The third-largest US bank said trading conditions have “substantially deteriorated” in the third quarter compared with those of the second, and spreads on mortgage-backed securities and loans have “sharply widened.”

In addition, if the firm’s own credit spreads tighten, the change in the fair value of certain trading liabilities would also negatively affect trading results, the company said.

JPMorgan held $16.3 billion of legacy leveraged loans and unfunded commitments as of June 30.

“Leveraged loans and unfunded commitments are difficult to hedge effectively, and if market conditions further deteriorate, additional markdowns may be necessary on this asset class,” JPMorgan said.

As of June 30, the company also held an aggregate $19.5 billion of prime and Alt-A mortgage exposure, $1.9 billion of subprime mortgage exposure, and $11.6 billion of commercial mortgage-backed securities (CMBS) exposure, a regulatory filing showed.

“These mortgage exposures could be adversely affected by worsening market conditions, further deterioration in the housing market and market activity reflecting distressed sellers,” the company said.

Last month, JPMorgan Chase posted a smaller-than-expected drop in earnings on resilient stock and bond underwriting revenue, but cautioned that the mortgage market and the economy were getting worse.

In the August 11 filing, the company said it also expects continued deterioration in credit trends for its consumer portfolios, and that this will likely require additions to the consumer loan loss allowance during the rest of 2008.

Quarterly net charge-offs in the home equity portfolio could continue to increase for the rest of 2008, the company said.

Prime and subprime mortgage net charge-offs were likely to continue to rise “significantly” in the second half of 2008, with deterioration expected to continue into 2009, JPMorgan said. Shares of the company closed at $41.89 Monday on the New York Stock Exchange. (Reuters)