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Maiden Lane LLC (A Special Purpose Vehicle Consolidated by the Federal Reserve Bank of New York) Consolidated Financial Statements as of and for the Years Ended December 31, 2011 and 2010, and Independent Auditors’ Report Maiden Lane LLC Table of Contents Page Management’s Report on Internal Control over Financial Reporting Independent Auditors’ Report 1 2-3 Consolidated Financial Statements as of and for the years ended December 31, 2011 and 2010: Consolidated Statements of Financial Condition 4 Consolidated Statements of Income 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7-28 Deloitte & Touche LLP Two World Financial Center New York, NY 10281-1414 USA Tel: +1 212 436 2000 Fax: +1 212 436 5000 www.deloitte.com INDEPENDENT AUDITORS’ REPORT To the Managing Member of Maiden Lane LLC: We have audited the accompanying Consolidated Statements of Financial Condition of Maiden Lane LLC (a Special Purpose Vehicle consolidated by the Federal Reserve Bank of New York) and subsidiaries (the “LLC”) as of December 31, 2011 and 2010, and the related Consolidated Statements of Income, and Cash Flows for the years then ended. We also have audited the LLC’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The LLC’s management is responsible for these Consolidated Financial Statements, for maintaining effective internal control over financial reporting, and for its assertion of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these Consolidated Financial Statements and an opinion on the LLC’s internal control over financial reporting based on our audits. We conducted our audits in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the Consolidated Financial Statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the Consolidated Financial Statements included examining, on a test basis, evidence supporting the amounts and disclosures in the Consolidated Financial Statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. The LLC’s internal control over financial reporting is a process designed by, or under the supervision of, the LLC’s principal executive and principal financial officers, or persons performing similar functions, and effected by the LLC’s Managing Member to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The LLC’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the LLC; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of Consolidated Financial Statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the LLC are being made only in accordance with authorizations of Member of Deloitte Touche Tohmatsu Limited the Managing Member; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the LLC’s assets that could have a material effect on the Consolidated Financial Statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, such Consolidated Financial Statements present fairly, in all material respects, the financial position of Maiden Lane LLC (a Special Purpose Vehicle consolidated by the Federal Reserve Bank of New York) and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the LLC maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. March 20, 2012 Maiden Lane LLC Consolidated Statements of Financial Condition As of December 31, 2011 and 2010 (Amounts in thousands, except par value and share data) 2011 Assets Cash and cash equivalents (includes restricted cash of $79,148 and $81,024, respectively) Investments, at fair value (cost of $9,003,325 and $27,766,954, respectively, and includes assets pledged of $551,763 and $1,042,612, respectively) Swap contracts, at fair value Principal and interest receivable Receivable for investments sold Other assets Total assets Liabilities and Member's Equity Senior Loan, at fair value Subordinated Loan, at fair value Swap contracts, at fair value Cash collateral on swap contracts Other liabilities and accrued expenses Total liabilities $ 533,817 $ 6,551,724 656,873 33,594 17,475 11,562 7,805,045 $ Member's equity ($10 par value, 1 share issued and outstanding) Total liabilities and member's equity 2010 5,736,025 1,384,975 105,657 553,556 24,832 7,805,045 $ 1,601,291 $ 25,363,888 851,035 121,451 23,465 27,961,130 $ $ 7,805,045 $ The accompanying notes are an integral part of these consolidated financial statements. 4 25,845,272 1,200,604 201,458 694,735 19,061 27,961,130 27,961,130 Maiden Lane LLC Consolidated Statements of Income For the years ended December 31, 2011 and 2010 (Amounts in thousands) 2011 Revenues Interest income Realized gains (losses) on investments, swap contracts, and other derivatives, net Unrealized gains on investments, swap contracts, and other derivatives, net Other income Total revenues $ 2010 798,522 $ 1,131,713 246,629 (872,647) 187,610 9,034 1,241,795 3,443,312 1,402 3,703,780 208,015 42,889 250,904 271,080 68,596 339,676 Net operating income 990,891 3,364,104 Non-operating losses Unrealized losses on the Loans Total non-operating losses (990,891) (990,891) (3,364,104) (3,364,104) Expenses Interest expense Professional fees and other expenses Total expenses $ Net income - $ The accompanying notes are an integral part of these consolidated financial statements. 5 - Maiden Lane LLC Consolidated Statements of Cash Flows For the years ended December 31, 2011 and 2010 (Amounts in thousands) 2011 Cash flows from operating activities Net income $ 2010 - $ - Adjustments to reconcile net income to net cash provided by operating activities: Amortization of discounts and premiums on investments Realized (gains) losses on investments, swap contracts, and other derivatives, net Unrealized gains on investments, swap contracts, and other derivatives, net Unrealized losses on the Loans Increase in accrued and capitalized interest on the Loans Decrease in principal and interest receivable (Increase) decrease in other assets and receivable for investments sold Increase in other liabilities and accrued expenses Net cash flow provided by operating activities (217,229) (276,300) (246,629) (187,610) 990,891 208,015 87,857 (3,579) 5,771 637,487 872,647 (3,443,312) 3,364,104 271,080 42,039 9,172 3,905 843,335 Cash flows from investing activities Payments for purchase of investments Proceeds from principal paydowns on investments Proceeds from sale of investments Payments for purchase of swap contracts, and other derivatives Proceeds from disposition of swap contracts, and other derivatives Periodic payments from (for) swap contracts, and other derivatives, net Net cash flow provided by investing activities (787,177) 3,173,444 17,148,579 (47,353) 62,746 9,761 19,560,000 (7,904,304) 6,660,212 4,886,267 (52,659) 261,122 (457,880) 3,392,758 Cash flows from financing activities Repayments of Senior Loan Repayments of collateral received on swap contracts Net cash flow used in financing activities (21,123,782) (141,179) (21,264,961) (3,592,002) (285,112) (3,877,114) Net (decrease) increase in cash and cash equivalents Beginning cash and cash equivalents Ending cash and cash equivalents $ (1,067,474) 1,601,291 533,817 $ 358,979 1,242,312 1,601,291 $ 208,015 $ 271,080 Supplemental non-cash operating and financing activities: Accrued and capitalized interest on the Loans The accompanying notes are an integral part of these consolidated financial statements. 