JP Morgan Chase 2008 Annual Report Download - page 181

JPMorgan Chase & Co./ 2008 Annual Report 179
The formula-based component covers performing wholesale and con-
sumer loans. For risk-rated loans (generally loans originated by the
wholesale lines of business), it is based on a statistical calculation,
which is adjusted to take into consideration model imprecision, exter-
nal factors and current economic events that have occurred but are
not yet reflected in the factors used to derive the statistical calcula-
tion. The statistical calculation is the product of probability of default
(“PD”) and loss given default (“LGD”). These factors are differentiat-
ed by risk rating and expected maturity. PD estimates are based on
observable external data, primarily credit-rating agency default statis-
tics. LGD estimates are based on a study of actual credit losses over
more than one credit cycle. For scored loans (generally loans originat-
ed by the consumer lines of business), loss is primarily determined by
applying statistical loss factors, including loss frequency and severity
factors, to pools of loans by asset type. In developing loss frequency
and severity assumptions, known and anticipated changes in the eco-
nomic environment, including changes in housing prices, unemploy-
ment rates and other risk indicators, are considered. Multiple forecast-
ing methods are used to estimate statistical losses, including credit
loss forecasting models and vintage-based loss forecasting.
Management applies its judgment within specified ranges to adjust
the statistical calculation. Where adjustments are made to the statis-
tical calculation for the risk-rated portfolios, the determination of the
appropriate point within the range are based upon management’s
quantitative and qualitative assessment of the quality of underwrit-
ing standards; relevant internal factors affecting the credit quality of
the current portfolio; and external factors such as current macroeco-
nomic and political conditions that have occurred but are not yet
reflected in the loss factors. 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 his-
torical loss experience for each major product segment. The specific
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, the 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 manage-
ment’s estimate of probable credit losses inherent in the Firm’s
process of extending credit. Management establishes an asset-specif-
ic 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.
Determining the appropriateness of the allowance is complex and
requires judgment by management about the effect of matters that
are inherently uncertain. Subsequent evaluations of the loan portfo-
lio, in light of the factors then prevailing, may result in significant
changes in the allowances for loan losses and lending-related com-
mitments in future periods.
At least quarterly, the allowance for credit losses is reviewed by the
Chief Risk Officer, the Chief Financial Officer and the Controller of
the Firm and discussed with the Risk Policy and Audit Committees of
the Board of Directors of the Firm. As of December 31, 2008,
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).
The table below summarizes the changes in the allowance for
loan losses.
Year ended December 31, (in millions) 2008 2007 2006
Allowance for loan losses at
January 1 $ 9,234 $ 7,279 $ 7,090
Cumulative effect of change in
accounting principles(a) —(56) —
Allowance for loan losses at
January 1, adjusted 9,234 7,223 7,090
Gross charge-offs 10,764 5,367 3,884
Gross (recoveries) (929) (829) (842)
Net charge-offs 9,835 4,538 3,042
Provision for loan losses
Provision excluding accounting
conformity 19,660 6,538 3,153
Provision for loan losses – accounting
conformity(b) 1,577 ——
Total provision for loan losses 21,237 6,538 3,153
Addition resulting from
Washington Mutual transaction 2,535 ——
Other(c) (7) 11 78
Allowance for loan losses at
December 31 $ 23,164 $ 9,234 $ 7,279
Components:
Asset-specific $ 786 $ 188 $ 118
Formula-based 22,378 9,046 7,161
Total Allowance for loan losses $ 23,164 $ 9,234 $ 7,279
(a) Reflects the effect of the adoption of SFAS 159 at January 1, 2007. For a further
discussion of SFAS 159, see Note 5 on pages 156–158 of this Annual Report.
(b) Relates to the Washington Mutual transaction in 2008.
(c) The 2008 amount represents foreign-exchange translation. The 2007 amount repre-
sents assets acquired of $5 million and $5 million of foreign-exchange translation.
The 2006 amount represents the Bank of New York transaction.