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JPMorgan Earns $5B Derivatives Profit


By Matthew Leising and Elizabeth Hester

JPMorgan Chase & Co. managed to generate $5 billion in profit during the worst year in Wall Street history by trading over-the-counter fixed-income derivatives, two people with knowledge of the results said. The largest U.S. bank by market value, which reported $5.6 billion of total net income in 2008, hasn’t disclosed earnings for its interest-rate swap, municipal bond and foreign-exchange derivatives group. The unit was among the most profitable at the New York-based company, said the people, who declined to be identified because they weren’t authorized to divulge the figures. JPMorgan spokeswoman Kristin Lemkau declined to comment.

The JPMorgan trading desk, led by the 38-year-old Matt Zames, who previously worked at hedge fund Long-Term Capital Management LP, may have benefited as the collapse of Lehman Brothers Holdings Inc. and JPMorgan’s takeover of Bear Stearns Cos. left companies and hedge funds with fewer trading partners in the private derivatives markets. JPMorgan emerged “unscathed by the disasters” on Wall Street and positioned to capture more revenue as trading volumes grew, said Craig Pirrong, a finance professor at the University of Houston.

“It’s a flight to quality,” Pirrong said. “They expanded the scale of business, the number of trades people wanted to do with them, and it gave them pricing power.”

Derivatives are contracts whose value is derived from an underlying asset such as stocks, commodities or interest rates.

Over-the-counter refers to a type of private, unregulated derivative contract banks trade amongst themselves or with clients.

Link to Debt

The derivatives trades for JPMorgan are often linked to corporate debt underwritten by the bank. JPMorgan led its competitors last year with $132 billion in U.S. corporate bond underwriting, according to Bloomberg data. Corporations often enter into interest-rate swaps with banks to manage rate exposure on the debt they issue.

Among commercial lenders, JPMorgan dominates OTC derivatives trading, according to data compiled by the Office of the Comptroller of the Currency. The bank held $87.7 trillion worth of outstanding OTC contracts as of Sept. 30, more than the next two banks, Bank of America Corp. and Citigroup Inc., combined.

The OCC hasn’t yet released figures for Goldman Sachs Group Inc. and Morgan Stanley, the New York-based securities firms that converted into bank holding companies in September.

Client Fees Jump

JPMorgan told investors at a Feb. 26 conference in New York that client fees from interest rates and foreign exchange rose 60 percent last year from 2007. William Winters, co-head of JPMorgan’s investment bank, said the gap between bids to buy and offers to sell in OTC derivative markets doubled in the past 18 months. As that so-called spread widens, firms like JPMorgan that create the trades for clients can capture higher earnings.

“You take two times the bid offer, the volumes have stayed robust and an increase in market share, it’s a good business,”

Winters, 47, said at the conference.

Chief Executive Officer Jamie Dimon, 52, touted the firm’s trading results in the current quarter during a conference call with investors three days earlier.

“We’ve had strong quarter-to-date trading results, solid fee income in the investment banking side,” Dimon said on Feb.

23. “I should point out to you that this is my general conservatism. If it was up to the folks in the investment bank, they would have said extremely strong trading results.”

Source of Gains

The majority of JPMorgan’s OTC trading profit may have stemmed from interest-rate swaps in 2008, according to revenue figures reported by the OCC. During the first three quarters of last year, JPMorgan took in a total of $6.36 billion in OTC derivatives-trading revenue. Of that, $4.87 billion resulted from interest-rate positions, according to data from the OCC.

The remaining $1.49 billion came from foreign-exchange trading.

The OCC doesn’t report how much profit banks wring from OTC trading. The regulator hasn’t yet released fourth quarter results.



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