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3 Reasons to Sell JPMorgan Chase

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JPMorgan Chase (NYSE: JPM  ) has sailed through 2012 not much the worse for wear considering its major trading fiasco this past spring. Though the bank may finish up the year looking pretty good, there are some looming problems that may cause more trouble in 2013 than the London Whale did in 2012. Here are three reasons the Ship of Dimon may headed for a titanic disaster, and soon.

1. London Whale fiasco revealed underlying institutional problems
The trading loss that cost JPMorgan more than $6 billion revealed some internal issues at the big bank, namely the inscrutable and esoteric nature of the industry's value-at-risk modeling techniques.

A New York Times article published shortly after CEO Jamie Dimon testified before the Senate Banking Committee regarding the trading error highlights how convoluted the VaR models really are. Dimon related how JPMorgan had rejiggered its risk model to conform with new Basel rules. Instead of ameliorating risk, as you would think, the change made trading even riskier, hence the huge loss. However, as the piece points out, such tweaks to VaR by banks across the pond have usually tightened things up, rather than opened the door to laxity.

The bank switched back to the old model, but changed it up again in October. The announcement regarding this change stated that this new formula reduced the risk of its derivatives portfolio by 24%, according to Bloomberg. What does that mean, you ask? Well, Dimon noted that the models change all the time, which is not very good news. Also, since the formulation of the VaR is basically proprietary, it seems that no one outside of the company, including investors, may ever know just how safe the model actually is.

2. JPMorgan may be facing more of a mortgage morass than once thought
While Bank of America's (NYSE: BAC  ) mortgage muddle is common knowledge, it looks as if JPMorgan has a similar mess -- something that is not as well known.

The bank's Q3 report made note of higher net charge-offs related to soured mortgage loans for the quarter, due to new regulations regarding how banks must treat loans held by borrowers who have declared bankruptcy. Dimon acknowledged  that the bank is experiencing high levels of mortgage loan defaults, and that he expects costs related to these loans to continue to rise in the near future. He wasn't kidding: JPMorgan's allotment  for such loans was $825 million for the quarter, higher than Citigroup's   (NYSE: C  ) $635 million, Wells Fargo's   (NYSE: WFC  ) $567 million, and Bank of America's  $435 million.

That's a lot of loans gone bad, and there are obviously more to come. These expenses are high, but they probably don't count the thousands of workers that the bank has hired on to help with the mess. While other banks have been reducing staff, JPMorgan has hired nearly 13,000 , many of whom are helping process these troubled mortgages.

3. Mortgage-backed securities repurchase claims threaten to drown the company
An article on Thomson Reuters News & Insight mentions a very interesting tidbit hidden in JPMorgan's recently filed 10-Q form. Thirty pages from the end  of the 278-page document, the bank reveals that it is currently being targeted by lawsuits demanding that it repurchase about $140 billion of mortgage-backed securities that have gone south. As the author points out, that is just the value of the instruments being litigated, not the amount JPMorgan will pay. But, since litigants usually claim a failure rate of more than half, that's a whole lot of scratch for which the bank could be on the hook.

And that's not all of it. The document goes on to note that, in addition to these investor claims, monoline insurers are also piling on, or are planning to. One of these insurers is CIFG Assurance, which claims that trashy collateralized debt obligations fashioned several years ago by Bear Stearns have cost the insurer over $100 million. CIFG is also suing  B of A, of course, alleging at least $170 in losses, and last year it sued Goldman Sachs (NYSE: GS  ) for $275 million. There are also three class action suits pending against the Bank of Dimon, as well as one that named Washington Mutual, which JPMorgan acquired around the time it absorbed Bear Stearns, which is currently pending settlement.

But wait, there's more. The really big show involves the $33 billion in crummy MBSes that the Federal Housing Finance Agency is claiming that banks like JPMorgan, B of A, Citigroup, and Morgan Stanley (NYSE: MS  ) sold to Fannie Mae and Freddie Mac under false pretenses. JPMorgan lost out  in its attempt to block the lawsuits, as have Bank of America, Citi, and HSBC   (NYSE: HSBC  )  -- claiming, among other things, that the government-sponsored entities did not file timely.

Is JPMorgan a losing bet?
Though all of these issues together are a heavy burden, they likely won't sink the huge bank. These things should give investors pause, however, as any one of them could wind up causing a big dent in the bank's profits. The bank just declared a $0.30 per share dividend, payable after Jan. 1, 2013. That could very well be as good as it gets for quite a long time.

With big finance firms still trading at deep discounts to their historic norms, investors everywhere are wondering if this is the new normal, or whether finance stocks are a screaming buy today. The answer depends on the company, so to help figure out whether JPMorgan is a buy today, I invite you to read our premium research report on the company today. Click here now for instant access!

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