JP Morgan Chase 2005 Annual Report Download - page 109

JPMorgan Chase & Co. /2005 Annual Report 107
The following table reflects information about the Firm’s loans held for sale,
principally mortgage-related:
Year ended December 31, (in millions)(a) 2005 2004 2003
Net gains on sales of loans held for sale $ 596 $ 368 $ 933
Lower of cost or fair value adjustments (332) 39 26
(a) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
Impaired loans
JPMorgan Chase accounts for and discloses nonaccrual loans as impaired loans
and recognizes their interest income as discussed previously for nonaccrual
loans. The Firm excludes from impaired loans its small-balance, homogeneous
consumer loans; loans carried at fair value or the lower of cost or fair value;
debt securities; and leases.
The table below sets forth information about JPMorgan Chase’s impaired
loans. The Firm primarily uses the discounted cash flow method for valuing
impaired loans:
December 31, (in millions)(a) 2005 2004
Impaired loans with an allowance $ 1,095 $ 1,496
Impaired loans without an allowance(b) 80 284
Total impaired loans $ 1,175 $ 1,780
Allowance for impaired loans under SFAS 114(c) $ 257 $ 521
Average balance of impaired loans during the year 1,478 1,883
Interest income recognized on impaired
loans during the year 58
(a) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
(b) When the discounted cash flows, collateral value or market price equals or exceeds the
carrying value of the loan, then the loan does not require an allowance under SFAS 114.
(c) The allowance for impaired loans under SFAS 114 is included in JPMorgan Chase’s
Allowance for loan losses.
Note 12 – Allowance for credit losses
JPMorgan Chase’s Allowance for loan losses covers the wholesale (risk-rated)
and consumer (scored) loan portfolios and represents management’s estimate
of probable credit losses inherent in the Firm’s loan portfolio. Management
also computes an Allowance for wholesale lending-related commitments
using a methodology similar to that used for the wholesale loans.
The Allowance for loan losses includes an asset-specific component and a
formula-based component. Within the formula-based component is a statistical
calculation and an adjustment to the statistical calculation.
The asset-specific component relates to provisions for losses on loans considered
impaired and measured pursuant to SFAS 114. An allowance is established
when the discounted cash flows (or collateral value or observable market
price) of the loan is lower than the carrying value of that loan. To compute
the asset-specific component of the allowance, 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.
The formula-based component covers performing wholesale and consumer
loans and is the product of a statistical calculation, as well as adjustments to
such calculation. These adjustments take into consideration model imprecision,
external factors and economic events that have occurred but are not yet
reflected in the factors used to derive the statistical calculation.
The statistical calculation is the product of probability of default and loss
given default. For risk-rated loans (generally loans originated by the wholesale
lines of business), these factors are differentiated by risk rating and maturity.
For scored loans (generally loans originated by the consumer lines of business),
loss is primarily determined by applying statistical loss factors and other risk
indicators to pools of loans by asset type. Adjustments to the statistical
calculation for the risk-rated portfolios are determined by creating estimated
ranges using historical experience of both loss given default and probability
of default. Factors related to concentrated and deteriorating industries are
also incorporated into the calculation where relevant. Adjustments to the
statistical calculation for the scored loan portfolios are accomplished in part
by analyzing the historical loss experience for each major product segment.
The estimated ranges and the determination of the appropriate point within
the range are based upon management’s view of uncertainties that relate
to current macroeconomic and political conditions, quality of underwriting
standards, and other relevant internal and external factors affecting the credit
quality of the portfolio.
The Allowance for lending-related commitments represents management’s
estimate of probable credit losses inherent in the Firm’s process of extending
credit. Management establishes an asset-specific allowance for lending-related
commitments that are considered impaired and computes a formula-based
allowance for performing wholesale lending-related commitments. These are
computed using a methodology similar to that used for the wholesale loan
portfolio, modified for expected maturities and probabilities of drawdown.
The allowance for credit losses is reviewed at least quarterly by the Chief
Risk Officer of the Firm, the Risk Policy Committee, a risk subgroup of the
Operating Committee, and the Audit Committee of the Board of Directors of
the Firm relative to the risk profile of the Firm’s credit portfolio and current
economic conditions. As of December 31, 2005, JPMorgan Chase deemed the
allowance for credit losses to be appropriate (i.e., sufficient to absorb losses
that are inherent in the portfolio, including those not yet identifiable).
As a result of the Merger, management modified its methodology for deter-
mining the Provision for credit losses for the combined Firm. The effect of
conforming methodologies in 2004 was a decrease in the consumer allowance
of $254 million and a decrease in the wholesale allowance (including both
funded loans and lending-related commitments) of $330 million. In addition,
the Bank One seller’s interest in credit card securitizations was decertificated;
this resulted in an increase to the provision for loan losses of approximately
$1.4 billion (pre-tax) in 2004.