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J.P. Morgan Bosses Hit By Bank Regulator

Published: March 22, 2013 | 8:26 am
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By Dan Fitzpatrick and Joann S. Lublin
1211 words
20 March 2013
The Wall Street Journal
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(Copyright (c) 2013, Dow Jones & Company, Inc.)

J.P. Morgan Chase & Co. was downgraded in a confidential government scorecard over concerns about the company’s management and its board, a blow to a firm that has long been considered one of the best-run on Wall Street.

The New York company’s management rating from the Office of the Comptroller of the Currency fell one notch last July to a level that signifies oversight “needs improvement,” following the revelation of what are known as the “London whale” trading losses, said people familiar with the regulatory assessment.

Grading is on a scale of 1 to 5, with 5 being worst. J.P. Morgan had been at level 2, indicating “satisfactory management.” The people said the downgrade to level 3 wasn’t solely related to a London employee’s large trades — in indexes tracking the health of a group of companies — that led to losses exceeding $6 billion.

The downgrade marks an unusual setback for a bank that last year reported record profit of $21.3 billion and bears a stock-market value of $187 billion, second only among U.S. financial companies to Wells Fargo & Co.’s $198 billion.

U.S. regulators determine the strength of financial institutions using a confidential ratings yardstick that has several parts and is known by the acronym CAMELS. They rarely disclose the various scores that make up the measure because of concerns about how the public might react.

During the financial crisis in 2008 and 2009, Citigroup Inc. and Bank of America Corp. had their overall ratings cut to 3 on concerns about their exposure to the credit crisis and risks they took on in purchasing troubled companies, according to documents and people close to the companies.

Both banks declined to comment.

A J.P. Morgan spokesman declined to comment on the rating change but said, “We are working hard to strengthen all of our processes and have already remediated many significant issues.”

J.P. Morgan sidestepped many of the problems that bedeviled its rivals during the crisis and emerged as among the healthiest of the big banks.

The regulators’ action last July ranks among the most serious steps taken against J.P. Morgan by regulators since Chief Executive James Dimon took the reins in late 2005.

Last week, the Senate Permanent Subcommittee on Investigations held hearings where five current and former bank executives explained their actions in the London whale trading debacle. And the Federal Reserve said it found weaknesses in the capital-management plan the company submitted for this year’s “stress tests,” even as it allowed the company to raise its dividend by eight cents a share and buy back $6 billion of common stock.

The bank is taking corrective steps including forming a new board compliance committee to work through a number of fixes required by regulators.

The board also is looking for a new director with a strong compliance background, said people close to the board. Another person said that Mr. Dimon is always on the hunt for new board members and that no special search is under way.

The downgrade to a key component of the bank’s so-called CAMELS rating is one of many hits the bank has taken from regulators since the “whale” trades came to light last spring. Each letter in the acronym stands for a different aspect of a bank’s condition; the “M” stands for Management.

The move cut J.P. Morgan‘s management rating to 3 from 2. A 3 in the category means that “the capabilities of management or the board of directors may be insufficient,” according to OCC guidelines, and that management and board performance “need improvement.”

The change was communicated in a July 27, 2012, supervisory letter that cited “lax governance and oversight” in the office responsible for the London whale trades as well as “other oversight deficiencies,” according to a report released last week by the Senate panel. The report didn’t identify the specific rating or how low it had dropped.

It isn’t known whether the bank’s composite CAMELS rating moved up or down in the past year.

The management-category rating “is given special consideration when assigning a composite rating,” according to OCC guidelines.

The downgrade was met with “surprise” within the bank last July, said a person familiar with the move.

The same day, J.P. Morgan announced a reshuffling of its executive ranks that elevated two executives who mopped up the trading mess and stripped power from the bank’s top finance officer and investment-bank boss. Later in the year, the bank named a new chief financial officer.

Tensions between the OCC and J.P. Morgan have been building for some time. Top OCC officials said last Friday during an appearance before the Senate panel that J.P. Morgan hadn’t provided accurate or timely information about the bad trades as they deteriorated in early 2012.

In the second half of 2012, the OCC served the bank with six supervisory letters that included 20 “Matters Requiring Attention” in areas ranging from risk models and regulatory capital reporting to quality of audit oversight, quality of risk management and how the bank values its trading positions, according to the Senate report.

In a Dec. 12 letter, the OCC concluded that “board and management failed to ensure” that the office responsible for the London whale trades “was properly supervised and that adequate risk management and control infrastructure was in place.”

On Jan. 14, the OCC and the Fed hit the bank with public enforcement actions targeting lapses in risk management and money-laundering controls. One of the OCC actions requires J.P. Morgan to form a three-person compliance committee to deal with new requirements and send regulators its first report by mid-April.

Mr. Dimon told investors last month that the two big areas of focus for the bank in 2013 are growing “organically” and meeting “a wave of our regulatory demands. Just doing those two things will tax even J.P. Morgan.”

How Banks Get

Their CAMELS

U.S. regulators use a secret ratings scorecard to determine the soundness of financial institutions. The system, in place since 1979, is known by its acronym, CAMELS, which stands for:

– Capital adequacy: sizing up the cushion against losses.

– Asset quality: the likelihood that loans will pay off.

– Management capability: reflecting controls and strategy.

– Earnings quality: measuring source, steadiness of profit.

– Liquidity adequacy: how long a bank can go without raising money in the market.

– Sensitivity to market risk: whether a market shock would create outsize losses.

Regulators rank banks in each category and overall on a scale of 1 to 5, with 5 as the worst rating. If a bank receives a composite CAMELS rating of 4 or 5, it lands on the Federal Deposit Insurance Corp.’s confidential problem-bank list.

Bank ratings and their components are rarely disclosed to the public because regulators are concerned about a negative reaction from customers and investors. Usually the number is known only to senior executives and board members.

– Dan Fitzpatrick

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