JPMORGAN CHASE & CO
Item 1. Business.
Overview
JPMorgan Chase & Co., (“JPMorgan Chase” or the “Firm”) a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the United States of America (“U.S.”), with operations worldwide; the Firm had $2.5 trillion in assets and $254.2 billion in stockholders’ equity as of December 31, 2016. The Firm is a leader in investment banking, financial services for consumers and small businesses, commercial banking, financial transaction processing and asset management. Under the J.P. Morgan and Chase brands, the Firm serves millions of customers in the U.S. and many of the world’s most prominent corporate, institutional and government clients.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank, N.A.”), a national banking association with U.S. branches in 23 states, and Chase Bank USA, National Association (“Chase Bank USA, N.A.”), a national banking association that is the Firm’s credit card-issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan Securities LLC (“JPMorgan Securities”), the Firm’s U.S. investment banking firm. The bank and nonbank subsidiaries of JPMorgan Chase operate nationally as well as through overseas branches and subsidiaries, representative offices and subsidiary foreign banks. One of the Firm’s principal operating subsidiaries in the U.K. is J.P. Morgan Securities plc, a subsidiary of JPMorgan Chase Bank, N.A.
The Firm’s website is www.jpmorganchase.com. JPMorgan Chase makes available free of charge, through its website, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the U.S. Securities and Exchange Commission (the “SEC”). The Firm has adopted, and posted on its website, a Code of Conduct for all employees of the Firm and a Code of Ethics for its Chairman and Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer and all other professionals of the Firm worldwide serving in a finance, accounting, tax or investor relations role.
Business segments
JPMorgan Chase’s activities are organized, for management reporting purposes, into four major reportable business segments, as well as a Corporate segment. The Firm’s consumer business is the Consumer & Community Banking (“CCB”) segment. The Firm’s wholesale business segments are Corporate & Investment Bank (“CIB”), Commercial Banking (“CB”), and Asset & Wealth Management (“AWM”) (formerly Asset Management or “AM”).
A description of the Firm’s business segments and the products and services they provide to their respective client bases is provided in the “Business segment results” section
of Management’s discussion and analysis of financial condition and results of operations (“MD&A”), beginning on page 36 and in Note 33.
Competition
JPMorgan Chase and its subsidiaries and affiliates operate in a highly competitive environment. Competitors include other banks, brokerage firms, investment banking companies, merchant banks, hedge funds, commodity trading companies, private equity firms, insurance companies, mutual fund companies, investment managers, credit card companies, mortgage banking companies, trust companies, securities processing companies, automobile financing companies, leasing companies, e-commerce and other Internet-based companies, financial technology companies, and other companies engaged in providing similar products and services. The Firm’s businesses generally compete on the basis of the quality and variety of the Firm’s products and services, transaction execution, innovation, reputation and price. Competition also varies based on the types of clients, customers, industries and geographies served. With respect to some of its geographies and products, JPMorgan Chase competes globally; with respect to others, the Firm competes on a national or regional basis. The Firm’s ability to compete also depends on its ability to attract and retain professional and other personnel, and on its reputation.
It is likely that competition in the financial services industry will become even more intense as the Firm’s businesses continue to compete with other financial institutions that may have a stronger local presence in certain geographies or that operate under different rules and regulatory regimes than the Firm, or with companies that provide new or innovative products or services that the Firm does not provide.
Supervision and regulation
The Firm is subject to regulation under state and federal laws in the U.S., as well as the applicable laws of each of the various jurisdictions outside the U.S. in which the Firm does business.
As a result of regulatory reforms enacted and proposed in the U.S. and abroad, the Firm has been experiencing a period of significant change in regulation which has had and could continue to have significant consequences for how the Firm conducts business. The Firm continues to work diligently in assessing the regulatory changes it is facing, and is devoting substantial resources to comply with all the new regulations, while, at the same time, endeavoring to best meet the needs and expectations of its customers, clients and shareholders. These efforts include the implementation of new policies, procedures and controls, and appropriate adjustments to the Firm’s business and operations, legal entity structure, and capital and liquidity management. The combined effect of numerous rule-makings by multiple governmental agencies and regulators, and the potential conflicts or inconsistencies among such
Part I
rules, present challenges and risks to the Firm’s business and operations. Given the current status of the regulatory developments, the Firm cannot currently quantify all of the possible effects on its business and operations of the significant changes that are underway. For more information, see Risk Factors on pages 8-21.
Financial holding company:
Consolidated supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company (“BHC”) and a financial holding company, JPMorgan Chase is subject to comprehensive consolidated supervision, regulation and examination by the Federal Reserve. The Federal Reserve acts as an “umbrella regulator” and certain of JPMorgan Chase’s subsidiaries are regulated directly by additional authorities based on the particular activities of those subsidiaries. For example, JPMorgan Chase’s national bank subsidiaries, including JPMorgan Chase Bank, N.A., and Chase Bank USA, N.A., are subject to supervision and regulation by the Office of the Comptroller of the Currency (“OCC”) and, with respect to certain matters, by the Federal Reserve and the Federal Deposit Insurance Corporation (the “FDIC”). Certain non-bank subsidiaries, such as the Firm’s U.S. broker-dealers, are subject to supervision and regulation by the SEC, and subsidiaries of the Firm that engage in certain futures-related and swaps-related activities are subject to supervision and regulation by the Commodity Futures Trading Commission (“CFTC”). J.P. Morgan Securities plc, is a U.K. bank licensed within the European Economic Area (the “EEA”) to undertake all banking activity and is regulated by the U.K. Prudential Regulation Authority (the “PRA”), a subsidiary of the Bank of England which has responsibility for prudential regulation of banks and other systemically important institutions, and by the Financial Conduct Authority (“FCA”), which regulates prudential matters for firms that are not so regulated by the PRA and conduct matters for all market participants. The Firm’s other non-U.S. subsidiaries are regulated by the banking and securities regulatory authorities in the countries in which they operate. See Securities and broker-dealer regulation, Investment management regulation and Derivatives regulation below. In addition, the Firm’s consumer activities are subject to supervision and regulation by the Consumer Financial Protection Bureau (“CFPB”) and to regulation under various state statutes which are enforced by the respective state’s Attorney General.
Scope of permissible business activities. The Bank Holding Company Act generally restricts BHCs from engaging in business activities other than the business of banking and certain closely related activities. Financial holding companies generally can engage in a broader range of financial activities than are otherwise permissible for BHCs, including underwriting, dealing and making markets in securities, and making merchant banking investments in non-financial companies. The Federal Reserve has the authority to limit a financial holding company’s ability to conduct otherwise permissible activities if the financial
holding company or any of its depositary institution subsidiaries ceases to meet the applicable eligibility requirements (including requirements that the financial holding company and each of its U.S. depository institution subsidiaries maintain their status as “well-capitalized” and “well-managed”). The Federal Reserve may also impose corrective capital and/or managerial requirements on the financial holding company and may, for example, require divestiture of the holding company’s depository institutions if the deficiencies persist. Federal regulations also provide that if any depository institution controlled by a financial holding company fails to maintain a satisfactory rating under the Community Reinvestment Act, the Federal Reserve must prohibit the financial holding company and its subsidiaries from engaging in any activities other than those permissible for bank holding companies. In addition, a financial holding company must obtain Federal Reserve approval before engaging in certain banking and other financial activities both in the U.S. and internationally, as further described under Regulation of acquisitions below.
Activities restrictions under the Volcker Rule. Section 619 of the Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) (the “Volcker Rule”) prohibits banking entities, including the Firm, from engaging in certain “proprietary trading” activities, subject to exceptions for underwriting, market-making, risk-mitigating hedging and certain other activities. In addition, the Volcker Rule limits the sponsorship of, and investment in, “covered funds” (as defined by the Volcker Rule) and imposes limits on certain transactions between the Firm and its sponsored funds (see JPMorgan Chase’s subsidiary banks - Restrictions on transactions with affiliates below). The Volcker Rule requires banking entities to establish comprehensive compliance programs reasonably designed to help ensure and monitor compliance with the restrictions under the Volcker Rule, including, in order to distinguish permissible from impermissible risk-taking activities, the measurement, monitoring and reporting of certain key metrics.
Capital and liquidity requirements. The Federal Reserve establishes capital and leverage requirements for the Firm and evaluates its compliance with such requirements. The OCC establishes similar capital and leverage requirements for the Firm’s national banking subsidiaries. For more information about the applicable requirements relating to risk-based capital and leverage in the U.S. under the most recent capital framework established by the Basel Committee on Banking Supervision (the “Basel Committee”)(“Basel III”), see Capital Risk Management on pages 76-85 and Note 28. Under Basel III, bank holding companies and banks are required to measure their liquidity against two specific liquidity tests: the liquidity coverage ratio (“LCR”) and the net stable funding ratio (“NSFR”). The U.S. banking regulators have approved the final LCR rule (“U.S. LCR”), which became effective on January 1, 2015. In April 2016, the U.S. banking regulators issued a proposed rule for NSFR. For additional information on these ratios, see Liquidity Risk Management on pages 110-115. On December 19, 2016 the Federal Reserve published final
U.S. LCR public disclosure requirements. Starting with the second quarter of 2017, the Firm will be required to disclose quarterly its consolidated LCR pursuant to the U.S. LCR rule, including the Firm’s average LCR for the quarter and the key quantitative components of the average LCR in a standardized template, along with a qualitative discussion of material drivers of the ratio, changes over time, and causes of such changes. On September 8, 2016 the Federal Reserve published the framework that will apply to the setting of the countercyclical capital buffer. As of October 24, 2016 the Federal Reserve reaffirmed setting the U.S. countercyclical capital buffer at 0%, and stated that it will review the amount at least annually. Banking supervisors continue to consider refinements and enhancements to the Basel III capital framework for financial institutions. The Basel Committee finalized revisions to market risk capital for trading books and the treatment of interest rate risk in the banking book; other proposals being contemplated by the Basel Committee include revisions to, among others, standardized credit and operational risk capital frameworks, a recalibration of the leverage ratio, revisions to the securitization framework, and changes to the definition of defaulted assets. In January 2017, the Basel Committee announced that the review of the proposals to finalize the post-crisis regulatory reforms has been postponed. After a proposal is finalized by the Basel Committee, U.S. banking regulators would then need to propose requirements applicable to U.S. financial institutions. In March 2016, the Federal Reserve Board released a revised proposal to establish single-counterparty credit limits for large U.S. bank holding companies and foreign banking organizations.
Stress tests. The Federal Reserve has adopted supervisory stress tests for large bank holding companies, including JPMorgan Chase, which form part of the Federal Reserve’s annual Comprehensive Capital Analysis and Review (“CCAR”) framework. Under the framework, the Firm must conduct semi-annual company-run stress tests and, in addition, must submit an annual capital plan to the Federal Reserve, taking into account the results of separate stress tests designed by the Firm and the Federal Reserve. In reviewing the Firm’s capital plan, the Federal Reserve considers both quantitative and qualitative factors. Qualitative assessments include, among other things, the comprehensiveness of the plan, the assumptions and analysis underlying the plan, and the extent to which the Firm has satisfied certain supervisory matters related to the Firm’s processes and analyses, including the design and operational effectiveness of the controls governing such processes. Moreover, the Firm is required to receive a notice of non-objection from the Federal Reserve before taking capital actions, such as paying dividends, implementing common equity repurchase programs or redeeming or repurchasing capital instruments. The OCC requires JPMorgan Chase Bank, N.A. to perform separate, similar annual stress tests. The Firm publishes each year the results of its mid-cycle stress tests under the Firm’s internally-developed “severely adverse” scenario and the results of its
(and its two primary subsidiary banks’) annual stress tests under the supervisory “severely adverse” scenarios provided by the Federal Reserve and the OCC. The Firm will file its 2017 annual CCAR submission on April 5. Results will be published by the Federal Reserve by June 30, with disclosures of results by BHCs, including the Firm, to follow within 15 days. The mid-cycle capital stress test submissions are due on October 5 and BHCs, including the Firm, will publish results by November 4. For additional information on the Firm’s CCAR, see Capital Risk Management on pages 76-85.
Enhanced prudential standards. The Financial Stability Oversight Council (“FSOC”), among other things, recommends prudential standards and reporting and disclosure requirements to the Federal Reserve for systemically important financial institutions (“SIFIs”), such as JPMorgan Chase. The Federal Reserve has adopted several rules to implement the heightened prudential standards, including final rules relating to risk management and corporate governance of subject BHCs. BHCs with $50 billion or more in total consolidated assets are required to comply with enhanced liquidity and overall risk management standards, and their boards of directors are required to conduct appropriate oversight of their risk management activities. For information on liquidity measures, see Liquidity Risk Management on pages 110-115. Several additional proposed rules are still being considered, including an “early remediation” framework to address financial distress or material management weaknesses.
Orderly liquidation authority and resolution and recovery. As a BHC with assets of $50 billion or more, the Firm is required to submit annually to the Federal Reserve and the FDIC a plan for resolution under the Bankruptcy Code in the event of material distress or failure (a “resolution plan”). The FDIC also requires each insured depository institution with $50 billion or more in assets, such as JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., to provide a resolution plan. For more information about the Firm’s resolution plan, see Risk Factors on pages 8-21 as well as Business Overview on pages 37-38 for information regarding the Firm’s 2016 Resolution Submission. In addition, certain financial companies, including JPMorgan Chase and certain of its subsidiaries, can be subjected to resolution under an “orderly liquidation authority.” The U.S. Treasury Secretary, in consultation with the President of the United States, must first make certain extraordinary financial distress and systemic risk determinations, and action must be recommended by the FDIC and the Federal Reserve. Absent such actions, the Firm, as a BHC, would remain subject to resolution under the Bankruptcy Code. In December 2013, the FDIC issued a draft policy statement describing its “single point of entry” strategy for resolution of systemically important financial institutions under the orderly liquidation authority. This strategy seeks to keep operating subsidiaries of the BHC open and impose losses on shareholders and creditors of the holding company in
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receivership according to their statutory order of priority. For further information see Risk Factors on pages 8-21.
The Firm has a comprehensive recovery plan detailing the actions it would take to avoid failure by remaining well-capitalized and well-funded in the case of an adverse event. JPMorgan Chase has provided the Federal Reserve with comprehensive confidential supervisory information and analyses about the Firm’s businesses, legal entities and corporate governance and about its crisis management governance, capabilities and available alternatives to raise liquidity and capital in severe market circumstances. The OCC has published guidelines establishing standards for recovery planning by insured national banks, and JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. have submitted their recovery plans to the OCC. For further information see Risk Factors on pages 8-21. In addition, certain of the Firm’s non-U.S. subsidiaries are subject to resolution and recovery planning requirements in the jurisdictions in which they operate.
Regulators in the U.S. and abroad continue to be focused on developing measures designed to address the possibility or perception that large financial institutions, including the Firm, may be “too big to fail,” and to provide safeguards so that, if a large financial institution does fail, it can be resolved without the use of public funds. Higher capital surcharges on global systemically important banks (“GSIBs”), requirements for certain large bank holding companies to maintain a minimum amount of long-term debt to facilitate orderly resolution of those firms, and the International Swaps and Derivatives Association (“ISDA”) protocol relating to the “close-out” of derivatives transactions during the resolution of a large cross-border financial institution, are examples of initiatives to address “too big to fail.” For further information on the GSIB framework and Total Loss Absorbing Capacity (“TLAC”), see Capital Risk Management on pages 76-85 and Risk Factors on pages 8-21, and on the ISDA close-out protocol, see Derivatives regulation below.
Holding company as source of strength for bank subsidiaries. JPMorgan Chase & Co. is required to serve as a source of financial strength for its depository institution subsidiaries and to commit resources to support those subsidiaries. This support may be required by the Federal Reserve at times when the Firm might otherwise determine not to provide it.
Regulation of acquisitions. Acquisitions by bank holding companies and their banks are subject to multiple requirements by the Federal Reserve and the OCC. For example, financial holding companies and bank holding companies are required to obtain the approval of the Federal Reserve before they may acquire more than 5% of the voting shares of an unaffiliated bank. In addition, acquisitions by financial companies are prohibited if, as a result of the acquisition, the total liabilities of the financial company would exceed 10% of the total liabilities of all financial companies. In addition, for certain acquisitions, the Firm must provide written notice to the Federal Reserve prior to acquiring direct or indirect ownership or control of
any voting shares of any company with over $10 billion in assets that is engaged in activities that are “financial in nature.”
JPMorgan Chase’s subsidiary banks:
The Firm’s two primary subsidiary banks, JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., are FDIC-insured national banks regulated by the OCC. As national banks, the activities of JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. are limited to those specifically authorized under the National Bank Act and related interpretations by the OCC.
FDIC deposit insurance. The FDIC deposit insurance fund provides insurance coverage for certain deposits and is funded through assessments on banks, such as JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. Changes in the methodology used to calculate such assessments, resulting from the enactment of the Dodd-Frank Act, significantly increased the assessments that the Firm’s bank subsidiaries pay annually to the FDIC. The FDIC instituted a new assessment surcharge on insured depository institutions with total consolidated assets greater than $10 billion in order to raise the reserve ratio for the FDIC deposit insurance fund. Future FDIC rule-making could further increase such assessments.
FDIC powers upon a bank insolvency. Upon the insolvency of an insured depository institution, such as JPMorgan Chase Bank, N.A., the FDIC could be appointed as the conservator or receiver under the Federal Deposit Insurance Act (“FDIA”). The FDIC has broad powers to transfer any assets and liabilities without the approval of the institution’s creditors. For further information on the impact to creditors, see Risk Factors on pages 8-21.
Cross-guarantee. An FDIC-insured depository institution can be held liable for any loss incurred or expected to be incurred by the FDIC if another FDIC-insured institution that is under common control with such institution is in default or is deemed to be “in danger of default” (commonly referred to as “cross-guarantee” liability). An FDIC cross-guarantee claim against a depository institution is generally superior in right of payment to claims of the holding company and its affiliates against such depository institution.
Prompt corrective action and early remediation. The Federal Deposit Insurance Corporation Improvement Act of 1991 requires the relevant federal banking regulator to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards. While these regulations apply only to banks, such as JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., the Federal Reserve is authorized to take appropriate action against the parent BHC, such as JPMorgan Chase & Co., based on the undercapitalized status of any bank subsidiary. In certain instances, the BHC would be required to guarantee the performance of the capital restoration plan for its undercapitalized subsidiary.
OCC Heightened Standards. The OCC has established guidelines setting forth heightened standards for large banks. The guidelines establish minimum standards for the design and implementation of a risk governance framework for banks. While the bank can use certain components of the parent company’s risk governance framework, the framework must ensure that the bank’s risk profile is easily distinguished and separate from the parent for risk management purposes. The bank’s board or risk committee is responsible for approving the bank’s risk governance framework, providing active oversight of the bank’s risk-taking activities, and holding management accountable for adhering to the risk governance framework.
Restrictions on transactions with affiliates. The bank subsidiaries of JPMorgan Chase (including subsidiaries of those banks) are subject to certain restrictions imposed by federal law on extensions of credit to, investments in stock or securities of, and derivatives, securities lending and certain other transactions with, JPMorgan Chase & Co. and certain other affiliates. These restrictions prevent JPMorgan Chase & Co. and other affiliates from borrowing from such subsidiaries unless the loans are secured in specified amounts and comply with certain other requirements. For more information, see Note 27. In addition, the Volcker Rule imposes a prohibition on such transactions between any JPMorgan Chase entity and covered funds for which a JPMorgan Chase entity serves as the investment manager, investment advisor, commodity trading advisor or sponsor, as well as, subject to a limited exception, any covered fund controlled by such funds.
Dividend restrictions. Federal law imposes limitations on the payment of dividends by national banks, such as JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. See Note 27 for the amount of dividends that the Firm’s principal bank subsidiaries could pay, at January 1, 2017, to their respective bank holding companies without the approval of their banking regulators.
In addition to the dividend restrictions described above, the OCC and the Federal Reserve have authority to prohibit or limit the payment of dividends of the bank subsidiaries they supervise, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the bank.
Depositor preference. Under federal law, the claims of a receiver of an insured depository institution for administrative expense and the claims of holders of U.S. deposit liabilities (including the FDIC and foreign deposits that are payable in the U.S. as well as in a foreign branch) have priority over the claims of other unsecured creditors of the institution, including public noteholders and depositors in non-U.S. offices. As a result, such persons could receive substantially less than the depositors in U.S. offices of the depository institution.
CFPB regulation and supervision, and other consumer regulations. JPMorgan Chase and its national bank subsidiaries, including JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., are subject to supervision and
regulation by the CFPB with respect to federal consumer protection laws, including laws relating to fair lending and the prohibition of unfair, deceptive or abusive acts or practices in connection with the offer, sale or provision of consumer financial products and services. These laws include the Truth-in-Lending, Equal Credit Opportunity Act (“ECOA”), Fair Credit Reporting, Fair Debt Collection Practice, Electronic Funds Transfer, Credit Card Accountability, Responsibility and Disclosure (“CARD”) and Home Mortgage Disclosure Acts. The CFPB has authority to impose new disclosure requirements for any consumer financial product or service. The CFPB’s rule-making efforts have addressed mortgage-related topics, including ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, high-cost mortgage requirements, Home Mortgage Disclosure Act requirements, appraisal and escrow standards and requirements for higher-priced mortgages. The CFPB continues to issue informal guidance on a variety of topics (such as the collection of consumer debts and credit card marketing practices). Other areas of focus include sales incentives, pre-authorized electronic funds transfers, “add-on” products, matters involving consumer populations considered vulnerable by the CFPB (such as students), credit reporting, and the furnishing of credit scores to individuals. As part of its regulatory oversight, the CFPB has taken enforcement actions against certain financial institutions, including the Firm.
Securities and broker-dealer regulation:
The Firm conducts securities underwriting, dealing and brokerage activities in the U.S. through J.P. Morgan Securities LLC and other broker-dealer subsidiaries, all of which are subject to regulations of the SEC, the Financial Industry Regulatory Authority and the New York Stock Exchange, among others. The Firm conducts similar securities activities outside the U.S. subject to local regulatory requirements. In the U.K., those activities are conducted by J.P. Morgan Securities plc and are regulated PRA and the FCA. Broker-dealers are subject to laws and regulations covering all aspects of the securities business, including sales and trading practices, securities offerings, publication of research reports, use of customers’ funds, the financing of clients’ purchases, capital structure, record-keeping and retention, and the conduct of their directors, officers and employees. For information on the net capital of J.P. Morgan Securities LLC, and the applicable requirements relating to risk-based capital for J.P. Morgan Securities plc, see Broker-dealer regulatory capital on page 85. In addition, rules adopted by the Department of Labor would impose (among other things) a new standard of care applicable to broker-dealers when dealing with customers. For more information see - Investment management regulation below.
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Investment management regulation:
The Firm’s asset management businesses are subject to significant investment management regulation in numerous jurisdictions around the world relating to, among other things, the safeguarding of client assets, offerings of funds, marketing activities, transactions among affiliates and management of client funds. Certain of the Firm’s subsidiaries are registered with, and subject to oversight by, the SEC as investment advisers. As such, the Firm’s registered investment advisers are subject to the fiduciary and other obligations imposed under the Investment Advisers Act of 1940 and the rules and regulations promulgated thereunder, as well as various state securities laws. For information regarding investigations and litigation in connection with disclosures to clients related to proprietary products, see Note 31.
The Firm’s asset management businesses continue to be affected by ongoing rule-making and implementation of new regulations. The SEC amendments to rules that govern money-market funds, requiring a floating net asset value for institutional prime money-market funds became effective October 14, 2016. In addition, the SEC adopted amendments regarding enhanced liquidity risk management for open-end mutual funds and exchange-traded funds (“ETFs”) and enhanced reporting for funds and advisors. The Department of Labor (“DOL”) “fiduciary” rule would significantly expand the universe of persons viewed as investment advice fiduciaries to retirement plans and individual retirement accounts (“IRAs”) under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Among the most significant impacts of the rule and related prohibited transaction exemptions would be the impact on the fee and compensation practices at financial institutions that offer investment advice to retail retirement clients. The related exemptions would require new client contracts, adherence to “impartial conduct” standards (including a requirement to act in the “best interest” of retirement clients), implementation of policies and procedures, websites and other disclosures to both investors and the DOL. The rule was due to become applicable from April 10, 2017; however following a recent memorandum from the White House directing review of the rule, the DOL announced that it is considering legal options for delaying the rule’s applicability.
Derivatives regulation:
The Firm is subject to comprehensive regulation of its derivatives businesses. The regulations impose capital and margin requirements (including the collecting and posting of variation margin and initial margin in respect of non-centrally cleared derivatives), require central clearing of standardized over-the-counter (“OTC”) derivatives, require that certain standardized over-the-counter swaps be traded on regulated trading venues, and provide for reporting of certain mandated information. In addition, the Dodd-Frank Act requires the registration of “swap dealers” and “major swap participants” with the CFTC and of “security-based swap dealers” and “major security-based swap participants” with the SEC. JPMorgan Chase Bank, N.A., J.P. Morgan
Securities LLC, J.P. Morgan Securities plc and J.P. Morgan Ventures Energy Corporation have registered with the CFTC as swap dealers, and JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC and J.P. Morgan Securities plc may be required to register with the SEC as security-based swap dealers. As a result of their registration as swap dealers or security-based swap dealers, these entities will be subject to a comprehensive regulatory framework applicable to their swap or security-based swap activities, which includes capital requirements, rules regulating their swap activities, rules requiring the collateralization of uncleared swaps, rules regarding segregation of counterparty collateral, business conduct and documentation standards, record-keeping and reporting obligations, and anti-fraud and anti-manipulation requirements. Further, some of the rules for derivatives apply extraterritorially to U.S. firms doing business with clients outside of the U.S., as well as to the overseas activities of non-U.S. subsidiaries of the Firm that either deal with U.S. persons or that are guaranteed by U.S. subsidiaries of the Firm; however, the full scope of the extra-territorial impact of the U.S. swaps regulation has not been finalized and therefore remains unclear. The effect of these rules may require banking entities, such as the Firm, to modify the structure of their derivatives businesses and face increased operational and regulatory costs. In the European Union (the “EU”), the implementation of the European Market Infrastructure Regulation (“EMIR”) and the revision of the Markets in Financial Instruments Directive (“MiFID II”) will result in comparable, but not identical, changes to the European regulatory regime for derivatives. The combined effect of the U.S. and EU requirements, and the potential conflicts and inconsistencies between them, present challenges and risks to the structure and operating model of the Firm’s derivatives businesses.
The Firm and other financial institutions have agreed to adhere to an updated Resolution Stay Protocol developed by ISDA in response to regulator concerns that the close-out of derivatives and other financial transactions during the resolution of a large cross-border financial institution could impede resolution efforts and potentially destabilize markets. The Resolution Stay Protocol provides for the contractual recognition of cross-border stays under various statutory resolution regimes and a contractual stay on certain cross-default rights.
In the U.S., one subsidiary of the Firm is registered as a futures commission merchant, and other subsidiaries are either registered with the CFTC as commodity pool operators and commodity trading advisors or are exempt from such registration. These CFTC-registered subsidiaries are also members of the National Futures Association.
Data regulation:
The Firm and its subsidiaries are subject to federal, state and international laws and regulations concerning the use and protection of certain customer, employee and other personal and confidential information, including those imposed by the Gramm-Leach-Bliley Act and the Fair Credit
Reporting Act, as well as the EU Data Protection Directive. In addition, various U.S. regulators, including the Federal Reserve, the OCC and the SEC, have increased their focus on cybersecurity through guidance, examinations and regulations.
In May 2018, the General Data Protection Regulation (“GDPR”) will replace the EU Data Protection Directive, and it will have a significant impact on how businesses can collect and process the personal data of EU individuals. In addition, numerous proposals regarding privacy and data protection are pending before U.S. and non-U.S. legislative and regulatory bodies.
The Bank Secrecy Act and Economic Sanctions:
The Bank Secrecy Act (“BSA”) requires all financial institutions, including banks and securities broker-dealers, to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA includes a variety of record-keeping and reporting requirements (such as cash transaction and suspicious activity reporting), as well as due diligence/know your customer documentation requirements. In January 2013, the Firm entered into Consent Orders with its banking regulators relating to the Firm’s Bank Secrecy Act/Anti-Money Laundering policies, procedures and controls; the Firm has taken significant steps to modify and enhance its processes and controls with respect to its Anti-Money Laundering procedures and to remediate the issues identified in the Consent Order. The Firm is also subject to the regulations and economic sanctions programs administered by the U.S. Treasury’s Office of Foreign Assets Control (“OFAC”).
Anti-Corruption:
The Firm is subject to laws and regulations relating to corrupt and illegal payments to government officials and others in the jurisdictions in which it operates, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. For more information on the Firm’s consent judgment and non-prosecution agreement relating to referral hiring practices, see Note 31.
Compensation practices:
The Firm’s compensation practices are subject to oversight by the Federal Reserve, as well as other agencies. The Federal Reserve has issued guidance jointly with the FDIC and the OCC that is designed to ensure that incentive compensation paid by banking organizations does not encourage imprudent risk-taking that threatens the organizations’ safety and soundness. In addition, under the Dodd-Frank Act, federal regulators, including the Federal Reserve, must issue regulations or guidelines requiring covered financial institutions, including the Firm, to report the structure of all incentive-based compensation arrangements and prohibit incentive-based payment arrangements that encourage inappropriate risks by providing compensation that is excessive or that could lead to material financial loss to the institution. Proposed regulations were issued in 2016, and the public comment period has closed. Final regulations have not yet been
published. The Federal Reserve has conducted a review of the incentive compensation policies and practices of a number of large banking institutions, including the Firm. In addition to the Federal Reserve, the Financial Stability Board has established standards covering compensation principles for banks. In Europe, the Fourth Capital Requirements Directive (“CRD IV”) includes compensation provisions and the European Banking Authority has instituted guidelines on compensation policies under CRD IV. In the U.K., compensation standards are governed by the Remuneration Code of the PRA and the FCA. The implementation of the Federal Reserve’s and other banking regulators’ guidelines regarding compensation are expected to evolve over the next several years, and may affect the manner in which the Firm structures its compensation programs and practices.
Significant international regulatory initiatives:
In the EU, there is an extensive and complex program of final and proposed regulatory enhancement that reflects, in part, the EU’s commitments to policies of the Group of Twenty Finance Ministers and Central Bank Governors (“G-20”) together with other plans specific to the EU. The EU operates a European Systemic Risk Board that monitors financial stability, together with European Supervisory Agencies that set detailed regulatory rules and encourage supervisory convergence across the 28 Member States. The EU has also created a Single Supervisory Mechanism for the euro-zone, under which the regulation of all banks in that zone will be under the auspices of the European Central Bank, together with a Single Resolution Mechanism and Single Resolution Board, having jurisdiction over bank resolution in the zone. At both the G-20 and EU levels, various proposals are under consideration to address risks associated with global financial institutions. Some of the initiatives adopted include increased capital requirements for certain trading instruments or exposures and compensation limits on certain employees located in affected countries.
Guided by the G20 policy framework, the EU and national financial regulators have proposed or adopted several market reforms, including EMIR, which requires, among other things, the central clearing of standardized derivatives; and MiFID II, which gives effect to the G-20 commitment to trading of derivatives through central clearing houses and exchanges and also includes significantly enhanced requirements for pre- and post-trade transparency and a significant reconfiguration of the regulatory supervision of execution venues. Key aspects of EMIR and MiFID II have been finalized, although the implementation date of MiFID II has been delayed to 2018.
The EU is also currently considering or implementing significant revisions to laws covering depositary activities; credit-rating activities; resolution of banks, investment firms and market infrastructures; anti-money laundering controls; data security and privacy; corporate governance in financial firms; and implementation in the EU of the Basel III capital and liquidity standards, including the introduction of
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an intermediate holding company requirement for foreign banks and the implementation of the standard for TLAC.
The EU is also considering proposed legislation providing for a proprietary trading ban and mandatory separation of other trading activities within certain banks; various EU Member States have separately enacted similar measures. In the U.K., legislation was adopted that mandates the separation (or “ring-fencing”) of deposit-taking activities from securities trading and other analogous activities within banks, subject to certain exemptions. The legislation includes the supplemental recommendation of the Parliamentary Commission on Banking Standards (the “Tyrie Commission”) that such ring-fences should be “electrified” by the imposition of mandatory forced separation on banking institutions that are deemed to test the limits of the safeguards. Parallel but distinct provisions have been enacted by the French and German governments. These measures may separately or taken together have significant implications for the Firm’s organizational structure in Europe, as well as its permitted activities and capital deployment in the EU.
Much of the G20 policy framework has been finalized; however, the Basel Committee is currently reviewing the framework, and proposing recalibrations of certain requirements. As such, the EU is considering or implementing significant revisions to laws covering: bank and investment firm recovery and resolution; bank structure; securities settlement; transparency and disclosure of securities financing transactions; benchmarks; resolution of market infrastructures (central counterparties (“CCPs”)); anti-money laundering controls; data security and privacy; and corporate governance in financial firms; together with new amendments to capital and liquidity standards.
Consistent with the G20 and EU policy frameworks, U.K. regulators have adopted a range of policy measures that have significantly changed the markets and prudential regulatory environment in the U.K. In addition to broad recommendations made by the Fair and Effective Markets Review which focused on fixed income currencies and commodities markets, U.K. regulators are considering measures to raise standards and accountability of individuals, and promote forward-looking conduct risk identification and mitigation, including by introducing the new Senior Managers and Certification Regimes.
On June 23, 2016, the U.K. voted by referendum to leave the European Union (“Brexit”). The U.K. Government has since announced that it will invoke Article 50 of the Lisbon Treaty and will start the formal exit negotiations by the end of March 2017, giving an expected exit date of the end of March 2019. More recently, the British Prime Minister laid out twelve “negotiation objectives” for Brexit, which confirmed the U.K. will not remain a member of the Single Market, but will pursue a Free Trade Agreement that provides the greatest possible access to the Single Market. Further, the U.K. Government will seek a phased arrangement to ensure the orderly transition of the legal
and regulatory framework for financial services, and promote stability and market confidence. Following a recent ruling by the U.K. Supreme Court, the House of Commons approved legislation on February 8, 2017 that allows the British Prime Minister to invoke Article 50. The legislation must now be approved by the House of Lords before it is signed into law.
Many international banks, including the Firm, operate substantial parts of their European Union businesses from entities based in the U.K. Upon the U.K. leaving the European Union, the regulatory and legal environment that would then exist, and to which the Firm’s U.K. operations would then be subject, will depend on, in certain respects, the nature of the arrangements the U.K. agreed with the European Union and other trading partners. These arrangements cannot be predicted, but currently the Firm does not believe any of the likely identified scenarios would threaten the viability of the Firm’s business units or the Firm’s ability to serve clients across the European Union and in the U.K. However, it is possible that under some scenarios, changes to the Firm’s legal entity structure and operations would be required, which might result in a less efficient operating model across the Firm’s European legal entities.
The Firm is in the process of evaluating plans to ensure its continued ability to operate in the U.K. and the EU beyond the expected exit date.
Item 1A. Risk Factors.
The following discussion sets forth the material risk factors that could affect JPMorgan Chase’s financial condition and operations. Readers should not consider any descriptions of such factors to be a complete set of all potential risks that could affect the Firm.
Regulatory Risk
JPMorgan Chase operates within a highly regulated industry, and the Firm’s businesses and results are significantly affected by the laws and regulations to which the Firm is subject.
As a global financial services firm, JPMorgan Chase is subject to extensive and comprehensive regulation under federal and state laws in the U.S. and the laws of the various jurisdictions outside the U.S. in which the Firm does business. The financial services industry has in recent years experienced an unprecedented increase in regulations and supervision, both in the U.S. and globally. The cumulative effect of the new and currently proposed legislation and regulations could require the Firm to make further changes to its businesses or operations, which could result in a significant loss of revenue for the Firm and impose additional compliance and other costs on the Firm or otherwise reduce the Firm’s profitability. These changes could also: limit the products and services that the Firm offers; reduce the liquidity that the Firm is able to offer its clients or counterparties through its market-making activities; impede the Firm’s ability to pursue business opportunities in which it might otherwise consider engaging; require the Firm to dispose of or curtail certain
businesses; affect the value of assets that the Firm holds; require the Firm to increase its prices and therefore reduce demand for its products; or otherwise adversely affect the Firm’s businesses. To the extent that these initiatives have been, or continue to be, imposed on a limited subset of financial institutions (based on size, activities, geography or other criteria), the requirements to which the Firm may be subject under such laws and regulations could require the Firm to restructure further its businesses, or further re-price or curtail the products or services that it offers to customers, which could result in the Firm not being able to compete effectively with other institutions that are not impacted in the same way.
Authorities in some non-U.S. jurisdictions in which the Firm has operations have enacted legislation or regulations requiring that certain subsidiaries of the Firm operating in those countries maintain independent capital and liquidity. In addition, some non-U.S. regulators have proposed that large banks which conduct certain businesses in their jurisdictions operate through separate subsidiaries located in those countries. These requirements, and any future laws or regulations that seek to impose restrictions on the way the Firm organizes its business units or increase the capital or liquidity requirements on non-U.S. subsidiaries of the Firm, could hinder the Firm’s ability to efficiently manage its operations, increase its funding and liquidity costs and thereby decrease the Firm’s net income. In addition, there can be significant differences in the ways that similar regulatory initiatives affecting the financial services industry are implemented in the U.S. and in different countries and regions in which JPMorgan Chase does business. For example, recent legislative and regulatory initiatives within the EU, including those relating to the resolution of financial institutions, the establishment by non-EU financial institutions of intermediate holding companies in the EU, the separation of trading activities from core banking services, mandatory on-exchange trading, position limits and reporting rules for derivatives, governance and accountability regimes, conduct of business requirements and restrictions on compensation, could require the Firm to make significant modifications to its non-U.S. business, operations and legal entity structure in order to comply with these requirements. These differences in implemented or proposed non-U.S. regulations and initiatives may be inconsistent or may conflict with current or proposed regulations in the U.S., which could subject the Firm to increased compliance and legal costs, as well as higher operational, capital and liquidity costs, all of which could have an adverse effect on the Firm’s business, results of operations and profitability.
Recent political developments in the U.S. and abroad have increased the uncertainty regarding the regulatory environment in which the Firm will operate. Although certain of the proposals being mentioned in the U.S. include the possibility of regulatory reform related to the financial services industry, it is too early to determine the full extent to which these measures will ultimately modify or reduce the regulatory requirements currently imposed on the Firm, and the resulting possible effect on the Firm and its business and operations. In addition, the U.K.’s planned
departure from the EU has engendered significant uncertainty concerning the regulatory framework under which global financial services institutions, including JPMorgan Chase, will need to conduct their business and operations in the EU after the U.K.’s departure.
Expanded regulatory and governmental oversight of JPMorgan Chase’s businesses may continue to increase the Firm’s costs and risks.
The Firm’s businesses and operations are subject to heightened governmental and regulatory oversight and scrutiny. The Firm has paid significant fines (or has provided significant monetary and other relief) to resolve a number of investigations or enforcement actions by governmental agencies. The Firm continues to devote substantial resources to satisfying the requirements of regulatory consent orders and other settlements to which it is subject, which increases the Firm’s operational and compliance costs.
Certain regulators have taken measures in connection with specific enforcement actions against financial institutions (including the Firm) that require admissions of wrongdoing and compliance with other conditions in connection with settling such matters. Such admissions and conditions can lead to, among other things, greater exposure in civil litigation, harm to reputation, disqualification from providing business to certain clients and in certain jurisdictions, and other direct and indirect adverse effects.
In addition, U.S. government officials have indicated and demonstrated a willingness to bring criminal actions against financial institutions, including the Firm, and have increasingly sought, and obtained, resolutions that include criminal pleas or other admissions of wrongdoing from those institutions, such as the Firm’s agreement in May 2015 to plead guilty to a single violation of federal antitrust law in connection with its settlements with certain government authorities relating to its foreign exchange sales and trading activities and controls related to those activities, and the non-prosecution agreement entered into by a subsidiary of the Firm with the U.S. Department of Justice in November 2016 in connection with settlements to resolve various governmental investigations relating to a former hiring program for candidates referred by clients, potential clients and government officials in the Asia Pacific region. Such resolutions, whether with U.S. or non-U.S. authorities, could have significant collateral consequences for a subject financial institution, including loss of customers and business, or the inability to offer certain products or services, or losing permission to operate certain businesses, for a period of time (absent the forbearance of, or the granting of waivers by, applicable regulators).
The Firm expects that it and the financial services industry as a whole will continue to be subject to regulatory scrutiny and governmental investigations and enforcement actions and that violations of law will more frequently be met with formal and punitive enforcement action, including the imposition of significant monetary and other sanctions, rather than with informal supervisory action. In addition, if the Firm fails to meet the requirements of the various governmental settlements to which it is subject, or more
Part I
generally, to maintain risk and control procedures and processes that meet the heightened standards established by its regulators and other government agencies, it could be required to enter into further orders and settlements, pay additional fines, penalties or judgments, or accept material regulatory restrictions on its businesses. The extent of the Firm’s exposure to legal and regulatory matters may be unpredictable and could, in some cases, substantially exceed the amount of reserves that the Firm has established for such matters.
Requirements for the orderly resolution of the Firm could require JPMorgan Chase to restructure or reorganize its businesses.
Under Title I of the Dodd-Frank Act (“Title I”) and Federal Reserve and FDIC rules, the Firm is required to prepare and submit periodically to the Federal Reserve and the FDIC a detailed plan (the “Resolution Plan”) for the rapid and orderly resolution, without extraordinary government support, of JPMorgan Chase & Co. and certain of its subsidiaries under the U.S. Bankruptcy Code and other applicable insolvency laws in the event of future material financial distress of the Firm.
In April 2016, the Federal Reserve and the FDIC jointly provided firm-specific feedback on the 2015 Resolution Plans of eight systemically important domestic banking institutions, and determined that five of these 2015 Resolution Plans, including that of the Firm, were not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code. In addition to the identified deficiencies, the Federal Reserve and the FDIC also identified certain shortcomings which were required to be satisfactorily addressed in the Firm’s Resolution Plan due on July 1, 2017. On October 1, 2016, the Firm filed with the Federal Reserve and the FDIC its submission (the “2016 Resolution Submission”) describing how the Firm remediated the identified deficiencies and providing a status report of its actions to address the identified shortcomings.
On December 13, 2016, the Federal Reserve and the FDIC advised the Firm of their determinations that the Firm’s 2016 Resolution Submission adequately remediated the deficiencies in the Firm’s 2015 Resolution Plan identified by the agencies. On July 1, 2017, the Firm will file with the Federal Reserve and the FDIC its 2017 Resolution Plan which will, among other things, describe how the Firm has remediated the remaining shortcomings identified by the agencies in April 2016. If the Federal Reserve and the FDIC were to jointly determine that the Firm did not remediate the identified shortcomings, or that the Firm’s 2017 Resolution Plan, or any future update of that plan, is not credible, and the Firm is unable to remedy the identified deficiencies in a timely manner, the regulators may jointly impose more stringent capital, leverage or liquidity requirements on the Firm or restrictions on growth, activities or operations of the Firm, and could, if such deficiencies are not remedied within two years after such a determination, require the Firm to restructure, reorganize or divest businesses, legal entities, operational systems and/or intercompany transactions in ways that could
materially and adversely affect the Firm’s operations and strategy. In addition, in order to continue to maintain a Title I Resolution Plan that the Federal Reserve and FDIC determine is credible, the Firm may need to make additional changes to its legal entity structure and to certain intercompany and external activities, which could result in increased funding or operational costs.
Holders of JPMorgan Chase’s debt and equity securities will absorb losses if JPMorgan Chase were to enter into a resolution.
The Federal Reserve has issued final rules (the “TLAC rules”) regarding the minimum levels of unsecured external long-term debt and other loss-absorbing capacity that bank holding companies are required to have issued and outstanding, as well as guidelines defining the terms of qualifying debt instruments, to ensure that adequate levels of debt are maintained at the holding company level for purposes of recapitalizing the Firm’s operating subsidiaries (“eligible LTD”). If JPMorgan Chase & Co. were to enter into a resolution, either in a proceeding under Chapter 11 of the U.S. Bankruptcy Code or in a receivership administered by the FDIC under Title II of the Dodd-Frank Act, holders of eligible LTD and other debt and equity securities of the Firm will absorb the losses of JPMorgan Chase & Co. and its affiliates.
Under the Firm’s Resolution Plan, the Firm’s preferred resolution strategy contemplates that only JPMorgan Chase & Co. would enter bankruptcy proceedings under Chapter 11 of the U.S. Bankruptcy Code pursuant to a “single point of entry” recapitalization strategy. JPMorgan Chase & Co.’s subsidiaries would be recapitalized as needed so that they could continue normal operations or subsequently be wound down in an orderly manner. As a result, JPMorgan Chase & Co.’s losses and any losses incurred by its subsidiaries would be imposed first on holders of JPMorgan Chase & Co.’s equity securities and thereafter on unsecured creditors, including holders of JPMorgan Chase & Co.’s eligible LTD and other debt securities. Claims of holders of those debt securities would have a junior position to the claims of creditors of JPMorgan Chase & Co.’s subsidiaries and to the claims of priority (as determined by statute) and secured creditors of JPMorgan Chase & Co. Accordingly, in a resolution of JPMorgan Chase & Co. under Chapter 11 of the U.S. Bankruptcy Code, holders of eligible LTD and other debt securities of JPMorgan Chase & Co. would realize value only to the extent available to JPMorgan Chase & Co. as a shareholder of JPMorgan Chase Bank, N.A. and its other subsidiaries, and only after any claims of priority and secured creditors of JPMorgan Chase & Co. have been fully repaid. If JPMorgan Chase & Co. were to enter into a resolution, none of JPMorgan Chase & Co., the Federal Reserve or the FDIC is obligated to follow the Firm’s preferred resolution strategy under its Resolution Plan.
The FDIC has similarly indicated that a single point of entry recapitalization model could be a desirable strategy to resolve a systemically important financial institution, such as JPMorgan Chase & Co., under Title II of the Dodd-Frank Act. Pursuant to that strategy, the FDIC would use its power to create a “bridge entity” for JPMorgan Chase & Co.;
transfer the systemically important and viable parts of its business, principally the stock of JPMorgan Chase & Co.’s main operating subsidiaries and any intercompany claims against such subsidiaries, to the bridge entity; recapitalize those subsidiaries using assets of JPMorgan Chase & Co. that have been transferred to the bridge entity; and exchange external debt claims against JPMorgan Chase & Co. for equity in the bridge entity. Under this Title II resolution strategy, the value of the stock of the bridge entity that would be redistributed to holders of eligible LTD and other debt securities of JPMorgan Chase & Co. may not be sufficient to repay all or part of the principal amount and interest on such securities. To date, the FDIC has not formally adopted a single point of entry resolution strategy and it is not obligated to follow such a strategy in a Title II resolution of JPMorgan Chase & Co.
Market Risk
JPMorgan Chase’s results of operations have been, and may continue to be, adversely affected by U.S. and global financial market and economic conditions and political developments.
JPMorgan Chase’s businesses are materially affected by economic and market conditions, including the liquidity of the global financial markets; the level and volatility of debt and equity prices, interest rates, currency and commodities prices (including oil prices) and other market indices; investor, consumer and business sentiment; events that reduce confidence in the financial markets; inflation and unemployment; the availability and cost of capital and credit; the economic effects of natural disasters, health emergencies or pandemics, severe weather conditions, outbreaks of hostilities, terrorism or other geopolitical instabilities; monetary policies and actions taken by the Federal Reserve and other central banks; and the health of the U.S. and global economies.
Recent political developments in the U.S. and abroad have increased the uncertainty regarding the economic environment in which the Firm will operate. Although certain of the proposals being considered in the U.S., such as tax reform or increased expenditure on infrastructure projects, could lead to higher levels of U.S. economic activity and more expansive U.S. domestic economic growth, others, such as protectionist trade policies or isolationist foreign policies, could contract economic growth. The uncertainty around the manner and extent to which these economic policies are ultimately enacted could impact market volatility and affect the Firm’s businesses, both directly and through their impact on the businesses and activities of the Firm’s clients and customers. In addition, the effects of various referenda in Europe, including the vote by the U.K. electorate to leave the EU, as well as the uncertainties regarding the outcome of Eurozone presidential elections in 2017, have triggered political and economic uncertainty in the Eurozone. There is no assurance that such uncertainty, and any resultant market volatility, will not adversely affect the Firm’s results of operations.
In the Firm’s wholesale businesses, market and economic factors can affect the volume of transactions that the Firm
executes for its clients and, therefore, the revenue that the Firm receives, as well as the willingness of other financial institutions and investors to participate in loan syndications or underwritings managed by the Firm.
The Firm generally maintains market-making positions in the fixed income, currency, commodities, credit and equity markets to facilitate client demand and provide liquidity to clients. The revenue derived from these positions is affected by many factors, including the Firm’s success in effectively hedging its market and other risks; volatility in interest rates and equity, debt and commodities markets; interest rate and credit spreads; and the availability of liquidity in the capital markets, all of which are affected by global economic and market conditions, political events and regulatory restrictions on market-making activities. In addition, the Firm’s market-making businesses can expose the Firm to unexpected market, credit and operational risks that could cause the Firm to suffer unexpected losses. Severe declines in asset values, unanticipated credit events, or unforeseen circumstances that may cause previously uncorrelated factors to become correlated (and vice versa) may create losses resulting from risks not having been appropriately taken into account in the development, structuring or pricing of a financial instrument.
The Firm may be adversely affected by declining asset values. This is particularly true for businesses that earn fees for managing third-party assets or receive or post collateral. For example, a higher level of U.S. or non-U.S. interest rates or a downturn in financial markets could affect the valuations of the client assets that the Firm manages or holds in custody, which, in turn, could affect the Firm’s revenue from fees that are based on the amount of assets under management or custody. Macroeconomic or market concerns, as well as legislative and regulatory developments (such as, for example, the recently-adopted SEC rules relating to money-market funds), may also prompt outflows from the Firm’s funds or accounts or cause clients to invest funds in products that generate lower revenue.
Changes in interest rates will affect the level of assets and liabilities held on the Firm’s balance sheet and the revenue that the Firm earns from net interest income. An increasing or high interest rate environment, while generally increasing the net interest income earned by the Firm, may under certain circumstances also result in lower levels of commercial and residential loan originations and diminished returns on the investment securities portfolio (to the extent that the Firm is unable to reinvest contemporaneously in higher-yielding assets), thereby adversely affecting the Firm’s revenues and capital levels. Conversely, a low interest rate environment may compress net interest margins, reducing the amounts that the Firm earns on its investment securities portfolio, or reducing the value of its mortgage servicing rights (“MSRs”) asset, thereby reducing the Firm’s net interest income and other revenues.
The Firm’s consumer businesses are particularly affected by U.S. domestic economic conditions, including U.S. interest
Part I
rates, the rate of unemployment, housing prices, the level of consumer confidence, changes in consumer spending and the number of personal bankruptcies. Sustained low growth in the U.S. economy could diminish demand for the products and services offered by the Firm’s consumer businesses, or increase the cost to provide such products and services. In addition, adverse economic conditions, such as economic dislocations in certain geographies due to high levels of unemployment resulting from declining industrial or manufacturing activity, or other market or economic factors, could lead to an increase in mortgage, credit card, auto, student and other loan delinquencies and higher net charge-offs, which can reduce the Firm’s earnings. The Firm’s earnings from its consumer businesses could also be adversely affected by changes in government policies that affect consumers, including those relating to medical insurance, immigration, employment status and taxation, as well as governmental policies aimed at the economy more broadly, such as infrastructure spending and global trade, which could result in, among other things, higher inflation or reductions in consumer disposable income.
Widening of credit spreads makes it more expensive for the Firm to borrow on both a secured and unsecured basis, and may adversely affect the credit markets and the Firm’s businesses. Credit spreads widen or narrow not only in response to Firm-specific events and circumstances, but also as a result of general economic and geopolitical events and conditions. Changes in the Firm’s credit spreads will impact, positively or negatively, the Firm’s earnings on certain liabilities that are recorded at fair value.
Sudden and significant volatility in the prices of securities and other assets (including loans and derivatives) may curtail the trading markets for such securities and assets, make it difficult to sell or hedge such securities and assets, adversely affect the Firm’s profitability, capital or liquidity, or increase the Firm’s funding costs. The Federal Reserve has recently observed that market volatility may be exacerbated by regulatory restrictions, as market participants that are subject to the Volcker Rule are likely to decrease their market-making activities, and thereby constrain market liquidity, during periods of market stress. In addition, in a difficult or less liquid market environment, the Firm’s risk management strategies may not be effective because other market participants may be attempting to use the same or similar strategies to deal with the challenging market conditions. In such circumstances, it may be difficult for the Firm to reduce its risk positions due to the activity of such other market participants or widespread market dislocations. Sustained volatility in the financial markets may also negatively affect consumer or investor confidence, which could lead to lower client activity and decreased revenue for the Firm.
Credit Risk
The financial condition of JPMorgan Chase’s clients and counterparties, particularly other financial institutions, could adversely affect the Firm.
The Firm routinely executes transactions with clients and counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, investment managers and other types of financial institutions. Many of these transactions expose the Firm to the credit risk of its counterparties and, in some cases, disputes and litigation in the event of a default by the counterparty or client. Disputes with counterparties may also arise regarding the terms or the settlement procedures of derivative contracts, including with respect to the value of underlying collateral, which could cause the Firm to incur unexpected costs, including transaction, operational, legal and litigation costs, or result in credit losses, all of which may impair the Firm’s ability to manage effectively its credit risk exposure from these products.
The failure of a significant market participant, or concerns about a default by such an institution, could also lead to significant liquidity problems for, or losses or defaults by, other institutions, which in turn could adversely affect the Firm. In addition, in recent years the perceived interrelationship among financial institutions has also led to claims by other market participants and regulators that the Firm and other financial institutions have allegedly violated anti-trust or anti-competition laws by colluding to manipulate markets, prices or indices, and there is no assurance that such allegations will not arise in the same or similar contexts in the future.
As part of providing clearing services, the Firm is a member of a number of CCPs, and may be required to pay a portion of the losses incurred by such organizations as a result of the default of other members. As a clearing member, the Firm is also exposed to the risk of non-performance by its clients, which it seeks to mitigate through the maintenance of adequate collateral. In addition, the Firm can be exposed to intra-day credit risk of its clients in connection with providing cash management, clearing, custodial and other transaction services to such clients. If a client for which the Firm provides such services becomes bankrupt or insolvent, the Firm may suffer losses, become involved in disputes and litigation with various parties, including one or more CCPs, or the client’s bankruptcy estate and other creditors, or involved in regulatory investigations. All of such events can increase the Firm’s operational and litigation costs and may result in losses if any collateral received by the Firm is insufficient to cover such losses.
During periods of market stress or illiquidity, the Firm’s credit risk also may be further increased when the Firm cannot realize the fair value of the collateral held by it or when collateral is liquidated at prices that are not sufficient to recover the full amount of the loan, derivative or other exposure due to the Firm. Further, disputes with obligors concerning the valuation of collateral could increase in
times of significant market stress, volatility or illiquidity, and the Firm could suffer losses during such periods if it is unable to realize the fair value of collateral or manage declines in the value of collateral.
Concentration of credit and market risk could increase the potential for significant losses.
JPMorgan Chase has exposure to increased levels of risk when clients or counterparties are engaged in similar business activities or activities in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. For example, a significant deterioration in the credit quality of one of the Firm’s borrowers or counterparties could lead to concerns about the credit quality of other borrowers or counterparties in similar, related or dependent industries and thereby could exacerbate the Firm’s credit risk exposure and potentially increase its losses, including mark-to-market losses in its trading businesses. Similarly, challenging economic conditions affecting a particular industry or geographic area could lead to concerns about the credit quality of the Firm’s borrowers or counterparties, not only in that particular industry or geography but in related or dependent industries, wherever located, or about the ability of customers of the Firm’s consumer businesses living in such areas or working in such affected industries or related or dependent industries to meet their obligations to the Firm. Although the Firm regularly monitors various segments of its exposures to assess potential concentration or contagion risks, the Firm’s efforts to diversify or hedge its exposures against concentration risks may not be successful.
In addition, disruptions in the liquidity or transparency of the financial markets may result in the Firm’s inability to sell, syndicate or realize the value of its positions, thereby leading to increased concentrations. The inability to reduce the Firm’s positions may not only increase the market and credit risks associated with such positions, but may also increase the level of risk-weighted assets (“RWA”) on the Firm’s balance sheet, thereby increasing its capital requirements and funding costs, all of which could adversely affect the operations and profitability of the Firm’s businesses.
Liquidity Risk
If JPMorgan Chase does not effectively manage its liquidity, its business could suffer.
JPMorgan Chase’s liquidity is critical to its ability to operate its businesses. Some potential conditions that could impair the Firm’s liquidity include markets that become illiquid or are otherwise experiencing disruption, unforeseen cash or capital requirements (including, among others, commitments that may be triggered to special purpose entities (“SPEs”) or other entities), difficulty in selling or inability to sell assets, default by a CCP or other counterparty, unforeseen outflows of cash or collateral, and lack of market or customer confidence in the Firm or financial markets in general. These conditions may be caused by events over which the Firm has little or no control. The widespread crisis in investor confidence and
resulting liquidity crisis experienced in 2008 and into early 2009 increased the Firm’s cost of funding and limited its access to some of its traditional sources of liquidity (such as securitized debt offerings backed by mortgages, credit card receivables and other assets) during that time, and there is no assurance that these severe conditions could not occur in the future.
If the Firm’s access to stable and low cost sources of funding, such as bank deposits, is reduced, the Firm may need to raise alternative funding which may be more expensive or of limited availability. In addition, the Firm’s cost of funding could be affected by actions that the Firm may take in order to satisfy applicable liquidity coverage ratio and net stable funding ratio requirements, to lower its GSIB systemic risk score, to satisfy the amount of eligible LTD that the Firm must have outstanding under the TLAC rules, to address obligations under the Firm’s Resolution Plan or to satisfy regulatory requirements in non-U.S. jurisdictions relating to the pre-positioning of liquidity in subsidiaries that are material legal entities.
JPMorgan Chase is a holding company and depends on the cash flows of its subsidiaries to fund payments of dividends on its equity securities, principal and interest payments on its debt securities and redemptions and repurchases of its outstanding securities.
As a holding company, JPMorgan Chase & Co. is dependent on the earnings of its subsidiaries to meet its payment obligations. Under the arrangements contemplated by the Firm’s Resolution Plan, JPMorgan Chase & Co. has established a new intermediate holding company, JPMorgan Chase Holdings LLC (the “IHC”), and has contributed to the IHC the stock of substantially all of its direct subsidiaries (other than JPMorgan Chase Bank, N.A.) as well as other assets and intercompany indebtedness owing to it. Under these arrangements, JPMorgan Chase & Co. is obligated to contribute to the IHC substantially all the net proceeds received by it from securities issuances (including, without limitation, issuances of senior and subordinated debt securities and of preferred and common stock). As a result of these arrangements, JPMorgan Chase & Co.’s ability to pay interest on its debt securities and dividends on its equity securities, to redeem or repurchase its outstanding securities and to fulfill its other payment obligations is dependent on it receiving dividends from JPMorgan Chase Bank, N.A. and dividends and extensions of credit from the IHC. JPMorgan Chase Bank, N.A. is subject to restrictions on its dividend distributions, capital adequacy and liquidity coverage requirements, and other regulatory restrictions on its ability to make payments to JPMorgan Chase & Co., and the IHC is prohibited from paying dividends or extending credit to JPMorgan Chase & Co. if certain capital or liquidity “thresholds” are breached or if limits are otherwise imposed by the Firm’s management or Board of Directors. These regulatory restrictions and limitations on the payments that JPMorgan Chase & Co. is permitted to receive from JPMorgan Chase Bank, N.A. and the IHC could reduce or hinder its ability to pay dividends and satisfy its debt and other obligations, or result in JPMorgan Chase & Co. seeking protection under bankruptcy laws at a time earlier than
Part I
would have been the case absent the existence of such thresholds.
Reductions in JPMorgan Chase’s credit ratings may adversely affect its liquidity and cost of funding, as well as the value of debt obligations issued by the Firm.
JPMorgan Chase & Co. and certain of its principal subsidiaries are currently rated by credit rating agencies. Rating agencies evaluate both general and firm- and industry-specific factors when determining their credit ratings for a particular financial institution, including economic and geopolitical trends, regulatory developments, future profitability, risk management practices, legal expenses, assumptions surrounding government support, and ratings differentials between bank holding companies and their bank and non-bank subsidiaries. Although the Firm closely monitors and manages, to the extent it is able, factors that could influence its credit ratings, there is no assurance that the Firm’s credit ratings will not be lowered in the future, or that any such downgrade would not occur at times of broader market instability when the Firm’s options for responding to events may be more limited and general investor confidence is low.
Furthermore, a reduction in the Firm’s credit ratings could reduce the Firm’s access to capital markets, materially increase the cost of issuing securities, trigger additional collateral or funding requirements, and decrease the number of investors and counterparties willing or permitted, contractually or otherwise, to do business with or lend to the Firm, thereby curtailing the Firm’s business operations and reducing its profitability. In addition, any such reduction in credit ratings may increase the credit spreads charged by the market for taking credit risk on JPMorgan Chase & Co. and its subsidiaries and, as a result, could adversely affect the value of debt and other obligations that JPMorgan Chase & Co. and its subsidiaries have issued or may issue in the future.
Legal Risk
JPMorgan Chase faces significant legal risks, both from regulatory investigations and proceedings and from private actions brought against the Firm.
JPMorgan Chase is named as a defendant or is otherwise involved in various legal proceedings, including class actions and other litigation or disputes with third parties. Actions currently pending against the Firm may result in judgments, settlements, fines, penalties or other results adverse to the Firm, which could materially and adversely affect the Firm’s business, financial condition or results of operations, or cause serious harm to the Firm’s reputation. As a participant in the financial services industry, it is likely that the Firm will continue to experience a high level of litigation related to its businesses and operations.
In addition, and as noted above, the Firm’s businesses and operations are also subject to heightened regulatory oversight and scrutiny, which may lead to additional regulatory investigations or enforcement actions. Regulators and other government agencies examine the operations of the Firm and its subsidiaries on both a routine- and targeted-exam basis, and there is no assurance
that they will not pursue additional regulatory settlements or other enforcement actions against the Firm in the future. A violation of law or regulation by another financial institution is likely to give rise to an investigation by regulators and other governmental agencies of the same or similar practices by the Firm. For example, various regulatory and governmental agencies have made inquiries to the Firm about its sales practices with retail customers, including, among other matters, the Firm’s incentive compensation structures related to such practices. In addition, a single event may give rise to numerous and overlapping investigations and proceedings, either by multiple federal and state agencies and officials in the U.S. or, in some instances, regulators and other governmental officials in non-U.S. jurisdictions. These and other initiatives from U.S. and non-U.S. governmental authorities and officials may subject the Firm to further judgments, settlements, fines or penalties, or cause the Firm to be required to restructure its operations and activities or to cease offering certain products or services, all of which could harm the Firm’s reputation or lead to higher operational costs, thereby reducing the Firm’s profitability, or result in collateral consequences as discussed above.
Other Business Risks
Any significant failure by the Firm’s management to anticipate and respond quickly and appropriately to changes in the Firm’s operating environment or trends affecting the financial services industry, to make prudent decisions regarding the Firm’s strategy or to execute on that strategy could adversely affect the Firm’s competitive standing and its earnings and future results of operations.
The Firm operates in many jurisdictions and offers a wide variety of products and services to its clients and customers. The Firm’s strategies concerning the products and services that it will offer, the geographies in which it will operate, the types of clients and customers that it will serve and the counterparties with which it will do business, and the methods and distribution channels by which it will offer its products and services, will all affect the Firm’s competitive standing and its results of operations. If the Firm’s management makes choices about the Firm’s business strategies and goals that later prove to have been incorrect, does not accurately assess the competitive landscape and the industry trends affecting the Firm or does not formulate effective business plans to address the Firm’s near- and longer-term strategic priorities, as well as the changing regulatory and market environments in which the Firm operates both in the U.S. and abroad, the franchise values and growth prospects of the Firm’s businesses will suffer and revenues will decline. The prospects of the Firm will also depend on management’s ability to execute effectively against the Firm’s strategic plans and to manage the Firm’s resources to grow revenues, control expenses and return capital to the Firm’s shareholders. Any significant failure by the Firm’s Board of Directors to exercise appropriate oversight of management’s strategic decisions, or any significant failure by the Firm’s management to develop and execute on the Firm’s strategic plans and business initiatives, or the ineffectual
implementation of business decisions, the failure of the Firm’s products or services or dealings with customers to meet customer expectations, inadequate responses to regulatory requirements, the failure to react quickly to changes in market conditions or structure, or the failure to develop the necessary operational, technology, risk, financial, and managerial resources necessary to grow and manage the Firm and its various businesses could adversely affect the Firm’s competitive standing and negatively affect the Firm’s earnings and future results of operations.
JPMorgan Chase’s operations are subject to risk of loss from unfavorable economic, monetary and political developments in the U.S. and around the world.
JPMorgan Chase’s businesses and earnings are affected by the fiscal and other policies that are adopted by various U.S. and non-U.S. regulatory authorities and agencies. The Federal Reserve regulates the supply of money and credit in the U.S. and its policies determine in large part the cost of funds for lending and investing in the U.S. and the return earned on those loans and investments. Changes in Federal Reserve policies (as well as the fiscal and monetary policies of non-U.S. central banks or regulatory authorities and agencies, such as “pegging” the exchange rate of their currency to the currencies of others) are beyond the Firm’s control and may be difficult to predict, and consequently, unanticipated changes in these policies could have a negative impact on the Firm’s activities and results of operations.
The Firm’s businesses and revenue are also subject to risks inherent in investing and market-making in securities, loans and other obligations of companies worldwide. These risks include, among others, negative effects from slowing growth rates or recessionary economic conditions, or the risk of loss from unfavorable political, legal or other developments, including social or political instability, in the countries or regions in which such companies operate, as well as the other risks and considerations as described further below.
Several of the Firm’s businesses engage in transactions with, or trade in obligations of, U.S. and non-U.S. governmental entities, including national, state, provincial, municipal and local authorities. These activities can expose the Firm to enhanced sovereign, credit-related, operational and reputation risks, including the risks that a governmental entity may default on or restructure its obligations, claim that actions taken by government officials were beyond the legal authority of those officials or repudiate transactions authorized by a previous incumbent government, any or all of which could adversely affect the Firm’s financial condition and results of operations.
Further, various countries or regions in which the Firm operates or invests, or in which the Firm may do so in the future, have in the past experienced severe economic disruptions particular to those countries or regions. In some cases, concerns regarding the fiscal condition of one or more countries can cause a contraction of available credit and reduced activity among trading partners or create market volatility that could lead to “market contagion” affecting other countries in the same region or beyond the
region. In addition, governments in particular countries or regions in which the Firm or its client do business may choose to adopt protectionist economic or trade policies in response to concerns about domestic economic conditions which could lead to diminished cross-border trade and financing activity within that country or region, all of which could negatively affect the Firm’s business and earnings in those jurisdictions.
Political and economic uncertainty can also undermine consumer, business and investor confidence, and thereby contribute to market volatility. For example, uncertainties concerning the timing and terms of the U.K.’s planned departure from the EU could have an adverse effect on global financial markets and may adversely impact global economic conditions more generally. Furthermore, depending on the nature of the arrangements agreed between the U.K. and the EU, including with respect to the ability of financial services companies to engage in business in the EU from legal entities organized in or operating from the U.K., it is possible that under some scenarios, the Firm may need to make changes to its legal entity structure and operations and the locations in which it operates, which might result in a less efficient operating model across the Firm’s European legal entities. Accordingly, it is possible that political or economic developments in certain countries, even in countries in which the Firm does not conduct business or have operations or engages in only limited activities, may adversely affect the Firm.
The Firm must comply with economic sanctions and embargo programs administered by OFAC and similar multi-national bodies and governmental agencies outside U.S., including, most recently, sanctions targeted at individuals and companies in Russia. A violation of a sanction or embargo program could subject the Firm, and individual employees, to regulatory enforcement actions as well as significant civil and criminal penalties.
JPMorgan Chase’s operations in emerging markets may be hindered by local political, social and economic factors, and may be subject to additional compliance costs and risks.
Some of the countries in which JPMorgan Chase conducts its businesses have economies or markets that are less developed and more volatile, and may have legal and regulatory regimes that are less established or predictable, than the U.S. and other developed markets in which the Firm currently operates. Some of these countries have in the past experienced severe economic disruptions, including extreme currency fluctuations, high inflation, low or negative growth, or defaults or potential defaults on sovereign debt, among other negative conditions, or have imposed restrictive monetary policies such as currency exchange controls and other laws and restrictions that adversely affect the local and regional business environment. In addition, these countries, as well as certain more developed countries, have recently been more susceptible to unfavorable political, social or economic developments; these developments have in the past resulted in, and may in the future lead to, social unrest,
Part I
general strikes and demonstrations, crime and corruption, security and personal safety issues, outbreaks of hostilities, overthrow of incumbent governments, terrorist attacks or other forms of internal discord, all of which can adversely affect the Firm’s operations or investments in such countries. Political, social or economic disruption or dislocation in certain countries or regions in which the Firm conducts its businesses can hinder the growth and profitability of those operations.
Less developed legal and regulatory systems in certain countries can also have adverse consequences on the Firm’s operations in those countries, including, among others, the absence of a statutory or regulatory basis or guidance for engaging in specific types of business or transactions; the promulgation of conflicting or ambiguous laws and regulations or the inconsistent application or interpretation of existing laws and regulations; uncertainty as to the enforceability of contractual obligations; difficulty in competing in economies in which the government controls or protects all or a portion of the local economy or specific businesses, or where graft or corruption may be pervasive; and the threat of arbitrary regulatory investigations, civil litigations or criminal prosecutions, the termination of licenses required to operate in the local market or the suspension of business relationships with governmental bodies.
Revenue from international operations and trading in non-U.S. securities and other obligations may be subject to negative fluctuations as a result of the above considerations, as well as due to governmental actions including monetary policies, expropriation, nationalization, confiscation of assets, price controls, capital controls, exchange controls, and changes in laws and regulations. The impact of these fluctuations could be accentuated as some trading markets are smaller, less liquid and more volatile than larger markets. Also, any of the above-mentioned events or circumstances in one country can affect, and in the past conditions of these types have affected, the Firm’s operations and investments in another country or countries, including the Firm’s operations in the U.S. As a result, any such unfavorable conditions or developments could have an adverse impact on the Firm’s business and results of operations.
Conducting business in countries with less developed legal and regulatory regimes often requires the Firm to devote significant additional resources to understanding, and monitoring changes in, local laws and regulations, as well as structuring its operations to comply with local laws and regulations and implementing and administering related internal policies and procedures. There can be no assurance that the Firm will always be successful in its efforts to conduct its business in compliance with laws and regulations in countries with less predictable legal and regulatory systems or that the Firm will be able to develop effective working relationships with local regulators. In addition, the Firm can also incur higher costs, and face greater compliance risks, in structuring and operating its businesses outside the U.S. to comply with U.S. anti-corruption and anti-money laundering laws and regulations.
JPMorgan Chase relies on the effectiveness and integrity of its processes, operational systems and employees, and those of third parties, and certain failures of such processes or systems, or errors or misconduct by such employees, could materially and adversely affect the Firm’s operations.
JPMorgan Chase’s businesses are dependent on the Firm’s ability to process, record and monitor an increasingly large number of complex transactions and to do so on a faster and more frequent basis. The Firm’s front- and back-office trading systems similarly rely on their access to, and on the functionality of, the operational systems maintained by third parties such as clearing and payment systems, central counterparties, securities exchanges and data processing and technology companies. If the Firm’s financial, accounting, trading or other data processing systems, or the operational systems of third parties on which the Firm’s businesses are dependent, are unable to meet these increasingly demanding standards, or if they fail or have other significant shortcomings, the Firm could be materially and adversely affected. Moreover, as the speed, frequency, volume and complexity of transactions (and the requirements to report such transactions on a real-time basis to clients, regulators and financial intermediaries) increases, the risk of human and/or systems error in connection with such transactions increases, and it becomes more challenging to maintain the Firm’s operational systems and infrastructure. The effective functioning of the Firm’s operational systems is also dependent on the competence and reliability of its employees, as well as the employees of third parties on whom the Firm relies for technological support, and the Firm could be materially and adversely affected by a significant operational breakdown or failure caused by human error or misconduct by an employee of the Firm or a third party. In addition, when the Firm changes processes or introduces new products and services or new connectivity solutions, the Firm may not fully appreciate or identify new operational risks that may arise from such changes. Any of these occurrences could diminish the Firm’s ability to operate one or more of its businesses, or result in potential liability to clients and customers, increased operating expenses, higher litigation costs (including fines and sanctions), damage to reputation, impairment of liquidity, regulatory intervention or weaker competitive standing, any of which could materially and adversely affect the Firm.
Third parties with which the Firm does business, including retailers, data aggregators and other third parties with which the Firm’s customers do business, can also be sources of operational risk to the Firm, particularly where activities of customers or such third parties are beyond the Firm’s security and control systems, such as through the use of the internet, personal smart phones and other mobile devices or services. As the Firm’s interconnectivity with customers and other third parties increases, the Firm increasingly faces the risk of operational failure with respect to their systems. Security breaches affecting the Firm’s customers, or systems breakdowns or failures, security breaches or human error or misconduct affecting such other third
parties, may require the Firm to take steps to protect the integrity of its own operational systems or to safeguard confidential information of the Firm or its customers, thereby increasing the Firm’s operational costs and potentially diminishing customer satisfaction. Furthermore, the interconnectivity of multiple financial institutions with central agents, exchanges and clearing houses, and the increased importance of these entities, increases the risk that an operational failure at one institution or entity may cause an industry-wide operational failure that could materially impact the Firm’s ability to conduct business.
The Firm’s businesses are subject to complex and evolving U.S. and non-U.S. laws and regulations governing the privacy and protection of personal information of individuals (including clients, client’s clients, employees of the Firm and its suppliers and other third parties). Ensuring that the Firm’s collection, use, transfer and storage of personal information complies with all applicable laws and regulations, including where the laws of different jurisdictions are in conflict, can increase the Firm’s operating costs, impact the development of new products or services and require significant oversight by management, and may require the Firm to structure its businesses, operations and systems in less efficient ways. Furthermore, the Firm may not be able to ensure that all of its clients, suppliers, counterparties and other third parties have appropriate controls in place to protect the confidentiality of the information exchanged between them and the Firm, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of clients, customers, employees or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), the Firm could be exposed to litigation or regulatory sanctions. Concerns regarding the effectiveness of the Firm’s measures to safeguard personal information, or even the perception that such measures are inadequate, could cause the Firm to lose customers or potential customers for its products and services and thereby reduce the Firm’s revenues. Accordingly, any failure or perceived failure by the Firm to comply with applicable privacy or data protection laws and regulations may subject it to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or significant liabilities, fines or penalties, and could damage the Firm’s reputation and otherwise adversely affect its businesses.
The Firm may be subject to disruptions of its operational systems arising from events that are wholly or partially beyond the Firm’s control, which may include, for example, security breaches (as discussed further below); electrical or telecommunications outages; failures of computer servers or other damage to the Firm’s property or assets; natural disasters or severe weather conditions; health emergencies or pandemics; or events arising from local or larger-scale political events, including outbreaks of hostilities or terrorist acts. JPMorgan Chase maintains a global resiliency and crisis management program that is intended to ensure
that the Firm has the ability to recover its critical business functions and supporting assets, including staff, technology and facilities, in the event of a business interruption. While the Firm believes that its current resiliency plans are both sufficient and adequate, there can be no assurance that such plans will fully mitigate all potential business continuity risks to the Firm or its customers and clients. Any failures or disruptions of the Firm’s systems or operations could give rise to losses in service to customers and clients, adversely affect the Firm’s business and results of operations by subjecting the Firm to losses or liability, or require the Firm to expend significant resources to correct the failure or disruption, as well as by exposing the Firm to litigation, regulatory fines or penalties or losses not covered by insurance.
A breach in the security of JPMorgan Chase’s systems, or those of other market participants, could disrupt the Firm’s businesses, result in the disclosure of confidential information, damage the Firm’s reputation and create significant financial and legal exposure for the Firm.
Although JPMorgan Chase devotes significant resources to maintain and regularly upgrade its systems and processes that are designed to protect the security of the Firm’s computer systems, software, networks and other technology assets, as well as the confidentiality, integrity and availability of information belonging to the Firm and its customers and clients, there is no assurance that all of the Firm’s security measures will provide absolute security. JPMorgan Chase and other companies, as well as governmental and political organizations, have reported significant breaches in the security of their websites, networks or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage, including through the introduction of computer viruses or malware, cyberattacks and other means. The Firm is regularly targeted by unauthorized parties using malicious code and viruses, and has experienced several significant distributed denial-of-service attacks from technically sophisticated and well-resourced third parties which were intended to disrupt online banking services.
Despite the Firm’s efforts to ensure the security and integrity of its systems, it is possible that the Firm may not be able to anticipate, detect or recognize threats to its systems or to implement effective preventive measures against all security breaches of these types inside or outside the Firm, especially because the techniques used change frequently or are not recognized until launched, and because cyberattacks can originate from a wide variety of sources, including third parties who are or may be involved in organized crime or linked to terrorist organizations or hostile foreign governments, and such third parties may seek to gain access to the Firm’s systems either directly or using equipment or security passwords belonging to employees, customers, third-party service providers or other users of the Firm’s systems. These risks may increase in the future as the Firm continues to increase its mobile-payment and other internet-based product offerings and
Part I
expands its internal usage of web-based products and applications.
Given the breadth of the Firm’s operations, the high volume of transactions that it processes, the large number of customers, counterparties and third-party service providers with which the Firm does business, and the proliferation and increasing sophistication of cyberattacks, a particular cyberattack could occur and persist for an extended period of time before being detected. The extent of a particular cyberattack and the steps that the Firm may need to take to investigate the attack may not be immediately clear, and it may take a significant amount of time before such an investigation could be completed and full and reliable information about the attack is known. During such time the Firm may not necessarily know the extent of the harm or how best to remediate it, and certain errors or actions could be repeated or compounded before they are discovered and remediated, any or all of which could further increase the costs and consequences of a cyberattack.
A successful penetration or circumvention of the security of the Firm’s systems or the systems of another market participant could cause serious negative consequences for the Firm, including significant disruption of the Firm’s operations and those of its clients, customers and counterparties, misappropriation of confidential information of the Firm or that of its clients, customers, counterparties or employees, or damage to computers or systems of the Firm and those of its clients, customers and counterparties, and could result in violations of applicable privacy and other laws, financial loss to the Firm or to its customers, loss of confidence in the Firm’s security measures, customer dissatisfaction, significant litigation exposure and harm to the Firm’s reputation, all of which could have a material adverse effect on the Firm.
Risk Management
JPMorgan Chase’s framework for managing risks and its risk management procedures and practices may not be effective in identifying and mitigating every risk to the Firm, thereby resulting in losses.
JPMorgan Chase’s risk management framework seeks to mitigate risk and loss to the Firm. The Firm has established processes and procedures intended to identify, measure, monitor, report and analyze the types of risk to which the Firm is subject. However, as with any risk management framework, there are inherent limitations to the Firm’s risk management strategies because there may exist, or develop in the future, risks that the Firm has not appropriately anticipated or identified. In addition, the Firm relies on data to aggregate and assess its various risk exposures, and any deficiencies in the quality or effectiveness of the Firm’s data aggregation and validation procedures could result in ineffective risk management practices or inaccurate risk reporting. Any lapse in the Firm’s risk management framework and governance structure or other inadequacies in the design or implementation of the Firm’s risk management framework, governance, procedures, practices, models or risk reporting systems could, individually or in the aggregate, cause unexpected losses for the Firm, materially and adversely affect the Firm’s
financial condition and results of operations, require significant resources to remediate any risk management deficiency, attract heightened regulatory scrutiny, expose the Firm to regulatory investigations or legal proceedings, subject the Firm to fines, penalties or judgments, harm the Firm’s reputation, or otherwise cause a decline in investor confidence.
The Firm establishes allowances for probable credit losses inherent in its credit exposures, and also employs stress testing and other techniques to determine the capital and liquidity necessary to protect the Firm in the event of adverse economic or market events. These processes are critical to the Firm’s financial results and condition, and require difficult, subjective and complex judgments, including forecasts of how economic conditions might impair the ability of the Firm’s borrowers and counterparties to repay their loans or other obligations. As is the case with any such assessments, there is always the possibility that the Firm will fail to identify the proper factors or that the Firm will fail to accurately estimate the impact of factors that it identifies.
Certain of the Firm’s trading transactions require the physical settlement by delivery of securities or other obligations that the Firm does not own; if the Firm is unable to obtain such securities or obligations within the required timeframe for delivery, this could cause the Firm to forfeit payments otherwise due to it and could result in settlement delays, which could damage the Firm’s reputation and ability to transact future business. In addition, in situations where trades are not settled or confirmed on a timely basis, the Firm may be subject to heightened credit and operational risk, and in the event of a default, the Firm may be exposed to market and operational losses.
Many of the Firm’s risk management strategies or techniques have a basis in historical market behavior, and all such strategies and techniques are based to some degree on management’s subjective judgment. For example, many models used by the Firm are based on assumptions regarding correlations among prices of various asset classes or other market indicators. In times of market stress, including difficult or less liquid market environments, or in the event of other unforeseen circumstances, previously uncorrelated indicators may become correlated, or conversely, previously correlated indicators may make unrelated movements. These sudden market movements or unanticipated or unidentified market or economic movements have in some circumstances limited and could again limit the effectiveness of the Firm’s risk management strategies, causing the Firm to incur losses.
Many of the models used by the Firm are subject to review not only by the Firm’s Model Risk function but also by the Firm’s regulators in order that the Firm may utilize such models in connection with the Firm’s calculations of market risk RWA, credit risk RWA and operational risk RWA under Basel III. The Firm may be subject to higher capital charges, which could adversely affect its financial results or limit its ability to expand its businesses, if such models do not receive approval by its regulators.
