* CEO Dimon apologizes
* Stock drops 7 percent after market close
* Losses could grow by another $1 bln -Dimon
* Dimon says problem was execution of hedging strategy
* New heat from Washington expected for banks
By David Henry and Rick Rothacker
May 10 JPMorgan Chase & Co, the biggest
U.S. bank by assets, said it suffered a trading loss of at least
$2 billion from a failed hedging strategy, a shock disclosure
that hit financial stocks and the reputation of the bank and its
CEO, Jamie Dimon.
For a bank viewed as a strong risk manager that went through
the financial crisis without reporting a loss, the errors are
embarrassing, especially given Dimon's public criticism of the
so-called Volcker rule to ban proprietary trading by big banks.
"This puts egg on our face," Dimon said, apologizing on a
hastily called conference call with stock analysts. He conceded
the losses were linked to a Wall Street Journal report last
month about a trader, nicknamed the 'London Whale', who, the
report said, amassed an outsized position which hedge funds bet
JPMorgan said in a filing with the Securities and Exchange
Commission that since end-March, its Chief Investment Office has
had significant mark-to-market losses in its synthetic credit
portfolio - these typically include derivatives in a way
intended to mimic the performance of securities.
While other gains partially offset the trading loss, the
bank estimates the business unit with the portfolio will post a
loss of $800 million in the current quarter, excluding private
equity results and litigation expenses. The bank previously
forecast the unit would make a profit of about $200 million.
"It could cost us as much as $1 billion or more," in
addition to the loss estimated so far, Dimon said. "It is risky
and it will be for a couple quarters."
The dollar loss, though, could be less significant than the
hit to Dimon and the reputation of a bank which was strong
enough to take over investment bank Bear Stearns and consumer
bank Washington Mutual when they collapsed in 2008.
JPMorgan had $2.32 trillion of assets supported by $190
billion of shareholder equity at the end of March - an equity
ratio of almost 13 percent, four times the industry mean and
ahead of 10-11 percent at Citigroup and Bank of America
Corp - and has been earning more than $4 billion each
quarter, on average, for the past two years.
"Jamie has always styled himself as one of the kings of Wall
Street," said Nancy Bush, a longtime bank analyst and
contributing editor at SNL Financial. "I don't know how this
went so bad so quickly with his knowledge and aversion to risk."
JPMorgan shares fell almost 7 percent after the closing bell
and dragged other financial shares lower, with Citigroup down
3.6 percent and Bank of America down 2.6 percent. FBR
Capital Markets analyst Paul Miller cut his target for the stock
to $37 from $50 in response to the disclosures. The shares were
at $40.74 before the news.
Dimon said he still believes in his arguments against the
Volcker rule. The problem at JPMorgan, he said, was with the
execution of the hedging strategy, which "morphed over time" and
was "ineffective, poorly monitored, poorly constructed and all
On the call, Dimon said he wouldn't take questions about
specific people or their specific trading strategies. But he
indicated that some people may lose their jobs as executives
sort out what when wrong. "All appropriate corrective action
will be taken as necessary in the future," he said.
WHALE OF A LOSS
The April Wall Street Journal report said Bruno Iksil , a
London-based trader in JPMorgan's Chief Investment Office,
nicknamed the 'London Whale', had amassed an outsized position
that prompted hedge funds to bet against it. On an earnings
conference call last month, Dimon called the concern "a complete
tempest in a teapot." On Thursday, however, he said the bank's
loss had "a bit to do with the article in the press." He added:
"I also think we acted a little too defensively to that."
The Chief Investment Office is an arm of the bank that
JPMorgan has said is used to make broad bets to hedge its
portfolios of individual holdings, such as loans to
The failed hedge likely involved a bet on the flattening of
a credit derivative curve, part of the CDX family of investment
grade credit indices, said two sources with knowledge of the
industry, but not directly involved in the matter. JPMorgan was
then caught by sharp moves at the long end of the bet, they
said. The CDX index gives traders exposure to credit risk across
a range of assets, and gets its value from a basket of
individual credit derivatives.
Two financial industry sources in Asia said they heard the
JPMorgan trader took a position that a credit derivative curve,
part of the CDX family of investment grade credit indices, would
flatten, but was caught out by sharp moves at the long end. The
CDX index gives traders exposure to credit risk across a range
of assets, and gets its value from a basket of individual credit
"It's a pretty stunning admission for a company that prides
itself on its risk management systems and the strength of its
balance sheet," said Sterne Agee analyst Todd Hagerman. "The
timing couldn't be worse for the industry. It will have
ramifications across the broker-dealer community."
Just last week Dimon and leaders of other large banks met
Federal Reserve Governor Daniel Tarullo in New York to question
the way the regulators conduct stress tests to see if banks have
enough capital to withstand possible losses. They also made
arguments over trading restrictions.
Allegations that traders at the banks take outsized risks
with bank capital to earn big bonuses have been among the
drivers of government regulations adopted, and pending, since
the financial crisis.
JPMorgan spokesman Joseph Evangelisti said the company uses
pay formulas to reduce the chance of that happening in the Chief
Investment Office and throughout the bank. Except for people
handling the bank's private equity investments, "no one at
JPMorgan is paid on their profits and losses," he said.
PUSHING FOR DETAIL
Regulators and lawmakers are now likely to push Dimon for
more details about the trades. Those details will guide how
regulators now view the issue and its impact on the Volcker
rule, said Karen Petrou, managing partner of Washington-based
Federal Financial Analytics.
If the trades were meant to hedge against specific risks as
opposed to clearly being done as a proprietary bet on the
markets, it may not play as clearly into the Volcker rule debate
as supporters of the crackdown want it to, she said.
"The question is whether this in fact was a hedge and I
think that's to be determined," she said. "That's really the
heart of the matter."
But some in Washington quickly expressed views on the
lessons from the episode. Senator Carl Levin, in a statement
issued two hours after the news broke, said, "The enormous loss
JPMorgan announced today is just the latest evidence that what
banks call 'hedges' are often risky bets that so-called 'too big
to fail' banks have no business making."