JP Morgan Chase 2009 Annual Report Download - page 94

Management’s discussion and analysis
JPMorgan Chase & Co./2009 Annual Report
92
Broker-dealer regulatory capital
JPMorgan Chase’s principal U.S. broker-dealer subsidiaries
are J.P. Morgan Securities Inc. (“JPMorgan Securities”) and
J.P. Morgan Clearing Corp. JPMorgan Securities and J.P. Morgan
Clearing Corp. are each subject to Rule 15c3-1 under the Securi-
ties Exchange Act of 1934 (“Net Capital Rule”). JPMorgan
Securities and J.P. Morgan Clearing Corp. are also registered as
futures commission merchants and subject to Rule 1.17 under the
Commodity Futures Trading Commission (“CFTC”). J.P. Morgan
Clearing Corp., a subsidiary of JPMorgan Securities, provides
clearing and settlement services.
JPMorgan Securities and J.P. Morgan Clearing Corp. have elected to
compute their minimum net capital requirements in accordance with
the “Alternative Net Capital Requirements” of the Net Capital Rule.
At December 31, 2009, JPMorgan Securities’ net capital, as defined
by the Net Capital Rule, of $7.4 billion exceeded the minimum re-
quirement by $6.9 billion. J.P. Morgan Clearing Corp.’s net capital of
$5.2 billion exceeded the minimum requirement by $3.6 billion.
In addition to its minimum net capital requirement, JPMorgan
Securities is required to hold tentative net capital in excess of $1.0
billion and is also required to notify the Securities and Exchange
Commission (“SEC”) in the event that tentative net capital is less
than $5.0 billion, in accordance with the market and credit risk
standards of Appendix E of the Net Capital Rule. As of December
31, 2009, JPMorgan Securities had tentative net capital in excess of
the minimum and notification requirements.
Economic risk capital
JPMorgan Chase assesses its capital adequacy relative to the risks
underlying its business activities, using internal risk-assessment
methodologies. The Firm measures economic capital primarily
based on four risk factors: credit, market, operational and private
equity risk. The growth in economic risk capital from 2008 was
primarily driven by higher credit risk capital within the consumer
businesses, due to the full year effect of the Washington Mutual
transaction and revised performance data in light of the recent
weak economic environment.
Economic risk capital Yearly Average
(in billions) 2009
2008
Credit risk $ 51.3 $
37.8
Market risk 15.4
10.5
Operational risk 8.5
6.3
Private equity risk 4.7
5.3
Economic risk capital 79.9
59.9
Goodwill 48.3
46.1
Other(a) 17.7
23.1
Total common stockholders’ equity $ 145.9 $
129.1
(a) Reflects additional capital required, in the Firm’s view, to meet its regulatory
and debt rating objectives.
Credit risk capital
Credit risk capital is estimated separately for the wholesale businesses
(IB, CB, TSS and AM) and consumer businesses (RFS and CS).
Credit risk capital for the overall wholesale credit portfolio is de-
fined 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 allowance for credit losses are maintained. The
capital methodology is based on 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 on 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. Results for certain segments or portfolios are
derived from available benchmarks and are not model-driven.
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, taking into account the
liquidity of the financial instruments. Results from daily VaR, biweekly
stress-test, issuer credit spread and default risk calculations as well as
other factors are used to determine appropriate capital levels. Market
risk capital is allocated to each business segment based on its risk
contribution. See Market Risk Management on pages 126–132 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
operational risk on a bottoms-up basis. The operational risk capital
model is based on 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 products. The Firm believes its model is consistent with the
new Basel II Framework. See Operational Risk Management on
page 133 of this Annual Report for more information about opera-
tional risk.
Private equity risk capital
Capital is allocated to privately- and publicly- held securities, third-
party fund investments, and commitments in the private equity port-
folio to cover the potential loss associated with a decline in equity
markets and related asset devaluations. In addition to negative
market fluctuations, potential losses in private equity investment
portfolios can be magnified by liquidity risk. The capital allocation for
the private equity portfolio is based on measurement of the loss
experience suffered by the Firm and other market participants over a
prolonged period of adverse equity market conditions.
Line of business equity
The Firm’s framework for allocating capital is based on the following
objectives:
• Integrate firmwide capital management activities with capital
management activities within each of the lines of business