JP Morgan Chase 2009 Annual Report Download - page 112

Management’s discussion and analysis
JPMorgan Chase & Co./2009 Annual Report
110
The following table presents the change in the nonperforming loan
portfolio for the years ended December 31, 2009 and 2008.
Nonperforming loan activity
Wholesale
Year ended December 31, (in millions) 2009 2008
Beginning balance $ 2,382 $ 514
Additions 13,591 3,381
Reductions:
Paydowns and other 4,964 859
Gross charge-offs 2,974 521
Returned to performing 341 93
Sales 790 40
Total reductions 9,069 1,513
Net additions 4,522 1,868
Ending balance $ 6,904 $ 2,382
The following table presents net charge-offs, which are defined as
gross charge-offs less recoveries, for the years ended December 31,
2009 and 2008. The amounts in the table below do not include
gains from sales of nonperforming loans.
Net charge-offs
Wholesale
Year ended December 31,
(in millions, except ratios) 2009 2008
Loans – reported
Average loans retained $ 223,047 $ 219,612
Net charge-offs 3,132 402
Average annual net charge-off rate 1.40%
0.18 %
Derivative contracts
In the normal course of business, the Firm uses derivative instru-
ments to meet the needs of customers; to generate revenue
through trading activities; to manage exposure to fluctuations in
interest rates, currencies and other markets; and to manage the
Firm’s credit exposure. For further discussion of these contracts, see
Note 5 and Note 32 on pages 175–183 and 242–243 of this
Annual Report.
The following tables summarize the net derivative receivables MTM
for the periods presented.
Derivative receivables marked to market
December 31, Derivative receivables MTM
(in millions) 2009 2008
Interest rate(a) $ 26,777 $ 49,996
Credit derivatives 18,815 44,695
Foreign exchange(a) 21,984 38,820
Equity 6,635 14,285
Commodity 5,999 14,830
Total, net of cash collateral 80,210 162,626
Liquid securities collateral held
against derivative receivables (15,519) (19,816)
Total, net of all collateral $ 64,691 $ 142,810
(a) In 2009, cross-currency interest rate swaps previously reported in interest
rate contracts were reclassified to foreign exchange contracts to be more
consistent with industry practice. The effect of this change resulted in a
reclassification of $14.1 billion of cross-currency interest rate swaps to for-
eign exchange contracts as of December 31, 2008.
The amount of derivative receivables reported on the Consoli-
dated Balance Sheets of $80.2 billion and $162.6 billion at
December 31, 2009 and 2008, respectively, are the amount of
the MTM or fair value of the derivative contracts after giving
effect to legally enforceable master netting agreements, cash
collateral held by the Firm and CVA. These amounts on the Con-
solidated Balance Sheets represent the cost to the Firm to replace
the contracts at current market rates should the counterparty
default. However, in management’s view, the appropriate meas-
ure of current credit risk should also reflect additional liquid
securities held as collateral by the Firm of $15.5 billion and $19.8
billion at December 31, 2009 and 2008, respectively, resulting in
total exposure, net of all collateral, of $64.7 billion and $142.8
billion at December 31, 2009 and 2008, respectively. The de-
crease of $78.1 billion in derivative receivables MTM, net of the
above mentioned collateral, from December 31, 2008, was pri-
marily related to tightening credit spreads, volatile foreign exchange
rates and rising rates on interest rate swaps.
The Firm also holds additional collateral delivered by clients at the
initiation of transactions, as well as collateral related to contracts that
have a non-daily call frequency and collateral that the Firm has
agreed to return but has not yet settled as of the reporting date.
Though this collateral does not reduce the balances noted in the table
above, it is available as security against potential exposure that could
arise should the MTM of the client’s derivative transactions move in
the Firm’s favor. As of December 31, 2009 and 2008, the Firm held
$16.9 billion and $22.2 billion of this additional collateral, respec-
tively. The derivative receivables MTM, net of all collateral, also do
not include other credit enhancements, such as letters of credit.
While useful as a current view of credit exposure, the net MTM
value of the derivative receivables does not capture the potential
future variability of that credit exposure. To capture the potential
future variability of credit exposure, the Firm calculates, on a client-
by-client basis, three measures of potential derivatives-related
credit loss: Peak, Derivative Risk Equivalent (“DRE”), and Average
exposure (“AVG”). These measures all incorporate netting and
collateral benefits, where applicable.
Peak exposure to a counterparty is an extreme measure of exposure
calculated at a 97.5% confidence level. DRE exposure is a measure
that expresses the risk of derivative exposure on a basis intended to
be equivalent to the risk of loan exposures. The measurement is done
by equating the unexpected loss in a derivative counterparty exposure
(which takes into consideration both the loss volatility and the credit
rating of the counterparty) with the unexpected loss in a loan expo-
sure (which takes into consideration only the credit rating of the
counterparty). DRE is a less extreme measure of potential credit loss
than Peak and is the primary measure used by the Firm for credit
approval of derivative transactions.
Finally, AVG is a measure of the expected MTM value of the Firm’s
derivative receivables at future time periods, including the benefit
of collateral. AVG exposure over the total life of the derivative
contract is used as the primary metric for pricing purposes and is
used to calculate credit capital and the CVA, as further described
below. AVG exposure was $49.0 billion and $83.7 billion at De-
cember 31, 2009 and 2008, respectively, compared with derivative
receivables MTM, net of all collateral, of $64.7 billion and $142.8
billion at December 31, 2009 and 2008, respectively.
The MTM value of the Firm’s derivative receivables incorporates an
adjustment, the CVA, to reflect the credit quality of counterparties.