6 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 1. Organization and Nature of Business Maiden Lane LLC (the “LLC”), a special purpose vehicle consolidated by the Federal Reserve Bank of New York (“FRBNY” or “Managing Member”), is a single member Delaware limited liability company that was formed to acquire approximately $30 billion of The Bear Stearns Companies’ Inc. (“Bear Stearns”) assets in connection with and to facilitate the merger of Bear Stearns and JPMorgan Chase & Co. (“JPMC”). FRBNY is the sole and managing member of the LLC as well as the controlling party of the assets of the LLC, and will remain as such as long as FRBNY retains an economic interest in the LLC. Financing for the LLC was provided by FRBNY, as the senior lender (the “Senior Loan”), and by JPMC, as the subordinated lender (the “Subordinated Loan”) (together the “Loans”). The Loans are collateralized by all the assets of the LLC through a pledge to State Street Bank and Trust (“State Street”) as collateral agent. Bear Stearns’ assets purchased by the LLC largely consisted of mortgage-related debt securities, whole mortgage loans (held by two grantor trusts as discussed below), credit default and interest rate swap contracts, primarily through a total return swap agreement with JPMC (the “TRS”). Bear Stearns’ assets were acquired and transferred to the LLC on June 26, 2008 with a purchase and effective valuation date of March 14, 2008. Two grantor trusts were established to directly acquire the whole mortgage loans. One was formed to acquire a portfolio of commercial mortgage loans and one was formed to acquire a portfolio of residential mortgage loans (Maiden Lane Commercial Mortgage-Backed Securities Trust 2008-1 [“CRE Trust”] and Maiden Lane Asset-Backed Securities I Trust 2008-1, together the “Grantor Trusts”). The LLC owns the trust certificates representing all of the beneficial ownership interest in each of the Grantor Trusts. The Grantor Trusts are controlled by FRBNY as long as the LLC remains a certificate holder. The LLC is the sole certificate holder as of December 31, 2011. The trustee and master servicers for each Grantor Trust are nationally recognized financial institutions. The master servicers to the Grantor Trusts are responsible for remitting to the Grantor Trusts all principal and interest payments and any other amounts collected by the primary loan servicers on the underlying loans of each respective trust. Payments received by each Grantor Trust are passed on to the LLC as the sole beneficiary after deducting certain trust expenses, advances, servicing costs, and fees. BlackRock Financial Management, Inc. (the “Investment Manager” or “BlackRock”) manages the investment portfolio of the LLC under a multi-year contract with FRBNY that includes provisions governing termination of the contract. State Street provides administrative, collateral administration, and custodial services and has been appointed to serve as collateral agent under multi-year contracts with FRBNY that include provisions governing termination of the contracts. The LLC does not have any employees and therefore does not bear any employee-related costs. 2. Summary of Significant Accounting Policies The consolidated financial statements are prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”), which require the Managing Member to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of income and expense during the reporting period. Significant estimates include the fair value of investments, swap contracts, and other derivatives, and the Loans. Actual results could differ from those estimates. 7 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The consolidated financial statements include the accounts and operations of the LLC as well as the Grantor Trusts. Intercompany balances and transactions have been eliminated in consolidation. The following is a summary of the significant accounting policies followed by the LLC: A. Cash and Cash Equivalents The LLC defines cash and cash equivalents as cash, money market funds and other short-term, highly liquid investments with maturities of three months or less when acquired. Money market funds and other shortterm investments are carried at fair value based on quoted prices in active markets for identical assets. All cash equivalents are classified as Level 1 under the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820 (“ASC 820”), Fair Value Measurement. Refer to Note 5 for more information. The LLC invests available cash in US Treasury bills, Agency Discount Notes and Government Money Market Funds registered under the Investment Company Act of 1940. As of December 31, 2011 the LLC had approximately $0.1 billion in US Treasury bills and Agency Discount Notes and $0.4 billion in Government Money Market Funds. As of December 31, 2010 the LLC had approximately $1.4 billion in US Treasury bills and Agency Discount Notes and $0.2 billion in Government Money Market Funds. Restricted cash principally represents collateral for unfunded commitments to extend credit on commercial loans acquired by the Grantor Trusts. For more information on these commitments, refer to Note 7. B. Investments The LLC’s investments consist primarily of Federal agency and Government Sponsored Enterprise mortgagebacked securities (“GSE MBS”), non-agency residential mortgage-backed securities (“non-agency RMBS”), commercial and residential mortgage loans, and derivatives and associated hedges. The LLC follows the guidance in FASB ASC Topic 320, Investments – Debt and Equity Securities, when accounting for investments in debt securities. Investment transactions are accounted for at trade date. Interest income is recorded when earned and includes amortization of premiums, accretion of discounts, and paydown gains and losses on investments. Realized gains or losses on investment transactions are determined on the identified cost basis. C. Valuation of Financial Assets and Liabilities The LLC has elected the fair value option in accordance with FASB ASC Topic 825 (“ASC 825”), Financial Instruments, for investments and the Loans (including accrued and capitalized interest), all of which are recorded at fair value in accordance with ASC 820. The Managing Member believes that accounting for the investments and Loans at fair value appropriately reflects the LLC’s purpose and intent with respect to its financial assets and liabilities and most closely reflects the LLC’s obligations. For more information on the valuation of investments and the Loans, refer to Note 5 and Note 6. Swap contracts and other derivative instruments are recorded at fair value in accordance with ASC 820 and FASB ASC Topic 815 (“ASC 815”), Derivatives and Hedging. For more information on the valuation of swap contracts, and other derivative instruments, refer to Note 5 and Note 6. 8 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 Fair Value Hierarchy ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that distinguishes between assumptions developed using market data obtained from independent sources (observable inputs) and the LLC's assumptions developed using the best information available in the circumstances (unobservable inputs). The three levels established by ASC 820 are described as follows: • Level 1 – Valuation is based on quoted prices for identical instruments traded in active markets. • Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. • Level 3 – Valuation is based on model-based techniques that use significant inputs and assumptions not observable in the market. These unobservable inputs and assumptions reflect the LLC’s own estimates of inputs and assumptions that market participants would use in pricing the assets and liabilities. