Analyzing of The Company Jpmorgan & Chase

Introduction

As one of the oldest and largest financial institutions in the world, JPMorgan Chase & Co. (JPM) serves millions of consumers around the world. Headquartered in New York City and operating primarily in the United States, JPMorgan Chase also services some of the world’s most prominent corporate, institutional, and government clients. Throughout its history, JPMorgan Chase and its predecessors have been serial acquirers, merging with peers and competitive firms to reach the global scale of what is now the largest bank in the United States, and the world's sixth largest bank by total assets. JPMorgan Chase was established as the result of the combination of several large U.S. banking companies in 1996 and prior, including Chase Manhattan Bank, J.P. Morgan & Co., Bank One, Bear Stearns and Washington Mutual. The company and name JPMorgan Chase was formalized in 2000 (JPMorgan Chase). JPMorgan Chase has integrated these acquisitions into their model as an integrated universal bank, the result of which has been a full-service portfolio of banking products and services available to a variety of clients. As we look at JPMorgan Chase, we see four main business segments of the firm that operate and offer a wide variety of financial services to a comprehensive range of clients around the globe. As a large multinational bank, JPMorgan Chase is faced with different types of risks. We look at not only how these risks are measured, but also how JPMorgan Chase typically protects itself from them. Given the history of fraudulent cases and illegal acts by similar firms, we will also be looking at a number of institutions, both foreign and domestic, that oversee and regulate JPMorgan Chase and its subsidiary firms (JPMorgan Chase).

Business Segments

On a broad scale, JPMorgan Chase has four operating segments—consumer and community banking, corporate and investment banking, commercial banking, and asset management. The largest of the four, contributing 46% to the company's total revenues, is consumer and community banking, with corporate and investment banking coming in second with 34% in revenues. Asset management and commercial banking contribute 12% and 7% respectively (King, 2015). In 2012 JPMorgan Chase chase took a substantial step forward by combining Chase’s three key retail businesses: consumer and business banking, mortgage banking, and Card, merchant services and auto finance into one franchise—consumer and community banking. This branch serves consumers and businesses through personal service such as ATMs, online, mobile, and telephone banking. Consumer and Business Banking provides deposit and investment products and services to consumers and small businesses are offered lending, deposit, and cash management. Within credit card services, credit cards are issued to consumers and small businesses to provide payment services to the corporate and public sector. This subsection also offers clients auto and student loan services. Lastly, mortgage banking includes mortgage orientation and portfolios made up of residential mortgages and home equity loans (Annual Report 2014).

Another key segment of JPMorgan Chase is its corporate and investment banking sector. Here the firm strives to deliver strategic advice and solutions including raising capital, risk management and underwriting. This segment is broken up into two main components: banking services and markets and investor services. The first offers a full range of investment banking products including raising capital in equity and debt markets as well as loan origination. This service also includes treasury services, which is composed of transaction services dealing with cash management and liquidity solutions. On the other hand, the markets and investors services segment is a global market maker offering myriad risk management solutions, and also includes the securities services business which oversees the lending products that are sold to investment funds and insurance companies (Annual Report 2014).

When it comes to commercial banking the company aims to deliver extensive industry knowledge, local expertise, and dedicated service to both U.S and international clients. Overall, the firm provides comprehensive financial solutions that deal with lending, investment banking, and asset management (Annual Report 2014). This segment is further divided into four primary client segments: middle market banking (covering corporate, municipal, and nonprofit clients, with annual revenue generally ranging from between $20 million and $500 million), corporate client banking (covering clients with annual revenue generally ranging from between $500 million to $2 billion and focuses on clients that have broader investment banking needs), commercial term lending (providing term financing to real estate investors), and real estate banking (providing full-service banking to investors and developers). This segment seeks to further differentiate the company’s service and capabilities to continue to improve in the future by increasing the client base and building deeper client relationships (Annual Report 2014).

