JP Morgan Chase 2009 Annual Report Download - page 162

Notes to consolidated financial statements
JPMorgan Chase & Co./2009 Annual Report 160
and such interests are therefore typically classified within level
3 of the valuation hierarchy.
For both MSRs and certain other retained interests in securitiza-
tions, the Firm compares its fair value estimates and assumptions
to observable market data where available and to recent market
activity and actual portfolio experience. For further discussion of
the most significant assumptions used to value retained interests
and MSRs, as well as the applicable stress tests for those assump-
tions, see Note 17 on pages 222–225 of this Annual Report.
Private equity investments
The valuation of nonpublic private equity investments, which are
held primarily by the Private Equity business within the Corpo-
rate/Private Equity line of business, requires significant manage-
ment judgment due to the absence of quoted market prices, the
inherent lack of liquidity and the long-term nature of such assets.
As such, private equity investments are valued initially based on
cost. Each quarter, valuations are reviewed utilizing available and
relevant market data to determine if the carrying value of these
investments should be adjusted. Such market data primarily
include observations of the trading multiples of public companies
considered comparable to the private companies being valued
and the operating performance of the underlying portfolio com-
pany, including its historical and projected net income and earn-
ings before interest, taxes, depreciation and amortization
(“EBITDA”). Valuations are adjusted to account for company-
specific issues, the lack of liquidity inherent in a nonpublic in-
vestment and the fact that comparable public companies are not
identical to the companies being valued. In addition, a variety of
additional factors are reviewed by management, including, but
not limited to, financing and sales transactions with third parties,
future expectations of the particular investment, changes in
market outlook and the third-party financing environment. Non-
public private equity investments are included in level 3 of the
valuation hierarchy.
Private equity investments also include publicly held equity invest-
ments, generally obtained through the initial public offering of
privately held equity investments. Publicly held investments in liquid
markets are marked to market at the quoted public value less
adjustments for regulatory or contractual sales restrictions. Dis-
counts for restrictions are quantified by analyzing the length of the
restriction period and the volatility of the equity security. Publicly
held investments are largely classified in level 2 of the valuation
hierarchy.
Other fund investments
The Firm holds investments in mutual/collective investment funds,
private equity funds, hedge funds and real estate funds. Where
the funds produce a daily net asset value (“NAV”) that is vali-
dated by a sufficient level of observable activity (purchases and
sales at NAV), the NAV is used to value the fund investment and
it is classified in level 1 of the valuation hierarchy. Where adjust-
ments to the NAV are required, for example, with respect to
interests in funds subject to restrictions on redemption (such as
lock-up periods or withdrawal limitations) and/or observable
activity for the fund investment is limited, investments are classi-
fied within level 2 or 3 of the valuation hierarchy.
Liabilities
Securities sold under repurchase agreements (“repur-
chase agreements”)
To estimate the fair value of repurchase agreements, cash flows
are evaluated taking into consideration any derivative features of
the repurchase agreements and are then discounted using the
appropriate market rates for the applicable maturity. Generally,
for these types of agreements, there is a requirement that collat-
eral be maintained with a market value equal to, or in excess of,
the principal amount loaned; as a result, there would be no
adjustment, or an immaterial adjustment, to reflect the credit
quality of the Firm (i.e., DVA) related to these agreements. As the
inputs into the valuation are primarily based on observable pric-
ing information, repurchase agreements are classified within level
2 of the valuation hierarchy.
Beneficial interests issued by consolidated VIEs
The fair value of beneficial interests issued by consolidated VIEs
(“beneficial interests”) is estimated based on the fair value of the
underlying assets held by the VIEs. The valuation of beneficial
interests does not include an adjustment to reflect the credit
quality of the Firm, as the holders of these beneficial interests do
not have recourse to the general credit of JPMorgan Chase.
Where the inputs into the valuation are based on observable
market pricing information, the beneficial interests are classified
within level 2 of the valuation hierarchy. Where significant inputs
into the valuation are unobservable, the beneficial interests are
classified within level 3 of the valuation hierarchy.
Deposits, other borrowed funds and long-term debt
Included within deposits, other borrowed funds and long-term debt
are structured notes issued by the Firm that are financial instru-
ments containing embedded derivatives. To estimate the fair value
of structured notes, cash flows are evaluated taking into considera-
tion any derivative features and are then discounted using the
appropriate market rates for the applicable maturities. In addition,
the valuation of structured notes includes an adjustment to reflect
the credit quality of the Firm (i.e., the DVA). Where the inputs into
the valuation are primarily based on observable market prices, the
structured notes are classified within level 2 of the valuation hierar-
chy. Where significant inputs are unobservable, the structured notes
are classified within level 3 of the valuation hierarchy.