SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
J.P. MORGAN CHASE & CO.(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code (212) 270-6000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Number of shares outstanding of common stock on October 31, 2001.
TABLE OF CONTENTS
FORM 10-QTABLE OF CONTENTS
The Management’s Discussion and Analysis contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of J.P. Morgan Chase & Co.’s management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. Factors that could cause J.P. Morgan Chase & Co.’s results to differ materially from those described in the forward-looking statements are enumerated under “Important Factors That May Affect Future Results” in this Form 10-Q and are further described in the 2000 Annual Report on Form 10-K of J.P. Morgan Chase & Co. filed with the Securities and Exchange Commission.
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Part I
Item 1
J.P. MORGAN CHASE & CO.CONSOLIDATED STATEMENT OF INCOME(in millions, except per share data)
The Notes to Consolidated Financial Statements are an integral part of these Statements.
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Item 1 (continued)
J.P. MORGAN CHASE & CO.CONSOLIDATED BALANCE SHEET(in millions, except share data)
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J.P. MORGAN CHASE & CO.CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(in millions, except per share data)
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J.P. MORGAN CHASE & CO.CONSOLIDATED STATEMENT OF CASH FLOWS(in millions)
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See Glossary of Terms on page 52 for definition of terms used throughout the Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – MERGER WITH J.P. MORGAN & CO. INCORPORATED
On December 31, 2000, J.P. Morgan & Co. Incorporated (“J.P. Morgan”) merged with and into The Chase Manhattan Corporation (“Chase”). Upon consummation of the merger, Chase changed its name to J.P. Morgan Chase & Co. (“JPMorgan Chase” or “the Firm”). The merger was accounted for as a pooling of interests, and, accordingly, the information included in these financial statements and consolidated notes reflects the combined results of Chase and J.P. Morgan as if the merger had been in effect for all periods presented. In addition, certain amounts have been reclassified to conform to the current presentation.
NOTE 2 – BASIS OF PRESENTATION
The accounting and financial reporting policies of JPMorgan Chase and its subsidiaries conform to U.S. generally accepted accounting principles (“GAAP”) and prevailing industry practices for interim reporting. Additionally, where applicable, the policies conform to bank regulatory accounting and reporting guidelines. The unaudited consolidated financial statements prepared in conformity with GAAP require management to make estimates and assumptions that affect reported revenues, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Actual results could be different from these estimates. In the opinion of management, all necessary adjustments, consisting only of normal recurring adjustments, have been included for a fair presentation of this interim financial information. These unaudited financial statements should be read in conjunction with the audited financial statements included in JPMorgan Chase’s 2000 Annual Report on Form 10-K (“2000 Annual Report”), with the exception of Note 3 below, “Accounting for Derivative Instruments and Hedging Activities.”
NOTE 3 – ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
On January 1, 2001, JPMorgan Chase adopted SFAS 133, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and used for hedging activities. The adoption of SFAS 133 resulted in an after-tax reduction to net income of $25 million and an after-tax reduction to other comprehensive income (“OCI”) of $36 million. The impact of reclassifying certain SFAS 115 securities from available-for-sale to trading was not material at the adoption date.
The majority of JPMorgan Chase’s derivatives are entered into for trading purposes and were not affected by the adoption of SFAS 133. The Firm also uses derivatives as an end user to hedge market exposures, modify the interest rate characteristics of related balance sheet instruments or meet longer-term investment objectives. Both trading and end-user derivatives are recorded in trading assets and liabilities. For further discussion of the Firm’s use of derivative instruments, see Note 3 of the JPMorgan Chase March 31, 2001 Form 10-Q in addition to Note 25 and page 50 of the JPMorgan Chase 2000 Annual Report.
The following table presents derivative instrument and hedging related activities for the periods indicated.
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NOTE 4 – MERGER AND RESTRUCTURING COSTS
The following table shows the components of merger and restructuring costs during the third quarter and nine months of 2001.
The following table shows the utilization of the original $1.25 billion merger liability during the third quarter of 2001.
Management originally estimated that the Firm would incur one-time pre-tax costs of $3.2 billion in connection with the merger of J.P. Morgan and Chase. These costs consisted of a $1.25 billion merger charge that was recorded on the December 31, 2000 merger date and $1.95 billion of other costs to be incurred in 2001 and 2002 that were not accruable under existing accounting pronouncements. Management now estimates that $650 million of additional nonaccruable merger costs will be incurred in 2001 and 2002. This results in approximately $1.42 billion of total nonaccruable merger costs yet to be incurred at September 30, 2001. These costs consist primarily of system integration costs, facilities costs and retention payments. Cumulative merger-related employee reductions, including attrition, since the merger announcement are approximately 5,500.
Management estimates that the Firm also will incur one-time pre-tax costs of $400 million in connection with the right-sizing of employee levels of certain businesses (2,000 employee reductions) beyond that planned at the time of the merger. These severance costs consist of a $300 million charge that was recorded on September 30, 2001 related to employees who were notified that their positions had been eliminated and $100 million of costs which are expected to be incurred in the fourth quarter of 2001 and in 2002 and which are not accruable under existing accounting pronouncements.
For a further discussion of JPMorgan Chase’s merger and restructuring costs, refer to Note 7 and page 42 of JPMorgan Chase’s 2000 Annual Report.
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NOTE 5 – TRADING ASSETS AND LIABILITIES
For a discussion of the accounting policies relating to trading assets and liabilities, see Note 1 of JPMorgan Chase’s 2000 Annual Report.
The following table presents trading assets and trading liabilities for the dates indicated.
Debt and equity instruments pledged as collateral that can be sold or repledged by the secured party amounted to $65.8 billion at September 30, 2001 and $53.6 billion at December 31, 2000.
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NOTE 6 – SECURITIES
For a discussion of the accounting policies relating to securities, see Note 1 of JPMorgan Chase’s 2000 Annual Report.
The following table presents realized gains and losses from available-for-sale (“AFS”) securities.
The amortized cost and estimated fair value of securities were as follows for the dates indicated.
AFS securities pledged as collateral that can be sold or repledged by the secured party amounted to $29.6 billion and $28.7 billion at September 30, 2001 and December 31, 2000, respectively.
NOTE 7 – MORTGAGE SERVICING RIGHTS
The following table summarizes the changes in residential mortgage servicing rights (“MSR”).
CPR – Constant prepayment rate.
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Interest rate derivatives and AFS securities are used to manage the interest rate risk of the residential mortgage servicing rights. Certain interest rate derivatives qualify as fair value hedges under SFAS 133 which results in recording adjustments to the carrying value of the hedged MSRs. In addition, certain derivatives and AFS securities are used as economic hedges of the MSRs. For the nine months ended September 30, 2001, the SFAS 133 hedge valuation adjustments and the change in the valuation allowance totaled $2,509 million. These losses were substantially offset by derivative gains, including SFAS 133 hedges, and realized gains from sales of AFS securities of $2,317 million.
NOTE 8 – OTHER ASSETS AND ACCOUNTS PAYABLE AND OTHER LIABILITIES
As a result of the events of September 11th, Other Assets and Other Liabilities increased $40 billion and $34 billion, respectively, at September 30, 2001 from December 31, 2000, primarily due to the securities industry's temporary delay in clearing and settling cash and securities. The growth in Other Assets and Other Liabilities is primarily composed of failed to deliver securities and fail to receive securities, respectively.
NOTE 9 – SUBORDINATED DEFERRABLE INTEREST DEBENTURES
At September 30, 2001, 11 wholly owned Delaware statutory business trusts established by JPMorgan Chase had issued an aggregate $4,439 million of capital securities, net of discount. There were no issuances or redemptions of capital securities during the third quarter of 2001. For a discussion of these business trusts, see page 78 of JPMorgan Chase’s 2000 Annual Report and Note 8 of JPMorgan Chase’s March 31, 2001 Form 10-Q.
NOTE 10 – EARNINGS PER SHARE
For a discussion of JPMorgan Chase’s earnings per share (“EPS”), see Note 17 of the 2000 Annual Report. For the calculation of basic and diluted EPS for the third quarter and nine months ended September 30, 2001 and 2000, see Exhibit 11 on page 58.
