JP Morgan Chase 2015 Annual Report Download - page 210

Notes to consolidated financial statements
200 JPMorgan Chase & Co./2015 Annual Report
Credit and funding adjustments
When determining the fair value of an instrument, it may be
necessary to record adjustments to the Firm’s estimates of
fair value in order to reflect counterparty credit quality, the
Firm’s own creditworthiness, and the impact of funding:
• CVA is taken to reflect the credit quality of a
counterparty in the valuation of derivatives. Derivatives
are generally valued using models that use as their basis
observable market parameters. These market
parameters may not consider counterparty non-
performance risk. Therefore, an adjustment may be
necessary to reflect the credit quality of each derivative
counterparty to arrive at fair value.
The Firm estimates derivatives CVA using a scenario
analysis to estimate the expected credit exposure across
all of the Firm’s positions with each counterparty, and
then estimates losses as a result of a counterparty credit
event. The key inputs to this methodology are (i) the
expected positive exposure to each counterparty based
on a simulation that assumes the current population of
existing derivatives with each counterparty remains
unchanged and considers contractual factors designed
to mitigate the Firm’s credit exposure, such as collateral
and legal rights of offset; (ii) the probability of a default
event occurring for each counterparty, as derived from
observed or estimated CDS spreads; and (iii) estimated
recovery rates implied by CDS, adjusted to consider the
differences in recovery rates as a derivative creditor
relative to those reflected in CDS spreads, which
generally reflect senior unsecured creditor risk. As such,
the Firm estimates derivatives CVA relative to the
relevant benchmark interest rate.
• DVA is taken to reflect the credit quality of the Firm in
the valuation of liabilities measured at fair value. The
DVA calculation methodology is generally consistent
with the CVA methodology described above and
incorporates JPMorgan Chase’s credit spreads as
observed through the CDS market to estimate the
probability of default and loss given default as a result of
a systemic event affecting the Firm. Structured notes
DVA is estimated using the current fair value of the
structured note as the exposure amount, and is
otherwise consistent with the derivative DVA
methodology.
• FVA is taken to incorporate the impact of funding in the
Firm’s valuation estimates where there is evidence that a
market participant in the principal market would
incorporate it in a transfer of the instrument. For
collateralized derivatives, the fair value is estimated by
discounting expected future cash flows at the relevant
overnight indexed swap (“OIS”) rate given the
underlying collateral agreement with the counterparty.
For uncollateralized (including partially collateralized)
over-the-counter (“OTC”) derivatives and structured
notes, effective in 2013, the Firm implemented a FVA
framework to incorporate the impact of funding into its
valuation estimates. The Firm’s FVA framework
leverages its existing CVA and DVA calculation
methodologies, and considers the fact that the Firm’s
own credit risk is a significant component of funding
costs. The key inputs to FVA are: (i) the expected funding
requirements arising from the Firm’s positions with each
counterparty and collateral arrangements; (ii) for
assets, the estimated market funding cost in the
principal market; and (iii) for liabilities, the hypothetical
market funding cost for a transfer to a market
participant with a similar credit standing as the Firm.
Upon the implementation of the FVA framework in 2013,
the Firm recorded a one-time $1.5 billion loss in principal
transactions revenue that was recorded in the CIB. While the
FVA framework applies to both assets and liabilities, the
loss on implementation largely related to uncollateralized
derivative receivables given that the impact of the Firm’s
own credit risk, which is a significant component of funding
costs, was already incorporated in the valuation of liabilities
through the application of DVA.
The following table provides the impact of credit and
funding adjustments on principal transactions revenue in
the respective periods, excluding the effect of any
associated hedging activities. The DVA and FVA reported
below include the impact of the Firm’s own credit quality on
the inception value of liabilities as well as the impact of
changes in the Firm’s own credit quality over time.
Year ended December 31,
(in millions) 2015 2014 2013
Credit adjustments:
Derivatives CVA $ 620 $ (322) $ 1,886
Derivatives DVA and FVA(a) 73 (58) (1,152)
Structured notes DVA and FVA(b) 754 200 (760)
(a) Included derivatives DVA of $(6) million, $(1) million and $(115) million
for the years ended December 31, 2015, 2014 and 2013, respectively.
(b) Included structured notes DVA of $171 million, $20 million and $(337)
million for the years ended December 31, 2015, 2014 and 2013,
respectively.