JP Morgan Chase 2008 Annual Report Download - page 158

Notes to consolidated financial statements
156 JPMorgan Chase & Co./ 2008 Annual Report
Note 5 – Fair value option
In February 2007, the FASB issued SFAS 159, which was effective for
fiscal years beginning after November 15, 2007, with early adoption
permitted. The Firm chose early adoption for SFAS 159 effective
January 1, 2007. SFAS 159 provides an option to elect fair value as
an alternative measurement for selected financial assets, financial lia-
bilities, unrecognized firm commitments, and written loan commit-
ments not previously carried at fair value.
Elections
The following is a discussion of the primary financial instruments for
which fair value elections were made and the basis for those elections:
Loans and unfunded lending-related commitments
On January 1, 2007, the Firm elected to record, at fair value, the fol-
lowing:
• Loans and unfunded lending-related commitments that are
extended as part of IB’s principal investing activities. The transi-
tion amount related to these loans included a reversal of the
allowance for loan losses of $56 million.
• Certain loans held-for-sale. These loans were reclassified to trad-
ing assets – debt and equity instruments. This election enabled
the Firm to record loans purchased as part of the Investment
Bank’s commercial mortgage securitization activity and propri-
etary activities at fair value and discontinue SFAS 133 fair value
hedge relationships for certain originated loans.
Beginning on January 1, 2007, the Firm chose to elect fair value as
the measurement attribute for the following loans originated or pur-
chased after that date:
• Loans purchased or originated as part of IB’s securitization
warehousing activities.
• Prime mortgage loans originated with the intent to sell within
Retail Financial Services (“RFS”).
The election to fair value the above loans did not include loans
within these portfolios that existed on January 1, 2007, based upon
the short holding period of the loans and/or the negligible impact of
the elections.
Warehouse loans elected to be reported at fair value are classified as
trading assets – debt and equity instruments. For additional informa-
tion regarding warehouse loans, see Note 16 on pages 180–188 of
this Annual Report.
Beginning in the third quarter of 2007, the Firm elected the fair
value option for newly originated bridge financing activity in IB.
These elections were made to align further the accounting basis of
the bridge financing activities with their related risk management
practices. For these activities, the loans continue to be classified
within loans on the Consolidated Balance Sheets; the fair value of
the unfunded commitments is recorded within accounts payable and
other liabilities.
Securities Financing Arrangements
On January 1, 2007, the Firm elected to record at fair value resale
and repurchase agreements with an embedded derivative or a
maturity of greater than one year. The intent of this election was to
mitigate volatility due to the differences in the measurement basis
for the agreements (which were previously accounted for on an
accrual basis) and the associated risk management arrangements
(which are accounted for on a fair value basis). An election was not
made for short-term agreements, as the carrying value for such
agreements generally approximates fair value. For additional infor-
mation regarding these agreements, see Note 13 on pages
174–175 of this Annual Report.
In the second quarter of 2008, the Firm began electing the fair value
option for newly transacted securities borrowed and securities lend-
ing agreements with a maturity of greater than one year. An election
was not made for any short-term agreements, as the carrying value
for such agreements generally approximates fair value.
Structured Notes
IB issues structured notes as part of its client-driven activities.
Structured notes are financial instruments that contain embedded
derivatives and are included in long-term debt. On January 1, 2007,
the Firm elected to record at fair value all structured notes not previ-
ously elected or eligible for election under SFAS 155. The election
was made to mitigate the volatility due to the differences in the
measurement basis for structured notes and the associated risk man-
agement arrangements as well as to eliminate the operational bur-
dens of having different accounting models for the same type of
financial instrument.
Other
In the third quarter of 2008, the Firm elected the fair value option
for the ABCP investments purchased under the Federal Reserve’s
AML Facility for U.S. money market mutual funds, as well as the
related nonrecourse advance from the Federal Reserve Bank of
Boston (“FRBB”). At December 31, 2008, ABCP investments of
$11.2 billion were recorded in other assets; the corresponding non-
recourse liability to the FRBB in the same amount was recorded in
other borrowed funds. For further discussion, see Note 21 on page
202 of this Annual Report.
In 2008, the Firm elected the fair value option for certain loans
acquired as part of the Bear Stearns merger that were included in
the trading portfolio and for prime mortgages previously designated
as held-for-sale by Washington Mutual as part of the Washington
Mutual transaction. In addition, the Firm elected the fair value option
for certain tax credit and other equity investments acquired as part
of the Washington Mutual transaction.