JP Morgan Chase 2009 Annual Report Download - page 243

JPMorgan Chase & Co./2009 Annual Report 241
third parties. As part of this program, the Firm provides an indemni-
fication in the lending agreements which protects the lender
against the failure of the third-party borrower to return the lent
securities in the event the Firm did not obtain sufficient collateral.
To minimize its liability under these indemnification agreements,
the Firm obtains cash or other highly liquid collateral with a market
value exceeding 100% of the value of the securities on loan from
the borrower. Collateral is marked to market daily to help assure
that collateralization is adequate. Additional collateral is called
from the borrower if a shortfall exists, or collateral may be released
to the borrower in the event of overcollateralization. If a borrower
defaults, the Firm would use the collateral held to purchase re-
placement securities in the market or to credit the lending customer
with the cash equivalent thereof. Also, as part of this program, the
Firm invests cash collateral received from the borrower in accor-
dance with approved guidelines.
Indemnification agreements – general
In connection with issuing securities to investors, the Firm may enter
into contractual arrangements with third parties that require the Firm
to make a payment to them in the event of a change in tax law or an
adverse interpretation of tax law. In certain cases, the contract also
may include a termination clause, which would allow the Firm to
settle the contract at its fair value in lieu of making a payment under
the indemnification clause. The Firm may also enter into indemnifica-
tion clauses in connection with the licensing of software to clients
(“software licensees”) or when it sells a business or assets to a third
party (“third-party purchasers”), pursuant to which it indemnifies
software licensees for claims of liability or damages that may occur
subsequent to the licensing of the software, or third-party purchasers
for losses they may incur due to actions taken by the Firm prior to the
sale of the business or assets. It is difficult to estimate the Firm’s
maximum exposure under these indemnification arrangements, since
this would require an assessment of future changes in tax law and
future claims that may be made against the Firm that have not yet
occurred. However, based on historical experience, management
expects the risk of loss to be remote.
Loan sale and securitization-related indemnifications
Indemnifications for breaches of representations and warranties
As part of the Firm’s loan sale and securitization activities, as
described in Note 13 and Note 15 on pages 200–204 and 206–
213, respectively, of this Annual Report, the Firm generally makes
representations and warranties in its loan sale and securitization
agreements that the loans sold meet certain requirements. These
agreements may require the Firm (including in its roles as a servicer)
to repurchase the loans and/or indemnify the purchaser of the loans
against losses due to any breaches of such representations or
warranties. Generally, the maximum amount of future payments
the Firm would be required to make for breaches under these
representations and warranties would be equal to the unpaid
principal balance of such loans held by purchasers, including securi-
tization-related SPEs, that are deemed to have defects plus, in
certain circumstances, accrued and unpaid interest on such loans
and certain expense.
At December 31, 2009 and 2008, the Firm had recorded repur-
chase liabilities of $1.7 billion and $1.1 billion, respectively. The
repurchase liabilities are intended to reflect the likelihood that
JPMorgan Chase will have to perform under these representations
and warranties and is based on information available at the report-
ing date. The estimate incorporates both presented demands and
probable future demands and is the product of an estimated cure
rate, an estimated loss severity and an estimated recovery rate from
third parties, where applicable. The liabilities have been reported
net of probable recoveries from third-parties and predominately as
a reduction of mortgage fees and related income. During 2009,
the Firm settled certain current and future claims for certain loans
originated and sold by Washington Mutual Bank.
Loans sold with recourse
The Firm provides servicing for mortgages and certain commercial
lending products on both a recourse and nonrecourse basis. In nonre-
course servicing, the principal credit risk to the Firm is the cost of
temporary servicing advances of funds (i.e., normal servicing ad-
vances). In recourse servicing, the servicer agrees to share credit risk
with the owner of the mortgage loans, such as Fannie Mae or Freddie
Mac or a private investor, insurer or guarantor. Losses on recourse
servicing predominantly occur when foreclosure sales proceeds of the
property underlying a defaulted loan are less than the sum of the
outstanding principal balance, plus accrued interest on the loan and
the cost of holding and disposing of the underlying property. The
Firm’s securitizations are predominantly nonrecourse, thereby effec-
tively transferring the risk of future credit losses to the purchaser of
the mortgage-backed securities issued by the trust. At December 31,
2009 and 2008, the unpaid principal balance of loans sold with
recourse totaled $13.5 billion and $15.0 billion, respectively. The
carrying value of the related liability that the Firm has recorded, which
is representative of the Firm’s view of the likelihood it will have to
perform under this guarantee, was $271 million and $241 million at
December 31, 2009 and 2008, respectively.
Credit card charge-backs
Prior to November 1, 2008, the Firm was a partner with one of the
leading companies in electronic payment services in a joint venture
operating under the name of Chase Paymentech Solutions, LLC (the
“joint venture”). The joint venture was formed in October 2005, as a
result of an agreement by the Firm and First Data Corporation, its
joint venture partner, to integrate the companies’ jointly owned
Chase Merchant Services and Paymentech merchant businesses. The
joint venture provided merchant processing services in the United
States and Canada. The dissolution of the joint venture was com-
pleted on November 1, 2008, and JPMorgan Chase retained ap-
proximately 51% of the business under the Chase Paymentech name.
Under the rules of Visa USA, Inc., and MasterCard International,
JPMorgan Chase Bank, N.A., is liable primarily for the amount of
each processed credit card sales transaction that is the subject of a
dispute between a cardmember and a merchant. If a dispute is
resolved in the cardmember’s favor, Chase Paymentech will
(through the cardmember’s issuing bank) credit or refund the
amount to the cardmember and will charge back the transaction to
the merchant. If Chase Paymentech is unable to collect the amount
from the merchant, Chase Paymentech will bear the loss for the
amount credited or refunded to the cardmember. Chase Paymen-
tech mitigates this risk by withholding future settlements, retaining
cash reserve accounts or by obtaining other security. However, in
the unlikely event that: (1) a merchant ceases operations and is
unable to deliver products, services or a refund; (2) Chase Paymen-
tech does not have sufficient collateral from the merchant to pro-