JP Morgan Chase 2014 Annual Report Download - page 128

Management’s discussion and analysis
126 JPMorgan Chase & Co./2014 Annual Report
While useful as a current view of credit exposure, the net
fair value of the derivative receivables does not capture the
potential future variability of that credit exposure. To
capture the potential future variability of credit exposure,
the Firm calculates, on a client-by-client basis, three
measures of potential derivatives-related credit loss: Peak,
Derivative Risk Equivalent (“DRE”), and Average exposure
(“AVG”). These measures all incorporate netting and
collateral benefits, where applicable.
Peak exposure to a counterparty is an extreme measure of
exposure calculated at a 97.5% confidence level. DRE
exposure is a measure that expresses the risk of derivative
exposure on a basis intended to be equivalent to the risk of
loan exposures. The measurement is done by equating the
unexpected loss in a derivative counterparty exposure
(which takes into consideration both the loss volatility and
the credit rating of the counterparty) with the unexpected
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 fair 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 calculate credit
capital and the CVA, as further described below. The three
year AVG exposure was $37.5 billion and $35.4 billion at
December 31, 2014 and 2013, respectively, compared with
derivative receivables, net of all collateral, of $59.4 billion
and $51.3 billion at December 31, 2014 and 2013,
respectively.
The fair value of the Firm’s derivative receivables
incorporates an adjustment, the CVA, to reflect the credit
quality of counterparties. The CVA is based on the Firm’s
AVG to a counterparty and the counterparty’s credit spread
in the credit derivatives market. The primary components of
changes in CVA are credit spreads, new deal activity or
unwinds, and changes in the underlying market
environment. The Firm believes that active risk
management is essential to controlling the dynamic credit
risk in the derivatives portfolio. In addition, the Firm’s risk
management process takes into consideration the potential
impact of wrong-way risk, which is broadly defined as the
potential for increased correlation between the Firm’s
exposure to a counterparty (AVG) and the counterparty’s
credit quality. Many factors may influence the nature and
magnitude of these correlations over time. To the extent
that these correlations are identified, the Firm may adjust
the CVA associated with that counterparty’s AVG. The Firm
risk manages exposure to changes in CVA by entering into
credit derivative transactions, as well as interest rate,
foreign exchange, equity and commodity derivative
transactions.
The accompanying graph shows exposure profiles to the
Firm’s current derivatives portfolio over the next 10 years
as calculated by the DRE and AVG metrics. The two
measures generally show that exposure will decline after
the first year, if no new trades are added to the portfolio.
The following table summarizes the ratings profile by derivative counterparty of the Firm’s derivative receivables, including credit
derivatives, net of other liquid securities collateral, for the dates indicated. The ratings scale is based on the Firm’s internal ratings,
which generally correspond to the ratings as defined by S&P and Moody’s.
Ratings profile of derivative receivables
Rating equivalent 2014 2013(a)
December 31,
(in millions, except ratios) Exposure net of all collateral
% of exposure
net of all
collateral Exposure net of all collateral
% of exposure
net of all
collateral
AAA/Aaa to AA-/Aa3 $ 19,202 32% $ 12,953 25%
A+/A1 to A-/A3 13,940 24 12,930 25
BBB+/Baa1 to BBB-/Baa3 19,008 32 15,220 30
BB+/Ba1 to B-/B3 6,384 11 6,806 13
CCC+/Caa1 and below 837 1 3,415 7
Total $ 59,371 100% $ 51,324 100%
(a) The prior period amounts have been revised to conform with the current period presentation.