In addition, the Firm must comply with enhanced standards for the assessment and management of risks associated with vendors and other third parties that provide services to the Firm. These requirements apply to the Firm both under general guidance issued by its banking regulators and, more specifically, under certain of the consent orders to which the Firm has been subject. The Firm has incurred and expects to incur additional costs and expenses in connection with its initiatives to address the risks associated with oversight of its third party relationships. Failure by the Firm to appropriately assess and manage third party relationships, especially those involving significant banking functions, shared services or other critical activities, could result in potential liability to clients and customers, fines, penalties or judgments imposed by the Firm’s regulators, increased operating expenses and harm to the Firm’s reputation, any of which could materially and adversely affect the Firm.
Other Risks
Actions or inaction by employees of the Firm may cause harm to the Firm’s clients and customers, damage the Firm’s reputation, negatively impact the Firm’s culture and lead to liability and regulatory and other governmental actions against the Firm.
JPMorgan Chase’s employees interact with clients, customers and counterparties every day, and they are expected through their conduct to demonstrate the Firm’s values and exhibit the culture and behaviors that are an integral part of the Firm’s How We Do Business Principles, including the Firm’s commitment to “do first class business in a first class way”. If an employee takes an action (including a failure to act) that does not comply with the Firm’s Code of Conduct, is inconsistent with the Firm’s How We Do Business Principles or that otherwise harms clients, consumers or the market, such as improperly selling and marketing the Firm’s product or services, acting illegally with others to establish market prices, improperly hiring individuals related to “politically exposed persons” or misappropriating Firm property or confidential or proprietary information or technology belonging to the Firm, its customers or third parties, such activities could give rise to litigation, regulatory or other governmental investigations or enforcement actions, and judgments, settlements, fines or penalties, and lead to requirements that the Firm restructure certain of its operations and activities, all of which could harm the Firm’s reputation or result in collateral consequences. Although the Firm endeavors to embed culture and conduct risk management throughout an employee’s life cycle, including recruiting, onboarding, training and development, and performance management, as well as through the Firm’s promotion and compensation processes, employees of the Firm have, from time to time in the past, engaged in improper or illegal conduct resulting in litigation as well as settlements involving consent orders, deferred prosecution agreements and non-prosecution agreements, as well as other civil and criminal settlements with regulators and other governmental entities, and there is no assurance that further inappropriate actions by employees will not occur or
that any such actions will always be deterred or quickly prevented.
The financial services industry is highly competitive, and JPMorgan Chase’s inability to compete successfully may adversely affect its results of operations.
JPMorgan Chase operates in a highly competitive environment, and the Firm expects that competition in the U.S. and global financial services industry will continue to be intense. Competitors of the Firm include other banks and financial institutions, trading, advisory and investment management firms, finance companies and technology companies and other firms that are engaged in providing similar products and services. Technological advances and the growth of e-commerce have made it possible for non-depository institutions to offer products and services that traditionally were banking products, and for financial institutions and other companies to provide electronic and internet-based financial solutions, including electronic securities trading, payment processing and online automated algorithmic-based investment advice. New technologies have required and could require the Firm to spend more to modify or adapt its products to attract and retain customers or to match products and services offered by its competitors, including technology companies.
Ongoing or increased competition, on the basis of the quality and variety of products and services offered, transaction execution, innovation, reputation, price or other factors, may put downward pressure on prices and fees for the Firm’s products and services or may cause the Firm to lose market share. In addition, the failure of any of the Firm’s businesses to meet the expectations of clients and customers, whether due to general market conditions or underperformance (relative to competitors or to benchmarks), could impact the Firm’s ability to retain clients and customers or attract new clients and customers, thereby reducing the Firm’s revenues. Increased competition also may require the Firm to make additional capital investments in its businesses, or to extend more of its capital on behalf of its clients in order to remain competitive. The Firm cannot provide assurance that the significant competition in the financial services industry will not materially and adversely affect its future results of operations.
Non-U.S. competitors of the Firm’s wholesale businesses outside the U.S. are typically subject to different, and in some cases, less stringent, legislative and regulatory regimes. The more restrictive laws and regulations applicable to U.S. financial services institutions, such as JPMorgan Chase, can put the Firm at a competitive disadvantage to its non-U.S. competitors, including prohibiting the Firm from engaging in certain transactions, imposing higher capital and liquidity requirements on the Firm, making the Firm’s pricing of certain transactions more expensive for clients or adversely affecting the Firm’s cost structure for providing certain products, all of which can reduce the revenue and profitability of the Firm’s wholesale businesses.
Part I
JPMorgan Chase’s ability to attract and retain qualified employees is critical to its success.
JPMorgan Chase’s employees are the Firm’s most important resource, and in many areas of the financial services industry, competition for qualified personnel is intense. The Firm endeavors to attract talented and diverse new employees and retain and motivate its existing employees. There is the potential for changes in immigration policies in multiple jurisdictions around the world, including the U.S., and to the extent that immigration policies were to unduly restrict or otherwise make it more difficult for qualified employees to work in, or transfer among, jurisdictions in which the Firm has operations or conducts its business, the Firm could be adversely affected. The Firm also seeks to retain a pipeline of senior employees with superior talent, augmented from time to time by external hires, to provide continuity of succession for the Firm’s Operating Committee, including the Chief Executive Officer position, and senior positions below the Operating Committee. The Firm regularly reviews candidates for senior management positions to assess whether they currently are ready for a next-level role. In addition, the Firm’s Board of Directors is deeply involved in succession planning, including review of the succession plans for the Chief Executive Officer and the members of the Operating Committee. If the Firm were unable to continue to attract or retain qualified employees, including successors to the Chief Executive Officer or members of the Operating Committee, the Firm’s performance, including its competitive position, could be materially and adversely affected.
JPMorgan Chase’s financial statements are based in part on estimates and judgments which, if incorrect, could result in unexpected losses in the future.
Under accounting principles generally accepted in the U.S. (“U.S. GAAP”), JPMorgan Chase is required to use estimates and apply judgments in preparing its financial statements, including in determining allowances for credit losses and reserves related to litigation, among other items. Certain of the Firm’s financial instruments, including trading assets and liabilities, instruments in the investment securities portfolio, certain loans, MSRs, structured notes and certain repurchase and resale agreements, among other items, require a determination of their fair value in order to prepare the Firm’s financial statements. Where quoted market prices are not available, the Firm may make fair value determinations based on internally developed models or other means which ultimately rely to some degree on management estimates and judgment. In addition, sudden illiquidity in markets or declines in prices of certain loans and securities may make it more difficult to value certain balance sheet items, which may lead to the possibility that such valuations will be subject to further change or adjustment. If estimates or judgments underlying the Firm’s financial statements are incorrect, the Firm may experience material losses.
Lapses in disclosure controls and procedures or internal control over financial reporting could materially and adversely affect the Firm’s operations, profitability or reputation.
There can be no assurance that the Firm’s disclosure controls and procedures will be effective in every circumstance or that a material weakness or significant deficiency in internal control over financial reporting will not occur. Any such lapses or deficiencies may materially and adversely affect the Firm’s business and results of operations or financial condition, restrict its ability to access the capital markets, require the Firm to expend significant resources to correct the lapses or deficiencies, expose the Firm to regulatory or legal proceedings, subject it to fines, penalties or judgments, harm the Firm’s reputation, or otherwise cause a decline in investor confidence.
Damage to JPMorgan Chase’s reputation could damage its businesses.
Maintaining trust in JPMorgan Chase is critical to the Firm’s ability to attract and maintain customers, investors and employees. Damage to the Firm’s reputation can therefore cause significant harm to the Firm’s business and prospects. Harm to the Firm’s reputation can arise from numerous sources, including, among others, employee misconduct, security breaches, compliance failures, litigation or regulatory outcomes or governmental investigations. The Firm’s reputation could also be harmed by the failure or perceived failure of an affiliate, joint-venturer or merchant banking portfolio company, or a vendor or other third party with which the Firm does business, to comply with laws or regulations. In addition, the Firm’s reputation or prospects may be significantly damaged by adverse publicity or negative information regarding the Firm, whether or not true, that may be posted on social media, non-mainstream news services or other parts of the internet, and this risk can be magnified by the speed and pervasiveness with which information is disseminated through those channels.
Management of potential conflicts of interest has become increasingly complex as the Firm continues to expand its business activities through more numerous transactions, obligations and interests with and among the Firm’s clients. The failure or perceived failure to adequately address or appropriately disclose conflicts of interest has given rise to litigation and enforcement actions. Likewise, the failure or perceived failure to deliver appropriate standards of service and quality, to treat customers and clients fairly, to provide fiduciary products or services in accordance with the applicable legal and regulatory standards, or to handle or use confidential information of customers or clients appropriately or in compliance with applicable data protection and privacy laws and regulations has given rise to litigation and enforcement actions. In the future, a failure or perceived failure to appropriately address conflicts or fiduciary obligations could result in customer dissatisfaction, litigation and heightened regulatory scrutiny and enforcement actions, all of which can lead to lost
revenue and higher operating costs and cause serious harm to the Firm’s reputation.
Actions by the financial services industry generally or by certain members of or individuals in the industry can also affect the Firm’s reputation. For example, the role played by financial services firms during and after the financial crisis, including concerns that consumers have been treated unfairly by financial institutions or that a financial institution had acted inappropriately with respect to the methods employed in offering products to customers, have damaged the reputation of the industry as a whole. Should any of these or other events or factors that can undermine the Firm’s reputation occur, there is no assurance that the additional costs and expenses that the Firm may need to incur to address the issues giving rise to the damage to its reputation could not adversely affect the Firm’s earnings and results of operations, or that damage to the Firm’s reputation will not impair the Firm’s ability to retain its existing or attract new customers, investors and employees.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
JPMorgan Chase’s headquarters is located in New York City at 270 Park Avenue, a 50-story office building it owns.
The Firm owned or leased facilities in the following locations at December 31, 2016.
(a)
At December 31, 2016, the Firm owned or leased 5,258 retail branches in 23 states.
The premises and facilities occupied by JPMorgan Chase are used across all of the Firm’s business segments and for corporate purposes. JPMorgan Chase continues to evaluate its current and projected space requirements and may determine from time to time that certain of its properties (including the premises and facilities noted above) are no longer necessary for its operations. There is no assurance that the Firm will be able to dispose of any such excess properties, premises, and facilities or that it will not incur charges in connection with such dispositions. Such disposition costs may be material to the Firm’s results of operations in a given period. For information on occupancy expense, see the Consolidated Results of Operations on pages 40-42.
Item 3. Legal Proceedings.
For a description of the Firm’s material legal proceedings, see Note 31.
Item 4. Mine Safety Disclosures.
Not applicable.
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market for registrant’s common equity
The outstanding shares of JPMorgan Chase common stock are listed and traded on the New York Stock Exchange and the London Stock Exchange. For the quarterly high and low prices of and cash dividends declared on JPMorgan Chase’s common stock for the last two years, see the section entitled “Supplementary information - Selected quarterly financial data (unaudited)” on pages 272-273. For a comparison of the cumulative total return for JPMorgan Chase common stock with the comparable total return of the S&P 500 Index, the KBW Bank Index and the S&P Financial Index over the five-year period ended December 31, 2016, see “Five-year stock performance,”
on page 35.
For information on the common dividend payout ratio, see Capital actions in the Capital Risk Management section of Management’s discussion and analysis on page 84. For a discussion of restrictions on dividend payments, see Note 22 and Note 27. On January 31, 2017, there were 196,792 holders of record of JPMorgan Chase common stock. For information regarding securities authorized for issuance under the Firm’s employee stock-based compensation plans, see Part III, Item 12 on page 25.
Repurchases under the common equity repurchase program
For information regarding repurchases under the Firm’s common equity repurchase program, see Capital actions in the Capital Risk Management section of Management’s discussion and analysis on page 84.
Shares repurchased, on a settlement-date basis, pursuant to the common equity repurchase program during 2016 were as follows.
(a)
Excludes commissions cost.
(b)
The $58 million unused portion under the prior Board authorization was canceled when the $10.6 billion repurchase program was authorized by the Board of Directors on June 29, 2016.
(c)
Represents the amount remaining under the $10.6 billion repurchase program.
Item 6. Selected Financial Data.
For five-year selected financial data, see “Five-year summary of consolidated financial highlights (unaudited)” on page 34.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s discussion and analysis of financial condition and results of operations, entitled “Management’s discussion and analysis,” appears on pages 36-138. Such information should be read in conjunction with the Consolidated Financial Statements and Notes thereto, which appear on pages 141-271.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
For a discussion of the quantitative and qualitative disclosures about market risk, see the Market Risk Management section of Management’s discussion and analysis on pages 116-123.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Financial Statements, together with the Notes thereto and the report thereon dated February 28, 2017, of PricewaterhouseCoopers LLP, the Firm’s independent registered public accounting firm, appear on pages 140-271.
Supplementary financial data for each full quarter within the two years ended December 31, 2016, are included on pages 272-273 in the table entitled “Selected quarterly financial data (unaudited).” Also included is a “Glossary of terms and Acronyms’’ on pages 279-285.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
The internal control framework promulgated by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), “Internal Control - Integrated Framework” (“COSO 2013”) provides guidance for designing, implementing and conducting internal control and assessing its effectiveness. The Firm used the COSO 2013 framework to assess the effectiveness of the Firm’s internal control over financial reporting as of December 31, 2016. See “Management’s report on internal control over financial reporting” on page 139.
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Firm’s management, including its Chairman and Chief Executive Officer and its Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chairman and Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective. See Exhibits 31.1 and 31.2 for the Certification statements issued by the Chairman and Chief Executive Officer and Chief Financial Officer.
The Firm is committed to maintaining high standards of internal control over financial reporting. Nevertheless, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, in a firm as large and complex as JPMorgan Chase, lapses or deficiencies in internal controls may occur from time to time, and there can be no assurance that any such deficiencies will not result in significant deficiencies or material weaknesses in internal control in the future. For further information, see “Management’s report on internal control over financial reporting” on page 139. There was no change in the Firm’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the three months ended December 31, 2016, that has materially affected, or is reasonably likely to materially affect, the Firm’s internal control over financial reporting.
Item 9B. Other Information.
None.
Part III
Item 10. Directors, Executive Officers and Corporate Governance.
Executive officers of the registrant
Unless otherwise noted, during the five fiscal years ended December 31, 2016, all of JPMorgan Chase’s above-named executive officers have continuously held senior-level positions with JPMorgan Chase. There are no family relationships among the foregoing executive officers. Information to be provided in Items 10, 11, 12, 13 and 14 of the Form 10-K and not otherwise included herein is incorporated by reference to the Firm’s Definitive Proxy Statement for its 2017 Annual Meeting of Stockholders to be held on May 16, 2017, which will be filed with the SEC within 120 days of the end of the Firm’s fiscal year ended December 31, 2016.
Item 11. Executive Compensation.
See Item 10.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
For security ownership of certain beneficial owners and management, see Item 10.
The following table sets forth the total number of shares available for issuance under JPMorgan Chase’s employee stock-based incentive plans (including shares available for issuance to non-employee directors). The Firm is not authorized to grant stock-based incentive awards to non-employees, other than to non-employee directors.
(a)
Does not include restricted stock units or performance stock units granted under the shareholder-approved Long-Term Incentive Plan (“LTIP”), as amended and restated effective May 19, 2015. For further discussion, see Note 10.
(b)
Represents future shares available under the shareholder-approved LTIP.
All future shares will be issued under the shareholder-approved LTIP. For further discussion, see Note 10.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
See Item 10.
Item 14. Principal Accounting Fees and Services.
See Item 10.
Part IV
Item 15. Exhibits, Financial Statement Schedules.
Financial statements
The Consolidated Financial Statements, the Notes thereto and the report of the Independent Registered Public Accounting Firm thereon listed in Item 8 are set forth commencing on page 140.
Financial statement schedules
Exhibits
3.1
Restated Certificate of Incorporation of JPMorgan Chase & Co., effective April 5, 2006 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 7, 2006).
3.2
Amendment to the Restated Certificate of Incorporation of JPMorgan Chase & Co., effective June 7, 2013 (incorporated by reference to Appendix F to the Proxy Statement on Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805) filed April 10, 2013).
3.3
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series I (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 24, 2008).
3.4
Certificate of Designations for 5.50% Non-Cumulative Preferred Stock, Series O (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed August 27, 2012).
3.5
Certificate of Designations for 5.45% Non-Cumulative Preferred Stock, Series P (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed February 5, 2013).
3.6
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series Q (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 23, 2013).
3.7
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series R (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed July 29, 2013).
3.8
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series S (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 22, 2014).
3.9
Certificate of Designations for 6.70% Non-Cumulative Preferred Stock, Series T (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 30, 2014).
3.10
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series U (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed on March 10, 2014).
3.11
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series V (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed on June 9, 2014).
3.12
Certificate of Designations for 6.30% Non-Cumulative Preferred Stock, Series W (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed on June 23, 2014).
3.13
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series X (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed on September 23, 2014).
3.14
Certificate of Designations for 6.125% Non-Cumulative Preferred Stock, Series Y (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed February 17, 2015).
3.15
Certificate of Designations for Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series Z (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 21, 2015).
3.16
Certificate of Designations for 6.10% Non-Cumulative Preferred Stock, Series AA (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed June 4, 2015).
3.17
Certificate of Designations for 6.15% Non-Cumulative Preferred Stock, Series BB (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed July 29, 2015).
3.18
By-laws of JPMorgan Chase & Co., effective January 19, 2016 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 21, 2016).
4.1(a)
Indenture, dated as of October 21, 2010, between JPMorgan Chase & Co. and Deutsche Bank Trust Company Americas, as Trustee (incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.1-5805) filed October 21, 2010).
4.1(b)
First Supplemental Indenture, dated as of January 13, 2017, between JPMorgan Chase & Co. and Deutsche Bank Trust Company Americas, as Trustee, to the Indenture, dated as of October 21, 2010 (incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 13, 2017).
4.2(a)
Subordinated Indenture, dated as of March 14, 2014, between JPMorgan Chase & Co. and U.S. Bank Trust National Association, as Trustee (incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.1-5805) filed March 14, 2014).
4.2(b)
First Supplemental Indenture, dated as of January 13, 2017, between JPMorgan Chase & Co. and U.S. Bank Trust National Association, as Trustee, to the Subordinated Indenture, dated as of March 14, 2014 (incorporated by reference to Exhibit 4.2 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 13, 2017).
4.3(a)
Indenture, dated as of May 25, 2001, between JPMorgan Chase & Co. and Bankers Trust Company (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4(a)(1) to the Registration Statement on Form S-3 of JPMorgan Chase & Co. (File No. 333-52826) filed June 13, 2001).
4.3(b)
Sixth Supplemental Indenture, dated as of January 13, 2017, between JPMorgan Chase & Co. and Bankers Trust Company (succeeded by Deutsche Bank Trust Company Americas), as Trustee, to the Indenture, dated as of May 25, 2001 (incorporated by reference to Exhibit 4.3 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed January 13, 2017).
4.4
Indenture, dated as of February 19, 2016, among JPMorgan Chase Financial Company LLC, JPMorgan Chase & Co. and Deutsche Bank Trust Company Americas, as Trustee (incorporated by reference to Exhibit 4(a)(7) to the Registration Statement on Form S-3 of JPMorgan Chase & Co. and JPMorgan Chase Financial Company LLC (File No. 333-209682) filed February 24, 2016).
4.5
Form of Deposit Agreement (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-3 of JPMorgan Chase & Co. (File No. 333-191692) filed October 11, 2013).
4.6
Form of Warrant to purchase common stock (incorporated by reference to Exhibit 4.2 to the Form 8-A of JPMorgan Chase & Co. (File No. 1-5805) filed December 11, 2009).
Other instruments defining the rights of holders of long-term debt securities of JPMorgan Chase & Co. and its subsidiaries are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of Regulation S-K. JPMorgan Chase & Co. agrees to furnish copies of these instruments to the SEC upon request.
10.1
Deferred Compensation Plan for Non-Employee Directors of JPMorgan Chase & Co., as amended and restated July 2001 and as of December 31, 2004 (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007).(a)
10.2
2005 Deferred Compensation Plan for Non-Employee Directors of JPMorgan Chase & Co., effective as of January 1, 2005 (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007).(a)
10.3
2005 Deferred Compensation Program of JPMorgan Chase & Co., restated effective as of December 31, 2008 (incorporated by reference to Exhibit 10.4 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.4
JPMorgan Chase & Co. Long-Term Incentive Plan as amended and restated effective May 19, 2015 (incorporated by reference to Appendix C of the Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805) filed April 8, 2015).(a)
10.5
Key Executive Performance Plan of JPMorgan Chase & Co., as amended and restated effective January 1, 2014 (incorporated by reference to Appendix G of the Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805) filed April 10, 2013).(a)
10.6
Excess Retirement Plan of JPMorgan Chase & Co., restated and amended as of December 31, 2008, as amended (incorporated by reference to Exhibit 10.7 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2009).(a)
Part IV
10.7
1995 Stock Incentive Plan of J.P. Morgan & Co. Incorporated and Affiliated Companies, as amended, dated December 11, 1996 (incorporated by reference to Exhibit 10.8 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.8
Executive Retirement Plan of JPMorgan Chase & Co., as amended and restated December 31, 2008 (incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.9
Bank One Corporation Stock Performance Plan, as amended and restated effective February 20, 2001 (incorporated by reference to Exhibit 10.12 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.10
Bank One Corporation Supplemental Savings and Investment Plan, as amended and restated effective December 31, 2008 (incorporated by reference to Exhibit 10.13 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.11
Banc One Corporation Revised and Restated 1995 Stock Incentive Plan, effective April 17, 1995 (incorporated by reference to Exhibit 10.15 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.12
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 22, 2008 stock appreciation rights (incorporated by reference to Exhibit 10.25 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007).(a)
10.13
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 22, 2008 stock appreciation rights for James Dimon (incorporated by reference to Exhibit 10.27 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007).(a)
10.14
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for stock appreciation rights, dated as of January 20, 2009 (incorporated by reference to Exhibit 10.20 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.15
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for Operating Committee member stock appreciation rights, dated as of January 20, 2009 (incorporated by reference to Exhibit 10.21 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2008).(a)
10.16
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for Operating Committee member stock appreciation rights, dated as of February 3, 2010 (incorporated by reference to Exhibit 10.23 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2009).(a)
10.17
Forms of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for stock appreciation rights and restricted stock units, dated as of January 18, 2012 (incorporated by reference to Exhibit 10.25 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2011).(a)
10.18
Forms of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for stock appreciation rights and restricted stock units for Operating Committee members, dated as of January 17, 2013 (incorporated by reference to Exhibit 10.23 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2012).(a)
10.19
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for restricted stock units for Operating Committee members, dated as of January 22, 2014 (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of JPMorgan Chase & Co. (File No. 1-5805) for the quarter ended March 31, 2014).(a)
10.20
Forms of JPMorgan Chase & Co. Long-Term Incentive Plan Terms & Conditions for restricted stock units for Operating Committee members (U.S., E.U. and U.K.), dated as of January 20, 2015 (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of JPMorgan Chase & Co. (File No. 1-5805) for the quarter ended March 31, 2015).(a)
10.21
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for restricted stock units for Operating Committee members, dated as of January 19, 2016 (incorporated by reference to Exhibit 10.21 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2015).(a)
10.22
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for performance share units for Operating Committee members, dated as of January 19, 2016 (incorporated by reference to Exhibit 10.22 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2015).(a)
10.23
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for performance share units and restricted stock units for Operating Committee members (U.S. and U.K.), dated as of January 17, 2017.(a)(b)
10.24
Form of JPMorgan Chase & Co. Terms and Conditions of Fixed Allowance (UK) (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of JPMorgan Chase & Co. (File No. 1-5805) for the quarter ended June 30, 2014).(a)
10.25
Form of JPMorgan Chase & Co. Performance-Based Incentive Compensation Plan, effective as of January 1, 2006, as amended (incorporated by reference to Exhibit 10.27 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2009).(a)
10.26
Plea Agreement dated May 20, 2015 between JPMorgan Chase & Co. and the U.S. Department of Justice (incorporated by reference to Exhibit 99.3 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed May 20, 2015).
12.1
Computation of ratio of earnings to fixed charges.(b)
12.2
Computation of ratio of earnings to fixed charges and preferred stock dividend requirements.(b)
List of subsidiaries of JPMorgan Chase & Co.(b)
22.1
Annual Report on Form 11-K of The JPMorgan Chase 401(k) Savings Plan for the year ended December 31, 2016 (to be filed pursuant to Rule 15d-21 under the Securities Exchange Act of 1934).
Consent of independent registered public accounting firm.(b)
31.1
Certification.(b)
31.2
Certification.(b)
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(c)
101.INS
XBRL Instance Document.(b)(d)
101.SCH
XBRL Taxonomy Extension Schema
Document.(b)
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.(b)
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.(b)
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.(b)
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.(b)
(a)
This exhibit is a management contract or compensatory plan or arrangement.
(b)
Filed herewith.
(c)
Furnished herewith. This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
(d)
Pursuant to Rule 405 of Regulation S-T, includes the following financial information included in the Firm’s Annual Report on Form 10-K for the year ended December 31, 2016, formatted in XBRL (eXtensible Business Reporting Language) interactive data files: (i) the Consolidated statements of income for the years ended December 31, 2016, 2015 and 2014, (ii) the Consolidated statements of comprehensive income for the years ended December 31, 2016, 2015 and 2014, (iii) the Consolidated balance sheets as of December 31, 2016 and 2015, (iv) the Consolidated statements of changes in stockholders’ equity for the years ended December 31, 2016, 2015 and 2014, (v) the Consolidated statements of cash flows for the years ended December 31, 2016, 2015 and 2014, and (vi) the Notes to Consolidated Financial Statements.
pages 30-32 not used
Financial:
Five-Year Summary of Consolidated Financial Highlights
Audited financial statements:
Five-Year Stock Performance
Management’s Report on Internal Control Over Financial Reporting
Management’s discussion and analysis:
Report of Independent Registered Public Accounting Firm
Introduction
Consolidated Financial Statements
Executive Overview
Notes to Consolidated Financial Statements
Consolidated Results of Operations
Consolidated Balance Sheets Analysis
Off-Balance Sheet Arrangements and Contractual Cash Obligations
Consolidated Cash Flows Analysis
Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Performance Measures
Supplementary information:
Business Segment Results
Selected quarterly financial data (unaudited)
Enterprise-wide Risk Management
Distribution of assets, liabilities and stockholders’ equity; interest rates and interest differentials
Capital Risk Management
Glossary of Terms and Acronyms
Credit Risk Management
Country Risk Management
Liquidity Risk Management
Market Risk Management
Principal Risk Management
Compliance Risk Management
Conduct Risk Management
Legal Risk Management
Model Risk Management
Operational Risk Management
Reputation Risk Management
Critical Accounting Estimates Used by the Firm
Accounting and Reporting Developments
Forward-Looking Statements
JPMorgan Chase & Co./2016 Annual Report
Financial
FIVE-YEAR SUMMARY OF CONSOLIDATED FINANCIAL HIGHLIGHTS
Note: Effective January 1, 2016, the Firm adopted new accounting guidance related to (1) the recognition and measurement of debit valuation adjustments (“DVA”) on financial liabilities where the fair value option has been elected, and (2) the accounting for employee stock-based incentive payments. For additional information, see Accounting and Reporting Developments on pages 135-137 and Notes 3, 4 and 25.
(a)
Share prices are from the New York Stock Exchange.
(b)
TBVPS and ROTCE are non-GAAP financial measures. For further discussion of these measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Financial Performance Measures on pages 48-50.
(c)
HQLA represents the amount of assets that qualify for inclusion in the liquidity coverage ratio under the final U.S. rule (“U.S. LCR”) for December 31, 2016 and 2015, and the Firm’s estimated amount for December 31, 2014 prior to the effective date of the final rule, and under the Basel III liquidity coverage ratio (“Basel III LCR”) for prior periods. For additional information, see HQLA on page 111.
(d)
Ratios presented are calculated under the Basel III Transitional rules, which became effective on January 1, 2014, and for the capital ratios, represent the Collins Floor. Prior to 2014, the ratios were calculated under the Basel I rules. See Capital Risk Management on pages 76-85 for additional information on Basel III.
(e)
Included unsecured long-term debt of $212.6 billion, $211.8 billion, $207.0 billion, $198.9 billion and $200.1 billion respectively, as of December 31, of each year presented.
(f)
Excluded the impact of residential real estate purchased credit-impaired (“PCI”) loans, a non-GAAP financial measure. For further discussion of these measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Performance Measures on pages 48-50. For further discussion, see Allowance for credit losses on pages 105-107.
JPMorgan Chase & Co./2016 Annual Report
FIVE-YEAR STOCK PERFORMANCE
The following table and graph compare the five-year cumulative total return for JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”) common stock with the cumulative return of the S&P 500 Index, the KBW Bank Index and the S&P Financial Index. The S&P 500 Index is a commonly referenced United States of America (“U.S.”) equity benchmark consisting of leading companies from different economic sectors. The KBW Bank Index seeks to reflect the performance of banks and thrifts that are publicly traded in the U.S. and is composed of leading national money center and regional banks and thrifts. The S&P Financial Index is an index of financial companies, all of which are components of the S&P 500. The Firm is a component of all three industry indices.
The following table and graph assume simultaneous investments of $100 on December 31, 2011, in JPMorgan Chase common stock and in each of the above indices. The comparison assumes that all dividends are reinvested.
December 31,
(in dollars)
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
This section of JPMorgan Chase’s Annual Report for the year ended December 31, 2016 (“Annual Report”), provides Management’s discussion and analysis of the financial condition and results of operations (“MD&A”) of JPMorgan Chase. See the Glossary of Terms and Acronyms on pages 279-285 for definitions of terms used throughout this Annual Report. The MD&A included in this Annual Report contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on the current beliefs and expectations of JPMorgan Chase’s management and are subject to significant risks and uncertainties. These risks and uncertainties could cause the Firm’s actual results to differ materially from those set forth in such forward-looking statements. Certain of such risks and uncertainties are described herein (see Forward-looking Statements on page 138) and in JPMorgan Chase’s Annual Report on Form 10-K for the year ended December 31, 2016 (“2016 Form 10-K”), in Part I, Item 1A: Risk factors; reference is hereby made to both.
INTRODUCTION
JPMorgan Chase & Co., a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the United States of America (“U.S.”), with operations worldwide; the Firm had $2.5 trillion in assets and $254.2 billion in stockholders’ equity as of December 31, 2016. The Firm is a leader in investment banking, financial services for consumers and small businesses, commercial banking, financial transaction processing and asset management. Under the J.P. Morgan and Chase brands, the Firm serves millions of customers in the U.S. and many of the world’s most prominent corporate, institutional and government clients.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank, N.A.”), a national banking association with U.S. branches in 23 states, and Chase Bank USA, National Association (“Chase Bank USA, N.A.”), a national banking association that is the Firm’s credit card-issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan Securities LLC (“JPMorgan Securities”), the Firm’s U.S. investment banking firm. The bank and nonbank subsidiaries of JPMorgan Chase operate nationally as well as through overseas branches and subsidiaries, representative offices and subsidiary foreign banks. One of the Firm’s principal operating subsidiaries in the U.K. is J.P. Morgan Securities plc, a subsidiary of JPMorgan Chase Bank, N.A.
For management reporting purposes, the Firm’s activities are organized into four major reportable business segments, as well as a Corporate segment. The Firm’s consumer business is the Consumer & Community Banking (“CCB”) segment. The Firm’s wholesale business segments are Corporate & Investment Bank (“CIB”), Commercial Banking (“CB”), and Asset & Wealth Management (“AWM”) (formerly Asset Management or “AM”). For a description of the Firm’s business segments, and the products and services they provide to their respective client bases, refer to Business Segment Results on pages 51-70, and Note 33.
JPMorgan Chase & Co./2016 Annual Report
EXECUTIVE OVERVIEW
This executive overview of the MD&A highlights selected information and may not contain all of the information that is important to readers of this Annual Report. For a complete description of the trends and uncertainties, as well as the risks and critical accounting estimates affecting the Firm and its various lines of business, this Annual Report should be read in its entirety.
(a)
Ratios presented are calculated under the Basel III Transitional rules and represent the Collins Floor. See Capital Risk Management on pages 76-85 for additional information on Basel III.
Summary of 2016 results
JPMorgan Chase reported strong results for full year 2016 with net income of $24.7 billion, or $6.19 per share, on net revenue of $95.7 billion. The Firm reported ROE of 10% and ROTCE of 13%.
Net income increased 1% compared with the prior year driven by lower noninterest expense and higher net revenue, predominantly offset by higher income tax expense and provision for credit losses.
Total net revenue increased by 2% primarily reflecting higher net interest income across all the Firm’s business segments and higher Markets noninterest revenue in CIB, partially offset by lower card income in CCB and lower asset management fees in AWM.
Noninterest expense was $55.8 billion, down 5% compared with the prior year, driven by lower legal expense.
The provision for credit losses was $5.4 billion, an increase of $1.5 billion, reflecting an increase in the total consumer provision related to additions in the allowance for loan losses and higher net charge-offs in the credit card portfolio, and a lower benefit in the residential real estate portfolio driven by a lower reduction in the allowance for
loan losses compared with the prior year. The wholesale provision had a modest increase, largely driven by the impact of downgrades in the Oil & Gas and Natural Gas Pipelines portfolios.
The total allowance for credit losses was $14.9 billion at December 31, 2016, and the Firm had a loan loss coverage ratio, excluding the PCI portfolio, of 1.34%, compared with 1.37% in the prior year. The Firm’s nonperforming assets totaled $7.5 billion, an increase from the prior-year level of $7.0 billion.
Firmwide average core loans increased 15% compared with the prior year.
Within CCB, average core loans increased 20% from the prior year. CCB had record growth in average deposits, with a 10% increase from the prior year. Credit card sales volume increased 10%, and merchant processing volume increased 12%, from the prior year. CCB had nearly 27 million active mobile customers at year-end 2016, an increase of 16% from the prior year.
CIB maintained its #1 ranking for Global Investment Banking fees with a 8.1% wallet share for the full-year ended December 31, 2016. Within CB, record average loans increased 14% from the prior year as loans in the commercial and industrial client segment increased 9% and loans in the wholesale commercial real estate client segment increased 18%. AWM had record average loans, an increase of 5% over the prior year, and 79% of AWM’s mutual fund assets under management ranked in the 1st or 2nd quartiles over the past 5 years.
For a detailed discussion of results by line of business (“LOB”), refer to the Business Segment Results on
pages 51-52.
The Firm added to its capital, ending the full-year of 2016 with a TBVPS of $51.44, up 7% over the prior year. The Firm’s estimated Basel III Advanced Fully Phased-In CET1 capital and ratio were $182 billion and 12.2%, respectively. The Fully Phased-In supplementary leverage ratio (“SLR”) for the Firm and for JPMorgan Chase Bank, N.A. was 6.5% and 6.6%, respectively, at December 31, 2016. The Firm also was compliant with the Fully Phased-In U.S. LCR and had $524 billion of HQLA as of December 31, 2016. For further discussion of the LCR and HQLA, see Liquidity Risk Management on pages 110-115.
ROTCE and TBVPS are non-GAAP financial measures. Core loans are considered a key performance measure. Each of the Fully Phased-In capital and leverage measures is considered a key regulatory capital measure. For a further discussion of these measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Performance Measures on pages 48-50, and Capital Risk Management on pages 76-85.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
JPMorgan Chase continues to support consumers, businesses and communities around the globe. The Firm provided credit and raised capital of $2.4 trillion for commercial and consumer clients during the full-year of 2016:
•
$265 billion of credit for consumers
•
$24 billion of credit for U.S. small businesses
•
$772 billion of credit for corporations
•
$1.2 trillion of capital raised for corporate clients and non-U.S. government entities
•
$90 billion of credit and capital raised for nonprofit and U.S. government entities, including states, municipalities, hospitals and universities
On October 1, 2016, the Firm filed with the Federal Reserve and the FDIC its submission (the “2016 Resolution Submission”) describing how the Firm remediated certain deficiencies, and providing a status report on its actions to address certain shortcomings, that had been identified by the Federal Reserve and the FDIC in April 2016 when those agencies provided feedback to the Firm as well as to seven other systemically important domestic banking institutions on their respective 2015 Resolution Plans.
Among the steps taken by the Firm to address the identified deficiencies and shortcomings were: (i) establishing a new subsidiary that has become an “intermediate holding company” and to which JPMorgan Chase & Co. has contributed the stock of substantially all of its direct subsidiaries (other than JPMorgan Chase Bank, N.A.), as well as other assets and intercompany indebtedness owing to JPMorgan Chase & Co.; (ii) increasing the Firm’s liquidity reserves and pre-positioning significant amounts of capital and liquidity at the Firm’s “material legal entities” (as defined in the 2016 Resolution Submission); (iii) refining the Firm’s liquidity and capital governance frameworks, including establishing a Firmwide “trigger framework” that identifies key actions and escalations that would need to be taken, as well as decisions that would need to be made, at critical points in time if certain defined liquidity and/or capital metrics were to fall below defined thresholds; (iv) establishing clear, actionable legal entity rationalization criteria and related governance procedures; and (v) improving divestiture readiness, including determining and analyzing divestiture options in a crisis. On December 13, 2016, the Federal Reserve and the FDIC informed the Firm that they had determined that the Firm’s 2016 Resolution Submission adequately remediated the identified deficiencies in the Firm’s 2015 Resolution Plan. For more information, see the Federal Reserve and FDIC websites, and the Firm’s website for the public portion of the 2016 Resolution Submission.
Business outlook
These current expectations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on the current beliefs and expectations of JPMorgan Chase’s management and are subject to significant risks and uncertainties. These risks and uncertainties could cause the Firm’s actual results to differ materially from those set forth in such forward-looking statements. See Forward-Looking Statements on page 138 and the Risk Factors section on pages 8-21.
Business outlook
JPMorgan Chase’s outlook for the full-year 2017 should be viewed against the backdrop of the global and U.S. economies, financial markets activity, the geopolitical environment, the competitive environment, client activity levels, and regulatory and legislative developments in the U.S. and other countries where the Firm does business. Each of these inter-related factors will affect the performance of the Firm and its lines of business. The Firm expects it will continue to make appropriate adjustments to its businesses and operations in response to ongoing developments in the legal and regulatory, as well as business and economic, environment in which it operates.
In the first quarter of 2017, management expects net interest income to increase modestly compared with the fourth quarter of 2016. During 2017, assuming no change in interest rates since December 31, 2016, management expects net interest income could be approximately $3 billion higher than in 2016, reflecting the Federal Reserve’s rate increase in December 2016 and expected loan growth. Management expects average core loan growth of approximately 10% in 2017.
The Firm continues to experience charge-off rates at or near historically low levels, reflecting favorable credit trends across the consumer and wholesale portfolios. Management expects total net charge-offs of approximately $5 billion in 2017. In Card, management expects the portfolio average net charge-off rate to increase in 2017, but remain below 3.00%, reflecting continued loan growth and the seasoning of newer vintages, with quarterly net-charge offs reflecting normal seasonal trends.
Management believes that the consumer allowance for credit losses could increase by approximately $300 million in 2017, reflecting growth across businesses, offset by reductions in the allowance for the residential real estate portfolio. Excluding the allowance related to the Oil & Gas and Natural Gas Pipelines and Metals & Mining portfolios, management expects that the wholesale allowance for credit losses could increase modestly in 2017 reflecting growth across businesses. Continued stability in the energy sector could result in a reduction in the allowance for credit losses in future periods. As management continually looks to enhance its credit loss estimation methodologies, the outlook for the allowance for credit losses does not take into consideration any such potential refinements.
JPMorgan Chase & Co./2016 Annual Report
The Firm continues to take a disciplined approach to managing its expenses, while investing in growth and innovation. As a result, Firmwide adjusted expense in 2017 is expected to be approximately $58 billion (excluding Firmwide legal expense).
In CCB, management expects Mortgage noninterest revenue to decrease approximately $700 million in 2017, driven by margin compression in a smaller mortgage market and continued run-off of the Servicing portfolio, as well as approximately $200 million of MSR gains in 2016 which are not expected to recur in 2017. Management expects Card Services noninterest revenue to decrease approximately $600 million in 2017, reflecting the amortization of premiums on strong new product originations and the absence in 2017 of a gain on the sale of Visa Europe interests in 2016, although total Card Services revenue is expected to increase due to strong growth in net interest income.
In the first quarter of 2017, management expects CCB expense to increase by approximately $150 million, compared to the prior quarter.
In CIB, Investment Banking revenue in the first quarter of 2017 is expected to be approximately in line with the fourth quarter of 2016, dependent on the timing of the closing of a number of transactions. Treasury Services revenue is expected to be approximately $950 million in the first quarter of 2017. In addition, management currently expects Markets revenue in the first quarter of 2017 to increase modestly compared to the prior year quarter, with results sensitive to market conditions in March in light of particularly strong revenue in March 2016. In Securities Services, management expects revenue of approximately $900 million in the first quarter of 2017.
In CB, management expects expense of approximately $775 million in the first quarter of 2017.
In AWM, management expects revenue to be approximately $3 billion in the first quarter of 2017.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
CONSOLIDATED RESULTS OF OPERATIONS
This section provides a comparative discussion of JPMorgan Chase’s Consolidated Results of Operations on a reported basis for the three-year period ended December 31, 2016, unless otherwise specified. Factors that relate primarily to a single business segment are discussed in more detail within that business segment. For a discussion of the Critical Accounting Estimates Used by the Firm that affect the Consolidated Results of Operations, see pages 132-134.
(a)
Effective January 1, 2016, changes in DVA on fair value option elected liabilities previously recorded in principal transactions revenue are recorded in other comprehensive income (“OCI”). For additional information, see the segment results of CIB and Accounting and Reporting Developments on pages 58-62 and page 135, respectively.
(b)
Included operating lease income of $2.7 billion, $2.1 billion and $1.7 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
2016 compared with 2015
Total net revenue increased by 2% primarily reflecting higher net interest income across all the Firm’s business segments and higher Markets noninterest revenue in CIB, partially offset by lower card income in CCB and lower asset management fees in AWM.
Investment banking fees decreased predominantly due to lower equity underwriting fees driven by declines in industry-wide fee levels. For additional information on investment banking fees, see CIB segment results on pages 58-62 and Note 7.
Principal transactions revenue increased reflecting broad-based strength across products in CIB’s Fixed Income Markets business. Rates performance was strong, with increased client activity driven by high issuance-based flows, global political developments, and central bank actions. Credit revenue improved driven by higher market-making revenue from the secondary market as clients’ appetite for risk recovered. For additional information, see CIB and Corporate segment results on pages 58-62 and pages 69-70, respectively, and Note 7.
Asset management, administration and commissions revenue decreased reflecting lower asset management fees in AWM driven by a reduction in revenue related to the disposal of assets at the beginning of 2016, the impact of lower average equity market levels and lower performance
fees, as well as due to lower brokerage commissions and other fees in CIB and AWM. For additional information, see the segment discussions of CIB and AWM on pages 58-62 and pages 66-68, respectively, and Note 7.
For information on lending- and deposit-related fees, see the segment results for CCB on pages 53-57, CIB on pages 58-62, and CB on pages 63-65 and Note 7; on securities gains, see the Corporate segment discussion on pages 69-70.
Mortgage fees and related income were relatively flat, as lower mortgage servicing revenue related to lower average third-party loans serviced was predominantly offset by higher MSR risk management results. For further information on mortgage fees and related income, see the segment discussion of CCB on pages 53-57 and Notes 7 and 17.
Card income decreased predominantly driven by higher new account origination costs and the impact of renegotiated co-brand partnership agreements, partially offset by higher card sales volume and other card-related fees. For further information, see CCB segment results on pages 53-57 and Note 7.
Other income increased primarily reflecting:
▪
higher operating lease income from growth in auto operating lease assets in CCB
▪
a gain on the sale of Visa Europe interests in CCB
▪
a gain related to the redemption of guaranteed capital debt securities (“trust preferred securities”)
▪
the absence of losses recognized in 2015 related to the accelerated amortization of cash flow hedges associated with the exit of certain non-operating deposits
▪
a gain on disposal of an asset in AWM at the beginning of 2016
partially offset by
▪
a $514 million benefit recorded in the prior year from a legal settlement in Corporate.
For further information on other income, see Note 7.
Net interest income increased primarily driven by loan growth across the businesses and the net impact of higher rates, partially offset by lower investment securities balances and higher interest expense on long-term debt. The Firm’s average interest-earning assets were $2.1 trillion in 2016, and the net interest yield on these assets, on a fully taxable equivalent (“FTE”) basis, was 2.25%, an increase of 11 basis points from the prior year.
2015 compared with 2014
Total net revenue for 2015 was down by 2%, predominantly driven by lower Corporate private equity gains, lower CIB revenue reflecting the impact of business simplification initiatives, and lower CCB Mortgage Banking revenue. These decreases were partially offset by a benefit from a legal settlement in Corporate, and higher operating lease income, predominantly in CCB.
JPMorgan Chase & Co./2016 Annual Report
Investment banking fees increased reflecting higher advisory fees, partially offset by lower equity and debt underwriting fees. The increase in advisory fees was driven by a greater share of fees for completed transactions as well as growth in industry-wide fee levels. The decrease in equity underwriting fees resulted from lower industry-wide issuance, and the decrease in debt underwriting fees resulted primarily from lower loan syndication and bond underwriting fees on lower industry-wide fee levels.
Principal transactions revenue decreased reflecting lower private equity gains in Corporate driven by lower valuation gains and lower net gains on sales as the Firm exits this non-core business. The decrease was partially offset by higher client-driven market-making revenue, particularly in foreign exchange, interest rate and equity-related products in CIB, as well as a gain of approximately $160 million on CCB’s investment in Square, Inc. upon its initial public offering.
Asset management, administration and commissions revenue decreased largely as a result of lower fees in CIB and lower performance fees in AWM. The decrease was partially offset by higher asset management fees as a result of net client inflows into assets under management and the impact of higher average market levels in AWM and CCB.
Mortgage fees and related income decreased reflecting lower servicing revenue, largely as a result of lower average third-party loans serviced, and lower net production revenue reflecting a lower repurchase benefit.
For information on lending- and deposit-related fees, see the segment results for CCB on pages 53-57, CIB on pages 58-62, and CB on pages 63-65 and Note 7; on securities gains, see the Corporate segment discussion on pages 69-70; and card income, see CCB segment results on pages 53-57.
Other income was relatively flat reflecting a $514 million benefit from a legal settlement in Corporate, higher operating lease income as a result of growth in auto operating lease assets in CCB, and the absence of losses related to the exit of non-core portfolios in Card. These increases were offset by the impact of business simplification in CIB; the absence of a benefit recognized in 2014 from a franchise tax settlement; and losses related to the accelerated amortization of cash flow hedges associated with the exit of certain non-operating deposits.
Net interest income was relatively flat as lower loan yields, lower investment securities net interest income, and lower trading asset balance and yields were offset by higher average loan balances and lower interest expense on deposits. The Firm’s average interest-earning assets were $2.1 trillion in 2015, and the net interest yield on these assets, on a FTE basis, was 2.14%, a decrease of 4 basis points from the prior year.
2016 compared with 2015
The provision for credit losses reflected an increase in the total consumer provision and, to a lesser extent, the wholesale provision. The increase in the total consumer provision was predominantly driven by:
▪
a $920 million increase related to the credit card portfolio, due to a $600 million addition in the allowance for loan losses, as well as $320 million of higher net charge-offs, driven by loan growth (including growth in newer vintages which, as anticipated, have higher loss rates compared to the overall portfolio), and
▪
a $470 million lower benefit related to the residential real estate portfolio, as the current year reduction in the allowance for loan losses was lower than the prior year. The reduction in both periods reflected continued improvements in home prices and lower delinquencies.
The increase in the wholesale provision was largely driven by the impact of downgrades in the Oil & Gas and Natural Gas Pipelines portfolios. For a more detailed discussion of the credit portfolio and the allowance for credit losses, see the segment discussions of CCB on pages 53-57, CIB on pages 58-62 , CB on pages 63-65, the Allowance For Credit Losses on pages 105-107 and Note 15.
2015 compared with 2014
The provision for credit losses increased as a result of an increase in the wholesale provision, largely reflecting the impact of downgrades in the Oil & Gas portfolio. The increase was partially offset by a decrease in the consumer provision, reflecting lower net charge-offs due to continued discipline in credit underwriting, as well as improvement in the economy driven by increasing home prices and lower unemployment levels. The decrease in the consumer provision was partially offset by a lower reduction in the allowance for loan losses.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(a)
Included legal (benefit)/expense of $(317) million, $3.0 billion and $2.9 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
(b)
Included FDIC-related expense of $1.3 billion, $1.2 billion and $1.0 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
2016 compared with 2015
Total noninterest expense decreased by 5% driven by lower legal expense.
Compensation expense was relatively flat predominantly driven by higher performance-based compensation expense and investments in several businesses, offset by the impact of continued expense reduction initiatives, including lower headcount in certain businesses.
Noncompensation expense decreased as a result of lower legal expense (including lower legal professional services expense), the impact of efficiencies, and reduced non-U.S. tax surcharges. These factors were partially offset by higher depreciation expense from growth in auto operating lease assets and higher investments in marketing. For a further discussion of legal expense, see Note 31.
2015 compared with 2014
Total noninterest expense decreased by 4% as a result of lower CIB expense, predominantly reflecting the impact of business simplification; and lower CCB expense resulting from efficiencies related to declines in headcount-related expense and lower professional fees. These decreases were partially offset by investment in the businesses, including for infrastructure and controls.
Compensation expense decreased predominantly driven by lower performance-based incentives and reduced headcount, partially offset by higher postretirement benefit costs and investment in the businesses, including for infrastructure and controls.
Noncompensation expense decreased reflecting benefits from business simplification in CIB; lower professional and outside services expense, reflecting lower legal services expense and a reduced number of contractors in the businesses; lower amortization of intangibles; and the absence of a goodwill impairment in Corporate. These factors were partially offset by higher depreciation expense, largely associated with higher auto operating lease assets in CCB; higher marketing expense in CCB; and higher FDIC-related assessments. Legal expense was relatively flat compared with the prior year.
2016 compared with 2015
The effective tax rate in 2016 was affected by changes in the mix of income and expense subject to U.S. federal and state and local taxes, tax benefits related to the utilization of certain deferred tax assets, as well as the adoption of new accounting guidance related to employee stock-based incentive payments. These tax benefits were partially offset by higher income tax expense from tax audits. The lower effective tax rate in 2015 was predominantly driven by $2.9 billion of tax benefits, which reduced the Firm’s effective tax rate by 9.4 percentage points. The recognition of tax benefits in 2015 resulted from the resolution of various tax audits, as well as the release of U.S. deferred taxes associated with the restructuring of certain non-U.S. entities. For additional details on the impact of the new accounting guidance, see Accounting and Reporting Developments on page 135 and for further information see Note 26.
2015 compared with 2014
The effective tax rate decreased predominantly due to the recognition in 2015 of tax benefits of $2.9 billion and other changes in the mix of income and expense subject to U.S. federal, state and local income taxes, partially offset by prior-year tax adjustments. See above for details on the $2.9 billion of tax benefits.
JPMorgan Chase & Co./2016 Annual Report
CONSOLIDATED BALANCE SHEETS ANALYSIS
The following is a discussion of the significant changes between December 31, 2016 and 2015.
Cash and due from banks and deposits with banks
The increase was primarily driven by deposit growth in excess of loan growth. The Firm’s excess cash is placed with various central banks, predominantly Federal Reserve Banks.
Federal funds sold and securities purchased under resale agreements
The increase was due to higher demand for securities to cover short positions related to client-driven market-making activities in CIB, and the deployment of excess cash by Treasury and Chief Investment Office (“CIO”). For additional information on the Firm’s Liquidity Risk Management, see pages 110-115.
Trading assets and liabilities-debt and equity instruments
The increase in trading assets and liabilities was predominantly related to client-driven market-making activities in CIB. The increase in trading assets reflected higher debt and, to a lesser extent, equity instrument inventory levels to facilitate client demand. The increase in trading liabilities reflected higher levels of client-driven short positions in both debt and equity instruments. For additional information, refer to Note 3.
Trading assets and liabilities-derivative receivables and payables
The change in derivative receivables and payables was predominantly related to client-driven market-making activities in CIB. The increase in derivative receivables reflected the impact of market movements, which increased foreign exchange receivables, partially offset by reduced commodity derivative receivables. The decrease in derivative payables reflected the impact of market
movements, which reduced commodity payables. For additional information, refer to Derivative contracts on pages 102-103, and Notes 3 and 6.
Securities
The decrease was predominantly due to net sales, maturities and paydowns during the year of non-agency mortgage-backed securities (“MBS”), corporate debt securities and asset-backed securities (“ABS”), offset by purchases of U.S. Treasuries. For additional information, see Notes 3 and 12.
Loans and allowance for loan losses
The increase in loans was driven by higher consumer and wholesale loans. The increase in consumer loans was due to retention of originated high-quality prime mortgages in CCB and AWM, and growth in credit card and auto loans in CCB. The increase in wholesale loans was predominantly driven by originations of commercial real estate loans in CB and commercial and industrial loans across multiple industries in CB and CIB.
The increase in the allowance for loan losses was attributable to additions to the wholesale allowance driven by downgrades in the Oil & Gas and Natural Gas Pipelines portfolios. The consumer allowance was flat from the prior year and reflected reductions in the allowance for loan losses in the residential real estate portfolio reflecting continued improvement in home prices and delinquencies, and due to runoff in the student loan portfolio; these factors were offset by additions to the allowance reflecting the impact of loan growth in the credit card portfolio (including newer vintages which, as anticipated, have higher loss rates compared to the overall portfolio), as well as due
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
to loan growth in the auto and business banking loan portfolios. For a more detailed discussion of loans and the allowance for loan losses, refer to Credit Risk Management on pages 86-107, and Notes 3, 4, 14 and 15.
Accrued interest and accounts receivable
The increase reflected higher receivables from merchants in CCB and higher client receivables related to client-driven activity in CIB.
Mortgage servicing rights
For additional information on MSRs, see Note 17.
Other assets
The increase reflected higher auto operating lease assets from growth in business volume in CCB and higher cash collateral pledged in CIB.
Deposits
The increase was attributable to higher consumer and wholesale deposits. The consumer increase reflected continuing strong growth from existing and new customers, and the impact of low attrition rates. The wholesale increase was driven by growth in operating deposits related to client activity in CIB’s Treasury Services business, and inflows in AWM primarily from business growth and the impact of new rules governing money market funds. For more information on deposits, refer to the Liquidity Risk Management discussion on pages 110-115; and Notes 3
and 19.
Federal funds purchased and securities loaned or sold under repurchase agreements
The increase was predominantly due to higher client-driven market-making activities in CIB. For additional information on the Firm’s Liquidity Risk Management, see pages 110-115.
Commercial paper
The decrease reflected lower issuance in the wholesale markets consistent with Treasury and CIO’s short-term funding plans. For additional information, see Liquidity Risk Management on pages 110-115.
Accounts payable and other liabilities
The increase was largely driven by higher client-driven activity in CIB.
Beneficial interests issued by consolidated VIEs
The decrease was predominantly due to a reduction in commercial paper issued by conduits to third parties, partially offset by net new credit card securitizations. For further information on Firm-sponsored VIEs and loan securitization trusts, see Off-Balance Sheet Arrangements on pages 45-46 and Note 16.
Long-term debt
The increase was due to net issuance of structured notes driven by client demand in CIB, and other net issuance consistent with Treasury and CIO’s long-term funding plans, including liquidity actions related to the 2016 Resolution Submission. For additional information on the Firm’s long-term debt activities, see Liquidity Risk Management on pages 110-115 and Note 21.
Stockholders’ equity
The increase was due to net income offset partially by cash dividends on common and preferred stock, and repurchases of common stock. For additional information on changes in stockholders’ equity, see page 144, and on the Firm’s capital actions, see Capital actions on page 84.
JPMorgan Chase & Co./2016 Annual Report
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS
In the normal course of business, the Firm enters into various contractual obligations that may require future cash payments. Certain obligations are recognized on-balance sheet, while others are off-balance sheet under accounting principles generally accepted in the U.S. (“U.S. GAAP”). The Firm is involved with several types of off-balance sheet arrangements, including through nonconsolidated SPEs, which are a type of VIE, and through lending-related financial instruments (e.g., commitments and guarantees).
Special-purpose entities
The most common type of VIE is an SPE. SPEs are commonly used in securitization transactions in order to isolate certain assets and distribute the cash flows from those assets to investors. SPEs are an important part of the financial markets, including the mortgage- and asset-backed securities and commercial paper markets, as they provide market liquidity by facilitating investors’ access to specific portfolios of assets and risks. SPEs may be organized as trusts, partnerships or corporations and are typically established for a single, discrete purpose. SPEs are not typically operating entities and usually have a limited life and no employees. The basic SPE structure involves a company selling assets to the SPE; the SPE funds the purchase of those assets by issuing securities to investors.
JPMorgan Chase uses SPEs as a source of liquidity for itself and its clients by securitizing financial assets, and by creating investment products for clients. The Firm is involved with SPEs through multi-seller conduits, investor intermediation activities, and loan securitizations. See Note 16 for further information on these types of SPEs.
The Firm holds capital, as deemed appropriate, against all SPE-related transactions and related exposures, such as derivative transactions and lending-related commitments and guarantees.
The Firm has no commitments to issue its own stock to support any SPE transaction, and its policies require that transactions with SPEs be conducted at arm’s length and reflect market pricing. Consistent with this policy, no JPMorgan Chase employee is permitted to invest in SPEs with which the Firm is involved where such investment would violate the Firm’s Code of Conduct. These rules prohibit employees from self-dealing and acting on behalf of the Firm in transactions with which they or their family have any significant financial interest.
Implications of a credit rating downgrade to JPMorgan Chase Bank, N.A.
For certain liquidity commitments to SPEs, JPMorgan Chase Bank, N.A. could be required to provide funding if its short-term credit rating were downgraded below specific levels, primarily “P-1”, “A-1” and “F1” for Moody’s Investors Service (“Moody’s”), Standard & Poor’s and Fitch,
respectively. These liquidity commitments support the issuance of asset-backed commercial paper by Firm-administered consolidated SPEs. In the event of a short-term credit rating downgrade, JPMorgan Chase Bank, N.A., absent other solutions, would be required to provide funding to the SPE if the commercial paper could not be reissued as it matured. The aggregate amounts of commercial paper outstanding held by third parties as of December 31, 2016 and 2015, was $2.7 billion and $8.7 billion, respectively. The aggregate amounts of commercial paper issued by these SPEs could increase in future periods should clients of the Firm-administered consolidated SPEs draw down on certain unfunded lending-related commitments. These unfunded lending-related commitments were $7.4 billion and $5.6 billion at December 31, 2016 and 2015, respectively. The Firm could facilitate the refinancing of some of the clients’ assets in order to reduce the funding obligation. For further information, see the discussion of Firm-administered multi-seller conduits in Note 16.
The Firm also acts as liquidity provider for certain municipal bond vehicles. The Firm’s obligation to perform as liquidity provider is conditional and is limited by certain termination events, which include bankruptcy or failure to pay by the municipal bond issuer and any credit enhancement provider, an event of taxability on the municipal bonds or the immediate downgrade of the municipal bond to below investment grade. See Note 16 for additional information.
Off-balance sheet lending-related financial instruments, guarantees, and other commitments
JPMorgan Chase provides lending-related financial instruments (e.g., commitments and guarantees) to meet the financing needs of its customers. The contractual amount of these financial instruments represents the maximum possible credit risk to the Firm should the counterparty draw upon the commitment or the Firm be required to fulfill its obligation under the guarantee, and should the counterparty subsequently fail to perform according to the terms of the contract. Most of these commitments and guarantees are refinanced, extended, cancelled, or expire without being drawn or a default occurring. As a result, the total contractual amount of these instruments is not, in the Firm’s view, representative of its actual future credit exposure or funding requirements. For further discussion of lending-related financial instruments, guarantees and other commitments, and the Firm’s accounting for them, see Lending-related commitments on page 101 and Note 29. For a discussion of liabilities associated with loan sales and securitization-related indemnifications, see Note 29.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Contractual cash obligations
The accompanying table summarizes, by remaining maturity, JPMorgan Chase’s significant contractual cash obligations at December 31, 2016. The contractual cash obligations included in the table below reflect the minimum contractual obligation under legally enforceable contracts with terms that are both fixed and determinable. Excluded from the below table are certain liabilities with variable cash flows and/or no obligation to return a stated amount of principal at maturity.
The carrying amount of on-balance sheet obligations on the Consolidated balance sheets may differ from the minimum contractual amount of the obligations reported below. For a discussion of mortgage repurchase liabilities and other obligations, see Note 29.
(a)
Excludes structured notes on which the Firm is not obligated to return a stated amount of principal at the maturity of the notes, but is obligated to return an amount based on the performance of the structured notes.
(b)
Primarily includes dividends declared on preferred and common stock, deferred annuity contracts, pension and other postretirement employee benefit obligations and insurance liabilities.
(c)
For further information, refer to unsettled reverse repurchase and securities borrowing agreements in Note 29.
(d)
Includes accrued interest and future contractual interest obligations. Excludes interest related to structured notes for which the Firm’s payment obligation is based on the performance of certain benchmarks.
(e)
Includes noncancelable operating leases for premises and equipment used primarily for banking purposes and for energy-related tolling service agreements. Excludes the benefit of noncancelable sublease rentals of $1.4 billion and $1.9 billion at December 31, 2016 and 2015, respectively. See Note 30 for more information on lease commitments.
(f)
At December 31, 2016 and 2015, included unfunded commitments of $48 million and $50 million, respectively, to third-party private equity funds, and $1.0 billion and $871 million of unfunded commitments, respectively, to other equity investments.
JPMorgan Chase & Co./2016 Annual Report
CONSOLIDATED CASH FLOWS ANALYSIS
Operating activities
JPMorgan Chase’s operating assets and liabilities support the Firm’s lending and capital markets activities, including the origination or purchase of loans initially designated as held-for-sale. Operating assets and liabilities can vary significantly in the normal course of business due to the amount and timing of cash flows, which are affected by client-driven and risk management activities and market conditions. The Firm believes cash flows from operations, available cash balances and its capacity to generate cash through secured and unsecured sources are sufficient to meet the Firm’s operating liquidity needs.
Cash provided by operating activities in 2016, 2015 and 2014 reflected net income after noncash operating adjustments. Additionally, in 2016 cash provided reflected increases in accounts payable and trading liabilities related to client-driven market-making activities in CIB. The increase in trading liabilities reflected higher levels of client-driven short positions in both debt and equity instruments. Cash used in 2016 reflected an increase in trading assets, an increase in accounts receivable from merchants in CCB and higher client receivables related to client-driven activities in CIB; and higher net originations and purchases from loan held-for-sale activities. The increase in trading assets reflected higher debt and, to a lesser extent, equity instrument inventory levels to facilitate client demand. Cash provided in 2015 resulted from a decrease in trading assets, predominantly due to client-driven market-making activities in CIB, resulting in lower levels of debt and equity securities. Additionally, cash provided reflected a decrease in accounts receivable due to lower client receivables and higher net proceeds from loan sales activities. This was partially offset by cash used due to a decrease in accounts payable and other liabilities, resulting from lower brokerage customer payables related to client activity in CIB. In 2014, cash provided reflected higher net proceeds from loan securitizations and sales activities.
Investing activities
The Firm’s investing activities predominantly include originating loans for investment, depositing cash at banks, and investing in the securities portfolio and other short-term interest-earning assets. Cash used in investing activities in 2016 resulted from net originations of consumer and wholesale loans. The increase in consumer loans was due to retention of originated high-quality prime
mortgages in CCB and AWM, and growth of credit card and auto loans in CCB. The increase in wholesale loans was predominantly driven by originations of commercial real estate loans in CB and commercial and industrial loans across multiple industries in CB and CIB. Additionally, in 2016, cash outflows reflected an increase in deposits with banks primarily due to growth in deposits in excess of growth in loans; an increase in securities purchased under resale agreements due to higher demand for securities to cover short positions related to client-driven market-making activities in CIB and the deployment of excess cash by Treasury and CIO. Cash provided by investing activities during 2015 predominantly resulted from lower deposits with banks due to the Firm’s actions to reduce wholesale non-operating deposits; and net proceeds from paydowns, maturities, sales and purchases of investment securities. Partially offsetting these net inflows was cash used for net originations of consumer and wholesale loans, a portion of which reflected a shift from investment securities. Cash used in investing activities during 2014 resulted from increases in deposits with banks attributable to higher levels of excess funds; cash was also used for growth in wholesale and consumer loans in 2014. Partially offsetting these cash outflows in 2014 was a net decline in securities purchased under resale agreements due to a shift in the deployment of the Firm’s excess cash by Treasury and CIO. Investing activities in 2014 also reflected net proceeds from paydowns, maturities, sales and purchases of investment securities.
Financing activities
The Firm’s financing activities includes acquiring customer deposits, issuing long-term debt, as well as preferred and common stock. Cash provided by financing activities in 2016 resulted from higher consumer and wholesale deposits, and an increase in securities loaned or sold under repurchase agreements, predominantly due to higher client-driven market-making activities in CIB. Cash used in financing activities in 2015 resulted from lower wholesale deposits partially offset by higher consumer deposits. Additionally, in 2015 cash outflows were attributable to lower levels of commercial paper due to the discontinuation of a cash management product that offered customers the option of sweeping their deposits into commercial paper; lower commercial paper issuances in the wholesale markets; and a decrease in securities loaned or sold under repurchase agreements due to a decline in secured financings. Cash provided by financing activities in 2014 predominantly resulted from higher consumer and wholesale deposits. For all periods, cash was provided by net proceeds from long-term borrowings; and cash was used for repurchases of common stock and cash dividends on common and preferred stock.
* * *
For a further discussion of the activities affecting the Firm’s cash flows, see Consolidated Balance Sheets Analysis on pages 43-44, Capital Risk Management on pages 76-85, and Liquidity Risk Management on pages 110-115.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
EXPLANATION AND RECONCILIATION OF THE FIRM’S USE OF NON-GAAP FINANCIAL MEASURES AND KEY PERFORMANCE MEASURES
Non-GAAP financial measures
The Firm prepares its Consolidated Financial Statements using U.S. GAAP; these financial statements appear on pages 141-145. That presentation, which is referred to as “reported” basis, provides the reader with an understanding of the Firm’s results that can be tracked consistently from year to year and enables a comparison of the Firm’s performance with other companies’ U.S. GAAP financial statements.
In addition to analyzing the Firm’s results on a reported basis, management reviews the Firm’s results, including the overhead ratio, and the results of the lines of business, on a “managed” basis, which are non-GAAP financial measures. The Firm’s definition of managed basis starts with the reported U.S. GAAP results and includes certain reclassifications to present total net revenue for the Firm (and each of the reportable business segments) on an FTE basis. Accordingly, revenue from investments that receive tax credits and tax-exempt securities is presented in the managed results on a basis comparable to taxable investments and securities. These non-GAAP financial measures allow management to assess the comparability of revenue from year-to-year arising from both taxable and tax-exempt sources. The corresponding income tax impact
related to tax-exempt items is recorded within income tax expense. These adjustments have no impact on net income as reported by the Firm as a whole or by the lines of business.
Management also uses certain non-GAAP financial measures at the Firm and business-segment level, because these other non-GAAP financial measures provide information to investors about the underlying operational performance and trends of the Firm or of the particular business segment, as the case may be, and, therefore, facilitate a comparison of the Firm or the business segment with the performance of its relevant competitors. For additional information on these non-GAAP measures, see Business Segment Results on pages 51-70.
Additionally, certain credit metrics and ratios disclosed by the Firm exclude PCI loans, and are therefore non-GAAP measures. For additional information on these non-GAAP measures, see Credit Risk Management on pages 86-107.
Non-GAAP financial measures used by the Firm may not be comparable to similarly named non-GAAP financial measures used by other companies.
The following summary table provides a reconciliation from the Firm’s reported U.S. GAAP results to managed basis.
(a) Predominantly recognized in CIB and CB business segments and Corporate.
JPMorgan Chase & Co./2016 Annual Report
Net interest income excluding CIB’s Markets businesses
In addition to reviewing net interest income on a managed basis, management also reviews net interest income excluding net interest income arising from CIB’s Markets businesses to assess the performance of the Firm’s lending, investing (including asset-liability management) and deposit-raising activities. CIB’s Markets businesses represent both Fixed Income Markets and Equity Markets. The data presented below are non-GAAP financial measures due to the exclusion of net interest income from CIB’s Markets businesses (“CIB Markets”).
Management believes this exclusion provides investors and analysts with another measure by which to analyze the non-markets-related business trends of the Firm and provides a comparable measure to other financial institutions that are primarily focused on lending, investing and deposit-raising activities.
(a)
Interest includes the effect of related hedges. Taxable-equivalent amounts are used where applicable.
(b)
For a reconciliation of net interest income on a reported and managed basis, see reconciliation from the Firm’s reported U.S. GAAP results to managed basis on page 48.
(c)
Prior period amounts were revised to align with CIB’s Markets businesses. For further information on CIB’s Markets businesses, see page 61.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Tangible common equity, ROTCE and TBVPS
Tangible common equity (“TCE”), ROTCE and TBVPS are each non-GAAP financial measures. TCE represents the Firm’s common stockholders’ equity (i.e., total stockholders’ equity less preferred stock) less goodwill and identifiable intangible assets (other than MSRs), net of related deferred tax liabilities. ROTCE measures the Firm’s net income applicable to common equity as a percentage of average TCE. TBVPS represents the Firm’s TCE at period-end divided by common shares at period-end. TCE, ROTCE, and TBVPS are utilized by the Firm, as well as investors and analysts, in assessing the Firm’s use of equity. The following summary table provides a reconciliation from the Firm’s common stockholders’ equity to TCE.
(a)
Represents deferred tax liabilities related to tax-deductible goodwill and to identifiable intangibles created in nontaxable transactions, which are netted against goodwill and other intangibles when calculating TCE.
Key performance measures
The Firm’s capital, RWA, and capital and leverage ratios that are presented under Basel III Standardized and Advanced Fully Phased-In rules and the Firm’s, JPMorgan Chase Bank, N.A.’s and Chase Bank USA, N.A.’s SLRs calculated under the Basel III Advanced Fully Phased-In rules are considered key regulatory capital measures. Such measures are used by banking regulators, investors and analysts to assess the Firm’s regulatory capital position and to compare the Firm’s regulatory capital to that of other financial services companies.
For additional information on these measures, see Capital Risk Management on pages 76-85.
Core loans are also considered a key performance measure. Core loans represent loans considered central to the Firm’s ongoing businesses; and exclude loans classified as trading assets, runoff portfolios, discontinued portfolios and portfolios the Firm has an intent to exit. Core loans are utilized by the Firm and its investors and analysts in assessing actual growth in the loan portfolio.
JPMorgan Chase & Co./2016 Annual Report
BUSINESS SEGMENT RESULTS
The Firm is managed on a line of business basis. There are four major reportable business segments - Consumer & Community Banking, Corporate & Investment Bank, Commercial Banking and Asset & Wealth Management (formerly Asset Management). In addition, there is a Corporate segment.
The business segments are determined based on the products and services provided, or the type of customer
served, and they reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on a managed basis. For a definition of managed basis, see Explanation and Reconciliation of the Firm’s use of Non-GAAP Financial Measures, on pages 48-50.
(a) Formerly Global Investment Management
(b) Formerly Global Wealth Management
Description of business segment reporting methodology
Results of the business segments are intended to reflect each segment as if it were essentially a stand-alone business. The management reporting process that derives business segment results includes the allocation of certain income and expense items described in more detail below. The Firm also assesses the level of capital required for each line of business on at least an annual basis. For further information about line of business capital, see Line of business equity on page 83.
The Firm periodically assesses the assumptions, methodologies and reporting classifications used for segment reporting, and further refinements may be implemented in future periods.
Revenue sharing
When business segments join efforts to sell products and services to the Firm’s clients, the participating business segments agree to share revenue from those transactions. The segment results reflect these revenue-sharing agreements.
Funds transfer pricing
Funds transfer pricing is used to allocate interest income and expense to each business segment and to transfer the primary interest rate risk and liquidity risk exposures to Treasury and CIO within Corporate. The funds transfer pricing process considers the interest rate risk, liquidity risk and regulatory requirements of a business segment as if it were operating independently. This process is overseen by
senior management and reviewed by the Firm’s Asset-Liability Committee (“ALCO”).
Debt expense and preferred stock dividend allocation
As part of the funds transfer pricing process, largely all of the cost of the credit spread component of outstanding unsecured long-term debt and preferred stock dividends is allocated to the reportable business segments, while the balance of the cost is retained in Corporate. The methodology to allocate the cost of unsecured long-term debt and preferred stock dividend to the business segments is aligned with the Firm’s process to allocate capital. The allocated cost of unsecured long-term debt is included in a business segment’s net interest income, and net income is reduced by preferred stock dividends to arrive at a business segment’s net income applicable to common equity.
Business segment capital allocation changes
The amount of capital assigned to each business is referred to as common equity. On at least an annual basis, the Firm assesses the level of capital required for each line of business as well as the assumptions and methodologies used to allocate capital. Through the end of 2016, capital was allocated to the lines of business based on a single measure, Basel III Advanced Fully Phased-In RWA. Effective January 1, 2017, the Firm’s methodology used to allocate capital to the Firm’s business segments was updated. The new methodology incorporates Basel III Standardized Fully Phased-In RWA (as well as Basel III Advanced Fully Phased-In RWA), leverage, the GSIB surcharge, and a simulation of
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
capital in a severe stress environment. The methodology will continue to be weighted towards Basel III Advanced Fully Phased-In RWA because the Firm believes it to be the best proxy for economic risk. The Firm will consider further changes to its capital allocation methodology as the regulatory framework evolves. In addition, under the new methodology, capital is no longer allocated to each line of business for goodwill and other intangibles associated with acquisitions effected by the line of business.
Expense allocation
Where business segments use services provided by corporate support units, or another business segment, the costs of those services are allocated to the respective business segments. The expense is generally
allocated based on actual cost and use of services provided. In contrast, certain other costs related to corporate support units, or to certain technology and operations, are not allocated to the business segments and are retained in Corporate. Expense retained in Corporate generally includes parent company costs that would not be incurred if the segments were stand-alone businesses; adjustments to align corporate support units; and other items not aligned with a particular business segment.
The following provides a comparative discussion of business segment results as of or for the years ended December 31, 2016, 2015 and 2014.
Segment Results - Managed Basis
The following tables summarize the business segment results for the periods indicated.
JPMorgan Chase & Co./2016 Annual Report
CONSUMER & COMMUNITY BANKING
Note: In the discussion and the tables which follow, CCB presents certain financial measures which exclude the impact of PCI loans; these are non-GAAP financial measures.
(a)
Included operating lease depreciation expense of $1.9 billion, $1.4 billion and $1.2 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
(b)
Included MSR risk management of $217 million, $(117) million and $(28) million for the years ended December 31, 2016, 2015 and 2014, respectively.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
2016 compared with 2015
Consumer & Community Banking net income was $9.7 billion, a decrease of 1% compared with the prior year, driven by higher provision for credit losses predominantly offset by higher net revenue.
Net revenue was $44.9 billion, an increase of 2% compared with the prior year. Net interest income was $29.7 billion, up 5%, driven by higher deposit balances and higher loan balances, partially offset by deposit spread compression and an increase in the reserve for uncollectible interest and fees in Credit Card. Noninterest revenue was $15.3 billion, down 2%, driven by higher new account origination costs and the impact of renegotiated co-brand partnership agreements in Credit Card and lower mortgage servicing revenue predominantly as a result of a lower level of third-party loans serviced; these factors were predominantly offset by higher auto lease and card sales volume, higher card- and deposit-related fees, higher MSR risk management results and a gain on the sale of Visa Europe interests. See Note 17 for further information regarding changes in value of the MSR asset and related hedges, and mortgage fees and related income.
The provision for credit losses was $4.5 billion, an increase of 47% from the prior year. The increase in the provision was driven by:
▪
a $920 million increase related to the credit card portfolio, due to a $600 million addition in the allowance for loan losses, as well as $320 million of higher net charge-offs, driven by loan growth, including growth in newer vintages which, as anticipated, have higher loss rates compared to the overall portfolio,
▪
a $450 million lower benefit related to the residential real estate portfolio, as the current year reduction in the allowance for loan losses was lower than the prior year. The reduction in both periods reflected continued improvements in home prices and lower delinquencies and
▪
a $150 million increase related to the auto and business banking portfolio, due to additions to the allowance for loan losses and higher net charge-offs, reflecting loan growth in the portfolios.
Noninterest expense of $24.9 billion was flat compared with the prior year, driven by lower legal expense and branch efficiencies offset by higher auto lease depreciation and higher investment in marketing.
2015 compared with 2014
Consumer & Community Banking net income was $9.8 billion, an increase of 7% compared with the prior year, driven by lower noninterest expense and lower provision for credit losses, partially offset by lower net revenue.
Net revenue was $43.8 billion, a decrease of 1% compared with the prior year. Net interest income was $28.2 billion, down 1%, driven by spread compression, predominantly offset by higher deposit balances, higher loan balances largely resulting from originations of high-quality mortgage loans that have been retained, and improved credit quality including lower reversals of interest and fees due to lower net charge-offs in Credit Card. Noninterest revenue was $15.6 billion, down 2%, driven by lower mortgage servicing revenue largely as a result of lower average third-party loans serviced, lower net mortgage production revenue reflecting a lower repurchase benefit and the impact of renegotiated co-brand partnership agreements in Credit Card, largely offset by higher auto lease and card sales volume, the impact of non-core portfolio exits in Credit Card in the prior year, and a gain on the investment in Square, Inc. upon its initial public offering.
The provision for credit losses was $3.1 billion, a decrease of 13% from the prior year, reflecting lower net charge-offs, partially offset by a lower reduction in the allowance for loan losses. The current-year provision reflected a $1.0 billion reduction in the allowance for loan losses due to continued improvement in home prices and lower delinquencies as well as increased granularity in the impairment estimates in the residential real estate portfolio and runoff in the student loan portfolio. The prior-year provision reflected a $1.3 billion reduction in the allowance for loan losses due to continued improvement in home prices and lower delinquencies in the residential real estate portfolio, a decrease in the Credit Card asset-specific allowance resulting from increased granularity of the impairment estimates and lower balances related to credit card loans modified in troubled debt restructurings (“TDRs”), runoff in the student loan portfolio and lower estimated losses in auto loans.
Noninterest expense was $24.9 billion, a decrease of 3% from the prior year, driven by lower headcount-related expense and lower professional fees, partially offset by higher auto lease depreciation.
JPMorgan Chase & Co./2016 Annual Report
(a)
Excludes PCI loans. The Firm is recognizing interest income on each pool of PCI loans as they are all performing.
(b)
At December 31, 2016, 2015 and 2014, nonaccrual loans excluded loans 90 or more days past due as follows: (1) mortgage loans insured by U.S. government agencies of $5.0 billion, $6.3 billion and $7.8 billion respectively; and (2) student loans insured by U.S. government agencies under the Federal Family Education Loan Program (“FFELP”) of $263 million, $290 million and $367 million, respectively. These amounts have been excluded based upon the government guarantee.
(c)
Net charge-offs and the net charge-off rates for the years ended December 31, 2016, 2015 and 2014, excluded $156 million, $208 million, and $533 million, respectively, of write-offs in the PCI portfolio. These write-offs decreased the allowance for loan losses for PCI loans. For further information on PCI write-offs, see summary of changes in the allowance on page 106.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(d)
Excludes the impact of PCI loans. For the years ended December 31, 2016, 2015 and 2014, the net charge-off rates including the impact of PCI loans were as follows: (1) home equity of 0.34%, 0.45% and 0.65%, respectively; (2) residential mortgage and other of 0.01%, -% and 0.01%, respectively; (3) Mortgage Banking of 0.09%, 0.14% and 0.27%, respectively; and (4) total CCB of 0.95%, 0.99% and 1.22%, respectively.
(e)
Average credit card loans included loans held-for-sale of $84 million, $1.6 billion and $509 million for the years ended December 31, 2016, 2015 and 2014, respectively. These amounts are excluded when calculating the net charge-off rate.
(f)
At December 31, 2016, 2015 and 2014, excluded mortgage loans insured by U.S. government agencies of $7.0 billion, $8.4 billion and $9.7 billion, respectively, that are 30 or more days past due. These amounts have been excluded based upon the government guarantee.
(g)
Excludes PCI loans. The 30+ day delinquency rate for PCI loans was 9.82%, 11.21% and 13.33% at December 31, 2016, 2015 and 2014, respectively.
(h)
Period-end credit card loans included loans held-for-sale of $105 million, $76 million and $3.0 billion at December 31, 2016, 2015 and 2014, respectively. These amounts are excluded when calculating delinquency rates.
(i)
Excluded student loans insured by U.S. government agencies under FFELP of $468 million, $526 million and $654 million at December 31, 2016, 2015 and 2014, respectively, that are 30 or more days past due. These amounts have been excluded based upon the government guarantee.
(a)
Users of all web and/or mobile platforms who have logged in within the past 90 days.
(b)
Users of all mobile platforms who have logged in within the past 90 days.
(c)
Firmwide mortgage origination volume was $117.4 billion, $115.2 billion and $83.3 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
(d)
Represents the ratio of MSR carrying value (period-end) to third-party mortgage loans serviced (period-end) divided by the ratio of loan servicing-related revenue to third-party mortgage loans serviced (average).
JPMorgan Chase & Co./2016 Annual Report
Mortgage servicing-related matters
The Firm has resolved the majority of the consent orders and settlements into which it entered with federal and state governmental agencies and private parties related to mortgage servicing, origination, and residential mortgage-backed securities activities. However, among those obligations, the mortgage servicing-related Consent Order entered into with the Federal Reserve on April 13, 2011, as amended on February 28, 2013, and certain other settlements remain outstanding. The Audit Committee of the Board of Directors provides governance and oversight of the Federal Reserve Consent Order.
