JP Morgan Chase 2010 Annual Report Download - page 150

Management’s discussion and analysis
150 JPMorgan Chase & Co./2010 Annual Report
of the current economic downturn, as well as its potential impact on
housing prices and the labor market. While the allowance for credit
losses is highly sensitive to both home prices and unemployment
rates, in the current market it is difficult to estimate how potential
changes in one or both of these factors might affect the allowance for
credit losses. For example, while both factors are important determi-
nants of overall allowance levels, changes in one factor or the other
may not occur at the same rate, or changes may be directionally
inconsistent such that improvement in one factor may offset deterio-
ration in the other. In addition, changes in these factors would not
necessarily be consistent across all geographies or product types.
Finally, it is difficult to predict the extent to which changes in both or
either of these factors would ultimately affect the frequency of losses,
the severity of losses or both; overall loss rates are a function of both
the frequency and severity of individual loan losses.
The consumer allowance is calculated by applying statistical loss
factors and other risk indicators to pools of loans with similar risk
characteristics to arrive at an estimate of incurred losses in the
portfolio. Management applies judgment to the statistical loss
estimates for each loan portfolio category, using delinquency trends
and other risk characteristics to estimate probable losses inherent
in the portfolio. Management uses additional statistical methods
and considers portfolio and collateral valuation trends to review the
appropriateness of the primary statistical loss estimate. The statisti-
cal calculation is then adjusted to take into consideration model
imprecision, external factors and current economic events that have
occurred but are not yet reflected in the factors used to derive the
statistical calculation; this adjustment is accomplished in part by
analyzing the historical loss experience for each major product
segment. In the current economic environment, it is difficult to
predict whether historical loss experience is indicative of future loss
levels. Management applies judgment in making this adjustment,
taking into account uncertainties associated with current macro-
economic and political conditions, quality of underwriting stan-
dards, borrower behavior and other relevant internal and external
factors affecting the credit quality of the portfolio. For junior lien
products, management considers the delinquency and/or modifica-
tion status of any senior liens in determining the adjustment. The
application of different inputs into the statistical calculation, and
the assumptions used by management to adjust the statistical
calculation, are subject to management judgment, and emphasizing
one input or assumption over another, or considering other inputs
or assumptions, could affect the estimate of the allowance for loan
losses for the consumer credit portfolio.