JP Morgan Chase 2010 Annual Report Download - page 233

JPMorgan Chase & Co./2010 Annual Report 233
Purchased credit-impaired (“PCI”) loans
PCI loans were determined to be credit-impaired upon acquisition
based on specific risk characteristics of the loan, including prod-
uct type, loan-to-value ratios, FICO scores, and past-due status.
Upon acquisition, credit-impaired loans acquired in the same
fiscal quarter may be aggregated into one or more pools, pro-
vided that the loans have common risk characteristics. A pool is
then accounted for as a single asset with a single composite
interest rate and an aggregate expectation of cash flows. With
respect to the Washington Mutual transaction, all of the con-
sumer loans were aggregated into pools of loans with common
risk characteristics.
PCI loans are initially recorded at fair value upon acquisition. For
each PCI loan, or pool of loans, the Firm is required to estimate the
total cash flows (both principal and interest) expected to be col-
lected over the remaining life of the loan or pool. These estimates
incorporate assumptions regarding default rates, loss severities, the
amounts and timing of prepayments and other factors that reflect
then-current market conditions.
The excess of cash flows expected to be collected over the carrying
value of the underlying loans is referred to as the accretable yield.
This amount is not reported on the Firm’s Consolidated Balance
Sheets but is accreted into interest income at a level rate of return
over the remaining estimated lives of the underlying pools of loans.
For variable-rate loans, expected future cash flows were initially
based on the rate in effect at acquisition; expected future cash
flows are recalculated as rates change over the lives of the loans.
On a quarterly basis, the Firm updates the amount of loan princi-
pal and interest cash flows expected to be collected. Probable
decreases in expected loan principal cash flows trigger the recog-
nition of impairment, which is then measured as the present
value of the expected principal loss plus any related foregone
interest cash flows, discounted at the pool’s effective interest
rate. Impairments are recognized through the provision and
allowance for loan losses. Probable and significant increases in
expected cash flows (e.g., decreased principal credit losses, the
net benefit of modifications) would first reverse any previously
recorded allowance for loan losses with any remaining increases
recognized prospectively as a yield adjustment over the remaining
estimated lives of the underlying loans. The impacts of (i) pre-
payments, (ii) changes in variable interest rates, and (iii) any other
changes in the timing of expected cash flows are recognized
prospectively as adjustments to interest income. Disposals of
loans – which may include sales of loans, receipt of payments in
full by the borrower, or foreclosure – result in removal of the loan
from the PCI portfolio.
If the timing and/or amounts of expected cash flows on PCI loans
were determined not to be reasonably estimable, no interest
would be accreted and the loans would be reported as nonac-
crual loans; however, since the timing and amounts of expected
cash flows for the Firm’s PCI consumer loans are reasonably
estimable, interest is being accreted and the loans are being
reported as performing loans.
Charge-offs are not recorded on PCI loans until actual losses
exceed the estimated losses that were recorded as purchase
accounting adjustments at acquisition date. To date, no charge-
offs have been recorded for these consumer loans.
The PCI portfolio affects the Firm’s results of operations primarily
through: (i) contribution to net interest margin; (ii) expense re-
lated to defaults and servicing resulting from the liquidation of
the loans; and (iii) any provision for loan losses. The PCI loans
acquired in the Washington Mutual transaction were funded
based on the interest rate characteristics of the loans. For exam-
ple, variable-rate loans were funded with variable-rate liabilities
and fixed-rate loans were funded with fixed-rate liabilities with a
similar maturity profile. A net spread will be earned on the declin-
ing balance of the portfolio, which is estimated as of December
31, 2010, to have a remaining weighted-average life of 7.0
years.
The Firm continues to modify certain PCI loans. The impact of
these modifications is incorporated into the Firm’s quarterly
assessment of whether a probable and significant change in
expected cash flows has occurred, and the loans continue to be
accounted for and reported as PCI loans. The impact of modifica-
tions on expected cash flows is estimated using the Firm’s experi-
ence with previously modified loans and other relevant data.
Additionally, the Firm monitors the performance of modifications
and updates and/or refines assumptions as experience and
changes in circumstances or data warrant.