JPMorgan Chase - 10-Q quarterly report FY

JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the United States of America (“U.S.”), with $2.0 trillion in assets, $162.3 billion in stockholders’ equity and operations in more than 60 countries as of September 30, 2009. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing and asset management. Under the J.P. Morgan and Chase brands, the Firm serves millions of customers in the U.S. and many of the world’s most prominent corporate, institutional and government clients.

JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank, N.A.”), a U.S. national banking association with branches in 23 states; and Chase Bank USA, National Association (“Chase Bank USA, N.A.”), a national bank that is the Firm’s credit card-issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan Securities Inc., the Firm’s U.S. investment banking firm.

JPMorgan Chase’s activities are organized, for management reporting purposes, into six business segments, as well as Corporate/Private Equity. The Firm’s wholesale businesses comprise the Investment Bank, Commercial Banking, Treasury & Securities Services and Asset Management segments. The Firm’s consumer businesses comprise the Retail Financial Services and Card Services segments. A description of the Firm’s business segments, and the products and services they provide to their respective client bases, follows.

J.P. Morgan is one of the world’s leading investment banks, with deep client relationships and broad product capabilities. The clients of the Investment Bank (“IB”) are corporations, financial institutions, governments and institutional investors. The Firm offers a full range of investment banking products and services in all major capital markets, including advising on corporate strategy and structure, capital-raising in equity and debt markets, sophisticated risk management, market-making in cash securities and derivative instruments, prime brokerage and research. IB also selectively commits the Firm’s own capital to principal investing and trading activities.

Retail Financial Services (“RFS”), which includes the Retail Banking and Consumer Lending reporting segments, serves consumers and businesses through personal service at bank branches and through ATMs, online banking and telephone banking, as well as through auto dealerships and school financial-aid offices. Customers can use more than 5,100 bank branches (third-largest nationally) and 15,000 ATMs (second-largest nationally), as well as online and mobile banking around the clock. More than 22,400 branch salespeople assist customers with checking and savings accounts, mortgages, home equity and business loans, and investments across a 23-state footprint from New York and Florida to California. Consumers also can obtain loans through 15,900 auto dealerships and nearly 2,400 schools and universities nationwide.

Chase Card Services (“CS”) is one of the nation’s largest credit card issuers, with more than 146 million cards in circulation and more than $165 billion in managed loans. In the nine months ended September 30, 2009, customers used Chase cards to meet more than $241 billion worth of their spending needs. Chase has a market leadership position in building loyalty and rewards programs with many of the world’s most respected brands and through its proprietary products, including the Chase Freedom program.

Through Chase Paymentech Solutions, its merchant acquiring business, Chase is one of the leading processors of MasterCard and Visa payments.

Commercial Banking (“CB”) serves more than 26,000 clients nationally, including corporations, municipalities, financial institutions and not-for-profit entities with annual revenue generally ranging from $10 million to $2 billion, and approximately 30,000 real estate investors/owners. Delivering extensive industry knowledge, local expertise and dedicated service, CB partners with the Firm’s other businesses to provide comprehensive solutions, including lending, treasury services, investment banking and asset management to meet its clients’ domestic and international financial needs.

Treasury & Securities Services (“TSS”) is a global leader in transaction, investment and information services. TSS is one of the world’s largest cash management providers and a leading global custodian. Treasury Services (“TS”) provides cash management, trade, wholesale card and liquidity products and services to small and mid-sized companies, multinational corporations, financial institutions and government entities. TS partners with the Commercial Banking, Retail Financial Services and Asset Management businesses to serve clients firmwide. As a result, certain TS revenue is included in other segments’ results. Worldwide Securities Services holds, values, clears and services securities, cash and alternative investments for investors and broker-dealers, and it manages depositary receipt programs globally.

Asset Management (“AM”), with assets under supervision of $1.7 trillion, is a global leader in investment and wealth management. AM clients include institutions, retail investors and high-net-worth individuals in every major market throughout the world. AM offers global investment management in equities, fixed income, real estate, hedge funds, private equity and liquidity products, including money-market instruments and bank deposits. AM also provides trust and estate, banking and brokerage services to high-net-worth clients, and retirement services for corporations and individuals. The majority of AM’s client assets are in actively managed portfolios.

JPMorgan Chase reported third-quarter 2009 net income of $3.6 billion, compared with net income of $527 million in the third quarter of 2008. Earnings per share were $0.82, compared with $0.09 in the prior year. Return on common equity was 9%.

