JP Morgan Chase 2006 Annual Report Download - page 115

JPMorgan Chase & Co. / 2006 Annual Report 113
Impaired loans
JPMorgan Chase accounts for and discloses nonaccrual loans as impaired loans
and recognizes their interest income as discussed previously for nonaccrual
loans. The following are excluded from impaired loans: small-balance, homo-
geneous consumer loans; loans carried at fair value or the lower of cost or
fair value; debt securities; and leases.
The table below sets forth information about JPMorgan Chase’s impaired
loans. The Firm primarily uses the discounted cash flow method for valuing
impaired loans:
December 31, (in millions) 2006 2005
Impaired loans with an allowance $ 623 $ 1,095
Impaired loans without an allowance(a) 66 80
Total impaired loans $ 689 $ 1,175
Allowance for impaired loans under SFAS 114(b) 153 257
(a) When the discounted cash flows, collateral value or market price equals or exceeds the
carrying value of the loan, then the loan does not require an allowance under SFAS 114.
(b) The allowance for impaired loans under SFAS 114 is included in JPMorgan Chase’s
Allowance for loan losses.
Year ended December 31,
(in millions) 2006 2005 2004
Average balance of impaired
loans during the year $ 990 $ 1,478 $ 1,883
Interest income recognized on
impaired loans during the year 258
Note 13 – Allowance for credit losses
JPMorgan Chase’s Allowance for loan losses covers the wholesale (risk-rated)
and consumer (scored) loan portfolios and represents management’s estimate
of probable credit losses inherent in the Firm’s loan portfolio as of December
31, 2006, 2005 and 2004. Management also computes an allowance for
wholesale lending-related commitments using a methodology similar to that
used for the wholesale loans.
The table below summarizes the Firm’s reporting of its allowance for credit losses:
Reported in:
Allowance for
credit losses on: Balance sheet Income statement
Loans Allowance for loan losses Provision for credit losses
Lending-related
commitments Other liabilities Provision for credit losses
The Allowance for loan losses includes an asset-specific component and a
formula-based component. Within the formula-based component is a statistical
calculation and an adjustment to the statistical calculation.
The asset-specific component relates to provisions for losses on loans considered
impaired and measured pursuant to SFAS 114. An allowance is established
when the discounted cash flows (or collateral value or observable market
price) of the loan is lower than the carrying value of that loan. To compute
the asset-specific component of the allowance, larger impaired loans are
evaluated individually, and smaller impaired loans are evaluated as a pool
using historical loss experience for the respective class of assets.
The formula-based component covers performing wholesale and consumer
loans and is the product of a statistical calculation, as well as adjustments to
such calculation. These adjustments take into consideration model imprecision,
external factors and economic events that have occurred but are not yet
reflected in the factors used to derive the statistical calculation.
The statistical calculation is the product of probability of default and loss given
default. For risk-rated loans (generally loans originated by the wholesale lines of
business), these factors are differentiated by risk rating and maturity. For scored
loans (generally loans originated by the consumer lines of business), loss is pri-
marily determined by applying statistical loss factors and other risk indicators to
pools of loans by asset type. Adjustments to the statistical calculation for the
risk-rated portfolios are determined by creating estimated ranges using histori-
cal experience of both probability of default and loss given default. Factors
related to concentrated and deteriorating industries are also incorporated into
the calculation where relevant. Adjustments to the statistical calculation for the
scored loan portfolios are accomplished in part by analyzing the historical loss
experience for each major product segment. The estimated ranges and the
determination of the appropriate point within the range are based upon man-
agement’s view of uncertainties that relate to current macroeconomic and polit-
ical conditions, quality of underwriting standards, and other relevant internal
and external factors affecting the credit quality of the portfolio.
The Allowance for lending-related commitments represents management’s
estimate of probable credit losses inherent in the Firm’s process of extending
credit as of December 31, 2006, 2005 and 2004. Management establishes an
asset-specific allowance for lending-related commitments that are considered
impaired and computes a formula-based allowance for performing wholesale
lending-related commitments. These are computed using a methodology simi-
lar to that used for the wholesale loan portfolio, modified for expected matu-
rities and probabilities of drawdown.
At least quarterly, the allowance for credit losses is reviewed by the Chief Risk
Officer, the Chief Financial Officer and the Controller of the Firm, and discussed
with the Risk Policy and Audit Committees of the Board of Directors of the
Firm. As of December 31, 2006, JPMorgan Chase deemed the allowance for
credit losses to be appropriate (i.e., sufficient to absorb losses that are inher-
ent in the portfolio, including those not yet identifiable).
The table below summarizes the changes in the Allowance for loan losses:
Year ended December 31, (in millions) 2006 2005 2004(d)
Allowance for loan losses at
January 1 $ 7,090 $ 7,320 $ 4,523
Addition resulting from the Merger,
July 1, 2004 —— 3,123
Gross charge-offs (3,884) (4,869) (3,805)(e)
Gross recoveries 842 1,050 706
Net charge-offs (3,042) (3,819) (3,099)
Provision for loan losses:
Provision excluding accounting
policy conformity 3,153 3,575 1,798
Accounting policy conformity —— 1,085
Total Provision for loan losses 3,153 3,575 2,883
Other 78(a) 14 (110)(f)
Allowance for loan losses at
December 31 $ 7,279(b) $ 7,090(c) $ 7,320(g)
(a) Primarily relates to loans acquired in The Bank of New York transaction in the fourth quarter
of 2006.
(b) Includes $51 million of asset-specific and $7.2 billion of formula-based allowance. Included
within the formula-based allowance was $5.1 billion related to a statistical calculation and an
adjustment to the statistical calculation of $2.1 billion.
(c) Includes $203 million of asset-specific and $6.9 billion of formula-based allowance. Included with-
in the formula-based allowance was $5.1 billion related to a statistical calculation (including $400
million related to Hurricane Katrina), and an adjustment to a statistical calculation of $1.8 billion.
(d) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
(e) Includes $406 million related to the Manufactured Home Loan portfolio in the fourth quar-
ter of 2004.
(f) Primarily represents the transfer of the allowance for accrued interest and fees on reported
and securitized credit card loans.
(g) Includes $469 million of asset-specific and $6.8 billion of formula-based allowance.
Included within the formula-based allowance was $4.8 billion related to a statistical calcu-
lation and an adjustment to the statistical calculation of $2.0 billion.