The Federal Reserve Consent Order and other obligations under certain mortgage-related settlements are the subject of ongoing reporting to various regulators and independent overseers. The Firm’s compliance with certain of these settlements is detailed in periodic reports published by the independent overseers. The Firm is committed to fulfilling its commitments with appropriate diligence.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
CORPORATE & INVESTMENT BANK
(a)
Included tax-equivalent adjustments, predominantly due to income tax credits related to alternative energy investments; income tax credits and amortization of the cost of investments in affordable housing projects; and tax-exempt income from municipal bonds of $2.0 billion, $1.7 billion and $1.6 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
(a)
Effective January 1, 2016, consists primarily of credit valuation adjustments (“CVA”) managed by the Credit Portfolio Group, Funding valuation adjustment (“FVA”) and DVA on derivatives. Results are primarily reported in Principal transactions. Prior periods also include DVA on fair value option elected liabilities. Results are presented net of associated hedging activities and net of CVA and FVA amounts allocated to Fixed Income Markets and Equity Markets. Effective January 1, 2016, changes in DVA on fair value option elected liabilities is recognized in OCI. For additional information, see Accounting and Reporting Developments on page 135 and Notes 3, 4 and 25.
2016 compared with 2015
Net income was $10.8 billion, up 34% compared with the prior year, driven by lower noninterest expense and higher net revenue, partially offset by a higher provision for credit losses.
Banking revenue was $10.8 billion, down 6% compared with the prior year. Investment banking revenue was $6.0 billion, down 7% from the prior year, largely driven by lower equity underwriting fees. The Firm maintained its #1 ranking for Global Investment Banking fees, according to Dealogic. Equity underwriting fees were $1.2 billion, down 19% driven by lower industry-wide fee levels; however, the Firm improved its market share and maintained its #1 ranking in equity underwriting fees globally as well as in both North America and Europe and its #1 ranking by volumes across all products, according to Dealogic. Advisory fees were $2.1 billion, down 1%; the Firm maintained its #2 ranking for M&A, according to Dealogic. Debt underwriting fees were $3.2 billion; the Firm maintained its #1 ranking globally in fees across high grade, high yield, and loan products, according to Dealogic. Treasury Services revenue was $3.6 billion. Lending revenue was $1.2 billion, down 17% from the prior year, reflecting fair value losses on hedges of accrual loans.
JPMorgan Chase & Co./2016 Annual Report
Markets & Investor Services revenue was $24.4 billion, up 11% from the prior year. Fixed Income Markets revenue was $15.3 billion, up 21% from the prior year, driven by broad strength across products. Rates performance was strong, with increased client activity driven by high issuance-based flows, global political developments, and central bank actions. Credit and Securitized Products revenue improved driven by higher market-making revenue from the secondary market as clients’ risk appetite recovered, and due to increased financing activity. Equity Markets revenue was $5.7 billion, up 1%, compared to a strong prior-year. Securities Services revenue was $3.6 billion, down 5% from the prior year, largely driven by lower fees and commissions. Credit Adjustments and Other was a loss of $175 million driven by valuation adjustments, compared with an $11 million gain in prior-year, which included funding spread gains on fair value option elected liabilities.
The provision for credit losses was $563 million, compared to $332 million in the prior year, reflecting a higher allowance for credit losses, including the impact of select downgrades within the Oil & Gas portfolio.
Noninterest expense was $19.0 billion, down 11% compared with the prior year, driven by lower legal and compensation expenses.
2015 compared with 2014
Net income was $8.1 billion, up 17% compared with $6.9 billion in the prior year. The increase primarily reflected lower income tax expenses largely reflecting the release in 2015 of U.S. deferred taxes associated with the restructuring of certain non-U.S. entities and lower noninterest expense partially offset by lower net revenue, both driven by business simplification, as well as higher provisions for credit losses.
Banking revenue was $11.5 billion, up 1% versus the prior year. Investment banking revenue was $6.4 billion, up 4% from the prior year, driven by higher advisory fees, partially offset by lower debt and equity underwriting fees. Advisory fees were $2.1 billion, up 31% on a greater share of fees for completed transactions as well as growth in the industry-wide fee levels. The Firm maintained its #2 ranking for M&A, according to Dealogic. Debt underwriting fees were $3.2 billion, down 6%, primarily related to lower bond underwriting and loan syndication fees on lower industry-wide fee levels. The Firm ranked #1 globally in fee share across high grade, high yield and loan products. Equity underwriting fees were $1.4 billion, down 9%, driven by lower industry-wide fee levels. The Firm was #1 in equity underwriting fees in 2015, up from #3 in 2014. Treasury Services revenue was $3.6 billion, down 3% compared with the prior year, primarily driven by lower net interest income. Lending revenue was $1.5 billion, down 6% from the prior year, driven by lower trade finance revenue on lower loan balances.
Markets & Investor Services revenue was $22.1 billion, down 5% from the prior year. Fixed Income Markets revenue was $12.6 billion, down 11% from the prior year, primarily driven by the impact of business simplification as well as lower revenue in credit-related products on an industry-wide slowdown, partially offset by increased revenue in Rates and Currencies & Emerging Markets on higher client activity. The lower Fixed Income revenue also reflected higher interest costs on higher long-term debt. Equity Markets revenue was $5.7 billion, up 13%, primarily driven by higher equity derivatives revenue across all regions. Securities Services revenue was $3.8 billion, down 13% from the prior year, driven by lower fees as well as lower net interest income.
The provision for credit losses was $332 million, compared to a benefit of $161 million in the prior year, reflecting a higher allowance for credit losses, including the impact of select downgrades within the Oil & Gas portfolio.
Noninterest expense was $21.4 billion, down 8% compared with the prior year, driven by the impact of business simplification as well as lower legal and compensation expenses.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(a)
Loans retained includes credit portfolio loans, loans held by consolidated Firm-administered multi-seller conduits, trade finance loans, other held-for-investment loans and overdrafts.
(b)
Prior period amounts were revised to conform with current period presentation.
(a)
Allowance for loan losses of $113 million, $177 million and $18 million were held against these nonaccrual loans at December 31, 2016, 2015 and 2014, respectively.
(b)
Management uses allowance for loan losses to period-end loans retained, excluding trade finance and conduits, a non-GAAP financial measure, to provide a more meaningful assessment of CIB’s allowance coverage ratio.
(a) Includes loans syndication
JPMorgan Chase & Co./2016 Annual Report
(a)
Source: Dealogic as of January 3, 2017. Reflects the ranking of revenue wallet and market share.
(b)
Long-term debt rankings include investment-grade, high-yield, supranationals, sovereigns, agencies, covered bonds, ABS and MBS; and exclude money market, short-term debt, and U.S. municipal securities.
(c)
Global equity and equity-related ranking includes rights offerings and Chinese A-Shares.
(d)
Global M&A reflect the removal of any withdrawn transactions. U.S. M&A revenue wallet represents wallet from client parents based in the U.S.
(e)
Global investment banking fees exclude money market, short-term debt and shelf deals.
Markets Revenue
The following table summarizes select income statement data for the Markets businesses. Markets includes both Fixed Income Markets and Equity Markets. Markets revenue comprises principal transactions, fees, commissions and other income, as well as net interest income. For a description of the composition of these income statement line items, see Notes 7 and 8.
Principal transactions reflects revenue on financial instruments and commodities transactions that arise from client-driven market making activity. Principal transactions revenue includes amounts recognized upon executing new transactions with market participants, as well as “inventory-related revenue”, which is revenue recognized from gains and losses on derivatives and other instruments that the Firm has been holding in anticipation of, or in response to, client demand, and changes in the fair value of instruments used by the Firm to actively manage the risk exposure arising from such inventory. Principal transactions revenue recognized upon executing new transactions with market participants is driven by many factors including the level of client activity, the bid-offer spread (which is the difference between the price at which a market participant is willing to sell an instrument to the Firm and the price at which another market participant is willing to buy it from the Firm, and vice versa), market liquidity and volatility. These factors are interrelated and sensitive to the same factors that drive inventory-related revenue, which include general market conditions, such as interest rates, foreign exchange rates, credit spreads, and equity and commodity prices, as well as other macroeconomic conditions.
For the periods presented below, the predominant source of principal transactions revenue was the amounts recognized upon executing new transactions.
(a)
Loss days represent the number of days for which Markets posted losses. The loss days determined under this measure differ from the loss days that are determined based on the disclosure of market risk-related gains and losses for the Firm in the value-at-risk (“VaR”) back-testing discussion on pages 118-120.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(a)
Consists of mutual funds, unit investment trusts, currencies, annuities, insurance contracts, options and other contracts.
(b)
Client deposits and other third party liabilities pertain to the Treasury Services and Securities Services businesses.
(a)
Total net revenue is based predominantly on the domicile of the client or location of the trading desk, as applicable. Loans outstanding (excluding loans held-for-sale and loans at fair value), client deposits and other third-party liabilities, and AUC are based predominantly on the domicile of the client.
(b)
Client deposits and other third party liabilities pertain to the Treasury Services and Securities Services businesses.
JPMorgan Chase & Co./2016 Annual Report
COMMERCIAL BANKING
(a)
Includes revenue from investment banking products and commercial card transactions.
(b)
Total net revenue included tax-equivalent adjustments from income tax credits related to equity investments in designated community development entities that provide loans to qualified businesses in low-income communities, as well as tax-exempt income related to municipal financing activities of $505 million, $493 million and $462 million for the years ended December 31, 2016, 2015 and 2014, respectively.
2016 compared with 2015
Net income was $2.7 billion, an increase of 21% compared with the prior year, driven by higher net revenue and a lower provision for credit losses, partially offset by higher noninterest expense.
Net revenue was $7.5 billion, an increase of 8% compared with the prior year. Net interest income was $5.1 billion, an increase of 14% compared with the prior year, driven by higher loan balances and deposit spreads. Noninterest revenue was $2.3 billion, a decrease of 2% compared with the prior year, largely driven by lower lending-and-deposit-related fees and other revenue, partially offset by higher investment banking revenue.
Noninterest expense was $2.9 billion, an increase of 2% compared with the prior year, reflecting increased hiring of bankers and business-related support staff and investments in technology.
The provision for credit losses was $282 million and $442 million for 2016 and 2015, respectively, with both periods driven by downgrades in the Oil & Gas portfolio and select client downgrades in other industries.
2015 compared with 2014
Net income was $2.2 billion, a decrease of 17% compared with the prior year, driven by a higher provision for credit losses and higher noninterest expense.
Net revenue was $6.9 billion, flat compared with the prior year. Net interest income was $4.5 billion, flat compared with the prior year, with interest income from higher loan balances offset by spread compression. Noninterest revenue was $2.4 billion, flat compared with the prior year, with higher investment banking revenue offset by lower lending-related fees.
Noninterest expense was $2.9 billion, an increase of 7% compared with the prior year, reflecting investment in controls.
The provision for credit losses was $442 million, reflecting an increase in the allowance for credit losses for Oil & Gas exposure and select client downgrades in other industries. The prior year was a benefit of $189 million.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(a)
Includes total Firm revenue from investment banking products sold to CB clients, net of revenue sharing with the CIB.
(b)
Represents total Firm revenue from investment banking products sold to CB clients.
(c)
Certain clients were transferred from Middle Market Banking to Corporate Client Banking and from Real Estate Banking to Corporate Client Banking during 2016. Prior period client segment amounts were revised to conform with the current period presentation.
JPMorgan Chase & Co./2016 Annual Report
(a)
Certain clients were transferred from Middle Market Banking to Corporate Client Banking and from Real Estate Banking to Corporate Client Banking during 2016. Prior period client segment amounts were revised to conform with the current period presentation.
(a)
An allowance for loan losses of $155 million, $64 million and $45 million was held against nonaccrual loans retained at December 31, 2016, 2015 and 2014, respectively.
(b)
Loans held-for-sale and loans at fair value were excluded when calculating the net charge-off/(recovery) rate.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
ASSET & WEALTH MANAGEMENT
2016 compared with 2015
Net income was $2.3 billion, an increase of 16% compared with the prior year, reflecting lower noninterest expense, partially offset by lower net revenue.
Net revenue was $12.0 billion, a decrease of 1%. Net interest income was $3.0 billion, up 19%, driven by higher deposit and loan spreads and loan growth. Noninterest revenue was $9.0 billion, a decrease of 6%, reflecting the impact of lower average equity market levels, a reduction in revenue related to the disposal of assets at the beginning of 2016, and lower performance fees and placement fees.
Revenue from Asset Management was $6.0 billion, down 5% from the prior year, driven by a reduction in revenue related to the disposal of assets at the beginning of 2016, the impact of lower average equity market levels and lower performance fees. Revenue from Wealth Management was $6.1 billion, up 4% from the prior year, reflecting higher net interest income from higher deposit and loan spreads and continued loan growth, partially offset by the impact of lower average equity market levels and lower placement fees.
Noninterest expense was $8.5 billion, a decrease of 5%, predominantly due to a reduction in expense related to the disposal of assets at the beginning of 2016 and lower legal expense.
2015 compared with 2014
Net income was $1.9 billion, a decrease of 10% compared with the prior year, reflecting higher noninterest expense, predominantly offset by higher net revenue.
Net revenue was $12.1 billion, an increase of 1%. Net interest income was $2.6 billion, up 5%, driven by higher loan balances and spreads. Noninterest revenue was $9.6 billion, flat from last year, as net client inflows into assets under management and the impact of higher average market levels were predominantly offset by lower performance fees and the sale of Retirement Plan Services (“RPS”) in 2014.
Revenue from Asset Management was $6.3 billion, flat from the prior year as the sale of RPS in 2014 and lower performance fees were largely offset by net client inflows. Revenue from Wealth Management was $5.8 billion, up 2% from the prior year due to higher net interest income from higher loan balances and spreads and net client inflows, partially offset by lower brokerage revenue.
Noninterest expense was $8.9 billion, an increase of 4%, predominantly due to higher legal expense and investment in both infrastructure and controls.
JPMorgan Chase & Co./2016 Annual Report
(a)
Represents the “overall star rating” derived from Morningstar for the U.S., the U.K., Luxembourg, Hong Kong and Taiwan domiciled funds; and Nomura “star rating” for Japan domiciled funds. Includes only Asset Management retail open-ended mutual funds that have a rating. Excludes money market funds, Undiscovered Managers Fund, and Brazil and India domiciled funds.
(b)
Prior period amounts were revised to conform with current period presentation.
(c)
Quartile ranking sourced from: Lipper for the U.S. and Taiwan domiciled funds; Morningstar for the U.K., Luxembourg and Hong Kong domiciled funds; Nomura for Japan domiciled funds and FundDoctor for South Korea domiciled funds. Includes only Asset Management retail open-ended mutual funds that are ranked by the aforementioned sources. Excludes money market funds, Undiscovered Managers Fund, and Brazil and India domiciled funds.
(d)
Included $32.8 billion, $26.6 billion and $22.1 billion of prime mortgage loans reported in the Consumer, excluding credit card, loan portfolio at December 31, 2016, 2015 and 2014, respectively.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Client assets
2016 compared with 2015
Client assets were $2.5 trillion, an increase of 4% compared with the prior year. Assets under management were $1.8 trillion, an increase of 3% from the prior year reflecting inflows into both liquidity and long-term products and the effect of higher market levels, partially offset by asset sales at the beginning of 2016.
2015 compared with 2014
Client assets were $2.4 trillion, a decrease of 2% compared with the prior year. Assets under management were $1.7 trillion, a decrease of 1% from the prior year reflecting the effect of lower market levels, partially offset by net inflows to long-term products.
(a)
Prior period amounts were revised to conform with current period presentation.
(b)
Represents assets under management, as well as client balances in brokerage accounts.
(a)
Prior period amounts were revised to conform with current period presentation.
(a)
Regional revenue is based on the domicile of the client.
JPMorgan Chase & Co./2016 Annual Report
CORPORATE
(a)
Included tax-equivalent adjustments, predominantly due to tax-exempt income from municipal bond investments of $885 million, $839 million and $730 million for the years ended December 31, 2016, 2015 and 2014, respectively.
(b)
Included legal expense/(benefit) of $(385) million, $832 million and $821 million for the years ended December 31, 2016, 2015 and 2014, respectively.
(c)
Average core loans were $1.9 billion, $2.5 billion and $3.3 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
2016 compared with 2015
Net loss was $704 million, compared with net income of $2.4 billion in the prior year.
Net revenue was a loss of $487 million, compared with a gain of $267 million in the prior year. The prior year included a $514 million benefit from a legal settlement.
Net interest income was a loss of $1.4 billion, compared with a loss of $533 million in the prior year. The loss in the current year was primarily driven by higher interest expense on long-term debt and lower investment securities balances during the year, partially offset by higher interest income on deposits with banks and securities purchased under resale agreements as a result of higher rates.
Noninterest expense was $462 million, a decrease of $515 million from the prior year driven by lower legal expense, partially offset by higher compensation expense.
The prior year reflected tax benefits of $2.6 billion predominantly from the resolution of various tax audits.
2015 compared with 2014
Net income was $2.4 billion, compared with net income of $864 million in the prior year.
Net revenue was $267 million, compared with $12 million in the prior year. The current year included a $514 million benefit from a legal settlement. Treasury and CIO included a benefit of approximately $178 million associated with recognizing the unamortized discount on certain debt securities which were called at par and a $173 million pretax loss primarily related to accelerated amortization of cash flow hedges associated with the exit of certain non-operating deposits. Private Equity gains were $1.2 billion lower compared with the prior year, reflecting lower valuation gains and lower net gains on sales as the Firm exits this non-core business.
Noninterest expense was $977 million, a decrease of $182 million from the prior year which had included a $276 million goodwill impairment related to the sale of a portion of the Private Equity business.
The current year reflected tax benefits of $2.6 billion predominantly from the resolution of various tax audits compared with tax benefits of $1.1 billion in the prior year.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Treasury and CIO overview
Treasury and CIO are predominantly responsible for measuring, monitoring, reporting and managing the Firm’s liquidity, funding and structural interest rate and foreign exchange risks, as well as executing the Firm’s capital plan. The risks managed by Treasury and CIO arise from the activities undertaken by the Firm’s four major reportable business segments to serve their respective client bases, which generate both on- and off-balance sheet assets and liabilities.
Treasury and CIO achieve the Firm’s asset-liability management objectives generally by investing in high-quality securities that are managed for the longer-term as part of the Firm’s investment securities portfolio. Treasury and CIO also use derivatives to meet the Firm’s asset-liability management objectives. For further information on derivatives, see Note 6. The investment securities portfolio primarily consists of U.S. and non-U.S. government securities, agency and nonagency mortgage-backed securities, other ABS, corporate debt securities and obligations of U.S. states and municipalities. At December 31, 2016, the investment securities portfolio was $286.8 billion, and the average credit rating of the securities comprising the portfolio was AA+ (based upon external ratings where available and where not available, based primarily upon internal ratings that correspond to ratings as defined by S&P and Moody’s). During 2016, the Firm transferred commercial mortgage-backed securities and obligations of U.S. states and municipalities with a fair value of $7.5 billion from available-for-sale (“AFS”) to held-to maturity (“HTM”). These securities were transferred at fair value. The transfers reflect the Firm’s intent to hold the securities to maturity in order to reduce the impact of price volatility on accumulated other comprehensive income (“AOCI”).
See Note 12 for further information on the details of the Firm’s investment securities portfolio.
For further information on liquidity and funding risk, see Liquidity Risk Management on pages 110-115. For information on interest rate, foreign exchange and other risks, Treasury and CIO VaR and the Firm’s earnings-at-risk, see Market Risk Management on pages 116-123.
(a)
Average investment securities included HTM balances of $51.4 billion, $50.0 billion and $47.2 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
(b)
Period-end investment securities included HTM securities of $50.2 billion, $49.1 billion, $49.3 billion at December 31, 2016, 2015 and 2014, respectively.
Private equity portfolio information(a)
(a)
For more information on the Firm’s methodologies regarding the valuation of the Private Equity portfolio, see Note 3.
2016 compared with 2015
The carrying value of the private equity portfolio at December 31, 2016 was $1.8 billion, down from $2.1 billion at December 31, 2015, driven by portfolio sales.
2015 compared with 2014
The carrying value of the private equity portfolio at
December 31, 2015 was $2.1 billion, down from $5.9
billion at December 31, 2014, driven by the sale of a
portion of the Private Equity business and porfolio sales.
JPMorgan Chase & Co./2016 Annual Report
ENTERPRISE-WIDE RISK MANAGEMENT
Risk is an inherent part of JPMorgan Chase’s business activities. When the Firm extends a consumer or wholesale loan, advises customers on their investment decisions, makes markets in securities, or offers other products or services, the Firm takes on some degree of risk. The Firm’s overall objective is to manage its businesses, and the associated risks, in a manner that balances serving the interests of its clients, customers and investors and protects the safety and soundness of the Firm.
Firmwide Risk Management is overseen and managed on an enterprise-wide basis. The Firm’s approach to risk management covers a broad spectrum of economic and other core risk areas, such as credit, market, liquidity, model, principal, country, operational, compliance, conduct, legal, capital and reputation risk, with controls and governance established for each area, as appropriate.
The Firm believes that effective risk management requires:
•
Acceptance of responsibility, including identification and escalation of risk issues, by all individuals within the Firm;
•
Ownership of risk identification, assessment, data and management within each of the lines of business and corporate functions; and
•
Firmwide structures for risk governance.
The Firm’s Operating Committee, which consists of the Firm’s Chief Executive Officer (“CEO”), Chief Risk Officer (“CRO”), Chief Operating Officer (“COO”), Chief Financial Officer (“CFO”) and other senior executives, is the ultimate management escalation point in the Firm, and may refer matters to the Firm’s Board of Directors. The Operating Committee is responsible and accountable to the Firm’s Board of Directors.
The Firm strives for continual improvement through efforts to enhance controls, ongoing employee training and development, talent retention, and other measures. The Firm follows a disciplined and balanced compensation framework with strong internal governance and independent Board oversight. The impact of risk and control issues are carefully considered in the Firm’s performance evaluation and incentive compensation processes.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The following sections outline the key risks that are inherent in the Firm’s business activities:
JPMorgan Chase & Co./2016 Annual Report
Governance and oversight
The Firm’s overall appetite for risk is governed by a “Risk Appetite” framework. The framework and the Firm’s risk appetite are set and approved by the Firm’s CEO, CFO, CRO and COO. LOB-level risk appetite is set by the respective LOB CEO, CFO and CRO and is approved by the Firm’s CEO, CFO, CRO and COO. Quantitative parameters and qualitative factors are used to monitor and measure the Firm’s capacity to take risk against stated risk appetite. Quantitative parameters have been established to assess stressed net income, capital, credit risk, market risk, structural interest rate risk and liquidity risk. Qualitative factors have been established for select risks. Risk Appetite results are reported quarterly to the Board of Directors’ Risk Policy Committee (“DRPC”).
The Firm’s CRO is the head of the Independent Risk Management (“IRM”) function and reports to the CEO and the DRPC. The CEO appoints the CRO to create the Risk Management Framework subject to approval by the DRPC in the form of the Primary Risk Policies. The Chief Compliance Officer (“CCO”), who reports to the CRO, is also responsible for reporting to the Audit Committee for the Global Compliance Program. The Firm’s Global Compliance Program focuses on overseeing compliance with laws, rules and regulations applicable to the Firm’s products and services to clients and counterparties.
The IRM function, comprised of Risk Management and Compliance Organizations, is independent of the businesses. The IRM function sets various standards for the risk management governance framework, including risk policy, identification, measurement, assessment, testing, limit setting (e.g., risk appetite, thresholds, etc.), monitoring and reporting. Various groups within the IRM function are aligned to the LOBs and to corporate functions, regions and core areas of risk such as credit, market, country and liquidity risks, as well as operational, model and reputational risk governance.
The Firm places key reliance on each of its LOBs and other functional areas giving rise to risk. Each LOB or other functional area giving rise to risk is expected to operate its activities within the parameters identified by the IRM function, and within their own management-identified risk and control standards. Because these LOBs and functional areas are accountable for identifying and addressing the risks in their respective businesses and for operating within a sound control environment, they are considered the “first line of defense” within the Firm’s risk governance framework.
The Firmwide Oversight and Control Group consists of dedicated control officers within each of the lines of business and corporate functions, as well as having a central oversight function. The group is charged with enhancing the Firm’s control environment by looking within and across the lines of business and corporate functions to help identify and remediate control issues. The group enables the Firm to detect control problems more quickly, escalate issues promptly and engage other stakeholders to understand common themes and interdependencies among the various parts of the Firm.
As the “second line of defense”, the IRM function provides oversight and independent challenge, consistent with its policies and framework, to the risk-creating LOBs and functional areas.
Internal Audit, a function independent of the businesses and the IRM function, tests and evaluates the Firm’s risk governance and management, as well as its internal control processes. This function, the “third line of defense” in the risk governance framework, brings a systematic and disciplined approach to evaluating and improving the effectiveness of the Firm’s governance, risk management and internal control processes. The Internal Audit Function is headed by the General Auditor, who reports to the Audit Committee.
The independent status of the IRM function is supported by a governance structure that provides for escalation of risk issues to senior management, the Firmwide Risk Committee, or the Board of Directors.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The chart below illustrates the key senior management level committees in the Firm’s risk governance structure. Other committees, forums and paths of escalation are in place that are responsible for management and oversight of risk, although they are not shown in the chart below.
The Board of Directors provides oversight of risk principally through the DRPC, Audit Committee and, with respect to compensation and other management-related matters, the Compensation & Management Development Committee. Each committee of the Board oversees reputation risk issues within its scope of responsibility.
The Directors’ Risk Policy Committee of the Board oversees the Firm’s global risk management framework and approves the primary risk management policies of the Firm. The Committee’s responsibilities include oversight of management’s exercise of its responsibility to assess and manage the Firm’s risks, and its capital and liquidity planning and analysis. Breaches in risk appetite, liquidity issues that may have a material adverse impact on the Firm and other significant risk-related matters are escalated to the Committee.
The Audit Committee of the Board assists the Board in its oversight of management’s responsibilities to assure that there is an effective system of controls reasonably designed to safeguard the assets and income of the Firm, assure the integrity of the Firm’s financial statements and maintain compliance with the Firm’s ethical standards, policies, plans and procedures, and with laws and regulations. In addition, the Audit Committee assists the Board in its oversight of the Firm’s independent registered public accounting firm’s qualifications, independence and performance, and of the performance of the Firm’s Internal Audit function.
The Compensation & Management Development Committee (“CMDC”) assists the Board in its oversight of the Firm’s compensation programs and reviews and approves the Firm’s overall compensation philosophy, incentive compensation pools, and compensation practices consistent with key business objectives and safety and soundness. The Committee reviews Operating Committee members’ performance against their goals, and approves their compensation awards. The Committee also periodically reviews the Firm’s diversity programs and management development and succession planning, and provides oversight of the Firm’s culture and conduct programs.
Among the Firm’s senior management-level committees that are primarily responsible for key risk-related functions are:
The Firmwide Risk Committee (“FRC”) is the Firm’s highest management-level risk committee. It provides oversight of the risks inherent in the Firm’s businesses. The Committee is co-chaired by the Firm’s CEO and CRO. This Committee serves as an escalation point for risk topics and issues raised by its members, the Line of Business Risk
JPMorgan Chase & Co./2016 Annual Report
Committees, Firmwide Control Committee, Firmwide Fiduciary Risk Governance Committee, and regional Risk Committees, as appropriate. The Committee escalates significant issues to the DRPC, as appropriate.
The Firmwide Control Committee (“FCC”) provides a forum for senior management to review and discuss firmwide operational risks including existing and emerging issues, and operational risk metrics, and to review operational risk management execution in the context of the Operational Risk Management Framework (“ORMF”) which provides the framework for the governance, assessment, measurement, and monitoring and reporting of operational risk. The FCC is co-chaired by the Chief Control Officer and the Firmwide Risk Executive for Operational Risk Governance. The committee relies upon the prompt escalation of issues from businesses and functions as the primary owners of the operational risk. Operational risk issues may be escalated by business or function control committees to the FCC, which may, in turn, escalate to the FRC, as appropriate.
The Firmwide Fiduciary Risk Governance Committee is a forum for risk matters related to the Firm’s fiduciary activities. The Committee oversees the firmwide fiduciary risk governance framework, which supports the consistent identification and escalation of fiduciary risk issues by the relevant lines of business; establishes policies and best practices to effectuate the Committee’s oversight responsibility; and creates metrics reporting to track fiduciary activity and issue resolution Firmwide. The Committee escalates significant fiduciary issues to the FRC, the DRPC and the Audit Committee, as appropriate.
Line of Business and Regional Risk Committees review the ways in which the particular line of business or the business operating in a particular region could be exposed to adverse outcomes with a focus on identifying, accepting, escalating and/or requiring remediation of matters brought to these committees. These committees may escalate to the FRC, as appropriate. LOB risk committees are co-chaired by the LOB CEO and the LOB CRO. Each LOB risk committee may create sub-committees with requirements for escalation. The regional committees are established similarly, as appropriate, for the region.
In addition, each line of business and function is required to have a Control Committee. These control committees oversee the control environment of their respective business or function. As part of that mandate, they are responsible for reviewing data which indicates the quality and stability of the processes in a business or function, reviewing key operational risk issues and focusing on processes with shortcomings and overseeing process remediation. These committees escalate to the FCC, as appropriate.
The Firmwide Asset Liability Committee (“ALCO”), chaired by the Firm’s Treasurer and Chief Investment Officer under the direction of the COO, monitors the Firm’s balance sheet, liquidity risk and structural interest rate risk. ALCO reviews the Firm’s overall structural interest rate risk position,
funding requirements and strategy, and securitization programs (and any required liquidity support by the Firm of such programs). ALCO is responsible for reviewing and approving the Firm’s Funds Transfer Pricing Policy (through which lines of business “transfer” interest rate risk to Treasury and CIO) and the Firm’s Intercompany Funding and Liquidity Policy. ALCO is also responsible for reviewing the Firm’s Contingency Funding Plan.
The Firmwide Capital Governance Committee, chaired by the Head of the Regulatory Capital Management Office is responsible for reviewing the Firm’s Capital Management Policy and the principles underlying capital issuance and distribution alternatives and decisions. The Committee oversees the capital adequacy assessment process, including the overall design, scenario development and macro assumptions and ensures that capital stress test programs are designed to adequately capture the risks specific to the Firm’s businesses.
The Firmwide Valuation Governance Forum (“VGF”) is composed of senior finance and risk executives and is responsible for overseeing the management of risks arising from valuation activities conducted across the Firm. The VGF is chaired by the firmwide head of the Valuation Control Group (“VCG”) (under the direction of the Firm’s Controller), and includes sub-forums covering the Corporate & Investment Bank, Consumer & Community Banking, Commercial Banking, Asset & Wealth Management and certain corporate functions, including Treasury and CIO.
In addition, the JPMorgan Chase Bank, N.A. Board of Directors is responsible for the oversight of management of the Bank. The JPMorgan Chase Bank, N.A. Board accomplishes this function acting directly and through the principal standing committees of the Firm’s Board of Directors. Risk oversight on behalf of JPMorgan Chase Bank N.A. is primarily the responsibility of the DRPC and Audit Committee of the Firm’s Board of Directors and, with respect to compensation and other management-related matters, the Compensation & Management Development Committee of the Firm’s Board of Directors.
Risk measurement
The Firm has a broad spectrum of risk management metrics, as appropriate for each risk category. For further information on risk management metrics, see table on key risks on page 72. Additionally, the Firm is exposed to certain potential low-probability, but plausible and material, idiosyncratic risks that are not well-captured by its other existing risk analysis and reporting metrics. These idiosyncratic risks may arise in a number of ways, such as changes in legislation, an unusual combination of market events, or specific counterparty events. The Firm has a process intended to identify these risks in order to allow the Firm to monitor vulnerabilities that are not adequately covered by its other standard risk measurements.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
CAPITAL RISK MANAGEMENT
Capital risk is the risk the Firm has an insufficient level and composition of capital to support its business activities and associated risks during both normal economic environments and under stressed conditions.
A strong capital position is essential to the Firm’s business strategy and competitive position. Maintaining a strong balance sheet to manage through economic volatility is considered a strategic imperative of the Firm’s Board of Directors, CEO and Operating Committee. The Firm’s balance sheet philosophy focuses on risk-adjusted returns, strong capital and robust liquidity. The Firm’s capital management strategy focuses on maintaining long-term stability to enable it to build and invest in market-leading businesses, even in a highly stressed environment. Prior to making any decisions on future business activities, senior management considers the implications on the Firm’s capital. In addition to considering the Firm’s earnings outlook, senior management evaluates all sources and uses of capital with a view to preserving the Firm’s capital strength.
The Firm’s capital management objectives are to hold capital sufficient to:
•
Maintain “well-capitalized” status for the Firm and its principal bank subsidiaries;
•
Support risks underlying business activities;
•
Maintain sufficient capital in order to continue to build and invest in its businesses through the cycle and in stressed environments;
•
Retain flexibility to take advantage of future investment opportunities;
•
Serve as a source of strength to its subsidiaries;
•
Meet capital distribution objectives; and
•
Maintain sufficient capital resources to operate throughout a resolution period in accordance with the Firm’s preferred resolution strategy.
These objectives are achieved through the establishment of minimum capital targets and a strong capital governance framework. Capital management is intended to be flexible in order to react to a range of potential events. The Firm’s minimum capital targets are based on the most binding of three pillars: an internal assessment of the Firm’s capital needs; an estimate of required capital under the CCAR and Dodd-Frank Act stress testing requirements; and Basel III Fully Phased-In regulatory minimums. Where necessary, each pillar may include a management-established buffer. The capital governance framework requires regular monitoring of the Firm’s capital positions, stress testing and defining escalation protocols, both at the Firm and material legal entity levels.
JPMorgan Chase & Co./2016 Annual Report
The following tables present the Firm’s Transitional and Fully Phased-In risk-based and leverage-based capital metrics under both the Basel III Standardized and Advanced Approaches. The Firm’s Basel III ratios exceed both the current and Fully Phased-In regulatory minimums as of December 31, 2016 and 2015. For further discussion of these capital metrics and the Standardized and Advanced approaches, refer to Monitoring and management of capital on pages 78-82.
Note: As of December 31, 2016 and 2015, the lower of the Standardized or Advanced capital ratios under each of the Transitional and Fully Phased-In approaches in the table above represents the Firm’s Collins Floor, as discussed in Monitoring and management of Capital on page 78.
(a)
The Tier 1 leverage ratio is calculated by dividing Tier 1 capital by adjusted average assets.
(b)
The SLR leverage ratio is calculated by dividing Tier 1 capital by SLR leverage exposure.
(c)
Represents the Transitional minimum capital ratios applicable to the Firm under Basel III as of December 31, 2016 and 2015. At December 31, 2016, the CET1 minimum
capital ratio includes 0.625% resulting from the phase-in of the Firm’s 2.5% capital conservation buffer and 1.125%, resulting from the phase-in of the Firm’s 4.5%
global systemically important banks (“GSIB”) surcharge.
(d)
Represents the minimum capital ratios applicable to the Firm on a Fully Phased-In Basel III basis. At December 31, 2016, the ratios include the Firm’s estimate of its Fully Phased-In U.S. GSIB surcharge of 3.5%. The minimum capital ratios will be fully phased-in effective January 1, 2019. For additional information on the GSIB surcharge, see page 79.
(e)
In the case of the SLR, the Fully Phased-In minimum ratio is effective beginning January 1, 2018.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Strategy and governance
The Firm’s CEO, in conjunction with the Board of Directors, establishes principles and guidelines for capital planning, issuance, usage and distributions, and minimum capital targets for the level and composition of capital in both business-as-usual and highly stressed environments. The DRPC assesses and approves the capital management and governance processes of the Firm. The Firm’s Audit Committee is responsible for reviewing and approving the capital stress testing end-to-end control framework.
The Capital Governance Committee and the Regulatory Capital Management Office (“RCMO”) support the Firm’s strategic capital decision-making. The Capital Governance Committee oversees the capital adequacy assessment process, including the overall design, scenario development and macro assumptions and ensures that capital stress test programs are designed to adequately capture the risks specific to the Firm’s businesses. RCMO, which reports to the Firm’s CFO, is responsible for designing and monitoring the Firm’s execution of its capital policies and strategies once approved by the Board, as well as reviewing and monitoring the execution of its capital adequacy assessment process. The Basel Independent Review function (“BIR”), which reports to the RCMO and has direct access to both the DRPC and Capital Governance Committee, conducts independent assessments of the Firm’s regulatory capital framework to ensure compliance with the applicable U.S. Basel rules in support of senior management’s responsibility for assessing and managing capital and for the DRPC’s oversight of management in executing that responsibility. For additional discussion on the DRPC, see Enterprise-wide Risk Management on pages 71-75.
Monitoring and management of capital
In its monitoring and management of capital, the Firm takes into consideration an assessment of economic risk and all regulatory capital requirements to determine the level of capital needed to meet and maintain the objectives discussed above, as well as to support the framework for allocating capital to its business segments. While economic risk is considered prior to making decisions on future business activities, in most cases, the Firm considers risk-based regulatory capital to be a proxy for economic risk capital.
Regulatory capital
The Federal Reserve establishes capital requirements, including well-capitalized standards, for the consolidated financial holding company. The OCC establishes similar minimum capital requirements for the Firm’s national banks, including JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. The U.S. capital requirements generally follow the Capital Accord of the Basel Committee, as amended from time to time.
Basel III overview
Capital rules under Basel III establish minimum capital ratios and overall capital adequacy standards for large and internationally active U.S. bank holding companies and banks, including the Firm and its insured depository institution (“IDI”) subsidiaries. Basel III presents two comprehensive methodologies for calculating RWA: a general (standardized) approach (“Basel III Standardized”), and an advanced approach (“Basel III Advanced”). Certain of the requirements of Basel III are subject to phase-in periods that began on January 1, 2014 and continue through the end of 2018 (“transitional period”).
Basel III establishes capital requirements for calculating credit risk and market risk RWA, and in the case of Basel III Advanced, operational risk RWA. Key differences in the calculation of credit risk RWA between the Standardized and Advanced approaches are that for Basel III Advanced, credit risk RWA is based on risk-sensitive approaches which largely rely on the use of internal credit models and parameters, whereas for Basel III Standardized, credit risk RWA is generally based on supervisory risk-weightings which vary primarily by counterparty type and asset class. Market risk RWA is calculated on a generally consistent basis between Basel III Standardized and Basel III Advanced. In addition to the RWA calculated under these methodologies, the Firm may supplement such amounts to incorporate management judgment and feedback from its bank regulators.
Basel III also includes a requirement for Advanced Approach banking organizations, including the Firm, to calculate SLR. For additional information on SLR, see
page 82.
Basel III Fully Phased-In
Basel III capital rules will become fully phased-in on January 1, 2019, at which point the Firm will continue to calculate its capital ratios under both the Basel III Standardized and Advanced Approaches. The Firm manages each of the businesses, as well as the corporate functions, primarily on a Basel III Fully Phased-In basis. For additional information on the Firm, JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A.’s capital, RWA and capital ratios under Basel III Standardized and Advanced Fully Phased-In rules and SLRs calculated under the Basel III Advanced Fully Phased-In rules, all of which are considered key regulatory capital measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Performance Measures on pages 48-50.
JPMorgan Chase & Co./2016 Annual Report
The Firm’s estimates of its Basel III Standardized and Advanced Fully Phased-In capital, RWA and capital ratios and SLRs for the Firm, JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. are based on the current published U.S. Basel III rules and on the application of such rules to the Firm’s businesses as currently conducted. The actual impact on the Firm’s capital ratios and SLR as of the
effective date of the rules may differ from the Firm’s current estimates depending on changes the Firm may make to its businesses in the future, further implementation guidance from the regulators, and regulatory approval of certain of the Firm’s internal risk models (or, alternatively, regulatory disapproval of the Firm’s internal risk models that have previously been conditionally approved).
Risk-based capital regulatory minimums
The following chart presents the Basel III minimum CET1 capital ratio during the transitional periods and on a fully phased-in basis under the Basel III rules currently in effect.
The Basel III rules include minimum capital ratio requirements that are subject to phase-in periods through the end of 2018. The capital adequacy of the Firm and its national bank subsidiaries, both during the transitional period and upon full-phase in, is evaluated against the Basel III approach (Standardized or Advanced) which results for each quarter in the lower ratio as required by the Collins Amendment of the Dodd-Frank Act (the “Collins Floor”). Additional information regarding the Firm’s capital ratios, as well as the U.S. federal regulatory capital standards to which the Firm is subject, is presented in Note 28. For further information on the Firm’s Basel III measures, see the Firm’s Pillar 3 Regulatory Capital Disclosures reports, which are available on the Firm’s website (http://investor.shareholder.com/jpmorganchase/basel.cfm).
All banking institutions are currently required to have a minimum capital ratio of 4.5% of CET1 capital. Certain banking organizations, including the Firm, are required to hold additional amounts of capital to serve as a “capital conservation buffer”. The capital conservation buffer is intended to be used to absorb potential losses in times of financial or economic stress. If not maintained, the Firm could be limited in the amount of capital that may be
distributed, including dividends and common equity repurchases. The capital conservation buffer is subject to a phase-in period that began January 1, 2016 and continues through the end of 2018.
As an expansion of the capital conservation buffer, the Firm is also required to hold additional levels of capital in the form of a GSIB surcharge and a countercyclical capital buffer.
Under the Federal Reserve’s final rule, GSIBs, including the Firm, are required to calculate their GSIB surcharge on an annual basis under two separately prescribed methods, and are subject to the higher of the two. The first (“Method 1”), reflects the GSIB surcharge as prescribed by the Basel Committee’s assessment methodology, and is calculated across five criteria: size, cross-jurisdictional activity, interconnectedness, complexity and substitutability. The second (“Method 2”), modifies the Method 1 requirements to include a measure of short-term wholesale funding in place of substitutability, and introduces a GSIB score “multiplication factor”.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The Firm’s Fully Phased-In GSIB surcharge for 2016 was calculated to be 2.5% under Method 1 and 4.5% under Method 2. Accordingly, the Firm’s minimum capital ratios applicable in 2016 include a GSIB surcharge of 1.125%, resulting from the application of the transition provisions to the 4.5% fully phased-in GSIB surcharge. For 2017, the Firm has calculated its Fully Phased-In GSIB surcharge to be 2.5% under Method 1 and 3.5% under Method 2 resulting in the inclusion of a GSIB surcharge of 1.75% in the Firm’s minimum capital ratios after application of the transition provisions.
The countercyclical capital buffer takes into account the macro financial environment in which large, internationally active banks function. On September 8, 2016 the Federal Reserve published the framework that will apply to the setting of the countercyclical capital buffer. As of October 24, 2016 the Federal Reserve reaffirmed setting the U.S. countercyclical capital buffer at 0%, and stated that it will review the amount at least annually. The countercyclical capital buffer can be increased if the Federal Reserve, FDIC and OCC determine that credit growth in the economy has become excessive and can be set at up to an additional 2.5% of RWA subject to a 12-month implementation period.
Based on the Firm’s most recent estimate of its GSIB surcharge and the current countercyclical buffer being set at 0%, the Firm estimates its Fully Phased-In CET1 capital requirement, at January 1, 2019, would be 10.5% (reflecting the 4.5% CET1 capital requirement, the Fully Phased-In 2.5% capital conservation buffer and the GSIB surcharge of 3.5%). As well as meeting the capital ratio requirements of Basel III, the Firm must, in order to be “well-capitalized”, maintain a minimum 6% Tier 1 capital and a 10% Total capital requirement. At December 31, 2016 and 2015, JPMorgan Chase maintained Basel III Standardized Transitional and Basel III Advanced Transitional ratios in excess of the well-capitalized standards established by the Federal Reserve.
The Firm continues to believe that over the next several years, it will operate with a Basel III CET1 capital ratio between 11% and 12.5%. It is the Firm’s intention that the Firm’s capital ratios continue to meet regulatory minimums as they are fully implemented in 2019 and thereafter.
Each of the Firm’s IDI subsidiaries must maintain a minimum 6.5% CET1, 8% Tier 1 capital, 10% Total capital and 5% Tier 1 leverage requirement to meet the definition of “well-capitalized” under the Prompt Corrective Action (“PCA”) requirements of the FDIC Improvement Act (“FDICIA”) for IDI subsidiaries.
Capital
A reconciliation of total stockholders’ equity to Basel III Fully Phased-In CET1 capital, Tier 1 capital and Basel III Advanced and Standardized Fully Phased-In Total capital is presented in the table below. For additional information on the components of regulatory capital, see Note 28.
(a)
Represents deferred tax liabilities related to tax-deductible goodwill and to identifiable intangibles created in nontaxable transactions, which are netted against goodwill and other intangibles when calculating TCE.
(b)
Includes the deduction associated with the permissible holdings of covered funds (as defined by the Volcker Rule) acquired after December 31, 2013. The deduction was not material as of December 31, 2016.
JPMorgan Chase & Co./2016 Annual Report
The following table presents a reconciliation of the Firm’s Basel III Transitional CET1 capital to the Firm’s estimated Basel III Fully Phased-In CET1 capital as of December 31, 2016.
(a)
Includes the remaining balance of AOCI related to AFS debt securities and defined benefit pension and other postretirement employee benefit (“OPEB”) plans that will qualify as Basel III CET1 capital upon full phase-in.
(b)
Predominantly includes regulatory adjustments related to changes in DVA, as well as CET1 deductions for defined benefit pension plan assets and deferred tax assets related to net operating loss (“NOL”) and tax credit carryforwards.
(c)
Relates to intangible assets, other than goodwill and MSRs, that are required to be deducted from CET1 capital upon full phase-in.
(d)
Includes minority interest and the Firm’s investments in its own CET1 capital instruments.
Capital rollforward
The following table presents the changes in Basel III Fully Phased-In CET1 capital, Tier 1 capital and Tier 2 capital for the year ended December 31, 2016.
(a)
Effective January 1, 2016, the adjustment reflects the impact of the adoption of DVA through OCI. For further discussion of the accounting change refer to Note 25.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
RWA rollforward
The following table presents changes in the components of RWA under Basel III Standardized and Advanced Fully Phased-In for the year ended December 31, 2016. The amounts in the rollforward categories are estimates, based on the predominant driver of the change.
(a)
Model & data changes refer to movements in levels of RWA as a result of revised methodologies and/or treatment per regulatory guidance (exclusive of rule changes).
(b)
Portfolio runoff for credit risk RWA reflects reduced risk from position rolloffs in legacy portfolios in Mortgage Banking (under both the Standardized and Advanced framework), and for market risk RWA reflects reduced risk from position rolloffs in legacy portfolios in the wholesale businesses.
(c)
Movement in portfolio levels for credit risk RWA refers to changes in book size, composition, credit quality, and market movements; and for market risk RWA refers to changes in position and market movements.
Supplementary leverage ratio
The SLR is defined as Tier 1 capital under Basel III divided by the Firm’s total leverage exposure. Total leverage exposure is calculated by taking the Firm’s total average on-balance sheet assets, less amounts permitted to be deducted for Tier 1 capital, and adding certain off-balance sheet exposures, such as undrawn commitments and derivatives potential future exposure.
U.S. bank holding companies, including the Firm, are required to have a minimum SLR of 5% and IDI subsidiaries, including JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., are required to have a minimum SLR of 6%, both beginning January 1, 2018. As of December 31, 2016, the Firm estimates that JPMorgan Chase Bank, N.A.’s and Chase Bank USA, N.A.’s Fully Phased-In SLRs are approximately 6.6% and 9.6%, respectively.
The following table presents the components of the Firm’s Fully Phased-In SLR as of December 31, 2016.
(a)
Adjusted average assets, for purposes of calculating the SLR, includes total quarterly average assets adjusted for on-balance sheet assets that are subject to deduction from Tier 1 capital, predominantly goodwill and other intangible assets.
(b)
Off-balance sheet exposures are calculated as the average of the three month-end spot balances in the reporting quarter.
JPMorgan Chase & Co./2016 Annual Report
Line of business equity
The Firm’s framework for allocating capital to its business segments (line of business equity) is based on the following objectives:
•
Integrate firmwide and line of business capital management activities;
•
Measure performance consistently across all lines of business; and
•
Provide comparability with peer firms for each of the lines of business.
Each business segment is allocated capital by taking into consideration stand-alone peer comparisons and regulatory capital requirements (as estimated under Basel III Advanced Fully Phased-In). For 2016, capital was allocated to each business segment for, among other things, goodwill and other intangibles associated with acquisitions effected by the line of business. ROE is measured and internal targets for expected returns are established as key measures of a business segment’s performance.
On at least an annual basis, the Firm assesses the level of capital required for each line of business as well as the assumptions and methodologies used to allocate capital. Through the end of 2016, capital was allocated to the lines of business based on a single measure, Basel III Advanced Fully Phased-In RWA. Effective January 1, 2017, the Firm’s methodology used to allocate capital to the Firm’s business segments was updated. The new methodology incorporates Basel III Standardized Fully Phased-In RWA (as well as Basel III Advanced Fully Phased-In RWA), leverage, the GSIB surcharge, and a simulation of capital in a severe stress environment. The methodology will continue to be weighted towards Basel III Advanced Fully Phased-In RWA because the Firm believes it to be the best proxy for economic risk. The Firm will consider further changes to its capital allocation methodology as the regulatory framework evolves. In addition, under the new methodology, capital is no longer allocated to each line of business for goodwill and other intangibles associated with acquisitions effected by the line of business. The Firm will continue to establish internal ROE targets for its business segments, against which they will be measured, as a key performance indicator.
The table below reflects the Firm’s assessed level of capital required for each line of business as of the dates indicated.
Planning and stress testing
Comprehensive Capital Analysis and Review
The Federal Reserve requires large bank holding companies, including the Firm, to submit a capital plan on an annual basis. The Federal Reserve uses the CCAR and Dodd-Frank Act stress test processes to ensure that large BHCs have sufficient capital during periods of economic and financial stress, and have robust, forward-looking capital assessment and planning processes in place that address each BHC’s unique risks to enable them to absorb losses under certain stress scenarios. Through the CCAR, the Federal Reserve evaluates each BHC’s capital adequacy and internal capital adequacy assessment processes (“ICAAP”), as well as its plans to make capital distributions, such as dividend payments or stock repurchases.
On June 29, 2016, the Federal Reserve informed the Firm that it did not object, on either a quantitative or qualitative basis, to the Firm’s 2016 capital plan. For information on actions taken by the Firm’s Board of Directors following the 2016 CCAR results, see Capital actions on page 84.
The Firm’s CCAR process is integrated into and employs the same methodologies utilized in the Firm’s ICAAP process, as discussed below.
Internal Capital Adequacy Assessment Process
Semiannually, the Firm completes the ICAAP, which provides management with a view of the impact of severe and unexpected events on earnings, balance sheet positions, reserves and capital. The Firm’s ICAAP integrates stress testing protocols with capital planning.
The process assesses the potential impact of alternative economic and business scenarios on the Firm’s earnings and capital. Economic scenarios, and the parameters underlying those scenarios, are defined centrally and applied uniformly across the businesses. These scenarios are articulated in terms of macroeconomic factors, which are key drivers of business results; global market shocks, which generate short-term but severe trading losses; and idiosyncratic operational risk events. The scenarios are intended to capture and stress key vulnerabilities and idiosyncratic risks facing the Firm. However, when defining a broad range of scenarios, realized events can always be worse. Accordingly,
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
management considers additional stresses outside these scenarios, as necessary. ICAAP results are reviewed by management and the Board of Directors.
Capital actions
Dividends
The Firm’s common stock dividend policy reflects JPMorgan Chase’s earnings outlook, desired dividend payout ratio, capital objectives, and alternative investment opportunities.
On May 17, 2016, the Firm announced that its Board of Directors increased the quarterly common stock dividend to $0.48 per share, effective with the dividend paid on July 31, 2016. The Firm’s dividends are subject to the Board of Directors’ approval at the customary times those dividends are to be declared.
For information regarding dividend restrictions, see Note 22 and Note 27.
The following table shows the common dividend payout ratio based on net income applicable to common equity.
Common equity
During the year ended December 31, 2016, warrant holders exercised their right to purchase 22.5 million shares of the Firm’s common stock. The Firm issued from treasury stock 11.1 million shares of its common stock as a result of these exercises. As of December 31, 2016, 24.9 million warrants remained outstanding, compared with 47.4 million outstanding as of December 31, 2015.
On March 17, 2016, the Firm announced that its Board of Directors had authorized the repurchase of up to an additional $1.9 billion of common equity (common stock and warrants) through June 30, 2016 under its equity repurchase program. This amount is in addition to the $6.4 billion of common equity that was previously authorized for repurchase between April 1, 2015 and June 30, 2016.
Following receipt in June 2016 of the Federal Reserve’s non-objection to the Firm’s 2016 capital plan, the Firm’s Board of Directors authorized the repurchase of up to $10.6 billion of common equity (common stock and warrants) between July 1, 2016 and June 30, 2017.
This authorization includes shares repurchased to offset issuances under the Firm’s equity-based compensation plans.
As of December 31, 2016, $6.1 billion of authorized repurchase capacity remained under the program.
The following table sets forth the Firm’s repurchases of common equity for the years ended December 31, 2016, 2015 and 2014. There were no warrants repurchased during the years ended December 31, 2016, 2015 and 2014.
The Firm may, from time to time, enter into written trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate repurchases in accordance with the common equity repurchase program. A Rule 10b5-1 repurchase plan allows the Firm to repurchase its equity during periods when it would not otherwise be repurchasing common equity - for example, during internal trading blackout periods. All purchases under a Rule 10b5-1 plan must be made according to a predefined plan established when the Firm is not aware of material nonpublic information.
The authorization to repurchase common equity will be utilized at management’s discretion, and the timing of purchases and the exact amount of common equity that may be repurchased is subject to various factors, including market conditions; legal and regulatory considerations affecting the amount and timing of repurchase activity; the Firm’s capital position (taking into account goodwill and intangibles); internal capital generation; and alternative investment opportunities. The repurchase program does not include specific price targets or timetables; may be executed through open market purchases or privately negotiated transactions, or utilize Rule 10b5-1 programs; and may be suspended at any time.
For additional information regarding repurchases of the Firm’s equity securities, see Part II, Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities on page 22.
Preferred stock
Preferred stock dividends declared were $1.6 billion for the year ended December 31, 2016. For additional information on the Firm’s preferred stock, see Note 22.
Redemption of outstanding trust preferred securities
The Firm redeemed $1.6 billion and $1.5 billion of trust preferred securities in the years ended December 31, 2016 and 2015, respectively.
JPMorgan Chase & Co./2016 Annual Report
Other capital requirements
TLAC
On December 15, 2016, the Federal Reserve issued its final TLAC rule which requires the top-tier holding companies of eight U.S. global systemically important bank holding companies, including the Firm, among other things, to maintain minimum levels of external TLAC and external long-term debt that satisfies certain eligibility criteria (“eligible LTD”) by January 1, 2019. The minimum external TLAC requirement is the greater of (A) 18% of the financial institution’s RWA plus applicable buffers, including its GSIB surcharge as calculated under Method 1 and (B) 7.5% of its total leverage exposure plus a buffer equal to 2.0%. The required minimum level of eligible long-term debt is equal to the greater of (A) 6% of the financial institution’s RWA, plus its U.S. Method 2 GSIB surcharge and (B) 4.5% of the Firm’s total leverage exposure. The final rule permanently grandfathered all long-term debt issued before December 31, 2016, to the extent these securities would be ineligible only due to containing impermissible acceleration rights or being governed by foreign law. While the Firm may have to raise long-term debt to be in full compliance with the rule, management estimates the net amount to be raised is not material and the timing for raising such funds is manageable.
Broker-dealer regulatory capital
JPMorgan Chase’s principal U.S. broker-dealer subsidiary is JPMorgan Securities. Prior to October 1, 2016 the Firm had two principal U.S. broker-dealer subsidiaries. Effective October 1, 2016 JPMorgan Clearing merged with JPMorgan Securities. JPMorgan Securities is the surviving entity in the merger and its name remain unchanged.
JPMorgan Securities is subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the “Net Capital Rule”). JPMorgan Securities is also registered as futures commission merchants and subject to Rule 1.17 of the CFTC.
JPMorgan Securities has elected to compute its minimum net capital requirements in accordance with the “Alternative Net Capital Requirements” of the Net Capital Rule. At December 31, 2016, JPMorgan Securities’ net capital, as defined by the Net Capital Rule, was $14.7 billion, exceeding the minimum requirement by $11.9 billion.
In addition to its minimum net capital requirement, JPMorgan Securities is required to hold tentative net capital in excess of $1.0 billion and is also required to notify the SEC in the event that tentative net capital is less than $5.0 billion, in accordance with the market and credit risk standards of Appendix E of the Net Capital Rule. As of December 31, 2016, JPMorgan Securities had tentative net capital in excess of the minimum and notification requirements.
J.P. Morgan Securities plc is a wholly owned subsidiary of JPMorgan Chase Bank, N.A. and is the Firm’s principal operating subsidiary in the U.K. It has authority to engage in banking, investment banking and broker-dealer activities. J.P. Morgan Securities plc is jointly regulated by the U.K. PRA and the FCA. J.P. Morgan Securities plc is subject to the European Union Capital Requirements Regulation and the U.K. PRA capital rules, under which it has implemented Basel III.
At December 31, 2016, J.P. Morgan Securities plc had estimated total capital of $34.5 billion, its estimated CET1 capital ratio was 13.8% and its estimated total capital ratio was 17.4%. Both ratios exceeded the minimum standards of 4.5% and 8.0%, respectively, under the transitional requirements of the European Union’s (“EU”) Basel III Capital Requirements Directive and Regulation, as well as the additional capital requirements specified by the PRA.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
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 mortgage banking, 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 monitors and measures 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
•
Estimating credit losses and ensuring appropriate credit risk-based capital management
Risk identification and measurement
The Credit Risk Management function 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 held-for-investment 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 that considers alternative economic scenarios as described in the Stress testing section below. For further information, see Critical Accounting Estimates used by the Firm on pages 132-134.
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 AWM, 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 probability of default is the likelihood that a borrower will default on its obligation; the loss given default (“LGD”) is the estimated loss on the loan that would be realized upon the default and takes into consideration collateral and structural support for each credit facility. The estimation process includes assigning risk ratings to each borrower and credit facility to differentiate risk within the portfolio. These risk ratings are reviewed regularly by Credit Risk Management and revised as needed to reflect the
JPMorgan Chase & Co./2016 Annual Report
borrower’s current financial position, risk profile and related collateral. The calculations and assumptions are based on both internal and external historical experience and management judgment and are reviewed regularly.
Stress testing
Stress testing is important in measuring and managing credit risk in the Firm’s credit portfolio. The process assesses the potential impact of alternative economic and business scenarios on estimated credit losses for the Firm. Economic scenarios and the underlying parameters are defined centrally, articulated in terms of macroeconomic factors and applied across the businesses. The stress test results may indicate credit migration, changes in delinquency trends and potential losses in the credit portfolio. In addition to the periodic stress testing processes, management also considers additional stresses outside these scenarios, including industry and country- specific stress scenarios, as necessary. The Firm uses stress testing to inform decisions on setting risk appetite both at a Firm and LOB level, as well as to assess the impact of stress on individual counterparties.
Risk monitoring and management
The Firm has developed policies and practices that are designed to preserve the independence and integrity of the approval and decision-making process of extending credit to ensure credit risks are assessed accurately, approved properly, monitored regularly and managed actively at both the transaction and portfolio levels. The policy framework establishes credit approval authorities, concentration limits, risk-rating methodologies, portfolio review parameters and guidelines for management of distressed exposures. In addition, certain models, assumptions and inputs used in evaluating and monitoring credit risk are independently validated by groups that are separate from the line of businesses.
Consumer credit risk is monitored for delinquency and other trends, including any concentrations at the portfolio level, as certain of these trends can be modified through changes in underwriting policies and portfolio guidelines. Consumer Risk Management evaluates delinquency and other trends against business expectations, current and forecasted economic conditions, and industry benchmarks. Historical and forecasted trends are incorporated into the modeling of estimated consumer credit losses and are part of the monitoring of the credit risk profile of the portfolio.
Wholesale credit risk is monitored regularly at an aggregate portfolio, industry, and individual client and counterparty level with established concentration limits that are reviewed and revised as deemed appropriate by management, typically on an annual basis. Industry and counterparty limits, as measured in terms of exposure and economic risk appetite, are subject to stress-based loss constraints. In addition, wrong-way risk - the risk that exposure to a counterparty is positively correlated with the impact of a default by the same counterparty, which could cause exposure to increase at the same time as the counterparty’s capacity to meet its obligations is decreasing - is actively monitored as this risk could result in greater exposure at default compared with a transaction with another counterparty that does not have this risk.
Management of the Firm’s wholesale credit risk exposure is accomplished through a number of means, including:
•
Loan underwriting and credit approval process
•
Loan syndications and participations
•
Loan sales and securitizations
•
Credit derivatives
•
Master netting agreements
•
Collateral and other risk-reduction techniques
In addition to Credit Risk Management, an independent Credit Review function, is responsible for:
•
Independently validating or changing the risk grades assigned to exposures in the Firm’s wholesale and commercial-oriented retail credit portfolios, and assessing the timeliness of risk grade changes initiated by responsible business units; and
•
Evaluating the effectiveness of business units’ credit management processes, including the adequacy of credit analyses and risk grading/LGD rationales, proper monitoring and management of credit exposures, and compliance with applicable grading policies and underwriting guidelines.
For further discussion of consumer and wholesale loans, see Note 14.
Risk reporting
To enable monitoring of credit risk and effective decision-making, aggregate credit exposure, credit quality forecasts, concentration levels and risk profile changes are reported regularly to senior members of Credit Risk Management. Detailed portfolio reporting of industry, customer, product and geographic concentrations occurs monthly, and the appropriateness of the allowance for credit losses is reviewed by senior management at least on a quarterly basis. Through the risk reporting and governance structure, credit risk trends and limit exceptions are provided regularly to, and discussed with, risk committees, senior management and the Board of Directors as appropriate.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
CREDIT PORTFOLIO
In the following tables, reported loans include loans retained (i.e., held-for-investment); loans held-for-sale; and certain loans accounted for at fair value. In addition, the Firm records certain loans accounted for at fair value in trading assets. For further information regarding these loans, see Note 3 and Note 4. For additional information on the Firm’s loans, lending-related commitments, and derivative receivables, including the Firm’s accounting policies, see Note 14, Note 29, and Note 6, respectively. For further information regarding the credit risk inherent in the Firm’s cash placed with banks, investment securities portfolio, and securities financing portfolio, see Note 5, Note 12, and Note 13, respectively.
For discussion of the consumer credit environment and consumer loans, see Consumer Credit Portfolio on pages 89-95 and Note 14. For discussion of wholesale credit environment and wholesale loans, see Wholesale Credit Portfolio on pages 96-104 and Note 14.
(a)
Represents the net notional amount of protection purchased and sold through credit derivatives used to manage both performing and nonperforming wholesale credit exposures; these derivatives do not qualify for hedge accounting under U.S. GAAP. For additional information, see Credit derivatives on pages 103-104 and Note 6.
(b)
Excludes PCI loans. The Firm is recognizing interest income on each pool of PCI loans as each of the pools is performing.
(c)
At December 31, 2016 and 2015, nonperforming assets excluded: (1) mortgage loans insured by U.S. government agencies of $5.0 billion and $6.3 billion, respectively, that are 90 or more days past due; (2) student loans insured by U.S. government agencies under the FFELP of $263 million and $290 million, respectively, that are 90 or more days past due; and (3) Real estate owned (“REO”) insured by U.S. government agencies of $142 million and $343 million, respectively. These amounts have been excluded based upon the government guarantee. In addition, the Firm’s policy is generally to exempt credit card loans from being placed on nonaccrual status as permitted by regulatory guidance issued by the Federal Financial Institutions Examination Council (“FFIEC”).
JPMorgan Chase & Co./2016 Annual Report
CONSUMER CREDIT PORTFOLIO
The Firm’s consumer portfolio consists primarily of residential real estate loans, credit card loans, auto loans, business banking loans and student loans, and associated lending-related commitments. The Firm’s focus is on serving primarily the prime segment of the consumer credit market. The credit performance of the consumer portfolio continues to benefit from discipline in credit underwriting as well as improvement in the economy driven by increasing home
prices and lower unemployment. Both early-stage delinquencies (30-89 days delinquent) and late-stage delinquencies (150+ days delinquent) for residential real estate, excluding government guaranteed loans, declined from December 31, 2015 levels. The Credit Card 30+ day delinquency rate and the net charge-off rate increased from the prior year but remain near record lows. For further information on consumer loans, see Note 14.
The following table presents consumer credit-related information with respect to the credit portfolio held by CCB, prime mortgage and home equity loans held by AWM, and prime mortgage loans held by Corporate. For further information about the Firm’s nonaccrual and charge-off accounting policies, see Note 14.
(a)
At December 31, 2016 and 2015, excluded operating lease assets of $13.2 billion and $9.2 billion, respectively.
(b)
Predominantly includes Business Banking loans as well as deposit overdrafts.
(c)
At December 31, 2016 and 2015, approximately 66% and 64%, respectively, of the PCI option adjustable rate mortgages (“ARMs”) portfolio has been modified into fixed-rate, fully amortizing loans.
(d)
Credit card and home equity lending-related commitments represent the total available lines of credit for these products. The Firm has not experienced, and does not anticipate, that all available lines of credit would be used at the same time. For credit card and home equity commitments (if certain conditions are met), the Firm can reduce or cancel these lines of credit by providing the borrower notice or, in some cases as permitted by law, without notice.
(e)
Receivables from customers represent margin loans to brokerage customers that are collateralized through assets maintained in the clients’ brokerage accounts, as such no allowance is held against these receivables. These receivables are reported within accrued interest and accounts receivable on the Firm’s Consolidated balance sheets.
(f)
Includes billed interest and fees net of an allowance for uncollectible interest and fees.
(g)
Predominantly represents prime mortgage loans held-for-sale.
(h)
At December 31, 2016 and 2015, nonaccrual loans excluded loans 90 or more days past due as follows: (1) mortgage loans insured by U.S. government agencies of $5.0 billion and $6.3 billion, respectively; and (2) student loans insured by U.S. government agencies under the FFELP of $263 million and $290 million, respectively. These amounts have been excluded from nonaccrual loans based upon the government guarantee. In addition, the Firm’s policy is generally to exempt credit card loans from being placed on nonaccrual status, as permitted by regulatory guidance issued by the FFIEC.
(i)
Excludes PCI loans. The Firm is recognizing interest income on each pool of PCI loans as they are all performing.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(j)
Net charge-offs and net charge-off rates excluded write-offs in the PCI portfolio of $156 million and $208 million for the years ended December 31, 2016 and 2015. These write-offs decreased the allowance for loan losses for PCI loans. See Allowance for Credit Losses on pages 105-107 for further details.
(k)
Average consumer loans held-for-sale were $496 million and $2.1 billion for the years ended December 31, 2016 and 2015, respectively. These amounts were excluded when calculating net charge-off rates.
Consumer, excluding credit card
Portfolio analysis
Consumer loan balances increased during the year ended December 31, 2016, predominantly due to originations of high-quality prime mortgage and auto loans that have been retained on the balance sheet, partially offset by paydowns and the charge-off or liquidation of delinquent loans. The credit environment remained favorable as the economy strengthened and home prices increased.
PCI loans are excluded from the following discussions of individual loan products and are addressed separately below. For further information about the Firm’s consumer portfolio, including information about delinquencies, loan modifications and other credit quality indicators, see
Note 14.
Home equity: The home equity portfolio declined from December 31, 2015 primarily reflecting loan paydowns and charge-offs. Both early-stage and late-stage delinquencies declined from December 31, 2015. Nonaccrual loans improved from December 31, 2015 primarily as a result of loss mitigation activities. Net charge-offs for the year ended December 31, 2016, declined when compared with the prior year as a result of improvement in home prices and delinquencies.
At December 31, 2016, approximately 90% of the Firm’s home equity portfolio consists of home equity lines of credit (“HELOCs”) and the remainder consists of home equity loans (“HELOANs”). HELOANs are generally fixed-rate, closed-end, amortizing loans, with terms ranging from 3-30 years. In general, HELOCs originated by the Firm are revolving loans for a 10-year period, after which time the HELOC recasts into a loan with a 20-year amortization period. At the time of origination, the borrower typically selects one of two minimum payment options that will generally remain in effect during the revolving period: a monthly payment of 1% of the outstanding balance, or interest-only payments based on a variable index (typically Prime). HELOCs originated by Washington Mutual were generally revolving loans for a 10-year period, after which time the HELOC converts to an interest-only loan with a balloon payment at the end of the loan’s term.
The carrying value of HELOCs outstanding was $34 billion at December 31, 2016. Of such amounts, approximately:
•
$13 billion have recast from interest-only to fully amortizing payments or have been modified,
•
$15 billion are scheduled to recast from interest-only to fully amortizing payments in future periods, and
•
$6 billion are interest-only balloon HELOCs, which primarily mature after 2030.
The following chart illustrates the payment recast composition of the approximately $21 billion of HELOCs scheduled to recast in the future, based upon their current contractual terms.
HELOCs scheduled to recast
(at December 31, 2016)
The Firm has considered this payment recast risk in its allowance for loan losses based upon the estimated amount of payment shock (i.e., the excess of the fully-amortizing payment over the interest-only payment in effect prior to recast) expected to occur at the payment recast date, along with the corresponding estimated PD and loss severity assumptions. As part of its allowance estimate, the Firm also expects, based on observed activity in recent years, that approximately 30% of the carrying value of HELOCs scheduled to recast will voluntarily prepay prior to or after the recast. The HELOCs that have previously recast to fully amortizing payments generally have higher delinquency rates than the HELOCs within the revolving period, primarily as a result of the payment shock at the time of recast. Certain other factors, such as future developments in both unemployment rates and home prices, could also have a significant impact on the performance of these loans.
The Firm manages the risk of HELOCs during their revolving period by closing or reducing the undrawn line to the extent permitted by law when borrowers are exhibiting a material deterioration in their credit risk profile. The Firm will continue to evaluate both the near-term and longer-term recast risks inherent in its HELOC portfolio to ensure that changes in the Firm’s estimate of incurred losses are appropriately considered in the allowance for loan losses and that the Firm’s account management practices are appropriate given the portfolio’s risk profile.
JPMorgan Chase & Co./2016 Annual Report
Junior lien loans where the borrower has a senior lien loan that is either delinquent or has been modified are considered high-risk seconds. Such loans are considered to pose a higher risk of default than junior lien loans for which the senior lien loan is neither delinquent nor modified. At December 31, 2016, the Firm estimated that the carrying value of its home equity portfolio contained approximately $1.1 billion of current junior lien loans that were considered high risk seconds, compared with $1.4 billion at December 31, 2015. The Firm estimates the balance of its total exposure to high-risk seconds on a quarterly basis using internal data and loan level credit bureau data (which typically provides the delinquency status of the senior lien loan). The Firm considers the increased PD associated with these high-risk seconds in estimating the allowance for loan losses and classifies those loans that are subordinated to a first lien loan that is more than 90 days delinquent as nonaccrual loans. The estimated balance of these high-risk seconds may vary from quarter to quarter for reasons such as the movement of related senior lien loans into and out of the 30+ day delinquency bucket. The Firm continues to monitor the risks associated with these loans. For further information, see Note 14.
Residential mortgage: The residential mortgage portfolio predominantly consists of high-quality prime mortgage loans with a small component (approximately 2%) of the residential mortgage portfolio in subprime mortgage loans. These subprime mortgage loans continue to run-off and are performing in line with expectations. The residential mortgage portfolio, including loans held-for-sale, increased from December 31, 2015 due to retained originations of primarily high-quality fixed rate prime mortgage loans partially offset by paydowns. Both early-stage and late-stage delinquencies showed improvement from December 31, 2015. Nonaccrual loans decreased from the prior year primarily as a result of loss mitigation activities. Net charge-offs for the year ended December 31, 2016 remain low, reflecting continued improvement in home prices and delinquencies.
At December 31, 2016 and 2015, the Firm’s residential mortgage portfolio, including loans held-for-sale, included $9.5 billion and $11.1 billion, respectively, of mortgage loans insured and/or guaranteed by U.S. government agencies, of which $7.0 billion and $8.4 billion, respectively, were 30 days or more past due (of these past due loans, $5.0 billion and $6.3 billion, respectively, were 90 days or more past due). The Firm monitors its exposure to certain potential unrecoverable claim payments related to government insured loans and considers this exposure in estimating the allowance for loan losses.
At December 31, 2016 and 2015, the Firm’s residential mortgage portfolio included $19.1 billion and $17.8 billion, respectively, of interest-only loans. These loans have an interest-only payment period generally followed by an adjustable-rate or fixed-rate fully amortizing payment period to maturity and are typically originated as higher-balance loans to higher-income borrowers. To date, losses on this portfolio generally have been consistent with the broader residential mortgage portfolio and the Firm’s expectations. The Firm continues to monitor the risks associated with these loans.
Auto: Auto loans increased from December 31, 2015, as a result of growth in new originations. Nonaccrual loans increased compared with December 31, 2015, primarily due to downgrades of select auto dealer risk-rated loans. Net charge-offs for the year ended December 31, 2016 increased compared with the prior year, as a result of higher retail auto loan balances and a moderate increase in loss severity. The auto portfolio predominantly consists of prime-quality loans.
Business banking: Business banking loans increased compared with December 31, 2015 as a result of growth in loan originations. Nonaccrual loans at December 31, 2016 and net charge-offs for the year ended December 31, 2016 increased from the prior year as a result of growth in the portfolio.
Student and other: Student and other loans decreased from December 31, 2015 primarily as a result of the run-off of the student loan portfolio as the Firm ceased originations of student loans during the fourth quarter of 2013. Nonaccrual loans and net charge-offs also declined as a result of the run-off of the student loan portfolio.
Purchased credit-impaired loans: PCI loans decreased as the portfolio continues to run off. As of December 31, 2016, approximately 12% of the option ARM PCI loans were delinquent and approximately 66% of the portfolio had been modified into fixed-rate, fully amortizing loans. Substantially all of the remaining loans are making amortizing payments, although such payments are not necessarily fully amortizing. This latter group of loans is subject to the risk of payment shock due to future payment recast. Default rates generally increase on option ARM loans when payment recast results in a payment increase. The expected increase in default rates is considered in the Firm’s quarterly impairment assessment.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The following table provides a summary of lifetime principal loss estimates included in either the nonaccretable difference or the allowance for loan losses.
(a)
Includes the original nonaccretable difference established in purchase accounting of $30.5 billion for principal losses plus additional principal losses recognized subsequent to acquisition through the provision and allowance for loan losses. The remaining nonaccretable difference for principal losses was $1.1 billion and $1.5 billion at December 31, 2016 and 2015, respectively.
(b)
Life-to-date liquidation losses represent both realization of loss upon loan resolution and any principal forgiven upon modification.
For further information on the Firm’s PCI loans, including write-offs, see Note 14.
Geographic composition of residential real estate loans
At December 31, 2016, $139.7 billion, or 63% of total retained residential real estate loan portfolio, excluding mortgage loans insured by U.S. government agencies and PCI loans, were concentrated in California, New York, Illinois, Texas and Florida, compared with $123.0 billion, or 61%, at December 31, 2015. California had the greatest concentration of retained residential loans with 30% at December 31, 2016, compared with 28% at December 31, 2015. The unpaid principal balance of PCI loans concentrated in California represented 55% of total PCI loans at both December 31, 2016 and 2015. The following charts illustrate the percentages of the total retained residential real estate portfolio held in the top 5 states, excluding mortgage loans insured by U.S. government agencies and PCI loans. For further information on the geographic composition of the Firm’s residential real estate loans, see Note 14.
JPMorgan Chase & Co./2016 Annual Report
Current estimated loan-to-values of residential real estate loans
The current estimated average loan-to-value (“LTV”) ratio for residential real estate loans retained, excluding mortgage loans insured by U.S. government agencies and PCI loans, was 58% at December 31, 2016 compared with 59% at December 31, 2015.
Although the delinquency rate for loans with high LTV ratios is generally greater than the delinquency rate for loans in which the borrower has greater equity in the collateral, the average LTV ratios have declined consistent with improvements in home prices, reducing the number of loans with a current estimated LTV ratio greater than 100%.
The current estimated average LTV ratio for residential real estate PCI loans, based on the unpaid principal balances, was 64% at December 31, 2016, compared with 69% at December 31, 2015. Of the total PCI portfolio, 4% of the loans had a current estimated LTV ratio greater than 100%, and 1% had a current LTV ratio greater than 125% at December 31, 2016, compared with 6% and 1%, respectively, at December 31, 2015.
While the current estimated collateral value is greater than the net carrying value of PCI loans, the ultimate performance of this portfolio is highly dependent on borrowers’ behavior and ongoing ability and willingness to continue to make payments on homes with negative equity, as well as on the cost of alternative housing.
For further information on current estimated LTVs of residential real estate loans, see Note 14.
Loan modification activities - residential real estate loans
The performance of modified loans generally differs by product type due to differences in both the credit quality and the types of modifications provided. Performance metrics for modifications to the residential real estate portfolio, excluding PCI loans, that have been seasoned more than six months show weighted-average redefault rates of 21% for home equity and 22% for residential mortgages. The cumulative performance metrics for modifications to the PCI residential real estate portfolio that have been seasoned more than six months show weighted average redefault rates of 20% for home equity, 19% for prime mortgages, 16% for option ARMs and 32% for subprime mortgages. The cumulative redefault rates reflect the performance of modifications completed under both the U.S. Government’s Home Affordable Modification Program (“HAMP”) and the Firm’s proprietary modification programs (primarily the Firm’s modification program that was modeled after HAMP) from October 1, 2009, through December 31, 2016.
Certain loans that were modified under HAMP and the Firm’s proprietary modification programs have interest rate reset provisions (“step-rate modifications”). Interest rates on these loans generally began to increase commencing in 2014 by 1% per year, and continue to do so, until the rate reaches a specified cap, typically at a prevailing market interest rate for a fixed-rate loan as of the modification date. At December 31, 2016, the carrying value of non-PCI loans and the unpaid principal balance of PCI loans
modified in active step-rate modifications were $3 billion and $9 billion, respectively. The Firm continues to monitor this risk exposure and the impact of these potential interest rate increases is considered in the Firm’s allowance for loan losses.
The following table presents information as of December 31, 2016 and 2015, relating to modified retained residential real estate loans for which concessions have been granted to borrowers experiencing financial difficulty. Modifications of PCI loans continue to be accounted for and reported as PCI loans, and the impact of the modification is incorporated into the Firm’s quarterly assessment of estimated future cash flows. Modifications of consumer loans other than PCI loans are generally accounted for and reported as TDRs. For further information on modifications for the years ended December 31, 2016 and 2015, see Note 14.
(a)
Amounts represent the carrying value of modified residential real estate loans.
(b)
At December 31, 2016 and 2015, $3.4 billion and $3.8 billion, respectively, of loans modified subsequent to repurchase from Ginnie Mae in accordance with the standards of the appropriate government agency (i.e., Federal Housing Administration (“FHA”), U.S. Department of Veterans Affairs (“VA”), Rural Housing Service of the U.S. Department of Agriculture (“RHS”)) are not included in the table above. When such loans perform subsequent to modification in accordance with Ginnie Mae guidelines, they are generally sold back into Ginnie Mae loan pools. Modified loans that do not re-perform become subject to foreclosure. For additional information about sales of loans in securitization transactions with Ginnie Mae, see Note 16.
(c)
Amounts represent the unpaid principal balance of modified PCI loans.
(d)
As of December 31, 2016 and 2015, nonaccrual loans included $2.3 billion and $2.5 billion, respectively, of TDRs for which the borrowers were less than 90 days past due. For additional information about loans modified in a TDR that are on nonaccrual status, see Note 14.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Nonperforming assets
The following table presents information as of December 31, 2016 and 2015, about consumer, excluding credit card, nonperforming assets.
(a)
At December 31, 2016 and 2015, nonperforming assets excluded: (1) mortgage loans insured by U.S. government agencies of $5.0 billion and $6.3 billion, respectively, that are 90 or more days past due; (2) student loans insured by U.S. government agencies under the FFELP of $263 million and $290 million, respectively, that are 90 or more days past due; and (3) real estate owned insured by U.S. government agencies of $142 million and $343 million, respectively. These amounts have been excluded based upon the government guarantee.
(b)
Excludes PCI loans which are accounted for on a pool basis. Since each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, the past-due status of the pools, or that of individual loans within the pools, is not meaningful. The Firm is recognizing interest income on each pool of loans as they are all performing.
Nonaccrual loans in the residential real estate portfolio decreased to $4.1 billion from $4.8 billion at December 31, 2016, and 2015, respectively, of which 29% and 31% were greater than 150 days past due, respectively. In the aggregate, the unpaid principal balance of residential real estate loans greater than 150 days past due was charged down by approximately 43% and 44% to the estimated net realizable value of the collateral at December 31, 2016 and 2015, respectively.
Active and suspended foreclosure: For information on loans that were in the process of active or suspended foreclosure, see Note 14.
Nonaccrual loans: The following table presents changes in the consumer, excluding credit card, nonaccrual loans for the years ended December 31, 2016 and 2015.
(a)
Other reductions includes loan sales.
JPMorgan Chase & Co./2016 Annual Report
Credit card
Total credit card loans increased from December 31, 2015 due to strong new account growth and higher sales volume. The December 31, 2016 30+ day delinquency rate increased to 1.61% from 1.43% at December 31, 2015. For the years ended December 31, 2016 and 2015, the net charge-off rates were 2.63% and 2.51%, respectively. The credit card portfolio continues to reflect a largely well-seasoned, rewards-based portfolio that has good U.S. geographic diversification. New originations continue to grow as a percentage of the total portfolio, in line with the Firm’s credit parameters; these originations have generated higher loss rates, as anticipated, than the more seasoned portion of the portfolio, given the higher mix of near-prime accounts being originated. These near-prime accounts have
net revenue rates and returns on equity that are higher than the portfolio average.
