Whaledemort's Soul, Portfolio Broken Up And Hidden In JPMorgan Investment Bank

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Who wins the call-the-Whale-close? The headline number is a $4.4 billion loss this quarter but that is lower than it could have been because those losses propagated backwards through time:

JPMorgan Chase & Co. (NYSE: JPM) today reported that it will restate its previously-filed interim financial statements for the first quarter of 2012. The restatement will have no effect on total earnings or revenues for the company year-to-date.*

The restatement announced today will reduce the firm’s previously-reported net income for the 2012 first quarter by $459 million. The restatement relates to valuations of certain positions in the synthetic credit portfolio in the firm’s Chief Investment Office (CIO).

The total loss in the first quarter is now $1,378mm for Q1 (footnote 3 of page 14 here); add $4,409mm for Q2 (page 3 here) and you get a total final official loss of $5,787mm. So far.**

The restatement is fascinating, and Dimon is proud of it: "This is what the SEC chairwoman herself would have done if she had seen all the same facts at the same time." Okay! But she probably wouldn't have done this:

The restatement results from information that has recently come to the Firm’s attention in connection with management’s internal review of activities related to CIO’s synthetic credit portfolio. Under Firm policy, the positions in the portfolio are to be marked at fair value, based on the traders’ reasonable judgment as to the prices at which transactions could occur. As an independent check on those marks, the CIO’s valuation control group (“VCG”), a finance function within CIO, verifies that the traders’ marks are within pre-established price testing thresholds around external “mid-market” benchmarks and, if not, adjusts trader marks outside the relevant threshold. The thresholds consider market bid/offer spreads and are intended to establish a range of reasonable fair value estimates for each relevant position. At March 31, 2012, the trader marks, subject to the VCG verification process, formed the basis for preparing the Firm’s reported first quarter results.

However, the recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter. As a result, the Firm is no longer confident that the trader marks used to prepare the Firm’s reported first quarter results (although within the established thresholds) reflect good faith estimates of fair value at quarter end.

Specifically "Emails, voice tapes and other documents, supplemented by interviews, suggestive of trader intent not to mark positions where they believed they could execute." Where have we heard that before?

The hits really keep on coming for Jamie Dimon. The Whale losses, even at $5.8bn, aren't that big: JPMorgan still reported net income of $5bn this quarter (and $4.9bn in restated last quarter), and the $5.8bn is 0.25% of assets and 3.9% of tier 1 capital. And losing money isn't a crime, or even all that uncommon, so he could take a certain amount of high ground talking to Congress. You can read more about what Whale & friends did here, in Mike Cavanagh's shame-the-CIO presentation; it's kind of what everyone thought and not great but also not outrageously outrageous. And sure there had been rumors that the CIO was mis-marking its portfolio, which is ... maybe criminal-ish ... but sounded sort of like garden-variety trader optimism and not that big a deal.

But to then have to announce that the CIO was doing exactly that - and that they were doing it with the intent of hiding losses and making themselves look better - and to the tune of hundreds of millions of dollars - and that there were emails about it - probably hurts more than the money. And it is just terrible to have to announce that right smack in the middle of Liborgate, when there is a lot of press and regulator and Congressional attention to banks making themselves look better by reporting numbers that, although arguably within a reasonable range, were not executable. That maybe was garden-variety mild misbehavior, both at JPM CIO and in Libor - but that does not look like a great defense any more.

In any case, this seems to be the end of the line for the Whale and his famous trade - not so much because JPMorgan is out of the trade, but because it's moved it somewhere less visible:

“Since the end of the first quarter, we have significantly reduced the total synthetic credit risk in CIO – whether measured by notional amounts, stress testing or other statistical methods. The reduction in risk has brought the portfolio to a scale that allowed us to transfer substantially all remaining synthetic credit positions to the Investment Bank. The Investment Bank has the expertise, capacity, trading platforms and market franchise to effectively manage these positions and maximize economic value going forward. As a result of the transfer, the Investment Bank’s Value-at-Risk and Risk Weighted Assets will increase, but we believe they will come down over time.”

The transfer is around $30bn of risk-weighted assets, around $40mm of VaR, around $7mm of CS01, and "Extreme simulated scenarios indicate potential losses between $800mm-$1.6B." What's left seems to be hedged tranches of credit indices. And, I'd guess, being very conservatively marked.

JPMorgan earnings stuff [JPM]
Earnings 8-K [EDGAR]
Restatement 8-K [EDGAR]

* Isn't that sort of a jarring thing to say btw? Like, "we discovered we lost an extra $459mm last quarter, but it's okay, we would have lost it this quarter anyway."

** Updated with exact numbers etc.

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