JPMorgan $2 billion trading loss spooks bank stocks
JPMorgan Chase & Co's shock trading loss of at least $2 billion from a failed hedging strategy knocked financial stocks across the globe on Friday, as well as the reputation of the biggest U.S. bank by assets and its CEO Jamie Dimon.
For a bank viewed as a strong risk manager that navigated the fallout from the 2008 financial crisis without reporting a loss, the errors are embarrassing, especially given Dimon's public criticism of the so-called Volcker rule to ban proprietary trading by big banks.
"This puts egg on our face," Dimon said.
He conceded the losses were linked to a Wall Street Journal report last month about a London-based trader Bruno Iksil, nicknamed the 'London Whale', who, the paper said, amassed an outsized position which hedge funds bet against.
JPMorgan had informed the UK's Financial Services Authority (FSA) of the situation, but this was a regulatory requirement and there was no indication at this stage that the regulator would take any action, a source familiar with the situation said. Talks between the bank and the watchdog were continuing.
Iksil, who is French and graduated in engineering from the Ecole Centrale in Paris in 1991, was not immediately available for comment. JP Morgan's Chief Investment Office - and Iksil in particular - are well known by credit traders for taking large positions.
Iksil was brought into the CIO unit to head its credit desk, an asset class the unit had not previously covered, a person who worked in the unit said. It built up credit positions over several years through trades vetted by management and the losses now likely resulted from a combination of these trades, the person said.
These traders say other banks have comparable functions to JPMorgan's CIO. The French banks, Citigroup, Deutsche Bank and UBS were all cited as examples of large treasury functions that hedge credit exposures in similar ways.
In a Securities and Exchange Commission filing, JPMorgan reported that since the end of March, its Chief Investment Office has had significant mark-to-market losses in its synthetic credit portfolio - these typically include derivatives intended to mimic the performance of securities.
While other gains partially offset the trading loss, the bank estimates the business unit will post a loss of $800 million in the current quarter, excluding private equity results and litigation expenses. The bank previously forecast the unit would make a profit of about $200 million.
"It could cost us as much as $1 billion or more," in addition to the loss estimated so far, Dimon said. "It is risky and it will be for a couple quarters."
The dollar loss, though, could be less significant than the hit to Dimon and the reputation of a bank which was strong enough to take over investment bank Bear Stearns and consumer bank Washington Mutual when they collapsed in 2008.
JPMorgan had $2.32 trillion of assets supported by $190 billion of shareholder equity at the end of March - an equity ratio of almost 13 percent. That is four times the industry mean and ahead of 10-11 percent at Citigroup and Bank of America Corp. JPMorgan has been earning more than $4 billion each quarter, on average, for the past two years.
"Jamie has always styled himself as one of the kings of Wall Street," said Nancy Bush, a longtime bank analyst and contributing editor at SNL Financial. "I don't know how this went so bad so quickly with his knowledge and aversion to risk."
JPMorgan shares fell almost 7 percent after the closing bell and dragged other financial shares lower, with Citigroup down 3.6 percent and Bank of America down 2.6 percent. FBR Capital Markets analyst Paul Miller cut his target for the stock to $37 from $50 in response to the disclosures. The shares were at $40.74 before the news.
Although the loss was specific to JPMorgan, it could have broader negative implications - raising the threat of further regulatory scrutiny and the difficulties of risk management, analysts said.
European bank stocks fell on Friday after news of the loss and as fears about the fallout on banks from debt crises in Greece and Spain rattled investors. The STOXX Europe 600 banking index was down 1.4 percent at 1000 GMT. Many banks were down more than 2 percent, including Barclays, Deutsche Bank, and BNP Paribas.
Dimon said he remained opposed to the Volcker rule. The problem, he said, was with the way the hedging strategy had been carried out. It had "morphed over time", he said, and was "ineffective, poorly monitored, poorly constructed and all of that."
On a hastily convened conference call with analysts, Dimon wouldn't take questions about specific people or their specific trading strategies. But he indicated that some people may lose their jobs as executives sort out what when wrong.
Whale of a Loss
The Wall Street Journal report said Iksil, who is French, had amassed a huge position that prompted hedge funds to bet against him. On an earnings conference call last month, Dimon called the concern "a complete tempest in a teapot."
But on Thursday, Dimon said the bank's loss had "a bit to do with the article in the press." He added: "I also think we acted a little too defensively to that."
JPMorgan has said the Chief Investment Office where Iksil works is used to make broad bets to hedge its portfolios of individual holdings, such as loans to speculative-grade firms.
Two financial industry sources in Asia said they heard the JPMorgan trader took a position that a credit derivative curve, part of the CDX family of investment grade credit indices, would flatten, but was caught out by sharp moves at the long end.
The CDX index gives traders exposure to credit risk across a range of assets, and gets its value from a basket of individual credit derivatives.
"It's a pretty stunning admission for a company that prides itself on its risk management systems and the strength of its balance sheet," said Sterne Agee analyst Todd Hagerman. "The timing couldn't be worse for the industry. It will have ramifications across the broker-dealer community."
Last week Dimon and leaders of other large banks met Federal Reserve Governor Daniel Tarullo in New York to question the way regulators conduct stress tests to see if banks have enough capital to withstand possible losses. They also made arguments over trading restrictions.
Allegations that traders at the banks take outsized risks with bank capital to earn big bonuses have been among the drivers of government regulations since the financial crisis.
JPMorgan spokesman Joseph Evangelisti said the bank uses pay formulas to reduce the chance of that happening throughout the bank. Except for people handling the bank's private equity investments, "no one at JPMorgan is paid on their profits and losses," he said.
Regulators and lawmakers are now likely to push Dimon for more details about the trades. Those details will guide how regulators now view the issue and its impact on the Volcker rule, said Karen Petrou, managing partner of Washington-based Federal Financial Analytics.
If the trades were meant to hedge against specific risks as opposed to clearly being done as a proprietary bet on the markets, it may not play as clearly into the Volcker rule debate as supporters of the crackdown want it to, she said.
[Source: By David Henry and Rick Rothacker, Reuters, 11May12]
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