During the first week of October 2008, JP Morgan Chase, one of the oldest and biggest New York financial institutions, became the latest major banking institutions to expand on its loan modification program in the hope of helping their borrowers avoid foreclosure. To understand how JP Morgan Chase became riddled with troubled mortgage loans despite its reputation as an investment company, it is important to look back on its recent history and acquisitions.
Brief History of JP Morgan and How It Acquired Troubled Loans
JP Morgan Chase is the result of multiple large-scale acquisitions in the American banking history. It is the product of four renowned establishments that were combined within a 10-year timeframe. The four banks were namely Chase Manhattan Bank, Chemical Bank and Manufacturer Bank, the J.P. Morgan and company, and the Bank One Corp. The $58 billion deal with Bank One still remains the largest of its type today. The deal with Bank One also made JP Morgan a candidate in becoming the world’s largest financial institution.
In 2006, James Dimon who was an executive at Citigroup, before he was forced out by the Citigroup chairman, became the chief executive of JP Morgan Chase. He was known to be cautious with making big deals. Nevertheless, it acquired Bear Stearns as it was facing bankruptcy in 2008. JP Morgan, despite its losses from mortgage securities, was still in good shape at the time.
When the financial crisis struck in September, Washington Mutual (WaMu), a major savings and loan institution that was hobbled by troubled mortgage loans, was on the brink of bankruptcy. The Federal Insurance Deposit Corporation called James Dimon. JP Morgan bought WaMu for $1.9 billion. With its acquisition of WaMu, JP Morgan had $905 billion in deposits, 5,400 branches nationwide, and $31 billion in losses.
The Loan Modification Program
By acquiring Washington Mutual, JP Morgan inherited around $16 billion worth of subprime mortgages. The loan modification program of JP Morgan Chase will modify the terms and conditions of $70 billion worth of mortgages for borrowers who are late or soon-could-be late on their payments. The program is expected to benefit 400,000 borrowers over a two year period. In essence, the loan modification will reduce the interest rate of the mortgage by moving the loans that carry lower interest and principal amounts.
These changes will specifically focus on structuring the loan in a way that the borrower’s outstanding balance will sometimes group monthly. Rival banks have similar plans in place but JP Morgan’s is among the biggest in the industry. The loan modification program of major banks suggests that banking institutions are realizing they can increase the value of their portfolio through wide scale modifications rather than on foreclosures. Traditionally, foreclosures tend to produce more losses.
Around the country, 7.3 million Americans are projected to default on their mortgage payments from 2008 to 2010. This is triple the typical rate and 4.3 million of them are projected to lose their homes. The loan expansion is also putting pressure on other mortgage companies to offer similar programs that will help hassled borrowers. By setting itself as a precedent, JP Morgan has ensured that many other companies will follow its lead.
It is estimated that the mortgage loans affected by the program comprises 4.7% of the home loans it owns. The terms of the loan modification program is expected to cost JP Morgan billions in interest payments, loan fees, and other associated fees. But at the same time, it will save the bank from having to foreclose on the home and sell the much-devalued property in today’s market.
Before the banking sector, particularly JP Morgan Chase, can recover, it will need to sustain its financial consequences. When asked about the plan’s impact on the bank, Mr. Scharf stated that “Our goal in doing this was to come up with something that we think will lead the industry in helping as much as possible on this issue.”
To make the most contribution to the market, the bank will focus on the adjustable-rate mortgages. These are the type of mortgage that permits borrowers to make the minimum payment only. Because its structure does not cover the interest payment due, it results to a higher loan balance. Under the program, the adjustable-rate mortgages will become fixed so it becomes more stable for borrowers who are on the verge of defaulting.