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. D. Accounting for Senior Loan and Subordinated Loan The consolidated financial statements reflect the fair value of the Loans and related accrued and capitalized interest. The Loans are recorded as “Senior Loan, at fair value” and “Subordinated Loan, at fair value” in the Consolidated Statements of Financial Condition. Changes in fair value are recorded as “Unrealized losses on the Loans” in the Consolidated Statements of Income. E. Variable Interest Entities The identification of variable interest entities (“VIEs”) and determination whether to consolidate VIEs were assessed in accordance with FASB ASC Topic 810 (“ASC 810”), Consolidation, which requires a variable interest entity to be consolidated by its controlling financial interest holder. The LLC consolidates a VIE if it has a controlling financial interest, which is defined as the power to direct the significant economic activities of the entity and the obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the VIE. To determine whether it is the controlling financial interest holder of a VIE, the LLC evaluates the VIE’s design, capital structure, and relationships with the variable interest holders. The LLC reconsiders whether it has a controlling financial interest in a VIE, as required by ASC 810, at each reporting date. The LLC holds certain interests in VIEs through investments in non-agency RMBS, commercial mortgagebacked securities (“CMBS”), collateralized debt obligations (“CDOs”), collateralized loan obligations and swap contracts. VIEs generally finance the purchase of assets by issuing debt and equity instruments. In assessing the nature and extent of its financial interests in these VIEs, the LLC considered the nature and purpose of its involvement with these VIEs, which is primarily as investor, and in limited instances, as 9 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 seller of protection through credit default swaps. The LLC has made a determination that there are no material VIEs that required consolidation into its consolidated financial statements as of December 31, 2011 and 2010. As of December 31, 2011, the LLC’s significant interests in non-consolidated VIEs consisted of approximately $400 million of investments, at fair value and a payable of approximately $36 million, which was recorded as a component of “Swap contracts, at fair value” in the Consolidated Statements of Financial Condition. The fair value and total maximum exposure to non-consolidated VIEs was $436 million and $549 million as of December 31, 2011 and 2010, respectively. F. Professional Fees and Other Expenses Professional fees and other expenses are primarily comprised of the fees charged by the Investment Manager and administrator as well as fees and expenses related to the servicing of residential and commercial loans held by the Grantor Trusts. G. Income Taxes The LLC is a single member limited liability company and was structured as a disregarded entity for U.S. Federal, state and local income tax purposes. Accordingly, no provision for income taxes is made in the consolidated financial statements. H. Immaterial Restatement Subsequent to the issuance of the LLC’s 2010 consolidated financial statements, it was determined that certain investing activities had been incorrectly netted within the Consolidated Statement of Cash Flows for the year ended December 31, 2010. As a result, lines within the “Cash flows from investing activities” section have been restated and the line “Periodic payments from (for) swap contracts, and other derivatives, net” has been added. The following table displays all changes to the Consolidated Statement of Cash Flows for the year ended December 31, 2010 (in thousands): As Reported Cash flows from investing activities Payments for purchase of investments Proceeds from principal paydowns on investments Proceeds from sale of investments Payments for purchase of swap contracts, and other derivatives Proceeds from disposition of swap contracts, and other derivatives Periodic payments from (for) swap contracts, and other derivatives, net Net cash flow provided by investing activities I. $ $ (7,328,926) 5,789,128 4,858,075 (507) 74,988 3,392,758 As Restated $ $ (7,904,304) 6,660,212 4,886,267 (52,659) 261,122 (457,880) 3,392,758 Recently Issued Accounting Standards In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. New requirements for disclosure of information about transfers among the hierarchy’s classification and the level of disaggregation of classes of assets were effective for the LLC for the year beginning on January 1, 2010, and the required disclosures are included in Note 5. Other required disclosures include the gross presentation of purchases, sales, issuances, and settlements in the reconciliation for Level 3 fair value 10 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 measurements, which were effective for the LLC for the year beginning on January 1, 2011 and are included in Note 5. In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This update will result in common fair value measurement and disclosure requirements for GAAP and International Financial Reporting Standards. In addition, this update requires additional disclosures for fair value measurements categorized as Level 3, including quantitative information about the unobservable inputs and assumptions used in the fair value measurement, a description of the valuation policies and procedures, and a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs. In addition, disclosure of the amounts and reasons for all transfers in and out of Level 1 and Level 2 will be required. The adoption of this update is effective for the LLC for the year ending December 31, 2012, and is not expected to have a material effect on the LLC’s consolidated financial statements. In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This update will require a reporting entity to present enhanced disclosures for financial instruments and derivative instruments that are offset or subject to master netting agreements or similar such agreements. This update is effective for the LLC for the year ending December 31, 2013, and is not expected to have a material effect on the LLC’s consolidated financial statements. 3. Senior Loan and Subordinated Loan On June 26, 2008, FRBNY funded the Senior Loan of approximately $28.8 billion and JPMC funded the Subordinated Loan of approximately $1.15 billion to finance the initial acquisition of the LLC’s assets. Each loan has a ten-year term and matures on June 26, 2018. FRBNY may extend the date of final maturity of the Senior Loan to any later date and, without the consent of JPMC, may extend the date of final maturity of the Subordinated Loan to any later date, provided that such extension of the Subordinated Loan does not extend the Subordinated Loan beyond the date of maturity of the Senior Loan and there remains outstanding obligations due on the Senior Loan beyond the contingent interest. The Senior Loan bears interest at the primary credit rate in effect and is entitled to receive additional contingent interest in amounts equal to any proceeds from the sale of the LLC’s assets that are available for distribution pursuant to the order of priority described in Note 4. The Subordinated Loan bears interest at the primary credit rate plus 450 basis points. The primary credit rate is the rate charged by FRBNY for loans under its primary credit program. Interest on the Loans is capitalized quarterly and accrues daily based on the amount of principal and capitalized interest outstanding on the last day of the last month in each calendar quarter. Consistent with the terms of the Security Agreement, repayment of the Senior Loan commenced in July 2010 and will be made monthly, subject to availability of funds in the LLC’s accounts unless otherwise directed by FRBNY pursuant to the order of priority described in Note 4. 