JP Morgan Chase 2013 Annual Report Download - page 268

Notes to consolidated financial statements
274 JPMorgan Chase & Co./2013 Annual Report
Purchased credit-impaired loans
PCI loans are initially recorded at fair value at acquisition;
PCI loans acquired in the same fiscal quarter may be
aggregated into one or more pools, provided 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 consumer PCI
loans were aggregated into pools of loans with common risk
characteristics.
On a quarterly basis, the Firm estimates the total cash flows
(both principal and interest) expected to be collected over
the remaining life of each 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. Probable decreases
in expected cash flows (i.e., increased credit losses) trigger
the recognition 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 for credit losses and an increase in
the allowance for loan losses. Probable and significant
increases in expected cash flows (e.g., decreased 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) prepayments, (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.
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. In
evaluating the effect of modifications on expected cash
flows, the Firm incorporates the effect of any foregone
interest and also considers the potential for redefault. The
Firm develops product-specific probability of default
estimates, which are used to compute expected credit
losses. In developing these probabilities of default, the Firm
considers the relationship between the credit quality
characteristics of the underlying loans and certain
assumptions about home prices and unemployment based
upon industry-wide data. The Firm also considers its own
historical loss experience to-date based on actual
redefaulted modified PCI loans.
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.
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 nonaccrual 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.
The liquidation of PCI loans, which may include sales of
loans, receipt of payment in full by the borrower, or
foreclosure, results in removal of the loans from the
underlying PCI pool. When the amount of the liquidation
proceeds (e.g., cash, real estate), if any, is less than the
unpaid principal balance of the loan, the difference is first
applied against the PCI pool’s nonaccretable difference for
principal losses (i.e., the lifetime credit loss estimate
established as a purchase accounting adjustment at the
acquisition date). When the nonaccretable difference for a
particular loan pool has been fully depleted, any excess of
the unpaid principal balance of the loan over the liquidation
proceeds is written off against the PCI pool’s allowance for
loan losses. Because the Firm’s PCI loans are accounted for
at a pool level, the Firm does not recognize charge-offs of
PCI loans when they reach specified stages of delinquency
(i.e., unlike non-PCI consumer loans, these loans are not
charged off based on FFIEC standards).
The PCI portfolio affects the Firm’s results of operations
primarily through: (i) contribution to net interest margin;
(ii) expense related 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 example, 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
declining balance of the portfolio, which is estimated as of
December 31, 2013, to have a remaining weighted-average
life of 8 years.