JP Morgan Chase 2008 Annual Report Download - page 222

Notes to consolidated financial statements
220 JPMorgan Chase & Co./ 2008 Annual Report
Derivatives qualifying as guarantees
In addition to the contracts described above, the Firm transacts cer-
tain derivative contracts that meet the characteristics of a guarantee
under FIN 45. These contracts include written put options that
require the Firm to purchase assets upon exercise by the option hold-
er at a specified price by a specified date in the future. The Firm may
enter into written put option contracts in order to meet client needs,
or for trading purposes. The terms of written put options are typically
five years or less. Derivative guarantees also include contracts such
as stable value derivatives that require the Firm to make a payment
of the difference between the market value and the book value of a
counterparty’s reference portfolio of assets in the event that market
value is less than book value and certain other conditions have been
met. Stable value derivatives, commonly referred to as “stable value
wraps”, are transacted in order to allow investors to realize invest-
ment returns with less volatility than an unprotected portfolio, and
typically have a longer-term maturity or allow either party to termi-
nate the contract subject to contractually specified terms.
Derivative guarantees are recorded on the Consolidated Balance
Sheets at fair value in trading assets and trading liabilities. The total
notional value of the derivatives that the Firm deems to be guaran-
tees was $83.8 billion and $85.3 billion at December 31, 2008 and
2007, respectively. The notional value generally represents the Firm’s
maximum exposure to derivatives qualifying as guarantees, although
exposure to certain stable value derivatives is contractually limited to
a substantially lower percentage of the notional value. The fair value
of the contracts reflects the probability of whether the Firm will be
required to perform under the contract. The fair value related to
derivative guarantees was a derivative receivable of $184 million and
$213 million, and a derivative payable of $5.6 billion and $2.5 bil-
lion at December 31, 2008 and 2007, respectively. The Firm reduces
exposures to these contracts by entering into offsetting transactions,
or by entering into contracts that hedge the market risk related to
the derivative guarantees.
In addition to derivative contracts that meet the characteristics of a
guarantee under FIN 45, the Firm is both a purchaser and seller of
credit protection in the credit derivatives market. For a further discus-
sion of credit derivatives, see Note 32 on pages 214–217 of this
Annual Report.
Securities lending indemnification
Through the Firm’s securities lending program, customers’ securities,
via custodial and non-custodial arrangements, may be lent to third
parties. As part of this program, the Firm provides an indemnification
in the lending agreements which protects the lender against the fail-
ure of the third-party borrower to return the lent securities in the
event the Firm did not obtain sufficient collateral. To minimize its lia-
bility under these indemnification agreements, the Firm obtains cash
or other highly liquid collateral with a market value exceeding 100%
of the value of the securities on loan from the borrower. Collateral is
marked to market daily to help assure that collateralization is ade-
quate. Additional collateral is called from the borrower if a shortfall
exists, or collateral may be released to the borrower in the event of
overcollateralization. If a borrower defaults, the Firm would use the
collateral held to purchase replacement securities in the market or to
credit the lending customer with the cash equivalent thereof.
Also, as part of this program, the Firm invests cash collateral received
from the borrower in accordance with approved guidelines.
Based upon historical experience, management believes that risk of
loss under its indemnification obligations is remote.
The following table summarizes the type of facilities under which standby letters of credit and other letters of credit arrangements are outstanding
by the ratings profiles of the Firm’s customers as of December 31, 2008 and 2007. The ratings scale is representative of the payment or perform-
ance risk to the Firm under the guarantee and is based upon the Firm’s internal risk ratings, which generally correspond to ratings defined by S&P
and Moody’s.
2008 2007
Standby letters Standby letters
of credit and other Other letters of credit and other Other letters
December 31, (in millions) financial guarantees of credit financial guarantees of credit
Investment-grade(a) $ 73,394 $ 4,165 $ 71,904 $ 4,153
Noninvestment-grade(a) 21,958 762 28,318 1,218
Total contractual amount $ 95,352(b) $ 4,927 $ 100,222(b) $ 5,371
Allowance for lending-related commitments $ 274 $ 2 $ 254 $ 1
Commitments with collateral 30,972 1,000 31,502 809
(a) Ratings scale is based upon the Firm’s internal ratings which generally correspond to ratings defined by S&P and Moody’s.
(b) Represents contractual amount net of risk participations totaling $28.3 billion at both December 31, 2008 and 2007.