The increase in earnings from the third quarter of 2008 was driven by significantly higher net revenue, partially offset by an increase in the provision for credit losses and higher noninterest expense. Both revenue and expense were higher due to the impact of the acquisition of the banking operations of Washington Mutual Bank (“Washington Mutual”) on September 25, 2008. In addition, the increase in net revenue was driven by strong trading results and gains on legacy leveraged-lending and mortgage-related positions, compared with markdowns in the prior year in IB; gains on trading positions and higher net interest income in Corporate/Private Equity; and wider loan spreads across most businesses. The increase to the provision for credit losses resulted from a significant increase in the consumer provision, reflecting higher net charge-offs and an increase in the allowance for credit losses in the home lending and credit card loan portfolios. In addition to the impact of the Washington Mutual transaction, the increase in noninterest expense was driven by higher performance-based compensation expense, partially offset by lower headcount-related expense.

Net income for the first nine months of 2009 was $8.5 billion, or $1.51 per share, compared with $4.9 billion, or $1.30 per share, in the first nine months of 2008. The following factors that drove the 2009 third-quarter results also generally drove the increase in earnings from the comparable 2008 nine-month period: strong net revenue growth, driven by the Washington Mutual transaction; higher principal transactions revenue; and increased net interest income; partially offset by higher credit costs and higher noninterest expense. The first nine months of 2009 also reflected higher net revenue from mortgage servicing rights (“MSR”) risk management results in RFS and higher noninterest expense resulting from an accrual for an FDIC special assessment in the second quarter of 2009.

The U.S. and most other economies grew in the third quarter of 2009, with various industry sectors showing signs of stability. Conditions in financial markets also improved, as evidenced by the following: credit spreads have stabilized in the interbank term funding markets and continued to narrow for investment-grade borrowers; credit markets opened for noninvestment-grade borrowers; and the broader equity markets rose significantly. Activity in the housing sector increased, with new home construction picking up for the first time in three and a half years. Consumer spending stabilized, despite losses on household balance sheets and poor job market conditions, as the unemployment rate rose to 9.8% at the end of the third quarter. Business capital spending leveled out, aided by a slowing in the pace of inventory liquidation. Inflation remained low, and the Federal Reserve indicated that the federal funds rate would likely remain low for an “extended period,” reiterating its intent to continue to use a wide range of tools to promote economic recovery and maintain price stability.

JPMorgan Chase’s line-of-business results for the third quarter of 2009 reflected the broad-based nature of the economic improvement. Pre-provision profit remained strong at $13.2 billion, up by $9.6 billion from the prior year. Five of the six lines of business produced revenue growth, and the Investment Bank, Asset Management, Commercial Banking and the Retail Banking segment within Retail Financial Services grew net income. In contrast, Card Services and the Consumer Lending segment within Retail Financial Services reported net losses; in spite of initial signs of improvement, particularly in early-stage delinquencies, credit costs continued to be elevated in these businesses. Accordingly, the Firm increased its consumer allowance for credit losses by $2.0 billion, bringing the total allowance for credit losses to $31.5 billion, or 5.28% of total loans. This addition, combined with capital generation in the quarter, helped the Firm maintain a strong balance sheet, with a Tier 1 Capital ratio of 10.2% and a Tier 1 Common Capital ratio of 8.2%.

The Firm continued to help consumers and communities navigate the challenging economy by announcing a revamp of its overdraft policies to provide customers with more control over the fees they pay; developing new, innovative products in Card Services to enhance the way customers manage their spending and borrowing; and working with struggling mortgage customers to modify their loans. JPMorgan Chase has approved more than 262,000 new trial modifications under the U.S. Making Home Affordable Program and its own modification program, nearly 90% of which include a reduction in payments for the homeowner. Since 2007, the Firm has helped families by initiating approximately 782,000 actions to prevent foreclosure.

Investment Bank net income increased, reflecting higher net revenue partially offset by increases in both noninterest expense and the provision for credit losses. Fixed Income Markets drove the revenue growth, with strong results across most products and gains on legacy leveraged-lending and mortgage-related positions, compared with markdowns on these positions in the prior year. The increase in the provision for credit losses reflected deterioration in the credit environment compared with the third quarter of 2008. Noninterest expense increased, driven by higher performance-based compensation, partially offset by lower headcount-related expense.

