Management’s discussion and analysis 110 JPMorgan Chase & Co.  / 2008 Annual Report The allowance for credit losses increased $13.7 billion from the prior year to $23.8 billion.
The increase included $4.1 billion of allowance related to noncredit-impaired loans acquired in the Washington Mutual transaction and the related accounting conformity provision.
Excluding held-for-sale loans, loans carried at fair value, and purchased credit-impaired consumer loans, the allowance for loan losses represented 3.62% of loans at December 31, 2008, compared with 1.88% at December 31, 2007.
The consumer allowance for loan losses increased $10.5 billion from the prior year as a result of the Washington Mutual transaction and increased allowance for loan loss in residential real estate and credit card.
The increase included additions to the allowance for loan losses of $4.7 billion driven by higher estimated losses for residential mortgage and home equity loans as the weak labor market and weak overall economic conditions have resulted in increased delinquencies, while continued weak housing prices have driven a significant increase in loss severity.
The allowance for loan losses related to credit card increased $4.3 billion from the prior year primarily due to the acquired allowance and subsequent conforming provision for loan loss related to the Washington Mutual Bank acquisition and an increase in provision for loan losses of $2.3 billion in 2008 over 2007, as higher estimated net charge-offs are expected in the portfolio resulting from the current economic conditions.
The wholesale allowance for loan losses increase of $3.4 billion from December 31, 2007, reflected the effect of a weakening credit environment and the transfer of $4.9 billion of funded and unfunded leveraged lending commitments to retained loans from held-for-sale.
To provide for the risk of loss inherent in the Firm’s process of extending credit, an allowance for lending-related commitments is held for both wholesale and consumer, which is reported in other liabilities.
The wholesale component is computed using a methodology similar to that used for the wholesale loan portfolio, modified for expected maturities and probabilities of drawdown and has an assetspecific component and a formula-based component.
For a further discussion on the allowance for lending-related commitment see Note 15 on pages 178–180 of this Annual Report.
The allowance for lending-related commitments for both wholesale and consumer was $659 million and $850 million at December 31, 2008 and 2007, respectively.
The decrease reflects the reduction in lending-related commitments at December 31, 2008.
For more information, see page 102 of this Annual Report.
The following table presents the allowance for loan losses and net charge-offs (recoveries) by business segment at December 31, 2008 and 2007.
## Table 0 ##
Notes to consolidated financial statements Consolidation analysis The multi-seller conduits administered by the Firm were not consolidated at December 31, 2008 and 2007, because each conduit had issued expected loss notes (“ELNs”), the holders of which are committed to absorbing the majority of the expected loss of each respective conduit.
Implied support The Firm did not have and continues not to have any intent to protect any ELN holders from potential losses on any of the conduits’ holdings and has no plans to remove any assets from any conduit unless required to do so in its role as administrator.
Should such a transfer occur, the Firm would allocate losses on such assets between itself and the ELN holders in accordance with the terms of the applicable ELN.
Expected loss modeling In determining the primary beneficiary of the conduits the Firm uses a Monte Carlo–based model to estimate the expected losses of each of the conduits and considers the relative rights and obligations of each of the variable interest holders.
The Firm’s expected loss modeling treats all variable interests, other than the ELNs, as its own to determine consolidation.
The variability to be considered in the modeling of expected losses is based on the design of the entity.
The Firm’s traditional multi-seller conduits are designed to pass credit risk, not liquidity risk, to its variable interest holders, as the assets are intended to be held in the conduit for the longer term.
Under FIN 46(R), the Firm is required to run the Monte Carlo-based expected loss model each time a reconsideration event occurs.
In applying this guidance to the conduits, the following events, are considered to be reconsideration events, as they could affect the determination of the primary beneficiary of the conduits: ?
New deals, including the issuance of new or additional variable interests (credit support, liquidity facilities, etc); ?
Changes in usage, including the change in the level of outstanding variable interests (credit support, liquidity facilities, etc); ?
Modifications of asset purchase agreements; and ?
Sales of interests held by the primary beneficiary.
From an operational perspective, the Firm does not run its Monte Carlo-based expected loss model every time there is a reconsideration event due to the frequency of their occurrence.
Instead, the Firm runs its expected loss model each quarter and includes a growth assumption for each conduit to ensure that a sufficient amount of ELNs exists for each conduit at any point during the quarter.
