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.
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 each of the issuer’s classes of common stock on April 30, 2002.
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 2001 Annual Report on Form 10-K of J.P. Morgan Chase & Co. filed with the Securities and Exchange Commission.
2
Part IItem 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.
3
Part IItem 1 (continued)
J.P. MORGAN CHASE & CO.CONSOLIDATED BALANCE SHEET(in millions, except share data)
4
J.P. MORGAN CHASE & CO.CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(in millions, except per share data)
5
J.P. MORGAN CHASE & CO.CONSOLIDATED STATEMENT OF CASH FLOWS(in millions)
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – BASIS OF PRESENTATION
The accounting and financial reporting policies of J.P. Morgan Chase & Co. (“JPMorgan Chase” or “the Firm”) 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 the accounting and reporting guidelines prescribed by bank regulatory authorities. The unaudited consolidated financial statements prepared in conformity with GAAP require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expense, and disclosure of contingent assets and liabilities. In addition, certain amounts have been reclassified to conform with current methodologies. In the opinion of management, all necessary 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 2001 Annual Report on Form 10-K (“2001 Annual Report”), with the exception of Note 2 in this Form 10-Q, “Goodwill and Other Intangibles.”
Special-Purpose Entities
Refer to Note 1 of the 2001 Annual Report for a further description of special-purpose entities (“SPE”) and the Firm’s policy on consolidation relating to these entities.
As detailed in the 2001 Annual Report, JPMorgan Chase categorizes SPE transactions as follows: securitizations, commercial paper conduits, and client intermediation. Assets sold to SPEs as part of the Firm’s consumer and commercial securitization activities are generally not reflected in JPMorgan Chase’s balance sheet (except for retained interests and the Providian Master Trust, as described in Note 7 in this Form 10-Q, Loan Securitizations), but are included on the balance sheet of the SPE purchasing the assets. Assets held in securitization-related SPEs as of March 31, 2002 and December 31, 2001 were as follows:
For commercial paper conduits and certain client intermediation vehicles, primarily structured loan vehicles as described in the 2001 Annual Report, JPMorgan Chase provides contingency liquidity. JPMorgan Chase Bank has commitments to provide liquidity to these vehicles in an amount up to $39.2 billion of commercial paper issuance at March 31, 2002, versus $41.9 billion as of December 31, 2001. The Firm would be required to fund these commitments in the event these vehicles could not issue commercial paper. As of March 31, 2002, these vehicles had issued commercial paper of $28.4 billion, compared with $29.3 billion as of December 31, 2001. For certain of the commercial paper conduits, JPMorgan Chase provides limited credit enhancement through the issuance of letters of credit. JPMorgan Chase’s obligations under these letters of credit are secondary to the first risk of loss provided by the client or other third parties; for example, by the over-collateralization of the SPE with assets sold to it. As of March 31, 2002 and December 31, 2001, commitments under these letters of credit totaled $3.4 billion. Both the liquidity commitments and the letters of credit are included in the Firm’s commitments to lend described in more detail in Note 16 in this Form 10-Q and in the discussion of Liquidity Risk Management in the 2001 Annual Report. JPMorgan Chase has other contractual relationships with SPEs it structures, primarily derivative contracts. These contracts are captured in the Firm’s balance sheet in Trading assets or Trading liabilities in the same manner as other derivative contracts and are marked-to-market through Trading revenue. Fees received from administrative functions related to these SPEs (underwriter, trustee, custodian, etc.) are included when earned in Fees and commissions.
The Firm may also enter into transactions with SPEs structured by other parties. These transactions can include, for example, acting as derivative counterparty, liquidity provider, investor, underwriter, trustee or custodian. JPMorgan Chase records and reports these positions similar to any other third party transaction. JPMorgan Chase receives arm’s-length fees for services provided.
The Firm has no commitments to issue its own stock to support an SPE transaction. The Firm’s transactions with SPEs have been conducted at arm’s-length and reflect market pricing. Consistent with this policy, no JPMorgan Chase employee is permitted to invest in the SPEs with which the Firm is involved.
7
NOTE 2 – GOODWILL AND OTHER INTANGIBLES
Effective January 1, 2002, the Firm adopted SFAS 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 requires that goodwill and other intangible assets with an indefinite life no longer be amortized, but instead be tested for impairment at least annually. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. There was no impairment of goodwill upon adoption of SFAS 142. Additionally, upon adoption, JPMorgan Chase reclassified certain intangible assets from Goodwill to All Other Intangibles. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.
The following table presents the impact of SFAS 142 on net income and earnings per share had the accounting standard been in effect for the first quarter of 2001.
During the first quarter of 2002, the Firm acquired approximately $16 million of goodwill in its acquisition of an institutional trust services business. Goodwill was not impaired nor written-off during the quarter. As of March 31, 2002, the Firm had goodwill of $7,924 million. Goodwill by business segment is as follows: Investment Bank, $2,017 million; Investment Management & Private Banking, $4,076 million; Treasury & Securities Services, $947 million; JPMorgan Partners, $377 million; and Retail & Middle Market Financial Services, $507 million.
All of the Firm’s acquired intangible assets are subject to amortization. Purchased credit card relationships increased by approximately $1 billion during the first quarter of 2002 primarily due to the acquisition of the Providian Master Trust, which has an estimated useful life of seven years. Intangible assets amortization expense was $69 million for the first quarter of 2002. The intangible assets listed below do not include Mortgage Servicing Rights; amortization of mortgage servicing rights is recorded as a reduction of mortgage servicing revenues within Fees and Commissions. See Note 8 for a discussion of Mortgage Servicing Rights.
The components of intangible assets were as follows:
Amortization expense for the net carrying amount of intangible assets at March 31, 2002 is estimated to be $258 million for the remainder of 2002 (exclusive of the $69 million in the first quarter), $307 million in 2003, $287 million in 2004, $275 million in 2005, and $258 million in 2006.
8
NOTE 3 – TRADING ASSETS AND LIABILITIES
For a discussion of the accounting policies relating to trading assets and liabilities, see Note 3 of JPMorgan Chase’s 2001 Annual Report.
The following table presents trading assets and trading liabilities for the dates indicated.
NOTE 4 – INTEREST INCOME AND INTEREST EXPENSE
The following table details the components of interest income and interest expense.
9
NOTE 5 – MERGER AND RESTRUCTURING COSTS
The following table shows the components of merger and restructuring costs incurred during the first quarters of 2002 and 2001.
The following table shows the utilization of the $1.25 billion merger-related charge recorded on December 31, 2000 and the $300 million right-sizing charge recorded September 30, 2001, during the first quarter of 2002.
For a further discussion of JPMorgan Chase’s merger and restructuring costs, refer to Note 6 and page 44 of JPMorgan Chase’s 2001 Annual Report.
NOTE 6 – SECURITIES
For a discussion of the accounting policies relating to securities, see Note 7 of JPMorgan Chase’s 2001 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:
10
NOTE 7 — LOAN SECURITIZATIONS
JPMorgan Chase securitizes, sells and services residential mortgage, credit card, automobile and commercial loans. Interests in the securitized and sold loans are generally retained in the form of senior or subordinated interest-only strips, subordinated tranches, escrow accounts and servicing rights. Refer to Note 9 of the 2001 Annual Report for further information and policies regarding loan securitizations.
During the first quarter of 2002, JPMorgan Chase securitized approximately $2.4 billion of residential mortgage loans, $1.0 billion of credit card loans and $2.0 billion of automobile loans, resulting in pre-tax gains on securitizations of $12 million, $7 million and $2 million, respectively. During the first quarter of 2001, JPMorgan Chase securitized approximately $1.2 billion of residential mortgage loans, $0.9 billion of credit card loans, and $1.2 billion of commercial loans, resulting in pre-tax gains on securitizations of $48 million, $4 million, and $9 million, respectively. In addition, JPMorgan Chase sold residential mortgage loans totaling $16.4 billion and $7.6 billion during the first quarters of 2002 and 2001, respectively, primarily as GNMA, FNMA and Freddie Mac mortgage-backed securities, which sales resulted in gains of $60 million and $28 million, respectively.
On February 5, 2002, JPMorgan Chase acquired the Providian Master Trust consisting of credit card receivables of approximately $7.9 billion and related relationships. Accounting guidance requires such receivables to be reflected on JPMorgan Chase’s balance sheet until such receivables are either paid off or revolve and the resulting new receivables are sold to investors. As of March 31, 2002, $6.4 billion remained on the balance sheet.