Retail Financial Services net income declined, as an increase in the provision for credit losses was largely offset by the positive impact of the Washington Mutual transaction. Growth in net revenue was also driven by higher net mortgage servicing revenue, wider loan spreads and higher deposit balances, offset partially by lower mortgage production revenue and lower loan balances. The provision for credit losses rose significantly as weak economic conditions and housing price declines continued to drive higher estimated losses for the home equity and mortgage loan portfolios. Included in the third-quarter 2009 addition to the allowance for loan losses was an increase related to estimated deterioration in the Washington Mutual purchased credit-impaired portfolio. Noninterest expense increased, reflecting the impact of the Washington Mutual transaction and higher servicing expense, partially offset by lower mortgage reinsurance losses.

Card Services reported a net loss, compared with net income in the prior year. The decrease was driven by a higher provision for credit losses, partially offset by higher net revenue. The increase in net revenue was driven by the impact of the Washington Mutual transaction, wider loan spreads and higher merchant servicing revenue related to the dissolution of the Chase Paymentech Solutions joint venture. These benefits were offset partially by higher revenue reversals associated with higher charge-offs, lower average loan balances and a decreased level of fees. The provision for credit losses reflected a higher level of charge-offs and an increase in the allowance for loan losses. Noninterest expense increased due to the dissolution of the Chase Paymentech Solutions joint venture and the impact of the Washington Mutual transaction.

Commercial Banking net income increased, driven by higher net revenue, reflecting the impact of the Washington Mutual transaction, predominantly offset by a higher provision for credit losses and higher noninterest expense. Net revenue also increased due to wider loan spreads, a shift to higher-spread liability products, overall growth in liability balances and higher lending- and deposit-related fees. These benefits were offset predominantly by spread compression on liability products and lower loan balances. The increase in the provision for credit losses reflected continued deterioration in the credit environment across all business segments, particularly real estate-related segments. Noninterest expense rose due to the impact of the Washington Mutual transaction and higher FDIC insurance premiums.

Treasury & Securities Services net income decreased, driven by lower net revenue offset partially by lower noninterest expense. Worldwide Securities Services revenue declined, driven by lower securities lending balances, primarily as a result of declines in asset valuations and demand; lower spreads and balances on liability products; and the effect of market depreciation on certain custody assets. Treasury Services revenue declined as well, reflecting spread compression on deposit products offset by higher trade revenue driven by wider spreads, and higher card product volumes. Noninterest expense decreased, reflecting lower headcount-related expense, offset partially by higher FDIC insurance premiums.

Asset Management net income increased, due to higher net revenue and lower noninterest expense, offset partially by a higher provision for credit losses. Growth in net revenue was driven by gains on the Firm’s seed capital investments, wider loan spreads, higher deposit balances and net inflows. These benefits were partially offset by the effect of lower market levels, narrower deposit spreads, lower loan balances and decreased placement fees. The increase in the provision for credit losses reflected continued deterioration in the credit environment. Noninterest expense decreased due to lower headcount-related expense, offset by higher performance-based compensation and higher FDIC insurance premiums.

Corporate/Private Equity reported net income, compared with a net loss in the prior year, reflecting continued gains on trading positions, higher net interest income and private equity gains in the third quarter of 2009, compared with losses in the third quarter of 2008.

Firmwide, the managed provision for credit losses was $9.8 billion, up by $3.1 billion, or 47%, from the prior year. The prior-year quarter included a $2.0 billion charge to conform Washington Mutual’s allowance for loan losses, which affected both the consumer and wholesale portfolios. For the purposes of the following analysis, this charge is excluded. The consumer-managed provision for credit losses was $9.0 billion, compared with $4.3 billion in the prior year, reflecting an increase in the allowance for credit losses in the home lending and credit card loan portfolios. Consumer-managed net charge-offs were $7.0 billion, compared with $3.3 billion, resulting in managed net charge-off rates of 6.29% and 3.39%, respectively. The wholesale provision for credit losses was $779 million, compared with $398 million, reflecting continued deterioration in the credit environment. Wholesale net charge-offs were $1.1 billion, compared with $52 million, resulting in net charge-off rates of 1.93% and 0.10%, respectively. The Firm’s nonperforming assets totaled $20.4 billion at September 30, 2009, up from $9.5 billion. The allowance for credit losses increased by $1.6 billion during the quarter; this resulted in a loan loss coverage ratio at September 30, 2009, of 5.28%, compared with 5.01% at June 30, 2009, and 2.87% at September 30, 2008. The above mentioned net charge-off rates and allowance for loan loss ratios exclude loans accounted for at fair value and loans held-for-sale, and the impact of purchased credit-impaired loans. The allowance for loan loss ratios also excluded the impact of loans held by the Washington Mutual Master Trust, which were consolidated on the Firm’s balance sheet at fair value during the second quarter of 2009 and the $1.1 billion of allowance related to the purchased credit-impaired portfolio.

