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2. The London Whale, a perfect witness?

The ultimate effect of rising rates on bank portfolios is not an easy issue. It's fair to say that even as interest rates tick up, bank still face the cringing need to enhance their portfolio returns. That had previously pushed banks into some interesting situations. Many bank CIOs felt they had no choice, given the poor loan environment, but to push deeper into more speculative structured securities, where the returns were higher.

So what effect will rising rates have on banks willingness to hold CLOs?

Bloomberg notes that there are other considerations, notably an FDIC rule that redefines how their insurance premiums are accounted for. The net effect was that holding CLOs has gotten a bit more expensive across the risk spectrum.

Fitch has suggested that "banks that choose to keep investing in CLOs may stick to the riskier tranches instead of the AAA-rated portions because they offer greater returns. An executive was quoted: "The FDIC is trying to keep ahead of any emerging risk related to CLOs…. Their general intention is to keep it simple and have an assessment for higher capital charges for what they view as a riskier potential asset class."

But if rates continue to rise, banks may find themselves with a little more flexibility. The safest tranches may end up offering the optimal investment after all, which regulators would find more acceptable anyway. Of course, every bank faces a unique NIM situation. The effect from an industry-wide perspective may be difficult to discern.

For more:
- here's the article

Read more about: banks, CLO
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By Jim Kim

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3. A new four letter word in hedge fund industry

What to make of Bruno Iksil, the infamous London Whale, who made such outsized, losing derivatives bets that it cratered JPMorgan's CIO office? As the scandal unfolded, he was marked in the minds of some as ripe for prosecution. But in something of a twist, he has emerged with a non-prosecution agreement, as long as he cooperates and testifies for the government, who are apparently convinced they found the perfect cooperating witness.

Iksil stands to do very well in all this. No matter how the charges against his former colleagues and his bank work out, he'll emerge with no criminal taint and no restrictions on his work.

To some this might seem cringe-worthy, a full partner in a crime ratting out the others to save his skin. But in this case, the record that has been so far released to the public suggests that Iksil was uncomfortable with attempts to paint an overly rosy picture of his derivatives positions and even pushed back against his bosses.

Beyond that, prosecutors obviously feel that he will project well from the witness stand. All of which explains the rare non-prosecution deal that they were willing to extend.

To be sure, the feds need him. It has been difficult to win trials without credible witnesses, as pointed out by the New York Times. Emails, IMs, voice recordings will only get you so far. When you have a credible voice---as in the case of Fabrice Tourre ---as a witness, the game changes.

It's unclear if any of the JPMorgan cases will ever get to trial. In fact, all this could drag on for years. For Iksil, it might seem like a sentence, but a light one.

For more:
- here's the article

Read more about: London Whale, JPMorgan Chase
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By Jim Kim

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4. JPMorgan vulnerable on lack-of-internal-controls issues

Not too long ago, equity hedge funds pretty much had to offer some sort of "edge" to attract clients. In the wake of the SAC Capital insider trading scandals, the word has been defined more by the most negative connotations. To put it bluntly, "edge" strikes some as a euphemism for illegal insider information, the type that SAC Capital got in so much trouble with.

"Hedge funds dealing in equities have long promised 'edge' to justify their exorbitant fees. Few had more of it than SAC, which, perhaps not coincidentally, also charged the highest fees—up to half the profits it generated for investors," according to The Economist.

At this point, however, more people are no doubt wondering, given the apparent extent of alleged insider trading at the firm, if outsized returns are possible at all. Sure, if you invest legally, you will have some good years, even some great years. But is a winning streak, the likes of which SAC Capital is famous for, really possible without the vaunted "edge." Increasingly, people will be skeptical, including the SEC. Outsized returns over many years is now, fairly or not, a massive red flag---too good to be true.

Limited partners will likely embrace this sort of thinking as well. If a hedge fund goes on a multi-year winning streak, it would be wise to attribute it to anything other than "edge."

For more:
- here's the article

By Jim Kim

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5. Latest consumer issue: fees charged to dead people

What do SAC Capital and JPMorgan Chase have in common?

One could argue that both are run by big-name personalities. Both are facing waves of litigation. And both are perceived as having massive compliance issues.

On that last point, SAC Capital would appear to be the more vulnerable of the two. No fewer than nine former and current employees have been charged with insider trading violations. Five have admitted guilt. That's enough to conclude that the prosecution will have an easy time with their lack-of-compliance cases.

As for JPMorgan Chase, likewise, the more employees who are charged with criminal violations in the sordid London Whale incident, the more difficult it becomes for the bank to fight civil charges related to faulty compliance systems.

According to DealBook, "While just two former London traders for JPMorgan were criminally charged on Wednesday, the cases intensify the scrutiny of the bank's executives in New York, where lax controls and the pressure for profits aggravated the problem.

"Federal authorities outlined the breakdown in the bank's oversight in the two criminal complaints against the employees: Javier Martin-Artajo, a manager who oversaw the trading strategy, and Julien Grout, a low-level trader in London."

The bank, to its credit, has sought to tighten up its internal controls. It has made a rash of changes, including gutting the CIO unit. In the end, it will likely have to pay even more, as a settlement of civil charges may not come cheap.

For more:
- here's the article

Read more about: Compliance, Internal Controls
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By Jim Kim

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