JP Morgan Chase 2009 Annual Report Download - page 158

Notes to consolidated financial statements
JPMorgan Chase & Co./2009 Annual Report 156
Data Corporation. Upon dissolution, the Firm consolidated the
retained Chase Paymentech Solutions business.
Proceeds from Visa Inc. shares
On March 19, 2008, Visa Inc. (“Visa”) completed its initial public
offering (“IPO”). Prior to the IPO, JPMorgan Chase held approxi-
mately a 13% equity interest in Visa. On March 28, 2008, Visa
used a portion of the proceeds from the offering to redeem a
portion of the Firm’s equity interest, which resulted in the recog-
nition of a pretax gain of $1.5 billion (recorded in other income).
In conjunction with the IPO, Visa placed $3.0 billion in escrow to
cover liabilities related to certain litigation matters. The escrow
was increased by $1.1 billion in 2008 and by $700 million in
2009. JPMorgan Chase’s interest in the escrow was recorded as a
reduction of other expense and reported net to the extent of
established litigation reserves.
Purchase of remaining interest in Highbridge Capital
Management
In January 2008, JPMorgan Chase purchased an additional equity
interest in Highbridge Capital Management, LLC (“Highbridge”),
which resulted in the Firm owning 77.5% of Highbridge. In July
2009, JPMorgan Chase completed its purchase of the remaining
interest in Highbridge, which resulted in a $228 million adjustment
to capital surplus.
Subsequent events
The Firm has performed an evaluation of events that have oc-
curred subsequent to December 31, 2009, and through February
24, 2010 (the date of the filing of this Annual Report). There have
been no material subsequent events that occurred during such
period that would require disclosure in this Annual Report, or
would be required to be recognized in the Consolidated Financial
Statements, as of or for the year ended December 31, 2009.
Note 3 – Fair value measurement
JPMorgan Chase carries a portion of its assets and liabilities at
fair value. The majority of such assets and liabilities are carried at
fair value on a recurring basis. Certain assets and liabilities are
carried at fair value on a nonrecurring basis, including loans
accounted for at the lower of cost or fair value that are only
subject to fair value adjustments under certain circumstances.
The Firm has an established and well-documented process for
determining fair values. Fair value is defined as the price that
would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the meas-
urement date. Fair value is based on quoted market prices, where
available. If listed prices or quotes are not available, fair value is
based on internally developed models that primarily use, as
inputs, market-based or independently sourced market parame-
ters, including but not limited to yield curves, interest rates,
volatilities, equity or debt prices, foreign exchange rates and
credit curves. In addition to market information, models also
incorporate transaction details, such as maturity of the instru-
ment. Valuation adjustments may be made to ensure that finan-
cial instruments are recorded at fair value. These adjustments
include amounts to reflect counterparty credit quality, the Firm’s
creditworthiness, constraints on liquidity and unobservable pa-
rameters. Valuation adjustments are applied consistently over
time.
• Credit valuation adjustments (“CVA”) are necessary when the
market price (or parameter) is not indicative of the credit qual-
ity of the counterparty. As few classes of derivative contracts
are listed on an exchange, the majority of derivative positions
are valued using internally developed models that use as their
basis observable market parameters. Market practice is to
quote parameters equivalent to an “AA” credit rating whereby
all counterparties are assumed to have the same credit quality.
Therefore, an adjustment is necessary to reflect the credit
quality of each derivative counterparty to arrive at fair value.
The adjustment also takes into account contractual factors de-
signed to reduce the Firm’s credit exposure to each counter-
party, such as collateral and legal rights of offset.
• Debit valuation adjustments (“DVA”) are necessary to reflect
the credit quality of the Firm in the valuation of liabilities
measured at fair value. The methodology to determine the ad-
justment is consistent with CVA and incorporates JPMorgan
Chase’s credit spread as observed through the credit default
swap market.
• Liquidity valuation adjustments are necessary when the Firm
may not be able to observe a recent market price for a finan-
cial instrument that trades in inactive (or less active) markets
or to reflect the cost of exiting larger-than-normal market-size
risk positions (liquidity adjustments are not taken for positions
classified within level 1 of the fair value hierarchy). The Firm
tries to ascertain the amount of uncertainty in the initial valua-
tion based on the degree of liquidity in the market in which
the financial instrument trades and makes liquidity adjust-
ments to the carrying value of the financial instrument. The
Firm measures the liquidity adjustment based on the following
factors: (1) the amount of time since the last relevant pricing
point; (2) whether there was an actual trade or relevant exter-
nal quote; and (3) the volatility of the principal risk component
of the financial instrument. Costs to exit larger-than-normal
market-size risk positions are determined based on the size of
the adverse market move that is likely to occur during the pe-
riod required to bring a position down to a nonconcentrated
level.
• Unobservable parameter valuation adjustments are necessary
when positions are valued using internally developed models
that use as their basis unobservable parameters – that is, pa-
rameters that must be estimated and are, therefore, subject to
management judgment. These positions are normally traded
less actively. Examples include certain credit products where
parameters such as correlation and recovery rates are unob-
servable. Unobservable parameter valuation adjustments are
applied to mitigate the possibility of error and revision in the
estimate of the market price provided by the model.
The Firm has numerous controls in place intended to ensure that
its fair valuations are appropriate. An independent model review
group reviews the Firm’s valuation models and approves them for