The nature and timing of JPMorgan Chase’s (NYSE:JPM) Chief Investment Office (NYSE:CIO) portfolio loss of $2 billion was unfortunate both for the reputation of the bank and the recovering financial sector. Mr. Dimon’s exemplary response and clear acceptance of the bank’s responsibility should form the template for any CEOs in this type of predicament
However, the source and nature of the loss reveals the challenge for financial markets. As its CEO stated, JPM is “not in business where we won’t make mistakes.” This is a key and crucial statement, underlining the nature of the banking business, financial services broadly and the risks inherent in investing in financial sector stocks. An investment approach based solely on numerical analysis that lacks the benefit of experience and insight into these businesses is generally the basis for disaster. However, avoiding investment in the sector is not feasible either.
A review of disclosure pertinent to these losses is as follows: at the end of Q1/2012, debt and equity trading assets in the CIO portfolio totaled $299.1 billion, out of the bank’s $2,320.3 billion balance sheet. This CIO portfolio is 5% higher than the 2011 year end balance. However, as was clearly pointed out during yesterday’s call, value-at-risk* (VaR, 95% confidence level) for this portfolio has increased significantly: during Q1/2012, $129 million average daily loss vs $60 million during Q1/2011 and $57 million during full year 2011. Furthermore, the segment’s loss profile has changed dramatically, with a new range of $85 million – $187 million.
Overall, the distribution of VaR for the bank is significantly skewed towards fatter losses vs. its profile during all of 2011. JPM experienced 29 trading days during this quarter where losses exceeded its expected $114 average daily revenue. A modest shift in either the asset correlations underlying VaR or its loss probability would materially change the loss realized from the current portfolio. In other words, the current $2 billion loss is not indicative of this portfolio’s future result magnitude or direction.