The asset management division offers investment management across all major asset classes, including equities, fixed income securities, multi-asset solutions, and alternative investments (See Appendix Graphic 1). While there are a variety of clients, the majority of asset management client assets are in actively managed portfolios (Annual Report 2014). There are two distinct lines of service within asset management—global investment management, which provides investment services on a global scale like active risk-budgeting strategies. The second is global wealth management that focuses on investment advice and investment management as well as specialty wealth advisory services. JP Morgan Chase prides themselves on the unique combination of the two (See Appendix Graphic 2). Furthermore, the client segments within asset management can be broken down into private banking, including high and ultra-high net worth individuals, institutional, including corporate and public institutions, and finally retail clients which are composed of financial intermediaries and individual investors.

These business segments have a global footprint comparable in scale to JPMorgan Chase’s largest institutional clients and the geographic diversity of their smallest retail clients. The firm operates in more than 60 countries with a primary focus in North American. However, given JPMorgan Chase’s size, the scale of operations in each smaller foreign market remains large. In 2014, JPMorgan Chase recorded more than $34 billion in revenue, 50% of which was acquired from consumers and clients outside of the United States. Of this $17 billion in international revenue, 66% was derived from the EMEA region (Europe, Middle East, and Africa), representing a market where JPMorgan Chase’s business is mature and well-known. 27% was generated from the Asian region and the last 7% came from the Latin American region, a place where management perceives their ability to grow and develop the JPMorgan Chase brand may be the greatest (Annual Report 2014). Most revenues from international markets are being generated through the corporate and investment banking and asset management business segments of JPMorgan Chase.

Risk Management

JP Morgan’s total assets and total liabilities both increased from December 31, 2013 by 157.4 billion and 136.6 billion, respectively. The assets for the period ending December, 2014 totaled $2,573,126 (See Appendix Graphic 4). These assets included cash and fees from banks and deposits with banks, federal funds sold, and securities purchased under resale agreements. Cash items on a bank’s balance sheet generally are composed of reserves, cash items in process of collection, and deposits at other banks (Mishkin 402). Assets also included are trading assets, which were driven by client market making activities in corporate and investment banking. Additionally, securities made up a big chunk at $348,004, and these are generally made up of debt instruments because banks are not allowed to hold stock (Mishkin 402). Other assets that played a role in JPMorgan Chase’s bank statements were loans and allowance for loan losses. These are a reflection of probable credit losses that arise in the consumer and wholesale loan portfolios. These losses are estimated using statistical analyses. Moreover, accrued interest in accounts receivables was a direct result of market making activities and security sales. Additionally, there are other assets listed that can be the result of physical capital as well as private equity investments due to sales (Annual Report 2014).

The liabilities can also be broken down further (See Appendix Graphic 3). Deposits made up the majority of liabilities at $1,363,427, and are comprised of consumer and wholesale deposits driven by client activity and growth. Another large liability on JPMorgan’s balance sheet is federal funds purchased and securities loaned or sold under repurchase agreements. This liability is attributable to higher financing of the firm’s trading of debt and equity instruments. Commercial paper is also a liability for the institution. The increase in the issuance of commercial paper can be attributed to short-term funding plans which consist primarily of securities loaned or sold under repurchase agreements. Another liability, accounts payable, can increase due to both client short positions as well as security purchases that did not settle, and the final component was long-term debt. This debt is a result of long term funding, the majority of which is issued by the parent holding company to provide flexibility and additional liquidity for the firm. Long term funding objectives include maximizing market access and optimizing funding costs (Annual Report 2014).

JPMorgan Chase, like most major banks and financial institutions, faces eight main types of risk. These risks are credit risk, market risk, operational risk, liquidity risk, reputational risk, business risk, systemic risk, and moral hazard risk. The first three risks are the major ones, with the following three also being important. The last two are generally unrelated to JPMorgan Chase’s everyday operations, but nevertheless warrant consideration, as they can still affect their bottom line. According to the website Market Realist “The Basel Committee on Banking Supervision (or BCBS) defines credit risk as the potential that a bank borrower, or counterparty, will fail to meet its payment obligations regarding the terms agreed with the bank.” (Market Realist, 2014) This type of risk is measured by credit scoring, credit analysis, stress testing (Annual Report 2014), and through the use of credit ratings through rating services companies such as Standard and Poor’s via letter grades from AAA to D. For market risk, the website Market Realist states “The Basel Committee on Banking Supervision defines market risk as the risk of losses in on- or off-balance sheet positions that arise from movement in market prices.” Because JPMorgan Chase is heavily involved in investment banking, this is of particular concern to them. There are many ways to measure market risk, including gap analysis, duration analysis, scenario analysis, portfolio theory, and derivatives risk measures such as delta, gamma, vomma, zomma, et cetera.

