JP Morgan Chase 2015 Annual Report Download - page 122

Management’s discussion and analysis
112 JPMorgan Chase & Co./2015 Annual Report
CREDIT RISK MANAGEMENT
Credit risk is the risk of loss arising from the default of a
customer, client or counterparty. The Firm provides credit
to a variety of customers, ranging from large corporate and
institutional clients to individual consumers and small
businesses. In its consumer businesses, the Firm is exposed
to credit risk primarily through its residential real estate,
credit card, auto, business banking and student lending
businesses. Originated mortgage loans are retained in the
mortgage portfolio, securitized or sold to U.S. government
agencies and U.S. government-sponsored enterprises; other
types of consumer loans are typically retained on the
balance sheet. In its wholesale businesses, the Firm is
exposed to credit risk through its underwriting, lending,
market-making, and hedging activities with and for clients
and counterparties, as well as through its operating services
activities (such as cash management and clearing
activities), securities financing activities, investment
securities portfolio, and cash placed with banks. A portion
of the loans originated or acquired by the Firm’s wholesale
businesses are generally retained on the balance sheet; the
Firm’s syndicated loan business distributes a significant
percentage of originations into the market and is an
important component of portfolio management.
Credit risk management
Credit risk management is an independent risk
management function that identifies and monitors credit
risk throughout the Firm and defines credit risk policies and
procedures. The credit risk function reports to the Firm’s
CRO. The Firm’s credit risk management governance
includes the following activities:
• Establishing a comprehensive credit risk policy
framework
• Monitoring and managing credit risk across all portfolio
segments, including transaction and exposure approval
• Setting industry concentration limits and establishing
underwriting guidelines
• Assigning and managing credit authorities in connection
with the approval of all credit exposure
• Managing criticized exposures and delinquent loans
• Determining the allowance for credit losses and ensuring
appropriate credit risk-based capital management
Risk identification and measurement
The Credit Risk Management function identifies, measures,
limits, manages and monitors credit risk across the Firm’s
businesses. To measure credit risk, the Firm employs
several methodologies for estimating the likelihood of
obligor or counterparty default. Methodologies for
measuring credit risk vary depending on several factors,
including type of asset (e.g., consumer versus wholesale),
risk measurement parameters (e.g., delinquency status and
borrower’s credit score versus wholesale risk-rating) and
risk management and collection processes (e.g., retail
collection center versus centrally managed workout
groups). Credit risk measurement is based on the
probability of default of an obligor or counterparty, the loss
severity given a default event and the exposure at default.
Based on these factors and related market-based inputs,
the Firm estimates credit losses for its exposures. Probable
credit losses inherent in the consumer and wholesale loan
portfolios are reflected in the allowance for loan losses, and
probable credit losses inherent in lending-related
commitments are reflected in the allowance for lending-
related commitments. These losses are estimated using
statistical analyses and other factors as described in Note
15. In addition, potential and unexpected credit losses are
reflected in the allocation of credit risk capital and
represent the potential volatility of actual losses relative to
the established allowances for loan losses and lending-
related commitments. The analyses for these losses include
stress testing considering alternative economic scenarios as
described in the Stress testing section below. For further
information, see Critical Accounting Estimates used by the
Firm on pages 165–169.
The methodologies used to estimate credit losses depend
on the characteristics of the credit exposure, as described
below.
Scored exposure
The scored portfolio is generally held in CCB and
predominantly includes residential real estate loans, credit
card loans, certain auto and business banking loans, and
student loans. For the scored portfolio, credit loss estimates
are based on statistical analysis of credit losses over
discrete periods of time. The statistical analysis uses
portfolio modeling, credit scoring, and decision-support
tools, which consider loan-level factors such as delinquency
status, credit scores, collateral values, and other risk
factors. Credit loss analyses also consider, as appropriate,
uncertainties and other factors, including those related to
current macroeconomic and political conditions, the quality
of underwriting standards, and other internal and external
factors. The factors and analysis are updated on a quarterly
basis or more frequently as market conditions dictate.
Risk-rated exposure
Risk-rated portfolios are generally held in CIB, CB and AM,
but also include certain business banking and auto dealer
loans held in CCB that are risk-rated because they have
characteristics similar to commercial loans. For the risk-
rated portfolio, credit loss estimates are based on estimates
of the probability of default (“PD”) and loss severity given a
default. The estimation process begins with risk ratings that
are assigned to each loan facility to differentiate risk within
the portfolio. These risk ratings are reviewed regularly by
Credit Risk Management and revised as needed to reflect
the borrower’s current financial position, risk profile and
related collateral. The probability of default is the likelihood
that a loan will default and not be fully repaid by the
borrower. The loss given default (“LGD”) is the estimated
loss on the loan that would be realized upon the default of