JP Morgan Chase 2010 Annual Report Download - page 102

Management’s discussion and analysis
102 JPMorgan Chase & Co./2010 Annual Report
CAPITAL MANAGEMENT
A strong capital position is essential to the Firm’s business strategy
and competitive position. The Firm’s capital strategy focuses on
long-term stability, which enables it to build and invest in market-
leading businesses, even in a highly stressed environment. Senior
management considers the implications on the Firm’s capital
strength prior to making any decision on future business activities.
Capital and earnings are inextricably linked, as earnings directly
affect capital generation for the Firm. In addition to considering the
Firm’s earnings outlook, senior management evaluates all sources
and uses of capital and makes decisions to vary sources or uses to
preserve the Firm’s capital strength.
The Firm’s capital management objectives are to hold capital suffi-
cient to:
• Cover all material risks underlying the Firm’s business activities;
• Maintain “well-capitalized” status under regulatory requirements;
• Achieve debt rating targets;
• Remain flexible to take advantage of future opportunities; and
• Build and invest in businesses, even in a highly stressed
environment.
To meet these objectives, the Firm maintains a robust and disci-
plined capital adequacy assessment process, which is performed
quarterly, and which is intended to enable the Firm to remain well-
capitalized and fund ongoing operations under adverse conditions.
The process assesses the potential impact of alternative economic
and business scenarios on earnings and capital for the Firm’s busi-
nesses individually and in the aggregate over a rolling three-year
period. Economic scenarios, and the parameters underlying those
scenarios, are defined centrally and applied uniformly across the
businesses. These scenarios are articulated in terms of macroeco-
nomic factors, which are key drivers of business results; global
market shocks, which generate short-term but severe trading
losses; and operational risk events, which generate significant one-
time losses. However, even when defining a broad range of scenar-
ios, realized events can always be worse. Accordingly, management
considers additional stresses outside these scenarios as necessary.
The Firm utilized this capital adequacy process in completing the
Federal Reserve Comprehensive Capital Plan. The assessment of
capital adequacy is also evaluated together with the Firm’s Liquidity
Risk Management processes. For further information on the Firm’s
liquidity risk management, see pages 110–115 of this Annual
Report.
The quality and composition of capital are key factors in senior
management’s evaluation of the Firm’s capital adequacy. Accord-
ingly, the Firm holds a significant amount of its capital in the form
of common equity. The Firm uses three capital disciplines:
•
Regulatory capital – The capital required according to standards
stipulated by U.S. bank regulatory agencies.
• Economic risk capital – A bottom-up assessment of the underly-
ing risks of the Firm’s business activities, utilizing internal risk-
assessment methodologies.
• Line of business equity – The amount of equity the Firm believes
each business segment would require if it were operating inde-
pendently, which incorporates sufficient capital to address eco-
nomic risk measures, regulatory capital requirements and capital
levels for similarly rated peers.
Regulatory capital
The Federal Reserve establishes capital requirements, including
well-capitalized standards, for the consolidated financial holding
company. The Office of the Comptroller of the Currency (“OCC”)
establishes similar capital requirements and standards for the Firm’s
national banks, including JPMorgan Chase Bank, N.A. and Chase
Bank USA, N.A.
In connection with the U.S. Government’s Supervisory Capital
Assessment Program in 2009, U.S. banking regulators developed a
new measure of capital, Tier 1 common, which is defined as Tier 1
capital less elements of Tier 1 capital not in the form of common
equity – such as perpetual preferred stock, noncontrolling interests
in subsidiaries and trust preferred capital debt securities. Tier 1
common, a non-GAAP financial measure, is used by banking regu-
lators, investors and analysts to assess and compare the quality and
composition of the Firm’s capital with the capital of other financial
services companies. The Firm uses Tier 1 common along with the
other capital measures to assess and monitor its capital position.
At December 31, 2010 and 2009, JPMorgan Chase maintained Tier
1 and Total capital ratios in excess of the well-capitalized standards
established by the Federal Reserve, as indicated in the tables be-
low. In addition, the Firm’s Tier 1 common ratio was significantly
above the 4% well-capitalized standard established at the time of
the Supervisory Capital Assessment Program. For more information,
see Note 29 on pages 273–274 of this Annual Report.