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 retained loan portfolio. The allowance for loan losses includes a formula-based component, an asset-specific component, and a component related to PCI loans, as described below. Management also estimates an allowance for wholesale and certain consumer lending-related commitments using methodologies similar to those used to estimate the allowance on the underlying loans. During 2016, 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.

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 CRO, the CFO and the Controller of the Firm and discussed with the DRPC and the Audit Committee. As of December 31, 2016, JPMorgan Chase deemed the allowance for credit losses to be appropriate (i.e., sufficient to absorb probable credit losses inherent in the portfolio).

Formula-based component

The formula-based component is based on a statistical calculation to provide for incurred credit losses in all consumer loans and performing risk-rated loans, except for any loans restructured in TDRs and PCI loans, which are calculated as a part of the asset-specific and PCI components, respectively, and are discussed later in this Note. See Note 14 for more information on TDRs and PCI loans.

Formula-based component - Consumer loans and certain lending-related commitments

The formula-based allowance for credit losses for the consumer portfolio segments is calculated by applying statistical credit loss factors (estimated PD and loss severities) to the recorded investment balances or loan-equivalent amounts of pools of loan exposures with similar risk characteristics over a loss emergence period to arrive at an estimate of incurred credit losses. 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 actual portfolio performance, including actual losses recognized on defaulted loans and collateral valuation trends, to review the appropriateness of the primary statistical loss estimate. 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.

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 credit 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., housing prices), FICO scores, borrower behavior and other risk factors. While all of these factors are important determinants of overall allowance levels, changes in the various factors may not occur at the same time or at the same rate, or changes may be directionally inconsistent such that improvement in one factor may offset deterioration in the other. In addition, changes in these factors would not necessarily be consistent across all geographies or product types. Finally, it is difficult to predict the extent to which changes in these factors would ultimately affect the frequency of losses, the severity of losses or both.

Formula-based component - Wholesale loans and lending-related commitments

The Firm’s methodology for determining the allowance for loan losses and the allowance for lending-related commitments involves the early identification of credits that are deteriorating. The formula-based component of the allowance for wholesale loans and lending-related commitments is calculated by applying statistical credit loss factors (estimated PD and LGD) to the recorded investment balances or loan-equivalent amount over a loss emergence period to arrive at an estimate of incurred credit losses.

The Firm assesses the credit quality of its borrower or counterparty and assigns a risk rating. Risk ratings are assigned at origination or acquisition, and if necessary, adjusted for changes in credit quality over the life of the exposure. In assessing the risk rating of a particular loan or lending-related commitment, 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. Determining risk ratings involves significant judgment; emphasizing one factor over another or considering additional factors could affect the risk rating assigned by the Firm.

PD estimates are based on observable external through-the-cycle data, using credit rating agency default statistics.

An LGD estimate is assigned to each loan or lending-related commitment. The estimate represents the amount of economic loss if the obligor were to default. The type of obligor, quality of collateral, and the seniority of the Firm’s lending exposure in the obligor’s capital structure affect LGD. LGD estimates are based on the Firm’s history of actual credit losses over more than one credit cycle. Changes to the time period used for PD and LGD estimates (for example, point-in-time loss versus longer-term views of the credit cycle) could also affect the allowance for credit losses.

The Firm applies judgment in estimating PD, LGD, loss emergence period and loan-equivalent amounts used in calculating the allowance for credit losses. Wherever possible, the Firm uses independent, verifiable data or the Firm’s own historical loss experience in its models for estimating the allowances, but differences in characteristics between the Firm’s specific loans or lending-related commitments and those reflected in external and Firm-specific historical data could affect loss estimates. Estimates of PD, LGD, loss emergence period and loan-equivalent used are subject to periodic refinement based on any changes to underlying external or Firm-specific historical data. The use of different inputs, estimates or methodologies could change the amount of the allowance for credit losses determined appropriate by the Firm.

