FORM 10-Q
 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

     
For the Quarterly Period Ended March 31, 2005   Commission file number 1-5805
     
     
JPMORGAN CHASE & CO.
(Exact name of registrant as specified in its charter)
     
     
Delaware   13-2624428
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
270 Park Avenue, New York, New York   10017
(Address of principal executive offices)   (Zip Code)

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 [X] No [   ]

    Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [X] No [   ]

Common Stock, $1 Par Value   3,518,702,996

 

Number of shares outstanding of each of the issuer’s classes of common stock on April 30, 2005.

 

 


 

FORM 10-Q

TABLE OF CONTENTS
             
        Page  
             
Part I – Financial information        
 
Item 1  
Consolidated Financial Statements – JPMorgan Chase & Co.:
 
   
       
   
Consolidated statements of income (unaudited) for the three months ended March 31, 2005, and March 31, 2004
  55
             
   
Consolidated balance sheets (unaudited) at March 31, 2005, and December 31, 2004
  56
             
   
Consolidated statements of changes in stockholders’ equity (unaudited) for the three months ended March 31, 2005, and March 31, 2004
  57
             
   
Consolidated statements of cash flows (unaudited) for the three months ended March 31, 2005, and March 31, 2004
  58
             
   
Notes to consolidated financial statements (unaudited)
  59
             
   
Consolidated average balance sheet, interest and rates for the three months ended March 31, 2005, and March 31, 2004
  76
             
   
Glossary of Terms and Line of Business Metrics
  77
             
Item 2  
Management’s Discussion and Analysis of Financial Condition and Results of Operations:
       
             
 
Consolidated Financial Highlights
  3
             
   
Introduction
  4
             
   
Executive Overview
  6
             
   
Consolidated Results of Operations
  8
             
   
Explanation and Reconciliation of the Firm’s Use of Non-GAAP Financial Measures
  10
             
   
Business Segment Results
  13
             
   
Balance Sheet Analysis
  34
             
   
Capital Management
  35
             
   
Off-Balance Sheet Arrangements and Contractual Cash Obligations
  38
             
   
Risk Management
  39
             
   
Supervision and Regulation
  52
             
   
Critical Accounting Estimates Used by the Firm
  52
             
   
Accounting and Reporting Developments
  53
             
Item 3  
Quantitative and Qualitative Disclosures About Market Risk
  81
             
Item 4  
Controls and Procedures
  81
             
Part II – Other information        
             
Item 1  
Legal Proceedings
  81
             
Item 2  
Unregistered Sales of Equity Securities and Use of Proceeds
  82
             
Item 3  
Defaults Upon Senior Securities
  82
             
Item 4  
Submission of Matters to a Vote of Security Holders
  82
             
Item 5  
Other Information
  82
             
Item 6  
Exhibits
  82

 

2


 

JPMORGAN CHASE & CO.
CONSOLIDATED FINANCIAL HIGHLIGHTS

                                         
(in millions, except per share, ratio and headcount data)                           Heritage JPMC only  
As of or for the period ended   1Q 2005  (a)   4Q 2004  (a)   3Q 2004  (a)   2Q 2004     1Q 2004  
 
Selected income statement data
                                       
Net interest income
  $ 5,225     $ 5,329     $ 5,452     $ 2,994     $ 2,986  
Noninterest revenue
    8,422       7,621       7,053       5,637       6,025  
 
Total net revenue
    13,647       12,950       12,505       8,631       9,011  
Provision for credit losses
    427       1,157       1,169       203       15  
Noninterest expense before Merger costs and Litigation reserve charge
    8,892       8,863       8,625       5,713       6,093  
Merger costs
    145       523       752       90        
Litigation reserve charge
    900                   3,700        
 
Total noninterest expense
    9,937       9,386       9,377       9,503       6,093  
 
Income (loss) before income tax expense (benefit)
    3,283       2,407       1,959       (1,075 )     2,903  
Income tax expense (benefit)
    1,019       741       541       (527 )     973  
 
Net income (loss)
  $ 2,264     $ 1,666     $ 1,418     $ (548 )   $ 1,930  
Per common share
                                       
Net income (loss) per share:
                                       
Basic
  $ 0.64     $ 0.47     $ 0.40     $ (0.27 )   $ 0.94  
Diluted
    0.63       0.46       0.39       (0.27 )     0.92  
Cash dividends declared per share
    0.34       0.34       0.34       0.34       0.34  
Book value per share
    29.78       29.61       29.42       21.52       22.62  
Common shares outstanding (average)
                                       
Basic
    3,518       3,515       3,514       2,043       2,032  
Diluted
    3,570       3,602       3,592       2,043       2,093  
Common shares at period-end
    3,525       3,556       3,564       2,088       2,082  
Selected ratios
                                       
Return on common equity (“ROE”)(b)
    9 %     6 %     5 %     NM       17 %
Return on assets (“ROA”)(b)(c)
    0.79       0.57       0.50       NM       1.01  
Tier 1 capital ratio
    8.6       8.7       8.6       8.2 %     8.4  
Total capital ratio
    11.9       12.2       12.0       11.2       11.4  
Tier 1 leverage ratio
    6.3       6.2       6.5       5.5       5.9  
Selected balance sheet data (period-end)
                                       
Total assets
  $ 1,178,305     $ 1,157,248     $ 1,138,469     $ 817,763     $ 801,078  
Securities
    75,251       94,512       92,816       64,915       70,747  
Total loans
    402,669       402,114       393,701       225,938       217,630  
Deposits
    531,379       521,456       496,454       346,539       336,886  
Long-term debt
    99,329       95,422       91,754       52,981       50,062  
Common stockholders’ equity
    105,001       105,314       104,844       44,932       47,092  
Total stockholders’ equity
    105,340       105,653       105,853       45,941       48,101  
Credit quality metrics
                                       
Allowance for credit losses
  $ 7,423     $ 7,812     $ 8,034     $ 4,227     $ 4,417  
Nonperforming assets
    2,949       3,231       3,637       2,482       2,882  
Allowance for loan losses to total loans(d)
    1.83 %     1.94 %     2.01 %     1.92 %     2.08 %
Net charge-offs
  $ 816     $ 1,398     $ 865     $ 392     $ 444  
Net charge-off rate(b)(e)
    0.88 %     1.47 %     0.93 %     0.77 %     0.92 %
Wholesale net charge-off rate(b)(e)
    (0.03 )     0.21       (0.08 )     0.29       0.50  
Managed Card net charge-off rate(b)
    4.83       5.24       4.88       5.85       5.81  
Headcount
    164,381       160,968       162,275       94,615       96,010  
Share price(f)
                                       
High
  $ 39.69     $ 40.45     $ 40.25     $ 42.57     $ 43.84  
Low
    34.32       36.32       35.50       34.62       36.30  
Close
    34.60       39.01       39.73       38.77       41.95  
 
 
(a)  
Quarterly results include three months of the combined Firm’s results.
(b)  
Based on annualized amounts.
(c)  
Represents Net income divided by Total average assets.
(d)  
Excluded from this ratio were loans held for sale.
(e)  
Excluded from this ratio were average loans held for sale.
(f)  
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange, the London Stock Exchange Limited and the Tokyo Stock Exchange. The high, low and closing prices of JPMorgan Chase’s common stock are from The New York Stock Exchange Composite Transaction Tape.
NM – Not meaningful due to net loss.

3


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section of this Form 10–Q provides management’s discussion and analysis (“MD&A”) of the financial condition and results of operations of JPMorgan Chase. See the Glossary of terms on pages 77–78 for a definition of terms used throughout this Form 10–Q. The MD&A included in 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. Factors that could cause JPMorgan Chase’s results to differ materially from those described in the forward-looking statements can be found in the JPMorgan Chase 2004 Annual Report on Form 10–K for the year ended December 31, 2004, filed with the Securities and Exchange Commission and available at the Securities and Exchange Commission’s Internet site (http://www.sec.gov).

INTRODUCTION
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, with $1.2 trillion in assets, $105 billion in stockholders’ equity and operations in more than 50 countries. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, investment management, private banking and private equity. JPMorgan Chase serves more than 90 million customers, including consumers nationwide and many of the world’s most prominent wholesale clients.

JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank”), a national banking association with branches in 17 states; and Chase Bank USA, National Association, a national bank headquartered in Delaware that is the Firm’s credit card issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan Securities Inc. (“JPMSI”), its U.S. investment banking firm.

The headquarters for JPMorgan Chase is in New York City. The retail banking business, which includes the consumer banking, small business banking and consumer lending activities (with the exception of credit card), is headquartered in Chicago. Chicago also serves as the headquarters for the commercial banking business.

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

Investment Bank
JPMorgan Chase is one of the world’s leading investment banks, as evidenced by the breadth of its client relationships and product capabilities. The Investment Bank (“IB”) has extensive relationships with corporations, financial institutions, governments and institutional investors worldwide. The Firm provides 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, and market-making in cash securities and derivative instruments. The IB also commits the Firm’s own capital to proprietary investing and trading activities.

Retail Financial Services
Retail Financial Services (“RFS”) includes Home Finance, Consumer & Small Business Banking, Auto & Education Finance and Insurance. Through this group of businesses, the Firm provides consumers and small businesses with a broad range of financial products and services including deposits, investments, loans and insurance. Home Finance is a leading provider of consumer real estate loan products and is one of the largest originators and servicers of home mortgages. Consumer & Small Business Banking offers one of the largest branch networks in the United States, covering 17 states with 2,517 branches and 6,687 automated teller machines. Auto & Education Finance is the largest bank originator of automobile loans as well as a top provider of loans for college students. Through its Insurance operations, the Firm sells and underwrites an extensive range of financial protection products and investment alternatives, including life insurance, annuities and debt protection products.

Card Services
Card Services (“CS”) is the largest issuer of general purpose credit cards in the United States, with approximately 94 million cards in circulation, and is the largest merchant acquirer. CS offers a wide variety of products to satisfy the needs of its cardmembers, including cards issued on behalf of many well-known partners, such as major airlines, hotels, universities, retailers and other financial institutions.

4


 

Commercial Banking
Commercial Banking (“CB”) serves more than 25,000 corporations, municipalities, financial institutions and not-for-profit entities, with annual revenues generally ranging from $10 million to $2 billion. A local market presence and a strong customer service model, coupled with a focus on risk management, provide a solid infrastructure for CB to provide the Firm’s complete product set – lending, treasury services, investment banking and investment management – to both corporate clients and their executives. CB’s clients benefit greatly from the Firm’s extensive branch network and often use the Firm exclusively to meet their financial services needs.

Treasury & Securities Services
Treasury & Securities Services (“TSS”) is a global leader in providing transaction, investment and information services to support the needs of corporations, issuers and institutional investors worldwide. TSS is the largest cash management provider in the world and the leading global custodian. The Treasury Services (“TS”) business provides clients with a broad range of capabilities, including U.S. dollar and multi-currency clearing, ACH, trade, and short-term liquidity and working capital tools. The Investor Services (“IS”) business provides a wide range of capabilities, including custody, funds services, securities lending, and performance measurement and execution products. The Institutional Trust Services (“ITS”) business provides trustee, depository and administrative services for debt and equity issuers. Treasury Services partners with the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management segments to serve clients firmwide. As a result, certain Treasury Services revenues are included in other segments’ results. On April 18, 2005, TSS announced that it combined its investor and issuer services capabilities under the name Worldwide Securities Services. The integrated franchise brought together the former Investor Services and Institutional Trust Services businesses, and will provide custody and investor services as well as securities clearance and trust services to clients globally.

Asset & Wealth Management
Asset & Wealth Management (“AWM”) provides investment management to retail and institutional investors, financial intermediaries and high-net-worth families and individuals globally. For retail investors, AWM provides investment management products and services, including a global mutual fund franchise, retirement plan administration and brokerage services. AWM delivers investment management to institutional investors across all asset classes. The Private Bank and Private Client Services businesses provide integrated wealth management services to ultra-high-net-worth and high-net-worth clients, respectively.

MERGER WITH BANK ONE CORPORATION
Bank One Corporation’s (“Bank One”) results of operations were included in the Firm’s results beginning July 1, 2004. Therefore, results of operations for the three months ended March 31, 2005, reflect three months of operations of the combined Firm, while the results of operations for the three months ended March 31, 2004, reflect the operations of heritage JPMorgan Chase only.

Management expects that, as a result of the Merger, cost savings of approximately $3.0 billion (pre-tax) will be achieved by the end of 2007; approximately two-thirds of the savings are anticipated to be realized by the end of 2005. During the first quarter of 2005, approximately $380 million of merger savings were realized, which is an annualized run rate of $1.5 billion. Management currently expects one-time merger costs to combine the operations of JPMorgan Chase and Bank One to range from approximately $4.0 billion to $4.5 billion (pre-tax). Of these costs, approximately $1.0 billion, specifically related to Bank One, were accounted for as purchase accounting adjustments and were recorded as an increase to goodwill in 2004. Of the approximately $3.0 billion to $3.5 billion in remaining Merger-related costs, $145 million (pre-tax) were incurred during the first quarter of 2005, and $1.4 billion (pre-tax) were incurred in 2004; these costs have been charged to income. Additional merger costs of approximately $1.3 billion (pre-tax) are expected to be incurred in 2005, and the remaining costs are expected to be incurred in 2006. These estimated Merger-related charges will result from actions taken with respect to both JPMorgan Chase’s and Bank One’s operations, facilities and employees. The charges will be recorded based on the nature and timing of these integration actions.

OTHER BUSINESS EVENTS

Cazenove
On February 28, 2005, JPMorgan Chase and Cazenove Group plc (“Cazenove”) formed a joint venture partnership which combined Cazenove’s investment banking business and JPMorgan Chase’s United Kingdom-based investment banking business in order to provide investment banking services in the United Kingdom and Ireland. The new company is called JPMorgan Cazenove Holdings.

JPMorgan Partners
On March 1, 2005, the Firm announced that the management team of JPMorgan Partners, LLC, a private equity unit of the Firm, will become independent when it completes the investment of the current $6.5 billion Global Fund, which it advises. The independent management team intends to raise a new fund as a successor to the Global Fund. JPMorgan Chase has committed to invest 24.9% of the limited partnership interests, up to $1 billion, in the new fund.

5


 

WorldCom litigation settlement
On March 17, 2005, JPMorgan Chase settled, for $2.0 billion (pre-tax), the WorldCom, Inc. class action litigation. In connection with the settlement, JPMorgan Chase increased its Litigation reserve by $900 million (pre-tax).

Vastera
On April 1, 2005, JPMorgan Chase acquired Vastera, a provider of global trade management solutions, for approximately $129 million. Vastera’s business was combined with the Logistics and Trade Services businesses of TSS’s Treasury Services unit. Vastera automates trade management processes associated with the physical movement of goods internationally; the acquisition enables Treasury Services to offer management of information and processes in support of physical goods movement, together with financial settlement.

EXECUTIVE OVERVIEW
This overview of management’s discussion and analysis highlights selected information and may not contain all of the information that is important to readers of this Form 10–Q. For a more complete understanding of events, trends, uncertainties, liquidity, capital resources and critical accounting estimates affecting the Firm and its various lines of business, this Form 10–Q should be read in its entirety.

Business overview
The Firm reported net income for the first quarter of 2005 of $2.3 billion, or $0.63 per share, compared with $1.9 billion, or $0.92 per share, in the first quarter of 2004. Return on common equity for the quarter was 9%. Results included $648 million of after-tax charges, or $0.18 per share, which included a litigation reserve charge of $558 million and Merger costs of $90 million. Excluding these charges, operating earnings were $2.9 billion, or $0.81 per share, and return on common equity was 11%. Operating earnings represent business results without merger-related costs and the litigation reserve charge.

In the first quarter of 2005, both the global and U.S. economies continued to expand although the pace of growth slowed later in the quarter. The U.S. economy experienced a continued rise in short-term interest rates, driven by two quarter-point increases in the federal funds rate, from 2.25% to 2.75%. This led to continued yield curve flattening, as long-term interest rates were relatively stable. Equity markets, both domestic and international, enjoyed positive returns versus the prior-quarter and prior-year. However, equity markets did weaken noticeably late in the quarter. The U.S. consumer sector showed positive trends during the first quarter, but spending growth appeared to be moderating following strong gains in the second half of 2004. New hiring and income gains offset higher energy prices.

On an operating basis, net income in each of the Firm’s business segments, in comparison to 2004, was affected significantly by the Merger. The following discussion highlights factors, other than the Merger, that affected operating results.

Investment Banking revenues benefited from increased investment banking fees, with strength in debt underwriting, advisory and equity underwriting. Offsetting this improved performance were lower net interest income and slightly lower trading revenues, compared to record results in the prior year. The reduction in the allowance for credit losses was primarily related to the improved quality of the loan portfolio, resulting from turnover in the mix of the loan portfolio towards higher-rated clients and from net recoveries. Higher expenses were related to performance-based compensation accruals.

Retail Financial Services revenues benefited from higher net interest income due to wider deposit spreads, growth in deposit balances and growth in retained home equity loan balances, partially offset by several loan portfolio sales. Revenues also benefited from improved MSR asset risk management results and secondary marketing activities in Home Finance. Partially offsetting these benefits was a decrease in revenue due to lower prime mortgage originations and a write-down related to the transfer of auto loans to held-for-sale. The provision for credit losses benefited from improving credit quality in all portfolios and reductions in the allowance for credit losses reflecting the sale of recreational vehicle loans and the transfer of auto loans to held-for-sale. Expenses decreased due to merger-related savings and ongoing efficiency improvements, partially offset by continued expansion of the retail distribution network and a charge related to the dissolution of a student loan joint venture.

Card Services revenue benefited from higher loan balances, which resulted in higher net interest income. Additionally, higher customer charge volume generated increased interchange income. Partially offsetting these revenue improvements were volume-driven increases in payments to partners and higher reward payments. The provision for credit losses benefited from lower net charge-offs reflecting lower bankruptcies and delinquencies, partially offset by additions to the allowance for loan losses related to growth in on-balance sheet loans. Expenses benefited from lower compensation and processing costs, which were partially offset by increased marketing spend.

Commercial Banking revenues benefited from wider spreads on increased liability balances. These benefits were partially offset by lower fees in lieu of compensating balances and lower gains on the sale of assets acquired in the satisfaction of debt. Credit quality remained strong, allowing the provision for credit losses to be a slight net benefit. Expenses increased due to higher Treasury Services product-unit costs.

6


 

Treasury & Securities Services revenues benefited from wider spreads on increased liability balances, growth in assets under custody and broad-based growth in product revenues. These benefits were partially offset by lower service charges on deposits. Expenses increased due to compensation and technology-related costs, but were partially offset by higher product-unit costs charged to other lines of business.

Asset & Wealth Management revenues were positively affected by the acquisition of a majority interest in Highbridge Capital Management, net asset inflows, global equity market appreciation and deposit growth. Provision for credit losses improved due to lower charge-offs, and expenses increased due to Highbridge and higher performance-based compensation.

Performance in the Corporate segment was negatively affected by securities losses related to the repositioning of the investment securities portfolio. Private Equity results were strong and included two large gains.

The Firm’s balance sheet remains strong, with total stockholders’ equity of $105 billion and a Tier 1 capital ratio at March 31, 2005 of 8.6%. The Firm repurchased $1.3 billion, or 36 million shares, of common stock during the quarter.

Business outlook
The Investment Bank entered 2005 with a strong pipeline for advisory and underwriting business and, at March 31, 2005, the pipeline remained at these levels. In addition, the Investment Bank continues to focus on growing its client-driven trading business, although overall trading revenues are difficult to predict and can be volatile from period to period. Trading revenues have historically been seasonally stronger in the first quarter, and trading conditions have been less favorable in April. Compared with 2004, the Investment Bank expects a reduction in credit portfolio revenues, as both net interest income on loans and gains from workouts are likely to decrease.

Card Services expects to maintain a relatively stable net interest margin with loan repricing opportunities offset by higher funding costs. Marketing spend is also expected to increase from the first quarter level. Within Retail Financial Services, net interest income will be negatively affected by recent loan portfolio sales. Home Finance will continue to be affected by the market-driven decline in mortgage originations and the volatility of MSR risk management revenues. Consumer & Small Business Banking expects continued growth in core deposits and associated revenue, partially offset by ongoing investments in the branch distribution network. New branch openings are expected to accelerate during the remainder of the year.

The revenue outlook for the Private Equity business is directly related to the strength of equity market conditions. Given the large gains in the first quarter, it is expected that the level of quarterly gains for the remainder of the year will be in the range of $150 million to $200 million, although results can be volatile from quarter to quarter.

It is expected that, over time, the provision for credit losses will return to a more normal level for the wholesale businesses. The consumer provision for credit losses should reflect generally stable credit quality, increased balances and the lack of allowance reductions related to portfolio sales. The Firm plans to begin implementing new minimum-payment rules in the Card Services business during the third quarter of 2005 that will result in higher required payments from some customers. It is anticipated that this may increase delinquency and net charge-off rates in 2006. The magnitude of the impact is currently being assessed. The Firm expects the level of bankruptcy filings to accelerate prior to the October effective date of the bankruptcy legislation signed into law on April 20, 2005. Bankruptcy filings subsequent to the October effective date are expected to normalize.

Expenses in the first quarter, excluding performance-based compensation, were down because merger-related saves and other efficiencies more than offset incremental spending and increased expenses related to acquisitions. Expenses, excluding performance-based compensation, are expected to increase in the second quarter over the first quarter by approximately $200 million to $250 million. This increase is expected to include $200 million to $250 million of incremental spending related to technology, marketing and distribution network expansion and $70 million of acquisition-related expenses, partially offset by $60 million of incremental merger saves. For the full year, expenses, excluding performance-based compensation, are expected to be essentially flat to 2004, as increases related to acquisitions and incremental spending are expected to be offset by incremental merger saves.

7


 

 
CONSOLIDATED RESULTS OF OPERATIONS
 

The following section provides a discussion of JPMorgan Chase’s consolidated results of operations on a reported basis. Factors that are primarily related 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 52–53 of this Form 10–Q, and pages 77–79 of the JPMorgan Chase 2004 Annual Report.

The following table presents the components of Total net revenue:

                         
Three months ended March 31,(a) (in millions)   2005     2004     Change  
 
Investment banking fees
  $ 993     $ 692       43 %
Trading revenue
    1,859       1,720       8  
Lending & deposit related fees
    820       414       98  
Asset management, administration and commissions
    2,455       1,771       39  
Securities/private equity gains (losses)
    (45 )     432       NM  
Mortgage fees and related income
    405       259       56  
Credit card income
    1,734       605       187  
Other income
    201       132       52  
         
Noninterest revenue
    8,422       6,025       40  
Net interest income
    5,225       2,986       75  
         
Total net revenue
  $ 13,647     $ 9,011       51 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Total net revenues, at $13.6 billion, rose by $4.6 billion, or 51%, primarily due to the Merger, which affected most revenue categories. Additional factors that contributed to the revenue growth were significantly higher Investment banking fees, reflecting continued strong levels of advisory and underwriting activities with particular strength in Europe; higher Asset management, administration and commissions, which benefited from an increase in the value of assets under management, supervision and custody, the result of global equity market appreciation, net asset inflows and an acquisition; private equity gains, driven by two large transactions; and consumer-related revenues stemming from stronger demand for credit products, higher credit card charge volume and growth in deposit levels. Partially offsetting these increases were securities losses on Treasury’s investment portfolio, the result of repositioning the investment portfolio; and, in RFS, lower prime mortgage originations and write-downs of auto loans that were transferred to the held-for-sale portfolio. The discussion that follows highlights factors other than the Merger that affected the comparison of the results of the three months ended March 31, 2005 and 2004.

