JP Morgan Chase 2005 Annual Report Download - page 71

JPMorgan Chase & Co. /2005 Annual Report 69
The Firm actively pursues the use of collateral agreements to mitigate
counterparty credit risk in derivatives. The percentage of the Firm’s derivatives
transactions subject to collateral agreements increased slightly, to 81% as
of December 31, 2005, from 79% at December 31, 2004. The Firm posted
$27 billion and $31 billion of collateral as of December 31, 2005 and
2004, respectively.
Certain derivative and collateral agreements include provisions that require the
counterparty and/or the Firm, upon specified downgrades in their respective
credit ratings, to post collateral for the benefit of the other party. As of
December 31, 2005, the impact of a single-notch ratings downgrade to
JPMorgan Chase Bank, from its current rating of AA- to A+, would have been
an additional $1.4 billion of collateral posted by the Firm; the impact of a
six-notch ratings downgrade (from AA- to BBB-) would have been $3.8 billion
of additional collateral. Certain derivative contracts also provide for termination of
the contract, generally upon a downgrade of either the Firm or the counterparty,
at the then-existing MTM value of the derivative contracts.
Credit derivatives
The following table presents the Firm’s notional amounts of credit derivatives
protection purchased and sold by the respective businesses as of December 31,
2005 and 2004:
Credit derivatives positions
Notional amount
Portfolio management Dealer/client
December 31, Protection Protection Protection Protection
(in billions) purchased(a) sold purchased sold Total
2005 $ 31 $ 1 $ 1,096 $ 1,113 $ 2,241
2004 37 — 501 533 1,071
(a) Includes $848 million and $2 billion at December 31, 2005 and 2004, respectively,
of portfolio credit derivatives.
In managing wholesale credit exposure, the Firm purchases single-name and
portfolio credit derivatives; this activity does not reduce the reported level
of assets on the balance sheet or the level of reported off-balance sheet
commitments. The Firm also diversifies exposures by providing (i.e., selling)
credit protection, which increases exposure to industries or clients where the
Firm has little or no client-related exposure. This activity is not material to the
Firm’s overall credit exposure.
The following table summarizes the ratings profile of the Firm’s Consolidated balance sheets Derivative receivables MTM, net of cash and other liquid securities
collateral, for the dates indicated:
Ratings profile of derivative receivables MTM
Rating equivalent 2005 2004
December 31, Exposure net % of exposure Exposure net % of exposure
(in millions) of collateral(a) net of collateral of collateral(b) net of collateral
AAA to AA- $ 20,735 48% $ 30,384 53%
A+ to A- 8,074 18 9,109 16
BBB+ to BBB- 8,243 19 9,522 17
BB+ to B- 6,580 15 7,271 13
CCC+ and below 155 —395 1
Total $ 43,787 100% $ 56,681 100%
(a) The Firm held $33 billion of collateral against derivative receivables as of December 31, 2005, consisting of $27 billion in net cash received under credit support annexes to legally enforceable master
netting agreements, and $6 billion of other liquid securities collateral. The benefit of the $27 billion is reflected within the $50 billion of derivative receivables MTM. Excluded from the $33 billion of
collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the derivatives portfolio should the MTM of the client’s
transactions move in the Firm’s favor. Also excluded are credit enhancements in the form of letters of credit and surety receivables.
(b) The Firm held $41 billion of collateral against derivative receivables as of December 31, 2004, consisting of $32 billion in net cash received under credit support annexes to legally enforceable master
netting agreements, and $9 billion of other liquid securities collateral. The benefit of the $32 billion is reflected within the $66 billion of derivative receivables MTM. Excluded from the $41 billion of
collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the derivatives portfolio should the MTM of the client’s
transactions move in the Firm’s favor. Also excluded are credit enhancements in the form of letters of credit and surety receivables.
The MTM value of the Firm’s derivative receivables incorporates an adjustment,
the CVA, to reflect the credit quality of counterparties. The CVA is based
upon the Firm’s AVG exposure to a counterparty and the counterparty’s credit
spread in the credit derivatives market. The primary components of changes
in CVA are credit spreads, new deal activity or unwinds, and changes in the
underlying market environment. The Firm believes that active risk management
is essential to controlling the dynamic credit risk in the derivatives portfolio.
The Firm risk manages exposure to changes in CVA by entering into credit
derivative transactions, as well as interest rate, foreign exchange, equity and
commodity derivative transactions. The MTM value of the Firm’s derivative
payables does not incorporate a valuation adjustment to reflect JPMorgan
Chase’s credit quality.