11 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents a reconciliation of the Loans as of December 31, 2011 and 2010 (in thousands): Senior Loan Fair value, January 1, 2010 1 $ 27,002,694 Subordinated Loan 2 $ Total - $ 27,002,694 2010 Activity: Accrued and capitalized interest Repayments Unrealized losses on the Loans Fair value, December 31, 2010 204,684 (3,592,002) 2,229,896 25,845,272 66,396 1,134,208 1,200,604 271,080 (3,592,002) 3,364,104 27,045,876 2011 Activity: Accrued and capitalized interest Repayments Unrealized losses on the Loans Fair value, December 31, 2011 137,628 (21,123,782) 876,907 $ 5,736,025 70,387 113,984 1,384,975 208,015 (21,123,782) 990,891 $ 7,121,000 1 2 $ The outstanding principal and accrued interest balances of the Senior Loan were $4,859,118 (principal of $4,103,748 and interest of $755,370) and $25,845,272 (principal of $25,227,530 and interest of $617,742) as of December 31, 2011 and 2010, respectively. The outstanding principal and accrued interest balances of the Subordinated Loan were $1,384,975 (principal of $1,150,000 and interest of $234,975) and $1,314,588 (principal of $1,150,000 and interest of $164,588) as of December 31, 2011 and 2010, respectively. The weighted average interest rates on the Senior Loan and Subordinated Loan for the year ended December 31, 2011 were 0.75 percent and 5.25 percent, respectively. The weighted average interest rates on the Senior Loan and Subordinated Loan for the year ended December 31, 2010 were 0.72 percent and 5.22 percent, respectively. 4. Distribution of Proceeds In accordance with the Security Agreement, amounts available in the accounts of the LLC are distributed monthly in the following order of priority: first, to pay any costs, fees, and expenses of the LLC then due and payable; second, to pay any amounts owed to derivative counterparties under the related derivative contracts; third, to repay the outstanding principal amount of the Senior Loan; fourth, so long as the entire outstanding principal amount of the Senior Loan has been repaid in full, to pay unpaid interest outstanding on the Senior Loan; 12 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 fifth, so long as the entire outstanding principal amount of and all accrued and unpaid interest outstanding on the Senior Loan have been paid in full, to repay the outstanding principal amount of the Subordinated Loan; sixth, so long as (i) the entire outstanding principal amount of and all accrued and unpaid interest on the Senior Loan have been paid in full and (ii) the entire outstanding principal amount of the Subordinated Loan has been repaid in full, to pay unpaid interest outstanding on the Subordinated Loan; seventh, so long as the entire outstanding principal amount of and all accrued and unpaid interest on the Loans have been paid in full, and after termination and payment of any amounts owed to the counterparties under the related derivative contracts, to pay all available proceeds to FRBNY as holder of the Senior Loan. 5. Fair Value Measurements The LLC measures all investments, swap contracts, and other derivatives, and the Loans at fair value in accordance with ASC 820. Determination of Fair Value The LLC values its investments on the basis of last available bid prices or current market quotations provided by dealers or pricing services selected under the supervision of the Investment Manager. To determine the value of a particular investment, pricing services may use certain information with respect to market transactions in such investment or comparable investments, various relationships observed in the market between investments, quotations from dealers, and pricing metrics and calculated yield measures based on valuation methodologies commonly employed in the market for such investments. Financial futures contracts traded on exchanges are valued at their last sale price. The fair value of swap agreements is provided by JPMC as calculation agent, subject to review by the Investment Manager. Market quotations may not represent fair value in certain instances in which the Investment Manager and the LLC believe that facts and circumstances applicable to an issuer, a seller or a purchaser, or the market for a particular investment cause such market quotations to not reflect the fair value of an investment. In such cases, the Investment Manager applies proprietary valuation models that use collateral performance scenarios and pricing metrics derived from the reported performance of bonds with similar characteristics as well as available market data to determine fair value. The fair value of the Loans is determined based on the fair value of the underlying assets held by the LLC and the allocation of the LLC’s net operating income or loss, as presented in the reconciliation of the Loans in Note 3. Due to the uncertainty inherent in determining the fair value of investments, derivatives, and debt instruments that do not have a readily available fair value, the fair values of the LLC’s investments, swap contracts, other derivatives, and the Loans may differ from the values that may ultimately be realized and paid. 13 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 Valuation Methodologies for Level 3 Assets and Liabilities In certain cases where there is limited trading activity for particular investments or where current market quotations are not reflective of the fair value of an instrument, the valuation is based on model-based techniques that use inputs, estimates and assumptions that market participants would use in pricing the investments. To the extent that such inputs, estimates and assumptions are not observable, the investments are classified within Level 3 of the valuation hierarchy. For instance, in valuing certain debt securities and whole mortgage loans, the determination of fair value is based on proprietary valuation models when external price information is not available. Key inputs to the model may include market spreads or yield estimates for comparable instruments, data for each credit rating, valuation estimates for underlying property collateral, projected cash flows, and other relevant contractual features. The following table presents the assets and liabilities recorded at fair value as of December 31, 2011 by the fair value hierarchy (in thousands): Fair value hierarchy Level 1 Assets: Money market funds 1 Other short-term investments 1 Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Swap contracts CDS Total assets Liabilities: Senior Loan Subordinated Loan Swap contracts CDS Total liabilities 1 2 $ Level 2 426,776 104,000 $ 720,839 720,839 $ $ $ 1,251,615 - - $ 440,441 772,694 1,463,174 288,063 2,964,372 $ 2,964,372 $ $ Netting 2 Level 3 - $ 764,771 1,397,487 378,477 325,778 2,866,513 $ 1,630,129 4,496,642 - $ (5,736,025) (1,384,975) - (790,647) $ (7,911,647) Total fair value - $ - $ $ $ (973,256) (973,256) 426,776 104,000 440,441 1,537,465 2,860,661 378,477 1,334,680 6,551,724 $ 656,873 7,739,373 - $ (5,736,025) (1,384,975) 684,990 684,990 (105,657) $ (7,226,657) Recorded as a component of "Cash and cash equivalents" in the Consolidated Statements of Financial Condition. The LLC has elected to net derivative receivables and payables and the related cash collateral received and paid when a legally enforceable master netting agreement exists. 14 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents the assets and liabilities recorded at fair value as of December 31, 2010 by the fair value hierarchy (in thousands): Fair value hierarchy Level 1 Assets: Money market funds 1 Other short-term investments 1 Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Swap contracts IRS CDS Total swap contracts Other derivatives 2 Total assets Liabilities: Senior Loan Subordinated Loan Swap contracts IRS CDS Total swap contracts Other derivatives 2 Total liabilities $ $ $ $ Level 2 165,768 1,411,998 $ Netting 3 Level 3 - $ - $ Total fair value - $ 165,768 1,411,998 - 16,812,145 1,177,381 3,198,843 699,118 21,887,487 29,878 694,051 1,930,926 602,867 218,679 3,476,401 - 16,842,023 1,871,432 5,129,769 602,867 917,797 25,363,888 1,577,766 8,679 8,679 4,188 $ 21,900,354 2,317,163 2,317,163 5,793,564 (8,679) (1,466,128) (1,474,807) $ (1,474,807) 851,035 851,035 4,188 $ 27,796,877 $ - $ (25,845,272) (1,200,604) 214,554 1,160,341 1,374,895 1,374,895 (14,312) (187,146) (201,458) (2,343) $ (27,249,677) (2,343) (2,343) $ $ $ - $ (25,845,272) (1,200,604) (228,866) (228,866) (228,866) (1,347,487) (1,347,487) $ (28,393,363) $ 1 Recorded as a component of "Cash and cash equivalents" in the Consolidated Statements of Financial Condition. 