At March 31, 2002 and December 31, 2001, JPMorgan Chase had $4.4 billion and $3.9 billion, respectively, related to its undivided interest in its Chase Credit Card Master Trust. JPMorgan Chase also maintains escrow accounts up to predetermined limits for some of its residential mortgage, credit card and automobile securitizations in the unlikely event that deficiencies in cash flows owed to investors occur. The amounts available in such escrow accounts totaled $4 million, $502 million and $96 million as of March 31, 2002 for residential mortgage, credit card and automobile securitizations, respectively, and $1 million, $341 million and $79 million as of December 31, 2001, respectively. In addition, the Firm had other retained interests as of March 31, 2002 and December 31, 2001 totaling $984 million and $1.0 billion from its residential mortgage, $115 million and $38 million from its credit card, $186 million and $141 million from its automobile securitizations, and $66 million and $66 million from its commercial securitizations, respectively. These retained interests are primarily subordinated or residual interests, which are carried at fair value on the Firm’s balance sheet.
The table below outlines the key economic assumptions and the sensitivity of the fair value at March 31, 2002 of the remaining retained interests to immediate 10% and 20% adverse changes in those assumptions:
11
The sensitivity analysis in the preceding table is hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10% and 20% variation in assumptions generally cannot easily be extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
NOTE 8 — MORTGAGE SERVICING RIGHTS
For a further description of mortgage servicing rights (“MSR”), see Note 10 of the 2001 Annual Report. The following table summarizes the changes in residential MSRs.
Interest rate derivatives and AFS securities are used to manage the interest rate risk of the residential mortgage servicing rights. As of January 1, 2001, certain interest rate derivatives qualify as fair value hedges under SFAS 133 which results in recording adjustments to the carrying value of the MSRs. In addition, certain derivatives and AFS securities are used to further mitigate the interest rate risk inherent in the MSRs.
For the quarter ended March 31, 2002, the value of the MSRs increased due to a SFAS 133 valuation adjustment of $338 million, partly offset by an increase in the change in the valuation allowance due to impairment of $162 million. The net increase in revenue was offset by total losses of $245 million relating to a combination of derivative losses, including those that qualify as SFAS 133 hedges, and realized losses from sales of AFS securities.
For the quarter ended March 31, 2001, the decrease in revenue resulting from SFAS 133 valuation adjustments of $495 million and the change in the valuation allowance due to impairment of $335 million totaled $830 million. These losses were substantially offset by total gains of $794 million relating to a combination of derivative gains, including those that qualify as SFAS 133 hedges, and realized gains from sales of AFS securities.
NOTE 9 — SUBORDINATED DEFERRABLE INTEREST DEBENTURES
At March 31, 2002, 12 wholly owned Delaware statutory business trusts established by JPMorgan Chase had issued an aggregate $5,439 million in capital securities, net of discount. For a discussion of the business trusts, see Note 11 in JPMorgan Chase’s 2001 Annual Report. During the 2002 first quarter, J.P. Morgan Chase Capital X issued $1 billion of capital securities having a stated maturity of February 15, 2032 and bearing an interest rate of 7.00%, payable quarterly commencing on May 15, 2002. There were no other issuances or redemptions of capital securities during the first quarter 2002.
NOTE 10 — PREFERRED STOCK OF SUBSIDIARY
On February 28, 2002, Chase Preferred Capital Corporation redeemed all 22 million outstanding shares of its 8.10% cumulative preferred stock, Series A, at a redemption price per share of $25 plus accrued and unpaid dividends.
NOTE 11 — EARNINGS PER SHARE
For a discussion of JPMorgan Chase’s earnings per share (“EPS”), see Note 15 of the 2001 Annual Report. For the calculation of basic and diluted EPS for the first quarter ended March 31, 2002 and 2001, see Exhibit 11 on page 53.
12
NOTE 12 — 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.
NOTE 13 — CAPITAL
For a discussion of the calculation of risk-based capital ratios, see Note 21 of JPMorgan Chase’s 2001 Annual Report.
The following table presents the risk-based capital ratios for JPMorgan Chase and its significant banking subsidiaries. At March 31, 2002, the Firm and each of its depository institutions, including those listed in the table below, were “well-capitalized” as defined by banking regulators.
13
NOTE 14 — COMMITMENTS AND CONTINGENCIES
For a discussion of legal proceedings, see Part II, Item 1 of this Form 10-Q.
NOTE 15 — ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The majority of JPMorgan Chase’s derivatives are entered into for trading purposes. 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 24 and page 51 of the JPMorgan Chase 2001 Annual Report.
The following table presents derivative instrument and hedging related activities for the periods indicated.
NOTE 16 — OFF-BALANCE SHEET LENDING-RELATED FINANCIAL INSTRUMENTS
JPMorgan Chase utilizes lending-related financial instruments as one method by which to meet the financing needs of its customers. JPMorgan Chase issues commitments to extend credit, standby letters of credit and guarantees and also provides securities-lending services to its customers. For lending-related financial instruments, the contractual amount of the financial instrument represents the maximum potential credit risk to JPMorgan Chase if the counterparty does not perform according to the terms of the contract. A large majority of these commitments expire without being drawn upon. As a result, total contractual amounts are not representative of the Firm’s actual future credit exposure or liquidity requirements.
As with on-balance sheet extensions of credit, management computes specific and expected loss components as well as a residual component for off-balance sheet lending-related commitments. At March 31, 2002 and December 31, 2001, the Allowance for credit losses related to off-balance sheet lending-related commitments, which is reported in Other liabilities, was $281 million and $282 million, respectively.
The following table summarizes the contractual amounts relating to JPMorgan Chase’s off-balance sheet lending-related financial instruments at March 31, 2002 and December 31, 2001:
14
NOTE 17 — FAIR VALUE OF FINANCIAL INSTRUMENTS
For a discussion of JPMorgan Chase’s fair value methodologies, see Note 27 of JPMorgan Chase’s 2001 Annual Report. The following table presents the financial assets and liabilities valued under SFAS 107.
NOTE 18 — SEGMENT INFORMATION
JPMorgan Chase is organized into five major businesses: Investment Bank, Treasury & Securities Services, Investment Management & Private Banking, 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 is currently evaluated by the Firm’s management. For a further discussion concerning JPMorgan Chase’s business segments, see Segment Results in the Management’s Discussion and Analysis (“MD&A”) section of this Form 10-Q on pages 19 through 28.
JPMorgan Chase uses Shareholder Value Added (“SVA”) and Operating Earnings as its principal measures of franchise profitability. A 12% cost of capital is used for all businesses except JPMorgan Partners, which has a 15% cost of capital. See Segment Results in the MD&A on page 28 and Note 29 of JPMorgan Chase’s 2001 Annual Report for a further discussion of performance measurements and policies for cost allocation. The following table provides the Firm’s segment results for first quarter 2002 and 2001.
15
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.
16
Part IItem 2
MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Highlights: Reported net income was $982 million, or $0.48 per share, in the first quarter of 2002. This compared with $1,199 million, or $0.58 per share, in the first quarter of 2001.
First quarter 2002 operating earnings were $0.57 per share, compared with $0.17 in the fourth quarter of 2001 and $0.74 in the first quarter of 2001. Operating earnings were $1,150 million in the first quarter 2002, compared with $356 million in the fourth quarter of 2001 and $1,527 million one year ago. Operating earnings for 2001 have been adjusted by adding back amortization of goodwill to present 2001 results on a basis comparable to this year’s first quarter, which included the impact of the implementation of SFAS 142.
Operating earnings in the 2002 first quarter were negatively affected by three broad trends. The first trend was the deterioration in credit quality of the consumer and commercial loan portfolios. Commercial net charge-offs were 127 bp of the commercial loan portfolio and nonperforming commercial assets increased $347 million from year-end. Consumer net charge-offs were 2.22% in the 2002 first quarter and 1.98% in the fourth quarter of 2001. The second trend adversely affecting first quarter earnings was the continued decline in private equity valuations, which resulted in negative earnings at JPMorgan Partners. Finally, the continued weakness in capital markets activities, particularly in the IPO and M&A marketplace, adversely affected revenues at the Investment Bank. Investment banking fees of $741 million represented the lowest quarterly total in the last three years.
