JP Morgan Chase 2008 Annual Report Download - page 94

Management’s discussion and analysis
92 JPMorgan Chase & Co./ 2008 Annual Report
On December 19, 2008, S&P lowered the senior long-term debt
ratings on JPMorgan Chase & Co. and its principal bank subsidiaries
one notch from “AA-” and “AA”, respectively; lowered the short-term
debt rating of JPMorgan Chase & Co. from “A-1+”; and affirmed the
short-term debt ratings of its principal bank subsidiaries. These actions
were primarily the result of S&P’s belief that the Firm’s earnings are
likely to decline over the next couple of years in response to increas-
ing loan losses associated with the Firm’s exposure to consumer
lending, as well as declining business volumes. S&P’s current outlook
is negative. On January 15, 2009, Moody’s lowered the senior long-
term debt ratings on JPMorgan Chase & Co. and its principal bank
subsidiaries from “Aa2” and “Aaa”, respectively.These actions were
primarily the result of Moody’s view that, in the current economic
environment, the Firm may experience difficulties generating capital
and could face significant earnings pressure. Moody’s affirmed the
short-term debt ratings of JPMorgan Chase & Co. and its principal
bank subsidiaries at “P-1”. Moody’s also revised the outlook to
stable from negative due to the Firm’s strong capital ratios, signifi-
cant loan loss reserves, and strong franchise. Ratings from Fitch on
JPMorgan Chase & Co. and its principal bank subsidiaries remained
unchanged from December 31, 2007, and Fitch’s outlook remained
stable. The recent rating actions by S&P and Moody’s did not have a
material impact on the cost or availability of the Firm’s funding. If the
Firm’s senior long-term debt ratings were downgraded by one addi-
tional notch, the Firm believes the incremental cost of funds or loss
of funding would be manageable within the context of current mar-
ket conditions and the Firm’s liquidity resources. JPMorgan Chase’s
unsecured debt, other than in certain cases IB structured notes, does
not contain requirements that would call for an acceleration of pay-
ments, maturities or changes in the structure of the existing debt, nor
contain collateral provisions or the creation of an additional financial
obligation, based on unfavorable changes in the Firm’s credit ratings,
financial ratios, earnings, cash flows or stock price. To the extent any
IB structured notes do contain such provisions, the Firm believes
that, in the event of an acceleration of payments or maturities or
provision of collateral, the securities used by the Firm to risk manage
such structured notes, together with other liquidity resources, are
expected to generate funds sufficient to satisfy the Firm’s obligations.
CREDIT RISK MANAGEMENT
Credit risk is the risk of loss from obligor or counterparty default. The
Firm provides credit (for example, through loans, lending-related
commitments and derivatives) to a variety of customers, from large
corporate and institutional clients to the individual consumer. For the
wholesale business, credit risk management includes the distribution
of syndicated loans originated by the Firm into the marketplace (pri-
marily to IB clients), with exposure held in the retained portfolio
averaging less than 10% of the total originated loans. Wholesale
loans generated by CB and AM are generally retained on the balance
sheet. With regard to the consumer credit market, the Firm focuses
on creating a portfolio that is diversified from both a product and a
geographic perspective. Loss mitigation strategies are being
employed for all home lending portfolios. These strategies include
rate reductions, principal forgiveness, forbearance and other actions
intended to minimize the economic loss and avoid foreclosure. In the
mortgage business, originated loans are either retained in the mort-
gage portfolio or securitized and sold to U.S. government agencies
and U.S. government-sponsored enterprises.
Credit risk organization
Credit risk management is overseen by the Chief Risk Officer and
implemented within the lines of business. The Firm’s credit risk man-
agement governance consists of the following functions:
• establishing a comprehensive credit risk policy framework
• monitoring and managing credit risk across all portfolio seg-
ments, including transaction and line approval
• assigning and managing credit authorities in connection with the
approval of all credit exposure
• managing criticized exposures
• calculating the allowance for credit losses and ensuring appropri-
ate credit risk-based capital management
Risk identification
The Firm is exposed to credit risk through lending and capital mar-
kets activities. The credit risk management organization works in
partnership with the business segments in identifying and aggregat-
ing exposures across all lines of business.
Risk measurement
To measure credit risk, the Firm employs several methodologies for
estimating the likelihood of obligor or counterparty default.
Methodologies for measuring credit risk vary depending on several
factors, including type of asset (e.g., consumer installment versus
wholesale loan), risk measurement parameters (e.g., delinquency sta-
tus and credit bureau score versus wholesale risk rating) and risk
management and collection processes (e.g., retail collection center
versus centrally managed workout groups). Credit risk measurement
is based upon the amount of exposure should the obligor or the
counterparty default, the probability of default and the loss severity
given a default event. Based upon these factors and related market-
based inputs, the Firm estimates both probable and unexpected loss-
es for the wholesale and consumer portfolios. Probable losses,
reflected in the provision for credit losses, are based primarily upon
statistical estimates of credit losses as a result of obligor or counter-
party default. However, probable losses are not the sole indicators of
risk. If losses were entirely predictable, the probable loss rate could
be factored into pricing and covered as a normal and recurring cost
of doing business. Unexpected losses, reflected in the allocation of
credit risk capital, represent the potential volatility of actual losses
relative to the probable level of losses. Risk measurement for the
wholesale portfolio is assessed primarily on a risk-rated basis; for the
consumer portfolio, it is assessed primarily on a credit-scored basis.