JP Morgan Chase 2010 Annual Report Download - page 196

Notes to consolidated financial statements
196 JPMorgan Chase & Co./2010 Annual Report
Risk management derivatives gains and losses (not designated as
hedging instruments)
The following table presents nontrading derivatives, by contract
type, that were not designated in hedge accounting relationships,
and the pretax gains/(losses) recorded on such derivatives for the
years ended December 31, 2010 and 2009. These derivatives are
risk management instruments used to mitigate or transform market
risk exposures arising from banking activities other than trading
activities, which are discussed separately below.
Year ended December 31,
Derivatives gains/(losses)
recorded in income
(in millions)
2010
2009
Contract type
Interest rate
(a)
$ 4,997 $ (3,113 )
Credit
(b)
(237) (3,222 )
Foreign exchange
(c)
(85) (197 )
Equity
(b)
— (8 )
Commodity
(b)
(24) (50 )
Total
$
4,651
$ (6,590 )
(a) Gains and losses were recorded in principal transactions revenue, mortgage
fees and related income, and net interest income.
(b) Gains and losses were recorded in principal transactions revenue.
(c) Gains and losses were recorded in principal transactions revenue and net
interest income.
Trading derivative gains and losses
The Firm has elected to present derivative gains and losses related
to its trading activities together with the cash instruments with
which they are risk managed. All amounts are recorded in principal
transactions revenue in the Consolidated Statements of Income for
the years ended December 31, 2010 and 2009. The amounts below
do not represent a comprehensive view of the Firm’s trading activi-
ties because they do not include certain revenue associated with
those activities, including net interest income earned on cash
instruments used in trading activities and gains and losses on cash
instruments that are risk managed without derivative instruments.
Year ended December 31,
Gains/(losses) recorded in
principal transactions revenue
(in millions)
2010
2009
Type of instrument
Interest rate
$
(68
3
)
$ 4,375
Credit
4,636
5,022
Foreign exchange
(a)
1,854 2,583
Equity
1,827
1,475
Commodity
256
1,329
Total
$
7,
890
$ 14,784
(a) In 2010, the reporting of trading gains and losses was enhanced to include trading
gains and losses related to certain trading derivatives designated as fair value hedg-
ing instruments. Prior period amounts have been revised to conform to the current
presentation.
Credit risk, liquidity risk and credit-related contingent features
In addition to the specific market risks introduced by each deriva-
tive contract type, derivatives expose JPMorgan Chase to credit risk
– the risk that derivative counterparties may fail to meet their
payment obligations under the derivative contracts and the collat-
eral, if any, held by the Firm proves to be of insufficient value to
cover the payment obligation. It is the policy of JPMorgan Chase to
enter into legally enforceable master netting agreements as well as
to actively pursue the use of collateral agreements to mitigate
derivative counterparty credit risk. The amount of derivative receiv-
ables reported on the Consolidated Balance Sheets is the fair value
of the derivative contracts after giving effect to legally enforceable
master netting agreements and cash collateral held by the Firm.
These amounts represent the cost to the Firm to replace the con-
tracts at then-current market rates should the counterparty default.
While derivative receivables expose the Firm to credit risk, deriva-
tive payables expose the Firm to liquidity risk, as the derivative
contracts typically require the Firm to post cash or securities
collateral with counterparties as the mark-to-market (“MTM”) of
the contracts moves in the counterparties’ favor, or upon speci-
fied downgrades in the Firm’s and its subsidiaries’ respective
credit ratings. Certain derivative contracts also provide for termi-
nation of the contract, generally upon a downgrade of either the
Firm or the counterparty, at the fair value of the derivative con-
tracts. The aggregate fair value of net derivative payables that
contain contingent collateral or termination features triggered
upon a downgrade was $19.8 billion and $22.6 billion at De-
cember 31, 2010 and 2009, respectively, for which the Firm has
posted collateral of $14.6 billion and $22.3 billion, respectively,
in the normal course of business. At December 31, 2010 and
2009, the impact of a single-notch and two-notch ratings down-
grade to JPMorgan Chase & Co. and its subsidiaries, primarily
JPMorgan Chase Bank, National Association (“JPMorgan Chase
Bank, N.A.”), would have required $1.9 billion and $3.5 billion,
respectively, and $1.2 billion and $2.2 billion, respectively, of
additional collateral to be posted by the Firm. In addition, at
December 31, 2010 and 2009, the impact of single-notch and
two-notch ratings downgrades to JPMorgan Chase & Co. and its
subsidiaries, primarily JPMorgan Chase Bank, N.A., related to
contracts with termination triggers would have required the Firm
to settle trades with a fair value of $430 million and $1.0 billion,
respectively, and $260 million and $270 million, respectively.