As part of its normal quarterly modeling, the Firm updates, when applicable, the inputs and assumptions used in the expected loss model.
Specifically, risk ratings and loss given default assumptions are continually updated.
The total amount of expected loss notes outstanding at December 31, 2008 and 2007, were $136 million and $130 million, respectively.
Management has concluded that the model assumptions used were reflective of market participants’ assumptions and appropriately considered the probability of changes to risk ratings and loss given defaults.
Qualitative considerations The multi-seller conduits are primarily designed to provide an efficient means for clients to access the commercial paper market.
The Firm believes the conduits effectively disperse risk among all parties and that the preponderance of the economic risk in the Firm’s multiseller conduits is not held by JPMorgan Chase.
Consolidated sensitivity analysis on capital The table below shows the impact on the Firm’s reported assets, liabilities, Tier 1 capital ratio and Tier 1 leverage ratio if the Firm were required to consolidate all of the multi-seller conduits that it administers at their current carrying value.
## Table 1 ##
(a) The table shows the impact of consolidating the assets and liabilities of the multiseller conduits at their current carrying value; as such, there would be no income statement or capital impact at the date of consolidation.
If the Firm were required to consolidate the assets and liabilities of the conduits at fair value, the Tier 1 capital ratio would be approximately 10.8%.
The fair value of the assets is primarily based upon pricing for comparable transactions.
The fair value of these assets could change significantly because the pricing of conduit transactions is renegotiated with the client, generally, on an annual basis and due to changes in current market conditions.
(b) Consolidation is assumed to occur on the first day of the quarter, at the quarter-end levels, in order to provide a meaningful adjustment to average assets in the denominator of the leverage ratio.
The Firm could fund purchases of assets from VIEs should it become necessary.2007 activity In July 2007, a reverse repurchase agreement collateralized by prime residential mortgages held by a Firm-administered multi-seller conduit was put to JPMorgan Chase under its deal-specific liquidity facility.
The asset was transferred to and recorded by JPMorgan Chase at its par value based on the fair value of the collateral that supported the reverse repurchase agreement.
During the fourth quarter of 2007, additional information regarding the value of the collateral, including performance statistics, resulted in the determination by the Firm that the fair value of the collateral was impaired.
Impairment losses were allocated to the ELN holder (the party that absorbs the majority of the expected loss from the conduit) in accordance with the contractual provisions of the ELN note.
On October 29, 2007, certain structured CDO assets originated in the second quarter of 2007 and backed by subprime mortgages were transferred to the Firm from two Firm-administered multi-seller conduits.
It became clear in October that commercial paper investors and rating agencies were becoming increasingly concerned about CDO assets backed by subprime mortgage exposures.
Because of these concerns, and to ensure the continuing viability of the two conduits as financing vehicles for clients and as investment alternatives for commercial paper investors, the Firm, in its role as administrator, transferred the CDO assets out of the multi-seller conduits.
The structured CDO assets were transferred to the Firm at
JPMorgan Chase is subject to ongoing tax examinations by the tax authorities of the various jurisdictions in which it operates, including U. S.  federal and state and non-U.
S.  jurisdictions.
The Firm’s consolidated federal income tax returns are presently under examination by the Internal Revenue Service (“IRS”) for the years 2003, 2004 and 2005.
The consolidated federal income tax returns of Bank One Corporation, which merged with and into JPMorgan Chase on July 1, 2004, are under examination for the years 2000 through 2003, and for the period January 1, 2004, through July 1, 2004.
The consolidated federal income tax returns of Bear Stearns for the years ended November 30, 2003, 2004 and 2005, are also under examination.
All three examinations are expected to conclude in 2009.
The IRS audits of the consolidated federal income tax returns of JPMorgan Chase for the years 2006 and 2007, and for Bear Stearns for the years ended November 30, 2006 and 2007, are expected to commence in 2009.
Administrative appeals are pending with the IRS relating to prior examination periods.
For 2002 and prior years, refund claims relating to income and credit adjustments, and to tax attribute carrybacks, for JPMorgan Chase and its predecessor entities, including Bank One, have been filed.
Amended returns to reflect refund claims primarily attributable to net operating losses and tax credit carrybacks will be filed for the final Bear Stearns federal consolidated tax return for the period December 1, 2007, through May 30, 2008, and for prior years.
The following table presents the U. S.  and non-U.