NOTE 11 – COMPREHENSIVE INCOME
Comprehensive income is composed of net income and other comprehensive income, which includes the after-tax change in unrealized gains and losses on AFS securities, cash flow hedging activities and foreign currency translation adjustments.
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NOTE 12 – CAPITAL
For a discussion of the calculation of risk-based capital ratios, see Note 23 of JPMorgan Chase’s 2000 Annual Report.
The following table presents the risk-based capital ratios for JPMorgan Chase and its significant banking subsidiaries. At September 30, 2001, the Firm and each of its depository institutions, including those listed in the table below, were “well-capitalized” as defined by banking regulators.
NOTE 13 – INTEREST INCOME AND INTEREST EXPENSE
The following table details the components of interest income and interest expense as reported on the Consolidated Statement of Income.
NOTE 14 – COMMITMENTS AND CONTINGENCIES
For a discussion of legal proceedings, see Part II, Item 1 of this Form 10-Q.
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NOTE 15 – FAIR VALUE OF FINANCIAL INSTRUMENTS
For a discussion of JPMorgan Chase’s fair value methodologies, see Note 28 of JPMorgan Chase’s 2000 Annual Report. The following table presents the financial assets and liabilities valued under SFAS 107.
NOTE 16 – ACCOUNTING DEVELOPMENTS
For a discussion of JPMorgan Chase’s recent accounting developments, see page 46 of this Form 10-Q.
NOTE 17 – SEGMENT INFORMATION
JPMorgan Chase is organized into five major businesses: Investment Bank, Investment Management & Private Banking, Treasury & Securities Services, JPMorgan Partners and Retail & Middle Market Financial Services. These businesses are segmented based on the products and services provided, or the type of customer serviced, and reflect the manner in which financial information currently is evaluated by the Firm’s management. For a further discussion concerning JPMorgan Chase’s business segments, see Lines of Business Results in the Management’s Discussion and Analysis (“MD&A”) section of this Form 10-Q on pages 18-28.
Shareholder Value Added (“SVA”) is a primary performance measure of the Firm’s businesses. SVA represents operating earnings excluding the amortization of goodwill and certain other intangibles (i.e., cash operating earnings) minus preferred dividends and an explicit charge for capital. The Firm implemented an integrated cost of capital during the first quarter of 2001. A 12% cost of capital has been used for all businesses except JPMorgan Partners. This business is charged a 15% cost of equity capital, which is equivalent to a representative after-tax hurdle rate for private equity investments. The effective cost of equity capital used in the SVA framework for JPMorgan Chase overall is 12%. All prior periods have been restated. See Management Performance Measurements in the MD&A on page 25 and Note 29 of JPMorgan Chase’s 2000 Annual Report for a further discussion of performance measurements and policies for cost allocation.
The table below presents a reconciliation of the combined segment information to the Firm’s reported net income as included in the Consolidated Statement of Income.
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The following table provides the Firm’s segment results.
NM – Not meaningful.
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Item 2
MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Results for all periods give effect to the merger of The Chase Manhattan Corporation and J.P. Morgan & Co. Incorporated on December 31, 2000.
Financial Results: Reported net income, which includes merger and restructuring costs, was $449 million, or $0.22 per share, in the third quarter of 2001. This compares with $378 million, or $0.18 per share, in the second quarter of 2001 and $1,398 million, or $0.69 per share, in the third quarter of 2000. For the first nine months of 2001, reported net income was $2,026 million, or $0.97 per share, compared with $5,019 million, or $2.53 per share, in the same period last year.
bp – Denotes basis points; 100 bp equals 1%.
In addition to disclosing its results on a reported basis, JPMorgan Chase manages its financial performance on an operating basis. As used by JPMorgan Chase, “operating basis” excludes the impact of credit card securitizations, merger and restructuring costs, special items and the net effect of changes in accounting principles. For a reconciliation between reported results and results on an operating basis, see page 29.
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Item 2 (continued)
On an operating basis, JPMorgan Chase’s diluted earnings per share for the third quarter of 2001 were $0.51, compared with $0.33 in the second quarter of 2001 and $0.70 in the third quarter of 2000. Operating earnings were $1,036 million in the 2001 third quarter, compared with $690 million in the second quarter of 2001 and $1,419 million one year ago. For the first nine months of 2001, operating earnings were $3,162 million, or $1.53 per share, as against $5,164 million, or $2.60 per share, in last year’s same period.
Management also tracks the operating performance of JPMorgan Chase excluding the results of JPMorgan Partners (“JPMP”). Management believes that the valuation of JPMP should not be assessed simply by assigning a multiple to gains and losses recorded during a quarterly accounting period. Excluding the results of JPMorgan Partners, operating earnings were $1,196 million in the third quarter of 2001, compared with $1,317 million in the second quarter of 2001 and $1,542 million in the 2000 third quarter. Operating earnings excluding JPMP for the first nine months of 2001 were $3,972 million, compared with $4,768 million in the first nine months of 2000.
Over the past few years, volatile stock markets have produced significant fluctuations in the values of the securities held by JPMorgan Partners, resulting in unrealized and realized valuation adjustments for various periods that have significantly affected, both favorably and unfavorably, the Firm’s operating results. The contribution of JPMP to operating earnings per share was a loss of $0.08 in the third quarter of 2001, compared with a $0.31 loss in the second quarter of 2001 and a loss of $0.07 in the third quarter of 2000. Excluding the results of JPMP, operating earnings per share were $0.59 in the third quarter of 2001. This compares with $0.64 in the second quarter of 2001 and $0.77 in the third quarter of 2000.
The impact of the amortization of intangibles was $0.09 per share in both the third and second quarters of 2001 and $0.08 per share one year ago.
For a reconciliation of diluted EPS from reported net income to cash operating earnings excluding JPMP, see the table below.
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Highlights of Third Quarter 2001 Operating Results:
(All periods in 2000 are on a pro forma basis, which assumes that the purchase of Robert Fleming Holdings Limited (“Flemings”) had occurred at the beginning of that year.) Highlights for the third quarter 2001 are as follows:
Nonperforming assets were $2.65 billion at September 30, 2001, compared with $2.50 billion and $1.94 billion at June 30, 2001 and September 30, 2000, respectively. Net charge-offs on a managed basis (i.e., treating securitized credit card receivables as if continued to be owned by the Firm) were $815 million in the 2001 third quarter, an increase from $798 million in the second quarter of 2001 and $559 million in the third quarter of 2000. Provisions in excess of charge-offs of $200 million were recorded in the third quarter of 2001, of which $140 million related to the commercial portfolio and $60 million related to the consumer portfolio. Management of JPMorgan Chase believes nonperforming assets will continue to increase.
Total assets as of September 30, 2001 were $799 billion, compared with $713 billion as of June 30, 2001 and $707 billion one year ago. The increase partly reflected the effect of clearing and settlement issues following the events of September 11th, which are expected to be temporary. During the third quarter of 2001, the Firm purchased approximately 19 million shares of common stock pursuant to JPMorgan Chase’s stock buy-back program. The cost for these repurchases, net of stock issuance, was approximately $500 million. JPMorgan Chase’s Tier One Capital ratio was 8.2% at September 30, 2001, 8.7% at June 30, 2001 and 8.1% one year ago.
JPMorgan Chase’s third quarter 2001 special items included $876 million (pre-tax) in merger and restructuring costs, including an additional $300 million related to the right-sizing of employee levels beyond that planned at the time of the merger. Special items in the third quarter of 2000 included an $81 million gain from the sale of a business in Panama, a $35 million loss resulting from the economic hedge of the purchase price of Flemings prior to its acquisition and $79 million in restructuring costs.
General Outlook:
Results for the quarter were overshadowed by the tragic events of September 11th. In the days immediately following that tragedy, management’s attention was focused on the needs of the Firm’s clients, employees and community. The current climate continues to be challenging and is expected to remain challenging for at least the remainder of the year. In this environment, management’s strategy is to continue to control the Firm’s risk and level of expenses. Actions include accelerating the right-sizing of market-sensitive businesses; setting profit margin targets for each line of business; focusing on distribution and diversification within the credit-related portfolios; and continuing capital discipline. These efforts are intended to produce significant operating leverage once the markets return to more normal activity levels.
