JP Morgan Chase 2006 Annual Report Download - page 122

120 JPMorgan Chase & Co. / 2006 Annual Report
The Firm structures credit-linked notes in which the VIE purchases highly rated
assets (such as asset-backed securities) and enters into a credit derivative con-
tract with the Firm to obtain exposure to a referenced credit not held by the
VIE. Credit-linked notes are issued by the VIE to transfer the risk of the refer-
enced credit to the investors in the VIE. Clients and investors often prefer a
VIE structure, since the credit-linked notes generally carry a higher credit rat-
ing than they would if issued directly by JPMorgan Chase.
The Firm is involved with municipal bond vehicles for the purpose of creating
a series of secondary market trusts that allow tax-exempt investors to finance
their investments at short-term tax-exempt rates. The VIE purchases fixed-rate,
longer-term highly rated municipal bonds by issuing puttable floating-rate
certificates and inverse floating-rate certificates; the investors that purchase
the inverse floating-rate certificates are exposed to the residual losses of the
VIE (the “residual interests”). For vehicles in which the Firm owns the residual
interests, the Firm consolidates the VIE. In vehicles in which third-party
investors own the residual interests, the Firm’s exposure is limited because of
the high credit quality of the underlying municipal bonds, the unwind triggers
based upon the market value of the underlying collateral and the residual
interests held by third parties. The Firm often serves as remarketing agent for
the VIE and provides liquidity to support the remarketing.
Assets held by credit-linked and municipal bond vehicles at December 31,
2006 and 2005, were as follows:
December 31, (in billions) 2006 2005
Credit-linked note vehicles(a) $ 20.2 $ 13.5
Municipal bond vehicles(b) 16.9 13.7
(a) Assets of $1.8 billion reported in the table above were recorded on the Firm’s Consolidated
balance sheets at December 31, 2006 and 2005, due to contractual relationships held by
the Firm that relate to collateral held by the VIE.
(b) Total amounts consolidated due to the Firm owning residual interests were $4.7 billion and
$4.9 billion at December 31, 2006 and 2005, respectively, and are reported in the table.
Total liquidity commitments were $10.2 billion and $5.8 billion at December 31, 2006 and
2005, respectively. The Firm’s maximum credit exposure to all municipal bond vehicles was
$14.9 billion and $10.7 billion at December 31, 2006 and 2005, respectively.
The Firm may enter into transactions with VIEs structured by other
parties. These transactions can include, for example, acting as a derivative
counterparty, liquidity provider, investor, underwriter, placement agent, trustee
or custodian. These transactions are conducted at arm’s length, and individual
credit decisions are based upon the analysis of the specific VIE, taking into con-
sideration the quality of the underlying assets. Where these activities do not
cause JPMorgan Chase to absorb a majority of the expected losses of the VIEs
or to receive a majority of the residual returns of the VIE, JPMorgan Chase
records and reports these positions similarly to any other third-party transac-
tion. These transactions are not considered significant for disclosure purposes.
Consolidated VIE assets
The following table summarizes the Firm’s total consolidated VIE assets, by
classification, on the Consolidated balance sheets, as of December 31, 2006
and 2005:
December 31, (in billions) 2006(d) 2005
Consolidated VIE assets(a)
Securities purchased under resale agreements(b) $8.0 $ 2.6
Trading assets(c) 9.8 9.3
Investment securities 0.2 1.9
Interests in purchased receivables —29.6
Loans(b) 15.9 8.1
Other assets 2.9 0.4
Total consolidated assets $ 36.8 $ 51.9
(a) The Firm also holds $3.5 billion and $3.9 billion of assets, at December 31, 2006 and
2005, respectively, primarily as a seller’s interest, in certain consumer securitizations in a
segregated entity, as part of a two-step securitization transaction. This interest is included
in the securitization activities disclosed in Note 14 on pages 114–118 of this Annual
Report.
(b) Includes activity conducted by the Firm in a principal capacity, primarily in the IB.
(c) Includes the fair value of securities and derivative receivables.
(d) Certain multi-seller conduits administered by the Firm were deconsolidated as of June 30,
2006; the assets deconsolidated consisted of $29 billion of Interests in purchased receiv-
ables, $3 billion of Loans and $1 billion of investment securities.
Interests in purchased receivables included interests in receivables purchased
by Firm-administered conduits, which had been consolidated in accordance
with FIN 46R. Interests in purchased receivables were carried at cost and
reviewed to determine whether an other-than-temporary impairment existed.
The interest-bearing beneficial interest liabilities issued by consolidated VIEs
are classified in the line item titled, “Beneficial interests issued by consolidated
variable interest entities” on the Consolidated balance sheets. The holders
of these beneficial interests do not have recourse to the general credit of
JPMorgan Chase. See Note 19 on page 124 of this Annual Report for the
maturity profile of FIN 46 long-term beneficial interests.
FIN 46(R)-6 Transition
In April 2006, the FASB issued FSP FIN 46(R)-6, which requires an analysis of
the design of a VIE in determining the variability to be considered in the
application of FIN 46(R). The Firm adopted the guidance in FSP FIN 46(R)-6
prospectively on July 1, 2006. The adoption of FSP FIN 46(R)-6 did not signifi-
cantly change the way in which the Firm evaluated its interests in VIEs under
FIN 46(R); thus, it had an immaterial impact on the Firm’s consolidated finan-
cial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JPMorgan Chase & Co.