JP Morgan Chase 2015 Annual Report Download - page 273

JPMorgan Chase & Co./2015 Annual Report 263
Loss factors are statistically derived and sensitive to
changes in delinquency status, credit scores, collateral
values and other risk factors. The Firm uses a number of
different forecasting models to estimate both the PD and
the loss severity, including delinquency roll rate models and
credit loss severity models. In developing PD and loss
severity assumptions, the Firm also considers known and
anticipated changes in the economic environment, including
changes in home prices, unemployment rates and other risk
indicators.
A nationally recognized home price index measure is used
to estimate both the PD and the loss severity on residential
real estate loans at the metropolitan statistical areas
(“MSA”) level. Loss severity estimates are regularly
validated by comparison to actual losses recognized on
defaulted loans, market-specific real estate appraisals and
property sales activity. The economic impact of potential
modifications of residential real estate loans is not included
in the statistical calculation because of the uncertainty
regarding the type and results of such modifications.
For risk-rated loans, the statistical calculation is the product
of an estimated PD and an estimated LGD. These factors are
determined based on the credit quality and specific
attributes of the Firm’s loans and lending-related
commitments to each obligor. In assessing the risk rating of
a particular loan, among the factors considered are the
obligor’s debt capacity and financial flexibility, the level of
the obligor’s earnings, the amount and sources for
repayment, the level and nature of contingencies,
management strength, and the industry and geography in
which the obligor operates. These factors are based on an
evaluation of historical and current information, and involve
subjective assessment and interpretation. Emphasizing one
factor over another or considering additional factors could
impact the risk rating assigned by the Firm. PD estimates
are based on observable external through-the-cycle data,
using credit-rating agency default statistics. LGD estimates
are based on the Firm’s history of actual credit losses over
more than one credit cycle. Estimates of PD and LGD are
subject to periodic refinement based on changes to
underlying external and Firm-specific historical data.
Management applies judgment within an established
framework to adjust the results of applying the statistical
calculation described above. The determination of the
appropriate adjustment is based on management’s view of
loss events that have occurred but that are not yet reflected
in the loss factors and that relate to current macroeconomic
and political conditions, the quality of underwriting
standards and other relevant internal and external factors
affecting the credit quality of the portfolio. For the scored
loan portfolios, adjustments to the statistical calculation are
made in part by analyzing the historical loss experience for
each major product segment. Factors related to
unemployment, home prices, borrower behavior and lien
position, the estimated effects of the mortgage foreclosure-
related settlement with federal and state officials and
uncertainties regarding the ultimate success of loan
modifications are incorporated into the calculation, as
appropriate. For junior lien products, management
considers the delinquency and/or modification status of any
senior liens in determining the adjustment. In addition, for
the risk-rated portfolios, any adjustments made to the
statistical calculation take into consideration model
imprecision, deteriorating conditions within an industry,
product or portfolio type, geographic location, credit
concentration, and current economic events that have
occurred but that are not yet reflected in the factors used to
derive the statistical calculation.
Management establishes an asset-specific allowance for
lending-related commitments that are considered impaired
and computes a formula-based allowance for performing
consumer and wholesale lending-related commitments.
These are computed using a methodology similar to that
used for the wholesale loan portfolio, modified for expected
maturities and probabilities of drawdown.
Determining the appropriateness of the allowance is
complex and requires judgment by management about the
effect of matters that are inherently uncertain. Subsequent
evaluations of the loan portfolio, in light of the factors then
prevailing, may result in significant changes in the
allowances for loan losses and lending-related
commitments in future periods. At least quarterly, the
allowance for credit losses is reviewed by the Chief Risk
Officer, the Chief Financial Officer and the Controller of the
Firm and discussed with the Risk Policy and Audit
Committees of the Board of Directors of the Firm. As of
December 31, 2015, JPMorgan Chase deemed the
allowance for credit losses to be appropriate (i.e., sufficient
to absorb probable credit losses inherent in the portfolio).