The increase in Investment banking fees reflected continued strong levels of debt underwriting, advisory and equity underwriting. Investment banking fees from European deals more than doubled from last year. Higher Trading revenue was driven by strong client activity and portfolio management performance in the credit and interest rate markets across most major asset classes, partially offset by lower equity revenue from lower portfolio management results. For a further discussion of Investment banking fees and Trading revenue, which are primarily recorded in the IB, see the IB segment results on pages 14–16 of this Form 10–Q.

Lending & deposit related fees rose due to the Merger, but the increase was partially offset by lower fees in lieu of compensating balances as a result of rising interest rates. Throughout 2004 and the first quarter of 2005, deposit balances grew. For a further discussion on deposits, see page 35 of this Form 10-Q.

The increase in Asset management, administration and commissions was attributable to global equity market appreciation, net asset inflows and growth in custody, securities lending and trust products, including collateralized debt obligation (“CDO”) administration. In addition, asset management and administration fees rose as a result of the acquisition of a majority interest in Highbridge Capital Management in the fourth quarter of 2004. For additional information on these fees and commissions, see the segment discussions for AWM on pages 29–32, TSS on pages 27–29 and RFS on pages 17–23 of this Form 10–Q.

Securities/private equity gains (losses) were affected by securities losses of $822 million, primarily related to Treasury’s repositioning of the investment portfolio to manage exposure to rising interest rates and Private equity gains of $777 million. The increase in Private equity gains of $471 million from the prior year was primarily due to two large transactions. For a further discussion of Securities/private equity gains (losses) , which are primarily recorded in the Firm’s Treasury and Private Equity businesses, see the Corporate segment discussion on pages 32–34 of this Form 10–Q.

The increase in Mortgage fees and related income reflected an increase in risk management results related to the mortgage servicing rights (“MSRs”) asset and secondary marketing activities. These increases were offset in part by a reduction in revenue related to lower prime mortgage originations. Mortgage fees and related income excludes the impact of NII and AFS securities gains related to home mortgage activities. For a discussion of Mortgage fees and related income, which is primarily recorded in RFS’s Home Finance business, see the Home Finance discussion on pages 18–20 of this Form 10–Q.

8


 

Credit card income increased due to higher charge volume, which resulted in increased interchange income, partially offset by higher volume-driven payments to partners and rewards expense. For a further discussion of Credit card income, see CS’s segment results on pages 23–25 of this Form 10-Q.

The increase in Other income reflected higher net results from corporate and bank-owned life insurance policies, higher gains on sales of securities from loan workouts, and a gain on the sale of RFS’s recreational vehicle loan portfolio. These gains were offset in part by write-downs related to auto loans that were transferred to the held-for-sale portfolio in RFS.

Net interest income was also favorably affected by growth in consumer and wholesale deposit balances and spreads; higher consumer loans outstanding; the acquisition of a private-label portfolio in CS; and a $40 million charge taken in the first quarter of 2004 related to auto lease residuals. These increases were partially offset by lower wholesale loan balances and spreads, and the absence of the $4 billion manufactured home loan portfolio that was sold in late 2004. The Firm’s total average interest-earning assets for the three months ended March 31, 2005, were $898 billion, up 49% from March 31, 2004, primarily as a result of the Merger. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.39%, an increase of 38 basis points from the prior year.

Provision for credit losses
The Provision for credit losses of $427 million was up $412 million compared with the prior year. The increase was the result of the Merger and growth in consumer loan balances in RFS and CS. These increases were partially offset by reductions in the allowance reflecting improved credit quality in the wholesale and RFS loan portfolios, and lower loan balances as a result of the sale of the recreational vehicle loan portfolio and the transfer of auto loans to the held-for-sale portfolio. For further information about the Provision for credit losses and the Firm’s management of credit risk, see the Credit risk management discussion on pages 41–49 of this Form 10–Q.

Noninterest expense
The following table presents the components of Noninterest expense:

                         
Three months ended March 31,(a) (in millions)   2005     2004     Change  
 
Compensation expense
  $ 4,702     $ 3,302       42 %
Occupancy expense
    525       431       22  
Technology and communications expense
    920       819       12  
Professional & outside services
    1,074       816       32  
Marketing
    483       199       143  
Other expense
    805       447       80  
Amortization of intangibles
    383       79       385  
         
Total noninterest expense before merger costs and litigation reserve charge
    8,892       6,093       46  
Merger costs
    145             NM  
Litigation reserve charge
    900             NM  
         
Total noninterest expense
  $ 9,937     $ 6,093       63 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Total Noninterest expense was $9.9 billion for the three months ended March 31, 2005, up $3.8 billion, or 63%, primarily due to the Merger. Excluding $145 million of Merger costs, and the $900 million Litigation reserve charge, Noninterest expense would have been $8.9 billion, up 46%. In addition to the Merger and litigation charges, expenses increased due to higher performance-based incentives and investments in employees and technology to support the businesses, including acquisitions. These were partially offset by ongoing efficiency improvements and merger-related savings. Each category of Noninterest expense was affected by the Merger. The discussion that follows highlights factors other than the Merger that affected the comparison of the results of the three months ended March 31, 2005 and 2004.

Compensation expense rose partially as a result of higher performance-related incentive accruals. The Firm added to its headcount as a result of insourcing its global technology infrastructure (effective December 31, 2004, JPMorgan Chase terminated its outsourcing agreement with IBM), and as a result of several acquisitions, including Highbridge. These increases were partially offset by ongoing efficiency improvements, merger-related savings throughout the Firm and a reduction in pension costs. The decline in pension costs was primarily attributable to the increase in the expected return on plan assets from a discretionary $1.1 billion contribution to the Firm’s defined benefit pension plan in April 2004, as well as changes in actuarial assumptions for 2005. For a detailed discussion of pension and other postretirement benefit costs, see Note 5 on page 61 of this Form 10-Q.

The Merger-related increase in Technology and communications expense was partially offset by lower costs associated with insourcing the global technology infrastructure support.

Professional & outside services rose, reflecting the costs of improving the Firm’s systems and technology, the termination of the aforementioned IBM outsourcing agreement and increased business growth. These expense increases were partially offset by the benefits of expense management initiatives.

9


 

Marketing expense increased due to the costs of acquiring new credit card and retail banking accounts, and of launching the new Chase brand.

Other expense was higher, reflecting a $40 million charge related to the dissolution of a student loan joint venture, and incremental expenses associated with several acquisitions, including Highbridge. These increases were partially offset by merger-related savings.

For a discussion of Amortization of intangibles and Merger costs, refer to Note 14 and Note 7 on pages 69–71 and 62, respectively, of this Form 10-Q.

In March 2005, the Firm recorded a $900 million ($558 million after-tax) litigation charge in connection with its settlement of the WorldCom class action litigation. For a further discussion of litigation, refer to Note 17 on page 72, and Part II, Item 1, Legal Proceedings, on pages 81–82 of this Form 10-Q.

Income tax expense
The Firm’s Income before income tax expense, Income tax expense and effective tax rate were as follows for each of the periods indicated:

                 
Three months ended March 31,(a) (in millions, except rate)   2005     2004  
 
Income before income tax expense
  $ 3,283     $ 2,903  
Income tax expense
    1,019       973  
Effective tax rate
    31.0 %     33.5 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

The reduction in the effective tax rate was the result of changes in the proportion of income subject to federal, state and local taxes, including a higher level of tax-exempt income and business tax credits. The Merger costs and Litigation reserve charge in the first quarter of 2005, reflecting tax benefits at a 38% marginal tax rate, also contributed to the reduction in the 2005 effective tax rate.

 
EXPLANATION AND RECONCILIATION OF THE FIRM’S USE OF NON-GAAP FINANCIAL MEASURES
 

The Firm prepares its Consolidated financial statements using accounting principles generally accepted in the United States of America (“U.S. GAAP”); these financial statements appear on pages 55–58 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 consistently tracked 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 and the lines of business’ results on an “operating basis,” which is a non-GAAP financial measure. The definition of operating basis starts with the reported U.S. GAAP results. In the case of the IB, noninterest revenue on an operating basis includes, in Trading revenue, Net interest income related to trading activities. Trading activities generate revenues, which are recorded for U.S. GAAP purposes in two line items on the income statement: Trading revenue, which includes the mark-to-market gains or losses on trading positions; and Net interest income, which includes the interest income or expense related to those positions. Combining both the Trading revenue and related Net interest income enables management to evaluate IB’s trading activities, by considering all revenue related to these activities, and facilitates operating comparisons to other competitors.

In the case of CS, operating, or managed, basis excludes the impact of credit card securitizations on total net revenue, the Provision for credit losses, net charge-offs and loan receivables. Through securitization the Firm transforms a portion of its credit card receivables into securities, which are sold to investors. The credit card receivables are removed from the Consolidated balance sheet through the transfer of principal credit card receivables to a trust, and the sale of undivided interests in the trusts to investors that entitle the investors to specific cash flows generated from the credit card receivables. The Firm retains the remaining undivided interests in the trust as seller’s interests, which are recorded in Loans on the Consolidated balance sheet. A gain or loss on the sale of credit card receivables to investors is recorded in Other income. Securitization also affects the Firm’s Consolidated income statement by reclassifying as Credit card income, interest income, certain fee revenue, and recoveries in excess of interest paid to the investors, gross credit losses and other trust expenses related to the securitized receivables. For a reconciliation of reported to managed basis of CS results, see page 25 of this Form 10–Q. For information regarding loans and residual interests sold and securitized, see Note 12 on pages 65–68 of this Form 10–Q. JPMorgan Chase uses the concept of “managed receivables” to evaluate the credit performance and overall financial performance of the underlying credit card loans, both sold and not sold: as the same borrower is continuing to use the credit card for ongoing charges, a borrower’s credit performance will affect both the loan receivables sold under SFAS 140 and those not sold. Thus, in its disclosures regarding managed loan receivables, JPMorgan Chase treats the sold receivables as if they were still on the balance sheet in order to disclose the credit performance (such as net charge-off rates) of the entire managed credit card portfolio. In addition, CS operations are funded, operating results are evaluated, and decisions about allocating resources such as employees and capital are based, on managed financial information.

Operating basis also excludes Merger costs and the Litigation reserve charge, as management believes these items are not part of the Firm’s normal daily business operations (and, therefore, are not indicative of trends) and do not provide meaningful comparisons with other periods.

10


 

Finally, Operating revenue (Noninterest Revenue and Net interest income) for each of the segments and the Firm is presented on a tax-equivalent basis. Accordingly, revenue from tax-exempt securities and investments that receive tax credits are presented in the operating results on a basis comparable to taxable securities and investments. This allows management to assess the comparability of revenues arising from both taxable and tax-exempt sources. The corresponding income tax impact related to these items is recorded within Income tax expense. In the first quarter of 2005, the Corporate sector’s and the Firm’s operating revenue and income tax expense have been restated to be similarly presented on a tax-equivalent basis. Previously, only the segments’ operating results were presented on a tax-equivalent basis, and the impact of the segments’ tax-equivalent adjustments was eliminated in the Corporate sector. This restatement had no impact on the Corporate sector’s or the Firm’s operating earnings.

Management uses certain non-GAAP financial measures at the segment level. Management believes these non-GAAP financial measures provide information to investors in understanding the underlying operational performance and trends of the particular business segment and facilitate a comparison of the business segment with the performance of competitors.

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

                                                         
Three months ended March 31,(a)   2005  
(in millions, except per share and ratio data)
  Reported     Trading     Credit     Merger     Litigation     Tax-equivalent     Operating  
  results     reclass(c)     card(d)     costs(e)     charge(e)     adjustments     basis  
 
Revenue
                                                       
Investment banking fees
  $ 993     $     $     $     $     $     $ 993  
Trading revenue
    1,859       328                               2,187  
Lending & deposit related fees
    820                                     820  
Asset management, administration and commissions
    2,455                                     2,455  
Securities/private equity gains (losses)
    (45 )                                   (45 )
Mortgage fees and related income
    405                                     405  
Credit card income
    1,734             (815 )                       919  
Other income
    201                               115       316  
 
Noninterest revenue
    8,422       328       (815 )                 115       8,050  
Net interest income
    5,225       (328 )     1,732                   61       6,690  
 
Total net revenue
    13,647             917                   176       14,740  
Provision for credit losses
    427             917                         1,344  
Noninterest expense
                                                       
Merger costs
    145                   (145 )                  
Litigation reserve charge
    900                         (900 )            
All other noninterest expense
    8,892                                     8,892  
 
Total noninterest expense
    9,937                   (145 )     (900 )           8,892  
 
Income before income tax expense
    3,283                   145       900       176       4,504  
Income tax expense
    1,019                   55       342       176       1,592  
 
Net income
  $ 2,264     $     $     $ 90     $ 558     $     $ 2,912  
 
Earnings per share – diluted
  $ 0.63     $     $     $ 0.03     $ 0.15     $     $ 0.81  
 
Return on common equity
    9 %     %     %     %     2 %     %     11 %
Return on equity – goodwill(b)
    15                   1       3             19  
 
Return on assets
    0.79       NM       NM       NM       NM       NM       0.96  
 
Overhead ratio
    73       NM       NM       NM       NM       NM       60  
 
Effective income tax rate
    31       NM       NM       38       38       100       35  
 

11


 

                                         
Three months ended March 31,(a)   2004  
    Reported     Trading     Credit     Tax-equivalent     Operating  
(in millions, except per share and ratio data)   results     reclass(c)     card(d)     adjustments     basis  
 
Revenue
                                       
Investment banking fees
  $ 692     $     $     $     $ 692  
Trading revenue
    1,720       576                   2,296  
Lending & deposit related fees
    414                         414  
Asset management, administration and commissions
    1,771                         1,771  
Securities/private equity gains
    432                         432  
Mortgage fees and related income
    259                         259  
Credit card income
    605             (326 )           279  
Other income
    132             (39 )     34       127  
 
Noninterest revenue
    6,025       576       (365 )     34       6,270  
Net interest income
    2,986       (576 )     838       14       3,262  
 
Total net revenue
    9,011             473       48       9,532  
Provision for credit losses
    15             473             488  
Noninterest expense
                                       
Merger costs
                             
Litigation reserve charge
                             
All other noninterest expense
    6,093                         6,093  
 
Total noninterest expense
    6,093                         6,093  
 
Income before income tax expense
    2,903                   48       2,951  
Income tax expense
    973                   48       1,021  
 
Net income
  $ 1,930     $     $     $     $ 1,930  
 
Earnings per share – diluted
  $ 0.92     $     $     $     $ 0.92  
 
Return on common equity
    17 %     %     %     %     17 %
Return on equity – goodwill(b)
    21                         21  
 
Return on assets
    1.01       NM       NM       NM       0.96  
 
Overhead ratio
    68       NM       NM       NM       64  
 
Effective income tax rate
    34       NM       NM       100       35  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Net income applicable to common stock divided by Total average common equity (net of goodwill). The Firm uses return on equity less goodwill, a non-GAAP financial measure, to evaluate the operating performance of the Firm. The Firm utilizes this measure to facilitate operating comparisons to other competitors.
(c)  
The reclassification of trading-related net interest income from Net interest income to Trading revenue primarily impacts the Investment Bank segment results. See page 10 of this Form 10–Q for further information.
(d)  
The impact of credit card securitizations affects CS. See pages 23–25 of this Form 10–Q for further information.
(e)  
The impact of Merger costs and Litigation reserve charges are excluded from Operating earnings, as management believes these items are not part of the Firm’s normal daily business operations and, therefore, are not indicative of trends and do not provide meaningful comparisons with other periods. There were no such items in 2004.
NM
Not meaningful.
                                                 
Three months ended March 31,(a)   2005     2004  
(in millions)   Reported     Securitized     Managed     Reported     Securitized     Managed  
 
Loans – Period-end
  $ 402,669     $ 67,328     $ 469,997     $ 217,630     $ 34,478     $ 252,108  
Total assets – average
    1,162,818       67,509       1,230,327       771,318       33,357       804,675  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

12


 

 
BUSINESS SEGMENT RESULTS
 

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 & Wealth Management, as well as a Corporate segment. The segments are based on the products and services provided, or the type of customer served, and they reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on an operating basis. For a further discussion of Business segment results, see pages 28–29 of JPMorgan Chase’s 2004 Annual Report.

Segment results for periods prior to July 1, 2004, reflect heritage JPMorgan Chase–only results and have been restated to reflect the current business segment organization and reporting classifications. The following table summarizes the business segment results for the periods indicated:

                                                                                         
Segment results – Operating basis(a)                                                                           Return on  
Three months ended March 31,(b)   Total net revenue     Noninterest expense     Operating earnings     equity-goodwill  
(in millions, except ratios)   2005     2004     Change     2005     2004     Change     2005     2004     Change     2005     2004  
 
 
                                                                                       
Investment Bank
  $ 4,180     $ 3,764       11 %   $ 2,525     $ 2,326       9 %   $ 1,325     $ 1,017       30 %     27 %     27 %
Retail Financial Services
    3,847       1,611       139       2,162       1,241       74       988       206       380       31       16  
Card Services
    3,779       1,557       143       1,313       599       119       522       162       222       18       19  
Commercial Banking
    850       322       164       458       209       119       243       74       228       29       37  
Treasury & Securities Services
    1,482       1,012       46       1,065       867       23       245       98       150       52       12  
Asset & Wealth Management
    1,361       848       60       934       649       44       276       122       126       47       9  
Corporate
    (759 )     418     NM     435       202       115       (687 )     251     NM   NM   NM
 
Total
  $ 14,740     $ 9,532       55 %   $ 8,892     $ 6,093       46 %   $ 2,912     $ 1,930       51 %     19 %     21 %
 
 
(a)  
Represents reported results excluding the impact of credit card securitizations and, in 2005, Merger costs and significant litigation reserve charges.
(b)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Description of business segment reporting methodology
Results of the business segments are intended to reflect each segment as if it were essentially a stand-alone business. The management reporting process that derives these results allocates income and expense using market-based methodologies. At the time of the Merger, several of the allocation methodologies were revised, effective July 1, 2004. For a further discussion of those methodologies, see page 29 of JPMorgan Chase’s 2004 Annual Report. In addition, during the first quarter 2005, the Firm refined cost allocation methodologies related to certain corporate functions, technology and operations expense in order to provide better consistency in reporting across business segments. Prior periods have not been revised to reflect these new cost allocation methodologies. The Firm intends to continue to assess the assumptions, methodologies and reporting reclassifications used for segment reporting, and it is anticipated that further refinements may be implemented in future periods.

13


 

 
INVESTMENT BANK
 

For a discussion of the business profile of the IB, see pages 30–32 of JPMorgan Chase’s 2004 Annual Report.

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Investment banking fees:
                       
Advisory
  $ 263     $ 147       79 %
Equity underwriting
    239       177       35  
Debt underwriting
    483       366       32  
         
Total investment banking fees
    985       690       43  
Trading-related revenue:(b)
                       
Fixed income and other
    1,915       1,885       2  
Equities
    225       335       (33 )
Credit portfolio
    59       56       5  
         
Total trading-related revenue(b)
    2,199       2,276       (3 )
Lending & deposit related fees
    157       96       64  
Asset management, administration and commissions
    408       393       4  
Other income
    127       14       NM  
         
Noninterest revenue
    3,876       3,469       12  
Net interest income(b)
    304       295       3  
         
Total net revenue(c)
    4,180       3,764       11  
Provision for credit losses
    (366 )     (188 )     (95 )
Credit reimbursement from TSS(d)
    38       2       NM  
Noninterest expense
                       
Compensation expense
    1,616       1,386       17  
Noncompensation expense
    909       940       (3 )
         
Total noninterest expense
    2,525       2,326       9  
         
Operating earnings before income tax expense
    2,059       1,628       26  
Income tax expense
    734       611       20  
         
Operating earnings
  $ 1,325     $ 1,017       30  
         
Financial ratios
                       
ROE
    27 %     27 %     bp
ROA
    0.95       0.97       (2 )
Overhead ratio
    60       62       (200 )
Compensation expense as % of total net revenue
    39       37       200  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Trading revenue, on a reported basis, excludes the impact of net interest income related to the IB’s trading activities; this income is recorded in Net interest income. However, in this presentation, to assess the profitability of the IB’s trading business, the Firm combines these revenues for segment reporting. The amount reclassified from Net interest income to Trading revenue was $324 million and $581 million for the three months ended March 31, 2005 and 2004, respectively.
(c)  
Total net revenue includes tax-equivalent adjustments, primarily due to tax-exempt income from municipal bonds and income tax credits related to affordable housing investments, of $155 million and $44 million for the three months ended March 31, 2005 and 2004, respectively.
(d)  
TSS is charged a credit reimbursement related to certain exposures managed within the IB credit portfolio on behalf of clients shared with TSS. For a further discussion, see Credit reimbursement on page 29 of the JPMorgan Chase 2004 Annual Report.

Operating earnings were $1.3 billion, an increase of $308 million, or 30%, from the prior year. Results were driven by the Merger, increased Investment banking fees, and an increased benefit from the Provision for credit losses, partially offset by lower Net interest income and higher compensation expense. Compared to the prior quarter, operating earnings doubled, primarily due to higher trading revenues.

Revenues of $4.2 billion were up $416 million, or 11%, compared to the prior year. Investment banking fees of $985 million increased by $295 million, or 43%, compared to the prior year, reflecting continued strong levels of debt underwriting, advisory and equity underwriting fees and the Merger. European investment banking fees were very strong, more than doubling from the prior year and up nearly 50% from the prior quarter. Fixed Income Markets revenues of $2.3 billion were up 9% from the prior

14


 

year, primarily driven by the Merger, and up 50% from the prior quarter on strength in trading revenues in credit and interest rate markets. Equity Markets revenues of $556 million were down 12% from the prior year reflecting reduced trading results, but increased significantly from the prior quarter. Credit Portfolio revenues of $350 million were up marginally from the prior year, reflecting the Merger and gains from loan workouts offset by lower loan balances and spreads.

The Provision for credit losses was a benefit of $366 million compared to a benefit of $188 million in the prior year. The increased benefit was primarily attributable to a greater reduction in the allowance for credit losses, reflecting improvement in credit quality as a result of the turnover in the mix of the loan portfolio towards higher-rated clients and net recoveries.

Expenses of $2.5 billion were up $199 million, or 9%, from the prior year, due to the Merger and increased compensation costs. The increase in compensation expense reflected higher incentive compensation accruals to recognize improved financial performance.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except headcount and ratio data)   2005     2004     Change  
 
Revenue by business
                       
Investment banking fees
  $ 985     $ 690       43 %
Fixed income markets
    2,289       2,097       9  
Equities markets
    556       632       (12 )
Credit portfolio
    350       345       1  
         
Total net revenue
  $ 4,180     $ 3,764       11  
         
Revenue by region
                       
Americas
  $ 2,224     $ 1,953       14  
Europe/Middle East/Africa
    1,535       1,296       18  
Asia/Pacific
    421       515       (18 )
         
Total net revenue
  $ 4,180     $ 3,764       11  
         
Selected balance sheet data (average)
                       
Total assets
  $ 566,778     $ 422,151       34  
Trading assets–debt and equity instruments(c)
    225,367       176,788       27  
Trading assets–derivatives receivables
    63,574       57,042       11  
Loans(d)
    47,468       38,199       24  
Adjusted assets(e)
    445,840       367,525       21  
Equity(f)
    20,000       15,085       33  
 
                       
Headcount
    17,993       14,930       21  
 
                       
Credit data and quality statistics
                       
Net charge-offs
  $ (5 )   $ 34       NM  
Nonperforming assets:
                       
Nonperforming loans(g)
    814       1,498       (46 )
Other nonperforming assets
    242       357       (32 )
Allowance for loan losses
    1,191       855       39  
Allowance for lending-related commitments
    296       215       38  
 
                       
Net charge-off (recovery) rate(d)
    (0.05 )%     0.41 %     (46 )bp
Allowance for loan losses to average loans(d)
    3.03       2.59       44  
Allowance for loan losses to nonperforming loans(g)
    147       58       8,900  
Nonperforming loans to average loans
    1.71       3.92       (221 )
Market risk–average trading and credit portfolio VAR(h)(i)
                       
Trading activities:
                       
Fixed income(h)
  $ 57     $ 73       (22 )%
Foreign exchange
    23       22       5  
Equities
    18       40       (55 )
Commodities and other
    10       8       25  
Diversification
    (43 )     (49 )     12  
         
Total trading VAR
    65       94       (31 )
Credit portfolio VAR(i)
    13       15       (13 )
Diversification
    (8 )     (7 )     (14 )
         
Total trading and credit portfolio VAR
  $ 70     $ 102       (31 )
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 79 of this Form 10-Q.
(c)  
2004 has been restated to conform with current presentation.

