FORWARD-LOOKING STATEMENTS
Level 3 financial instruments
The following table presents the Firm’s primary level 3 financial instruments, the valuation techniques used to measure the fair value of those financial instruments, and the significant unobservable inputs and the range of values for those inputs.
While the determination to classify an instrument within level 3 is based on the significance of the unobservable inputs to the overall fair value measurement, level 3 financial instruments typically include observable components (that is, components that are actively quoted and can be validated to external sources) in addition to the unobservable components. The level 1 and/or level 2 inputs are not included in the table. In addition, the Firm manages the risk of the observable components of level 3 financial
instruments using securities and derivative positions that are classified within levels 1 or 2 of the fair value hierarchy.
The range of values presented in the table is representative of the highest and lowest level input used to value the significant instruments within a classification. The input range does not reflect the level of input uncertainty, instead
it is driven by the different underlying characteristics of the various instruments within the classification.
For more information on valuation inputs and control, see Note 3 on pages 184–198 of JPMorgan Chase’s 2011 Annual Report.
Level 3 inputs (a)
March 31, 2012 (in millions, except for ratios and basis points)
Product/Instrument Fair value
Principal valuation
technique Unobservable inputs Range of input values Residential mortgage-backed securities and
loans
$ 9,488 Discounted cash flows Discount rate 5 % - 25 %
Constant prepayment rate 0 % - 40 %
Constant default rate 0 % - 70 %
Loss severity 0 % - 90 %
Commercial mortgage-backed securities and loans (b)
2,166 Discounted cash flows Discount rate 5 % - 45 %
Constant prepayment rate 0 % - 10 %
Constant default rate 0 % - 100 %
Loss severity 0 % - 40 %
Corporate debt securities, obligations of U.S.
states and municipalities, and other
19,725 Discounted cash flows Credit spread 130 bps - 225 bps
Discount rate 1 % - 35 %
Consensus pricing Price 25 - 115
Net interest rate derivatives 3,238 Option pricing Interest rate correlation (75 )% - 100 %
Interest rate spread volatility 0 % - 60 %
Net credit derivatives (b) 4,808 Discounted cash flows Credit correlation 15 % - 75 %
Net foreign exchange derivatives (1,060 ) Option pricing Foreign exchange correlation (55 )% - 45 %
Net equity derivatives (2,829 ) Option pricing Equity volatility 20 % - 60 %
Net commodity derivatives (600 ) Option pricing Commodity volatility 30 % - 50 %
Collateralized loan obligations (c) 31,040 Discounted cash flows Default correlation (e) 70 % - 99 %
Recovery lag (f) 18 Months
Liquidity spread (g) 150 bps - 250 bps
Recovery rate 0 % - 55 %
Default rate 0 % - 75 %
Prepayment rate 10 % - 20 %
Mortgage servicing rights (“MSRs”) 8,039 Discounted cash flows Refer to Note 16 on pages 144–146 of this Form 10-Q.
Private equity direct investments 4,812 Market comparables EBITDA multiple 3.2x - 10.8x
Liquidity adjustment 0 % - 40 %
Private equity fund investments 1,927 Net asset value Net asset value (h) Long-term debt, other borrowed funds, and
deposits (d)
12,437 Option pricing Interest rate correlation (75 )% - 100 %
Foreign exchange correlation (55 )% - 45 %
Equity correlation (50 )% - 75 %
Discounted cash flows Credit correlation 15 % - 75 %
(a) The categories presented in the table have been aggregated based upon product type which may differ from balance sheet classification.
(b) The unobservable inputs and associated input ranges for approximately $2.3 billion in credit derivative receivables and $1.6 billion in credit derivative payables with underlying mortgage risk have been included in the inputs and ranges provided for commercial mortgage-backed securities and loans.
(c) CLOs are securities backed by corporate loans. At March 31, 2012, $25.2 billion of CLOs were held in the AFS securities portfolio and $5.8 billion were included in asset-backed securities held in the trading portfolio. Substantially all of the securities are rated "AAA", "AA" and "A." For a further discussion of CLOs held in the AFS securities portfolio, see Note 11 on pages 113–117 of this Form 10-Q.
(d) Long-term debt, other borrowed funds, and deposits include structured notes issued by the Firm that are financial instruments containing embedded derivatives.
The estimation of the fair value of structured notes is predominantly based on the derivative features embedded within the instruments. The significant unobservable inputs are broadly consistent with those presented for derivative receivables.