Loans outstanding in the top five states of California, Texas, New York, Florida and Illinois consisted of $62.8 billion in receivables, or 44% of the retained loan portfolio, at December 31, 2016, compared with $57.5 billion, or 44%, at December 31, 2015. The greatest geographic concentration of credit card retained loans is in California, which represented 15% and 14% of total retained loans at December 31, 2016 and 2015, respectively. For further information on the geographic and FICO composition of the Firm’s credit card loans, see Note 14.
Modifications of credit card loans
At December 31, 2016 and 2015, the Firm had $1.2 billion and $1.5 billion, respectively, of credit card loans outstanding that have been modified in TDRs. These balances included both credit card loans with modified payment terms and credit card loans that reverted back to their pre-modification payment terms because the cardholder did not comply with the modified payment terms. The decrease in modified credit card loans outstanding from December 31, 2015, was attributable to a reduction in new modifications as well as ongoing payments and charge-offs on previously modified credit card loans.
Consistent with the Firm’s policy, all credit card loans typically remain on accrual status until charged off. However, the Firm establishes an allowance, which is offset against loans and charged to interest income, for the estimated uncollectible portion of accrued and billed interest and fee income.
For additional information about loan modification programs to borrowers, see Note 14.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
WHOLESALE CREDIT PORTFOLIO
The Firm’s wholesale businesses are exposed to credit risk through underwriting, lending, market-making, and hedging activities with and for clients and counterparties, as well as through various operating services such as cash management and clearing activities. A portion of the loans originated or acquired by the Firm’s wholesale businesses is generally retained on the balance sheet. The Firm distributes a significant percentage of the loans it originates into the market as part of its syndicated loan business and to manage portfolio concentrations and credit risk.
The wholesale credit portfolio, excluding the Oil & Gas, Natural Gas Pipelines, and Metals & Mining portfolios, continued to be generally stable for the year ended December 31, 2016, characterized by low levels of criticized exposure, nonaccrual loans and charge-offs. See industry discussion on pages 97-101 for further information. Growth in retained loans was predominantly driven within the commercial real estate portfolio in Commercial Banking, and across multiple commercial and industrial industries in Commercial Banking and the Corporate & Investment Bank. Discipline in underwriting across all areas of lending continues to remain a key point of focus. The wholesale portfolio is actively managed, in part by conducting ongoing, in-depth reviews of client credit quality and transaction structure, inclusive of collateral where applicable; and of industry, product and client concentrations.
(a)
Receivables from customers and other include $17.3 billion and $13.3 billion of margin loans at December 31, 2016 and 2015, respectively, to prime brokerage customers; these are classified in accrued interest and accounts receivable on the Consolidated balance sheets.
(b)
Represents the net notional amount of protection purchased and sold through credit derivatives used to manage both performing and nonperforming wholesale credit exposures; these derivatives do not qualify for hedge accounting under U.S. GAAP. For additional information, see Credit derivatives on pages 103-104, and Note 6.
(c)
Excludes assets acquired in loan satisfactions.
JPMorgan Chase & Co./2016 Annual Report
The following tables present the maturity and ratings profiles of the wholesale credit portfolio as of December 31, 2016 and 2015. The ratings scale is based on the Firm’s internal risk ratings, which generally correspond to the ratings defined by S&P and Moody’s. For additional information on wholesale loan portfolio risk ratings, see Note 14.
(a)
Represents loans held-for-sale, primarily related to syndicated loans and loans transferred from the retained portfolio, and loans at fair value.
(b)
These derivatives do not qualify for hedge accounting under U.S. GAAP.
(c)
The notional amounts are presented on a net basis by underlying reference entity and the ratings profile shown is based on the ratings of the reference entity on which protection has been purchased. Predominantly all of the credit derivatives entered into by the Firm where it has purchased protection for credit portfolio management activities are executed with investment-grade counterparties.
(d)
The maturity profile of retained loans, lending-related commitments and derivative receivables is based on remaining contractual maturity. Derivative contracts that are in a receivable position at December 31, 2016, may become a payable prior to maturity based on their cash flow profile or changes in market conditions.
Wholesale credit exposure - industry exposures
The Firm focuses on the management and diversification of its industry exposures, paying particular attention to industries with actual or potential credit concerns. Exposures deemed criticized align with the U.S. banking regulators’ definition of criticized exposures, which consist of the special mention, substandard and doubtful
categories. The total criticized component of the portfolio, excluding loans held-for-sale and loans at fair value, was $19.8 billion at December 31, 2016, compared with $14.6 billion at December 31, 2015, driven by downgrades, including within the Oil & Gas, Natural Gas Pipelines, and Metals & Mining portfolios.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Below are summaries of the Firm’s exposures as of December 31, 2016 and 2015. For additional information on industry concentrations, see Note 5.
JPMorgan Chase & Co./2016 Annual Report
(a)
The industry rankings presented in the table as of December 31, 2015, are based on the industry rankings of the corresponding exposures at December 31, 2016, not actual rankings of such exposures at December 31, 2015.
(b)
In addition to the credit risk exposure to states and municipal governments (both U.S. and non-U.S.) at December 31, 2016 and 2015, noted above, the Firm held: $9.1 billion and $7.6 billion, respectively, of trading securities; $31.6 billion and $33.6 billion, respectively, of AFS securities; and $14.5 billion and $12.8 billion, respectively, of HTM securities, issued by U.S. state and municipal governments. For further information, see Note 3 and Note 12.
(c)
All other includes: individuals; SPEs; holding companies; and private education and civic organizations, representing approximately 56%, 36%, 4% and 4%, respectively, at December 31, 2016, and 54%, 37%, 5% and 4%, respectively, at December 31, 2015.
(d)
Excludes cash placed with banks of $380.2 billion and$351.0 billion, at December 31, 2016 and 2015, respectively, which is predominantly placed with various central banks, primarily Federal Reserve Banks.
(e)
Credit exposure is net of risk participations and excludes the benefit of credit derivatives used in credit portfolio management activities held against derivative receivables or loans and liquid securities and other cash collateral held against derivative receivables.
(f)
Represents the net notional amounts of protection purchased and sold through credit derivatives used to manage the credit exposures; these derivatives do not qualify for hedge accounting under U.S. GAAP. The All other category includes purchased credit protection on certain credit indices.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Presented below is a discussion of certain industries to which the Firm has significant exposures and/or which present actual or potential credit concerns.
Real Estate
Exposure to the Real Estate industry was approximately 16.1% and 14.6% of the Firm’s total wholesale exposure as of December 31, 2016 and 2015, respectively. Exposure to this industry increased by $18.2 billion, or 16%, in 2016 to $135.0 billion primarily driven by Commercial Banking. The investment-grade percentage of the portfolio increased to 77% in 2016, up from 75% in 2015. As of December 31,
2016, $106.3 billion of the exposure was drawn, of which 83% was investment-grade, and 83% of the $135.0 billion exposure was secured. As of December 31, 2016, $80.1 billion of the $135.0 billion was multifamily, largely in California; of the $80.1 billion, 82% was investment-grade and 98% was secured. For further information on commercial real estate loans, see Note 14.
Oil & Gas and Natural Gas Pipelines
The following table presents Oil & Gas and Natural Gas Pipeline exposures as of December 31, 2016, and December 31, 2015.
(a) Noninvestment-grade exposure to E&P and Oilfield Services is largely secured.
(b) Other Oil & Gas includes Integrated Oil & Gas companies, Midstream/Oil Pipeline companies and refineries.
(c) Natural Gas Pipelines is reported within the Utilities Industry.
Exposure to the Oil & Gas and Natural Gas Pipelines portfolios was approximately 5.3% and 5.8% of the Firm’s total wholesale exposure as of December 31, 2016 and 2015, respectively. Exposure to these industries decreased by $1.9 billion in 2016 to $44.5 billion; of the $44.5 billion, $14.4 billion was drawn at year-end. As of December 31, 2016, approximately $21.4 billion of the exposure was investment-grade, of which approximately $5.3 billion was drawn, and approximately $23.1 billion of the exposure was noninvestment grade, of which approximately $9.0 billion was drawn; 21% of the total exposure to the Oil & Gas and Natural Gas Pipelines industries was criticized. Secured lending, of which approximately half is reserve-based lending to the Exploration & Production sub-sector of the Oil & Gas industry, was $14.3 billion as of December 31, 2016; 44% of the secured lending exposure was drawn. Exposure to commercial real estate, which is reported within the Real Estate industry, in certain areas of Texas, California and Colorado that are deemed sensitive to the Oil & Gas industry, was $4.5 billion as of December 31, 2016. While the overall trends and sentiment have been stabilizing, the Firm continues to actively monitor and manage its exposure to these portfolios.
JPMorgan Chase & Co./2016 Annual Report
Metals & Mining
Exposure to the Metals & Mining industry was approximately 1.6% and 1.8% of the Firm’s total wholesale exposure as of December 31, 2016 and 2015, respectively. Exposure to the Metals & Mining industry decreased by $630 million in 2016 to $13.4 billion, of which $4.4 billion was drawn. The portfolio largely consisted of exposure in North America, and was concentrated in the Steel and Diversified Mining sub-sectors. Approximately 41% and 46% of the exposure in the Metals & Mining portfolio was investment-grade as of December 31, 2016 and December 31, 2015, respectively. While the overall trends and sentiment have been stabilizing, the Firm continues to actively monitor and manage its exposure to this industry.
Loans
In the normal course of its wholesale business, the Firm provides loans to a variety of customers, ranging from large corporate and institutional clients to high-net-worth individuals. For further discussion on loans, including information on credit quality indicators and sales of loans, see Note 14.
The following table presents the change in the nonaccrual loan portfolio for the years ended December 31, 2016 and 2015. Wholesale nonaccrual loans increased primarily driven by downgrades in the Oil & Gas portfolio.
(a) Loans are placed on nonaccrual status when management believes full payment of principal or interest is not expected, regardless of delinquency status, or when principal or interest have been in default for a period of 90 days or more unless the loan is both well-secured and in the process of collection.
The following table presents net charge-offs/recoveries, which are defined as gross charge-offs less recoveries, for the years ended December 31, 2016 and 2015. The amounts in the table below do not include gains or losses from sales of nonaccrual loans.
Lending-related commitments
The Firm uses lending-related financial instruments, such as commitments (including revolving credit facilities) and guarantees, to meet the financing needs of its customers. The contractual amounts of these financial instruments represent the maximum possible credit risk should the counterparties draw down on these commitments or the Firm fulfill its obligations under these guarantees, and the counterparties subsequently fail to perform according to the terms of these contracts.
In the Firm’s view, the total contractual amount of these wholesale lending-related commitments is not representative of the Firm’s future credit exposure or funding requirements. In determining the amount of credit risk exposure the Firm has to wholesale lending-related commitments, the Firm has estimated a loan-equivalent amount for each commitment. The loan-equivalent amount of the Firm’s lending-related commitments was $204.6 billion and $212.4 billion as of December 31, 2016 and 2015, respectively.
Clearing services
The Firm provides clearing services for clients entering into securities and derivative transactions. Through the provision of these services the Firm is exposed to the risk of non-performance by its clients and may be required to share in losses incurred by central counterparties. Where possible, the Firm seeks to mitigate its credit risk to its clients through the collection of adequate margin at inception and throughout the life of the transactions and can also cease provision of clearing services if clients do not adhere to their obligations under the clearing agreement. For further discussion of clearing services, see Note 29.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Derivative contracts
In the normal course of business, the Firm uses derivative instruments predominantly for market-making activities. Derivatives enable customers to manage exposures to fluctuations in interest rates, currencies and other markets. The Firm also uses derivative instruments to manage its own credit and other market risk exposure. The nature of the counterparty and the settlement mechanism of the derivative affect the credit risk to which the Firm is exposed. For OTC derivatives the Firm is exposed to the credit risk of the derivative counterparty. For exchange-traded derivatives (“ETD”), such as futures and options and “cleared” over-the-counter (“OTC-cleared”) derivatives, the Firm is generally exposed to the credit risk of the relevant CCP. Where possible, the Firm seeks to mitigate its credit risk exposures arising from derivative transactions through the use of legally enforceable master netting arrangements and collateral agreements. For further discussion of derivative contracts, counterparties and settlement types, see Note 6.
The following table summarizes the net derivative receivables for the periods presented.
(a)
Includes collateral related to derivative instruments where an appropriate legal opinion has not been either sought or obtained.
Derivative receivables reported on the Consolidated balance sheets were $64.1 billion and $59.7 billion at December 31, 2016 and 2015, respectively. These amounts represent the fair value of the derivative contracts after giving effect to legally enforceable master netting agreements and cash collateral held by the Firm. However, in management’s view, the appropriate measure of current credit risk should also take into consideration additional liquid securities (primarily U.S. government and agency securities and other group of seven nations (“G7”) government bonds) and other cash collateral held by the Firm aggregating $22.7 billion and $16.6 billion at December 31, 2016 and 2015, respectively, that may be used as security when the fair value of the client’s exposure is in the Firm’s favor. The change in derivative receivables was predominantly related to client-driven market-making activities in CIB. The increase in derivative receivables reflected the impact of market movements, which increased foreign exchange receivables, partially offset by reduced commodity derivative receivables.
In addition to the collateral described in the preceding paragraph, the Firm also holds additional collateral (primarily cash, G7 government securities, other liquid government-agency and guaranteed securities, and corporate debt and equity securities) delivered by clients at the initiation of transactions, as well as collateral related to contracts that have a non-daily call frequency and collateral that the Firm has agreed to return but has not yet settled as of the reporting date. Although this collateral does not reduce the balances and is not included in the table above, it is available as security against potential exposure that could arise should the fair value of the client’s derivative transactions move in the Firm’s favor. The derivative receivables fair value, net of all collateral, also does not include other credit enhancements, such as letters of credit. For additional information on the Firm’s use of collateral agreements, see Note 6.
While useful as a current view of credit exposure, the net fair value of the derivative receivables does not capture the potential future variability of that credit exposure. To capture the potential future variability of credit exposure, the Firm calculates, on a client-by-client basis, three measures of potential derivatives-related credit loss: Peak, Derivative Risk Equivalent (“DRE”), and Average exposure (“AVG”). These measures all incorporate netting and collateral benefits, where applicable.
Peak represents a conservative measure of potential exposure to a counterparty calculated in a manner that is broadly equivalent to a 97.5% confidence level over the life of the transaction. Peak is the primary measure used by the Firm for setting of credit limits for derivative transactions, senior management reporting and derivatives exposure management. DRE exposure is a measure that expresses the risk of derivative exposure on a basis intended to be equivalent to the risk of loan exposures. DRE is a less extreme measure of potential credit loss than Peak and is used for aggregating derivative credit risk exposures with loans and other credit risk.
Finally, AVG is a measure of the expected fair value of the Firm’s derivative receivables at future time periods, including the benefit of collateral. AVG exposure over the total life of the derivative contract is used as the primary metric for pricing purposes and is used to calculate credit capital and the CVA, as further described below. The three year AVG exposure was $31.1 billion and $32.4 billion at December 31, 2016 and 2015, respectively, compared with derivative receivables, net of all collateral, of $41.4 billion and $43.1 billion at December 31, 2016 and 2015, respectively.
The fair value of the Firm’s derivative receivables incorporates an adjustment, the CVA, to reflect the credit quality of counterparties. The CVA is based on the Firm’s AVG to a counterparty and the counterparty’s credit spread in the credit derivatives market. The primary components of changes in CVA are credit spreads, new deal activity or unwinds, and changes in the underlying market environment. The Firm believes that active risk management is essential to controlling the dynamic credit
JPMorgan Chase & Co./2016 Annual Report
risk in the derivatives portfolio. In addition, the Firm’s risk management process takes into consideration the potential impact of wrong-way risk, which is broadly defined as the potential for increased correlation between the Firm’s exposure to a counterparty (AVG) and the counterparty’s credit quality. Many factors may influence the nature and magnitude of these correlations over time. To the extent that these correlations are identified, the Firm may adjust the CVA associated with that counterparty’s AVG. The Firm risk manages exposure to changes in CVA by entering into credit derivative transactions, as well as interest rate, foreign exchange, equity and commodity derivative transactions.
The accompanying graph shows exposure profiles to the Firm’s current derivatives portfolio over the next 10 years as calculated by the Peak, DRE and AVG metrics. The three measures generally show that exposure will decline after the first year, if no new trades are added to the portfolio.
Exposure profile of derivatives measures
December 31, 2016
(in billions)
The following table summarizes the ratings profile by derivative counterparty of the Firm’s derivative receivables, including credit derivatives, net of all collateral, at the dates indicated. The ratings scale is based on the Firm’s internal ratings, which generally correspond to the ratings as defined by S&P and Moody’s.
(a)
Prior period amounts have been revised to conform with the current period presentation.
As previously noted, the Firm uses collateral agreements to mitigate counterparty credit risk. The percentage of the Firm’s derivatives transactions subject to collateral agreements - excluding foreign exchange spot trades, which are not typically covered by collateral agreements due to their short maturity - was 90% as of December 31, 2016, largely unchanged compared with 87% as of December 31, 2015.
Credit derivatives
The Firm uses credit derivatives for two primary purposes: first, in its capacity as a market-maker, and second, as an end-user to manage the Firm’s own credit risk associated with various exposures. For a detailed description of credit derivatives, see Credit derivatives in Note 6.
Credit portfolio management activities
Included in the Firm’s end-user activities are credit derivatives used to mitigate the credit risk associated with traditional lending activities (loans and unfunded commitments) and derivatives counterparty exposure in the Firm’s wholesale businesses (collectively, “credit portfolio management” activities). Information on credit portfolio management activities is provided in the table below. For further information on derivatives used in credit portfolio management activities, see Credit derivatives in Note 6.
The Firm also uses credit derivatives as an end-user to manage other exposures, including credit risk arising from certain securities held in the Firm’s market-making businesses. These credit derivatives are not included in credit portfolio management activities; for further information on these credit derivatives as well as credit derivatives used in the Firm’s capacity as a market-maker in credit derivatives, see Credit derivatives in Note 6.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
(a)
Amounts are presented net, considering the Firm’s net protection purchased or sold with respect to each underlying reference entity or index.
The credit derivatives used in credit portfolio management activities do not qualify for hedge accounting under U.S. GAAP; these derivatives are reported at fair value, with gains and losses recognized in principal transactions revenue. In contrast, the loans and lending-related commitments being risk-managed are accounted for on an accrual basis. This asymmetry in accounting treatment,
between loans and lending-related commitments and the credit derivatives used in credit portfolio management activities, causes earnings volatility that is not representative, in the Firm’s view, of the true changes in value of the Firm’s overall credit exposure.
The effectiveness of credit default swaps (“CDS”) as a hedge against the Firm’s exposures may vary depending on a number of factors, including the named reference entity (i.e., the Firm may experience losses on specific exposures that are different than the named reference entities in the purchased CDS); the contractual terms of the CDS (which may have a defined credit event that does not align with an actual loss realized by the Firm); and the maturity of the Firm’s CDS protection (which in some cases may be shorter than the Firm’s exposures). However, the Firm generally seeks to purchase credit protection with a maturity date that is the same or similar to the maturity date of the exposure for which the protection was purchased, and remaining differences in maturity are actively monitored and managed by the Firm.
JPMorgan Chase & Co./2016 Annual Report
ALLOWANCE FOR CREDIT LOSSES
JPMorgan Chase’s allowance for loan losses covers both the consumer (primarily scored) portfolio and wholesale (risk-rated) portfolio. The allowance represents management’s estimate of probable credit losses inherent in the Firm’s loan portfolio. Management also determines an allowance for wholesale and certain consumer lending-related commitments.
For a further discussion of the components of the allowance for credit losses and related management judgments, see Critical Accounting Estimates Used by the Firm on pages 132-134 and Note 15.
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 and sufficient to absorb probable credit losses inherent in the portfolio.
The consumer allowance for loan losses remained relatively unchanged from December 31, 2015. Changes to the allowance for loan losses included reductions in the residential real estate portfolio, reflecting continued improvements in home prices and lower delinquencies, as well as runoff in the student loan portfolio. These reductions were offset by increases in the allowance for loan losses reflecting loan growth in the credit card portfolio (including newer vintages which, as anticipated, have higher loss rates compared to the overall portfolio), as well as loan growth in the auto and business banking loan portfolios. For additional information about delinquencies and nonaccrual loans in the consumer, excluding credit card, loan portfolio, see Consumer Credit Portfolio on pages 89-95 and Note 14.
The wholesale allowance for credit losses increased from December 31, 2015, reflecting the impact of downgrades in the Oil & Gas and Natural Gas Pipelines portfolios. For additional information on the wholesale portfolio, see Wholesale Credit Portfolio on pages 96-104 and Note 14.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Note:
In the table above, the financial measures which exclude the impact of PCI loans are non-GAAP financial measures.
(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).
(b)
Includes risk-rated loans that have been placed on nonaccrual status and loans that have been modified in a TDR. The asset-specific credit card allowance for loan losses modified in a TDR is calculated based on the loans’ original contractual interest rates and does not consider any incremental penalty rates.
(c)
The allowance for lending-related commitments is reported in accounts payable and other liabilities on the Consolidated balance sheets.
(d)
The Firm’s policy is generally to exempt credit card loans from being placed on nonaccrual status as permitted by regulatory guidance.
JPMorgan Chase & Co./2016 Annual Report
Provision for credit losses
For the year ended December 31, 2016, the provision for credit losses was $5.4 billion, compared with $3.8 billion for the year ended December 31, 2015.
The total consumer provision for credit losses increased for the year ended December 31, 2016 when compared with the prior year. The increase in the provision was driven by:
•
a $920 million increase related to the credit card portfolio, due to a $600 million addition in the allowance for loan losses, as well as $320 million of higher net charge-offs, driven by loan growth, including growth in newer vintages which, as anticipated, have higher loss rates compared to the overall portfolio,
•
a $450 million lower benefit related to the residential real estate portfolio, as the current year reduction in the
allowance for loan losses was lower than the prior year. The reduction in both periods reflected continued improvements in home prices and lower delinquencies and
•
a $150 million increase related to the auto and business banking portfolio, due to additions to the allowance for loan losses and higher net charge-offs, reflecting loan growth in the portfolios.
The wholesale provision for credit losses increased for the year ended December 31, 2016 reflecting the impact of downgrades in the Oil & Gas and Natural Gas Pipelines portfolios.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
COUNTRY RISK MANAGEMENT
Country risk is the risk that a sovereign event or action alters the value or terms of contractual obligations of obligors, counterparties and issuers or adversely affects markets related to a particular country. The Firm has a comprehensive country risk management framework for assessing country risks, determining risk tolerance, and measuring and monitoring direct country exposures in the Firm. The Country Risk Management group is responsible for developing guidelines and policies for managing country risk in both emerging and developed countries. The Country Risk Management group actively monitors the various portfolios giving rise to country risk to ensure the Firm’s country risk exposures are diversified and that exposure levels are appropriate given the Firm’s strategy and risk tolerance relative to a country.
Country risk organization
The Country Risk Management group, part of the independent risk management function, works in close partnership with other risk functions to assess and monitor country risk within the Firm. The Firmwide Risk Executive for Country Risk reports to the Firm’s CRO.
Country Risk Management is responsible for the following functions:
•
Developing guidelines and policies consistent with a comprehensive country risk framework
•
Assigning sovereign ratings and assessing country risks
•
Measuring and monitoring country risk exposure and stress across the Firm
•
Managing country limits and reporting trends and limit breaches to senior management
•
Developing surveillance tools for early identification of potential country risk concerns
•
Providing country risk scenario analysis
Country risk identification and measurement
The Firm is exposed to country risk through its lending and deposits, investing, and market-making activities, whether cross-border or locally funded. Country exposure includes activity with both government and private-sector entities in a country. Under the Firm’s internal country risk management approach, country exposure is reported based on the country where the majority of the assets of the obligor, counterparty, issuer or guarantor are located or where the majority of its revenue is derived, which may be different than the domicile (legal residence) or country of incorporation of the obligor, counterparty, issuer or guarantor. Country exposures are generally measured by considering the Firm’s risk to an immediate default of the counterparty or obligor, with zero recovery. Assumptions are sometimes required in determining the measurement and allocation of country exposure, particularly in the case of certain tranched credit derivatives. Different measurement approaches or assumptions would affect the amount of reported country exposure.
Under the Firm’s internal country risk measurement framework:
•
Lending exposures are measured at the total committed amount (funded and unfunded), net of the allowance for credit losses and cash and marketable securities collateral received
•
Deposits are measured as the cash balances placed with central and commercial banks
•
Securities financing exposures are measured at their receivable balance, net of collateral received
•
Debt and equity securities are measured at the fair value of all positions, including both long and short positions
•
Counterparty exposure on derivative receivables is measured at the derivative’s fair value, net of the fair value of the related collateral. Counterparty exposure on derivatives can change significantly because of market movements
•
Credit derivatives protection purchased and sold is reported based on the underlying reference entity and is measured at the notional amount of protection purchased or sold, net of the fair value of the recognized derivative receivable or payable. Credit derivatives protection purchased and sold in the Firm’s market-making activities is measured on a net basis, as such activities often result in selling and purchasing protection related to the same underlying reference entity; this reflects the manner in which the Firm manages these exposures
Some activities may create contingent or indirect exposure related to a country (for example, providing clearing services or secondary exposure to collateral on securities financing receivables). These exposures are managed in the normal course of business through the Firm’s credit, market, and operational risk governance, rather than through Country Risk Management.
The Firm’s internal country risk reporting differs from the reporting provided under the FFIEC bank regulatory requirements. For further information on the FFIEC’s reporting methodology, see Cross-border outstandings on page 292.
JPMorgan Chase & Co./2016 Annual Report
Country risk stress testing
The country risk stress framework aims to estimate losses arising from a country crisis by capturing the impact of large asset price movements in a country based on market shocks combined with counterparty specific assumptions. Country Risk Management periodically defines and runs ad hoc stress scenarios for individual countries in response to specific market events and sector performance concerns.
Country risk monitoring and control
The Country Risk Management group establishes guidelines for sovereign ratings reviews and limit management. Country stress and nominal exposures are measured under a comprehensive country limit framework. Country ratings and limits are actively monitored and reported on a regular basis. Country limit requirements are reviewed and approved by senior management as often as necessary, but at least annually. In addition, the Country Risk Management group uses surveillance tools, such as signaling models and ratings indicators, for early identification of potential country risk concerns.
Country risk reporting
The following table presents the Firm’s top 20 exposures by country (excluding the U.S.) as of December 31, 2016. The selection of countries is based solely on the Firm’s largest total exposures by country, based on the Firm’s internal country risk management approach, and does not represent the Firm’s view of any actual or potentially adverse credit conditions. Country exposures may fluctuate from period to period due to client activity and market flows.
The increase in exposure to Germany, Japan and Luxembourg since December 31, 2015 largely reflects higher Euro and Yen balances, predominantly placed on deposit at the central banks of these countries, driven by changing client positions and prevailing market and liquidity conditions.
(a)
Lending and deposits includes loans and accrued interest receivable (net of collateral and the allowance for loan losses), deposits with banks (including central banks), acceptances, other monetary assets, issued letters of credit net of participations, and unused commitments to extend credit. Excludes intra-day and operating exposures, such as from settlement and clearing activities.
(b)
Includes market-making inventory, AFS securities, counterparty exposure on derivative and securities financings net of collateral and hedging.
(c)
Includes single reference entity (“single-name”), index and tranched credit derivatives for which one or more of the underlying reference entities is in a country listed in the above table.
(d)
Includes capital invested in local entities and physical commodity inventory.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
LIQUIDITY RISK MANAGEMENT
Liquidity risk is the risk that the Firm will be unable to meet its contractual and contingent obligations or that it does not have the appropriate amount, composition and tenor of funding and liquidity to support its assets and liabilities.
Liquidity risk oversight
The Firm has a liquidity risk oversight function whose primary objective is to provide assessment, measurement, monitoring, and control of liquidity risk across the Firm. Liquidity risk oversight is managed through a dedicated firmwide Liquidity Risk Oversight group. The CIO, Treasury and Corporate (“CTC”) CRO, who reports to the CRO, as part of the independent risk management function, has responsibility for firmwide Liquidity Risk Oversight. Liquidity Risk Oversight’s responsibilities include but are
not limited to:
•
Establishing and monitoring limits, indicators, and thresholds, including liquidity appetite tolerances;
•
Defining, monitoring, and reporting internal firmwide and material legal entity liquidity stress tests, and monitoring and reporting regulatory defined liquidity stress testing;
•
Monitoring and reporting liquidity positions, balance sheet variances and funding activities;
•
Conducting ad hoc analysis to identify potential emerging liquidity risks.
Risk governance and measurement
Specific committees responsible for liquidity governance include firmwide ALCO as well as line of business and regional ALCOs, and the CTC Risk Committee. In addition, the DRPC reviews and recommends to the Board of Directors, for formal approval, the Firm’s liquidity risk tolerances, liquidity strategy, and liquidity policy at least annually. For further discussion of ALCO and other risk-related committees, see Enterprise-wide Risk Management on pages 71-75.
Internal Stress testing
Liquidity stress tests are intended to ensure the Firm has sufficient liquidity under a variety of adverse scenarios, including scenarios analyzed as part of the Firm’s resolution and recovery planning. Stress scenarios are produced for JPMorgan Chase & Co. (“Parent Company”) and the Firm’s material legal entities on a regular basis and ad hoc stress tests are performed, as needed, in response to specific market events or concerns. Liquidity stress tests assume all of the Firm’s contractual obligations are met and take into consideration varying levels of access to unsecured and secured funding markets, estimated non-contractual and contingent outflows and potential impediments to the availability and transferability of liquidity between jurisdictions and material legal entities such as regulatory, legal or other restrictions. Liquidity outflow assumptions are modeled across a range of time horizons and contemplate both market and idiosyncratic stress.
Results of stress tests are considered in the formulation of the Firm’s funding plan and assessment of its liquidity position. The Parent Company acts as a source of funding for the Firm through stock and long-term debt issuances, and the IHC provides funding support to the ongoing operations of the Parent Company and its subsidiaries, as necessary. The Firm maintains liquidity at the Parent Company and the IHC, in addition to liquidity held at the operating subsidiaries, at levels sufficient to comply with liquidity risk tolerances and minimum liquidity requirements, to manage through periods of stress where access to normal funding sources is disrupted.
Liquidity management
Treasury and CIO is responsible for liquidity management. The primary objectives of effective liquidity management are to ensure that the Firm’s core businesses and material legal entities are able to operate in support of client needs, meet contractual and contingent obligations through normal economic cycles as well as during stress events, and to manage an optimal funding mix, and availability of liquidity sources. The Firm manages liquidity and funding using a centralized, global approach across its entities, taking into consideration both their current liquidity profile and any potential changes over time, in order to optimize liquidity sources and uses.
In the context of the Firm’s liquidity management, Treasury and CIO is responsible for:
•
Analyzing and understanding the liquidity characteristics of the Firm, lines of business and legal entities’ assets and liabilities, taking into account legal, regulatory, and operational restrictions;
•
Defining and monitoring firmwide and legal entity-specific liquidity strategies, policies, guidelines, and contingency funding plans;
•
Managing liquidity within approved liquidity risk appetite tolerances and limits;
•
Setting transfer pricing in accordance with underlying liquidity characteristics of balance sheet assets and liabilities as well as certain off-balance sheet items.
Contingency funding plan
The Firm’s contingency funding plan (“CFP”), which is reviewed by ALCO and approved by the DRPC, is a compilation of procedures and action plans for managing liquidity through stress events. The CFP incorporates the limits and indicators set by the Liquidity Risk Oversight group. These limits and indicators are reviewed regularly to identify the emergence of risks or vulnerabilities in the Firm’s liquidity position. The CFP identifies the alternative contingent liquidity resources available to the Firm in a stress event.
JPMorgan Chase & Co./2016 Annual Report
LCR and NSFR
The U.S. LCR rule requires the Firm to measure the amount of HQLA held by the Firm in relation to estimated net cash outflows within a 30-day period during an acute stress event. The LCR was required to be 90% at January 1, 2016, increased to a minimum of 100% commencing January 1, 2017. At December 31, 2016, the Firm was compliant with the Fully Phased-In U.S. LCR.
On December 19, 2016 the Federal Reserve published final U.S. LCR public disclosure requirements for certain bank holding companies and nonbank financial companies. Starting with the second quarter of 2017, the Firm will be required to disclose quarterly its consolidated LCR pursuant to the U.S. LCR rule, including the Firm’s average LCR for the quarter and the key quantitative components of the average LCR in a standardized template, along with a qualitative discussion of material drivers of the ratio, changes over time, and causes of such changes.
The Basel Committee final standard for the net stable funding ratio (“Basel NSFR”) is intended to measure the adequacy of “available” and “required” amounts of stable funding over a one-year horizon. Basel NSFR will become a minimum standard by January 1, 2018 and requires that this ratio be equal to at least 100% on an ongoing basis.
On April 26, 2016, the U.S. NSFR proposal was released for large banks and bank holding companies and was largely consistent with Basel NSFR. The proposed requirement would apply beginning on January 1, 2018, consistent with the Basel NSFR timeline.
The Firm estimates it was compliant with the proposed U.S. NSFR as of December 31, 2016 based on its current understanding of the proposed rule.
HQLA
HQLA is the amount of assets that qualify for inclusion in the U.S. LCR. HQLA primarily consists of cash and certain unencumbered high quality liquid assets as defined in the final rule.
As of December 31, 2016, the Firm’s HQLA was $524 billion, compared with $496 billion as of December 31, 2015. The increase in HQLA primarily reflects the impact of sales, maturities and paydowns in non-HQLA-eligible securities, as well as deposit growth in excess of loan growth. Certain of these actions resulted in increased excess liquidity at JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. which is excluded from the Firm’s HQLA as required under the U.S. LCR rules. The Firm’s HQLA may fluctuate from period to period primarily due to normal flows from client activity.
The following table presents the Firm’s estimated HQLA included in the U.S. LCR broken out by HQLA-eligible cash and securities as of December 31, 2016.
(a)
Cash on deposit at central banks.
(b)
Predominantly includes U.S. agency MBS, U.S. Treasuries, and sovereign bonds net of applicable haircuts under U.S. LCR rules.
(c)
Excludes excess HQLA at JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A.
As of December 31, 2016, in addition to HQLA reported above, the Firm had approximately $262 billion of unencumbered marketable securities, such as equity securities and fixed income debt securities, available to raise liquidity, if required. This includes HQLA-eligible securities included as part of the excess liquidity at JPMorgan Chase Bank, N.A. The Firm also maintains borrowing capacity at various Federal Home Loan Banks (“FHLBs”), the Federal Reserve Bank discount window and various other central banks as a result of collateral pledged by the Firm to such banks. Although available, the Firm does not view the borrowing capacity at the Federal Reserve Bank discount window and the various other central banks as a primary source of liquidity. As of December 31, 2016, the Firm’s remaining borrowing capacity at various FHLBs and the Federal Reserve Bank discount window was approximately $221 billion. This remaining borrowing capacity excludes the benefit of securities included in HQLA or other unencumbered securities that are currently held at the Federal Reserve Bank discount window, but for which the Firm has not drawn liquidity.
Funding
Sources of funds
Management believes that the Firm’s unsecured and secured funding capacity is sufficient to meet its on- and off-balance sheet obligations.
The Firm funds its global balance sheet through diverse sources of funding including a stable deposit franchise as well as secured and unsecured funding in the capital markets. The Firm’s loan portfolio ($894.8 billion at December 31, 2016), is funded with a portion of the Firm’s deposits ($1,375.2 billion at December 31, 2016) and through securitizations and, with respect to a portion of the Firm’s real estate-related loans, with secured borrowings from the FHLBs. Deposits in excess of the amount utilized to fund loans are primarily invested in the Firm’s investment securities portfolio or deployed in cash or other short-term liquid investments based on their interest rate and liquidity risk characteristics. Securities borrowed or purchased under resale agreements and trading assets-
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
debt and equity instruments are primarily funded by the Firm’s securities loaned or sold under agreements to repurchase, trading liabilities-debt and equity instruments, and a portion of the Firm’s long-term debt and stockholders’ equity. In addition to funding securities borrowed or purchased under resale agreements and trading assets-debt and equity instruments, proceeds from
the Firm’s debt and equity issuances are used to fund certain loans and other financial and non-financial assets, or may be invested in the Firm’s investment securities portfolio. See the discussion below for additional information relating to Deposits, Short-term funding, and Long-term funding and issuance.
Deposits
The table below summarizes, by line of business, the period-end and average deposit balances as of and for the years ended December 31, 2016 and 2015.
A key strength of the Firm is its diversified deposit franchise, through each of its lines of business, which provides a stable source of funding and limits reliance on the wholesale funding markets. A significant portion of the Firm’s deposits are consumer deposits, which are considered a stable source of liquidity. Additionally, the majority of the Firm’s wholesale operating deposits are also considered to be stable sources of liquidity because they are generated from customers that maintain operating service relationships with the Firm.
The Firm’s loans-to-deposits ratio was 65% at both December 31, 2016 and 2015.
As of December 31, 2016, total deposits for the Firm were $1,375.2 billion, compared with $1,279.7 billion at December 31, 2015 (61% of total liabilities at each of December 31, 2016 and 2015). The increase was attributable to higher consumer and wholesale deposits. The increase in consumer deposits reflected continuing strong growth from existing and new customers, and the impact of low attrition rates. The wholesale increase was driven by growth in operating deposits related to client activity in CIB’s Treasury Services business, and inflows in AWM primarily from business growth and the impact of new rules governing money market funds.
The Firm believes average deposit balances are generally more representative of deposit trends. The increase in average deposits for the year ended December 31, 2016 compared with the year ended December 31, 2015, was predominantly driven by an increase in consumer deposits, partially offset by a reduction in wholesale non-operating deposits, driven by the Firm’s actions in 2015 to reduce such deposits. For further discussions of deposit and liability balance trends, see the discussion of the Firm’s business segments results and the Consolidated Balance Sheet Analysis on pages 51-70 and pages 43-44, respectively.
JPMorgan Chase & Co./2016 Annual Report
The following table summarizes short-term and long-term funding, excluding deposits, as of December 31, 2016 and 2015, and average balances for the years ended December 31, 2016 and 2015. For additional information, see the Consolidated Balance Sheet Analysis on pages 43-44 and Note 21.
(a)
Included in beneficial interest issued by consolidated variable interest entities on the Firm’s Consolidated balance sheets.
(b)
Prior period amounts have been revised to conform with current period presentation.
(c)
Excludes federal funds purchased.
(d)
Excludes long-term structured repurchase agreements of $1.8 billion and $4.2 billion as of December 31, 2016 and 2015, respectively, and average balances of $2.9 billion and $3.9 billion for the years ended December 31, 2016 and 2015, respectively.
(e)
Excludes long-term securities loaned of $1.2 billion and $1.3 billion as of December 31, 2016, and December 31, 2015, respectively, and average balances of $1.3 billion and $0.9 billion for the years ended December 31, 2016 and 2015, respectively.
(f)
Other securitizations includes securitizations of student loans. The Firm’s wholesale businesses also securitize loans for client-driven transactions, which are not considered to be a source of funding for the Firm and are not included in the table.
(g)
Includes long-term structured notes which are secured.
(h)
For additional information on preferred stock and common stockholders’ equity see Capital Risk Management on pages 76-85, Consolidated statements of changes in stockholders’ equity, Note 22 and Note 23.
(i)
During 2015 the Firm discontinued its commercial paper customer sweep cash management program.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Short-term funding
The Firm’s sources of short-term secured funding primarily consist of securities loaned or sold under agreements to repurchase. Securities loaned or sold under agreements to repurchase are secured predominantly by high-quality securities collateral, including government-issued debt and agency MBS, and constitute a significant portion of the federal funds purchased and securities loaned or sold under repurchase agreements on the Consolidated balance sheets. The decrease in the average balance of securities loaned or sold under agreements to repurchase for the year ended December 31, 2016, compared with the balance at December 31, 2015, was largely due to lower secured financing of trading assets-debt and equity instruments in the CIB related to client-driven market-making activities. The balances associated with securities loaned or sold under agreements to repurchase fluctuate over time due to customers’ investment and financing activities; the Firm’s demand for financing; the ongoing management of the mix of the Firm’s liabilities, including its secured and unsecured financing (for both the investment securities and market-making portfolios); and other market and portfolio factors.
Long-term funding and issuance
Long-term funding provides additional sources of stable funding and liquidity for the Firm. The Firm’s long-term funding plan is driven by expected client activity, liquidity considerations, and regulatory requirements, including TLAC requirements. Long-term funding objectives include maintaining diversification, maximizing market access and optimizing funding costs. The Firm evaluates various funding markets, tenors and currencies in creating its optimal long-term funding plan.
The significant majority of the Firm’s long-term unsecured funding is issued by the Parent Company to provide maximum flexibility in support of both bank and nonbank subsidiary funding needs. The Parent Company advances substantially all net funding proceeds to the IHC. The IHC does not issue debt to external counterparties. The following table summarizes long-term unsecured issuance and maturities or redemptions for the years ended December 31, 2016 and 2015. For additional information, see Note 21.
The Firm raises secured long-term funding through securitization of consumer credit card loans and advances from the FHLBs.
The following table summarizes the securitization issuance and FHLB advances and their respective maturities or redemption for the years ended December 31, 2016 and 2015.
(a)
Other securitizations includes securitizations of student loans.
(b)
Includes long-term structured notes which are secured.
The Firm’s wholesale businesses also securitize loans for client-driven transactions; those client-driven loan securitizations are not considered to be a source of funding for the Firm and are not included in the table above. For further description of the client-driven loan securitizations, see Note 16.
JPMorgan Chase & Co./2016 Annual Report
Credit ratings
The cost and availability of financing are influenced by credit ratings. Reductions in these ratings could have an adverse effect on the Firm’s access to liquidity sources, increase the cost of funds, trigger additional collateral or funding requirements and decrease the number of investors and counterparties willing to lend to the Firm. Additionally, the Firm’s funding requirements for VIEs and other third-
party commitments may be adversely affected by a decline in credit ratings. For additional information on the impact of a credit ratings downgrade on the funding requirements for VIEs, and on derivatives and collateral agreements, see SPEs on page 45, and credit risk, liquidity risk and credit-related contingent features in Note 6 on page 181.
The credit ratings of the Parent Company and the Firm’s principal bank and nonbank subsidiaries as of December 31, 2016, were as follows.
(a)
On February 22, 2017, Moody’s published its updated rating methodologies for securities firms. Subsequently, as a result of this action, J.P. Morgan Securities LLC’s long-term issuer rating was downgraded by one notch from Aa3 to A1. The short-term issuer rating was unchanged and the outlook remained stable.
Downgrades of the Firm’s long-term ratings by one or two notches could result in an increase in its cost of funds, and access to certain funding markets could be reduced as noted above. The nature and magnitude of the impact of ratings downgrades depends on numerous contractual and behavioral factors (which the Firm believes are incorporated in its liquidity risk and stress testing metrics). The Firm believes that it maintains sufficient liquidity to withstand a potential decrease in funding capacity due to ratings downgrades.
JPMorgan Chase’s unsecured debt does not contain requirements that would call for an acceleration of payments, maturities or changes in the structure of the existing debt, provide any limitations on future borrowings or require additional collateral, based on unfavorable changes in the Firm’s credit ratings, financial ratios, earnings, or stock price.
Critical factors in maintaining high credit ratings include a stable and diverse earnings stream, strong capital ratios, strong credit quality and risk management controls, diverse funding sources, and disciplined liquidity monitoring procedures. Rating agencies continue to evaluate economic and geopolitical trends, regulatory developments, future profitability, risk management practices, and litigation matters, as well as their broader ratings methodologies. Changes in any of these factors could lead to changes in the Firm’s credit ratings.
Although the Firm closely monitors and endeavors to manage, to the extent it is able, factors influencing its credit ratings, there is no assurance that its credit ratings will not be changed in the future.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
MARKET RISK MANAGEMENT
Market risk is the risk of loss arising from potential adverse changes in the value of the Firm’s assets and liabilities resulting from changes in market variables such as interest rates, foreign exchange rates, equity prices, commodity prices, implied volatilities or credit spreads.
Market Risk Management
Market Risk Management monitors market risks throughout the Firm and defines market risk policies and procedures. The Market Risk Management function reports to the Firm’s CRO.
Market Risk Management seeks to manage risk, facilitate efficient risk/return decisions, reduce volatility in operating performance and provide transparency into the Firm’s market risk profile for senior management, the Board of Directors and regulators. Market Risk Management is responsible for the following functions:
•
Establishment of a market risk policy framework
•
Independent measurement, monitoring and control of line of business and firmwide market risk
•
Definition, approval and monitoring of limits
•
Performance of stress testing and qualitative risk assessments
Risk measurement
Tools used to measure risk
Because no single measure can reflect all aspects of market risk, the Firm uses various metrics, both statistical and nonstatistical, to assess risk including:
•
VaR
•
Economic-value stress testing
•
Nonstatistical risk measures
•
Loss advisories
•
Profit and loss drawdowns
•
Earnings-at-risk
•
Other sensitivities
Risk monitoring and control
Market risk exposure is managed primarily through a series of limits set in the context of the market environment and business strategy. In setting limits, the Firm takes into consideration factors such as market volatility, product liquidity and accommodation of client business and management experience. The Firm maintains different levels of limits. Corporate level limits include VaR and stress limits. Similarly, line of business limits include VaR and stress limits and may be supplemented by loss advisories, nonstatistical measurements and profit and loss drawdowns. Limits may also be set within the lines of business, as well at the portfolio or legal entity level.
Market Risk Management sets limits and regularly reviews and updates them as appropriate, with any changes approved by line of business management and Market Risk Management. Senior management, including the Firm’s CEO and CRO, are responsible for reviewing and approving certain of these risk limits on an ongoing basis. All limits that have not been reviewed within specified time periods by Market Risk Management are escalated to senior management. The lines of business are responsible for adhering to established limits against which exposures are monitored and reported.
Limit breaches are required to be reported in a timely manner to limit approvers, Market Risk Management and senior management. In the event of a breach, Market Risk Management consults with Firm senior management and the line of business senior management to determine the appropriate course of action required to return to compliance, which may include a reduction in risk in order to remedy the breach. Certain Firm or line of business-level limits that have been breached for three business days or longer, or by more than 30%, are escalated to senior management and the Firmwide Risk Committee.
JPMorgan Chase & Co./2016 Annual Report
The following table summarizes by line of business the predominant business activities that give rise to market risk, and the primary market risk management tools utilized to manage those risks.
As part of the Firm’s evaluation and periodic enhancement of its market risk measures, during the third quarter of 2016 the Firm refined the scope of positions included in risk management VaR. In particular, certain private equity positions in the CIB, exposure arising from non-U.S. dollar denominated funding activities in Corporate, as well as seed capital investments in AWM were removed from the VaR calculation. Commencing with the third quarter of 2016, exposure arising from these positions is captured using other sensitivity-based measures, such as a 10% decline in market value or a 1 basis point parallel shift in spreads, as appropriate. For more information, see Other sensitivity-based measures at page 123. The Firm believes this refinement to its reported VaR measures more appropriately captures the risk of its market risk sensitive instruments. This change did not impact Regulatory VaR as these positions are not included in the calculation of Regulatory VaR. Regulatory VaR is used to derive the Firm’s regulatory VaR-based capital requirements under Basel III.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Value-at-risk
JPMorgan Chase utilizes VaR, a statistical risk measure, to estimate the potential loss from adverse market moves in a normal market environment. The Firm has a single VaR framework used as a basis for calculating Risk Management VaR and Regulatory VaR.
The framework is employed across the Firm using historical simulation based on data for the previous 12 months. The framework’s approach assumes that historical changes in market values are representative of the distribution of potential outcomes in the immediate future. The Firm believes the use of Risk Management VaR provides a stable measure of VaR that is closely aligned to the day-to-day risk management decisions made by the lines of business, and provides the appropriate information needed to respond to risk events on a daily basis.
The Firm’s Risk Management VaR is calculated assuming a one-day holding period and an expected tail-loss methodology which approximates a 95% confidence level. Risk Management VaR provides a consistent framework to measure risk profiles and levels of diversification across product types and is used for aggregating risks and monitoring limits across businesses. Those VaR results are reported to senior management, the Board of Directors and regulators.
Under the Firm’s Risk Management VaR methodology, assuming current changes in market values are consistent with the historical changes used in the simulation, the Firm would expect to incur VaR “back-testing exceptions,” defined as losses greater than that predicted by VaR estimates, on average five times every 100 trading days. The number of VaR back-testing exceptions observed can differ from the statistically expected number of back-testing exceptions if the current level of market volatility is materially different from the level of market volatility during the 12 months of historical data used in the VaR calculation.
Underlying the overall VaR model framework are individual VaR models that simulate historical market returns for individual products and/or risk factors. To capture material market risks as part of the Firm’s risk management framework, comprehensive VaR model calculations are performed daily for businesses whose activities give rise to market risk. These VaR models are granular and incorporate numerous risk factors and inputs to simulate daily changes in market values over the historical period; inputs are selected based on the risk profile of each portfolio, as sensitivities and historical time series used to generate daily market values may be different across product types or risk management systems. The VaR model results across all portfolios are aggregated at the Firm level.
Since VaR is based on historical data, it is an imperfect measure of market risk exposure and potential losses, and it is not used to estimate the impact of stressed market conditions or to manage any impact from potential stress events. In addition, based on their reliance on available historical data, limited time horizons, and other factors, VaR measures are inherently limited in their ability to measure certain risks and to predict losses, particularly those associated with market illiquidity and sudden or severe shifts in market conditions.
For certain products, specific risk parameters are not captured in VaR due to the lack of inherent liquidity and availability of appropriate historical data. The Firm uses proxies to estimate the VaR for these and other products when daily time series are not available. It is likely that using an actual price-based time series for these products, if available, would affect the VaR results presented. The Firm therefore considers other measures such as stress testing, in addition to VaR, to capture and manage its market risk positions.
The daily market data used in VaR models may be different than the independent third-party data collected for VCG price testing in its monthly valuation process. For example, in cases where market prices are not observable, or where proxies are used in VaR historical time series, the data sources may differ (see Valuation process in Note 3 for further information on the Firm’s valuation process). Because VaR model calculations require daily data and a consistent source for valuation, it may not be practical to use the data collected in the VCG monthly valuation process for VaR model calculations.
The Firm’s VaR model calculations are periodically evaluated and enhanced in response to changes in the composition of the Firm’s portfolios, changes in market conditions, improvements in the Firm’s modeling techniques and measurements, and other factors. Such changes may affect historical comparisons of VaR results. For information regarding model reviews and approvals, see Model Risk Management on page 128.
The Firm calculates separately a daily aggregated VaR in accordance with regulatory rules (“Regulatory VaR”), which is used to derive the Firm’s regulatory VaR-based capital requirements under Basel III. This Regulatory VaR model framework currently assumes a ten business-day holding period and an expected tail loss methodology which approximates a 99% confidence level. Regulatory VaR is applied to “covered” positions as defined by Basel III, which may be different than the positions included in the Firm’s Risk Management VaR. For example, credit derivative hedges of accrual loans are included in the Firm’s Risk Management VaR, while Regulatory VaR excludes these credit derivative hedges. In addition, in contrast to the Firm’s Risk Management VaR, Regulatory VaR currently excludes the diversification benefit for certain VaR models.
JPMorgan Chase & Co./2016 Annual Report
For additional information on Regulatory VaR and the other components of market risk regulatory capital for the Firm (e.g. VaR-based measure, stressed VaR-based measure and the respective backtesting), see JPMorgan Chase’s Basel III
Pillar 3 Regulatory Capital Disclosures reports, which are available on the Firm’s website at: (http://investor.shareholder.com/jpmorganchase/basel.cfm).
The table below shows the results of the Firm’s Risk Management VaR measure using a 95% confidence level.
(a)
Average portfolio VaR and period-end portfolio VaR were less than the sum of the VaR of the components described above, which is due to portfolio diversification. The diversification effect reflects the fact that risks are not perfectly correlated.
(b)
Designated as NM, because the minimum and maximum may occur on different days for distinct risk components, and hence it is not meaningful to compute a portfolio-diversification effect.
As discussed on page 117, during the third quarter of 2016 the Firm refined the scope of positions included in Risk Management VaR. In the absence of these refinements, the average VaR, without diversification, for each of the following reported components would have been higher by the following amounts for the full year 2016: CIB Equities VaR by $3 million; CIB trading VaR by $2 million; CIB VaR by $3 million; Corporate VaR by $4 million; AWM VaR by $2 million; Other VaR by $4 million; and Total VaR by $3 million. Additionally, the Total VaR at December 31, 2016 would have been higher by $7 million in the absence of these refinements.
Average Total VaR decreased $2 million for the full year ending December 31, 2016 as compared with the respective prior year period. The reduction in average Total VaR is due to the aforementioned scope changes as well as a lower risk profile in the Equities risk type. This was offset by changes in the risk profiles of the Foreign exchange and Fixed Income risk types. Additionally, average Credit portfolio VaR declined as a result of lower exposures arising from select positions.
The Firm’s average Total VaR diversification benefit was $8 million or 18% of the sum for 2016, compared with $10 million or 21% of the sum for 2015.
The Firm continues to enhance its VaR model calculations and the time series inputs related to certain asset-backed products.
VaR can vary significantly as positions change, market volatility fluctuates, and diversification benefits change.
VaR back-testing
The Firm evaluates the effectiveness of its VaR methodology by back-testing, which compares the daily Risk Management VaR results with the daily gains and losses recognized on market-risk related revenue.
The Firm’s definition of market risk-related gains and losses is consistent with the definition used by the banking regulators under Basel III. Under this definition market risk-related gains and losses are defined as: gains and losses on the positions included in the Firm’s Risk Management VaR, excluding fees, commissions, certain valuation adjustments (e.g., liquidity and DVA), net interest income, and gains and losses arising from intraday trading.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The following chart compares the daily market risk-related gains and losses with the Firm’s Risk Management VaR for the year ended December 31, 2016. As the chart presents market risk-related gains and losses related to those positions included in the Firm’s Risk Management VaR, the results in the table below differ from the results of back-testing disclosed in the Market Risk section of the Firm’s Basel III Pillar 3 Regulatory Capital Disclosures reports, which are based on Regulatory VaR applied to covered positions. The chart shows that for the year ended December 31, 2016 the Firm observed 5 VaR back-testing exceptions and posted Market-risk related gains on 151 of the 260 days in this period.
Daily Market Risk-Related Gains and Losses
vs. Risk Management VaR (1-day, 95% Confidence level)
Year ended December 31, 2016
Market Risk-Related Gains and Losses
Risk Management VaR
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
For the year ended December 31, 2016, there were 5 back-testing exceptions. The two exceptions that occurred towards the end of June 2016, subsequent to the U.K. referendum on membership in the European Union, reflect the elevated market volatility observed across multiple asset classes following the outcome of the vote.
JPMorgan Chase & Co./2016 Annual Report
Other risk measures
Economic-value stress testing
Along with VaR, stress testing is an important tool in measuring and controlling risk. While VaR reflects the risk of loss due to adverse changes in markets using recent historical market behavior as an indicator of losses, stress testing is intended to capture the Firm’s exposure to unlikely but plausible events in abnormal markets. The Firm runs weekly stress tests on market-related risks across the lines of business using multiple scenarios that assume significant changes in risk factors such as credit spreads, equity prices, interest rates, currency rates and commodity prices.
The Firm uses a number of standard scenarios that capture different risk factors across asset classes including geographical factors, specific idiosyncratic factors and extreme tail events. The stress framework calculates multiple magnitudes of potential stress for both market rallies and market sell-offs for each risk factor and combines them in multiple ways to capture different market scenarios. For example, certain scenarios assess the potential loss arising from current exposures held by the Firm due to a broad sell off in bond markets or an extreme widening in corporate credit spreads. The flexibility of the stress testing framework allows risk managers to construct new, specific scenarios that can be used to form decisions about future possible stress events.
Stress testing complements VaR by allowing risk managers
to shock current market prices to more extreme levels relative to those historically realized, and to stress test the relationships between market prices under extreme scenarios. Stress scenarios are defined and reviewed by Market Risk Management, and significant changes are reviewed by the relevant LOB Risk Committees and may be redefined on a periodic basis to reflect current market conditions.
Stress-test results, trends and qualitative explanations based on current market risk positions are reported to the respective LOBs and the Firm’s senior management to allow them to better understand the sensitivity of positions to certain defined events and to enable them to manage their risks with more transparency. Results are also reported to the Board of Directors.
The Firm’s stress testing framework is utilized in calculating results under scenarios mandated by the Federal Reserve’s CCAR and ICAAP processes. In addition, the results are incorporated into the quarterly assessment of the Firm’s Risk Appetite Framework and are also presented to the DRPC.
Nonstatistical risk measures
Nonstatistical risk measures include sensitivities to variables used to value positions, such as credit spread sensitivities, interest rate basis point values and market values. These measures provide granular information on the Firm’s market risk exposure. They are aggregated by line of
business and by risk type, and are also used for monitoring internal market risk limits.
Loss advisories and profit and loss drawdowns
Loss advisories and profit and loss drawdowns are tools used to highlight trading losses above certain levels of risk tolerance. Profit and loss drawdowns are defined as the decline in net profit and loss since the year-to-date peak revenue level.
Earnings-at-risk
The VaR and sensitivity measures described above illustrate the economic sensitivity of the Firm’s Consolidated balance sheets to changes in market variables. The effect of interest rate exposure on the Firm’s reported net income is also important as interest rate risk represents one of the Firm’s significant market risks. Interest rate risk arises not only from trading activities but also from the Firm’s traditional banking activities, which include extension of loans and credit facilities, taking deposits and issuing debt. The Firm evaluates its structural interest rate risk exposure through earnings-at-risk, which measures the extent to which changes in interest rates will affect the Firm’s net interest income and certain interest rate-sensitive fees. For a summary by line of business, identifying positions included in earnings-at-risk, see the table on page 117.
The CTC Risk Committee establishes the Firm’s structural interest rate risk policies and market risk limits, which are subject to approval by the DRPC. Treasury and CIO, working in partnership with the lines of business, calculates the Firm’s structural interest rate risk profile and reviews it with senior management including the CTC Risk Committee and the Firm’s ALCO. In addition, oversight of structural interest rate risk is managed through a dedicated risk function reporting to the CTC CRO. This risk function is responsible for providing independent oversight and governance around assumptions and establishing and monitoring limits for structural interest rate risk. The Firm manages structural interest rate risk generally through its investment securities portfolio and interest rate derivatives.
Structural interest rate risk can occur due to a variety of factors, including:
•
Differences in the timing among the maturity or repricing of assets, liabilities and off-balance sheet instruments
•
Differences in the amounts of assets, liabilities and off-balance sheet instruments that are repricing at the same time
•
Differences in the amounts by which short-term and long-term market interest rates change (for example, changes in the slope of the yield curve)
•
The impact of changes in the maturity of various assets, liabilities or off-balance sheet instruments as interest rates change
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
The Firm manages interest rate exposure related to its assets and liabilities on a consolidated, firmwide basis. Business units transfer their interest rate risk to Treasury and CIO through a transfer-pricing system, which takes into account the elements of interest rate exposure that can be risk-managed in financial markets. These elements include asset and liability balances and contractual rates of interest, contractual principal payment schedules, expected prepayment experience, interest rate reset dates and maturities, rate indices used for repricing, and any interest rate ceilings or floors for adjustable rate products. All transfer-pricing assumptions are dynamically reviewed.
The Firm generates a baseline for net interest income and certain interest rate sensitive fees, and then conducts simulations of changes for interest rate-sensitive assets and liabilities denominated in U.S. dollar and other currencies (“non-U.S. dollar” currencies). Earnings-at-risk scenarios estimate the potential change in this baseline, over the following 12 months utilizing multiple assumptions. These scenarios consider the impact on exposures as a result of changes in interest rates from baseline rates, as well as pricing sensitivities of deposits, optionality and changes in product mix. The scenarios include forecasted balance sheet changes, as well as modeled prepayment and reinvestment behavior, but do not include assumptions about actions that could be taken by the Firm in response to any such instantaneous rate changes. Mortgage prepayment assumptions are based on scenario interest rates compared with underlying contractual rates, the time since origination, and other factors which are updated periodically based on historical experience. The Firm’s earnings-at-risk scenarios are periodically evaluated and enhanced in response to changes in the composition of the Firm’s balance sheet, changes in market conditions, improvements in the Firm’s simulation and other factors.
The Firm’s U.S. dollar sensitivities are presented in the table below. The non-U.S. dollar sensitivity scenarios are not material to the Firm’s earnings-at-risk at December 31, 2016 and 2015.
(a)
Given the current level of market interest rates, downward parallel 100 and 200 basis point earnings-at-risk scenarios are not considered to be meaningful.
The Firm’s benefit to rising rates on U.S. dollar assets and liabilities is largely a result of reinvesting at higher yields and assets repricing at a faster pace than deposits.
The Firm’s net U.S. dollar sensitivity to a 200 bps and
100 bps instantaneous increase in rates decreased by approximately $1.2 billion and $700 million, respectively, when compared to December 31, 2015. The primary driver of that decrease was the updating of the Firm’s baseline to reflect higher interest rates. As higher interest rates are reflected in the Firm’s baselines, the magnitude of the sensitivity to further increases in rates would be expected to be less significant. The net change in mix in the Firm’s spot and forecasted balance sheet also contributed to a decrease in the net U.S. dollar sensitivity when compared to December 31, 2015.
Separately, another U.S. dollar interest rate scenario used by the Firm - involving a steeper yield curve with long-term rates rising by 100 basis points and short-term rates staying at current levels - results in a 12-month benefit to net interest income of approximately $800 million. The increase under this scenario reflects the Firm reinvesting at the higher long-term rates, with funding costs remaining unchanged. The result of the comparable non-U.S. dollar scenario was not material to the Firm.
Non-U.S. dollar foreign exchange risk
Non-U.S. dollar FX risk is the risk that changes in foreign exchange rates affect the value of the Firm’s assets or liabilities or future results. The Firm has structural non-U.S. dollar FX exposures arising from capital investments, forecasted expense and revenue, the investment securities portfolio and non-U.S. dollar-denominated debt issuance. Treasury and CIO, working in partnership with the lines of business, primarily manage these risks on behalf of the Firm. Treasury and CIO may hedge certain of these risks using derivatives within risk limits governed by the CTC Risk Committee.
JPMorgan Chase & Co./2016 Annual Report
Other sensitivity-based measures
The Firm quantifies the market risk of certain investment and funding activities by assessing the potential impact on net revenue and OCI due to changes in relevant market variables. For additional information on the positions captured in other sensitivity-based measures, please refer to the Risk identification and classification table on page 117.
The table below represents the potential impact to net revenue or OCI for market risk sensitive instruments that are not included in VaR or earnings-at-risk. Where appropriate, instruments used for hedging purposes are reported along with the positions being hedged. The sensitivities disclosed in the table below may not be representative of the actual gain or loss that would have been realized at December 31, 2016, as the movement in market parameters across maturities may vary and are not intended to imply management’s expectation of future deterioration in these sensitivities.
(a)
Impact recognized through OCI.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
PRINCIPAL RISK MANAGEMENT
Principal investments are predominantly privately-held financial assets and instruments, typically representing ownership or junior capital positions, that have unique risks due to their illiquidity or for which there is less observable market or valuation data. Such positions are typically intended to be held over extended investment periods and, accordingly, the Firm has no expectation for short-term gain with respect to these investments. Principal investments cover multiple asset classes and are made either in stand-alone investing businesses or as part of a broader business platform. Asset classes include tax-oriented investments (e.g., affordable housing and alternative energy investments), private equity and various debt investments. Increasingly, new principal investment activity seeks to enhance or accelerate line of business strategic business initiatives.
The Firm’s principal investments are managed under various lines of business and are reflected within the respective LOBs financial results. The Firm’s approach to managing principal risk is consistent with the Firm’s general risk governance structure. A Firmwide risk policy framework exists for all principal investing activities. All investments are approved by investment committees that include executives who are independent from the investing businesses. The Firm’s independent control functions are responsible for reviewing the appropriateness of the carrying value of principal investments in accordance with relevant policies. Approved levels for such investments are established for each relevant business in order to manage the overall size of the portfolios. Industry, geographic and position level concentration limits are in place and are intended to ensure diversification of the portfolios. The Firm also conducts stress testing on these portfolios using specific scenarios that estimate losses based on significant market moves and/or other risk events.
JPMorgan Chase & Co./2016 Annual Report
COMPLIANCE RISK MANAGEMENT
Compliance risk is the risk of failure to comply with applicable laws, rules and regulations.
Overview
Each line of business is accountable for managing its compliance risk. The Firm’s Compliance Organization (“Compliance”), which is independent of the lines of business, works closely with senior management to provide independent review, monitoring and oversight of business operations with a focus on compliance with the legal and regulatory obligations applicable to the offering of the Firm’s products and services to clients and customers.
These compliance risks relate to a wide variety of legal and regulatory obligations, depending on the line of business and the jurisdiction, and include those related to products and services, relationships and interactions with clients and customers, and employee activities. For example, compliance risks include those associated with anti-money laundering compliance, trading activities, market conduct, and complying with the rules and regulations related to the offering of products and services across jurisdictional borders, among others.
Other Functions such as Finance (including Tax), Technology and Human Resources provide oversight of significant regulatory obligations that are specific to their respective areas of responsibility.
Compliance implements various practices designed to identify and mitigate compliance risk by establishing policies, testing, monitoring, training and providing guidance.
In recent years, the Firm has experienced heightened scrutiny by its regulators of its compliance with regulations, and with respect to its controls and operational processes. In certain instances, the Firm has entered into Consent Orders with its regulators requiring the Firm to take certain specified actions to remediate compliance with regulations and improve its controls. The Firm expects that such regulatory scrutiny will continue.
Governance and oversight
Compliance is led by the Firms’ CCO who reports, effective September 2016, to the Firm’s CRO.
The Firm maintains oversight and coordination of its Compliance Risk Management practices through the Firm’s CCO, lines of business CCOs and regional CCOs to implement the Compliance program globally across the lines of business and regions. The Firm’s CCO is a member of the FCC and the FRC. The Firm’s CCO also provides regular updates to the Audit Committee and DRPC. In addition, from time to time, special committees of the Board have been established to oversee the Firm’s compliance with regulatory Consent Orders.
The Firm has in place a Code of Conduct (the “Code”), and each employee is given annual training in respect of the Code and is required annually to affirm his or her compliance with the Code. The Code sets forth the Firm’s core principles and fundamental values, including that no employee should ever sacrifice integrity - or give the impression that he or she has. The Code requires prompt reporting of any known or suspected violation of the Code, any internal Firm policy, or any law or regulation applicable to the Firm’s business. It also requires the reporting of any illegal conduct, or conduct that violates the underlying principles of the Code, by any of the Firm’s employees, customers, suppliers, contract workers, business partners, or agents. Specified employees are specially trained and designated as “code specialists” who act as a resource to employees on Code matters. In addition, concerns may be reported anonymously and the Firm prohibits retaliation against employees for the good faith reporting of any actual or suspected violations of the Code. The Code and the associated employee compliance program are focused on the regular assessment of certain key aspects of the Firm’s culture and conduct initiatives.
JPMorgan Chase & Co./2016 Annual Report
CONDUCT RISK MANAGEMENT
Conduct risk is the risk that an employee’s action or inaction causes undue harm to the Firm’s clients and customers, damages market integrity, undermines the Firm’s reputation, or negatively impacts the Firm’s culture.
Overview
Each line of business or function is accountable for identifying and managing its conduct risk to provide appropriate engagement, ownership and sustainability of a culture consistent with the Firm’s How We Do Business Principles (“Principles”). The Principles serve as a guide for how employees are expected to conduct themselves. With the Principles serving as a guide, the Firm’s Code sets out the Firm’s expectations for each employee and provides certain information and the resources to help employees conduct business ethically and in compliance with the law everywhere the Firm operates. For further discussion of the Code, see Compliance Risk Management on page 125.
Governance and oversight
The CMDC is the primary Board-level Committee that oversees the Firm’s culture and conduct programs. The Audit Committee has responsibility to review the program established by management that monitors compliance with the Code. Additionally, the DRPC reviews, at least annually, the Firm’s qualitative factors included in the Risk Appetite Framework, including conduct risk. The DRPC also meets annually with the CMDC to review and discuss aspects of the Firm’s compensation practices.
Conduct risk management is incorporated into various aspects of people management practices throughout the employee life cycle, including recruiting, onboarding, training and development, performance management, promotion and compensation processes. Businesses undertake annual Risk and Control Self-Assessment (“RCSA”) assessments; and, as part of these RCSA reviews, they identify their respective key inherent operational risks (including conduct risks), evaluate the design and effectiveness of their controls, identify control gaps and develop associated action plans. The Firm’s Know Your Employee framework generally addresses how the Firm manages, oversees and responds to workforce conduct related matters that may otherwise expose the Firm to financial, reputational, compliance and other operating risks. The Firm also has a HR Control Forum, the primary purpose of which is to discuss conduct and accountability for more significant risk and control issues and review, when appropriate, employee actions including but not limited to promotion and compensation actions.
JPMorgan Chase & Co./2016 Annual Report
LEGAL RISK MANAGEMENT
Legal risk is the risk of loss or imposition of damages, fines, penalties or other liability arising from the failure to comply with a contractual obligation or to comply with laws, rules or regulations to which the Firm is subject.
Overview
In addition to providing legal services and advice to the Firm, and communicating and helping the lines of business adjust to the legal and regulatory changes they face, including the heightened scrutiny and expectations of the Firm’s regulators, the global Legal function is responsible for working with the businesses and corporate functions to fully understand and assess their adherence to laws, rules and regulations. In particular, Legal assists Oversight & Control, Risk, Finance, Compliance and Internal Audit in their efforts to ensure compliance with all applicable laws and regulations and the Firm’s corporate standards for doing business. The Firm’s lawyers also advise the Firm on potential legal exposures on key litigation and transactional matters, and perform a significant defense and advocacy role by defending the Firm against claims and potential claims and, when needed, pursuing claims against others. In addition, they advise the Firm’s Conflicts Office which reviews the Firm’s wholesale transactions that may have the potential to create conflicts of interest for the Firm.
Governance and oversight
The Firm’s General Counsel reports to the CEO and is a member of the Operating Committee, the Firmwide Risk Committee and the FCC. The General Counsel’s leadership team includes a General Counsel for each line of business, the heads of the Litigation and Corporate & Regulatory practices, as well as the Firm’s Corporate Secretary. Each region (e.g., Latin America, Asia Pacific) has a General Counsel who is responsible for managing legal risk across all lines of business and functions in the region.
Legal works with various committees (including new business initiative and reputation risk committees) and the Firm’s businesses to protect the Firm’s reputation beyond any particular legal requirements.
JPMorgan Chase & Co./2016 Annual Report
MODEL RISK MANAGEMENT
Model risk is the potential for adverse consequences from decisions based on incorrect or misused model outputs.
The Firm uses models across various businesses and functions. The models are of varying levels of sophistication and are used for many purposes including, for example, the valuation of positions and the measurement of risk, such as assessing regulatory capital requirements, conducting stress testing, and making business decisions.
Model risks are owned by the users of the models within the various businesses and functions in the Firm based on the specific purposes of such models. Users and developers of models are responsible for developing, implementing and testing their models, as well as referring models to the Model Risk function for review and approval. Once models have been approved, model users and developers are responsible for maintaining a robust operating environment, and must monitor and evaluate the performance of the models on an ongoing basis. Model users and developers may seek to enhance models in response to changes in the portfolios and in product and market developments, as well as to capture improvements in available modeling techniques and systems capabilities.
The Model Risk function reviews and approves a wide range of models, including risk management, valuation and regulatory capital models used by the Firm. The Model Risk function is independent of model users and developers. The Firmwide Model Risk Executive reports to the Firm’s CRO.
Models are tiered based on an internal standard according to their complexity, the exposure associated with the model and the Firm’s reliance on the model. This tiering is subject to the approval of the Model Risk function. A model review conducted by the Model Risk function considers the model’s suitability for the specific uses to which it will be put. The factors considered in reviewing a model include whether the model accurately reflects the characteristics of the product and its significant risks, the selection and reliability of model inputs, consistency with models for similar products, the appropriateness of any model-related adjustments, and sensitivity to input parameters and assumptions that cannot be observed from the market. When reviewing a model, the Model Risk function analyzes and challenges the model methodology and the reasonableness of model assumptions and may perform or require additional testing, including back-testing of model outcomes. Model reviews are approved by the appropriate level of management within the Model Risk function based on the relevant model tier.
Under the Firm’s Model Risk Policy, the Model Risk function reviews and approves new models, as well as material changes to existing models, prior to implementation in the operating environment. In certain circumstances, the head of the Model Risk function may grant exceptions to the Firm’s model risk policy to allow a model to be used prior to review or approval. The Model Risk function may also require the user to take appropriate actions to mitigate the model risk if it is to be used in the interim. These actions will depend on the model and may include, for example, limitation of trading activity.
For a summary of valuations based on models, see Critical Accounting Estimates Used by the Firm on pages 132-134 and Note 3.
JPMorgan Chase & Co./2016 Annual Report
OPERATIONAL RISK MANAGEMENT
Operational risk is the risk of loss resulting from inadequate or failed processes or systems, human factors or due to external events that are neither market- nor credit-related. Operational risk is inherent in the Firm’s activities and can manifest itself in various ways, including fraudulent acts, business interruptions, inappropriate employee behavior, failure to comply with applicable laws and regulations or failure of vendors to perform in accordance with their arrangements. These events could result in financial losses, litigation and regulatory fines, as well as other damages to the Firm. The goal is to keep operational risk at appropriate levels in light of the Firm’s financial strength, the characteristics of its businesses, and the markets and regulatory environments in which it operates.
Operational Risk Management Framework
To monitor and control operational risk, the Firm has an Operational Risk Management Framework which is designed to enable the Firm to maintain a sound and well-controlled operational environment. The ORMF is comprised of four main components: Governance, Risk Assessment, Measurement, and Monitoring and Reporting.
Governance
The lines of business and corporate functions are responsible for owning and managing their operational risks. The Firmwide Oversight and Control Group, which consists of control officers within each line of business and corporate function, is responsible for the day-to-day execution of the ORMF.
Line of business and corporate function control committees oversee the operational risk and control environments of their respective businesses and functions. These committees escalate operational risk issues to the FCC, as appropriate. For additional information on the FCC, see Enterprise Risk Management on pages 71-75.
The Firmwide Risk Executive for Operational Risk Governance (“ORG”), a direct report to the CRO, is responsible for defining the ORMF and establishing minimum standards for its execution. Operational Risk Officers report to both the line of business CROs and to the Firmwide Risk Executive for ORG, and are independent of the respective businesses or corporate functions they oversee.
The Firm’s Operational Risk Appetite Policy is approved by the DRPC. This policy establishes the Operational Risk Management Framework for the Firm. The assessments of operational risk using this framework are reviewed with the DRPC.
Risk assessment
The Firm utilizes several tools to identify, assess, mitigate and manage its operational risk. One such tool is the RCSA program which is executed by LOBs and corporate functions in accordance with the minimum standards established by ORG. As part of the RCSA program, lines of business and corporate functions identify key operational risks inherent in their activities, evaluate the effectiveness of relevant
controls in place to mitigate identified risks, and define actions to reduce residual risk. Action plans are developed for identified control issues and businesses are held accountable for tracking and resolving issues in a timely manner. Operational Risk Officers independently challenge the execution of the RCSA program and evaluate the appropriateness of the residual risk results.
In addition to the RCSA program, the Firm tracks and monitors events that have or could lead to actual operational risk losses, including litigation-related events. Responsible businesses and corporate functions analyze their losses to evaluate the efficacy of their control environment to assess where controls have failed, and to determine where targeted remediation efforts may be required. ORG provides oversight of these activities and may also perform independent assessments of significant operational risk events and areas of concentrated or emerging risk.
Measurement
In addition to the level of actual operational risk losses, operational risk measurement includes operational risk-based capital and operational risk losses under both baseline and stressed conditions.
The primary component of the operational risk capital estimate is the Loss Distribution Approach (“LDA”) statistical model, which simulates the frequency and severity of future operational risk loss projections based on historical data. The LDA model is used to estimate an aggregate operational risk loss over a one-year time horizon, at a 99.9% confidence level. The LDA model incorporates actual internal operational risk losses in the quarter following the period in which those losses were realized, and the calculation generally continues to reflect such losses even after the issues or business activities giving rise to the losses have been remediated or reduced.
As required under the Basel III capital framework, the Firm’s operational risk-based capital methodology, which uses the Advanced Measurement Approach, incorporates internal and external losses as well as management’s view of tail risk captured through operational risk scenario analysis, and evaluation of key business environment and internal control metrics.
The Firm considers the impact of stressed economic conditions on operational risk losses and develops a forward looking view of material operational risk events that may occur in a stressed environment. The Firm’s operational risk stress testing framework is utilized in calculating results for the Firm’s CCAR and ICAAP processes.
For information related to operational risk RWA, CCAR or ICAAP, see Capital Risk Management section, pages 76-85.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
Monitoring and reporting
ORG has established standards for consistent operational risk reporting. The standards also reinforce escalation protocols to senior management and to the Board of Directors. Operational risk reports are produced on a firmwide basis as well as by line of business and corporate function.
Other operational risks
As mentioned previously, operational risk can manifest itself in various ways. Risks such as Compliance risk, Conduct risk, Legal risk and Model risk as well as other operational risks, can lead to losses which are captured through the Firm’s operational risk measurement processes. More information on Compliance risk, Conduct risk, Legal risk and Model risk are discussed on pages 125, 126, 127 and 128, respectively. Details on other select operational risks are provided below.
Cybersecurity risk
The Firm devotes significant resources to protect the security of the Firm’s computer systems, software, networks and other technology assets. The Firm’s security efforts are intended to protect against cybersecurity attacks by unauthorized parties to obtain access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage. The Firm continues to make significant investments in enhancing its cyber defense capabilities and to strengthen its partnerships with the appropriate government and law enforcement agencies and other businesses in order to understand the full spectrum of cybersecurity risks in the environment, enhance defenses and improve resiliency against cybersecurity threats. Third parties with which the Firm does business or that facilitate the Firm’s business activities (e.g., vendors, exchanges, clearing houses, central depositories, and financial intermediaries) could also be sources of cybersecurity risk to the Firm. Third party cybersecurity incidents such as system breakdowns or failures, misconduct by the employees of such parties, or cyberattacks could affect their ability to deliver a product or service to the Firm or result in lost or compromised information of the Firm or its clients. Clients can also be sources of cybersecurity risk to the Firm, particularly when their activities and systems are beyond the Firm’s own security and control systems. However, where cybersecurity incidents are due to client failure to maintain the security of their own systems and processes, clients will generally be responsible for losses incurred.
To protect the confidentiality, integrity and availability of the Firm’s infrastructure, resources and information, the Firm leverages the ORMF to ensure risks are identified and managed within defined corporate tolerances. The Firm’s Board of Directors and the Audit Committee are regularly briefed on the Firm’s cybersecurity policies and practices as well as its efforts regarding significant cybersecurity events.
Payment fraud risk
Payment fraud risk is the risk of external and internal parties unlawfully obtaining personal benefit at the expense of the Firm. Over the past year, the risk of payment fraud has increased across the industry, with the number of
attempts hitting record highs. The complexities of these attacks along with perpetrators’ strategies continue to evolve. A Payments Control Program has been established that includes Cybersecurity, Operations, Technology, Risk and the lines of business to manage the risk, implement controls and provide client education and awareness training. The program monitors and measures payment fraud activity, evaluates the Firm’s cybersecurity defenses, limits access to sensitive data, and provides training to both employees and clients.
Third-party outsourcing risk
To identify and manage the operational risk inherent in its outsourcing activities, the Firm has a Third-Party Oversight (“TPO”) framework to assist lines of business and corporate functions in selecting, documenting, onboarding, monitoring and managing their supplier relationships. The objective of the TPO framework is to hold third parties to the same high level of operational performance as is expected of the Firm’s internal operations. The Third-Party Oversight group is responsible for Firmwide TPO training, monitoring, reporting and standards.
Business and technology resilience risk
Business disruptions can occur due to forces beyond the Firm’s control such as severe weather, power or telecommunications loss, flooding, transit strikes, terrorist threats or infectious disease. The safety of the Firm’s employees and customers is of the highest priority. The Firm’s global resiliency program is intended to ensure that the Firm has the ability to recover its critical business functions and supporting assets (i.e., staff, technology and facilities) in the event of a business interruption. The program includes corporate governance, awareness and training, as well as strategic and tactical initiatives to identify, assess, and manage business interruption and public safety risks.
The strength and proficiency of the Firm’s global resiliency program has played an integral role in maintaining the Firm’s business operations during and quickly after various events.
Insurance
One of the ways operational loss may be mitigated is through insurance maintained by the Firm. The Firm purchases insurance to be in compliance with local laws and regulations (e.g., workers compensation), as well as to serve other needs (e.g., property loss and public liability). Insurance may also be required by third parties with whom the Firm does business. The insurance purchased is reviewed and approved by senior management.
JPMorgan Chase & Co./2016 Annual Report
REPUTATION RISK MANAGEMENT
Reputation risk is the risk that an action, transaction, investment or event will reduce trust in the Firm’s integrity or competence by its various constituents, including clients, counterparties, investors, regulators, employees and the broader public. Maintaining the Firm’s reputation is the responsibility of each individual employee of the Firm. The Firm’s Reputation Risk Governance policy explicitly vests each employee with the responsibility to consider the reputation of the Firm when engaging in any activity. Since the types of events that could harm the Firm’s reputation are so varied across the Firm’s lines of business, each line of business has a separate reputation risk governance
infrastructure in place, which consists of three key elements: clear, documented escalation criteria appropriate to the business; a designated primary discussion forum - in most cases, one or more dedicated reputation risk committees; and a list of designated contacts, to whom questions relating to reputation risk should be referred. Line of business reputation risk governance is overseen by a Firmwide Reputation Risk Governance function which provides oversight of the governance infrastructure and process to support the consistent identification, escalation, management and monitoring of reputation risk issues firmwide.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
CRITICAL ACCOUNTING ESTIMATES USED BY THE FIRM
JPMorgan Chase’s accounting policies and use of estimates are integral to understanding its reported results. The Firm’s most complex accounting estimates require management’s judgment to ascertain the appropriate carrying value of assets and liabilities. The Firm has established policies and control procedures intended to ensure that estimation methods, including any judgments made as part of such methods, are well-controlled, independently reviewed and applied consistently from period to period. The methods used and judgments made reflect, among other factors, the nature of the assets or liabilities and the related business and risk management strategies, which may vary across the Firm’s businesses and portfolios. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The Firm believes its estimates for determining the carrying value of its assets and liabilities are appropriate. The following is a brief description of the Firm’s critical accounting estimates involving significant judgments.
