JPMorgan Europe Home-Loan Debt Raises Anxiety: Mortgages
JPMorgan Chase & Co. (JPM)’s holdings of home-loan bonds from outside the U.S. soared 35-fold in the past three years. Now, with its chief investment office facing scrutiny after a $2 billion trading loss, investors are raising concern the European market’s biggest buyer will pull back.
The largest U.S. bank by assets accelerated its purchases last quarter, adding $8.5 billion to lift its total to $74.5 billion, according to regulatory filings. The New York-based company’s investments approached 9 percent of the size of the Dutch and U.K. mortgage-bond markets it’s been focusing on.
“If they stop buying, it would be pretty bad as they are one of the major buyers at the moment,” said Frank Erik Meijer, head of asset-backed securities at The Hague-based Aegon Asset Management, which manages 220 billion euros ($280 billion). “If they need to sell, that would certainly give rise to quite some” increases in yields relative to benchmark rates.
JPMorgan bolstered prices and issuance when Europe’s lenders were forced to shrink and other potential buyers shunned asset-backed notes after U.S. subprime mortgage debt sparked a global credit crisis, according to six people at banks and investment firms active in the home-loan bond market who declined to be identified because they were speaking about a competitor. Chief Executive Officer Jamie Dimon, 56, last month described the securities as part of the chief investment office’s “very conservative” holdings, four weeks before announcing an unrelated $2 billion derivative loss that highlighted the division’s influence in certain credit markets.
As the global economic slump limited loan demand and increased deposits across the banking industry, securities held in JPMorgan’s chief investment office and treasury more than tripled to $374 billion as of March 31, from $76.5 billion since 2007, filings show. The European mortgage investments began to jump in 2009, starting that year at $2.1 billion and rising to $47.1 billion by the end of 2010.
The bank has been the lead investor, or among the biggest buyers, of deals backed by loans from banks including Royal Bank of Scotland Group Plc (RBS), Lloyds Banking Group Plc (LLOY), Banco Santander SA (SAN)’s U.K. unit, ING Groep NV (INGA) and Aegon NV (AGN) in the Netherlands. Transactions, particularly in 2009 and 2010, often began with potential issuers calling the bank, three of the people said.
Lloyds revived the European securitization market in September, 2009, after a more than yearlong freeze. JPMorgan bought or committed to buy 2.25 billion pounds ($3.6 billion) of notes issued by Lloyds vehicles and Nationwide Building Society issuance entities.
JPMorgan approached Lloyds to issue the bonds and “provided the catalyst for us to start work on a new transaction as we then knew there was a deal to be done,” Robert Plehn, the London-based head of securitization at Lloyds’s Bank of Scotland unit, said at the time. The U.S. bank’s order “probably provided other investors with some confidence” to buy, he said.
JPMorgan has also bought outstanding securities tied to home loans originated by Northern Rock Plc, the British lender rescued by the Bank of England in 2007, two of the people said. Those purchases meant it was bolstering the market even more than the volume of its buying suggested because the debt, among the most liquid of its type, is used as a market benchmark.
“They have been since the crash a very large player in the market,” said Ronald Thompson Jr., a Greenwich, Connecticut- based consultant on asset-backed securities, and former head of strategy on the debt at Knight Libertas LLC. “You’ve always got to be concerned if there’s a large player that it’s a potential problem if they go away.”
JPMorgan’s chief investment office, which invests its excess cash and hedges its risks, failed in using synthetic credit bets to protect against a “stressed credit environment,” the bank says, such as a deepening of Europe’s debt crisis. Dimon announced its loss on May 10, describing the handling of the positions as “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”
The disclosure has prompted investigations by the U.S. Department of Justice, the Federal Bureau of Investigation, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the U.K.’s Financial Services Authority.
Dimon has been asked to testify before a U.S. Senate committee on the loss, which has prompted the Federal Reserve Bank of New York to examine how banks across its district are managing a wave of deposits that has flooded the financial system since the credit crisis, according to a person familiar with the matter.
At JPMorgan, Ina Drew, 55, the chief investment officer starting in 2005 who reported directly to Dimon, retired this month. Matt Zames, 41, replaced her, shaking up the division’s leadership and announcing in a May 14 memo a “sharp, renewed focus on our hedging strategies, risk management and execution.”
The cost to protect JPMorgan’s debt against losses with credit-default swaps rose 21.7 basis points last week to 154.1 basis points, at about the highest level since November, according to prices compiled by Bloomberg. That means it costs $154,100 annually to protect $10 million of debt for five years.