Merger Update:
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LINES OF BUSINESS RESULTS
The table below provides summary financial information on a cash operating basis for the five major business segments. All periods below have been restated on a comparable basis to reflect the changes in capital allocation adopted in the first quarter of 2001; restatements may occur in future periods to reflect further alignment of management accounting policies or changes in organizational structures between businesses. For a discussion of each business profile, see pages 28-36 of the JPMorgan Chase 2000 Annual Report.
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INVESTMENT BANK
The following table sets forth selected financial data of the Investment Bank.
(All comments related to 2000 give pro forma effect to the purchase of Flemings, which is treated as if it had occurred at the beginning of that year.)
The Investment Bank’s operating revenues were $3.60 billion in the third quarter of 2001, a decline of 4% from the second quarter and a decline of 10% from the third quarter of 2000. Cash operating expenses of $2.18 billion were down by 7% from the second quarter and by 15% from the third quarter of 2000. The decline in expenses was spread across all expense categories and reflected merger synergies and expense management initiatives. By year-end, management expects to have eliminated approximately 6,000 positions in the Investment Bank since the merger announcement date. These initiatives resulted in stable operating margins during 2001 despite difficult market conditions, as the overhead ratio for the quarter was 61%. The Investment Bank is targeting a cash overhead ratio of 60% for the full-year 2001, assuming no further deterioration in market conditions.
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Trading revenues (including related net interest income (“NII”)) of $1.52 billion declined by 6% from the second quarter and by 3% from the third quarter of 2000. Overall trading was only marginally lower, as fixed income and other trading activities generated higher revenues, compared with the prior periods, while equity trading was lower as a result of market conditions. In addition, due to heightened market activity in September, the Investment Bank realized a greater demand for its market-making services across a broad range of products, including fixed income products such as debt instruments and interest rate contracts.
Investment banking fees totaled $807 million in the third quarter of 2001, declining 12% from the second quarter and 24% from the third quarter of 2000. High-grade bond underwriting continued to generate strong results, although results were lower than the record level in the second quarter. The continued weak equity market conditions resulted in lower equity underwriting fees. Advisory revenues in the third quarter increased 9% from the second, but decreased 28% from the third quarter of 2000. During the first nine months of 2001, important product leadership positions were maintained in leveraged and syndicated lending (No.1) and U.S. high-grade bonds (No.2). In addition, the Investment Bank increased its market share of global announced M&A transactions to 21% for the first nine months of 2001 from 18% in 2000 (derived from Thomson Financial Securities Data, based on proceeds). Nevertheless, investment banking revenues for the remainder of the year will be largely dependent upon the level of market activity for underwriting and M&A advisory work, which are currently expected to remain at the same weak levels as experienced during the first nine months of this year.
Net interest income rose 11% and 28% from the second quarter of 2001 and last year’s third quarter, respectively. The increases were primarily attributable to the favorable impact of the continuing decline in interest rates in 2001 as spreads on interest-earning assets were slightly wider than in each of the two other prior periods, reflecting the fact that the interest expense related to carrying the interest-earning assets declined faster than the interest income earned.
Fees and commissions of $390 million in the third quarter of 2001 declined by 2% from the second quarter and by 12% from the third quarter of 2000. In each instance, the declines reflected lower equity brokerage commissions.
All other revenue declined significantly from the second quarter of 2001 and the third quarter of last year as a result of unfavorable valuation adjustments, primarily on loans that were syndicated or originated for distribution but still are currently carried on the Consolidated Balance Sheet.
The Investment Bank’s cash operating earnings totaled $710 million in the third quarter, a 10% decline from the second quarter and a 19% reduction from the third quarter of 2000. Earnings declines also were affected negatively by higher credit costs, including $140 million in provisions in excess of charge-offs.
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JPMORGAN PARTNERS
The following table sets forth selected financial data of JPMorgan Partners. Due to the significant fluctuations in JPMP’s operating results, prior periods are shown in absolute dollars rather than percent changes from the current period.
JPMorgan Partners had private equity losses of $103 million in the third quarter of 2001, compared with losses of $826 million in the second quarter and losses of $20 million in the third quarter of 2000. The unrealized losses were primarily related to mark-to-market losses taken on public positions during the quarter and included the positive impact of economic hedging actions aimed at reducing the portfolio’s sensitivity to market movements. Realized gains were attributable to investment returns from both direct and third-party fund investments, highlighted by strong returns from JPMP’s energy sector.
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JPMORGAN PARTNERS INVESTMENT PORTFOLIO
The following table presents the carrying values and costs of the JPMP investment portfolio for the dates indicated.
The book value of JPMP’s investment portfolio was $2.3 billion lower on September 30, 2001 than on September 30, 2000, reflecting write-downs and write-offs in the portfolio, particularly those taken in the second quarter of 2001 relating to JPMP’s technology, media and telecommunications investments (“TMT”). At September 30, 2001, TMT investments represented approximately 32% of the total carrying value of JPMP’s portfolio, unchanged from June 30, 2001. During the remainder of 2001 and in 2002, JPMP will continue to focus on increasing the industry and geographic diversification of its portfolio. JPMP reviews investments in its portfolio on an ongoing basis.
During the first nine months of 2001, JPMP invested $0.6 billion of its own funds in direct equity. The following table presents information about the 10 largest holdings of public securities in the JPMP investment portfolio at September 30, 2001.
The carrying values of the equity investments recorded on JPMorgan Chase’s financial statements are net of interests of investors other than the Firm. JPMP has sold interests in certain of its fund investments to persons not affiliated with the Firm. In November 2001, JPMP completed its first closing, in the amount of approximately $825 million, on the sale to unaffiliated third parties of interests in a new investment fund that will co-invest with JPMP in its direct investments. As a result, JPMorgan Chase’s proportional ownership share of investments to be made by JPMP in the future is expected to be reduced. However, the Firm continues to believe JPMP’s equity-related investments will create long-term value for JPMorgan Chase. The Firm currently is prepared to commit at least $1.5 billion of its own funds to JPMP in each of the next four years.
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INVESTMENT MANAGEMENT & PRIVATE BANKING
The following table reflects selected financial data for Investment Management & Private Banking (“IMPB”).
IMPB had operating revenues of $733 million in the third quarter of 2001, an 8% decline from the second quarter of 2001 and a 23% decline from the third quarter of 2000. For the first nine months of 2001, revenues decreased 20% from the same period a year ago. The declines were mainly due to lower brokerage commissions driven by the reduction in clients' self-directed market activities at the Private Bank; lower net interest income due to the adverse effects of declining interest rates on deposit spreads at the Private Bank; and lower investment fees as a result of the lower values of funds under management as a result of the weaker market environment of 2001.
IMPB’s cash operating expenses declined 11% from last quarter and 19% from the third quarter of 2000. Cash operating expenses for the first nine months of 2001 declined 10% from the first nine months of 2000. The decreases were driven by expense management initiatives, in particular lower compensation expense as a result of headcount reductions. Cash operating earnings were $118 million, down 29% from the third quarter of 2000. For the first nine months of 2001, cash operating earnings were $340 million, a 35% decline from 2000.
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Part 1Item 2 (continued)
The table below reflects the assets under management in IMPB and assets under supervision in Private Banking as of September 30, 2001 and 2000, respectively.
Equity market conditions in 2001 led to a 10% decline in assets under management at September 30, 2001, compared with September 30, 2000. Net cash flows for the 2001 third quarter were positive as a result of a significant increase in clients’ cash and money market assets. This excludes assets managed by other lines of business and assets attributable to the Firm’s 45% interest in American Century Companies, Inc. (“American Century”).
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TREASURY & SECURITIES SERVICES
The following table sets forth selected financial data of Treasury & Securities Services (“T&SS”).
