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JPMorgan Credibility Cut With Fitch Downgrade

NEW YORK ( TheStreet) -- Fitch Ratings has cut JPMorgan Chase's (JPM - Get Report) long term-debt rating by one notch to A+ from AA- as the nation's largest bank continues to reel from a $2 billion trading loss it disclosed late on Thursday.

The ratings cut caps a dramatic 24 hours after the trading loss was unveiled, which has humbled the bank's chief executive Jamie Dimon, one of Wall Street's most credible advocates, and reignited calls for financial industry reform. Fitch's move adds to mounting negative developments for JPMorgan that include reports of regulatory inquiries, analyst downgrades and lingering uncertainty over the magnitude of its trading loss.
JPMorgan Chase CEO Jamie Dimon

JPMorgan CEO James Dimon's announcement of a $2 billion trading loss just under 45 days into the second-quarter pushed the company's shares down over 9% in Friday trading, to a closing price of $36.96. Shares fell slightly in after-hours trading on Fitch's ratings cut.

JPMorgan's ratings cut and its tumbling shares come after the bank disclosured a trading loss to its synthetic credit positions in its Chief Investment Office. Those positions were intended to hedge JPM's overall credit exposure during periods of credit stress; however, CEO Dimon said they were poorly executed.

"Fitch views the size of loss as manageable. That said, the magnitude of the loss and ongoing nature of these positions implies a lack of liquidity. It also raises questions regarding JPM's risk appetite, risk management framework, practices and oversight; all key credit factors. Fitch believes the potential reputational risk and risk governance issues raised at JPM are no longer consistent with an 'AA-' rating," said the agency in its cut.

The agency also said it would keep JPMorgan's ratings on a negative watch, citing an expected lingering volatility of earnings that CEO Dimon said could lead to a further loss of $1 billion.In its Thursday filing, JPMorgan said a key risk measurement, value-at-risk, changed in first-quarter 2012, leading to a spike in the amount that the bank says it could lose on any given trading day. "This resulted in a near doubling of VaR to $170 million... Fitch believes this also highlights some problems with modeling related to this portfolio," said the agency in its assessment.

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Fitch noted that at A+, JPMorgan's ratings reflect "its dominant domestic franchise as well as its solid and growing international franchise in investment banking and commercial banking," in addition to a strong capital base that puts it ahead of most peers and in accordance with Basel III standards.

In an unscheduled conference call on Thusday, CEO Dimon revealed that the bank's $2 billion trading loss in its synthetic credit portfolio, offset by a $1 billion securities gain, as a strategy to re-hedge the bank's overall credit risk backfired. Dimon described the trades as "flawed, poorly reviewed, poorly executed" and reflected "sloppiness" and " bad judgment."

As a result of what Dimon called an "egregious" trading mistake, the bank's corporate division could post a $800 million loss after tax, compared to its earlier guidance of plus or minus $200 million.

The Securities and Exchange Commission is conducting a civil investigation into JPMorgan derivatives loss, according to a New York Times report. Separately, Bloomberg reported late on Friday that Federal Reserve officials are gathering more information about JPMorgan's trading position.

News of a JPMorgan trader holding large credit positions was first reported by Bloomberg on April 5. In an April 13 earnings call, Dimon dismissed the story as a "complete tempest in a teapot" and that it was executives' "job to invest our portfolio wisely and intelligently."

"We hold a fortress balance sheet to handle surprises," Dimon said but acknowledged that the recent errors was "not how we want to run our business."

"The losses were unlikely to affect the bank's stress test results or its capital return plans. The proforma Basel Tier 3 capital ratio at the end of the first quarter will fall to 8.2% from 8.4% previously stated. JPMorgan should continue to meet its capital targets for 2012 and 2013, the CEO said.

JPMorgan had the synthetic credit portfolio in place as a hedge against a stressed credit environment, Dimon said. But the repositioning of the portfolio was poorly monitored and poorly executed, resulting in the losses. He also said market conditions played a role in the losses but said he did not want to use that as an excuse.

The bank will continue to reposition its portfolio and there could be more volatility, leading to potential losses of up to $1 billion in the current quarter.

"This portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed," the bank said in its 10-Q. "The Firm is currently repositioning CIO's synthetic credit portfolio, which it is doing in conjunction with its assessment of the Firm's overall credit exposure."

As of March 31, 2012, the value of total Available-for-Sale (AFS) securities portfolio exceeded its cost by approximately $8 billion.

Still, in spite of JPMorgan's strong financial footing and its record in managing risks through the crisis, uncertainty abounds about how big its trading problem will become. "[This] could be a binary event where the company either gains or loses on this trading position and, until the company is able to unwind this portfolio, there is little clarity into and a lot of uncertainty surrounding JPMorgan's future earnings," wrote FBR Capital Markets analyst Paul Miller, when downgrading his outlook on shares to market perform.

Dimon said so much in JPMorgan's call on Thursday. "[We're] willing to bear volatility... Obviously, we're going to work hard to have that not be a negative at all. But it is risky, and it will be for a couple of quarters."

-- Written by Antoine Gara and Shanthi Bharatwaj from New York.

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