JPM Sees Light at End of Tunnel: KBW

NEW YORK ( TheStreet) -- KBW's global research team estimates big banks' legal tab from civil lawsuits by the Federal Housing Finance Agency, as well as lawsuits tied to manipulation of LIBOR and foreign exchange markets, could hit $100 billion.

After spewing your coffee, please take comfort, as this is an estimate for "the next decade."

According to a KBW research report published Wednesday, global investment banks have set aside $44 billion for legal expenses since the first quarter of 2012. "The banks have provisioned for more cases than they have settled for, something we feel the banks are often not given credit for," the analysts, led by Andrew Stimson, wrote.

A slew of global investment banks disclosed their cooperation with European and U.S. regulators' massive probe of possible manipulation of foreign exchange markets. Meanwhile, the LIBOR manipulation scandal continued to unfold with the privately held Rabobank of Utrecht, the Netherlands, settling for over $1 billion and its CEO resigning. The first of a slew of banks settling with regulators while admitting it had manipulated rates submissions for the compiling or the London Interbank Offered Rate was Barclays ( BCS), which coughed up $454 million in June 2012, soon followed by the resignation of its CEO and Chairman

The Federal Housing Finance Agency (FHFA) which regulates Fannie Mae ( FNMA) and Freddie Mac ( FMCC) in September 2011 sued 17 global banks at home and abroad over the sale of $196.2 billion in private label mortgage-backed securities to the government sponsored mortgage giants.

Most of those lawsuits are still unfolding, but JPMorgan Chase ( JPM) last month settled with the FHFA, agreeing to pay $5.1 billion to Fannie and Freddie, while not admitting any wrongdoing.

The FHFA just wanted the money for the GSEs, which were taken under government conservatorship in September 2008. But JPMorgan is continuing to negotiate with the Department of Justice to settle other criminal and civil investigations of the company's mortgage lending and sales activities and will probably have to admit to some wrongdoing, according to myriad leaks to the media, which also peg the overall settlement amount at $13 billion, including the money being forked over to the FHFA.

Setting aside $9.15 billion for litigation expenses during the third quarter wiped out JPMorgan's earnings, but the company for the first time disclosed its total litigation reserves, which stood at a hefty $23 billion as of Sept 30.

"Our estimated costs for Libor/Euribor ($46bn) and FX ($26bn) might seem high, but actually reflect only ~1bp of outstanding rate derivatives and ~5bp of daily average FX turnover. With the faster-moving FHFA costs estimated at $24bn, future civil settlement costs could reach $96bn," the KBW analysts wrote. They added that "Other issues such as Madoff or other US mortgage market issues would come on top."

But KBW continues to consider JPMorgan Chase a "top pick," among global investment banks, because the company "should start 2014 with a cleaner slate than most peers and despite being exposed on civil Libor actions according to KBWs estimates , the balance sheet is more than strong enough to take it."

JPMorgan's shares closed at $53.97 Wednesday and traded for 9.0 times the consensus 2014 earnings estimate of $6.02, among analysts polled by Thomson Reuters. That's a very low valuation for U.S banks in the current market environment, reflecting investors' uncertainty over the bank's legal and regulatory burden.

KBW analyst Christopher Mutascio's price target for JPMorgan Chase is $63, and he estimates the company's earnings will grow from $5.95 in 2014 to $6.30 in 2015.

KBW's other "top pick" among global investment banks "with manageable litigation issues, little deleveraging requirement with good valuation," is Societe General ( SCGLY).

"SocGen continues to be one of our favourite wholesale names given (i) lower IB-related litigation risks and (ii) still attractive valuation," KBW analyst Stimpson wrote. Stimpson expects 34% upside for Societe General over the next 12 months.

JPMorgan's shares were down 1.4% in late morning trading Wednesday, to $53.17. Societe General's American depositary receipts were down 1.5%, changing hands over the counter for $10.90.

-- 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.