15


 

(d)  
Loans include loans held for sale of $8.2 billion and $5.2 billion for the first quarters of 2005 and 2004, respectively. These amounts are not included in the allowance coverage ratios and net charge-off rates.
(e)  
Adjusted assets, a non-GAAP financial measure, equals total average assets minus (1) securities purchased under resale agreements and securities borrowed less securities sold, not yet purchased; (2) assets of variable interest entities (VIEs) consolidated under FIN 46R; (3) cash and securities segregated and on deposit for regulatory and other purposes; and (4) goodwill and intangibles. The amount of adjusted assets is presented to assist the reader in comparing the IB’s asset and capital levels to other investment banks in the securities industry. Asset-to-equity leverage ratios are commonly used as one measure to assess a company’s capital adequacy. The IB believes an adjusted asset amount, which excludes certain assets considered to have a low-risk profile, provides a more meaningful measure of balance sheet leverage in the securities industry. See Capital management on pages 35–37 of this Form 10–Q for a discussion of the Firm’s overall capital adequacy and capital management.
(f)  
Equity includes $13.8 billion of economic risk capital assigned to the IB for the quarter ended March 31, 2005.
(g)  
Nonperforming loans include loans held for sale of $2 million and $30 million as of March 31, 2005 and 2004, respectively. These amounts are not included in the allowance coverage ratios.
(h)  
Includes all mark-to-market trading activities, plus available-for-sale securities held for proprietary purposes.
(i)  
Includes VAR on derivative credit valuation adjustments, credit valuation adjustment hedges and mark-to-market loan hedges, which are reported in Trading revenue. This VAR does not include the accrual loan portfolio, which is not marked to market.

According to Thomson Financial, the Firm improved its ranking to #4 from #6 in Global Equity and Equity-related category, while improving its market share from 6% to 10%. In U.S. Equities, momentum was sustained with a #4 ranking in Equity and Equity-related category and a #5 ranking in IPO’s. The Firm maintained its 25% market share of Global Announced M&A with a #4 ranking compared with #3 in the prior year. In Europe the Firm realized significant market share gains resulting in M&A ranking rising to #3 from #6, Equity and Equity-related up to #2 from #7 and Convertibles up to #1 from #2.

                                 
Market shares and rankings(a)   First Quarter 2005     Full Year 2004  
  Market Share     Rankings     Market Share     Rankings  
 
Global debt, equity and equity-related
    6 %     #5       7 %     # 3  
Global syndicated loans
    13       #1       19       # 1  
Global long-term debt
    6       #5       7       # 2  
Global equity and equity-related
    10       #4       6       # 6  
Global announced M&A
    25       #4       25       # 3  
U.S. debt, equity and equity-related
    7       #4       8       # 5  
U.S. syndicated loans
    27       #1       32       # 1  
U.S. long-term debt
    7       #4       12       # 2  
U.S. equity and equity-related
    11       #4       8       # 6  
U.S. announced M&A
    22       #6       33       #1  
 
 
(a)  
Source: Thomson Financial Securities data. Global announced M&A is based on rank value; all other rankings are based on proceeds, with full credit to each book manager/equal if joint. Because of joint assignments, market share of all participants will add up to more than 100%. The market share and rankings for the year ended December 31, 2004 are presented on a combined basis, as if the merger of JPMorgan Chase and Bank One had been in effect during the period.

COMPOSITION OF REVENUE

                                                         
                            Asset                      
Three months ended March 31,(a)   Investment     Trading-     Lending &     management,                      
  banking     related     deposit     administration     Other             Total net  
(in millions)   fees     revenue     related fees     and commissions     income     NII     revenue  
 
2005
                                                       
Investment banking fees
  $ 985     $     $     $     $     $     $ 985  
Fixed income markets
          1,915       65       64       104       141       2,289  
Equities markets
          225             333       (20 )     18       556  
Credit portfolio
          59       92       11       43       145       350  
 
Total
  $ 985     $ 2,199     $ 157     $ 408     $ 127     $ 304     $ 4,180  
 
 
                                                       
2004
                                                       
Investment banking fees
  $ 690     $     $     $     $     $     $ 690  
Fixed income markets
          1,885       26       60       49       77       2,097  
Equities markets
          335             325       (47 )     19       632  
Credit portfolio
          56       70       8       12       199       345  
 
Total
  $ 690     $ 2,276     $ 96     $ 393     $ 14     $ 295     $ 3,764  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

16


 

 
RETAIL FINANCIAL SERVICES
 

For a discussion of the business profile of RFS and each of its businesses, see pages 33–38 of JPMorgan Chase’s 2004 Annual Report.

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Lending & deposit related fees
  $ 340     $ 121       181 %
Asset management, administration and commissions
    351       95       269  
Securities/private equity gains (losses)
    10             NM  
Mortgage fees and related income
    411       255       61  
Credit card income
    94       19       395  
Other income
    (12 )     (24 )     50  
         
Noninterest revenue
    1,194       466       156  
Net interest income
    2,653       1,145       132  
         
Total net revenue
    3,847       1,611       139  
Provision for credit losses
    94       54       74  
Noninterest expense
                       
Compensation expense
    822       509       61  
Noncompensation expense
    1,215       731       66  
Amortization of intangibles
    125       1       NM  
         
Total noninterest expense
    2,162       1,241       74  
         
Operating earnings before income tax expense
    1,591       316       403  
Income tax expense
    603       110       448  
         
Operating earnings
  $ 988     $ 206       380 %
         
Financial ratios
                       
ROE
    31 %     16 %     1,500 bp
ROA
    1.78       0.59       119  
Overhead ratio
    56       77       (2,100 )
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Operating earnings were $988 million, up $782 million from the prior year. The increase was largely due to the Merger, but also reflected improved risk management results in Home Finance, wider spreads on deposits, increased deposit balances, and lower expenses due to merger-related savings in all businesses. These improvements were partially offset by a reduction in revenue related to lower prime mortgage originations.

Total net revenue increased to $3.8 billion, up $2.2 billion from the prior year. Net interest income of $2.7 billion increased $1.5 billion as a result of the Merger, as well as from wider spreads on deposits, increased deposit balances, growth in retained home equity loans, and the absence of a $40 million charge taken in the first quarter of 2004 related to auto lease residuals. These benefits were partially offset by the absence of net interest revenue from the $4 billion manufactured home loan portfolio that was sold in late 2004. Noninterest revenue of $1.2 billion increased $728 million due to the Merger, improved Home Finance risk management results and a gain of $24 million on the sale of a recreational vehicle loan portfolio. These increases were offset partially by lower revenue related to a decline in prime mortgage originations and an $88 million write-down on $2.7 billion of auto loans transferred to held-for-sale.

The Provision for credit losses totaled $94 million, up $40 million from last year. The increase was largely due to the Merger. Both the prior year and current quarter included reductions in the allowance for loan losses due to improved credit trends in most consumer lending portfolios. Results also included the benefit of reductions in the allowance for loan losses totaling $20 million related to the sale of the recreational vehicle loan portfolio and the transfer of auto loans to held-for-sale. These benefits were partially offset by an increase in provision expense related to the decision to retain subprime mortgage loans rather than securitize.

Expenses rose to $2.2 billion, an increase of $921 million, primarily due to the Merger. Results also included continued investment in the retail banking distribution system and a $40 million charge related to the dissolution of a student loan joint venture in the Education Finance segment. These increases were more than offset by merger-related savings in all businesses.

17


 

                         
Selected metrics                  
Three months ended March 31, (a)                  
(in millions, except headcount and ratios)   2005     2004     Change  
 
Selected balance sheet (ending)
                       
Total assets
  $ 224,562     $ 138,747       62 %
Loans(b)
    199,215       123,923       61  
Core deposits(c)(d)
    162,241       81,392       99  
Total deposits(d)
    187,225       91,478       105  
 
                       
Selected balance sheet (average)
                       
Total assets
  $ 225,120     $ 139,727       61  
Loans(e)
    198,494       121,357       64  
Core deposits(c)(d)
    159,682       79,801       100  
Total deposits(d)
    184,336       88,788       108  
Equity
    13,100       5,177       153  
 
                       
Headcount
    59,322       31,377       89  
 
                       
Credit data and quality statistics
                       
Net charge-offs
  $ 152     $ 85       79  
Nonperforming loans(f)
    1,150       546       111  
Nonperforming assets
    1,351       736       84  
Allowance for loan losses
    1,168       1,063       10  
 
                       
Net charge-off rate(e)
    0.34 %     0.32 %     2 bp
Allowance for loan losses to ending loans(b)
    0.64       0.97       (33 )
Allowance for loan losses to nonperforming loans(f)
    104       214       NM  
Nonperforming loans to total loans
    0.58       0.44       14  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
End-of-period loans include loans held for sale of $16,532 million and $14,334 million at March 31, 2005 and 2004, respectively. These amounts are not included in the allowance coverage ratios.
(c)  
Includes demand and savings deposits.
(d)  
Reflects the transfer of certain consumer deposits from Retail Financial Services to Asset & Wealth Management.
(e)  
Average loans include loans held for sale of $15,861 million and $15,311 million for the first quarter of 2005 and 2004, respectively. These amounts are not included in the net charge-off rate.
(f)  
Nonperforming loans include loans held for sale of $31 million and $50 million at March 31, 2005 and 2004, respectively. These amounts are not included in the allowance coverage ratios.

HOME FINANCE

                         
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Prime production and servicing
                       
Production
  $ 228     $ 178       28 %
Servicing:
                       
Mortgage servicing revenue, net of amortization
    146       155       (6 )
MSR risk management results
    106       61       74  
         
Total net revenue
    480       394       22  
Noninterest expense
    229       289       (21 )
Operating earnings
    158       65       143  
 
                       
Consumer real estate lending
                       
Total net revenue
  $ 713     $ 435       64  
Provision for credit losses
    30       (9 )     NM  
Noninterest expense
    238       203       17  
Operating earnings
    284       156       82  
 
                       
Total Home Finance
                       
Total net revenue
  $ 1,193     $ 829       44  
Provision for credit losses
    30       (9 )     NM  
Noninterest expense
    467       492       (5 )
Operating earnings
    442       221       100  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

18


 

Operating earnings were $442 million, up $221 million compared to the prior year. Operating earnings for the Prime Production & Servicing segment of $158 million were up $93 million from the prior year. Results benefited from an increase in risk management revenue associated with the MSR asset and secondary marketing activities, as well as lower expenses. Secondary marketing involves the sale of mortgage loans into the secondary market and risk management of this activity from the point of loan commitment to customers through loan closing and subsequent sale. These were partially offset by a decrease in revenue due to lower prime mortgage originations. Earnings for the Consumer Real Estate Lending segment of $284 million were up $128 million from the prior year. Growth was largely due to the Merger, but also reflected higher retained home equity loan balances and merger-related expense savings. These increases were partially offset by the absence of the $4 billion manufactured home loan portfolio that was sold in late 2004.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except ratios and where otherwise noted)   2005     2004     Change  
 
Origination volume by channel (in billions)
                       
Retail
  $ 18.3     $ 15.2       20 %
Wholesale
    10.7       9.5       13  
Correspondent
    2.3       5.3       (57 )
Correspondent negotiated transactions
    7.2       7.7       (6 )
         
Total
  $ 38.5     $ 37.7       2  
         
Origination volume by business (in billions)
                       
Mortgage
  $ 26.6     $ 31.0       (14 )
Home equity
    11.9       6.7       78  
         
Total
  $ 38.5     $ 37.7       2  
         
Business metrics (in billions)
                       
Loans serviced – Mortgage (ending)(c)
  $ 495.8     $ 450.4       10  
MSR net carrying value (ending)
    5.7       4.2       36  
End of period loans owned
                       
Mortgage loans held for sale
  $ 9.6     $ 12.8       (25 )
Mortgage loans retained
    46.0       36.5       26  
Home equity and other loans
    68.8       26.3       162  
         
Total end of period loans owned
  $ 124.4     $ 75.6       65  
         
Average loans owned
                       
Mortgage loans held for sale
  $ 11.4     $ 12.9       (12 )
Mortgage loans retained
    44.3       35.8       24  
Home equity and other loans
    66.5       24.1       176  
         
Total average loans owned
  $ 122.2     $ 72.8       68  
         
Overhead ratio
    39 %     59 %     (2,000 )bp
 
                       
Credit quality statistics
                       
30+ day delinquency rate
    1.15 %     1.32 %     (17 )bp
Net charge-offs
                       
Mortgage
  $ 6     $ 3       100 %
Home equity and other loans
    35       25       40  
         
Total net charge-offs
    41       28       46  
Net charge-off rate
                       
Mortgage
    0.05 %     0.03 %     2 bp
Home equity and other loans
    0.21       0.42       (21 )
Total net charge-off rate(d)
    0.15       0.19       (4 )
Nonperforming assets
  $ 841     $ 516       63 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 79 of this Form 10-Q.
(c)  
Includes prime first mortgage loans and subprime loans.
(d)  
Excludes mortgage loans held for sale.

19


 

The table below reconciles management’s disclosure of Home Finance’s revenue to the reported U.S. GAAP line items shown on the Consolidated statements of income and in the related Notes to Consolidated financial statements:

                                                 
Three months ended March 31,(a)   Prime production     Consumer real        
  and servicing     estate lending     Total revenue  
(in millions)   2005     2004     2005     2004     2005     2004  
 
Net interest income
  $ 115     $ 182     $ 678     $ 397     $ 793     $ 579  
Securities / private equity gains (losses)
    2       (4 )                 2       (4 )
Mortgage fees and related income(b)
    363       216       35       38       398       254  
 
Total
  $ 480     $ 394     $ 713     $ 435     $ 1,193     $ 829  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Includes activity reported elsewhere as Other income.

The following table details the MSR risk management results in the Home Finance business:

MSR Risk Management Results

                 
Three months ended March 31,(a)            
(in millions)   2005     2004  
 
Reported amounts:
               
MSR valuation adjustments(b)
  $ 551     $ (625 )
Derivative valuation adjustments and other risk management gains (losses)(c)
    (445 )     686  
 
MSR risk management results
  $ 106     $ 61  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Excludes subprime loan MSR activity of $(3) million and $4 million for the three months ended March 31, 2005 and 2004, respectively.
(c)  
Includes gains, losses, and interest income associated with derivatives, both designated and not designated, as a SFAS 133 hedge, and securities classified as both trading and available-for-sale.

Home Finance uses a combination of derivatives, AFS securities and trading securities to manage changes in the fair value of the MSR asset. These risk management activities are intended to protect the economic value of the MSR asset by providing offsetting changes in the fair value of the related risk management instruments. The type and amount of hedging instruments used in this risk management activity change over time as market conditions and risk management approaches dictate.

MSR valuation adjustments of $551 million were partially offset by $445 million of aggregate risk management losses, including net interest earned on securities. In 2004, negative MSR valuation adjustments of $625 million were more than offset by $686 million of aggregate risk management gains, including net interest earned on securities. Unrealized gains/(losses) on AFS securities were $(4) million and $(71) million at March 31, 2005 and 2004, respectively. For a further discussion of MSRs, see Note 14 on pages 69–71 of this Form 10–Q, and Critical accounting estimates on page 79, and Note 15 on pages 109–111 of JPMorgan Chase’s 2004 Annual Report.

CONSUMER & SMALL BUSINESS BANKING

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Noninterest revenue
  $ 729     $ 198       268 %
Net interest revenue
    1,428       391       265  
         
Total net revenue
    2,157       589       266  
Provision for credit losses
    36       27       33  
Noninterest expense
    1,339       647       107  
Operating earnings (loss)
    477       (49 )     NM  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

20


 

Operating earnings totaled $477 million, up $526 million from the prior year. While growth was largely due to the Merger, the results also benefited from wider spreads on deposits, increased deposit balances and merger-related expense savings. These benefits were partially offset by continued investment in the distribution network. Compared to the prior quarter, operating earnings increased $47 million, or 11%, primarily due to the seasonal impact of tax-refund anticipation lending.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except ratios and where otherwise noted)   2005     2004     Change  
 
Business metrics (in billions)
End-of-period balances
                       
Small business loans
  $ 12.4     $ 2.2       464 %
Consumer and other loans(c)
    2.2       2.0       10  
         
Total loans
    14.6       4.2       248  
Core deposits(d)(e)
    150.8       69.5       117  
Total deposits(e)
    175.7       79.6       121  
 
                       
Average balances
                       
Small business loans
    12.4       2.2       464  
Consumer and other loans(c)
    2.6       2.0       30  
         
Total loans
    15.0       4.2       257  
Core deposits(d)(e)
    149.3       70.3       112  
Total deposits(e)
    173.9       79.2       120  
 
                       
Number of:
                       
Branches
    2,517       564       1,953 #
ATMs
    6,687       1,927       4,760  
Personal bankers(f)
    5,798       1,763       4,035  
Personal checking accounts (in thousands)
    7,445       1,984       5,461  
Business checking accounts (in thousands)
    905       350       555  
Active online customers (in thousands)
    3,671       NA       NM  
Debit cards issued (in thousands)
    8,596       2,368       6,228  
 
                       
Overhead ratio
    62 %     110 %     (4,800 )bp
 
                       
Retail brokerage business metrics
                       
Investment sales volume
  $ 2,870     $ 944       204 %
Number of dedicated investment sales representatives
    1,352       377       259  
 
                       
Credit quality statistics
                       
Net charge-offs
                       
Small business
  $ 19     $ 9       111  
Consumer and other loans
    9       8       13  
         
Total net charge-offs
    28       17       65  
Net charge-off rate
                       
Small business
    0.62 %     1.65 %     (103 )bp
Consumer and other loans
    1.40       1.61       (21 )
Total net charge-off rate
    0.76       1.63       (87 )
Nonperforming assets
  $ 293     $ 80       266 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 79 of this Form 10-Q.
(c)  
Primarily community development loans.
(d)  
Includes demand and savings deposits.
(e)  
Reflects the transfer of certain deposits from Retail Financial Services to Asset & Wealth Management.
(f)  
Reflects realignment of job families and responsibilities.
NA—Data is not available on a comparable basis.

21


 

AUTO & EDUCATION FINANCE

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Total net revenue
  $ 324     $ 166       95 %
Provision for credit losses
    28       36       (22 )
Noninterest expense
    205       81       153  
Operating earnings
    55       30       83  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Operating earnings of $55 million were up $25 million from last year. The current quarter results included a $78 million loss associated with auto loans transferred to held-for-sale, a $40 million charge related to the dissolution of the student loan joint venture, and a benefit of $34 million from the sale of a $2 billion recreational vehicle loan portfolio. The prior year results included a $40 million charge related to auto lease residuals. Excluding the after-tax impact of these four items, operating earnings would have increased $51 million over the prior year, primarily due to the Merger and improved credit quality. Results continued to reflect lower production volumes and narrower margins, due to the competitive nature of the operating environment.

                         
Selected metrics                  
Three months ended March 31,(a)                  
(in millions, except ratios and where otherwise noted)   2005     2004     Change  
 
Business metrics (in billions)
                       
End of period loans and lease receivables
                       
Loans outstanding
  $ 52.8     $ 34.9       51 %
Lease receivables
    7.0       9.1       (23 )
         
Total end-of-period loans and lease receivables
    59.8       44.0       36  
 
                       
Average loans and lease receivables
                       
Loans outstanding (average)(b)
  $ 53.3     $ 35.0       52  
Lease receivables (average)
    7.6       9.3       (18 )
         
Total average loans and lease receivables(b)
    60.9       44.3       37  
 
                       
Overhead ratio
    63 %     49 %     1,400 bp
 
                       
Credit quality statistics
                       
30+ day delinquency rate
    1.33 %     1.05 %     28 bp
Net charge-offs
Loans
  $ 74     $ 28       164 %
Lease receivables
    9       12       (25 )
         
Total net charge-offs
    83       40       108  
Net charge off rate
                       
Loans(b)
    0.61 %     0.35 %     26 bp
Lease receivables
    0.48       0.52       (4 )
Total net charge-off rate(b)
    0.60       0.38       22  
Nonperforming assets
  $ 217     $ 140       55 %
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Average loans include loans held for sale of $4.5 billion and $2.4 billion for the first quarter of 2005 and 2004, respectively. These are not included in the net charge-off rate.

INSURANCE

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Total net revenue
  $ 173     $ 27       NM  
Noninterest expense
    151       21       NM  
Operating earnings
    14       4       250 %
Memo: Consolidated gross insurance-related revenue(b)
    416       176       136  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Includes revenue reported in the results of other businesses.

22


 

Operating earnings totaled $14 million on net revenues of $173 million. The increase over the prior year was primarily due to the Merger. Results also reflected an increase in commissions on proprietary annuity sales and investments in technology infrastructure.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except where otherwise noted)   2005     2004     Change  
 
Business metrics – ending balances
                       
Invested assets
  $ 7,349     $ 1,710       330 %
Policy loans
    394           NM  
Insurance policy and claims reserves
    7,337       1,193     NM  
Term premiums – first year annualized
    14           NM  
Proprietary annuity sales
    119       76       57  
Number of policies in force – direct/assumed (in thousands)
    2,540       622       308  
Insurance in force – direct/assumed
    280,082       33,161     NM  
Insurance in force – retained
    83,799       33,161       153  
A.M. Best rating
    A       A          
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 79 of this Form 10-Q.

CARD SERVICES

For a discussion of the business profile of CS, see pages 39–40 of JPMorgan Chase’s 2004 Annual Report.

JPMorgan Chase uses the concept of “managed receivables” to evaluate the credit performance of the underlying credit card loans, both sold and not sold. For further information, see Explanation and reconciliation of the Firm’s use of non-GAAP financial measures on page 10 of this Form 10-Q. Operating results exclude the impact of credit card securitizations on revenue, the provision for credit losses, net charge-offs and receivables. Securitization does not change reported net income versus operating earnings; however, it does affect the classification of items on the Consolidated statements of income.

                         
Selected income statement data – managed basis                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Asset management, administration and commissions
  $     $ 24     NM  
Credit card income
    761       238       220 %
Other income
    11       22       (50 )
         
Noninterest revenue
    772       284       172  
Net interest income
    3,007       1,273       136  
         
Total net revenue
    3,779       1,557       143  
 
                       
Provision for credit losses
    1,636       706       132  
 
                       
Noninterest expense
                       
Compensation expense
    285       156       83  
Noncompensation expense
    839       381       120  
Amortization of intangibles
    189       62       205  
         
Total noninterest expense
    1,313       599       119  
         
Operating earnings before income tax expense
    830       252       229  
Income tax expense
    308       90       242  
         
Operating earnings
  $ 522     $ 162       222  
         
 
                       
Financial metrics
                       
ROE
    18 %     19 %   (100 )bp
Overhead ratio
    35       38       (300 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

Operating earnings of $522 million increased $360 million from the prior year due to the Merger, higher Net interest income, lower Provision for credit losses and lower expenses, partially offset by higher marketing spend.

