JP Morgan Chase 2006 Annual Report Download - page 123

JPMorgan Chase & Co. / 2006 Annual Report 121
Note 16 – Goodwill and other intangible assets
Goodwill is not amortized. It is instead tested for impairment in accordance with
SFAS 142 at the reporting-unit segment, which is generally one level below the
six major reportable business segments (as described in Note 33 on pages
139–141 of this Annual Report); plus Private Equity (which is included in
Corporate). Goodwill is tested annually (during the fourth quarter) or more often
if events or circumstances, such as adverse changes in the business climate,
indicate there may be impairment. Intangible assets determined to have indefi-
nite lives are not amortized but instead are tested for impairment at least annu-
ally, or more frequently if events or changes in circumstances indicate that the
asset might be impaired. The impairment test compares the fair value of the
indefinite-lived intangible asset to its carrying amount. Other acquired intangi-
ble assets determined to have finite lives, such as core deposits and credit card
relationships, are amortized over their estimated useful lives in a manner that
best reflects the economic benefits of the intangible asset. In addition, impair-
ment testing is performed periodically on these amortizing intangible assets.
Goodwill and other intangible assets consist of the following:
December 31, (in millions) 2006 2005
Goodwill $ 45,186 $ 43,621
Mortgage servicing rights 7,546 6,452
Purchased credit card relationships 2,935 3,275
All other intangibles:
Other credit card–related intangibles $ 302 $ 124
Core deposit intangibles 2,623 2,705
Other intangibles 1,446 2,003
Total All other intangible assets $ 4,371 $ 4,832
Goodwill
As of December 31, 2006, Goodwill increased by $1.6 billion compared with
December 31, 2005. The increase is due principally to the $1.8 billion of
goodwill resulting from the acquisition of the consumer, business banking and
middle-market banking businesses of The Bank of New York, as well as $510
million of goodwill resulting from the acquisition of Collegiate Funding
Services. The increase from acquisitions was offset partially by a reduction to
Goodwill: of $402 million due to the sale of selected corporate trust business-
es to The Bank of New York; resulting from purchase accounting adjustments
related to the acquisition of the Sears Canada credit card business; of $111
million due to the sale of the insurance business; and of $70 million related
to reclassifying net assets of a subsidiary as held-for-sale.
Goodwill attributed to the business segments was as follows:
December 31, (in millions) 2006 2005
Investment Bank $ 3,526 $ 3,531
Retail Financial Services 16,955 14,991
Card Services 12,712 12,984
Commercial Banking 2,901 2,651
Treasury & Securities Services 1,605 2,062
Asset Management 7,110 7,025
Corporate (Private Equity) 377 377
Total Goodwill $ 45,186 $ 43,621
Mortgage servicing rights
JPMorgan Chase recognizes as intangible assets mortgage servicing rights,
which represent the right to perform specified residential mortgage servicing
activities for others. MSRs are either purchased from third parties or retained
upon sale or securitization of mortgage loans. Servicing activities include col-
lecting principal, interest, and escrow payments from borrowers; making tax
and insurance payments on behalf of the borrowers; monitoring delinquencies
and executing foreclosure proceedings; and accounting for and remitting prin-
cipal and interest payments to the investors of the mortgage-backed securities.
The amount initially capitalized as MSRs represents the amount paid to third
parties to acquire MSRs or is the estimate of fair value, if retained upon the
sale or securitization of mortgage loans. The Firm estimates the fair value of
MSRs for initial capitalization and ongoing valuation using an option-adjusted
spread (“OAS”) model, which projects MSR cash flows over multiple interest
rate scenarios in conjunction with the Firm’s proprietary prepayment model,
and then discounts these cash flows at risk-adjusted rates. The model consid-
ers portfolio characteristics, contractually specified servicing fees, prepayment
assumptions, delinquency rates, late charges, other ancillary revenues, and
costs to service, and other economic factors. The Firm compares fair value esti-
mates and assumptions to observable market data where available and to
recent market activity and actual portfolio experience.
The fair value of MSRs is sensitive to changes in interest rates, including their
effect on prepayment speeds. JPMorgan Chase uses or has used combinations
of derivatives, AFS securities and trading instruments to manage changes in
the fair value of MSRs. The intent is to offset any changes in the fair value of
MSRs with changes in the fair value of the related risk management instru-
ments. MSRs decrease in value when interest rates decline. Conversely, securi-
ties (such as mortgage-backed securities), principal-only certificates and cer-
tain derivatives (when the Firm receives fixed-rate interest payments) increase
in value when interest rates decline.
In March 2006, the FASB issued SFAS 156, which permits an entity a one-
time irrevocable election to adopt fair value accounting for a class of servicing
assets. JPMorgan Chase elected to adopt the standard effective January 1,
2006, and defined MSRs as one class of servicing assets for this election.
At the transition date, the fair value of the MSRs exceeded their carrying
amount, net of any related valuation allowance, by $150 million net of taxes.
This amount was recorded as a cumulative-effect adjustment to retained
earnings as of January 1, 2006. MSRs are recognized in the Consolidated
balance sheet at fair value, and changes in their fair value are recorded in
current-period earnings. During 2006, as in prior years, revenue amounts
related to MSRs and the financial instruments used to manage the risk of
MSRs are recorded in Mortgage fees and related income.
For the years ended December 31, 2005 and 2004, MSRs were accounted for
under SFAS 140, using a lower of cost or fair value approach. Under this
approach, MSRs were amortized as a reduction of the actual servicing income
received in proportion to, and over the period of, the estimated future net
servicing income stream of the underlying mortgage loans. For purposes of
evaluating and measuring impairment of MSRs, the Firm stratified the portfolio
on the basis of the predominant risk characteristics, which are loan type and
interest rate. Any indicated impairment was recognized as a reduction in rev-
enue through a valuation allowance, which represented the extent to which
the carrying value of an individual stratum exceeded its estimated fair value.
Any gross carrying value and related valuation allowance amounts which were
not expected to be recovered in the foreseeable future, based upon the inter-
est rate scenario, were considered to be other-than-temporary.