment and the institution probably has a large dollar amount set aside, perhaps as much as $20 billion, to cover litigation costs.

Nevertheless, more settlements and new tough capital buffer rules in the months to come will likely put additional pressure on the bank to cut back dividends, stock buy-backs and perhaps even sell more assets. The Fed recently introduced a tough leverage cap proposal, one that, if adopted as is, will likely create problems because "a lot of their derivatives" are held in their commercial bank, according to one analyst. It may take them a year or more to raise capital to meet that restriction, the analyst said.

JPMorgan was also singled out, together with Goldman Sachs ( GS) by the Fed in March because of "weaknesses" in its capital distribution plan. The central bank took the unusual step of requiring the two institutions to re-submit their dividend and stock buyback plans to the central bank by the end of the third quarter -- yesterday. A JPMorgan spokesman said the bank sent in its plans last month, but the Fed hasn't announced yet whether it was approved.

NAB Research's Bush said the decision to have JPMorgan resubmit its plan points to possible problems for the bank when it must conduct annual stress tests in 2014.

"The Fed will look at the sum total of all thing things that will be weighing on JPM and they will have a far better idea about what the expected results of all the settlements are for the institution than anyone on the outside," she said. "I would not have heroic expectations for dividends or stock-repurchase plans for JPM in 2014."

Whether the bank admits guilt or just negligence is critical to identifying just how much collateral damage there will be for the institution. Duke Law School professor Lawrence Baxter said that a big point of contention in negotiations is likely to revolve around the level of culpability on the part of JPMorgan. Admitting guilt could add fuel to the fire of private litigation efforts against the bank.

"There is a big distinction between admitting and not admitting guilt because, of course, it affects your posture in private litigation," Baxter said. "However, over time, the scale of the fines is getting to the point where you might ask if there is any point of operating a bank of this size?"

Written Ronald D. Orol

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