(e) Default correlation measures whether the loans that collateralize an issued CLO are more likely to default together or separately.
(f) Recovery lag is the assumed length of time between an underlying loan default and its liquidation.
(g) Liquidity spread is an adjustment taken to the discount rate to adjust for the level of liquidity in the CLO market.
(h) The range has not been disclosed due to the diverse nature of the underlying investments.
Level 3 analysis
The following provides a general description of the impact of a change in an unobservable input on the fair value measurement and the interrelationship of unobservable inputs, where
relevant/significant. Interrelationships may also exist between observable and unobservable inputs (for example, as interest rates rise, prepayment rates decline). Such relationships have not been included in the discussion below.
In general, an increase in the discount rate, default rates, loss severity and credit spreads, in isolation, would result in a decrease in the fair value measurement. In addition, an increase in default rates would generally be accompanied by a decrease in recovery rates, slower prepayment rates and an increase in liquidity spreads. For derivatives, given a long position to the parameter, an increase in correlation or volatility, in isolation, would result in an increase in the fair value measurement. For direct private equity investments, an increase in the EBITDA (i.e., earnings before interest, taxes, depreciation and amortization) input, net of adjustments, would result in an increase in the fair value measurement. For each of the individual relationships described above, the inverse relationship would also generally apply.
Consolidated Balance Sheets changes
Level 3 assets (including assets measured at fair value on a nonrecurring basis) were 4.7% of total Firm assets at March 31, 2012. The following describes significant changes to level 3 assets since December 31, 2011.
For the three months ended March 31, 2012
Level 3 assets decreased by $9.2 billion during 2012, due to the following:
Gains and Losses
Included in the tables for the three months ended March 31, 2012
Included in the tables for the three months ended March 31, 2011
Credit adjustments
When determining the fair value of an instrument, it may be necessary to record a valuation adjustment to arrive at an exit price under U.S. GAAP. Valuation adjustments include, but are not limited to, amounts to reflect counterparty credit quality and the Firm’s own creditworthiness. The
• $5.5 billion decrease in derivative receivables, predominantly driven by tightening of credit spreads; and
• $2.6 billion decrease in trading assets – debt and equity instruments, predominantly driven by sales and settlements of loans and corporate debt.
• $1.6 billion of net losses on derivatives, related to tightening of credit spreads, partially offset by gains in interest rate
derivatives.
• $905 million gain in private equity, largely driven by net increase in investment valuations in the portfolio.
market’s view of the Firm’s credit quality is reflected in credit spreads observed in the credit default swap (“CDS”) market. For a detailed discussion of the valuation adjustments the Firm considers, see the valuation discussion in Note 3 on pages 184–188 of JPMorgan Chase’s 2011 Annual Report.
The following table provides the credit adjustments, excluding the effect of any hedging activity, reflected within the
Consolidated Balance Sheets as of the dates indicated.
The following table provides the impact of credit adjustments on earnings in the respective periods, excluding the effect of any hedging activity.
(in millions) March 31, 2012 December 31,
2011 Derivative receivables balance (net of
derivatives CVA) $ 85,377 $ 92,477
Derivatives CVA (a) (5,475 ) (6,936 )
Derivative payables balance (net of
derivatives DVA) 74,474 74,977
Derivatives DVA (981 ) (1,420 )
Structured notes balance (net of
structured notes DVA) (b)(c) 50,894 49,229
Structured notes DVA (1,584 ) (2,052 )
(a) Derivatives credit valuation adjustments (“CVA”), gross of hedges, includes results managed by the Credit Portfolio and other lines of business within the Investment Bank (“IB”).
(b) Structured notes are recorded within long-term debt, other borrowed funds or deposits on the Consolidated Balance Sheets, depending upon the tenor and legal form of the note.
(c) Structured notes are measured at fair value based on the Firm’s election under the fair value option. For further information on these elections, see Note 4 on pages 101–102 of this Form 10-Q.
(a) Derivatives CVA, gross of hedges, includes results managed by the Credit Portfolio and other lines of business within IB.
(b) Structured notes are measured at fair value based on the Firm’s election under the fair value option. For further information on these elections, see Note 4 on pages 101–102 of this Form 10-Q.
