JP Morgan Chase 2012 Annual Report Download - page 149

JPMorgan Chase & Co./2012 Annual Report 159
Credit Portfolio Management activities
Credit Portfolio Management derivatives
Notional amount of
protection
purchased and sold (a)
December 31, (in millions) 2012 2011
Credit derivatives used to manage:
Loans and lending-related commitments $ 2,166 $ 3,488
Derivative receivables 25,347 22,883
Total net protection purchased 27,513 26,371
Total net protection sold 66 131
Credit Portfolio Management derivatives
net notional $ 27,447 $ 26,240
(a) Amounts are presented net, considering the Firm’s net protection
purchased or sold with respect to each underlying reference entity or
index.
The credit derivatives used in Credit Portfolio Management
activities do not qualify for hedge accounting under U.S.
GAAP; these derivatives are reported at fair value, with
gains and losses recognized in principal transactions
revenue. In contrast, the loans and lending-related
commitments being risk-managed are accounted for on an
accrual basis. This asymmetry in accounting treatment,
between loans and lending-related commitments and the
credit derivatives used in credit portfolio management
activities, causes earnings volatility that is not
representative, in the Firm’s view, of the true changes in
value of the Firm’s overall credit exposure. In addition, the
effectiveness of the Firm’s credit default swap (“CDS”)
protection as a hedge of the Firm’s exposures may vary
depending on a number of factors, including the maturity of
the Firm’s CDS protection (which in some cases may be
shorter than the Firm’s exposures), the named reference
entity (i.e., the Firm may experience losses on specific
exposures that are different than the named reference
entities in the purchased CDS), and the contractual terms of
the CDS (which may have a defined credit event that does
not align with an actual loss realized by the Firm).
The fair value related to the Firm’s credit derivatives used
for managing credit exposure, as well as the fair value
related to the CVA (which reflects the credit quality of
derivatives counterparty exposure), are included in the
gains and losses realized on credit derivatives disclosed in
the table below. These results can vary from period to
period due to market conditions that affect specific
positions in the portfolio.
Net gains and losses on credit portfolio hedges
Year ended December 31,
(in millions) 2012 2011 2010
Hedges of loans and lending-
related commitments $ (163) $ (32) $ (279)
CVA and hedges of CVA 127 (769) (403)
Net gains/(losses) $ (36) $ (801) $ (682)
COMMUNITY REINVESTMENT ACT EXPOSURE
The Community Reinvestment Act (“CRA”) encourages
banks to meet the credit needs of borrowers in all segments
of their communities, including neighborhoods with low or
moderate incomes. The Firm is a national leader in
community development by providing loans, investments
and community development services in communities
across the United States.
At December 31, 2012 and 2011, the Firm’s CRA loan
portfolio was approximately $16 billion and $15 billion,
respectively. At December 31, 2012 and 2011, 62% and
63%, respectively, of the CRA portfolio were residential
mortgage loans; 18% and 17%, respectively, were business
banking loans; 13% and 14%, respectively, were
commercial real estate loans; and 7% and 6%, respectively,
were other loans. CRA nonaccrual loans were 4% and 6%,
respectively, of the Firm’s total nonaccrual loans. For the
years ended December 31, 2012 and 2011, net charge-offs
in the CRA portfolio were 3% of the Firm’s net charge-offs
in both years.
ALLOWANCE FOR CREDIT LOSSES
JPMorgan Chase’s allowance for loan losses covers the
consumer, including credit card, portfolio segments
(primarily scored); and wholesale (risk-rated) portfolio. The
allowance represents management’s estimate of probable
credit losses inherent in the Firm’s loan portfolio.
Management also determines an allowance for wholesale
and certain consumer, excluding credit card, lending-related
commitments.
The allowance for loan losses includes an asset-specific
component, a formula-based component, and a component
related to PCI loans. The asset-specific component and the
PCI loan component are generally based on an estimate of
cash flows expected to be collected from specifically
identified impaired or PCI loans. The formula-based
component is based on a statistical calculation to provide
for probable principal losses inherent in the remaining loan
portfolios. Within the formula-based component,
management applies judgment within an established
framework to adjust the results of applying its statistical
loss calculation. The determination of the appropriate
adjustment is based on management’s view of uncertainties
that have occurred but are not yet reflected in the statistical
calculation and that relate to current macroeconomic and
political conditions, the quality of underwriting standards,
and other relevant internal and external factors affecting