In addition to the modeled loss estimates applied to wholesale loans and lending-related commitments, management applies its judgment to adjust the modeled loss estimates for wholesale loans, taking into consideration model imprecision, external factors and economic events that have occurred but are not yet reflected in the loss factors. Historical experience of both LGD and PD are considered when estimating these adjustments. Factors related to concentrated and deteriorating industries also are incorporated where relevant. These estimates are based on management’s view of uncertainties that relate to current macroeconomic, quality of underwriting standards and other relevant internal and external factors affecting the credit quality of the current portfolio.

Asset-specific component

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 allowance 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. For any of these impaired loans, the amount of the asset-specific allowance required to be recorded, if any, is dependent upon the recorded investment in the loan (including prior charge-offs), expected cash flows and/or fair value of assets. 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 forgone 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 management’s expectation of the borrower’s ability to repay under the modified terms.

Estimating the timing and amounts of future cash flows is highly judgmental as these cash flow projections rely upon estimates such as loss severities, asset valuations, default rates (including redefault rates on modified loans), the amounts and timing of interest or principal payments (including any expected prepayments) or other factors that are reflective of current and expected market conditions. These estimates are, in turn, dependent on factors such as the duration of current overall economic conditions, industry-, portfolio-, or borrower-specific factors, the expected outcome of insolvency proceedings as well as, in certain circumstances, other economic factors, including the level of future home prices. All of these estimates and assumptions require significant management judgment and certain assumptions are highly subjective.

PCI loans

In connection with the Washington Mutual transaction, JPMorgan Chase acquired certain PCI loans, which are accounted for as described in Note 14. The allowance for loan losses for the PCI portfolio is based on quarterly estimates of the amount of principal and interest cash flows expected to be collected over the estimated remaining lives of the loans.

These cash flow projections are based on estimates regarding default rates (including redefault rates on modified loans), loss severities, the amounts and timing of prepayments and other factors that are reflective of current and expected future market conditions. These estimates are dependent on assumptions regarding the level of future home prices, and the duration of current overall economic conditions, among other factors. These estimates and assumptions require significant management judgment and certain assumptions are highly subjective.

Allowance for credit losses and related information

The table below summarizes information about the allowances for loan losses, and lending-relating commitments, and includes a breakdown of loans and lending-related commitments by impairment methodology.



	2016
Year ended December 31, (in millions)	Consumer, excluding credit card			Credit card				Wholesale			Total
Allowance for loan losses
Beginning balance at January 1,	$	5,806		$	3,434			$	4,315		$	13,555
Gross charge-offs	1,500			3,799				398			5,697
Gross recoveries	(591		)	(357		)		(57		)	(1,005		)
Net charge-offs/(recoveries)	909			3,442				341			4,692
Write-offs of PCI loans^(a)	156			—				—			156
Provision for loan losses	467			4,042				571			5,080
Other	(10		)	—				(1		)	(11		)
Ending balance at December 31,	$	5,198		$	4,034			$	4,544		$	13,776

Allowance for loan losses by impairment methodology
Asset-specific^(b)	$	308		$	358		^(c)	$	342		$	1,008
Formula-based	2,579			3,676				4,202			10,457
PCI	2,311			—				—			2,311
Total allowance for loan losses	$	5,198		$	4,034			$	4,544		$	13,776

Loans by impairment methodology
Asset-specific	$	8,940		$	1,240			$	2,017		$	12,197
Formula-based	319,787			140,471				381,770			842,028
PCI	35,679			—				3			35,682
Total retained loans	$	364,406		$	141,711			$	383,790		$	889,907

Impaired collateral-dependent loans
Net charge-offs	$	98		$	—			$	7		$	105
Loans measured at fair value of collateral less cost to sell	2,391			—				300			2,691

Allowance for lending-related commitments
Beginning balance at January 1,	$	14		$	—			$	772		$	786
Provision for lending-related commitments	—			—				281			281
Other	12			—				(1		)	11
Ending balance at December 31,	$	26		$	—			$	1,052		$	1,078