Additional disclosures about the fair value of financial instruments that are not carried on the Consolidated Balance Sheets at fair value
The following table presents the carrying values and estimated fair values at March 31, 2012, of financial assets and liabilities, excluding financial instruments which are carried at fair value on a recurring basis, and information is provided on their classification within the fair value hierarchy. For additional information regarding the financial instruments within the scope of this disclosure, and the methods and significant assumptions used to estimate their fair value, see Note 3 on pages 184–198 of JPMorgan Chase’s 2011 Annual Report.
The majority of the Firm’s lending-related commitments are not carried at fair value on a recurring basis on the Consolidated Balance Sheets, nor are they actively traded. The carrying value and estimated fair value of the Firm’s wholesale lending-related commitments were as follows for the periods indicated.
The Firm does not estimate the fair value of consumer lending-related commitments. In many cases, the Firm can reduce or cancel these commitments by providing the borrower notice or, in some cases, without notice as permitted by law. For a further discussion of the valuation of lending-related commitments, see pages 97–98 of this Note.
Trading assets and liabilities – average balances
Average trading assets and liabilities were as follows for the periods indicated.
March 31, 2012 December 31, 2011
(in billions)
Carrying value
Estimated
fair value Carrying value
Estimated fair value
Financial assets
Cash and due from banks $ 55.4 $ 55.4 (a) $ 59.6 $ 59.6
Deposits with banks 115.0 115.0 (a) 85.3 85.3
Accrued interest and accounts receivable 64.8 64.8 (b) 61.5 61.5
Federal funds sold and securities purchased under resale agreements 214.2 214.2 (b) 210.4 210.4
Securities borrowed 123.1 123.1 (b) 127.2 127.2
Loans 692.8 692.0 (c) 694.0 693.7
Other 47.7 48.2 (b) 49.8 50.3
Financial liabilities
Deposits $ 1,123.2 $ 1,123.8 (b) $ 1,122.9 $ 1,123.4
Federal funds purchased and securities loaned or sold under repurchase agreements 237.2 237.2 (b) 204.0 204.0
Commercial paper 50.6 50.6 (b) 51.6 51.6
Other borrowed funds 17.1 17.1 (b) 12.3 12.3
Accounts payable and other liabilities 168.6 168.5 (b) 166.9 166.8
Beneficial interests issued by consolidated VIEs 66.7 67.0 (b) 64.7 64.9
Long-term debt and junior subordinated deferrable interest debentures 220.4 222.2 (b) 222.1 219.5
(a) Products/instruments are predominantly classified within level 1 of the fair value hierarchy.
(b) Products/instruments are predominantly classified within level 2 of the fair value hierarchy.
(c) Loans are predominantly classified within level 3 of the fair value hierarchy. Fair value is typically estimated using a discounted cash flow model that incorporates the characteristics of the underlying loans (including principal, contractual interest rate and contractual fees) and other key inputs, including expected lifetime credit losses, interest rates, prepayment rates, and primary origination or secondary market spreads. For certain loans, the fair value is measured based on the value of the underlying collateral.
The difference between the estimated fair value and carrying value of a financial asset or liability is the result of the different methodologies used to determine fair value as compared with carrying value. For example, credit losses are estimated for a financial asset’s remaining life in a fair value calculation but are estimated for a loss emergence period in a loan loss reserve calculation; future loan income (interest and fees) is incorporated in a fair value calculation but is generally not considered in the allowance for loan losses. For a further discussion of the Firm’s methodologies for estimating the fair value of loans and lending-related commitments, see Note 3 on pages 184–198 of JPMorgan Chase’s 2011 Annual Report and pages 97–98 of this Note.
March 31, 2012 December 31, 2011
(in billions) Carrying value (a)
Estimated fair
value Carrying value (a)
Estimated fair value
Wholesale lending-related commitments $ 0.7 $ 1.9
(b)
$ 0.7 $ 3.4
(a) Represents the allowance for wholesale lending-related commitments. Excludes the current carrying values of the guarantee liability and the offsetting asset, each of which are recognized at fair value at the inception of guarantees.
(b) Products/instruments are predominantly classified within level 3 of the fair value hierarchy.
Three months ended March 31,
(in millions) 2012 2011
Trading assets – debt and equity instruments (a) $ 355,335 $ 417,463
Trading assets – derivative receivables 90,446 85,437
Trading liabilities – debt and equity instruments (a)(b) 68,984 82,919
Trading liabilities – derivative payables 76,069 71,288