JPMorgan Chase’s outlook for the fourth quarter of 2009 should be viewed against the backdrop of the global and U.S. economies, financial markets activity, the geopolitical environment, the competitive environment and client activity levels. Each of these linked factors will affect the performance of the Firm and its lines of business. The Firm continues to monitor the global and U.S. economic environments. The outlook for the capital markets remains uncertain, and further declines in U.S. housing prices in certain markets and increases in the unemployment rate, either of which could adversely affect the Firm’s financial results, are possible. In addition, as a result of recent market conditions, the U.S. Congress and regulators have increased their focus on the regulation of financial institutions; any legislation or regulations that may be adopted as a result could limit or restrict the Firm’s operations, or impose additional costs on the Firm in order to comply with such new laws or rules.

Given the potential stress on the consumer from rising unemployment and continued downward pressure on housing prices, management remains cautious with respect to the credit outlook for the consumer loan portfolios. Possible continued deterioration in credit trends could result in higher credit costs and require additions to the consumer allowance for credit losses. Based on management’s current economic outlook, quarterly net charge-offs could reach $1.4 billion for the home equity portfolio, $600 million for the prime mortgage portfolio and $500 million for the subprime mortgage portfolio over the next several quarters. The managed net charge-off rate for Card Services (excluding the Washington Mutual credit card portfolio) could approach 10.5% by the first half of 2010, and thereafter will remain highly dependent on unemployment levels. The managed net charge-off rate for the Washington Mutual credit card portfolio could approach 24% over the next several quarters. These charge-off rates are likely to move even higher if the economic environment deteriorates beyond management’s current expectations. Similarly, wholesale credit costs, and net charge-offs could increase over the next several quarters if the credit environment continues to deteriorate.

The Investment Bank continues to operate in an uncertain environment and, as noted above, results could be adversely affected if the credit environment deteriorates further. Trading results can be volatile and recent market conditions, which include elevated client volumes and spread levels, are not likely to continue. As such, management does not expect recent strong results in both Fixed Income and Equity Markets segments to continue at the same levels. Finally, if the Firm’s own credit spreads tighten, as was the case in the third quarter of 2009, the change in fair value of certain trading liabilities would also negatively affect trading results.

Although management expects underlying growth in Retail Banking, results will be under pressure from the credit environment and ongoing lower consumer spending levels. In addition, there could be further declines over the remainder of the year in average retail deposits due to anticipated downward repricing of certain legacy Washington Mutual deposits. Finally, as a result of recent changes in the Firm’s policies relating to non-sufficient funds and overdraft fees, management expects lower Retail Banking revenue in 2010. Although management estimates are, at this point in time, preliminary and subject to change, the impact of such changes could result in an annualized reduction in net income of approximately $500 million.

Card Services faces rising credit costs, as noted above, as well as continued pressure on both charge volumes and credit card receivables growth, reflecting continued lower levels of consumer spending. In addition, as a result of the recently-enacted credit card legislation, management estimates, which are preliminary and subject to change, are that Card Services’ annual net income may be adversely affected by approximately $500 million to $750 million. As a result of all these factors, management currently expects Card Services to have a net loss for the full year 2010.

Commercial Banking results could be negatively affected by rising credit costs, a decline in loan demand and reduced liability balances.

Earnings in Treasury & Securities Services and Asset Management will be affected by the impact of market levels on assets under management, supervision and custody. Additionally, earnings in Treasury & Securities Services could be affected by liability balance flows.

Private Equity results will likely be volatile and continue to be influenced by capital market activity, market levels, the performance of the broader economy and investment-specific issues. Net interest income levels will generally trend with the size of the investment portfolio in Corporate; however, the high level of trading gains in Corporate in the third quarter of 2009 is not likely to continue. In the near-term, Corporate quarterly net income (excluding Private Equity, merger-related items and any significant nonrecurring items) is expected to decline to approximately $500 million and continue trending lower through the course of 2010.

