“We made an error of judgment. Frankly, we made a bit of a rookie error. We got overexposed in the market and made ourselves vulnerable to a squeeze.” Blythe Masters. August, 2010.
Blythe Masters, JPMorgan Chase & Co.â€™s head of commodities, sought to reassure her team on an internal conference call after â€œextremely difficultâ€ dismissals, defections and a first half in which some results were as much as 20 percent below expectations.
â€œDonâ€™t panic,â€ she said in summing up the 35-minute call, a recording of which was obtained by Bloomberg News. â€œNo oneâ€™s going to get screwed. Weâ€™re not going to do crazy things on compensation at the end of the year.â€
Masters, who was named to run the business in late 2006, said the bank began dismissals on July 21, a day before the call, to trim overlap after buying parts of RBS Sempra Commodities LLP. The bank cut less than 10 percent of the combined front office, even as the oil unit lost â€œkey peopleâ€ who needed to be replaced, she said. She was discussing results with top executives after â€œwe made a bit of a rookie errorâ€ that left the firm â€œvulnerable to a squeeze,â€ she said.
The 41-year-old banker, who helped develop credit-default swaps while at JPMorgan in the 1990s, delivered her talk from a conference room in New York, where the bank is based, less than a month after the firm closed its $1.7 billion RBS Sempra purchase. The deal almost doubled the number of corporate clients the bank can serve for commodities, Jes Staley, Chief Executive Officer of JPMorganâ€™s investment bank, said in February.
Commodities trading, the target of new rules from the regulators, can be volatile and unpredictable — â€œa dangerous business,â€ as Goldman Sachs Group Inc. Chief Financial Officer David Viniar put it three years ago. Hedge fund Amaranth Advisors LLC collapsed in 2006 under $6.6 billion of losses after wrong-way bets on natural gas and later sued JPMorgan, its broker at the time, for derailing a last-minute rescue by Citadel Investment Group LLC.
â€œIt is a very, very difficult thing to trade for a living,â€ Masters said. â€œAnd it is very difficult to put on risk and try to generate results for the company that you work for in a difficult trading market where chitchats and loose lips and talk leads to widespread dissemination of both fact and rumor.â€
JPMorgan spokesman Brian Marchiony declined to comment on the call and didnâ€™t make Masters available for comment. JPMorganâ€™s investment bank, which houses the commodities division, employed 26,279 people as of June 30, according to the company. The firm doesnâ€™t break out the number of employees within commodities.
â€˜Significantly Below Planâ€™
JPMorganâ€™s fixed-income revenue, which includes commodities, fell 27.7 percent year-over-year to $3.6 billion in the second quarter, compared with $4.9 billion a year earlier and $5.5 billion in the first quarter. The company attributed the drop to poor results in the credit and commodities markets, and a squeeze in interest rates.
â€œIf you look at our overall client-driven results across the entire franchise over the first half of the year, the printed number leaves us 20 percent below plan,â€ she said on the call.
She said she hopes the second quarter â€œproves to be a record bad quarter for us in that thereâ€™s nothing but upside from here,â€ she said. â€œThe outcome was both significantly below plan, significantly below last quarter and significantly below the year-ago linked quarter,â€ she said. The unit would have been in position to meet goals for the first half except for $83 million in revenue that the company deferred booking during the first six months â€œfor a variety of sensible reasons.â€
Competitors Are â€˜Scaredâ€™
Masters said the market is still â€œchoppyâ€ and that competitors who exited the market have returned.
â€œWeâ€™ve got too many banks chasing too little volume and margins have compressed,â€ she said.
Even so, competitors are â€œscared shitless of us,â€ said Masters, who is based in New York and joined the bank in 1991 after internships that began in 1987. â€œTheyâ€™d better be, because this is a platform thatâ€™s going to win.â€
The layoffs, split about evenly between JPMorgan and RBS Sempra, werenâ€™t evidence of â€œpanickingâ€ by the bank, said Masters, who received a bachelorâ€™s degree in economics from Cambridge Universityâ€™s Trinity College, which says it has produced 32 Nobel Prize winners.
Those who left of their own accord mostly came from RBS Sempra, Masters said, and were mainly in â€œglobal physical oil.â€ Many of them joined smaller commodity-trading firms with less capital, choices she characterized as â€œvery interesting career decisions.â€ Masters didnâ€™t name any of them.
Not â€˜Running Awayâ€™
â€œYou should think of this as business as usual and definitely not a reaction to losses in coal, or anything like that,â€ she said. â€œItâ€™s not because we are panicking. It is not because we are changing our minds, backing off, backing out, backing down, running away, none of the above.â€
Masters said had she spent the previous several days in meetings with Staley, Chief Executive Officer Jamie Dimon and the investment bankâ€™s operating committee and was preparing a â€œdeep diveâ€ with JPMorganâ€™s board and Chief Financial Officer Doug Braunstein.
