JP Morgan Chase 2008 Annual Report Download - page 95

JPMorgan Chase & Co./ 2008 Annual Report 93
Risk-rated exposure
For portfolios that are risk-rated (generally held in IB, CB, TSS and
AM), probable and unexpected loss calculations are based upon esti-
mates of probability of default and loss given default. Probability of
default is the expected default calculated on an obligor basis. Loss
given default is an estimate of losses given a default event and takes
into consideration collateral and structural support for each credit
facility. Calculations and assumptions are based upon management
information systems and methodologies which are under continual
review. Risk ratings are assigned to differentiate risk within the port-
folio and are reviewed on an ongoing basis by credit risk manage-
ment and revised, if needed, to reflect the borrowers’ current risk
profiles and the related collateral and structural positions.
Credit-scored exposure
For credit-scored portfolios (generally held in RFS and CS), probable
loss is based upon a statistical analysis of inherent losses over dis-
crete periods of time. Probable losses are estimated using sophisti-
cated portfolio modeling, credit scoring and decision-support tools to
project credit risks and establish underwriting standards. In addition,
common measures of credit quality derived from historical loss expe-
rience are used to predict consumer losses. Other risk characteristics
evaluated include recent loss experience in the portfolios, changes in
origination sources, portfolio seasoning, loss severity and underlying
credit practices, including charge-off policies. These analyses are
applied to the Firm’s current portfolios in order to estimate delin-
quencies and severity of losses, which determine the amount of
probable losses. These factors and analyses are updated at least on a
quarterly basis or more frequently as market conditions dictate.
Risk monitoring
The Firm has developed policies and practices that are designed to
preserve the independence and integrity of the approval and decision
making of extending credit and are intended to ensure credit risks
are assessed accurately, approved properly, monitored regularly and
managed actively at both the transaction and portfolio levels. The
policy framework establishes credit approval authorities, concentra-
tion limits, risk-rating methodologies, portfolio review parameters
and guidelines for management of distressed exposure. Wholesale
credit risk is monitored regularly on both an aggregate portfolio level
and on an individual customer basis. Management of the Firm’s
wholesale exposure is accomplished through a number of means
including loan syndication and participations, loan sales, securitiza-
tions, credit derivatives, use of master netting agreements and collat-
eral and other risk-reduction techniques, which are further discussed
in the following risk sections. For consumer credit risk, the key focus
items are trends and concentrations at the portfolio level, whereby
potential problems can be remedied through changes in underwrit-
ing policies and portfolio guidelines. Consumer Credit Risk
Management monitors trends against business expectations and
industry benchmarks.
Risk reporting
To enable monitoring of credit risk and decision-making, aggregate
credit exposure, credit quality forecasts, concentrations levels and risk
profile changes are reported regularly to senior credit risk manage-
ment. Detailed portfolio reporting of industry, customer and geo-
graphic concentrations occurs monthly, and the appropriateness of
the allowance for credit losses is reviewed by senior management at
least on a quarterly basis. Through the risk reporting and governance
structure, credit risk trends and limit exceptions are provided regular-
ly to, and discussed with, senior management, for further informa-
tion, see page 86 of this Annual Report.
2008 Credit risk overview
During 2008, credit markets experienced deterioration and increased
defaults and downgrades reflecting, among other things, reduced liq-
uidity. The liquidity and credit crisis has adversely affected many
financial institutions, resulting in the failure of some in both the U.S.
and Europe, and has impacted the functioning of credit markets, par-
ticularly, the loan syndication and asset-backed securitization mar-
kets. The Firm’s credit portfolio was affected by these market condi-
tions and experienced deteriorating credit quality, especially in the
latter part of the year, generally consistent with the market. In 2008,
for the wholesale portfolio, criticized assets and NPAs increased,
from historical lows, 301% and 525%, respectively, from the previ-
ous year. Charge-offs, which typically lag other portfolio deteriora-
tion, have increased from historical lows by 458% over 2007. The
Firm has remained focused on aggressively managing the portfolio,
including ongoing, in-depth reviews of credit quality, as well as of
revisions of industry, product and client concentrations. Risk levels
are adjusted as needed to reflect the Firm’s risk tolerance.
Underwriting standards across all areas of lending have been
strengthened, consistent with evolving market conditions in order to
permit the Firm to lend in a safe and prudent manner. In light of the
current market conditions, the wholesale allowance for loan loss cov-
erage ratio has been strengthened to 2.64%, from 1.67% at the end
of 2007.
Consumer portfolio credit performance continues to be negatively
affected by the economic environment, particularly the weak labor
market and the decline in housing prices which occurred nationally.
As a result, the Firm took actions throughout the year to reduce risk
exposure by tightening underwriting and loan qualification standards
in those markets most affected by the housing downturn. In the
fourth quarter of 2008, the Firm announced plans to significantly
expand loss mitigation efforts related to its mortgage and home
equity portfolios. During the implementation period of these expand-
ed loss mitigation efforts, which was substantially in place in early
2009, the Firm did not place loans into foreclosure. These loss miti-
gation efforts are expected to result in additional increases in the
balance of modified loans carried on the Firm’s balance sheet,
including loans accounted for as troubled debt restructurings, while
minimizing the economic loss to the Firm and assisting homeowners
to remain in their homes.
More detailed discussion of the domestic consumer credit environ-
ment can be found on pages 103–108 of this Annual Report.