JP Morgan Chase 2010 Annual Report Download - page 127

JPMorgan Chase & Co./2010 Annual Report 127
Of the Firm’s $80.5 billion of total derivative receivables MTM at
December 31, 2010, $7.7 billion, or 10%, was associated with
credit derivatives, before the benefit of liquid securities collateral.
One type of credit derivatives the Firm enters into with counterparties
are credit default swaps (“CDS”). The large majority of CDS are
subject to collateral arrangements to protect the Firm from counter-
party credit risk. The use of collateral to settle against defaulting
counterparties generally performed as designed in significantly miti-
gating the Firm’s exposure to these counterparties. In 2010, the
frequency and size of defaults related to the underlying debt refer-
enced in credit derivatives was lower than 2009. For further discus-
sion of derivatives, see Note 6 on pages 191–199 of this Annual
Report.
The following table presents the Firm’s notional amounts of credit
derivatives protection purchased and sold as of December 31, 2010
and 2009, distinguishing between dealer/client activity and credit
portfolio activity.
2010
2009
Dealer/client
Credit portfolio
Dealer/client
Credit portfolio
December 31,
Prot
ection
Protection
Protection
Protection
Protection
Protection
Protection
Protection
(in millions) purchased
(b)
sold purchased
(c)
sold Total purchased
(b)
sold purchased
(c)
sold Total
Credit default
swaps $ 2,661,657 $ 2,658,825 $ 23,523 $ 415 $ 5,344,420 $ 2,957,277 $ 2,936,987 $ 48,831 $ 455 $ 5,943,550
Other credit
derivatives(a) 34,250 93,776 — — 128,026 39,763 10,575 — — 50,338
Total
$
2,695,907
$
2,752,601
$
23,523
$
415
$
5,472,446
$ 2,997,040 $ 2,947,562 $ 48,831 $ 455 $ 5,993,888
(a) Primarily consists of total return swaps and credit default swap options.
(b) Included $2,662 billion and $2,987 billion at December 31, 2010 and 2009, respectively, of notional exposure where the Firm has sold protection on the identical
underlying reference instruments.
(c) Included zero and $19.7 billion at December 31, 2010 and 2009, respectively, that represented the notional amount for structured portfolio protection; the Firm retains
the first risk of loss on this portfolio.
Dealer/client business
Within the dealer/client business, the Firm actively manages credit
derivatives by buying and selling credit protection, predominantly on
corporate debt obligations, according to client demand. For further
information, see Note 6 on pages 191–199 of this Annual Report.
At December 31, 2010, the total notional amount of protection
purchased and sold decreased by $496.1 billion from year-end
2009. The decrease was primarily due to the impact of industry
efforts to reduce offsetting trade activity.
Credit portfolio activities
Management of the Firm’s wholesale exposure is accomplished
through a number of means including loan syndication and partici-
pations, loan sales, securitizations, credit derivatives, use of master
netting agreements, and collateral and other risk-reduction tech-
niques. The Firm also manages its wholesale credit exposure by
purchasing protection through single-name and portfolio credit
derivatives to manage the credit risk associated with loans, lend-
ing-related commitments and derivative receivables. Changes in
credit risk on the credit derivatives are expected to offset changes
in credit risk on the loans, lending-related commitments or deriva-
tive receivables. This activity does not reduce the reported level of
assets on the balance sheet or the level of reported off–balance
sheet commitments, although it does provide the Firm with credit
risk protection. The Firm also diversifies its exposures by selling
credit protection, which increases exposure to industries or clients
where the Firm has little or no client-related exposure; however,
this activity is not material to the Firm’s overall credit exposure.
Use of single-name and portfolio credit derivatives
Notional amount
of protection
purchased and sold
December 31, (in millions)
2010
2009
Credit derivatives used to manage
Loans and lending-related commitments
$
6,698
$ 36,873
Derivative receivables
16,825
11,958
Total protection purchased
(a)
23,523 48,831
Total protection sold
415
455
Credit derivatives hedges notional
, net
$
23,108
$ 48,376
(a) Included zero and $19.7 billion at December 31, 2010 and 2009, respec-
tively, that represented the notional amount for structured portfolio protec-
tion; the Firm retains the first risk of loss on this portfolio.
The credit derivatives used by JPMorgan Chase for credit portfolio
management activities do not qualify for hedge accounting under
U.S. GAAP; these derivatives are reported at fair value, with gains
and losses recognized in principal transactions revenue. In contrast,
the loans and lending-related commitments being risk-managed are
accounted for on an accrual basis. This asymmetry in accounting
treatment, between loans and lending-related commitments and
the credit derivatives used in credit portfolio management activities,
causes earnings volatility that is not representative, in the Firm’s
view, of the true changes in value of the Firm’s overall credit expo-
sure. The MTM value related to the Firm’s credit derivatives used
for managing credit exposure, as well as the MTM value related to
the CVA (which reflects the credit quality of derivatives counter-
party exposure) are included in the gains and losses realized on
credit derivatives disclosed in the table below. These results can
vary from period to period due to market conditions that affect
specific positions in the portfolio.