JP Morgan Chase 2010 Annual Report Download - page 116

Management’s discussion and analysis
116 JPMorgan Chase & Co./2010 Annual Report
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, guarantees and derivatives) to a variety of
customers, from large corporate and institutional clients to the
individual consumer. Loans originated or acquired by the Firm’s
wholesale businesses are generally retained on the balance sheet.
Credit risk management actively monitors the wholesale portfolio to
ensure that it is well diversified across industry, geography, risk
rating, maturity and individual client categories. Portfolio manage-
ment for wholesale loans includes, for the Firm’s syndicated loan
business, distributing originations into the market place, targeting
exposure held in the retained wholesale portfolio at less than 10%
of the customer facility. With regard to the consumer credit market,
the Firm focuses on creating a portfolio that is diversified from a
product, industry and geographic perspective. Loss mitigation
strategies are being employed for all home lending portfolios.
These strategies include rate reductions, forbearance and other
actions intended to minimize economic loss and avoid foreclosure.
In the mortgage business, originated loans are either retained in
the mortgage 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
management governance consists of the following functions:
• Establishing a comprehensive credit risk policy framework
• Monitoring and managing credit risk across all portfolio
segments, including transaction and line approval
• Assigning and managing credit authorities in connection with
the approval of all credit exposure
• Managing criticized exposures and delinquent loans
• Determining the allowance for credit losses and ensuring appro-
priate credit risk-based capital management
Risk identification
The Firm is exposed to credit risk through lending and capital
markets activities. Credit Risk Management works in partnership
with the business segments in identifying and aggregating expo-
sures 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. Meth-
odologies for measuring credit risk vary depending on several
factors, including type of asset (e.g., consumer versus wholesale),
risk measurement parameters (e.g., delinquency status and bor-
rower’s credit score versus wholesale risk-rating) and risk manage-
ment and collection processes (e.g., retail collection center versus
centrally managed workout groups). Credit risk measurement is
based on the amount of exposure should the obligor or the coun-
terparty default, the probability of default and the loss severity
given a default event. Based on these factors and related market-
based inputs, the Firm estimates both probable and unexpected
losses for the wholesale and consumer portfolios as follows:
• Probable losses are based primarily upon statistical estimates of
credit losses as a result of obligor or counterparty default. How-
ever, probable losses are not the sole indicators of risk.
• Unexpected losses, reflected in the allocation of credit risk capi-
tal, 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.
Risk-rated exposure
Risk ratings are assigned to differentiate risk within the portfolio
and are reviewed on an ongoing basis by Credit Risk Management
and revised, if needed, to reflect the borrowers’ current financial
positions, risk profiles and the related collateral. For portfolios that
are risk-rated, probable and unexpected loss calculations are based
on estimates of probability of default and loss severity given a
default. These risk-rated portfolios are generally held in IB, CB, TSS
and AM; they also include approximately $18 billion of certain
business banking and auto loans in RFS that are risk-rated because
they have characteristics similar to commercial loans. Probability of
default is the likelihood that a loan will not be repaid and will
default. Probability of default is calculated for each client who has a
risk-rated loan (wholesale and certain risk-rated consumer loans).
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 on manage-
ment information systems and methodologies which are under
continual review.