Treasury & Securities Services’ operating revenues were $917 million in the third quarter of 2001, essentially flat with the second quarter of 2001 and an increase of 3% from the third quarter of 2000. Operating revenues for Treasury Services increased by 3% from the second quarter and by 7% from the prior year, reflecting higher cash management product revenues in the United States and Europe that offset the negative effect of declining short-term interest rates on deposits. Institutional Trust revenues increased 12%, when compared with the third quarter of 2000, driven by stronger volumes in debt markets as well as the impact of acquisitions. Investor Services’ operating revenues were virtually flat, when compared with the second quarter of 2001 but declined 3% from the third quarter of 2000, reflecting lower fees based on asset values, lower foreign exchange revenue and lower spreads on deposits.
Operating expenses declined 3% from the second quarter of 2001 but increased 6% from the third quarter of 2000. The combination of modest revenue growth and improved expense control resulted in a 9% improvement in cash operating earnings from the second quarter. Cash operating earnings declined 1% from the third quarter of 2000. Cash ROCE was 25% in the third quarter of 2001 and 24% year-to-date.
Expense discipline will continue, and management of T&SS continues to work towards its long-term target of a cash overhead ratio of approximately 65%.
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RETAIL & MIDDLE MARKET FINANCIAL SERVICES
The following table reflects selected financial data for Retail & Middle Market Financial Services (“RMMFS”).
RMMFS’ operating revenues in the third quarter of 2001 were $2.78 billion, increasing by 6% from the third quarter of 2000 and 4% from the 2001 second quarter. The growth reflected higher production in home and auto financing, growth in managed credit card outstandings, and higher deposit volumes in retail and middle market banking. These increases were partially offset by the impact of lower rates on deposit spreads, mortgage servicing prepayments and an overall market decline in investment volume. In addition, comparisons with the first nine months of 2000 benefited from the $100 million charge for auto lease residual taken in the first quarter of 2000. The risk of future charges for residual values was substantially mitigated in the first quarter of 2001 through the purchase of a residual value insurance policy to cover previously uninsured auto leases in the portfolio.
Cash expenses increased by 6% from the third quarter of last year and 2% from the second quarter of 2001, reflecting the higher production volumes in credit card and mortgage originations. Cash operating earnings of $439 million for the third quarter of 2001 were down 15% from the record third quarter of 2000 as a result of higher net charge-offs, a $60 million provision in excess of charge-offs taken in the third quarter of 2001, and the sale of the consumer banking operations in Hong Kong at the end of 2000. In comparison to the second quarter of 2001, cash operating earnings were down 3%. For the first nine months of 2001, however, cash operating earnings were relatively flat from the first nine months of 2000.
Management is cautious about consumer credit conditions and anticipates consumer credit quality may worsen over the remainder of the year.
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The following table sets forth certain key financial performance measures of the businesses within RMMFS.
Cardmember Services
Cardmember Services’ operating revenues were up 17% for the third quarter and 13% for the first nine months of 2001, compared with the same periods last year. The level of operating revenues in the third quarter of 2001 represents the seventh consecutive quarterly increase for Cardmember Services. The higher revenues were driven by an increase in new accounts over the last several quarters, higher purchase volume and greater fee-based revenue. The increase in revenues for the third quarter and nine-month period was partly offset by higher credit costs. In addition, expenses rose as a result of higher business volumes. Cash operating earnings were up 2% for the third quarter of 2001 and 9% for the first nine months of 2001, compared with the same periods in 2000. Credit card related outstandings grew more than 14% from one year ago to more than $39 billion.
Regional Banking Group
Regional Banking Group’s operating revenues for the third quarter of 2001 and the first nine months of 2001 declined 7% and 3% from the respective periods of 2000, and cash operating earnings for the third quarter of 2001 and the first nine months of 2001 declined 16% and 6%, when compared with the third quarter and first nine months of 2000, respectively. These results reflected the adverse effects of declining interest rates on deposit spreads and lower investment brokerage volume as a result of weaker market conditions in 2001, partly offset by deposit growth of 4%.
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Home Finance
Home Finance’s operating revenues and cash operating earnings rose 28% and 20%, respectively, in the third quarter of 2001 versus the prior year’s quarter and were up 20% and 23%, respectively, for the first nine months of 2001 over the same period last year. The increases in the third quarter of 2001 were due to a 132% growth in origination volume (as a result of lower interest rates during 2001), 21% growth in servicing balances and higher net interest margin. Home Finance’s revenues were reduced in the first nine months of 2001 by $279 million due to impairments on MSRs and other assets, partially offset by gains on AFS securities and derivative instruments used to economically hedge MSRs. This reduction in revenues resulted from accelerated prepayments from borrowers due to the decline in interest rates. Originations (residential, home equity and manufactured housing) for the third quarter of 2001 were $47 billion, and the Home Finance servicing portfolio exceeded $400 billion at September 30, 2001.
Middle Markets
Middle Markets’ operating revenues and cash operating earnings for the third quarter of 2001 declined 5% and 13%, respectively, from the third quarter of 2000. Operating revenues decreased 2% compared with the first nine months of 2000, while cash operating earnings decreased 5% over that same time period. The decrease in cash operating earnings in the third quarter of 2001 reflected the negative impact of narrower spreads on deposits, partially offset by deposit growth of 6%.
Auto Finance
Auto Finance’s operating revenues and cash operating earnings were $379 million and $88 million, respectively, in the first nine months of 2001. These results reflected a 65% increase in originations volume for the first nine months of 2001, the impact of lower interest rates, and the effect of a $100 million charge recognized last year for the estimated decrease in auto lease residual value. In the third quarter of 2001, Auto Finance’s market share increased to 4% from 2% during last year’s same period.
SUPPORT UNITS AND CORPORATE
JPMorgan Chase’s Support Units and Corporate include LabMorgan, Enterprise Technology Services, Corporate Business Services and the net effect of management accounting policies. For the third quarter of 2001, Support Units and Corporate had a cash operating loss of $78 million, compared with a cash operating loss of $23 million in the third quarter of 2000.
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RESULTS OF OPERATIONS
The following section provides a discussion of JPMorgan Chase’s results of operations on both a reported and operating basis. The table below provides a reconciliation between the Firm’s reported and operating results.
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REVENUES
Investment Banking Fees
Investment banking fees in the third quarter and first nine months of 2001 declined significantly from last year’s respective periods. Weak market conditions in equity underwriting and merger and acquisition advisory services drove the decline in revenues. For a further discussion of JPMorgan Chase’s investment banking fees, see the Investment Bank line of business results on pages 19-20 of this Form 10-Q.
Trading-Related Revenue
Trading-related revenue (including associated NII) in the third quarter of 2001 was relatively flat, when compared with the third quarter of 2000 but for the first nine months of 2001 was down 6% from the first nine months of 2000.
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Fees and Commissions
Fees and commissions for the third quarter of 2001 declined 4%, when compared with the third quarter of 2000. For the first nine months of 2001, fees and commissions were flat, when compared with the same period last year. The table below presents the significant components of fees and commissions.
Investment Management, Custody and Processing Services
Investment management fees were slightly lower than the third quarter of 2000 but significantly higher in the first nine months of 2001 than the same period last year. The decline from the third quarter of 2000 was driven by the lower value of assets under investment management and lower transaction volume; however, net cash flows for the 2001 third quarter were positive, compared with the prior quarter as a result of significant increases in cash and money market assets. The increase for the nine months of 2001 when compared with last year was primarily attributable to the contributions of Flemings, which increased the level of funds under management.
Custody and processing services fees decreased slightly from the third quarter of 2000 but for the first nine months of 2001 were flat, when compared with the first nine months of 2000. The decrease for the quarter was largely due to the lower values of securities under custody and slower investment flows overseas, partly offset by new business related to processing the issuance of debt instruments and servicing their interest payments, coupled with higher cash management fees related to treasury activities.
Credit Card Revenue
The increases of over 20% for both the third quarter and first nine months of 2001 reflected the impact of higher card fees, including higher interchange income as a result of greater customer purchase volume. Also contributing to the increases were higher late fees as a result of the rise in delinquencies.