Nevertheless, during the first quarter 2002, there was significant progress by other areas of the Firm. First quarter results reflected very strong revenue growth in Retail & Middle Market Financial Services (“RMMFS”) and improved margins in Investment Management & Private Banking (“IMPB”). Earnings at RMMFS at $526 million for the quarter represented 25% growth from the first quarter of 2001. IMPB earnings increased 30% from the fourth quarter of 2001 as a result of lower expenses which increased the pre-tax operating margin to 22%.
In addition, despite the challenging capital market environment, the Investment Bank maintained leadership positions in loan syndication and investment-grade bonds and, for the first time, ranked as the third leading underwriter of stocks and bonds globally. Management believes there are early indications that credit quality has begun to stabilize and that private equity exit opportunities, although muted, have begun to improve across several industries, particularly in the industrial and consumer sectors. Loan loss provisions equaled net charge-offs in the 2002 first quarter, in contrast to the fourth quarter of 2001 where provisions of $650 million in excess of charge-offs were recorded.
17
Part IItem 2 (continued)
Finally, during the first quarter, the Firm continued to be focused on maintaining expense and capital discipline. Operating expenses in the first quarter of 2002, although higher than the fourth quarter of 2001, included $106 million in nonmerger-related severance costs, $78 million related to the settlement of litigation with Sumitomo Corporation and $46 million in operating costs related to the acquisition of the Providian Master Trust. Management is targeting lower operating expenses for full year 2002 versus full-year 2001. In addition, strong capital and liquidity positions remained a priority for the Firm. Until the revenue environment becomes stronger, management will continue to maintain a Tier 1 capital ratio that is somewhat higher than the announced long-term target of 8.0%-8.25% and to take actions to raise additional liquidity and to extend the average maturities of the Firm’s debt obligations. Management continues to believe these actions will enable the Firm to produce higher returns when the economy more fully recovers.
RECONCILIATION OF REPORTED TO OPERATING RESULTS
The Firm prepares its financial statements using generally accepted accounting principles (“GAAP”). This presentation is referred to as the “reported basis.” The Firm also analyzes its results on an “operating basis” which starts with the reported GAAP results and then excludes the impact of merger and restructuring costs and special items. For a further discussion on the reconciliation between reported and operating results, see page 27 of the 2001 Annual Report.
The following summary table provides a reconciliation between the Firm’s reported and operating results.
18
19
INVESTMENT BANK
For a discussion of the business profile of the Investment Bank, see pages 30-31 of the JPMorgan Chase 2001 Annual Report. The following table sets forth selected financial data of the Investment Bank.
The Investment Bank had operating earnings of $755 million in the 2002 first quarter, more than double the fourth quarter of 2001 but 27% lower than the first quarter of 2001. Operating ROE was 16% for the 2002 first quarter compared with 8% for the 2001 fourth quarter and 21% for the first quarter of 2001. The decline in earnings relative to the first quarter of last year reflected a 16% decline in revenues and an $187 million increase in credit costs, partially offset by a 17% decline in expenses. In comparison with the fourth quarter of 2001, revenue growth of 17% and lower credit costs of 54% drove the doubling of earnings.
Trading revenues (including related net interest income) of $1.70 billion increased 66% from the fourth quarter of 2001 which included the impact of $359 million in losses relating to Enron and Argentina. In comparison with last year’s strong first quarter, trading revenues declined 19% primarily due to lower equity trading revenues as a result of lower client activity and lower volatility. In addition, fixed income trading was lower when compared with the first quarter of 2001 as strong credit trading results in the quarter were offset by lower interest rate trading, reflecting reduced opportunities from declining rates that existed one year ago.
Investment banking fees were $741 million in the 2002 first quarter, the lowest quarterly level in the last three years. The declines from each of the fourth and first quarters of 2001 reflected continued weakness in the M&A and equity underwriting markets as well as lower loan syndication activity. For the quarter, leadership positions were maintained in syndicated lending (#1) and high-grade bonds (#2), in a much weaker environment.
20
Fees and commissions of $380 million in the 2002 first quarter increased by 5% from the fourth quarter of 2001 but declined 10% from the first quarter of 2001. The year-on-year decline was primarily due to lower commissions from equity brokerage activities.
Operating expenses for the 2002 first quarter of $2.12 billion increased by 14% from the fourth quarter of 2001 but declined 17% from the first quarter of last year. Expenses in the first quarter 2002 included incremental costs associated with the Sumitomo settlement and severance-related costs beyond the previously planned merger and restructuring costs. Operating expenses also increased from the fourth quarter in part due to higher incentives linked to improved revenues and earnings. Despite the expense pressures created by the severance costs and litigation settlement, the overhead ratio for the 2002 first quarter was 58% reflecting ongoing productivity and expense management initiatives. These expense initiatives are intended to allow the Investment Bank to make strategic investments despite the current revenue environment. The first quarter’s overhead ratio is lower than the Investment Bank’s announced target of 60% and demonstrates the Investment Bank’s discipline in managing expenses particularly in light of the effect of higher credit costs on earnings.
TREASURY & SECURITIES SERVICES
For a discussion of the profiles for each business within Treasury & Securities Services (“T&SS”), see pages 32-33 of JPMorgan Chase’s 2001 Annual Report. The following table sets forth selected financial data of Treasury & Securities Services.
Treasury & Securities Services had operating earnings of $141 million in the first quarter of 2002, 14% lower than the 2001 fourth quarter and 16% lower than the first quarter of 2001. Despite the lower earnings in the first quarter, the operating ROE was 19%.
Operating revenues were $935 million in the first quarter of 2002, down 1% from the 2001 fourth quarter and down 2% from the first quarter of 2001. Revenues at Investor Services declined 10% from the first quarter of 2001 as a result of weak global equity markets and lower asset levels, reduced international money flows and lower business activity. Institutional Trust Services revenues increased 6% from both the fourth and first quarters of 2001 reflecting the impact of an acquisition, partially offset by slower fixed income activity. Treasury Services revenues were down 5% from the fourth quarter but up 4% from the first quarter of 2001, as the effect of lower interest rates was offset by higher overall deposit levels resulting from increased business volumes.
21
Operating expenses rose 4% from the 2001 fourth quarter and 3% from the first quarter of 2001. With continued pressure on revenue growth, each of the businesses are focusing on expense initiatives. In particular, Investor Services is evaluating the right level of staffing and infrastructure, with several Six Sigma projects underway.
T&SS’s overhead ratio for the first quarter was 77%, up from 73% in both the fourth and first quarters of 2001. In the 2002 first quarter, the Firm adopted EITF 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred,” which principally impacted the T&SS business. This adoption caused T&SS’s first quarter 2002 revenues and expenses each to increase by $51 million which had the effect of increasing the overhead ratio by 1.4%. Results for 2001 were restated for this adoption, which increased T&SS’s revenues and expenses by $52 million in the first quarter and $217 million for the full year. As a result of this change, the target overhead ratio of 65% for T&SS will be increased by 1.5-2.0%.
RETAIL & MIDDLE MARKET FINANCIAL SERVICES
For a description of Retail & Middle Market Financial Services (“RMMFS”) and a discussion of the profiles for each business, see pages 38-40 of JPMorgan Chase’s 2001 Annual Report. The following table reflects selected financial data for RMMFS.
Retail & Middle Market Financial Services had record operating earnings of $526 million for the first quarter of 2002, up 59% from the 2001 fourth quarter and an increase of 25% from the first quarter of 2001. Operating ROE for the first quarter was 22%, compared with 14% in the fourth quarter of 2001 and 20% for the first quarter of 2001.
Operating revenues of $3.13 billion (including $152 million of revenues from the Providian Master Trust card portfolio) were up 7% and 18% from the fourth and first quarters of 2001, respectively. Credit card outstandings grew 31% to $49 billion. Internally generated new accounts exceeded 900,000 for the quarter. Mortgage originations totaled $33 billion in the quarter, down from $50 billion in the 2001 fourth quarter but up from the first quarter of 2001. Auto finance originations were a record $5.8 billion in the first quarter of 2002, up 2% from the fourth quarter of 2001 and 34% over the first quarter of 2001. Total RMMFS deposits were up 5% and 14% from the fourth and first quarters of 2001, respectively, as economic uncertainty and interest rate decreases have caused customers to seek liquidity. As a result, deposit balances have grown at higher than normal rates.
