JP Morgan Chase 2008 Annual Report Download - page 85

JPMorgan Chase & Co./ 2008 Annual Report 83
Credit risk capital
Credit risk capital is estimated separately for the wholesale business-
es (IB, CB, TSS and AM) and consumer businesses (RFS and CS).
Credit risk capital for the overall wholesale credit portfolio is defined
in terms of unexpected credit losses, both from defaults and declines
in the portfolio value due to credit deterioration, measured over a
one-year period at a confidence level consistent with an “AA” credit
rating standard. Unexpected losses are losses in excess of those for
which provisions for credit losses are maintained. The capital
methodology is based upon several principal drivers of credit risk:
exposure at default (or loan-equivalent amount), default likelihood,
credit spreads, loss severity and portfolio correlation.
Credit risk capital for the consumer portfolio is based upon product
and other relevant risk segmentation. Actual segment level default
and severity experience are used to estimate unexpected losses for a
one-year horizon at a confidence level consistent with an “AA” credit
rating standard. Statistical results for certain segments or portfolios
are adjusted to ensure that capital is consistent with external bench-
marks, such as subordination levels on market transactions or capital
held at representative monoline competitors, where appropriate.
Market risk capital
The Firm calculates market risk capital guided by the principle that
capital should reflect the risk of loss in the value of portfolios and
financial instruments caused by adverse movements in market vari-
ables, such as interest and foreign exchange rates, credit spreads,
securities prices and commodities prices. Daily Value-at-Risk (“VaR”),
biweekly stress-test results and other factors are used to determine
appropriate capital levels. The Firm allocates market risk capital to
each business segment according to a formula that weights that seg-
ment’s VaR and stress-test exposures. See Market Risk Management
on pages 111–116 of this Annual Report for more information about
these market risk measures.
Operational risk capital
Capital is allocated to the lines of business for operational risk using
a risk-based capital allocation methodology which estimates opera-
tional risk on a bottom-up basis. The operational risk capital model is
based upon actual losses and potential scenario-based stress losses,
with adjustments to the capital calculation to reflect changes in the
quality of the control environment or the use of risk-transfer prod-
ucts. The Firm believes its model is consistent with the new Basel II
Framework.
Private equity risk capital
Capital is allocated to privately and publicly held securities, third-party
fund investments and commitments in the private equity portfolio to
cover the potential loss associated with a decline in equity markets
and related asset devaluations. In addition to negative market fluctua-
tions, potential losses in private equity investment portfolios can be
magnified by liquidity risk. The capital allocation for the private equity
portfolio is based upon measurement of the loss experience suffered
by the Firm and other market participants over a prolonged period of
adverse equity market conditions.
Regulatory capital
The Board of Governors of the Federal Reserve System (the “Federal
Reserve”) establishes capital requirements, including well-capitalized
standards for the consolidated financial holding company. The Office
of the Comptroller of the Currency (“OCC”) establishes similar capital
requirements and standards for the Firm’s national banks, including
JPMorgan Chase Bank, N.A., and Chase Bank USA, N.A.
The Federal Reserve granted the Firm, for a period of 18 months fol-
lowing the Bear Stearns merger, relief up to a certain specified
amount and subject to certain conditions from the Federal Reserve’s
risk-based capital and leverage requirements with respect to Bear
Stearns’ risk-weighted assets and other exposures acquired. The
amount of such relief is subject to reduction by one-sixth each quarter
subsequent to the merger and expires on October 1, 2009. The OCC
granted JPMorgan Chase Bank, N.A. similar relief from its risk-based
capital and leverage requirements.
JPMorgan Chase maintained a well-capitalized position, based upon
Tier 1 and Total capital ratios at December 31, 2008 and 2007, as
indicated in the tables below. For more information, see Note 30 on
pages 212–213 of this Annual Report.
Risk-based capital components and assets
December 31, (in millions) 2008 2007
Total Tier 1 capital(a) $ 136,104 $ 88,746
Total Tier 2 capital 48,616 43,496
Total capital $ 184,720 $ 132,242
Risk-weighted assets $ 1,244,659 $1,051,879
Total adjusted average assets 1,966,895 1,473,541
(a) The FASB has been deliberating certain amendments to both SFAS 140 and FIN 46R
that may impact the accounting for transactions that involve QSPEs and VIEs. Based
on the provisions of the current proposal and the Firm’s interpretation of the propos-
al, the Firm estimates that the impact of consolidation could be up to $70 billion of
credit card receivables, $40 billion of assets related to Firm-sponsored multi-seller
conduits, and $50 billion of other loans (including residential mortgages); the
decrease in the Tier 1 capital ratio could be approximately 80 basis points. The ulti-
mate impact could differ significantly due to the FASB’s continuing deliberations on
the final requirements of the rule and market conditions.