JPMorgan reaps $29 bn windfall as bad loans turn into income

JPMorgan Chase & Co stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest US bank transform bad loans it purchased from Washington Mutual Inc into income.

Wells Fargo & Co, Bank of America Corp and PNC Financial Services Group Inc are also poised to benefit from taking over home lenders Wachovia Corp, Countrywide Financial Corp and National City Corp, regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest US unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardising how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

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 per cent. 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.

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favourable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in US history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages 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.