JP Morgan Chase 2008 Annual Report Download - page 224

Notes to consolidated financial statements
222 JPMorgan Chase & Co./ 2008 Annual Report
Under the rules of Visa USA, Inc., and MasterCard International,
JPMorgan Chase Bank, N.A., is liable primarily for the amount of each
processed credit card sales transaction that is the subject of a dispute
between a cardmember and a merchant. If a dispute is resolved in the
cardmember’s favor, Chase Paymentech Solutions will (through the
cardmember’s issuing bank) credit or refund the amount to the
cardmember and will charge back the transaction to the merchant.
If Chase Paymentech Solutions is unable to collect the amount from
the merchant, Chase Paymentech Solutions will bear the loss for the
amount credited or refunded to the cardmember. Chase Paymentech
Solutions mitigates this risk by withholding future settlements, retain-
ing cash reserve accounts or by obtaining other security. However, in
the unlikely event that: (1) a merchant ceases operations and is unable
to deliver products, services or a refund; (2) Chase Paymentech
Solutions does not have sufficient collateral from the merchant to pro-
vide customer refunds; and (3) Chase Paymentech Solutions does not
have sufficient financial resources to provide customer refunds,
JPMorgan Chase Bank, N.A., would be liable for the amount of the
transaction. For the year ended December 31, 2008, Chase
Paymentech Solutions incurred aggregate credit losses of $13 million
on $713.9 billion of aggregate volume processed, and at December
31, 2008, it held $222 million of collateral. For the year ended
December 31, 2007, the joint venture incurred aggregate credit losses
of $10 million on $719.1 billion of aggregate volume processed, and
at December 31, 2007, the joint venture held $779 million of collater-
al. The Firm believes that, based upon historical experience and the
collateral held by Chase Paymentech Solutions, the amount of the
Firm’s charge back-related obligations, which is representative of the
payment or performance risk to the Firm, is immaterial.
Credit card association, exchange and clearinghouse
guarantees
The Firm holds an equity interest in VISA Inc. During October 2007,
certain VISA-related entities completed a series of restructuring
transactions to combine their operations, including VISA USA, under
one holding company, VISA Inc. Upon the restructuring, the Firm’s
membership interest in VISA USA was converted into an equity inter-
est in VISA Inc. VISA Inc. sold shares via an initial public offering and
used a portion of the proceeds from the offering to redeem a portion
of the Firm’s equity interest in Visa Inc. Prior to the restructuring,
VISA USA’s by-laws obligated the Firm upon demand by VISA USA to
indemnify VISA USA for, among other things, litigation obligations of
Visa USA. The accounting for that guarantee was not subject to fair
value accounting under FIN 45, because the guarantee was in effect
prior to the effective date of FIN 45. Upon the restructuring event,
the Firm’s obligation to indemnify Visa Inc. was limited to certain
identified litigations. Such a limitation is deemed a modification of
the indemnity by-law and, accordingly, is now subject to the provi-
sions of FIN 45. The value of the litigation guarantee has been
recorded in the Firm’s financial statements based on its fair value;
the net amount recorded (within other liabilities) did not have a
material adverse effect on the Firm’s financial statements.
In addition to Visa, the Firm is a member of other associations,
including several securities and futures exchanges and clearinghous-
es, both in the United States and other countries. Membership in
some of these organizations requires the Firm to pay a pro rata share
of the losses incurred by the organization as a result of the default of
another member. Such obligations vary with different organizations.
These obligations may be limited to members who dealt with the
defaulting member or to the amount (or a multiple of the amount) of
the Firm’s contribution to a member’s guarantee fund, or, in a few
cases, the obligation may be unlimited. It is difficult to estimate the
Firm’s maximum exposure under these membership agreements,
since this would require an assessment of future claims that may be
made against the Firm that have not yet occurred. However, based
upon historical experience, management expects the risk of loss to
be remote.
Residual value guarantee
In connection with the Bear Stearns merger, the Firm succeeded to
an operating lease arrangement for the building located at 383
Madison Avenue in New York City (the “Synthetic Lease”). Under the
terms of the Synthetic Lease, the Firm is obligated to make periodic
payments based on the lessor’s underlying interest costs. The
Synthetic Lease expires on November 1, 2010. Under the terms of
the Synthetic Lease, the Firm has the right to purchase the building
for the amount of the then outstanding indebtedness of the lessor, or
to arrange for the sale of the building, with the proceeds of the sale
to be used to satisfy the lessor’s debt obligation. If the sale does not
generate sufficient proceeds to satisfy the lessor’s debt obligation,
the Firm is required to fund the shortfall up to a maximum residual
value guarantee. As of December 31, 2008, there was no expected
shortfall, and the maximum residual value guarantee was approxi-
mately $670 million. Under a separate ground lease, the land on
which the building is built was leased to an affiliate of Bear Stearns
which, as part of the Synthetic Lease, assigned this position to the
Synthetic Lease lessor. The owner of the land sued the Firm, alleging
that certain provisions of the merger agreement violated a “right of
first offer” provision of the ground lease. The Firm’s motion to dis-
miss the lawsuit was granted, and a judgment of dismissal was
entered on January 12, 2009. The owner has filed a notice of appeal.
Note 34 – Credit risk concentrations
Concentrations of credit risk arise when a number of customers are
engaged in similar business activities or activities in the same geo-
graphic region, or when they have similar economic features that
would cause their ability to meet contractual obligations to be simi-
larly affected by changes in economic conditions.
JPMorgan Chase regularly monitors various segments of its credit
portfolio to assess potential concentration risks and to obtain collat-
eral when deemed necessary. Senior management is significantly
involved in the credit approval and review process, and risk levels are
adjusted as needed to reflect management’s risk tolerance.