Bloomberg News

JPMorgan’s Eminence Seen Fading in Default Swaps

October 23, 2013

JPMorgan offices in New York

Pedestrians walk by the offices of JPMorgan Chase & Co. in New York. Photographer: Victor J. Blue/Bloomberg

JPMorgan Chase & Co. (JPM:US)’s advantage over its Wall Street peers is fading in the eyes of credit-derivatives traders as fines and regulator probes hobble profits while firms from Citigroup Inc. to Morgan Stanley rebound.

Credit-default swaps traders are demanding 16 basis points less to protect against losses on JPMorgan bonds than the average cost to insure debt of the bank’s five-biggest U.S. rivals, according to prices compiled by Bloomberg. The gap, a measure of the bank’s credit strength relative to its competitors, has narrowed from an average 80 basis points since 2008 and 152 in April 2012, the month before JPMorgan disclosed a trading loss that reached $6.2 billion.

With regulatory fines and penalties that are poised to approach $15 billion, the playing field is leveling between the only Wall Street bank to stay profitable through the financial crisis and rivals that the credit seizure pushed to the edge of failure. Swaps tied to Citigroup, which last month removed the final vestiges of its government bailout, narrowed to within 6 basis points of JPMorgan’s for the first time since 2007.

‘JPMorgan’s Turn’

“It’s JPMorgan’s turn to have its own types of concerns, albeit ones that are much less severe from a credit perspective than the others” and in an improved economy, said Pri De Silva, a bank analyst at debt-research firm CreditSights Inc. in New York. For lenders such as Citigroup, Bank of America and Morgan Stanley, “the balance sheets are in much better shape now compared with credit-crisis days,” he said.

The New York-based lender has tentatively agreed to pay a record $13 billion to end civil claims over its sales of mortgage bonds. The anticipated deal, which won’t absolve the bank of potential criminal liability, comes amid mounting lawsuits and regulatory probes and prompted JPMorgan to take a $7.2 billion charge in the third quarter. That led to the bank’s first loss (JPM:US) under Chief Executive Officer Jamie Dimon.

Credit swaps protecting buyers against a default by JPMorgan for five years have dropped 15 basis points this year to 76 basis points, Bloomberg prices show. That compares with a 44.1 basis-point decline for Citigroup, Morgan Stanley, Goldman Sachs Group Inc., Bank of America Corp. (BAC:US) and Wells Fargo & Co., which average 92.5.

Citigroup Swaps

Joe Evangelisti, a spokesman for JPMorgan in New York, didn’t respond to an e-mail message.

Contracts tied to Citigroup, which since the end of 2007 has almost doubled a measure of its financial strength known as the tier-1 capital ratio, have declined 48.5 to 83.7 since December. Swaps on Morgan Stanley, which last week reported earnings that beat analyst estimates, plunged 73.2 to 114.2.

“JPMorgan has always been viewed as having the fortress-type balance sheet, while the other banks have been viewed as having weaker balance sheets,” said Charles Peabody, a senior analyst at New York-based Portales Partners LLC. “Recently, that perception has narrowed dramatically.”

Elsewhere in credit markets, Shellpoint Partners LLC, canceled a planned sale of U.S. home-loan securities without government backing, saying it would instead sell the loans without packaging them into bonds. Deutsche Bank AG is preparing to market at least $300 million of bonds linked to rental-home payments. Fomento de Construcciones & Contratas SA is in talks with creditor banks to convert part of the Spanish infrastructure company’s loans into payment-in-kind debt.

Financial Conditions

A measure of the health of U.S. financial conditions that declines as the environment weakens fell from a record high. The Bloomberg U.S. Financial Conditions Index (BFCIUS), which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, decreased 0.07 to 1.51.

The cost of protecting corporate bonds from default in the U.S. fell to the lowest level in almost six years. The Markit CDX North American Investment Grade Index, a credit-swaps benchmark used to hedge against losses or to speculate on creditworthiness, decreased 2.5 basis points to 69.9 basis points, Bloomberg prices show.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 2 to 86 at 11:34 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan dropped 2.7 to 133.

Verizon Bonds

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bonds of Verizon Communications Inc. (C:US) were the most actively traded dollar-denominated corporate securities by dealers yesterday, accounting for 3.1 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The New York-based telephone carrier raised $49 billion on Sept. 11 in the largest corporate bond issue ever.