Allowance for credit losses
JPMorgan Chase’s allowance for credit losses covers the retained consumer and wholesale loan portfolios, as well as the Firm’s wholesale and certain consumer lending-related commitments. The allowance for loan losses is intended to adjust the carrying value of the Firm’s loan assets to reflect probable credit losses inherent in the loan portfolio as of the balance sheet date. Similarly, the allowance for lending-related commitments is established to cover probable credit losses inherent in the lending-related commitments portfolio as of the balance sheet date.
The allowance for credit losses includes a formula-based component, an asset-specific component, and a component related to PCI loans. The determination of each of these components involves significant judgment on a number of matters. For further discussion of these components, areas of judgment and methodologies used in establishing the Firm’s allowance for credit losses, see Note 15.
Allowance for credit losses sensitivity
The Firm’s allowance for credit losses is sensitive to numerous factors, which may differ depending on the portfolio. Changes in economic conditions or in the Firm’s assumptions and estimates could affect its estimate of probable credit losses inherent in the portfolio at the balance sheet date. The Firm uses its best judgment to assess these economic conditions and loss data in estimating the allowance for credit losses and these estimates are subject to periodic refinement based on changes to underlying external or Firm-specific historical data. The use of alternate estimates, data sources, adjustments to modeled loss estimates for model imprecision and other factors would result in a different estimated allowance for credit losses.
To illustrate the potential magnitude of certain alternate judgments, the Firm estimates that changes in the following inputs would have the following effects on the Firm’s modeled credit loss estimates as of December 31, 2016, without consideration of any offsetting or correlated effects of other inputs in the Firm’s allowance for loan losses:
•
For PCI loans, a combined 5% decline in housing prices and a 100 basis point increase in unemployment rates from current levels could imply an increase to modeled credit loss estimates of approximately $600 million.
•
For the residential real estate portfolio, excluding PCI loans, a combined 5% decline in housing prices and a 100 basis point increase in unemployment rates from current levels could imply an increase to modeled annual loss estimates of approximately $125 million.
•
For credit card loans, a 100 basis point increase in unemployment rates from current levels could imply an increase to modeled annual loss estimates of approximately $900 million.
•
An increase in PD factors consistent with a one-notch downgrade in the Firm’s internal risk ratings for its entire wholesale loan portfolio could imply an increase in the Firm’s modeled loss estimates of approximately $2.3 billion.
•
A 100 basis point increase in estimated LGD for the Firm’s entire wholesale loan portfolio could imply an increase in the Firm’s modeled credit loss estimates of approximately $175 million.
The purpose of these sensitivity analyses is to provide an indication of the isolated impacts of hypothetical alternative assumptions on modeled loss estimates. The changes in the inputs presented above are not intended to imply management’s expectation of future deterioration of those risk factors. In addition, these analyses are not intended to estimate changes in the overall allowance for loan losses, which would also be influenced by the judgment management applies to the modeled loss estimates to reflect the uncertainty and imprecision of these modeled loss estimates based on then-current circumstances and conditions.
It is difficult to estimate how potential changes in specific factors might affect the overall allowance for credit losses because management considers a variety of factors and inputs in estimating the allowance for credit losses. Changes in these factors and inputs may not occur at the same rate and may not be consistent across all geographies or product types, and changes in factors may be directionally inconsistent, such that improvement in one factor may offset deterioration in other factors. In addition, it is difficult to predict how changes in specific economic conditions or assumptions could affect borrower behavior or other factors considered by management in estimating the allowance for credit losses. Given the process the Firm
JPMorgan Chase & Co./2016 Annual Report
follows and the judgments made in evaluating the risk factors related to its loss estimates, management believes that its current estimate of the allowance for credit losses is appropriate.
Fair value of financial instruments, MSRs and commodities inventory
JPMorgan Chase carries a portion of its assets and liabilities at fair value. The majority of such assets and liabilities are measured at fair value on a recurring basis. Certain assets and liabilities are measured at fair value on a nonrecurring basis, including certain mortgage, home equity and other loans, where the carrying value is based on the fair value of the underlying collateral.
Assets measured at fair value
The following table includes the Firm’s assets measured at fair value and the portion of such assets that are classified within level 3 of the valuation hierarchy. For further information, see Note 3.
(a)
For purposes of table above, the derivative receivables total reflects the impact of netting adjustments; however, the $5.8 billion of derivative receivables classified as level 3 does not reflect the netting adjustment as such netting is not relevant to a presentation based on the transparency of inputs to the valuation of an asset. The level 3 balances would be reduced if netting were applied, including the netting benefit associated with cash collateral.
(b)
Private equity instruments represent investments within Corporate.
Valuation
Details of the Firm’s processes for determining fair value are set out in Note 3. Estimating fair value requires the application of judgment. The type and level of judgment required is largely dependent on the amount of observable market information available to the Firm. For instruments valued using internally developed models that use significant unobservable inputs and are therefore classified within level 3 of the valuation hierarchy, judgments used to estimate fair value are more significant than those required when estimating the fair value of instruments classified within levels 1 and 2.
In arriving at an estimate of fair value for an instrument within level 3, management must first determine the appropriate model to use. Second, the lack of observability of certain significant inputs requires management to assess all relevant empirical data in deriving valuation inputs including, for example, transaction details, yield curves, interest rates, prepayment rates, default rates, volatilities, correlations, equity or debt prices, valuations of comparable instruments, foreign exchange rates and credit curves. For further discussion of the valuation of level 3 instruments, including unobservable inputs used, see
Note 3.
For instruments classified in levels 2 and 3, management judgment must be applied to assess the appropriate level of valuation adjustments to reflect counterparty credit quality, the Firm’s creditworthiness, market funding rates, liquidity considerations, unobservable parameters, and for portfolios that meet specified criteria, the size of the net open risk position. The judgments made are typically affected by the type of product and its specific contractual terms, and the level of liquidity for the product or within the market as a whole. For further discussion of valuation adjustments applied by the Firm see Note 3.
Imprecision in estimating unobservable market inputs or other factors can affect the amount of gain or loss recorded for a particular position. Furthermore, while the Firm believes its valuation methods are appropriate and consistent with those of other market participants, the methods and assumptions used reflect management judgment and may vary across the Firm’s businesses and portfolios.
The Firm uses various methodologies and assumptions in the determination of fair value. The use of methodologies or assumptions different than those used by the Firm could result in a different estimate of fair value at the reporting date. For a detailed discussion of the Firm’s valuation process and hierarchy, and its determination of fair value for individual financial instruments, see Note 3.
Goodwill impairment
Under U.S. GAAP, goodwill must be allocated to reporting units and tested for impairment at least annually. The Firm’s process and methodology used to conduct goodwill impairment testing is described in Note 17.
Management applies significant judgment when estimating the fair value of its reporting units. Estimates of fair value are dependent upon estimates of (a) the future earnings potential of the Firm’s reporting units, including the estimated effects of regulatory and legislative changes, (b) long-term growth rates and (c) the estimated market cost of equity. Imprecision in estimating these factors can affect the estimated fair value of the reporting units.
Based upon the updated valuations for all of its reporting units, the Firm concluded that the goodwill allocated to its reporting units was not impaired at December 31, 2016. The fair values of these reporting units exceeded their carrying values by approximately 10% - 130% for all
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
reporting units and did not indicate a significant risk of goodwill impairment based on current projections and valuations.
The projections for all of the Firm’s reporting units are consistent with management’s current short-term business outlook assumptions, and in the longer term, incorporate a set of macroeconomic assumptions and the Firm’s best estimates of long-term growth and returns on equity of its businesses. Where possible, the Firm uses third-party and peer data to benchmark its assumptions and estimates.
Declines in business performance, increases in credit losses, increases in equity capital requirements, as well as deterioration in economic or market conditions, adverse estimates of regulatory or legislative changes or increases in the estimated market cost of equity, could cause the estimated fair values of the Firm’s reporting units or their associated goodwill to decline in the future, which could result in a material impairment charge to earnings in a future period related to some portion of the associated goodwill.
For additional information on goodwill, see Note 17.
Income taxes
JPMorgan Chase is subject to the income tax laws of the various jurisdictions in which it operates, including U.S. federal, state and local, and non-U.S. jurisdictions. These laws are often complex and may be subject to different interpretations. To determine the financial statement impact of accounting for income taxes, including the provision for income tax expense and unrecognized tax benefits, JPMorgan Chase must make assumptions and judgments about how to interpret and apply these complex tax laws to numerous transactions and business events, as well as make judgments regarding the timing of when certain items may affect taxable income in the U.S. and non-U.S. tax jurisdictions.
JPMorgan Chase’s interpretations of tax laws around the world are subject to review and examination by the various taxing authorities in the jurisdictions where the Firm operates, and disputes may occur regarding its view on a tax position. These disputes over interpretations with the various taxing authorities may be settled by audit, administrative appeals or adjudication in the court systems of the tax jurisdictions in which the Firm operates. JPMorgan Chase regularly reviews whether it may be assessed additional income taxes as a result of the resolution of these matters, and the Firm records additional reserves as appropriate. In addition, the Firm may revise its estimate of income taxes due to changes in income tax laws, legal interpretations, and business strategies. It is possible that revisions in the Firm’s estimate of income taxes may materially affect the Firm’s results of operations in any reporting period.
The Firm’s provision for income taxes is composed of current and deferred taxes. Deferred taxes arise from differences between assets and liabilities measured for financial reporting versus income tax return purposes. Deferred tax assets are recognized if, in management’s judgment, their realizability is determined to be more likely than not. The Firm has also recognized deferred tax assets in connection with certain NOLs and tax credits. The Firm
performs regular reviews to ascertain whether its deferred tax assets are realizable. These reviews include management’s estimates and assumptions regarding future taxable income, which also incorporates various tax planning strategies, including strategies that may be available to utilize NOLs before they expire. In connection with these reviews, if it is determined that a deferred tax asset is not realizable, a valuation allowance is established. The valuation allowance may be reversed in a subsequent reporting period if the Firm determines that, based on revised estimates of future taxable income or changes in tax planning strategies, it is more likely than not that all or part of the deferred tax asset will become realizable. As of December 31, 2016, management has determined it is more likely than not that the Firm will realize its deferred tax assets, net of the existing valuation allowance.
JPMorgan Chase does not record U.S. federal income taxes on the undistributed earnings of certain non-U.S. subsidiaries, to the extent management has determined such earnings have been reinvested abroad for an indefinite period of time. Changes to the income tax rates applicable to these non-U.S. subsidiaries may have a material impact on the effective tax rate in a future period if such changes were to occur.
The Firm adjusts its unrecognized tax benefits as necessary when additional information becomes available. Uncertain tax positions that meet the more-likely-than-not recognition threshold are measured to determine the amount of benefit to recognize. An uncertain tax position is measured at the largest amount of benefit that management believes is more likely than not to be realized upon settlement. It is possible that the reassessment of JPMorgan Chase’s unrecognized tax benefits may have a material impact on its effective income tax rate in the period in which the reassessment occurs.
For additional information on income taxes, see Note 26.
Litigation reserves
For a description of the significant estimates and judgments associated with establishing litigation reserves, see
Note 31.
JPMorgan Chase & Co./2016 Annual Report
ACCOUNTING AND REPORTING DEVELOPMENTS
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
JPMorgan Chase & Co./2016 Annual Report
(a)
Early adoption is permitted.
(b)
Early adoption is permitted on January 1, 2019.
JPMorgan Chase & Co./2016 Annual Report
Management’s discussion and analysis
FORWARD-LOOKING STATEMENTS
From time to time, the Firm has made and will make forward-looking statements. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as “anticipate,” “target,” “expect,” “estimate,” “intend,” “plan,” “goal,” “believe,” or other words of similar meaning. Forward-looking statements provide JPMorgan Chase’s current expectations or forecasts of future events, circumstances, results or aspirations. JPMorgan Chase’s disclosures in this Annual Report contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Firm also may make forward-looking statements in its other documents filed or furnished with the SEC. In addition, the Firm’s senior management may make forward-looking statements orally to investors, analysts, representatives of the media and others.
All forward-looking statements are, by their nature, subject to risks and uncertainties, many of which are beyond the Firm’s control. JPMorgan Chase’s actual future results may differ materially from those set forth in its forward-looking statements. While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain factors which could cause actual results to differ from those in the forward-looking statements:
•
Local, regional and global business, economic and political conditions and geopolitical events;
•
Changes in laws and regulatory requirements, including
capital and liquidity requirements affecting the Firm’s businesses, and the ability of the Firm to address those requirements;
•
Heightened regulatory and governmental oversight and scrutiny of JPMorgan Chase’s business practices, including dealings with retail customers;
•
Changes in trade, monetary and fiscal policies and laws;
•
Changes in income tax laws and regulations;
•
Securities and capital markets behavior, including changes in market liquidity and volatility;
•
Changes in investor sentiment or consumer spending or savings behavior;
•
Ability of the Firm to manage effectively its capital and liquidity, including approval of its capital plans by banking regulators;
•
Changes in credit ratings assigned to the Firm or its subsidiaries;
•
Damage to the Firm’s reputation;
•
Ability of the Firm to deal effectively with an economic slowdown or other economic or market disruption;
•
Technology changes instituted by the Firm, its counterparties or competitors;
•
The success of the Firm’s business simplification initiatives and the effectiveness of its control agenda;
•
Ability of the Firm to develop new products and services, and the extent to which products or services previously sold by the Firm (including but not limited to mortgages and asset-backed securities) require the Firm to incur liabilities or absorb losses not contemplated at their initiation or origination;
•
Acceptance of the Firm’s new and existing products and services by the marketplace and the ability of the Firm to innovate and to increase market share;
•
Ability of the Firm to attract and retain qualified employees;
•
Ability of the Firm to control expense;
•
Competitive pressures;
•
Changes in the credit quality of the Firm’s customers and counterparties;
•
Adequacy of the Firm’s risk management framework, disclosure controls and procedures and internal control over financial reporting;
•
Adverse judicial or regulatory proceedings;
•
Changes in applicable accounting policies, including the introduction of new accounting standards;
•
Ability of the Firm to determine accurate values of certain assets and liabilities;
•
Occurrence of natural or man-made disasters or calamities or conflicts and the Firm’s ability to deal effectively with disruptions caused by the foregoing;
•
Ability of the Firm to maintain the security of its financial, accounting, technology, data processing and other operational systems and facilities;
•
Ability of the Firm to effectively defend itself against cyberattacks and other attempts by unauthorized parties to access information of the Firm or its customers or to disrupt the Firm’s systems; and
•
The other risks and uncertainties detailed in Part I, Item 1A: Risk Factors in the Firm’s Annual Report on Form 10-K for the year ended December 31, 2016.
Any forward-looking statements made by or on behalf of the Firm speak only as of the date they are made, and JPMorgan Chase does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. The reader should, however, consult any further disclosures of a forward-looking nature the Firm may make in any subsequent Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, or Current Reports on Form 8-K.
JPMorgan Chase & Co./2016 Annual Report
Management’s report on internal control over financial reporting
Management of JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Firm’s principal executive and principal financial officers, or persons performing similar functions, and effected by JPMorgan Chase’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
JPMorgan Chase’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Firm’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Firm are being made only in accordance with authorizations of JPMorgan Chase’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Firm’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management has completed an assessment of the effectiveness of the Firm’s internal control over financial reporting as of December 31, 2016. In making the assessment, management used the “Internal Control - Integrated Framework” (“COSO 2013”) promulgated by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based upon the assessment performed, management concluded that as of December 31, 2016, JPMorgan Chase’s internal control over financial reporting was effective based upon the COSO 2013 framework. Additionally, based upon management’s assessment, the Firm determined that there were no material weaknesses in its internal control over financial reporting as of December 31, 2016.
The effectiveness of the Firm’s internal control over financial reporting as of December 31, 2016, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
James Dimon
Chairman and Chief Executive Officer
Marianne Lake
Executive Vice President and Chief Financial Officer
February 28, 2017
JPMorgan Chase & Co./2016 Annual Report
Report of independent registered public accounting firm
To the Board of Directors and Stockholders of JPMorgan Chase & Co.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of JPMorgan Chase & Co. and its subsidiaries (the “Firm”) at December 31, 2016 and 2015 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Firm maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Firm’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s report on internal control over financial reporting”. Our responsibility is to express opinions on these financial statements and on the Firm’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
February 28, 2017
PricewaterhouseCoopers LLP  300 Madison Avenue  New York, NY 10017
JPMorgan Chase & Co./2016 Annual Report
Consolidated statements of income
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co./2016 Annual Report
Consolidated statements of comprehensive income
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co./2016 Annual Report
Consolidated balance sheets
(a)
The following table presents information on assets and liabilities related to VIEs that are consolidated by the Firm at December 31, 2016 and 2015. The difference between total VIE assets and liabilities represents the Firm’s interests in those entities, which were eliminated in consolidation.
December 31, (in millions)
Assets
Trading assets
$
3,185
$
3,736
Loans
75,614
75,104
All other assets
3,321
2,765
Total assets
$
82,120
$
81,605
Liabilities
Beneficial interests issued by consolidated VIEs
$
39,047
$
41,879
All other liabilities
Total liabilities
$
39,537
$
42,688
The assets of the consolidated VIEs are used to settle the liabilities of those entities. The holders of the beneficial interests do not have recourse to the general credit of JPMorgan Chase. At December 31, 2016 and 2015, the Firm provided limited program-wide credit enhancement of $2.4 billion and $2.0 billion, respectively, related to its Firm-administered multi-seller conduits, which are eliminated in consolidation. For further discussion, see Note 16.
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co./2016 Annual Report
Consolidated statements of changes in stockholders’ equity
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co./2016 Annual Report
Consolidated statements of cash flows
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 1 - Basis of presentation
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the U.S., with operations worldwide. The Firm is a leader in investment banking, financial services for consumers and small business, commercial banking, financial transaction processing and asset management. For a discussion of the Firm’s business segments, see Note 33.
The accounting and financial reporting policies of JPMorgan Chase and its subsidiaries conform to U.S. GAAP. Additionally, where applicable, the policies conform to the accounting and reporting guidelines prescribed by regulatory authorities.
Certain amounts reported in prior periods have been reclassified to conform with the current presentation.
Consolidation
The Consolidated Financial Statements include the accounts of JPMorgan Chase and other entities in which the Firm has a controlling financial interest. All material intercompany balances and transactions have been eliminated.
Assets held for clients in an agency or fiduciary capacity by the Firm are not assets of JPMorgan Chase and are not included on the Consolidated balance sheets.
The Firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity.
Effective January 1, 2016, the Firm adopted new accounting guidance related to the consolidation of legal entities such as limited partnerships, limited liability corporations, and securitization structures. The guidance eliminated the deferral issued by the FASB in February 2010 of the accounting guidance for VIEs for certain investment funds, including mutual funds, private equity funds and hedge funds. In addition, the guidance amends the evaluation of fees paid to a decision-maker or a service provider, and exempts certain money market funds from consolidation. Furthermore, asset management funds structured as limited partnerships or certain limited liability companies are now evaluated for consolidation as voting interest entities if the non-managing partners or members have the ability to remove the Firm as the general partner or managing member without cause (i.e., kick-out rights) based on a simple majority vote, or the non-affiliated partners or members have rights to participate in important decisions. Accordingly, the Firm does not consolidate these voting interest entities. However, in the limited cases where the non-managing partners or members do not have substantive kick-out or participating rights, the Firm evaluates the funds as VIEs and consolidates if it is the general partner or managing member and has a potentially significant variable interest. There was no material impact on the Firm’s Consolidated
Financial Statements upon adoption of this accounting guidance.
Voting Interest Entities
Voting interest entities are entities that have sufficient equity and provide the equity investors voting rights that enable them to make significant decisions relating to the entity’s operations. For these types of entities, the Firm’s determination of whether it has a controlling interest is primarily based on the amount of voting equity interests held. Entities in which the Firm has a controlling financial interest, through ownership of the majority of the entities’ voting equity interests, or through other contractual rights that give the Firm control, are consolidated by the Firm.
Investments in companies in which the Firm has significant influence over operating and financing decisions (but does not own a majority of the voting equity interests) are accounted for (i) in accordance with the equity method of accounting (which requires the Firm to recognize its proportionate share of the entity’s net earnings), or (ii) at fair value if the fair value option was elected. These investments are generally included in other assets, with income or loss included in other income.
Certain Firm-sponsored asset management funds are structured as limited partnerships or limited liability companies. For many of these entities, the Firm is the general partner or managing member, but the non-affiliated partners or members have the ability to remove the Firm as the general partner or managing member without cause (i.e., kick-out rights), based on a simple majority vote, or the non-affiliated partners or members have rights to participate in important decisions. Accordingly, the Firm does not consolidate these funds. In the limited cases where the nonaffiliated partners or members do not have substantive kick-out or participating rights, the Firm consolidates the funds.
The Firm’s investment companies have investments in both publicly-held and privately-held entities, including investments in buyouts, growth equity and venture opportunities. These investments are accounted for under investment company guidelines and accordingly, irrespective of the percentage of equity ownership interests held, are carried on the Consolidated balance sheets at fair value, and are recorded in other assets.
Variable Interest Entities
VIEs are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make significant decisions relating to the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity.
JPMorgan Chase & Co./2016 Annual Report
The most common type of VIE is an SPE. SPEs are commonly used in securitization transactions in order to isolate certain assets and distribute the cash flows from those assets to investors. The basic SPE structure involves a company selling assets to the SPE; the SPE funds the purchase of those assets by issuing securities to investors. The legal documents that govern the transaction specify how the cash earned on the assets must be allocated to the SPE’s investors and other parties that have rights to those cash flows. SPEs are generally structured to insulate investors from claims on the SPE’s assets by creditors of other entities, including the creditors of the seller of the assets.
The primary beneficiary of a VIE (i.e., the party that has a controlling financial interest) is required to consolidate the assets and liabilities of the VIE. The primary beneficiary is the party that has both (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance; and (2) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.
To assess whether the Firm has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, the Firm considers all the facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes, first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE (such as asset managers, collateral managers, servicers, or owners of call options or liquidation rights over the VIE’s assets) or have the right to unilaterally remove those decision-makers are deemed to have the power to direct the activities of a VIE.
To assess whether the Firm has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, the Firm considers all of its economic interests, including debt and equity investments, servicing fees, and derivatives or other arrangements deemed to be variable interests in the VIE. This assessment requires that the Firm apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by the Firm.
The Firm performs on-going reassessments of: (1) whether entities previously evaluated under the majority voting-interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework; and (2) whether changes in the facts and circumstances regarding the Firm’s involvement with a VIE cause the Firm’s consolidation conclusion to change.
Use of estimates in the preparation of consolidated financial statements
The preparation of the Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expense, and disclosures of contingent assets and liabilities. Actual results could be different from these estimates.
Foreign currency translation
JPMorgan Chase revalues assets, liabilities, revenue and expense denominated in non-U.S. currencies into U.S. dollars using applicable exchange rates.
Gains and losses relating to translating functional currency financial statements for U.S. reporting are included in OCI within stockholders’ equity. Gains and losses relating to nonfunctional currency transactions, including non-U.S. operations where the functional currency is the U.S. dollar, are reported in the Consolidated statements of income.
Offsetting assets and liabilities
U.S. GAAP permits entities to present derivative receivables and derivative payables with the same counterparty and the related cash collateral receivables and payables on a net basis on the Consolidated balance sheets when a legally enforceable master netting agreement exists. U.S. GAAP also permits securities sold and purchased under repurchase agreements to be presented net when specified conditions are met, including the existence of a legally enforceable master netting agreement. The Firm has elected to net such balances when the specified conditions are met.
The Firm uses master netting agreements to mitigate counterparty credit risk in certain transactions, including derivatives transactions, repurchase and reverse repurchase agreements, and securities borrowed and loaned agreements. A master netting agreement is a single contract with a counterparty that permits multiple transactions governed by that contract to be terminated and settled through a single payment in a single currency in the event of a default (e.g., bankruptcy, failure to make a required payment or securities transfer or deliver collateral or margin when due after expiration of any grace period). Upon the exercise of termination rights by the non-defaulting party (i) all transactions are terminated, (ii) all transactions are valued and the positive value or “in the money” transactions are netted against the negative value or “out of the money” transactions and (iii) the only remaining payment obligation is of one of the parties to pay the netted termination amount. Upon exercise of repurchase agreement and securities loan default rights in general (i) all transactions are terminated and accelerated, (ii) all values of securities or cash held or to be delivered are calculated, and all such sums are netted against each other and (iii) the only remaining payment obligation is of one of the parties to pay the netted termination amount.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Typical master netting agreements for these types of transactions also often contain a collateral/margin agreement that provides for a security interest in, or title transfer of, securities or cash collateral/margin to the party that has the right to demand margin (the “demanding party”). The collateral/margin agreement typically requires a party to transfer collateral/margin to the demanding party with a value equal to the amount of the margin deficit on a net basis across all transactions governed by the master netting agreement, less any threshold. The collateral/margin agreement grants to the demanding party, upon default by the counterparty, the right to set-off any amounts payable by the counterparty against any posted collateral or the cash equivalent of any posted collateral/margin. It also grants to the demanding party the right to liquidate collateral/margin and to apply the proceeds to an amount payable by the counterparty.
For further discussion of the Firm’s derivative instruments, see Note 6. For further discussion of the Firm’s repurchase and reverse repurchase agreements, and securities borrowing and lending agreements, see Note 13.
Statements of cash flows
For JPMorgan Chase’s Consolidated statements of cash flows, cash is defined as those amounts included in cash and due from banks.
Significant accounting policies
The following table identifies JPMorgan Chase’s other significant accounting policies and the Note and page where a detailed description of each policy can be found.
Fair value measurement
Note 3
Fair value option
Note 4
Derivative instruments
Note 6
Noninterest revenue
Note 7
Interest income and interest expense
Note 8
Pension and other postretirement employee benefit plans
Note 9
Employee stock-based incentives
Note 10
Securities
Note 12
Securities financing activities
Note 13
Loans
Note 14
Allowance for credit losses
Note 15
Variable interest entities
Note 16
Goodwill and Mortgage servicing rights
Note 17
Premises and equipment
Note 18
Long-term debt
Note 21
Income taxes
Note 26
Off-balance sheet lending-related financial instruments, guarantees and other commitments
Note 29
Litigation
Note 31
Note 2 - Business changes and developments
None
JPMorgan Chase & Co./2016 Annual Report
Note 3 - Fair value measurement
JPMorgan Chase carries a portion of its assets and liabilities at fair value. These assets and liabilities are predominantly carried at fair value on a recurring basis (i.e., assets and liabilities that are measured and reported at fair value on the Firm’s Consolidated balance sheets). Certain assets (e.g., certain mortgage, home equity and other loans where the carrying value is based on the fair value of the underlying collateral), liabilities and unfunded lending-related commitments are measured at fair value on a nonrecurring basis; that is, they are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment).
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is based on quoted market prices or inputs, where available. If prices or quotes are not available, fair value is based on models that consider relevant transaction characteristics (such as maturity) and use as inputs observable or unobservable market parameters, including but not limited to yield curves, interest rates, volatilities, equity or debt prices, foreign exchange rates and credit curves. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, as described below.
The level of precision in estimating unobservable market inputs or other factors can affect the amount of gain or loss recorded for a particular position. Furthermore, while the Firm believes its valuation methods are appropriate and consistent with those of other market participants, the methods and assumptions used reflect management judgment and may vary across the Firm’s businesses and portfolios.
The Firm uses various methodologies and assumptions in the determination of fair value. The use of different methodologies or assumptions by other market participants compared with those used by the Firm could result in a different estimate of fair value at the reporting date.
Valuation process
Risk-taking functions are responsible for providing fair value estimates for assets and liabilities carried on the Consolidated balance sheets at fair value. The Firm’s VCG, which is part of the Firm’s Finance function and independent of the risk-taking functions, is responsible for verifying these estimates and determining any fair value adjustments that may be required to ensure that the Firm’s positions are recorded at fair value. The VGF is composed of senior finance and risk executives and is responsible for overseeing the management of risks arising from valuation activities conducted across the Firm. The VGF is chaired by the Firmwide head of the VCG (under the direction of the Firm’s Controller), and includes sub-forums covering the CIB, CCB, CB, AWM and certain corporate functions including Treasury and CIO.
Price verification process
The VCG verifies fair value estimates provided by the risk-taking functions by leveraging independently derived prices, valuation inputs and other market data, where available. Where independent prices or inputs are not available, the VCG performs additional review to ensure the reasonableness of the estimates. The additional review may include evaluating the limited market activity including client unwinds, benchmarking valuation inputs to those used for similar instruments, decomposing the valuation of structured instruments into individual components, comparing expected to actual cash flows, reviewing profit and loss trends, and reviewing trends in collateral valuation. There are also additional levels of management review for more significant or complex positions.
The VCG determines any valuation adjustments that may be required to the estimates provided by the risk-taking functions. No adjustments are applied for instruments classified within level 1 of the fair value hierarchy (see below for further information on the fair value hierarchy). For other positions, judgment is required to assess the need for valuation adjustments to appropriately reflect liquidity considerations, unobservable parameters, and, for certain portfolios that meet specified criteria, the size of the net open risk position. The determination of such adjustments follows a consistent framework across the Firm:
•
Liquidity valuation adjustments are considered where an observable external price or valuation parameter exists but is of lower reliability, potentially due to lower market activity. Liquidity valuation adjustments are applied and determined based on current market conditions. Factors that may be considered in determining the liquidity adjustment include analysis of: (1) the estimated bid-offer spread for the instrument being traded; (2) alternative pricing points for similar instruments in active markets; and (3) the range of reasonable values that the price or parameter could take.
•
The Firm manages certain portfolios of financial instruments on the basis of net open risk exposure and, as permitted by U.S. GAAP, has elected to estimate the fair value of such portfolios on the basis of a transfer of the entire net open risk position in an orderly transaction. Where this is the case, valuation adjustments may be necessary to reflect the cost of exiting a larger-than-normal market-size net open risk position. Where applied, such adjustments are based on factors that a relevant market participant would consider in the transfer of the net open risk position, including the size of the adverse market move that is likely to occur during the period required to reduce the net open risk position to a normal market-size.
•
Unobservable parameter valuation adjustments may be made when positions are valued using prices or input parameters to valuation models that are unobservable due to a lack of market activity or because they cannot
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
be implied from observable market data. Such prices or parameters must be estimated and are, therefore, subject to management judgment. Unobservable parameter valuation adjustments are applied to reflect the uncertainty inherent in the resulting valuation estimate.
•
Where appropriate, the Firm also applies adjustments to its estimates of fair value in order to appropriately reflect counterparty credit quality (CVA), the Firm’s own creditworthiness (DVA) and the impact of funding (FVA), using a consistent framework across the Firm. For more information on such adjustments see Credit and funding adjustments on page 164 of this Note.
Valuation model review and approval
If prices or quotes are not available for an instrument or a similar instrument, fair value is generally determined using valuation models that consider relevant transaction data such as maturity and use as inputs market-based or independently sourced parameters. Where this is the case the price verification process described above is applied to the inputs to those models.
The Model Risk function reviews and approves a wide range of models, including risk management, valuation, and regulatory capital models used by the Firm. The Model Risk function is independent of model users and developers. The Firmwide Model Risk Executive reports to the Firm’s CRO. When reviewing a model, the Model Risk function analyzes and challenges the model methodology, and the reasonableness of model assumptions and may perform or require additional testing, including back-testing of model outcomes.
The Model Risk function reviews and approves new models, as well as material changes to existing models, prior to implementation in the operating environment. In certain circumstances, the head of the Model Risk function may grant exceptions to the Firm’s model risk policy to allow a model to be used prior to review or approval. The Model Risk function may also require the user to take appropriate actions to mitigate the model risk if it is to be used in the interim.
Valuation hierarchy
A three-level valuation hierarchy has been established under U.S. GAAP for disclosure of fair value measurements. The valuation hierarchy is based on the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows.
•
Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•
Level 3 - one or more inputs to the valuation methodology are unobservable and significant to the fair value measurement.
A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.
JPMorgan Chase & Co./2016 Annual Report
The following table describes the valuation methodologies generally used by the Firm to measure its significant products/instruments at fair value, including the general classification of such instruments pursuant to the valuation hierarchy.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
JPMorgan Chase & Co./2016 Annual Report
(a)
Excludes certain investments that are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following table presents the assets and liabilities reported at fair value as of December 31, 2016 and 2015, by major product category and fair value hierarchy.
JPMorgan Chase & Co./2016 Annual Report
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
At December 31, 2016 and 2015, included total U.S. government-sponsored enterprise obligations of $80.6 billion and $67.0 billion, respectively, which were predominantly mortgage-related.
(b)
At December 31, 2016 and 2015, included within trading loans were $16.5 billion and $11.8 billion, respectively, of residential first-lien mortgages, and $3.3 billion and $4.3 billion, respectively, of commercial first-lien mortgages. Residential mortgage loans include conforming mortgage loans originated with the intent to sell to U.S. government agencies of $11.0 billion and $5.3 billion, respectively, and reverse mortgages of $2.0 billion and $2.5 billion, respectively.
(c)
Physical commodities inventories are generally accounted for at the lower of cost or market. “Market” is a term defined in U.S. GAAP as not exceeding fair value less costs to sell (“transaction costs”). Transaction costs for the Firm’s physical commodities inventories are either not applicable or immaterial to the value of the inventory. Therefore, market approximates fair value for the Firm’s physical commodities inventories. When fair value hedging has been applied (or when market is below cost), the carrying value of physical commodities approximates fair value, because under fair value hedge accounting, the cost basis is adjusted for changes in fair value. For a further discussion of the Firm’s hedge accounting relationships, see Note 6. To provide consistent fair value disclosure information, all physical commodities inventories have been included in each period presented.
(d)
Balances reflect the reduction of securities owned (long positions) by the amount of identical securities sold but not yet purchased (short positions).
(e)
As permitted under U.S. GAAP, the Firm has elected to net derivative receivables and derivative payables and the related cash collateral received and paid when a legally enforceable master netting agreement exists. For purposes of the tables above, the Firm does not reduce derivative receivables and derivative payables balances for this netting adjustment, either within or across the levels of the fair value hierarchy, as such netting is not relevant to a presentation based on the transparency of inputs to the valuation of an asset or liability. The level 3 balances would be reduced if netting were applied, including the netting benefit associated with cash collateral.
(f)
Certain investments that are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient are not required to be classified in the fair value hierarchy. At December 31, 2016 and 2015, the fair values of these investments, which include certain hedge funds, private equity funds, real estate and other funds, were $1.0 billion and $1.2 billion, respectively. Included in the balances at December 31, 2016 and 2015, were trading assets of $52 million and $61 million, respectively, and other assets of $1.0 billion and $1.2 billion, respectively.
(g)
Private equity instruments represent investments within Corporate. The portion of the private equity investment portfolio carried at fair value on a recurring basis had a cost basis of $2.5 billion and $3.5 billion at December 31, 2016 and 2015, respectively.
Transfers between levels for instruments carried at
fair value on a recurring basis
For the years ended December 31, 2016 and 2015, there were no significant transfers between levels 1 and 2.
During the year ended December 31, 2016, transfers from level 3 to level 2 included the following:
•
$1.4 billion of long-term debt driven by an increase in observability and a reduction of the significance in the unobservable inputs for certain structured notes.
During the year ended December 31, 2016, transfers from level 2 to level 3 included the following:
•
$1.1 billion of gross equity derivative receivables and $1.0 billion of gross equity derivative payables as a result of a decrease in observability and an increase in the significance in unobservable inputs.
•
$1.0 billion of trading loans driven by a decrease in observability.
During the year ended December 31, 2015, transfers from level 3 to level 2 included the following:
•
$3.1 billion of long-term debt and $1.0 billion of deposits driven by an increase in observability on certain structured notes with embedded interest rate and FX derivatives and a reduction of the significance in the unobservable inputs for certain structured notes with embedded equity derivatives.
•
$2.1 billion of gross equity derivatives for both receivables and payables as a result of an increase in observability and a decrease in the significance in unobservable inputs; partially offset by transfers into level 3 resulting in net transfers of approximately $1.2 billion for both receivables and payables.
•
$2.8 billion of trading loans driven by an increase in observability of certain collateralized financing transactions.
During the year ended December 31, 2015, transfers from level 2 to level 3 included the following:
•
$2.4 billion of corporate debt driven by a decrease in the significance in the unobservable inputs and an increase in observability for certain structured products
During the year ended December 31, 2014, transfers from level 3 to level 2 included the following:
•
$4.3 billion and $4.4 billion of gross equity derivative receivables and payables, respectively, due to increased observability of certain equity option valuation inputs
•
$2.7 billion of trading loans, $2.6 billion of margin loans, $2.3 billion of private equity investments, $2.0 billion of corporate debt, and $1.3 billion of long-term debt, based on increased liquidity and price transparency
•
Transfers from level 2 into level 3 included $1.1 billion of other borrowed funds, $1.1 billion of trading loans and $1.0 billion of long-term debt, based on a decrease in observability of valuation inputs and price transparency.
All transfers are assumed to occur at the beginning of the quarterly reporting period in which they occur.
JPMorgan Chase & Co./2016 Annual Report
Level 3 valuations
The Firm has established well-structured processes for determining fair value, including for instruments where fair value is estimated using significant unobservable inputs (level 3). For further information on the Firm’s valuation process and a detailed discussion of the determination of fair value for individual financial instruments, see pages 150-153 of this Note.
Estimating fair value requires the application of judgment. The type and level of judgment required is largely dependent on the amount of observable market information available to the Firm. For instruments valued using internally developed models that use significant unobservable inputs and are therefore classified within level 3 of the fair value hierarchy, judgments used to estimate fair value are more significant than those required when estimating the fair value of instruments classified within levels 1 and 2.
In arriving at an estimate of fair value for an instrument within level 3, management must first determine the appropriate model to use. Second, due to the lack of observability of significant inputs, management must assess all relevant empirical data in deriving valuation inputs including, but not limited to, transaction details, yield curves, interest rates, prepayment speed, default rates, volatilities, correlations, equity or debt prices, valuations of comparable instruments, foreign exchange rates and credit curves.
The following table presents the Firm’s primary level 3 financial instruments, the valuation techniques used to measure the fair value of those financial instruments, the significant unobservable inputs, the range of values for those inputs and, for certain instruments, the weighted averages of such inputs. While the determination to classify an instrument within level 3 is based on the significance of the unobservable inputs to the overall fair value measurement, level 3 financial instruments typically include observable components (that is, components that are actively quoted and can be validated to external sources) in addition to the unobservable components. The level 1 and/or level 2 inputs are not included in the table. In addition, the Firm manages the risk of the observable components of level 3 financial instruments using securities and derivative positions that are classified within levels 1 or 2 of the fair value hierarchy.
The range of values presented in the table is representative of the highest and lowest level input used to value the significant groups of instruments within a product/instrument classification. Where provided, the weighted averages of the input values presented in the table are calculated based on the fair value of the instruments that the input is being used to value.
In the Firm’s view, the input range and the weighted average value do not reflect the degree of input uncertainty or an assessment of the reasonableness of the Firm’s estimates and assumptions. Rather, they reflect the characteristics of the various instruments held by the Firm and the relative distribution of instruments within the range of characteristics. For example, two option contracts may have similar levels of market risk exposure and valuation uncertainty, but may have significantly different implied volatility levels because the option contracts have different underlyings, tenors, or strike prices. The input range and weighted average values will therefore vary from period-to-period and parameter-to-parameter based on the characteristics of the instruments held by the Firm at each balance sheet date.
For the Firm’s derivatives and structured notes positions classified within level 3 at December 31, 2016, interest rate correlation inputs used in estimating fair value were concentrated towards the upper end of the range presented; equity correlation inputs were concentrated at the upper end of the range; the credit correlation inputs were distributed across the range presented; and the foreign exchange correlation inputs were concentrated at the upper end of the range presented. In addition, the interest rate volatility inputs used in estimating fair value were distributed across the range presented; equity volatilities were concentrated in the lower half end of the range; and forward commodity prices used in estimating the fair value of commodity derivatives were concentrated in the middle of the range presented.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
The categories presented in the table have been aggregated based upon the product type, which may differ from their classification on the Consolidated balance sheets. Furthermore, the inputs presented for each valuation technique in the table are, in some cases, not applicable to every instrument valued using the technique as the characteristics of the instruments can differ.
(b)
The unobservable inputs and associated input ranges for approximately $394 million of credit derivative receivables and $226 million of credit derivative payables with underlying commercial mortgage risk have been included in the inputs and ranges provided for commercial mortgage-backed securities and loans.
(c)
The unobservable inputs and associated input ranges for approximately $362 million of credit derivative receivables and $333 million of credit derivative payables with underlying ABS risk have been included in the inputs and ranges provided for corporate debt securities, obligations of U.S. states and municipalities and other.
(d)
Long-term debt, other borrowed funds and deposits include structured notes issued by the Firm that are predominantly financial instruments containing embedded derivatives. The estimation of the fair value of structured notes includes the derivative features embedded within the instrument. The significant unobservable inputs are broadly consistent with those presented for derivative receivables.
JPMorgan Chase & Co./2016 Annual Report
Changes in and ranges of unobservable inputs
The following discussion provides a description of the impact on a fair value measurement of a change in each unobservable input in isolation, and the interrelationship between unobservable inputs, where relevant and significant. The impact of changes in inputs may not be independent, as a change in one unobservable input may give rise to a change in another unobservable input. Where relationships do exist between two unobservable inputs, those relationships are discussed below. Relationships may also exist between observable and unobservable inputs (for example, as observable interest rates rise, unobservable prepayment rates decline); such relationships have not been included in the discussion below. In addition, for each of the individual relationships described below, the inverse relationship would also generally apply.
The following discussion also provides a description of attributes of the underlying instruments and external market factors that affect the range of inputs used in the valuation of the Firm’s positions.
Yield - The yield of an asset is the interest rate used to discount future cash flows in a discounted cash flow calculation. An increase in the yield, in isolation, would result in a decrease in a fair value measurement.
Credit spread - The credit spread is the amount of additional annualized return over the market interest rate that a market participant would demand for taking exposure to the credit risk of an instrument. The credit spread for an instrument forms part of the discount rate used in a discounted cash flow calculation. Generally, an increase in the credit spread would result in a decrease in a fair value measurement.
The yield and the credit spread of a particular mortgage-backed security primarily reflect the risk inherent in the instrument. The yield is also impacted by the absolute level of the coupon paid by the instrument (which may not correspond directly to the level of inherent risk). Therefore, the range of yield and credit spreads reflects the range of risk inherent in various instruments owned by the Firm. The risk inherent in mortgage-backed securities is driven by the subordination of the security being valued and the characteristics of the underlying mortgages within the collateralized pool, including borrower FICO scores, LTV ratios for residential mortgages and the nature of the property and/or any tenants for commercial mortgages. For corporate debt securities, obligations of U.S. states and municipalities and other similar instruments, credit spreads reflect the credit quality of the obligor and the tenor of the obligation.
Prepayment speed - The prepayment speed is a measure of the voluntary unscheduled principal repayments of a prepayable obligation in a collateralized pool. Prepayment speeds generally decline as borrower delinquencies rise. An increase in prepayment speeds, in isolation, would result in a decrease in a fair value measurement of assets valued at a premium to par and an increase in a fair value measurement of assets valued at a discount to par.
Prepayment speeds may vary from collateral pool to collateral pool, and are driven by the type and location of the underlying borrower, and the remaining tenor of the obligation as well as the level and type (e.g., fixed or floating) of interest rate being paid by the borrower. Typically collateral pools with higher borrower credit quality have a higher prepayment rate than those with lower borrower credit quality, all other factors being equal.
Conditional default rate - The conditional default rate is a measure of the reduction in the outstanding collateral balance underlying a collateralized obligation as a result of defaults. While there is typically no direct relationship between conditional default rates and prepayment speeds, collateralized obligations for which the underlying collateral has high prepayment speeds will tend to have lower conditional default rates. An increase in conditional default rates would generally be accompanied by an increase in loss severity and an increase in credit spreads. An increase in the conditional default rate, in isolation, would result in a decrease in a fair value measurement. Conditional default rates reflect the quality of the collateral underlying a securitization and the structure of the securitization itself. Based on the types of securities owned in the Firm’s market-making portfolios, conditional default rates are most typically at the lower end of the range presented.
Loss severity - The loss severity (the inverse concept is the recovery rate) is the expected amount of future realized losses resulting from the ultimate liquidation of a particular loan, expressed as the net amount of loss relative to the outstanding loan balance. An increase in loss severity is generally accompanied by an increase in conditional default rates. An increase in the loss severity, in isolation, would result in a decrease in a fair value measurement.
The loss severity applied in valuing a mortgage-backed security investment depends on factors relating to the underlying mortgages, including the LTV ratio, the nature of the lender’s lien on the property and other instrument-specific factors.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Correlation - Correlation is a measure of the relationship between the movements of two variables (e.g., how the change in one variable influences the change in the other). Correlation is a pricing input for a derivative product where the payoff is driven by one or more underlying risks. Correlation inputs are related to the type of derivative (e.g., interest rate, credit, equity and foreign exchange) due to the nature of the underlying risks. When parameters are positively correlated, an increase in one parameter will result in an increase in the other parameter. When parameters are negatively correlated, an increase in one parameter will result in a decrease in the other parameter. An increase in correlation can result in an increase or a decrease in a fair value measurement. Given a short correlation position, an increase in correlation, in isolation, would generally result in a decrease in a fair value measurement. The range of correlation inputs between risks within the same asset class are generally narrower than those between underlying risks across asset classes. In addition, the ranges of credit correlation inputs tend to be narrower than those affecting other asset classes.
The level of correlation used in the valuation of derivatives with multiple underlying risks depends on a number of factors including the nature of those risks. For example, the correlation between two credit risk exposures would be different than that between two interest rate risk exposures. Similarly, the tenor of the transaction may also impact the correlation input, as the relationship between the underlying risks may be different over different time periods. Furthermore, correlation levels are very much dependent on market conditions and could have a relatively wide range of levels within or across asset classes over time, particularly in volatile market conditions.
Volatility - Volatility is a measure of the variability in possible returns for an instrument, parameter or market index given how much the particular instrument, parameter or index changes in value over time. Volatility is a pricing input for options, including equity options, commodity options, and interest rate options. Generally, the higher the volatility of the underlying, the riskier the instrument. Given a long position in an option, an increase in volatility, in isolation, would generally result in an increase in a fair value measurement.
The level of volatility used in the valuation of a particular option-based derivative depends on a number of factors, including the nature of the risk underlying the option (e.g., the volatility of a particular equity security may be significantly different from that of a particular commodity index), the tenor of the derivative as well as the strike price of the option.
EBITDA multiple - EBITDA multiples refer to the input (often derived from the value of a comparable company) that is multiplied by the historic and/or expected earnings before interest, taxes, depreciation and amortization (“EBITDA”) of a company in order to estimate the company’s value. An increase in the EBITDA multiple, in isolation, net of adjustments, would result in an increase in a fair value measurement.
Changes in level 3 recurring fair value measurements
The following tables include a rollforward of the Consolidated balance sheets amounts (including changes in fair value) for financial instruments classified by the Firm within level 3 of the fair value hierarchy for the years ended December 31, 2016, 2015 and 2014. When a determination is made to classify a financial instrument within level 3, the determination is based on the significance of the unobservable parameters to the overall fair value measurement. However, level 3 financial instruments typically include, in addition to the unobservable or level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources); accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology. Also, the Firm risk-manages the observable components of level 3 financial instruments using securities and derivative positions that are classified within level 1 or 2 of the fair value hierarchy; as these level 1 and level 2 risk management instruments are not included below, the gains or losses in the following tables do not reflect the effect of the Firm’s risk management activities related to such level 3 instruments.
JPMorgan Chase & Co./2016 Annual Report
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
JPMorgan Chase & Co./2016 Annual Report
(a)
All level 3 derivatives are presented on a net basis, irrespective of underlying counterparty.
(b)
Level 3 liabilities as a percentage of total Firm liabilities accounted for at fair value (including liabilities measured at fair value on a nonrecurring basis) were 12%, 13% and 15% at December 31, 2016, 2015 and 2014, respectively.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(c)
Predominantly reported in principal transactions revenue, except for changes in fair value for CCB mortgage loans, and lending-related commitments originated with the intent to sell, and mortgage loan purchase commitments, which are reported in mortgage fees and related income.
(d)
Realized gains/(losses) on AFS securities, as well as other-than-temporary impairment (“OTTI”) losses that are recorded in earnings, are reported in securities gains. Unrealized gains/(losses) are reported in OCI. Realized gains/(losses) and foreign exchange hedge accounting adjustments recorded in income on AFS securities were zero, $(7) million, and $(43) million for the years ended December 31, 2016, 2015 and 2014, respectively. Unrealized gains/(losses) recorded on AFS securities in OCI were $1 million, $(25) million and $(16) million for the years ended December 31, 2016, 2015 and 2014, respectively.
(e)
Changes in fair value for CCB MSRs are reported in mortgage fees and related income.
(f)
Predominantly reported in other income.
(g)
Loan originations are included in purchases.
(h)
Includes financial assets and liabilities that have matured, been partially or fully repaid, impacts of modifications, and deconsolidation associated with beneficial interests in VIEs.
(i)
All transfers into and/or out of level 3 are assumed to occur at the beginning of the quarterly reporting period in which they occur.
Level 3 analysis
Consolidated balance sheets changes
Level 3 assets (including assets measured at fair value on a nonrecurring basis) were 1.0% of total Firm assets at December 31, 2016. The following describes significant changes to level 3 assets since December 31, 2015, for those items measured at fair value on a recurring basis. For further information on changes impacting items measured at fair value on a nonrecurring basis, see Assets and liabilities measured at fair value on a nonrecurring basis on page 165.
For the year ended December 31, 2016
Level 3 assets were $23.2 billion at December 31, 2016, reflecting a decrease of $8.0 billion from December 31, 2015. This decrease was driven by settlements (including repayments and restructurings) and transfers to Level 2 due to an increase in observability and a decrease in the significance of unobservable inputs. In particular:
•
$4.0 billion decrease in trading assets - debt and equity instruments was predominantly driven by a decrease of $1.8 billion in trading loans largely due to settlements, and a $1.5 billion decrease in asset-backed securities due to settlements and transfers from level 3 to level 2 as a result of increased observability of certain valuation inputs
•
$2.1 billion decrease in gross derivative receivables was driven by a decrease in credit and foreign exchange derivative receivables due to market movements and transfers from level 3 to level 2 as a result of increased observability of certain valuation inputs
Gains and losses
The following describes significant components of total realized/unrealized gains/(losses) for instruments measured at fair value on a recurring basis for the years ended December 31, 2016, 2015 and 2014. For further information on these instruments, see Changes in level 3 recurring fair value measurements rollforward tables on pages 160-164.
•
There were no individually significant movements for the year ended December 31, 2016.
•
$1.6 billion of net gains in interest rate, foreign exchange and equity derivative receivables largely due to market movements; partially offset by losses on commodity derivatives due to market movements
•
$1.3 billion of net gains in liabilities due to market movements
•
$1.8 billion of losses on MSRs. For further discussion of the change, refer to Note 17
•
$1.1 billion of net gains on trading assets - debt and equity instruments, largely driven by market movements and client-driven financing transactions
Credit and funding adjustments - derivatives
Derivatives are generally valued using models that use as their basis observable market parameters. These market parameters generally do not consider factors such as counterparty nonperformance risk, the Firm’s own credit quality, and funding costs. Therefore, it is generally necessary to make adjustments to the base estimate of fair value to reflect these factors.
CVA represents the adjustment, relative to the relevant benchmark interest rate, necessary to reflect counterparty nonperformance risk. The Firm estimates CVA using a scenario analysis to estimate the expected credit exposure across all of the Firm’s positions with each counterparty, and then estimates losses as a result of a counterparty credit event. The key inputs to this methodology are (i) the expected positive exposure to each counterparty based on a simulation that assumes the current population of existing derivatives with each counterparty remains unchanged and considers contractual factors designed to mitigate the Firm’s credit exposure, such as collateral and legal rights of offset; (ii) the probability of a default event occurring for each counterparty, as derived from observed or estimated CDS spreads; and (iii) estimated recovery rates implied by CDS spreads, adjusted to consider the differences in recovery rates as a derivative creditor relative to those reflected in CDS spreads, which generally reflect senior unsecured creditor risk.
DVA represents the adjustment, relative to the relevant benchmark interest rate, necessary to reflect the credit quality of the Firm. The derivative DVA calculation methodology is generally consistent with the CVA methodology described above and incorporates JPMorgan Chase’s credit spread as observed through the CDS market to estimate the PD and LGD as a result of a systemic event affecting the Firm.
FVA represents the adjustment to reflect the impact of funding and is recognized where there is evidence that a market participant in the principal market would incorporate it in a transfer of the instrument. The Firm’s FVA framework, applied to uncollateralized (including partially collateralized) OTC derivatives, leverages its existing CVA and DVA calculation methodologies, and considers the fact that the Firm’s own credit risk is a significant component of funding costs.
JPMorgan Chase & Co./2016 Annual Report
The key inputs to FVA are: (i) the expected funding requirements arising from the Firm’s positions with each counterparty and collateral arrangements; (ii) for assets, the estimated market funding cost in the principal market; and (iii) for liabilities, the hypothetical market funding cost for a transfer to a market participant with a similar credit standing as the Firm. For collateralized derivatives, the fair value is estimated by discounting expected future cash flows at the relevant overnight indexed swap rate given the underlying collateral agreement with the counterparty, and therefore a separate FVA is not necessary.
The following table provides the impact of credit and funding adjustments on principal transactions revenue in the respective periods, excluding the effect of any associated hedging activities. The DVA and FVA reported below include the impact of the Firm’s own credit quality on the inception value of liabilities as well as the impact of changes in the Firm’s own credit quality over time.
Valuation adjustments on fair value option elected liabilities
The valuation of the Firm’s liabilities for which the fair value option has been elected requires consideration of the Firm’s own credit risk. DVA on fair value option elected liabilities is measured using (i) the current fair value of the liability and (ii) changes (subsequent to the issuance of the liability) in the Firm’s probability of default and LGD, which are estimated based on changes in the Firm’s credit spread observed in the bond market. Effective January 1, 2016, the effect of DVA on fair value option elected liabilities is recognized in OCI. See Note 25 for further information.
Assets and liabilities measured at fair value on a nonrecurring basis
At December 31, 2016 and 2015, assets measured at fair value on a nonrecurring basis were $1.6 billion and $1.7 billion, respectively, consisting predominantly of loans that had fair value adjustments for the years ended December 31, 2016 and 2015. At December 31, 2016, $735 million and $822 million of these assets were classified in levels 2 and 3 of the fair value hierarchy, respectively. At December 31, 2015, $696 million and $959 million of these assets were classified in levels 2 and 3 of the fair value hierarchy, respectively. Liabilities measured at fair value on a nonrecurring basis were not significant at December 31, 2016 and 2015. For the years ended December 31, 2016, 2015 and 2014, there were no significant transfers between levels 1, 2 and 3 related to assets held at the balance sheet date.
Of the $822 million in level 3 assets measured at fair value on a nonrecurring basis as of December 31, 2016:
•
$462 million related to residential real estate loans carried at the net realizable value of the underlying collateral (i.e., collateral-dependent loans and other loans charged off in accordance with regulatory
guidance). These amounts are classified as level 3, as they are valued using a broker’s price opinion and discounted based upon the Firm’s experience with actual liquidation values. These discounts to the broker price opinions ranged from 12% to 47%, with a weighted average of 25%.
The total change in the recorded value of assets and liabilities for which a fair value adjustment has been included in the Consolidated statements of income for the years ended December 31, 2016, 2015 and 2014, related to financial instruments held at those dates, were losses of $172 million, $294 million and $992 million respectively; these reductions were predominantly associated with loans.
For further information about the measurement of impaired collateral-dependent loans, and other loans where the carrying value is based on the fair value of the underlying collateral (e.g., residential mortgage loans charged off in accordance with regulatory guidance), see Note 14.
Additional disclosures about the fair value of financial instruments that are not carried on the Consolidated balance sheets at fair value
U.S. GAAP requires disclosure of the estimated fair value of certain financial instruments, and the methods and significant assumptions used to estimate their fair value. Financial instruments within the scope of these disclosure requirements are included in the following table. However, certain financial instruments and all nonfinancial instruments are excluded from the scope of these disclosure requirements. Accordingly, the fair value disclosures provided in the following table include only a partial estimate of the fair value of JPMorgan Chase’s assets and liabilities. For example, the Firm has developed long-term relationships with its customers through its deposit base and credit card accounts, commonly referred to as core deposit intangibles and credit card relationships. In the opinion of management, these items, in the aggregate, add significant value to JPMorgan Chase, but their fair value is not disclosed in this Note.
Financial instruments for which carrying value approximates fair value
Certain financial instruments that are not carried at fair value on the Consolidated balance sheets are carried at amounts that approximate fair value, due to their short-term nature and generally negligible credit risk. These instruments include cash and due from banks, deposits with banks, federal funds sold, securities purchased under resale agreements and securities borrowed, short-term receivables and accrued interest receivable, commercial paper, federal funds purchased, securities loaned and sold under repurchase agreements, other borrowed funds, accounts payable, and accrued liabilities. In addition, U.S. GAAP requires that the fair value of deposit liabilities with no stated maturity (i.e., demand, savings and certain money market deposits) be equal to their carrying value; recognition of the inherent funding value of these instruments is not permitted.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following table presents by fair value hierarchy classification the carrying values and estimated fair values at December 31, 2016 and 2015, of financial assets and liabilities, excluding financial instruments that are carried at fair value on a recurring basis, and their classification within the fair value hierarchy. For additional information regarding the financial instruments within the scope of this disclosure, and the methods and significant assumptions used to estimate their fair value, see pages 150-153 of this Note.
(a)
Fair value is typically estimated using a discounted cash flow model that incorporates the characteristics of the underlying loans (including principal, contractual interest rate and contractual fees) and other key inputs, including expected lifetime credit losses, interest rates, prepayment rates, and primary origination or secondary market spreads. For certain loans, the fair value is measured based on the value of the underlying collateral. The difference between the estimated fair value and carrying value of a financial asset or liability is the result of the different methodologies used to determine fair value as compared with carrying value. For example, credit losses are estimated for a financial asset’s remaining life in a fair value calculation but are estimated for a loss emergence period in the allowance for loan loss calculation; future loan income (interest and fees) is incorporated in a fair value calculation but is generally not considered in the allowance for loan losses. For a further discussion of the Firm’s methodologies for estimating the fair value of loans and lending-related commitments, see Valuation hierarchy on pages 150-153.
JPMorgan Chase & Co./2016 Annual Report
The majority of the Firm’s lending-related commitments are not carried at fair value on a recurring basis on the Consolidated balance sheets, nor are they actively traded. The carrying value of the wholesale allowance for lending-related commitments and the estimated fair value of these wholesale lending-related commitments were as follows for the periods indicated.
(a)
Excludes the current carrying values of the guarantee liability and the offsetting asset, each of which is recognized at fair value at the inception of the guarantees.
The Firm does not estimate the fair value of consumer lending-related commitments. In many cases, the Firm can reduce or cancel these commitments by providing the borrower notice or, in some cases as permitted by law, without notice. For a further discussion of the valuation of lending-related commitments, see page 151 of this Note.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 4 - Fair value option
The fair value option provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments.
The Firm has elected to measure certain instruments at fair value for several reasons including to mitigate income statement volatility caused by the differences between the measurement basis of elected instruments (e.g. certain instruments elected were previously accounted for on an accrual basis) and the associated risk management arrangements that are accounted for on a fair value basis, as well as to better reflect those instruments that are managed on a fair value basis.
The Firm’s election of fair value includes the following instruments:
•
Loans purchased or originated as part of securitization warehousing activity, subject to bifurcation accounting, or managed on a fair value basis
•
Certain securities financing arrangements with an embedded derivative and/or a maturity of greater than one year
•
Owned beneficial interests in securitized financial assets that contain embedded credit derivatives, which would otherwise be required to be separately accounted for as a derivative instrument
•
Structured notes, which are predominantly financial instruments that contain embedded derivatives, that are issued as part of CIB’s client-driven activities
•
Certain long-term beneficial interests issued by CIB’s consolidated securitization trusts where the underlying assets are carried at fair value
JPMorgan Chase & Co./2016 Annual Report
Changes in fair value under the fair value option election
The following table presents the changes in fair value included in the Consolidated statements of income for the years ended December 31, 2016, 2015 and 2014, for items for which the fair value option was elected. The profit and loss information presented below only includes the financial instruments that were elected to be measured at fair value; related risk management instruments, which are required to be measured at fair value, are not included in the table.
(a)
Effective January 1, 2016, unrealized gains/(losses) due to instrument-specific credit risk (DVA) for liabilities for which the fair value option has been elected is recorded in OCI, while realized gains/(losses) are recorded in principal transactions revenue. DVA for 2015 and 2014 was included in principal transactions revenue, and includes the impact of the Firm’s own credit quality on the inception value of liabilities as well as the impact of changes in the Firm’s own credit quality subsequent to issuance. See Notes 3 and 25 for further information.
(b)
Long-term debt measured at fair value predominantly relates to structured notes containing embedded derivatives. Although the risk associated with the structured notes is actively managed, the gains/(losses) reported in this table do not include the income statement impact of the risk management instruments used to manage such risk.
(c)
Reported in mortgage fees and related income.
(d)
Reported in other income.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Determination of instrument-specific credit risk for items for which a fair value election was made
The following describes how the gains and losses that are attributable to changes in instrument-specific credit risk, were determined.
•
Loans and lending-related commitments: For floating-rate instruments, all changes in value are attributed to instrument-specific credit risk. For fixed-rate instruments, an allocation of the changes in value for the period is made between those changes in value that are interest rate-related and changes in value that are credit-related. Allocations are generally based on an analysis of borrower-specific credit spread and recovery information, where available, or benchmarking to similar entities or industries.
•
Long-term debt: Changes in value attributable to instrument-specific credit risk were derived principally from observable changes in the Firm’s credit spread.
•
Resale and repurchase agreements, securities borrowed agreements and securities lending agreements: Generally, for these types of agreements, there is a requirement that collateral be maintained with a market value equal to or in excess of the principal amount loaned; as a result, there would be no adjustment or an immaterial adjustment for instrument-specific credit risk related to these agreements.
Difference between aggregate fair value and aggregate remaining contractual principal balance outstanding
The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding as of December 31, 2016 and 2015, for loans, long-term debt and long-term beneficial interests for which the fair value option has been elected.
(a)
There were no performing loans that were ninety days or more past due as of December 31, 2016 and 2015, respectively.
(b)
Remaining contractual principal is not applicable to nonprincipal-protected notes. Unlike principal-protected structured notes, for which the Firm is obligated to return a stated amount of principal at the maturity of the note, nonprincipal-protected structured notes do not obligate the Firm to return a stated amount of principal at maturity, but to return an amount based on the performance of an underlying variable or derivative feature embedded in the note. However, investors are exposed to the credit risk of the Firm as issuer for both nonprincipal-protected and principal protected notes.
(c)
Where the Firm issues principal-protected zero-coupon or discount notes, the balance reflects the contractual principal payment at maturity or, if applicable, the contractual principal payment at the Firm’s next call date.
At December 31, 2016 and 2015, the contractual amount of lending-related commitments for which the fair value option was elected was $4.6 billion for both years, with a corresponding fair value of $(118) million and $(94) million, respectively. For further information regarding off-balance sheet lending-related financial instruments, see Note 29.
JPMorgan Chase & Co./2016 Annual Report
Structured note products by balance sheet classification and risk component
The table below presents the fair value of the structured notes issued by the Firm, by balance sheet classification and the primary risk type.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 5 - Credit risk concentrations
Concentrations of credit risk arise when a number of customers are engaged in similar business activities or activities in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions.
JPMorgan Chase regularly monitors various segments of its credit portfolios to assess potential credit risk concentrations and to obtain collateral when deemed necessary. Senior management is significantly involved in the credit approval and review process, and risk levels are adjusted as needed to reflect the Firm’s risk appetite.
In the Firm’s consumer portfolio, concentrations are evaluated primarily by product and by U.S. geographic region, with a key focus on trends and concentrations at the portfolio level, where potential credit risk concentrations can be remedied through changes in underwriting policies and portfolio guidelines. In the wholesale portfolio, credit risk concentrations are evaluated primarily by industry and monitored regularly on both an aggregate portfolio level and on an individual customer basis. The Firm’s wholesale exposure is managed through loan syndications and participations, loan sales, securitizations, credit derivatives, master netting agreements, and collateral and other risk-reduction techniques. For additional information on loans, see Note 14.
The Firm does not believe that its exposure to any particular loan product (e.g., option ARMs), or industry segment (e.g., commercial real estate), or its exposure to residential real estate loans with high LTV ratios, results in a significant concentration of credit risk.
Terms of loan products and collateral coverage are included in the Firm’s assessment when extending credit and establishing its allowance for loan losses.
JPMorgan Chase & Co./2016 Annual Report
The table below presents both on-balance sheet and off-balance sheet consumer and wholesale-related credit exposure by the Firm’s three credit portfolio segments as of December 31, 2016 and 2015.
(a)
Receivables from customers primarily represent margin loans to brokerage customers that are collateralized through assets maintained in the clients’ brokerage accounts, as such no allowance is held against these receivables. These receivables are reported within accrued interest and accounts receivable on the Firm’s Consolidated balance sheets.
(b)
The industry rankings presented in the table as of December 31, 2015, are based on the industry rankings of the corresponding exposures at December 31, 2016, not actual rankings of such exposures at December 31, 2015.
(c)
In addition to the credit risk exposure to states and municipal governments (both U.S. and non-U.S.) at December 31, 2016 and 2015, noted above, the Firm held: $9.1 billion and 7.6 billion, respectively, of trading securities; $31.6 billion and $33.6 billion, respectively, of AFS securities; and $14.5 billion and $12.8 billion, respectively, of HTM securities, issued by U.S. state and municipal governments. For further information, see Note 3 and Note 12.
(d)
All other includes: individuals; SPEs; holding companies; and private education and civic organizations. For more information on exposures to SPEs, see Note 16.
(e)
For further information regarding on-balance sheet credit concentrations by major product and/or geography, see Note 6 and Note 14. For information regarding concentrations of off-balance sheet lending-related financial instruments by major product, see Note 29.
(f)
Excludes cash placed with banks of $380.2 billion and $351.0 billion, at December 31, 2016 and 2015, respectively, which is predominantly placed with various central banks, primarily Federal Reserve Banks
(g)
Represents lending-related financial instruments.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 6 - Derivative instruments
Derivative contracts derive their value from underlying asset prices, indices, reference rates, other inputs or a combination of these factors and may expose counterparties to risks and rewards of an underlying asset or liability without having to initially invest in, own or exchange the asset or liability. JPMorgan Chase makes markets in derivatives for clients and also uses derivatives to hedge or manage its own risk exposures. Predominantly all of the Firm’s derivatives are entered into for market-making or risk management purposes.
Market-making derivatives
The majority of the Firm’s derivatives are entered into for market-making purposes. Clients use derivatives to mitigate or modify interest rate, credit, foreign exchange, equity and commodity risks. The Firm actively manages the risks from its exposure to these derivatives by entering into other derivative transactions or by purchasing or selling other financial instruments that partially or fully offset the exposure from client derivatives.
Risk management derivatives
The Firm manages certain market and credit risk exposures using derivative instruments, including derivatives in hedge accounting relationships and other derivatives that are used to manage risks associated with specified assets and liabilities.
Interest rate contracts are used to minimize fluctuations in earnings that are caused by changes in interest rates. Fixed-rate assets and liabilities appreciate or depreciate in market value as interest rates change. Similarly, interest income and expense increases or decreases as a result of variable-rate assets and liabilities resetting to current market rates, and as a result of the repayment and subsequent origination or issuance of fixed-rate assets and liabilities at current market rates. Gains or losses on the derivative instruments that are related to such assets and liabilities are expected to substantially offset this variability in earnings. The Firm generally uses interest rate swaps, forwards and futures to manage the impact of interest rate fluctuations on earnings.
Foreign currency forward contracts are used to manage the foreign exchange risk associated with certain foreign currency-denominated (i.e., non-U.S. dollar) assets and liabilities and forecasted transactions, as well as the Firm’s net investments in certain non-U.S. subsidiaries or branches whose functional currencies are not the U.S. dollar. As a result of fluctuations in foreign currencies, the U.S. dollar-equivalent values of the foreign currency-denominated assets and liabilities or the forecasted revenues or expenses increase or decrease. Gains or losses on the derivative instruments related to these foreign currency-denominated assets or liabilities, or forecasted transactions, are expected to substantially offset this variability.
Commodities contracts are used to manage the price risk of certain commodities inventories. Gains or losses on these derivative instruments are expected to substantially offset the depreciation or appreciation of the related inventory.
Credit derivatives are used to manage the counterparty credit risk associated with loans and lending-related commitments. Credit derivatives compensate the purchaser when the entity referenced in the contract experiences a credit event, such as bankruptcy or a failure to pay an obligation when due. Credit derivatives primarily consist of CDS. For a further discussion of credit derivatives, see the discussion in the Credit derivatives section on pages 184-186 of this Note.
For more information about risk management derivatives, see the risk management derivatives gains and losses table on page 184 of this Note, and the hedge accounting gains and losses tables on pages 182-184 of this Note.
Derivative counterparties and settlement types
The Firm enters into OTC derivatives, which are negotiated and settled bilaterally with the derivative counterparty. The Firm also enters into, as principal, certain ETD such as futures and options, and OTC-cleared derivative contracts with CCPs. ETD contracts are generally standardized contracts traded on an exchange and cleared by the CCP, which is the Firm’s counterparty from the inception of the transactions. OTC-cleared derivatives are traded on a bilateral basis and then novated to the CCP for clearing.
Derivative clearing services
The Firm provides clearing services for clients where the Firm acts as a clearing member with respect to certain derivative exchanges and clearing houses. The Firm does not reflect the clients’ derivative contracts in its Consolidated Financial Statements. For further information on the Firm’s clearing services, see Note 29.
Accounting for derivatives
All free-standing derivatives that the Firm executes for its own account are required to be recorded on the Consolidated balance sheets at fair value.
As permitted under U.S. GAAP, the Firm nets derivative assets and liabilities, and the related cash collateral receivables and payables, when a legally enforceable master netting agreement exists between the Firm and the derivative counterparty. For further discussion of the offsetting of assets and liabilities, see Note 1. The accounting for changes in value of a derivative depends on whether or not the transaction has been designated and qualifies for hedge accounting. Derivatives that are not designated as hedges are reported and measured at fair value through earnings. The tabular disclosures on pages 178-184 of this Note provide additional information on the amount of, and reporting for, derivative assets, liabilities, gains and losses. For further discussion of derivatives embedded in structured notes, see Notes 3 and 4.
JPMorgan Chase & Co./2016 Annual Report
Derivatives designated as hedges
The Firm applies hedge accounting to certain derivatives executed for risk management purposes - generally interest rate, foreign exchange and commodity derivatives. However, JPMorgan Chase does not seek to apply hedge accounting to all of the derivatives involved in the Firm’s risk management activities. For example, the Firm does not apply hedge accounting to purchased CDS used to manage the credit risk of loans and lending-related commitments, because of the difficulties in qualifying such contracts as hedges. For the same reason, the Firm does not apply hedge accounting to certain interest rate, foreign exchange, and commodity derivatives used for risk management purposes.
To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, for a derivative to be designated as a hedge, the risk management objective and strategy must be documented. Hedge documentation must identify the derivative hedging instrument, the asset or liability or forecasted transaction and type of risk to be hedged, and how the effectiveness of the derivative is assessed prospectively and retrospectively. To assess effectiveness, the Firm uses statistical methods such as regression analysis, as well as nonstatistical methods including dollar-value comparisons of the change in the fair value of the derivative to the change in the fair value or cash flows of the hedged item. The extent to which a derivative has been, and is expected to continue to be, effective at offsetting changes in the fair value or cash flows of the hedged item must be assessed and documented at least quarterly. Any hedge ineffectiveness (i.e., the amount by which the gain or loss on the designated derivative instrument does not exactly offset the change in the hedged item attributable to the hedged risk) must be reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.
There are three types of hedge accounting designations: fair value hedges, cash flow hedges and net investment hedges. JPMorgan Chase uses fair value hedges primarily to hedge fixed-rate long-term debt, AFS securities and certain commodities inventories. For qualifying fair value hedges, the changes in the fair value of the derivative, and in the value of the hedged item for the risk being hedged, are recognized in earnings. If the hedge relationship is terminated, then the adjustment to the hedged item continues to be reported as part of the basis of the hedged item, and for benchmark interest rate hedges, is amortized to earnings as a yield adjustment. Derivative amounts affecting earnings are recognized consistent with the classification of the hedged item - primarily net interest income and principal transactions revenue.
JPMorgan Chase uses cash flow hedges primarily to hedge the exposure to variability in forecasted cash flows from floating-rate assets and liabilities and foreign currency-denominated revenue and expense. For qualifying cash flow hedges, the effective portion of the change in the fair value of the derivative is recorded in OCI and recognized in the Consolidated statements of income when the hedged cash flows affect earnings. Derivative amounts affecting earnings are recognized consistent with the classification of the hedged item - primarily interest income, interest expense, noninterest revenue and compensation expense. The ineffective portions of cash flow hedges are immediately recognized in earnings. If the hedge relationship is terminated, then the value of the derivative recorded in AOCI is recognized in earnings when the cash flows that were hedged affect earnings. For hedge relationships that are discontinued because a forecasted transaction is not expected to occur according to the original hedge forecast, any related derivative values recorded in AOCI are immediately recognized in earnings.
JPMorgan Chase uses net investment hedges to protect the value of the Firm’s net investments in certain non-U.S. subsidiaries or branches whose functional currencies are not the U.S. dollar. For foreign currency qualifying net investment hedges, changes in the fair value of the derivatives are recorded in the translation adjustments account within AOCI.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following table outlines the Firm’s primary uses of derivatives and the related hedge accounting designation or disclosure category.
JPMorgan Chase & Co./2016 Annual Report
Notional amount of derivative contracts
The following table summarizes the notional amount of derivative contracts outstanding as of December 31, 2016 and 2015.
(a)
For more information on volumes and types of credit derivative contracts, see the Credit derivatives discussion on pages 184-186.
(b)
Represents the sum of gross long and gross short third-party notional derivative contracts.
While the notional amounts disclosed above give an indication of the volume of the Firm’s derivatives activity, the notional amounts significantly exceed, in the Firm’s view, the possible losses that could arise from such transactions. For most derivative transactions, the notional amount is not exchanged; it is used simply as a reference to calculate payments.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Impact of derivatives on the Consolidated balance sheets
The following table summarizes information on derivative receivables and payables (before and after netting adjustments) that are reflected on the Firm’s Consolidated balance sheets as of December 31, 2016 and 2015, by accounting designation (e.g., whether the derivatives were designated in qualifying hedge accounting relationships or not) and contract type.
(a)
Balances exclude structured notes for which the fair value option has been elected. See Note 4 for further information.
(b)
As permitted under U.S. GAAP, the Firm has elected to net derivative receivables and derivative payables and the related cash collateral receivables and payables when a legally enforceable master netting agreement exists.
JPMorgan Chase & Co./2016 Annual Report
Derivatives netting
The following tables present, as of December 31, 2016 and 2015, gross and net derivative receivables and payables by contract and settlement type. Derivative receivables and payables, as well as the related cash collateral from the same counterparty, have been netted on the Consolidated balance sheets where the Firm has obtained an appropriate legal opinion with respect to the master netting agreement. Where such a legal opinion has not been either sought or obtained, amounts are not eligible for netting on the Consolidated balance sheets, and those derivative receivables and payables are shown separately in the tables below.
In addition to the cash collateral received and transferred that is presented on a net basis with derivative receivables and payables, the Firm receives and transfers additional collateral (financial instruments and cash). These amounts mitigate counterparty credit risk associated with the Firm’s derivative instruments, but are not eligible for net presentation:
•
collateral that consists of non-cash financial instruments (generally U.S. government and agency securities and other G7 government bonds) and cash collateral held at third party custodians, which are shown separately as “Collateral not nettable on the Consolidated balance sheets” in the tables below, up to the fair value exposure amount.
•
the amount of collateral held or transferred that exceeds the fair value exposure at the individual counterparty level, as of the date presented, which is excluded from the tables below; and
•
collateral held or transferred that relates to derivative receivables or payables where an appropriate legal opinion has not been either sought or obtained with respect to the master netting agreement, which is excluded from the tables below.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
Exchange-traded derivative balances that relate to futures contracts are settled daily.
(b)
Net derivatives receivable included cash collateral netted of $71.9 billion and $73.7 billion at December 31, 2016 and 2015, respectively. Net derivatives payable included cash collateral netted of $57.3 billion and $61.6 billion related to OTC and OTC-cleared derivatives at December 31, 2016 and 2015, respectively.
(c)
Excludes all collateral related to derivative instruments where an appropriate legal opinion has not been either sought or obtained.
(d)
Represents liquid security collateral as well as cash collateral held at third-party custodians related to derivative instruments where an appropriate legal opinion has been obtained. For some counterparties, the collateral amounts of financial instruments may exceed the derivative receivables and derivative payables balances. Where this is the case, the total amount reported is limited to the net derivative receivables and net derivative payables balances with that counterparty.
(e)
Derivative payables collateral relates only to OTC and OTC-cleared derivative instruments. Amounts exclude collateral transferred related to exchange-traded derivative instruments.
JPMorgan Chase & Co./2016 Annual Report
Liquidity risk and credit-related contingent features
In addition to the specific market risks introduced by each derivative contract type, derivatives expose JPMorgan Chase to credit risk - the risk that derivative counterparties may fail to meet their payment obligations under the derivative contracts and the collateral, if any, held by the Firm proves to be of insufficient value to cover the payment obligation. It is the policy of JPMorgan Chase to actively pursue, where possible, the use of legally enforceable master netting arrangements and collateral agreements to mitigate derivative counterparty credit risk. The amount of derivative receivables reported on the Consolidated balance sheets is the fair value of the derivative contracts after giving effect to legally enforceable master netting agreements and cash collateral held by the Firm.
While derivative receivables expose the Firm to credit risk, derivative payables expose the Firm to liquidity risk, as the derivative contracts typically require the Firm to post cash or securities collateral with counterparties as the fair value
of the contracts moves in the counterparties’ favor or upon specified downgrades in the Firm’s and its subsidiaries’ respective credit ratings. Certain derivative contracts also provide for termination of the contract, generally upon a downgrade of either the Firm or the counterparty, at the fair value of the derivative contracts. The following table shows the aggregate fair value of net derivative payables related to OTC and OTC-cleared derivatives that contain contingent collateral or termination features that may be triggered upon a ratings downgrade, and the associated collateral the Firm has posted in the normal course of business, at December 31, 2016 and 2015.
The following table shows the impact of a single-notch and two-notch downgrade of the long-term issuer ratings of JPMorgan Chase & Co. and its subsidiaries, predominantly JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank, N.A.”), at December 31, 2016 and 2015, related to OTC and OTC-cleared derivative contracts with contingent collateral or termination features that may be triggered upon a ratings downgrade. Derivatives contracts generally require additional collateral to be posted or terminations to be triggered when the predefined threshold rating is breached. A downgrade by a single rating agency that does not result in a rating lower than a preexisting corresponding rating provided by another major rating agency will generally not result in additional collateral (except in certain instances in which additional initial margin may be required upon a ratings downgrade), nor in termination payments requirements. The liquidity impact in the table is calculated based upon a downgrade below the lowest current rating of the rating agencies referred to in the derivative contract.
(a)
Includes the additional collateral to be posted for initial margin.
(b)
Amounts represent fair values of derivative payables, and do not reflect collateral posted.
Derivatives executed in contemplation of a sale of the underlying financial asset
In certain instances the Firm enters into transactions in which it transfers financial assets but maintains the economic exposure to the transferred assets by entering into a derivative with the same counterparty in contemplation of the initial transfer. The Firm generally accounts for such transfers as collateralized financing transactions as described in Note 13, but in limited circumstances they may qualify to be accounted for as a sale and a derivative under U.S. GAAP. The amount of such transfers accounted for as a sale where the associated derivative was outstanding at December 31, 2016 was not material.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Impact of derivatives on the Consolidated statements of income
The following tables provide information related to gains and losses recorded on derivatives based on their hedge accounting
designation or purpose.
Fair value hedge gains and losses
The following tables present derivative instruments, by contract type, used in fair value hedge accounting relationships, as well as pre-tax gains/(losses) recorded on such derivatives and the related hedged items for the years ended December 31, 2016, 2015 and 2014, respectively. The Firm includes gains/(losses) on the hedging derivative and the related hedged item in the same line item in the Consolidated statements of income.
(a)
Primarily consists of hedges of the benchmark (e.g., London Interbank Offered Rate (“LIBOR”)) interest rate risk of fixed-rate long-term debt and AFS securities. Gains and losses were recorded in net interest income.
(b)
Excludes the amortization expense associated with the inception hedge accounting adjustment applied to the hedged item. This expense is recorded in net interest income and substantially offsets the income statement impact of the excluded components.
(c)
Primarily consists of hedges of the foreign currency risk of long-term debt and AFS securities for changes in spot foreign currency rates. Gains and losses related to the derivatives and the hedged items, due to changes in foreign currency rates, were recorded primarily in principal transactions revenue and net interest income.
(d)
Consists of overall fair value hedges of physical commodities inventories that are generally carried at the lower of cost or market (market approximates fair value). Gains and losses were recorded in principal transactions revenue.
