JPMorgan Shows Charged Former Traders No Bar: Corporate Finance

On the same day prosecutors charged two former JPMorgan Chase & Co. employees with concealing $6.2 billion of losses on derivatives trades, the bank persuaded bond investors to lend it money for 30 years at an interest rate less than similar securities.

The largest U.S. bank sold $750 million of bonds yesterday that are due in 2043 and yield 5.68 percent, below the 6.38 percent average for similarly-rated, dollar-denominated subordinated debt maturing in 20 to 40 years, according to data compiled by Bloomberg.

Terms of the deal show that at least in the bond market, JPMorgan is suffering little to no negative repercussions 16 months after Bloomberg News first reported that bets from its chief investment office in London were distorting the derivatives market. Bruno Iksil, the trader at the center of the case who became known as the “London Whale” because his bets were so big, pledged to cooperate with investigators.

“Managers have moved past the Whale story,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York. “As it relates to JPM’s future business, investors care little at this point.”

The 5.625 percent, subordinated notes yielded 190 basis points more than similar-maturity Treasuries, Bloomberg data show.

Kristin Lemkau, a spokeswoman at JPMorgan in New York, declined to comment about the new issue.

‘$6 Billion Ding’

“Timing is 90 percent of life,” Craig Pirrong, a former futures trader and now a professor of finance at the University of Houston, said of the subordinated debt issue and allegations. “Maybe investors will figure if they can survive a $6 billion ding no problem, the bonds are safe as can be,” he said.

Prosecutors said in court filings that Javier Martin-Artajo and Julien Grout falsified the value of positions in JPMorgan’s Synthetic Credit Portfolio, which the government said had been profitable for the unit, raking in more than $1 billion in 2009.

Disclosed by Chief Executive Officer Jamie Dimon in May 2012, the bad derivative bets led to an earnings restatement, a U.S. Senate subcommittee hearing and probes by the Securities and Exchange Commission and U.K. Financial Conduct Authority.

‘Next Crisis’

The divergent performances by the CIO unit in 2009 and 2012 demonstrate the “yin and yang of that operation,” Pirrong said in an e-mail. “In the next crisis, their trade could exacerbate the problems rather than save them.”

Credit-default swaps tied to the company’s debt, which typically rise as investor confidence deteriorates, rose 0.2 basis point to a mid-price of 82 basis points at 12:45 p.m. in New York, up from a 2013 low of 72.3 basis points in March, according to Bloomberg prices. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The contracts, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, reached as high as 174 basis points in June 2012 as investors sought to estimate the size of the loss.

JPMorgan never lost its investment-grade status in the eyes of swaps traders, according to Moody’s Corp.’s capital markets research group. At worst, the contract’s prices climbed to levels in September and October that implied the debt should be rated Baa2, the second-lowest step of investment grade. Moody’s Investors Service grades the company A2, and Standard & Poor’s an equivalent A.

Earnings Increase

Investment-grade debt is rated Baa3 or more by Moody’s and BBB- at S&P.

JPMorgan reported a 31 percent increase in second-quarter profit of $6.5 billion on July 12 that beat analysts’ estimates as revenue from trading stocks and bonds climbed. It was profitable every year during the financial crisis.

In the context of the investment-grade corporate market, “a 30-year single-A rated subordinated note yielding 190 over is attractive,” said Bonnie Baha, the head of global developed credit at Los Angeles-based DoubleLine Capital LP.

While JPMorgan is “still big, still generating tremendous profitability, and well-capitalized,” buying bank debt and benefiting as yields fell relative to Treasuries, a strategy that’s been profitable since 2009, is “getting toward the end of the road,” she said in a telephone interview.

“Investors have made a lot of money on that play, but going forward, where’s the revenue generation going to come from that drives profitability?”

Narrowing Spread

The average spread investors demand to hold U.S. bank bonds has dropped to 153 basis points through yesterday, from as high as 834 during the financial crisis, according to the Bank of America Merrill Lynch U.S. Banking Corporate Index. That compares with a spread of 150 basis points for industrial debt, from 602 basis points in December 2008, according to a Bank of America Merrill Lynch index of U.S. industrial issuers.

JPMorgan’s new subordinated notes were priced at a spread closer to the average industrial bond rated at the lowest level of investment grade, which fell to 198 basis points yesterday, according to the Bank of America Merrill Lynch BBB U.S. Industrial Excluding Financial, Telecom, Transportation and Utility Index.

That enabled investors “to get BBB-like spreads while still getting a single-A rating,” which is important for some money managers, according to Joel Levington, managing director of corporate credit for Brookfield Investment Management Inc. in New York.

Most people “don’t have a perfect view of an organization’s risk policies and how they are implemented on a daily basis,” Levington said in an e-mail. “JPMorgan was able to take a big hit and bounce back quickly. That says something about the earnings power and balance sheet quality here.”

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