Shellpoint, the lender backed by mortgage-bond pioneer Lewis Ranieri, last week reduced the size of its potential home-loan securities deal, originally planned for September, to include $250.8 million of jumbo mortgages, down from $308.6 million, according to Kroll Bond Rating Agency reports. It’s now pulling the transaction, which would have been its second, because it can be paid more selling the whole loans, the New York-based firm said yesterday in a statement.

Deutsche Bank

The securities from Deutsche Bank will include a portion with an investment-grade ranking from at least one ratings firm, according to a person with knowledge of the transaction who asked not to be identified because terms aren’t public. The rental homes are owned by Blackstone Group LP.

FCC’s higher-yielding PIKs, which allow borrowers to roll up interest so that it’s paid when the debt comes due, will total about 1.5 billion euros ($2.1 billion), according to two people with knowledge of the matter. The Barcelona-based company is currently seeking to refinance about 5 billion euros of loans, they said. A spokesman for FCC in Madrid declined to comment on the negotiations.

Leveraged Loans

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose 0.03 cent to 97.68 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 3.65 percent this year.

Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

In emerging markets, relative yields widened 5 basis points to 332 basis points, or 3.32 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 312.8 this year.

The spread between JPMorgan swaps and those linked to the other five major Wall Street banks has averaged 84 basis points since the collapse of Lehman Brothers Holdings Inc. five years ago. That’s about five times wider than the current gap, with swaps on San Francisco-based Wells Fargo’s debt the only contracts that cost less than those tied to JPMorgan.

Derivatives markets are signaling the creditworthiness of America’s banking industry has improved even with the six biggest U.S. banks, led by JPMorgan and Bank of America, piling up more than $100 billion in legal costs since the financial crisis, a figure that exceeds all of the dividends paid to shareholders in the past five years.

Resolving Probes

JPMorgan is the target of investigations in the U.S. and abroad, including probes of its hiring practices in Asia. The bank has tapped $8 billion of $28 billion in reserves set aside since 2010 to cover its legal costs.

Over the past two months, JPMorgan resolved U.S. and U.K. investigations into its record 2012 trading loss linked to positions built by Bruno Iksil, who came to be known as the London Whale because of the size of the bets. It also settled unrelated claims it unfairly charged customers for credit-monitoring products.

Citigroup and Bank of America have each increased their tier-1 risk-based capital ratios, a measure of their cushions against losses, to more than 12 percent to exceed the 11.7 percent gauge at JPMorgan, Bloomberg data show. Citigroup has boosted its ratio to 13.6 at the end of September from 7.12 in December 2007.

‘Beaten Down’

Bank of America, based in Charlotte, North Carolina, increased its ratio to 12.33 from 6.87 during the same period. Credit swaps on the lender have dropped 41.3 basis points to 91.2 this year.

“JPMorgan is getting beaten down and Citi and Bank of America are getting stronger,” said Marc Pinto, the head of corporate bond strategy at Susquehanna International Group LLP.

Contracts linked to Morgan Stanley, which is relying more on wealth-management revenue and reducing the capital allocated to fixed-income trading, now cost less than those insuring against a default by Goldman Sachs for the first time since 2007. Contracts on New York-based Goldman have dropped 34 basis points this year to 115.1, Bloomberg prices show.

After banks bolstered their balance sheets, bond buyers have been demanding less to own their debt relative to Treasuries than they are for debentures of industrial companies.

Relative yields for bank debt average 138 basis points more than similar-maturity Treasuries, 8 basis points less than the average spread for industrials including Caterpillar Inc. and 3M Co., Bank of America Merrill Lynch index data show. Until last month, lenders were paying more in relative yields than corporate borrowers as investor confidence deteriorated during the financial crisis.

Bonds of JPMorgan yielded an extra 109 basis points more than Treasuries on Oct. 21, according to the banking index, which tracks $972 billion of total lender debt.

“The regulatory overhang continues to be a headwind” for JPMorgan, David Schawel, a money manager at Square 1 Bank in Durham, North Carolina, said in an e-mail. “The rest of the banking industry, while still facing challenges,” he said, “continues to build capital levels. It makes sense that everyone else is getting tighter.”

To contact the reporters on this story: Callie Bost in New York at cbost2@bloomberg.net; Charles Mead in New York at cmead11@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • JPM
    (JPMorgan Chase & Co)
    • $55.56 USD
    • -0.46
    • -0.83%
  • BAC
    (Bank of America Corp)
    • $15.44 USD
    • -0.16
    • -1.04%
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