JP Morgan Chase 2003 Annual Report Download - page 62

M anagement’s discussion and analysis
J.P. M organ Chase & Co.
60 J.P. Morgan Chase & Co. / 2003 Annual Report
Use of credit derivatives
The follow ing table presents the notional amounts of credit deriva-
tives protection bought and sold at December 31, 2003 and 2002:
Credit derivative positions
Portfolio management Dealer/Client
Notional amount Notional amount
December 31, Protection Protection Protection Protection
(in millions) bought(a) sold bought sold Total
2003 $ 37,349 $ 67 $264,389 $275,888 $577,693
2002 34,262 495 158,794 172,494 366,045
(a) Includes $2.2 billion and $10.1 billion at 2003 and 2002, respectively, of portfolio credit
derivatives.
JPM organ Chase has limited counterparty exposure as a result
of credit derivatives transactions. Of the $84 billion of total
derivative receivables at December 31, 2003, approximately
$3 billion, or 4% , was associated w ith credit derivatives, before
the benefit of collateral. The use of credit derivatives to manage
exposures does not reduce the reported level of assets on the bal-
ance sheet or the level of reported off–balance sheet commitments.
Port f olio management activit y
In managing its commercial credit exposure, the Firm purchases
single-name and portfolio credit derivatives to hedge its exposures.
As of December 31, 2003, the notional outstanding amount of
protection purchased via single-name and portfolio credit derivatives
w as $35 billion and $2 billion, respectively. The Firm also diversifies
its exposures by providing (i.e., selling) small amounts of credit
protection, w hich increases exposure to industries or clients w here
the Firm has little or no client-related exposure. This activity is not
material to the Firm’s overall credit exposure; credit protection sold
totaled $67 million in notional exposure at December 31, 2003.
Use of single-name and portfolio credit derivatives
Notional amount of protection bought
December 31, (in millions) 2003 2002
Credit derivative hedges of:
Loans and lending-related commitments $22,471 $ 25,222
Derivative receivables 14,878 9,040
Total $37,349 $ 34,262
The credit derivatives used by JPM organ Chase for its portfolio
management activities do not qualify for hedge accounting under
SFAS 133. These derivatives are marked to market in Trading
revenue. The M TM value incorporates both the cost of hedge
premiums and changes in value due to movement in spreads and
credit events, w hereas the loans and lending-related commitments
being hedged are accounted for on an accrual basis in Net interest
income and assessed for impairment in the Provision for credit
The table below summarizes the ratings profile, as of December 31,
2003, of the Firm’s balance sheet derivative receivables M TM ,net
of cash and other highly liquid collateral:
Ratings profile of derivative receivables MTM
Rating equivalent Exposure net % of exposure
(in millions) of collateral (a) net of collateral
AAA to AA- $24,697 52%
A+ to A- 7,677 16
BBB+ to BBB- 7,564 16
BB+ to B- 6,777 14
CCC+ and below 822 2
Total $47,537 100%
(a) Total derivative receivables exposure and collateral held by the Firm against this exposure were
$84 billion and $36 billion, respectively. The $36 billion excludes $8 billion of collateral
delivered by clients at the initiation of transactions; this collateral secures exposure that could
arise in the existing portfolio of derivatives should the MTM of the clients’ transactions move
in the Firm’s favor. The $36 billion also excludes credit enhancements in the form of letters of
credit and surety receivables.
The Firm actively pursues the use of collateral agreements to
mitigate counterparty credit risk in derivatives. The percentage of
the Firm’s derivatives transactions subject to collateral agreements
increased to 78% on December 31, 2003, from 67% on
December 31, 2002. The increase of collateralized transactions
w as driven largely by new collateral agreements. The Firm held
$36 billion of collateral as of December 31, 2003, compared w ith
$30 billion as of December 31, 2002. The Firm posted $27 billion
of collateral at year-end 2003, compared w ith $19 billion at the
end of 2002.
Certain derivative and collateral agreements include provisions
that require both the Firm and the counterparty, upon specified
dow ngrades in their respective credit ratings, to post collateral
for the benefit of the other party. The impact on required collat-
eral of a single-notch ratings downgrade to JPM organ Chase
Bank, from its current rating of AA- to A+, w ould have been
an additional $1.3 billion of collateral as of December 31, 2003.
The impact of a six-notch ratings dow ngrade to JPM organ Chase
Bank (from AA- to BBB-) w ould have been $3.7 billion of addi-
tional collateral from levels as of December 31, 2003. The amount
of additional collateral required upon dow ngrade moves in tan-
dem w ith the mark-to-market value of the derivatives portfolio
and ranged (with respect to a six-notch dow ngrade) from
$3.4 billion to $4.2 billion throughout 2003, as the level of U.S.
interest rates changed. Certain derivatives contracts also provide
for termination of the contract, generally upon JPM organ Chase
Bank being dow ngraded, at the then-existing M TM value of the
derivative receivables.