Operating expenses of $1.56 billion increased by 4% from the fourth quarter of 2001 and by 13% from the first quarter of 2001. The increases reflected the impact of the Providian Master Trust acquisition as well as higher expenses related to production volumes. Partially offsetting these increases were savings related to Six Sigma and other productivity programs. The overhead ratio for the first quarter was 50%, compared with 51% for the fourth quarter and 52% last year.
Credit costs of $726 million were 22% lower than the 2001 fourth quarter, which included $250 million in provision in excess of charge-offs, but were 22% higher than the first quarter of 2001, partially due to higher outstandings.
22
The following table sets forth certain key financial performance measures of the businesses within RMMFS.
Cardmember Services
Cardmember Services’ operating earnings of $147 million in the first quarter of 2002 increased 50% from the comparable quarter of last year reflecting the February 5, 2002 acquisition of the Providian Master Trust. Operating revenues rose 35% from the first quarter of last year driven by lower funding costs, a higher level of receivables as well as higher credit card fees. Fees reflected higher transaction volume (customer purchases, cash advances and balance transfers), as well as higher levels of delinquencies, which increased late fees. The decline in operating earnings from the fourth quarter of 2001 reflected the normal seasonal decline from peak purchase volume in the holiday season. Operating revenues increased 7% from the fourth quarter of 2001 due to the Providian acquisition. The overhead ratio decreased from first quarter 2001 to 35% due to strong revenue growth, including the positive impact of the Providian acquisition.
The managed net charge-off rate was 5.82% for the first quarter of 2002, an increase of 26 basis points from the fourth quarter of 2001, resulting from increased bankruptcies and contractual charge-offs partially offset by higher outstandings. The loss rate associated with the Providian card portfolio was only 6.3% for the two months, reflecting purchases of non-impaired accounts. For the remainder of the year, the Providian credit card receivables will contribute to a higher managed charge-off rate versus the prior year.
Regional Banking Group
Regional Banking Group’s first quarter 2002 operating revenues of $731 million declined 9% and operating earnings were lower by 12% from last year. The decline in operating revenue reflected the low interest rate environment, which unfavorably affected the net interest earned on deposit balances, despite a growth of 12% in the overall level of retail deposits. Partially offsetting the decline were higher fee revenues associated with deposit service fees and volume growth in the Chase Banking Card. Operating revenues decreased 2% from the fourth quarter of 2001, while operating earnings increased from the fourth quarter of 2001 due to lower credit costs. The overhead ratio increased from the same period last year to 74% as a result of lower revenue, primarily due to lower interest rates, and higher expenses.
Home Finance
Home Finance’s operating revenues and operating earnings increased 46% and 50%, respectively, for the first quarter of 2002 over the same period in the prior year. Revenue growth was fueled by a strong housing market and the positive impact of lower interest rates, which resulted in improved warehouse spreads and lower funding costs on mortgage servicing rights (“MSR”) and contributed to an 8% growth in servicing balances. Originations (residential, home equity and manufactured housing) for the first quarter of 2002 were $33 billion and included originations from the retail, wholesale and correspondent (traditional and negotiated) channels. The mortgage servicing portfolio was $425 billion at March 31, 2002. The overhead ratio decreased to 55% from the same quarter last year due to strong revenue growth.
23
Middle Markets
Middle Market’s operating revenues in the 2002 first quarter were up 2% from the first quarter of 2001 and up 7% from the fourth quarter of 2001. The positive impact of the higher interest-earning asset levels was partly offset by the effect of the narrower spreads earned on deposits, driven by the low interest rate environment. Also contributing to the higher revenues was the increase in fees earned from deposit transactions as a result of more clients choosing to pay fees for their transactions rather than maintaining high levels of deposit balances that would earn minimal interest. The increase in operating earnings of over 20% versus both periods in 2001 was primarily attributable to the higher revenues and lower credits costs. The overhead ratio remained relatively flat compared with the prior year due to steady revenue growth in proportion to expenses.
Auto Finance
Auto Finance’s operating revenues increased 53% from 2001’s first quarter and 4% from the fourth quarter of 2001. The revenue increase was principally due to record growth of 34% in originations relative to the first quarter of last year and a favorable interest rate environment.
Operating earnings increased 39% from last year’s first quarter, which was positively affected by the growth in the portfolio, record number of originations at higher spreads and increased efficiency in expenses. Operating earnings decreased 14% from the 2001 fourth quarter due to increased credit costs. The overhead ratio for the first quarter 2002 was 34%, decreasing from the prior year as a result of higher revenue growth in relation to a steady increase in originations.
INVESTMENT MANAGEMENT & PRIVATE BANKING
For a discussion of the business profile of Investment Management & Private Banking (“IMPB”) see pages 34-35 of JPMorgan Chase’s 2001 Annual Report. The following table reflects selected financial data for IMPB.
Investment Management & Private Banking had operating earnings of $126 million, up 30% from the 2001 fourth quarter and 19% better than the first quarter of 2001. Lower expenses led to an increase in the pre-tax margin in the first quarter of 2002 to 22% compared with 16% in each of the fourth and first quarters of 2001. The return on common equity was 8% in the first quarter of 2002 (return on tangible common equity, which eliminates goodwill capital, improved to 27%).
Operating revenues of $741 million in the first quarter were better than the 2001 fourth quarter but 10% lower than the first quarter of 2001. Revenues decreased due to lower assets under management, reduced earnings on deposits and brokerage, but were aided by investment performance fees and placement fees on alternative investments. Operating expenses of $557 million for the first quarter of 2002 were 5% lower than the 2001 fourth quarter and down 19% from last year’s first quarter reflecting the impact of staffing, compensation and other cost reductions taken in 2001. Lower loan quality, due to persistent economic weakness, led to a $24 million year-on-year increase in credit costs within the Private Bank.
24
The table below reflects the assets under management in IMPB as of March 31, 2002.
Total assets under management at quarter-end of $583 billion were 4% lower than the prior quarter, and 4% lower than the first quarter of 2001. Higher assets under management in retail mutual funds reflected growth across all asset classes, with particular strength in the international sector, where inflows were at a five-quarter high. This growth was more than offset by outflows within the institutional segment, primarily from lower-fee money market funds. In the retail segment, JPMorgan Fleming international mutual funds received 82 awards for performance including Best Overall Group and Best-Mixed Asset Manager (Source: Lipper, March 2002).
JPMORGAN PARTNERS
For a discussion of the business profile of JPMorgan Partners, see pages 36-37 of the JPMorgan Chase 2001 Annual Report. The following table sets forth selected financial data of JPMorgan Partners.
JPMorgan Partners had an operating loss of $248 million for the 2002 first quarter compared with an operating loss of $345 million in the 2001 fourth quarter and a small operating loss of $4 million in the first quarter of 2001.
25
Total private equity gains (losses) for the first quarter 2002 was a negative $255 million. During the quarter there were net unrealized losses of $242 million, principally due to the decline in value of Triton PCS. Hedging put in place to partially offset fluctuations in the values of public securities contributed $47 million in gains in the first quarter. Realized losses in the quarter were $13 million which was the net of cash gains of $167 million offset by $180 million of write-offs on direct and fund investments. Total private equity results were negative $398 million in the 2001 fourth quarter but a positive $139 million in the first quarter of 2001. Private equity exit opportunities remain muted in most sectors.
26
JPMorgan Partners Investment Portfolio
The following table presents the carrying values and costs of the JPMP investment portfolio for the dates indicated.
The following table presents information about the 10 largest holdings of public securities in the JPMP investment portfolio at March 31, 2002:
Technology, media and telecommunications (“TMT”) investments at March 31, 2002 were $2.1 billion, or 24% of the total portfolio, down from 27% at 2001 year-end. Management’s goal is to continue to decrease TMT investments as a percentage of the total portfolio while increasing the industrial and consumer sectors.
The Firm believes that JPMP will continue to create value over time. Given the volatile nature of the markets, and the Nasdaq market in particular, JPMP’s reported results for any period may include significant public securities unrealized gains or losses. The Firm makes no assumptions about the unrealized gains or losses that may be experienced by the JPMP portfolio. JPMP’s investment pace continues to be slow at $139 million during the first quarter of 2002 with deal flow primarily in the life sciences industry.
