JP Morgan Chase 2009 Annual Report Download - page 114

Management’s discussion and analysis
JPMorgan Chase & Co./2009 Annual Report
112
The following table presents the Firm’s notional amounts of credit
derivatives protection purchased and sold as of December 31, 2009
and 2008, distinguishing between dealer/client activity and credit
portfolio activity.
Notional amount
Dealer/client
Credit portfolio
December 31, Protection Protection Protection Protection
(in billions) purchased(a) sold purchased(a)(b) sold Total
2009 $ 2,997 $ 2,947 $ 49 $ 1
$ 5,994
2008 $ 4,193 $ 4,102 $ 92 $ 1 $ 8,388
(a) Included $3.0 trillion and $4.0 trillion at December 31, 2009 and 2008,
respectively, of notional exposure within protection purchased where the Firm
has protection sold with identical underlying reference instruments. For a fur-
ther discussion on credit derivatives, see Note 5 on pages 175–183 of this
Annual Report.
(b) Included $19.7 billion and $34.9 billion at December 31, 2009 and 2008,
respectively, that represented the notional amount for structured portfolio
protection; the Firm retains the first risk of loss on this portfolio.
Dealer/client business
Within the dealer/client business, the Firm actively manages credit
derivatives by buying and selling credit protection, predominantly on
corporate debt obligations, according to client demand for credit risk
protection on the underlying reference instruments. Protection may be
bought or sold by the Firm on single reference debt instruments
(“single-name” credit derivatives), portfolios of referenced instru-
ments (“portfolio” credit derivatives) or quoted indices (“indexed”
credit derivatives). The risk positions are largely matched as the Firm’s
exposure to a given reference entity under a contract to sell protec-
tion to a counterparty may be offset partially, or entirely, with a
contract to purchase protection from another counterparty on the
same underlying instrument. Any residual default exposure and
spread risk is actively managed by the Firm’s various trading desks.
At December 31, 2009, the total notional amount of protection
purchased and sold decreased by $2.4 trillion from year-end 2008.
The decrease was primarily due to the impact of industry efforts to
reduce offsetting trade activity.
Credit portfolio activities
Management of the Firm’s wholesale exposure is accomplished
through a number of means including loan syndication and partici-
pations, loan sales, securitizations, credit derivatives, use of master
netting agreements, and collateral and other risk-reduction tech-
niques. The Firm also manages its wholesale credit exposure by
purchasing protection through single-name and portfolio credit
derivatives to manage the credit risk associated with loans, lend-
ing-related commitments and derivative receivables. Gains or losses
on the credit derivatives are expected to offset the unrealized
increase or decrease in credit risk on the loans, lending-related
commitments or derivative receivables. This activity does not reduce
the reported level of assets on the balance sheet or the level of
reported off–balance sheet commitments, although it does provide
the Firm with credit risk protection. The Firm also diversifies its
exposures by selling credit protection, which increases exposure to
industries or clients where the Firm has little or no client-related
exposure; however, this activity is not material to the Firm’s overall
credit exposure.
Use of single-name and portfolio credit derivatives
Notional amount
of protection
purchased and sold
December 31,
(in millions) 2009 2008
Credit derivatives used to manage:
Loans and lending-related commitments $ 36,873 $ 81,227
Derivative receivables 11,958 10,861
Total protection purchased(a) $ 48,831 $ 92,088
Total protection sold 455 637
Credit derivatives hedges notional $ 48,376 $ 91,451
(a) Included $19.7 billion and $34.9 billion at December 31, 2009 and 2008,
respectively, that represented the notional amount for structured portfolio
protection; the Firm retains the first risk of loss on this portfolio.
The credit derivatives used by JPMorgan Chase for credit portfolio
management activities do not qualify for hedge accounting under
U.S. GAAP; these derivatives are reported at fair value, with gains
and losses recognized in principal transactions revenue. In contrast,
the loans and lending-related commitments being risk-managed are
accounted for on an accrual basis. This asymmetry in accounting
treatment, between loans and lending-related commitments and
the credit derivatives used in credit portfolio management activities,
causes earnings volatility that is not representative, in the Firm’s
view, of the true changes in value of the Firm’s overall credit expo-
sure. The MTM related to the Firm’s credit derivatives used for
managing credit exposure, as well as the MTM related to the CVA
(which reflects the credit quality of derivatives counterparty expo-
sure) are included in the gains and losses realized on credit deriva-
tives disclosed in the table below. These results can vary from
period to period due to market conditions that affect specific posi-
tions in the portfolio.
Year ended December 31,
(in millions) 2009 2008 2007
Hedges of lending-related commitments(a)
$ (3,258) $ 2,216 $ 350
CVA and hedges of CVA(a) 1,920 (2,359) (363 )
Net gains/(losses)(b) $ (1,338) $ (143)
$ (13 )
(a) These hedges do not qualify for hedge accounting under U.S. GAAP.
(b) Excludes losses of $2.7 billion and gains of $530 million and $373 million for
the years ended December 31, 2009, 2008 and 2007, respectively, of other
principal transactions revenue that are not associated with hedging activities.