2 Represents futures and options, which are recorded in "Other assets" and "Other liabilities and accrued expenses" in the Consolidated Statements of Financial Condition. 3 The LLC has elected to net derivative receivables and payables and the related cash collateral received and paid when a legally enforceable master netting agreement exists. 15 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents a reconciliation of all assets and liabilities measured at fair value using significant unobservable inputs (Level 3) for the year ended December 31, 2011, including net realized and unrealized gains (losses) (in thousands): Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Net swap contracts 1 CDS Loans payable Senior Loan Subordinated Loan Total loans payable 1 2 3 Fair value at December 31, 2010 Purchases, sales, issuances, and settlements, net $ $ $ 29,878 694,051 1,930,926 602,867 218,679 3,476,401 $ 969,676 $ $ (25,845,272) (1,200,604) (27,045,876) Net realized / unrealized gains (losses) $ (28,399) (236,225) (625,550) (175,261) (68,642) (1,134,077) $ $ $ $ $ (1,479) 78,782 92,111 (49,129) (381) 119,904 (235,298) $ 20,986,154 (70,387) 20,915,767 $ $ Gross Gross transfers in 2, 3 transfers out 2, 3 Fair value at December 31, 2011 Change in unrealized gains (losses) related to financial instruments held at December 31, 2011 $ $ $ $ $ 445,370 210,441 655,811 105,104 $ (876,907) (113,984) (990,891) $ $ $ (217,207) (34,319) (251,526) - $ - $ $ $ 764,771 1,397,487 378,477 325,778 2,866,513 $ (2,297) 64,733 263,295 4 325,735 - $ 839,482 $ 83,127 - $ $ (876,907) (113,984) (990,891) (5,736,025) (1,384,975) (7,121,000) $ $ Level 3 swap assets and liabilities are presented net for the purposes of this table. Non-agency RMBS, with a December 31, 2010 fair value of $217,207, were transferred from Level 3 to Level 2 because they are valued at December 31, 2011 based on quoted prices for identical or similar assets in non-active markets (Level 2). These investments were valued in the prior year based on non-observable inputs (Level 3). There were also Non-agency RMBS and other investments that became less observable during the year ending December 31, 2011, which resulted in $445,370 and $210,441, respectively, in transfers from Level 2 to Level 3. There were no other significant transfers between Levels during the year ended December 31, 2011. The amount of transfers is based on fair values of the transferred assets at the beginning of the reporting period. The following table presents the gross components of purchases, sales, issuances, and settlements, net, shown above for the year ended December 31, 2011 (in thousands): Purchases Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Net swap contracts 1 CDS $ Sales Issuances $ (17,109) (277) (557,103) (97,323) (25,077) $ (696,889) $ $ 1,594 1,594 $ - $ $ (48,159) - $ - Settlements 3 Purchases, sales, issuances, and settlements, net $ $ $ (11,290) (235,948) (68,447) (77,938) (45,159) (438,782) $ (28,399) (236,225) (625,550) (175,261) (68,642) (1,134,077) $ (187,139) $ (235,298) Loans payable Senior Loan Subordinated Loan Total loans payable 1 2 3 $ (137,628) 2 (70,387) $ (208,015) 2 $ - $ - Level 3 swap assets and liabilities are presented net for the purposes of this table. Represents accrued and capitalized interest. Includes paydowns. 16 $ - $ 21,123,782 $ 20,986,154 $ - $ 21,123,782 $ (70,387) 20,915,767 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents a reconciliation of all assets and liabilities measured at fair value using significant unobservable inputs (Level 3) during the period ended December 31, 2010, including net realized and unrealized gains (losses) (in thousands): Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Net swap contracts 1 CDS Loans payable Senior Loan Subordinated Loan Total loans payable 1 2 3 Fair value at December 31, 2009 Purchases, sales, issuances, and settlements, net $ $ $ 24,484 1,035,048 4,024,973 583,343 139,532 5,807,380 $ $ $ Net realized / unrealized gains (losses) $ (33,813) (320,952) (335,085) (91,820) (31,352) (813,022) $ 1,455,974 $ (325,163) $ (27,002,694) (27,002,694) $ 3,387,318 (66,396) 3,320,922 $ $ $ $ 1,544 245,042 680,893 111,344 89,611 1,128,434 Gross Gross transfers in 3 transfers out 2,3 Fair value at December 31, 2010 Change in unrealized gains (losses) related to financial instruments held at December 31, 2010 $ $ $ $ $ 62,147 144,375 30,301 236,823 $ (161,135) $ - $ (2,229,896) (1,134,208) (3,364,104) $ - $ $ (24,484) (409,462) (2,439,855) (9,413) (2,883,214) $ $ 29,878 694,051 1,930,926 602,867 218,679 3,476,401 $ 1,544 143,983 542,169 197,240 37,204 922,140 - $ 969,676 $ (137,105) - $ $ (2,229,896) (1,134,208) (3,364,104) $ (25,845,272) (1,200,604) (27,045,876) $ Level 3 swap assets and liabilities are presented net for the purposes of this table. Commercial mortgage loans, with a December 31, 2009 fair value of $2,439,855, were transferred from Level 3 to Level 2 because they are valued at December 31, 2010 based on quoted prices for identical or similar assets in non-active markets (Level 2). These investments were valued in the prior year based on non-observable inputs (Level 3). There were no other significant transfers between Levels during the year ended December 31, 2010. The amount of transfers is based on fair values of the transferred assets at the beginning of the reporting period. The following table presents the gross components of purchases, sales, issuances, and settlements, net, shown above for the year ended December 31, 2010 (in thousands)*: Purchases Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans Residential mortgage loans Other investments Total investments Net swap contracts CDS Sales Issuances Settlements 3 Purchases, sales, issuances, and settlements, net $ 198 16,258 $ (2,253) (268,691) (2,247) $ - $ (33,813) (318,897) (66,394) (91,820) (45,363) $ (33,813) (320,952) (335,085) (91,820) (31,352) $ 16,456 $ (273,191) $ - $ (556,287) $ (813,022) $ - $ $ $ (305,812) $ (325,163) - $ 3,592,002 $ 3,387,318 - - - $ 3,592,002 $ 3,320,922 1 (19,351) - Loans payable Senior Loan Subordinated Loan Total loans payable 1 2 3 $ (204,684) 2 (66,396) 2 $ (271,080) $ - $ $ - $ (66,396) Level 3 swap assets and liabilities are presented net for the purposes of this table. Represents accrued and capitalized interest. Includes paydowns. * The LLC chose to include the gross presentation of purchases, sales, issuances, and settlements in the reconciliation for Level 3 fair value measurements as of December 31, 2010, though not specifically required, so as to provide a more consistent presentation to the format seen above for the Level 3 fair value measurements as of December 31, 2011. 17 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents total realized and unrealized gains (losses) associated with the LLC’s assets and liabilities measured at fair value for the year ended December 31, 2011 (in thousands): Total realized gains (losses) Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans 1 1 Residential mortgage loans Other investments $ Total investments Swap contracts, net IRS CDS Total swap contracts, net Other derivatives 2 Total investments, swap contracts, and other derivatives Loans Senior Loan Subordinated Loan Total loans 1 2 1,221,466 45,065 (367,773) (312,424) (31,455) Fair value changes unrealized gains (losses) Total realized / unrealized gains (losses) $ $ (895,268) 100,338 406,739 263,295 76,361 326,198 145,403 38,966 (49,129) 44,906 554,879 (48,535) 506,344 (268,254) 10,687 (257,567) 130,626 94,417 225,043 (137,628) 105,104 (32,524) (50,683) 11,102 (39,581) $ 246,629 $ 187,610 $ 434,239 $ - $ (876,907) (113,984) (990,891) $ (876,907) (113,984) (990,891) $ $ $ Substantially all unrealized gains (losses) on the commercial and residential mortgage loans are attributable to changes in instrument-specific credit risk. Includes realized and unrealized gains (losses) on futures. 