Dimon has sought to allay investor concern that the bank will do something “stupid” as a result of the upheaval.
“We will do what we have to do to maximize the shareholder value,” Dimon said on a May 10 conference call, talking about unwinding the derivative bets. “We’ve got staying power and we are going to use it.”
Unlike the company’s derivatives positions, gains and losses on the securities holdings typically don’t affect its earnings because of accounting rules.
While it had about $8 billion in unrealized gains within its bond portfolio at the end of March, and sold debt to reap $1 billion of those this quarter, sales are usually “tax- inefficient, so we’re very careful about taking gains,” Dimon said.
JPMorgan may at least test the liquidity of its European mortgage bonds with sales, even if it doesn’t otherwise shift its strategy, one of the people said.
The chief investment office’s push into risk-taking was led by Achilles Macris, 50, according to three former employees, Bloomberg News reported on April 13. He was hired in 2006 as its top executive in London and led an expansion into corporate and mortgage-debt investments to generate profits, they said. The bank said May 14 that Macris would hand off his duties.
Those in London given the task of adding European mortgage- backed securities include Anthony Brown, Francois Brochard and Swen Nicolaus according to two of the people.
Analysts such as Morningstar Inc.’s Jim Leonard and investors including John Kerschner, Janus Capital Group Inc.’s head of securitized products, said when Bloomberg News reported the expanded holdings on Feb. 23 that the types of bonds JPMorgan targeted represent generally safe long-term bets, since they are among the most senior-ranked in deals.
The bank had unrealized losses of $273 million on the bonds as of March 31, down from $530 million on Sept. 30, according to its filings. “Substantially all of these securities” carry ratings of AAA, AA or A, and they are “primarily” from the U.K. and Netherlands, it said in the filings. Those figures were “gross” amounts, meaning similar holdings could be worth more than purchase prices. Unrealized gains totaled $657 million.
Its portions of deals can withstand losses of about 10 percent on the underlying mortgages because other classes will take writedowns first. JPMorgan said it projects lifetime losses of 1 percent. The so-called credit enhancement on U.K. bonds it bought in October was 22.4 percent of losses.
U.K., Dutch Markets
The market for U.K and Dutch home-loan bonds totals 691 billion euros, according to the data from the bank’s analysts. The broader European market’s size is 1.2 trillion euros.
Homeowners from the U.K. and Netherlands are considered the most creditworthy in Europe by bond investors, even with the U.K. returning to recession in the first quarter and Dutch home prices set to drop about 5 percent this year because of the region’s debt crisis and stricter mortgage lending rules, according to a January forecast by Nederlandse Vereniging van Makelaars, which represents property brokers.
Investors are demanding 138 basis points more than benchmark rates to hold Dutch mortgage notes and 132 basis points extra for British securities. That compares with a spread of 600 basis points for Spanish bonds. A basis point is 0.01 percentage point.
While JPMorgan remains important to issuance, a shift to structuring U.K. deals with U.S. dollar-dominated classes through the use of currency swaps may mitigate the impact of any retreat by the bank, one of the investors said.
“Reliance on JPMorgan has been declining since the investor base is expanding especially in the U.S. but still it’s a big player,” Aegon’s Meijer said.
Citigroup Inc. (C) is emerging as a bigger buyer from the U.S., increasing its holdings of residential-mortgage securities from elsewhere by $1.7 billion in the first three months of this year to $9.8 billion, according to a company filing. Shannon Bell, a spokeswoman for the New York-based, declined to comment.
The market got a test with a May 16 sale of about $3.6 billion of securities by Santander’s U.K. unit, with slices in pounds, yen and U.S. and Australian dollars. The lender’s Fosse Master Issuer’s $700 million portion with an average life of 5 years was priced at 150 basis points above the London interbank offered rate, or Libor, according to Bloomberg data.
That was in line with marketing guidance from underwriters and compares with a spread of 155 basis points on $1.25 billion of bonds with a similar expected duration sold in April by the lender from its Holmes program.
The transaction “shows that it is possible to sell a deal without one particular anchor investor,” said Patrick Janssen, a fund manager at M&G Investments in London, which manages 20 billion euros of asset-backed securities. Top-rated “U.K and Dutch RMBS are perceived as a safe haven with a yield pickup so the investor base is growing.”
Bob Paterson, head of asset-backed securities syndication at Lloyds, said the market has been “rather stable in terms of performance and pricing. With strong structural support and sound asset quality we don’t anticipate this changing.”