(e)
Hedge ineffectiveness is the amount by which the gain or loss on the designated derivative instrument does not exactly offset the gain or loss on the hedged item attributable to the hedged risk.
(f)
The assessment of hedge effectiveness excludes certain components of the changes in fair values of the derivatives and hedged items such as forward points on foreign exchange forward contracts and time values.
JPMorgan Chase & Co./2016 Annual Report
Cash flow hedge gains and losses
The following tables present derivative instruments, by contract type, used in cash flow hedge accounting relationships, and the pre-tax gains/(losses) recorded on such derivatives, for the years ended December 31, 2016, 2015 and 2014, respectively. The Firm includes the gain/(loss) on the hedging derivative and the change in cash flows on the hedged item in the same line item in the Consolidated statements of income.
(a)
Primarily consists of benchmark interest rate hedges of LIBOR-indexed floating-rate assets and floating-rate liabilities. Gains and losses were recorded in net interest income, and for the forecasted transactions that the Firm determined during the year ended December 31, 2015, were probable of not occurring, in other income.
(b)
Primarily consists of hedges of the foreign currency risk of non-U.S. dollar-denominated revenue and expense. The income statement classification of gains and losses follows the hedged item - primarily noninterest revenue and compensation expense.
(c)
Hedge ineffectiveness is the amount by which the cumulative gain or loss on the designated derivative instrument exceeds the present value of the cumulative expected change in cash flows on the hedged item attributable to the hedged risk.
The Firm did not experience any forecasted transactions that failed to occur for the years ended 2016 and 2014. In 2015, the Firm reclassified approximately $150 million of net losses from AOCI to other income because the Firm determined that it was probable that the forecasted interest payment cash flows would not occur as a result of the planned reduction in wholesale non-operating deposits.
Over the next 12 months, the Firm expects that approximately $151 million (after-tax) of net losses recorded in AOCI at December 31, 2016, related to cash flow hedges will be recognized in income. For terminated cash flow hedges, the maximum length of time over which forecasted transactions are remaining is approximately six years. For open cash flow hedges, the maximum length of time over which forecasted transactions are hedged is approximately one year. The Firm’s longer-dated forecasted transactions relate to core lending and borrowing activities.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Net investment hedge gains and losses
The following table presents hedging instruments, by contract type, that were used in net investment hedge accounting relationships, and the pre-tax gains/(losses) recorded on such instruments for the years ended December 31, 2016, 2015 and 2014.
(a)
Certain components of hedging derivatives are permitted to be excluded from the assessment of hedge effectiveness, such as forward points on foreign exchange forward contracts. Amounts related to excluded components are recorded in other income. The Firm measures the ineffectiveness of net investment hedge accounting relationships based on changes in spot foreign currency rates and, therefore, there was no significant ineffectiveness for net investment hedge accounting relationships during 2016, 2015 and 2014.
Gains and losses on derivatives used for specified risk management purposes
The following table presents pre-tax gains/(losses) recorded on a limited number of derivatives, not designated in hedge accounting relationships, that are used to manage risks associated with certain specified assets and liabilities, including certain risks arising from the mortgage pipeline, warehouse loans, MSRs, wholesale lending exposures, foreign currency denominated assets and liabilities, and commodities-related contracts and investments.
(a)
Primarily represents interest rate derivatives used to hedge the interest rate risk inherent in the mortgage pipeline, warehouse loans and MSRs, as well as written commitments to originate warehouse loans. Gains and losses were recorded predominantly in mortgage fees and related income.
(b)
Relates to credit derivatives used to mitigate credit risk associated with lending exposures in the Firm’s wholesale businesses. These derivatives do not include credit derivatives used to mitigate counterparty credit risk arising from derivative receivables, which is included in gains and losses on derivatives related to market-making activities and other derivatives. Gains and losses were recorded in principal transactions revenue.
(c)
Primarily relates to derivatives used to mitigate foreign exchange risk of specified foreign currency-denominated assets and liabilities. Gains and losses were recorded in principal transactions revenue.
(d)
Primarily relates to commodity derivatives used to mitigate energy price risk associated with energy-related contracts and investments. Gains and losses were recorded in principal transactions revenue.
Gains and losses on derivatives related to market-making activities and other derivatives
The Firm makes markets in derivatives in order to meet the needs of customers and uses derivatives to manage certain risks associated with net open risk positions from its market-making activities, including the counterparty credit risk arising from derivative receivables. All derivatives not included in the hedge accounting or specified risk management categories above are included in this category. Gains and losses on these derivatives are primarily recorded in principal transactions revenue. See Note 7 for information on principal transactions revenue.
Credit derivatives
Credit derivatives are financial instruments whose value is derived from the credit risk associated with the debt of a third-party issuer (the reference entity) and which allow one party (the protection purchaser) to transfer that risk to another party (the protection seller). Credit derivatives expose the protection purchaser to the creditworthiness of the protection seller, as the protection seller is required to make payments under the contract when the reference entity experiences a credit event, such as a bankruptcy, a failure to pay its obligation or a restructuring. The seller of credit protection receives a premium for providing protection but has the risk that the underlying instrument referenced in the contract will be subject to a credit event.
The Firm is both a purchaser and seller of protection in the credit derivatives market and uses these derivatives for two primary purposes. First, in its capacity as a market-maker, the Firm actively manages a portfolio of credit derivatives by purchasing and selling credit protection, predominantly on corporate debt obligations, to meet the needs of customers. Second, as an end-user, the Firm uses credit derivatives to manage credit risk associated with lending exposures (loans and unfunded commitments) and derivatives counterparty exposures in the Firm’s wholesale businesses, and to manage the credit risk arising from certain financial instruments in the Firm’s market-making businesses. Following is a summary of various types of credit derivatives.
JPMorgan Chase & Co./2016 Annual Report
Credit default swaps
Credit derivatives may reference the credit of either a single reference entity (“single-name”) or a broad-based index. The Firm purchases and sells protection on both single- name and index-reference obligations. Single-name CDS and index CDS contracts are either OTC or OTC-cleared derivative contracts. Single-name CDS are used to manage the default risk of a single reference entity, while index CDS contracts are used to manage the credit risk associated with the broader credit markets or credit market segments. Like the S&P 500 and other market indices, a CDS index consists of a portfolio of CDS across many reference entities. New series of CDS indices are periodically established with a new underlying portfolio of reference entities to reflect changes in the credit markets. If one of the reference entities in the index experiences a credit event, then the reference entity that defaulted is removed from the index. CDS can also be referenced against specific portfolios of reference names or against customized exposure levels based on specific client demands: for example, to provide protection against the first $1 million of realized credit losses in a $10 million portfolio of exposure. Such structures are commonly known as tranche CDS.
For both single-name CDS contracts and index CDS contracts, upon the occurrence of a credit event, under the terms of a CDS contract neither party to the CDS contract has recourse to the reference entity. The protection purchaser has recourse to the protection seller for the difference between the face value of the CDS contract and the fair value of the reference obligation at settlement of the credit derivative contract, also known as the recovery value. The protection purchaser does not need to hold the debt instrument of the underlying reference entity in order to receive amounts due under the CDS contract when a credit event occurs.
Credit-related notes
A credit-related note is a funded credit derivative where the issuer of the credit-related note purchases from the note investor credit protection on a reference entity or an index. Under the contract, the investor pays the issuer the par value of the note at the inception of the transaction, and in return, the issuer pays periodic payments to the investor, based on the credit risk of the referenced entity. The issuer also repays the investor the par value of the note at maturity unless the reference entity (or one of the entities that makes up a reference index) experiences a specified credit event. If a credit event occurs, the issuer is not obligated to repay the par value of the note, but rather, the issuer pays the investor the difference between the par value of the note and the fair value of the defaulted reference obligation at the time of settlement. Neither party to the credit-related note has recourse to the defaulting reference entity.
The following tables present a summary of the notional amounts of credit derivatives and credit-related notes the Firm sold and purchased as of December 31, 2016 and 2015. Upon a credit event, the Firm as a seller of protection would typically pay out only a percentage of the full notional amount of net protection sold, as the amount actually required to be paid on the contracts takes into account the recovery value of the reference obligation at the time of settlement. The Firm manages the credit risk on contracts to sell protection by purchasing protection with identical or similar underlying reference entities. Other purchased protection referenced in the following tables includes credit derivatives bought on related, but not identical, reference positions (including indices, portfolio coverage and other reference points) as well as protection purchased through credit-related notes.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The Firm does not use notional amounts of credit derivatives as the primary measure of risk management for such derivatives, because the notional amount does not take into account the probability of the occurrence of a credit event, the recovery value of the reference obligation, or related cash instruments and economic hedges, each of which reduces, in the Firm’s view, the risks associated with such derivatives.
Total credit derivatives and credit-related notes
(a)
Other credit derivatives largely consists of credit swap options.
(b)
Represents the total notional amount of protection purchased where the underlying reference instrument is identical to the reference instrument on protection sold; the notional amount of protection purchased for each individual identical underlying reference instrument may be greater or lower than the notional amount of protection sold.
(c)
Does not take into account the fair value of the reference obligation at the time of settlement, which would generally reduce the amount the seller of protection pays to the buyer of protection in determining settlement value.
(d)
Represents protection purchased by the Firm on referenced instruments (single-name, portfolio or index) where the Firm has not sold any protection on the identical reference instrument.
The following tables summarize the notional amounts by the ratings, maturity profile, and total fair value, of credit derivatives and credit-related notes as of December 31, 2016 and 2015, where JPMorgan Chase is the seller of protection. The maturity profile is based on the remaining contractual maturity of the credit derivative contracts. The ratings profile is based on the rating of the reference entity on which the credit derivative contract is based. The ratings and maturity profile of credit derivatives and credit-related notes where JPMorgan Chase is the purchaser of protection are comparable to the profile reflected below.
(a)
The ratings scale is primarily based on external credit ratings defined by S&P and Moody’s.
(b)
Amounts are shown on a gross basis, before the benefit of legally enforceable master netting agreements and cash collateral received by the Firm.
JPMorgan Chase & Co./2016 Annual Report
Note 7 - Noninterest revenue
Investment banking fees
The following table presents the components of investment banking fees.
Underwriting fees are recognized as revenue when the Firm has rendered all services to, and is entitled to collect the fee from, the issuer, and there are no other contingencies associated with the fee. Underwriting fees are net of syndicate expense; the Firm recognizes credit arrangement and syndication fees as revenue after satisfying certain retention, timing and yield criteria. Advisory fees are recognized as revenue when the related services have been performed and the fee has been earned.
Principal transactions
Principal transactions revenue is driven by many factors, including the bid-offer spread, which is the difference between the price at which the Firm is willing to buy a financial or other instrument and the price at which the Firm is willing to sell that instrument. It also consists of the realized (as a result of closing out or termination of transactions, or interim cash payments) and unrealized (as a result of changes in valuation) gains and losses on financial and other instruments (including those accounted for under the fair value option) primarily used in client-driven market-making activities and on private equity investments. In connection with its client-driven market-making activities, the Firm transacts in debt and equity instruments, derivatives and commodities (including physical commodities inventories and financial instruments that reference commodities).
Principal transactions revenue also includes certain realized and unrealized gains and losses related to hedge accounting and specified risk-management activities, including: (a) certain derivatives designated in qualifying hedge accounting relationships (primarily fair value hedges of commodity and foreign exchange risk), (b) certain derivatives used for specific risk management purposes, primarily to mitigate credit risk, foreign exchange risk and commodity risk, and (c) other derivatives. For further information on the income statement classification of gains and losses from derivatives activities, see Note 6.
In the financial commodity markets, the Firm transacts in OTC derivatives (e.g., swaps, forwards, options) and ETD that reference a wide range of underlying commodities. In the physical commodity markets, the Firm primarily purchases and sells precious and base metals and may hold other commodities inventories under financing and other arrangements with clients.
The following table presents all realized and unrealized gains and losses recorded in principal transactions revenue. This table excludes interest income and interest expense on trading assets and liabilities, which are an integral part of the overall performance of the Firm’s client-driven market-making activities. See Note 8 for further information on interest income and interest expense. Trading revenue is presented primarily by instrument type. The Firm’s client-driven market-making businesses generally utilize a variety of instrument types in connection with their market-making and related risk-management activities; accordingly, the trading revenue presented in the table below is not representative of the total revenue of any individual line of business.
(a)
Includes revenue on private equity investments held in the Private Equity business within Corporate, as well as those held in other business segments.
Lending- and deposit-related fees
The following table presents the components of lending- and deposit-related fees.
Lending-related fees include fees earned from loan commitments, standby letters of credit, financial guarantees, and other loan-servicing activities. Deposit-related fees include fees earned in lieu of compensating balances, and fees earned from performing cash management activities and other deposit account services. Lending- and deposit-related fees in this revenue category are recognized over the period in which the related service is provided.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Asset management, administration and commissions
The following table presents Firmwide asset management, administration and commissions income:
(a)
Represents fees earned from managing assets on behalf of the Firm’s clients, including investors in Firm-sponsored funds and owners of separately managed investment accounts.
(b)
Represents fees for services that are ancillary to investment management services, such as commissions earned on the sales or distribution of mutual funds to clients.
(c)
Predominantly includes fees for custody, securities lending, funds services and securities clearance.
This revenue category includes fees from investment management and related services, custody and brokerage services, insurance premiums and commissions, and fees from other products and services. These fees are recognized over the period in which the related product or service is provided. Performance-based fees, which are earned based on exceeding certain benchmarks or other performance targets, are accrued and recognized at the end of the performance period in which the target is met. The Firm has contractual arrangements with third parties to provide certain services in connection with its asset management activities. Amounts paid to third-party service providers are predominantly expensed, such that asset management fees are recorded gross of payments made to third parties.
Mortgage fees and related income
This revenue category primarily reflects CCB’s Mortgage Banking production and servicing revenue, including fees and income derived from mortgages originated with the intent to sell; mortgage sales and servicing including losses related to the repurchase of previously sold loans; the impact of risk-management activities associated with the mortgage pipeline, warehouse loans and MSRs; and revenue related to any residual interests held from mortgage securitizations. This revenue category also includes gains and losses on sales and lower of cost or fair value adjustments for mortgage loans held-for-sale, as well as changes in fair value for mortgage loans originated with the intent to sell and measured at fair value under the fair value option. Changes in the fair value of MSRs are reported in mortgage fees and related income. For a further discussion of MSRs, see Note 17. Net interest income from mortgage loans is recorded in interest income.
Card income
This revenue category includes interchange income from credit and debit cards and net fees earned from processing card transactions for merchants. Card income is recognized as earned. Costs related to rewards programs are recorded when the rewards are earned by the customer and presented as a reduction to interchange income. Annual fees and direct loan origination costs are deferred and recognized on a straight-line basis over a 12-month period.
Credit card revenue sharing agreements
The Firm has contractual agreements with numerous co-brand partners which grant the Firm exclusive rights to market to the customers or members of such partners. These partners endorse the credit card programs and provide their customer or member lists to the Firm, and they may also conduct marketing activities and provide awards under the various credit card programs. The terms of these agreements generally range from five to ten years.
The Firm typically makes incentive payments to the partners based on new account originations, sales volumes and the cost of the partners’ marketing activities and awards. Payments based on new account originations are accounted for as direct loan origination costs. Payments to partners based on sales volumes are deducted from interchange income as the related revenue is earned. Payments based on marketing efforts undertaken by the partners are expensed by the Firm as incurred and reported as noninterest expense.
Other income
Other income on the Firm’s Consolidated statements of income included the following:
Operating lease income is recognized on a straight-line basis over the lease term.
JPMorgan Chase & Co./2016 Annual Report
Note 8 - Interest income and Interest expense
Interest income and interest expense are recorded in the Consolidated statements of income and classified based on the nature of the underlying asset or liability.
The following table presents the components of interest income and interest expense:
(a)
Includes the amortization of purchase price discounts or premiums, as well as net deferred loan fees or costs.
(b)
Represents securities that are tax exempt for U.S. federal income tax purposes.
(c)
Securities borrowed’s negative interest income, for the years ended December 31, 2016, 2015 and 2014, is a result of client-driven demand for certain securities combined with the impact of low interest rates; this is matched book activity and the negative interest expense on the corresponding securities loaned is recognized in interest expense.
(d)
Largely margin loans.
(e)
Includes brokerage customer payables.
Interest income and interest expense includes the current-period interest accruals for financial instruments measured at fair value, except for derivatives and financial instruments containing embedded derivatives that would be separately accounted for in accordance with U.S. GAAP, absent the fair value option election; for those instruments, all changes in fair value including any interest elements, are reported in principal transactions revenue. For financial instruments that are not measured at fair value, the related interest is included within interest income or interest expense, as applicable.
Note 9 - Pension and other postretirement employee benefit plans
The Firm has various defined benefit pension plans and OPEB plans that provide benefits to its employees. These plans are discussed below.
Defined benefit pension plans
The Firm has a qualified noncontributory U.S. defined benefit pension plan that provides benefits to substantially all U.S. employees. The U.S. plan employs a cash balance formula in the form of pay and interest credits to determine the benefits to be provided at retirement, based on years of service and eligible compensation (generally base salary/regular pay and variable cash incentive compensation capped at $100,000 annually). Employees begin to accrue plan benefits after completing one year of service, and benefits generally vest after three years of service. The Firm also offers benefits through defined benefit pension plans to qualifying employees in certain non-U.S. locations based on factors such as eligible compensation, age and/or years of service.
It is the Firm’s policy to fund the pension plans in amounts sufficient to meet the requirements under applicable laws. The Firm does not anticipate at this time any contribution to the U.S. defined benefit pension plan in 2017. The 2017 contributions to the non-U.S. defined benefit pension plans are expected to be $44 million of which $28 million are contractually required.
JPMorgan Chase also has a number of defined benefit pension plans that are not subject to Title IV of the Employee Retirement Income Security Act. The most significant of these plans is the Excess Retirement Plan, pursuant to which certain employees previously earned pay credits on compensation amounts above the maximum stipulated by law under a qualified plan; no further pay credits are allocated under this plan. The Excess Retirement Plan had an unfunded projected benefit obligation (“PBO”) in the amount of $215 million and $237 million, at December 31, 2016 and 2015, respectively.
Defined contribution plans
JPMorgan Chase currently provides two qualified defined contribution plans in the U.S. and other similar arrangements in certain non-U.S. locations, all of which are administered in accordance with applicable local laws and regulations. The most significant of these plans is the JPMorgan Chase 401(k) Savings Plan (the “401(k) Savings Plan”), which covers substantially all U.S. employees. Employees can contribute to the 401(k) Savings Plan on a pretax and/or Roth 401(k) after-tax basis. The JPMorgan Chase Common Stock Fund, which is an investment option under the 401(k) Savings Plan, is a nonleveraged employee stock ownership plan.
The Firm matches eligible employee contributions up to 5% of eligible compensation (generally base salary/regular pay and variable cash incentive compensation) on an annual basis. Employees begin to receive matching contributions
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
after completing a one-year-of-service requirement. Employees with total annual cash compensation of $250,000 or more are not eligible for matching contributions. Matching contributions vest after three years of service. The 401(k) Savings Plan also permits discretionary profit-sharing contributions by participating companies for certain employees, subject to a specified vesting schedule.
OPEB plans
JPMorgan Chase offers postretirement medical and life insurance benefits to certain retirees and postretirement medical benefits to qualifying U.S. employees. These benefits vary with the length of service and the date of hire and provide for limits on the Firm’s share of covered medical benefits. The medical and life insurance benefits are both contributory. Effective January 1, 2015, there was
a transition of certain Medicare eligible retirees from JPMorgan Chase group sponsored coverage to Medicare exchanges. As a result of this change, eligible retirees will receive a Healthcare Reimbursement Account amount each year if they enroll through the Medicare exchange. The impact of this change was not material. Postretirement medical benefits also are offered to qualifying U.K. employees.
JPMorgan Chase’s U.S. OPEB obligation is funded with corporate-owned life insurance (“COLI”) purchased on the lives of eligible employees and retirees. While the Firm owns the COLI policies, COLI proceeds (death benefits, withdrawals and other distributions) may be used only to reimburse the Firm for its net postretirement benefit claim payments and related administrative expense. The U.K. OPEB plan is unfunded.
The following table presents the changes in benefit obligations, plan assets and funded status amounts reported on the Consolidated balance sheets for the Firm’s U.S. and non-U.S. defined benefit pension and OPEB plans.
(a)
Represents plans with an aggregate overfunded balance of $4.0 billion and $4.1 billion at December 31, 2016 and 2015, respectively, and plans with an aggregate underfunded balance of $639 million and $636 million at December 31, 2016 and 2015, respectively.
(b)
At December 31, 2016 and 2015, approximately $390 million and $533 million, respectively, of U.S. plan assets included participation rights under participating annuity contracts.
(c)
At December 31, 2016 and 2015, defined benefit pension plan amounts that were not measured at fair value included $130 million and $74 million, respectively, of accrued receivables, and $224 million and $123 million, respectively, of accrued liabilities, for U.S. plans.
(d)
Includes an unfunded accumulated postretirement benefit obligation of $35 million and $32 million at December 31, 2016 and 2015, respectively, for the U.K. plan.
JPMorgan Chase & Co./2016 Annual Report
Gains and losses
For the Firm’s defined benefit pension plans, fair value is used to determine the expected return on plan assets. Amortization of net gains and losses is included in annual net periodic benefit cost if, as of the beginning of the year, the net gain or loss exceeds 10% of the greater of the PBO or the fair value of the plan assets. Any excess is amortized over the average future service period of defined benefit pension plan participants, which for the U.S. defined benefit pension plan is currently seven years and for the non-U.S. defined benefit pension plans is the period appropriate for the affected plan. In addition, prior service costs are amortized over the average remaining service period of active employees expected to receive benefits under the plan when the prior service cost is first recognized. The average remaining amortization period for the U.S. defined benefit pension plan for current prior service costs is three years.
For the Firm’s OPEB plans, a calculated value that recognizes changes in fair value over a five-year period is used to determine the expected return on plan assets. This value is referred to as the market related value of assets. Amortization of net gains and losses, adjusted for gains and losses not yet recognized, is included in annual net periodic benefit cost if, as of the beginning of the year, the net gain or loss exceeds 10% of the greater of the accumulated postretirement benefit obligation or the market related value of assets. Any excess net gain or loss is amortized over the average expected lifetime of retired participants, which is currently twelve years; however, prior service costs resulting from plan changes are amortized over the average years of service remaining to full eligibility age, which is currently two years.
The following table presents pretax pension and OPEB amounts recorded in AOCI.
The following table presents the components of net periodic benefit costs reported in the Consolidated statements of income and other comprehensive income for the Firm’s U.S. and non-U.S. defined benefit pension, defined contribution and OPEB plans.
(a)
Includes various defined benefit pension plans which are individually immaterial.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The estimated pretax amounts that will be amortized from AOCI into net periodic benefit cost in 2017 are as follows.
The following table presents the actual rate of return on plan assets for the U.S. and non-U.S. defined benefit pension and OPEB plans.
Plan assumptions
JPMorgan Chase’s expected long-term rate of return for U.S. defined benefit pension and OPEB plan assets is a blended average of the investment advisor’s projected long-term
(10 or more years) returns for the various asset classes, weighted by the asset allocation. Returns on asset classes are developed using a forward-looking approach and are not strictly based on historical returns. Equity returns are generally developed as the sum of inflation, expected real earnings growth and expected long-term dividend yield. Bond returns are generally developed as the sum of inflation, real bond yield and risk spread (as appropriate), adjusted for the expected effect on returns from changing yields. Other asset-class returns are derived from their relationship to the equity and bond markets. Consideration is also given to current market conditions and the short-term portfolio mix of each plan.
For the U.K. defined benefit pension plans, which represent the most significant of the non-U.S. defined benefit pension plans, procedures similar to those in the U.S. are used to develop the expected long-term rate of return on plan assets, taking into consideration local market conditions and the specific allocation of plan assets. The expected long-term rate of return on U.K. plan assets is an average of projected long-term returns for each asset class. The return on equities has been selected by reference to the yield on long-term U.K. government bonds plus an equity risk premium above the risk-free rate. The expected return on “AA” rated long-term corporate bonds is based on an implied yield for similar bonds.
The discount rate used in determining the benefit obligation under the U.S. defined benefit pension and OPEB plans was provided by the Firm’s actuaries. This rate was selected by reference to the yields on portfolios of bonds with maturity dates and coupons that closely match each of the plan’s projected cash flows; such portfolios are derived from a broad-based universe of high-quality corporate bonds as of the measurement date. In years in which these hypothetical bond portfolios generate excess cash, such excess is assumed to be reinvested at the one-year forward rates
implied by the Mercer Yield Curve published as of the measurement date. The discount rate for the U.K. defined benefit pension plan represents a rate of appropriate duration from the analysis of yield curves provided by the Firm’s actuaries.
At December 31, 2016, the Firm decreased the discount rates used to determine its benefit obligations for the U.S. defined benefit pension and OPEB plans in light of current market interest rates, which will increase expense by approximately $45 million in 2017. The 2017 expected long-term rate of return on U.S. defined benefit pension plan assets and U.S. OPEB plan assets are 6.00% and 5.00%, respectively. For 2017, the initial health care benefit obligation trend assumption has been set at 5.00%, while the ultimate health care trend assumption and the year to reach the ultimate rate remain at 5.00% and 2017, respectively, unchanged from 2016. As of December 31, 2016, the interest crediting rate assumption remained at 5.00% and the assumed rate of compensation increase was reduced to 2.30%.
JPMorgan Chase & Co./2016 Annual Report
The following tables present the weighted-average annualized actuarial assumptions for the projected and accumulated postretirement benefit obligations, and the components of net periodic benefit costs, for the Firm’s significant U.S. and non-U.S. defined benefit pension and OPEB plans, as of and for the periods indicated.
The following table presents the effect of a one-percentage-point change in the assumed health care cost trend rate on JPMorgan Chase’s accumulated postretirement benefit obligation. As of December 31, 2016, there was no material effect on total service and interest cost.
JPMorgan Chase’s U.S. defined benefit pension and OPEB plan expense is sensitive to the expected long-term rate of return on plan assets and the discount rate. With all other assumptions held constant, a 25-basis point decline in the expected long-term rate of return on U.S. plan assets would result in an aggregate increase of approximately $40 million in 2017 U.S. defined benefit pension and OPEB plan expense. A 25-basis point decline in the discount rate for the U.S. plans would result in an increase in 2017 U.S. defined benefit pension and OPEB plan expense of approximately an aggregate $31 million and an increase in the related benefit obligations of approximately an aggregate $316 million. A 25-basis point decrease in the interest crediting rate for the U.S. defined benefit pension plan would result in a decrease in 2017 U.S. defined benefit pension expense of approximately $36 million and a decrease in the related PBO of approximately $160 million. A 25-basis point decline in the discount rates for the non-U.S. plans would result in an increase in the 2017 non-U.S. defined benefit pension plan expense of approximately $12 million.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Investment strategy and asset allocation
The Firm’s U.S. defined benefit pension plan assets are held in trust and are invested in a well-diversified portfolio of equity and fixed income securities, cash and cash equivalents, and alternative investments (e.g., hedge funds, private equity, real estate and real assets). Non-U.S. defined benefit pension plan assets are held in various trusts and are also invested in well-diversified portfolios of equity, fixed income and other securities. Assets of the Firm’s COLI policies, which are used to partially fund the U.S. OPEB plan, are held in separate accounts of an insurance company and are allocated to investments intended to replicate equity and fixed income indices.
The investment policy for the Firm’s U.S. defined benefit pension plan assets is to optimize the risk-return relationship as appropriate to the needs and goals of the plan using a global portfolio of various asset classes diversified by market segment, economic sector, and issuer. Assets are managed by a combination of internal and external investment managers. Periodically the Firm performs a comprehensive analysis on the U.S. defined benefit pension plan asset allocations, incorporating projected asset and liability data, which focuses on the short- and long-term impact of the asset allocation on cumulative pension expense, economic cost, present value of contributions and funded status. Currently, approved asset allocation ranges are: U.S. equity 0% to 45%, international equity 0% to 40%, debt securities 0% to 80%, hedge funds 0% to 5%, real estate 0% to 10%, real assets 0% to 10% and private equity 0% to 20%. Asset allocations are not managed to a specific target but seek to shift asset class allocations within these stated ranges. Investment strategies incorporate the economic outlook and the anticipated implications of the macroeconomic environment on the various asset classes while maintaining an appropriate level of liquidity for the plan. The Firm
regularly reviews the asset allocations and asset managers, as well as other factors that impact the portfolio, which is rebalanced when deemed necessary.
For the U.K. defined benefit pension plans, which represent the most significant of the non-U.S. defined benefit pension plans, the assets are invested to maximize returns subject to an appropriate level of risk relative to the plans’ liabilities. To reduce the volatility in returns relative to the plans’ liability profiles, the U.K. defined benefit pension plans’ largest asset allocations are to debt securities of appropriate durations. Other assets, mainly equity securities, are then invested for capital appreciation, to provide long-term investment growth. Similar to the U.S. defined benefit pension plan, asset allocations and asset managers for the U.K. plans are reviewed regularly and the portfolios are rebalanced when deemed necessary.
Investments held by the U.S. and non-U.S. defined benefit pension and OPEB plans include financial instruments that are exposed to various risks such as market, credit, liquidity and country risks. Exposure to a concentration of credit risk is mitigated by the broad diversification of both U.S. and non-U.S. investment instruments. Additionally, the investments in each of the common/collective trust funds and registered investment companies are further diversified into various financial instruments. As of December 31, 2016, assets held by the Firm’s U.S. and non-U.S. defined benefit pension and OPEB plans do not include JPMorgan Chase common stock, except through indirect exposures through investments in third-party stock-index funds. The plans hold investments in funds that are sponsored or managed by affiliates of JPMorgan Chase in the amount of $3.4 billion and $3.2 billion for U.S. plans and $1.2 billion and $1.2 billion for non-U.S. plans, as of December 31, 2016 and 2015, respectively.
The following table presents the weighted-average asset allocation of the fair values of total plan assets at December 31 for the years indicated, as well as the respective approved range/target allocation by asset category, for the Firm’s U.S. and non-U.S. defined benefit pension and OPEB plans.
(a)
Debt securities primarily include corporate debt, U.S. federal, state, local and non-U.S. government, and mortgage-backed securities.
(b)
Alternatives primarily include limited partnerships.
(c)
Represents the U.S. OPEB plan only, as the U.K. OPEB plan is unfunded.
JPMorgan Chase & Co./2016 Annual Report
Fair value measurement of the plans’ assets and liabilities
For information on fair value measurements, including descriptions of level 1, 2, and 3 of the fair value hierarchy and the valuation methods employed by the Firm, see Note 3.
(a)
At December 31, 2016 and 2015, common/collective trust funds primarily included a mix of short-term investment funds, domestic and international equity investments (including index) and real estate funds.
(b)
Unfunded commitments to purchase limited partnership investments for the plans were $735 million and $895 million for 2016 and 2015, respectively.
(c)
Corporate debt securities include debt securities of U.S. and non-U.S. corporations.
(d)
Other consists primarily of money market funds and participating and non-participating annuity contracts. Money market funds are primarily classified within level 1 of the fair value hierarchy given they are valued using market observable prices. Participating and non-participating annuity contracts are classified within level 3 of the fair value hierarchy due to a lack of market mechanisms for transferring each policy and surrender restrictions.
(e)
Certain investments that are measured at fair value using the net asset value per share (or its equivalent) as a practical expedient are not required to be classified in the fair value hierarchy. At December 31, 2016 and 2015, the fair values of these investments, which include certain limited partnerships and common/collective trust funds, were $4.0 billion and $4.1 billion, respectively, of U.S. defined benefit pension plan investments, and $243 million and $234 million, respectively, of non-U.S. defined benefit pension plan investments.
(f)
At December 31, 2016 and 2015, excluded U.S. defined benefit pension plan receivables for investments sold and dividends and interest receivables of $130 million and $74 million, respectively.
(g)
At December 31, 2016 and 2015, excluded $203 million and $106 million, respectively, of U.S. defined benefit pension plan payables for investments purchased; and $21 million and $17 million, respectively, of other liabilities.
(h)
There were zero assets or liabilities classified as level 3 for the non-U.S. defined benefit pension plans as of December 31, 2016 and 2015.
The Firm’s U.S. OPEB plan was partially funded with COLI policies of $2.0 billion and $1.9 billion at December 31, 2016 and 2015, which were classified in level 3 of the valuation hierarchy.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Estimated future benefit payments
The following table presents benefit payments expected to be paid, which include the effect of expected future service, for the years indicated. The OPEB medical and life insurance payments are net of expected retiree contributions.
JPMorgan Chase & Co./2016 Annual Report
Note 10 - Employee stock-based incentives
Employee stock-based awards
In 2016, 2015 and 2014, JPMorgan Chase granted long-term stock-based awards to certain employees under its LTIP, as amended and restated effective May 19, 2015. Under the terms of the LTIP, as of December 31, 2016, 78 million shares of common stock were available for issuance through May 2019. The LTIP is the only active plan under which the Firm is currently granting stock-based incentive awards. In the following discussion, the LTIP, plus prior Firm plans and plans assumed as the result of acquisitions, are referred to collectively as the “LTI Plans,” and such plans constitute the Firm’s stock-based incentive plans.
RSUs are awarded at no cost to the recipient upon their grant. Generally, RSUs are granted annually and vest at a rate of 50% after two years and 50% after three years and are converted into shares of common stock as of the vesting date. In addition, RSUs typically include full-career eligibility provisions, which allow employees to continue to vest upon voluntary termination, subject to post-employment and other restrictions based on age or service-related requirements. All RSU awards are subject to forfeiture until vested and contain clawback provisions that may result in cancellation under certain specified circumstances. RSUs entitle the recipient to receive cash payments equivalent to any dividends paid on the underlying common stock during the period the RSUs are outstanding and, as such, are considered participating securities as discussed in Note 24.
In January 2016, the Firm’s Board of Directors approved the grant of performance share units (“PSUs”) to members of the Firm’s Operating Committee under the variable compensation program for performance year 2015. PSUs are subject to the Firm’s achievement of specified performance criteria over a three-year period. The number of awards that vest can range from zero to 150% of the grant amount. The awards vest and are converted into shares of common stock in the quarter after the end of the three-year performance period. In addition, dividends are notionally reinvested in the Firm’s common stock and will be delivered only in respect of any earned shares.
Once the PSUs have vested, the shares of common stock that are delivered, after applicable tax withholding, must be held for an additional two-year period, for a total combined vesting and holding period of five years from the grant date.
Under the LTI Plans, stock options and stock appreciation rights (“SARs”) have generally been granted with an exercise price equal to the fair value of JPMorgan Chase’s common stock on the grant date. The Firm periodically grants employee stock options to individual employees. There were no material grants of stock options or SARs
in 2016, 2015 and 2014. SARs generally expire ten years after the grant date.
The Firm separately recognizes compensation expense for each tranche of each award, net of estimated forfeitures, as if it were a separate award with its own vesting date. Generally, for each tranche granted, compensation expense is recognized on a straight-line basis from the grant date until the vesting date of the respective tranche, provided that the employees will not become full-career eligible during the vesting period. For awards with full-career eligibility provisions and awards granted with no future substantive service requirement, the Firm accrues the estimated value of awards expected to be awarded to employees as of the grant date without giving consideration to the impact of post-employment restrictions. For each tranche granted to employees who will become full-career eligible during the vesting period, compensation expense is recognized on a straight-line basis from the grant date until the earlier of the employee’s full-career eligibility date or the vesting date of the respective tranche.
The Firm’s policy for issuing shares upon settlement of employee stock-based incentive awards is to issue either new shares of common stock or treasury shares. During 2016, 2015 and 2014, the Firm settled all of its employee stock-based awards by issuing treasury shares.
In January 2008, the Firm awarded to its Chairman and Chief Executive Officer up to 2 million SARs. The terms of this award are distinct from, and more restrictive than, other equity grants regularly awarded by the Firm. On July 15, 2014, the Compensation & Management Development Committee and Board of Directors determined that all requirements for the vesting of the 2 million SAR awards had been met and thus, the awards became exercisable. The SARs, which will expire in January 2018, have an exercise price of $39.83 (the price of JPMorgan Chase common stock on the date of grant). The expense related to this award was dependent on changes in fair value of the SARs through July 15, 2014 (the date when the vested number of SARs were determined), and the cumulative expense was recognized ratably over the service period, which was initially assumed to be five years but, effective in the first quarter of 2013, was extended to six and one-half years. The Firm recognized $3 million in compensation expense in 2014 for this award.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
RSUs, PSUs, employee stock options and SARs activity
Compensation expense for RSUs and PSUs is measured based on the number of units granted multiplied by the stock price at the grant date, and for employee stock options and SARs, is measured at the grant date using the Black-Scholes valuation model. Compensation expense for these awards is recognized in net income as described previously. The following table summarizes JPMorgan Chase’s RSUs, PSUs, employee stock options and SARs activity for 2016.
The total fair value of RSUs that vested during the years ended December 31, 2016, 2015 and 2014, was $2.2 billion, $2.8 billion and $3.2 billion, respectively. The total intrinsic value of options exercised during the years ended December 31, 2016, 2015 and 2014, was $338 million, $335 million and $539 million, respectively.
Compensation expense
The Firm recognized the following noncash compensation expense related to its various employee stock-based incentive plans in its Consolidated statements of income.
At December 31, 2016, approximately $700 million (pretax) of compensation expense related to unvested awards had not yet been charged to net income. That cost is expected to be amortized into compensation expense over a weighted-average period of 1.0 year. The Firm does not capitalize any compensation expense related to share-based compensation awards to employees.
Cash flows and tax benefits
Effective January 1, 2016, the Firm adopted new accounting guidance related to employee share-based payments. As a result of the adoption of this new guidance, all excess tax benefits (including tax benefits from dividends or dividend equivalents) on share-based payment awards are recognized within income tax expense in the Consolidated statements of income. In prior years these tax benefits were recorded as increases to additional paid-in capital. Income tax benefits related to stock-based incentive arrangements recognized in the Firm’s Consolidated statements of income for the years ended December 31, 2016, 2015 and 2014, were $916 million, $746 million and $854 million, respectively.
The following table sets forth the cash received from the exercise of stock options under all stock-based incentive arrangements, and the actual income tax benefit related to tax deductions from the exercise of the stock options.
JPMorgan Chase & Co./2016 Annual Report
Note 11 - Noninterest expense
For details on noninterest expense, see Consolidated statements of income on page 141. Included within other expense are the following:
Note 12 - Securities
Securities are classified as trading, AFS or HTM. Securities classified as trading assets are discussed in Note 3. Predominantly all of the Firm’s AFS and HTM investment securities (the “investment securities portfolio”) are held by Treasury and CIO in connection with its asset-liability management objectives. At December 31, 2016, the investment securities portfolio consisted of debt securities with an average credit rating of AA+ (based upon external ratings where available, and where not available, based primarily upon internal ratings which correspond to ratings as defined by S&P and Moody’s). AFS securities are carried at fair value on the Consolidated balance sheets. Unrealized gains and losses, after any applicable hedge accounting adjustments, are reported as net increases or decreases to AOCI. The specific identification method is used to determine realized gains and losses on AFS securities, which are included in securities gains/(losses) on the Consolidated statements of income. HTM debt securities, which management has the intent and ability to hold until maturity, are carried at amortized cost on the Consolidated balance sheets. For both AFS and HTM debt securities, purchase discounts or premiums are generally amortized into interest income over the contractual life of the security.
During 2016, the Firm transferred commercial MBS and obligations of U.S. states and municipalities with a fair value of $7.5 billion from AFS to HTM. These securities were transferred at fair value. AOCI included net pretax unrealized gains of $78 million on the securities at the date of transfer. The transfers reflect the Firm’s intent to hold the securities to maturity in order to reduce the impact of price volatility on AOCI. This transfer was a non-cash transaction.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The amortized costs and estimated fair values of the investment securities portfolio were as follows for the dates indicated.
(a)
Includes total U.S. government-sponsored enterprise obligations with fair values of $45.8 billion and $42.3 billion at December 31, 2016 and 2015, respectively, which were predominantly mortgage-related.
(b)
Prior period amounts have been revised to conform with current period presentation.
(c)
Included total U.S. government-sponsored enterprise obligations with amortized cost of $25.6 billion and $30.8 billion at December 31, 2016 and 2015, respectively, which were mortgage-related.
JPMorgan Chase & Co./2016 Annual Report
Securities impairment
The following tables present the fair value and gross unrealized losses for the investment securities portfolio by aging category at December 31, 2016 and 2015.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
Prior period amounts have been revised to conform with current period presentation.
JPMorgan Chase & Co./2016 Annual Report
Gross unrealized losses
The Firm has recognized unrealized losses on securities it intends to sell as OTTI. The Firm does not intend to sell any of the remaining securities with an unrealized loss in AOCI as of December 31, 2016, and it is not likely that the Firm will be required to sell these securities before recovery of their amortized cost basis. Except for the securities for which credit losses have been recognized in income, the Firm believes that the securities with an unrealized loss in AOCI are not other-than-temporarily impaired as of December 31, 2016.
Other-than-temporary impairment
AFS debt and equity securities and HTM debt securities in unrealized loss positions are analyzed as part of the Firm’s ongoing assessment of OTTI. For most types of debt securities, the Firm considers a decline in fair value to be other-than-temporary when the Firm does not expect to recover the entire amortized cost basis of the security. For beneficial interests in securitizations that are rated below “AA” at their acquisition, or that can be contractually prepaid or otherwise settled in such a way that the Firm would not recover substantially all of its recorded investment, the Firm considers an impairment to be other-than-temporary when there is an adverse change in expected cash flows. For AFS equity securities, the Firm considers a decline in fair value to be other-than-temporary if it is probable that the Firm will not recover its cost basis.
Potential OTTI is considered using a variety of factors, including the length of time and extent to which the market value has been less than cost; adverse conditions specifically related to the industry, geographic area or financial condition of the issuer or underlying collateral of a security; payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and the Firm’s intent and ability to hold the security until recovery.
For AFS debt securities, the Firm recognizes OTTI losses in earnings if the Firm has the intent to sell the debt security, or if it is more likely than not that the Firm will be required to sell the debt security before recovery of its amortized cost basis. In these circumstances the impairment loss is equal to the full difference between the amortized cost basis and the fair value of the securities. For debt securities in an unrealized loss position that the Firm has the intent and ability to hold, the expected cash flows to be received from the securities are evaluated to determine if a credit loss exists. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. Amounts relating to factors other than credit losses are recorded in OCI.
The Firm’s cash flow evaluations take into account the factors noted above and expectations of relevant market and economic data as of the end of the reporting period. For securities issued in a securitization, the Firm estimates cash flows considering underlying loan-level data and structural features of the securitization, such as subordination, excess spread, overcollateralization or other forms of credit enhancement, and compares the losses projected for the underlying collateral (“pool losses”) against the level of credit enhancement in the securitization structure to determine whether these features are sufficient to absorb the pool losses, or whether a credit loss exists. The Firm also performs other analyses to support its cash flow projections, such as first-loss analyses or stress scenarios.
For equity securities, OTTI losses are recognized in earnings if the Firm intends to sell the security. In other cases the Firm considers the relevant factors noted above, as well as the Firm’s intent and ability to retain its investment for a period of time sufficient to allow for any anticipated recovery in market value, and whether evidence exists to support a realizable value equal to or greater than the cost basis. Any impairment loss on an equity security is equal to the full difference between the cost basis and the fair value of the security.
Securities gains and losses
The following table presents realized gains and losses and OTTI from AFS securities that were recognized in income.
(a)
Excludes realized losses on securities sold of $24 million, $5 million and $3 million for the years ended December 31, 2016, 2015 and 2014, respectively that had been previously reported as an OTTI loss due to the intention to sell the securities.
Changes in the credit loss component of credit-impaired debt securities
The cumulative credit loss component, including any changes therein, of OTTI losses that have been recognized in income related to AFS debt securities was not material as of and during the years ended December 31, 2016, 2015 and 2014.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Contractual maturities and yields
The following table presents the amortized cost and estimated fair value at December 31, 2016, of JPMorgan Chase’s investment securities portfolio by contractual maturity.
(a)
U.S. government-sponsored enterprises were the only issuers whose securities exceeded 10% of JPMorgan Chase’s total stockholders’ equity at December 31, 2016.
(b)
Average yield is computed using the effective yield of each security owned at the end of the period, weighted based on the amortized cost of each security. The effective yield considers the contractual coupon, amortization of premiums and accretion of discounts, and the effect of related hedging derivatives. Taxable-equivalent amounts are used
JPMorgan Chase & Co./2016 Annual Report
where applicable. The effective yield excludes unscheduled principal prepayments; and accordingly, actual maturities of securities may differ from their contractual or expected maturities as certain securities may be prepaid.
(c)
Includes securities with no stated maturity. Substantially all of the Firm’s residential MBS and collateralized mortgage obligations are due in 10 years or more, based on contractual maturity. The estimated weighted-average life, which reflects anticipated future prepayments, is approximately seven years for agency residential MBS, three years for agency residential collateralized mortgage obligations and three years for nonagency residential collateralized mortgage obligations.
Note 13 - Securities financing activities
JPMorgan Chase enters into resale agreements, repurchase agreements, securities borrowed transactions and securities loaned transactions (collectively, “securities financing agreements”) primarily to finance the Firm’s inventory positions, acquire securities to cover short positions, accommodate customers’ financing needs, and settle other securities obligations.
Securities financing agreements are treated as collateralized financings on the Firm’s Consolidated balance sheets. Resale and repurchase agreements are generally carried at the amounts at which the securities will be subsequently sold or repurchased. Securities borrowed and securities loaned transactions are generally carried at the amount of cash collateral advanced or received. Where appropriate under applicable accounting guidance, resale and repurchase agreements with the same counterparty are reported on a net basis. For further discussion of the offsetting of assets and liabilities, see Note 1. Fees received and paid in connection with securities financing agreements are recorded in interest income and interest expense on the Consolidated statements of income.
The Firm has elected the fair value option for certain securities financing agreements. For further information regarding the fair value option, see Note 4. The securities financing agreements for which the fair value option has been elected are reported within securities purchased under resale agreements, securities loaned or sold under repurchase agreements, and securities borrowed on the Consolidated balance sheets. Generally, for agreements carried at fair value, current-period interest accruals are recorded within interest income and interest expense, with changes in fair value reported in principal transactions revenue. However, for financial instruments containing embedded derivatives that would be separately accounted for in accordance with accounting guidance for hybrid instruments, all changes in fair value, including any interest elements, are reported in principal transactions revenue.
Securities financing transactions expose the Firm to credit and liquidity risk. To manage these risks, the Firm monitors the value of the underlying securities (predominantly high-quality securities collateral, including government-issued debt and agency MBS) that it has received from or provided to its counterparties compared to the value of cash proceeds and exchanged collateral, and either requests additional collateral or returns securities or collateral when appropriate. Margin levels are initially established based upon the counterparty, the type of underlying securities, and the permissible collateral, and are monitored on an ongoing basis.
In resale agreements and securities borrowed transactions, the Firm is exposed to credit risk to the extent that the value of the securities received is less than initial cash principal advanced and any collateral amounts exchanged. In repurchase agreements and securities loaned transactions, credit risk exposure arises to the extent that the value of underlying securities exceeds the value of the initial cash principal advanced, and any collateral amounts exchanged.
Additionally, the Firm typically enters into master netting agreements and other similar arrangements with its counterparties, which provide for the right to liquidate the underlying securities and any collateral amounts exchanged in the event of a counterparty default. It is also the Firm’s policy to take possession, where possible, of the securities underlying resale agreements and securities borrowed transactions. For further information regarding assets pledged and collateral received in securities financing agreements, see Note 30.
As a result of the Firm’s credit risk mitigation practices with respect to resale and securities borrowed agreements as described above, the Firm did not hold any reserves for credit impairment with respect to these agreements as of December 31, 2016 and 2015.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The table below summarizes the gross and net amounts of the Firm’s securities financing agreements, as of December 31, 2016, and 2015. When the Firm has obtained an appropriate legal opinion with respect to the master netting agreement with a counterparty and where other relevant netting criteria under U.S. GAAP are met, the Firm nets, on the Consolidated balance sheets, the balances outstanding under its securities financing agreements with the same counterparty. In addition, the Firm exchanges securities and/or cash collateral with its counterparties; this collateral also reduces, in the Firm’s view, the economic exposure with the counterparty. Such collateral, along with securities financing balances that do not meet all these relevant netting criteria under U.S. GAAP, is presented as “Amounts not nettable on the Consolidated balance sheets,” and reduces the “Net amounts” presented below, if the Firm has an appropriate legal opinion with respect to the master netting agreement with the counterparty. Where a legal opinion has not been either sought or obtained, the securities financing balances are presented gross in the “Net amounts” below, and related collateral does not reduce the amounts presented.
(a)
Includes securities-for-securities lending transactions of $9.1 billion and $4.4 billion at December 31, 2016 and 2015, respectively, accounted for at fair value, where the Firm is acting as lender. These amounts are presented within other liabilities in the Consolidated balance sheets.
(b)
Includes securities financing agreements accounted for at fair value. At December 31, 2016 and 2015, included securities purchased under resale agreements of $21.5 billion and $23.1 billion, respectively, and securities sold under agreements to repurchase of $687 million and $3.5 billion, respectively. There were no securities borrowed at December 31, 2016 and $395 million at December 31, 2015. There were no securities loaned accounted for at fair value in either period.
(c)
In some cases, collateral exchanged with a counterparty exceeds the net asset or liability balance with that counterparty. In such cases, the amounts reported in this column are limited to the related asset or liability with that counterparty.
(d)
Includes securities financing agreements that provide collateral rights, but where an appropriate legal opinion with respect to the master netting agreement has not been either sought or obtained. At December 31, 2016 and 2015, included $4.8 billion and $2.3 billion, respectively, of securities purchased under resale agreements; $27.1 billion and $31.3 billion, respectively, of securities borrowed; $15.9 billion and $12.6 billion, respectively, of securities sold under agreements to repurchase; and $90 million and $45 million, respectively, of securities loaned and other.
(e)
Prior period amounts have been revised to conform with the current presentation.
JPMorgan Chase & Co./2016 Annual Report
The tables below present as of December 31, 2016 and 2015 the types of financial assets pledged in securities financing agreements and the remaining contractual maturity of the securities financing agreements.
(a)
Includes securities-for-securities lending transactions of $9.1 billion and $4.4 billion at December 31, 2016 and 2015, respectively, accounted for at fair value, where the Firm is acting as lender. These amounts are presented within other liabilities on the Consolidated balance sheets.
Transfers not qualifying for sale accounting
At December 31, 2016 and 2015, the Firm held $5.9 billion and $7.5 billion, respectively, of financial assets for which the rights have been transferred to third parties; however, the transfers did not qualify as a sale in accordance with U.S. GAAP. These transfers have been recognized as collateralized financing transactions. The transferred assets are recorded in trading assets and loans, and the corresponding liabilities are recorded predominantly in other borrowed funds on the Consolidated balance sheets.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 14 - Loans
Loan accounting framework
The accounting for a loan depends on management’s strategy for the loan, and on whether the loan was credit-impaired at the date of acquisition. The Firm accounts for loans based on the following categories:
•
Originated or purchased loans held-for-investment (i.e., “retained”), other than PCI loans
•
Loans held-for-sale
•
Loans at fair value
•
PCI loans held-for-investment
The following provides a detailed accounting discussion of these loan categories:
Loans held-for-investment (other than PCI loans)
Originated or purchased loans held-for-investment, other than PCI loans, are recorded at the principal amount outstanding, net of the following: charge-offs; interest applied to principal (for loans accounted for on the cost recovery method); unamortized discounts and premiums; and net deferred loan fees or costs. Credit card loans also include billed finance charges and fees net of an allowance for uncollectible amounts.
Interest income
Interest income on performing loans held-for-investment, other than PCI loans, is accrued and recognized as interest income at the contractual rate of interest. Purchase price discounts or premiums, as well as net deferred loan fees or costs, are amortized into interest income over the contractual life of the loan to produce a level rate of return.
Nonaccrual loans
Nonaccrual loans are those on which the accrual of interest has been suspended. Loans (other than credit card loans and certain consumer loans insured by U.S. government agencies) are placed on nonaccrual status and considered nonperforming when full payment of principal and interest is not expected, regardless of delinquency status, or when principal and interest has been in default for a period of 90 days or more, unless the loan is both well-secured and in the process of collection. A loan is determined to be past due when the minimum payment is not received from the borrower by the contractually specified due date or for certain loans (e.g., residential real estate loans), when a monthly payment is due and unpaid for 30 days or more. Finally, collateral-dependent loans are typically maintained on nonaccrual status.
On the date a loan is placed on nonaccrual status, all interest accrued but not collected is reversed against interest income. In addition, the amortization of deferred amounts is suspended. Interest income on nonaccrual loans may be recognized as cash interest payments are received (i.e., on a cash basis) if the recorded loan balance is deemed fully collectible; however, if there is doubt regarding the ultimate collectibility of the recorded loan balance, all interest cash receipts are applied to reduce the
carrying value of the loan (the cost recovery method). For consumer loans, application of this policy typically results in the Firm recognizing interest income on nonaccrual consumer loans on a cash basis.
A loan may be returned to accrual status when repayment is reasonably assured and there has been demonstrated performance under the terms of the loan or, if applicable, the terms of the restructured loan.
As permitted by regulatory guidance, credit card loans are generally exempt from being placed on nonaccrual status; accordingly, interest and fees related to credit card loans continue to accrue until the loan is charged off or paid in full. However, the Firm separately establishes an allowance, which is offset against loans and charged to interest income, for the estimated uncollectible portion of accrued and billed interest and fee income on credit card loans. The allowance is established with a charge to interest income and is reported as an offset to loans.
Allowance for loan losses
The allowance for loan losses represents the estimated probable credit losses inherent in the held-for-investment loan portfolio at the balance sheet date and is recognized on the balance sheet as a contra asset, which brings the recorded investment to the net carrying value. Changes in the allowance for loan losses are recorded in the provision for credit losses on the Firm’s Consolidated statements of income. See Note 15 for further information on the Firm’s accounting policies for the allowance for loan losses.
Charge-offs
Consumer loans, other than risk-rated business banking, risk-rated auto and PCI loans, are generally charged off or charged down to the net realizable value of the underlying collateral (i.e., fair value less costs to sell), with an offset to the allowance for loan losses, upon reaching specified stages of delinquency in accordance with standards established by the FFIEC. Residential real estate loans, non-modified credit card loans and scored business banking loans are generally charged off no later than 180 days past due. Auto, student and modified credit card loans are charged off no later than 120 days past due.
Certain consumer loans will be charged off earlier than the FFIEC charge-off standards in certain circumstances as follows:
•
A charge-off is recognized when a loan is modified in a TDR if the loan is determined to be collateral-dependent.
•
Loans to borrowers who have experienced an event (e.g., bankruptcy) that suggests a loss is either known or highly certain are subject to accelerated charge-off standards. Residential real estate and auto loans are charged off when the loan becomes 60 days past due, or sooner if the loan is determined to be collateral-dependent. Credit card, student and scored business banking loans are charged off within 60 days of
JPMorgan Chase & Co./2016 Annual Report
receiving notification of the bankruptcy filing or other event.
•
Auto loans are written down to net realizable value upon repossession of the automobile and after a redemption period (i.e., the period during which a borrower may cure the loan) has passed.
Other than in certain limited circumstances, the Firm typically does not recognize charge-offs on government-guaranteed loans.
Wholesale loans, risk-rated business banking loans and risk-rated auto loans are charged off when it is highly certain that a loss has been realized, including situations where a loan is determined to be both impaired and collateral-dependent. The determination of whether to recognize a charge-off includes many factors, including the prioritization of the Firm’s claim in bankruptcy, expectations of the workout/restructuring of the loan and valuation of the borrower’s equity or the loan collateral.
When a loan is charged down to the estimated net realizable value, the determination of the fair value of the collateral depends on the type of collateral (e.g., securities, real estate). In cases where the collateral is in the form of liquid securities, the fair value is based on quoted market prices or broker quotes. For illiquid securities or other financial assets, the fair value of the collateral is estimated using a discounted cash flow model.
For residential real estate loans, collateral values are based upon external valuation sources. When it becomes likely that a borrower is either unable or unwilling to pay, the Firm obtains a broker’s price opinion of the home based on an exterior-only valuation (“exterior opinions”), which is then updated at least every six months thereafter. As soon as practicable after the Firm receives the property in satisfaction of a debt (e.g., by taking legal title or physical possession), generally, either through foreclosure or upon the execution of a deed in lieu of foreclosure transaction with the borrower, the Firm obtains an appraisal based on an inspection that includes the interior of the home (“interior appraisals”). Exterior opinions and interior appraisals are discounted based upon the Firm’s experience with actual liquidation values as compared with the estimated values provided by exterior opinions and interior appraisals, considering state- and product-specific factors.
For commercial real estate loans, collateral values are generally based on appraisals from internal and external valuation sources. Collateral values are typically updated every six to twelve months, either by obtaining a new appraisal or by performing an internal analysis, in accordance with the Firm’s policies. The Firm also considers both borrower- and market-specific factors, which may result in obtaining appraisal updates or broker price opinions at more frequent intervals.
Loans held-for-sale
Held-for-sale loans are measured at the lower of cost or fair value, with valuation changes recorded in noninterest revenue. For consumer loans, the valuation is performed on a portfolio basis. For wholesale loans, the valuation is performed on an individual loan basis.
Interest income on loans held-for-sale is accrued and recognized based on the contractual rate of interest.
Loan origination fees or costs and purchase price discounts or premiums are deferred in a contra loan account until the related loan is sold. The deferred fees and discounts or premiums are an adjustment to the basis of the loan and therefore are included in the periodic determination of the lower of cost or fair value adjustments and/or the gain or loss recognized at the time of sale.
Held-for-sale loans are subject to the nonaccrual policies described above.
Because held-for-sale loans are recognized at the lower of cost or fair value, the Firm’s allowance for loan losses and charge-off policies do not apply to these loans.
Loans at fair value
Loans used in a market-making strategy or risk managed on a fair value basis are measured at fair value, with changes in fair value recorded in noninterest revenue.
Interest income on loans is accrued and recognized based on the contractual rate of interest. Changes in fair value are recognized in noninterest revenue. Loan origination fees are recognized upfront in noninterest revenue. Loan origination costs are recognized in the associated expense category as incurred.
Because these loans are recognized at fair value, the Firm’s allowance for loan losses and charge-off policies do not apply to these loans.
See Note 4 for further information on the Firm’s elections of fair value accounting under the fair value option. See Note 3 and Note 4 for further information on loans carried at fair value and classified as trading assets.
PCI loans
PCI loans held-for-investment are initially measured at fair value. PCI loans have evidence of credit deterioration since the loan’s origination date and therefore it is probable, at acquisition, that all contractually required payments will not be collected. Because PCI loans are initially measured at fair value, which includes an estimate of future credit losses, no allowance for loan losses related to PCI loans is recorded at the acquisition date. See page 219 of this Note for information on accounting for PCI loans subsequent to their acquisition.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Loan classification changes
Loans in the held-for-investment portfolio that management decides to sell are transferred to the held-for-sale portfolio at the lower of cost or fair value on the date of transfer. Credit-related losses are charged against the allowance for loan losses; non-credit related losses such as those due to changes in interest rates or foreign currency exchange rates are recognized in noninterest revenue.
In the event that management decides to retain a loan in the held-for-sale portfolio, the loan is transferred to the held-for-investment portfolio at the lower of cost or fair value on the date of transfer. These loans are subsequently assessed for impairment based on the Firm’s allowance methodology. For a further discussion of the methodologies used in establishing the Firm’s allowance for loan losses, see Note 15.
Loan modifications
The Firm seeks to modify certain loans in conjunction with its loss-mitigation activities. Through the modification, JPMorgan Chase grants one or more concessions to a borrower who is experiencing financial difficulty in order to minimize the Firm’s economic loss, avoid foreclosure or repossession of the collateral, and to ultimately maximize payments received by the Firm from the borrower. The concessions granted vary by program and by borrower-specific characteristics, and may include interest rate reductions, term extensions, payment deferrals, principal forgiveness, or the acceptance of equity or other assets in lieu of payments.
Such modifications are accounted for and reported as TDRs. A loan that has been modified in a TDR is generally considered to be impaired until it matures, is repaid, or is otherwise liquidated, regardless of whether the borrower performs under the modified terms. In certain limited cases, the effective interest rate applicable to the modified loan is at or above the current market rate at the time of the restructuring. In such circumstances, and assuming that the loan subsequently performs under its modified terms and the Firm expects to collect all contractual principal and interest cash flows, the loan is disclosed as impaired and as a TDR only during the year of the modification; in subsequent years, the loan is not disclosed as an impaired loan or as a TDR so long as repayment of the restructured loan under its modified terms is reasonably assured.
Loans, except for credit card loans, modified in a TDR are generally placed on nonaccrual status, although in many cases such loans were already on nonaccrual status prior to modification. These loans may be returned to performing status (the accrual of interest is resumed) if the following criteria are met: (i) the borrower has performed under the modified terms for a minimum of six months and/or six payments, and (ii) the Firm has an expectation that repayment of the modified loan is reasonably assured based on, for example, the borrower’s debt capacity and level of future earnings, collateral values, LTV ratios, and other current market considerations. In certain limited and well-defined circumstances in which the loan is current at the modification date, such loans are not placed on nonaccrual status at the time of modification.
Because loans modified in TDRs are considered to be impaired, these loans are measured for impairment using the Firm’s established asset-specific allowance methodology, which considers the expected re-default rates for the modified loans. A loan modified in a TDR generally remains subject to the asset-specific allowance methodology throughout its remaining life, regardless of whether the loan is performing and has been returned to accrual status and/or the loan has been removed from the impaired loans disclosures (i.e., loans restructured at market rates). For further discussion of the methodology used to estimate the Firm’s asset-specific allowance, see Note 15.
Foreclosed property
The Firm acquires property from borrowers through loan restructurings, workouts, and foreclosures. Property acquired may include real property (e.g., residential real estate, land, and buildings) and commercial and personal property (e.g., automobiles, aircraft, railcars, and ships).
The Firm recognizes foreclosed property upon receiving assets in satisfaction of a loan (e.g., by taking legal title or physical possession). For loans collateralized by real property, the Firm generally recognizes the asset received at foreclosure sale or upon the execution of a deed in lieu of foreclosure transaction with the borrower. Foreclosed assets are reported in other assets on the Consolidated balance sheets and initially recognized at fair value less costs to sell. Each quarter the fair value of the acquired property is reviewed and adjusted, if necessary, to the lower of cost or fair value. Subsequent adjustments to fair value are charged/credited to noninterest revenue. Operating expense, such as real estate taxes and maintenance, are charged to other expense.
JPMorgan Chase & Co./2016 Annual Report
Loan portfolio
The Firm’s loan portfolio is divided into three portfolio segments, which are the same segments used by the Firm to determine the allowance for loan losses: Consumer, excluding credit card; Credit card; and Wholesale. Within each portfolio segment the Firm monitors and assesses the credit risk in the following classes of loans, based on the risk characteristics of each loan class.
(a)
Includes loans held in CCB, prime mortgage and home equity loans held in AWM and prime mortgage loans held in Corporate.
(b)
Includes senior and junior lien home equity loans.
(c)
Includes prime (including option ARMs) and subprime loans.
(d)
Includes certain business banking and auto dealer risk-rated loans that apply the wholesale methodology for determining the allowance for loan losses; these loans are managed by CCB, and therefore, for consistency in presentation, are included with the other consumer loan classes.
(e)
Predominantly includes Business Banking loans as well as deposit overdrafts.
(f)
Includes loans held in CIB, CB, AWM and Corporate. Excludes prime mortgage and home equity loans held in AWM and prime mortgage loans held in Corporate. Classes are internally defined and may not align with regulatory definitions.
(g)
Includes loans to: individuals; SPEs; holding companies; and private education and civic organizations. For more information on exposures to SPEs, see Note 16.
The following tables summarize the Firm’s loan balances by portfolio segment.
(a)
Includes billed interest and fees net of an allowance for uncollectible interest and fees.
(b)
Loans (other than PCI loans and those for which the fair value option has been elected) are presented net of unearned income, unamortized discounts and premiums, and net deferred loan costs. These amounts were not material as of December 31, 2016 and 2015.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following tables provide information about the carrying value of retained loans purchased, sold and reclassified to held-for-sale during the periods indicated. These tables exclude loans recorded at fair value. The Firm manages its exposure to credit risk on an ongoing basis. Selling loans is one way that the Firm reduces its credit exposures.
(a)
Purchases predominantly represent the Firm’s voluntary repurchase of certain delinquent loans from loan pools as permitted by Government National Mortgage Association (“Ginnie Mae”) guidelines. The Firm typically elects to repurchase these delinquent loans as it continues to service them and/or manage the foreclosure process in accordance with applicable requirements of Ginnie Mae, FHA, RHS, and/or VA.
(b)
Excludes purchases of retained loans sourced through the correspondent origination channel and underwritten in accordance with the Firm’s standards. Such purchases were $30.4 billion, $50.3 billion and $15.1 billion for the years ended December 31, 2016, 2015 and 2014, respectively.
The following table provides information about gains and losses, including lower of cost or fair value adjustments, on loan sales by portfolio segment.
(a)
Excludes sales related to loans accounted for at fair value.
JPMorgan Chase & Co./2016 Annual Report
Consumer, excluding credit card, loan portfolio
Consumer loans, excluding credit card loans, consist primarily of residential mortgages, home equity loans and lines of credit, auto loans, business banking loans, and student and other loans, with a focus on serving the prime consumer credit market. The portfolio also includes home equity loans secured by junior liens, prime mortgage loans with an interest-only payment period, and certain payment-option loans that may result in negative amortization.
The table below provides information about retained consumer loans, excluding credit card, by class.
Delinquency rates are a primary credit quality indicator for consumer loans. Loans that are more than 30 days past due provide an early warning of borrowers who may be experiencing financial difficulties and/or who may be unable or unwilling to repay the loan. As the loan continues to age, it becomes more clear that the borrower is likely either unable or unwilling to pay. In the case of residential real estate loans, late-stage delinquencies (greater than 150 days past due) are a strong indicator of loans that will ultimately result in a foreclosure or similar liquidation transaction. In addition to delinquency rates, other credit quality indicators for consumer loans vary based on the class of loan, as follows:
•
For residential real estate loans, including both non-PCI and PCI portfolios, the current estimated LTV ratio, or the combined LTV ratio in the case of junior lien loans, is an indicator of the potential loss severity in the event of default. Additionally, LTV or combined LTV ratios can provide insight into a borrower’s continued willingness to pay, as the delinquency rate of high-LTV loans tends to be greater than that for loans where the borrower has equity in the collateral. The geographic distribution of
the loan collateral also provides insight as to the credit quality of the portfolio, as factors such as the regional economy, home price changes and specific events such as natural disasters, will affect credit quality. The borrower’s current or “refreshed” FICO score is a secondary credit-quality indicator for certain loans, as FICO scores are an indication of the borrower’s credit payment history. Thus, a loan to a borrower with a low FICO score (660 or below) is considered to be of higher risk than a loan to a borrower with a high FICO score. Further, a loan to a borrower with a high LTV ratio and a low FICO score is at greater risk of default than a loan to a borrower that has both a high LTV ratio and a high FICO score.
•
For scored auto, scored business banking and student loans, geographic distribution is an indicator of the credit performance of the portfolio. Similar to residential real estate loans, geographic distribution provides insights into the portfolio performance based on regional economic activity and events.
•
Risk-rated business banking and auto loans are similar to wholesale loans in that the primary credit quality indicators are the risk rating that is assigned to the loan and whether the loans are considered to be criticized and/or nonaccrual. Risk ratings are reviewed on a regular and ongoing basis by Credit Risk Management and are adjusted as necessary for updated information about borrowers’ ability to fulfill their obligations. For further information about risk-rated wholesale loan credit quality indicators, see pages 224-225 of this Note.
Residential real estate - excluding PCI loans
The following table provides information by class for residential real estate - excluding retained PCI loans in the consumer, excluding credit card, portfolio segment.
The following factors should be considered in analyzing certain credit statistics applicable to the Firm’s residential real estate - excluding PCI loans portfolio: (i) junior lien home equity loans may be fully charged off when the loan becomes 180 days past due, and the value of the collateral does not support the repayment of the loan, resulting in relatively high charge-off rates for this product class; and (ii) the lengthening of loss-mitigation timelines may result in higher delinquency rates for loans carried at the net realizable value of the collateral that remain on the Firm’s Consolidated balance sheets.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
Individual delinquency classifications include mortgage loans insured by U.S. government agencies as follows: current included $2.5 billion and $2.6 billion; 30-149 days past due included $3.1 billion and $3.2 billion; and 150 or more days past due included $3.8 billion and $4.9 billion at December 31, 2016 and 2015, respectively.
(b)
At December 31, 2016 and 2015, residential mortgage loans excluded mortgage loans insured by U.S. government agencies of $6.9 billion and $8.1 billion, respectively, that are 30 or more days past due. These amounts have been excluded based upon the government guarantee.
(c)
These balances, which are 90 days or more past due, were excluded from nonaccrual loans as the loans are guaranteed by U.S government agencies. Typically the principal balance of the loans is insured and interest is guaranteed at a specified reimbursement rate subject to meeting agreed-upon servicing guidelines. At December 31, 2016 and 2015, these balances included $2.2 billion and $3.4 billion, respectively, of loans that are no longer accruing interest based on the agreed-upon servicing guidelines. For the remaining balance, interest is being accrued at the guaranteed reimbursement rate. There were no loans that were not guaranteed by U.S. government agencies that are 90 or more days past due and still accruing interest at December 31, 2016 and 2015.
(d)
Represents the aggregate unpaid principal balance of loans divided by the estimated current property value. Current property values are estimated, at a minimum, quarterly, based on home valuation models using nationally recognized home price index valuation estimates incorporating actual data to the extent available and forecasted data where actual data is not available. These property values do not represent actual appraised loan level collateral values; as such, the resulting ratios are necessarily imprecise and should be viewed as estimates. Current estimated combined LTV for junior lien home equity loans considers all available lien positions, as well as unused lines, related to the property.
(e)
Refreshed FICO scores represent each borrower’s most recent credit score, which is obtained by the Firm on at least a quarterly basis.
(f)
At December 31, 2016 and 2015, included mortgage loans insured by U.S. government agencies of $9.4 billion and $10.7 billion, respectively.
(g)
Includes residential real estate loans to private banking clients in AWM, for which the primary credit quality indicators are the borrower’s financial position and LTV.
JPMorgan Chase & Co./2016 Annual Report
The following table represents the Firm’s delinquency statistics for junior lien home equity loans and lines as of December 31, 2016 and 2015.
(a) These HELOCs are predominantly revolving loans for a 10-year period, after which time the HELOC converts to a loan with a 20-year amortization period, but also include HELOCs that allow interest-only payments beyond the revolving period.
(b) The Firm manages the risk of HELOCs during their revolving period by closing or reducing the undrawn line to the extent permitted by law when borrowers are experiencing financial difficulty or when the collateral does not support the loan amount.
HELOCs beyond the revolving period and HELOANs have higher delinquency rates than HELOCs within the revolving period. That is primarily because the fully-amortizing payment that is generally required for those products is higher than the minimum payment options available for HELOCs within the revolving period. The higher delinquency rates associated with amortizing HELOCs and HELOANs are factored into the Firm’s allowance for loan losses.
Impaired loans
The table below sets forth information about the Firm’s residential real estate impaired loans, excluding PCI loans. These loans are considered to be impaired as they have been modified in a TDR. All impaired loans are evaluated for an asset-specific allowance as described in Note 15.
(a)
Represents collateral-dependent residential real estate loans that are charged off to the fair value of the underlying collateral less cost to sell. The Firm reports, in accordance with regulatory guidance, residential real estate loans that have been discharged under Chapter 7 bankruptcy and not reaffirmed by the borrower (“Chapter 7 loans”) as collateral-dependent nonaccrual TDRs, regardless of their delinquency status. At December 31, 2016, Chapter 7 residential real estate loans included approximately 12% home equity and 16% of residential mortgages that were 30 days or more past due.
(b)
At December 31, 2016 and 2015, $3.4 billion and $3.8 billion, respectively, of loans modified subsequent to repurchase from Ginnie Mae in accordance with the standards of the appropriate government agency (i.e., FHA, VA, RHS) are not included in the table above. When such loans perform subsequent to modification in accordance with Ginnie Mae guidelines, they are generally sold back into Ginnie Mae loan pools. Modified loans that do not re-perform become subject to foreclosure.
(c)
Predominantly all residential real estate impaired loans, excluding PCI loans, are in the U.S.
(d)
Represents the contractual amount of principal owed at December 31, 2016 and 2015. The unpaid principal balance differs from the impaired loan balances due to various factors including charge-offs, net deferred loan fees or costs, and unamortized discounts or premiums on purchased loans.
(e)
As of December 31, 2016 and 2015, nonaccrual loans included $2.3 billion and $2.5 billion, respectively, of TDRs for which the borrowers were less than 90 days past due. For additional information about loans modified in a TDR that are on nonaccrual status refer, to the Loan accounting framework on pages 208-210 of this Note.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following table presents average impaired loans and the related interest income reported by the Firm.
(a)
Generally, interest income on loans modified in TDRs is recognized on a cash basis until such time as the borrower has made a minimum of six payments under the new terms, unless the loan is deemed to be collateral-dependent.
Loan modifications
Modifications of residential real estate loans, excluding PCI loans, are generally accounted for and reported as TDRs. There were no additional commitments to lend to borrowers whose residential real estate loans, excluding PCI loans, have been modified in TDRs.
The following table presents new TDRs reported by the Firm.
Nature and extent of modifications
The U.S. Treasury’s Making Home Affordable programs, as well as the Firm’s proprietary modification programs, generally provide various concessions to financially troubled borrowers including, but not limited to, interest rate reductions, term or payment extensions and deferral of principal and/or interest payments that would otherwise have been required under the terms of the original agreement.
The following table provides information about how residential real estate loans, excluding PCI loans, were modified under the Firm’s loss mitigation programs described above during the periods presented. This table excludes Chapter 7 loans where the sole concession granted is the discharge of debt.
(a)
Represents concessions granted in permanent modifications as a percentage of the number of loans permanently modified. The sum of the percentages exceeds 100% because predominantly all of the modifications include more than one type of concession. A significant portion of trial modifications include interest rate reductions and/or term or payment extensions.
(b)
Represents variable interest rate to fixed interest rate modifications.
JPMorgan Chase & Co./2016 Annual Report
Financial effects of modifications and redefaults
The following table provides information about the financial effects of the various concessions granted in modifications of residential real estate loans, excluding PCI, under the loss mitigation programs described above and about redefaults of certain loans modified in TDRs for the periods presented. Because the specific types and amounts of concessions offered to borrowers frequently change between the trial modification and the permanent modification, the following table presents only the financial effects of permanent modifications. This table also excludes Chapter 7 loans where the sole concession granted is the discharge of debt.
(a)
Represents loans permanently modified in TDRs that experienced a payment default in the periods presented, and for which the payment default occurred within one year of the modification. The dollar amounts presented represent the balance of such loans at the end of the reporting period in which such loans defaulted. For residential real estate loans modified in TDRs, payment default is deemed to occur when the loan becomes two contractual payments past due. In the event that a modified loan redefaults, it is probable that the loan will ultimately be liquidated through foreclosure or another similar type of liquidation transaction. Redefaults of loans modified within the last 12 months may not be representative of ultimate redefault levels.
At December 31, 2016, the weighted-average estimated remaining lives of residential real estate loans, excluding PCI loans, permanently modified in TDRs were 9 years for home equity and 10 years for residential mortgage. The estimated remaining lives of these loans reflect estimated prepayments, both voluntary and involuntary (i.e., foreclosures and other forced liquidations).
Active and suspended foreclosure
At December 31, 2016 and 2015, the Firm had non-PCI residential real estate loans, excluding those insured by U.S. government agencies, with a carrying value of $932 million and $1.2 billion, respectively, that were not included in REO, but were in the process of active or suspended foreclosure.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Other consumer loans
The table below provides information for other consumer retained loan classes, including auto, business banking and student loans.
(a)
Student loan delinquency classifications included loans insured by U.S. government agencies under the FFELP as follows: current included $3.3 billion and $3.8 billion; 30-119 days past due included $257 million and $299 million; and 120 or more days past due included $211 million and $227 million at December 31, 2016 and 2015, respectively.
(b)
These amounts represent student loans, insured by U.S. government agencies under the FFELP. These amounts were accruing as reimbursement of insured amounts is proceeding normally.
(c)
For risk-rated business banking and auto loans, the primary credit quality indicator is the risk rating of the loan, including whether the loans are considered to be criticized and/or nonaccrual.
(d)
December 31, 2016 and 2015, excluded loans 30 days or more past due and still accruing, that are insured by U.S. government agencies under the FFELP, of $468 million and $526 million, respectively. These amounts were excluded as reimbursement of insured amounts is proceeding normally.
Other consumer impaired loans and loan modifications
The following table sets forth information about the Firm’s other consumer impaired loans, including risk-rated business banking and auto loans that have been placed on nonaccrual status, and loans that have been modified in TDRs.
(a)
When discounted cash flows, collateral value or market price equals or exceeds the recorded investment in the loan, the loan does not require an allowance. This typically occurs when the impaired loans have been partially charged off and/or there have been interest payments received and applied to the loan balance.
(b)
Predominantly all other consumer impaired loans are in the U.S.
(c)
Other consumer average impaired loans were $635 million, $566 million and $599 million for the years ended December 31, 2016, 2015 and 2014, respectively. The related interest income on impaired loans, including those on a cash basis, was not material for the years ended December 31, 2016, 2015 and 2014.
(d)
Represents the contractual amount of principal owed at December 31, 2016 and 2015. The unpaid principal balance differs from the impaired loan balances due to various factors, including charge-offs, interest payments received and applied to the principal balance, net deferred loan fees or costs and unamortized discounts or premiums on purchased loans.
JPMorgan Chase & Co./2016 Annual Report
Loan modifications
Certain other consumer loan modifications are considered to be TDRs as they provide various concessions to borrowers who are experiencing financial difficulty. All of these TDRs are reported as impaired loans in the table above.The following table provides information about the Firm’s other consumer loans modified in TDRs. New TDRs were not material for the years ended December 31, 2016 and 2015.
(a)
The impact of these modifications was not material to the Firm for the years ended December 31, 2016 and 2015.
(b)
Additional commitments to lend to borrowers whose loans have been modified in TDRs as of December 31, 2016 and 2015 were immaterial.
Purchased credit-impaired loans
PCI loans are initially recorded at fair value at acquisition. PCI loans acquired in the same fiscal quarter may be aggregated into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. With respect to the Washington Mutual transaction, all of the consumer PCI loans were aggregated into pools of loans with common risk characteristics.
On a quarterly basis, the Firm estimates the total cash flows (both principal and interest) expected to be collected over the remaining life of each pool. These estimates incorporate assumptions regarding default rates, loss severities, the amounts and timing of prepayments and other factors that reflect then-current market conditions. Probable decreases in expected cash flows (i.e., increased credit losses) trigger the recognition of impairment, which is then measured as the present value of the expected principal loss plus any related forgone interest cash flows, discounted at the pool’s effective interest rate. Impairments are recognized through the provision for credit losses and an increase in the allowance for loan losses. Probable and significant increases in expected cash flows (e.g., decreased credit losses, the net benefit of modifications) would first reverse any previously recorded allowance for loan losses with any remaining increases recognized prospectively as a yield adjustment over the remaining estimated lives of the underlying loans. The impacts of (i) prepayments, (ii) changes in variable interest rates, and (iii) any other changes in the timing of expected cash flows are recognized prospectively as adjustments to interest income.
The Firm continues to modify certain PCI loans. The impact of these modifications is incorporated into the Firm’s quarterly assessment of whether a probable and significant change in expected cash flows has occurred, and the loans continue to be accounted for and reported as PCI loans. In evaluating the effect of modifications on expected cash flows, the Firm incorporates the effect of any forgone interest and also considers the potential for redefault. The Firm develops product-specific probability of default estimates, which are used to compute expected credit 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 PCI loans.
The excess of cash flows expected to be collected over the carrying value of the underlying loans is referred to as the accretable yield. This amount is not reported on the Firm’s Consolidated balance sheets but is accreted into interest income at a level rate of return over the remaining estimated lives of the underlying pools of loans.
If the timing and/or amounts of expected cash flows on PCI loan pools were determined not to be reasonably estimable, no interest would be accreted and the loan pools would be reported as nonaccrual loans; however, since the timing and amounts of expected cash flows for the Firm’s PCI consumer loan pools are reasonably estimable, interest is being accreted and the loan pools are being reported as performing loans.
The liquidation of PCI loans, which may include sales of loans, receipt of payment in full from the borrower, or foreclosure, results in removal of the loans from the underlying PCI pool. When the amount of the liquidation proceeds (e.g., cash, real estate), if any, is less than the unpaid principal balance of the loan, the difference is first applied against the PCI pool’s nonaccretable difference for principal losses (i.e., the lifetime credit loss estimate established as a purchase accounting adjustment at the acquisition date). When the nonaccretable difference for a particular loan pool has been fully depleted, any excess of the unpaid principal balance of the loan over the liquidation proceeds is written off against the PCI pool’s allowance for loan losses. Beginning in 2014, write-offs of PCI loans also include other adjustments, primarily related to interest forgiveness modifications. Because the Firm’s PCI loans are accounted for at a pool level, the Firm does not recognize charge-offs of PCI loans when they reach specified stages of delinquency (i.e., unlike non-PCI consumer loans, these loans are not charged off based on FFIEC standards).
The PCI portfolio affects the Firm’s results of operations primarily through: (i) contribution to net interest margin; (ii) expense related to defaults and servicing resulting from the liquidation of the loans; and (iii) any provision for loan losses. The PCI loans acquired in the Washington Mutual transaction were funded based on the interest rate characteristics of the loans. For example, variable-rate loans were funded with variable-rate liabilities and fixed-rate loans were funded with fixed-rate liabilities with a similar maturity profile. A net spread will be earned on the declining balance of the portfolio, which is estimated as of December 31, 2016, to have a remaining weighted-average life of 8 years.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Residential real estate - PCI loans
The table below sets forth information about the Firm’s consumer, excluding credit card, PCI loans.
