JP Morgan Chase 2010 Annual Report Download - page 175

JPMorgan Chase & Co./2010 Annual Report 175
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, nonpublic private equity investments are valued initially
based on cost. Each quarter, valuations are reviewed using avail-
able and relevant market data to determine if the carrying value
of these investments should be adjusted. Such market data pri-
marily 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
company, including its historical and projected net income and its
earnings 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 in-
vestments, generally obtained through the initial public offering
of privately held equity investments. Investments in securities of
publicly held companies that trade in liquid markets are marked
to market at the quoted public value less adjustments for regula-
tory or contractual sales restrictions. Discounts for restrictions are
quantified by analyzing the length of the restriction period and
the volatility of the equity security. Publicly held investments are
predominantly 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 first evaluated taking into consideration any derivative fea-
tures 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 collateral 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
pricing 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
To estimate the fair value of long-term debt, cash flows are
discounted using the appropriate market rates for the applicable
maturities, with an adjustment to reflect the credit quality of the
Firm (i.e., the DVA). Included within deposits, other borrowed
funds and long-term debt are structured notes issued by the Firm
that are financial instruments containing embedded derivatives.
In addition to the above, the estimation of the fair value of struc-
tured notes takes into consideration any derivative features.
Where the inputs into the valuation are primarily based on observ-
able market prices, the structured notes are classified within level 2
of the valuation hierarchy. Where significant inputs are unobserv-
able, the structured notes are classified within level 3 of the valua-
tion hierarchy.