The following table reconciles JPMorgan Chase’s reported credit card revenue and operating credit card revenue (which excludes the impact of credit card securitizations). The decline in revenue relating to securitized credit cards was due to the maturity of several securitizations.
Brokerage and Investment Services
Brokerage and investment services in the 2001 third quarter decreased $45 million from the prior year’s same quarter but rose $54 million in the first nine months of 2001 from the prior year. The decline in the third quarter of 2001 was partly due to the weaker markets that reduced the volume of institutional and retail brokerage activities. The Flemings acquisition significantly contributed to the increase in revenues for the first nine months of 2001.
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Mortgage Servicing Fees
Mortgage servicing fees in the third quarter and first nine months of 2001 decreased $130 million and $569 million, respectively, from the same periods last year as a result of the net impairment of mortgage servicing rights due to the decline in mortgage interest rates. The impairment of the rights was substantially offset by the favorable results of their linked SFAS 133 derivatives and other economic hedges. Economic hedge results are reflected in trading revenue and securities gains. While lower mortgage rates negatively affected mortgage servicing fees, they positively affected loan origination volume; higher loan origination volume increased net interest income, as well as residential mortgage origination and sales activities, which are recognized in other revenue.
Other Lending-Related Service Fees
Other lending-related service fees were $18 million lower than the third quarter of 2000 and $70 million lower than the first nine months of last year. The declines were primarily attributable to the lower volume at, and the repositioning of, the trade finance business.
Deposit Service Charges
Deposit service charges in the 2001 third quarter rose $41 million from the prior year’s quarter and, for the first nine months of 2001, increased $78 million from the prior year. The increases reflected the impact of the lower interest rates as institutional customers at Treasury & Securities Services who customarily would pay for deposit products and services by maintaining a higher level of compensating balances instead reduced their balances and paid for the services through separate fees. Also contributing to the increase were new pricing schedules implemented for the deposit products in the third quarter of 2001.
Other Fees
All other fees rose $24 million in the third quarter of 2001 from the same period last year, partly as a result of the acquisition of Colson Services Corp. (“Colson”), a provider of record keeping, paying agent and other financial services. Other fees for the first nine months of 2001 were $99 million higher than the prior year, reflecting the growth in the volume of annuity sales and the addition of Flemings and Colson.
Private Equity Gains
Private equity gains (losses) were significantly affected by the continuing downturn in the equities market. Realized gains of $204 million and $570 million in the third quarter and first nine months of 2001, respectively, were offset by unrealized losses, which included mark-to-market losses on public securities. Unrealized losses also includes an unrealized gain of approximately $65 million on a NASDAQ-based hedge instrument that was entered into in mid-August. For a further discussion of JPMorgan Chase’s private equity results, see the JPMP line of business results on pages 21-22 of this Form 10-Q.
Securities Gains
Securities gains in the third quarter of 2001 were up 58% from last year’s same quarter and, on a year-to-date basis, were up significantly from last year. These increases were principally the result of positioning the available-for-sale securities of the Firm in anticipation of a continued reduction in interest rates in the United States and Europe. As a consequence of the interest rate declines in the first nine months of 2001, the value of debt securities held this year rose and produced significant gains upon the sale of those securities.
Home Finance utilized debt securities in addition to derivatives to hedge the value of the mortgage servicing rights it carries on the Balance Sheet. In the 2001 first quarter, Home Finance realized $315 million of gains from the sale of debt securities used as economic hedges of the mortgage servicing rights. These gains partially offset the decline in mortgage servicing fees as a result of the impairment. In the 2001 second and third quarters, no material gains were recorded from the sale of securities.
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Part IItem 2 (continued)
Other Revenue
Residential mortgage activities (which include originations and sales of loans and selective dispositions of mortgage servicing rights) in the third quarter and first nine months of 2001 rose as a result of the higher volume of mortgage loans originated and sold in 2001. The decline in mortgage interest rates and a strong housing market led to the growth of residential loan originations and refinancings.
All other revenue decreases were attributable to lower equity income from the American Century investment, reflecting the decline in the value of its funds under management; decline in hedge gains on planned overseas revenues; and unfavorable valuation adjustments, primarily on loans that were syndicated or originated for distribution but still are carried on the Consolidated Balance Sheet.
On a reported basis, results for the third quarter and nine months of 2000 also included a gain of $81 million on the sale of the Panama operations offset by losses of $35 million and $176 million, respectively, resulting from the economic hedge for the purchase price of Flemings prior to its acquisition.
Net Interest Income
Operating NII adjusts reported NII for the impact of credit card securitizations and trading-related NII that is considered part of total trading-related revenue. The following table reconciles reported and operating NII.
Net interest income in the third quarter and nine months of 2001 grew from the same periods last year, both on a reported and operating basis. The primary contributor to the increases was the continuing decline in interest rates in 2001, which led to growth in the level of interest-earning assets (in particular, consumer loans such as residential mortgages, credit card receivables and auto financings). The reduction in interest rates also favorably affected the spreads on interest-earning assets as the cost related to carrying these assets declined faster than the interest income earned on them.
In addition, both 2001 periods included the receipts of several interest refunds on prior years’ taxes aggregating $84 million ($13 million in the third quarter).
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NONINTEREST EXPENSE
Total operating noninterest expenses were $5.1 billion in the third quarter of 2001, down 4% from the same period in 2000. On a pro forma basis, operating expenses for the first nine months of 2001 declined 6% from last year. JPMorgan Chase continues to target cash operating expenses for full year 2001 to be lower than pro forma cash operating expenses for full year 2000. The declines in expenses primarily reflected lower compensation expense as a result of headcount reductions, partly offset by investments in technology and communications facilities. The following table presents the components of noninterest expense on an operating and reported basis.
Compensation Expense
Compensation expense declined 8% from the third quarter and 2% from the first nine months of 2000. The decreases were driven by headcount reductions, in particular in areas affected by the merger such as the Investment Bank and Investment Management & Private Banking, as well as by lower incentive costs as a result of the decrease in revenues in these areas. Partially offsetting the decline in the first nine months were the additions of Flemings and the mortgage business of Advanta Corp. and the impact of new hires at Home Finance and Cardmember Services to support the high production volumes.
The Firm had 96,633 and 99,189 full-time equivalent employees at September 30, 2001 and September 30, 2000, respectively. The decline in full-time equivalent employees was attributable to the elimination of positions in the Investment Bank and Investment Management & Private Banking.
Occupancy Expense
Occupancy expense was relatively flat from last year’s third quarter due to the savings derived from relocations of certain functions from the New York metropolitan area to the South and Southwest regions of the United States, partially offset by leasing costs for additional space requirements. The 8% increase in the first nine months of 2001 was primarily attributable to the acquisition of Flemings, coupled with moderate inflationary increases across various occupancy expenses.
Technology and Communications
The increases from both the third quarter and first nine months of 2000 mainly reflected the depreciation of hardware systems and amortization of capitalized software applications. In addition, the increases reflected higher telecommunications expenses, primarily associated with the increase in demand for market data, and higher leasing and maintenance costs for various telecommunications, computer and other office equipment.
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Other Expense
Other expense declined 2% from the third quarter of 2000 and 1% from the first nine months of 2000. The following table presents the components of other expense.
Amortization of Intangibles
The increases in amortization of intangibles over both periods in 2000 were attributable to the acquisitions of Flemings and The Beacon Group, LLC in August and July of 2000, respectively.
Merger and Restructuring Costs
As indicated in Note 4 on page 8 of this Form 10-Q, management currently estimates that $650 million of nonaccruable merger costs will be incurred in 2001 and 2002. These nonaccruable merger costs will be in addition to the original total merger cost estimate of $3.2 billion. Expense savings have also increased from the $2 billion originally estimated at the time of the merger to $3.2 billion.
Additionally, management currently estimates that the Firm will incur one-time pre-tax costs of $400 million in connection with the right-sizing of employee levels of certain businesses (2,000 employee reductions) beyond that planned at the time of the merger. Expense savings estimated to be realized from these right-sizing costs are $400 million. These severance costs consist of a $300 million charge that was recorded on September 30, 2001 related to employees who were notified that their positions had been eliminated and $100 million of costs which are expected to be incurred in the fourth quarter of 2001 and in 2002 and which are not accruable under existing accounting pronouncements.
