Fed data expose US$100bn JP Morgan blunder
|May 24th, 2012, 08:11 PM||#1 (permalink)|
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Fed data expose US$100bn JP Morgan blunder
Official data from the US Federal Reserve have laid bare the eye-watering size of trading positions built up by JP Morgan’s chief investment office in synthetic credit indices, raising further questions about risk management standards at the bank.
According to the figures, JP Morgan’s position in investment-grade credit default swaps jumped eightfold from a net long of US$10bn notional at the end of 2011 to US$84bn at the end of the first quarter this year.
The Fed data support previous reports about the nature of the trading strategy that has led to the losses. In investment-grade CDS with a maturity of one-year or less, JP Morgan’s net short position rocketed from US$3.6bn notional at the end of September 2011 to US$54bn at the end of the first quarter. Over the same period, JP Morgan’s long position in investment grade CDS with a maturity of more than five years leapt five times from US$24bn to US$102bn (see chart).
“I don’t care how big a bank you are, that’s still a big move,” said one seasoned credit analyst.
This supports reports from market sources that the CIO positions were duration-neutral curve flatteners intended to benefit from credit markets quickly souring. One of the main strategies is understood to be buying the Markit CDX North America Investment Grade index Series 9 maturing in December 2012, and selling protection on the same contract maturing in December 2017.
The size of the positions lends credence to credit experts’ views that it will take JP Morgan a long time to close-out the position, particularly given the illiquidity of the off-the-run indices that are thought to be involved (see article). It also illustrates that the CIO will not be able to allow the risk to simply roll off its books due to the substantial portion of it that is long-dated.
JP Morgan’s chief executive Jamie Dimon said his firm began closely examining the CIO’s controversial trading strategy in closer detail when large mark-to-market losses – put at US$2bn by Dimon during an analyst call on May 10 – started appearing in the second quarter.
But the increasing concentration of risk was already apparent by the end of the first quarter. While the bank had reduced a long position in high-yield CDS from US$54bn notional to a short position of US$4bn to the end of March, its long position in investment-grade CDS had rocketed eight times over.
This dramatic re-jigging of its CDS exposures showed up in the net amount of CDS protection the firm had sold, which more than doubled from US$65bn to US$148bn over the same period, according to the Fed data.
There are even indications that losses had started to materialise as a result of the bungled trading strategy, which Dimon said was originally designed to reduce a synthetic credit portfolio that was hedging JP Morgan against a stressed credit environment.
The Fed filing shows the US bank had negative trading revenues from credit exposures of US$324m in the first quarter. It is not clear the CIO’s revenues are included in this figure. However, these are the first losses related to credit exposures JP Morgan has registered since September 2009, and contrasts with the US$3.4bn of credit trading revenues it reported in the final quarter of 2011.
“[Dimon] says that the CIO operations are separate from trading [from a reporting perspective], but I don’t see how they could be,” said the credit analyst.
“I don’t care how big a bank you are, that’s still a big move”
Questions will be raised about senior management signing off on a trading strategy that vastly increased the banks’ exposure to a worsening credit environment at a time when other banks were battening down the hatches.
In stark contrast to JP Morgan, the Fed data show other major US banks maintained large short positions in investment-grade credit in expectation of a continuation of the rocky market environment that persisted throughout the second half of 2011. All US banks are obliged to report such data to the Fed.
JP Morgan was a complete outlier among its peers, most of which decided to load up on investment grade credit protection in preparation for a deterioration in credit markets (see chart).
Goldman Sachs, for instance, took almost the polar opposite position to JP Morgan with a net short of US$80bn in investment-grade CDS at the end of the first quarter. Other major dealers were similarly positioned: Citigroup’s net short was US$69bn and Morgan Stanley’s was US$63bn. Bank of America ran a relatively flat investment-grade CDS book, with a net short of US$3bn.
The figures highlight JP Morgan’s failure to act at an earlier stage given the large concentrations of risk it was accumulating, as well as the inability of regulators to discern abnormal trading patterns among the piles of data banks already report to them (see article).