S.  components of income from continuing operations before income tax expense (benefit).
## Table 2 ##
(a) For purposes of this table, non-U.
S.  income is defined as income generated from operations located outside the U. S.  Note 29 – 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 Office of the Comptroller of the Currency (“OCC”).
The Bank is a member of the U. S.  Federal Reserve System, and its deposits are insured by the FDIC as discussed in Note 20 on page 202 of this Annual Report.
The Board of Governors of the Federal Reserve System (the “Federal Reserve”) requires depository institutions to maintain cash reserves with a Federal Reserve Bank.
The average amount of reserve balances deposited by the Firm’s bank subsidiaries with various Federal Reserve Banks was approximately $1.6 billion in 2008 and 2007.
Restrictions imposed by U. S.  federal law prohibit JPMorgan Chase and certain of its affiliates from borrowing from banking subsidiaries unless the loans are secured in specified amounts.
Such secured loans to the Firm or to other affiliates are generally limited to 10% of the banking subsidiary’s total capital, as determined by the riskbased capital guidelines; the aggregate amount of all such loans is limited to 20% of the banking subsidiary’s total capital.
The principal sources of JPMorgan Chase’s income (on a parent company–only basis) are dividends and interest from JPMorgan Chase Bank, N. A. , and the other banking and nonbanking subsidiaries of JPMorgan Chase.
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, 2009 and 2008, JPMorgan Chase’s banking subsidiaries could pay, in the aggregate, $17.0 billion and $16.2 billion, respectively, in dividends to their respective bank holding companies without the prior approval of their relevant banking regulators.
The capacity to pay dividends in 2009 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, 2008 and 2007, cash in the amount of $20.8 billion and $16.0 billion, respectively, and securities with a fair value of $12.1 billion and $3.4 billion, respectively, were segregated in special bank accounts for the benefit of securities and futures brokerage customers.
Credit risk capital Credit risk capital is estimated separately for the wholesale businesses (IB, CB, TSS and AM) and consumer businesses (RFS and CS).
Credit risk capital for the overall wholesale credit portfolio is defined in terms of unexpected credit losses, both from defaults and declines in the portfolio value due to credit deterioration, measured over a one-year period at a confidence level consistent with an “AA” credit rating standard.
Unexpected losses are losses in excess of those for which provisions for credit losses are maintained.
The capital methodology is based upon several principal drivers of credit risk: exposure at default (or loan-equivalent amount), default likelihood, credit spreads, loss severity and portfolio correlation.
Credit risk capital for the consumer portfolio is based upon product and other relevant risk segmentation.
Actual segment level default and severity experience are used to estimate unexpected losses for a one-year horizon at a confidence level consistent with an “AA” credit rating standard.
Statistical results for certain segments or portfolios are adjusted to ensure that capital is consistent with external benchmarks, such as subordination levels on market transactions or capital held at representative monoline competitors, where appropriate.
Market risk capital The Firm calculates market risk capital guided by the principle that capital should reflect the risk of loss in the value of portfolios and financial instruments caused by adverse movements in market variables, such as interest and foreign exchange rates, credit spreads, securities prices and commodities prices.
Daily Value-at-Risk (“VaR”), biweekly stress-test results and other factors are used to determine appropriate capital levels.
The Firm allocates market risk capital to each business segment according to a formula that weights that segment’s VaR and stress-test exposures.
See Market Risk Management on pages 111–116 of this Annual Report for more information about these market risk measures.
Operational risk capital Capital is allocated to the lines of business for operational risk using a risk-based capital allocation methodology which estimates operational risk on a bottom-up basis.
The operational risk capital model is based upon actual losses and potential scenario-based stress losses, with adjustments to the capital calculation to reflect changes in the quality of the control environment or the use of risk-transfer products.
The Firm believes its model is consistent with the new Basel II Framework.
Private equity risk capital Capital is allocated to privately and publicly held securities, third-party fund investments and commitments in the private equity portfolio to cover the potential loss associated with a decline in equity markets and related asset devaluations.
In addition to negative market fluctuations, potential losses in private equity investment portfolios can be magnified by liquidity risk.
The capital allocation for the private equity portfolio is based upon measurement of the loss experience suffered by the Firm and other market participants over a prolonged period of adverse equity market conditions.
Regulatory capital The Board of Governors of the Federal Reserve System (the “Federal Reserve”) establishes capital requirements, including well-capitalized standards for the consolidated financial holding company.
