Botched trades by a unit of JPMorgan Chase & Co. that Jamie Dimon had pushed to boost profit were masked by weak internal controls and may ultimately saddle the bank with a $7.5 billion loss.
JPMorgan’s chief investment office has lost $5.8 billion on the trades so far, and that figure may grow by $1.7 billion in a worst-case scenario, Dimon, the bank’s chairman and chief executive officer, said today. Net income fell 9 percent to $4.96 billion in the second quarter, the bank said. It restated first-quarter results to reduce profit by $459 million after a review of the unit found employees may have hid souring bets.
By capping the size of the potential loss and revamping management of the businesses responsible, Dimon may help restore investor confidence after the bank’s market value dropped $39.7 billion since April 5, when Bloomberg News first reported that the company had amassed an illiquid book of credit derivatives at the London chief investment office.
“You can’t prove that there will never be another loss, because in fact, there will be another loss,” said Thomas Brown, chief executive officer of Second Curve Capital LLC in New York and a Bloomberg contributing editor. “But you put in as tight of controls that you can. I have a lot of confidence that JPMorgan has done that.”
Shares of the company, which had gained 2.4 percent this year through yesterday, advanced 4.4 percent to $35.53 in New York trading at 10:57 a.m., the biggest gain in seven weeks.
“We have already completely overhauled CIO management and enhanced the governance standards within CIO,” Dimon said in a statement. “We believe these events to be isolated to CIO, but have taken the opportunity to apply lessons learned across the firm,” Dimon, 56, said.
Dimon had brushed off concerns raised by some of his most senior advisers, including heads of JPMorgan’s investment bank, about the lack of transparency and the quality of internal controls in the CIO in recent years, Bloomberg News reported last month, citing a person with direct knowledge of the matter. He exempted the unit from the rigorous scrutiny applied to risk management in the investment bank, two people said at the time.
JPMorgan said today that it ousted managers responsible for the CIO loss and will claw back their pay after an internal investigation found that traders may have intentionally tried to hide the problem. The company didn’t name the managers.
Bruno Iksil, known as the London Whale, his boss Javier Martin-Artajo and former Europe CIO head Achilles Macris were responsible for overseeing the trades.
JPMorgan accepted an offer by Ina Drew, the former head of the CIO, to return as much as two years of her compensation, according to Joseph Evangelisti, a spokesman for the bank.
Drew, 55, was awarded about $29 million in total compensation for 2010 and 2011, according to JPMorgan’s regualtory filings. She retired May 14 with about $57.5 million in stock, pension and other pay, according to regulatory filings and estimates from consulting firm Meridian Compensation Partners LLC. About $21.5 million of that, based on the stock’s May 14 closing price, would have been automatically forfeited if she had been fired for cause.
“I have enormous respect for Ina as a person and a professional,” Dimon said at a meeting with analysts today.
Brown at Second Curve said he was surprised by how much the company pursued in clawbacks.
“Four people gave back two years’ worth of income, which surprised me on the high side,” Brown said in an interview with Betty Liu on Bloomberg Television. “That’s the maximum clawback provision. I think it’s impressive on one hand; it’s certainly more severe than I would have expected.”
The share gains today may not last, according to Paul Miller, a former examiner for the Philadelphia Federal Reserve Bank and an analyst at FBR Capital Markets Corp. in Arlington, Virginia.
“The stock is doing really well this morning, but I think over time, it will still drift down,” Miller said in an interview. “There’s a lot of unanswered questions with this CIO office out there and this is not going to go down to alleviate a lot of those things.”
Dimon dismissed reports about the London operation as a “tempest in a teapot” when the bank reported first-quarter earnings on April 13. He reversed course less than four weeks later, disclosing a $2 billion loss that he said could grow to $3 billion or more during the quarter.
JPMorgan said May 10 that it had taken $1 billion in profits from securities sales in the CIO to mitigate the trading loss and planned more asset sales if needed to offset the damage, which was caused by a wrong-way bet on credit derivatives by Iksil. Dimon hired Macris in 2006 with a mandate to generate profits. Macris and Iksil eventually built up a position in credit derivatives that was so large it couldn’t be unwound without roiling markets.
Dimon is also grappling with historically low interest rates that have compressed profit margins on lending as well as yields on investments. Moshe Orenbuch, of Credit Suisse Group AG, was among analysts who lowered earnings projections for banks amid weak trading revenue and market turmoil caused by Europe’s sovereign-debt crisis.
Second-quarter net income excluding the effect of accounting adjustments known as DVA was $1.09 a share. Excluding DVA, loan-loss reserve reductions and a recovery related to Bear Stearns Cos., profit was 67 cents. Analysts surveyed by Bloomberg had estimated adjusted earnings per share of 76 cents.
The company restated first-quarter earnings after executives and outside attorneys conducted interviews and reviewed “tens of thousands of hours” of voice tapes as well as about 1 million e-mails, Michael Cavanagh, JPMorgan’s head of Treasury & Securities Services, told reporters on a conference call.
“We just have questions about whether the traders were doing what they need to do for accounting, which is put a mark on their positions where they think they can exit,” Cavanagh said. “Instead it felt more like they were pricing their marks a little bit more aggressively, but generally inside the bid-ask spread.”