Following the disclosure of $2 billion trading loss in the first six weeks of the current quarter, two major ratings agencies - Fitch Ratings and Standards & Poor's (S&P) - revised their assessments for JPMorgan Chase & Co. ( JPM ). Fitch lowered its long-term issuer default rating (IDR) on the company to "A+" from "AA-" and placed all long-term ratings on Rating Watch Negative. Though S&P did not lower its ratings immediately, it downgraded the outlook on the company to "Negative" from "Stable".
Last week, JPMorgan had announced that its chief investment office (CIO) incurred substantial mark-to-market losses in an index of credit default swap (a type of derivative), which was to protect the company against the potential losses on its large holdings of loans and bonds. However, the company's strategy backfired as the repositioning of the credit portfolio was poorly monitored and executed.
While assessing JPMorgan's disclosures related to the trading loss, Fitch stated that though the amount of loss is manageable, the inherent risks are not. The rating agency also commented that the significant mark-to-market losses raise doubts about the company's risk management techniques.
Further, Fitch also observed that JPMorgan's risk to governance practices and reputation no longer warrants "AA-" ratings; therefore, it lowered the ratings by one notch. The current ratings reflect the company's growing domestic and international operations, strong capital position and sufficient liquidity to withstand any future losses.
However, it becomes difficult to assess JPMorgan's exposure to risk and future implications related to these on the company's financials as well as goodwill due to the complexity of its operations. Hence, Fitch has placed the outlook under Rating Watch Negative until it fully reviews the company's risk management practices and reputation damage as a result of this loss.
The "Negative" outlook by S&P implies that the company's ratings could be lowered in the future. However, the ratings agency affirmed issuer credit rating (ICR) of "A/A-1" on the company.
Another ratings agency, Moody's Ratings Services, the ratings arm of Moody's Corp. ( MCO ), has placed JPMorgan's ratings and outlook on review for potential downgrade. Moody's had placed the company's ratings under review earlier this year.
JPMorgan is a leader in the U.S. banking sector as it has exposure in almost all the banking businesses. Even at the time of the financial crisis, the company was viewed as strong risk manager as it did not report losses.
All the major banks in the country follow the trend set by JPMorgan. Over the last several quarters, we have seen that even the announcements of quarterly financial results by almost all the major banks followed the trend set by the company. However, we hope that other banks are not going to turn up with similar trading loss announcements.
Additionally, had the implementation of all provisions of the Dodd-Frank Act, including the Volcker rule, been expedited, JPMorgan may not have recorded such a huge trading loss. The Volcker rule requires the banks to curb investments in hedge funds and private equity to 3% of the total assets of the fund or the bank's regulatory capital as well as completely stop proprietary trading.
With the date for the implementation of the Volcker rule already set by the regulators, we anticipate the chances of making hedging-related losses by all the financial institutions, including JPMorgan, to diminish over time.
Currently, JPMorgan retains a Zacks #3 Rank, which translates into a short-term 'Hold' rating. Considering the fundamentals, we also maintain a long-term "Neutral" rating on the stock.