Total revenues of $3.8 billion increased $2.2 billion, primarily due to the Merger. Net interest income of $3.0 billion increased $1.7 billion, primarily due to the Merger, including the acquisition of a private label portfolio, and higher loan balances. Noninterest revenue of $772 million increased $488 million due to the Merger and higher charge volume, which resulted in increased interchange income, partially offset by higher volume-driven payments to partners and higher rewards expense.

23


 

The managed Provision for credit losses of $1.6 billion increased $930 million, primarily due to the Merger, including the acquisition of a private label portfolio, and additions to the Allowance for loan losses related to growth in on-balance sheet loans, partially offset by lower net charge-offs. Managed credit ratios remained strong, benefiting from lower bankruptcies and a continued low level of delinquencies. The managed net charge-off rate for the quarter was 4.83%, down from 5.81% in the prior year. The 30-day managed delinquency rate was 3.54%, down from 4.41% in the prior year.

Expenses of $1.3 billion increased $714 million, primarily due to the Merger, including the acquisition of a private label portfolio. Merger saves, including lower compensation and processing costs, were partially offset by higher marketing spend.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except headcount, ratios and where otherwise noted)   2005     2004     Change  
 
Net securitization gains (amortization)
  $ (12 )   $ (2 )     (500 )%
 
                       
% of average managed outstandings:
                       
Net interest income
    9.13 %     9.95 %   (82 )bp
Provision for credit losses
    4.97       5.52       (55 )
Noninterest revenue
    2.34       2.22       12  
Risk adjusted margin(c)
    6.51       6.65       (14 )
Noninterest expense
    3.99       4.68       (69 )
Pre-tax income
    2.52       1.97       55  
Operating earnings
    1.58       1.27       31  
 
                       
Business metrics
                       
Charge volume (in billions)
  $ 70.3     $ 21.5       227 %
Net accounts opened (in thousands)
    2,744       1,026       167  
Credit cards issued (in thousands)
    94,367       35,239       168  
Number of registered internet customers (in millions)
    10.9       4.1       166  
 
                       
Merchant acquiring business
                       
Bank card volume (in billions)
  $ 125.1     $ 65.0       92  
Total transactions (in millions)
    4,285       1,757       144  
 
                       
Selected ending balances
                       
Loans:
                       
Loans on balance sheet
  $ 66,053     $ 16,639       297  
Securitized loans
    67,328       34,478       95  
         
Managed loans
  $ 133,381     $ 51,117       161  
         
 
                       
Selected average balances
                       
Managed assets
  $ 138,512     $ 51,749       168  
Loans:
                       
Loans on balance sheet
  $ 64,218     $ 17,037       277  
Securitized loans
    69,370       34,425       102  
         
Managed loans
  $ 133,588     $ 51,462       160  
         
Equity
    11,800       3,392       248  
 
                       
Headcount
    20,137       10,838       86  
 
                       
Credit quality statistics
                       
Net charge-offs
  $ 1,590     $ 743       114  
Net charge-off rate
    4.83 %     5.81 %   (98 )bp
 
                       
Delinquency ratios
                       
30+ days
    3.54 %     4.41 %     (87 )
90+ days
    1.71       2.15       (44 )
 
                       
Allowance for loan losses
  $ 3,040     $ 1,188       156 %
Allowance for loan losses to period-end loans
    4.60 %     7.14 %   (254 )bp
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see pages 79-80 of this Form 10-Q.
(c)  
Represents Total net revenue less Provision for credit losses.

24


 

The financial information presented below reconciles reported basis and managed basis to disclose the effect of securitizations.

                 
Three months ended March 31,(a)            
(in millions)   2005     2004  
 
Income statement data
               
Credit card income
               
Reported data for the period
  $ 1,576     $ 564  
Securitization adjustments
    (815 )     (326 )
 
Managed credit card income
  $ 761     $ 238  
 
 
               
Other income
               
Reported data for the period
  $ 11     $ 61  
Securitization adjustments
          (39 )
 
Managed other income
  $ 11     $ 22  
 
 
               
Net interest income
               
Reported data for the period
  $ 1,275     $ 435  
Securitization adjustments
    1,732       838  
 
Managed net interest income
  $ 3,007     $ 1,273  
 
 
               
Total net revenue(b)
               
Reported data for the period
  $ 2,862     $ 1,084  
Securitization adjustments
    917       473  
 
Managed total net revenue(b)
  $ 3,779     $ 1,557  
 
 
               
Provision for credit losses
               
Reported data for the period
  $ 719     $ 233  
Securitization adjustments
    917       473  
 
Managed provision for credit losses
  $ 1,636     $ 706  
 
 
               
Balance sheet – average balances
               
Total average assets
               
Reported data for the period
  $ 71,003     $ 18,392  
Securitization adjustments
    67,509       33,357  
 
Managed average assets
  $ 138,512     $ 51,749  
 
 
               
Credit quality statistics
               
Net charge-offs
               
Reported net charge-offs data for the period
  $ 673     $ 270  
Securitization adjustments
    917       473  
 
Managed net charge-offs
  $ 1,590     $ 743  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Includes Credit card income, Other income and Net interest income.

25


 

COMMERCIAL BANKING
For a discussion of the business profile of CB, see pages 41–42 of JPMorgan Chase’s 2004 Annual Report.
                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Lending & deposit related fees
  $ 142     $ 65       118 %
Asset management, administration and commissions
    15       4       275  
Other income(b)
    68       26       162  
         
Noninterest revenue
    225       95       137  
Net interest income
    625       227       175  
         
Total net revenue
    850       322       164  
Provision for credit losses
    (6 )     (13 )     54  
Noninterest expense
                       
Compensation expense
    163       71       130  
Noncompensation expense
    278       138       101  
Amortization of intangibles
    17           NM  
         
Total noninterest expense
    458       209       119  
         
Operating earnings before income tax expense
    398       126       216  
Income tax expense
    155       52       198  
         
Operating earnings
  $ 243     $ 74       228  
         
Financial ratios
                       
ROE
    29 %     37 %   (800 )bp
ROA
    1.79       1.83       (4 )
Overhead ratio
    54       65       (1,100 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
IB-related and commercial card revenues are includes in Other income.

Operating earnings were $243 million, an increase of $169 million from the prior year, primarily due to the Merger.

Revenues were $850 million, an increase of $528 million, primarily due to the Merger. In addition, Net interest income of $625 million was positively affected by higher liability balances and spreads, partially offset by margin compression on loans. Liability balances include deposits and deposits “swept” to on-balance sheet liabilities. Noninterest revenue of $225 million reflected lower fees in lieu of compensating balances and lower gains on the sale of assets acquired in the satisfaction of debt.

Provision for credit losses was a net benefit of $6 million for the quarter, compared to a net benefit of $13 million in the prior year. Net charge-offs for the quarter were $2 million.

Expenses increased $249 million to $458 million, primarily related to the Merger and higher allocations of Treasury Services product unit costs due to methodology changes.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except headcount and ratio data)   2005     2004     Change  
 
Revenue by product:
                       
Lending
  $ 269     $ 84       220 %
Treasury services
    542       219       147  
Investment banking
    40       15       167  
Other
    (1 )     4     NM  
         
Total Commercial Banking revenue
  $ 850     $ 322       164  
 
 
                       
Revenue by business:
                       
Middle market
  $ 572     $ 185       209  
Corporate banking
    123       57       116  
Real estate
    119       52       129  
Other
    36       28       29  
         
Total Commercial Banking revenue
  $ 850     $ 322       164  
 
 
                       

26


 

                         
Selected balance sheet data (average)
                       
Total assets
  $ 55,080     $ 16,239       239  
Loans and leases
    49,969       13,764       263  
Liability balances(c)
    71,613       36,596       96  
Equity
    3,400       795       328  
 
                       
Memo:
                       
Loans by business:
                       
Middle market
  $ 30,216     $ 5,109       491  
Corporate banking
    5,788       2,549       127  
Real estate
    10,345       3,610       187  
Other
    3,620       2,496       45  
         
Total Commercial Banking loans
  $ 49,969     $ 13,764       263  
         
Headcount
    4,495       1,701       164  
 
                       
Credit quality statistics
                       
Net charge-offs (recoveries)
  $ 2     $ (1 )   NM  
Nonperforming loans
    433       165       162  
Allowance for loan losses
    1,312       111     NM  
Allowance for lending-related commitments
    170       28     NM  
 
                       
Net charge-off (recovery) rate
    0.02 %     (0.03 )%   5 bp
Allowance for loan losses to average loans
    2.63       0.81       182  
Allowance for loan losses to nonperforming loans
    303       67     NM  
Nonperforming loans to average loans
    0.87       1.20       (33 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 80 of this Form 10-Q.
(c)  
Liability balances include deposits and deposits that are swept to on-balance sheet liabilities.

TREASURY & SECURITIES SERVICES

For a discussion of the business profile of TSS, see pages 43–44 of JPMorgan Chase’s 2004 Annual Report.

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Lending & deposit related fees
  $ 170     $ 118       44 %
Asset management, administration and commissions
    692       582       19  
Other income
    124       69       80  
         
Noninterest revenue
    986       769       28  
Net interest income
    496       243       104  
         
Total net revenue
    1,482       1,012       46  
Provision for credit losses
    (3 )     1     NM  
Credit reimbursement to IB(b)
    (38 )     (2 )   NM  
Noninterest expense
                       
Compensation expense
    504       339       49  
Noncompensation expense
    532       512       4  
Amortization of intangibles
    29       16       81  
         
Total noninterest expense
    1,065       867       23  
         
Operating earnings before income tax expense
    382       142       169  
Income tax expense
    137       44       211  
         
Operating earnings
  $ 245     $ 98       150 %
         
Financial ratios
                       
ROE
    52 %     12 %   4,000 bp
Overhead ratio
    72       86       (1,400 )
Pre-tax margin ratio(c)
    26       14       1,200  
Memo
                       
Treasury Services firmwide overhead ratio(d)
    56       69       (1,300 )
Treasury & Securities Services firmwide overhead ratio(d)
    63       78       (1,500 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

27


 

(b)  
TSS is charged a credit reimbursement related to certain exposures managed within the IB credit portfolio on behalf of clients shared with TSS. For a further discussion, see Credit reimbursement on page 29 of the JPMorgan Chase 2004 Annual Report.
(c)  
Pre-tax margin represents operating earnings before income tax divided by total net revenue, which is a comprehensive measure of pre-tax performance and is another basis by which TSS management evaluates its performance and that of its competitors. Pre-tax margin is an effective measure of TSS’s earnings after all operating costs are taken into consideration.
(d)  
TSS and TS firmwide overhead ratios have been calculated based on the firmwide revenues described in footnote (c) on page 29 of this Form 10–Q and TSS and TS expenses, respectively, including those allocated to certain other lines of business. Foreign Exchange (“FX”) revenues and expenses recorded in the IB for TSS-related FX activity are not included in this ratio.

Operating earnings for the quarter were $245 million, an increase of $147 million, primarily related to the Merger.

TSS net revenues of $1.5 billion were up $470 million, or 46%. Revenue growth reflected the benefit of the Merger, wider spreads on liability balances (which include deposits and deposits “swept” to on–balance sheet liabilities), improved product revenues, and growth in average liability balances and assets under custody. Net interest income grew to $496 million, up $253 million, as a result of the Merger, wider spreads on liability balances, and average liability balance growth of 49% to $155 billion. Growth in Noninterest revenue was driven largely by the Merger and an increase in assets under custody to $10.2 trillion. Beginning March 31, 2005, assets under custody include an estimated $400 billion of Institutional Trust Services’ assets under custody. Excluding this amount, assets under custody increased $1.8 trillion, or 22%, attributable to new business, increased volumes and market value appreciation. Also contributing to Noninterest revenue improvement was growth in commercial card products, securities lending, trade and trust products, including CDO administration. Partially offsetting these improvements were lower service charges on deposits.

Treasury Services net revenue grew to $618 million, Investor Services to $508 million and Institutional Trust Services to $356 million. TSS firmwide net revenue, which includes Treasury Services net revenue recorded in other lines of business, grew to $2.1 billion, up $841 million, or 67%, primarily as a result of the Merger. TS firmwide net revenue grew to $1.2 billion, up $632 million, or 104%, primarily as a result of the Merger.

Credit reimbursement to the Investment Bank was $38 million, up $36 million, principally due to the Merger and a Merger-related change in methodology. TSS is charged a credit reimbursement related to certain exposures managed within the Investment Bank credit portfolio on behalf of clients shared with TSS.

Noninterest expense of $1.1 billion was up $198 million, or 23%, due to the Merger, increased compensation and technology-related expenses. Offsetting these increases were lower allocations of Corporate segment expenses and higher product-unit costs charged to other lines of business, primarily Commercial Banking, due to segment reporting methodology changes.

Vastera
On April 1, 2005, JPMorgan Chase acquired Vastera, a provider of global trade management solutions, for approximately $129 million. Vastera’s business was combined with the Logistics and Trade Services businesses of TSS’s Treasury Services unit.

Worldwide Securities Services
On April 18, 2005, TSS announced that it combined its investor and issuer services capabilities under the name Worldwide Securities Services. The integrated franchise brought together the former Investor Services and Institutional Trust Services businesses, and will provide custody and investor services as well as securities clearance and trust services to clients globally.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except headcount and where otherwise noted)   2005     2004     Change  
 
Revenue by business
                       
Treasury Services(c)
  $ 618     $ 357       73 %
Investor Services
    508       398       28  
Institutional Trust Services
    356       257       39  
         
Total net revenue
  $ 1,482     $ 1,012       46  
         
Memo
                       
Treasury Services firmwide revenue(c)
  $ 1,237     $ 605       104  
Treasury & Securities Services firmwide revenue(c)
    2,101       1,260       67  
 
                       
Business metrics
                       
Assets under custody (in billions) (d)
  $ 10,154     $ 8,001       27  
Corporate trust securities under administration (in billions)(e)
    6,745       6,373       6  
 
                       
Selected balance sheet data (average)
                       
Total assets
  $ 27,033     $ 19,241       40  
Loans
    10,091       6,137       64  
Liability balances(f)
    154,673       103,467       49  
Equity
    1,900       3,189       (40 )

28


 

                         
Memo
                       
Treasury Services firmwide liability balances(g)
  $ 133,770     $ 74,817       79  
Treasury & Securities Services firmwide liability balances(g)
    226,286       140,063       62  
Headcount
    23,073       15,341       50  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 80 of this Form 10-Q.
(c)  
TSS and TS firmwide revenues include TS revenues recorded in certain other lines of business and exclude FX revenues recorded in the IB for TSS-related FX activity. Revenue associated with TS’ customers who are also customers of the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management lines of business are reported in these other lines of business and are excluded from TS, as follows:
                         
    2005     2004     Change  
 
Treasury Services revenue reported in Commercial Banking
  $ 542     $ 219       147 %
Treasury Services revenue reported in other lines of business
    77       29       166  
 
 
   
TSS firmwide FX revenues, which include FX revenues recorded in TSS and FX revenues associated with TSS customers who are FX customers of the IB, were $90 million for the quarter ended March 31, 2005.
(d)  
Beginning March 31, 2005, assets under custody include an estimated $400 billion of ITS assets under custody that have not been included previously. Assets under custody was increased by approximately $160 billion for the quarter ended March 31, 2005 to include assets under custody transferred from AWM.
(e)  
Corporate trust securities under administration include debt held in trust on behalf of third parties and debt serviced as agent.
(f)  
Liability balances include deposits and deposits swept to on-balance sheet liabilities.
(g)  
TSS and TS firmwide liability balances include TS’ liability balances recorded in certain other lines of business. Liability balances associated with TS customers who are also customers of the Commercial Banking line of business are reported in that line of business and are excluded from TS.

ASSET & WEALTH MANAGEMENT

For a discussion of the business profile of AWM, see pages 45–46 of JPMorgan Chase’s 2004 Annual Report.

                         
Selected income statement data                  
Three months ended March 31,(a)                  
(in millions, except ratios)   2005     2004     Change  
 
Revenue
                       
Lending & deposit related fees
  $ 9     $ 4       125 %
Asset management, administration and commissions
    975       672       45  
Other income
    95       50       90  
         
Noninterest revenue
    1,079       726       49  
Net interest income
    282       122       131  
         
Total net revenue
    1,361       848       60  
 
                       
Provision for credit losses
    (7 )     10     NM  
 
                       
Noninterest expense
                       
Compensation expense
    538       325       66  
Noncompensation expense
    371       322       15  
Amortization of intangibles
    25       2     NM  
         
Total noninterest expense
    934       649       44  
         
Operating earnings before income tax expense
    434       189       130  
Income tax expense
    158       67       136  
         
Operating earnings
  $ 276     $ 122       126  
         
 
                       
Financial ratios
                       
ROE
    47 %     9 %   3,800bp
Overhead ratio
    69       77       (800 )
Pre-tax margin ratio(b)
    32       22       1,000  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Pre-tax margin represents operating earnings before income taxes divided by Total net revenue, which is a comprehensive measure of pre-tax performance and is another basis by which AWM management evaluates its performance and that of its competitors. Pre-tax margin is an effective measure of AWM’s earnings, after all operating costs are taken into consideration.

Operating earnings were $276 million, up $154 million from the prior year, primarily due to the Merger. In addition, performance was driven by increased revenue and decreased Provision for credit losses, partially offset by higher compensation expense.

29


 

Total revenue was $1.4 billion, up $513 million, primarily due to the Merger. In addition, fees and commissions increased due to the acquisition of a majority interest in Highbridge Capital Management in the fourth quarter of 2004; net asset inflows, primarily in brokerage and equities products; and global equity market appreciation. Net interest income increased due to higher deposit product balances.

The Provision for credit losses was a benefit of $7 million, an improvement of $17 million, primarily due to lower net charge-offs and the overall improvement in credit quality.

Expenses increased to $934 million, up $285 million, due to the Merger and increased compensation expense, primarily related to incentives and the acquisition of Highbridge.

                         
Selected metrics                  
Three months ended March 31,(a)(b)                  
(in millions, except ratio, headcount and ranking data, and where otherwise noted)   2005     2004     Change  
 
Revenue by client segment
                       
Private bank
  $ 422     $ 376       12 %
Retail(c)
    346       265       31  
Institutional(c)
    322       187       72  
Private client services
    271       20     NM  
         
Total net revenue
  $ 1,361     $ 848       60  
         
Business metrics
                       
Number of:
                       
Client advisors(c)
    1,390       647       115 %
Brown Co. average daily trades
    29,753       36,470       (18 )
Retirement Plan Services participants
    1,181,000       816,000       45  
 
                       
Star rankings(d)
                       
% of customer assets in funds ranked 4 or better
    48 %     49 %     (2 )
% of customer assets in funds ranked 3 or better
    79 %     74 %     7  
 
                       
Selected balance sheet data (average)
                       
Total assets
  $ 39,716     $ 35,295       13  
Loans
    26,357       17,097       54  
Deposits(e)
    42,043       23,109       82  
Equity
    2,400       5,471       (56 )
 
                       
Headcount
    12,378       8,554       45  
 
                       
Credit quality statistics
                       
Net charge-offs
  $ (6 )   $ 55     NM  
Nonperforming loans
    78       115       (32 )
Allowance for loan losses
    214       86       149  
Allowance for lending-related commitments
    5       3       67  
 
                       
Net charge-off (recovery) rate
    (0.09 )%     1.29 %   (138 )bp
Allowance for loan losses to average loans
    0.81       0.50       31  
Allowance for loan losses to nonperforming loans
    274       75     NM  
Nonperforming loans to average loans
    0.30       0.67       (37 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For a discussion of selected line of business metrics, see page 80 of this Form 10-Q.
(c)  
2004 has been restated to conform with the current presentation.
(d)  
Derived from Morningstar for the United States; Micropal for the United Kingdom, Luxembourg, Hong Kong and Taiwan; and Nomura for Japan.
(e)  
Reflects the transfer of certain consumer deposits from Retail Financial Services to Asset & Wealth Management.

Assets under supervision
Assets under supervision (“AUS”) at March 31, 2005, were $1.1 trillion, up 36% from the prior year, and Assets under management (“AUM”) were $790 billion, up 34% from the prior year. The increases were primarily the result of the Merger, as well as market appreciation, net asset inflows, primarily in equities products, and the acquisition of a majority interest in Highbridge Capital Management. The Firm also has a 43% interest in American Century Companies, Inc., whose AUM totaled $96 billion and $90 billion at March 31, 2005 and 2004, respectively. Custody, brokerage, administration, and deposits were $302 million, up 40%, primarily due to the Merger, as well as market appreciation and net inflows, primarily in brokerage.

30


 

                 
ASSETS UNDER SUPERVISION(a)            
March 31,(b) (in billions)   2005     2004  
 
Asset class
               
Liquidity
  $ 228     $ 159  
Fixed income
    171       120  
Equities & balanced
    326       266  
Alternatives
    65       44  
 
Assets under management
    790       589  
Custody/brokerage/administration/deposits
    302       216  
 
Total Assets under supervision (c)
  $ 1,092     $ 805  
 
Client segment
               
Private bank
               
Assets under management
  $ 138     $ 141  
Custody/brokerage/administration/deposits
    161       135  
 
Assets under supervision
    299       276  
Retail
               
Assets under management
    138       106  
Custody/brokerage/administration/deposits
    94       78  
 
Assets under supervision
    232       184  
Institutional
               
Assets under management
    462       335  
Custody/brokerage/administration/deposits
    5        
 
Assets under supervision
    467       335  
Private client services
               
Assets under management
    52       7  
Custody/brokerage/administration/deposits
    42       3  
 
Assets under supervision
    94       10  
 
Total Assets under supervision(c)
  $ 1,092     $ 805  
 
Geographic region
               
Americas
               
Assets under management
  $ 558     $ 377  
Custody/brokerage/administration/deposits
    263       186  
 
Assets under supervision
    821       563  
International
               
Assets under management
    232       212  
Custody/brokerage/administration/deposits
    39       30  
 
Assets under supervision
    271       242  
 
Total Assets under supervision(c)
  $ 1,092     $ 805  
 
Memo:
               
Mutual fund assets:
               
Liquidity
  $ 175     $ 119  
Fixed income
    45       31  
Equity, balanced & alternatives
    106       87  
 
Total mutual funds assets(c)
  $ 326     $ 237  
 

31


 

                 
Assets under management rollforward
               
Beginning balance
  $ 791     $ 561  
Liquidity net asset flows
    (6 )     3  
Fixed income net asset flows
    4       (1 )
Equity, balanced & alternative net asset flows
    1       7  
Market/other impacts
          19  
 
Ending balance
  $ 790     $ 589  
 
 
Custody/brokerage/administration/deposits rollforward
               
Beginning balance
  $ 315     $ 203  
Custody/brokerage/administration net asset flows
    7       6  
Market/other impacts
    (20 )     7  
 
Ending balance
  $ 302     $ 216  
 
 
Assets under supervision rollforward
               
Beginning balance
  $ 1,106     $ 764  
Net asset flows
    6       15  
Market/other impacts
    (20 )     26  
 
Ending balance
  $ 1,092     $ 805  
 
(a)  
Excludes Assets under management of American Century.
(b)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(c)  
2004 has been restated to conform with current presentation.

CORPORATE

For a discussion of the business profile of Corporate, see pages 47–48 of JPMorgan Chase’s 2004 Annual Report.

