JPMorgan Chase & Co.’s biggest U.S. competitors say their corporate investment offices avoid the use of derivatives that led to the bank’s $2 billion loss and buy fewer bonds exposed to credit risk.
Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. say the offices don’t trade credit-default swaps on indexes linked to the health of companies. JPMorgan is said to have amassed positions in such indexes that were so large they drove price moves in the $10 trillion market.
The loss has prompted shareholders to join regulators in scrutinizing how banks use their investment offices to hedge risks and manage deposits they aren’t using for loans. JPMorgan’s competitors confine corporate-level trading mostly to interest-rate and currency swaps — the most common derivatives — and put a greater percentage of funds into U.S. government- backed securities such as Treasury bonds.
“Traditionally, banks use government bonds, because they’re safer,” said Ray Soifer, a former Brown Brothers Harriman & Co. bank analyst who’s now chairman of Green Valley, Arizona-based Soifer Consulting LLC, which advises banks and investors on strategy and risk management. “JPMorgan is going down the credit spectrum from U.S. Treasurys, because they’re reaching for yield.”
The concentration of assets that carry the risk a borrower might default reflects JPMorgan Chief Executive Officer Jamie Dimon’s push over the past five years to seek higher returns at the New York-based bank’s chief investment office, as reported by Bloomberg News April 13. Dimon said at an investment conference yesterday that the bank has more of such assets than competitors, while asserting it isn’t taking undue risks.
“We have more credit exposure than other people, and we think when we put that credit exposure on, it was actually very good,” said Dimon, 56. “We bought some triple-A securities that we think are as good as gold.”
About half of the $381.7 billion in JPMorgan’s chief investment office portfolio is in company bonds, asset-backed securities and mortgage debt not backed by the U.S. government, according to a March 31 filing. That compares with 7.7 percent at the end of 2007. The amount, $188.1 billion, is more than the holdings of such securities by its three biggest competitors combined. It exceeds the total assets of Atlanta-based SunTrust Banks Inc., the 10th-biggest U.S. lender.
Similar assets at San Francisco-based Wells Fargo represent 34 percent of a $230.3 billion portfolio. It’s 11 percent of New York-based Citigroup’s $270.6 billion book, and 10 percent of the $297.1 billion pool of securities at Charlotte, North Carolina-based Bank of America.
Fewer Treasury Bonds
JPMorgan has about 30 percent of its holdings in U.S. Treasurys and bonds issued or guaranteed by U.S. government-backed agencies, according to its filings. That compares with 87 percent at Bank of America, 50 percent at Citigroup and 47 percent at Wells Fargo.
The payoff: JPMorgan, the largest U.S. bank, gets a yield of 3.2 percent on its corporate bonds, compared with 1 percent for Treasurys and debt issued by government-backed agencies.
The pressure to take bigger risks has increased as the Federal Reserve keeps benchmark interest rates near zero, shrinking the returns banks can get from keeping their money in short-term U.S. government bonds.
JPMorgan is “more credit-heavy” than other banks, said David Hendler, an analyst with CreditSights Inc. in New York. “It’s just another indication that they’re searching for yield like other money managers.”
Citigroup senior managers were getting so many questions about corporate liquidity that Chief Financial Officer John Gerspach and Chief Risk Officer Brian Leach last week sent a memo to staff outlining how the money is managed. Liquidity is the term financial executives and regulators use to describe cash or investments that can be easily sold and converted into cash to meet redemption requests from depositors or pay off short-term debts.
“We are conservative in our mix of assets,” Gerspach and Leach wrote in the May 14 memo. “There are clear risk limits and parameters throughout the firm.”
At issue is how banks manage their securities portfolios — the investments they buy with funds left over when deposits exceed the amount of loans. Putting the money into bonds is supposed to bring higher yields than the bank could get from parking the money at the Fed, currently paying 0.25 percent on deposits. The four biggest U.S. banks manage a combined $1.2 trillion in these portfolios.
‘Everyone Does It’
JPMorgan’s holdings are overseen by the chief investment office, where the flawed derivatives trades took place. The former head of the unit, Ina Drew, reported directly to Dimon until she resigned last week.
“Think of this as a big fixed-income portfolio,” Dimon said yesterday. “Almost every single bank, whether you call it CIO or treasury, almost everyone does it.”
Bank of America’s portfolio is run by Chief Investment Officer Walter Muller, who reports to CFO Bruce Thompson. Citigroup Treasurer Eric Aboaf manages his bank’s pool, overseeing a chief investment office and deputy treasurers in countries outside the U.S. At Wells Fargo, the function is split between CFO Tim Sloan and John Shrewsberry, who runs the investment banking and trading division.
The differences between JPMorgan and its competitors extend to the use of credit derivatives by corporate investment offices to hedge macroeconomic risks in the company, such as the possibility that more loans might sour as unemployment rises. While all four banks buy and sell credit-default swaps, such transactions typically are done in trading departments.
Dimon, on a May 10 conference call with analysts and investors, said the bank’s losses stemmed from a “strategy to hedge the firm’s overall credit exposure, which is our largest risk overall, in a stressed credit environment.” He said the bank now plans to scale back.
“We are reducing that hedge,” Dimon said. “The portfolio has proven to be riskier, more volatile and less effective as an economic hedge than we thought.”
While Citigroup’s corporate office tries to hedge some credit risks, those trades are small and linked to consumers’ financial health, said Shannon Bell, a spokeswoman for the bank.
“Citi has a small amount of straightforward economic hedges managed at the corporate center to mitigate our credit exposure, principally relating to consumer loans,” Bell said, declining to provide a figure.
Wells Fargo, BofA
Wells Fargo also shuns such bets, Mary Eshet, a company spokeswoman, said in an e-mailed statement.
“Wells Fargo does not have a CIO function that employs large-scale macroeconomic credit-derivative hedges,” she wrote.
Bank of America CEO Brian T. Moynihan said yesterday at the investment conference that while his company sometimes uses credit-default swaps tied to individual companies, it doesn’t hedge against broader macroeconomic risk.
“We don’t do the macro hedging from a corporate perspective,” he said. “We obviously manage our interest-rate risk every day.”
That doesn’t make Bank of America, Wells Fargo or Citigroup risk-free.
“The scale of their transactions remains an important issue,” said Eric Hilt, an associate professor of economics at Wellesley College in Massachusetts. “A currency hedge could be just as damaging and risky as a credit hedge if done on an absurdly large scale.”
Bank treasury departments are a “sleepy little world,” and aggressive risk-taking should be left to the trading division, said Thomas Obermaier, a former Citigroup risk officer who’s now CEO of Regulatory DataCorp Inc., a consulting firm based in King of Prussia, Pennsylvania. JPMorgan is a client and owns a stake in the company, he said.
“This was clearly a treasury department designed to maximize profit as much as trying to manage the portfolio, and they got burned,” Obermaier said. “They can eat a $3 billion loss. But you shouldn’t eat a $3 billion loss from treasury trading.”
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