The financial services sector has been the hardest hit sector in the credit crisis so far. Banks with large exposures to mortgage-backed securities like Citigroup, UBS and Merrill Lynch have suffered the most. This is largely because the crisis has been in asset prices — chiefly home prices. However, as credit has become severely restricted, the credit crisis has become a global recession and that means the real economy will be impacted. This spells trouble for JPMorgan Chase.
As the global economy slips into recession, the categories of credits that will sour in the U.S. will expand to include:
- Residential Property (like Alt-A, Payment Option, Negative Amortisation Mortgages)
- Commercial Property (Commercial Real Estate and Construction Loans)
- Leveraged Loans and High Yield Bonds (from Private Equity LBOs)
- Credit Card Receivables and Asset Backed Securities
- Auto Loan Receivables and Securitised Auto Loan Bonds
And JPMorgan Chase is more exposed in many of these categories in addition to being one of the largest players in credit default swaps and other derivative instruments. Below is a good article from yesterday’s Financial Times which highlights this fact. While I greatly respect the managerial acumen of Jamie Dimon, JPMorgan Chase’s CEO who came to the bank via Bank One after losing out in a Citigroup power struggle, I do expect the company to be hit hard by writedowns in the coming quarters. JPMorgan Chase is no Citigroup but it is going to take a beating nonetheless.
“As the credit crisis ripples through the real economy, perceptions about strength and risk management will change,” says Charles Peabody of Portales Partners, a research boutique. Mr Peabody predicts that losses from commercial loans can increase up to six-fold. He says he is especially concerned about JPMorgan Chase, so far the symbol of prudence. JPMorgan has a far bigger book of corporate loans than Citi, far bigger exposure to the commercial real estate market and it is at continuing risk from its exposure to leveraged buy-out deals. Indeed, according to the calculations of Mr Peabody, those exposures amount to some $288bn.
The buy-out loans include such troubled deals as the $6bn JPMorgan put up to help Cerberus finance its purchase of ailing Chrysler.
The bank has already marked down its $12.9bn leveraged loan book almost 30 per cent to $9bn, but investors in private equity deals say they expect there are far more drastic markdowns to come.
Most of the corporate targets of recent buy-outs have so much debt and carry such low ratings that defaults on such private equity-owned companies are expected to reach record highs and recoveries record lows. All that means is that companies owned by private equity, whether retailers or semiconductor companies or media firms will be the first hit – not the only ones.
JPMorgan’s management and its risk management are far more impressive than any of its peers among the commercial banks. It has been conservative and is becoming more so. So far, its charge-offs have been modest and a spokesman says that the level remains low even by historical standards.
Still, in anticipation of harder times, the bank has been adding to reserves, which now stand at 3.85 per cent just for the non-retail loans made out of the investment bank. In addition, JPMorgan has extensive hedges to help safeguard its exposures. Still, precisely because JPMorgan is so big, it cannot escape unscathed, as CEO Jamie Dimon frequently warns. Moreover, one of the lessons of the past two years is that sometimes hedging activity, instead of reducing risk, actually amplifies it. For example, JPMorgan is one of the biggest dealers in the credit default swap market. As a massive lender, appropriately, it has bought more protection against declining creditworthiness and defaults than it has sold. Still, the total gross face value of its credit derivatives book is $9,200bn. That means JPMorgan is on one side or another of one out of every six contracts in the opaque market. It has counterparty risk on the contracts it has bought, even with collateral and faces losses on the contracts it has sold.
Economy bears brunt of the biggest banks’ miscalculations – Financial Times