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Tuesday, May 26, 2009

Revisiting the JPMorgan / WaMu Acquisition

by Calculated Risk on 5/26/2009 03:01:00 PM

From Bloomberg: JPMorgan’s WaMu Windfall Turns Bad Loans Into Income (ht Mike in Long Island)

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.
JPMorgan took a $29.4-billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages (ARMs) and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.
emphasis added
Let's review the JPMorgan's "judgment at the time" of the acquisition. First, here is the presentation material from last September.

JPM WaMu Click on graph for larger image in new window.

Here are the bad asset details. Also see page 16 for assumptions.

This shows the $50 billion in Option ARMs, $59 billion in home equity loans, and $15 billion in subprime loans on WaMu's books at the time of the acquisition. Plus another $15 billion in other mortgage loans.

And the second excerpt shows JPMorgan's economic judgment at the time of the acquisition.

JPM WaMu JPMorgan's marks assumed that the unemployment rate would peak at 7.0% and house prices would decline about 25% peak-to-trough.

Note that the projected losses at the bottom of the table are from Dec 2007. As the article noted, in September 2008, JPMorgan took a writedown of close to $30 billion mostly for Option ARMs and home equity loans.

JPM WaMu Unemployment This graphic shows the unemployment rate when the deal was announced (in purple), the three scenarios JPMorgan presented (the writedowns were based on unemployment peaking at 7%) and the current unemployment rate (8.9%).

Clearly JPMorgan underestimated the rise in unemployment, and this suggests the $29.4 billion writedown was too small.

JPM WaMu House Prices And the last graph compares JPMorgan's forecast for additional house price declines and the actual declines using the Case-Shiller national home price index and the Case-Shiller composite 20 index.

House prices have declined about 32.2% peak-to-trough according to Case-Shiller - nearing JPMorgan's 37% projection for a severe recession.

This shows JPMorgan underestimated additional house price declines when they acquired WaMu. Instead of $36 billion in additional losses since December 31, 2007 (and the $29.4 billion writedown), this suggests JPMorgan expects losses will be $54 billion or more.