Lastly, on a Firmwide matter, the decision of the Firm’s Board of Directors regarding any increase in the level of common stock dividends will be subject to their judgment that the likelihood of another severe economic downturn has sufficiently diminished, and that overall business performance has stabilized. When, in the Board’s judgment, it is appropriate to increase the dividend, the likely result might involve an initial increase to a $0.75 to $1.00 per share annual payout level, followed by a subsequent return to the Firm’s historical dividend payout ratio of 30% to 40% of normalized earnings over time.

This section provides a comparative discussion of JPMorgan Chase’s Consolidated Results of Operations on a reported basis. Factors that relate primarily to a single business segment are discussed in more detail within that business segment. For a discussion of the Critical Accounting Estimates Used by the Firm that affect the Consolidated Results of Operations, see pages 92-94 of this Form 10-Q and pages 107-111 of JPMorgan Chase’s 2008 Annual Report.

Total net revenue for the third quarter of 2009 was $26.6 billion, up by $11.9 billion, or 81%, from the third quarter of 2008. For the first nine months of 2009, total net revenue was $77.3 billion, up by $27.2 billion, or 54%, from the equivalent period of 2008. The increase from both prior-year periods was driven by higher principal transactions revenue, primarily related to the strong results across most fixed income and equity products and the absence of markdowns on legacy leveraged lending and mortgage positions in IB, as well as higher levels of trading gains and investment securities income in Corporate. The results also benefited from the impact of the Washington Mutual transaction, which contributed to the increases in net interest income, lending- and deposit-related fees, mortgage fees and related income. These benefits were offset partially by reduced fees and commissions resulting from lower market levels on assets under management and custody. For the year-to-date comparison, an additional driver of the increase in revenue was higher net revenue from MSR risk management results, offset by the absence of proceeds from the sale of Visa shares in its initial public offering in the first quarter of 2008.

Investment banking fees for the third quarter and first nine months of 2009 increased from the comparable periods in 2008, reflecting higher equity and debt underwriting fees, offset partially by lower advisory fees. For a further discussion of investment banking fees, which are primarily recorded in IB, see IB segment results on pages 21-24 of this Form 10-Q.

Principal transactions revenue, which consists of revenue from the Firm’s trading and private equity investing activities, rose from the third quarter and first nine months of 2008. Trading revenue increased in the third quarter of 2009, driven by strong results across most fixed income and equity products; gains of approximately $400 million on legacy leveraged lending and mortgage-related positions, compared with markdowns of $3.6 billion in the prior year; and gains on trading positions in Corporate, compared with losses in the prior year of $1.0 billion on markdowns of Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) preferred securities. These benefits were offset partially by an aggregate loss of $1.0 billion in the quarter from the tightening of the Firm’s credit spread on certain structured liabilities and derivatives, compared with gains of $956 million in the prior year from the widening of the spread on those liabilities. For the first nine months of 2009, trading revenue rose as a result of the same drivers in the quarter, including significantly lower net markdowns on legacy leveraged lending and mortgage-related positions, compared with markdowns of $7.7 billion in the prior year; these benefits were offset partially by an aggregate loss of $1.9 billion from the tightening of the Firm’s credit spread on certain structured liabilities and derivatives, compared with gains of $2.8 billion in the prior year from the widening of spreads on those liabilities. The Firm’s private equity investments generated net gains in the third quarter of 2009, compared with net losses in the prior year. For the first nine months of 2009, the private equity investments produced net losses, compared with net gains in the prior year. For a further discussion of principal transactions revenue, see IB and Corporate/Private Equity segment results on pages 21-24 and 47-49 respectively, and Note 3 on pages 106-121 of this Form 10-Q.

Lending- and deposit-related fees rose from the third quarter and first nine months of 2008, predominantly reflecting the impact of the Washington Mutual transaction and organic growth in both lending- and deposit-related fees in RFS and IB, as well as in CB. For a further discussion of lending- and deposit-related fees, which are mostly recorded in RFS, CB and TSS, see the RFS segment results on pages 25-32, the CB segment results on pages 37-39, and the TSS segment results on pages 40-43 of this Form 10-Q.

The decline in asset management, administration and commissions revenue compared with the third quarter of 2008 reflected lower brokerage commissions revenue in IB, predominantly related to lower transaction volume; lower asset management fees in AM, from the impact of lower market levels on assets under management; and lower administration fees in TSS, driven by the effect of market depreciation on certain custody assets and lower securities lending balances. For the first nine months of 2009, the decline was largely due to lower asset management fees in AM from the impact of lower market levels on assets under management. Lower brokerage commissions revenue in IB and lower administrative fees in TSS also contributed to the decrease.