                         
SELECTED INCOME STATEMENT DATA                  
Three months ended March 31,(a)(b)                  
(in millions)   2005     2004     Change  
 
Revenue
                       
Securities/private equity gains (losses)
  $ (130 )   $ 419     NM  
Other income
    48       42       14 %
         
Noninterest revenue
    (82 )     461     NM  
Net interest income
    (677 )     (43 )   NM  
         
Total net revenue
    (759 )     418     NM  
 
                       
Provision for credit losses
    (4 )     (82 )     95  
 
                       
Noninterest expense
                       
Compensation expense
    774       516       50  
Noncompensation expense
    996       870       14  
         
Subtotal
    1,770       1,386       28  
Net expenses allocated to other businesses
    (1,335 )     (1,184 )     (13 )
         
Total noninterest expense
    435       202       115  
         
Operating earnings before income tax expense
    (1,190 )     298     NM  
Income tax expense (benefit)
    (503 )     47     NM  
         
Operating earnings (loss)
  $ (687 )   $ 251     NM  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
In the first quarter of 2005, the Corporate sector’s and the Firm’s operating revenue and income tax expense have been restated to be presented on a tax-equivalent basis. Previously, only the business segments’ operating revenue and income tax expense were presented on a tax-equivalent basis, and the impact of the business segments’ tax-equivalent adjustments was eliminated in the Corporate sector. This restatement had no impact on the Corporate sector’s or the Firm’s operating earnings.

Operating earnings were a loss of $687 million, down from earnings of $251 million in the prior year.

Net revenues of negative $759 million were down $1.2 billion from the prior year. Noninterest revenue of negative $82 million declined $543 million and included Treasury investment securities losses of $918 million and Private Equity gains of $789 million. The Treasury investment securities losses were the result of repositioning the investment portfolio to manage exposure to rising interest rates. Private Equity gains were $789 million, an increase of $493 million from the prior year. Net interest income was

32


 

negative $677 million, compared to negative $43 million in the prior year. The decline was driven primarily by actions and policies adopted in conjunction with the Merger.

Noninterest expenses were $435 million, up $233 million from the prior year, primarily due to the Merger, partially offset by merger related saves, expense efficiencies, and further refinements to certain cost allocation methodologies in order to provide better consistency in reporting across business segments.

On September 15, 2004, JPMorgan Chase and IBM announced the Firm’s plans to reintegrate the portions of its technology infrastructure – including data centers, help desks, distributed computing, data networks and voice networks – that were previously outsourced to IBM. In January 2005, approximately 3,100 employees and 800 contract employees were transferred to the Firm.

                         
Selected metrics                  
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Selected average balance sheet
                       
Short-term investments(b)
  $ 13,164     $ 2,592       408 %
Investment portfolio(c)
    71,021       56,755       25  
Goodwill(d)
    43,306       346     NM  
Total assets
    178,089       120,273       48  
 
                       
Headcount
    26,983       13,269       103  
 
                       
Treasury
                       
Securities gains (losses)(e)
  $ (918 )   $ 120     NM  
Investment portfolio (average)
    65,646       50,580       30  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Represents Federal funds sold, Securities borrowed, Trading assets – debt and equity instruments, and Trading assets – derivative receivables.
(c)  
Represents investment securities and private equity investments.
(d)  
Effective with the third quarter of 2004, all goodwill is allocated to the Corporate line of business. Prior to the third quarter of 2004, goodwill was allocated to the various lines of business.
(e)  
Losses primarily due to the sale of $20 billion of investment securities during the month of March 2005. Excludes gains/losses on securities used to manage risk associated with MSRs.
                         
Selected income statement and balance sheet data – Private equity                  
Three months ended March 31,(a)                  
(in millions)   2005     2004     Change  
 
Private equity gains (losses)
                       
Direct investments
Realized gains
  $ 633     $ 302       110 %
Write-ups / (write-downs)
    206       (23 )   NM  
Mark-to-market gains (losses)
    (89 )     25     NM  
         
Total direct investments
    750       304       147  
Third-party fund investments
    39       (8 )   NM  
         
Total private equity gains (losses)
    789       296       167  
Other income
    5       12       (58 )
Net interest income
    (50 )     (59 )     15  
         
Total net revenue
    744       249       199  
Total noninterest expense
    62       69       (10 )
         
Operating earnings before income tax expense
    682       180       279  
Income tax expense
    245       64       283  
         
Operating earnings
  $ 437     $ 116       277  
 

33


 

                         
Private equity portfolio information(b)                  
Direct investments   March 31, 2005     December 31, 2004     Change  
 
Publicly-held securities
                       
Carrying value
  $ 1,149     $ 1,170       (2 )%
Cost
    808       744       9  
Quoted public value
    1,713       1,758       (3 )
 
                       
Privately-held direct securities
                       
Carrying value
    5,490       5,686       (3 )
Cost
    6,689       7,178       (7 )
 
                       
Third-party fund investments(c)
                       
Carrying value
    550       641       (14 )
Cost
    934       1,042       (10 )
         
 
                       
Total private equity portfolio
                       
Carrying value
  $ 7,189     $ 7,497       (4 )
Cost
  $ 8,431     $ 8,964       (6 )
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
For further information on the Firm’s policies regarding the valuation of the private equity portfolio, see Note 9 on pages 98–100 of JPMorgan Chase’s 2004 Annual Report.
(c)  
Unfunded commitments to private third-party equity funds were $494 million and $563 million at March 31, 2005, and December 31, 2004, respectively.

The carrying value of the Private Equity portfolio at March 31, 2005, was $7.2 billion, a decrease of $308 million from December 31, 2004. The decrease was primarily the result of sales of investments, consistent with management’s intention to reduce over time the capital committed to private equity.

BALANCE SHEET ANALYSIS
                 
Selected balance sheet data (in millions)   March 31, 2005     December 31, 2004  
 
Assets
               
Cash and due from banks
  $ 37,593     $ 35,168  
Deposits with banks and Federal funds sold
    29,867       28,958  
Securities purchased under resale agreements and Securities borrowed
    170,389       141,504  
Trading assets – debt and equity instruments
    230,725       222,832  
Trading assets – derivative receivables
    60,388       65,982  
Securities:
               
Available-for-sale
    75,150       94,402  
Held-to-maturity
    101       110  
Loans, net of allowance
    395,734       394,794  
Other receivables
    38,046       31,086  
Goodwill and other intangible assets
    58,320       57,887  
All other assets
    81,992       84,525  
 
Total assets
  $ 1,178,305     $ 1,157,248  
 
Liabilities
               
Deposits
  $ 531,379     $ 521,456  
Securities sold under repurchase agreements
    118,370       105,912  
Trading liabilities – debt and equity instruments
    96,090       87,942  
Trading liabilities – derivative payables
    57,626       63,265  
Long-term debt
    99,329       95,422  
All other liabilities
    170,171       177,598  
 
Total liabilities
    1,072,965       1,051,595  
Stockholders’ equity
    105,340       105,653  
 
Total liabilities and stockholders’ equity
  $ 1,178,305     $ 1,157,248  
 

Balance sheet overview
At March 31, 2005, the Firm’s total assets were $1.2 trillion, an increase of $21 billion, or 2%, from December 31, 2004. Growth was primarily in securities purchased under resale agreements and securities borrowed, and in trading assets, partially offset by declines in derivative receivables and available-for-sale (“AFS”) securities.

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At March 31, 2005, the Firm’s total liabilities were $1.1 trillion, an increase of $21 billion, or 2%, from December 31, 2004. Growth was primarily driven by U.S. interest-bearing deposits, trading liabilities, securities sold under repurchase agreements, and long-term debt and capital debt securities. This growth was partially offset by a decline in derivative payables.

Trading assets and liabilities – debt and equity instruments
The Firm’s debt and equity trading instruments consist primarily of fixed income securities (including government and corporate debt) and cash equity and convertible instruments used for both market-making and proprietary risk taking activities. The increase over December 31, 2004, was primarily due to growth in client-driven market-making activities across interest rate, credit and equity markets, as well as an increase in proprietary trading activities.

Trading assets and liabilities – derivative receivables and payables
The Firm uses various interest rate, foreign exchange, equity, credit and commodity derivatives for market-making, proprietary risk-taking and risk management purposes. The decline from year-end 2004 was primarily due to appreciation of the dollar. For additional information, refer to Credit risk management and Note 3 on pages 41–49 and 60, respectively, of this Form 10-Q.

Securities
The AFS portfolio declined by $19.3 billion from 2004 year-end, primarily as a result of securities sales that occurred during the month of March 2005. These sales were the result of a management decision to reposition the investment portfolio to manage exposure to rising interest rates. For additional information related to securities, refer to Note 8 on page 63 of this Form 10-Q.

Loans
Loans, net of allowance, were $395.7 billion at March 31, 2005, an increase of $940 million from the 2004 year-end. The increase during the first quarter of 2005 was primarily due to slight growth in the CS and wholesale portfolios and a reduction in the Allowance for loan losses; these were partially offset by RFS’s sale of its $2 billion recreational vehicle loan portfolio. For a more detailed discussion of the loan portfolio and the Allowance for loan losses, refer to Credit risk management on pages 41–49 of this Form 10-Q.

Goodwill and other intangible assets
The $433 million increase in Goodwill and other intangible assets from December 31, 2004 was primarily the result of an increase in goodwill related to the joint venture with Cazenove, and the positive impact on the MSR asset of risk management results and a decline in the related valuation allowance; partially offsetting these increases was the amortization of intangibles, primarily purchased credit card relationships and core deposit intangibles. For additional information, see Note 14 on pages 69–71 of this Form 10-Q.

Deposits

Deposits increased by 2% from December 31, 2004. Retail deposit growth reflected successful marketing programs and the ongoing expansion of the branch distribution network. Wholesale deposits were higher, driven by growth in business volumes. For more information on deposits, refer to the RFS segment discussion and the Liquidity risk management discussion on pages 17–23 and 39–40, respectively, of this Form 10-Q. For more information on liability balances, refer to the CB and TSS segment discussions on pages 26–27 and 27–29, respectively, of this Form 10-Q.

Long-term debt

Long-term debt increased by $3.9 billion, or 4%, from December 31, 2004, primarily due to net new debt issuances. For additional information on the Firm’s long-term debt activity, see the Liquidity risk management discussion on pages 39–40 of this Form 10-Q.

Stockholders’ equity
Total stockholders’ equity decreased $313 million from year-end 2004, to $105.3 billion at March 31, 2005. Net income was more than offset by cash dividends and stock repurchases in the quarter. For a further discussion of capital, see Capital management on pages 35–37 of this Form 10-Q.

CAPITAL MANAGEMENT

The following discussion of JPMorgan Chase’s Capital Management highlights developments since December 31, 2004, and should be read in conjunction with pages 50-52 of JPMorgan Chase’s 2004 Annual Report.

The Firm’s capital management framework is intended to ensure that there is capital sufficient to support the underlying risks of the Firm’s business activities, measured by economic risk capital, and to maintain “well-capitalized” status under regulatory requirements. In addition, the Firm holds capital above these requirements in amounts deemed appropriate to achieve management’s debt rating objectives. The Firm’s capital framework is integrated into the process of assigning equity to the lines of business. The Firm may refine its methodology for assigning equity to the lines of business as the merger integration process continues.

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Line of Business Equity
Equity for a line of business represents the amount the Firm believes the business would require if it were operating independently, incorporating sufficient capital to address economic risk measures, regulatory capital requirements, and capital levels for similarly rated peers. Return on equity is measured and internal targets for expected returns are established as a primary measure of a business segment’s performance.

For performance management purposes, the Firm does not allocate goodwill to the lines of business because it believes that the accounting-driven allocation of goodwill could distort assessment of relative returns. In management’s view, this approach fosters better comparison of returns among the lines of business, as well as a better comparison of a line of business’ returns with external peers. The Firm assigns an amount of equity capital equal to the then current book value of the Firm’s goodwill to the Corporate segment. The return on invested capital related to the Firm’s goodwill assets is managed within the Corporate segment. In accordance with SFAS 142, the Firm allocates goodwill to the lines of business based on the underlying fair values of the businesses and then performs the required impairment testing. For a further discussion of goodwill and impairment testing, see Note 14 on pages 69–71 of this Form 10-Q, and Critical accounting estimates on page 79 of JPMorgan Chase’s 2004 Annual Report.

The current methodology used to assign line of business equity is not comparable to equity assigned to the lines of business prior to July 1, 2004. The increase in average common equity in the table below from 2004 was primarily attributable to the Merger.

                 
(in billions)   Quarterly Averages  
Line of business equity(a)   1Q05     1Q04  
 
Investment Bank
  $ 20.0     $ 15.1  
Retail Financial Services
    13.1       5.2  
Card Services
    11.8       3.4  
Commercial Banking
    3.4       0.8  
Treasury & Securities Services
    1.9       3.2  
Asset & Wealth Management
    2.4       5.5  
Corporate(b)
    52.7       12.6  
 
Total common stockholders’ equity
  $ 105.3     $ 45.8  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
First quarter of 2005 includes $43.3 billion of equity to offset goodwill and $9.4 billion of equity primarily related to Treasury, Private Equity and the Corporate Pension Plan.

Economic Risk Capital
JPMorgan Chase assesses its capital adequacy relative to the underlying risks of the Firm’s business activities utilizing internal risk-assessment methodologies. The Firm assigns economic capital based primarily on five risk factors: credit risk, market risk, operational risk and business risk for each business; and private equity risk, principally for the Firm’s private equity business.

                 
(in billions)   Quarterly Averages  
Economic risk capital(a)   1Q05     1Q04  
 
Credit risk
  $ 23.1     $ 9.5  
Market risk
    8.7       5.6  
Operational risk
    5.3       3.4  
Business risk
    2.1       1.7  
Private equity risk
    4.1       4.5  
 
Economic risk capital
    43.3       24.7  
Goodwill
    43.3       8.7  
Other(b)
    18.7       12.4  
 
Total common stockholders’ equity
  $ 105.3     $ 45.8  
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Additional capital required to meet internal regulatory/debt rating objectives.

Regulatory Capital
The Firm’s federal banking regulator, the Federal Reserve Board (“FRB”), establishes capital requirements, including well-capitalized standards for the consolidated financial holding company. The Office of the Comptroller of the Currency (“OCC”) establishes similar capital requirements and standards for the Firm’s national banks, including JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank”) and Chase Bank USA, National Association.

On March 1, 2005, the FRB issued a final rule that continues the inclusion of trust preferred securities in Tier 1 capital, subject to stricter quantitative limits. The rule provides for a five-year transition period. The Firm continues to assess the impact of the final rule, which became effective on April 11, 2005.

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On July 20, 2004, the federal banking regulatory agencies issued a final rule that excludes assets of asset-backed commercial paper programs that are consolidated as a result of FIN 46R from risk-weighted assets for purposes of computing Tier 1 and Total risk-based capital ratios. The final rule also requires that capital be held against short-term liquidity facilities supporting asset-backed commercial paper programs. The final rule became effective September 30, 2004. Adoption of the rule did not have a material effect on the capital ratios of the Firm. In addition, under the final rule, both short- and long-term liquidity facilities will be subject to certain asset quality tests effective September 30, 2005.

The following tables show that JPMorgan Chase maintained a well-capitalized position based on Tier 1 and Total capital ratios at March 31, 2005 and December 31, 2004.

                                                         
                            Adjusted            
    Tier 1   Total   Risk-weighted   average   Tier 1   Total   Tier 1
(in millions, except ratios)   capital   capital   assets(b)   assets(c)   capital ratio   capital ratio   leverage ratio
 
March 31, 2005
                                                       
JPMorgan Chase & Co.(a)
  $ 69,435     $ 96,378     $ 811,822     $ 1,110,058       8.6 %     11.9 %     6.3 %
JPMorgan Chase Bank, N.A.
    56,608       78,982       679,743       945,391       8.3       11.6       6.0  
Chase Bank USA, N.A.
    9,308       11,781       86,946       75,503       10.7       13.5       12.3  
 
                                                       
December 31, 2004
                                                       
JPMorgan Chase & Co.(a)
  $ 68,621     $ 96,807     $ 791,373     $ 1,102,456       8.7 %     12.2 %     6.2 %
JPMorgan Chase Bank, N.A.
    55,489       78,478       670,295       922,877       8.3       11.7       6.0  
Chase Bank USA, N.A.
    8,726       11,186       86,955       71,797       10.0       12.9       12.2  
 
                                                       
Well capitalized ratios(d)
                                    6.0 %     10.0 %     5.0 %(e)
Minimum capital ratios(d)
                                    4.0       8.0       3.0 (f)
 
(a)  
Assets and capital amounts for JPMorgan Chase’s banking subsidiaries include intercompany transactions, whereas the respective amounts for JPMorgan Chase reflect the elimination of intercompany transactions.
(b)  
Includes off–balance sheet risk-weighted assets in the amounts of $249.9 billion, $228.2 billion and $15.1 billion, respectively at March 31, 2005, and $250.3 billion, $229.6 billion and $15.5 billion, respectively, at December 31, 2004.
(c)  
Average adjusted assets for purposes of calculating the leverage ratio include total average assets adjusted for unrealized gains/losses on securities, less deductions for disallowed goodwill and other intangible assets, investments in subsidiaries and the total adjusted carrying value of nonfinancial equity investments that are subject to deductions from Tier 1 capital.
(d)  
As defined by the regulations issued by the FRB, Federal Deposit Insurance Corporation (“FDIC”), and OCC.
(e)  
Represents requirements for bank subsidiaries pursuant to regulations issued under the Federal Deposit Insurance Corporation Improvement Act. There is no Tier 1 leverage component in the definition of a well-capitalized bank holding company.
(f)  
The minimum Tier 1 leverage ratio is 3% at the Bank Holding Company level, and 3% or 4% at the Bank level as specified in regulations issued by the FRB and OCC.

Tier 1 capital was $69.4 billion at March 31, 2005, compared with $68.6 billion at December 31, 2004, an increase of $814 million. The increase was primarily due to net income of $2.3 billion and $1.0 billion of additional qualifying trust preferred securities; these were partially offset by dividends paid of $1.2 billion and common share repurchases of $1.3 billion.

Dividends
The Firm’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain an adequate capital level and alternative investment opportunities. In the first quarter of 2005, JPMorgan Chase declared a quarterly cash dividend on its common stock of $0.34 per share, payable April 30, 2005 to stockholders of record at the close of business April 6, 2005. The Firm has targeted a common stock dividend payout ratio of approximately 30%-40% of the Firm’s operating earnings over time.

Stock repurchases
On July 20, 2004, the Board of Directors approved an initial stock repurchase program in the aggregate amount of $6.0 billion. This amount includes shares to be repurchased to offset issuances under the Firm’s employee stock-based plans. The actual amount of shares repurchased will be subject to various factors, including market conditions; legal considerations affecting the amount and timing of repurchase activity; the Firm’s capital position (taking into account goodwill and intangibles); internal capital generation; and alternative potential investment opportunities. During the first quarter of 2005, under the stock repurchase program, the Firm repurchased 36 million shares for $1.3 billion at an average price per share of $36.57. The Firm did not repurchase any shares of its common stock during the first quarter of 2004. For additional information regarding repurchases of the Firm’s equity securities, see Part II, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds, on page 82 of this Form 10-Q.

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OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS

Special-purpose entities
JPMorgan Chase is involved with several types of off-balance sheet arrangements including special purpose entities (“SPEs”), lines of credit and loan commitments. The principal uses of SPEs are to obtain sources of liquidity for JPMorgan Chase and its clients by securitizing their financial assets, and to create investment products for clients. These arrangements are an important part of the financial markets, providing market liquidity by facilitating investors’ access to specific portfolios of assets and risks.

JPMorgan Chase is involved with SPEs in three broad categories of transactions: loan securitizations, multi-seller conduits and client intermediation. Capital is held, as appropriate, against all SPE-related transactions and related exposures, such as derivative transactions and lending-related commitments. For a further discussion of SPEs and the Firm’s accounting for them, see Note 12 on pages 65–68 and Note 13 on pages 68–69 of this Form 10–Q, and Off-balance sheet arrangements and contractual cash obligations on pages 52–53, Note 1 on page 88, Note 13 on pages 103–106 and Note 14 on pages 106–109 of JPMorgan Chase’s 2004 Annual Report.

For certain liquidity commitments to SPEs, the Firm could be required to provide funding if the credit rating of JPMorgan Chase Bank were downgraded below specific levels, primarily P-1, A-1 and F1 for Moody’s, Standard & Poor’s and Fitch, respectively. The amount of these liquidity commitments was $77.5 billion and $79.4 billion at March 31, 2005, and December 31, 2004, respectively. Alternatively, if JPMorgan Chase Bank were downgraded, the Firm could be replaced by another liquidity provider in lieu of funding under the liquidity commitment, or, in certain circumstances, could facilitate the sale or refinancing of the assets in the SPE in order to provide liquidity.

Of the $77.5 billion of liquidity commitments at March 31, 2005, $49.1 billion was included in the Firm’s total other unfunded commitments to extend credit, included in the table below. Of the $79.4 billion of liquidity commitments at December 31, 2004, $47.7 billion was included in the Firm’s total other unfunded commitments to extend credit. As a result of the Firm’s consolidation of multi-seller conduits in accordance with FIN 46R, $28.4 billion of the March 31, 2005 commitments were excluded from the table, as the underlying assets of the SPEs have been included on the Firm’s Consolidated balance sheets; this compares with $31.7 billion of commitments that were excluded at December 31, 2004.

The following table summarizes certain revenue information related to variable interest entities (“VIEs”) with which the Firm has significant involvement, and qualifying SPEs (“QSPEs”). For a further discussion of VIEs and QSPEs, see Note 1 on page  88 of JPMorgan Chase’s 2004 Annual Report.

Revenue from VIEs and QSPEs

                         
Three months ended March 31,(a)                  
(in millions)   VIEs(b)     QSPEs     Total  
 
2005
  $ 57     $ 404     $ 461  
2004
    23       265       288  
 
(a)  
2005 activity includes three months of combined Firm’s activity, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Includes VIE-related revenue (i.e., revenue associated with consolidated and significant interests in nonconsolidated VIEs).

The revenue reported in the table above primarily represents servicing and custodial fee income. The Firm also has exposure to certain SPEs arising from derivative transactions; these transactions are recorded at fair value on the Firm’s Consolidated balance sheets, with changes in fair value (i.e., mark-to-market (“MTM”) gains and losses) recorded in Trading revenue. Such MTM gains and losses are not included in the revenue amounts reported in the table above.

The accompanying table summarizes JPMorgan Chase’s off–balance sheet lending-related financial instruments by remaining maturity, at March 31, 2005.

                                         
Off-balance sheet lending-related financial instruments                    
By remaining maturity at March 31, 2005   Under   1–3   3–5   After    
(in millions)   1 year   years   years   5 years   Total
 
Consumer
  $ 562,871     $ 3,498     $ 4,670     $ 43,910     $ 614,949  
Wholesale:
                                       
Other unfunded commitments to extend credit(a)(b)
    118,275       66,170       36,495       9,498       230,438  
Standby letters of credit and guarantees(a)
    33,611       29,250       13,379       2,869       79,109  
Other letters of credit(a)
    5,679       869       162       25       6,735  
 
Total wholesale
    157,565       96,289       50,036       12,392       316,282  
 
Total off–balance sheet lending-related financial instruments
  $ 720,436     $ 99,787     $ 54,706     $ 56,302     $ 931,231  
 
(a)  
Represents contractual amount net of risk participations totaling $25.8 billion at March 31, 2005.

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(b)  
Includes unused advised lines of credit totaling $22.9 billion at March 31, 2005, which are not legally binding. In regulatory filings with the FRB, unused advised lines are not reportable.

