JPMorgan’s Botched Trades May Generate $7.5 Billion Loss

JPMorgan’s Botched Trades May Saddle Bank With $7.5 Billion Loss
Workmen raise the JP Morgan Chase Inc. flag outside company headquarters in New York, on July 13,, 2012. Photographer: Peter Foley/Bloomberg

Botched trades by a JPMorgan Chase & Co. unit that Jamie Dimon had pushed to boost profit were masked by weak internal controls and may ultimately saddle the bank with a $7.5 billion loss.

JPMorgan’s chief investment office has lost $5.8 billion on the trades so far, and that figure may climb by $1.7 billion in a worst-case scenario, Dimon, the bank’s chairman and chief executive officer, said yesterday. Net income fell 9 percent to $4.96 billion in the second quarter, the bank said. It restated first-quarter results to reduce profit by $459 million after a review of the unit found employees may have hid souring bets.

Dimon, 56, had brushed off concerns raised by some of his most senior advisers, including heads of JPMorgan’s investment bank, about the lack of transparency and the quality of internal controls in the CIO in past years, Bloomberg News reported last month, citing a person with direct knowledge of the matter. Capping the potential loss’s size and revamping management of the unit responsible may help him restore investor confidence.

The stock jumped 6 percent yesterday as shareholders expressed “relief that it wasn’t worse,” Gary Townsend, head of Hill-Townsend Capital LLC, said of the loss. “The loss is substantially better than many of the estimates that I was hearing.”

Still, the shares are down 19 percent since April 5, when Bloomberg News reported that the CIO had amassed an illiquid book of credit derivatives. The slump equates to a $32 billion drop in the firm’s market value.

London Whale

The mounting losses have focused regulators’ and investors’ attention on the CIO. Dimon transformed the once-conservative unit in recent years to boost profit by buying higher-yielding assets such as structured credit, equities and derivatives, Bloomberg News reported on April 13, citing former employees.

One trader, Bruno Iksil, amassed positions in credit derivatives so big and market-moving he became known as the London Whale. Bets on credit-default swaps known as the Markit CDX North America Investment Grade Series 9 backfired this year.

Dimon dismissed reports about the London operation as a “tempest in a teapot” when the bank reported first-quarter earnings April 13. He reversed course less than four weeks later, disclosing a $2 billion loss that he said could grow to $3 billion or more during the quarter.

Managers Ousted

The bank said yesterday it ousted managers responsible for the transactions and will claw back their pay after an internal inquiry found traders may have intentionally tried to hide souring bets during the first quarter. The company didn’t name the managers. Iksil’s boss Javier Martin-Artajo and former Europe CIO head Achilles Macris were among executives who also oversaw the trades.

JPMorgan accepted an offer by Ina Drew, the former head of the CIO, to return as much as two years of her compensation, according to Joseph Evangelisti, a spokesman for the bank. She was awarded about $29 million compensation for 2010 and 2011, according to JPMorgan’s regulatory filings.

The 55-year-old retired May 14 with about $57.5 million in stock, pension and other pay, according to regulatory filings and estimates from consulting firm Meridian Compensation Partners LLC. About $21.5 million of that, based on the stock’s May 14 closing price, would have been forfeited automatically if she had been fired for cause.

Maximum Clawback

“I have enormous respect for Ina as a person and a professional,” Dimon said yesterday at a meeting with analysts. Irvin Goldman, who oversaw risks in the unit from February through mid-May, said yesterday he also resigned voluntarily.

Thomas Brown, chief executive officer of Second Curve Capital LLC, said he was surprised by how much the company pursued in clawbacks.

“Four people gave back two years’ worth of income, which surprised me on the high side,” said Brown, a Bloomberg contributing editor, in an interview with Betty Liu on Bloomberg Television. “That’s the maximum clawback provision. I think it’s impressive on one hand; it’s certainly more severe than I would have expected.”

The share gains may not last, according to Paul Miller, a former examiner for the Philadelphia Federal Reserve Bank and an analyst at FBR Capital Markets Corp. in Arlington, Virginia.

“Over time, it will still drift down,” Miller said in an interview. “There’s a lot of unanswered questions with this CIO.”

Dimon is also grappling with historically low interest rates that have compressed profit margins on lending as well as yields on investments. Moshe Orenbuch, of Credit Suisse Group AG, was among analysts who lowered earnings projections for banks amid weak trading revenue and market turmoil caused by Europe’s sovereign-debt crisis.

Internal Review

Second-quarter net income excluding the effect of accounting adjustments known as DVA was $1.09 a share. Without DVA, loan-loss reserve reductions and a recovery related to Bear Stearns Cos., profit was 67 cents. Analysts surveyed by Bloomberg had estimated adjusted earnings per share of 76 cents.

The company decided to restate first-quarter figures after executives and lawyers interviewed employees, reviewed tens of thousands of hours of tapes and searched about 1 million e-mails, Michael Cavanagh, JPMorgan’s head of Treasury & Securities Services, told reporters on a conference call.

“We just have questions about whether the traders were doing what they need to do for accounting, which is put a mark on their positions where they think they can exit,” Cavanagh said. “Instead it felt more like they were pricing their marks a little bit more aggressively, but generally inside the bid-ask spread.”


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