Operational risk includes any risk of loss due to some failure of internal processes, which may include legal risk. Managerial, information technology and process-related risks are also all forms of operational risk. In measuring operational risks, JPMorgan Chase uses statistical measurements, scenario-based approaches, and scorecard approaches, in addition to “value at risk” (VaR). Any institution’s liquidity risk refers to the risk of not having enough cash on hand to meet its day-to-day obligations and expenses. This kind of risk can sometimes lead to a bank run. Measuring liquidity risk (particularly funding liquidity risk) involves normalizing bank bids and constructing an aggregate proxy of funding liquidity risk by summing across the adjusted bids of all banks. Reputational risk is any risk arising from the image of the bank in the eyes of consumers resulting from any action taken by the bank. This can lead to a loss of confidence in the bank from the public. JPMorgan’s reputational risk can be measured by examining a bank’s stock price reaction or sales of its products and services when the bank takes some action that negatively impacts the public’s perception of it, as well as through market surveys. A bank’s business risk relates to risks incurred from the bank’s long-term strategies, or the tradeoffs it makes to remain competitive. This pertains mainly to a bank choosing a faulty strategy. The measurements a bank can use to measure business risk include the contribution margin ratio, the operation leverage effect, the financial leverage effect, and the total leverage effect. A bank’s systemic risk refers to the probability that the entire financial industry could be disrupted negatively. It is the risk the entire industry and market faces. Some of the measures used to measure systemic risk include illiquidity and correlation, principal components analysis, regime-switching models, and granger causality tests. Referring again to the website Market Realist, a moral hazard risk “…refers to a situation where a person, a group (or persons), or an organization is likely to have a tendency or a willingness to take a high-level risk, even if it’s economically unsound. The reasoning is that the person, group, or organization knows that the costs of such risk-taking, if it materializes, won’t be borne by the person, group, or organization taking the risk.” Price elasticities of demand can be used (as an economic measure) to provide quantitative information regarding moral hazards risk.

The main ways in which a bank can protect itself from each of these risk factors is listed below in respective order:

1. Credit Risk—Creating provisions at the time of disbursing the loan, and making an acquisition of a business they immediately raise capital in common equity to protect capital position (Annual Report 2014).
2. Market Risk—Asset allocation or diversification. In the case of JPMorgan Chase, limits are set according to market risk and are regularly updated and approved by business segments and senior management (Annual Report 2014).
3. Operational Risk—Putting system and managerial controls in place and tracking key risk indicators (KRIs). JPMorgan Chase has its Firmwide Control Committee (FCC) that reviews and discusses firmwide operational risk and risk metrics (Annual Report 2014).
4. Liquidity Risk- JPMorgan has a Liquidity Risk Oversight Group which provides independent assessments, measurements, and control of liquidity risk. They can also borrow from the Central Bank
5. Reputational Risk—Bank advertisements, branding, and regulatory compliance and transparency.
6. Business Risk—Avoiding fast-growth strategies, maintaining managerial competence, hiring consultants. Specifically JPMorgan has a number of business risk committees that deal with this (Annual Report 2014).
7. Systemic Risk—Maintaining capital and liquidity, instituting more resilient market structures, and maintaining supervisory practices. They are also performing ongoing analyses regarding this type of risk.
8. Moral Hazard Risk—Offering incentives, implementing policies to prevent immoral behavior, and regular monitoring.

