JP Morgan Chase 2008 Annual Report Download - page 198

Notes to consolidated financial statements
196 JPMorgan Chase & Co./ 2008 Annual Report
Collateralized Debt Obligations vehicles
A CDO typically refers to a security that is collateralized by a pool of
bonds, loans, equity, derivatives or other assets. The Firm’s involve-
ment with a particular CDO vehicle may take one or more of the fol-
lowing forms: arranger, warehouse funding provider, placement
agent or underwriter, secondary market-maker for securities issued,
or derivative counterparty.
Prior to the formal establishment of a CDO vehicle, there is a ware-
housing period where a VIE may be used to accumulate the assets
which will be subsequently securitized and serve as the collateral for
the securities to be issued to investors. During this warehousing
period, the Firm may provide all or a portion of the financing to the
VIE, for which the Firm earns interest on the amounts it finances.
A third-party asset manager that will serve as the manager for the
CDO vehicle uses the warehouse funding provided by the Firm to
purchase the financial assets. The funding commitments generally
are one year in duration. In the event that the securitization of
assets does not occur within the committed financing period, the
warehoused assets are generally liquidated.
Because of the varied levels of support provided by the Firm during
the warehousing period, which typically averages six to nine
months, each CDO warehouse VIE is assessed in accordance with
FIN 46(R) to determine whether the Firm is considered the primary
beneficiary that should consolidate the VIE. In general, the Firm
would consolidate the warehouse VIE unless another third party,
typically the asset manager, provides significant protection for
potential declines in the value of the assets held by the VIE. In those
cases, the third party that provides the protection to the warehouse
VIE would consolidate the VIE.
Once the portfolio of warehoused assets is large enough, the VIE will
issue securities where market conditions permit. The proceeds from
the issuance of securities will be used to repay the warehouse
financing obtained from the Firm and other counterparties. In con-
nection with the establishment of the CDO vehicle, the Firm typically
earns a fee for arranging the CDO vehicle and distributing the securi-
ties (as placement agent and/or underwriter) and does not typically
own any equity tranches issued. Once the CDO vehicle closes and
issues securities, the Firm has no further obligation to provide further
support to the vehicle. At the time of closing, the Firm may hold
unsold securities that the Firm was not able to place with third-party
investors. The amount of unsold securities at December 31, 2008 and
2007, was insignificant. In addition, the Firm may on occasion hold
some of the CDO vehicles’ securities, including equity interests, as a
secondary market-maker or as a principal investor, or it may be a
derivative counterparty to the vehicles. At December 31, 2008 and
2007, these amounts were not significant.
Exposure to nonconsolidated asset swap VIEs at December 31, 2008 and 2007, was as follows.
2008 2007
Derivative Par value of Derivative Par value of
December 31, receivables Trading Total collateral held receivables Trading Total collateral held
(in billions) (payables) assets(a) exposure(b) by VIEs(c) (payables) assets(a) exposure(b) by VIEs(c)
Nonconsolidated
Asset swap vehicles(d) $ (0.2) $ — $ (0.2) $ 7.3 $ 0.2 $ — $ 0.2 $ 5.6
(a) Trading assets principally comprise notes issued by VIEs, which from time to time are held as part of the termination of a deal or to support limited market-making.
(b) On-balance sheet exposure that includes derivative receivables (payables) and trading assets.
(c) The Firm’s maximum exposure arises through the derivatives executed with the VIEs; the exposure varies over time with changes in the fair value of the derivatives. The Firm relies
upon the collateral held by the VIEs to pay any amounts due under the derivatives; the vehicles are structured at inception so that the par value of the collateral is expected to be suffi-
cient to pay amounts due under the derivative contracts.
(d) Excluded fair value of collateral of $1.0 billion and $976 million at December 31, 2008 and 2007, respectively, which was consolidated as the Firm, in its role as secondary market
maker, held a majority of the issued notes of certain vehicles.