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J.P. Morgan Debt Default Insurance More Than Doubles (Update1)
By George Stein
New York, Feb. 22 (Bloomberg) -- J.P. Morgan Chase & Co., the second-largest U.S. bank, has suddenly become a growing risk for bond investors.
The cost of insuring J.P. Morgan Chase's $43 billion of notes and bonds against default more than doubled in the past month. Some investors are concerned the bank holding company's credit rating may be lowered because of $3.8 billion in potential losses related to Enron Corp., Global Crossing Ltd., Kmart Corp. and Argentina that analysts estimate the bank made.
``The exposure they have to some of these risky companies is larger than the market would like to see,'' said Michael Pohly, executive director of credit derivatives for Morgan Stanley Dean Witter & Co., which matches buyers and sellers for the insurance.
The price for default protection rose to $80,000 for $10 million of J.P. Morgan Chase debt from $35,000 on Jan. 28, according to Morgan Stanley. At that price, the highest since the bank was formed in a January 2001 merger, investors are paying about twice as much as for comparable insurance on the bonds of Citigroup Inc., the world's largest financial-services company, and Bank One Corp., the sixth-largest U.S. bank.
The cost of default insurance reflects investor unease that began last year as J.P. Morgan Chase's shares plunged and the yield on its bonds rose. J.P. Morgan Chase's 6.75 percent bonds that mature in 2011 now yield 6.35 percent, the highest among the 10 biggest U.S. banks. In November, the yield was the fourth lowest among the big banks.
The bank, whose founder J. Pierpont Morgan Sr. saved the U.S. financial system in the 1907 panic, is far from default. Moody's Investors Service, Standard and Poor's and Fitch Ratings have all assigned J.P. Morgan Chase a rating that is six levels above non- investment grade, or junk.
Kristin Lemkau, a spokeswoman for J.P. Morgan Chase, which has about $800 billion in assets, said the bank would have no comment.
Decline in Shares
J.P. Morgan Chase's default insurance rates began climbing early this month after Chief Executive Officer William Harrison said the bank had assumed too many risks in its dealings with Enron.
``In light of J.P. Morgan's piecemeal disclosure about their Enron and Argentina exposure, the markets are pricing in a cushion to safeguard against anything else that might come out of the woodwork,'' said Michael Stead, who manages the $700 million SIFE Trust Fund, which owns 550,000 J.P. Morgan Chase shares.
J.P. Morgan Chase shares have fallen 43 percent in the past year in part because of concern the bank will suffer big loan losses. That compares with a 14 percent decline for Citigroup and a 26 percent gain for Bank of America Corp., the third-largest bank. J.P. Morgan shares fell 4.3 percent to $27.94 today after the Wall Street Journal reported the Federal Reserve Bank of New York is probing how the bank accounted for trades.
Shareholders sued the bank Feb. 15, alleging J.P. Morgan Chase broke securities laws by failing to disclose fully the amount of money it might lose because of its loans to Enron. J.P. Morgan Chase, which said the suit was without merit, wrote off $456 million of trading losses and loans to Enron in the fourth quarter. It still has $2.06 billion of Enron exposure.
The Securities and Exchange Commission also is reviewing J.P. Morgan Chase's transactions with Enron, according to people familiar with the situation.
Downgrade Prospects
Some investors said the drop in shares and bonds has been exaggerated and may soon end.
``I don't think things are as dire as some investors want to make out,'' said Steve Wharton, who helps Loomis Sayles & Co. manage about $70 billion, including 1.4 million J.P. Morgan Chase shares. ``I think the stock will be higher 12 months from now.''
The credit rating companies are more skeptical.
``It wouldn't take too much more bad news to downgrade'' the company, said Tanya Azarchs, senior financial services analyst at S&P, which has assigned the company a ``AA-'' rating.
``Whether you are looking at the price of their long-term debt or the credit default swap market, they are trading like a single-A company,'' Azarchs said. ``I have been deluged with calls.''
Moody's last week affirmed its ``Aa3'' rating with a ``stable'' outlook and Fitch yesterday changed to ``negative'' the outlook on its ``AA-'' rating.
Enron's Example
The volume of trading in J.P. Morgan credit-default swaps has risen in recent weeks to between $50 million and $75 million a day, Morgan Stanley's Pohly said.
In a credit default swap, buyers pay premiums in exchange for a guarantee to be repaid the value of the bonds if the company defaults. Swaps trade in an over-the-counter market; Trading of credit default swaps became active about five years ago.
Prices for credit-default insurance often rise before ratings agencies downgrade a company's debt, said John McEvoy, chief operating officer and a founder of Creditex Inc., a New York-based online exchange for credit derivatives, financial obligations derived from debt and equity securities, commodities and currencies.
In Enron's case, the price for credit-default insurance began increasing in August and the ratings agencies didn't downgrade the debt until late October and early November, McEvoy said. Enron declared bankruptcy in December.
While credit-default swaps rates also rose for some other banks, the increase was much smaller. Citigroup, which disclosed fourth-quarter loan losses of $698 million because of obligations to Enron and Argentina, saw the price of its credit default swaps rise to $28,000 from $23,000 since Jan. 28.
For J.P. Morgan, the increase in default swap rates is ``a vote of no confidence,'' said David Hendler, financial-services analyst at CreditSights Inc.
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