(a)
Carrying value includes the effect of fair value adjustments that were applied to the consumer PCI portfolio at the date of acquisition.
(b)
Management concluded as part of the Firm’s regular assessment of the PCI loan pools that it was probable that higher expected credit losses would result in a decrease in expected cash flows. As a result, an allowance for loan losses for impairment of these pools has been recognized.
(c)
Represents the aggregate unpaid principal balance of loans divided by the estimated current property value. Current property values are estimated, at a minimum, quarterly, based on home valuation models using nationally recognized home price index valuation estimates incorporating actual data to the extent available and forecasted data where actual data is not available. These property values do not represent actual appraised loan level collateral values; as such, the resulting ratios are necessarily imprecise and should be viewed as estimates. Current estimated combined LTV for junior lien home equity loans considers all available lien positions, as well as unused lines, related to the property.
(d)
Refreshed FICO scores represent each borrower’s most recent credit score, which is obtained by the Firm on at least a quarterly basis.
JPMorgan Chase & Co./2016 Annual Report
Approximately 24% of the PCI home equity portfolio are senior lien loans; the remaining balance are junior lien HELOANs or HELOCs. The following table sets forth delinquency statistics for PCI junior lien home equity loans and lines of credit based on the unpaid principal balance as of December 31, 2016 and 2015.
(a)
In general, these HELOCs are revolving loans for a 10-year period, after which time the HELOC converts to an interest-only loan with a balloon payment at the end of the loan’s term.
(b)
Substantially all undrawn HELOCs within the revolving period have been closed.
(c)
Includes loans modified into fixed rate amortizing loans.
The table below sets forth the accretable yield activity for the Firm’s PCI consumer loans for the years ended December 31, 2016, 2015 and 2014, and represents the Firm’s estimate of gross interest income expected to be earned over the remaining life of the PCI loan portfolios. The table excludes the cost to fund the PCI portfolios, and therefore the accretable yield does not represent net interest income expected to be earned on these portfolios.
(a)
Other changes in expected cash flows may vary from period to period as the Firm continues to refine its cash flow model, for example cash flows expected to be collected due to the impact of modifications and changes in prepayment assumptions.
(b)
Reclassifications from the nonaccretable difference in the year ended December 31, 2015 were driven by continued improvement in home prices and delinquencies, as well as increased granularity in the impairment estimates.
Active and suspended foreclosure
At December 31, 2016 and 2015, the Firm had PCI residential real estate loans with an unpaid principal balance of $1.7 billion and $2.3 billion, respectively, that were not included in REO, but were in the process of active or suspended foreclosure.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Credit card loan portfolio
The credit card portfolio segment includes credit card loans originated and purchased by the Firm. Delinquency rates are the primary credit quality indicator for credit card loans as they provide an early warning that borrowers may be experiencing difficulties (30 days past due); information on those borrowers that have been delinquent for a longer period of time (90 days past due) is also considered. In addition to delinquency rates, the geographic distribution of the loans provides insight as to the credit quality of the portfolio based on the regional economy.
While the borrower’s credit score is another general indicator of credit quality, the Firm does not view credit scores as a primary indicator of credit quality because the borrower’s credit score tends to be a lagging indicator. However, the distribution of such scores provides a general indicator of credit quality trends within the portfolio. Refreshed FICO score information, which is obtained at least quarterly, for a statistically significant random sample of the credit card portfolio is indicated in the following table; FICO is considered to be the industry benchmark for credit scores.
The Firm generally originates new card accounts to prime consumer borrowers. However, certain cardholders’ FICO scores may decrease over time, depending on the performance of the cardholder and changes in credit score technology.
The table below sets forth information about the Firm’s credit card loans.
(a)
The current period percentage of portfolio based on carrying value with estimated refreshed FICO scores disclosures have been updated to reflect where the FICO score is unavailable. The prior period amounts have been revised to conform with the current presentation.
JPMorgan Chase & Co./2016 Annual Report
Credit card impaired loans and loan modifications
The table below sets forth information about the Firm’s impaired credit card loans. All of these loans are considered to be impaired as they have been modified in TDRs.
(a)
The carrying value and the unpaid principal balance are the same for credit card impaired loans.
(b)
There were no impaired loans without an allowance.
(c)
Represents credit card loans outstanding to borrowers enrolled in a credit card modification program as of the date presented.
(d)
Represents credit card loans that were modified in TDRs but that have subsequently reverted back to the loans’ pre-modification payment terms. At December 31, 2016 and 2015, $94 million and $113 million, respectively, of loans have reverted back to the pre-modification payment terms of the loans due to noncompliance with the terms of the modified loans. The remaining $48 million and $66 million at December 31, 2016 and 2015, respectively, of these loans are to borrowers who have successfully completed a short-term modification program. The Firm continues to report these loans as TDRs since the borrowers’ credit lines remain closed.
(e)
Predominantly all impaired credit card loans are in the U.S.
The following table presents average balances of impaired credit card loans and interest income recognized on those loans.
Loan modifications
JPMorgan Chase may offer one of a number of loan modification programs to credit card borrowers who are experiencing financial difficulty. Most of the credit card loans have been modified under long-term programs for borrowers who are experiencing financial difficulties. Modifications under long-term programs involve placing the customer on a fixed payment plan, generally for 60 months. The Firm may also offer short-term programs for borrowers who may be in need of temporary relief; however, none are currently being offered. Modifications under all short- and long-term programs typically include reducing the interest rate on the credit card. Substantially all modifications are considered to be TDRs.
If the cardholder does not comply with the modified payment terms, then the credit card loan agreement reverts back to its pre-modification payment terms. Assuming that the cardholder does not begin to perform in accordance with those payment terms, the loan continues to age and will ultimately be charged-off in accordance with the Firm’s standard charge-off policy. In addition, if a borrower successfully completes a short-term modification program, then the loan reverts back to its pre-modification payment terms. However, in most cases, the Firm does not reinstate the borrower’s line of credit.
New enrollments in these loan modification programs for the years ended December 31, 2016, 2015 and 2014, were $636 million, $638 million and $807 million, respectively.
Financial effects of modifications and redefaults
The following table provides information about the financial effects of the concessions granted on credit card loans modified in TDRs and redefaults for the periods presented.
(a)
Represents loans modified in TDRs that experienced a payment default in the periods presented, and for which the payment default occurred within one year of the modification. The amounts presented represent the balance of such loans as of the end of the quarter in which they defaulted.
For credit card loans modified in TDRs, payment default is deemed to have occurred when the loans become two payments past due. A substantial portion of these loans is expected to be charged-off in accordance with the Firm’s standard charge-off policy. Based on historical experience, the estimated weighted-average default rate for modified credit card loans was expected to be 28.87%, 25.61% and 27.91% as of December 31, 2016, 2015 and 2014, respectively.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Wholesale loan portfolio
Wholesale loans include loans made to a variety of customers, ranging from large corporate and institutional clients to high-net-worth individuals.
The primary credit quality indicator for wholesale loans is the risk rating assigned to each loan. Risk ratings are used to identify the credit quality of loans and differentiate risk within the portfolio. Risk ratings on loans consider the PD and the LGD. The PD is the likelihood that a loan will default. The LGD is the estimated loss on the loan that would be realized upon the default of the borrower and takes into consideration collateral and structural support for each credit facility.
Management considers several factors to determine an appropriate risk rating, including 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. The Firm’s definition of criticized aligns with the banking regulatory definition of criticized exposures, which consist of special mention, substandard and doubtful categories. Risk ratings generally represent ratings profiles similar to those defined by S&P and Moody’s. Investment-grade ratings range from “AAA/Aaa” to “BBB-/Baa3.” Noninvestment-grade ratings are classified as noncriticized (“BB+/Ba1 and B-/B3”) and criticized (“CCC+”/“Caa1 and below”), and the criticized portion is further subdivided into performing and nonaccrual loans, representing management’s assessment of the collectibility of principal and interest. Criticized loans have a higher probability of default than noncriticized loans.
Risk ratings are reviewed on a regular and ongoing basis by Credit Risk Management and are adjusted as necessary for updated information affecting the obligor’s ability to fulfill its obligations.
As noted above, the risk rating of a loan considers the industry in which the obligor conducts its operations. As part of the overall credit risk management framework, the Firm focuses on the management and diversification of its industry and client exposures, with particular attention paid to industries with actual or potential credit concern. See Note 5 for further detail on industry concentrations.
JPMorgan Chase & Co./2016 Annual Report
The table below provides information by class of receivable for the retained loans in the Wholesale portfolio segment.
(a)
The U.S. and non-U.S. distribution is determined based predominantly on the domicile of the borrower.
(b)
The credit quality of wholesale loans is assessed primarily through ongoing review and monitoring of an obligor’s ability to meet contractual obligations rather than relying on the past due status, which is generally a lagging indicator of credit quality.
(c)
Represents loans that are considered well-collateralized and therefore still accruing interest.
(d)
Other includes individuals, SPEs, holding companies, and private education and civic organizations. For more information on exposures to SPEs, see Note 16.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following table presents additional information on the real estate class of loans within the Wholesale portfolio for the periods indicated. Exposure consists primarily of secured commercial loans, of which multifamily is the largest segment. Multifamily lending finances acquisition, leasing and construction of apartment buildings, and includes exposure to real estate investment trusts (“REITs”). Other commercial lending largely includes financing for acquisition, leasing and construction, largely for office, retail and industrial real estate, and includes exposure to REITs. Included in real estate loans is $9.2 billion and $7.3 billion as of December 31, 2016 and 2015, respectively, of construction and development exposure consisting of loans originally purposed for construction and development, general purpose loans for builders, as well as loans for land subdivision and pre-development.
Wholesale impaired loans and loan modifications
Wholesale impaired loans consist of loans that have been placed on nonaccrual status and/or that have been modified in a TDR. All impaired loans are evaluated for an asset-specific allowance as described in Note 15.
The table below sets forth information about the Firm’s wholesale impaired loans.
(a)
When the discounted cash flows, collateral value or market price equals or exceeds the recorded investment in the loan, the loan does not require an allowance. This typically occurs when the impaired loans have been partially charged-off and/or there have been interest payments received and applied to the loan balance.
(b)
Represents the contractual amount of principal owed at December 31, 2016 and 2015. The unpaid principal balance differs from the impaired loan balances due to various factors, including charge-offs; interest payments received and applied to the carrying value; net deferred loan fees or costs; and unamortized discount or premiums on purchased loans.
(c)
Based upon the domicile of the borrower, largely consists of loans in the U.S.
The following table presents the Firm’s average impaired loans for the years ended 2016, 2015 and 2014.
(a)
The related interest income on accruing impaired loans and interest income recognized on a cash basis were not material for the years ended December 31, 2016, 2015 and 2014.
Certain loan modifications are considered to be TDRs as they provide various concessions to borrowers who are experiencing financial difficulty. All TDRs are reported as impaired loans in the tables above. TDRs were $733 million and $208 million as of December 31, 2016 and 2015.
JPMorgan Chase & Co./2016 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 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.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
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
JPMorgan Chase & Co./2016 Annual Report
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.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
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.
(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.
JPMorgan Chase & Co./2016 Annual Report
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 16 - Variable interest entities
For a further description of JPMorgan Chase’s accounting policies regarding consolidation of VIEs, see Note 1.
The following table summarizes the most significant types of Firm-sponsored VIEs by business segment. The Firm considers a “sponsored” VIE to include any entity where: (1) JPMorgan Chase is the primary beneficiary of the structure; (2) the VIE is used by JPMorgan Chase to securitize Firm assets; (3) the VIE issues financial instruments with the JPMorgan Chase name; or (4) the entity is a JPMorgan Chase-administered asset-backed commercial paper conduit.
The Firm’s other business segments are also involved with VIEs, but to a lesser extent, as follows:
•
Asset & Wealth Management: AWM sponsors and manages certain funds that are deemed VIEs. As asset manager of the funds, AWM earns a fee based on assets managed; the fee varies with each fund’s investment objective and is competitively priced. For fund entities that qualify as VIEs, AWM’s interests are, in certain cases, considered to be significant variable interests that result in consolidation of the financial results of these entities.
•
Commercial Banking: CB makes investments in and provides lending to community development entities that may meet the definition of a VIE. In addition, CB provides financing and lending-related services to certain client-sponsored VIEs. In general, CB does not control the activities of these entities and does not consolidate these entities.
•
Corporate: Corporate is involved with entities that may meet the definition of VIEs; however these entities are generally subject to specialized investment company accounting, which does not require the consolidation of investments, including VIEs.
The Firm also invests in and provides financing and other services to VIEs sponsored by third parties, as described on page 237 of this Note.
Significant Firm-sponsored variable interest entities
Credit card securitizations
The Card business securitizes both originated and purchased credit card loans, primarily through the Chase Issuance Trust (the “Trust”). The Firm’s continuing involvement in credit card securitizations includes servicing the receivables, retaining an undivided seller’s interest in the receivables, retaining certain senior and subordinated securities and maintaining escrow accounts.
The Firm is considered to be the primary beneficiary of these Firm-sponsored credit card securitization trusts based on the Firm’s ability to direct the activities of these VIEs through its servicing responsibilities and other duties, including making decisions as to the receivables that are transferred into those trusts and as to any related modifications and workouts. Additionally, the nature and extent of the Firm’s other continuing involvement with the trusts, as indicated above, obligates the Firm to absorb losses and gives the Firm the right to receive certain benefits from these VIEs that could potentially be significant.
The underlying securitized credit card receivables and other assets of the securitization trusts are available only for payment of the beneficial interests issued by the securitization trusts; they are not available to pay the Firm’s other obligations or the claims of the Firm’s creditors.
The agreements with the credit card securitization trusts require the Firm to maintain a minimum undivided interest in the credit card trusts (generally 5%). As of December 31, 2016 and 2015, the Firm held undivided interests in Firm-sponsored credit card securitization trusts of $8.9 billion and $13.6 billion, respectively. The Firm maintained an average undivided interest in principal receivables owned by those trusts of approximately 16% and 22% for the years ended December 31, 2016 and 2015. As of both December 31, 2016 and 2015, the Firm did not retain any senior securities and retained $5.3 billion of subordinated securities in certain of its credit card securitization trusts. The Firm’s undivided interests in the credit card trusts and securities retained are eliminated in consolidation.
JPMorgan Chase & Co./2016 Annual Report
Firm-sponsored mortgage and other securitization trusts
The Firm securitizes (or has securitized) originated and purchased residential mortgages, commercial mortgages and other consumer loans (including student loans) primarily in its CCB and CIB businesses. Depending on the
particular transaction, as well as the respective business involved, the Firm may act as the servicer of the loans and/or retain certain beneficial interests in the securitization trusts.
The following table presents the total unpaid principal amount of assets held in Firm-sponsored private-label securitization entities, including those in which the Firm has continuing involvement, and those that are consolidated by the Firm. Continuing involvement includes servicing the loans, holding senior interests or subordinated interests, recourse or guarantee arrangements, and derivative transactions. In certain instances, the Firm’s only continuing involvement is servicing the loans. See Securitization activity on page 238 of this Note for further information regarding the Firm’s cash flows with and interests retained in nonconsolidated VIEs, and pages 238-239 of this Note for information on the Firm’s loan sales to U.S. government agencies.
(a)
Excludes U.S. government agency securitizations and re-securitizations, which are not Firm-sponsored. See pages 238-239 of this Note for information on the Firm’s loan sales to U.S. government agencies.
(b)
Consists of securities backed by commercial loans (predominantly real estate) and non-mortgage-related consumer receivables purchased from third parties.
(c)
Excludes the following: retained servicing (see Note 17 for a discussion of MSRs); securities retained from loan sales to U.S. government agencies; interest rate and foreign exchange derivatives primarily used to manage interest rate and foreign exchange risks of securitization entities (See Note 6 for further information on derivatives); senior and subordinated securities of $180 million and $49 million, respectively, at December 31, 2016, and $163 million and $73 million, respectively, at December 31, 2015, which the Firm purchased in connection with CIB’s secondary market-making activities.
(d)
Includes interests held in re-securitization transactions.
(e)
As of December 31, 2016 and 2015, 61% and 76%, respectively, of the Firm’s retained securitization interests, which are carried at fair value, were risk-rated “A” or better, on an S&P-equivalent basis. The retained interests in prime residential mortgages consisted of $1.5 billion and $1.9 billion of investment-grade and $77 million and $93 million of noninvestment-grade retained interests at December 31, 2016 and 2015, respectively. The retained interests in commercial and other securitizations trusts consisted of $2.4 billion and $3.7 billion of investment-grade and $210 million and $198 million of noninvestment-grade retained interests at December 31, 2016 and 2015, respectively.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Residential mortgage
The Firm securitizes residential mortgage loans originated by CCB, as well as residential mortgage loans purchased from third parties by either CCB or CIB. CCB generally retains servicing for all residential mortgage loans it originated or purchased, and for certain mortgage loans purchased by CIB. For securitizations of loans serviced by CCB, the Firm has the power to direct the significant activities of the VIE because it is responsible for decisions related to loan modifications and workouts. CCB may also retain an interest upon securitization.
In addition, CIB engages in underwriting and trading activities involving securities issued by Firm-sponsored securitization trusts. As a result, CIB at times retains senior and/or subordinated interests (including residual interests) in residential mortgage securitizations at the time of securitization, and/or reacquires positions in the secondary market in the normal course of business. In certain instances, as a result of the positions retained or reacquired by CIB or held by CCB, when considered together with the servicing arrangements entered into by CCB, the Firm is deemed to be the primary beneficiary of certain securitization trusts. See the table on page 237 of this Note for more information on consolidated residential mortgage securitizations.
The Firm does not consolidate a residential mortgage securitization (Firm-sponsored or third-party-sponsored) when it is not the servicer (and therefore does not have the power to direct the most significant activities of the trust) or does not hold a beneficial interest in the trust that could potentially be significant to the trust. At December 31, 2016 and 2015, the Firm did not consolidate the assets of certain Firm-sponsored residential mortgage securitization VIEs, in which the Firm had continuing involvement, primarily due to the fact that the Firm did not hold an interest in these trusts that could potentially be significant to the trusts. See the table on page 237 of this Note for more information on the consolidated residential mortgage securitizations, and the table on the previous page of this Note for further information on interests held in nonconsolidated residential mortgage securitizations.
Commercial mortgages and other consumer securitizations
CIB originates and securitizes commercial mortgage loans, and engages in underwriting and trading activities involving the securities issued by securitization trusts. CIB may retain unsold senior and/or subordinated interests in commercial mortgage securitizations at the time of securitization but, generally, the Firm does not service commercial loan securitizations. For commercial mortgage securitizations the power to direct the significant activities of the VIE generally is held by the servicer or investors in a specified class of securities (“controlling class”). The Firm generally does not retain an interest in the controlling class in its sponsored commercial mortgage securitization transactions. See the table on page 237 of this Note for more information on the consolidated commercial mortgage securitizations, and the table on the previous
page of this Note for further information on interests held in nonconsolidated securitizations.
The Firm retains servicing responsibilities for certain student loan securitizations. The Firm has the power to direct the activities of these VIEs through these servicing responsibilities. See the table on page 237 of this Note for more information on the consolidated student loan securitizations, and the table on the previous page of this Note for further information on interests held in nonconsolidated securitizations.
Re-securitizations
The Firm engages in certain re-securitization transactions in which debt securities are transferred to a VIE in exchange for new beneficial interests. These transfers occur in connection with both agency (Federal National Mortgage Association (“Fannie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”) and Government National Mortgage Association (“Ginnie Mae”)) and nonagency (private-label) sponsored VIEs, which may be backed by either residential or commercial mortgages. The Firm’s consolidation analysis is largely dependent on the Firm’s role and interest in the re-securitization trusts. During the years ended December 31, 2016, 2015 and 2014, the Firm transferred $11.2 billion, $21.9 billion and $22.7 billion, respectively, of securities to agency VIEs, and $647 million, $777 million and $1.1 billion, respectively, of securities to private-label VIEs.
Most re-securitizations with which the Firm is involved are client-driven transactions in which a specific client or group of clients is seeking a specific return or risk profile. For these transactions, the Firm has concluded that the decision-making power of the entity is shared between the Firm and its clients, considering the joint effort and decisions in establishing the re-securitization trust and its assets, as well as the significant economic interest the client holds in the re-securitization trust; therefore the Firm does not consolidate the re-securitization VIE.
In more limited circumstances, the Firm creates a nonagency re-securitization trust independently and not in conjunction with specific clients. In these circumstances, the Firm is deemed to have the unilateral ability to direct the most significant activities of the re-securitization trust because of the decisions made during the establishment and design of the trust; therefore, the Firm consolidates the re-securitization VIE if the Firm holds an interest that could potentially be significant.
Additionally, the Firm may invest in beneficial interests of third-party re-securitizations and generally purchases these interests in the secondary market. In these circumstances, the Firm does not have the unilateral ability to direct the most significant activities of the re-securitization trust, either because it was not involved in the initial design of the trust, or the Firm is involved with an independent third-party sponsor and demonstrates shared power over the creation of the trust; therefore, the Firm does not consolidate the re-securitization VIE.
JPMorgan Chase & Co./2016 Annual Report
As of December 31, 2016 and 2015, total assets (including the notional amount of interest-only securities) of nonconsolidated Firm-sponsored private-label re-securitization entities in which the Firm has continuing involvement were $875 million and $2.2 billion, respectively. At December 31, 2016 and 2015, the Firm held $2.0 billion and $4.6 billion, respectively, of interests in nonconsolidated agency re-securitization entities. The Firm’s exposure to non-consolidated private-label re-securitization entities as of December 31, 2016 and 2015 was not material. As of December 31, 2016 and 2015, the Firm did not consolidate any agency re-securitizations. As of December 31, 2016 and 2015, the Firm consolidated an insignificant amount of assets and liabilities of Firm-sponsored private-label re-securitizations.
Multi-seller conduits
Multi-seller conduit entities are separate bankruptcy remote entities that provide secured financing, collateralized by pools of receivables and other financial assets, to customers of the Firm. The conduits fund their financing facilities through the issuance of highly rated commercial paper. The primary source of repayment of the commercial paper is the cash flows from the pools of assets. In most instances, the assets are structured with deal-specific credit enhancements provided to the conduits by the customers (i.e., sellers) or other third parties. Deal-specific credit enhancements are generally structured to cover a multiple of historical losses expected on the pool of assets, and are typically in the form of overcollateralization provided by the seller. The deal-specific credit enhancements mitigate the Firm’s potential losses on its agreements with the conduits.
To ensure timely repayment of the commercial paper, and to provide the conduits with funding to provide financing to customers in the event that the conduits do not obtain funding in the commercial paper market, each asset pool financed by the conduits has a minimum 100% deal-specific liquidity facility associated with it provided by JPMorgan Chase Bank, N.A. JPMorgan Chase Bank, N.A. also provides the multi-seller conduit vehicles with uncommitted program-wide liquidity facilities and program-wide credit enhancement in the form of standby letters of credit. The amount of program-wide credit enhancement required is based upon commercial paper issuance and approximates 10% of the outstanding balance of commercial paper.
The Firm consolidates its Firm-administered multi-seller conduits, as the Firm has both the power to direct the significant activities of the conduits and a potentially significant economic interest in the conduits. As administrative agent and in its role in structuring transactions, the Firm makes decisions regarding asset types and credit quality, and manages the commercial paper funding needs of the conduits. The Firm’s interests that could potentially be significant to the VIEs include the fees received as administrative agent and liquidity and program-wide credit enhancement provider, as well as the potential exposure created by the liquidity and credit
enhancement facilities provided to the conduits. See page 237 of this Note for further information on consolidated VIE assets and liabilities.
In the normal course of business, JPMorgan Chase makes markets in and invests in commercial paper issued by the Firm-administered multi-seller conduits. The Firm held $21.2 billion and $15.7 billion of the commercial paper issued by the Firm-administered multi-seller conduits at December 31, 2016 and 2015, respectively. The Firm’s investments reflect the Firm’s funding needs and capacity and were not driven by market illiquidity. The Firm is not obligated under any agreement to purchase the commercial paper issued by the Firm-administered multi-seller conduits.
Deal-specific liquidity facilities, program-wide liquidity and credit enhancement provided by the Firm have been eliminated in consolidation. The Firm or the Firm-administered multi-seller conduits provide lending-related commitments to certain clients of the Firm-administered multi-seller conduits. The unfunded commitments were $7.4 billion and $5.6 billion at December 31, 2016 and 2015, respectively, and are reported as off-balance sheet lending-related commitments. For more information on off-balance sheet lending-related commitments, see Note 29.
VIEs associated with investor intermediation activities
As a financial intermediary, the Firm creates certain types of VIEs and also structures transactions with these VIEs, typically using derivatives, to meet investor needs. The Firm may also provide liquidity and other support. The risks inherent in the derivative instruments or liquidity commitments are managed similarly to other credit, market or liquidity risks to which the Firm is exposed. The principal types of VIEs for which the Firm is engaged in on behalf of clients are municipal bond vehicles.
Municipal bond vehicles
Municipal bond vehicles or tender option bond (“TOB”) trusts allow investors to finance their municipal bond investments at short-term rates. In a typical TOB transaction, the trust purchases highly rated municipal bond(s) of a single issuer and funds the purchase by issuing two types of securities: (1) puttable floating-rate certificates (“Floaters”) and (2) inverse floating-rate residual interests (“Residuals”). The Floaters are typically purchased by money market funds or other short-term investors and may be tendered, with requisite notice, to the TOB trust. The Residuals are retained by the investor seeking to finance its municipal bond investment. TOB transactions where the Residual is held by a third party investor are typically known as Customer TOB trusts, and Non-Customer TOB trusts are transactions where the Residual is retained by the Firm. The Firm serves as sponsor for all Non-Customer TOB transactions and certain Customer TOB transactions established prior to 2014. The Firm may provide various services to a TOB trust, including remarketing agent, liquidity or tender option provider, and/or sponsor.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
J.P. Morgan Securities LLC may serve as a remarketing agent on the Floaters for TOB trusts. The remarketing agent is responsible for establishing the periodic variable rate on the Floaters, conducting the initial placement and remarketing tendered Floaters. The remarketing agent may, but is not obligated to, make markets in Floaters. At December 31, 2016 and 2015, the Firm held an insignificant amount of Floaters on its Consolidated balance sheets and did not hold any significant amounts during 2016 and 2015.
JPMorgan Chase Bank, N.A. or J.P. Morgan Securities LLC often serves as the sole liquidity or tender option provider for the TOB trusts. The liquidity provider’s obligation to perform is conditional and is limited by certain events (“Termination Events”), which include bankruptcy or failure to pay by the municipal bond issuer or credit enhancement provider, an event of taxability on the municipal bonds or the immediate downgrade of the municipal bond to below investment grade. In addition, the liquidity provider’s exposure is typically further limited by the high credit quality of the underlying municipal bonds, the excess collateralization in the vehicle, or, in certain transactions, the reimbursement agreements with the Residual holders.
Holders of the Floaters may “put,” or tender, their Floaters to the TOB trust. If the remarketing agent cannot successfully remarket the Floaters to another investor, the liquidity provider either provides a loan to the TOB trust for the TOB trust’s purchase of the Floaters, or it directly purchases the tendered Floaters. In certain Customer TOB transactions, the Firm, as liquidity provider, has entered into a reimbursement agreement with the Residual holder. In those transactions, upon the termination of the vehicle, if the proceeds from the sale of the underlying municipal bonds are not sufficient to repay amounts owed to the Firm, as liquidity or tender option provider, the Firm has recourse to the third party Residual holders for any shortfall. Residual holders with reimbursement agreements are required to post collateral with the Firm to support such reimbursement obligations should the market value of the underlying municipal bonds decline. The Firm does not have any intent to protect Residual holders from potential losses on any of the underlying municipal bonds.
TOB trusts are considered to be variable interest entities. The Firm consolidates Non-Customer TOB trusts because as the Residual holder, the Firm has the right to make decisions that significantly impact the economic performance of the municipal bond vehicle, and it has the right to receive benefits and bear losses that could potentially be significant to the municipal bond vehicle. The Firm does not consolidate Customer TOB trusts, since the Firm does not have the power to make decisions that significantly impact the economic performance of the municipal bond vehicle. Certain non-consolidated Customer TOB trusts are sponsored by a third party, and not the Firm. See page 237 of this Note for further information on consolidated municipal bond vehicles.
The Firm’s exposure to nonconsolidated municipal bond VIEs at December 31, 2016 and 2015, including the ratings profile of the VIEs’ assets, was as follows.
(a)
Represents the excess/(deficit) of the fair values of municipal bond assets available to repay the liquidity facilities, if drawn.
(b)
The ratings scale is presented on an S&P-equivalent basis.
(c)
These security positions have been defeased by the municipality and no longer carry credit ratings, but are backed by high-quality assets such as U.S. treasuries and cash.
JPMorgan Chase & Co./2016 Annual Report
VIEs sponsored by third parties
The Firm enters into transactions with VIEs structured by other parties. These include, for example, acting as a derivative counterparty, liquidity provider, investor, underwriter, placement agent, remarketing agent, trustee or custodian. These transactions are conducted at arm’s-length, and individual credit decisions are based on the analysis of the specific VIE, taking into consideration the
quality of the underlying assets. Where the Firm does not have the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, or a variable interest that could potentially be significant, the Firm records and reports these positions on its Consolidated balance sheets in the same manner it would record and report positions in respect of any other third-party transaction.
Consolidated VIE assets and liabilities
The following table presents information on assets and liabilities related to VIEs consolidated by the Firm as of December 31, 2016 and 2015.
(a)
Excludes intercompany transactions, which are eliminated in consolidation.
(b)
Includes residential and commercial mortgage securitizations as well as re-securitizations.
(c)
Includes assets classified as cash, AFS securities, and other assets on the Consolidated balance sheets.
(d)
The assets of the consolidated VIEs included in the program types above are used to settle the liabilities of those entities. The difference between total assets and total liabilities recognized for consolidated VIEs represents the Firm’s interest in the consolidated VIEs for each program type.
(e)
The interest-bearing beneficial interest liabilities issued by consolidated VIEs are classified in the line item on the Consolidated balance sheets titled, “Beneficial interests issued by consolidated variable interest entities.” The holders of these beneficial interests do not have recourse to the general credit of JPMorgan Chase. Included in beneficial interests in VIE assets are long-term beneficial interests of $33.4 billion and $30.6 billion at December 31, 2016 and 2015, respectively. The maturities of the long-term beneficial interests as of December 31, 2016, were as follows: $11.6 billion under one year, $19.1 billion between one and five years, and $2.7 billion over five years.
(f)
Includes liabilities classified as accounts payable and other liabilities on the Consolidated balance sheets.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Loan securitizations
The Firm has securitized and sold a variety of loans, including residential mortgage, credit card, student and commercial (primarily related to real estate) loans, as well as debt securities. The purposes of these securitization transactions were to satisfy investor demand and to generate liquidity for the Firm.
For loan securitizations in which the Firm is not required to consolidate the trust, the Firm records the transfer of the loan receivable to the trust as a sale when all of the following accounting criteria for a sale are met: (1) the transferred financial assets are legally isolated from the Firm’s creditors; (2) the transferee or beneficial interest
holder can pledge or exchange the transferred financial assets; and (3) the Firm does not maintain effective control over the transferred financial assets (e.g., the Firm cannot repurchase the transferred assets before their maturity and it does not have the ability to unilaterally cause the holder to return the transferred assets).
For loan securitizations accounted for as a sale, the Firm recognizes a gain or loss based on the difference between the value of proceeds received (including cash, beneficial interests, or servicing assets received) and the carrying value of the assets sold. Gains and losses on securitizations are reported in noninterest revenue.
Securitization activity
The following table provides information related to the Firm’s securitization activities for the years ended December 31, 2016, 2015 and 2014, related to assets held in Firm-sponsored securitization entities that were not consolidated by the Firm, and where sale accounting was achieved based on the accounting rules in effect at the time of the securitization.
(a)
Excludes re-securitization transactions.
(b)
Includes cash paid by the Firm to reacquire assets from off-balance sheet, nonconsolidated entities - for example, loan repurchases due to representation and warranties and servicer “clean-up” calls.
(c)
Includes prime/Alt-A, subprime, and option ARMs. Excludes certain loan securitization transactions entered into with Ginnie Mae, Fannie Mae and Freddie Mac.
(d)
Key assumptions used to measure residential mortgage retained interests originated during the year included weighted-average life (in years) of 4.5, 4.2 and 5.9 for the years ended December 31, 2016, 2015 and 2014, respectively, and weighted-average discount rate of 4.2%, 2.9% and 3.4% for the years ended December 31, 2016, 2015 and 2014, respectively. Key assumptions used to measure commercial and other retained interests originated during the year included weighted-average life (in years) of 6.2, 6.2 and 6.5 for the years ended December 31, 2016, 2015 and 2014, respectively, and weighted-average discount rate of 5.8%, 4.1% and 4.8% for the years ended December 31, 2016, 2015 and 2014, respectively.
(e)
Includes commercial mortgage and student loan securitizations.
Loans and excess MSRs sold to U.S. government-sponsored enterprises, loans in securitization transactions pursuant to Ginnie Mae guidelines, and other third-party-sponsored securitization entities
In addition to the amounts reported in the securitization activity tables above, the Firm, in the normal course of business, sells originated and purchased mortgage loans and certain originated excess MSRs on a nonrecourse basis, predominantly to U.S. government sponsored enterprises (“U.S. GSEs”). These loans and excess MSRs are sold primarily for the purpose of securitization by the U.S. GSEs, who provide certain guarantee provisions (e.g., credit enhancement of the loans). The Firm also sells loans into securitization transactions pursuant to Ginnie Mae
guidelines; these loans are typically insured or guaranteed by another U.S. government agency. The Firm does not consolidate the securitization vehicles underlying these transactions as it is not the primary beneficiary. For a limited number of loan sales, the Firm is obligated to share a portion of the credit risk associated with the sold loans with the purchaser. See Note 29 for additional information about the Firm’s loan sales- and securitization-related indemnifications.
See Note 17 for additional information about the impact of the Firm’s sale of certain excess MSRs.
JPMorgan Chase & Co./2016 Annual Report
The following table summarizes the activities related to loans sold to the U.S. GSEs, loans in securitization transactions pursuant to Ginnie Mae guidelines, and other third-party-sponsored securitization entities.
(a)
Predominantly includes securities from U.S. GSEs and Ginnie Mae that are generally sold shortly after receipt.
(b)
Excludes the value of MSRs retained upon the sale of loans.
(c)
Gains on loan sales include the value of MSRs.
(d)
The carrying value of the loans accounted for at fair value approximated the proceeds received upon loan sale.
Options to repurchase delinquent loans
In addition to the Firm’s obligation to repurchase certain loans due to material breaches of representations and warranties as discussed in Note 29, the Firm also has the option to repurchase delinquent loans that it services for Ginnie Mae loan pools, as well as for other U.S. government agencies under certain arrangements. The Firm typically elects to repurchase delinquent loans from Ginnie Mae loan pools as it continues to service them and/or manage the foreclosure process in accordance with the applicable requirements, and such loans continue to be insured or guaranteed. When the Firm’s repurchase option becomes exercisable, such loans must be reported on the Consolidated balance sheets as a loan with a corresponding liability. As of December 31, 2016 and 2015, the Firm had recorded on its Consolidated balance sheets $9.6 billion and $11.1 billion, respectively, of loans that either had been repurchased or for which the Firm had an option to repurchase. Predominantly all of these amounts relate to loans that have been repurchased from Ginnie Mae loan pools. Additionally, at December 31, 2016 and 2015, the Firm had real estate owned of $142 million and $343 million, respectively, and certain foreclosed government-guaranteed residential mortgage loans included in accrued interest and accounts receivable of $1.0 billion and $1.1 billion, respectively, resulting from voluntary repurchases of loans. Substantially all of these loans and real estate are insured or guaranteed by U.S. government agencies. For additional information, refer to Note 14.
Loan delinquencies and liquidation losses
The table below includes information about components of nonconsolidated securitized financial assets held in Firm-sponsored private-label securitization entities, in which the Firm has continuing involvement, and delinquencies as of December 31, 2016 and 2015.
(a)
Total assets held in securitization-related SPEs were $199.6 billion and $233.6 billion, respectively, at December 31, 2016 and 2015. The $148.9 billion and $169.6 billion, respectively, of loans securitized at December 31, 2016 and 2015, excludes: $46.4 billion and $62.4 billion, respectively, of securitized loans in which the Firm has no continuing involvement, and $4.3 billion and $1.6 billion, respectively, of loan securitizations consolidated on the Firm’s Consolidated balance sheets at December 31, 2016 and 2015.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 17 - Goodwill and Mortgage servicing rights
Goodwill
Goodwill is recorded upon completion of a business combination as the difference between the purchase price and the fair value of the net assets acquired. Subsequent to initial recognition, goodwill is not amortized but is tested for impairment during the fourth quarter of each fiscal year, or more often if events or circumstances, such as adverse changes in the business climate, indicate there may be impairment.
The goodwill associated with each business combination is allocated to the related reporting units, which are determined based on how the Firm’s businesses are managed and how they are reviewed by the Firm’s Operating Committee. The following table presents goodwill attributed to the business segments.
The following table presents changes in the carrying amount of goodwill.
(a)
For 2016, represents AWM goodwill, which was disposed of as part of AWM sales completed in March 2016. For 2015 includes $101 million of Private Equity goodwill, which was disposed of as part of the Private Equity sale completed in January 2015.
(b)
Includes foreign currency translation adjustments, other tax-related adjustments, and, for 2014, goodwill impairment associated with the Firm’s Private Equity business of $276 million.
Impairment testing
The Firm’s goodwill was not impaired at December 31, 2016 and 2015. Further, except for goodwill related to its heritage Private Equity business of $276 million, the Firm’s goodwill was not impaired at December 31, 2014.
The goodwill impairment test is performed in two steps. In the first step, the current fair value of each reporting unit is compared with its carrying value, including goodwill. If the fair value is in excess of the carrying value (including goodwill), then the reporting unit’s goodwill is considered not to be impaired. If the fair value is less than the carrying value (including goodwill), then a second step is performed. In the second step, the implied current fair value of the reporting unit’s goodwill is determined by comparing the fair value of the reporting unit (as determined in step one) to the fair value of the net assets of the reporting unit, as if the reporting unit were being acquired in a business combination. The resulting implied current fair value of goodwill is then compared with the carrying value of the reporting unit’s goodwill. If the carrying value of the goodwill exceeds its implied current fair value, then an impairment charge is recognized for the excess. If the carrying value of goodwill is less than its implied current fair value, then no goodwill impairment is recognized.
The Firm uses the reporting units’ allocated equity plus goodwill capital as a proxy for the carrying amounts of equity for the reporting units in the goodwill impairment testing. Reporting unit equity is determined on a similar basis as the allocation of equity to the Firm’s lines of business, which takes into consideration the capital the business segment would require if it were operating independently, incorporating sufficient capital to address regulatory capital requirements (including Basel III) and capital levels for similarly rated peers. Proposed line of business equity levels are incorporated into the Firm’s annual budget process, which is reviewed by the Firm’s Board of Directors. Allocated equity is further reviewed on a periodic basis and updated as needed.
JPMorgan Chase & Co./2016 Annual Report
The primary method the Firm uses to estimate the fair value of its reporting units is the income approach. This approach projects cash flows for the forecast period and uses the perpetuity growth method to calculate terminal values. These cash flows and terminal values are then discounted using an appropriate discount rate. Projections of cash flows are based on the reporting units’ earnings forecasts, which include the estimated effects of regulatory and legislative changes, and which are reviewed with the senior management of the Firm. The discount rate used for each reporting unit represents an estimate of the cost of equity for that reporting unit and is determined considering the Firm’s overall estimated cost of equity (estimated using the Capital Asset Pricing Model), as adjusted for the risk characteristics specific to each reporting unit (for example, for higher levels of risk or uncertainty associated with the business or management’s forecasts and assumptions). To assess the reasonableness of the discount rates used for each reporting unit management compares the discount rate to the estimated cost of equity for publicly traded institutions with similar businesses and risk characteristics. In addition, the weighted average cost of equity (aggregating the various reporting units) is compared with the Firms’ overall estimated cost of equity to ensure reasonableness.
The valuations derived from the discounted cash flow analysis are then compared with market-based trading and transaction multiples for relevant competitors. Trading and transaction comparables are used as general indicators to assess the general reasonableness of the estimated fair values, although precise conclusions generally cannot be drawn due to the differences that naturally exist between the Firm’s businesses and competitor institutions. Management also takes into consideration a comparison between the aggregate fair values of the Firm’s reporting units and JPMorgan Chase’s market capitalization. In evaluating this comparison, management considers several factors, including (i) a control premium that would exist in a market transaction, (ii) factors related to the level of execution risk that would exist at the firmwide level that do not exist at the reporting unit level and (iii) short-term market volatility and other factors that do not directly affect the value of individual reporting units.
Declines in business performance, increases in credit losses, increases in equity capital requirements, as well as deterioration in economic or market conditions, estimates of adverse regulatory or legislative changes or increases in the estimated market cost of equity, could cause the estimated fair values of the Firm’s reporting units or their associated goodwill to decline in the future, which could result in a material impairment charge to earnings in a future period related to some portion of the associated goodwill.
Mortgage servicing rights
MSRs represent the fair value of expected future cash flows for performing servicing activities for others. The fair value considers estimated future servicing fees and ancillary revenue, offset by estimated costs to service the loans, and generally declines over time as net servicing cash flows are received, effectively amortizing the MSR asset against contractual servicing and ancillary fee income. MSRs are either purchased from third parties or recognized upon sale or securitization of mortgage loans if servicing is retained.
As permitted by U.S. GAAP, the Firm has elected to account for its MSRs at fair value. The Firm treats its MSRs as a single class of servicing assets based on the availability of market inputs used to measure the fair value of its MSR asset and its treatment of MSRs as one aggregate pool for risk management purposes. The Firm estimates the fair value of MSRs using an option-adjusted spread (“OAS”) model, which projects MSR cash flows over multiple interest rate scenarios in conjunction with the Firm’s prepayment model, and then discounts these cash flows at risk-adjusted rates. The model considers portfolio characteristics, contractually specified servicing fees, prepayment assumptions, delinquency rates, costs to service, late charges and other ancillary revenue, and other economic factors. The Firm compares fair value estimates and assumptions to observable market data where available, and also considers recent market activity and actual portfolio experience.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The fair value of MSRs is sensitive to changes in interest rates, including their effect on prepayment speeds. MSRs typically decrease in value when interest rates decline because declining interest rates tend to increase prepayments and therefore reduce the expected life of the net servicing cash flows that comprise the MSR asset. Conversely, securities (e.g., mortgage-backed securities), principal-only certificates and certain derivatives (i.e.,
those for which the Firm receives fixed-rate interest payments) increase in value when interest rates decline. JPMorgan Chase uses combinations of derivatives and securities to manage the risk of changes in the fair value of MSRs. The intent is to offset any interest-rate related changes in the fair value of MSRs with changes in the fair value of the related risk management instruments.
The following table summarizes MSR activity for the years ended December 31, 2016, 2015 and 2014.
(a)
Includes excess MSRs transferred to agency-sponsored trusts in exchange for stripped mortgage backed securities (“SMBS”). In each transaction, a portion of the SMBS was acquired by third parties at the transaction date; the Firm acquired the remaining balance of those SMBS as trading securities.
(b)
Represents both the impact of changes in estimated future prepayments due to changes in market interest rates, and the difference between actual and expected prepayments.
(c)
Represents changes in prepayments other than those attributable to changes in market interest rates.
(d)
Represents amounts the Firm pays as the servicer (e.g., scheduled principal and interest, taxes and insurance), which will generally be reimbursed within a short period of time after the advance from future cash flows from the trust or the underlying loans. The Firm’s credit risk associated with these servicer advances is minimal because reimbursement of the advances is typically senior to all cash payments to investors. In addition, the Firm maintains the right to stop payment to investors if the collateral is insufficient to cover the advance. However, certain of these servicer advances may not be recoverable if they were not made in accordance with applicable rules and agreements.
(e)
For the year ending December 31, 2014, the negative impact was primarily related to higher capital allocated to the Mortgage Servicing business, which, in turn, resulted in an increase in the OAS. The resulting OAS assumption was consistent with capital and return requirements the Firm believed a market participant would consider, taking into account factors such as the operating risk environment and regulatory and economic capital requirements.
JPMorgan Chase & Co./2016 Annual Report
The following table presents the components of mortgage fees and related income (including the impact of MSR risk management activities) for the years ended December 31, 2016, 2015 and 2014.
(a)
Represents both the impact of changes in estimated future prepayments due to changes in market interest rates, and the difference between actual and expected prepayments.
(b)
Represents the aggregate impact of changes in model inputs and assumptions such as projected cash flows (e.g., cost to service), discount rates and changes in prepayments other than those attributable to changes in market interest rates (e.g., changes in prepayments due to changes in home prices).
The table below outlines the key economic assumptions used to determine the fair value of the Firm’s MSRs at December 31, 2016 and 2015, and outlines the sensitivities of those fair values to immediate adverse changes in those assumptions, as defined below.
CPR: Constant prepayment rate.
The sensitivity analysis in the preceding table is hypothetical and should be used with caution. Changes in fair value based on variation in assumptions generally cannot be easily extrapolated, because the relationship of the change in the assumptions to the change in fair value are often highly interrelated and may not be linear. In this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which would either magnify or counteract the impact of the initial change.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 18 - Premises and equipment
Premises and equipment, including leasehold improvements, are carried at cost less accumulated depreciation and amortization. JPMorgan Chase computes depreciation using the straight-line method over the estimated useful life of an asset. For leasehold improvements, the Firm uses the straight-line method computed over the lesser of the remaining term of the leased facility or the estimated useful life of the leased asset.
JPMorgan Chase capitalizes certain costs associated with the acquisition or development of internal-use software. Once the software is ready for its intended use, these costs are amortized on a straight-line basis over the software’s expected useful life and reviewed for impairment on an ongoing basis.
Note 19 - Deposits
At December 31, 2016 and 2015, noninterest-bearing and interest-bearing deposits were as follows.
(a)
Includes structured notes classified as deposits for which the fair value option has been elected. For further discussion, see Note 4.
(b)
Prior periods have been revised to conform with current period presentation.
At December 31, 2016 and 2015, time deposits in denominations of $250,000 or more were as follows.
At December 31, 2016, the maturities of interest-bearing time deposits were as follows.
Note 20 - Accounts payable and other liabilities
Accounts payable and other liabilities consist of brokerage payables, which includes payables to customers, dealers and clearing organizations, and payables from security purchases that did not settle; income taxes payables; accrued expense, including interest-bearing liabilities; and all other liabilities, including litigation reserves and obligations to return securities received as collateral.
The following table details the components of accounts payable and other liabilities.
JPMorgan Chase & Co./2016 Annual Report
Note 21 - Long-term debt
JPMorgan Chase issues long-term debt denominated in various currencies, predominantly U.S. dollars, with both fixed and variable interest rates. Included in senior and subordinated debt below are various equity-linked or other indexed instruments, which the Firm has elected to measure at fair value. Changes in fair value are recorded in principal transactions revenue in the Consolidated statements of income. The following table is a summary of long-term debt carrying values (including unamortized premiums and discounts, issuance costs, valuation adjustments and fair value adjustments, where applicable) by remaining contractual maturity as of December 31, 2016.
(a)
The interest rates shown are the range of contractual rates in effect at December 31, 2016 and 2015, respectively, including non-U.S. dollar fixed- and variable-rate issuances, which excludes the effects of the associated derivative instruments used in hedge accounting relationships, if applicable. The use of these derivative instruments modifies the Firm’s exposure to the contractual interest rates disclosed in the table above. Including the effects of the hedge accounting derivatives, the range of modified rates in effect at December 31, 2016, for total long-term debt was (0.18)% to 8.88%, versus the contractual range of 0.00% to 8.75% presented in the table above. The interest rate ranges shown exclude structured notes accounted for at fair value.
(b)
Included long-term debt of $82.2 billion and $76.6 billion secured by assets totaling $205.6 billion and $171.6 billion at December 31, 2016 and 2015, respectively. The amount of long-term debt secured by assets does not include amounts related to hybrid instruments.
(c)
Included $37.7 billion and $33.1 billion of long-term debt accounted for at fair value at December 31, 2016 and 2015, respectively.
(d)
Included $7.5 billion and $5.5 billion of outstanding zero-coupon notes at December 31, 2016 and 2015, respectively. The aggregate principal amount of these notes at their respective maturities is $25.1 billion and $16.2 billion, respectively. The aggregate principal amount reflects the contractual principal payment at maturity, which may exceed the contractual principal payment at the Firm’s next call date, if applicable.
(e)
Included on the Consolidated balance sheets in beneficial interests issued by consolidated VIEs. Also included $120 million and $787 million accounted for at fair value at December 31, 2016 and 2015, respectively. Excluded short-term commercial paper and other short-term beneficial interests of $5.7 billion and $11.3 billion at December 31, 2016 and 2015, respectively.
(f)
At December 31, 2016, long-term debt in the aggregate of $81.8 billion was redeemable at the option of JPMorgan Chase, in whole or in part, prior to maturity, based on the terms specified in the respective instruments.
(g)
The aggregate carrying values of debt that matures in each of the five years subsequent to 2016 is $46.7 billion in 2017, $49.4 billion in 2018, $32.2 billion in 2019, $33.8 billion in 2020 and $30.6 billion in 2021.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The weighted-average contractual interest rates for total long-term debt excluding structured notes accounted for at fair value were 2.49% and 2.34% as of December 31, 2016 and 2015, respectively. In order to modify exposure to interest rate and currency exchange rate movements, JPMorgan Chase utilizes derivative instruments, primarily interest rate and cross-currency interest rate swaps, in conjunction with some of its debt issues. The use of these instruments modifies the Firm’s interest expense on the associated debt. The modified weighted-average interest rates for total long-term debt, including the effects of related derivative instruments, were 2.01% and 1.64% as of December 31, 2016 and 2015, respectively.
JPMorgan Chase & Co. has guaranteed certain long-term debt of its subsidiaries, including both long-term debt and structured notes. These guarantees rank on parity with the Firm’s other unsecured and unsubordinated indebtedness. The amount of such guaranteed long-term debt and structured notes was $3.9 billion and $152 million at December 31, 2016 and 2015, respectively.
The Firm’s unsecured debt does not contain requirements that would call for an acceleration of payments, maturities or changes in the structure of the existing debt, provide any limitations on future borrowings or require additional collateral, based on unfavorable changes in the Firm’s credit ratings, financial ratios, earnings or stock price.
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
At December 31, 2016, the Firm had outstanding eight wholly-owned Delaware statutory business trusts (“issuer trusts”) that had issued trust preferred securities.
The junior subordinated deferrable interest debentures issued by the Firm to the issuer trusts, totaling $2.3 billion and $4.0 billion at December 31, 2016 and 2015, respectively, were reflected on the Firm’s Consolidated balance sheets in long-term debt, and in the table on the preceding page under the caption “Junior subordinated debt.” The Firm also records the common capital securities issued by the issuer trusts in other assets in its Consolidated balance sheets at December 31, 2016 and 2015. Beginning in 2014, the debentures issued to the issuer trusts by the Firm, less the common capital securities of the issuer trusts, began being phased out from inclusion as Tier 1 capital under Basel III and they were fully phased out as of December 31, 2016. As of December 31, 2015, $992 million of these debentures qualified as Tier 1 capital. As of December 31, 2016 and 2015, $1.4 billion and $3.0 billion, respectively, qualified as Tier 2 capital.
The Firm redeemed $1.6 billion and $1.5 billion of trust preferred securities in the years ended December 31, 2016 and 2015, respectively.
JPMorgan Chase & Co./2016 Annual Report
Note 22 - Preferred stock
At December 31, 2016 and 2015, JPMorgan Chase was authorized to issue 200 million shares of preferred stock, in one or more series, with a par value of $1 per share.
In the event of a liquidation or dissolution of the Firm, JPMorgan Chase’s preferred stock then outstanding takes precedence over the Firm’s common stock with respect to the payment of dividends and the distribution of assets.
The following is a summary of JPMorgan Chase’s non-cumulative preferred stock outstanding as of December 31, 2016 and 2015.
(a)
Represented by depositary shares.
Each series of preferred stock has a liquidation value and redemption price per share of $10,000, plus accrued but unpaid dividends.
Dividends on fixed-rate preferred stock are payable quarterly. Dividends on fixed-to-floating-rate preferred stock are payable semiannually while at a fixed rate, and become payable quarterly after converting to a floating rate.
Redemption rights
Each series of the Firm’s preferred stock may be redeemed on any dividend payment date on or after the earliest redemption date for that series. All outstanding preferred stock series except Series I may also be redeemed following a “capital treatment event”, as described in the terms of each series. Any redemption of the Firm’s preferred stock is subject to non-objection from the Board of Governors of the Federal Reserve System (the “Federal Reserve”).
Note 23 - Common stock
At December 31, 2016 and 2015, JPMorgan Chase was authorized to issue 9.0 billion shares of common stock with a par value of $1 per share.
Common shares issued (newly issued or distributed from treasury) by JPMorgan Chase during the years ended December 31, 2016, 2015 and 2014 were as follows.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
At December 31, 2016, 2015, and 2014, respectively, the Firm had 24.9 million, 47.4 million and 59.8 million warrants outstanding to purchase shares of common stock (the “Warrants”). The Warrants are currently traded on the New York Stock Exchange, and they are exercisable, in whole or in part, at any time and from time to time until October 28, 2018. The original warrant exercise price was $42.42 per share. The number of shares issuable upon the exercise of each warrant and the warrant exercise price is subject to adjustment upon the occurrence of certain events, including, but not limited to, the extent to which regular quarterly cash dividends exceed $0.38 per share. As a result of the Firm’s quarterly common stock dividend exceeding $0.38 per share commencing with the second quarter of 2014, the exercise price of the Warrants has been adjusted each subsequent quarter. As of December 31, 2016 the exercise price was $42.073 and the Warrant share number was 1.01.
On June 29, 2016, in conjunction with the Federal Reserve’s release of its 2016 CCAR results, the Firm’s Board of Directors authorized a $10.6 billion common equity (i.e., common stock and warrants) repurchase program. As of December 31, 2016, $6.1 billion (on a settlement-date basis) of authorized repurchase capacity remained under the program. This authorization includes shares repurchased to offset issuances under the Firm’s equity-based compensation plans.
The following table sets forth the Firm’s repurchases of common equity for the years ended December 31, 2016, 2015 and 2014, on a settlement-date basis. There were no warrants repurchased during the years ended December 31, 2016, 2015 and 2014.
The Firm may, from time to time, enter into written trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate repurchases in accordance with the common equity repurchase program. A Rule 10b5-1 repurchase plan allows the Firm to repurchase its equity during periods when it would not otherwise be repurchasing common equity - for example, during internal trading “blackout periods.” All purchases under a Rule 10b5-1 plan must be made according to a predefined plan established when the Firm is not aware of material nonpublic information. For additional information regarding repurchases of the Firm’s equity securities, see Part II,
Item 5: Market for registrant’s common equity, related stockholder matters and issuer purchases of equity securities, on page 22.
As of December 31, 2016, approximately 154 million shares of common stock were reserved for issuance under various employee incentive, compensation, option and stock purchase plans, director compensation plans, and the Warrants.
Note 24 - Earnings per share
Earnings per share (“EPS”) is calculated under the two-class method under which all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities based on their respective rights to receive dividends. JPMorgan Chase grants restricted stock and RSUs to certain employees under its stock-based compensation programs, which entitle recipients to receive nonforfeitable dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock; these unvested awards meet the definition of participating securities.
The following table presents the calculation of basic and diluted EPS for the years ended December 31, 2016, 2015 and 2014.
(a)
Excluded from the computation of diluted EPS (due to the antidilutive effect) were certain options issued under employee benefit plans. The aggregate number of shares issuable upon the exercise of such options was not material for the years ended December 31, 2016 and 2015 and were 1 million for the year ended December 31, 2014.
(b)
Participating securities were included in the calculation of diluted EPS using the two-class method, as this computation was more dilutive than the calculation using the treasury stock method.
JPMorgan Chase & Co./2016 Annual Report
Note 25 - Accumulated other comprehensive income/(loss)
AOCI includes the after-tax change in unrealized gains and losses on investment securities, foreign currency translation adjustments (including the impact of related derivatives), cash flow hedging activities, and net loss and prior service costs/(credit) related to the Firm’s defined benefit pension and OPEB plans.
Effective January 1, 2016, the Firm adopted new accounting guidance related to the recognition and measurement of financial liabilities where the fair value option has been elected. This guidance requires the portion of the total change in fair value caused by changes in the Firm’s own credit risk (“DVA”) to be presented separately in OCI; previously these amounts were recognized in net income. The guidance was required to be applied as of the beginning of the fiscal year of adoption by means of a cumulative effect adjustment to the Consolidated balance sheets, which resulted in a reclassification from retained earnings to AOCI.
(a)
Represents the after-tax difference between the fair value and amortized cost of securities accounted for as AFS, including net unamortized unrealized gains and losses related to AFS securities transferred to HTM.
The following table presents the pre-tax and after-tax changes in the components of OCI.
(a)
The pre-tax amount is reported in securities gains in the Consolidated statements of income.
(b)
Reclassifications of pre-tax realized gains/(losses) on translation adjustments and related hedges are reported in other income/expense in the Consolidated statements of income. The amounts were not material for the periods presented.
(c)
The pre-tax amounts are predominantly recorded in net interest income in the Consolidated statements of income.
(d)
In 2015, the Firm reclassified approximately $150 million of net losses from AOCI to other income because the Firm determined that it is probable that the forecasted interest payment cash flows will not occur. For additional information, see Note 6.
(e)
The pre-tax amount is reported in compensation expense in the Consolidated statements of income.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 26 - Income taxes
JPMorgan Chase and its eligible subsidiaries file a consolidated U.S. federal income tax return. JPMorgan Chase uses the asset and liability method to provide income taxes on all transactions recorded in the Consolidated Financial Statements. This method requires that income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets or liabilities for book and tax purposes. Accordingly, a deferred tax asset or liability for each temporary difference is determined based on the tax rates that the Firm expects to be in effect when the underlying items of income and expense are realized. JPMorgan Chase’s expense for income taxes includes the current and deferred portions of that expense. A valuation allowance is established to reduce deferred tax assets to the amount the Firm expects to realize.
Due to the inherent complexities arising from the nature of the Firm’s businesses, and from conducting business and being taxed in a substantial number of jurisdictions, significant judgments and estimates are required to be made. Agreement of tax liabilities between JPMorgan Chase and the many tax jurisdictions in which the Firm files tax returns may not be finalized for several years. Thus, the Firm’s final tax-related assets and liabilities may ultimately be different from those currently reported.
Effective tax rate and expense
A reconciliation of the applicable statutory U.S. income tax rate to the effective tax rate for each of the years ended December 31, 2016, 2015 and 2014, is presented in the following table.
(a)
Predominantly includes earnings of U.K. subsidiaries that are deemed to be reinvested indefinitely.
The components of income tax expense/(benefit) included in the Consolidated statements of income were as follows for each of the years ended December 31, 2016, 2015, and 2014.
Total income tax expense includes $55 million, $2.4 billion and $451 million of tax benefits recorded in 2016, 2015, and 2014, respectively, as a result of tax audit resolutions.
Tax effect of items recorded in stockholders’ equity
The preceding table does not reflect the tax effect of certain items that are recorded each period directly in stockholders’ equity. The tax effect of all items recorded directly to stockholders’ equity resulted in an increase of $925 million in 2016, an increase of $1.5 billion in 2015, and a decrease of $140 million in 2014. Effective January 1, 2016, the Firm adopted new accounting guidance related to employee share-based payments. As a result of the adoption of this new guidance, all excess tax benefits (including tax benefits from dividends or dividend equivalents) on share-based payment awards are recognized within income tax expense in the Consolidated statements of income. In prior years these tax benefits were recorded as increases to additional paid-in capital.
Results from Non-U.S. earnings
The following table presents the U.S. and non-U.S. components of income before income tax expense for the years ended December 31, 2016, 2015 and 2014.
(a)
For purposes of this table, non-U.S. income is defined as income generated from operations located outside the U.S.
U.S. federal income taxes have not been provided on the undistributed earnings of certain non-U.S. subsidiaries, to the extent that such earnings have been reinvested abroad for an indefinite period of time. Based on JPMorgan Chase’s
JPMorgan Chase & Co./2016 Annual Report
ongoing review of the business requirements and capital needs of its non-U.S. subsidiaries, combined with the formation of specific strategies and steps taken to fulfill these requirements and needs, the Firm has determined that the undistributed earnings of certain of its subsidiaries would be indefinitely reinvested to fund current and future growth of the related businesses. As management does not intend to use the earnings of these subsidiaries as a source of funding for its U.S. operations, such earnings will not be distributed to the U.S. in the foreseeable future. For 2016, pretax earnings of $3.8 billion were generated and will be indefinitely reinvested in these subsidiaries. At December 31, 2016, the cumulative amount of undistributed pretax earnings in these subsidiaries were $38.4 billion. If the Firm were to record a deferred tax liability associated with these undistributed earnings, the amount would be $8.8 billion at December 31, 2016.
These undistributed earnings are related to subsidiaries located predominantly in the U.K. where the 2016 tax rate was 28%.
Affordable housing tax credits
The Firm recognized $1.7 billion, $1.6 billion and $1.6 billion of tax credits and other tax benefits associated with investments in affordable housing projects within income tax expense for the years 2016, 2015 and 2014, respectively. The amount of amortization of such investments reported in income tax expense under the current period presentation during these years was $1.2 billion, $1.1 billion and $1.1 billion, respectively. The carrying value of these investments, which are reported in other assets on the Firm’s Consolidated balance sheets, was $8.8 billion and $7.7 billion at December 31, 2016 and 2015, respectively. The amount of commitments related to these investments, which are reported in accounts payable and other liabilities on the Firm’s Consolidated balance sheets, was $2.8 billion and $2.0 billion at December 31, 2016 and 2015, respectively.
Deferred taxes
Deferred income tax expense/(benefit) results from differences between assets and liabilities measured for financial reporting purposes versus income tax return purposes. Deferred tax assets are recognized if, in management’s judgment, their realizability is determined to be more likely than not. If a deferred tax asset is determined to be unrealizable, a valuation allowance is established. The significant components of deferred tax assets and liabilities are reflected in the following table as of December 31, 2016 and 2015.
JPMorgan Chase has recorded deferred tax assets of $2.2 billion at December 31, 2016, in connection with U.S. federal and non-U.S. NOL carryforwards and foreign tax credit carryforwards. At December 31, 2016, total U.S. federal NOL carryforwards were approximately $3.8 billion and non-U.S. NOL carryforwards were $142 million. If not utilized, the U.S. federal NOL carryforwards will expire between 2025 and 2036 and the non-U.S. NOL carryforwards will expire in 2017. Foreign tax credit carryforwards were $776 million and will expire between 2022 and 2026.
The valuation allowance at December 31, 2016, was due to losses associated with non-U.S. subsidiaries.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Unrecognized tax benefits
At December 31, 2016, 2015 and 2014, JPMorgan Chase’s unrecognized tax benefits, excluding related interest expense and penalties, were $3.5 billion, $3.5 billion and $4.9 billion, respectively, of which $2.6 billion, $2.1 billion and $3.5 billion, respectively, if recognized, would reduce the annual effective tax rate. Included in the amount of unrecognized tax benefits are certain items that would not affect the effective tax rate if they were recognized in the Consolidated statements of income. These unrecognized items include the tax effect of certain temporary differences, the portion of gross state and local unrecognized tax benefits that would be offset by the benefit from associated U.S. federal income tax deductions, and the portion of gross non-U.S. unrecognized tax benefits that would have offsets in other jurisdictions. JPMorgan Chase is presently under audit by a number of taxing authorities, most notably by the Internal Revenue Service as summarized in the Tax examination status table below. As JPMorgan Chase is presently under audit by a number of taxing authorities, it is reasonably possible that over the next 12 months the resolution of these examinations may increase or decrease the gross balance of unrecognized tax benefits by as much as $800 million. Upon settlement of an audit, the change in the unrecognized tax benefit would result from payment or income statement recognition.
The following table presents a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2016, 2015 and 2014.
After-tax interest expense/(benefit) and penalties related to income tax liabilities recognized in income tax expense were $86 million, $(156) million and $17 million in 2016, 2015 and 2014, respectively.
At December 31, 2016 and 2015, in addition to the liability for unrecognized tax benefits, the Firm had accrued $687 million and $578 million, respectively, for income tax-related interest and penalties.
Tax examination status
JPMorgan Chase is continually under examination by the Internal Revenue Service, by taxing authorities throughout the world, and by many state and local jurisdictions throughout the U.S. The following table summarizes the status of significant income tax examinations of JPMorgan Chase and its consolidated subsidiaries as of December 31, 2016.
JPMorgan Chase & Co./2016 Annual Report
Note 27 - Restrictions on cash and
intercompany funds transfers
The business of JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank, N.A.”) is subject to examination and regulation by the OCC. The Bank is a member of the U.S. Federal Reserve System, and its deposits in the U.S. are insured by the FDIC, subject to applicable limits.
The Federal Reserve requires depository institutions to maintain cash reserves with a Federal Reserve Bank. The average required amount of reserve balances deposited by the Firm’s bank subsidiaries with various Federal Reserve Banks was approximately $19.3 billion and $14.4 billion in 2016 and 2015, respectively.
Restrictions imposed by U.S. federal law prohibit JPMorgan Chase & Co. (“Parent Company”) and certain of its affiliates from borrowing from banking subsidiaries unless the loans are secured in specified amounts. Such secured loans provided by any banking subsidiary to the Parent Company or to any particular affiliate, together with certain other transactions with such affiliate, (collectively referred to as “covered transactions”), are generally limited to 10% of the banking subsidiary’s total capital, as determined by the risk-based capital guidelines; the aggregate amount of covered transactions between any banking subsidiary and all of its affiliates is limited to 20% of the banking subsidiary’s total capital.
Prior to the establishment of the IHC in the fourth quarter of 2016, the principal sources of the Parent Company’s income were dividends and interest from the various bank and non-bank subsidiaries of the Firm; the principal source of the Parent Company’s income, commencing with the fourth quarter, will be dividends from the IHC and JPMorgan Chase Bank, N.A., the two principal subsidiaries of the Parent Company. In addition to dividend restrictions set forth in statutes and regulations, the Federal Reserve, the OCC and the FDIC have authority under the Financial Institutions Supervisory Act to prohibit or to limit the payment of dividends by the banking organizations they supervise, including JPMorgan Chase and its subsidiaries that are banks or bank holding companies, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking organization.
At January 1, 2017, JPMorgan Chase’s banking subsidiaries could pay, in the aggregate, approximately $20 billion in dividends to their respective bank holding companies without the prior approval of their relevant banking regulators. The capacity to pay dividends in 2017 will be supplemented by the banking subsidiaries’ earnings during the year.
In compliance with rules and regulations established by U.S. and non-U.S. regulators, as of December 31, 2016 and 2015, cash in the amount of $13.4 billion and $13.2 billion, respectively, were segregated in special bank accounts for the benefit of securities and futures brokerage customers. Also, as of December 31, 2016 and 2015, the Firm had receivables within other assets of $16.1 billion
and $15.6 billion, respectively, consisting of cash deposited with clearing organizations for the benefit of customers. Securities with a fair value of $19.3 billion and $20.0 billion, respectively, were also restricted in relation to customer activity. In addition, as of December 31, 2016 and 2015, the Firm had other restricted cash of $3.6 billion and $3.1 billion, respectively, primarily representing cash reserves held at non-U.S. central banks and held for other general purposes. Prior period amounts for segregated cash, receivables within other assets, and other restricted cash have been revised to conform with the current period presentation.
Note 28 - Regulatory capital
The Federal Reserve establishes capital requirements, including well-capitalized standards, for the consolidated financial holding company. The OCC establishes similar minimum capital requirements and standards for the Firm’s national banks, including JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A.
Capital rules under Basel III establish minimum capital ratios and overall capital adequacy standards for large and internationally active U.S. bank holding companies and banks, including the Firm and its IDI subsidiaries. Basel III presents two comprehensive methodologies for calculating RWA: a general (standardized) approach (“Basel III Standardized”) and an advanced approach (“Basel III Advanced”). Certain of the requirements of Basel III are subject to phase-in periods that began on January 1, 2014 and continue through the end of 2018 (“transitional period”).
There are three categories of risk-based capital under the Basel III Transitional rules: CET1 capital, as well as Tier 1 capital and Tier 2 capital. CET1 capital predominantly includes common stockholders’ equity (including capital for AOCI related to debt and equity securities classified as AFS as well as for defined-benefit pension and OPEB plans), less certain deductions for goodwill, MSRs and deferred tax assets that arise from NOL and tax credit carryforwards. Tier 1 capital predominantly consists of CET1 capital as well as perpetual preferred stock. Tier 2 capital includes long-term debt qualifying as Tier 2 and qualifying allowance for credit losses. Total capital is Tier 1 capital plus Tier 2 capital.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The following tables present the regulatory capital, assets and risk-based capital ratios for JPMorgan Chase and its significant national bank subsidiaries under both Basel III Standardized Transitional and Basel III Advanced Transitional at December 31, 2016 and 2015.
(a)
Includes the deduction associated with the permissible holdings of covered funds (as defined by the Volcker Rule) acquired after December 31, 2013. The deduction was not material as of December 31, 2016.
(b)
Adjusted average assets, for purposes of calculating the Tier 1 leverage ratio, includes total quarterly average assets adjusted for unrealized gains/(losses) on AFS securities, less deductions for goodwill and other intangible assets, defined benefit pension plan assets, and deferred tax assets related to NOL and tax credit carryforwards.
(c)
For each of the risk-based capital ratios, the capital adequacy of the Firm and its national bank subsidiaries are evaluated against the Basel III approach, Standardized or Advanced, resulting in the lower ratio (the “Collins Floor”), as required by the Collins Amendment of the Dodd-Frank Act.
(d)
The Tier 1 leverage ratio is not a risk-based measure of capital. This ratio is calculated by dividing Tier 1 capital by adjusted average assets.
Note:
Rating agencies allow measures of capital to be adjusted upward for deferred tax liabilities, which have resulted from both non-taxable business combinations and from tax-deductible goodwill. The Firm had deferred tax liabilities resulting from non-taxable business combinations of $83 million and $105 million at December 31, 2016, and 2015, respectively; and deferred tax liabilities resulting from tax-deductible goodwill of $3.1 billion and $3.0 billion at December 31, 2016, and 2015, respectively.
Under the risk-based capital guidelines of the Federal Reserve, JPMorgan Chase is required to maintain minimum ratios of CET1, Tier 1 and Total capital to RWA, as well as a minimum leverage ratio (which is defined as Tier 1 capital divided by adjusted quarterly average assets). Failure to meet these minimum requirements could cause the Federal Reserve to take action. National bank subsidiaries also are subject to these capital requirements by their respective primary regulators.
JPMorgan Chase & Co./2016 Annual Report
The following table presents the minimum ratios to which the Firm and its national bank subsidiaries are subject as of December 31, 2016.
Note: The ratios presented in the table above are as defined by the regulations issued by the Federal Reserve, OCC and FDIC and to which the Firm and its national bank subsidiaries are subject.
(a)
Represents the transitional minimum capital ratios applicable to the Firm under Basel III at December 31, 2016. Commencing in the first quarter of 2016, the CET1 minimum capital ratio includes 0.625% resulting from the phase in of the Firm’s 2.5% capital conservation buffer, and 1.125% resulting from the phase in of the Firm’s 4.5% GSIB surcharge.
(b)
Represents requirements for JPMorgan Chase’s banking subsidiaries. The CET1 minimum capital ratio includes 0.625% resulting from the phase in of the 2.5% capital conservation buffer that is applicable to the banking subsidiaries. The banking subsidiaries are not subject to the GSIB surcharge.
(c)
Represents requirements for bank holding companies pursuant to regulations issued by the Federal Reserve.
(d)
Represents requirements for bank subsidiaries pursuant to regulations issued under the FDIC Improvement Act.
As of December 31, 2016 and 2015, JPMorgan Chase and all of its banking subsidiaries were well-capitalized and met all capital requirements to which each was subject.
Note 29 - Off-balance sheet lending-related
financial instruments, guarantees, and other commitments
JPMorgan Chase provides lending-related financial instruments (e.g., commitments and guarantees) to meet the financing needs of its customers. The contractual amount of these financial instruments represents the maximum possible credit risk to the Firm should the counterparty draw upon the commitment or the Firm be required to fulfill its obligation under the guarantee, and should the counterparty subsequently fail to perform according to the terms of the contract. Most of these commitments and guarantees are refinanced, extended, cancelled, or expire without being drawn or a default occurring. As a result, the total contractual amount of these instruments is not, in the Firm’s view, representative of its actual future credit exposure or funding requirements.
To provide for probable credit losses inherent in wholesale and certain consumer lending-commitments, an allowance for credit losses on lending-related commitments is maintained. See Note 15 for further information regarding the allowance for credit losses on lending-related commitments. The following table summarizes the contractual amounts and carrying values of off-balance sheet lending-related financial instruments, guarantees and other commitments at December 31, 2016 and 2015. The amounts in the table below for credit card and home equity lending-related commitments represent the total available credit for these products. The Firm has not experienced, and does not anticipate, that all available lines of credit for these products will be utilized at the same time. The Firm can reduce or cancel credit card lines of credit by providing the borrower notice or, in some cases as permitted by law, without notice. In addition, the Firm typically closes credit card lines when the borrower is 60 days or more past due. The Firm may reduce or close HELOCs when there are significant decreases in the value of the underlying property, or when there has been a demonstrable decline in the creditworthiness of the borrower.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
(a)
Includes certain commitments to purchase loans from correspondents.
(b)
Predominantly all consumer lending-related commitments are in the U.S.
(c)
At December 31, 2016 and 2015, reflected the contractual amount net of risk participations totaling $328 million and $385 million, respectively, for other unfunded commitments to extend credit; $11.1 billion and $11.2 billion, respectively, for standby letters of credit and other financial guarantees; and $265 million and $341 million, respectively, for other letters of credit. In regulatory filings with the Federal Reserve these commitments are shown gross of risk participations.
(d)
At December 31, 2016 and 2015, the U.S. portion of the contractual amount of total wholesale lending-related commitments was 79% and 77%, respectively.
(e)
At December 31, 2016 and 2015, collateral held by the Firm in support of securities lending indemnification agreements was $143.2 billion and $190.6 billion, respectively. Securities lending collateral consist of primarily cash and securities issued by governments that are members of the Organisation for Economic Co-operation and Development (“OECD”) and U.S. government agencies.
(f)
At December 31, 2016 and 2015, included unfunded commitments of $48 million and $50 million, respectively, to third-party private equity funds; and $1.0 billion and $871 million, respectively, to other equity investments. These commitments included $34 million and $73 million, respectively, related to investments that are generally fair valued at net asset value as discussed in Note 3. In addition, at December 31, 2016 and 2015, included letters of credit hedged by derivative transactions and managed on a market risk basis of $4.6 billion and $4.6 billion, respectively.
(g)
For lending-related products, the carrying value represents the allowance for lending-related commitments and the guarantee liability; for derivative-related products, the carrying value represents the fair value.
JPMorgan Chase & Co./2016 Annual Report
Other unfunded commitments to extend credit
Other unfunded commitments to extend credit generally consist of commitments for working capital and general corporate purposes, extensions of credit to support commercial paper facilities and bond financings in the event that those obligations cannot be remarketed to new investors, as well as committed liquidity facilities to clearing organizations. The Firm also issues commitments under multipurpose facilities which could be drawn upon in several forms, including the issuance of a standby letter of credit.
The Firm acts as a settlement and custody bank in the U.S. tri-party repurchase transaction market. In its role as settlement and custody bank, the Firm is exposed to the intra-day credit risk of its cash borrower clients, usually broker-dealers. This exposure arises under secured clearance advance facilities that the Firm extends to its clients (i.e. cash borrowers); these facilities contractually limit the Firm’s intra-day credit risk to the facility amount
and must be repaid by the end of the day. As of December 31, 2016 and 2015, the secured clearance advance facility maximum outstanding commitment amount was $2.4 billion and $2.9 billion, respectively.
Guarantees
U.S. GAAP requires that a guarantor recognize, at the inception of a guarantee, a liability in an amount equal to the fair value of the obligation undertaken in issuing the guarantee. U.S. GAAP defines a guarantee as a contract that contingently requires the guarantor to pay a guaranteed party based upon: (a) changes in an underlying asset, liability or equity security of the guaranteed party; or (b) a third party’s failure to perform under a specified agreement. The Firm considers the following off-balance sheet lending-related arrangements to be guarantees under U.S. GAAP: standby letters of credit and other financial guarantees, securities lending indemnifications, certain indemnification agreements included within third-party contractual arrangements and certain derivative contracts.
As required by U.S. GAAP, the Firm initially records guarantees at the inception date fair value of the obligation
assumed (e.g., the amount of consideration received or the net present value of the premium receivable). For certain types of guarantees, the Firm records this fair value amount in other liabilities with an offsetting entry recorded in cash (for premiums received), or other assets (for premiums receivable). Any premium receivable recorded in other assets is reduced as cash is received under the contract, and the fair value of the liability recorded at inception is amortized into income as lending and deposit-related fees over the life of the guarantee contract. For indemnifications provided in sales agreements, a portion of the sale proceeds is allocated to the guarantee, which adjusts the gain or loss that would otherwise result from the transaction. For these indemnifications, the initial liability is amortized to income as the Firm’s risk is reduced (i.e., over time or when the indemnification expires). Any contingent liability that exists as a result of issuing the guarantee or indemnification is recognized when it becomes probable and reasonably estimable. The contingent portion of the liability is not recognized if the estimated amount is less than the carrying amount of the liability recognized at inception (adjusted for any amortization). The recorded amounts of the liabilities related to guarantees and indemnifications at December 31, 2016 and 2015, excluding the allowance for credit losses on lending-related commitments, are discussed below.
Standby letters of credit and other financial guarantees
Standby letters of credit and other financial guarantees are conditional lending commitments issued by the Firm to guarantee the performance of a customer to a third party under certain arrangements, such as commercial paper facilities, bond financings, acquisition financings, trade and similar transactions. The carrying values of standby and other letters of credit were $588 million and $550 million at December 31, 2016 and 2015, respectively, which were classified in accounts payable and other liabilities on the Consolidated balance sheets; these carrying values included $147 million and $123 million, respectively, for the allowance for lending-related commitments, and $441 million and $427 million, respectively, for the guarantee liability and corresponding asset.
The following table summarizes the types of facilities under which standby letters of credit and other letters of credit arrangements are outstanding by the ratings profiles of the Firm’s customers, as of December 31, 2016 and 2015.
Standby letters of credit, other financial guarantees and other letters of credit
(a)
The ratings scale is based on the Firm’s internal ratings, which generally correspond to ratings as defined by S&P and Moody’s.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Securities lending indemnifications
Through the Firm’s securities lending program, customers’ securities, via custodial and non-custodial arrangements, may be lent to third parties. As part of this program, the Firm provides an indemnification in the lending agreements which protects the lender against the failure of the borrower to return the lent securities. To minimize its liability under these indemnification agreements, the Firm obtains cash or other highly liquid collateral with a market value exceeding 100% of the value of the securities on loan from the borrower. Collateral is marked to market daily to help assure that collateralization is adequate. Additional collateral is called from the borrower if a shortfall exists, or collateral may be released to the borrower in the event of overcollateralization. If a borrower defaults, the Firm would use the collateral held to purchase replacement securities in the market or to credit the lending customer with the cash equivalent thereof.
Derivatives qualifying as guarantees
The Firm transacts certain derivative contracts that have the characteristics of a guarantee under U.S. GAAP. These contracts include written put options that require the Firm to purchase assets upon exercise by the option holder at a specified price by a specified date in the future. The Firm may enter into written put option contracts in order to meet client needs, or for other trading purposes. The terms of written put options are typically five years or less. Derivatives deemed to be guarantees also include contracts such as stable value derivatives that require the Firm to make a payment of the difference between the market value and the book value of a counterparty’s reference portfolio of assets in the event that market value is less than book value and certain other conditions have been met. Stable value derivatives, commonly referred to as “stable value wraps,” are transacted in order to allow investors to realize investment returns with less volatility than an unprotected portfolio and are typically longer-term or may have no stated maturity, but allow the Firm to elect to terminate the contract under certain conditions.
Derivatives deemed to be guarantees are recorded on the Consolidated balance sheets at fair value in trading assets and trading liabilities. The total notional value of the derivatives that the Firm deems to be guarantees was $52.0 billion and $53.8 billion at December 31, 2016 and 2015, respectively. The notional amount generally represents the Firm’s maximum exposure to derivatives qualifying as guarantees. However, exposure to certain stable value contracts is contractually limited to a substantially lower percentage of the notional amount; the notional amount on these stable value contracts was $28.7 billion and $28.4 billion at December 31, 2016 and 2015, respectively, and the maximum exposure to loss was $3.0 billion at both December 31, 2016 and 2015. The fair values of the contracts reflect the probability of whether the Firm will be required to perform under the contract. The fair value related to derivatives that the Firm deems to be guarantees were derivative payables of $96 million and $236 million and derivative receivables of $16 million and $14 million at December 31, 2016 and 2015, respectively. The Firm reduces exposures to these contracts by entering
into offsetting transactions, or by entering into contracts that hedge the market risk related to the derivative guarantees.
In addition to derivative contracts that meet the characteristics of a guarantee, the Firm is both a purchaser and seller of credit protection in the credit derivatives market. For a further discussion of credit derivatives, see Note 6.