Regulation

JPMorgan Chase is a financial holding company. As such, there are other companies operating under JPMorgan Chase. The main banking subsidiaries of JPMorgan Chase are JPMorgan Chase Bank (N.A. - National Association) and Chase Bank USA (N.A.). The principle non-banking subsidiary is JP Morgan Securities LLC, which is the investment bank of the firm in the U.S. The firm also has an asset management unit. (see Graphic 5 in the Appendix for the organizational framework) Because each subsidy conducts a different operation, there are different regulations concerning the subsidiaries of JPMorgan Chase. The firm is regulated for its commercial banking activities, investment banking activities, and investment management activities. For the commercial banking activities there are three major regulators supervising the firm’s activities. These regulators are the Federal Reserve Bank, the Office of the Comptroller of The Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC). The Federal Reserve Bank is an umbrella regulator, which means that it has authority over the entire company. This right was given to The Federal Reserve System by the Dodd-Frank Act, which was passed by the U.S. Congress in 2010, to increase the regulation on the financial sector after the fınancial crisis. The Office of the Comptroller of The Currency (OCC) is responsible for the soundness of the banking system. It also ensures equal access to financial services to all Americans. (OCC) Moreover, the Office of the Comptroller of The Currency is responsible for the protection of the banking system from money laundering and other finance-related crime. The Office of the Comptroller of The Currency is controlled by the Treasury of the U.S. Federal Deposit Insurance Corporation, which is also a government agency, and is another regulator that provides insurance for bank accounts in member banks. Each depositor is protected for up to $250,000 for each account ownership categories of checking accounts, savings accounts, money market deposit accounts, and certificates of deposit by the Federal Deposit Insurance Corporation. However, providing this insurance brings some extra regulation to JPMorgan Chase. The firm needs to report to the Federal Deposit Insurance Corporation regularly as well as fulfill some requirements to maintain transparency. The investment bank is under the regulation for its operations as a broker/dealer. The Securities and Exchange Commission regulates investment banking operations. The Securities and Exchange Commission regulates the investment banking subsidiary of JPMorgan Chase in regards to licensing, accounting, compensation, reporting, filing, advertising, product offerings, and fiduciary responsibilities (Securities and Exchange).

Additionally, certain futures- and swap-related activities are regulated by the Commodity Futures Trading Commission - CFTC. The asset management activities of JPMorgan Chase are regulated through the Volcker Rule that is under the Dodd-Frank Act. According to the Volcker Rule, a firm cannot engage in proprietary trading activities except for underwriting, market making and risk mitigation. The firm is also regulated for its derivatives trading under the Dodd-Frank Act. The banking activities of the firm are regulated according to Basel III Regulations. These regulations cover capital requirements and assets and liabilities management (Hummel 2015). The capital requirements consist of Tier 1, Tier 2. Tier 1 refers to the bank’s own equity (common stock and retained earnings) and, according to Basel III, the Tier 1 capital ratio (Tier 1 capital relative to the total risk-weighted assets) should be at least 6% (Bank of International). Tier 2 consists of the supplementary capital of the bank including revaluation reserves, undisclosed reserves, hybrid instruments, and subordinated term debt Tier 2) The capital adequacy ratio (Tier 1 capital and Tier 2 capital relative to the total risk-weighted assets) must be at least 8% (Bank For International). The capital conservation buffer (the additional capital the bank should hold relative to its risk-weighted assets) will go into effect in 2016 and it increases gradually each year until 2019 when the minimum capital conservation buffer must be at least 2.5% (Bank For International). Beginning in 2019 the capital adequacy ratio along with the capital conservation ratio must be at least 10.5%.

Additional capital ratios can be found in the appendix. The assets and liabilities management includes the liquidity coverage ratio and the net stable funding ratio. Banks must hold highly liquid assets, such as treasury bonds, that cover their net cash outflows for at least 30 days to comply with the liquidity coverage ratio (Basel 3 for Dummies). The net stable funding ratio states that a bank’s long-term (longer than 1 year) assets must exceed the longer term commitments. These commitments include the risks assigned to the assets and the off-balance sheet liquidity exposures. This ratio aims to promote medium-term and long-term funding for the banks.