JP Morgan Chase 2008 Annual Report Download - page 102

Management’s discussion and analysis
100 JPMorgan Chase & Co./ 2008 Annual Report
volatility and the credit rating of the counterparty) with the unex-
pected loss in a loan exposure (which takes into consideration only
the credit rating of the counterparty). DRE is a less extreme measure
of potential credit loss than Peak and is the primary measure used by
the Firm for credit approval of derivative transactions.
Finally, AVG is a measure of the expected MTM value of the Firm’s
derivative receivables at future time periods, including the benefit of
collateral. AVG exposure over the total life of the derivative contract
is used as the primary metric for pricing purposes and is used to cal-
culate credit capital and the Credit Valuation Adjustment (“CVA”), as
further described below. Average exposure was $83.7 billion and
$47.1 billion at December 31, 2008 and 2007, respectively, com-
pared with derivative receivables MTM, net of all collateral, of
$142.8 billion and $67.3 billion at December 31, 2008 and 2007,
respectively.
The MTM value of the Firm’s derivative receivables incorporates an
adjustment, the CVA, to reflect the credit quality of counterparties.
The CVA is based upon the Firm’s AVG to a counterparty and the
counterparty’s credit spread in the credit derivatives market. The pri-
mary components of changes in CVA are credit spreads, new deal
activity or unwinds, and changes in the underlying market environ-
ment. The Firm believes that active risk management is essential to
controlling the dynamic credit risk in the derivatives portfolio. In
addition, the Firm takes into consideration the potential for correla-
tion between the Firm’s AVG to a counterparty and the counterparty’s
credit quality within the credit approval process. The Firm risk man-
ages exposure to changes in CVA by entering into credit derivative
transactions, as well as interest rate, foreign exchange, equity and
commodity derivative transactions.
The graph below shows exposure profiles to derivatives over the next
ten years as calculated by the DRE and AVG metrics. The two meas-
ures generally show declining exposure after the first year, if no new
trades were added to the portfolio.
0
30
60
90
1
20
1
50
Exposure profile of derivatives measures
December 31, 2008
(in billions) DRE AVG
1 year 2 years 5 years 10 years
The following table summarizes the ratings profile of the Firm’s derivative receivables MTM, net of other liquid securities collateral, for the dates
indicated.
Ratings profile of derivative receivables MTM
Rating equivalent 2008 2007
December 31, Exposure net of % of exposure net Exposure net of % of exposure net
(in millions, except ratios) all collateral of all collateral all collateral of all collateral
AAA/Aaa to AA-/Aa3 $ 68,708 48% $ 38,314 57%
A+/A1 to A-/A3 24,748 17 9,855 15
BBB+/Baa1 to BBB-/Baa3 15,747 11 9,335 14
BB+/Ba1 to B-/B3 28,186 20 9,451 14
CCC+/Caa1 and below 5,421 4 357 —
Total $ 142,810 100% $ 67,312 100%