JPMorgan Swaps Pricing Differed

Chief investment office said to value some of its trades at prices that varied from investment bank’s.

The JPMorgan Chase & Co. unit responsible for at least $2 billion in losses on credit derivatives was valuing some of its trades at prices that differed from those of its investment bank, according to people familiar with the matter.

The discrepancy between prices used by the chief investment office and JPMorgan’s credit-swaps dealer, the biggest in the U.S., may have obscured by hundreds of millions of dollars the magnitude of the loss before it was disclosed May 10, said one of the people, who asked not to be identified because they aren’t authorized to discuss the matter.

“I’ve never run into anything like that,” said Sanford C. Bernstein & Co.’s Brad Hintz in New York, ranked by Institutional Investor magazine as the top analyst covering brokerage firms. “That’s why you have a centralized accounting group that’s comparing marks” between different parts of the bank “to make sure you don’t have any outliers,” said the former chief financial officer of Lehman Brothers Holdings Inc.

The biggest U.S. bank by assets is facing regulatory scrutiny and criminal probes over losses in the CIO, which Chief Executive Officer Jamie Dimon pushed in recent years to make bigger and riskier bets with the bank’s money. The loss, which Dimon said stemmed from positions that were “poorly monitored,” prompted calls from Congress for tighter bank regulation and triggered criminal investigations by the U.S. Department of Justice and Federal Bureau of Investigation.

Jennifer Zuccarelli, a spokeswoman for New York-based JPMorgan, declined to comment on whether the CIO and investment bank were using different prices.

“All components of the synthetic credit portfolio in the chief investment office were mark-to-market,” she said.

The trades in question, made by a CIO group that included Bruno Iksil, nicknamed the London Whale because his positions grew so large, were on so-called tranches of credit-swap indexes, the people said.

Tranches allow investors to wager on varying degrees of risk among a pool of companies. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Because JPMorgan had amassed such large positions, even a small change in how the prices were marked may have generated a big difference in the value of the trades, one of the people said.


Not ‘Normal’

“It would not be normal to book it at levels that were better than the dealer desk,” said Peter Tchir, founder of New York-based hedge fund TF Market Advisors. “That would strike me as a very big issue.”

Bloomberg News first reported April 5 that Iksil had built positions that were so large he was driving price moves in the $10 trillion market for credit-swap indexes. About a week later, on a conference call to announce quarterly results, Dimon, 56, called news about the trades a “complete tempest in a teapot.”

On the May 10 conference call briefing analysts on the $2 billion trading loss, Dimon said the trades, which he said initially had been a hedge against the bank’s credit exposure, turned out to be “riskier, more volatile and less effective as an economic hedge than we thought.”

“We were reducing that hedge,” he said. “But in hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored.”

Dimon also said on the call that the bank changed how it calculates the CIO unit’s so-called value at risk, or VaR, a measure of how much the company estimates it could lose on securities on 95 percent of days.

The bank increased its VaR for the first quarter, previously disclosed at $67 million, to $129 million. JPMorgan used a new model for calculating its trading risk in the first quarter that Dimon said was “inadequate.” The bank didn’t disclose any change to its model for the investment bank.

The U.S. Securities and Exchange Commission is reviewing the accuracy and timing of JPMorgan’s disclosure of those changes, Chairman Mary Schapiro said May 22 before the Senate Banking Committee in Washington. The bank changed its VaR model for the chief investment office during the first quarter without telling investors.

The net amount of credit-swaps protection sold by JPMorgan soared eight-fold to $97.4 billion in the three months ended March 31, Federal Reserve data show. The bank held total credit swaps contracts on $6.05 trillion, the biggest among the six largest U.S. bank holding companies, the data show.


Bloomberg News

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