The Office of the Comptroller of the Currency (“OCC”) establishes similar capital requirements and standards for the Firm’s national banks, including JPMorgan Chase Bank, N. A. , and Chase Bank USA, N. A.
The Federal Reserve granted the Firm, for a period of 18 months following the Bear Stearns merger, relief up to a certain specified amount and subject to certain conditions from the Federal Reserve’s risk-based capital and leverage requirements with respect to Bear Stearns’ risk-weighted assets and other exposures acquired.
The amount of such relief is subject to reduction by one-sixth each quarter subsequent to the merger and expires on October 1, 2009.
The OCC granted JPMorgan Chase Bank, N. A.  similar relief from its risk-based capital and leverage requirements.
JPMorgan Chase maintained a well-capitalized position, based upon Tier 1 and Total capital ratios at December 31, 2008 and 2007, as indicated in the tables below.
For more information, see Note 30 on pages 212–213 of this Annual Report.
Risk-based capital components and assets
## Table 3 ##
(a) The FASB has been deliberating certain amendments to both SFAS 140 and FIN 46R that may impact the accounting for transactions that involve QSPEs and VIEs.
Based on the provisions of the current proposal and the Firm’s interpretation of the proposal, the Firm estimates that the impact of consolidation could be up to $70 billion of credit card receivables, $40 billion of assets related to Firm-sponsored multi-seller conduits, and $50 billion of other loans (including residential mortgages); the decrease in the Tier 1 capital ratio could be approximately 80 basis points.
The ultimate impact could differ significantly due to the FASB’s continuing deliberations on the final requirements of the rule and market conditions.
wholesale loan sales and securitization activities; sales and maturities of AFS securities; the net decline in auto loans, which was caused partially by management’s decision to de-emphasize vehicle leasing; and the sale of the insurance business at the beginning of the second quarter.
Cash Flows from Financing Activities The Firm’s financing activities primarily reflect cash flows related to customer deposits, issuances of long-term debt and trust preferred capital debt securities, and issuances of preferred and common stock.
In 2008, net cash provided by financing activities was $250.5 billion due to: growth in wholesale deposits, in particular, interestand noninterest-bearing deposits in TSS (driven by both new and existing clients, and due to the deposit inflows related to the heightened volatility and credit concerns affecting the global markets), as well as increases in AM and CB (due to organic growth); proceeds of $25.0 billion from the issuance of preferred stock and a warrant to the U. S.  Treasury under the Capital Purchase Program; additional issuances of common stock and preferred stock used for general corporate purposes; an increase in other borrowings due to nonrecourse secured advances from the Federal Reserve Bank of Boston to fund the purchase of asset-backed commercial paper from money market mutual funds; increases in federal funds purchased and securities loaned or sold under repurchase agreements in connection with higher short-term requirements to fulfill client demand for liquidity and finance the Firm’s AFS securities inventory; and a net increase in long-term debt due to a combination of non-FDIC guaranteed debt and trust preferred capital debt securities issued prior to December 4, 2008, and the issuance of $20.8 billion of FDIC-guaranteed longterm debt issued during the fourth quarter of 2008.
The fourth-quarter FDIC-guaranteed issuance was offset partially by maturities of non-FDIC guaranteed long-term debt during the same period.
The increase in long-term debt and trust preferred capital debt securities was used primarily to fund certain illiquid assets held by the parent holding company and build liquidity.
Cash was also used to pay dividends on common and preferred stock.
The Firm did not repurchase any shares of its common stock in the open market during 2008 in order to maintain its capital objectives.
In 2007, net cash provided by financing activities was $183.0 billion due to a net increase in wholesale deposits from growth in business volumes, in particular, interest-bearing deposits at TSS, AM and CB; net issuances of long-term debt and trust preferred capital debt securities primarily to fund certain illiquid assets held by the parent holding company and build liquidity, and by IB from client-driven structured notes transactions; and growth in commercial paper issuances and other borrowed funds due to growth in the volume of liability balances in sweep accounts in TSS and CB, and to fund trading positions and to further build liquidity.
Cash was used to repurchase common stock and pay dividends on common stock, including an increase in the quarterly dividend in the second quarter of 2007.
In 2006, net cash provided by financing activities was $152.7 billion due to net cash received from growth in deposits, reflecting new retail account acquisitions and the ongoing expansion of the retail branch distribution network; higher wholesale business volumes; increases in securities sold under repurchase agreements to fund trading positions and higher AFS securities positions; and net issuances of long-term debt and trust preferred capital debt securities.
