JP Morgan Chase 2015 Annual Report Download - page 272

Notes to consolidated financial statements
262 JPMorgan Chase & Co./2015 Annual Report
Note 15 – 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, and
represents management’s estimate of probable credit losses
inherent in the Firm’s loan portfolio. The allowance for loan
losses includes an asset-specific component, a formula-
based component and a component related to PCI loans, as
described below. Management also estimates an allowance
for wholesale and consumer lending-related commitments
using methodologies similar to those used to estimate the
allowance on the underlying loans. During 2015, the Firm
did not make any significant changes to the methodologies
or policies used to determine its allowance for credit losses;
such policies are described in the following paragraphs.
The asset-specific component of the allowance relates to
loans considered to be impaired, which includes loans that
have been modified in TDRs as well as risk-rated loans that
have been placed on nonaccrual status. To determine the
asset-specific component of the allowance, larger loans are
evaluated individually, while smaller loans are evaluated as
pools using historical loss experience for the respective
class of assets. Scored loans (i.e., consumer loans) are
pooled by product type, while risk-rated loans (primarily
wholesale loans) are segmented by risk rating.
The Firm generally measures the asset-specific allowance as
the difference between the recorded investment in the loan
and the present value of the cash flows expected to be
collected, discounted at the loan’s original effective interest
rate. Subsequent changes in impairment are reported as an
adjustment to the provision for loan losses. In certain cases,
the asset-specific allowance is determined using an
observable market price, and the allowance is measured as
the difference between the recorded investment in the loan
and the loan’s fair value. Impaired collateral-dependent
loans are charged down to the fair value of collateral less
costs to sell and therefore may not be subject to an asset-
specific reserve as are other impaired loans. See Note 14
for more information about charge-offs and collateral-
dependent loans.
The asset-specific component of the allowance for impaired
loans that have been modified in TDRs incorporates the
effects of foregone interest, if any, in the present value
calculation and also incorporates the effect of the
modification on the loan’s expected cash flows, which
considers the potential for redefault. For residential real
estate loans modified in TDRs, the Firm develops product-
specific probability of default estimates, which are applied
at a loan level to compute expected 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 loans. For credit
card loans modified in TDRs, expected losses incorporate
projected redefaults based on the Firm’s historical
experience by type of modification program. For wholesale
loans modified in TDRs, expected losses incorporate
redefaults based on management’s expectation of the
borrower’s ability to repay under the modified terms.
The formula-based component is based on a statistical
calculation to provide for incurred credit losses in
performing risk-rated loans and all consumer loans, except
for any loans restructured in TDRs and PCI loans. See Note
14 for more information on PCI loans.
For scored loans, the statistical calculation is performed on
pools of loans with similar risk characteristics (e.g., product
type) and generally computed by applying loss factors to
outstanding principal balances over an estimated loss
emergence period. 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.