Here is the “transcript” that everyone is talking about, but it would seem only listened to with selective hearing and have read without reading. This is my analysis of what was said and what it could mean.
So he comes clean about the loss. It is $800 million after taxes. Just over $2 billion on the trade, offset by about $1 billion in gains from an Available for Sale (AFS) account run by the CIO’s office.
The CIO has a portfolio of $200 billion. It is clearly not all mark to market, but they had $8 billion in unrealized gains in the AFS at the end of Q1.
The Q&A starts with the timing of when they noticed the losses. It’s clear they saw them in the 1st quarter, but weren’t concerned, and as losses grew in the second quarter, they became more focused. This is important, because in assessing how much they have been to risk manage in advance of the call is key. He goes on to apologize to analysts saying that he knew about it during analyst week but couldn’t say anything about it.
My best guess is that they were working on this for at least two weeks and knew that they had until the release of the 10-Q to work on cleaning up the position in secret. Just to be clear here, it looks like the regulators knew, just not the market in general. Throughout the call he is clear to show that the regulators were informed, though obviously subject to some of the same bad data JPM was relying on.
There is some back and forth, largely not willing to go into detail, but saying it is being managed. It could get worse. That comes across loud and clear and has been repeated a lot. Hoping to get out without a loss was said, but I haven’t seen repeated very often.
By page 8 he says that they won’t make calls every time the portfolio moves around by $0.5 billion. Not sure how frequently we will see updates, but expect next one to be either that it has been largely closed down (unlikely any time soon), or that the position has had a gain or loss of $1 billion.
Stock purchase program still seems set to go and nothing about their capital plans (dividends) have been changed.
Page 10 is where it starts to get interesting. As I read this, I think they started with some shorts. I believe HY CDS tranches. It started last year. They made money (remember the jump to default risk in Eastman Kodak and AMR). Then it seems like rather than cutting those positions, they decided to sell protection (on IG9 tranches, and others) to offset the cost. Again, this is clearly a global portfolio and wouldn’t have been all, or even primarily, domestic.
Reading between the lines, there is some anger, that I can only guess was that the people involved were doing trades even after they had caused the market to move, so at best they weren’t getting good value, and at worse, they were keeping the P&L smoother than it really was. Just a feel and what I’ve heard, and would explain the backlash internally against the group better than backlash that they had the positions which he must have been aware of. The shift in VAR is supportive that it was “tranche” risk rather than outright risk as primary culprit. You can hit F9 as often as you want, and the risk in IG9 doesn’t change much, but the risk in an IG9 tranche could shift dramatically with some changes in correlation assumptions.
I like that he repeats over and over that they will manage this for “economics” and have patience and can absorb volatility to do it correctly. My guess is that they have done a lot of “hedge and wedging” since they first focused. Short IG18 now vs long IG9 tranches. Not a great hedge, but better than trying to cover a trade that would be hard to hide. Same with high yield. At some point they will want to reduce the basis, but they have probably put on trades that will control the larger directional risk.
By the end, it is back to talking about the AFS portfolio. Depending on market moves, what was in, etc., there should still be $7 billion of unrealized gains that they could try and take. Actually by page 17, he says it is higher than it was then. They could sell these positions and monetize the gains. For tax purposes they don’t like to do it, but that is a pretty nice cushion against this trade. The trade in question is fully mark to market, so gains and losses immediately flow through P&L. That gain that is remaining has never been taken as P&L and is just waiting to be plucked if they chose to.
If I was a lawyer for the CIO group, I would focus on the answers near the bottom of page 17. He goes through the trade and how it made money in the past, but again you get back to that feeling that something about marks, or size, or something wasn’t done the way it should have been. Or maybe he is just p*ssed off that this hit after he has been so vocal against regulation.
My conclusion is that betting the situation is going to get much worse is a bad idea, and that ignoring the doom and gloom crowd (for which I have temporarily lost my membership card) is the right trade here. Single stocks aren’t my focus, but the reaction to the news and ignoring so much of what was said on the conference call seems like a dangerous decision. He is good, and has had a long history of being very good.
I think our thoughtful gorilla story is worth a read, as it attempts to show how some of the thought process that was potentially behind the alleged trades. Also look to our notes on IG18 and JNK performance and see what you think about how much might have been covered already.
E-mail Sign-Up which we will update once we have time, it has been a crazy couple of weeks.