JPMorgan Risk Swap Ends Up at a Familiar Place: Rival Banks

When JPMorgan Chase & Co. arranged a series of trades to shift the risk of losses from $20 billion of its loans, some of those dangers wound up at a familiar place: rival banks.

The deal, struck late last year, was one of the biggest ever Synthetic Risk Transfer trades, or SRTs, opaque transactions heralded by Wall Street and approved by regulators that are supposed to hand possible loan losses to hedge funds and other nonbank investors. Yet some buyers in the JPMorgan deal — and in multiple other SRT trades — borrowed money from other banks to help finance their stakes and inflate returns, people familiar with the matter say.

Nomura Holdings Inc., Morgan Stanley and NatWest Group Plc, have emerged as some of the most active lenders to investors in SRTs, along with rivals including Banco Santander SA and Standard Chartered Plc. That leaves them well-placed to profit from an expected surge in the deals — but exposed to potential losses if debts end up going bad and the SRT investor hits trouble.

The lurking presence of Wall Street loans behind some of these complex trades suggests exposures that were meant to be shifted elsewhere remain tied to the banking system, an outcome that’s starting to spook regulators.

“If a bank’s lending against the SRT instrument as collateral, you’re clearly not transferring the risk outside the banking system,” says Sheila Bair, who led the Federal Deposit Insurance Corp. during the financial crisis. “Any counterparty investing in SRT using bank-provided leverage should be prohibited, full stop.”

Spokespeople for the banks declined to comment.

On the JPMorgan deal, DE Shaw & Co. and LuminArx Capital Management were among investors that used leverage, according to people with knowledge of the transactions. Both firms declined to comment.