The net cash provided was offset partially by the payment of cash dividends on stock and common stock repurchases.
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.
For additional information on the impact of a credit ratings downgrade on the funding requirements for VIEs, and on derivatives and collateral agreements, see Special-purpose entities on pages 79–80 and Ratings profile of derivative receivables marked to market (“MTM”) on page 100 of this Annual Report.
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.
The credit ratings of the parent holding company and each of the Firm’s significant banking subsidiaries as of January 15, 2009, were as follows.

Tables referenced above, in order (Table 0 first):
<table><tr><td>December 31,</td><td>Allowance for loan losses</td><td>Net charge-offs (recoveries) year ended</td></tr><tr><td>(in millions)</td><td>2008</td><td>2007</td><td>2008</td><td>2007</td></tr><tr><td>Investment Bank</td><td>$3,444</td><td>$1,329</td><td>$105</td><td>$36</td></tr><tr><td>Commercial Banking</td><td>2,826</td><td>1,695</td><td>288</td><td>44</td></tr><tr><td>Treasury & Securities Services</td><td>74</td><td>18</td><td>-2</td><td>—</td></tr><tr><td>Asset Management</td><td>191</td><td>112</td><td>11</td><td>-8</td></tr><tr><td>Corporate/Private Equity</td><td>10</td><td>—</td><td>—</td><td>—</td></tr><tr><td>Total Wholesale</td><td>6,545</td><td>3,154</td><td>402</td><td>72</td></tr><tr><td>Retail Financial Services</td><td>8,918</td><td>2,668</td><td>4,877</td><td>1,350</td></tr><tr><td>Card Services</td><td>7,692</td><td>3,407</td><td>4,556</td><td>3,116</td></tr><tr><td>Corporate/Private Equity</td><td>9</td><td>5</td><td>—</td><td>—</td></tr><tr><td>Total Consumer – reported</td><td>16,619</td><td>6,080</td><td>9,433</td><td>4,466</td></tr><tr><td>Credit card – securitized</td><td>—</td><td>—</td><td>3,612</td><td>2,380</td></tr><tr><td>Total Consumer – managed</td><td>16,619</td><td>6,080</td><td>13,045</td><td>6,846</td></tr><tr><td>Total</td><td>$23,164</td><td>$9,234</td><td>$13,477</td><td>$6,918</td></tr></table>
<table><tr><td>(in billions, except ratios)</td><td>Reported</td><td>Pro forma<sup>(a)(b)</sup></td></tr><tr><td>Assets</td><td>$2,175.1</td><td>$2,218.2</td></tr><tr><td>Liabilities</td><td>2,008.2</td><td>2,051.3</td></tr><tr><td>Tier 1 capital ratio</td><td>10.9%</td><td>10.9%</td></tr><tr><td>Tier 1 leverage ratio</td><td>6.9</td><td>6.8</td></tr></table>
<table><tr><td>Year ended December 31, (in millions)</td><td>2008</td><td>2007</td><td>2006</td></tr><tr><td>U.S.</td><td>$-2,094</td><td>$13,720</td><td>$12,934</td></tr><tr><td>Non-U.S.<sup>(a)</sup></td><td>4,867</td><td>9,085</td><td>6,952</td></tr><tr><td>Income from continuing operationsbefore income taxexpense (benefit)</td><td>$2,773</td><td>$22,805</td><td>$19,886</td></tr></table>
<table><tr><td>December 31, (in millions)</td><td>2008</td><td>2007</td></tr><tr><td>Total Tier 1capital<sup>(a)</sup></td><td>$136,104</td><td>$88,746</td></tr><tr><td>Total Tier 2 capital</td><td>48,616</td><td>43,496</td></tr><tr><td>Total capital</td><td>$184,720</td><td>$132,242</td></tr><tr><td>Risk-weighted assets</td><td>$1,244,659</td><td>$1,051,879</td></tr><tr><td>Total adjusted average assets</td><td>1,966,895</td><td>1,473,541</td></tr></table>

Question: by how many basis points would the tier 1 capital ratio improve if the firm were to consolidate the assets and liabilities of the conduits at fair value?
Answer: 10
Reasoning program: subtract(10.9,10.8), multiply(#0,const_100)