Approximately 90% of the expense savings from the above merger and “right-sizing” costs currently are anticipated to be realized by the end of 2002.
CREDIT COSTS
Credit costs on an operating basis are composed of the provision for loan losses related to loans on the Consolidated Balance Sheet and to the credit costs associated with credit card receivables that have been securitized.
The increases in the provision for loan losses were indicative of the more difficult market environment and the higher volume of consumer loans outstanding. Credit costs also included a $200 million provision in excess of charge-offs in response to the current weaker credit environment for both commercial and consumer loans. See page 41 of this Form 10-Q for a discussion of the allowance for credit losses.
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INCOME TAXES
JPMorgan Chase recognized income tax expense of $220 million in the third quarter of 2001, compared with $675 million in the third quarter of 2000. For the first nine months of 2001, JPMorgan Chase recorded income tax expense of $1,083 million, compared with $2,624 million for the first nine months of 2000. The effective tax rates were 33% in the third quarter of 2001 and 35% in the first nine months of 2001, compared with 33% and 34% in the third quarter of 2000 and first nine months of 2000, respectively.
RISK MANAGEMENT
JPMorgan Chase is in the business of managing risk to create shareholder value. The major risks to which the Firm is exposed are credit, market, operational and liquidity risk. For a discussion of these risks and definition of terms associated with managing these risks, please refer to the Glossary of Terms on page 52 of this Form 10-Q and pages 43-59 of JPMorgan Chase’s 2000 Annual Report.
CREDIT RISK MANAGEMENT
The following discussion of credit risk management and derivative and foreign exchange contracts used by JPMorgan Chase focuses primarily on developments since December 31, 2000 and should be read in conjunction with pages 46-53 and Notes 1 and 25 of JPMorgan Chase’s 2000 Annual Report, in addition to Note 3 of this Form 10-Q.
The following table presents the Firm’s credit-related information for the dates indicated.
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JPMorgan Chase’s managed credit-related assets of $327 billion at September 30, 2001 increased 6%, when compared with year-end 2000. Commercial loans decreased $2.9 billion, or 2%, reflecting the Firm’s ongoing discipline of originating loans for distribution and sale. Derivative and foreign exchange instruments increased by 12% from $76.4 billion at year-end 2000. Consumer managed credit-related assets increased $11.0 billion, or 10%, from December 31, 2000, largely in residential mortgages, auto financing and credit cards.
The portion of the commercial loan portfolio and counterparty credit outstanding considered investment grade was 66% at September 30, 2001, compared with 67% at year-end 2000. Management currently believes that credit conditions in the United States will remain challenging for the remainder of the year, which could have an adverse impact on credit quality over time.
The increase in nonperforming assets was primarily related to domestic commercial and industrial credits. Given the credit conditions noted above, management expects a further increase in nonperforming assets in the fourth quarter of 2001. However, management believes that the Firm’s credit performance this year will continue to be better than the industry average.
Net charge-offs in the managed portfolio were $815 million and $2,301 million in the third quarter and nine months of 2001, respectively, an increase of $256 million and $578 million, respectively, from the same periods one year ago, primarily reflecting increased net charge-offs in the telecommunications portion of the domestic commercial loan portfolio and in the consumer credit card portfolio.
Commercial Portfolio
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Part IItem 2 (continued)Commercial Portfolio (continued)
Commercial and Industrial: The domestic commercial and industrial portfolio increased $795 million from 2000 year-end. Domestic commercial and industrial net charge-offs in the 2001 third quarter amounted to $132 million, compared with $81 million in the 2000 third quarter. Nonperforming domestic commercial and industrial loans were $1.3 billion, an increase of $608 million from the 2000 year-end. The foreign commercial and industrial portfolio totaled $35.2 billion at September 30, 2001, a decrease of 5% from the 2000 year-end level. Nonperforming foreign commercial and industrial loans were $530 million, a decrease of $26 million from year-end 2000, primarily as a result of a reduction in nonperforming commercial loans in Asia but partially offset by an increase in nonperforming loans in Latin America. Net charge-offs in the foreign commercial and industrial loan portfolio for the third quarter of 2001 increased to $63 million from $4 million in the same period last year.
Financial Institutions: Loans to financial institutions decreased $1.3 billion during 2001, when compared with year-end, as a result of reductions in the foreign portion of the portfolio. Nonperforming financial institution loans were $44 million at September 30, 2001 and $42 million at December 31, 2000.
Derivative and Foreign Exchange Contracts
The following table provides the remaining maturities of derivative and foreign exchange contracts outstanding at September 30, 2001 and December 31, 2000.
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Country Exposure
The following table presents JPMorgan Chase’s exposure to selected countries. This disclosure is based on management’s current view of country exposure. The differences between the current presentation and that used at December 31, 2000 and March 31, 2001 are primarily as follows: (1) collateral held is used to reduce exposure on counterparty trades within a country; and (2) disclosure is based on total exposure, which includes local exposure funded locally in addition to cross-border exposure. Management believes the current presentation more accurately reflects JPMorgan Chase’s country exposure. Amounts as of December 31, 2000 have been restated to conform to the current presentation.
Selected Country Exposure
The Firm has been closely managing its exposure to Argentina over the prior several quarters and, in particular, in the months leading up to the government’s recent announcement of a restructuring of its bond obligations. Since June 30, 2001, the Firm has reduced its exposure to Argentina by $0.5 billion.
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Consumer Portfolio
Residential Mortgage Loans: Residential mortgage loans were $55.2 billion at September 30, 2001, a $4.9 billion increase, or 10%, from year-end. During the first nine months of 2001, the level of nonperforming residential mortgage loans increased 1%. The net charge-off rate of 0.10% for the third quarter of 2001 was four basis points higher than for the third quarter of 2000.
Credit Card Loans: JPMorgan Chase analyzes its credit card portfolio on a “managed basis,” which includes credit card receivables on the balance sheet as well as credit card receivables that have been securitized.
Managed credit card receivables of $38.0 billion as of September 30, 2001 increased 4%, when compared with year-end 2000. During the 2001 third quarter, net charge-offs as a percentage of average credit card receivables increased to 5.64%, compared with 4.99% in the prior-year period. Loans over 90 days past due remained stable at 1.95% of the portfolio at September 30, 2001, compared with 1.96% at December 31, 2000. Management anticipates that the managed credit card net charge-off ratio for full-year 2001 will be higher than the 5.12% for full-year 2000.
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Auto Financings: Auto financings outstanding increased 23% at September 30, 2001, when compared with year-end 2000. The net charge-off rate of 0.53% for the 2001 third quarter was 12 basis points higher than the same period a year ago. Total originations were $14.3 billion for the nine months of 2001, compared with $8.7 billion for the same 2000 period.
Other Consumer Loans: The level of other consumer loans of $7.8 billion at September 30, 2001 decreased 2% from year-end 2000. The net charge-off rates related to this portfolio were higher in the third quarter, when compared with the third quarter of 2000 due to losses for certain discontinued businesses.
Allowance for Credit Losses
Loans: JPMorgan Chase’s allowance for loan losses is intended to cover probable credit losses as of September 30, 2001, for which either the asset is not specifically identified or the size of the loss has not been fully determined. Within the allowance, there are both specific and expected loss components and a residual component. The allowance for loan losses was increased by approximately $200 million during the third quarter of 2001, reflecting the challenging credit conditions which resulted in an increase in the specific and expected loss components of the allowance. For a further discussion of the specific loss, expected loss and residual components of the allowance for loan losses, see page 53 of JPMorgan Chase’s 2000 Annual Report.
The provision for loan losses for the third quarter of 2001 increased $447 million, or 150%, when compared with the third quarter of 2000.
