JP Morgan Chase 2009 Annual Report Download - page 219

JPMorgan Chase & Co./2009 Annual Report 217
Consolidation analysis
Each nonconsolidated multi-seller conduit administered by the Firm at
December 31, 2009 and 2008, had issued ELNs, the holders of which
are committed to absorbing the majority of the expected loss of each
respective conduit. The total amounts of ELNs outstanding for noncon-
solidated conduits at December 31, 2009 and 2008, were $96 million
and $136 million, respectively.
The Firm could fund purchases of assets from nonconsolidated, Firm-
administered multi-seller conduits should it become necessary.
Implied support
The Firm did not have and continues not to have any intent to
protect any ELN holders from potential losses on any of the con-
duits’ holdings and has no plans to remove any assets from any
conduit unless required to do so in its role as administrator. Should
such a transfer occur, the Firm would allocate losses on such assets
between itself and the ELN holders in accordance with the terms of
the applicable ELN.
Expected loss modeling
In determining the primary beneficiary of the conduits the Firm
uses a Monte Carlo–based model to estimate the expected
losses of each of the conduits and considers the relative rights
and obligations of each of the variable interest holders. The
Firm’s expected loss modeling treats all variable interests, other
than the ELNs, as its own to determine consolidation. The
variability to be considered in the modeling of expected losses is
based on the design of the entity. The Firm’s traditional multi-
seller conduits are designed to pass credit risk, not liquidity risk,
to its variable interest holders, as the assets are intended to be
held in the conduit for the longer term.
The Firm is required to run the Monte Carlo–based expected loss
model each time a reconsideration event occurs. In applying this
guidance to the conduits, the following events are considered to
be reconsideration events, as they could affect the determination
of the primary beneficiary of the conduits:
• New deals, including the issuance of new or additional variable
interests (credit support, liquidity facilities, etc.);
• Changes in usage, including the change in the level of outstanding
variable interests (credit support, liquidity facilities, etc.);
• Modifications of asset purchase agreements; and
• Sales of interests held by the primary beneficiary.
From an operational perspective, the Firm does not run its Monte
Carlo–based expected loss model every time there is a reconsidera-
tion event due to the frequency of their occurrence. Instead, the Firm
runs its expected loss model each quarter and includes a growth
assumption for each conduit to ensure that a sufficient amount of
ELNs exists for each conduit at any point during the quarter.
As part of its normal quarterly modeling, the Firm updates, when
applicable, the inputs and assumptions used in the expected loss
model. Specifically, risk ratings and loss given default assumptions
are continually updated. Management has concluded that the
model assumptions used were reflective of market participants’
assumptions and appropriately considered the probability of
changes to risk ratings and loss given defaults.
Qualitative considerations
The multi-seller conduits are primarily designed to provide an
efficient means for clients to access the commercial paper market.
The Firm believes the conduits effectively disperse risk among all
parties and that the preponderance of the economic risk in the
Firm’s multi-seller conduits is not held by JPMorgan Chase.
Investor intermediation
As a financial intermediary, the Firm creates certain types of VIEs and
also structures transactions, typically derivative structures, with these
VIEs to meet investor needs. The Firm may also provide liquidity and
other support. The risks inherent in the derivative instruments or
liquidity commitments are managed similarly to other credit, market
or liquidity risks to which the Firm is exposed. The principal types of
VIEs for which the Firm is engaged in these structuring activities are
municipal bond vehicles, credit-linked note vehicles, asset swap
vehicles and collateralized debt obligation vehicles.
Municipal bond vehicles
The Firm has created a series of secondary market trusts that pro-
vide short-term investors with qualifying tax-exempt investments,
and that allow investors in tax-exempt securities to finance their
investments at short-term tax-exempt rates. In a typical transaction,
the vehicle purchases fixed-rate longer-term highly rated municipal
bonds and funds the purchase by issuing two types of securities: (1)
putable floating-rate certificates and (2) inverse floating-rate resid-
ual interests (“residual interests”). The maturity of each of the
putable floating-rate certificates and the residual interests is equal
to the life of the vehicle, while the maturity of the underlying mu-
nicipal bonds is longer. Holders of the putable floating-rate certifi-
cates may “put,” or tender, the certificates if the remarketing agent
cannot successfully remarket the floating-rate certificates to an-
other investor. A liquidity facility conditionally obligates the liquidity
provider to fund the purchase of the tendered floating-rate certifi-
cates. Upon termination of the vehicle, if the proceeds from the sale
of the underlying municipal bonds are not sufficient to repay the
liquidity facility, the liquidity provider has recourse either to excess
collateralization in the vehicle or the residual interest holders for
reimbursement.
The third-party holders of the residual interests in these vehicles
could experience losses if the face amount of the putable floating-
rate certificates exceeds the market value of the municipal bonds
upon termination of the vehicle. Certain vehicles require a smaller
initial investment by the residual interest holders and thus do not
result in excess collateralization. For these vehicles there exists a
reimbursement obligation which requires the residual interest
holders to post, during the life of the vehicle, additional collateral
to the vehicle on a daily basis as the market value of the municipal
bonds declines.