by Larry Gellar
In an unsurprising move, it appears that the first casualty of JP Morgan Chase's (NYSE:JPM) $2 billion trading loss will be chief investment officer Ina Drew. Considering the poor trades designed to hedge JPMorgan's other businesses were formulated in the chief investment office, this certainly seems like an appropriate step. Furthermore, Matt Zames, currently co-head of fixed income, will become the new chief investment officer, and Mike Cavanagh, head of treasury and security services, will be overseeing the company's review of the losses. Besides chief investment officer Ina Drew, some traders are expected to leave the bank as well, and this cleanout should help ease the concerns of shareholders going forward. In fact, I recommend investors consider buying JP Morgan Chase's stock once the downward momentum has subsided.
At the very least, Matt Zames appears to be a prime candidate for taking over as chief investment officer. His prior experience at failed hedge fund Long Term Capital Management should serve as a reminder of what poor trades can lead to, and he's worked at a couple of other Wall Street firms as well. Indeed, Mr. Zames had roles at Credit Suisse (NYSE:CS) and Morgan Stanley (NYSE:MS), and he has performed well at JPMorgan too. Chief executive officer Jamie Dimon has said, "Matt Zames is a world-class risk manager and executive - highly regarded for his judgment and integrity," although Jamie Dimon has come under a serious amount of criticism as well. With Mr. Dimon's comments from Thursday that losses could increase by another $1 billion, that criticism may not end soon, and Mr. Dimon's reputation has certainly hurt by this whole incident.
Fortunately, JPMorgan appears to be taking a number of steps that should serve to cut its losses going forward. Ashley Bacon, head of market risk, will be in charge of winding down the troublesome trades, and traders from other units are expected to help as well. JPMorgan is also set to examine whether the chief investment officer's traders should continue to be based in London rather than New York where the rest of the bank is headquartered. At the very least, the London unit will see a shake-up, and Achilles Macris and Javier Martin-Artajo are two senior members that are expected to resign soon. The problem is that while the trades may not have broken internal rules, they probably did exceed risk limits, and it also hurts that JP Morgan assuaged concerns over its chief investment office trades just one month ago.
Despite all this, Jamie Dimon has done a solid job of public relations since his initial announcement on Thursday. The key issue was that Jamie Dimon was actually scheduled to appear on NBC's Meet the Press (which airs on Sunday) to discuss one of the company's economic growth partnerships. The taping of that show was completed on Wednesday, and Mr. Dimon obviously could not comment on the trading losses at the time due to rules from the Securities and Exchange Commission. That meant that the show had to be re-taped on Friday so that Mr. Dimon could address the trading issues with Meet the Press host David Gregory. Playing his best move, Mr. Dimon acknowledged the losses were a "big-time screw-up" in the words of David Gregory.
Meanwhile, what may be the most interesting aspect of JPMorgan's trading losses is the effect it will have on future big-bank legislation. Most importantly, it now sheds light on a type of trading JPMorgan engaged in, called "portfolio hedging." This strategy will still be allowed under the Volcker rule that's part of the update Dodd-Frank Act, but it's not hard to see why banks could do almost anything they want under the guise of hedging their overall portfolio. Considering JPMorgan CEO Jamie Dimon is actually one of the leading opponents of the new regulation, the arguments on the part of banks could be seriously diminished, but I doubt this will affect JPMorgan's stock much going forward. Loose regulation can improve long-term profitability as banks take bigger risks that even out eventually, whereas tight regulation may simply decrease the type of volatility we're seeing now.
To the extent that JPMorgan's trading losses don't represent a problem with the bank itself (which is my opinion), the stock's price ratios look even more attractive due to the latest downturn. JPMorgan Chase has a price to earnings ratio of 8.07, which is only slightly above Citigroup (NYSE:C) (8.04) and significantly below Goldman Sachs (NYSE:GS) (14.81). JPMorgan Chase does have higher price to book (0.79) and price to sales (1.45) ratios than Citigroup and Goldman Sachs, but this merely a testament to JPMorgan Chase's strong book value and high margins. Specifically, JPMorgan Chase has a net profit margin of 19.5% and an operating margin of 27.5%. Both of those look solid compared to the competition.
With JPMorgan Chase's stock trading slightly above $36 at the time of this writing, the dividend yield comes out to 3.2%. That's terrific compared to other banking stocks, and I can't possibly imagine JPMorgan Chase would need to cut its dividend due to these trading losses. In the big scheme of things, the $2 billion loss is not very significant, although it could discourage JPMorgan Chase from increasing its dividend in the near future. I recommend investors take a look at JPMorgan Chase's statement of cash flows to see what makes this bank so strong overall. The company had $4.266 billion of operating cash inflow for the first quarter of 2012, and a host of investing activities and financing activities is allowing the bank to adjust to a new business climate. Investors may have to wait a little while for the downward momentum to subside, but JPMorgan Chase should be able to deliver long-term profits beyond that.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.