Unsettled reverse repurchase and securities borrowing agreements, and unsettled repurchase and securities lending agreements
In the normal course of business, the Firm enters into reverse repurchase agreements and securities borrowing agreements, which are secured financing agreements. Such agreements settle at a future date. At settlement, these commitments result in the Firm advancing cash to and receiving securities collateral from the counterparty. The Firm also enters into repurchase agreements and securities lending agreements. At settlement, these commitments result in the Firm receiving cash from and providing securities collateral to the counterparty. These agreements generally do not meet the definition of a derivative, and therefore, are not recorded on the Consolidated balance sheets until settlement date. These agreements predominantly consist of agreements with regular-way settlement periods. For a further discussion of securities purchased under resale agreements and securities borrowed, and securities sold under repurchase agreements and securities loaned, see Note 13.
Loan sales- and securitization-related indemnifications
Mortgage repurchase liability
In connection with the Firm’s mortgage loan sale and securitization activities with GSEs, as described in Note 16, the Firm has made representations and warranties that the loans sold meet certain requirements that may require the Firm to repurchase mortgage loans and/or indemnify the loan purchaser. Further, although the Firm’s securitizations are predominantly nonrecourse, the Firm does provide recourse servicing in certain limited cases where it agrees to share credit risk with the owner of the mortgage loans. To the extent that repurchase demands that are received relate to loans that the Firm purchased from third parties that remain viable, the Firm typically will have the right to seek a recovery of related repurchase losses from the third party. Generally, the maximum amount of future payments the Firm would be required to make for breaches of these representations and warranties would be equal to the unpaid principal balance of such loans that are deemed to have defects that were sold to purchasers (including securitization-related SPEs) plus, in certain circumstances, accrued interest on such loans and certain expense.
Private label securitizations
The liability related to repurchase demands associated with private label securitizations is separately evaluated by the Firm in establishing its litigation reserves.
For additional information regarding litigation, see Note 31.
JPMorgan Chase & Co./2016 Annual Report
Loans sold with recourse
The Firm provides servicing for mortgages and certain commercial lending products on both a recourse and nonrecourse basis. In nonrecourse servicing, the principal credit risk to the Firm is the cost of temporary servicing advances of funds (i.e., normal servicing advances). In recourse servicing, the servicer agrees to share credit risk with the owner of the mortgage loans, such as Fannie Mae or Freddie Mac or a private investor, insurer or guarantor. Losses on recourse servicing predominantly occur when foreclosure sales proceeds of the property underlying a defaulted loan are less than the sum of the outstanding principal balance, plus accrued interest on the loan and the cost of holding and disposing of the underlying property. The Firm’s securitizations are predominantly nonrecourse, thereby effectively transferring the risk of future credit losses to the purchaser of the mortgage-backed securities issued by the trust. At December 31, 2016 and 2015, the unpaid principal balance of loans sold with recourse totaled $2.7 billion and $4.3 billion, respectively. The carrying value of the related liability that the Firm has recorded, which is representative of the Firm’s view of the likelihood it will have to perform under its recourse obligations, was $64 million and $82 million at December 31, 2016 and 2015, respectively.
Other off-balance sheet arrangements
Indemnification agreements - general
In connection with issuing securities to investors, the Firm may enter into contractual arrangements with third parties that require the Firm to make a payment to them in the event of a change in tax law or an adverse interpretation of tax law. In certain cases, the contract also may include a termination clause, which would allow the Firm to settle the contract at its fair value in lieu of making a payment under the indemnification clause. The Firm may also enter into indemnification clauses in connection with the licensing of software to clients (“software licensees”) or when it sells a business or assets to a third party (“third-party purchasers”), pursuant to which it indemnifies software licensees for claims of liability or damages that may occur subsequent to the licensing of the software, or third-party purchasers for losses they may incur due to actions taken by the Firm prior to the sale of the business or assets. It is difficult to estimate the Firm’s maximum exposure under these indemnification arrangements, since this would require an assessment of future changes in tax law and future claims that may be made against the Firm that have not yet occurred. However, based on historical experience, management expects the risk of loss to be remote.
Card charge-backs
Commerce Solutions, Card’s merchant services business, is a global leader in payment processing and merchant acquiring.
Under the rules of Visa USA, Inc., and MasterCard International, JPMorgan Chase Bank, N.A., is primarily liable for the amount of each processed card sales transaction that is the subject of a dispute between a cardmember and a merchant. If a dispute is resolved in the cardmember’s favor, Commerce Solutions will (through the cardmember’s
issuing bank) credit or refund the amount to the cardmember and will charge back the transaction to the merchant. If Commerce Solutions is unable to collect the amount from the merchant, Commerce Solutions will bear the loss for the amount credited or refunded to the cardmember. Commerce Solutions mitigates this risk by withholding future settlements, retaining cash reserve accounts or by obtaining other security. However, in the unlikely event that: (1) a merchant ceases operations and is unable to deliver products, services or a refund; (2) Commerce Solutions does not have sufficient collateral from the merchant to provide customer refunds; and (3) Commerce Solutions does not have sufficient financial resources to provide customer refunds, JPMorgan Chase Bank, N.A., would recognize the loss.
Commerce Solutions incurred aggregate losses of $85 million, $12 million, and $10 million on $1,063.4 billion, $949.3 billion, and $847.9 billion of aggregate volume processed for the years ended December 31, 2016, 2015 and 2014, respectively. Incurred losses from merchant charge-backs are charged to other expense, with the offset recorded in a valuation allowance against accrued interest and accounts receivable on the Consolidated balance sheets. The carrying value of the valuation allowance was $45 million and $20 million at December 31, 2016 and 2015, respectively, which the Firm believes, based on historical experience and the collateral held by Commerce Solutions of $125 million and $136 million at December 31, 2016 and 2015, respectively, is representative of the payment or performance risk to the Firm related to charge-backs.
Clearing Services - Client Credit Risk
The Firm provides clearing services for clients by entering into securities purchases and sales and derivative transactions with CCPs, including ETDs such as futures and options, as well as OTC-cleared derivative contracts. As a clearing member, the Firm stands behind the performance of its clients, collects cash and securities collateral (margin) as well as any settlement amounts due from or to clients, and remits them to the relevant CCP or client in whole or part. There are two types of margin: variation margin is posted on a daily basis based on the value of clients’ derivative contracts and initial margin is posted at inception of a derivative contract, generally on the basis of the potential changes in the variation margin requirement for the contract.
As clearing member, the Firm is exposed to the risk of nonperformance by its clients, but is not liable to clients for the performance of the CCPs. Where possible, the Firm seeks to mitigate its risk to the client through the collection of appropriate amounts of margin at inception and throughout the life of the transactions. The Firm can also cease providing clearing services if clients do not adhere to their obligations under the clearing agreement. In the event of nonperformance by a client, the Firm would close out the client’s positions and access available margin. The CCP would utilize any margin it holds to make itself whole, with any remaining shortfalls required to be paid by the Firm as a clearing member.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
The Firm reflects its exposure to nonperformance risk of the client through the recognition of margin payables or receivables to clients and CCPs; the clients’ underlying securities or derivative contracts are not reflected in the Firm’s Consolidated Financial Statements.
It is difficult to estimate the Firm’s maximum possible exposure through its role as a clearing member, as this would require an assessment of transactions that clients may execute in the future. However, based upon historical experience, and the credit risk mitigants available to the Firm, management believes it is unlikely that the Firm will have to make any material payments under these arrangements and the risk of loss is expected to be remote.
For information on the derivatives that the Firm executes for its own account and records in its Consolidated Financial Statements, see Note 6.
Exchange & Clearing House Memberships
The Firm is a member of several securities and derivative exchanges and clearing houses, both in the U.S. and other countries, and it provides clearing services. Membership in some of these organizations requires the Firm to pay a pro rata share of the losses incurred by the organization as a result of the default of another member. Such obligations vary with different organizations. These obligations may be limited to members who dealt with the defaulting member or to the amount (or a multiple of the amount) of the Firm’s contribution to the guarantee fund maintained by a clearing house or exchange as part of the resources available to cover any losses in the event of a member default. Alternatively, these obligations may include a pro rata share of the residual losses after applying the guarantee fund. Additionally, certain clearing houses require the Firm as a member to pay a pro rata share of losses that may result from the clearing house’s investment of guarantee fund contributions and initial margin, unrelated to and independent of the default of another member. Generally a payment would only be required should such losses exceed the resources of the clearing house or exchange that are contractually required to absorb the losses in the first instance. It is difficult to estimate the Firm’s maximum possible exposure under these membership agreements, since this would require an assessment of future claims that may be made against the Firm that have not yet occurred. However, based on historical experience, management expects the risk of loss to be remote.
Guarantees of subsidiaries
In the normal course of business, JPMorgan Chase & Co. (“Parent Company”) may provide counterparties with guarantees of certain of the trading and other obligations of its subsidiaries on a contract-by-contract basis, as negotiated with the Firm’s counterparties. The obligations of the subsidiaries are included on the Firm’s Consolidated balance sheets or are reflected as off-balance sheet commitments; therefore, the Parent Company has not recognized a separate liability for these guarantees. The Firm believes that the occurrence of any event that would trigger payments by the Parent Company under these guarantees is remote.
The Parent Company has guaranteed certain long-term debt and structured notes of its subsidiaries, including JPMorgan Chase Financial Company LLC (“JPMFC”), a 100%-owned finance subsidiary. All securities issued by JPMFC are fully and unconditionally guaranteed by the Parent Company. These guarantees, which rank on a parity with the Firm’s unsecured and unsubordinated indebtedness, are not included in the table on page 256 of this Note. For additional information, see Note 21.
JPMorgan Chase & Co./2016 Annual Report
Note 30 - Commitments, pledged assets and
collateral
Lease commitments
At December 31, 2016, JPMorgan Chase and its subsidiaries were obligated under a number of noncancelable operating leases for premises and equipment used primarily for banking purposes, and for energy-related tolling service agreements. Certain leases contain renewal options or escalation clauses providing for increased rental payments based on maintenance, utility and tax increases, or they require the Firm to perform restoration work on leased premises. No lease agreement imposes restrictions on the Firm’s ability to pay dividends, engage in debt or equity financing transactions or enter into further lease agreements.
The following table presents required future minimum rental payments under operating leases with noncancelable lease terms that expire after December 31, 2016.
Total rental expense was as follows.
Pledged assets
The Firm may pledge financial assets that it owns to maintain potential borrowing capacity with central banks and for other purposes, including to secure borrowings and public deposits, and to collateralize repurchase and other securities financing agreements, and to cover customer short sales. Certain of these pledged assets may be sold or repledged or otherwise used by the secured parties and are identified as financial instruments owned (pledged to various parties) on the Consolidated balance sheets. At December 31, 2016 and 2015, the Firm had pledged assets of $441.9 billion and $385.6 billion, respectively, at Federal Reserve banks and FHLBs. In addition, as of December 31, 2016 and 2015, the Firm had pledged $53.5 billion and $50.7 billion, respectively, of financial assets that may not be sold or repledged or otherwise used by the secured parties. Total assets pledged do not include assets of consolidated VIEs; these assets are used to settle the liabilities of those entities. See Note 16 for additional information on assets and liabilities of consolidated VIEs. For additional information on the Firm’s securities financing activities and long-term debt, see Note 13 and Note 21, respectively. The significant components of the Firm’s pledged assets were as follows.
Collateral
At December 31, 2016 and 2015, the Firm had accepted financial assets as collateral that it could sell or repledge, deliver or otherwise use with a fair value of approximately $914.1 billion and $748.5 billion, respectively. This collateral was generally obtained under resale agreements, securities borrowing agreements, customer margin loans and derivative agreements. Of the collateral received, approximately $746.6 billion and $580.9 billion, respectively, were sold, repledged, delivered or otherwise used. Collateral was generally used under repurchase agreements, securities lending agreements or to cover customer short sales and to collateralize deposits and derivative agreements.
JPMorgan Chase & Co./2016 Annual Report
Notes to consolidated financial statements
Note 31 - Litigation
Contingencies
As of December 31, 2016, the Firm and its subsidiaries and affiliates are defendants or putative defendants in numerous legal proceedings, including private, civil litigations and regulatory/government investigations. The litigations range from individual actions involving a single plaintiff to class action lawsuits with potentially millions of class members. Investigations involve both formal and informal proceedings, by both governmental agencies and self-regulatory organizations. These legal proceedings are at varying stages of adjudication, arbitration or investigation, and involve each of the Firm’s lines of business and geographies and a wide variety of claims (including common law tort and contract claims and statutory antitrust, securities and consumer protection claims), some of which present novel legal theories.
The Firm believes the estimate of the aggregate range of reasonably possible losses, in excess of reserves established, for its legal proceedings is from $0 to approximately $3.0 billion at December 31, 2016. This estimated aggregate range of reasonably possible losses was based upon currently available information for those proceedings in which the Firm believes that an estimate of reasonably possible loss can be made. For certain matters, the Firm does not believe that such an estimate can be made, as of that date. The Firm’s estimate of the aggregate range of reasonably possible losses involves significant judgment, given the number, variety and varying stages of the proceedings (including the fact that many are in preliminary stages), the existence in many such proceedings of multiple defendants (including the Firm) whose share of liability has yet to be determined, the numerous yet-unresolved issues in many of the proceedings (including issues regarding class certification and the scope of many of the claims) and the attendant uncertainty of the various potential outcomes of such proceedings, including where the Firm has made assumptions concerning future rulings by the court or other adjudicator, or about the behavior or incentives of adverse parties or regulatory authorities, and those assumptions prove to be incorrect. In addition, the outcome of a particular proceeding may be a result which the Firm did not take into account in its estimate because the Firm had deemed the likelihood of that outcome to be remote. Accordingly, the Firm’s estimate of the aggregate range of reasonably possible losses will change from time to time, and actual losses may vary significantly.
Set forth below are descriptions of the Firm’s material legal proceedings.
CIO Litigation. The Firm has been sued in a consolidated shareholder class action, and in a consolidated putative class action brought under the Employee Retirement Income Security Act (“ERISA”), relating to 2012 losses in the synthetic credit portfolio formerly managed by the Firm’s Chief Investment Office (“CIO”). A settlement of the
shareholder class action, under which the Firm paid $150 million, has received full and final approval from the Court. The putative ERISA class action has been dismissed. That dismissal was affirmed by the appellate court, and a request by the plaintiffs for rehearing by the full appellate court was denied.
Foreign Exchange Investigations and Litigation. The Firm previously reported settlements with certain government authorities relating to its foreign exchange (“FX”) sales and trading activities and controls related to those activities. FX-related investigations and inquiries by government authorities, including competition authorities, are ongoing, and the Firm is cooperating with those matters. In May 2015, the Firm pleaded guilty to a single violation of federal antitrust law, and in January 2017, the Firm was sentenced, with judgment entered shortly thereafter. The Department of Labor granted the Firm a temporary one-year waiver, which was effective upon entry of judgment, to allow the Firm and its affiliates to continue to qualify for the Qualified Professional Asset Manager exemption under ERISA. The Firm’s application for a lengthier exemption is pending. Separately, in February 2017 the South Africa Competition Commission announced that it had referred its FX investigation of the Firm and other banks to the South Africa Competition Tribunal to commence civil proceedings.
The Firm is also one of a number of foreign exchange dealers defending a class action filed in the United States District Court for the Southern District of New York by U.S.-based plaintiffs, principally alleging violations of federal antitrust laws based on an alleged conspiracy to manipulate foreign exchange rates (the “U.S. class action”). In January 2015, the Firm entered into a settlement agreement in the U.S. class action. Following this settlement, a number of additional putative class actions were filed seeking damages for persons who transacted FX futures and options on futures (the “exchanged-based actions”), consumers who purchased foreign currencies at allegedly inflated rates (the “consumer action”), participants or beneficiaries of qualified ERISA plans (the “ERISA actions”), and purported indirect purchasers of FX instruments (the “indirect purchaser action”). Since then, the Firm has entered into a revised settlement agreement to resolve the consolidated U.S. class action, including the exchange-based actions, and that agreement has been preliminarily approved by the Court. The District Court has dismissed one of the ERISA actions, and the plaintiffs have filed an appeal. The consumer action, a second ERISA action and the indirect purchaser action remain pending in the District Court.
In September 2015, two class actions were filed in Canada against the Firm as well as a number of other FX dealers, principally for alleged violations of the Canadian Competition Act based on an alleged conspiracy to fix the prices of currency purchased in the FX market. The first action was filed in the province of Ontario, and seeks to represent all persons in Canada who transacted any FX
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instrument. The second action was filed in the province of Quebec, and seeks authorization to represent only those persons in Quebec who engaged in FX transactions. In late 2016, the Firm settled the Canadian class actions; those settlements are subject to Court approval.
General Motors Litigation. JPMorgan Chase Bank, N.A. participated in, and was the Administrative Agent on behalf of a syndicate of lenders on, a $1.5 billion syndicated Term Loan facility (“Term Loan”) for General Motors Corporation (“GM”). In July 2009, in connection with the GM bankruptcy proceedings, the Official Committee of Unsecured Creditors of Motors Liquidation Company (“Creditors Committee”) filed a lawsuit against JPMorgan Chase Bank, N.A., in its individual capacity and as Administrative Agent for other lenders on the Term Loan, seeking to hold the underlying lien invalid based on the filing of a UCC-3 termination statement relating to the Term Loan. In January 2015, following several court proceedings, the United States Court of Appeals for the Second Circuit reversed the Bankruptcy Court’s dismissal of the Creditors Committee’s claim and remanded the case to the Bankruptcy Court with instructions to enter partial summary judgment for the Creditors Committee as to the termination statement. The proceedings in the Bankruptcy Court continue with respect to, among other things, additional defenses asserted by JPMorgan Chase Bank, N.A. and the value of additional collateral on the Term Loan that was unaffected by the filing of the termination statement at issue. In addition, certain Term Loan lenders filed cross-claims against JPMorgan Chase Bank, N.A. in the Bankruptcy Court seeking indemnification and asserting various claims.
Interchange Litigation. A group of merchants and retail associations filed a series of class action complaints alleging that Visa and MasterCard, as well as certain banks, conspired to set the price of credit and debit card interchange fees, enacted respective rules in violation of antitrust laws, and engaged in tying/bundling and exclusive dealing. The parties entered into an agreement to settle the cases for a cash payment of $6.1 billion to the class plaintiffs (of which the Firm’s share is approximately 20%) and an amount equal to ten basis points of credit card interchange for a period of eight months to be measured from a date within 60 days of the end of the opt-out period. The agreement also provided for modifications to each credit card network’s rules, including those that prohibit surcharging credit card transactions. In December 2013, the District Court granted final approval of the settlement.
A number of merchants appealed to the United States Court of Appeals for the Second Circuit, which, in June 2016, vacated the District Court’s certification of the class action and reversed the approval of the class settlement. The case has been remanded to the District Court for further proceedings consistent with the appellate decision. Both the plaintiffs and the defendants have filed petitions seeking review by the U.S. Supreme Court of the Second Circuit’s decision.
In addition, certain merchants have filed individual actions against Visa and MasterCard, as well as against the Firm and other banks, and those actions are proceeding.
Investment Management Litigation. The Firm is defending two pending cases that are coordinated for pre-trial and trial purposes, alleging that investment portfolios managed by J.P. Morgan Investment Management (“JPMIM”) were inappropriately invested in securities backed by residential real estate collateral. Plaintiffs Assured Guaranty (U.K.) and Ambac Assurance UK Limited claim that JPMIM is liable for total losses of more than $1 billion in market value of these securities. Discovery has been completed. In January 2016, plaintiffs filed a joint partial motion for summary judgment in the coordinated actions. In February 2017, the Court ruled in plaintiffs’ favor as to the interpretation of an applicable statutory provision and the rejection of a certain defense, but otherwise preserved for trial the determination of whether JPMIM breached the governing contract and is liable for plaintiffs’ claimed losses under the standard of gross negligence. The trial is scheduled to begin in March 2017.
Lehman Brothers Bankruptcy Proceedings. In January 2016, JPMorgan Chase Bank, N.A. and Lehman Brothers Holdings Inc. (“LBHI”) and several of LBHI’s subsidiaries reached an agreement, approved by the Bankruptcy Court, resolving several disputes between the parties. The January 2016 settlement did not resolve the following remaining matters: In the Bankruptcy Court proceedings, LBHI and its Official Committee of Unsecured Creditors filed an objection to the claims asserted by JPMorgan Chase Bank, N.A. against LBHI with respect to clearing advances made to Lehman Brothers Inc., principally on the grounds that the Firm had not conducted the sale of the securities collateral held for its claims in a commercially reasonable manner. LBHI also brought two claims objections relating to securities lending claims and a group of other smaller claims. In January 2017, the Firm entered into an agreement to settle all of these remaining claims, and this settlement has been approved by the Bankruptcy Court.
LIBOR and Other Benchmark Rate Investigations and Litigation. JPMorgan Chase has received subpoenas and requests for documents and, in some cases, interviews, from federal and state agencies and entities, including the U.S. Department of Justice (“DOJ”), the U.S. Commodity Futures Trading Commission (“CFTC”), the U.S. Securities and Exchange Commission (“SEC”) and various state attorneys general, as well as the European Commission (“EC”), the U.K. Financial Conduct Authority (“FCA”), the Canadian Competition Bureau, the Swiss Competition Commission (“ComCo”) and other regulatory authorities and banking associations around the world relating primarily to the process by which interest rates were submitted to the British Bankers Association (“BBA”) in connection with the setting of the BBA’s London Interbank Offered Rate (“LIBOR”) for various currencies, principally in 2007 and 2008. Some of the inquiries also relate to similar processes by which information on rates is submitted to the European
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Notes to consolidated financial statements
Banking Federation (“EBF”) in connection with the setting of the EBF’s Euro Interbank Offered Rates (“EURIBOR”) and to the Japanese Bankers’ Association for the setting of Tokyo Interbank Offered Rates (“TIBOR”), as well as processes for the setting of U.S. dollar ISDAFIX rates and other reference rates in various parts of the world during similar time periods. The Firm is responding to and continuing to cooperate with these inquiries. As previously reported, the Firm has resolved EC inquiries relating to Yen LIBOR and Swiss Franc LIBOR. In December 2016, the Firm resolved ComCo inquiries relating to these same rates. ComCo’s investigation relating to EURIBOR, to which the Firm and other banks are subject, continues. In December 2016, the EC issued a decision against the Firm and other banks finding an infringement of European antitrust rules relating to EURIBOR. The Firm has filed an appeal with the European General Court. In June 2016, the DOJ informed the Firm that the DOJ had closed its inquiry into LIBOR and other benchmark rates with respect to the Firm without taking action. Other inquiries have been discontinued without any action against JPMorgan Chase, including by the SEC, FCA and the Canadian Competition Bureau.
In addition, the Firm has been named as a defendant along with other banks in a series of individual and putative class actions filed in various United States District Courts. These actions have been filed, or consolidated for pre-trial purposes, in the United States District Court for the Southern District of New York. In these actions, plaintiffs make varying allegations that in various periods, starting in 2000 or later, defendants either individually or collectively manipulated the U.S. dollar LIBOR, Yen LIBOR, Swiss franc LIBOR, Euroyen TIBOR, EURIBOR, Singapore Interbank Offered Rate (“SIBOR”), Singapore Swap Offer Rate (“SOR”) and/or the Bank Bill Swap Reference Rate (“BBSW”) by submitting rates that were artificially low or high. Plaintiffs allege that they transacted in loans, derivatives or other financial instruments whose values are affected by changes in U.S. dollar LIBOR, Yen LIBOR, Swiss franc LIBOR, Euroyen TIBOR, EURIBOR, SIBOR, SOR or BBSW and assert a variety of claims including antitrust claims seeking treble damages. These matters are in various stages of litigation.
In the U.S. dollar LIBOR-related actions, the District Court dismissed certain claims, including the antitrust claims, and permitted other claims under the Commodity Exchange Act and common law to proceed. In May 2016, the United States Court of Appeals for the Second Circuit vacated the dismissal of the antitrust claims and remanded the case to the District Court to consider, among other things, whether the plaintiffs have standing to assert antitrust claims. In July 2016, JPMorgan Chase and other defendants again moved in the District Court to dismiss the antitrust claims, and in December 2016, the District Court granted in part and denied in part defendants’ motion, finding that certain plaintiffs lacked standing to assert antitrust claims. Separately, in October 2016, JPMorgan Chase and other defendants filed a petition to the U.S. Supreme Court seeking review of the Second Circuit’s decision that vacated
the dismissal of plaintiffs’ antitrust claims. That petition was denied.
The Firm is one of the defendants in a number of putative class actions alleging that defendant banks and ICAP conspired to manipulate the U.S. dollar ISDAFIX rates. Plaintiffs primarily assert claims under the federal antitrust laws and Commodity Exchange Act. In April 2016, the Firm settled the ISDAFIX litigation, along with certain other banks. Those settlements have been preliminarily approved by the Court.
Madoff Litigation. A putative class action was filed in the United States District Court for the District of New Jersey by investors who were net winners (i.e., Madoff customers who had taken more money out of their accounts than had been invested) in Madoff’s Ponzi scheme and were not included in a prior class action settlement. These plaintiffs allege violations of the federal securities law, as well as other state and federal claims. A similar action was filed in the United States District Court for the Middle District of Florida, although it was not styled as a class action, and included claims pursuant to Florida statutes. The Florida court granted the Firm’s motion to dismiss the case, and in August 2016, the United States Court of Appeals for the Eleventh Circuit affirmed the dismissal. The plaintiffs have filed a petition for writ of certiorari with the United States Supreme Court. In addition, the same plaintiffs have re-filed their dismissed state claims in Florida state court, where the Firm’s motion to dismiss is pending. The New Jersey court granted a transfer motion to the United States District Court for the Southern District of New York, which granted the Firm’s motion to dismiss, and the plaintiffs have filed an appeal of that dismissal.
Mortgage-Backed Securities and Repurchase Litigation and Related Regulatory Investigations. The Firm and affiliates (together, “JPMC”), Bear Stearns and affiliates (together, “Bear Stearns”) and certain Washington Mutual affiliates (together, “Washington Mutual”) have been named as defendants in a number of cases in their various roles in offerings of mortgage-backed securities (“MBS”). Following the settlements referred to below, the remaining civil cases include one investor action, one action by a monoline insurer relating to Bear Stearns’ role solely as underwriter, and actions for repurchase of mortgage loans. The Firm and certain of its current and former officers and Board members have also been sued in shareholder derivative actions relating to the Firm’s MBS activities, and one action remains pending.
Issuer Litigation - Individual Purchaser Actions. With the exception of one remaining action, the Firm has settled all of the individual actions brought against JPMC, Bear Stearns and Washington Mutual as MBS issuers (and, in some cases, also as underwriters of their own MBS offerings).
Underwriter Actions. The Firm is defending one remaining action by a monoline insurer relating to Bear Stearns’ role solely as underwriter for another issuer’s MBS offering. The issuer is defunct.
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Repurchase Litigation. The Firm is defending a number of actions brought by trustees, securities administrators and/or master servicers of various MBS trusts on behalf of purchasers of securities issued by those trusts. These cases generally allege breaches of various representations and warranties regarding securitized loans and seek repurchase of those loans or equivalent monetary relief, as well as indemnification of attorneys’ fees and costs and other remedies. The Firm has reached a settlement with Deutsche Bank National Trust Company, acting as trustee for various MBS trusts, and the Federal Deposit Insurance Corporation (the “FDIC”) in connection with the litigation related to a significant number of MBS issued by Washington Mutual; that case is described in the Washington Mutual Litigations section below. Other repurchase actions, each specific to one or more MBS transactions issued by JPMC and/or Bear Stearns, are in various stages of litigation.
In addition, the Firm and a group of 21 institutional MBS investors made a binding offer to the trustees of MBS issued by JPMC and Bear Stearns providing for the payment of $4.5 billion and the implementation of certain servicing changes by JPMC, to resolve all repurchase and servicing claims that have been asserted or could have been asserted with respect to 330 MBS trusts created between 2005 and 2008. The offer does not resolve claims relating to Washington Mutual MBS. The trustees (or separate and successor trustees) for this group of 330 trusts have accepted the settlement for 319 trusts in whole or in part and excluded from the settlement 16 trusts in whole or in part. The trustees’ acceptance has received final approval from the court.
Additional actions have been filed against third-party trustees that relate to loan repurchase and servicing claims involving trusts sponsored by JPMC, Bear Stearns and Washington Mutual.
The Firm has entered into agreements with a number of MBS trustees or entities that purchased MBS that toll applicable statute of limitations periods with respect to their claims, and has settled, and in the future may settle, tolled claims. There is no assurance that the Firm will not be named as a defendant in additional MBS-related litigation.
Derivative Actions. A shareholder derivative action against the Firm, as nominal defendant, and certain of its current and former officers and members of its Board of Directors relating to the Firm’s MBS activities is pending in California federal court. Defendants have filed a motion to dismiss the action.
Government Enforcement Investigations and Litigation. The Firm is responding to an ongoing investigation being conducted by the DOJ’s Criminal Division and two United States Attorney’s Offices relating to MBS offerings securitized and sold by the Firm and its subsidiaries.
Mortgage-Related Investigations and Litigation. In January 2017, a Consent Judgment was entered by the United States District Court for the Southern District of New York
resolving allegations by the Civil Division of the United States Attorney’s Office for the Southern District of New York that the Firm violated the Fair Housing Act and Equal Credit Opportunity Act by giving pricing discretion to independent mortgage brokers in its wholesale lending distribution channel which, according to the government’s model, may have charged higher fees and interest rates to African-American and Hispanic borrowers than non-Hispanic White borrowers during the period between 2006 and 2009. The Firm denied liability but agreed to pay a total of approximately $55 million to resolve this matter. In addition, three municipalities have commenced litigation against the Firm alleging violations of an unfair competition law or the Fair Housing Act. The municipalities seek, among other things, civil penalties for the unfair competition claim, and, for the Fair Housing Act claims, damages resulting from lost tax revenue and increased municipal costs associated with foreclosed properties. The municipal actions are stayed pending an appeal by the City of Los Angeles to the United States Court of Appeals for the Ninth Circuit, as well as the United States Supreme Court’s review of decisions of the United States Court of Appeals for the Eleventh Circuit which held, among other things, that the City of Miami has standing under the Fair Housing Act to pursue similar claims against other banks.
Municipal Derivatives Litigation. Several civil actions were commenced in New York and Alabama courts against the Firm relating to certain Jefferson County, Alabama (the “County”) warrant underwritings and swap transactions. The claims in the civil actions generally alleged that the Firm made payments to certain third parties in exchange for being chosen to underwrite more than $3 billion in warrants issued by the County and to act as the counterparty for certain swaps executed by the County. The County filed for bankruptcy in November 2011. In June 2013, the County filed a Chapter 9 Plan of Adjustment, as amended (the “Plan of Adjustment”), which provided that all the above-described actions against the Firm would be released and dismissed with prejudice. In November 2013, the Bankruptcy Court confirmed the Plan of Adjustment, and in December 2013, certain sewer rate payers filed an appeal challenging the confirmation of the Plan of Adjustment. All conditions to the Plan of Adjustment’s effectiveness, including the dismissal of the actions against the Firm, were satisfied or waived and the transactions contemplated by the Plan of Adjustment occurred in December 2013. Accordingly, all the above-described actions against the Firm have been dismissed pursuant to the terms of the Plan of Adjustment. The appeal of the Bankruptcy Court’s order confirming the Plan of Adjustment remains pending.
Petters Bankruptcy and Related Matters. JPMorgan Chase and certain of its affiliates, including One Equity Partners (“OEP”), have been named as defendants in several actions filed in connection with the receivership and bankruptcy proceedings pertaining to Thomas J. Petters and certain affiliated entities (collectively, “Petters”) and the Polaroid
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Notes to consolidated financial statements
Corporation. The principal actions against JPMorgan Chase and its affiliates have been brought by a court-appointed receiver for Petters and the trustees in bankruptcy proceedings for three Petters entities. These actions generally seek to avoid certain putative transfers in connection with (i) the 2005 acquisition by Petters of Polaroid, which at the time was majority-owned by OEP; (ii) two credit facilities that JPMorgan Chase and other financial institutions entered into with Polaroid; and (iii) a credit line and investment accounts held by Petters. In January 2017, the Court denied the defendants’ motion to dismiss an amended complaint filed by the plaintiffs.
Proprietary Products Investigations and Litigation. In December 2015, JPMorgan Chase Bank, N.A. and J.P. Morgan Securities LLC agreed to a settlement with the SEC, and JPMorgan Chase Bank, N.A. agreed to a settlement with the CFTC, regarding disclosures to clients concerning conflicts associated with the Firm’s sale and use of proprietary products, such as J.P. Morgan mutual funds, in the Firm’s CCB and AWM wealth management businesses, and the U.S. Private Bank’s disclosures concerning the use of hedge funds that pay placement agent fees to JPMorgan Chase broker-dealer affiliates. The Firm settled with an additional government authority in July 2016, and continues to cooperate with inquiries from other government authorities concerning disclosure of conflicts associated with the Firm’s sale and use of proprietary products. A putative class action, which was filed in the United States District Court for the Northern District of Illinois on behalf of financial advisory clients from 2007 to the present whose funds were invested in proprietary funds and who were charged investment management fees, was dismissed by the Court. The dismissal has been affirmed on appeal.
Referral Hiring Practices Investigations. In November 2016, the Firm entered into settlements with DOJ, the SEC and the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to resolve those agencies’ respective investigations relating to a former hiring program for candidates referred by clients, potential clients and government officials in the Asia Pacific region. Other related investigations are ongoing, and the Firm continues to cooperate with these investigations.
Washington Mutual Litigations. Proceedings related to Washington Mutual’s failure are pending before the United States District Court for the District of Columbia and include a lawsuit brought by Deutsche Bank National Trust Company, initially against the FDIC and amended to include JPMorgan Chase Bank, N.A. as a defendant, asserting an estimated $6 billion to $10 billion in damages based upon alleged breaches of certain representations and warranties given by certain Washington Mutual affiliates in connection with mortgage securitization agreements. The case includes assertions that JPMorgan Chase Bank, N.A. may have assumed liabilities for the alleged breaches of representations and warranties in the mortgage securitization agreements. In June 2015, the court ruled in
favor of JPMorgan Chase Bank, N.A. on the question of whether the Firm or the FDIC bears responsibility for Washington Mutual Bank’s repurchase obligations, holding that JPMorgan Chase Bank, N.A. assumed only those liabilities that were reflected on Washington Mutual Bank’s financial accounting records as of September 25, 2008, and only up to the amount of the book value reflected therein. The FDIC has appealed that ruling.
JPMorgan Chase has also filed complaints in the United States District Court for the District of Columbia against the FDIC, in its corporate capacity as well as in its capacity as receiver for Washington Mutual Bank, asserting multiple claims for indemnification under the terms of the Purchase & Assumption Agreement between JPMorgan Chase Bank, N.A. and the FDIC relating to JPMorgan Chase Bank, N.A.’s purchase of substantially all of the assets and certain liabilities of Washington Mutual Bank (the “Purchase & Assumption Agreement”).
The Firm, Deutsche Bank National Trust Company and the FDIC have signed a settlement agreement to resolve (i) pending litigation brought by Deutsche Bank National Trust Company against the FDIC and JPMorgan Chase Bank, N.A., as defendants, relating to alleged breaches of certain representations and warranties given by certain Washington Mutual affiliates in connection with mortgage securitization agreements and (ii) JPMorgan Chase Bank, N.A.’s outstanding indemnification claims pursuant to the terms of the Purchase & Assumption Agreement. The settlement is subject to certain judicial approval procedures, and both matters are stayed pending approval of the settlement.
Wendel. Since 2012, the French criminal authorities have been investigating a series of transactions entered into by senior managers of Wendel Investissement (“Wendel”) during the period from 2004 through 2007 to restructure their shareholdings in Wendel. JPMorgan Chase Bank, N.A., Paris branch provided financing for the transactions to a number of managers of Wendel in 2007. JPMorgan Chase has cooperated with the investigation. The investigating judges issued an ordonnance de renvoi on November 30, 2016, referring JPMorgan Chase Bank, N.A. to the French tribunal correctionnel for alleged complicity in tax fraud. No date for trial has been set by the court. The Firm has been successful in legal challenges made to the Court of Cassation, France’s highest court, which have been referred back to and remain pending before the Paris Court of Appeal. In addition, civil proceedings have been commenced against JPMorgan Chase Bank, N.A. by a number of the managers. The claims are separate, involve different allegations and are at various stages of proceedings.
* * *
In addition to the various legal proceedings discussed above, JPMorgan Chase and its subsidiaries are named as defendants or are otherwise involved in a substantial number of other legal proceedings. The Firm believes it has meritorious defenses to the claims asserted against it in its currently outstanding legal proceedings and it intends to
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defend itself vigorously in all such matters. Additional legal proceedings may be initiated from time to time in the future.
The Firm has established reserves for several hundred of its currently outstanding legal proceedings. In accordance with the provisions of U.S. GAAP for contingencies, the Firm accrues for a litigation-related liability when it is probable that such a liability has been incurred and the amount of the loss can be reasonably estimated. The Firm evaluates its outstanding legal proceedings each quarter to assess its litigation reserves, and makes adjustments in such reserves, upwards or downward, as appropriate, based on management’s best judgment after consultation with counsel. During the years ended December 31, 2016, 2015 and 2014, the Firm’s legal expense was a benefit of $(317) million and an expense of $3.0 billion and $2.9 billion, respectively. There is no assurance that the Firm’s litigation reserves will not need to be adjusted in the future.
In view of the inherent difficulty of predicting the outcome of legal proceedings, particularly where the claimants seek very large or indeterminate damages, or where the matters present novel legal theories, involve a large number of parties or are in early stages of discovery, the Firm cannot state with confidence what will be the eventual outcomes of the currently pending matters, the timing of their ultimate resolution or the eventual losses, fines, penalties or impact related to those matters. JPMorgan Chase believes, based upon its current knowledge, after consultation with counsel and after taking into account its current litigation reserves, that the legal proceedings currently pending against it should not have a material adverse effect on the Firm’s consolidated financial condition. The Firm notes, however, that in light of the uncertainties involved in such proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves it has currently accrued or that a matter will not have material reputational consequences. As a result, the outcome of a particular matter may be material to JPMorgan Chase’s operating results for a particular period, depending on, among other factors, the size of the loss or liability imposed and the level of JPMorgan Chase’s income for that period.
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Notes to consolidated financial statements
Note 32 - International operations
The following table presents income statement- and balance sheet-related information for JPMorgan Chase by major international geographic area. The Firm defines international activities for purposes of this footnote presentation as business transactions that involve clients residing outside of the U.S., and the information presented below is based predominantly on the domicile of the client, the location from which the client relationship is managed, or the location of the trading desk. However, many of the Firm’s U.S. operations serve international businesses.
As the Firm’s operations are highly integrated, estimates and subjective assumptions have been made to apportion revenue and expense between U.S. and international operations. These estimates and assumptions are consistent with the allocations used for the Firm’s segment reporting as set forth in Note 33.
The Firm’s long-lived assets for the periods presented are not considered by management to be significant in relation to total assets. The majority of the Firm’s long-lived assets are located in the U.S.
(a)
Substantially reflects the U.S.
(b)
Revenue is composed of net interest income and noninterest revenue.
(c)
Expense is composed of noninterest expense and the provision for credit losses.
(d)
Total assets for the U.K. were approximately $310 billion, $306 billion, and $434 billion at December 31, 2016, 2015 and 2014, respectively.
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Note 33 - Business segments
The Firm is managed on a line of business basis. There are four major reportable business segments - Consumer & Community Banking, Corporate & Investment Bank, Commercial Banking and Asset & Wealth Management. In addition, there is a Corporate segment. The business segments are determined based on the products and services provided, or the type of customer served, and they reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on a managed basis. For a further discussion concerning JPMorgan Chase’s business segments, see Segment results of this footnote.
The following is a description of each of the Firm’s business segments, and the products and services they provide to their respective client bases.
Consumer & Community Banking
CCB offers services to consumers and businesses through bank branches, ATMs, online, mobile and telephone banking. CCB is organized into Consumer & Business Banking (including Consumer Banking/Chase Wealth Management and Business Banking), Mortgage Banking (including Mortgage Production, Mortgage Servicing and Real Estate Portfolios) and Card, Commerce Solutions & Auto. Consumer & Business Banking offers deposit and investment products and services to consumers, and lending, deposit, and cash management and payment solutions to small businesses. Mortgage Banking includes mortgage origination and servicing activities, as well as portfolios consisting of residential mortgages and home equity loans. Card, Commerce Solutions & Auto issues credit cards to consumers and small businesses, offers payment processing services to merchants, originates and services auto loans and leases, and services student loans.
Corporate & Investment Bank
The CIB, which consists of Banking and Markets & Investor Services, offers a broad suite of investment banking, market-making, prime brokerage, and treasury and securities products and services to a global client base of corporations, investors, financial institutions, government and municipal entities. Banking offers a full range of investment banking products and services in all major capital markets, including advising on corporate strategy and structure, capital-raising in equity and debt markets, as well as loan origination and syndication. Banking also includes Treasury Services, which provides transaction services, consisting of cash management and liquidity solutions. Markets & Investor Services is a global market-
maker in cash securities and derivative instruments, and also offers sophisticated risk management solutions, prime brokerage, and research. Markets & Investor Services also includes Securities Services, a leading global custodian that provides custody, fund accounting and administration, and securities lending products principally for asset managers, insurance companies and public and private investment funds.
Commercial Banking
CB delivers extensive industry knowledge, local expertise and dedicated service to U.S. and U.S. multinational clients, including corporations, municipalities, financial institutions and nonprofit entities with annual revenue generally ranging from $20 million to $2 billion. In addition, CB provides financing to real estate investors and owners. Partnering with the Firm’s other businesses, CB provides comprehensive financial solutions, including lending, treasury services, investment banking and asset management to meet its clients’ domestic and international financial needs.
Asset & Wealth Management
AWM, with client assets of $2.5 trillion, is a global leader in investment and wealth management. AWM clients include institutions, high-net-worth individuals and retail investors in many major markets throughout the world. AWM offers investment management across most major asset classes including equities, fixed income, alternatives and money market funds. AWM also offers multi-asset investment management, providing solutions for a broad range of clients’ investment needs. For Wealth Management clients, AWM also provides retirement products and services, brokerage and banking services, including trusts and estates, loans, mortgages and deposits. The majority of AWM’s client assets are in actively managed portfolios.
Corporate
The Corporate segment consists of Treasury and CIO and Other Corporate, which includes corporate staff units and expense that is centrally managed. Treasury and CIO are predominantly responsible for measuring, monitoring, reporting and managing the Firm’s liquidity, funding and structural interest rate and foreign exchange risks, as well as executing the Firm’s capital plan. The major Other Corporate units include Real Estate, Enterprise Technology, Legal, Compliance, Finance, Human Resources, Internal Audit, Risk Management, Oversight & Control, Corporate Responsibility and various Other Corporate groups.
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Notes to consolidated financial statements
Segment results
The following tables provide a summary of the Firm’s segment results as of or for the years ended December 31, 2016, 2015 and 2014 on a managed basis. The Firm’s definition of managed basis starts with the reported U.S. GAAP results and includes certain reclassifications to present total net revenue (noninterest revenue and net interest income) for each of the reportable business segments on a FTE basis. Accordingly, revenue from
investments receiving tax credits and tax-exempt securities is presented in the managed results on a basis comparable to taxable investments and securities. This allows management to assess the comparability of revenue from year-to-year arising from both taxable and tax-exempt sources. The corresponding income tax impact related to tax-exempt items is recorded within income tax expense/(benefit).
Segment results and reconciliation
(a)
Segment managed results reflect revenue on a FTE basis with the corresponding income tax impact recorded within income tax expense/(benefit). These adjustments are eliminated in reconciling items to arrive at the Firm’s reported U.S. GAAP results.
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Note 34 - Parent Company
The following tables present Parent Company-only financial statements.
(a)
On September 1, 2016, in connection with the Firm’s 2016 Resolution Submission, the Parent Company established the IHC, and during the fourth quarter of 2016 contributed substantially all of its direct subsidiaries, other than JPMorgan Chase Bank, N.A. (totaling $55.4 billion), as well as most of its other assets (totaling $160.5 billion) and intercompany indebtedness to the IHC. Total noncash assets contributed were $62.3 billion.
(b)
Affiliates include trusts that issued guaranteed capital debt securities (“issuer trusts”). For further discussion on these issuer trusts, see Note 21.
(c)
At December 31, 2016, long-term debt that contractually matures in 2017 through 2021 totaled $26.9 billion, $21.2 billion, $13.0 billion, $21.9 billion and $17.9 billion, respectively.
(d)
For information regarding the Parent Company’s guarantees of its subsidiaries’ obligations, see Notes 21 and 29.
JPMorgan Chase & Co./2016 Annual Report
Supplementary information
Selected quarterly financial data (unaudited)
JPMorgan Chase & Co./2016 Annual Report
Supplementary information
Note: Effective January 1, 2016, the Firm adopted new accounting guidance related to (1) the recognition and measurement of DVA on financial liabilities where the fair value option has been elected, and (2) the accounting for employee stock-based incentive payments. For additional information, see Accounting and Reporting Developments on pages 135-137 and Notes 3, 4, and 25.
(a)
Share prices are from the New York Stock Exchange.
(b)
TBVPS and ROTCE are non-GAAP financial measures. For further discussion of these measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Financial Performance Measures on pages 48-50.
(c)
HQLA represents the amount of assets that qualify for inclusion in the liquidity coverage ratio under the U.S. rule (“U.S. LCR”). For additional information, see HQLA on page 111.
(d)
Ratios presented are calculated under the Basel III Transitional rules and for the capital ratios represent the Collins Floor. See Capital Risk Management on pages 76-85 for additional information on Basel III.
(e)
Included unsecured long-term debt of $212.6 billion, $226.8 billion, $220.6 billion, $216.1 billion, $211.8 billion, $214.6 billion, $209.1 billion, $209.0 billion respectively, for the periods presented.
(f)
Excludes the impact of residential real estate PCI loans, a non-GAAP financial measure. For further discussion of these measures, see Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures and Key Performance Measures on pages 48-50. For further discussion, see Allowance for credit losses on pages 105-107.
JPMorgan Chase & Co./2016 Annual Report
Distribution of assets, liabilities and stockholders’ equity; interest rates and interest differentials
Consolidated average balance sheet, interest and rates
Provided below is a summary of JPMorgan Chase’s consolidated average balances, interest rates and interest differentials on a taxable-equivalent basis for the years 2014 through 2016. Income computed on a taxable-equivalent basis is the income reported in the Consolidated
statements of income, adjusted to present interest income and average rates earned on assets exempt from income taxes (primarily federal taxes) on a basis comparable with other taxable investments. The incremental tax rate used for calculating the taxable-equivalent adjustment was approximately 38% in 2016, 2015 and 2014.
(a)
Represents securities that are tax exempt for U.S. Federal income tax purposes.
(b)
Includes margin loans.
(c)
Includes brokerage customer payables.
(d)
The ratio of average stockholders’ equity to average assets was 10.2% for 2016, 9.7% for 2015, and 9.2% for 2014. The return on average stockholders’ equity, based on net income, was 9.9% for 2016, 10.2% for 2015, and 9.7% for 2014.
(e)
Interest includes the effect of related hedging derivatives. Taxable-equivalent amounts are used where applicable.
(f)
Securities borrowed’s negative interest income and yield, for the years ended December 31, 2016, 2015 and 2014, are a result of client-driven demand for certain securities combined with the impact of low interest rates; the offset of this stock borrow activity is reflected as lower net interest expense reported within short-term and other liabilities.
(g)
Fees and commissions on loans included in loan interest amounted to $808 million in 2016, $936 million in 2015, and $1.1 billion in 2014.
(h)
The annualized rate for securities based on amortized cost was 2.99% in 2016, 2.94% in 2015, and 2.82% in 2014, and does not give effect to changes in fair value that are reflected in AOCI.
(i)
Reflects a benefit from the favorable market environments for dollar-roll financings.
JPMorgan Chase & Co./2016 Annual Report
Within the Consolidated average balance sheets, interest and rates summary, the principal amounts of nonaccrual loans have been included in the average loan balances used to determine the average interest rate earned on loans. For additional information on nonaccrual loans, including interest accrued, see Note 14.
JPMorgan Chase & Co./2016 Annual Report
Interest rates and interest differential analysis of net interest income - U.S. and non-U.S.
Presented below is a summary of interest rates and interest differentials segregated between U.S. and non-U.S. operations for the years 2014 through 2016. The segregation of U.S. and non-U.S. components is based on
the location of the office recording the transaction. Intercompany funding generally consists of dollar-denominated deposits originated in various locations that are centrally managed by Treasury and CIO.
(a)
Includes commercial paper.
(b)
Represents the amount of noninterest-bearing liabilities funding interest-earning assets.
(c)
Securities borrowed’s negative interest income and yield, for the years ended December 31, 2016, 2015 and 2014, are a result of client-driven demand for certain securities combined with the impact of low interest rates; the offset of this stock borrow activity is reflected as lower net interest expense reported within trading liabilities - debt, short-term and other liabilities.
(d)
Reflects a benefit from the favorable market environments for dollar-roll financings.
JPMorgan Chase & Co./2016 Annual Report
For further information, see the “Net interest income” discussion in Consolidated Results of Operations on pages 40-42.
JPMorgan Chase & Co./2016 Annual Report
Changes in net interest income, volume and rate analysis
The table below presents an analysis of the effect on net interest income from volume and rate changes for the periods 2016 versus 2015 and 2015 versus 2014. In this analysis, when the change cannot be isolated to either volume or rate, it has been allocated to volume.
(a)
Includes commercial paper.
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
2016 Annual Report or 2016 Form 10-K: Annual report on Form 10-K for year ended December 31, 2016, filed with the U.S. Securities and Exchange Commission.
ABS: Asset-backed securities
Active foreclosures: Loans referred to foreclosure where formal foreclosure proceedings are ongoing. Includes both judicial and non-judicial states.
AFS: Available-for-sale
ALCO: Asset Liability Committee
Allowance for loan losses to total loans: Represents period-end allowance for loan losses divided by retained loans.
Alternative assets: The following types of assets constitute alternative investments - hedge funds, currency, real estate, private equity and other investment funds designed to focus on nontraditional strategies.
AWM: Asset & Wealth Management
AOCI: Accumulated other comprehensive income/(loss)
ARM: Adjustable rate mortgage(s)
AUC: Assets under custody
AUM: “Assets under management”: Represent assets managed by AWM on behalf of its Private Banking, Institutional and Retail clients. Includes “Committed capital not Called,” on which AWM earns fees.
Auto loan and lease origination volume: Dollar amount of auto loans and leases originated.
Beneficial interests issued by consolidated VIEs: Represents the interest of third-party holders of debt, equity securities, or other obligations, issued by VIEs that JPMorgan Chase consolidates.
Benefit obligation: Refers to the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for OPEB plans.
BHC: Bank holding company
Card Services includes the Credit Card and Commerce Solutions businesses.
CB: Commercial Banking
CBB: Consumer & Business Banking
CCAR: Comprehensive Capital Analysis and Review
CCB: Consumer & Community Banking
CCO: Chief Compliance Officer
CCP: “Central counterparty” is a clearing house that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the future performance of open contracts. A CCP becomes counterparty to trades with market participants
through novation, an open offer system, or another legally binding arrangement.
CDS: Credit default swaps
CEO: Chief Executive Officer
CET1 Capital: Common Equity Tier 1 Capital
CFTC: Commodity Futures Trading Commission
CFO: Chief Financial Officer
Chase Bank USA, N.A.: Chase Bank USA, National Association
CIB: Corporate & Investment Bank
CIO: Chief Investment Office
Client assets: Represent assets under management as well as custody, brokerage, administration and deposit accounts.
Client deposits and other third-party liabilities: Deposits, as well as deposits that are swept to on-balance sheet liabilities (e.g., commercial paper, federal funds purchased and securities loaned or sold under repurchase agreements) as part of client cash management programs. During the third quarter 2015 the Firm completed the discontinuation of its commercial paper customer sweep cash management program.
CLO: Collateralized loan obligations
CLTV: Combined loan-to-value
Collateral-dependent: A loan is considered to be collateral-dependent when repayment of the loan is expected to be provided solely by the underlying collateral, rather than by cash flows from the borrower’s operations, income or other resources.
Commerce Solutions is a business that primarily processes transactions for merchants.
Commercial Card: provides a wide range of payment services to corporate and public sector clients worldwide through the commercial card products. Services include procurement, corporate travel and entertainment, expense management services, and business-to-business payment solutions.
COO: Chief Operating Officer
Core loans: Represents loans considered central to the Firm’s ongoing businesses; core loans exclude loans classified as trading assets, runoff portfolios, discontinued portfolios and portfolios the Firm has an intent to exit.
Credit cycle: A period of time over which credit quality improves, deteriorates and then improves again (or vice versa). The duration of a credit cycle can vary from a couple of years to several years.
Credit derivatives: Financial instruments whose value is derived from the credit risk associated with the debt of a third-party issuer (the reference entity) which allow one party (the protection purchaser) to transfer that risk to
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
another party (the protection seller). Upon the occurrence of a credit event by the reference entity, which may include, among other events, the bankruptcy or failure to pay its obligations, or certain restructurings of the debt of the reference entity, neither party has recourse to the reference entity. The protection purchaser has recourse to the protection seller for the difference between the face value of the CDS contract and the fair value at the time of settling the credit derivative contract. The determination as to whether a credit event has occurred is generally made by the relevant International Swaps and Derivatives Association (“ISDA”) Determinations Committee.
Criticized: Criticized loans, lending-related commitments and derivative receivables that are classified as special mention, substandard and doubtful categories for regulatory purposes and are generally consistent with a rating of CCC+/Caa1 and below, as defined by S&P and Moody’s.
CRO: Chief Risk Officer
CTC: CIO, Treasury and Corporate
CVA: Credit valuation adjustments
Debit and credit card sales volume: Dollar amount of card member purchases, net of returns.
Deposit margin/deposit spread: Represents net interest income expressed as a percentage of average deposits.
Distributed denial-of-service attack: The use of a large number of remote computer systems to electronically send a high volume of traffic to a target website to create a service outage at the target. This is a form of cyberattack.
DFAST: Dodd-Frank Act Stress Test
Dodd-Frank Act: Wall Street Reform and Consumer Protection Act
DOJ: U.S. Department of Justice
DOL: U.S. Department of Labor
DRPC: Directors’ Risk Policy Committee
DVA: Debit valuation adjustment
E&P: Exploration & Production
EC: European Commission
Eligible LTD: Long-term debt satisfying certain eligibility criteria
Embedded derivatives: are implicit or explicit terms or features of a financial instrument that affect some or all of the cash flows or the value of the instrument in a manner similar to a derivative. An instrument containing such terms or features is referred to as a “hybrid.” The component of the hybrid that is the non-derivative instrument is referred to as the “host.” For example, callable debt is a hybrid instrument that contains a plain vanilla debt instrument (i.e., the host) and an embedded option that allows the issuer to redeem the debt issue at a specified date for a
specified amount (i.e., the embedded derivative). However, a floating rate instrument is not a hybrid composed of a fixed-rate instrument and an interest rate swap.
ERISA: Employee Retirement Income Security Act of 1974
EPS: Earnings per share
ETD: “Exchange-traded derivatives”: Derivative contracts that are executed on an exchange and settled via a central clearing house.
EU: European Union
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FCA: Financial Conduct Authority
FCC: Firmwide Control Committee
FDIA: Federal Depository Insurance Act
FDIC: Federal Deposit Insurance Corporation
Federal Reserve: The Board of the Governors of the Federal Reserve System
Fee share: Proportion of fee revenue based on estimates of investment banking fees generated across the industry from investment banking transactions in M&A, equity and debt underwriting, and loan syndications. Source: Dealogic, a third-party provider of investment banking fee competitive analysis and volume-based league tables for the above noted industry products.
FFELP: Federal Family Education Loan Program
FFIEC: Federal Financial Institutions Examination Council
FHA: Federal Housing Administration
FHLB: Federal Home Loan Bank
FICO score: A measure of consumer credit risk provided by credit bureaus, typically produced from statistical models by Fair Isaac Corporation utilizing data collected by the credit bureaus.
Firm: JPMorgan Chase & Co.
Forward points: Represents the interest rate differential between two currencies, which is either added to or subtracted from the current exchange rate (i.e., “spot rate”) to determine the forward exchange rate.
FRC: Firmwide Risk Committee
Free standing derivatives: a derivative contract entered into either separate and apart from any of the Firms other financial instruments or equity transactions. Or, in conjunction with some other transaction and is legally detachable and separately exercisable.
FSB: Financial Stability Board
FTE: Fully taxable equivalent
FVA: Funding valuation adjustment
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
FX: Foreign exchange
G7: Group of Seven nations: Countries in the G7 are Canada, France, Germany, Italy, Japan, the U.K. and the U.S.
G7 government bonds: Bonds issued by the government of one of the G7 nations.
Ginnie Mae: Government National Mortgage Association
GSE: Fannie Mae and Freddie Mac
GSIB: Global systemically important banks
HAMP: Home affordable modification program
Headcount-related expense: Includes salary and benefits (excluding performance-based incentives), and other noncompensation costs related to employees.
HELOAN: Home equity loan
HELOC: Home equity line of credit
Home equity - senior lien: Represents loans and commitments where JPMorgan Chase holds the first security interest on the property.
Home equity - junior lien: Represents loans and commitments where JPMorgan Chase holds a security interest that is subordinate in rank to other liens.
Households: A household is a collection of individuals or entities aggregated together by name, address, tax identifier and phone. Reported on a one-month lag.
HQLA: High quality liquid assets
HTM: Held-to-maturity
ICAAP: Internal capital adequacy assessment process
IDI: Insured depository institutions
IHC: JPMorgan Chase Holdings LLC, an intermediate holding company
Impaired loan: Impaired loans are loans measured at amortized cost, for which it is probable that the Firm will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the agreement. Impaired loans include the following:
•
All wholesale nonaccrual loans
•
All TDRs (both wholesale and consumer), including ones that have returned to accrual status
Interchange income: A fee paid to a credit card issuer in the clearing and settlement of a sales or cash advance transaction.
Investment-grade: An indication of credit quality based on JPMorgan Chase’s internal risk assessment system. “Investment grade” generally represents a risk profile similar to a rating of a “BBB-”/“Baa3” or better, as defined by independent rating agencies.
ISDA: International Swaps and Derivatives Association
JPMorgan Chase: JPMorgan Chase & Co.
JPMorgan Chase Bank, N.A.: JPMorgan Chase Bank, National Association
JPMorgan Clearing: J.P. Morgan Clearing Corp.
JPMorgan Securities: J.P. Morgan Securities LLC
Loan-equivalent: Represents the portion of the unused commitment or other contingent exposure that is expected, based on average portfolio historical experience, to become drawn prior to an event of a default by an obligor.
LCR: Liquidity coverage ratio
LDA: Loss Distribution Approach
LGD: Loss given default
LIBOR: London Interbank Offered Rate
LLC: Limited Liability Company
LOB: Line of business
Loss emergence period: Represents the time period between the date at which the loss is estimated to have been incurred and the realization of that loss.
LTIP: Long-term incentive plan
LTV: “Loan-to-value”: For residential real estate loans, the relationship, expressed as a percentage, between the principal amount of a loan and the appraised value of the collateral (i.e., residential real estate) securing the loan.
Origination date LTV ratio
The LTV ratio at the origination date of the loan. Origination date LTV ratios are calculated based on the actual appraised values of collateral (i.e., loan-level data) at the origination date.
Current estimated LTV ratio
An estimate of the LTV as of a certain date. The current estimated LTV ratios are calculated using estimated collateral values derived from a nationally recognized home price index measured at the metropolitan statistical area (“MSA”) level. These MSA-level home price indices consist of actual data to the extent available and forecasted data where actual data is not available. As a result, the estimated collateral values used to calculate these ratios do not represent actual appraised loan-level collateral values; as such, the resulting LTV ratios are necessarily imprecise and should therefore be viewed as estimates.
Combined LTV ratio
The LTV ratio considering all available lien positions, as well as unused lines, related to the property. Combined LTV ratios are used for junior lien home equity products.
Managed basis: A non-GAAP presentation of financial results that includes reclassifications to present revenue on a fully taxable-equivalent basis. Management uses this non- GAAP financial measure at the segment level, because it
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
believes this provides information to enable investors to understand the underlying operational performance and trends of the particular business segment and facilitates a comparison of the business segment with the performance of competitors.
Master netting agreement: An agreement between two counterparties who have multiple contracts with each other that provides for the net settlement of all contracts, as well as cash collateral, through a single payment, in a single currency, in the event of default on or termination of any one contract.
MBS: Mortgage-backed securities
MD&A: Management’s discussion and analysis
MMDA: Money Market Deposit Accounts
Moody’s: Moody’s Investor Services
Mortgage origination channels:
Retail - Borrowers who buy or refinance a home through direct contact with a mortgage banker employed by the Firm using a branch office, the Internet or by phone. Borrowers are frequently referred to a mortgage banker by a banker in a Chase branch, real estate brokers, home builders or other third parties.
Correspondent - Banks, thrifts, other mortgage banks and other financial institutions that sell closed loans to the Firm.
Mortgage product types:
Alt-A
Alt-A loans are generally higher in credit quality than subprime loans but have characteristics that would disqualify the borrower from a traditional prime loan. Alt-A lending characteristics may include one or more of the following: (i) limited documentation; (ii) a high CLTV ratio; (iii) loans secured by non-owner occupied properties; or (iv) a debt-to-income ratio above normal limits. A substantial proportion of the Firm’s Alt-A loans are those where a borrower does not provide complete documentation of his or her assets or the amount or source of his or her income.
Option ARMs
The option ARM real estate loan product is an adjustable-rate mortgage loan that provides the borrower with the option each month to make a fully amortizing, interest-only or minimum payment. The minimum payment on an option ARM loan is based on the interest rate charged during the introductory period. This introductory rate is usually significantly below the fully indexed rate. The fully indexed rate is calculated using an index rate plus a margin. Once the introductory period ends, the contractual interest rate charged on the loan increases to the fully indexed rate and adjusts monthly to reflect movements in the index. The minimum payment is typically insufficient to cover interest accrued in the prior month, and any unpaid interest is deferred and added to the principal balance of the loan.
Option ARM loans are subject to payment recast, which converts the loan to a variable-rate fully amortizing loan upon meeting specified loan balance and anniversary date triggers.
Prime
Prime mortgage loans are made to borrowers with good credit records who meet specific underwriting requirements, including prescriptive requirements related to income and overall debt levels. New prime mortgage borrowers provide full documentation and generally have reliable payment histories.
Subprime
Subprime loans are loans that, prior to mid-2008, were offered to certain customers with one or more high risk characteristics, including but not limited to: (i) unreliable or poor payment histories; (ii) a high LTV ratio of greater than 80% (without borrower-paid mortgage insurance); (iii) a high debt-to-income ratio; (iv) an occupancy type for the loan is other than the borrower’s primary residence; or (v) a history of delinquencies or late payments on the loan.
MSA: Metropolitan statistical areas
MSR: Mortgage servicing rights
Multi-asset: Any fund or account that allocates assets under management to more than one asset class.
NA: Data is not applicable or available for the period presented.
NAV: Net Asset Value
Net Capital Rule: Rule 15c3-1 under the Securities Exchange Act of 1934.
Net charge-off/(recovery) rate: Represents net charge-offs/(recoveries) (annualized) divided by average retained loans for the reporting period.
Net mortgage servicing revenue includes the following components:
Operating revenue predominantly represents the return on Mortgage Servicing’s MSR asset and includes:
- Actual gross income earned from servicing third-party mortgage loans, such as contractually specified servicing fees and ancillary income; and
- The change in the fair value of the MSR asset due to the collection or realization of expected cash flows.
Risk management represents the components of
Mortgage Servicing’s MSR asset that are subject to ongoing risk management activities, together with derivatives and other instruments used in those risk management activities.
Net production revenue: Includes net gains or losses on originations and sales of mortgage loans, other production-related fees and losses related to the repurchase of previously sold loans.
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
Net revenue rate: Represents Card Services net revenue (annualized) expressed as a percentage of average loans for the period.
Net yield on interest-earning assets: The average rate for interest-earning assets less the average rate paid for all sources of funds.
NM: Not meaningful
NOL: Net operating loss
Nonaccrual loans: Loans for which interest income is not recognized on an accrual basis. Loans (other than credit card loans and certain consumer loans insured by U.S. government agencies) are placed on nonaccrual status when full payment of principal and interest is not expected, regardless of delinquency status, or when principal and interest have been in default for a period of 90 days or more unless the loan is both well-secured and in the process of collection. Collateral-dependent loans are typically maintained on nonaccrual status.
Nonperforming assets: Nonperforming assets include nonaccrual loans, nonperforming derivatives and certain assets acquired in loan satisfaction, predominantly real estate owned and other commercial and personal property.
NOW: Negotiable Order of Withdrawal
NSFR: Net stable funding ratio
OAS: Option-adjusted spread
OCC: Office of the Comptroller of the Currency
OCI: Other comprehensive income/(loss)
OEP: One Equity Partners
OIS: Overnight index swap
OPEB: Other postretirement employee benefit
ORMF: Operational Risk Management Framework
OTTI: Other-than-temporary impairment
Over-the-counter (“OTC”) derivatives: Derivative contracts that are negotiated, executed and settled bilaterally between two derivative counterparties, where one or both counterparties is a derivatives dealer.
Over-the-counter cleared (“OTC-cleared”) derivatives: Derivative contracts that are negotiated and executed bilaterally, but subsequently settled via a central clearing house, such that each derivative counterparty is only exposed to the default of that clearing house.
Overhead ratio: Noninterest expense as a percentage of total net revenue.
Parent Company: JPMorgan Chase & Co.
Participating securities: Represents unvested stock-based compensation awards containing nonforfeitable rights to dividends or dividend equivalents (collectively, “dividends”),
which are included in the earnings per share calculation using the two-class method. JPMorgan Chase grants restricted stock and RSUs to certain employees under its stock-based compensation programs, which entitle the recipients to receive nonforfeitable dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock. These unvested awards meet the definition of participating securities. Under the two-class method, all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities, based on their respective rights to receive dividends.
PCA: Prompt corrective action
PCI: “Purchased credit-impaired” loans represents loans that were acquired in the Washington Mutual transaction and deemed to be credit-impaired on the acquisition date in accordance with the guidance of the FASB. The guidance allows purchasers to aggregate credit-impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics(e.g., product type, LTV ratios, FICO scores, past due status, geographic location). A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
PD: Probability of default
PRA: Prudential Regulatory Authority
Pre-provision profit/(loss): Represents total net revenue less noninterest expense. The Firm believes that this financial measure is useful in assessing the ability of a lending institution to generate income in excess of its provision for credit losses.
Pretax margin: Represents income before income tax expense divided by total net revenue, which is, in management’s view, a comprehensive measure of pretax performance derived by measuring earnings after all costs are taken into consideration. It is one basis upon which management evaluates the performance of AWM against the performance of their respective competitors.
Principal transactions revenue: Principal transactions revenue is driven by many factors, including the bid-offer spread, which is the difference between the price at which the Firm is willing to buy a financial or other instrument and the price at which the Firm is willing to sell that instrument. It also consists of realized (as a result of closing out or termination of transactions, or interim cash payments) and unrealized (as a result of changes in valuation) gains and losses on financial and other instruments (including those accounted for under the fair value option) primarily used in client-driven market-making activities and on private equity investments. In connection with its client-driven market-making activities, the Firm transacts in debt and equity instruments, derivatives and commodities (including physical commodities inventories and financial instruments that reference commodities).
Principal transactions revenue also includes certain realized
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
and unrealized gains and losses related to hedge accounting and specified risk-management activities, including: (a) certain derivatives designated in qualifying hedge accounting relationships (primarily fair value hedges of commodity and foreign exchange risk), (b) certain derivatives used for specific risk management purposes, primarily to mitigate credit risk, foreign exchange risk and commodity risk, and (c) other derivatives.
PSU(s): Performance share units
RCSA: Risk and Control Self-Assessment
Real assets: Real assets include investments in productive assets such as agriculture, energy rights, mining and timber properties and exclude raw land to be developed for real estate purposes.
REIT: “Real estate investment trust”: A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage income property (i.e., equity REIT) and/or mortgage loans (i.e., mortgage REIT). REITs can be publicly or privately held and they also qualify for certain favorable tax considerations.
Receivables from customers: Primarily represents margin loans to brokerage customers that are collateralized through assets maintained in the clients’ brokerage accounts, as such no allowance is held against these receivables. These receivables are reported within accrued interest and accounts receivable on the Firm’s Consolidated balance sheets.
Regulatory VaR: Daily aggregated VaR calculated in accordance with regulatory rules.
REO: Real estate owned
Reported basis: Financial statements prepared under U.S. GAAP, which excludes the impact of taxable-equivalent adjustments.
Retained loans: Loans that are held-for-investment (i.e., excludes loans held-for-sale and loans at fair value).
Revenue wallet: Proportion of fee revenue based on estimates of investment banking fees generated across the industry (i.e., the revenue wallet) from investment banking transactions in M&A, equity and debt underwriting, and loan syndications. Source: Dealogic, a third-party provider of investment banking competitive analysis and volume-based league tables for the above noted industry products.
RHS: Rural Housing Service of the U.S. Department of Agriculture
ROA: Return on assets
ROE: Return on equity
ROTCE: Return on tangible common equity
RSU(s): Restricted stock units
RWA: “Risk-weighted assets”: Basel III establishes two comprehensive methodologies for calculating RWA (a Standardized approach and an Advanced approach) which include capital requirements for credit risk, market risk, and in the case of Basel III Advanced, also operational risk. Key differences in the calculation of credit risk RWA between the Standardized and Advanced approaches are that for Basel III Advanced, credit risk RWA is based on risk-sensitive approaches which largely rely on the use of internal credit models and parameters, whereas for Basel III Standardized, credit risk RWA is generally based on supervisory risk-weightings which vary primarily by counterparty type and asset class. Market risk RWA is calculated on a generally consistent basis between Basel III Standardized and Basel III Advanced, both of which incorporate the requirements set forth in Basel 2.5.
S&P: Standard and Poor’s 500 Index
SAR(s): Stock appreciation rights
SCCL: single-counterparty credit limits
SEC: Securities and Exchange Commission
Seed capital: Initial JPMorgan capital invested in products, such as mutual funds, with the intention of ensuring the fund is of sufficient size to represent a viable offering to clients, enabling pricing of its shares, and allowing the manager to develop a track record. After these goals are achieved, the intent is to remove the Firm’s capital from the investment.
Short sale: A short sale is a sale of real estate in which proceeds from selling the underlying property are less than the amount owed the Firm under the terms of the related mortgage, and the related lien is released upon receipt of such proceeds.
Single-name: Single reference-entities
SLR: Supplementary leverage ratio
SMBS: Stripped mortgage-backed securities
SOA: Society of Actuaries
SPEs: Special purpose entities
Structural interest rate risk: Represents interest rate risk of the non-trading assets and liabilities of the Firm.
Structured notes: Structured notes are predominantly financial instruments containing embedded derivatives.
Suspended foreclosures: Loans referred to foreclosure where formal foreclosure proceedings have started but are currently on hold, which could be due to bankruptcy or loss mitigation. Includes both judicial and non-judicial states.
Taxable-equivalent basis: In presenting managed results, the total net revenue for each of the business segments and the Firm is presented on a tax-equivalent basis. Accordingly, revenue from investments that receive tax credits and tax-exempt securities is presented in the managed results on a basis comparable to taxable investments and securities; the
JPMorgan Chase & Co./2016 Annual Report
Glossary of Terms and Acronyms
corresponding income tax impact related to tax-exempt items is recorded within income tax expense.
TBVPS: Tangible book value per share
TCE: Tangible common equity
TDR: “Troubled debt restructuring” is deemed to occur when the Firm modifies the original terms of a loan agreement by granting a concession to a borrower that is experiencing financial difficulty.
TLAC: Total Loss Absorbing Capacity
U.K.: United Kingdom
Unaudited: Financial statements and information that have not been subjected to auditing procedures sufficient to permit an independent certified public accountant to express an opinion.
U.S.: United States of America
U.S. GAAP: Accounting principles generally accepted in the U.S.
U.S. government-sponsored enterprises (“U.S. GSEs”) and U.S. GSE obligations: In the U.S., GSEs are quasi-governmental, privately held entities established by Congress to improve the flow of credit to specific sectors of the economy and provide certain essential services to the public. U.S. GSEs include Fannie Mae and Freddie Mac, but do not include Ginnie Mae, which is directly owned by the U.S. Department of Housing and Urban Development. U.S. GSE obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.
U.S. LCR: Liquidity coverage ratio under the final U.S. rule.
U.S. Treasury: U.S. Department of the Treasury
VA: U.S. Department of Veterans Affairs
VaR: “Value-at-risk” is a measure of the dollar amount of potential loss from adverse market moves in an ordinary market environment.
VCG: Valuation Control Group
VGF: Valuation Governance Forum
VIEs: Variable interest entities
Warehouse loans: Consist of prime mortgages originated with the intent to sell that are accounted for at fair value and classified as trading assets.
Washington Mutual transaction: On September 25, 2008, JPMorgan Chase acquired certain of the assets of the banking operations of Washington Mutual Bank (“Washington Mutual”) from the FDIC.
JPMorgan Chase & Co./2016 Annual Report
Securities portfolio
For information regarding the securities portfolio as of December 31, 2016 and 2015, and for the years ended December 31, 2016 and 2015, see Note 12. For the available-for-sale securities portfolio, at December 31, 2014, the fair value and amortized cost of U.S. Treasury and government agency obligations was $79.0 billion and $76.7 billion, respectively; the fair value and amortized cost of all other available-for-sale securities was $219.8 billion and $214.3 billion, respectively; and the total fair value and amortized cost of the total available-for-sale securities portfolio was $298.8 billion and $291.0 billion, respectively.
At December 31, 2014, the fair value and amortized cost of U.S. Treasury and government agency obligations in the held-to-maturity securities portfolio was $40.3 billion and $39.0 billion, respectively; the fair value and amortized cost of all other HTM securities was $10.8 billion and $10.2 billion, respectively; and the total fair value and amortized cost of the total held-to-maturity securities portfolio was $51.2 billion and $49.3 billion, respectively.
Loan portfolio
The table below presents loans by portfolio segment and loan class that are presented in Credit Risk Management on page 88, pages 89-95 and page 96, and in Note 14, at the periods indicated.
(a)
Loans (other than purchased credit-impaired loans and those for which the fair value option have been elected) are presented net of unearned income, unamortized discounts and premiums, and net deferred loan costs. These amounts were not material as of December 31, 2016, 2015, 2014, 2013 and 2012.
Maturities and sensitivity to changes in interest rates
The table below sets forth, at December 31, 2016, wholesale loan maturity and distribution between fixed and floating interest rates based on the stated terms of the loan agreements. The table below also presents loans by loan class that are presented in Wholesale credit portfolio on pages 96-104 and Note 14. The table does not include the impact of derivative instruments.
(a)
Includes demand loans and overdrafts.
Risk elements
The following tables set forth nonperforming assets, contractually past-due assets, and accruing restructured loans by portfolio segment and loan class that are presented in Credit Risk Management on page 88, pages 89-90 and page 96, at the periods indicated.
(a)
Represents accruing loans past-due 90 days or more as to principal and interest, which are not characterized as nonaccrual loans. Excludes PCI loans which are accounted for on a pool basis. Since each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows, the past-due status of the pools, or that of individual loans within the pools, is not meaningful. The Firm is recognizing interest income on each pool of loans as they are all performing.
(b)
At December 31, 2016, 2015, 2014, 2013 and 2012, excluded loans 90 or more days past due and still accruing as follows: (1) mortgage loans insured by U.S. government agencies of $2.7 billion, $2.8 billion, $3.4 billion, $3.2 billion and $3.8 billion, respectively; and (2) student loans insured by U.S. government agencies under the FFELP of $263 million, $290 million, $367 million, $428 million and $525 million, respectively. These amounts have been excluded from the nonaccrual loans based upon the government guarantee. Prior period amounts have been revised to conform with current period presentation.
(a)
Represents performing loans modified in TDRs in which an economic concession was granted by the Firm and the borrower has demonstrated its ability to repay the loans according to the terms of the restructuring. As defined in U.S. GAAP, concessions include the reduction of interest rates or the deferral of interest or principal payments, resulting from deterioration in the borrowers’ financial condition. Excludes nonaccrual assets and contractually past-due assets, which are included in the sections above.
(b)
Includes credit card loans that have been modified in a TDR.
For a discussion of nonaccrual loans, past-due loan accounting policies, and accruing restructured loans see Credit Risk Management on pages 86-107, and Note 14.
Impact of nonaccrual loans and accruing restructured loans on interest income
The negative impact on interest income from nonaccrual loans represents the difference between the amount of interest income that would have been recorded on such nonaccrual loans according to their original contractual terms had they been performing and the amount of interest that actually was recognized on a cash basis. The negative impact on interest income from accruing restructured loans represents the difference between the amount of interest income that would have been recorded on such loans according to their original contractual terms and the amount of interest that actually was recognized under the modified terms. The following table sets forth this data for the years specified. The change in forgone interest income from 2014 through 2016 was primarily driven by the change in the levels of nonaccrual loans.
Cross-border outstandings
Cross-border disclosure is based on the FFIEC guidelines governing the determination of cross-border risk.
The reporting of country exposure under the FFIEC bank regulatory requirements provides information on the distribution, by country and sector, of claims on, and liabilities to, foreign residents held by U.S. banks and bank holding companies and is used by the regulatory agencies to determine the presence of credit and related risks,
including transfer and country risk. Country location under the FFIEC bank regulatory reporting is based on where the entity or counterparty is legally established.
JPMorgan Chase’s total cross-border exposure tends to fluctuate greatly, and the amount of exposure at year-end tends to be a function of timing rather than representing a consistent trend. For a further discussion of JPMorgan Chase’s country risk exposure, see Country Risk Management on pages 108-109.
The following table lists all countries in which JPMorgan Chase’s cross-border outstandings exceed 0.75% of consolidated assets as of the dates specified.
(a)
Consists primarily of commercial and industrial.
(b)
Outstandings include loans and accrued interest receivable, interest-bearing deposits with banks, acceptances, resale agreements, other monetary assets, cross-border trading debt and equity instruments, fair value of foreign exchange and derivative contracts, and local country assets, net of local country liabilities. The amounts associated with foreign exchange and derivative contracts are presented after taking into account the impact of legally enforceable master netting agreements.
(c)
Commitments include outstanding letters of credit, undrawn commitments to extend credit, and the gross notional value of credit derivatives where JPMorgan Chase is a protection seller.
The tables below summarize the changes in the allowance for loan losses and the allowance for lending-related commitments during the periods indicated. For a further discussion, see Allowance for credit losses on pages 105-107, and Note 15.
(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.
Summary of loan and lending-related commitments loss experience
Allowance for lending-related commitments
(a)
There were no net charge-offs/(recoveries) on lending-related commitments in 2016, 2015, 2014, 2013 or 2012.
(b)
The allowance for loan losses as a percentage of retained loans declined from 2012 to 2016, due to an improvement in credit quality of the consumer and wholesale credit portfolios. For a more detailed discussion of the 2014 through 2016 provision for credit losses, see Provision for credit losses on page 107.
Deposits
The following table provides a summary of the average balances and average interest rates of JPMorgan Chase’s various deposits for the years indicated.
(a) Prior periods have been revised to conform with current period presentation.
At December 31, 2016, other U.S. time deposits in denominations of $100,000 or more totaled $11.8 billion, substantially all of which mature in three months or less. In addition, the table below presents the maturities for U.S. time certificates of deposit in denominations of $100,000 or more.
Short-term and other borrowed funds
The following table provides a summary of JPMorgan Chase’s short-term and other borrowed funds for the years indicated.
(a)
Includes interest-bearing securities sold but not yet purchased.
(b)
Included on the Consolidated balance sheets in beneficial interests issued by consolidated VIEs.
Federal funds purchased represent overnight funds. Securities loaned or sold under repurchase agreements generally mature between one day and three months. Commercial paper generally is issued in amounts not less than $100,000, and with maturities of 270 days or less. Other borrowed funds consist of demand notes, term federal funds purchased, and various other borrowings that generally have maturities of one year or less.
NONEXCHANGE-TRADED COMMODITY DERIVATIVE CONTRACTS AT FAIR VALUE
In the normal course of business, JPMorgan Chase trades nonexchange-traded commodity derivative contracts. To determine the fair value of these contracts, the Firm uses various fair value estimation techniques, primarily based on internal models with significant observable market parameters. The Firm’s nonexchange-traded commodity derivative contracts are primarily energy-related.
The following table summarizes the changes in fair value for nonexchange-traded commodity derivative contracts for the year ended December 31, 2016.
The following table indicates the maturities of nonexchange-traded commodity derivative contracts at December 31, 2016.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf of the undersigned, thereunto duly authorized.
JPMorgan Chase & Co.
(Registrant)
By: /s/ JAMES DIMON
(James Dimon
Chairman and Chief Executive Officer)
February 28, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacity and on the date indicated. JPMorgan Chase & Co. does not exercise the power of attorney to sign on behalf of any Director.
Capacity
Date
/s/ JAMES DIMON
Director, Chairman and Chief Executive Officer
(Principal Executive Officer)
(James Dimon)
/s/ LINDA B. BAMMANN
Director
(Linda B. Bammann)
/s/ JAMES A. BELL
Director
(James A. Bell)
/s/ CRANDALL C. BOWLES
Director
(Crandall C. Bowles)
/s/ STEPHEN B. BURKE
Director
(Stephen B. Burke)
/s/ TODD A. COMBS
Director
(Todd A. Combs)
/s/ JAMES S. CROWN
Director
February 28, 2017
(James S. Crown)
/s/ TIMOTHY P. FLYNN
Director
(Timothy P. Flynn)
/s/ LABAN P. JACKSON, JR.
Director
(Laban P. Jackson, Jr.)
/s/ MICHAEL A. NEAL
Director
(Michael A. Neal)
/s/ LEE R. RAYMOND
Director
(Lee R. Raymond)
/s/ WILLIAM C. WELDON
Director
(William C. Weldon)
/s/ MARIANNE LAKE
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
(Marianne Lake)
/s/ NICOLE GILES
Managing Director and Corporate Controller
(Principal Accounting Officer)
(Nicole Giles)