Friday, 13 April 2012

Is JP Morgan getting too big not to fail ?

The investment bank, colloquially nicknamed JP Morgue, or the vampire squid posted a first quarter net-income of $5.4 billion, slightly down from last year`s $5.6 billion figure. Earnings per share increased by 4% due to the share buy-back programme which decreased the overall number of floating shares. Investment banking accounted for $7.3 billion our of the $27.4 billion total revenues, while retail financial services accounted for $7.65 billion. The interesting part is the ever-increasing market power attained by its proprietary trade desk, on huge markets such as the ones for MBS, Credit Default Swaps and Treasuries.

JP Morgan`s position -a white elephant ?

A few days ago, Bloomberg broke out the news that one of its CDS prop traders, Bruno Iksil acquired so big that when it trades in the market, he has the ability to move the price in his direction. When he would put a bulk order in the market, the sheer size of the contract prompts other market participants to take the same direction. Some of the traders approximate the notional amount of Iksil`s total portfolio to $100 billion, an enormous sum for the relatively thin CDS market. The money at risk is considerably less than the notional amount, because the actual bet is on the direction of the underlying company, country, institution or municipality interest yield. As the default risk is already priced in the yield of any type of debt, the CDS market (which officially acts as an insurance policy) should follow the spot market (the difference would be in the other types or interest risk).

Such large trades are very dangerous, as the market usually punishes elephants in the room. Specifically because most of the other participants know the approximate position and direction of trade, they can realise when JP Morgan is taking on more risk, or is de-risking, and they can front-run JP Morgan`s trades. This extracts profits from or increases the costs of JP Morgan`s trades as the other traders have more information than JP Morgan`s prop desk.

Even though it is hard to pick apart prop trading from hedging positions, with $2.27 trillion in assets, most of them in government backed securities (though not in student loan securities anymore), asset-backed securities, corporate bonds and US Treasuries and munies, the credit risk of their portfolio may be too high. If FED suspends its propping up programme of Treasury yields, all other debt instruments will experience price drops. From Bloomberg:

Since 2007, the value of securities held in JPMorgan’s chief investment office and treasury has more than tripled to surpass $350 billion from $76.5 billion, according to company filings. The biggest jump was in 2009, when the company disclosed that the CIO made “significant purchases” of government-backed mortgage securities, asset-backed securities, corporate securities, as well as U.S. Treasury and government- agency securities, according to the filings.
“These investments were generally associated with the chief investment office’s management of interest-rate risk and investment of cash resulting from the excess funding the firm continued to experience during 2009,” according to the company’s 10-K report for 2009, filed in February of 2010.
The securities portfolio is about $360 billion today, Braunstein said in the conference call with reporters. “That generates earnings for us, and it also balances our interest- rate risk,” he said.
One can remember a story about an insurer who failed spectacularly in its CDS bets and needed to be bailed out by the taxpayers. Does the history ever repeat itself ?

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