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 2012, 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 for other impaired loans. See Note 14 on pages 250–275 of this Annual Report 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 probable principal losses inherent in performing risk-rated loans and all consumer loans, except for any loans restructured in TDRs and PCI loans. See Note 14 on pages 250–275 of this Annual Report 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 expected 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.

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 differentiated by risk rating and expected maturity. 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 to that loan. 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.

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 uncertainties 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 accomplished 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 also consider concentrated and deteriorating industries.

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, 2012, JPMorgan Chase deemed the allowance for credit losses to be appropriate (i.e., sufficient to absorb probable credit losses that are inherent in the portfolio).

Allowance for credit losses and loans and lending-related commitments by impairment methodology

The table below summarizes information about the allowance for loan losses, loans by impairment methodology, the allowance for lending-related commitments and lending-related commitments by impairment methodology.



	2012
Year ended December 31, (in millions)	Consumer, excluding credit card				Credit card				Wholesale			Total
Allowance for loan losses
Beginning balance at January 1,	$	16,294			$	6,999			$	4,316		$	27,609
Cumulative effect of change in accounting principles^(a)	—				—				—			—
Gross charge-offs	4,805			^(c)	5,755				346			10,906
Gross recoveries	(508		)		(811		)		(524		)	(1,843		)
Net charge-offs	4,297			^(c)	4,944				(178		)	9,063
Provision for loan losses	302				3,444				(359		)	3,387
Other	(7		)		2				8			3
Ending balance at December 31,	$	12,292			$	5,501			$	4,143		$	21,936

Allowance for loan losses by impairment methodology
Asset-specific^(b)	$	729			$	1,681		^(d)	$	319		$	2,729
Formula-based	5,852				3,820				3,824			13,496
PCI	5,711				—				—			5,711
Total allowance for loan losses	$	12,292			$	5,501			$	4,143		$	21,936

Loans by impairment methodology
Asset-specific	$	13,938			$	4,762			$	1,475		$	20,175
Formula-based	218,945				123,231				304,728			646,904
PCI	59,737				—				19			59,756
Total retained loans	$	292,620			$	127,993			$	306,222		$	726,835

Impaired collateral-dependent loans
Net charge-offs	$	973		^(c)	$	—			$	77		$	1,050
Loans measured at fair value of collateral less cost to sell	3,272				—				445			3,717

Allowance for lending-related commitments
Beginning balance at January 1,	$	7			$	—			$	666		$	673
Cumulative effect of change in accounting principles^(a)	—				—				—			—
Provision for lending-related commitments	—				—				(2		)	(2		)
Other	—				—				(3		)	(3		)
Ending balance at December 31,	$	7			$	—			$	661		$	668

Allowance for lending-related commitments by impairment methodology
Asset-specific	$	—			$	—			$	97		$	97
Formula-based	7				—				564			571
Total allowance for lending-related commitments	$	7			$	—			$	661		$	668

Lending-related commitments by impairment methodology
Asset-specific	$	—			$	—			$	355		$	355
Formula-based	60,156				533,018				434,459			1,027,633
Total lending-related commitments	$	60,156			$	533,018			$	434,814		$	1,027,988

(a)

Effective January 1, 2010, the Firm adopted accounting guidance related to VIEs. Upon adoption of the guidance, the Firm consolidated its Firm-sponsored credit card securitization trusts, its Firm-administered multi-seller conduits and certain other consumer loan securitization entities, primarily mortgage-related. As a result, $7.4 billion, $14 million and $127 million, respectively, of allowance for loan losses were recorded on-balance sheet with the consolidation of these entities. For further discussion, see Note 16 on pages 280–291 of this Annual Report.


(b)	Includes risk-rated loans that have been placed on nonaccrual status and loans that have been modified in a TDR.


(c)	Consumer, excluding credit card, charge-offs for the year ended December 31, 2012, included $747 million of charge-offs for Chapter 7 residential real estate loans and $53 million of charge-offs for Chapter 7 auto loans.


(d)	The asset-specific credit card allowance for loan losses is related to loans that have been modified in a TDR; such allowance is calculated based on the loans’ original contractual interest rates and does not consider any incremental penalty rates.



(table continued from previous page)
2011													2010
Consumer, excluding credit card			Credit card				Wholesale			Total			Consumer, excluding credit card			Credit card				Wholesale			Total

$	16,471		$	11,034			$	4,761		$	32,266		$	14,785		$	9,672			$	7,145		$	31,602
—			—				—			—			127			7,353				14			7,494
5,419			8,168				916			14,503			8,383			15,410				1,989			25,782
(547		)	(1,243		)		(476		)	(2,266		)	(474		)	(1,373		)		(262		)	(2,109		)
4,872			6,925				440			12,237			7,909			14,037				1,727			23,673
4,670			2,925				17			7,612			9,458			8,037				(673		)	16,822
25			(35		)		(22		)	(32		)	10			9				2			21
$	16,294		$	6,999			$	4,316		$	27,609		$	16,471		$	11,034			$	4,761		$	32,266


$	828		$	2,727		^(d)	$	516		$	4,071		$	1,075		$	4,069		^(d)	$	1,574		$	6,718
9,755			4,272				3,800			17,827			10,455			6,965				3,187			20,607
5,711			—				—			5,711			4,941			—				—			4,941
$	16,294		$	6,999			$	4,316		$	27,609		$	16,471		$	11,034			$	4,761		$	32,266


$	9,892		$	7,214			$	2,549		$	19,655		$	6,220		$	10,005			$	5,486		$	21,711
232,989			124,961				275,825			633,775			248,481			125,519				216,980			590,980
65,546			—				21			65,567			72,763			—				44			72,807
$	308,427		$	132,175			$	278,395		$	718,997		$	327,464		$	135,524			$	222,510		$	685,498


$	110		$	—			$	128		$	238		$	304		$	—			$	636		$	940
830			—				833			1,663			890			—				1,269			2,159


$	6		$	—			$	711		$	717		$	12		$	—			$	927		$	939
—			—				—			—			—			—				(18		)	(18		)
2			—				(40		)	(38		)	(6		)	—				(177		)	(183		)
(1		)	—				(5		)	(6		)	—			—				(21		)	(21		)
$	7		$	—			$	666		$	673		$	6		$	—			$	711		$	717


$	—		$	—			$	150		$	150		$	—		$	—			$	180		$	180
7			—				516			523			6			—				531			537
$	7		$	—			$	666		$	673		$	6		$	—			$	711		$	717


$	—		$	—			$	865		$	865		$	—		$	—			$	1,005		$	1,005
62,307			530,616				381,874			974,797			65,403			547,227				345,074			957,704
$	62,307		$	530,616			$	382,739		$	975,662		$	65,403		$	547,227			$	346,079		$	958,709