The decrease in securities gains compared with the third quarter of 2008 was due to lower gains from the repositioning of the Corporate investment securities portfolio, in connection with managing the Firm’s structural interest rate risk. For the first nine months of 2009, the decrease reflected lower gains from the sale of MasterCard shares, which totaled $241 million in 2009, compared with $668 million in 2008. For a further discussion of securities gains, which are mostly recorded in the Firm’s Corporate business, see the Corporate/Private Equity segment discussion on pages 47-49 of this Form 10-Q.

Mortgage fees and related income increased during the third quarter and first nine months of 2009, as higher net mortgage servicing revenue was offset partially by a production-related net loss in the third quarter of 2009. The increase in net mortgage servicing revenue was driven by growth in average third-party loans serviced as a result of the Washington Mutual transaction and higher MSR risk management results, reflecting primarily, for the nine-month period, the positive impact of a decrease in estimated future mortgage prepayments and positive hedging results. Mortgage production generated a net loss for the third quarter of 2009, and a decline from the first nine months of 2008, reflecting an increase in reserves for the repurchase of previously-sold loans, offset by wider margins on new originations. For a discussion of mortgage fees and related income, which is recorded primarily in RFS’ Consumer Lending business, see the Consumer Lending discussion on pages 29-32 of this Form 10-Q.

Credit card income, which includes the impact of the Washington Mutual transaction, was flat compared with the third quarter and first nine months of 2008, as lower servicing fees earned in connection with CS securitization activities, largely as a result of higher credit losses, were offset by wider loan margins on securitized credit card loans. Also partially offsetting the decline were higher merchant servicing revenue related to the dissolution of the Chase Paymentech Solutions joint venture and higher interchange income. For a further discussion of credit card income, see the CS segment results on pages 33-36 of this Form 10-Q.

Other income increased in the third quarter of 2009 due to the absence of a $375 million charge recognized in the third quarter of 2008 related to the repurchase of auction-rate securities at par. Also contributing to the increase in other income during the quarter were higher markups on certain investments, including seed capital in AM, and higher gains on the sale of certain assets, including other real estate owned. For the first nine months of 2009, other income decreased, due predominantly to the absence of $1.5 billion in proceeds from the sale of Visa shares in the first quarter of 2008 during its initial public offering, lower net securitization income in CS and the dissolution of the Chase Paymentech Solutions joint venture. These items were partially offset by the absence of a $423 million loss incurred in the second quarter of 2008, reflecting the Firm’s 49.4% share in Bear Stearns’ losses from April 8 to May 30, 2008, and the same items that drove the increase in the third quarter of 2009 results compared with the third quarter of 2008.

Net interest income increased $3.7 billion to $12.7 billion, and $13.8 billion to $38.8 billion, for the third quarter and first nine months of 2009, respectively, compared with the comparable periods in 2008. The increase from the prior year was driven by the Washington Mutual transaction, which contributed to higher average loans and deposits, and the impact of a wider net interest margin. For the quarter, the net yield on the Firm’s interest-earning assets of $1.6 trillion, on a fully taxable-equivalent (FTE) basis, was 3.10%, an increase of 37 basis points from 2008. For the first nine months, the net yield on the Firm’s interest-earning assets of $1.7 trillion, on an FTE basis, was 3.15%, an increase of 47 basis points from 2008. Excluding the impact of the Washington Mutual transaction, the increase in net interest income in the quarter and first nine months of the year was driven by the overall decline in market interest rates during the periods, which benefited the net interest margin as rates paid on the Firm’s interest-bearing liabilities declined faster relative to the decline in rates earned on interest-earning assets. The higher level of the investment securities portfolio also contributed to the increase in net interest income. The increase in net interest income was offset partially by lower loan balances, which included the effect of loan charge-offs.

The provision for credit losses in the third quarter and first nine months of 2009 rose compared with the equivalent 2008 periods due to increases in the consumer provision. The prior-year quarter included a $2.0 billion charge to conform Washington Mutual’s allowance for loan losses, which affected both the consumer and wholesale portfolios. For the purpose of the following analysis, this charge is excluded. The consumer provision reflected additions to the allowance for loan losses for the home equity, mortgage and credit card portfolios, as weak economic conditions, housing price declines and higher unemployment rates continued to drive higher estimated losses for these portfolios. Included in the third-quarter 2009 addition to the allowance for loan losses was a $1.1 billion increase related to estimated deterioration in the Washington Mutual purchased credit-impaired portfolio. The wholesale provision increased from the comparable 2008 periods, reflecting continued deterioration in the credit environment. For a more detailed discussion of the loan portfolio and the allowance for loan losses, see the segment discussions for RFS on pages 25-32, CS on pages 33-36, IB on pages 21-24 and CB on pages 37-39, and the Allowance for Credit Losses section on pages 81-84 of this Form 10-Q.