Foreign commercial loan net charge-offs increased $81 million during the first nine months of 2001, when compared with the first nine months of 2000, while foreign commercial nonperforming loans decreased $164 million from September 30, 2000 to $580 million at September 30, 2001. However, domestic commercial loan net charge-offs and nonperforming loans increased $227 million and $767 million, respectively, during the same periods.
Lending-Related Commitments: JPMorgan Chase also has an allowance for its lending-related commitments, using a methodology similar to that used for the loan portfolio. This allowance, which is reported in Other Liabilities, was $283 million at September 30, 2001 and December 31, 2000 and was $304 million at September 30, 2000.
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MARKET RISK MANAGEMENT
Aggregate VAR Exposure
Value-at-Risk (“VAR”) is a measure of the dollar amount of potential loss from adverse market moves in an everyday market environment. VAR calculations are performed for all material trading and investment portfolios and for market risk-related asset/liability management (“A/L”) activities. Due to procedural differences at the heritage firms, combined VAR is not available for periods prior to the merger date.
Although no single risk statistic can reflect all aspects of market risk, the tables that follow provide an overview of the market risk exposure of JPMorgan Chase at the dates indicated. The following table represents JPMorgan Chase’s average and period-end VARs for its trading portfolios and its A/L activities.
Aggregate Portfolio
Market Risk-Related Activities
Value-at-Risk: JPMorgan Chase is exposed to interest rate, foreign exchange, equity and commodity market risks in its trading portfolio. The table below reflects VAR data for the trading portfolio by risk category. See the Aggregate VAR Exposure section above for average and period-end VARs for the total trading portfolio.
Marked-to-Market Trading Portfolio (a)
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Histogram:
The following histogram illustrates JPMorgan Chase’s daily market risk-related revenue, which is defined as the daily change in value of the marked-to-market trading portfolios plus any trading-related net interest income, brokerage commissions, underwriting fees or other revenue.
In the first nine months of 2001, JPMorgan Chase posted positive daily market risk-related revenue for 166 out of 189 business days, with 134 days exceeding positive $20 million. Losses were sustained on 23 of the 189 days represented in the histogram. JPMorgan Chase incurred five daily trading losses in excess of $20 million in the first nine months of 2001.
Stress Testing: Whereas VAR captures exposure to unlikely events in normal markets, stress testing discloses market risk under plausible events in abnormal markets.
The following table represents the potential stress test loss (pre-tax) in JPMorgan Chase’s trading portfolio predicted by JPMorgan Chase’s stress test scenarios.
Largest Monthly Stress Test Loss – Pre-Tax
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Investment Portfolio and Asset/Liability Activities
JPMorgan Chase is exposed to market risk in its investment portfolio and A/L activities. Market risk measurements for JPMorgan Chase’s investment portfolio and A/L activities reflect all significant market risk-related factors that have an effect on these activities. Non-market factors that are not included in market risk measurements, such as changes in credit quality, also may have an effect on these activities.
Value-at-Risk: See the VAR Aggregate Exposure section on page 42 for JPMorgan Chase’s average and period-end VARs for its investment portfolio and market risk-related A/L activities.
Stress Testing:Economic value stress testing measures the potential change in the market value of JPMorgan Chase’s investment portfolio and A/L activities. As of September 30, 2001, the largest potential loss under the various economic value stress test scenarios utilized by the Firm on the value of JPMorgan Chase’s investment portfolio and A/L activities would have been equivalent to 1% of JPMorgan Chase’s market capitalization.
The NII stress test measures the potential change in JPMorgan Chase’s interest earnings over a one-year time horizon. At September 30, 2001, JPMorgan Chase’s largest potential NII stress test loss was estimated to be approximately 1.3% of projected net income for the full-year 2001.
Nonstatistical Risk Measures: Exposure to interest rate risk is assessed using a Basis Point Value (“BPV”) method. BPV measures the change in market value of JPMorgan Chase’s investment portfolio and A/L activities to a one basis point increase in interest rates (directional risk) or one basis point widening of interest rate spreads (basis risk). The table that follows shows that JPMorgan Chase had a directional BPV of $(1.5) million (pre-tax) at September 30, 2001. This indicates that the market value of JPMorgan Chase’s A/L positions would have declined by approximately $1.5 million for every one basis point increase in interest rates along the interest rate yield curve. The table also shows that the economic value of JPMorgan Chase’s investment portfolio and A/L activities would have decreased by $11.0 million (pre-tax) for every one basis point widening of interest rate spreads (basis risk).
Market Risk-Related A/L Activities
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CAPITAL MANAGEMENT
The following discussion of JPMorgan Chase’s capital management focuses primarily on the developments since December 31, 2000 and should be read in conjunction with pages 44-45 and Note 23 of JPMorgan Chase’s 2000 Annual Report.
Capital
JPMorgan Chase’s capital levels at September 30, 2001 continued to exceed regulatory guidelines. At September 30, 2001, the Tier 1 and Total Capital ratios were 8.2% and 11.6%, respectively. In addition, at September 30, 2001, all of JPMorgan Chase’s subsidiary depository institutions were “well-capitalized” under bank regulatory agencies’ definitions. The Firm’s ratios were negatively affected as a result of market disruptions following the events of September 11th. Management estimates that the Firm experienced balance sheet growth of approximately $86 billion and risk-weighted asset growth of approximately $21 billion in the period between September 11, 2001 and September 30, 2001.
The following table shows JPMorgan Chase’s capital generation and use during the periods indicated.
In the first quarter of 2001, JPMorgan Chase raised the quarterly cash dividend on its common stock to $0.34 per share from $0.32 per share. The Firm’s current dividend policy is to pay over time common stock dividends equal to approximately 25% to 35% of operating earnings less preferred stock dividends, although in any given quarter the common stock dividend may be higher or lower than this range. The current quarterly dividend exceeds the target range given this quarter’s lower operating earnings. Future dividend policies will be determined by JPMorgan Chase’s Board of Directors after taking into consideration the Firm’s earnings, financial condition and applicable governmental regulations and policies.
On July 19, 2001, JPMorgan Chase’s Board of Directors authorized the repurchase of up to $6 billion of the Firm’s common stock. As of September 30, 2001, the Firm had repurchased, net of stock issuances, approximately $500 million of the Firm’s common stock.
At September 30, 2001, the total capitalization of JPMorgan Chase (the sum of Tier 1 and Tier 2 Capital) was $54.6 billion, an increase of $1.2 billion from December 31, 2000. This increase reflects retained earnings (net income less common and preferred dividends) generated during the period, aggregate common stock issuances and treasury stock reissuances of $1.2 billion and the issuance of an aggregate $2.5 billion in trust preferred capital securities and subordinated debt. These sources of capital were partially offset by the repurchase of common stock and the redemption of preferred stock and subordinated debt.
LIQUIDITY RISK MANAGEMENT
The following discussion of JPMorgan Chase’s liquidity risk management focuses primarily on the developments since December 31, 2000 and should be read in conjunction with page 59 of JPMorgan Chase’s 2000 Annual Report.
Liquidity
During the first nine months of 2001, JPMorgan Chase issued approximately $8.5 billion of long-term debt and $500 million of trust preferred capital securities. During the same period, $9.8 billion of long-term debt matured or was redeemed, and $0.5 billion of preferred stock was called.
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As a result of the events of September 11th, the Consolidated Balance Sheet increased $86 billion to $799 billion at September 30, 2001 from $713 billion at June 30, 2001, primarily due to the securities industry’s temporary delay in clearing and settling cash and securities. The balance sheet growth is primarily composed of federal funds sold/purchased, trading assets and failed to deliver/receive securities (Other Assets/Other Liabilities). Management of JPMorgan Chase expects a reduction in balance sheet levels once the market returns to a more normal environment.
OPERATIONAL RISK MANAGEMENT
For a discussion of JPMorgan Chase’s operational risk management, refer to page 58 of JPMorgan Chase’s 2000 Annual Report.
SUPERVISION AND REGULATION
The following discussion should be read in conjunction with the Supervision and Regulation section on pages 1 through 6 of JPMorgan Chase’s 2000 Form 10-K.
