JP Morgan Chase 2008 Annual Report Download - page 104

Management’s discussion and analysis
102 JPMorgan Chase & Co./ 2008 Annual Report
credit risk on the loans, lending-related commitments or derivative
receivables. This activity does not reduce the reported level of assets
on the balance sheet or the level of reported off-balance sheet com-
mitments, though it does provide the Firm with credit risk protection.
The Firm also diversifies its exposures by selling credit protection,
which increases exposure to industries or clients where the Firm has
little or no client-related exposure, however, this activity is not mate-
rial to the Firm’s overall credit exposure.
Use of single-name and portfolio credit derivatives
December 31, Notional amount of protection purchased
(in millions) 2008 2007
Credit derivatives used to manage:
Loans and lending-related commitments $ 81,227 $ 63,645
Derivative receivables 10,861 6,462
Total(a) $ 92,088 $ 70,107
(a) Included $34.9 billion and $31.1 billion at December 31, 2008 and 2007, respective-
ly, that represented the notional amount for structured portfolio protection; the Firm
retains a first risk of loss on this portfolio.
The credit derivatives used by JPMorgan Chase for credit portfolio
management activities do not qualify for hedge accounting under
SFAS 133, and therefore, effectiveness testing under SFAS 133 is not
performed. Loan interest and fees are generally recognized in net
interest income, and impairment is recognized in the provision for
credit losses. This asymmetry in accounting treatment between loans
and lending-related commitments and the credit derivatives utilized
in credit portfolio management activities causes earnings volatility
that is not representative, in the Firm’s view, of the true changes in
value of the Firm’s overall credit exposure. The MTM related to the
Firm’s credit derivatives used for managing credit exposure, as well
as the MTM related to the CVA, which reflects the credit quality of
derivatives counterparty exposure, are included in the table below.
These results can vary from period to period due to market condi-
tions that impact specific positions in the portfolio. For a further dis-
cussion of credit derivatives, see Note 32 on pages 214–217 of this
Annual Report.
Year ended December 31,
(in millions) 2008 2007 2006
Hedges of lending-related commitments(a) $ 2,216 $ 350 $ (246)
CVA and hedges of CVA(a) (2,359) (363) 133
Net gains (losses)(b) $ (143) $ (13) $ (113)
(a) These hedges do not qualify for hedge accounting under SFAS 133.
(b) Excludes gains of $530 million, $373 million and $56 million for the years ended
December 31, 2008, 2007 and 2006, respectively, of other principal transactions rev-
enue that are not associated with hedging activities. The amount for 2008 and 2007
incorporates an adjustment to the valuation of the Firm’s derivative liabilities as a
result of the adoption of SFAS 157 on January 1, 2007.
The Firm also actively manages wholesale credit exposure through IB
and CB loan and commitment sales. During 2008, 2007 and 2006,
these sales of $3.9 billion, $4.9 billion and $4.0 billion of loans and
commitments, respectively, resulted in losses of $41 million and $7
million in 2008 and 2007 and gains of $83 million in 2006, respec-
tively. These results include gains on sales of nonperforming loans, as
discussed on page 95 of this Annual Report. These activities are not
related to the Firm’s securitization activities, which are undertaken
for liquidity and balance sheet management purposes. For a further
discussion of securitization activity, see Liquidity Risk Management
and Note 16 on pages 88–92 and 180–188, respectively, of this
Annual Report.
Lending-related commitments
Wholesale lending-related commitments were $379.9 billion at
December 31, 2008, compared with $446.7 billion at December 31,
2007. The decrease was largely related to a reduction in multi-seller
conduit-related commitments. In the Firm’s view, the total contractual
amount of these instruments is not representative of the Firm’s actual
credit risk exposure or funding requirements. In determining the
amount of credit risk exposure the Firm has to wholesale lending-
related commitments, which is used as the basis for allocating credit
risk capital to these instruments, the Firm has established a “loan-
equivalent” amount for each commitment; this amount represents
the portion of the unused commitment or other contingent exposure
that is expected, based upon average portfolio historical experience,
to become outstanding in the event of a default by an obligor. The
loan-equivalent amount of the Firm’s lending-related commitments
was $204.3 billion and $238.7 billion as of December 31, 2008 and
2007, respectively.
Emerging markets country exposure
The Firm has a comprehensive internal process for measuring and
managing exposures to emerging markets countries. There is no com-
mon definition of emerging markets but the Firm generally, though
not exclusively, includes in its definition those countries whose sover-
eign debt ratings are equivalent to “A+” or lower. Exposures to a
country include all credit-related lending, trading and investment
activities, whether cross-border or locally funded. In addition to mon-
itoring country exposures, the Firm uses stress tests to measure and
manage the risk of extreme loss associated with sovereign crises.
The following table presents the Firm’s exposure to the top five
emerging markets countries. The selection of countries is based solely
on the Firm’s largest total exposures by country and not the Firm’s
view of any actual or potentially adverse credit conditions. Exposure
is reported based upon the country where the assets of the obligor,
counterparty or guarantor are located. Exposure amounts are adjust-
ed for collateral and for credit enhancements (e.g., guarantees and
letters of credit) provided by third parties; outstandings supported by
a guarantor outside the country or backed by collateral held outside
the country are assigned to the country of the enhancement provider.
In addition, the effects of credit derivative hedges and other short
credit or equity trading positions are reflected in the following table.
Total exposure includes exposure to both government and private
sector entities in a country.