JP Morgan Chase 2005 Annual Report Download - page 114

Notes to consolidated financial statements
JPMorgan Chase & Co.
112 JPMorgan Chase & Co. /2005 Annual Report
Program-wide liquidity in the form of revolving and short-term lending com-
mitments also is provided by the Firm to these vehicles in the event of short-
term disruptions in the commercial paper market.
Deal-specific credit enhancement that supports the commercial paper issued
by the conduits is generally structured to cover a multiple of historical losses
expected on the pool of assets and is provided primarily by customers (i.e.,
sellers) or other third parties. The deal-specific credit enhancement is typically
in the form of over-collateralization provided by the seller but also may
include any combination of the following: recourse to the seller or originator,
cash collateral accounts, letters of credit, excess spread, retention of subordi-
nated interests or third-party guarantees. In certain instances, the Firm
provides limited credit enhancement in the form of standby letters of credit.
JPMorgan Chase serves as the administrator and provides contingent liquidity
support and limited credit enhancement for several multi-seller conduits. The
commercial paper issued by the conduits is backed by collateral, credit enhance-
ments and commitments to provide liquidity sufficient to support receiving at
least a liquidity rating of A-1, P-1 and, in certain cases, F1.
As a means of ensuring timely repayment of the commercial paper, each asset
pool financed by the conduits has a minimum 100% deal-specific liquidity
facility associated with it. In the unlikely event an asset pool is removed from
the conduit, the administrator can draw on the liquidity facility to repay the
maturing commercial paper. The liquidity facilities are typically in the form of
asset purchase agreements and are generally structured such that the bank
liquidity is provided by purchasing, or lending against, a pool of non-defaulted,
performing assets. Deal-specific liquidity is the primary source of liquidity
support for the conduits.
The following table summarizes the Firm’s involvement with Firm-administered multi-seller conduits:
Consolidated Nonconsolidated Total
December 31, (in billions) 2005 2004 2005 2004(b) 2005 2004(b)
Total commercial paper issued by conduits $ 35.2 $ 35.8 $8.9 $ 9.3 $ 44.1 $ 45.1
Commitments
Asset-purchase agreements $ 47.9 $ 47.2 $ 14.3 $ 16.3 $ 62.2 $ 63.5
Program-wide liquidity commitments 5.0 4.0 1.0 2.0 6.0 6.0
Program-wide limited credit enhancements 1.3 1.4 1.0 1.2 2.3 2.6
Maximum exposure to loss(a) 48.4 48.2 14.8 16.9 63.2 65.1
(a) The Firm’s maximum exposure to loss is limited to the amount of drawn commitments (i.e., sellers’ assets held by the multi-seller conduits for which the Firm provides liquidity support) of $41.6
billion and $42.2 billion at December 31, 2005 and 2004, respectively, plus contractual but undrawn commitments of $21.6 billion and $22.9 billion at December 31, 2005 and 2004, respectively.
Since the Firm provides credit enhancement and liquidity to these multi-seller conduits, the maximum exposure is not adjusted to exclude exposure absorbed by third-party liquidity providers.
(b) In December 2003 and February 2004, two multi-seller conduits were restructured, with each conduit issuing preferred securities acquired by an independent third-party investor; the investor
absorbs the majority of the expected losses of the conduit. In determining the primary beneficiary of the restructured conduits, the Firm leveraged an existing rating agency model – an independent
market standard – to estimate the size of the expected losses, and the Firm considered the relative rights and obligations of each of the variable interest holders.
The Firm views its credit exposure to multi-seller conduit transactions as
limited. This is because, for the most part, the Firm is not required to fund
under the liquidity facilities if the assets in the VIE are in default. Additionally,
the Firm’s obligations under the letters of credit are secondary to the risk of
first loss provided by the customer or other third parties – for example, by
the overcollateralization of the VIE with the assets sold to it or notes
subordinated to the Firm’s liquidity facilities.
Client intermediation
As a financial intermediary, the Firm is involved in structuring VIE transactions
to meet investor and client needs. The Firm intermediates various types of
risks (including fixed income, equity and credit), typically using derivative
instruments as further discussed below. In certain circumstances, the Firm
also provides liquidity and other support to the VIEs to facilitate the transaction.
The Firm’s current exposure to nonconsolidated VIEs is reflected in its
Consolidated balance sheets or in the Notes to consolidated financial state-
ments. The risks inherent in derivative instruments or liquidity commitments
are managed similarly to other credit, market and liquidity risks to which the
Firm is exposed. The Firm intermediates principally with the following types of
VIEs: credit-linked note vehicles and municipal bond vehicles.