Dividends
JPMorgan Chase’s bank subsidiaries, without the approval of their relevant banking regulators, could pay dividends to their respective bank holding companies in amounts up to the limitations imposed upon such banks by regulatory restrictions. These dividend limitations, in the aggregate, totaled approximately $4.8 billion at September 30, 2001.
ACCOUNTING DEVELOPMENTS
Legal Isolation
In July 2001, the FASB issued a Technical Bulletin that would delay the effective date of SFAS 140 for certain provisions that impact entities subject to possible receivership by the FDIC. For those entities, the Technical Bulletin delays the isolation standards of SFAS 140 until at least December 31, 2001. The Firm currently is reviewing its transactions to determine what modifications will be required to conform with SFAS 140 and the Technical Bulletin.
Business Combinations and Intangible Assets
In June 2001, the FASB issued SFAS 141, which revises the financial accounting and reporting for business combinations, and also issued SFAS 142, which revises the financial accounting and reporting for goodwill and other intangible assets. SFAS 141 requires that all business combinations be accounted for using the purchase method. Accounting for business combinations using the pooling of interests method no longer is allowed. SFAS 141 also requires that intangible assets acquired in a business combination be recognized apart from goodwill if the intangible assets meet one of two criteria — the contractual-legal criterion or the separability criterion. The provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001 as well as business combinations accounted for by the purchase method for which the date of acquisition is July 1, 2001 or later. Certain transition provisions could affect the accounting for business combinations using the purchase method that were completed before July 1, 2001.
SFAS 142 establishes how intangible assets (other than those acquired in a business combination) should be accounted for upon acquisition. It also addresses how goodwill and other intangible assets should be accounted for subsequent to their acquisition. Goodwill and intangible assets that have indefinite useful lives no longer will be amortized but will be tested at least annually for impairment. Intangible assets with finite lives will continue to be amortized over their useful lives. The provisions of SFAS 142 are required to be adopted by the Firm beginning January 1, 2002. Impairment losses that arise due to the initial application of SFAS 142 are required to be reported as a change in accounting principle.
The Firm currently is assessing the impact of SFAS 141 and SFAS 142 on its financial condition and operating performance. The Firm has not yet determined the extent of goodwill impairment, if any, that may be recognized upon the adoption of SFAS 142. Based on current levels of amortization expense, the Firm estimates that the elimination of goodwill amortization expense will reduce total noninterest expense by approximately $580 million during 2002.
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J.P. MORGAN CHASE & CO.FINANCIAL HIGHLIGHTS(in millions, except per share data and ratios)
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J.P. MORGAN CHASE & CO.CONSOLIDATED AVERAGE BALANCE SHEET, INTEREST AND RATES(Taxable-Equivalent Interest and Rates; in millions, except rates)
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J.P. MORGAN CHASE & CO.QUARTERLY CONSOLIDATED STATEMENT OF INCOME(in millions, except per share data)
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J.P. MORGAN CHASE & CO.QUARTERLY CONSOLIDATED BALANCE SHEET(in millions)
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GLOSSARY OF TERMS
The page numbers included after each definition represent the pages in this Form 10-Q where the term primarily is used.
Basis Point Value (“BPV”): This measurement quantifies the change in the market value of JPMorgan Chase’s assets and liabilities (that are not part of its trading activities) that would result from a one basis point change in interest rates or one basis point widening of interest rate spreads. (Page 44)
Cash Operating Earnings: Operating earnings excluding the impact of the amortization of intangibles. (Pages 13-16, 18-21, 23, 25-28, 45 and 47)
Cash Overhead Ratio: Noninterest expense, excluding amortization of intangibles, as a percentage of the total of net interest income and noninterest revenue (excluding merger and restructuring costs and special items). (Pages 19, 23, 25-26, 34 and 47)
Chase USA: Chase Manhattan Bank USA, National Association. (Page 12)
FASB: Financial Accounting Standards Board. (Page 46)
Managed Credit Card Receivables or Managed Basis: JPMorgan Chase uses this terminology to refer to its credit card receivables on the balance sheet plus credit card receivables that have been securitized. (Pages 14, 17, 26, 36-37, 40 and 47)
Merger: The term refers to the December 31, 2000 merger of The Chase Manhattan Corporation and J.P. Morgan & Co. Incorporated. (Pages 7-8, 13, 15-19, 29, 34-35, 42, 47 and 50)
Operating Basis or Operating Earnings: Reported results excluding the impact of credit card securitizations, merger and restructuring costs, special items and the net effect of a change in accounting principle. (Pages 13-19, 21, 23, 25-31, 33-35, 45 and 47)
Overhead Ratio: Noninterest expense as a percentage of the total of net interest income and noninterest revenue (excluding merger and restructuring costs and special items). (Pages 19 and 34)
SFAS: Statement of Financial Accounting Standards.
SFAS 107: “Disclosures about Fair Value of Financial Instruments.” (Page 13)
SFAS 115: “Accounting for Certain Investments in Debt and Equity Securities.” (Page 7)
SFAS 133: “Accounting for Derivative Instruments and Hedging Activities.” (Pages 7, 10-11, 14, 47 and 50)
SFAS 140: “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities – a replacement of FASB Statement No. 125.” (Page 46)
SFAS 141: “Business Combinations.” (Page 46)
SFAS 142: “Goodwill and Other Intangible Assets.” (Page 46)
Shareholder Value Added (“SVA”): Represents cash operating earnings minus preferred dividends and an explicit charge for capital. (Pages 13-14, 19, 21, 23, 25-26 and 47)
Special Items: The first nine months of 2001 included $1,682 million (pre-tax) in merger and restructuring expenses and the cumulative effect of a transition adjustment of $(25) million (after-tax) related to the adoption of SFAS 133. Special items in the first nine months of 2000 include a $176 million (pre-tax) loss resulting from the economic hedge of the purchase price of Flemings prior to its acquisition, $129 million (pre-tax) in merger and restructuring costs and an $81 million (pre-tax) gain from the sale of a business in Panama. (Pages 13-18, 34, 45 and 47)
Stress Testing: Discloses market risk under plausible events in abnormal markets. (Pages 43 and 44)
Value-at-Risk (“VAR”): A measure of the dollar amount of potential loss from adverse market moves in an everyday market environment. (Pages 42, 43 and 44)
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This Form 10-Q contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of JPMorgan Chase's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. These uncertainties include: the risk that the tragic events of September 11, 2001 and their aftermath will have an adverse effect upon markets and businesses in general and exacerbate the following additional risks and uncertainties: the risk of adverse movements or volatility in the debt and equity securities markets or in interest or foreign exchange rates or indices; the risk of adverse impacts from an economic downturn; the risk of a downturn in domestic or foreign securities and trading conditions or markets; the risks involved in deal completion including an adverse development affecting a customer or the inability by a customer to receive a regulatory approval; the risks associated with increased competition; the risks associated with unfavorable political and diplomatic developments in foreign markets or adverse changes in domestic or foreign governmental or regulatory policies; the risk that the merger integration will not be successful or that the revenue synergies and cost savings anticipated from the merger may not be fully realized or may take longer to realize than expected; the risk that the integration process may result in the disruption of ongoing business or in the loss of key employees or may adversely affect relationships with employees, clients or suppliers; the risk that the credit, market, liquidity, and operational risks associated with the various businesses of JPMorgan Chase are not successfully managed; or other factors affecting operational plans. Additional factors that could cause JPMorgan Chase's results to differ materially from those described in the forward-looking statements can be found in the 2000 Annual Report on Form 10-K of J.P. Morgan Chase & Co., filed with the Securities and Exchange Commission and available at the Securities Exchange Commission's internet site (http://www.sec.gov).
Any forward-looking statements made by or on behalf of the Firm in this Form 10-Q speak only as of the date of this Form 10-Q. 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 statement was made. The reader should, however, consult any further disclosures of a forward-looking nature JPMorgan Chase may make in its Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q and its Current Reports on Form 8-K.
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Part II – OTHER INFORMATION
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Part II — OTHER INFORMATION (continued)
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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INDEX TO EXHIBITS
SEQUENTIALLY NUMBERED
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