JPMorgan's Dimon Says He Couldn't Spot 'London Whale'

NEW YORK ( TheStreet) -- In a statement prepared for his Wednesday testimony to the Senate Banking Committee, JPMorgan Chase ( JPM) chief executive Jamie Dimon will concede he was unaware of some of the risks that the bank's Chief Investment Office took when investing in risky derivative products that led to a $2 billion loss in May.

While Dimon will testify that he was not appraised of the risks some of his traders were taking, he will also makes the point that the unit's own traders didn't understand those same risks which eventually lead to the birth to the "London Whale."
JPMorgan Chase CEO Jamie Dimon

In spite of losses that JPMorgan previously said could grow by a billion, Dimon will make the point that the unit's losses won't eliminate second quarter profits at the nation's largest bank.

After previously reporting the loss in a 10-Q filing in May, Dimon will testify to the Senate that a change to the investing style of the bank's CIO office - a unit that invests billions in excess deposits to hedge credit risk and earn investment income -- went unknown to him and other top executives.

" The strategy was not carefully analyzed or subjected to rigorous stress testing within CIO and was not reviewed outside CIO," said Dimon in prepared remarks for the Senate released on Tuesday afternoon.

Echoing past statements about the trading loss, Dimon said that the unit's hedging strategy using credit derivatives tied to the creditworthiness of investment grade corporations was "poorly conceived and vetted."

According to the testimony, Dimon will say that after instructing traders to reduce the banks' exposure to the credit hedge, a decision by traders in the unit to double down on credit derivative products instead of simply selling them went against his instructions.

" As part of a firmwide effort in anticipation of new Basel capital requirements, we instructed CIO to reduce risk-weighted assets and associated risk. To achieve this in the synthetic credit portfolio, the CIO could have simply reduced its existing positions," Dimon's will say in a statement.

" Instead, starting in mid-January, it embarked on a complex strategy that entailed adding positions that it believed would offset the existing ones. This strategy, however, ended up creating a portfolio that was larger and ultimately resulted in even more complex and hard-to-manage risks."

In his statement, Dimon says that the CIO units traders did not have the "requisite understanding of the risks they took," causing them to conclude that losses starting in March and through early April were a result of anomalous market movements and would later reverse. However, after losses escalated in April after Bloomberg first reported on the size of the unit, JPMorgan was forced to disclose its multi-billion loss midway through the second quarter.

The bank also reported that a change to methodologies to calculate the unit's risk - known as value at risk or VaR - were done with poor monitoring. In disclosing its loss, JPMorgan returned to old VaR models, which showed a near doubling of risk at the unit. Dimon will also testify that changing personnel added to bad judgment and poor risk monitoring of the CIO's traders. "Risk committee structures and processes in CIO were not as formal or robust as they should have been," Dimon will testify. Those lapses in control extend to the banks top ranks.

In his statement, Dimon didn't say whether he was aware of the CIO's losses prior to an April 13 conference call where he called reports of the unit's trading position and its London Whale trader as a "tempest in a teapot."

"CIO, particularly the synthetic credit portfolio, should have gotten more scrutiny from both senior management and the firmwide risk control function," Dimon will say. In reaction to the loss, Ina Drew, the unit's former head resigned and JPMorgan installed Matt Zames to head the CIO. The bank has also installed a new chief risk officer and CFO for the unit, among a string of personnel changes.

"This portfolio morphed into something that, rather than protect the Firm, created new and potentially larger risks. As a result, we have let a lot of people down, and we are sorry for it," Dimon will testify.

Still, Dimon will make the point that JPMorgan's earnings and capital will remain at the top of the sector. "While there are still two weeks left in our second quarter, we expect our quarter to be solidly profitable," Dimon will testify, while highlighting the banks $30 billion in loss reserves and Basel I Tier 1 common ratio of 10.4%. He will also make the point that the CIO's loss did not put taxpayers, clients or customers at risk of loss, although shareholders have suffered.

JPMorgan's shares are off nearly 20% since it disclosed the loss in a May 10 filing. In Tuesday trading, JPMorgan shares closed at $33.77, off over 25% from 2012 highs.

Dimon will face a House Financial Services Committee hearing on June 19, as lawmakers debate whether JPMorgan's trading loss proves the rationale of Volcker Rule, a 2010 Dodd-Frank Act provision to limit banks abilities to trade on their own account or invest in hedge funds.

For more on JPMorgan, see why Dimon's testimony may offer few surprises. Also see why JPMorgan redeemed $9 billion in trust preferred securities for more on the banks finances.

-- Written by Antoine Gara from New York.

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