18 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table presents total realized and unrealized gains (losses) associated with the LLC’s assets and liabilities measured at fair value for the year ended December 31, 2010 (in thousands): Total realized gains (losses) Investments Federal agency & GSE MBS Non-agency RMBS Commercial mortgage loans 1 Residential mortgage loans 1 Other investments $ 291,262 105,201 (878,927) (85,896) 48,591 Fair value changes unrealized gains (losses) Total realized / unrealized gains (losses) $ $ 320,410 549,474 2,318,808 197,240 285,670 Total investments (519,769) Swap contracts, net IRS CDS Total swap contracts, net (186,817) 36,656 (150,161) (57,452) (197,791) (255,243) (244,269) (161,135) (405,404) (202,717) 26,953 (175,764) Other derivatives 2 Total investments, swap contracts, and other derivatives Loans Senior Loan Subordinated Loan Total loans 1 2 3,671,602 611,672 654,675 1,439,881 111,344 334,261 3,151,833 $ (872,647) $ 3,443,312 $ 2,570,665 $ - $ (2,229,896) (1,134,208) (3,364,104) $ (2,229,896) (1,134,208) (3,364,104) $ $ $ Substantially all unrealized gains (losses) on the commercial and residential mortgage loans are attributable to changes in instrument-specific credit risk. Includes realized and unrealized gains (losses) on futures. The LLC’s variation margin payable balance for open futures contracts was $2,343 as of December 31, 2010 and is recorded as a component of “Other liabilities and accured expenses” in the Consolidated Statements of Financial Condition. 19 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 6. Investment and Risk Profile The LLC’s investment portfolio consists primarily of Federal agency and GSE MBS, non-agency RMBS, commercial and residential mortgage loans, and derivatives and associated hedges. Following is a description of the significant holdings at December 31, 2011 and the associated credit risk for each holding: A. Debt Securities The LLC has investments in Federal agency and GSE MBS, which represent fractional ownership interests in residential mortgage-backed securities issued by Federal agencies and GSEs. The yield characteristics of these securities may differ from traditional debt securities. One such major difference is that all or a principal part of the obligations may be prepaid at any time because the underlying mortgages may be prepaid at any time. A portion of the LLC’s investments include interest only (“IO”) or principal only (“PO”) security classes. The IO class receives the interest cash flows from the underlying mortgages, while the PO class receives the principal cash flows. The yield to maturity on these securities is sensitive to the rate of principal repayments (including prepayments) on the related underlying mortgage assets. The principal prepayments may have a material effect on yield to maturity. If the underlying mortgage assets experience greater than anticipated pre-payments of principal, the LLC may not fully recoup its initial investment in IO classes. The yield to maturity on the PO classes may be impacted by delinquencies or defaults on the underlying mortgage assets. The rate of delinquencies and defaults on residential mortgage loans and the aggregate amount of the resulting losses will be affected by a number of factors, including general economic conditions, particularly those in the area where the related mortgaged property is located, the level of the borrower’s equity in the mortgaged property and the individual financial circumstances of the borrower. Changes in economic conditions, including delinquencies and defaults on the underlying mortgages, can affect the value, income, and liquidity of the LLC’s positions. The LLC’s non-agency RMBS investment portfolio is subject to varying levels of credit, interest rate, general market, and concentration risk. Credit-related risk on non-agency RMBS arises from losses due to delinquencies and defaults by borrowers on the underlying mortgage loans and breaches by originators and servicers of their obligations under the underlying documentation pursuant to which the non-agency RMBS were issued. The rate of delinquencies and defaults on residential mortgage loans and the aggregate amount of the resulting losses will be affected by a number of factors, including general economic conditions, particularly those in the area where the related mortgaged property is located; the level of the borrower's equity in the mortgaged property; and the individual financial circumstances of the borrower. Changes in economic conditions, including delinquencies and defaults on the underlying mortgages, can affect the value, income, and liquidity of the LLC’s positions. The rate of interest payable on certain non-agency RMBS may be set or effectively capped at the weighted average net coupon of the underlying mortgage loans themselves, often referred to as an “available funds cap.” As a result of this cap, the return to the LLC on such non-agency RMBS is dependent on the relative timing and rate of delinquencies and prepayments of mortgage loans bearing a higher interest rate. 20 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The fair value of any particular non-agency RMBS asset may be subject to substantial variation. The entire market or particular instruments traded on a market may decline in value, even if projected cash flow or other factors improve, because the prices of such instruments are subject to numerous other factors that have little or no correlation to the performance of a particular instrument. Adverse developments in the non-agency RMBS market could have a considerable effect on the LLC because of its investment concentration in non-agency RMBS. As of December 31, 2011, approximately 37.9 percent and 12.5 percent of the properties collateralizing the non-agency RMBS held by the LLC were located in California and Florida, respectively, based on the geographic location data available for the underlying loans by aggregate unpaid principal balance. As of December 31, 2011, other investments were primarily comprised of short-term investments (consisting mainly of US Treasury notes and Agency Discount Notes) and CDOs. As of December 31, 2010, other investments were primarily comprised of CDOs and CMBS. At December 31, 2011, the ratings breakdown, by sector, of debt securities, which are recorded at fair value as a component of “Investments, at fair value” on the Consolidated Statements of Financial Condition, as a percentage of the $3.3 billion aggregate fair value of debt securities in the portfolio was as follows: AAA Security Type 2: Federal agency & GSE MBS Non-agency RMBS Other investments 3 Total 1 2 3 4 5 0.3% 2.6% 2.9% Ratings 1, 4 BBB+ A+ to A- to BBB- AA+ to AA0.6% 1.9% 2.4% 0.7% 1.2% 1.9% 0.6% 6.1% 6.7% BB+ and lower 5 44.2% 6.8% 51.0% Gov't / Agency 13.3% 21.8% 35.1% Total 13.3% 46.4% 40.3% 100.0% Lowest of all ratings is used for the purpose of this table if rated by two or more nationally recognized statistical rating organizations. This table excludes the LLC’s commercial and residential mortgage loans, swaps, and other derivative contracts. Includes $701,753 thousand of short-term investments and $379,982 thousand of CDOs. Rows and columns may not total due to rounding. BB+ and lower includes debt securities that were not rated by a nationally recognized statistical rating organization as of December 31, 2011 . B. Commercial and Residential Mortgage Loans Commercial and residential mortgage loans are subject to a high degree of credit risk because of exposure to loss from loan defaults. Default rates are subject to a wide variety of factors, including, but not limited to, property performance, property management, supply and demand factors, construction trends, consumer behavior, regional economic conditions, interest rates, and other factors. 