27
SUPPORT UNITS AND CORPORATE
JPMorgan Chase’s support units include Enterprise Technology Services, Corporate Business Services, legal, audit and finance. For a further discussion of the business profiles of these Support Units as well as a description of Corporate, see page 41 of JPMorgan Chase’s 2001 Annual Report.
For the first quarter of 2002, Support Units and Corporate had an operating loss of $150 million, a positive variance of $47 million relative to the prior year period. Included in the first quarter of 2001 was a net loss of $50 million at LabMorgan, primarily as a result of investment write-offs. In comparison to the fourth quarter, first quarter 2002 improved by $107 million due to a net loss of approximately $58 million that was included in the fourth quarter related to LabMorgan investments.
CRITICAL ACCOUNTING POLICIES
The Firm’s accounting policies are integral to understanding the results reported. The Firm’s most complex accounting policies require management’s judgment to ascertain the valuation of certain assets and liabilities. The Firm has established detailed policies and control procedures that are intended to ensure valuation methods are well-controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The Firm’s most critical accounting policies involving the more significant management valuation judgments involve the accounting for the allowance for loan losses and for the fair value of financial instruments. For a further description of the types of judgments and estimates required in these accounting policies, see page 41 and the Notes to Consolidated Financial Statements in the 2001 Annual Report.
28
RESULTS OF OPERATIONS
The following section provides a discussion of JPMorgan Chase’s results of operations both on a reported and operating basis. The differences between reported and operating basis are the treatment of revenues from credit card securitizations and the reclassification of trading-related net interest income (“NII”) to trading revenue.
Investment Banking Fees
Investment banking fees of $755 million in the first quarter of 2002 declined $186 million from the comparable quarter of last year. The decline reflected the continuing weakness in mergers and acquisitions advisory activities, as well as equity securities issuances. Despite the decline, however, the Firm continued to gain market share and ranked as the third-leading underwriter of stocks and bonds globally in the first quarter of 2002 (according to Thomson Financial). For a further description of Investment Banking fees, see the Investment Bank segment discussion.
Trading-Related Revenue
In the first quarter of 2002, trading-related revenue, which includes $421 million of net interest income pertaining to trading activities, declined $447 million from the same period a year ago. The decline from the 2001 first quarter was due to lower equity trading revenue, reflecting lower client activity and lower volatility, as well as lower fixed-income trading revenue, reflecting reduced opportunities when compared with the declining rate environment that existed last year. For a further discussion, see the trading-related revenue discussion in the Investment Bank segment.
Fees and Commissions
Fees and commissions for first quarter 2002 increased 20% on an operating basis when compared with first quarter 2001. The table below provides the significant components of fees and commissions.
29
Investment Management, Custody and Processing Services
Investment management, custody and processing services fees declined from the first quarter 2001 reflecting lower values of assets under management and securities under safekeeping and fewer cross-border movements of securities. Growth in retail mutual funds across all asset classes was more than offset by outflows within the institutional segment, primarily outflows from lower-fee money market funds.
Credit Card Revenue
The increase in credit card revenue (operating basis) of $112 million, or 29%, over last year’s same period was attributable to the growth in the number of active credit card accounts and in average receivables outstanding by over $9 billion at March 31, 2002. The acquisition of the Providian Master Trust, which closed in February 2002, contributed to the higher revenues in the first quarter. The growth in the number of accounts led to increased transaction volume, higher interchange income, and higher overlimit and balance consolidation fees. Also contributing to the increase in fees were the late charges stemming from the rise in customer 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).
Brokerage and Investment Services
Brokerage and investment services in the first quarter of 2002 were lower by $59 million than in the first quarter of 2001. The decline reflected the weaker markets in 2002 which contributed to fewer opportunities to earn agency commissions from institutional and retail brokerage transactions.
Mortgage Servicing Fees
In comparison with the first quarter of 2001, mortgage servicing fees of $48 million in the 2002 first quarter were $281 million higher than last year, principally reflecting the significant improvement in the impairment charges for the value of MSRs. The improvement in impairment charges was attributable to the more stable interest rate environment versus last year.
As a result of the adoption of SFAS 133, the results of certain hedging transactions related to the value of the MSRs are recorded within this line. In last year’s first quarter, sales of debt securities were used as economic hedges of the value of MSRs at Home Finance. Total securities gains in the 2001 first quarter were $315 million and were recognized in the securities gains line (as discussed on the following page).
Deposit Service Charges
Deposit service charges in the first quarter of 2002 rose $64 million or 28% from last year’s same quarter. Aside from the higher transaction volume, the increase in fees reflected the impact of the lower interest rates that prompted institutional customers to pay for the deposit services rather than maintain a higher level of account balances that would earn minimal interest.
Other Fees
Other fees of $233 million in the 2002 first quarter increased $37 million from last year largely due to the acquisitions of Providian Master Trust and an institutional trust services business, which contributed to higher credit card-related insurance commissions and servicing fees related to corporate trust activities, respectively. Also contributing to the increase was the higher commissions earned from the sales of variable annuities.
30
Private Equity Gains
Private equity had a net loss of $238 million in the first quarter of 2002, compared with a net gain of $127 million in the prior year’s same quarter. Included in the 2002 first quarter were realized losses of $10 million, and unrealized losses of $228 million driven by the decline in the value of Triton PCS. Gains on hedges partially offset the loss in the value of public securities held by JPMP. The Firm may change the nature and type of hedges it enters into with respect to its private equity portfolio, as well as close a hedging position altogether, at any point in time. For a further discussion of the Firm’s private equity results, see the JPMP line of business results on page 25 of this Form 10-Q.
Securities Gains
Securities gains of $114 million in the first quarter of 2002 were significantly lower than the $455 million recognized in the same quarter a year ago. The decline primarily reflected last year’s $315 million gain on the sale of securities that were used as economic hedges for the value of mortgage servicing rights at Home Finance. In the first quarter of 2001, the value of the available-for-sale securities in the portfolio of Home Finance rose substantially as a result of the downward movement in the interest rates that prevailed at that time.
Other Revenue
The net gains on residential mortgage activities (which include originations and sales of loans) were relatively flat compared with the prior year’s equivalent quarter, reflecting the continued strength of the housing market driven by the favorable interest rate environment.
All other revenue of $37 million declined significantly from the first quarter of 2001. The first quarter of 2002 included writedowns of $57 million of Latin American investments and unfavorable valuation adjustments of $19 million related to held-for-sale (“HFS”) commercial loans. The first quarter of 2001 included $65 million of gains on the sale of several nonstrategic businesses in Texas, as well as several retail properties in New York.
Net Interest Income
Operating NII adjusts reported NII for the impact of credit card securitizations and trading-related NII considered part of total trading-related revenue. The following table reconciles reported and operating NII.
Net interest income on both reported and operating basis increased from the first quarter of last year as a result of the continued low interest rate environment. The favorable rate environment led to an increase in managed interest-earning assets, specifically domestic consumer loans such as credit card receivables, auto loans and residential mortgages. Also contributing to the increase in net interest income was the impact of wider spreads on certain interest-earning assets as the funding costs to carrying these assets declined faster than the interest income earned on them.
31
NONINTEREST EXPENSE
Total operating noninterest expense for the quarter was $5.1 billion, down 8% from the first quarter of 2001. The decline from the same quarter of last year was principally due to the expense management and productivity initiatives that were implemented to reduce expense levels given the weak market environment and continuing merger savings due to system integration efforts. The initiatives included containing incentives, which decreased 34% relative to last year’s first quarter. The lower incentive expense was partially offset by the settlement costs of the Sumitomo litigation, the severance-related costs beyond the planned merger and restructuring costs and the incremental expenses related to the acquisition of Providian. The following table presents the components of noninterest expense on an operating and reported basis.
Compensation Expense
In the first quarter of 2002, compensation expense was $2,823 million, 15% lower than last year’s first quarter. The decline in expense was driven by the alignment of incentives with the decrease in revenues, as well as the net reduction in the number of full-time equivalent employees, particularly in areas affected by the merger, such as the Investment Bank and Investment Management & Private Banking. The decline was partly offset by the impact of annual salary increases, the aforementioned severance-related costs and new employees from businesses that were acquired after the first quarter of 2001.
