JP Morgan Chase 2008 Annual Report Download - page 108

Management’s discussion and analysis
106 JPMorgan Chase & Co./ 2008 Annual Report
Mutual prior to the date of the Washington Mutual transaction. This
portfolio is primarily comprised of loans with low LTVs and high bor-
rower FICOs and for which the Firm currently expects substantially
lower losses in comparison with the purchased credit-impaired port-
folio. The Firm has not, and does not, originate option ARMs.
Option ARMs are adjustable-rate mortgage products that provide the
borrower with the option to make a fully amortizing, interest-only, or
minimum payment. The minimum payment is based upon the interest
rate charged during the introductory period. This introductory rate is
typically well below the fully indexed rate. The fully indexed rate is
calculated using an index rate plus a margin. Once the introductory
period ends, the contractual interest rate charged on the loan
increases to the fully indexed rate. If the borrower continues to make
the minimum monthly payment after the introductory period ends,
the payment may not be sufficient to cover interest accrued in the
previous month. In this case, the loan will “negatively amortize” as
unpaid interest is deferred and added to the principal balance of the
loan. Option ARMs typically become fully amortizing loans upon
reaching a negative amortization cap or on dates specified in the
borrowing agreement, at which time the required monthly payment
generally increases substantially.
Auto loans: As of December 31, 2008, auto loans of $42.6 billion
increased slightly from year-end 2007. The allowance for loan losses
for the auto loan portfolio was increased during 2008, reflecting an
increase in estimated losses due to an increase in loss severity and
further deterioration of older vintage loans as a result of the worsen-
ing credit environment and declines in auto resale values. The auto
loan portfolio reflects a high concentration of prime quality credits. In
response to recent increases in loan delinquencies and credit losses,
particularly in MSAs experiencing the greatest housing price depreci-
ation and highest unemployment, credit underwriting criteria have
been tightened, which has resulted in the reduction of both extend-
ed-term and high loan-to-value financing.
Credit card: JPMorgan Chase analyzes its credit card portfolio on
a managed basis, which includes credit card receivables on the
Consolidated Balance Sheets and those receivables sold to investors
through securitization. Managed credit card receivables were
$190.3 billion at December 31, 2008, an increase of $33.3 billion
from year-end 2007, reflecting the acquisition of credit card loans
as part of the Washington Mutual transaction, as well as organic
growth in the portfolio.
The managed credit card net charge-off rate increased to 5.01% for
2008 from 3.68% in 2007. This increase was due primarily to higher
charge-offs as a result of the current economic environment, espe-
cially in areas experiencing the greatest housing price depreciation
and highest unemployment. The 30-day managed delinquency rate
increased to 4.97% at December 31, 2008, from 3.48% at
December 31, 2007, partially as a result of the addition of credit card
loans acquired in the Washington Mutual transaction. Excluding the
Washington Mutual portfolio, the 30-day managed delinquency rate
was 4.36%. The Allowance for loan losses was increased due to high-
er estimated net charge-offs in the portfolio. As a result of continued
weakness in housing markets, account acquisition credit criteria and
account management credit practices have been tightened, particular-
ly in MSAs experiencing significant home price declines. The managed
credit card portfolio continues to reflect a well-seasoned, largely
rewards-based portfolio that has good U.S. geographic diversification.
All other loans: All other loans primarily include business banking
loans (which are highly collateralized loans, often with personal loan
guarantees), student loans, and other secured and unsecured con-
sumer loans. As of December 31, 2008, other loans, including loans
held-for-sale, of $35.5 billion were up $6.8 billion from year-end
2007, primarily as a result of organic growth in business banking
loans and student loans, as well as an increase in business banking
loans as a result of the Washington Mutual transaction.
Purchased credit-impaired loans: Purchased credit-impaired
loans of $88.8 billion in the home lending portfolio represent loans
acquired in the Washington Mutual transaction that were recorded at
fair value at the time of acquisition under SOP 03-3. The fair value of
these loans includes an estimate of losses that are expected to be
incurred over the estimated remaining lives of the loans, and there-
fore no allowance for loan losses was recorded for these loans as of
the transaction date. Through year-end 2008, the credit performance
of these loans has generally been consistent with the assumptions
used in determining the initial fair value of these loans, and the
Firm’s original expectations regarding the amounts and timing of
future cash flows has not changed. A probable decrease in manage-
ment’s expectation of future cash collections related to these loans
could result in the need to record an allowance for credit losses
related to these loans in the future. A significant and probable
increase in expected cash flows would generally result in an increase
in interest income recognized over the remaining life of the underly-
ing pool of loans.
Other real estate owned: As part of the residential real estate
foreclosure process, loans are written down to net realizable value
less a cost to sell the asset. In those instances where the Firm gains
title, ownership and possession of individual properties at the com-
pletion of the foreclosure process, these Other Real Estate Owned
(OREO) assets are managed for prompt sale and disposition at the
best possible economic value. Any further gain or loss on sale of the
disposition of OREO assets are recorded as part of other income.