JP Morgan Chase 2006 Annual Report Download - page 121

JPMorgan Chase & Co. / 2006 Annual Report 119
The Firm also provides vehicles with program-wide liquidity, in the form of
revolving and short-term lending commitments, in the event of short-term dis-
ruptions 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 overcollateralization 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 subordinated
interests or third-party guarantees. In certain instances, the Firm
provides limited credit enhancement in the form of standby letters of credit.
In June 2006, the Firm restructured four multi-seller conduits that it adminis-
ters: each conduit issued a capital note that was acquired by an independent
third-party investor who absorbs the majority of the expected losses of the
respective conduit whose note it had purchased. In determining the primary
beneficiary of the conduits, the Firm used a Monte Carlo–based model to size
the expected losses and considered the relative rights and obligations of each
of the variable interest holders. As a result of the restructuring, the Firm
deconsolidated approximately $33 billion of assets and liabilities as of June
30, 2006. The following table summarizes the Firm’s involvement with Firm-
administered multi-seller conduits:
Multi-seller conduits
The Firm is an active participant in the asset-backed securities business, helping
meet customers’ financing needs by providing access to the commercial paper
markets through VIEs known as multi-seller conduits. These companies are sep-
arate bankruptcy-remote companies in the business of purchasing interests in,
and making loans secured by, receivable pools and other financial assets pur-
suant to agreements with customers. The companies fund their purchases and
loans through the issuance of highly rated commercial paper. The primary
source of repayment of the commercial paper is the cash flow from the pools
of assets.
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 enable the conduit
to receive a liquidity rating of at least 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. The liquidity facilities are typically in the form of
asset purchase agreements and are generally structured such that the liquidity
is provided by the Firm purchasing, or lending against, a pool of nondefaulted,
performing assets. Deal-specific liquidity facilities are the primary source of
liquidity support for the conduits.
Consolidated Nonconsolidated Total
December 31, (in billions) 2006 2005 2006 2005 2006 2005
Total commercial paper issued by conduits $ 3.4 $ 35.2 $ 44.1 $ 8.9 $ 47.5 $ 44.1
Commitments
Asset-purchase agreements $ 0.5 $ 47.9 $ 66.0 $ 14.3 $ 66.5 $ 62.2
Program-wide liquidity commitments 1.0 5.0 4.0 1.0 5.0 6.0
Program-wide limited credit enhancements —1.3 1.6 1.0 1.6 2.3
Maximum exposure to loss(a) 1.0 48.4 67.0 14.8 68.0 63.2
(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 $43.9
billion and $41.6 billion at December 31, 2006 and 2005, respectively, plus contractual but undrawn commitments of $24.1 billion and $21.6 billion at December 31, 2006 and 2005, respectively.
Certain of the Firm’s administered multi-seller conduits were deconsolidated as of June 30, 2006; the assets deconsolidated were approximately $33 billion. Since the Firm provides credit enhance-
ment and liquidity to Firm administered multi-seller conduits, the maximum exposure is not adjusted to exclude exposure that would be absorbed by third-party liquidity providers.
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 subordinat-
ed 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.