The Firm had 96,938 full-time equivalent employees at March 31, 2002 compared with 98,518 at the same period last year. The decline in the number of employees was attributable to the right-sizing of positions at the Investment Bank, Investment Management & Private Banking and Corporate Support units. The decline was partly offset by the recently hired employees at Retail & Middle Market Financial Services and Treasury & Securities Services that was necessitated by the growth in their volume of activities.
Occupancy Expense
In the 2002 first quarter, Occupancy expense declined slightly from last year’s comparable period due to rental expense savings derived from the consolidation of offices and relocations of certain functions from New York City to New Jersey and the southern regions of the United States. The savings were partially offset by the impact of the additional space required by higher business volume at several businesses, as well as the marginal escalation in building maintenance and administration costs.
Technology and Communications Expense
Technology and communications expense in the first quarter of 2002 increased slightly when compared with the same period last year. Software expense increased due to the purchase of the technologies necessary to support more sophisticated hardware systems, and telecommunications expense grew as a result of the higher utilization of telephones and improvements in network connections. These were offset by the lower costs for leasing and maintaining workstations and lower expenses for noncapitalized hardware.
32
Amortization of Intangibles
The increase of $33 million (operating basis) in the amortization of intangibles for the first quarter of 2002 was primarily the result of the acquisition of the Providian Master Trust, which included credit card relationship intangibles. For a further discussion of the amortization of intangibles and the expected level of expense for the remainder of the year, see Note 2.
Other Expense
Other expenses rose only 5% from the first quarter of 2001. The following table presents the components of other expense.
Merger and Restructuring Costs
During the first quarter of 2002, the Firm incurred $255 million of restructuring costs relating to previously announced merger actions, right-sizing, and other restructuring costs ($211 million) and relocation costs ($44 million). Under current accounting pronouncements, these costs are not recognized until incurred. For further details of JPMorgan Chase’s merger and restructuring costs, refer to Note 5 of this Form 10-Q and page 44 of JPMorgan Chase’s 2001 Annual Report.
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.
Credit costs in the first quarter of 2002, when compared with the first quarter of 2001, increased as a result of higher charge-offs in the retained portfolio and on securitized credit cards. See pages 35-38 for a discussion of charge-offs associated with the consumer and commercial loan portfolios and pages 34-39 for a discussion of the allowance for credit losses.
INCOME TAXES
JPMorgan Chase recognized income tax expense of $505 million on income before the effect of an accounting change in the first quarter of 2002, compared with $656 million in the first quarter of 2001. The effective tax rates for the periods were 34% and 35%, respectively.
33
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 business, liquidity and private equity risk. For a discussion of these risks and definitions of terms associated with managing these risks, see pages 45-62 and the Glossary of Terms in the 2001 Annual Report.
The following discussion of JPMorgan Chase’s credit risk profile as of March 31, 2002 focuses primarily on developments since December 31, 2001 and should be read in conjunction with pages 47-54 and 75-77 of JPMorgan Chase’s 2001 Annual Report.
The following table presents the Firm’s credit-related information for the dates indicated.
JPMorgan Chase’s managed credit-related assets were $301 billion at March 31, 2002, a decrease of 3% and 4% compared with December 31, 2001 and March 31, 2001, respectively. Commercial loans decreased 3% and 10% from year-end 2001 and March 31, 2001, respectively, reflecting in part the Firm’s on-going discipline of originating loans for distribution and its strategy to reduce its commercial credit exposure. Derivative and foreign exchange instruments decreased 11% and 20% compared with year-end 2001 and March 31, 2001, respectively.
Consumer managed credit-related assets increased $2.0 billion, reflecting growth in the credit card portfolio due in large part to the Providian Master Trust acquisition, offset in part by a decline in the residential mortgage warehouse portfolio as a result of increased loan sales.
34
The portion of commercial credit-related assets considered investment grade was approximately 65% at March 31, 2002, unchanged from year-end 2001. Including unfunded commercial commitments, the portion of the portfolio considered investment grade was 77%, also unchanged from year-end 2001.
Total nonperforming assets were $4.31 billion at March 31, 2002, which included $1.13 billion in Enron-related surety receivables and letter of credit. Excluding this amount, which is the subject of litigation with credit-worthy entities, nonperforming assets totaled $3.18 billion. This compares to $2.79 billion at December 31, 2001 and $2.23 billion as of March 31, 2001. The increase in nonperforming assets from year-end was primarily related to one foreign commercial credit.
Total net charge-offs in the Firm’s managed commercial and consumer portfolio were $1,074 million in the first quarter of 2002, flat compared with the fourth quarter of 2001. An increase in consumer charge-offs were offset by lower charge-offs in the commercial portfolio.
35
The risk profile of the Firm’s total commercial credit exposure at March 31, 2002 (loans, derivatives and unfunded commitments) was 77% investment grade equivalent, unchanged from December 31, 2001.
The following sections reflect discussions relating to the specific loan categories within the commercial portfolio:
Commercial and Industrial: The domestic commercial and industrial portfolio decreased $2.7 billion from 2001 year-end. Net charge-offs in the 2002 first quarter were $191 million, compared to $392 million in the prior quarter. Nonperforming domestic commercial and industrial loans were $1,321 million, an increase of $135 million from the 2001 year-end. The foreign commercial and industrial portfolio totaled $33.6 billion at March 31, 2002, relatively flat compared to year-end 2001. Nonperforming foreign commercial and industrial loans were $924 million, an increase of $245 million from year-end 2001. Net charge-offs in the foreign commercial and industrial loan portfolio for the first quarter of 2002 increased to $103 million from $38 million in the prior quarter.
Financial Institutions: Loans to financial institutions remained level during 2002, when compared with year-end. Nonperforming financial institution loans decreased from $56 million to $29 million.
Derivative and Foreign Exchange Contracts
For a discussion of the derivative and foreign exchange contracts utilized by JPMorgan Chase in connection with its trading and Assets/Liabilities (“A/L”) activities, see Note 15 of this Form 10-Q, and page 51 and Note 24 of JPMorgan Chase’s 2001 Annual Report. The following table provides the remaining maturities of derivative and foreign exchange contracts outstanding at March 31, 2002 and December 31, 2001.
The following table summarizes the risk profile, as of March 31, 2002, of the Firm’s derivative and foreign exchange contract balance sheet exposure, net of collateral held, taking into account cash and other highly liquid collateral held by the Firm. The Firm’s internal risk ratings generally represent a risk profile similar to that of the independent rating agencies; ratings are based upon the Firm’s internal obligor risk ratings and presented on a Standard & Poor’s-equivalent basis:
36
Country Exposure
During the first quarter of 2002, the Firm’s exposure to Mexico increased driven by increased trading activity. Exposure to Brazil declined by about $600 million due to reductions in deposit and counterparty derivatives exposures. In Argentina, the Firm continues to manage down its exposure and, as of March 31, 2002, the total exposure was $500 million (before loan loss allowance). In Japan, the Firm’s exposure declined due to fluctuations in trading activity and other short-term positions. The following table presents JPMorgan Chase’s exposure to selected countries. This disclosure is based on management’s view of country exposure. For a further discussion of the Firm’s country exposure, see page 52 of the 2001 Annual Report.
37
JPMorgan Chase’s consumer portfolio is primarily domestic and is geographically well-diversified. JPMorgan Chase’s managed consumer portfolio totaled $136.0 billion at March 31, 2002, an increase of approximately $2.0 billion since 2001 year-end. Consumer net charge-offs, on a managed basis, were $754 million and $540 million for the first quarter of 2002 and 2001, respectively. The increase is primarily due to an increase in credit card net charge-offs due, in part, to a higher level of outstandings.
The following sections are discussions relating to the specific loan categories within the consumer portfolio:
Residential Mortgage Loans: Residential mortgage loans were $54.5 billion at March 31, 2002, a $5.0 billion decrease from 2001 year-end. Nonperforming 1-4 family residential mortgage loans increased $71 million from year-end, primarily due to an increase in nonperforming loans in the sub-prime portion of the portfolio. The net charge-off rate of 0.09% for the first quarter of 2002 was relatively unchanged from first quarter 2001.