Allowance for lending-related commitments by impairment methodology
Asset-specific	$	—		$	—			$	169		$	169
Formula-based	26			—				883			909
Total allowance for lending-related commitments	$	26		$	—			$	1,052		$	1,078

Lending-related commitments by impairment methodology
Asset-specific	$	—		$	—			$	506		$	506
Formula-based	54,797			553,891				367,508			976,196
Total lending-related commitments	$	54,797		$	553,891			$	368,014		$	976,702

(a)

Write-offs of PCI loans are recorded against the allowance for loan losses when actual losses for a pool exceed estimated losses that were recorded as purchase accounting adjustments at the time of acquisition. A write-off of a PCI loan is recognized when the underlying loan is removed from a pool (e.g., upon liquidation). During the fourth quarter of 2014, the Firm recorded a $291 million adjustment to reduce the PCI allowance and the recorded investment in the Firm’s PCI loan portfolio, primarily reflecting the cumulative effect of interest forgiveness modifications. This adjustment had no impact to the Firm’s Consolidated statements of income.


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


(c)	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.

(d)

Effective January 1, 2015, the Firm no longer includes within its disclosure of wholesale lending-related commitments the unused amount of advised uncommitted lines of credit as it is within the Firm’s discretion whether or not to make a loan under these lines, and the Firm’s approval is generally required prior to funding. Prior period amounts have been revised to conform with the current period presentation.



(table continued from previous page)
2015														2014
Consumer, excluding credit card			Credit card				Wholesale				Total			Consumer, excluding credit card			Credit card				Wholesale				Total

$	7,050		$	3,439			$	3,696			$	14,185		$	8,456		$	3,795			$	4,013			$	16,264
1,658			3,488				95				5,241			2,132			3,831				151				6,114
(704		)	(366		)		(85		)		(1,155		)	(814		)	(402		)		(139		)		(1,355		)
954			3,122				10				4,086			1,318			3,429				12				4,759
208			—				—				208			533			—				—				533
(82		)	3,122				623				3,663			414			3,079				(269		)		3,224
—			(5		)		6				1			31			(6		)		(36		)		(11		)
$	5,806		$	3,434			$	4,315			$	13,555		$	7,050		$	3,439			$	3,696			$	14,185


$	364		$	460		^(c)	$	274			$	1,098		$	539		$	500		^(c)	$	87			$	1,126
2,700			2,974				4,041				9,715			3,186			2,939				3,609				9,734
2,742			—				—				2,742			3,325			—				—				3,325
$	5,806		$	3,434			$	4,315			$	13,555		$	7,050		$	3,439			$	3,696			$	14,185


$	9,606		$	1,465			$	1,024			$	12,095		$	12,020		$	2,029			$	637			$	14,686
293,751			129,922				356,022				779,695			236,263			125,998				323,861				686,122
40,998			—				4				41,002			46,696			—				4				46,700
$	344,355		$	131,387			$	357,050			$	832,792		$	294,979		$	128,027			$	324,502			$	747,508


$	104		$	—			$	16			$	120		$	133		$	—			$	21			$	154
2,566			—				283				2,849			3,025			—				326				3,351


$	13		$	—			$	609			$	622		$	8		$	—			$	697			$	705
1			—				163				164			5			—				(90		)		(85		)
—			—				—				—			—			—				2				2
$	14		$	—			$	772			$	786		$	13		$	—			$	609			$	622


$	—		$	—			$	73			$	73		$	—		$	—			$	60			$	60
14			—				699				713			13			—				549				562
$	14		$	—			$	772			$	786		$	13		$	—			$	609			$	622


$	—		$	—			$	193			$	193		$	—		$	—			$	103			$	103
58,478			515,518				366,206			^(d)	940,202			58,153			525,963				366,778			^(d)	950,894
$	58,478		$	515,518			$	366,399			$	940,395		$	58,153		$	525,963			$	366,881			$	950,997