RISK MANAGEMENT

Risk is an inherent part of JPMorgan Chase’s business activities. The Firm’s risk management framework and governance structure is intended to provide comprehensive controls and ongoing management of its major risks. In addition, this framework recognizes the diversity among the Firm’s core businesses, which helps reduce the impact of volatility in any particular area on the Firm’s operating results as a whole. There are seven major risk types identified in the business activities of the Firm: liquidity risk, credit risk, market risk, operational risk, legal and reputation risk, fiduciary risk and principal risk.

For a further discussion of these risks see pages 54–76 of JPMorgan Chase’s 2004 Annual Report.

LIQUIDITY RISK MANAGEMENT

The following discussion of JPMorgan Chase’s liquidity management framework highlights developments since December 31, 2004, and should be read in conjunction with pages 55–56 of JPMorgan Chase’s 2004 Annual Report. Through active liquidity management, the Firm seeks to preserve stable, reliable and cost-effective sources of funding. Management uses a variety of liquidity risk measures that take into consideration market conditions, prevailing interest rates, liquidity needs and the desired maturity profile of liabilities.

Funding

Sources of funds
The diversity of the Firm’s funding sources enhances financial flexibility and limits dependence on any one source, thereby minimizing the cost of funds. A major source of liquidity for JPMorgan Chase Bank is provided by its large core deposit base. Core deposits include all U.S. deposits insured by the FDIC, up to the legal limit of $100,000 per depositor. In the first quarter of 2005, core bank deposits remained at approximately the same level as year-end.

Additional funding flexibility is provided by the Firm’s ability to access the repurchase and asset securitization markets. At March 31, 2005, $76.5 billion of securities were available for repurchase agreements, and $36.9 billion of credit card, automobile and mortgage loans were available for securitizations. These alternatives are evaluated on an ongoing basis to achieve an appropriate balance of secured and unsecured funding. The ability to securitize loans, and the associated gains on those securitizations, are principally dependent on the credit quality and yields of the assets securitized, and are generally not dependent on the credit ratings of the issuing entity. Transactions between the Firm and its securitization structures are reflected in JPMorgan Chase’s consolidated financial statements; these relationships include retained interests in securitization trusts, liquidity facilities and derivative transactions. For further details, see Notes 12 and 13 on pages 65–68 and 68–69, respectively, of this Form 10–Q.

The Firm is an active participant in the global financial markets. These markets serve as a cost-effective source of funds and are a critical component of the Firm’s liquidity management. Decisions concerning the timing and tenor of accessing these markets are based on relative costs, general market conditions, prospective views of balance sheet growth and a targeted liquidity profile.

Issuance
Corporate credit spreads narrowed to historically tight levels in the first two months of 2005 providing JPMorgan Chase with global access to funding and capital at highly competitive levels. The Firm further diversified its funding across the global markets, while reducing costs and lengthening maturities. Corporate market conditions deteriorated somewhat in March, erasing early 2005 gains; however, funding costs still remain attractive on a historical basis.

During the first quarter of 2005, JPMorgan Chase issued approximately $15.8 billion of long-term debt and capital securities. These issuances were partially offset by $9.9 billion of long-term debt and capital securities that matured or were redeemed. In addition, during the first quarter of 2005 the Firm securitized approximately $3.6 billion of residential mortgage loans and $425 million of credit card loans, resulting in pre-tax gains on securitizations of $10 million and $2 million, respectively. The Firm did not securitize any automobile loans during the first quarter of 2005. For a further discussion of loan securitizations, see Note 12 on pages 65–68 of this Form 10–Q.

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Credit ratings
The credit ratings of JPMorgan Chase’s parent holding company and each of its significant banking subsidiaries were, as of March 31, 2005, as follows:

                                                 
    Short-term debt   Senior long-term debt
    Moody’s   S&P   Fitch   Moody’s   S&P   Fitch
 
JPMorgan Chase & Co.
    P-1       A-1       F1     Aa3     A+       A+  
JPMorgan Chase Bank, N.A.
    P-1       A-1+       F1+     Aa2   AA-     A+  
Chase Bank USA, N.A.
    P-1       A-1+       F1+     Aa2   AA-     A+  
 

The Firm’s principal insurance subsidiaries had the following financial strength ratings as of March 31, 2005:

                         
    Moody’s   S&P   A.M. Best
 
Chase Insurance Life and Annuity Company
    A2       A+       A  
Chase Insurance Life Company
    A2       A+       A  
 

The cost and availability of unsecured financing are influenced by credit ratings. A reduction in these ratings could adversely affect the Firm’s access to liquidity sources, increase the cost of funds, trigger additional collateral requirements and decrease the number of investors and counterparties willing to lend. Critical factors in maintaining high credit ratings include a stable and diverse earnings stream, strong capital ratios, strong credit quality and risk management controls, diverse funding sources and strong liquidity monitoring procedures.

If the Firm’s ratings were downgraded by one notch, the Firm estimates the incremental cost of funds and the potential loss of funding to be negligible. Additionally, the Firm estimates the additional funding requirements for VIEs and other third-party commitments would not be material. In the current environment, the Firm believes a downgrade is unlikely. For additional information on the impact of a credit ratings downgrade on the funding requirements for VIEs, and on derivatives and collateral agreements, see Off–balance Sheet Arrangements on pages 38–39 and Ratings profile of derivative receivables mark-to-market (“MTM”) on page 45 of this Form 10–Q.

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CREDIT RISK MANAGEMENT

The following discussion of JPMorgan Chase’s credit portfolio as of March 31, 2005, highlights developments since December 31, 2004, and should be read in conjunction with pages 57–69, page 77 and Notes 11, 12, 27 and 28 of JPMorgan Chase’s 2004 Annual Report.

The Firm assesses its consumer credit exposure on a managed basis, which includes credit card securitizations. For a reconciliation of the Provision for credit losses on a reported basis to operating, or managed, basis, see pages 10–12 of this Form 10–Q.

CREDIT PORTFOLIO

The following table presents JPMorgan Chase’s credit portfolio as of March 31, 2005, and December 31, 2004. Total wholesale credit exposure was essentially unchanged from December 31, 2004, to March 31, 2005, while total consumer credit exposure increased by $8.5 billion from year-end 2004.

Wholesale and consumer credit portfolio

                                                                 
                    Nonperforming                     Average annual net  
    Credit exposure     assets(r)(s)     Net charge-offs(t)     charge-off rate(t)  
     
    Mar. 31,     Dec. 31,     Mar. 31,     Dec. 31,                          
(in millions, except ratios)   2005     2004     2005     2004     1Q05     1Q04     1Q05     1Q04  
 
Wholesale(a)(b)(c)
                                                               
Loans – reported(d)
  $ 137,401     $ 135,067     $ 1,329     $ 1,574     $ (9 )   $ 89       (0.03 )%     0.50 %
Derivative receivables(e)
    60,388       65,982       241       241     NA     NA     NA     NA  
Interests in purchased receivables
    28,484       31,722                 NA     NA     NA     NA  
 
Total wholesale credit-related assets(d)
    226,273       232,771       1,570       1,815       (9 )     89       (0.03 )     0.50  
Lending-related commitments(f)(g)
    316,282       309,399     NA     NA     NA     NA     NA     NA  
 
Total wholesale credit exposure(d)(h)
  $ 542,555     $ 542,170     $ 1,570     $ 1,815     $ (9 )   $ 89       (0.03 )%     0.50 %
 
Consumer(b)(i)(j)
                                                               
Loans – reported(k)
  $ 265,268     $ 267,047     $ 1,158     $ 1,169     $ 825     $ 355       1.36 %     1.16 %
Loans – securitized(k)(l)
    67,328       70,795                   917       473       5.36       5.53  
 
Total managed consumer loans(k)
  $ 332,596     $ 337,842     $ 1,158     $ 1,169     $ 1,742     $ 828       2.23       2.11  
Lending-related commitments
    614,949       601,196     NA     NA     NA     NA     NA     NA  
 
Total consumer credit exposure(m)
  $ 947,545     $ 939,038     $ 1,158     $ 1,169     $ 1,742     $ 828       2.23       2.11  
 
Total credit portfolio
                                                               
Loans – reported
  $ 402,669     $ 402,114     $ 2,487     $ 2,743     $ 816     $ 444       0.88 %     0.92 %
Loans – securitized(l)
    67,328       70,795                   917       473       5.36       5.53  
 
Total managed loans
    469,997       472,909       2,487       2,743       1,733       917       1.58       1.61  
Derivative receivables(e)
    60,388       65,982       241       241     NA     NA     NA     NA  
Interests in purchased receivables
    28,484       31,722                 NA     NA     NA     NA  
 
Total managed credit-related assets
    558,869       570,613       2,728       2,984       1,733       917       1.58       1.61  
Wholesale lending-related commitments(f)(g)
    316,282       309,399     NA     NA     NA     NA     NA     NA  
Consumer lending-related commitments
    614,949       601,196     NA     NA     NA     NA     NA     NA  
Assets acquired in loan satisfactions(n)
  NA     NA       221       247     NA     NA     NA     NA  
 
Total credit portfolio(o)
  $ 1,490,100     $ 1,481,208     $ 2,949     $ 3,231     $ 1,733     $ 917       1.58 %     1.61 %
 
Purchased held-for-sale wholesale loans(p)
  $ 319     $ 351     $ 319     $ 351     NA     NA     NA     NA  
Credit derivative hedges notional(q)
    (34,314 )     (37,200 )     (15 )     (15 )   NA     NA     NA     NA
Collateral held against derivatives
    (7,536 )     (9,301 )   NA     NA     NA     NA     NA     NA  
 
(a)  
Includes Investment Bank, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management.
(b)  
Amounts are presented gross of the Allowance for loan losses.
(c)  
Net charge-off rates exclude average wholesale loans HFS of $8.2 billion and $5.2 billion for the three months ended March 31, 2005 and 2004, respectively.
(d)  
Wholesale loans past-due 90 days and over and accruing were $14 million and $8 million at March 31, 2005, and December 31, 2004, respectively.
(e)  
The Firm also views its credit exposure on an economic basis. For derivative receivables, economic credit exposure is the three-year average of a measure known as Average exposure (which is the expected MTM value of derivative receivables at future time periods, including the benefit of collateral). Average exposure was $36 billion and $38 billion at March 31, 2005, and December 31, 2004, respectively. See pages 44–46 of this Form 10–Q, and pages 62–65 of JPMorgan Chase’s 2004 Annual Report, for a further discussion of the Firm’s derivative receivables.
(f)  
The Firm also views its credit exposure on an economic basis. For lending-related commitments, economic credit exposure is represented by a “loan equivalent” amount, which is the portion of the unused commitment or other contingent exposure that is expected, based on average

41


 

   
portfolio historical experience, to become outstanding in the event of a default by the obligor. Loan equivalents were $161 billion and $162 billion at March 31, 2005, and December 31, 2004, respectively. See page 46 of this Form 10–Q for a further discussion of this measure.
(g)  
Includes unused advised lines of credit totaling $22.9 billion and $22.8 billion at March 31, 2005, and December 31, 2004, respectively, which are not legally binding. In regulatory filings with the Federal Reserve Board, unused advised lines are not reportable.
(h)  
Represents Total wholesale loans, Derivative receivables, Interests in purchased receivables and Wholesale lending–related commitments.
(i)  
Net charge-off rates exclude average HFS consumer loans (excluding Card Services) in the amount of $15.9 billion and $15.3 billion for the three months ended March 31, 2005 and 2004, respectively.
(j)  
Includes Retail Financial Services and Card Services.
(k)  
Past-due loans 90 days and over and accruing includes credit card receivables of $1.0 billion, and related credit card securitizations of $1.3 billion at both March 31, 2005, and December 31, 2004.
(l)  
Represents securitized credit card receivables. For a further discussion of credit card securitizations, see Card Services on pages 23–25 of this Form 10–Q.
(m)  
Represents Total consumer loans, Credit card securitizations and Consumer lending–related commitments.
(n)  
At March 31, 2005, and December 31, 2004, includes $20 million and $23 million, respectively, of wholesale assets acquired in loan satisfactions, and $201 million and $224 million, respectively, of consumer assets acquired in loan satisfactions.
(o)  
At March 31, 2005, and December 31, 2004, excludes $1.3 billion and $1.5 billion, respectively, of residential mortgage receivables in foreclosure status that are insured by government agencies. These amounts are excluded, as reimbursement is proceeding normally.
(p)  
Represents distressed wholesale loans purchased as part of IB’s proprietary investing activities.
(q)  
Represents the net notional amount of protection bought and sold of single-name and portfolio credit derivatives used to manage the credit risk of wholesale credit exposure; these derivatives do not qualify for hedge accounting under SFAS 133.
(r)  
Excludes purchased HFS wholesale loans.
(s)  
Nonperforming assets include wholesale HFS loans of $2 million at both March 31, 2005, and December 31, 2004, and consumer HFS loans of $31 million and $13 million at March 31, 2005, and December 31, 2004, respectively. HFS loans are carried at the lower of cost or market, and declines in value are recorded in Other income.
(t)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
NA–  
Not applicable.

It is expected that the provision for credit losses for the wholesale business will return to a more normal level over time. Factors that could affect the level of charge-offs and nonperforming loans in the wholesale portfolios include, among others, a deterioration in the global economy, interest rate movements, changes in the U.S. and international debt and equity markets, and portfolio mix. While consumer credit quality is currently anticipated to remain relatively stable over the remainder of the year, significant deterioration in the U.S. economy could materially change this expectation. Factors that could affect the level of charge-offs and nonperforming loans in the RFS and CS portfolios include, among others, changes in consumer behavior, bankruptcy trends, portfolio seasoning, interest rate movements and portfolio mix.

WHOLESALE CREDIT PORTFOLIO

Wholesale exposure remained flat from December 31, 2004. Increases in lending-related commitments and loans of $7 billion and $2 billion, respectively, were offset by reductions in derivative receivables and interests in purchased receivables of $6 billion and $3 billion, respectively. The increase in lending-related commitments was primarily from the IB and Commercial Banking activities, and the decrease in derivative receivables was primarily due to appreciation of the dollar. Below are summaries of the maturity and ratings profiles of the wholesale portfolio as of March 31, 2005, and December 31, 2004. The ratings scale is based on the Firm’s internal risk ratings and is presented on an S&P-equivalent basis.

Wholesale exposure

                                                                                         
    Maturity profile(a)   Ratings profile
                    Investment-grade (“IG”)   Noninvestment-grade            
                                    BBB+                       Total
At March 31, 2005                   AAA   A+   to   BB+   CCC+           % of
(in billions, except ratios)   <1 year   1–5 years   >5 years   Total   to AA-   to A-   BBB-   to B-   & below   Total   IG
 
Loans
    46 %     38 %     16 %     100 %   $ 31     $ 20     $ 36     $ 47     $ 4     $ 138       63 %
Derivative receivables(b)
    12       42       46       100       28       10       11       11             60       82  
Interests in purchased receivables
    42       56       2       100       23       5       1                   29       100  
Lending-related commitments(b)(c)
    50       46       4       100       131       69       71       43       2       316       86  
 
Total exposure(d)
    45 %     44 %     11 %     100 %   $ 213     $ 104     $ 119     $ 101     $ 6     $ 543       80 %
 
Credit derivative hedges notional(e)
    16 %     78 %     6 %     100 %   $ (9 )   $ (11 )   $ (12 )   $ (2 )   $     $ (34 )     94 %
 

42


 

                                                                                         
    Maturity profile(a)   Ratings profile
                    Investment-grade (“IG”)   Noninvestment-grade            
                                    BBB+                       Total
At December 31, 2004                   AAA   A+   to   BB+   CCC+           % of
(in billions, except ratios)   <1 year   1-5 years   >5 years   Total   to AA-   to A-   BBB-   to B-   & below   Total   IG
 
Loans
    43 %     43 %     14 %     100 %   $ 31     $ 20     $ 36     $ 43     $ 5     $ 135       64 %
Derivative receivables(b)
    19       39       42       100       34       12       11       9             66       86  
Interests in purchased receivables
    37       61       2       100       3       24       5                   32       100  
Lending-related commitments(b)(c)
    46       52       2       100       124       68       74       40       3       309       86  
 
Total exposure(d)
    42 %     49 %     9 %     100 %   $ 192     $ 124     $ 126     $ 92     $ 8     $ 542       82 %
 
Credit derivative hedges notional(e)
    18 %     77 %     5 %     100 %   $ (11 )   $ (11 )   $ (13 )   $ (2 )   $     $ (37 )     95 %
 
(a)  
The maturity profile of loans and lending-related commitments is based upon the remaining contractual maturity. The maturity profile of derivative receivables is based upon the maturity profile of Average exposure. See footnote (e) on page 41 of this Form 10–Q for a further discussion of Average exposure.
(b)  
Based on economic credit exposure, the total percentage of Investment-grade for derivative receivables was 90% and 92% as of March 31, 2005, and December 31, 2004, respectively, and for lending-related commitments was 85% as of both March 31, 2005, and December 31, 2004. See footnotes (e) and (f) on pages 41–42 of this Form 10–Q for a further discussion of economic credit exposure.
(c)  
Based on economic credit exposure, the maturity profile for the <1 year, 1–5 years and >5 years categories would have been 35%, 59% and 6%, respectively, as of March 31, 2005, and 31%, 65% and 4%, respectively, as of December 31, 2004. See footnote (f) on pages 41–42 of this Form 10–Q for a further discussion of economic credit exposure.
(d)  
Based on economic credit exposure, the maturity profile for <1 year, 1–5 years and >5 years categories would have been 37%, 50% and 13%, respectively, as of March 31, 2005, and 35%, 54% and 11%, respectively, as of December 31, 2004. See footnotes (e) and (f) on pages 41–42 of this Form 10–Q for a further discussion of economic credit exposure.
(e)  
Ratings are based on the underlying referenced assets.

As of March 31, 2005, the wholesale exposure ratings profile remained relatively stable compared with December 31, 2004.

Wholesale credit exposure – selected industry concentration
The Firm continues to focus on management of its industry concentrations, with particular attention paid to industries with actual or potential credit concerns. As of March 31, 2005, Oil & Gas replaced Media among the Top 10 industries as a result of a $1.4 billion increase in exposure to Oil & Gas and a $1.2 billion decrease in Media exposure. There were no other material changes in industry concentrations during the first quarter of 2005. See pagev 61 of JPMorgan Chase’s 2004 Annual Report for the Top 10 industries as of December 31, 2004.

Wholesale criticized exposure
Exposures deemed criticized generally represent a ratings profile similar to a rating of CCC+/Caa1 and lower, as defined by Standard & Poor’s/Moody’s. The criticized component of the portfolio decreased to $6.4 billion at March 31, 2005, from $8.3 billion at year-end 2004. The portfolio continued to experience improvement due to client upgrades as a result of improved financial performance, refinancings and gross charge-offs. In addition, during the first quarter of 2005, the Firm conformed its methodology for reporting criticized exposure as a result of the Merger and further systems integration. This resulted in a decrease of $1.2 billion. Excluding this change, criticized exposure would have been $7.6 billion at March 31, 2005.

                                 
    March 31, 2005   December 31, 2004
Criticized exposure – industry concentrations           % of           % of
(in millions)   Amount   portfolio   Amount   portfolio
 
Utilities
  $ 735       11.4 %   $ 890       10.7 %
Real estate
    617       9.6       765       9.2  
Media
    481       7.5       509       6.1  
Business services
    447       6.9       444       5.4  
Consumer products
    350       5.4       479       5.8  
Airlines
    348       5.4       450       5.4  
Automotive
    337       5.2       359       4.3  
Machinery and equipment manufacturing
    320       5.0       459       5.6  
Building materials/construction
    304       4.7       430       5.2  
Metals/mining
    289       4.5       438       5.3  
All Other
    2,221       34.4       3,061       37.0  
 
Total
  $ 6,449       100.0 %   $ 8,284       100.0 %
 

43


 

Wholesale nonperforming assets (“NPA”)

                                         
Nonperforming assets by line of business                                        
 
(in millions, except ratios)   March 31, 2005   % of NPA   December 31, 2004   % of NPA   Change
 
Investment Bank
  $ 1,056       67 %   $ 1,196       65 %     (12 )%
Commercial Banking
    452       28       547       30       (17 )
Treasury & Securities Services
    4             14       1       (71 )
Asset & Wealth Management
    78       5       81       4       (4 )
 
Total(a)
  $ 1,590       100 %   $ 1,838       100 %     (13 )%
 
(a)  
Includes assets acquired in loan satisfactions of $20 million and $23 million at March 31, 2005, and December 31, 2004, respectively.

Wholesale nonperforming assets (excluding purchased held-for-sale wholesale loans) decreased by $248 million from $1.8 billion at December 31, 2004, to $1.6 billion at March 31, 2005, as a result of loan sales, repayments and gross charge-offs taken. Wholesale net recoveries of $9 million were an improvement over $89 million of net charge-offs in the prior year, the result of lower gross charge-offs. The wholesale net recovery rate was 0.03% for the first quarter of 2005, compared with a net charge-off rate of 0.50% in the prior year.

Derivative contracts
In the normal course of business, the Firm uses derivative instruments to meet the needs of customers, to generate revenues through trading activities, to manage exposure to fluctuations in interest rates, currencies and other markets and to manage the Firm’s credit exposure. For a further discussion of derivative contracts, see Note 18 on page 72 of this Form 10–Q, and pages 62–65 of JPMorgan Chase’s 2004 Annual Report.

The following table summarizes the aggregate notional amounts and the reported derivative receivables (i.e., the MTM or fair value of the derivative contracts after taking into account the effects of legally enforceable master netting agreements) at each of the dates indicated:

                                 
    Notional amounts(a)     Derivative receivables MTM  
(in billions)   March 31, 2005     December 31, 2004     March 31, 2005     December 31, 2004  
 
Interest rate
  $ 37,412     $ 37,022     $ 41     $ 46  
Foreign exchange
    1,710       1,886       5       8  
Equity
    446       434       7       6  
Credit derivatives
    1,333       1,071       3       3  
Commodity
    114       101       4       3  
 
Total
  $ 41,015     $ 40,514     $ 60     $ 66  
Collateral held against derivative receivables
  NA     NA       (7) (b)     (9 )(c)
 
Total
  NA     NA     $ 53     $ 57  
 
(a)  
The notional amounts represent the gross sum of long and short third-party notional derivative contracts, excluding written options and foreign exchange spot contracts.
(b)  
The Firm held $36 billion of collateral against derivative receivables as of March 31, 2005, consisting of $29 billion in net cash received under credit support annexes to legally enforceable master netting agreements, and $7 billion of other highly liquid collateral. The benefit of the $29 billion is reflected within the $60 billion of derivative receivables MTM. Excluded from the $36 billion of collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the existing derivatives portfolio should the MTM of the client’s transactions move in the Firm’s favor. Also excluded are credit enhancements in the form of letter-of-credit and surety receivables.
(c)  
The Firm held $41 billion of collateral against derivative receivables as of December 31, 2004, consisting of $32 billion in net cash received under credit support annexes to legally enforceable master netting agreements, and $9 billion of other highly liquid collateral. The benefit of the $32 billion is reflected within the $66 billion of derivative receivables MTM. Excluded from the $41 billion of collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the existing derivatives portfolio should the MTM of the client’s transactions move in the Firm’s favor. Also excluded are credit enhancements in the form of letter-of-credit and surety receivables.