The following table presents the components of noninterest expense.

Total noninterest expense for the third quarter of 2009 was $13.5 billion, up $2.3 billion, or 21%, from the third quarter of 2008; for the first nine months of 2009, total noninterest expense was $40.3 billion, up by $8.1 billion, or 25%, from the comparable 2008 period. The increase was driven by the impact of the Washington Mutual transaction, higher performance-based compensation expense, the accrual of $0.7 billion for an FDIC special assessment recognized in the second quarter of 2009, higher FDIC insurance premiums and increased mortgage-related servicing expense. These items were offset partially by lower headcount-related expense, which includes salary and benefits (excluding performance-based incentives), and other noncompensation costs related to employees.

Compensation expense increased in the third quarter and first nine months of 2009 compared with the prior-year periods, reflecting higher performance-based incentives, as well as the impact of the Washington Mutual transaction. Excluding these two items, compensation expense decreased as a result of the reduction in headcount, particularly in the wholesale businesses and in Corporate.

Noncompensation expense increased from the third quarter of 2008, due predominantly to the following: the impact of the Washington Mutual transaction; higher litigation costs, partly as a result of benefits recognized in 2008 from certain litigation matters; higher mortgage servicing-related expense due to increased delinquencies and defaults, which included an increase in foreclosed property expense of $0.3 billion; higher FDIC insurance premiums; and the impact of the dissolution of the Chase Paymentech Solutions joint venture. These items were offset partially by lower headcount-related expense, particularly in IB, TSS and AM, and lower mortgage reinsurance losses. Noncompensation expense increased from the first nine months of 2008, primarily due to the drivers discussed for the third quarter and an accrual of $0.7 billion for an FDIC special assessment recognized in the second quarter of 2009. The increase was partially offset by lower credit card marketing expense.

For information on merger costs, refer to Note 10 on page 135 of this Form 10-Q.

The following table presents the Firm’s income before income tax expense, income tax expense and effective tax rate.

The change in the effective tax rate for the third quarter and first nine months of 2009, compared with the same periods of 2008, was primarily the result of higher reported pretax income and changes in the proportion of income subject to federal, state and local taxes. In addition, the third quarter and first nine months of 2008 reflected the realization of benefits of $927 million and $1.1 billion, respectively, from the release of deferred tax liabilities associated with the undistributed earnings of certain non-U.S. subsidiaries that were deemed to be reinvested indefinitely. For a further discussion of income taxes, see Critical Accounting Estimates used by the Firm on pages 92-94 of this Form 10-Q.

The Firm recognized a $76 million increase in the extraordinary gain in the third quarter of 2009 associated with the final purchase accounting adjustments for the September 25, 2008 acquisition of the banking operations of Washington Mutual, compared with a preliminary gain of $581 million in the third quarter of 2008. The transaction was accounted for under the purchase method of accounting in accordance with U.S. GAAP for business combinations. The adjusted net asset value of the banking operations after purchase accounting adjustments was higher than the consideration paid by JPMorgan Chase, resulting in these extraordinary gains. For a further discussion of the Washington Mutual transaction, see Note 2 on pages 102-106 of this Form 10-Q.

The Firm prepares its consolidated financial statements using U.S. GAAP; these financial statements appear on pages 98-101 of this
Form 10-Q. That presentation, which is referred to as “reported basis,” provides the reader with an understanding of the Firm’s results that can be tracked consistently from year to year and enables a comparison of the Firm’s performance with other companies’ U.S. GAAP financial statements.

In addition to analyzing the Firm’s results on a reported basis, management reviews the Firm’s results and the results of the lines of business on a “managed” basis, which is a non-GAAP financial measure. The Firm’s definition of managed basis starts with the reported U.S. GAAP results and includes certain reclassifications that assume credit card loans securitized by CS remain on the balance sheet, and it presents revenue on a FTE basis. These adjustments do not have any impact on net income as reported by the lines of business or by the Firm as a whole.

