JPMorgan’s $2 Billion Hedging Loss Hits The Entire Banking Industry

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In a shocking announcement, JPMorgan (NYSE:JPM) reported a $2 billion loss in its trading business from a hedging bet gone wrong. [1] To make matters worse, the hedging strategy can lead to a loss of another billion dollars spread over subsequent quarters. But this incident has much bigger repercussions than the monetary loss that will shake up the company’s income statement for a few quarters. It raises serious doubts about the bank’s risk management system, and plays into the hands of supporters of the controversial Volcker Rule. And the fact that JPMorgan – the bank often cited as the example of a strong banking institution – has holes in its control framework casts a shadow of doubt on other competitors like Bank of America (NYSE:BAC) and Citigroup (NYSE:C). This and continued uncertainty in Europe weighed on the shares of most major banks Friday and Monday. JPMorgan lost over 9% of its market value on Friday, followed by a loss of over 4% value for Morgan Stanley (NYSE:MS) and Citigroup.

See our full analysis of JPMorgan

Trading Revenues Go For A Toss Again

JPMorgan’s joy at a reversal in fortunes of its investment banking business – more specifically its sales & trading operations – has proven short-lived, with the loss-making hedging strategy threatening to wipe out all of the unit’s profit for this quarter.

And the fact that the hedging trades have not been unwound completely and will linger for a few more quarters only means that the revenue downside will continue for some more time to come.

And All Banks May End Up Paying

The Volcker Rule, which is slated for implementation this July, lays down a ban on proprietary trades by banks besides limiting the involvement of banks with hedge funds. Considering the fact that the recent incident might have been avoided if the Volcker Rule in its current state is implemented, this considerably strengthens the camp of Volcker Rule supporters. It is also a crushing blow to all the effort put in by the banks to lobby for more leniency in the rule.

We have a price estimate of $48 for JPMorgan’s stock, which we are in the process of reviewing in view of the trading loss.

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Notes:
  1. JPMorgan $2 bln trading loss spooks bank stocks, Reuters, May 11 2012 []
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