JP Morgan Chase 2012 Annual Report Download - page 163

JPMorgan Chase & Co./2012 Annual Report 173
Effect of credit derivatives on selected European exposures
Country exposures in the Selected European exposure table above have been reduced by purchasing protection through single
name, index, and tranched credit derivatives. The following table presents the effect of purchased and sold credit derivatives
on the trading and portfolio hedging activities in the Selected European exposure table.
December 31, 2012 Trading Portfolio hedging
(in billions) Purchased Sold Net Purchased Sold Net
Spain $ (121.2) $ 120.2 $ (1.0) $ (1.2) $ 0.9 $ (0.3)
Italy (157.9) 156.5 (1.4) (11.0) 5.9 (5.1)
Ireland (7.1) 7.2 0.1 (1.0) 0.7 (0.3)
Portugal (43.2) 42.2 (1.0) (0.5) 0.1 (0.4)
Greece (11.7) 11.4 (0.3) — — —
Total $ (341.1) $ 337.5 $ (3.6) $ (13.7) $ 7.6 $ (6.1)
Under the Firm’s internal country risk management
approach, generally credit derivatives are reported based
on the country where the majority of the assets of the
reference entity are located. Exposures are measured
assuming that all of the reference entities in a particular
country default simultaneously with zero recovery. For
example, single-name and index credit derivatives are
measured at the notional amount, net of the fair value of
the derivative receivable or payable. Exposures for index
credit derivatives, which may include several underlying
reference entities, are determined by evaluating the
relevant country for each of the reference entities
underlying the named index, and allocating the applicable
amount of the notional and fair value of the index credit
derivative to each of the relevant countries. Tranched credit
derivatives are measured at the modeled change in value of
the derivative assuming the simultaneous default of all
underlying reference entities in a specific country; this
approach considers the tranched nature of the derivative
(i.e., that some tranches are subordinate to others) and the
Firm’s own position in the structure.
The total line in the table above represents the simple sum
of the individual countries. Changes in the Firm’s
methodology or assumptions would produce different
results.
The credit derivatives reflected in the “Trading” column
include those from the Firm’s market-making activities as
well as $(4.1) billion of net purchased protection in the
synthetic credit portfolio managed by CIB beginning in July
2012. Based on scheduled maturities and risk reduction
actions being taken in the synthetic credit portfolio, the
amount of protection provided by the synthetic credit
portfolio relative to the five named countries is likely to be
substantially reduced over time.
The credit derivatives reflected in the “Portfolio hedging”
column are used in the Firm’s Credit Portfolio Management
activities, which are intended to mitigate the credit risk
associated with traditional lending activities and derivative
counterparty exposure. These credit derivatives include
both purchased and sold protection, where the sold
protection is generally used to close out purchased
protection when appropriate under the Firm’s risk
mitigation strategies. In its Credit Portfolio Management
activities, the Firm generally seeks to purchase credit
protection with a maturity date that is the same or similar
to the maturity date of the exposures for which the
protection was purchased. However, there are instances
where the purchased protection has a shorter maturity date
than the maturity date of the exposure for which the
protection was purchased. These exposures are actively
monitored and managed by the Firm. The effectiveness of
the Firm’s CDS protection as a hedge of the Firm’s
exposures may vary depending upon a number of factors,
including the contractual terms of the CDS. For further
information about credit derivatives see Credit derivatives
on pages 158–159, and Note 6 on pages 218–227 of this
Annual Report.
The Firm’s net presentation of purchased and sold credit
derivatives reflects the manner in which this exposure is
managed, and reflects, in the Firm’s view, the substantial
mitigation of market and counterparty credit risk in its
credit derivative activities. Market risk is substantially
mitigated because market-making activities, and to a lesser
extent, hedging activities, often result in selling and
purchasing protection related to the same underlying
reference entity. For example, in each of the five countries
as of December 31, 2012, the protection sold by the Firm
was more than 92% offset by protection purchased on the
identical reference entity.
In addition, counterparty credit risk has been substantially
mitigated by the master netting and collateral agreements
in place for these credit derivatives. As of December 31,
2012, 99% of the purchased protection presented in the
table above is purchased under contracts that require
posting of cash collateral; 92% is purchased from
investment-grade counterparties domiciled outside of the
selected European countries; and 69% of the protection
purchased offsets protection sold on the identical reference
entity, with the identical counterparty subject to a master
netting agreement.