JPMorgan Leads Banks After Moving Closer to Clean Slate

NEW YORK ( TheStreet) -- JPMorgan Chase ( JPM) led the banking sector, with shares rising 1.6% to close at 55.74, on an otherwise weak day for most financial names.

The broad indices ended mixed and the KBW Banking Index ( I:BKX) pulled back slightly to 66.24, after the National Association for Homebuilders/Wells Fargo Housing Market Index reading for November came in at 54, which matched the downwardly revised number for October. A reading above 50 indicates that a majority of homebuilders are confident about market prospects.

JPMorgan has had a very busy fourth quarter so far, after the company saw its third-quarter earnings wiped out by provisions for litigation expenses of $9.15 billion. The company on Friday announced it had agreed to pay $4.5 billion to a group institutional investors to settle loss claims on residential mortgage-backed securities (RMBS) issued by the JPMorgan, Chase and Bear Stearns between 2005 and 2008.

JPMorgan Chase acquired Bear Stearns in March 2008, as Bear faced bankruptcy amid a liquidity crisis. The agreement announced Friday didn't cover RMBS issued by Washington Mutual before the nation's largest savings and loan institution was shuttered by regulators in September 2008 and sold by the Federal Deposit Insurance Corp. to JPMorgan Chase.

JPMorgan reported having $23 billion in litigation reserves as of Sept. 30. The company on Friday soothed investors by saying it was "appropriately reserved for this and any remaining RMBS litigation matters," meaning the agreement on Friday wouldn't affect fourth-quarter earnings.

The agreement on Friday followed a settlement with the Federal Housing Finance Agency (FHFA) late last month, under which JPMorgan and subsidiaries agreed to pay a total of $5.1 billion to Fannie Mae ( FNMA) and Freddie Mac ( FMCC), to settle the government sponsored enterprises' RMBS claims against the bank. JPMorgan didn't admit any fault under the FHFA settlement, although the settlement did cover RMBS sales by Washington Mutual.

JPMorgan Chase continues to negotiate an even larger agreement with the Department of Justice, federal regulators and states' attorneys general, to settle multiple civil and criminal investigations of its mortgage lending and sales activities, as well as those of Bear Stearns and Washington Mutual. Various media reports have pegged the bank's tab for this settlement at $13 billion, which would include the FHFA settlement.

A major sticking point in the negotiations has been JPMorgan's responsibility for actions taken by Washington Mutual before it failed. The Financial Times on Monday reported that the bank may be nearing another landmark settlement, citing unnamed sources who said the bank had "conceded it will take responsibility for the past misdeeds of Washington Mutual."

JPMorgan's shares are cheaply priced relative to most large-cap U.S. banks, trading for 9.3 times the consensus 2014 earnings estimate of $6.02 a share, among analysts polled by Thomson Reuters. The company's earnings for 2013 will not impress as they did over the previous three years, when it achieved record earnings, topping out at $21.3 billion, or $5.20 a share, during 2012.

The company's return on average tangible equity (ROTCE) was an impressive 14.72%, even though the company lost over $6 billion from the "London Whale" hedge trading debacle. Investors can expect a lower ROTCE this year, but the stock's relatively low valuation and Monday's market reaction underline the importance investors are placing on JPMorgan's attempt to put the bulk of its litigation mess behind it before the end of the year.

Morgan Stanley analyst Betsy Graseck has an "overweight" rating on JPMorgan, and in a client note on Monday called Friday's settlement a "positive catalyst" for the shares. When discussing JPMorgan's additional risk from Washington Mutual RMBS litigation, Graseck wrote "We assume that risk remains with the FDIC receivership. If we're wrong, our bear case assumes a $3.3b payout."

As strange as it may seem, taking that sort of hit for the sins of Washington Mutual would likely be seen as a major positive by investors, as JPM seeks a clean RMBS slate before year-end.

Graseck's price target for JPMorgan is $67.00. She estimates the company's EPS will grow from $4.41 this year to $6.21 in 2014 and $6.82 in 2015.

JPM Chart JPM data by YCharts

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

>Contact by Email.

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.

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