21 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The performance profile for the commercial and residential mortgage loans at December 31, 2011, was as follows (in thousands, except percentage data): Unpaid principal balance Performing loans: Commercial Residential Subtotal $ Non-performing / Non-accrual loans 1: Commercial Residential Subtotal Total loans: Commercial Residential Total 1 $ 3,705,105 617,441 4,322,546 Fair value as a percentage of unpaid principal balance Fair value $ 2,789,455 335,802 3,125,257 75.3% 54.4% 72.3% 125,979 119,400 245,379 71,206 42,675 113,881 56.5% 35.7% 46.4% 3,831,084 736,841 4,567,925 2,860,661 378,477 3,239,138 74.7% 51.4% 70.9% $ Non-performing/Non-accrual loans include loans with payments past due greater than 90 days. The following table summarizes the state in which residential mortgage loans are collateralized and the property types of the commercial mortgage loans held in the Grantor Trusts at December 31, 2011: Concentration of unpaid principal balances Residential By State California Florida Other 1 37.6% 7.5% 54.9% 100.0% By Property Type Hospitality Office Other 1 1 2 Commercial 2 74.7% 18.0% 7.3% 100.0% No other individual state or property type comprises more than 5 percent of the total. One borrower included in hospitality represents approximately 43% of total unpaid principal balance of the commercial mortgage loan portfolio. 22 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 Commercial mortgage loans held by the CRE Trust are composed of different levels of subordination with respect to the underlying properties, and relative to each other. Senior mortgage loans are secured property loans evidenced by a first mortgage that is senior to any subordinate or mezzanine financing. Subordinate mortgage interests, sometimes known as B Notes, are loans evidenced by a junior note or a junior participation in a mortgage loan. Mezzanine loans are loans made to the direct or indirect owner of the property-owning entity. Mezzanine loans are not secured by a mortgage on the property but rather by a pledge of the mezzanine borrower’s direct or indirect ownership interest in the property-owning entity. The following table summarizes the types of commercial mortgage loans held in the CRE Trust at December 31, 2011 (in thousands, except percentage data): Unpaid principal balances $ 2,694,921 74,268 1,061,895 $ 3,831,084 Loan type Senior mortgage loans Subordinate interests in mortgages Mezzanine loans Total Concentration of unpaid principal balances 70.3% 2.0% 27.7% 100.0% As discussed in Note 8, subsequent to December 31, 2011, the total unpaid principal balance was reduced by $1.6 billion due to the sale of commercial mortgage loans held in the CRE Trust. C. Derivative Instruments Derivative contracts are instruments, such as futures and options or swaps contracts, that derive their value from underlying assets, indices, reference rates or a combination of these factors. The LLC portfolio includes various derivative financial instruments, primarily consisting of the TRS. The LLC and JPMC entered into the TRS with reference obligations representing credit default swaps (“CDS”) primarily on residential mortgage-backed securities and CMBS and interest rate swaps (“IRS”) with various market participants, including JPMC. The LLC, through its Investment Manager, currently manages the CDS contracts within the TRS as a runoff portfolio and may unwind, amend, or novate reference obligations on an ongoing basis. On an ongoing basis, per the terms of the TRS, the LLC pledges collateral for credit- or liquidity-related shortfalls based on 20 percent of the notional amount of sold CDS protection and 10 percent of the present value of future premiums on purchased CDS protection. Separately, the LLC and JPMC engage in bilateral posting of collateral to cover the net mark-to-market (“MTM”) variations in the swap portfolio. The LLC only nets the collateral received from JPMC from the bilateral MTM posting for the reference obligations where JPMC is the counterparty. The values of the LLC’s cash equivalents, purchased by the re-hypothecation of cash collateral associated with the TRS, were $0.8 billion and $0.8 billion as of December 31, 2011 and 2010, respectively. In addition, the LLC has pledged $0.6 billion and $1.0 billion of Federal agency and GSE MBS and US Treasury notes to JPMC as of December 31, 2011 and 2010, respectively. The LLC enters into additional derivative contracts consisting of futures and IRS to economically hedge its exposure to interest rates. For 2011, there were 144 trades executed as IRS. All derivatives are recorded at fair value in accordance with ASC 815. None of the derivatives held in the LLC are designated as hedging 23 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 instruments for accounting purposes. As such, all changes in fair value are presented as a component of “Total operating income” in the Consolidated Statements of Income. The following risks are associated with the derivative instruments within the LLC as part of the TRS agreement with JPMC as well as any derivatives outside of the TRS: I. Market Risk Interest Rate Swaps and Futures IRS obligate two parties to exchange one or more payments typically calculated with reference to fixed or periodically reset rates of interest applied to a specified notional principal amount. Notional principal is the amount to which interest rates are applied to determine the payment streams under interest rate swaps. Such notional principal amounts often are used to express the volume of these transactions but are not actually exchanged between the counterparties. Futures contracts are agreements to buy and sell financial instruments for a set price on a future date. Initial margin deposits are made upon entering into futures contracts in the form of cash or securities. During the period that a futures contract is open, changes in the value of the contract are recorded as unrealized gains or losses by revaluing the contracts on a daily basis to reflect the market value of the contract at the end of each day’s trading. Variation margin payments are paid or received, depending upon whether unrealized gains or losses result. When the contract is closed, the LLC will record a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the LLC’s cost basis in the contract. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. The LLC is also at risk of not being able to enter into a closing transaction for the futures contract because of an illiquid secondary market. The LLC had pledged cash collateral related to futures contracts of $18 million as of December 31, 2010. There was no cash collateral pledged as of December 31, 2011. Credit Default Swaps CDS are agreements that provide protection for the buyer against the loss of principal, and in some cases, interest on a bond or loan in case of a default by the issuer. