JP Morgan Chase 2005 Annual Report Download - page 110

Notes to consolidated financial statements
JPMorgan Chase & Co.
108 JPMorgan Chase & Co. /2005 Annual Report
JPMorgan Chase maintains an allowance for credit losses as follows:
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 Allowance for loan losses:
December 31, (in millions) 2005 2004(c)
Allowance for loan losses at January 1 $ 7,320 $ 4,523
Addition resulting from the Merger, July 1, 2004 —3,123
Gross charge-offs (4,869) (3,805)(d)
Gross recoveries 1,050 706
Net charge-offs (3,819) (3,099)
Provision for loan losses:
Provision excluding
accounting policy conformity 3,575 1,798
Accounting policy conformity(a) —1,085
Total Provision for loan losses 3,575 2,883
Other 14 (110)(e)
Allowance for loan losses at December 31 $ 7,090(b) $ 7,320(f)
(a) Represents an increase of approximately $1.4 billion as a result of the decertification of
heritage Bank One seller’s interest in credit card securitizations, partially offset by a
reduction of $357 million to conform provision methodologies.
(b) 2005 includes $203 million of asset-specific and $6.9 billion of formula-based allowance.
Included within the formula-based allowance was $5.1 billion related to a statistical calculation
(including $400 million related to Hurricane Katrina), and an adjustment to the statistical
calculation of $1.8 billion.
(c) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
(d) Includes $406 million related to the Manufactured Home Loan portfolio in the fourth
quarter of 2004.
(e) Primarily represents the transfer of the allowance for accrued interest and fees on reported
and securitized credit card loans.
(f) 2004 includes $469 million of asset-specific loss and $6.8 billion of formula-based loss.
Included within the formula-based loss is $4.8 billion related to statistical calculation and
an adjustment to the statistical calculation of $2.0 billion.
The table below summarizes the changes in the Allowance for lending-related
commitments:
December 31, (in millions) 2005 2004(c)
Allowance for lending-related commitments
at January 1 $ 492 $ 324
Addition resulting from the Merger, July 1, 2004 —508
Provision for lending-related commitments:
Provision excluding
accounting policy conformity (92) (112)
Accounting policy conformity(a) —(227)
Total Provision for lending-related commitments (92) (339)
Other —(1)
Allowance for lending-related commitments
at December 31(b) $ 400 $ 492
(a) Represents a reduction of $227 million to conform provision methodologies in the
wholesale portfolio.
(b) 2005 includes $60 million of asset-specific and $340 million of formula-based allowance. 2004
includes $130 million of asset-specific and $362 million of formula-based allowance. The
formula-based allowance for lending-related commitments is based upon a statistical calculation.
There is no adjustment to the statistical calculation for lending-related commitments.
(c) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
Note 13 – Loan securitizations
JPMorgan Chase securitizes, sells and services various consumer loans, such
as consumer real estate, credit card and automobile loans, as well as certain
wholesale loans (primarily real estate) originated by the Investment Bank. In
addition, the Investment Bank purchases, packages and securitizes commercial
and consumer loans. All IB activity is collectively referred to below as Wholesale
activities. Interests in the sold and securitized loans may be retained.
The Firm records a loan securitization as a sale when the transferred loans are
legally isolated from the Firm’s creditors and the accounting criteria for a sale
are met. Those criteria are (1) the assets are legally isolated from the Firm’s
creditors; (2) the entity can pledge or exchange the financial assets or, if the
entity is a QSPE, its investors can pledge or exchange their interests; and (3) the
Firm does not maintain effective control via an agreement to repurchase the
assets before their maturity or have the ability to unilaterally cause the holder
to return the assets.
Gains or losses recorded on loan securitizations depend, in part, on the carrying
amount of the loans sold and are allocated between the loans sold and the
retained interests, based upon their relative fair values at the date of sale. Gains
on securitizations are reported in noninterest revenue. Since quoted market
prices are generally not available, the Firm usually estimates the fair value of
these retained interests by determining the present value of future expected
cash flows using modeling techniques. Such models incorporate management’s
best estimates of key variables, such as expected credit losses, prepayment
speeds and the discount rates appropriate for the risks involved.
Retained interests that are subject to prepayment risk, such that JPMorgan
Chase may not recover substantially all of its investment, are recorded at fair
value; subsequent adjustments are reflected in Other comprehensive income or in
earnings, if the fair value of the retained interest has declined below its carrying
amount and such decline has been determined to be other-than-temporary.
Interests in the securitized loans are generally retained by the Firm in the form
of senior or subordinated interest-only strips, subordinated tranches, escrow
accounts and servicing rights, and they are generally recorded in Other assets.
In addition, credit card securitization trusts require the Firm to maintain a
minimum undivided interest in the trusts, representing the Firm’s interests in
the receivables transferred to the trust that have not been securitized. These
interests are not represented by security certificates. The Firm’s undivided
interests are carried at historical cost and are classified in Loans. Retained
interests from wholesale activities are reflected as trading assets.
JPMorgan Chase retains servicing responsibilities for all residential mortgage,
credit card and automobile loan securitizations and for certain wholesale
activity securitizations it sponsors, and receives servicing fees based on the
securitized loan balance plus certain ancillary fees. The Firm also retains the
right to service the residential mortgage loans it sells in connection with
mortgage-backed securities transactions with the Government National
Mortgage Association (“GNMA”), Federal National Mortgage Association
(“FNMA”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”).
For a discussion of mortgage servicing rights, see Note 15 on pages 114–116
of this Annual report.
JPMorgan Chase-sponsored securitizations utilize SPEs as part of the securiti-
zation process. These SPEs are structured to meet the definition of a QSPE
(as discussed in Note 1 on page 91 of this Annual Report); accordingly, the
assets and liabilities of securitization-related QSPEs are not reflected in the
Firm’s Consolidated balance sheets (except for retained interests, as described
below) but are included on the balance sheet of the QSPE purchasing the