With so much investor distrust in the air these days, it doesn't take much of a rumor to roil a stock. When the stock is J.P. Morgan Chase ( JPM), the juiciest piece of meat you can throw around nowadays is any speculation concerning its massive derivatives trading and underwriting operation. Just consider what happened last week to the nation's second-largest bank. Not only did it have to deal with the fallout from a high-profile congressional investigation into its business dealings with Enron, it also had to move forcefully to squelch persistent rumors on the Street that the bank was facing potentially huge losses on some of its derivatives transactions.
Quieted DownFor now, the rumor mill is largely quiet. The whispers have all but stopped about J.P. Morgan's estimated $51 billion in net exposure to derivatives -- an amount that's nearly three times as much as any other U.S. bank. But many investors, not just short-sellers, remain uneasy about J.P. Morgan's derivatives operation, which is far and away the world's largest and most profitable. Indeed, one reason other banks don't find themselves dogged by similar rumors is because J.P. Morgan is such a dominant player in the market for selling these sophisticated securities, which are used by businesses to hedge themselves against fluctuations in interest rates, commodity prices and currency valuations. The notional, or total, value of all of J.P. Morgan's derivative transactions is a whopping $23.4 trillion, a figure that represents just over half the notional value of all the outstanding derivative transactions done by U.S. banks, according to the Comptroller of the Currency. "It's our business to take risk and we manage our risk better than our competitors," says J.P. Morgan spokesman Adam Castellani, who points out the bank won an award last year for its derivatives risk-management practices from the trade publication Risk magazine.
Law of Large NumbersBut it's big numbers like $23.4 trillion in total derivatives value and $51 billion in potential credit-risk to the bank that are enough to make many investors jittery, especially with so many companies going up in smoke these days. In fact, some say the poor job J.P. Morgan has done managing its exposure to troubled commercial loans during the economic downturn is helping to feed the unease about its credit-quality of its derivatives book. Last month, for instance, J.P. Morgan reported that it had $4.38 billion in nonperforming loans, investments and other assets on its books, a 75% increase over last year. So far, the problems on the derivative side have been much less severe. At the end of 2001, the bank reported $170 million in nonperforming derivative contracts compared to $37 million in the year before. But critics say with J.P. Morgan making so many bad bets in its lending division, investors have a right to be squeamish about the potential for potholes cropping up in its derivatives portfolio. "Morgan has been burnt in a number of these recent credit blowups, so it calls into question the effectiveness of their credit controls," says Sean Egan, president of Egan-Jones, a small credit-rating agency. "Hopefully they will be smart enough to address this before they have a major problem on their hands."
|It's So Derivative |
|Bank||Derivative Contracts' |
|J.P. Morgan Chase||$23.4 trillion||$68.8 billion|
|Bank of America||9.8 trillion||6.9 billion|
|Citigroup||6.6 trillion||22.4 billion|
|Source: Office of the Comptroller of the Currency as of March 31, 2002|