â€œWhen you have a bad quarter or a bad year, you should expect to spend a lot of time with senior management explaining yourself,â€ she said. â€œI have worked very hard, number 1, to own responsibility for what went on and to acknowledge it and not excuse it. We made an error of judgment. Frankly, we made a bit of a rookie error. We got overexposed in the market and made ourselves vulnerable to a squeeze.
â€˜Ainâ€™t That Badâ€™
â€˜â€˜But if you take that out and recognize that weâ€™re not going to allow that to happen to ourselves again, the rest of the story really ainâ€™t that bad,â€ she said. â€œIn fact, if you look through it all, itâ€™s extraordinarily encouraging.â€
Coal derivatives trader Chan Bhima made an error of judgment, not of character, in â€œtaking a risk on our behalf,â€ she said. Coal prices plunged 24 percent from January through March and then surged 35 percent through June. Marchiony, the bank spokesman, said Bhima wasnâ€™t available for comment.
The company took an oversized position both relative to their fledgling operation and relative to the market, Masters said. The error cost the company as much as $250 million, the New York Post reported June 8, without saying where it got the information.
â€˜Bigger Than Marketâ€™
The loss was â€œlarger than appropriate for a relatively fledging business within the fabric of the overall commodities franchise,â€ said Masters, who didnâ€™t specify the size of the loss.
JPMorgan â€œbecame bigger than the market,â€ said Robin Bhar, a metals and energy analyst at Credit Agricole CIB in London. â€œThey were the coal market,â€ Bhar said, adding, â€œthese mistakes could happen again.â€
Masters chastised employees after news of Bhimaâ€™s wrong-way bet leaked to the media.
â€œI donâ€™t want us talking to the press,â€ she said. â€œI donâ€™t want us talking to the outside world, neither about successes nor about failures. Itâ€™s not what top-class businesses do to themselves. This constitutes treading on our own toe and then kicking ourselves in our own shin in recompense for that.â€
Even if trading conditions donâ€™t improve, the commodities unit could produce â€œa perfectly respectable return on equity, net income and overhead ratio,â€ she said.
â€œAll itâ€™s going to take is a little pop to the upside,â€ she said. â€œWe could be producing a 30 to 35 percent ROE and looking like gods,â€ she said, referring to return on equity.
Jewel in Crown
JPMorgan missed out on opportunities in recent years, such as when oil prices surged in 2008, because it lacked the infrastructure to store and ship oil and other commodities, Masters said. JPMorgan has been expanding its commodities operations ever since, buying Bear Stearns Cos.â€™ energy business in 2008 and UBS AGâ€™s global agriculture and Canadian commodities divisions, a purchase it completed in 2009. In March 2008, the bank bought U.K.-based ClimateCare, which helps clients reduce carbon emissions and trades reduction credits.
The London team has also since devised a way to provide â€œsynthetic storageâ€ and the company now has physical assets â€œat our fingertipsâ€ to store and ship commodities like oil and metals across the globe, she said.
RBS Sempra brought JPMorgan the Henry Bath metals warehousing unit, â€œone of the jewels in the crownâ€ of the deal, said Bhar of Credit Agricole.
Banks are moving into physical commodities as regulators globally impose new rules on derivative markets, making them less attractive, Bhar said. JPMorgan could profit by renting the warehouses to traders betting on different metals forward contracts, he said. â€œPotentially there is a lot of money to be made,â€ Bhar said.
In the yearâ€™s first half, JPMorgan completed several large strategic structured transactions that have been in the works for several years, Masters said, without identifying them. They include storage transportation, long-dated power sales, commodity-linked financing, new JPMorgan index products and carbon derivatives, she said.
The company also provides commodities services to the airlines, a customer base it didnâ€™t have in 2008, Masters said. Goldman Sachs Group Inc. and Morgan Stanley were able to make â€œa tremendous amount of moneyâ€ as markets fell by restructuring their clientsâ€™ contracts, she said.
â€˜Gutsiest and Ballsiestâ€™
â€œIf that were to happen now going forward from here, we would be just as well positioned as the next player in terms of having opportunities to restructure business,â€ Masters said.
Although JPMorganâ€™s per-client revenue has dropped, the bank is doing business with more clients — 1,000 through the first half, compared with 1,200 for all of last year, Masters said. Once the merger with RBS Sempra is completed, JPMorgan will add about 1,100 entirely new clients as well as 1,000 existing clients who werenâ€™t previously using its commodities services, she said.
â€œEvery one of you needs to get away from the last six months, myself included, of pain associated with mergers and integration and the difficult market conditions, the losses that weâ€™ve encountered, the nonsense thatâ€™s been in the newspapers,â€ Masters said. â€œRemember that you work for a business that is one of the boldest and gutsiest and ballsiest businesses that Iâ€™ve ever had the pleasure and privilege to work with.â€