The Greatest Shareholder Letter Ever Written by a Bankster

By John Maxfield

Jamie Dimon's 2006 letter to shareholders is like fine wine -- it gets better with age. This is especially true when you compare it to the letters written that year by Dimon's counterparts at what were then the two biggest banks in America.

Even with the benefit of hindsight, it was impossible to predict that a crisis was around the corner when JPMorgan Chase's (NYSE:JPM) CEO wrote his letter at the beginning of 2007. His bank earned record profits the previous year. Bank of America (NYSE:BAC) did, too. And the only reason earnings fell at Citigroup (NYSE:C) in 2006 was because it was up against a historic performance in 2005.

These results fueled a sense of invincibility at JPMorgan Chase's biggest competitors, as they have at countless other imprudent firms at inopportune moments in time. Bank of America CEO Ken Lewis was one of many who insinuated that credit risk had been tamed:

We believe we are in a good position to weather any credit issues we currently see on the horizon. [...] Our ability to distribute credit risk through the securitization of various asset classes adds further stability. And as our risk managers analyze information about our customers in ever more sophisticated ways, we can grow our portfolio without significantly increasing our risk profile. In fact, in some parts of our business we are actually saying "yes" to more customers while at the same time improving the average quality of our loans.

Citigroup's Charles Prince made similar claims, though he at least had the foresight to use subtler language:

Helping our bottom-line results were lower credit costs, which reflected the continued favorable credit environment globally, including a very low level of bankruptcy filings in our U.S. Consumer business.

As we look to 2007, we believe the credit environment around the world, with some exceptions, is good, but we are very focused on managing our exposure. We expect moderate deterioration in credit in 2007 and are managing our portfolio accordingly.

I firmly believe that we have embarked on an era of renewed growth and that the changes we are making will lead to sustainable growth in shareholder value.

It was into this sea of optimism, in turn, that Dimon pitched his own shareholder letter. But while Lewis and Prince's missives were undisguised homilies to growth at all cost, Dimon's revealed an almost apocryphal sense of impending doom:

We do not know exactly what will occur or when, but we do know that bad things happen. There is no question that our company's earnings could go down substantially. But if we are prepared, we can both minimize the damage to our company and capitalize on opportunities in the marketplace.

Dimon then shared a list of things JPMorgan Chase had done right in 2006, including:

• We did not originate option ARMs or other negative amortization loans.
• We applied the same underwriting standards to all of our subprime loans, whether originated by us or purchased from third parties.
• We sold substantially all of our 2006 subprime originations.
• We were very careful in certain parts of the United States and were especially careful to seek accurate property appraisals.

He concluded his comments on credit risk with what may go down in history as the most prescient paragraph ever written by an American banker:

We do not yet know the ultimate impact of recent industry excesses and mismanagement in the subprime market. Bad underwriting practices probably extended into many mortgage categories. As government officials investigate the market and losses mount, the industry is tightening underwriting standards by reducing loan-to-value ratios and using more conservative property values. There will be more due diligence on incomes and credit quality. More rigid standards increase foreclosures and make it more difficult to buy homes. This will lead to a lower number of sales and a reduction in home values.

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