JP Morgan Chase 2005 Annual Report Download - page 126

Notes to consolidated financial statements
JPMorgan Chase & Co.
124 JPMorgan Chase & Co. /2005 Annual Report
Note 27 – Off-balance sheet lending-related
financial instruments and guarantees
JPMorgan Chase utilizes lending-related financial instruments (e.g., commitments
and guarantees) to meet the financing needs of its customers. The contractual
amount of these financial instruments represents the maximum possible credit
risk should the counterparty draw down the commitment or the Firm fulfills
its obligation under the guarantee, and the counterparty subsequently fails to
perform according to the terms of the contract. Most of these commitments
and guarantees expire without a default occurring or without being drawn.
As a result, the total contractual amount of these instruments is not, in the
Firm’s view, representative of its actual future credit exposure or funding
requirements. Further, certain commitments, primarily related to consumer
financings, are cancelable, upon notice, at the option of the Firm.
To provide for the risk of loss inherent in wholesale-related contracts, an
allowance for credit losses on lending-related commitments is maintained.
See Note 12 on pages 107–108 of this Annual Report for a further discussion
on the allowance for credit losses on lending-related commitments.
The following table summarizes the contractual amounts of off–balance
sheet lending-related financial instruments and guarantees and the related
allowance for credit losses on lending-related commitments at December 31,
2005 and 2004:
Off–balance sheet lending-related financial instruments
and guarantees
Allowance for
Contractual lending-related
amount commitments
December 31, (in millions) 2005 2004 2005 2004
Lending-related
Consumer $ 655,596 $ 601,196 $15 $12
Wholesale:
Other unfunded commitments
to extend credit(a)(b)(c) 208,469 185,822 208 183
Asset purchase agreements(d) 31,095 39,330 32
Standby letters of credit
and guarantees(a)(e) 77,199 78,084 173 292
Other letters of credit(a) 7,001 6,163 13
Total wholesale 323,764 309,399 385 480
Total lending-related $ 979,360 $ 910,595 $ 400 $ 492
Other guarantees
Securities lending guarantees(f) $ 244,316 $ 220,783 NA NA
Derivatives qualifying as
guarantees 61,759 53,312 NA NA
(a) Represents contractual amount net of risk participations totaling $29.3 billion and
$26.4 billion at December 31, 2005 and 2004, respectively.
(b) Includes unused advised lines of credit totaling $28.3 billion and $22.8 billion at
December 31, 2005 and 2004, respectively, which are not legally binding. In regulatory
filings with the FRB, unused advised lines are not reportable.
(c) Excludes unfunded commitments to private third-party equity funds of $242 million and
$563 million at December 31, 2005 and 2004, respectively.
(d) Represents asset purchase agreements to the Firm’s administered multi-seller asset-backed
commercial paper conduits, which excludes $32.4 billion and $31.7 billion at December 31,
2005 and 2004, respectively, related to conduits that were consolidated in accordance with
FIN 46R, as the underlying assets of the conduits are reported in the Firm’s Consolidated
balance sheets. It also includes $1.3 billion of asset purchase agreements to other third-
party entities at December 31, 2005 and $7.5 billion of asset purchase agreements to
structured wholesale loan vehicles and other third-party entities at December 31, 2004.
(e) Includes unused commitments to issue standby letters of credit of $37.5 billion and
$38.4 billion at December 31, 2005 and 2004, respectively.
(f) Collateral held by the Firm in support of securities lending indemnification agreements was
$245.0 billion and $221.6 billion at December 31, 2005 and 2004, respectively.
FIN 45 establishes accounting and disclosure requirements for guarantees,
requiring that a guarantor recognize, at the inception of a guarantee, a liability
in an amount equal to the fair value of the obligation undertaken in issuing
the guarantee. FIN 45 defines a guarantee as a contract that contingently
requires the Firm to pay a guaranteed party, based upon: (a) changes in an
underlying asset, liability or equity security of the guaranteed party; or (b) a
third party’s failure to perform under a specified agreement. The Firm considers
the following off–balance sheet lending arrangements to be guarantees under
FIN 45: certain asset purchase agreements, standby letters of credit and finan-
cial guarantees, securities lending indemnifications, certain indemnification
agreements included within third-party contractual arrangements and certain
derivative contracts. These guarantees are described in further detail below.
The fair value at inception of the obligation undertaken when issuing the
guarantees and commitments that qualify under FIN 45 is typically equal to
the net present value of the future amount of premium receivable under the
contract. The Firm has recorded this amount in Other Liabilities with an offset-
ting entry recorded in Other Assets. As cash is received under the contract,
it is applied to the premium receivable recorded in Other Assets, and the
fair value of the liability recorded at inception is amortized into income as
Lending & deposit related fees over the life of the guarantee contract. The
amount of the liability related to FIN 45 guarantees recorded at December 31,
2005 and 2004, excluding the allowance for credit losses on lending-related
commitments and derivative contracts discussed below, was approximately
$313 million and $341 million, respectively.
Unfunded commitments to extend credit are agreements to lend only when
a customer has complied with predetermined conditions, and they generally
expire on fixed dates.
The majority of the Firm’s unfunded commitments are not guarantees as
defined in FIN 45, except for certain asset purchase agreements that are prin-
cipally used as a mechanism to provide liquidity to SPEs, primarily multi-seller
conduits, as described in Note 14 on pages 111–113 of this Annual Report.
Some of these asset purchase agreements can be exercised at any time by
the SPE’s administrator, while others require a triggering event to occur.
Triggering events include, but are not limited to, a need for liquidity, a market
value decline of the assets or a downgrade in the rating of JPMorgan Chase
Bank. These agreements may cause the Firm to purchase an asset from the
SPE at an amount above the asset’s fair value, in effect providing a guarantee
of the initial value of the reference asset as of the date of the agreement. In
most instances, third-party credit enhancements of the SPE mitigate the Firm’s
potential losses on these agreements.
Standby letters of credit and financial guarantees are conditional lending
commitments issued by JPMorgan Chase to guarantee the performance of
a customer to a third party under certain arrangements, such as commercial
paper facilities, bond financings, acquisition financings, trade and similar
transactions. Approximately 58% of these arrangements mature within
three years. The Firm typically has recourse to recover from the customer any
amounts paid under these guarantees; in addition, the Firm may hold cash
or other highly liquid collateral to support these guarantees. At December 31,
2005 and 2004, the Firm held collateral relating to $9.0 billion and $7.4 billion,
respectively, of these arrangements.