JP Morgan Chase 2008 Annual Report Download - page 221

JPMorgan Chase & Co./ 2008 Annual Report 219
Other unfunded commitments to extend credit
Unfunded commitments to extend credit are agreements to lend or
to purchase securities only when a customer has complied with pre-
determined conditions, and they generally expire on fixed dates.
Other unfunded commitments to extend credit include commitments
to U.S. domestic states and municipalities, hospitals and other not-for-
profit entities to provide funding for periodic tenders of their variable-
rate demand bond obligations or commercial paper. Performance by
the Firm is required in the event that the variable-rate demand bonds
or commercial paper cannot be remarketed to new investors. The per-
formance required of the Firm under these agreements is conditional
and limited by certain termination events, which include bankruptcy
and the credit rating downgrade of the issuer of the variable-rate
demand bonds or commercial paper to below certain predetermined
thresholds. The commitment period is generally one to three years. The
amount of commitments related to variable-rate demand bonds and
commercial paper of U.S. domestic states and municipalities, hospitals
and not-for-profit entities at December 31, 2008 and 2007, was
$23.5 billion and $24.1 billion, respectively.
Included in other unfunded commitments to extend credit are com-
mitments to investment and noninvestment grade counterparties in
connection with leveraged acquisitions. These commitments are
dependent on whether the acquisition by the borrower is successful,
tend to be short-term in nature and, in most cases, are subject to
certain conditions based on the borrower’s financial condition or
other factors. Additionally, the Firm often syndicates portions of the
commitment to other investors, depending on market conditions.
These commitments often contain flexible pricing features to adjust
for changing market conditions prior to closing. Alternatively, the
borrower may turn to the capital markets for required funding
instead of drawing on the commitment provided by the Firm, and the
commitment may expire unused. As such, these commitments may
not necessarily be indicative of the Firm’s actual risk, and the total
commitment amount may not reflect actual future cash flow require-
ments. The amount of commitments related to leveraged acquisitions
at December 31, 2008 and 2007, was $3.6 billion and $8.2 billion,
respectively. For further information, see Note 4 and Note 5 on pages
141–155 and 156–158, respectively, of this Annual Report.
FIN 45 guarantees
FIN 45 establishes accounting and disclosure requirements for guar-
antees, requiring that a guarantor recognize, at the inception of a
guarantee, a liability in an amount equal to the fair value of the obli-
gation undertaken in issuing the guarantee. FIN 45 defines a guaran-
tee as a contract that contingently requires the guarantor to pay a
guaranteed party, based upon: (a) changes in an underlying asset,
liability or equity security of the guaranteed party; or (b) a third
party’s failure to perform under a specified agreement. The Firm con-
siders the following off-balance sheet lending-related arrangements
to be guarantees under FIN 45: certain asset purchase agreements,
standby letters of credit and financial guarantees, securities lending
indemnifications, certain indemnification agreements included within
third-party contractual arrangements and certain derivative contracts.
These guarantees are described in further detail below.
The fair value at inception of the obligation undertaken when issuing
the guarantees and commitments that qualify under FIN 45 is typi-
cally equal to the net present value of the future amount of premium
receivable under the contract. The Firm has recorded this amount in
other liabilities with an offsetting entry recorded in other assets. As
cash is received under the contract, it is applied to the premium
receivable recorded in other assets, and the fair value of the liability
recorded at inception is amortized into income as lending & deposit-
related fees over the life of the guarantee contract. The amount of
the liability related to FIN 45 guarantees recorded at December 31,
2008 and 2007, excluding the allowance for lending-related commit-
ments and derivative contracts discussed below, was approximately
$535 million and $335 million, respectively.
Asset purchase agreements
The majority of the Firm’s unfunded commitments are not guarantees
as defined in FIN 45, except for certain asset purchase agreements
that are principally used as a mechanism to provide liquidity to SPEs,
predominantly multi-seller conduits, as described in Note 17 on
pages 189–198 of this Annual Report. The conduit’s administrative
agent can require the liquidity provider to perform under their asset
purchase agreement with the conduit at any time. These agreements
may cause the Firm to purchase an asset from the SPE at an amount
above the asset’s then fair value, in effect providing a guarantee of
the initial value of the reference asset as of the date of the agree-
ment. In most instances, third-party credit enhancements of the SPE
mitigate the Firm’s potential losses on these agreements.
The carrying value of asset purchase agreements of $147 million at
December 31, 2008, classified in accounts payable and other liabili-
ties on the Consolidated Balance Sheets, includes $9 million for the
allowance for lending-related commitments and $138 million for the
FIN 45 guarantee liability.
Standby letters of credit
Standby letters of credit (“SBLC”) and financial guarantees are condi-
tional lending commitments issued by the Firm to guarantee the per-
formance of a customer to a third party under certain arrangements,
such as commercial paper facilities, bond financings, acquisition
financings, trade and similar transactions. The majority of SBLCs
mature in 5 years or less; as of December 31, 2008 and 2007, 64%
and 52%, respectively, of these arrangements mature within three
years. The Firm has recourse to recover from the customer any
amounts paid under these guarantees; in addition, the Firm may hold
cash or other highly liquid collateral to support these guarantees. The
carrying value of standby letters of credit of $673 million and $590
million at December 31, 2008 and 2007, respectively, which is classi-
fied in accounts payable and other liabilities in the Consolidated
Balance Sheets, includes $276 million and $255 million at December
31, 2008 and 2007, respectively, for the allowance for lending-related
commitments, and $397 million and $335 million at December 31,
2008 and 2007, respectively, for the FIN 45 guarantee.