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 were approximately $48.0 billion for the first quarter of 2002, an increase of 18% when compared with year-end 2001 and includes a portfolio of credit card assets acquired from Providian in February 2002. During the 2002 first quarter, net charge-offs as a percentage of average credit card receivables increased to 5.87%, compared with 5.05% in the prior-year period. Loans over 90 days past due increased to 2.29% of the portfolio at March 31, 2002, compared with 2.22% at December 31, 2001. Management anticipates that the managed credit card net charge-off ratio for the full-year 2002 will be higher than full-year 2001, due in part to the contribution of the Providian card portfolio.
Auto Financings: Auto financings outstanding increased slightly at March 31, 2002, when compared with year-end 2001. Although increased from the prior year, the charge-off rate of 0.58% for the 2002 first quarter continues to be indicative of this portfolio’s selective approach to asset origination. Total originations were $5.8 billion for the first three months of 2002, compared with $4.3 billion for the comparable period in 2001.
Other Consumer Loans: Other consumer loans of $7.6 billion at March 31, 2002 remained comparable with year-end levels. The net charge-off rate related to this portfolio increased in the first quarter to 2.16% when compared with the first quarter of 2001, as a result of slightly higher manufactured housing charge-offs.
Allowance for Credit Losses
Loans: JPMorgan Chase’s allowance for loan losses is intended to cover probable credit losses as of March 31, 2002, 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. For a further discussion of the specific loss, expected loss and residual components of the allowance for loan losses, see page 54 of JPMorgan Chase’s 2001 Annual Report.
The total specific and expected allowance for commercial loan losses was $1,798 million at March 31, 2002, an increase of $74 million from the 2001 year-end.
The consumer expected loss component of approximately $2.5 billion increased 20% from the 2001 year-end reflecting the addition to the allowance relating to the Providian portfolio.
The residual component at March 31, 2002 was $689 million, essentially the same as the 2001 year-end. The residual component represented approximately 14% of the total allowance for loan losses.
Lower credit quality for the Firm’s loan portfolios are reflected in the allowance for credit losses, which was increased by $850 million from March 31, 2001; the remaining increase in the allowance reflects the addition of the Providian portfolio. The allowance represented 2.33% of loans at March 31, 2002, compared with 2.08% at December 31, 2001.
As of March 31, 2002, management deemed the allowance to be adequate (i.e., sufficient to absorb losses that currently may exist but are not yet identifiable).
38
Allowance Components
Lending-Related Commitments: JPMorgan Chase also has an allowance for its off-balance sheet lending-related commitments, using a methodology similar to that for the loan portfolio. This allowance, which is reported in Other Liabilities, was $281 million at March 31, 2002 and $283 million at March 31, 2001.
Aggregate VAR Exposure
JPMorgan Chase’s statistical market risk measure value-at-risk (“VAR”), gauges the dollar amount of potential loss from adverse market moves in an ordinary market environment. Each business day, the Firm undertakes a comprehensive VAR calculation that includes its trading and investment portfolios, plus all of its market risk-related A/L activities.
Although no single risk statistic can reflect all aspects of market risk, the following table provides a meaningful overview of the Firm’s market risk exposure arising from trading activities and the investment and A/L portfolio.
Aggregate portfolio
39
Histogram:
The following histogram illustrates JPMorgan Chase’s daily market risk-related revenue, which is defined as the daily change in value of the mark-to-market trading portfolios plus any trading-related net interest income, brokerage commissions, underwriting fees or other revenue. In the first quarter 2002, JPMorgan Chase posted positive daily market risk-related revenue for 58 out of 61 days, with 42 days exceeding positive $25 million. Losses were sustained on only three of the 61 days represented in the histogram. JPMorgan Chase incurred only one daily trading loss in excess of $20 million in the first quarter of 2002.
Average daily revenue: $39.1 million
Stress Testing
While VAR reflects the risk of loss due to unlikely events in normal markets, stress testing captures the Firm’s exposure to unlikely but plausible events in abnormal markets. For a further discussion of the Firm’s stress testing methodology, see page 56 of the 2001 Annual Report.
The following table represents the potential economic value stress test loss (pre-tax) in JPMorgan Chase’s trading portfolio predicted by JPMorgan Chase’s stress test scenarios.
40
Capital
JPMorgan Chase’s capital levels at March 31, 2002 continued to improve with ratios well in excess of regulatory guidelines. At March 31, 2002, the Tier 1 and Total Capital ratios were 8.6% and 12.5%, respectively, and the Tier 1 leverage ratio was 5.4%. At March 31, 2002, the total capitalization of JPMorgan Chase (the sum of Tier 1 and Tier 2 Capital) was $56.1 billion, an increase of $2.0 billion from December 31, 2001. Approximately half of the increase was due to changes in Tier 1 capital, principally reflecting $0.3 billion in retained earnings (net income less common and preferred dividends) generated during the period, the issuance of $1 billion in trust preferred securities, and the net stock issuance of $0.2 billion, partially offset by the redemption of $550 million in preferred stock of subsidiary. The remaining increase in total capital reflected increases in the subordinated debt and allowance for credit losses components of Tier 2 capital. The Firm did not repurchase shares of its common stock during the first quarter.
In the first quarter of 2002, JPMorgan Chase declared a quarterly cash dividend on its common stock of $0.34 per share payable April 30, 2002 to stockholders of record at the close of business April 5, 2002.
The following table shows JPMorgan Chase’s capital generation and use during the periods indicated.
41
Liquidity
During the first three months of 2002, JPMorgan Chase issued approximately $3.5 billion of long-term debt and $1 billion of trust preferred capital securities. During the same period, $5.7 billion of long-term debt matured or was redeemed, and $550 million of preferred stock of subsidiary was redeemed.
The maturity profile of JPMorgan Chase’s lending-related commitments did not change materially from that reported at December 31, 2001.
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 $2.5 billion at March 31, 2002.
42
J.P. MORGAN CHASE & CO.FINANCIAL HIGHLIGHTS(in millions, except per share data and ratios)
43
J.P. MORGAN CHASE & CO.CONSOLIDATED AVERAGE BALANCE SHEET, INTEREST AND RATES(Taxable-Equivalent Interest and Rates; in millions, except rates)
44
J.P. MORGAN CHASE & CO.QUARTERLY CONSOLIDATED STATEMENT OF INCOME(in millions, except per share data)
45
J.P. MORGAN CHASE & CO.QUARTERLY CONSOLIDATED BALANCE SHEET(in millions)
46
GLOSSARY OF TERMS
Chase USA: Chase Manhattan Bank USA, National Association.
FASB: Financial Accounting Standards Board.
Managed Credit Card Receivables or Managed Basis: JPMorgan Chase uses this terminology to refer to its credit card receivables on the balance sheet plus securitized credit card receivables.
Net Yield on Interest-Earning Assets: The average rate for interest-earning assets less the average rate paid for all sources of funds.
Operating Basis or Operating Earnings: Reported results excluding the impact of merger and restructuring costs, special items, credit card securitizations and the amortization of goodwill.
Overhead Ratio: Operating expense (excluding merger and restructuring costs and special items) as a percentage of the operating revenues.
SFAS: Statement of Financial Accounting Standards.
SFAS 107: “Disclosures about Fair Value of Financial Instruments.”
SFAS 133: “Accounting for Derivative Instruments and Hedging Activities.”
SFAS 142: “Goodwill and Other Intangible Assets.”
Shareholder Value Added (“SVA”): Represents operating earnings minus preferred dividends and an explicit charge for capital.
Special Items: The 2002 first quarter included $255 million (pre-tax) in merger and restructuring expenses. The 2001 first quarter included $328 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.
Stress Testing: Discloses market risk under plausible events in abnormal markets.
Value-at-Risk (“VAR”): A measure of the dollar amount of potential loss from adverse market moves in an everyday market environment.
47
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 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; the risks associated with adverse changes in domestic or foreign governmental or regulatory policies, including adverse interpretations of regulatory guidelines; the risk that material litigation or investigations will be determined adversely to the Firm; the risk that a downgrade in the Firm’s credit ratings will adversely affect the Firm’s businesses or investor sentiment; the risk that management’s assumptions and estimates used in applying the Firm’s critical accounting policies prove unreliable, inaccurate, or not predictive of actual results; 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, private equity, 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 2001 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.
Item 3 Quantitative and Qualitative Disclosures about Market Risk
For a discussion of the quantitative and qualitative disclosures about market risk, see the market risk management section of the MD&A on pages 39-40 of this Form 10-Q.
