Is Investment Banking Worth the Risk for JP Morgan, Other Big Banks?
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Today, JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon gave testimony before the House Banking Committee. The focus of much of the testimony was that the bank, and Dimon in particular, had no knowledge of excessive risk in the bank's trading portfolio until it was really too late to do much about those risks. The facts are not quite consistent with that opinion, however, and I believe the time has come for Dimon to end his reign atop America's largest banking institution.
The testimony, which in general had a sharper tone than the pandering Senate Banking Committee hearing held last week, first delved into Dimon's pay. I have no qualms about the pay he receives as head of the nation's largest bank; pay is set not by him, but by his board. Over the past few years, Dimon has served as the de facto spokesman for the entire commercial banking industry, so I do not begrudge him a generous salary.
Next was the topic of whether JPMorgan disclosed its risky bets in a timely manner. My answer to that is a resounding “no," but I will discuss that more below. He testified that he was relying on the other bank employees when he uttered his famous “tempest in a teapot” at an April 13, 2012 analysts meeting where concerns were raised about the bank's exposure. It was not until May 10th that Dimon “went public” on the $2 billion trading loss.
It would help to take a look through an independent lens of some of the salient facts, and you can be the judge of how JPMorgan and Dimon really kept investors, institutional or individual, reasonably apprised of the risks they would be taking in buying JPMorgan's stock.
According to articles from Reuters, Bloomberg, and the Harvard Business Review in 2005, shortly after ascending to becoming CEO of JPMorgan, Dimon hired Ina Drew to head the bank's London trading office, which would become the bank's chief investment office. At first, the office had a $20 million dollar risk limit, but as the years went on and profits kept churning, the limit was eventually removed in 2011. All was relatively quiet, at least from Dimon's perspective, until he read a short article in the Wall Street Journal on April 4th identifying Bruno Iksil as having placed huge bets with potentially massive exposure. Three days later, in a meeting with Drew, Dimon was told the large bets were being effectively managed, and there was nothing to worry about. It was this meeting that resulted in the “tempest in a teapot” remark.
Yet, day, after day additional losses were coming out of the CIO, and Dimon grew increasingly concerned. On April 30th, Dimon demanded and reviewed the documentation of the specific trades at issue, and realized things were not as he was told. Finally, on May 10th, the trading losses became public knowledge. JPMorgan stock soon lost nearly $25 billion in value, dwarfing the actual trading loss. The issue was one of reputation and trust, which I am pleased to see are worth far more than the mere entries on a balance sheet or income statement.
But a banker of Dimon's alleged acumen must have known things were amiss. One statistic for any bank with a trading operation is the “value at risk”, or VAR. It is an indication of the exposure of the bank to trading disasters taken as a daily average. A change was made in January, 2012 to drive the number down to about half of what it used to be, and through the first quarter of the year, the VAR was consistently in the upper $60 million range. In a regulatory filing on April 13, the bank in fact reported its VAR at $67 million. Shortly after the April 13 filing, JPMorgan reverted back to its old ways and the VAR climbed immediately to $129 million, and later rose to as high as $186 million.
Dimon claims that there was no nefarious intent in the lowering of the VAR during the first quarter. Yet, it is clear that this change opened the door to bigger gambles (and bigger losses), and the Securities and Exchange Commission is worried investors were not made aware of JPMorgan's manipulation of the VAR.
In all, it seems clear that the CIO was running itself until early May, and Dimon was perhaps an unwitting accomplice. Whether Dimon's lack of oversight was due to commission or omission is largely irrelevant. On Dimon's watch, a far flung operation of the bank ran amok, and it is this writer's opinion that Dimon should atone for that by resigning.
Each of the three largest banks in the country, JPMorgan Chase, Bank of America (NYSE: BAC), and Citigroup (NYSE: C), have substantial trading operations, though there is nothing to suggest Bank of America or Citigroup have any of the sorts of trading issues that have befallen JPMorgan. But investment banking is inherently a high risk, high reward activity, and this makes earnings for the largest banks more volatile than they would otherwise be. Also, the large amount of capital required to operate a global investment bank diverts that capital from what might otherwise end up being interest earning loans. JPMorgan's loan to asset ratio is currently 31% , Bank of America's is 40%, and Citigroup's is 33%. These are the three lowest ratios for any of the nation's non trust banks with over $100 billion in assets.
For comparison's sake, U.S. Bank (USB) has 61% of in assets tied to its loan portfolio, and for Fifth Third Bancorp (FITB) the ratio is 73%. What do U.S. Bank and Fifth Third have that Bank of America, Citigroup and JPMorgan do not? Consistent profitability in excess of over 1% of assets. One of these “mega” banks ought to start to realize that having investment banking arms might look good, but it is just not as profitable an enterprise as traditional, quality banking.
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