JP Morgan Chase 2005 Annual Report Download - page 115

JPMorgan Chase & Co. /2005 Annual Report 113
The Firm structures credit-linked notes in which the VIE purchases highly-rated
assets (such as asset-backed securities) and enters into a credit derivative
contract with the Firm to obtain exposure to a referenced credit not held by
the VIE. Credit-linked notes are issued by the VIE to transfer the risk of the
referenced credit to the investors in the VIE. Clients and investors often prefer
a VIE structure, since the credit-linked notes generally carry a higher credit
rating than they would if issued directly by JPMorgan Chase.
The Firm is involved with municipal bond vehicles for the purpose of creating
a series of secondary market trusts that allow tax-exempt investors to finance
their investments at short-term tax-exempt rates. The VIE purchases fixed-rate,
longer-term highly-rated municipal bonds by issuing puttable floating-rate
certificates and inverse floating-rate certificates; the investors in the inverse
floating-rate certificates are exposed to the residual losses of the VIE (the
“residual interests”). For vehicles in which the Firm owns the residual interests,
the Firm consolidates the VIE. In vehicles where third-party investors own the
residual interests, the Firm’s exposure is limited because of the high credit
quality of the underlying municipal bonds, the unwind triggers based upon
the market value of the underlying collateral and the residual interests held
by third parties. The Firm often serves as remarketing agent for the VIE and
provides liquidity to support the remarketing.
Assets held by credit-linked and municipal bond vehicles at December 31,
2005 and 2004, were as follows:
December 31, (in billions) 2005 2004
Credit-linked note vehicles(a) $ 13.5 $ 17.8
Municipal bond vehicles(b) 13.7 7.5
(a) Assets of $1.8 billion and $2.3 billion reported in the table above were recorded on the
Firm’s Consolidated balance sheets at December 31, 2005 and 2004, respectively, due to
contractual relationships held by the Firm that relate to collateral held by the VIE.
(b) Total amounts consolidated due to the Firm owning residual interests were $4.9 billion and
$2.6 billion at December 31, 2005 and 2004, respectively, and are reported in the table.
Total liquidity commitments were $5.8 billion and $3.1 billion at December 31, 2005 and
2004, respectively. The Firm’s maximum credit exposure to all municipal bond vehicles was
$10.7 billion and $5.7 billion at December 31, 2005 and 2004, respectively.
Finally, the Firm may enter into transactions with VIEs structured by other
parties. These transactions can include, for example, acting as a derivative
counterparty, liquidity provider, investor, underwriter, placement agent, trustee
or custodian. These transactions are conducted at arm’s length, and individual
credit decisions are based upon the analysis of the specific VIE, taking into
consideration the quality of the underlying assets. JPMorgan Chase records
and reports these positions similarly to any other third-party transaction.
These activities do not cause JPMorgan Chase to absorb a majority of the
expected losses of the VIEs or to receive a majority of the residual returns of
the VIE, and they are not considered significant for disclosure purposes.
Consolidated VIE assets
The following table summarizes the Firm’s total consolidated VIE assets, by
classification on the Consolidated balance sheets, as of December 31, 2005
and 2004:
December 31, (in billions) 2005 2004
Consolidated VIE assets(a)
Investment securities(b) $ 1.9 $ 10.6
Trading assets(c) 9.3 4.7
Loans 8.1 3.4
Interests in purchased receivables 29.6 31.6
Other assets 3.0 0.4
Total consolidated assets $ 51.9 $ 50.7
(a) The Firm also holds $3.9 billion and $3.4 billion of assets, at December 31, 2005 and
December 31, 2004, respectively, primarily as a seller’s interest, in certain consumer securi-
tizations in a segregated entity, as part of a two-step securitization transaction. This interest
is included in the securitization activities disclosed in Note 13 on pages 108–111 of this
Annual Report.
(b) The decline in balance is primarily attributable to the sale of the Firm’s interest in a
structured investment vehicle’s capital notes and resulting deconsolidation of this vehicle
in 2005.
(c) Includes the fair value of securities and derivatives.
Interests in purchased receivables include interests in receivables purchased
by Firm-administered conduits, which have been consolidated in accordance
with FIN 46R. Interests in purchased receivables are carried at cost and are
reviewed to determine whether an other-than-temporary impairment exists.
Based upon the current level of credit protection specified in each transaction,
primarily through overcollateralization, the Firm determined that no other-
than-temporary impairment existed at December 31, 2005.
The interest-bearing beneficial interest liabilities issued by consolidated VIEs
are classified in the line item titled, “Beneficial interests issued by consolidated
variable interest entities” on the Consolidated balance sheets. The holders
of these beneficial interests do not have recourse to the general credit of
JPMorgan Chase. See Note 17 on page 117 of this Annual Report for the
maturity profile of FIN 46 long-term beneficial interests.
FIN 46R transition
In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”) to
address various technical corrections and implementation issues that had arisen
since the issuance of FIN 46. Effective March 31, 2004, JPMorgan Chase
implemented FIN 46R for all VIEs, excluding certain investments made by its
private equity business, as previously discussed. Implementation of FIN 46R did
not have a significant effect on the Firm’s Consolidated financial statements.