Part II – OTHER INFORMATION
Item 1 Legal Proceedings
J.P. Morgan Securities Inc. (“JPMSI”; formerly known as Chase Securities, Inc.) has been named as a defendant or third-party defendant in 16 actions that were filed in either the United States District Court for the Northern District of Oklahoma or in Oklahoma state court or New York state court beginning in October 1999 arising out of the failure of Commercial Financial Services, Inc. (“CFS”). Plaintiffs in these actions are institutional investors who purchased over $1.6 billion in original face amount of asset-backed securities issued by CFS. The securities were backed by delinquent credit card receivables. In addition to JPMSI, the defendants in various of the actions are the founders and key executives of CFS, as well as its auditors, its outside counsel and the rating agencies that rated the securities. JPMSI is alleged to have been the investment banker to CFS and to have acted as an initial purchaser and as placement agent in connection with the issuance of certain of the securities. Plaintiffs allege that defendants either knew or were reckless in not knowing that the securities were sold to plaintiffs on the basis of misleading misrepresentations and omissions of material facts. The complaints against JPMSI assert claims under the Securities Exchange Act of 1934, the Oklahoma Securities Act, and under common law theories of fraud and negligent misrepresentation. In the actions against JPMSI, damages in the amount of approximately $1.2 billion allegedly suffered as a result of defendants’ misrepresentations and omissions, plus punitive damages, are being claimed.
48
Part IIItem 1 (continued)
Beginning in May 2001, JPMorgan Chase and certain of its securities subsidiaries have been named, along with numerous other firms in the securities industry, as defendants in a large number of putative class action lawsuits filed in the United States District Court for the Southern District of New York. These suits purport to challenge alleged improprieties in the allocation of stock in various public offerings, including some offerings for which a JPMorgan Chase entity served as an underwriter. The suits allege violations of securities and antitrust laws arising from alleged material misstatements and omissions in registration statements and prospectuses for the initial public offerings and with respect to aftermarket transactions in the offered securities. The securities claims allege, among other things, misrepresentations concerning commissions paid to JPMorgan Chase and aftermarket transactions by customers who received allocations of shares in the respective initial public offerings. The antitrust claims allege an illegal conspiracy to require customers, in exchange for initial public offering allocations, to pay undisclosed and excessive commissions and to make aftermarket purchases of the initial public offering securities at a price higher than the offering price, as a precondition to receiving allocation. JPMorgan Chase also has received various subpoenas and informal requests from governmental and other agencies seeking information relating to initial public offering allocation practices. Recently, JPMSI was advised by the staff of the National Association of Securities Dealers (“NASD”) that it was considering recommending that disciplinary action be brought concerning activities of one of JPMSI’s predecessor entities (Hambrecht & Quist Group). JPMSI anticipates submitting to the NASD staff this month a letter outlining the basis for JPMSI’s position that no such action is warranted.
JPMorgan Chase continues to be involved in a number of lawsuits and investigations arising out of its banking relationships with Enron Corporation. The Firm initiated a lawsuit in New York in December 2001 against eleven insurance companies seeking payment under Enron-related surety bonds issued by these companies and a lawsuit in London against Westdeutsche Landesbank Girozentrale seeking to compel payment under an Enron-related letter of credit issued by the bank. On March 5, 2002, the court in New York denied the Firm’s motion for summary judgment against the insurance companies, ordered discovery, and set a trial date of December 2, 2002. JPMorgan Chase intends to pursue both litigations vigorously. Actions have also been initiated by other parties against JPMorgan Chase and its directors and certain of its officers. These lawsuits include a series of purported class actions brought on behalf of shareholders of Enron, captioned Newbie v. Enron Corp., and a series of purported class actions brought on behalf of Enron employees, captionedTittle v. Enron Corp., both of which are pending in Houston. The consolidated complaint filed in Newbie names as defendants, among others, JPMorgan Chase, several other investment banking firms, two law firms, Enron’s former accountants and affiliated entities and individuals and other individual defendants, including present and former officers and directors of Enron and purports to allege claims against JPMorgan Chase and the other defendants under federal and state securities laws. The Tittle complaint names as defendants, among others, JPMorgan Chase, several other investment banking firms, a law firm, Enron’s former accountants and affiliated entities and individuals and other individual defendants, including present and former officers and directors of Enron and purports to allege claims against JPMorgan Chase and certain other defendants under the Racketeer Influenced and Corrupt Organizations Act and state common law. Additional actions against JPMorgan Chase relating to Enron that have been filed as of May 1, 2002 include (i) purported class action lawsuits by JPMorgan Chase stockholders alleging that JPMorgan Chase issued false and misleading press releases and other public documents relating to Enron in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; (ii) purported shareholder derivative actions alleging breaches of fiduciary duties and alleged failures to exercise due care and diligence by the Firm’s directors and named officers in the management of JPMorgan Chase; (iii) a lawsuit filed by the Retirement Systems of Alabama alleging claims under the Alabama Securities Act and common law claims of fraud and unjust enrichment; (iv) a lawsuit filed by Unicredito Italiano (“Unicredito”) and its affiliate, Bank Pekao SA (“Bank Pekao”), alleging various common law claims relating to two credit agreements and a letter of credit and reimbursement agreement among Enron and a group of banks, including The Chase Manhattan Bank (predecessor to JPMorgan Chase Bank), Unicredito and Bank Pekao; and (v) a lawsuit filed in Texas state court by eight insurance companies and related entities asserting claims under Texas statutory and common law arising from alleged purchases of Enron securities. JPMorgan Chase believes that each of the lawsuits filed against the Firm, its directors and the named officers is without merit, and the Firm intends to defend each of these actions vigorously. In addition, a number of federal, state and local regulatory and law enforcement authorities and Congressional committees have initiated investigations of Enron and of certain of the Firm’s financial transactions with Enron. In that regard, the Firm has delivered, or is currently in the process of delivering, voluntarily and pursuant to subpoena, information to the House Energy and Commerce Committee, the Senate Government Affairs Committee, U.S. Representative Henry Waxman, the Securities and Exchange Commission, the Federal Reserve Bank of New York, the New York State Banking Department and the New York County District Attorney’s Office. The Firm intends to continue to cooperate with these authorities and with such other agencies and authorities as may request information from JPMorgan Chase.
49
In connection with its review of the independence of research analysts, the New York State Attorney General’s Office, the Securities and Exchange Commission, the National Association of Securities Dealers and the New York Stock Exchange have issued subpoenas to several financial services firms, including the Firm. The Firm is cooperating with this investigation.
In addition to the matters described above, JPMorgan Chase and its subsidiaries have been named from time to time as defendants in various legal actions and proceedings arising in connection with their respective businesses and have been involved from time to time in investigations and proceedings by governmental agencies. In view of the inherent difficulty of predicting the outcome of such matters, JPMorgan Chase cannot state what the eventual outcome of these pending matters will be, or of any other litigation, proceeding or investigation that may be brought against JPMorgan Chase in the future. JPMorgan Chase is contesting the allegations made in each pending matter and believes, based on current knowledge and after consultation with counsel, that the outcome of such matters will not have a material adverse effect on the consolidated financial condition of JPMorgan Chase, but may be material to JPMorgan Chase’s operating results for any particular period, depending on the level of JPMorgan Chase’s income for such period.
Item 2 Sales of Unregistered Common Stock
During the first quarter of 2002, shares of common stock of J.P. Morgan Chase & Co. were issued in transactions exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) thereof. Shares of common stock were issued to retired directors who had deferred receipt of such common stock pursuant to the Deferred Compensation Plan for Non-Employee Directors, as follows: January 2, 2002 – 3,340 shares. Shares of common stock were issued to retired employees who had deferred receipt of such common shares pursuant to the Corporate Performance Incentive Plan, as follows: January 31, 2002 – 1,491 shares; February 15, 2002 – 215 shares; March 26, 2002 – 177 shares.
Item 6 Exhibits and Reports on Form 8-K
JPMorgan Chase filed two reports on Form 8-K during the quarter ended March 31, 2002 as follows:
Form 8-K filed January 18, 2002: JPMorgan Chase announced fourth quarter and year-end 2001 results.
Form 8-K filed January 31, 2002: JPMorgan Chase announced the issuance of J.P. Morgan Chase Capital Securities X, Series J.
50
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.
51
INDEX TO EXHIBITS
SEQUENTIALLY NUMBERED
52