The $41 trillion of notional principal of the Firm’s derivative contracts outstanding at March 31, 2005, significantly exceeded, in the Firm’s view, the possible credit losses that could arise from such transactions. For most derivative transactions, the notional principal amount does not change hands; it is simply used as a reference to calculate payments. The appropriate measure of current credit risk is, in the Firm’s view, the MTM value of the contract, which represents the cost to replace the contracts at current market rates should the counterparty default. When JPMorgan Chase has more than one transaction outstanding with a counterparty, and a legally enforceable master netting agreement exists with that counterparty, the netted MTM exposure, less collateral held, represents, in the Firm’s view, the appropriate measure of current credit risk. At March 31, 2005, the MTM value of derivative receivables (after taking into account the effects of legally enforceable master netting agreements and the impact of net cash received under credit support annexes to such legally enforceable master netting agreements) was $60 billion. Further, after taking into account $7 billion of other highly liquid collateral held by the Firm, the net current MTM credit exposure was $53 billion.

44


 

The following table summarizes the ratings profile of the Firm’s Consolidated balance sheet Derivative receivables MTM, net of cash and other highly liquid collateral, for the dates indicated:

Ratings profile of derivative receivables MTM

                                 
    March 31, 2005   December 31, 2004
Rating equivalent   Exposure net   % of exposure   Exposure net   % of exposure
(in millions)   of collateral(a)   net of collateral   of collateral (b)   net of collateral
 
AAA to AA-
  25,179       48 %   30,384       53 %
A+ to A-
    7,964       15       9,109       16  
BBB+ to BBB-
    9,575       18       9,522       17  
BB+ to B-
    9,770       18       7,271       13  
CCC+ and below
    364       1       395       1  
 
Total
  52,852       100 %   56,681       100 %
 
 
(a)  
See footnote (b) on page 44.
(b)  
See footnote (c) on page 44.

The Firm actively pursues the use of collateral agreements to mitigate counterparty credit risk in derivatives. The percentage of the Firm’s derivatives transactions subject to collateral agreements decreased slightly, to 77% as of March 31, 2005, from 79% at December 31, 2004. The Firm held $36 billion of collateral as of March 31, 2005 (including $29 billion of net cash received under credit support annexes to legally enforceable master netting agreements), compared with $41 billion as of December 31, 2004 (including $32 billion of net cash received under credit support annexes to legally enforceable master netting agreements). The Firm posted $27 billion of collateral as of March 31, 2005, compared with $31 billion at the end of 2004.

Certain derivative and collateral agreements include provisions that require the counterparty and/or the Firm, upon specified downgrades in their respective credit ratings, to post collateral for the benefit of the other party. As of March 31, 2005, the impact of a single-notch ratings downgrade to JPMorgan Chase Bank, from its current rating of AA- to A+, would have been an additional $1.4 billion of collateral posted by the Firm; the impact of a six-notch ratings downgrade (from AA- to BBB-) would have been $3.6 billion of additional collateral. Certain derivative contracts also provide for termination of the contract, generally upon a downgrade of either the Firm or the counterparty, at the then-existing MTM value of the derivative contracts.

Use of credit derivatives
The following table presents the Firm’s notional amounts of credit derivatives protection bought and sold by the respective businesses as of March 31, 2005, and December 31, 2004:

Credit derivatives positions

                                         
    Notional amount        
    Portfolio management     Dealer/client        
    Protection     Protection     Protection     Protection        
(in millions)   bought(a)     sold     bought     sold     Total  
 
March 31, 2005
  $ 34,347     $ 33     $ 623,967     $ 674,757     $ 1,333,104  
December 31, 2004
    37,237       37       501,266       532,335       1,070,875  
 
 
(a)  
Includes $1 billion and $2 billion at March 31, 2005, and December 31, 2004, respectively, of portfolio credit derivatives.

JPMorgan Chase has limited counterparty exposure as a result of its credit derivatives transactions. Of the $60 billion of total Derivative receivables at March 31, 2005, approximately $3 billion, or 5%, was associated with credit derivatives, before the benefit of highly liquid collateral. The use of credit derivatives to manage exposures by the Credit Portfolio Group does not reduce the reported level of assets on the balance sheet or the level of reported off–balance sheet commitments.

Credit portfolio management activity
In managing its wholesale credit exposure, the Firm purchases single-name and portfolio credit derivatives. As of March 31, 2005, the notional outstanding amount of protection bought via single-name and portfolio credit derivatives was $33 billion and $1 billion, respectively. The Firm also diversifies its exposures by providing (i.e., selling) credit protection, which increases exposure to industries or clients where the Firm has little or no client-related exposure. This activity is not material to the Firm’s overall credit exposure.

Use of single-name and portfolio credit derivatives

                 
    Notional amount of protection bought
(in millions)   March 31, 2005   December 31, 2004
 
Credit derivatives used to manage:
               
Loans and lending-related commitments
  $ 22,941     $ 25,002  
Derivative receivables
    11,406       12,235  
 
Total
  $ 34,347     $ 37,237  
 

45


 

The credit derivatives used by JPMorgan Chase for its portfolio management activities do not qualify for hedge accounting under SFAS 133 and, therefore, effectiveness testing under SFAS 133 is not performed. These derivatives are reported at fair value, with gains and losses recognized as Trading revenue. The MTM value incorporates both the cost of credit derivative premiums and changes in value due to movement in spreads and credit events; in contrast, the loans and lending-related commitments being risk-managed are accounted for on an accrual basis. Loan interest and fees are generally recognized in Net interest income, and impairment is recognized in the Provision for credit losses. This asymmetry in accounting treatment, between loans and lending-related commitments and the credit derivatives utilized in portfolio management activities, causes earnings volatility that is not representative, in the Firm’s view, of the true changes in value of the Firm’s overall credit exposure. The MTM treatment of both the Firm’s credit derivatives used for managing credit exposure (“short” credit positions) and the Credit Valuation Adjustment (“CVA”), which reflects the credit quality of derivatives counterparty exposure (“long” credit positions), generally provides some natural offset.

Portfolio management activity in the first quarter of 2005 resulted in a gain of $54 million included in Trading revenue. This activity included $35 million of gains as a result of wider credit spreads on derivatives used to manage the Firm’s risk associated with accrual lending activities. The remaining $19 million of gains were driven by positive adjustments to the MTM value of the CVA. While credit spreads also widened in the overall derivatives portfolio, the impact was smaller due to the higher quality of the credit exposures. In addition, losses from spread widening were more than offset by lower expected losses due to the passage of time.

Portfolio management activity in the first quarter of 2004 resulted in a gain of $58 million included in Trading revenue. These gains included $21 million, the majority of which was the result of wider high yield credit spreads, on credit derivatives used to manage the Firm’s risk associated with accrual lending activities. The remaining $37 million of gains were driven by positive adjustments to the MTM value of the CVA. While credit spreads also widened in the overall derivatives portfolio, the impact was smaller due to the higher quality of the credit exposures. In addition, losses from spread widening were more than offset by lower expected losses due to the passage of time.

The Firm also actively manages its wholesale credit exposure through loan and commitment sales. During the first quarters of 2005 and 2004, the Firm sold $944 million and $1.8 billion of loans and commitments, respectively, in connection with the management of its wholesale credit exposure, resulting in gains of $11 million and losses of $6 million, respectively. These activities are not related to the Firm’s securitization activities, which are undertaken for liquidity and balance sheet management purposes. For a further discussion of securitization activity, see Note 12 on pages 65–68 of this Form 10–Q.

Dealer/client activity
As of March 31, 2005, the total notional amounts of protection purchased and sold by the dealer business were $624 billion and $675 billion, respectively. The mismatch between these notional amounts is attributable to the Firm selling protection on large, diversified, predominantly investment-grade portfolios (including the most senior tranches) and then risk managing these positions by buying protection on the more subordinated tranches of the same portfolios. In addition, the Firm may use securities to risk manage certain derivative positions. Consequently, while there is a mismatch in notional amounts of credit derivatives, in the Firm’s view, the risk positions are largely matched.

Lending-related commitments
The contractual amount of wholesale lending-related commitments was $316 billion at March 31, 2005, compared with $309 billion at December 31, 2004. The increase was primarily due to activity in the IB and Commercial Banking. In the Firm’s view, the total contractual amount of these instruments is not representative of the Firm’s actual credit risk exposure or funding requirements. In determining the amount of credit risk exposure the Firm has to wholesale lending-related commitments, which is used as the basis for allocating credit risk capital to these instruments, the Firm has established a “loan-equivalent” amount for each commitment; this represents the portion of the unused commitment or other contingent exposure that is expected, based on average portfolio historical experience, to become outstanding in the event of a default by an obligor. The amount of the loan equivalents as of March 31, 2005, and December 31, 2004, was $161 billion and $162 billion, respectively.

Country exposure
The Firm has a comprehensive process for measuring and managing its exposures and risk in emerging markets countries – defined as those countries potentially vulnerable to sovereign events. Exposures to a country include all credit-related lending, trading and investment activities, whether cross-border or locally funded. Exposure amounts are adjusted for credit enhancements (e.g., guarantees and letters of credit) provided by third parties located outside the country, if the enhancements fully cover the country risk as well as the business risk. As of March 31, 2005, the Firm’s exposure to any individual emerging markets country was not material.

46


 

 
CONSUMER CREDIT PORTFOLIO
 
JPMorgan Chase’s consumer portfolio consists primarily of residential mortgages and home equity loans, credit cards, auto and education financings and loans to small businesses. The domestic consumer portfolio reflects the benefit of diversification from both a product and a geographical perspective. The primary focus is on serving the prime consumer credit market.

The following table presents managed consumer credit–related information for the dates indicated:

Consumer portfolio

                                                                 
    Credit-related     Nonperforming           Average annual net  
    exposure     assets     Net charge-offs     charge-off rate(d)  
    Mar. 31,     Dec. 31,     Mar. 31,     Dec. 31,                          
(in millions, except ratios)   2005     2004     2005     2004     1Q05     1Q04(c)     1Q05     1Q04(c)  
 
Consumer real estate
                                                               
Home finance – home equity and other
  $ 68,779     $ 67,837     $ 390     $ 416     $ 35     $ 25       0.21 %     0.42 %
Home finance – mortgage
    55,588       56,816       301       257       6       3       0.05       0.03  
 
Total Home finance
    124,367       124,653       691       673       41       28       0.15       0.19  
Auto & education finance
    59,837       62,712       171       193       83       40       0.60       0.38  
Consumer & small business and other
    15,011       15,107       288       295       28       17       0.76       1.63  
Credit card receivables – reported(a)
    66,053       64,575       8       8       673       270       4.25       6.37  
 
Total consumer loans – reported
    265,268       267,047       1,158       1,169       825       355       1.36       1.16  
Credit card securitizations(a)(b)
    67,328       70,795                   917       473       5.36       5.53  
 
Total consumer loans – managed(a)
    332,596       337,842       1,158       1,169       1,742       828       2.23       2.11  
Assets acquired in loan satisfactions
  NA   NA     201       224     NA     NA     NA     NA  
 
Total consumer related assets – managed
    332,596       337,842       1,359       1,393       1,742       828       2.23       2.11  
Consumer lending–related commitments:
                                                               
Home finance
    60,380       53,223     NA     NA     NA     NA     NA     NA  
Auto & education finance
    5,655       5,193     NA     NA     NA     NA     NA     NA  
Consumer & small business and other
    7,961       10,312     NA     NA     NA     NA     NA     NA  
Credit cards
    540,953       532,468     NA     NA     NA     NA     NA     NA  
 
Total lending-related commitments
    614,949       601,196     NA     NA     NA     NA     NA     NA  
 
Total consumer credit portfolio
  $ 947,545     $ 939,038     $ 1,359     $ 1,393     $ 1,742     $ 828       2.23 %     2.11 %
 
 
(a)  
Past-due loans 90 days and over and accruing includes credit card receivables of $1.0 billion and related credit card securitizations of $1.3 billion at both March 31, 2005, and December 31, 2004.
(b)  
Represents securitized credit card receivables. For a further discussion of credit card securitizations, see Card Services on pages 23-25 of this Form 10–Q.
(c)  
Heritage JPMorgan Chase only.
(d)  
Net charge-off rates exclude average loans HFS of $15.9 billion and $15.3 billion for the three months ended March 31, 2005 and 2004, respectively.
NA–
Not applicable.

Total managed consumer loans as of March 31, 2005, were $333 billion, down from $338 billion at year-end 2004, reflecting the sale of the $2 billion recreational vehicle loan portfolio, and the seasonal pattern of credit card receivables. Consumer lending-related commitments increased by 2% to $615 billion at March 31, 2005, reflecting an increase in home equity and credit card commitments and a decrease in consumer & small business commitments. The following discussion relates to the specific loan and lending-related categories within the consumer portfolio:

Retail Financial Services
Loan balances for Retail Financial Services were $199.2 billion at March 31, 2005, down $3.3 billion, or 2%, from December 31, 2004. The decrease was driven primarily by the sale of a $2 billion recreational vehicle loan portfolio in the first quarter of 2005. The net charge-off rate was 0.34%, an increase of two basis points from the first quarter of 2004. The increase was primarily attributable to the Merger and the sale of the recreational vehicle loan portfolio, offset by improved credit trends in most consumer lending portfolios.

The Firm proactively manages its retail credit operation. Ongoing efforts include continual review and enhancement of credit underwriting criteria and refinement of pricing and risk management models.

Home Finance: Home Finance loans were $124 billion as of March 31, 2005, substantially unchanged from December 31, 2004. The loan balances comprised $69 billion of home equity and other loans and $55 billion of mortgages, including mortgage loans held for sale. Lower warehouse mortgage loan balances, driven by lower prime mortgage originations, were offset by higher retained balances in Home Equity and Mortgage Loans. Loan balances were also affected by the decision to retain, rather than

47


 

securitize, subprime mortgage loans, which caused subprime mortgage loans to increase from $7 billion at December 31, 2004, to $9 billion at March 31, 2005. Home Finance provides real estate lending to the full spectrum of credit borrowers and maintains a geographic distribution of consumer real estate loans that is well diversified.

Auto & Education Finance: Loan balances in Auto & Education Finance decreased to $60 billion at March 31, 2005, down $3 billion from $63 billion at year-end 2004. The decrease was attributable to the sale of a $2 billion recreational vehicle loan portfolio in the first quarter of 2005 and to a decline in the vehicle lease outstandings from $8 billion to $7 billion. During 2004, the Firm completed a strategic review of all consumer lending portfolio segments, which resulted in the Firm choosing to de-emphasize vehicle leasing. It is anticipated that, over time, vehicle leases will account for a smaller share of loan balances and exposure. This strategic review also resulted in the aforementioned sale of the $2 billion recreational vehicle portfolio in the first quarter of 2005. The remaining Auto & education loan portfolio reflects a high concentration of prime-quality credits.

Consumer & small business and other: As of March 31, 2005, Small business & other consumer loans remained flat, with 2004 year-end levels of $15 billion. This portfolio segment is primarily composed of loans to small businesses, which consists of highly collateralized loans, often with personal loan guarantees.

Card Services
JPMorgan Chase analyzes its credit card portfolio on a managed basis, which includes credit card receivables on the consolidated balance sheet and those receivables sold to investors through securitization. Managed credit card receivables were $133 billion at March 31, 2005, a decrease of $2 billion from year-end 2004, reflecting the normal seasonal pattern.

Consumer credit quality trends continue to improve overall, benefiting from lower bankruptcies and a continued low level of delinquencies as reflected in the decrease in the managed credit card net charge-off rate to 4.83% in the first quarter of 2005 from 5.81% in the first quarter of 2004. Management continues its emphasis on credit risk management, including disciplined underwriting and account management practices targeted to the prime and super-prime credit sectors. Credit Risk Management tools used to manage the level and volatility of losses for credit card accounts have been continually updated, and, where appropriate, these tools were adjusted with the goal of reducing credit risk. The managed credit card portfolio continues to reflect a well-seasoned portfolio that has good U.S. geographic diversification.

The Firm plans to begin implementing new minimum-payment rules in the Card Services business during the third quarter of 2005 that will result in higher required payments from some customers. It is anticipated that this may increase delinquency and net charge-off rates in 2006. The magnitude of the impact is currently being assessed. The Firm expects the level of bankruptcy filings to accelerate prior to the October effective date of the bankruptcy legislation signed into law on April 20, 2005. Bankruptcy filings subsequent to the October effective date are expected to normalize.

 
ALLOWANCE FOR CREDIT LOSSES
 
For a discussion of the components of the allowance for credit losses, see Critical accounting estimates used by the Firm on page 77 and Note 12 on pages 102–103 of the JPMorgan Chase 2004 Annual Report. At March 31, 2005, management deemed the allowance for credit losses to be sufficient to absorb losses that are inherent in the portfolio, including losses that are not specifically identified, or for which the size of the loss has not yet been fully determined.
                                                 
Three months ended March 31,(a)   2005     2004  
(in millions)   Wholesale     Consumer     Total     Wholesale     Consumer     Total  
 
Loans:
                                               
Beginning balance at January 1
  $ 3,098     $ 4,222     $ 7,320     $ 2,204     $ 2,319     $ 4,523  
Gross charge-offs
    (61 )     (972 )     (1,033 )     (168 )     (406 )     (574 )
Gross recoveries
    70       147       217       79       51       130  
 
Net charge-offs
    9       (825 )     (816 )     (89 )     (355 )     (444 )
Provision for loan losses
    (380 )     811       431       (246 )     288       42  
Other
                            (1 )     (1 )
 
Ending balance at March 31
  $ 2,727 (b)   $ 4,208 (c)   $ 6,935     $ 1,869     $ 2,251     $ 4,120  
 
 
                                               
Lending-related commitments:
                                               
Beginning balance at January 1
  $ 480     $ 12     $ 492     $ 320     $ 4     $ 324  
Net charge-offs
                                   
Provision for lending-related commitments
    (6 )     2       (4 )     (26 )     (1 )     (27 )
 
Ending balance at March 31
  $ 474     $ 14     $ 488 (d)   $ 294     $ 3     $ 297  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(b)  
Includes $385 million of asset-specific loss and $2.3 billion of formula-based loss. Included within the formula-based loss is $1.4 billion related to a statistical calculation, and adjustments to the statistical calculation of $894 million.
(c)  
Includes $3.1 billion and $1.1 billion of the consumer statistical component and adjustments to the statistical component, respectively.

48


 

(d)  
Includes $144 million of asset-specific loss and $344 million of formula-based loss. The formula-based loss for lending-related commitments is based on statistical calculation. There is no adjustment to the statistical calculation for lending-related commitments.

Overall: The Allowances for loan losses and lending-related commitments (collectively referred to as the allowance for credit losses) each have two components: asset-specific and formula-based. See Note 12 on pages 102–103 of the JPMorgan Chase 2004 Annual Report for a further discussion. The increase in the allowance for credit losses from March 31, 2004, was primarily driven by the Merger. The reduction in the allowance for credit losses of $385 million from December 31, 2004, to March 31, 2005, was primarily driven by improving credit quality in the wholesale business.

Loans: Excluding HFS loans, the Allowance for loan losses represented 1.83% of loans at March 31, 2005, compared with 1.94% at year-end 2004. The wholesale component of the Allowance was $2.7 billion as of March 31, 2005, a decrease from year-end 2004, reflecting improvement in IB’s credit quality as a result of turnover in the mix of the loan portfolio towards higher rated clients. The consumer component of the allowance was $4.2 billion as of March 31, 2005, and remained essentially unchanged from December 31, 2004.

Lending-related commitments: This allowance is reported in Other liabilities and was $488 million at March 31, 2005, compared with $492 million at December 31, 2004, again reflecting improved credit quality in the wholesale business.

Provision for credit losses
For a discussion of the reported Provision for credit losses, see page 9 of this Form 10–Q. The managed provision for credit losses, which reflects credit card securitizations, increased primarily due to the Merger.

                                                 
                    Provision for        
                    lending-related     Total provision for  
    Provision for loan losses     commitments     credit losses  
Three months ended March 31,(a) (in millions)   2005     2004     2005     2004     2005     2004  
 
Investment Bank
  $ (356 )   $ (161 )   $ (10 )   $ (27 )   $ (366 )   $ (188 )
Commercial Banking
    (8 )     (15 )     2       2       (6 )     (13 )
Treasury & Securities Services
    (5 )     1       2             (3 )     1  
Asset & Wealth Management
    (7 )     11             (1 )     (7 )     10  
Corporate
    (4 )     (82 )                 (4 )     (82 )
 
Total Wholesale
    (380 )     (246 )     (6 )     (26 )     (386 )     (272 )
 
Retail Financial Services
    92       55       2       (1 )     94       54  
Card Services
    719       233                   719       233  
 
Total Consumer
    811       288       2       (1 )     813       287  
 
Total provision
    431       42       (4 )     (27 )     427       15  
Add: Securitized credit losses
    917       473                   917       473  
 
Total managed provision
  $ 1,348     $ 515     $ (4 )   $ (27 )   $ 1,344     $ 488  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

 
MARKET RISK MANAGEMENT
 
Risk management process
For a discussion of the Firm’s market risk management organization, see pages 70–74 of JPMorgan Chase’s 2004 Annual Report.

Value-at-risk
JPMorgan Chase’s statistical risk measure, VAR, gauges the potential loss from adverse market moves in an ordinary market environment and provides a consistent cross-business measure of risk profiles and levels of risk diversification. VAR is used to compare risks across businesses, to monitor limits and to allocate economic capital to the business segments. VAR provides risk transparency in a normal trading environment. Each business day the Firm undertakes a comprehensive VAR calculation that includes both its trading and its nontrading activities. VAR for nontrading activities measures the amount of potential change in economic value. The Firm calculates VAR using a one-day time horizon and a 99% confidence level. This means the Firm would expect to incur losses greater than that predicted by VAR estimates only once in every 100 trading days, or about 2.5 times a year. For a further discussion of the Firm’s VAR methodology, see pages 71–73 of JPMorgan Chase’s 2004 Annual Report.

49


 

Trading VAR
IB trading VAR by risk type and credit portfolio VAR(a)

                                                                 
    2005   2004
Three months ended March 31,(b)   Average   Minimum   Maximum   At   Average   Minimum   Maximum   At
(in millions)   VAR   VAR   VAR   March 31, 2005   VAR   VAR   VAR   March 31, 2004
 
By risk type:
                                                               
Fixed income
  $ 57.2     $ 46.1     $ 71.6     $ 71.6     $ 73.4     $ 47.8     $ 97.6     $ 47.8  
Foreign exchange
    22.6       16.7       30.0       21.6       22.4       11.5       32.5       28.4  
Equities
    18.5       15.3       21.3       18.1       40.3       27.8       57.8       27.8  
Commodities and other
    9.8       6.5       17.4       10.0       8.1       7.1       9.6       7.1  
Less: portfolio diversification
    (43.1 )   NM(d)   NM(d)     (48.1 )     (49.9 )   NM(d)   NM(d)     (41.2 )
 
Total trading VAR
  $ 65.0     $ 52.9     $ 77.7     $ 73.2     $ 94.3     $ 69.9     $ 122.1     $ 69.9  
Credit portfolio VAR(c)
    13.2       12.2       15.5       12.9       14.9       13.9       15.7       15.5  
Less: portfolio diversification
    (8.2 )   NM (d)   NM (d)     (6.3 )     (7.6 )   NM (d)   NM (d)     (8.3 )
 
Total trading and credit portfolio VAR(e)
  $ 70.0     $ 57.4     $ 82.6     $ 79.8     $ 101.6     $ 77.1     $ 131.6     $ 77.1  
 
 
(a)  
Includes all mark-to-market trading activities in the IB, plus available-for-sale securities held for the IB’s proprietary purposes. Amounts exclude VAR related to the Firm’s private equity business. For a discussion of Private equity risk management, see page 52 of this Form 10–Q.
(b)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.
(c)  
Includes VAR on derivative credit valuation adjustments, credit valuation adjustment hedges and mark-to-market loan hedges, which are all reported in Trading revenue. This VAR does not include the accrual loan portfolio, which is not marked to market.
(d)  
Designated as NM because the minimum and maximum may occur on different days for different risk components, and hence it is not meaningful to compute a portfolio diversification effect. In addition, JPMorgan Chase’s average and period-end VARs are less than the sum of the VARs of its market risk components, due to risk offsets resulting from portfolio diversification.
(e)  
For the three months ended March 31, 2004, amounts have been revised to reflect the reclassification of hedge fund investments, reclassification of Treasury positions to portfolios outside the IB, and the inclusion of available-for-sale securities held for the IB’s proprietary purposes.

