JP Morgan Chase 2014 Annual Report Download - page 138

Management’s discussion and analysis
136 JPMorgan Chase & Co./2014 Annual Report
Nonstatistical risk measures
Nonstatistical risk measures include sensitivities to
variables used to value positions, such as credit spread
sensitivities, interest rate basis point values and market
values. These measures provide granular information on the
Firm’s market risk exposure. They are aggregated by line-of-
business and by risk type, and are used for tactical control
and monitoring limits.
Loss advisories and profit and loss drawdowns
Loss advisories and profit and loss drawdowns are tools
used to highlight trading losses above certain levels of risk
tolerance. Profit and loss drawdowns are defined as the
decline in net profit and loss since the year-to-date peak
revenue level.
Earnings-at-risk
The VaR and stress-test measures described above illustrate
the total economic sensitivity of the Firm’s Consolidated
balance sheets to changes in market variables. The effect of
interest rate exposure on the Firm’s reported net income is
also important as interest rate risk represents one of the
Firm’s significant market risks. Interest rate risk arises not
only from trading activities but also from the Firm’s
traditional banking activities, which include extension of
loans and credit facilities, taking deposits and issuing debt.
The Firm evaluates its structural interest rate risk exposure
through earnings-at-risk, which measures the extent to
which changes in interest rates will affect the Firm’s core
net interest income (see page 78 for further discussion of
core net interest income) and interest rate-sensitive fees.
Earnings-at-risk excludes the impact of trading activities
and MSR, as these sensitivities are captured under VaR.
The CIO, Treasury and Corporate (“CTC”) Risk Committee
establishes the Firm’s structural interest rate risk policies
and market risk limits, which are subject to approval by the
Risk Policy Committee of the Firm’s Board of Directors. CIO,
working in partnership with the lines of business, calculates
the Firm’s structural interest rate risk profile and reviews it
with senior management including the CTC Risk Committee
and the Firm’s ALCO. In addition, oversight of structural
interest rate risk is managed through a dedicated risk
function reporting to the CTC CRO. This risk function is
responsible for providing independent oversight and
governance around assumptions; and establishing and
monitoring limits for structural interest rate risk.
Structural interest rate risk can occur due to a variety of
factors, including:
• Differences in the timing among the maturity or repricing
of assets, liabilities and off-balance sheet instruments.
• Differences in the amounts of assets, liabilities and off-
balance sheet instruments that are repricing at the same
time.
• Differences in the amounts by which short-term and long-
term market interest rates change (for example, changes
in the slope of the yield curve).
• The impact of changes in the maturity of various assets,
liabilities or off-balance sheet instruments as interest
rates change.
The Firm manages interest rate exposure related to its
assets and liabilities on a consolidated, corporate-wide
basis. Business units transfer their interest rate risk to
Treasury through a transfer-pricing system, which takes into
account the elements of interest rate exposure that can be
risk-managed in financial markets. These elements include
asset and liability balances and contractual rates of interest,
contractual principal payment schedules, expected
prepayment experience, interest rate reset dates and
maturities, rate indices used for repricing, and any interest
rate ceilings or floors for adjustable rate products. All
transfer-pricing assumptions are dynamically reviewed.
The Firm manages structural interest rate risk generally
through its investment securities portfolio and related
derivatives.
The Firm conducts simulations of changes in structural
interest rate-sensitive revenue under a variety of interest
rate scenarios. Earnings-at-risk scenarios estimate the
potential change in this revenue, and the corresponding
impact to the Firm’s pretax core net interest income, over
the following 12 months, utilizing multiple assumptions as
described below. These scenarios highlight exposures to
changes in interest rates, pricing sensitivities on deposits,
optionality and changes in product mix. The scenarios
include forecasted balance sheet changes, as well as
prepayment and reinvestment behavior. Mortgage
prepayment assumptions are based on current interest
rates compared with underlying contractual rates, the time
since origination, and other factors which are updated
periodically based on historical experience.
JPMorgan Chase’s 12-month pretax core net interest
income sensitivity profiles.
(Excludes the impact of trading activities and MSRs)
Instantaneous change in rates
(in millions) +200 bps +100 bps -100 bps -200 bps
December 31, 2014 $ 4,667 $ 2,864 NM (a) NM (a)
(a) Downward 100- and 200-basis-points parallel shocks result in a
federal funds target rate of zero and negative three- and six-month
U.S. Treasury rates. The earnings-at-risk results of such a low-
probability scenario are not meaningful.
The Firm’s benefit to rising rates is largely a result of
reinvesting at higher yields and assets re-pricing at a faster
pace than deposits.
Additionally, another interest rate scenario used by the Firm
— involving a steeper yield curve with long-term rates rising
by 100 basis points and short-term rates staying at current
levels — results in a 12-month pretax core net interest
income benefit of $566 million. The increase in core net
interest income under this scenario reflects the Firm
reinvesting at the higher long-term rates, with funding costs
remaining unchanged.