JPMorgan’s Eminence Seen Fading in Default Swaps: Credit Markets

JPMorgan Chase & Co.’s advantage over its Wall Street peers is fading in the eyes of credit-derivatives traders as fines and regulator probes hobble profits while firms from Citigroup Inc. to Morgan Stanley rebound.

The month before JPMorgan disclosed a trading loss in May 2012 that reached $6.2 billion, credit-default swaps protecting against potential losses on bonds of the lender were trading 152 basis points lower than the average of its five-biggest U.S. rivals, according to prices compiled by Bloomberg. The gap, a measure of the bank’s credit strength relative to its competitors, has since narrowed to 16 basis points, and compares with the average of 80 since 2008.

With regulatory fines and penalties that are poised to approach $15 billion, the playing field is leveling between the only Wall Street bank to stay profitable through the financial crisis and rivals that the credit seizure pushed to the edge of failure. Swaps tied to Citigroup, which last month removed the final vestiges of its government bailout, narrowed to within 6 basis points of JPMorgan’s for the first time since 2007.

‘JPMorgan’s Turn’

“It’s JPMorgan’s turn to have its own types of concerns, albeit ones that are much less severe from a credit perspective than the others” and in an improved economy, said Pri De Silva, a bank analyst at debt-research firm CreditSights Inc. in New York. For lenders such as Citigroup, Bank of America and Morgan Stanley, “the balance sheets are in much better shape now compared with credit-crisis days,” he said.

The New York-based lender has tentatively agreed to pay a record $13 billion to end civil claims over its sales of mortgage bonds. The anticipated deal, which won’t absolve the bank of potential criminal liability, comes amid mounting lawsuits and regulatory probes and prompted JPMorgan to take a $7.2 billion charge in the third quarter. That led to the bank’s first loss under Chief Executive Officer Jamie Dimon.

Credit swaps protecting buyers against a default by JPMorgan for five years have dropped 15 basis points this year to 76 basis points through yesterday, Bloomberg prices show. That compares with a 44.1 basis-point decline for Citigroup, Morgan Stanley, Goldman Sachs Group Inc., Bank of America Corp. and Wells Fargo & Co., which average 92.5.

Citigroup Swaps

Joe Evangelisti, a spokesman for JPMorgan in New York, didn’t respond to an e-mail message.

Contracts tied to Citigroup, which since the end of 2007 has almost doubled a measure of its financial strength known as the tier-1 capital ratio, have declined 48.5 to 83.7 since December. Swaps on Morgan Stanley, which last week reported earnings that beat analyst estimates, plunged 73.2 to 114.2.

“JPMorgan has always been viewed as having the fortress-type balance sheet, while the other banks have been viewed as having weaker balance sheets,” said Charles Peabody, a senior analyst at New York-based Portales Partners LLC. “Recently, that perception has narrowed dramatically.”

Elsewhere in credit markets, the cost of protecting against losses on U.S. corporate bonds rose from the lowest in almost six years. A measure of the health of U.S. financial conditions that declines as the environment weakens fell for a second day.

Financial Conditions

The Bloomberg U.S. Financial Conditions Index, which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, decreased 0.03 to 1.48. The measure reached 1.57 on Oct. 21, the highest in data dating back to January 1994.

The Markit CDX North American Investment Grade Index, a credit-swaps benchmark used to hedge against losses or to speculate on creditworthiness, rose 2 basis points to 72.1 basis points as of 10:09 a.m. in New York, Bloomberg prices show. The measure yesterday reached the lowest since November 2007 in data that adjust for the effects of the market’s shift to a new version of the index in September.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 1.6 to 85.5.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Citigroup Bonds

Bonds of Citigroup are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 7.4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The spread between JPMorgan swaps and those linked to the other five major Wall Street banks has averaged 84 basis points since the collapse of Lehman Brothers Holdings Inc. five years ago. That’s about five times wider than the current gap, with swaps on San Francisco-based Wells Fargo’s debt the only contracts that cost less than those tied to JPMorgan.

Derivatives markets are signaling the creditworthiness of America’s banking industry has improved even with the six biggest U.S. banks, led by JPMorgan and Bank of America, piling up more than $100 billion in legal costs since the financial crisis, a figure that exceeds all of the dividends paid to shareholders in the past five years.

Resolving Probes

JPMorgan is the target of investigations in the U.S. and abroad, including probes of its hiring practices in Asia. The bank has tapped $8 billion of $28 billion in reserves set aside since 2010 to cover its legal costs.

Over the past two months, JPMorgan resolved U.S. and U.K. investigations into its record 2012 trading loss linked to positions built by Bruno Iksil, who came to be known as the London Whale because of the size of the bets. It also settled unrelated claims it unfairly charged customers for credit-monitoring products.

Citigroup and Bank of America have each increased their tier-1 risk-based capital ratios, a measure of their cushions against losses, to more than 12 percent to exceed the 11.7 percent gauge at JPMorgan, Bloomberg data show. Citigroup has boosted its ratio to 13.6 at the end of September from 7.12 in December 2007.

Bank of America, based in Charlotte, North Carolina, increased its ratio to 12.33 from 6.87 during the same period. Credit swaps on the lender have dropped 41.3 basis points to 91.2 this year.

‘Beaten Down’

“JPMorgan is getting beaten down and Citi and Bank of America are getting stronger,” said Marc Pinto, the head of corporate bond strategy at Susquehanna International Group LLP.

Contracts linked to Morgan Stanley, which is relying more on wealth-management revenue and reducing the capital allocated to fixed-income trading, now cost less than those insuring against a default by Goldman Sachs for the first time since 2007. Contracts on New York-based Goldman have dropped 34 basis points this year to 115.1, Bloomberg prices show.

After banks bolstered their balance sheets, bond buyers have been demanding less to own their debt relative to Treasuries than they are for debentures of industrial companies.

Relative yields for bank debt average 138 basis points more than similar-maturity Treasuries, 8 basis points less than the average spread for industrials including Caterpillar Inc. and 3M Co., Bank of America Merrill Lynch index data show. Until last month, lenders were paying more in relative yields than corporate borrowers as investor confidence deteriorated during the financial crisis.

Bonds of JPMorgan yielded an extra 109 basis points more than Treasuries on Oct. 21, according to the banking index, which tracks $972 billion of total lender debt.

“The regulatory overhang continues to be a headwind” for JPMorgan, David Schawel, a money manager at Square 1 Bank in Durham, North Carolina, said in an e-mail. “The rest of the banking industry, while still facing challenges,” he said, “continues to build capital levels. It makes sense that everyone else is getting tighter.”

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