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency or failure to meet payment obligations when due. The buyer of the CDS pays a premium in return for payment protection upon the occurrence, if any, of a credit event. Upon the occurrence of a triggering credit event, the maximum potential amount of future payments the seller could be required to make under a CDS is equal to the notional amount of the contract. Such future payments could be reduced or offset by amounts recovered under recourse or by collateral provisions outlined in the contract, including seizure and liquidation of collateral pledged by the buyer. The LLC’s derivatives portfolio consists of purchased credit protection and sold credit protection with differing underlying referenced names that do not necessarily offset. II. Credit Risk Credit risk is the risk of financial loss resulting from failure by a counterparty to meet its contractual obligations to the LLC. This can be caused by factors directly related to the counterparty, such as business or management. Taking collateral is the most common way to mitigate such risk. The LLC 24 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 takes financial collateral in the form of cash and marketable securities to cover JPMC counterparty risk as part of the TRS agreement with JPMC as well as the over-the-counter derivatives activities outside of the TRS. The following table summarizes the notional amounts of derivative instruments by contract type outstanding as of December 31, 2011 and 2010 (in thousands): 1 Notional amounts 2011 2010 Interest rate contracts: 2 IRS 3 Futures and options $ - Credit derivatives: 4 CDS 3,940,283 Total 1 2 3 4 $ $ 3,940,283 4,129,500 18 5,855,824 $ 9,985,342 Represents the sum of gross long and gross short notional derivative contracts. T he change in notional amount s is representative of the volume of activity for the year ended December 31, 2011. T here were no IRS contracts outst anding as of December 31, 2011 and 39 IRS contracts out standing as of December 31, 2010. Options and futures relate t o contract equivalents and not gross not ional amounts. T he reported notional amount of futures and options as of December 31, 2010 has been corrected (previously reported as $18,411). T here were 979 and 1,361 CDS contracts outstanding as of December 31, 2011 and 2010, respectively. The following table summarizes the fair value of derivative instruments by contract type on a gross basis as of December 31, 2011 and 2010 (in thousands): 2011 2010 Gross derivative assets Interest rate contracts: IRSs Futures and options $ Credit derivatives: CDS 1 1 - $ 1,630,129 Counterparty netting Cash collateral netting Total Gross derivative liabilities (684,990) (288,266) $ 656,873 $ Gross derivative assets - $ 8,679 4,188 Gross derivative liabilities $ (228,866) (2,343) (790,647) 2,317,163 (1,347,487) 684,990 - (1,374,895) (99,912) 1,374,895 - (105,657) $ 855,223 $ (203,801) CDS fair values as of December 31, 2011 for assets and liabilities includes interest receivables of $21,605 and payables of $13,164. CDS fair values as of December 31, 2010 for assets and liabilities includes interest receivables of $38,765 and payables of $27,862. 25 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table summarizes certain information regarding protection sold through CDS as of December 31, 2011 (in thousands): Credit Ratings of the Reference Obligation Credit protection sold: Investment grade (AAA to BBB-) Non-investment grade (BB+ or lower) Total credit protection sold 1 year or less $ $ Maximum potential payout / notional Years to maturity After 1 year After 3 years through 3 years through 5 years After 5 years - $ 150,000 150,000 $ - $ 100,000 100,000 $ - $ - $ 92,000 $ 903,655 995,655 $ Fair value Total Asset / (liability) 92,000 $ 1,153,655 1,245,655 $ (14,376) (762,993) (777,369) The following table summarizes certain information regarding protection sold through CDS as of December 31, 2010 (in thousands): Credit Ratings of the Reference Obligation Credit protection sold: Investment grade (AAA to BBB-) Non-investment grade (BB+ or lower) Total credit protection sold 1 year or less $ $ Maximum potential payout / notional Years to maturity After 1 year After 3 years through 3 years through 5 years After 5 years - $ 10,000 10,000 $ - $ 250,000 250,000 $ - $ - $ 120,000 $ 1,564,461 1,684,461 $ Fair value Total Asset / (liability) 120,000 $ (22,806) 1,824,461 (1,283,963) 1,944,461 $ (1,306,769) The following table summarizes certain information regarding protection bought through CDS as of December 31, 2011 (in thousands): Credit Ratings of the Reference Obligation Credit protection bought: Investment grade (AAA to BBB-) Non-investment grade (BB+ or lower) Total credit protection bought 1 year or less $ $ Maximum potential recovery / notional Years to maturity After 1 year After 3 years through 3 years through 5 years After 5 years 5,000 $ 351,000 356,000 $ - $ 100,000 100,000 $ 26 7,500 $ 21,500 29,000 $ 157,739 $ 2,051,889 2,209,628 $ Fair value Total Asset / (liability) 170,239 $ 2,524,389 2,694,628 $ 46,132 1,562,278 1,608,410 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 The following table summarizes certain information regarding protection bought through CDS as of December 31, 2010 (in thousands): Credit Ratings of the Reference Obligation Credit protection bought: Investment grade (AAA to BBB-) Non-investment grade (BB+ or lower) Total credit protection bought 7. 1 year or less $ $ Maximum potential recovery / notional Years to maturity After 1 year After 3 years through 3 years through 5 years After 5 years - $ 38,000 38,000 $ - $ 501,000 501,000 $ - $ 5,000 5,000 $ 263,329 $ 3,104,034 3,367,363 $ Fair value Total Asset / (liability) 263,329 $ 3,648,034 3,911,363 $ 76,167 2,189,375 2,265,542 Commitments and Contingencies Certain commercial mortgage loans acquired by the CRE Trust have unfunded commitments according to the underlying loan agreements with the respective borrowers. The CRE Trust had unfunded commitments to extend credit of $61 million and $72 million as of December 31, 2011 and 2010, respectively. The CRE Trust is obligated to honor these commitments as and when they are drawn by the borrower, subject to the terms and conditions of the loan agreements. The fair value adjustment on the unfunded commitments is recorded as a component of “Investments, at fair value” in the Consolidated Statements of Financial Condition. The collateral for the unfunded amount of the commitments, which is recorded as a component of “Cash and cash equivalents” (including restricted cash) in the Consolidated Statements of Financial Condition, is held in an escrow account by State Street, as custodian for the trustee of the CRE Trust. The balances in the escrow account were $61 million and $72 million, as of December 31, 2011 and 2010, respectively. The Trust and Master Servicing Agreement governing the CRE Trust requires that the amounts be held in escrow for all remaining unfunded commitments. There is an additional $18 million recorded in “Cash and cash equivalents” (including restricted cash) at December 31, 2011 that represents funds held for obligations of the CRE Trust under existing commercial loan agreements. This cash is held in an account at the master servicer. The LLC and the Grantor Trusts pay the reasonable out-of-pocket costs and expenses of its service providers incurred in connection with its duties under the respective agreements and agree to indemnify their service providers for any losses, claims, damages, liabilities and related expenses etc., which may arise out of the respective agreements unless they result from certain types of actions by the service providers. The indemnity, which is provided solely by the LLC or each of the Grantor Trusts, as applicable, survives termination of the respective agreements. The LLC and Grantor Trusts have not had any significant prior claims and have not had any losses pursuant to these contracts and expect the risk of loss to be remote. 27 Maiden Lane LLC Notes to Consolidated Financial Statements For the years ended December 31, 2011 and 2010 8. Subsequent Events Subsequent to December 31, 2011, the LLC, through a series of competitive bidding processes, sold or entered into an agreement to sell its interest in a senior commercial mortgage loan and has sold the majority of its mezzanine loan participation interests, with an aggregated unpaid principal balance of $1.6 billion as of December 31, 2011. There were no other subsequent events that require adjustments to or disclosures in the consolidated financial statements as of December 31, 2011. Subsequent events were evaluated through March 20, 2012, which is the date the LLC issued the consolidated financial statements. 28