JP Morgan Chase 2010 Annual Report Download - page 146

Management’s discussion and analysis
146 JPMorgan Chase & Co./2010 Annual Report
Immediate changes in interest rates present a limited view of risk,
and so a number of alternative scenarios are also reviewed. These
scenarios include the implied forward curve, nonparallel rate shifts
and severe interest rate shocks on selected key rates. These scenar-
ios are intended to provide a comprehensive view of JPMorgan
Chase’s earnings at risk over a wide range of outcomes.
JPMorgan Chase’s 12-month pretax earnings sensitivity profiles as
of December 31, 2010 and 2009, were as follows.
Immediate change in rates
December 31,
(in millions)
+200bp
+100bp
-
100bp
-
200
bp
2010 $ 2,465 $ 1,483 NM
(a)
(b)
NM
(a)(b)
2009 (1,594) (554) NM
(a)
NM
(a)
(a) Downward 100- and 200-basis-point parallel shocks result in a Fed Funds
target rate of zero, and negative three- and six-month Treasury rates. The
earnings-at-risk results of such a low-probability scenario are not meaningful.
(b) Excludes economic value stress losses.
The change in earnings at risk from December 31, 2009, resulted from
investment portfolio repositioning, assumed higher levels of deposit
balances and reduced levels of fixed-rate loans. The Firm’s risk to rising
rates was largely the result of widening deposit margins, which are
currently compressed due to very low short-term interest rates.
Additionally, another interest rate scenario conducted by the Firm –
involving a steeper yield curve with long-term rates rising by 100 basis
points and short-term rates staying at current levels – results in a 12-
month pretax earnings benefit of $770 million. The increase in earnings
under this scenario is due to reinvestment of maturing assets at the
higher long-term rates, with funding costs remaining unchanged.
Risk monitoring and control
Limits
Market risk is controlled primarily through a series of limits.
Limits reflect the Firm’s risk appetite in the context of the market
environment and business strategy. In setting limits, the Firm
takes into consideration factors such as senior management risk
appetite, market volatility, product liquidity, accommodation of
client business and management experience.
Market risk management regularly reviews and updates risk limits.
Senior management, including the Firm’s Chief Executive Officer
and Chief Risk Officer, is responsible for reviewing and approving
cetain risk limits on an ongoing basis.
The Firm maintains different levels of limits. Corporate-level limits
include VaR and stress limits. Similarly, line-of-business limits include
VaR and stress limits and may be supplemented by loss advisories,
nonstatistical measurements and profit and loss drawdowns. Busi-
nesses are responsible for adhering to established limits, against
which exposures are monitored and reported. Limit breaches are
reported in a timely manner to senior management, and the affected
line-of-business is required to reduce trading positions or consult with
senior management on the appropriate action.
Model review
Some of the Firm’s financial instruments cannot be valued based on
quoted market prices but are instead valued using pricing models.
These pricing models and VaR models are used for management of
risk positions, such as reporting against limits, as well as for valua-
tion. The Model Risk Group, which is independent of the businesses
and market risk management, reviews the models the Firm uses and
assesses model appropriateness and consistency. The model reviews
consider a number of factors about the model’s suitability for valua-
tion and risk management of a particular product. These factors
include whether the model accurately reflects the characteristics of
the transaction and its significant risks, the suitability and conver-
gence properties of numerical algorithms, reliability of data sources,
consistency of the treatment with models for similar products, and
sensitivity to input parameters and assumptions that cannot be priced
from the market.
Reviews are conducted of new or changed models, as well as previ-
ously accepted models, to assess whether there have been any
changes in the product or market that may affect the model’s validity
and whether there are theoretical or competitive developments that
may require reassessment of the model’s adequacy. For a summary of
valuations based on models, see Critical Accounting Estimates Used
by the Firm on pages 149–154 of this Annual Report.
Risk reporting
Nonstatistical risk measures, VaR, loss advisories and limit excesses
are reported daily to the lines of business and to senior manage-
ment. Market risk exposure trends, VaR trends, profit-and-loss
changes and portfolio concentrations are reported weekly. Stress-
test results are also reported weekly to the lines of business and to
senior management.