JPMorgan Bond Reduces Whale to Teapot Tempest: Corporate Finance
JPMorgan Chase & Co. (JPM)’s $6.2 billion trading loss last year is little more than a fading memory for bondholders who awarded the lender its cheapest U.S. borrowing costs ever at a debt sale yesterday.
The largest U.S. bank by assets sold $6 billion of securities, including $2.75 billion of 10-year notes with an unprecedented 3.2 percent coupon, according to data compiled by Bloomberg. The extra yield investors demanded to hold those securities rather than government debt was 56 basis points tighter than where average comparable JPMorgan spreads traded before the scandal came to light in April.
JPMorgan’s bond offering came a day after it reported a record profit for the third straight year even after posting the trading gaffe at the hands of an employee known as the London Whale. Aided by rising loan demand in a recovering economy, the New York-based bank boosted mortgage fees and related revenue almost threefold to $2.03 billion in the fourth quarter. The trading losses are close to being a “non-issue” Chief Executive Officer Jamie Dimon said.
“Having the capacity to brush away a whale-sized problem and still be able to generate such significant earnings should make a bondholder sleep well at night,” Joel Levington, managing director of corporate credit for Brookfield Investment Management Inc. in New York, which manages $150 billion, said in an e-mail. The lender “should generate north of $21 billion in profit annually for the next few years. That profile is highly unlikely to experience near-term default concerns.”
JPMorgan’s three-part debt sale was its biggest in the U.S. since the lender issued $7.2 billion of bonds in April 2011, Bloomberg data show. The bank sold $1.25 billion of five-year notes at its record low coupon of 1.8 percent to yield 103 basis points more than similar-maturity Treasuries, and $2 billion of five-year, floating-rate bonds at 90 basis points more than the London interbank offered rate. The 10-year portion had a spread of 133 basis points.
Average spreads on 10-year, A rated JPMorgan bonds plunged to 140 basis points Jan. 16, down from 243 basis points on May 18, according to Bank of America Merrill Lynch index data, a week after Fitch Ratings cut the bank’s debt as a result of the trading loss. That compares with 189 basis points on March 26, before reports of the credit-derivative trades surfaced.
Tasha Pelio, a spokeswoman for JPMorgan in New York, declined to comment.
The bank earned $21.3 billion in net income last year on improving credit quality, according to Kathleen Shanley, a bond analyst at New York-based researcher Gimme Credit LLC. A provision for credit losses declined by more than half to $3.4 billion from $7.6 billion in 2011, Shanley wrote yesterday in a report. It’s the third straight year the lender has earned at least $15 billion in profit.
“They continue to be a very solid position for a lot of fixed-income investors,” Marc Pinto, head of corporate bond strategy at Susquehanna International Group LLP, said in a telephone interview from New York. “They continue to perform extremely well.”
JPMorgan first disclosed the trading losses on May 10, after Dimon initially dismissed concern as a “tempest in a teapot” the month before. London-based trader Bruno Iksil, who worked in the chief investment office, built up positions in credit derivatives so large he was nicknamed the London Whale. The bank released a 129-page report Jan. 16 that blamed managers for roles in failing to halt the loss, as well as an “error prone” risk-modeling system.
The bank’s shares fell 9.3 percent May 11, the biggest drop in nine months, after JPMorgan estimated its trading losses at $2 billion. Fitch reduced the firm’s long-term default rating to A+ from AA- the same day, following the close of trading.
The cost to protect JPMorgan debt from losses for five years climbed 21 basis points to 132.5 basis points after the disclosure, Bloomberg prices show. Those credit-default swaps traded at 78.5 basis points at 11:26 a.m. in New York.
CDS prices typically fall when investor confidence improves and rise when it deteriorates. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
“We’re five years on from the beginning of the financial crisis and investors have now recognized that many banks have increased their capital dramatically, non-performing loans have come down or their asset quality has improved dramatically,” Pinto said. “They’re much more comfortable investing today in bank paper.”
The lender set aside $656 million in provisions against future mortgage loan losses, compared with an average estimate by analysts of about $1.5 billion, according to a Jan. 16 earnings statement. Mortgage fees and related revenue increased to $2.03 billion in the fourth quarter from $723 million a year earlier as the unemployment rate fell to 7.8 percent, indicating a strengthening economy.
The gap between spreads on investment-grade bank bonds and the broader high-grade market reached the narrowest level in more than five years, when relative yields on bank debt dropped to 154 basis points, or 9 basis points more than corporates, on Jan. 7, according to Bank of America Merrill Lynch index data.
“Everything is driven by what the Fed is doing,” said Pri de Silva, a bank analyst at New York-based CreditSights Inc., “Banks are opportunistically locking in the lower rates.”
The U.S. Federal Reserve has held interest rates near record lows for an unprecedented fifth straight year, pushing investors to riskier assets in the search for yield.
“The CIO fiasco blemished JPMorgan’s previously stellar reputation as a savvy risk control manager,” wrote Gimme Credit’s Shanley, who rates the bank’s debt a buy. “Jamie Dimon is no doubt glad to bid farewell to the year of the London Whale.”
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