JP Morgan Chase 2003 Annual Report Download - page 102

Notes to consolidated financial statements
J.P. M organ Chase & Co.
100 J.P. Morgan Chase & Co./ 2003 Annual Report
JPM organ Chase maintains an Allowance for credit losses
as follow s:
Reported in:
Allowance for
credit losses on: Balance sheet Income statement
Loans Allowance for loan losses Provision for credit losses
Lending-related
commitments Other liabilities Provision for credit losses
The table below summarizes the changes in the Allow ance for
loan losses:
Year ended December 31, (in millions) 2003 2002 2001
Allowance for loan losses at January 1 $5,350 $4,524 $ 3,665
Provision for loan losses 1,579 4,039 3,185
Charge-offs (2,818) (4,060) (2,582)
Recoveries 546 384 247
Net charge-offs (2,272) (3,676) (2,335)
Transfer to Other assets(a) (138) — —
Allowance related to purchased portfolios —460 —
Other 439
Allowance for loan losses at December 31 $4,523 $5,350 $ 4,524
(a) Includes $138 million related to the transfer of the allowance for accrued interest and fees on
securitized credit card loans.
Loan securitizations
JPM organ Chase securitizes, sells and services various consumer
loans originated by Chase Financial Services (residential
mortgage, credit card and automobile loans), as w ell as certain
commercial loans (primarily real estate) originated by the
Investment Bank. Interests in the sold and securitized loans may
be retained as described below.
JPM organ Chase records a loan securitization as a sale w hen
the transferred loans are legally isolated from the Firm’s creditors
and the accounting criteria for a sale are met. Gains or losses
recorded on loan securitizations depend, in part, on the carrying
amount of the loans sold and are allocated betw een the loans
sold and the retained interests, based on their relative fair values
at the date of sale. Since quoted market prices are generally not
Note 13
The table below summarizes the changes in the Allow ance for
lending-related commitments:
Year ended December 31, (in millions) 2003 2002 2001
Allowance for lending-related commitments
at January 1 $363 $282 $ 283
Provision for lending-related commitments (39) 292 (3)
Charge-offs —(212) —
Recoveries —— 3
Net charge-offs —(212) 3
Other —1(1)
Allowance for lending-related
commitments at December 31 $324 $363 $ 282
Allowance for credit losses
JPM organ Chase’s Allow ance for loan losses is intended to cover
probable credit losses for w hich either the asset is not specifically
identified or the size of the loss has not been fully determined.
Within the allow ance, there are specific and expected loss com-
ponents and a residual component.
The specific loss component covers those commercial loans
deemed by the Firm to be criticized. The Firm internally catego-
rizes its criticized commercial loans into three groups: doubtful,
substandard and special-mention.
Criticized nonperforming commercial loans (excluding leases) are
considered to be impaired loans. The allow ance for impaired
loans is computed using the methodology under SFAS 114. An
allow ance is established w hen the discounted cash flow s (or col-
lateral value or observable market price) of an impaired loan are
low er than the carrying value of that loan. To compute the spe-
cific loss component of the allow ance, larger impaired loans are
evaluated individually, and smaller impaired loans are evaluated
as a pool using historical loss experience for the respective class
of assets. Criticized but performing loans also are evaluated as a
pool, using historical loss rates.
The expected loss component covers performing commercial
loans (except criticized loans) and consumer loans. Expected
losses are the product of default probability and loss severity.
These factors are differentiated by risk rating and maturity for
commercial loans. The expected loss estimates for each
consumer loan portfolio are based primarily on the Firm’s histori-
cal loss experience for the applicable product portfolio.
Finally, a residual component is maintained to cover uncertain-
ties that could affect management’s estimate of probable losses.
The residual component of the allow ance reflects the margin of
imprecision in the underlying assumptions used for estimating
specific losses and expected losses. It is anticipated that the
residual component of the allow ance will range betw een 10%
and 20% of the total Allow ance for loan losses.
JPM organ Chase’s Risk M anagement Committee review s, at least
quarterly, the Allow ance for credit losses relative to the risk pro-
file of the Firm’s credit portfolio and current economic conditions.
The allow ance is adjusted based on that review if, in manage-
ment’s judgment, changes are w arranted. As of December 31,
2003, JPM organ Chase deemed the allow ance to be appropriate
(i.e., sufficient to absorb losses that are inherent in the portfolio
but not yet identifiable).
To provide for the risk of loss inherent in the credit extension
process, management also computes specific and expected loss
components, as w ell as a residual component, for lending-
related commitments using a methodology similar to that used
for the loan portfolio.
Note 12