JP Morgan Chase 2009 Annual Report Download - page 183

JPMorgan Chase & Co./2009 Annual Report 181
The following table shows the current credit risk of derivative receivables after netting adjustments, and the current liquidity risk of derivative
payables after netting adjustments, as of December 31, 2009.
December 31, 2009 (in millions) Derivative receivables Derivative payables
Gross derivative fair value $ 1,565,518 $ 1,519,183
Netting adjustment – offsetting receivables/payables (1,419,840) (1,419,840
)
Netting adjustment – cash collateral received/paid (65,468) (39,218
)
Carrying value on Consolidated Balance Sheets $ 80,210 $ 60,125
In addition to the collateral amounts reflected in the table above, at
December 31, 2009, the Firm had received and posted liquid secu-
rities collateral in the amount of $15.5 billion and $11.7 billion,
respectively. The Firm also receives and delivers collateral at the
initiation of derivative transactions, which is available as security
against potential exposure that could arise should the fair value of
the transactions move in the Firm’s or client’s favor, respectively.
Furthermore, the Firm and its counterparties hold collateral related
to contracts that have a non-daily call frequency for collateral to be
posted, and collateral that the Firm or a counterparty has agreed to
return but has not yet settled as of the reporting date. At December
31, 2009, the Firm had received $16.9 billion and delivered $5.8
billion of such additional collateral. These amounts were not netted
against the derivative receivables and payables in the table above,
because, at an individual counterparty level, the collateral exceeded
the fair value exposure at December 31, 2009.
Credit derivatives
Credit derivatives are financial instruments whose value is derived
from the credit risk associated with the debt of a third-party issuer
(the reference entity) and which allow one party (the protection
purchaser) to transfer that risk to another party (the protection
seller). Credit derivatives expose the protection purchaser to the
creditworthiness of the protection seller, as the protection seller is
required to make payments under the contract when the reference
entity experiences a credit event, such as a bankruptcy, a failure to
pay its obligation or a restructuring. The seller of credit protection
receives a premium for providing protection but has the risk that
the underlying instrument referenced in the contract will be subject
to a credit event.
The Firm is both a purchaser and seller of protection in the credit
derivatives market and uses these derivatives for two primary
purposes. First, in its capacity as a market-maker in the
dealer/client business, the Firm actively risk manages a portfolio of
credit derivatives by purchasing and selling credit protection, pre-
dominantly on corporate debt obligations, to meet the needs of
customers. As a seller of protection, the Firm’s exposure to a given
reference entity may be offset partially, or entirely, with a contract
to purchase protection from another counterparty on the same or
similar reference entity. Second, the Firm uses credit derivatives to
mitigate credit risk associated with its overall derivative receivables
and traditional commercial credit lending exposures (loans and
unfunded commitments) as well as to manage its exposure to
residential and commercial mortgages. See Note 3 on pages 156---
173 of this Annual Report for further information on the Firm’s
mortgage-related exposures. In accomplishing the above, the Firm
uses different types of credit derivatives. Following is a summary of
various types of credit derivatives.
Credit default swaps
Credit derivatives may reference the credit of either a single refer-
ence entity (“single-name”) or a broad-based index, as described
further below. The Firm purchases and sells protection on both
single- name and index-reference obligations. Single-name CDS
and index CDS contracts are both OTC derivative contracts. Single-
name CDS are used to manage the default risk of a single reference
entity, while CDS index are used to manage credit risk associated
with the broader credit markets or credit market segments. Like the
S&P 500 and other market indices, a CDS index is comprised of a
portfolio of CDS across many reference entities. New series of CDS
indices are established approximately every six months with a new
underlying portfolio of reference entities to reflect changes in the
credit markets. If one of the reference entities in the index experi-
ences a credit event, then the reference entity that defaulted is
removed from the index. CDS can also be referenced against spe-
cific portfolios of reference names or against customized exposure
levels based on specific client demands: for example, to provide
protection against the first $1 million of realized credit losses in a
$10 million portfolio of exposure. Such structures are commonly
known as tranche CDS.
For both single-name CDS contracts and index CDS, upon the
occurrence of a credit event, under the terms of a CDS contract
neither party to the CDS contract has recourse to the reference
entity. The protection purchaser has recourse to the protection
seller for the difference between the face value of the CDS contract
and the fair value of the reference obligation at the time of settling
the credit derivative contract, also known as the recovery value. The
protection purchaser does not need to hold the debt instrument of
the underlying reference entity in order to receive amounts due
under the CDS contract when a credit event occurs.
Credit-linked notes
A credit linked note (“CLN”) is a funded credit derivative where the
issuer of the CLN purchases credit protection on a referenced entity
from the note investor. Under the contract, the investor pays the
issuer par value of the note at the inception of the transaction, and in
return, the issuer pays periodic payments to the investor, based on
the credit risk of the referenced entity. The issuer also repays the
investor the par value of the note at maturity unless the reference
entity experiences a specified credit event. In that event, the issuer is
not obligated to repay the par value of the note, but rather, the issuer
pays the investor the difference between the par value of the note