The presentation of CS results on a managed basis assumes that credit card loans that have been securitized and sold in accordance with U.S. GAAP remain on the Consolidated Balance Sheets, and that the earnings on the securitized loans are classified in the same manner as the earnings on retained loans recorded on the Consolidated Balance Sheets. JPMorgan Chase uses the concept of managed basis to evaluate the credit performance and overall financial performance of the entire managed credit card portfolio. Operations are funded and decisions are made about allocating resources, such as employees and capital, based on managed financial information. In addition, the same underwriting standards and ongoing risk monitoring are used for both loans on the Consolidated Balance Sheets and securitized loans. Although securitizations result in the sale of credit card receivables to a trust, JPMorgan Chase retains the ongoing customer relationships, as the customers may continue to use their credit cards; accordingly, the customer’s credit performance will affect both the securitized loans and the loans retained on the Consolidated Balance Sheets. JPMorgan Chase believes managed basis information is useful to investors, enabling them to understand both the credit risks associated with the loans reported on the Consolidated Balance Sheets and the Firm’s retained interests in securitized loans. For a reconciliation of reported to managed basis results for CS, see CS segment results on pages 33-36 of this Form 10-Q. For information regarding the securitization process, and loans and residual interests sold and securitized, see Note 15 on pages 147-155 of this Form 10-Q.

Total net revenue for each of the business segments and the Firm is presented on a FTE basis. Accordingly, revenue from tax-exempt securities and investments that receive tax credits is presented in the managed results on a basis comparable to taxable securities and investments. This non-GAAP financial measure allows management to assess the comparability of revenue arising from both taxable and tax-exempt sources. The corresponding income tax impact related to these items is recorded within income tax expense.

Tangible common equity (“TCE”) represents common stockholders’ equity (i.e., total stockholders’ equity less preferred stock) less identifiable intangible assets (other than MSRs) and goodwill, net of related deferred tax liabilities. ROTCE, a non-GAAP financial ratio, measures the Firm’s earnings as a percentage of TCE, and is in management’s view a meaningful measure to assess the Firm’s use of equity.

Management also uses certain non-GAAP financial measures at the business-segment level, because it believes these other non-GAAP financial measures provide information to investors about the underlying operational performance and trends of the particular business segment and, therefore, facilitate a comparison of the business segment with the performance of its competitors.

The following summary table provides a reconciliation from the Firm’s reported U.S. GAAP results to managed basis.

The calculation of second-quarter 2009 net income applicable to common equity includes a one-time, noncash reduction of $1.1 billion resulting from the repayment of TARP preferred capital. Excluding this reduction ROE would have been 6% for the second quarter of 2009 as disclosed in the table below. The Firm views the adjusted ROE, a non-GAAP financial measure, as meaningful because it increases the comparability to prior periods.

Net income applicable to common equity for the second quarter of 2009 included a one-time, noncash reduction of approximately $1.1 billion resulting from the repayment of TARP preferred capital. The following table presents the calculations of the effect on net income applicable to common stockholders for the three months ended June 30, 2009 and the nine months ended September 30, 2009, and the $0.27 reduction to diluted earnings per share which resulted from the repayment. There was no impact on diluted earnings per share from the TARP repayment during the third quarter of 2009.

The Firm also discloses the allowance for loan losses to total retained loans, excluding home lending purchased credit-impaired loans and loans held by the Washington Mutual Master Trust. For a further discussion of this credit metric, see Allowance for Credit Losses on pages 81–84 of this Form 10-Q.

The Firm is managed on a line-of-business basis. The business segment financial results presented reflect the current organization of JPMorgan Chase. There are six major reportable business segments: the Investment Bank, Retail Financial Services, Card Services, Commercial Banking, Treasury & Securities Services and Asset Management, as well as a Corporate/Private Equity segment. The business segments are determined based on the products and services provided, or the type of customer served, and reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on a managed basis.

Results of the business segments are intended to reflect each segment as if it were essentially a stand-alone business. The management reporting process that derives business segment results allocates income and expense using market-based methodologies. For a further discussion of those methodologies, see Business Segment Results — Description of business segment reporting methodology on pages 40-41 of JPMorgan Chase’s 2008 Annual Report. The Firm continues to assess the assumptions, methodologies and reporting classifications used for segment reporting, and further refinements may be implemented in future periods.

Segment Results — Managed Basis^(a)(b)

The following table summarizes the business segment results for the periods indicated.