JP Morgan Chase 2008 Annual Report Download - page 147

JPMorgan Chase & Co./ 2008 Annual Report 145
Private equity investments
The valuation of nonpublic private equity investments, held primarily
by the Private Equity business within Corporate, requires significant
management judgment due to the absence of quoted market prices,
the inherent lack of liquidity and the long-term nature of such assets.
As such, private equity investments are valued initially based upon
cost. Each quarter, valuations are reviewed utilizing available and rel-
evant market data to determine if the carrying value of these invest-
ments should be adjusted. Such market data primarily includes
observations of the trading multiples of public companies considered
comparable to the private companies being valued and the operating
performance of the underlying portfolio company, including its histor-
ical and projected net income and earnings before interest, taxes,
depreciation and amortization (“EBITDA”). Valuations are adjusted to
account for company-specific issues, the lack of liquidity inherent in a
nonpublic investment and the fact that comparable public companies
are not identical to the companies being valued. In addition, a vari-
ety of additional factors are reviewed by management, including, but
not limited to, financing and sales transactions with third parties,
future expectations of the particular investment, changes in market
outlook and the third-party financing environment. The Firm applies
its valuation methodology consistently from period to period and
believes that the methodology and associated valuation adjustments
are appropriate. Nonpublic private equity investments are included in
level 3 of the valuation hierarchy.
Private equity investments also include publicly held equity invest-
ments, generally obtained through the initial public offering of privately
held equity investments. Publicly held investments in liquid markets are
marked to market at the quoted public value less adjustments for reg-
ulatory or contractual sales restrictions. Discounts for restrictions are
quantified by analyzing the length of the restriction period and the
volatility of the equity security. Publicly held investments are largely
classified in level 2 of the valuation hierarchy.
Other assets
The fair value of asset-backed commercial paper (“ABCP”) invest-
ments purchased under the Federal Reserve’s Asset-Backed
Commercial Paper Money Market Mutual Fund Liquidity Facility
(“AML Facility”) for U.S. money market mutual funds is determined
based on observable market information and is classified in level 2
of the valuation hierarchy.
Liabilities
Securities sold under repurchase agreements (“repurchase
agreements”)
To estimate the fair value of repurchase agreements, cash flows are
evaluated taking into consideration any derivative features and are
then discounted using the appropriate market rates for the applica-
ble maturity. Generally, for these types of agreements, there is a
requirement that collateral be maintained with a market value equal
to, or in excess of, the principal amount loaned; as a result, there
would be no adjustment, or an immaterial adjustment, to reflect the
credit quality of the Firm (i.e., DVA) related to these agreements. As
the inputs into the valuation are primarily based upon observable
pricing information, repurchase agreements are classified within level
2 of the valuation hierarchy.
Beneficial interests issued by consolidated VIEs
The fair value of beneficial interests issued by consolidated VIEs
(“beneficial interests”) is estimated based upon the fair value of the
underlying assets held by the VIEs. The valuation of beneficial inter-
ests does not include an adjustment to reflect the credit quality of
the Firm, as the holders of these beneficial interests do not have
recourse to the general credit of JPMorgan Chase. As the inputs into
the valuation are generally based upon readily observable market
pricing information, the majority of beneficial interests issued by con-
solidated VIEs are classified within level 2 of the valuation hierarchy.
Deposits, other borrowed funds and long-term debt
Included within deposits, other borrowed funds and long-term debt
are structured notes issued by the Firm that are financial instruments
containing embedded derivatives. To estimate the fair value of struc-
tured notes, cash flows are evaluated taking into consideration any
derivative features and are then discounted using the appropriate
market rates for the applicable maturities. In addition, the valuation
of structured notes includes an adjustment to reflect the credit quali-
ty of the Firm (i.e., the DVA). Where the inputs into the valuation are
primarily based upon readily observable market pricing information,
the structured notes are classified within level 2 of the valuation
hierarchy. Where significant inputs are unobservable, structured notes
are classified within level 3 of the valuation hierarchy.