JP Morgan Chase 2014 Annual Report Download - page 163

JPMorgan Chase & Co./2014 Annual Report 161
CRITICAL ACCOUNTING ESTIMATES USED BY THE FIRM
JPMorgan Chase’s accounting policies and use of estimates
are integral to understanding its reported results. The
Firm’s most complex accounting estimates require
management’s judgment to ascertain the appropriate
carrying value of assets and liabilities. The Firm has
established policies and control procedures intended to
ensure that estimation methods, including any judgments
made as part of such methods, are well-controlled,
independently reviewed and applied consistently from
period to period. The methods used and judgments made
reflect, among other factors, the nature of the assets or
liabilities and the related business and risk management
strategies, which may vary across the Firm’s businesses and
portfolios. In addition, the policies and procedures are
intended to ensure that the process for changing
methodologies occurs in an appropriate manner. The Firm
believes its estimates for determining the carrying value of
its assets and liabilities are appropriate. The following is a
brief description of the Firm’s critical accounting estimates
involving significant judgments.
Allowance for credit losses
JPMorgan Chase’s allowance for credit losses covers the
retained consumer and wholesale loan portfolios, as well as
the Firm’s consumer and wholesale lending-related
commitments. The allowance for loan losses is intended to
adjust the carrying value of the Firm’s loan assets to reflect
probable credit losses inherent in the loan portfolio as of
the balance sheet date. Similarly, the allowance for lending-
related commitments is established to cover probable credit
losses inherent in the lending-related commitments
portfolio as of the balance sheet date.
The allowance for loan losses includes an asset-specific
component, a formula-based component, and a component
related to PCI loans. The determination of each of these
components involves significant judgment on a number of
matters, as discussed below. For further discussion of the
methodologies used in establishing the Firm’s allowance for
credit losses, see Note 15.
Asset-specific component
The asset-specific allowance for loan losses for each of the
Firm’s portfolio segments is generally measured as the
difference between the recorded investment in the impaired
loan and the present value of the cash flows expected to be
collected, discounted at the loan’s original effective interest
rate. Estimating the timing and amounts of future cash
flows is highly judgmental as these cash flow projections
rely upon estimates such as redefault rates, loss severities,
the amounts and timing of prepayments and other factors
that are reflective of current and expected future market
conditions. These estimates are, in turn, dependent on
factors such as the level of future home prices, the duration
of current overall economic conditions, and other
macroeconomic and portfolio-specific factors. All of these
estimates and assumptions require significant management
judgment and certain assumptions are highly subjective.
Formula-based component - Consumer loans and lending-
related commitments, excluding PCI loans
The formula-based allowance for credit losses for the
consumer portfolio, including credit card, is calculated by
applying statistical credit loss factors to outstanding
principal balances over an estimated loss emergence period
to arrive at an estimate of incurred credit losses in the
portfolio. The loss emergence period represents the time
period between the date at which the loss is estimated to
have been incurred and the ultimate realization of that loss
(through a charge-off). Estimated loss emergence periods
may vary by product and may change over time;
management applies judgment in estimating loss
emergence periods, using available credit information and
trends. In addition, management applies judgment to the
statistical loss estimates for each loan portfolio category,
using delinquency trends and other risk characteristics to
estimate the total incurred credit losses 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 statistical calculation is then adjusted to take into
consideration model imprecision, external factors and
current economic events that have occurred but that are
not yet reflected in the factors used to derive the statistical
calculation; these adjustments are accomplished in part by
analyzing the historical loss experience for each major
product segment. However, 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
macroeconomic and political conditions, quality of
underwriting standards, borrower behavior, the potential
impact of payment recasts within the HELOC portfolio, and
other relevant internal and external factors affecting the
credit quality of the portfolio. In certain instances, the
interrelationships between these factors create further
uncertainties. For example, the performance of a HELOC
that experiences a payment recast may be affected by both
the quality of underwriting standards applied in originating
the loan and the general economic conditions in effect at
the time of the payment recast. For junior lien products,
management considers the delinquency and/or
modification 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.
Overall, the allowance for credit losses for the consumer
portfolio, including credit card, is sensitive to changes in the
economic environment (e.g., unemployment rates),
delinquency rates, the realizable value of collateral (e.g.,