Reuters: Regulatory News: UPDATE 1-JPMorgan $2 bln trading loss spooks bank stocks

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UPDATE 1-JPMorgan $2 bln trading loss spooks bank stocks May 11th 2012, 14:02 Fri May 11, 2012 10:02am EDT * CEO Dimon apologises * European bank stocks fall following JPMorgan loss * Losses could grow by another $1 bln - Dimon * Dimon says problem was execution of hedging strategy * JPMorgan keeping UK financial regulator informed By David Henry and Douwe Miedema NEW YORK/LONDON May 11 (Reuters) - JPMorgan Chase & Co's shock trading loss of at least $2 billion from a failed hedging strategy knocked financial stocks across the globe on Friday, as well as the reputation of the biggest U.S. bank by assets and its CEO Jamie Dimon. For a bank lauded for navigating the fallout from the 2008 financial crisis without reporting a loss, the errors are embarrassing, especially given Dimon's criticism of the so-called Volcker rule to ban proprietary trading by big banks. Dimon conceded the losses, which could rise by a further $1 billion, were linked to a Wall Street Journal report last month about a London-based trader Bruno Iksil, nicknamed the 'London Whale', who, the paper said, amassed an outsized position which hedge funds bet against. Iksil, who graduated in engineering from the Ecole Centrale in Paris in 1991, was not available for comment. The Frenchman, and the Chief Investment Office (CIO) where he works, are known by rival credit traders for taking extremely large positions. A friend and former JPMorgan colleague said Iksil and his team were not involved in so-called prop trading, where a bank makes bets with its own money, and its activities were known about at the highest levels. "The CIO does not do prop trading, let's be clear on that...It involves taking positions in the form of investments, trades, credit-default swaps, or other, with the aim of rebalancing the risks of JPMorgan's balance sheet. "The information comes from the very top of the bank and I do not even think that the CIO team members at Bruno's level are given the full picture," the ex-colleague said. The CIO is run by New York-based Ina Drew, who is Chief Investment Officer. Iksil was brought into the CIO unit to head its credit desk, an asset class it had not previously covered, a person who worked in the unit said. It built up large credit positions over several years through trades which were vetted by management and the losses now likely resulted from a combination of these trades going wrong, the person said. The CIO desk had grown rapidly in the past five years and was given free range to trade in a whole range of financial products, the only exception being commodities, they added. Credit market traders said other banks have comparable functions to JPMorgan's CIO. The French banks, Citigroup, Deutsche Bank and UBS were all cited as examples of large treasury functions that hedge credit exposures in similar ways. In a Securities and Exchange Commission filing, JPMorgan reported that since the end of March, its Chief Investment Office has had significant mark-to-market losses in its synthetic credit portfolio. While other gains partially offset the trading loss, the bank estimates the business unit will post a loss of $800 million in the current quarter. The bank previously forecast the unit would make a profit of about $200 million. Dimon said the problem was with the way the hedging strategy had been carried out, describing it as "ineffective, poorly monitored, poorly constructed". "It is risky and it will be for a couple quarters," Dimon, who admitted to having egg on his face due to the loss, said. He indicated that some people may lose their jobs as executives sort out what when wrong. JPMorgan had informed the UK's Financial Services Authority (FSA) of the situation, but this was a regulatory requirement and there was no indication at this stage that the regulator would take any action, a source familiar with the situation said. Talks between the bank and the watchdog were continuing. BAD STRATEGY More significant is the potential damage 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. The bank's position remains strong. It has been earning more than $4 billion each quarter, on average, for the past two years and had $2.32 trillion of assets supported by $190 billion of shareholder equity at the end of March - a ratio of almost 13 percent. That is four times the industry mean and ahead of 10-11 percent at Citigroup and Bank of America Corp. "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 by 9.5 percent at the open on Friday to $36.89 and dragged other financial shares lower. Bank of America fell by 2.86 percent and Citigroup by 4.9 percent. European banking stocks were down 2.24 percent at 1345 GMT. Although the loss was specific to JPMorgan, it could have broader negative implications - raising the threat of further regulatory scrutiny and the difficulties of risk management. European bank stocks fell on news of the loss and as fears about the fallout on banks from debt crises in Greece and Spain rattled investors. The STOXX Europe 600 banking index was down 1.4 percent at 1000 GMT. WHALE OF A LOSS The loss forced Dimon into a major volte face. During an earnings conference call last month he dismissed reports that Iksil had amassed a huge position that prompted hedge funds to bet against him as "a complete tempest in a teapot". But on Thursday, Dimon 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." JPMorgan has said the unit where Iksil works is used to make broad bets to hedge its portfolios of individual holdings, such as loans to speculative-grade firms. Questions over precisely what trades had gone wrong for JPMorgan bounced around London's credit markets on Friday, with the focus on credit derivatives. These financial instruments have been targeted by regulators who say their development played a central role in the financial crisis. Last week Dimon and leaders of other large banks met Federal Reserve Governor Daniel Tarullo in New York to question the way regulators conduct stress tests to see if banks have enough capital to withstand possible losses. "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." Allegations that traders at the banks take outsized risks with bank capital to earn big bonuses have been among the drivers of government regulations since the financial crisis. JPMorgan says it uses pay formulas to reduce the chance of that happening throughout the bank. 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. Dimon said he remained opposed to the Volcker rule. Link this Share this Digg this Email Reprints

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