JPMorgan goes on a diet to appease regulators

By David Henry

NEW YORK (Reuters) - JPMorgan Chase & Co (JPM.N), which has grown by more than 50 percent since the start of the financial crisis, is going on a diet. The largest U.S. bank is shedding holdings to appease regulators including the Federal Reserve: if the bank gets rid of enough trading assets, derivatives, and investment securities, it can be deemed a little less risky by the Fed, which in turn could help it boost profitability and return more capital to shareholders.

By the Fed's formula, JPMorgan is the U.S. bank whose failure would be the most catastrophic for the financial system, because of its size, complexity, and connections to other lenders and institutions. In the second quarter, in a little-noticed move, the bank cut almost $128 billion, or 5 percent, of assets from its books compared with the first quarter, bringing the total to $2.45 trillion.

The bank could post a decline in assets again when it reports third quarter earnings on Tuesday, making it the first time its assets have declined for two quarters in a row since 2009. Even if the bank does not cut total assets in the third quarter, it will likely shed some of its riskiest assets. Sources said the bank aims to cut more of its most problematic holdings without hurting revenue much. JPMorgan's efforts in the first half of the year alone could allow it to buy back as much as $3 billion more in shares, equal to about 1.5 percent of the outstanding total, according to a report from Susan Roth Katzke, a bank stock analyst at Credit Suisse.

By buying back more shares, the bank could increase its 2016 return on equity, a key measure of how effectively it wrings profits from shareholders' funds, to 10.9 percent from 10.8 percent, by her estimate. Another analyst, Steven Chubak of Nomura, reckons that the bank's moves could lift its share price by $2 a share. JPMorgan shares traded at about $61.50 on Tuesday afternoon.

The biggest U.S. banks grew much bigger during the financial crisis as they swallowed up rivals that came close to failing, such as Bear Stearns and Merrill Lynch. JPMorgan Chase's assets are now almost 60 percent higher than they were pre-crisis.

But in recent years regulators have been crafting new rules to help ensure that bigger banks do not create too much risk for the financial system. One of those rules, known as capital surcharges for globally systemically important banks, essentially forces banks that are too complicated to swallow higher costs: the banks must fund their operations with less debt, which is cheaper, and more equity, which is more costly.

JPMorgan's efforts to slim down underscore how new capital rules issued by the Fed are goading banks to rethink a host of businesses. In the second quarter, the bank returned $100 billion of deposits to customers, largely hedge funds that were parking money they had no immediate need to trade. JPMorgan sold the short-term assets it bought with those deposits. "Going out to your clients and saying we don't want your money is a very funny thing for a bank to do," Jamie Dimon, JPMorgan's chief executive officer, said at an investor conference last month. The bank also offloaded some $10 billion of unspecified hard-to-value assets in the second quarter, according to company filings, and uncluttered its derivatives books.

IT GETS HARDER

Those efforts should allow the bank to hold down the amount of equity it funds itself with and reduce its costs. Before the second quarter and under current rules, JPMorgan needed to fund at least 12 percent of its total adjusted assets with equity, and the rest with debt. That equity ratio is at least 4.5 percentage points higher than smaller lenders, and adjusts assets for how risky they are. After slimming down, the bank could fund itself with just 4 percentage points more equity than smaller lenders, according to Katzke, the Credit Suisse analyst.

Doing more cutting from here is possible, but won’t be easy, bank executives said. For example, JPMorgan wants to cut another $100 billion of deposits from customers that are not profitable for it. "The second one is a little harder," Dimon said at the conference last month.

Even as JPMorgan sheds some assets, it is willing to take on others. For example, JPMorgan is pouring technology and marketing dollars into credit cards. It is pushing rewards programs to encourage spending by cardholders and it is promoting transaction processing services for merchants, two businesses that bring in high fees and have relatively low capital needs.

The bank is likely to promote corporate treasury and cash management services, as well as asset management, for similar reasons, Katzke said.

(Reporting by David Henry in New York, Editing by Dan Wilchins and John Pickering)