The largest contributor to the IB trading VAR in the first quarter of 2005 was fixed income risk. Before portfolio diversification, fixed income risk accounted for roughly 53% of the average IB Trading Portfolio VAR. The diversification effect, which on average reduced the daily average IB Trading Portfolio VAR by $43.1 million in the first quarter of 2005, reflects the fact that the largest losses for different positions and risks do not typically occur at the same time. The risk of a portfolio of positions is therefore usually less than the sum of the risks of the positions themselves. The degree of diversification is determined both by the extent to which different market variables tend to move together and by the extent to which different businesses have similar positions.

Average IB trading and Credit Portfolio VAR during the first quarter of 2005 declined to $70.0 million, compared with $101.6 million for the same period in 2004. The decrease was driven by a decline in fixed income and equities VAR, primarily due to decreased risk positions and reduced correlation between lines of business. Period-end VAR increased slightly over March 31, 2004 to $79.8 million from $77.1 million. In general, over the course of a year, VAR exposures can vary significantly as trading positions change and market volatility fluctuates.

VAR backtesting
To evaluate the soundness of its VAR model, the Firm conducts daily backtesting of VAR against actual financial results, based on daily market risk–related revenue. Market risk–related revenue 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. The Firm’s definition of market risk–related revenue is consistent with the FRB’s implementation of the Basel Committee’s market risk capital rules. The accompanying histogram illustrates the daily market risk–related gains and losses for the IB trading businesses for the three months ended March 31, 2005. The chart shows that the IB posted market risk–related gains on 61 out of 64 days in this period, with four days exceeding $100 million. The inset graph looks at those days on which the IB experienced losses and depicts the amount by which VAR exceeded the actual loss on each of those days. Losses were sustained on three days, with no loss greater than $20 million, and with no loss exceeding the VAR measure.

50


 

(BAR CHART)

Economic value 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. Stress testing is equally as important as VAR in measuring and controlling risk. Stress testing enhances the understanding of the Firm’s risk profile and loss potential and is used for monitoring limits, cross-business risk measurement and economic capital allocation. Economic-value stress tests measure the potential change in the value of the Firm’s portfolios. Applying economic-value stress tests helps the Firm understand how the economic value of its balance sheet (i.e., not the amounts reported under U.S. GAAP) would change under certain scenarios. The Firm conducts economic-value stress tests monthly for both its trading and its nontrading activities, using multiple scenarios, as well as the same scenarios for both types of activities. Scenarios are continually reviewed and updated to reflect changes in the Firm’s risk profile and economic events.

Based on the Firm’s stress scenarios, the stress-test loss (pre-tax) in the IB’s trading portfolio ranged from $469 million to $745 million, and from $543 million to $1.2 billion for the three months ended March 31, 2005 and 2004, respectively. The 2005 results reflect the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only. In addition, the 2004 amounts have been revised to reflect the reclassification of hedge fund investments, reclassification of Treasury positions to portfolios outside the IB, and the inclusion of available-for-sale securities held for the IB’s proprietary purposes.

For a further discussion of the Firm’s stress-testing methodology, see page 73 of JPMorgan Chase’s 2004 Annual Report.

Earnings-at-risk stress testing
The VAR and stress-test measures described above illustrate the total economic sensitivity of the Firm’s balance sheet to changes in market variables. The effect of interest rate exposure on reported Net income is also critical. Interest rate risk exposure in the Firm’s core nontrading business activities (i.e., asset/liability management positions) results from on- and off–balance sheet positions. The Firm conducts simulations of NII for its nontrading activities under a variety of interest rate scenarios, which are consistent with the scenarios used for economic-value stress testing. Earnings-at-risk tests measure the potential change in the Firm’s Net interest income over the next 12 months. These tests highlight exposures to various rate-sensitive factors, such as the rates themselves (e.g., the prime lending rate), pricing strategies on deposits, optionality and changes in product mix. The tests included forecasted balance sheet changes, such as asset sales and securitizations, as well as prepayment and reinvestment behavior.

51


 

JPMorgan Chase’s 12-month pre-tax earnings sensitivity profile as of March 31, 2005, and December 31, 2004 were as follows:

                         
    Immediate change in rates
(in millions)   +200bp     +100bp     -100bp  
 
March 31, 2005
  $ (164 )   $ (29 )   $ (172 )
December 31, 2004
    (557 )     (164 )     (180 )
 

The Firm is exposed to both rising and falling rates. The Firm’s risk to rising rates is largely the result of increased funding costs. In contrast, the exposure to falling rates is the result of potential compression of deposit spreads, coupled with higher anticipated levels of loan prepayments. The Firm’s risk to rising rates has declined due to portfolio repositioning.

Immediate changes in interest rates present a limited view of risk, and so a number of alternative scenarios are also reviewed. These scenarios include the implied forward curve, nonparallel rate shifts and severe interest rate shocks on selected key rates. These scenarios are intended to provide a comprehensive view of JPMorgan Chase’s earnings-at-risk over a wide range of outcomes.

Earnings-at-risk can also result from changes in the slope of the yield curve, because the Firm has the ability to lend at fixed rates and borrow at variable or short-term fixed rates. Based on these scenarios, the Firm’s earnings would be negatively affected by a sudden and unanticipated increase in short-term rates without a corresponding increase in long-term rates. Conversely, higher long-term rates are generally beneficial to earnings, particularly when the increase is not accompanied by rising short-term rates.

 
OPERATIONAL RISK MANAGEMENT
 
For a discussion of JPMorgan Chase’s operational risk management, refer to page 75 of JPMorgan Chase’s 2004 Annual Report.

 
REPUTATION AND FIDUCIARY RISK MANAGEMENT
 
For a discussion of the Firm’s Reputation and Fiduciary Risk Management, see page 76 of JPMorgan Chase’s 2004 Annual Report.

 
PRIVATE EQUITY RISK MANAGEMENT
 
For a discussion of Private Equity Risk Management, see page 76 of JPMorgan Chase’s 2004 Annual Report. At March 31, 2005, the carrying value of the private equity portfolio was $7.2 billion.

 
SUPERVISION AND REGULATION
 
The following discussion should be read in conjunction with the Supervision and Regulation section on pages 1–4 of JPMorgan Chase’s 2004 Form 10–K.

Dividends
JPMorgan Chase’s bank subsidiaries could pay dividends to their respective bank holding companies, without the approval of their relevant banking regulators, in amounts up to the limitations imposed upon such banks by regulatory restrictions. These limitations, in the aggregate, totaled approximately $7.5 billion at March 31, 2005.

 
CRITICAL ACCOUNTING ESTIMATES USED BY THE FIRM
 
JPMorgan Chase’s accounting policies and use of estimates are integral to understanding its reported results. The Firm’s most complex accounting estimates require management’s judgment to ascertain the valuation of assets and liabilities. The Firm has established detailed policies and control procedures intended to ensure that valuation methods, including any judgments made as part of such methods, are well controlled, independently reviewed 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 believes its estimates for determining the valuation of its assets and liabilities are appropriate. For further description of the Firm’s critical accounting estimates involving significant management valuation judgments, see pages 77–79 and the Notes to consolidated financial statements in JPMorgan Chase’s 2004 Annual Report.

Allowance for credit losses
JPMorgan Chase’s allowance for credit losses covers the wholesale and consumer loan portfolios as well as the Firm’s portfolio of wholesale lending-related commitments. The Allowance for loan losses is intended to adjust the value of the Firm’s loan assets for probable credit losses as of the balance sheet date. For a further discussion of the methodologies used in establishing the Firm’s Allowance for credit losses, see Note 12 on pages 102–103 of JPMorgan Chase’s 2004 Annual Report. The methodology for calculating the Allowance for loan losses and allowance for lending-related commitments involves significant judgment. For a further description of these judgments, see the JPMorgan Chase 2004 Annual Report; for amounts recorded as of March 31, 2005 and 2004, see Allowance for credit losses on pages 48-49, and Note 11 on page 65 of this Form 10-Q.

52


 

Fair value of financial instruments
A portion of JPMorgan Chase’s assets and liabilities are carried at fair value, including trading assets and liabilities, AFS securities and private equity investments. Held-for-sale loans and mortgage servicing rights (“MSRs”) are carried at the lower of fair value or cost. At March 31, 2005, approximately $398 billion of the Firm’s assets were recorded at fair value.

Trading and available-for-sale portfolios
The following table summarizes the Firm’s trading and available-for-sale portfolios by valuation methodology at March 31, 2005:

                                         
    Trading assets   Trading liabilities    
    Securities           Securities           AFS
    purchased(a)   Derivatives(b)   sold(a)   Derivatives(b)   securities
 
Fair value based on:
                                       
 
                                       
Quoted market prices
    91 %     1 %     98 %     1 %     91 %
Internal models with significant observable market parameters
    8       98       1       98       3  
Internal models with significant unobservable market parameters
    1       1       1       1       6  
 
Total
    100 %     100 %     100 %     100 %     100 %
 
 
(a)  
Reflected as debt and equity instruments on the Firm’s Consolidated balance sheets.
(b)  
Based on gross mark-to-market valuations of the Firm’s derivatives portfolio prior to netting positions pursuant to FIN 39, as cross-product netting is not relevant to an analysis based upon valuation methodologies.

 
ACCOUNTING AND REPORTING DEVELOPMENTS
 
Accounting for income taxes – repatriation of foreign earnings under the American Jobs Creation Act of 2004
In December 2004, the FASB issued FSP SFAS 109-2, which provides accounting and disclosure guidance for the foreign earnings repatriation provision within the American Jobs Creation Act of 2004 (the “Act”). The Act was signed into law on October 22, 2004.

The Act creates a temporary incentive for U.S. companies to repatriate accumulated foreign earnings at a substantially reduced U.S. effective tax rate by providing a dividends received deduction on the repatriation of certain foreign earnings to the U.S. taxpayer (the “repatriation provision”). The new deduction is subject to a number of limitations and requirements.

Clarification of key elements of the repatriation provision from Congress or the U.S. Treasury Department may affect an enterprise’s evaluation of the effect of the Act on its plan for repatriation or reinvestment of foreign earnings. The FSP provides a practical exception to the SFAS 109 requirement to reflect the effect of a new tax law in the period of enactment, because of the lack of clarification of certain provisions of the Act and the timing of the enactment. Thus, companies have additional time to assess the effect of the Act on their plans for reinvestment or repatriation of foreign earnings for purposes of applying SFAS 109. A company should apply the provisions of SFAS 109 (i.e., reflect the tax impact in the financial statements) in the period in which it makes the decision to repatriate or reinvest unremitted foreign earnings in accordance with the Act. Decisions can be made in stages (e.g., by foreign country). The repatriation provision is effective for either the 2004 or 2005 tax years for calendar year taxpayers.

The range of possible amounts that may be considered by the Firm for repatriation under this provision is between zero and $1.9 billion. The Firm is currently assessing the impact of the repatriation provision and, at this time, cannot reasonably estimate the related range of income tax effects of such repatriation provision. Accordingly, the Firm has not reflected the tax effect of the repatriation provision in income tax expense or income tax liabilities.

Accounting for share-based payments
In December 2004, the FASB issued SFAS 123R, which revises SFAS 123 and supersedes APB 25. In March 2005, the SEC issued SAB 107 which provides interpretive guidance on SFAS 123R. Accounting and reporting under SFAS 123R is generally similar to the SFAS 123 approach. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123R permits adoption using one of two methods – modified prospective or modified retrospective.

The Firm has continued to account for stock options that were outstanding as of December 31, 2002 under APB 25 using the intrinsic value method. Therefore, compensation expense for some previously granted awards that was not recognized under SFAS 123 will be recognized under SFAS 123R. Had the Firm adopted SFAS 123R in prior periods, the impact would have approximated the impact of SFAS 123 as described in Note 6 on page 62 of this Form 10–Q. In April 2005, the Securities and Exchange Commission approved a new rule that, for public companies, delays the effective date to no later than January 1, 2006. The Firm intends to adopt SFAS 123R on January 1, 2006 under the modified prospective method.

53


 

Accounting for variable interest entities
The application of FIN 46R involved significant judgment and interpretations by management. The Firm is aware of differing interpretations being developed among accounting professionals and the EITF with regard to analyzing derivatives under FIN 46R. At its March 2005 meeting, the EITF suspended further deliberations on EITF Issue 04-7, subject to actions by the Financial Accounting Standard Board. Timing of these actions is not certain.

Accounting for conditional asset retirement obligations
In March 2005, FASB issued FIN 47 to clarify the term “conditional asset retirement obligation” as used in SFAS No. 143. Conditional asset retirement obligations are legal obligations to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the company. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN 47 clarifies that a company is required to recognize a liability for the fair value of the conditional asset retirement obligation if the fair value of the liability can be reasonably estimated and provides guidance for determining when a company would have sufficient information to reasonably estimate the fair value of the obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Firm is currently assessing the impact of this interpretation.

54


 

JPMORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in millions, except per share data)

                 
    Three months ended March 31, (a)  
    2005     2004  
 
Revenue
               
Investment banking fees
  $ 993     $ 692  
Trading revenue
    1,859       1,720  
Lending & deposit related fees
    820       414  
Asset management, administration and commissions
    2,455       1,771  
Securities/private equity gains (losses)
    (45 )     432  
Mortgage fees and related income
    405       259  
Credit card income
    1,734       605  
Other income
    201       132  
 
Noninterest revenue
    8,422       6,025  
 
 
               
Interest income
    10,632       5,626  
Interest expense
    5,407       2,640  
 
Net interest income
    5,225       2,986  
 
Total net revenue
    13,647       9,011  
 
 
               
Provision for credit losses
    427       15  
 
               
Noninterest expense
               
Compensation expense
    4,702       3,302  
Occupancy expense
    525       431  
Technology and communications expense
    920       819  
Professional & outside services
    1,074       816  
Marketing
    483       199  
Other expense
    805       447  
Amortization of intangibles
    383       79  
 
Total noninterest expense before merger costs and litigation reserve charge
    8,892       6,093  
Merger costs
    145        
Litigation reserve charge
    900        
 
Total noninterest expense
    9,937       6,093  
 
 
               
Income before income tax expense
    3,283       2,903  
Income tax expense
    1,019       973  
 
Net income
  $ 2,264     $ 1,930  
 
Net income applicable to common stock
  $ 2,259     $ 1,917  
 
 
               
Net income per common share
               
Basic earnings per share
  $ 0.64     $ 0.94  
Diluted earnings per share
    0.63       0.92  
 
               
Average basic shares
    3,517.5       2,032.3  
Average diluted shares
    3,569.8       2,092.7  
 
               
Cash dividends per common share
  $ 0.34     $ 0.34  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

55


 

JPMORGAN CHASE & CO.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in millions, except share data)

                 
    March 31,     December 31,  
    2005     2004  
 
Assets
               
Cash and due from banks
  $ 37,593     $ 35,168  
Deposits with banks
    14,331       21,680  
Federal funds sold and securities purchased under resale agreements
    132,751       101,354  
Securities borrowed
    53,174       47,428  
Trading assets (including assets pledged of $108,526 at March 31, 2005, and $77,266 at December 31, 2004)
    291,113       288,814  
Securities:
               
Available-for-sale (including assets pledged of $14,436 at March 31, 2005, and $26,881 at December 31, 2004)
    75,150       94,402  
Held-to-maturity (fair value: $106 at March 31, 2005, and $117 at December 31, 2004)
    101       110  
Interests in purchased receivables
    28,484       31,722  
Loans
    402,669       402,114  
Allowance for loan losses
    (6,935 )     (7,320 )
 
Loans, net of Allowance for loan losses
    395,734       394,794  
Private equity investments
    7,333       7,735  
Accrued interest and accounts receivable
    21,098       21,409  
Premises and equipment
    9,344       9,145  
Goodwill
    43,440       43,203  
Other intangible assets:
               
Mortgage servicing rights
    5,663       5,080  
Purchased credit card relationships
    3,703       3,878  
All other intangibles
    5,514       5,726  
Other assets
    53,779       45,600  
 
Total assets
  $ 1,178,305     $ 1,157,248  
 
Liabilities
               
Deposits:
               
U.S. offices:
               
Noninterest-bearing
  $ 130,533     $ 129,257  
Interest-bearing
    271,592       261,673  
Non-U.S. offices:
               
Noninterest-bearing
    6,669       6,931  
Interest-bearing
    122,585       123,595  
 
Total deposits
    531,379       521,456  
Federal funds purchased and securities sold under repurchase agreements
    137,062       127,787  
Commercial paper
    13,063       12,605  
Other borrowed funds
    10,124       9,039  
Trading liabilities
    153,716       151,207  
Accounts payable, accrued expenses and other liabilities (including the Allowance for lending-related commitments of $488 at March 31, 2005, and $492 at December 31, 2004)
    72,183       75,722  
Beneficial interests issued by consolidated VIEs
    44,827       48,061  
Long-term debt
    99,329       95,422  
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
    11,282       10,296  
 
Total liabilities
    1,072,965       1,051,595  
 
Commitments and contingencies (see Note 17 of this Form 10-Q)
               
Stockholders’ equity
               
Preferred stock
    339       339  
Common stock (authorized 9,000,000,000 shares; issued 3,597,803,183 shares and 3,584,747,502 shares at March 31, 2005, and December 31, 2004, respectively)
    3,598       3,585  
Capital surplus
    73,394       72,801  
Retained earnings
    31,253       30,209  
Accumulated other comprehensive income (loss)
    (623 )     (208 )
Treasury stock, at cost (72,504,703 shares at March 31, 2005, and 28,556,534 shares at December 31, 2004)
    (2,621 )     (1,073 )
 
Total stockholders’ equity
    105,340       105,653  
 
Total liabilities and stockholders’ equity
  $ 1,178,305     $ 1,157,248  
 
The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

56


 

JPMORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(in millions, except per share data)

                 
    Three months ended March 31, (a)  
    2005     2004  
 
Preferred stock
               
Balance at beginning of the year and end of period
  $ 339     $ 1,009  
 
 
               
Common stock
               
Balance at beginning of year
    3,585       2,044  
Issuance of common stock
    13       44  
 
Balance at end of period
    3,598       2,088  
 
 
               
Capital surplus
               
Balance at beginning of year
    72,801       13,512  
Shares issued and commitments to issue common stock for employee stock-based awards and related tax effects
    593       681  
 
Balance at end of period
    73,394       14,193  
 
 
               
Retained earnings
               
Balance at beginning of year
    30,209       29,681  
Net income
    2,264       1,930  
Cash dividends declared:
               
Preferred stock
    (5 )     (13 )
Common stock ($0.34 per share each period)
    (1,215 )     (720 )
 
Balance at end of period
    31,253       30,878  
 
 
               
Accumulated other comprehensive income (loss)
               
Balance at beginning of year
    (208 )     (30 )
Other comprehensive income (loss)
    (415 )     207  
 
Balance at end of period
    (623 )     177  
 
 
               
Treasury stock, at cost
               
Balance at beginning of year
    (1,073 )     (62 )
Purchase of treasury stock
    (1,316 )      
Share repurchases related to employee stock-based awards
    (232 )     (182 )
 
Balance at end of period
    (2,621 )     (244 )
 
Total stockholders’ equity at end of period
  $ 105,340     $ 48,101  
 
 
               
Comprehensive income
               
Net income
  $ 2,264     $ 1,930  
Other comprehensive income (loss)
    (415 )     207  
 
Comprehensive income
  $ 1,849     $ 2,137  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

57


 

JPMORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)

                 
    Three months ended March 31, (a)  
Operating activities
  2005     2004    
 
Net income
  $ 2,264     $ 1,930  
Adjustments to reconcile net income to net cash (used in) operating activities:
               
Provision for credit losses
    427       15  
Depreciation and amortization
    1,165       762  
Deferred tax (benefit) provision
    462       796  
Investment securities (gains) losses
    822       (126 )
Private equity unrealized (gains) losses
    (201 )     (159 )
Net change in:
               
Trading assets
    545       (23,610 )
Securities borrowed
    (5,746 )     (8,047 )
Accrued interest and accounts receivable
    338       (894 )
Other assets
    (6,974 )     (10,343 )
Trading liabilities
    (472 )     4,404  
Accounts payable, accrued expenses and other liabilities
    (4,349 )     (1,667 )
Other operating adjustments
          (120 )
 
Net cash (used in) operating activities
    (11,719 )     (37,059 )
 
               
Investing activities
               
Net change in:
               
Deposits with banks
    7,465       (25,425 )
Federal funds sold and securities purchased under resale agreements
    (31,239 )     (2,546 )
Other change in loans
    (22,732 )     (31,385 )
Held-to-maturity securities:
               
Proceeds
    9       19  
Purchases
           
Available-for-sale securities:
               
Proceeds from maturities
    8,703       2,060  
Proceeds from sales
    28,232       50,709  
Purchases
    (19,543 )     (62,899 )
Loans due to sales and securitizations
    21,373       28,080  
Net cash received (used) in business acquisitions
    (304 )     (24 )
All other investing activities, net
    1,374       (543 )
 
Net cash (used in) investing activities
    (6,662 )     (41,954 )
 
               
Financing activities
               
Net change in:
               
Deposits
    6,377       39,094  
Federal funds purchased and securities sold under repurchase agreements
    9,275       35,060  
Commercial paper and other borrowed funds
    1,543       1,954  
Proceeds from the issuance of long-term debt and capital debt securities
    15,796       4,943  
Repayments of long-term debt and capital debt securities
    (9,903 )     (2,805 )
Net issuance of stock and stock-based awards
    374       543  
Treasury stock purchased
    (1,316 )      
Cash dividends paid
    (1,227 )     (720 )
All other financing activities, net
    8       15  
 
Net cash provided by financing activities
    20,927       78,084  
 
Effect of exchange rate changes on cash and due from banks
    (121 )     80  
Net increase (decrease) in cash and due from banks
    2,425       (849 )
Cash and due from banks at the beginning of the year
    35,168       20,268  
 
Cash and due from banks at the end of the period
  $ 37,593     $ 19,419  
 
Cash interest paid
  $ 5,191     $ 2,619  
Cash income taxes paid
  $ 1,187     $ 325  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

58


 

See Glossary of Terms on pages 77-78 of this Form 10-Q for definitions of terms used throughout the Notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 — BASIS OF PRESENTATION
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the United States, with operations in more than 50 countries. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, investment management, private banking and private equity. For a discussion of the Firm’s business segment information, see Note 20 on pages 74-75 of this Form 10-Q.

The accounting and financial reporting policies of JPMorgan Chase and its subsidiaries conform to accounting principles generally accepted in the United States of America (“U.S. 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 U.S. GAAP require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and disclosures of contingent assets and liabilities. Actual results could be different from these estimates. In the opinion of management, all normal recurring adjustments have been included for a fair statement of this interim financial information. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in JPMorgan Chase’s Annual Report on Form 10-K for the year ended December 31, 2004 (“2004 Annual Report”).

As further described in Note 2 of this Form 10-Q, on July 1, 2004, the Firm merged with Bank One Corporation (“Bank One”) and acquired all of its outstanding stock. The merger was accounted for using the purchase method of accounting. Bank One’s results of operations were included in the Firm’s results beginning July 1, 2004.

Certain amounts in the prior periods have been reclassified to conform to the current presentation.

NOTE 2 — BUSINESS CHANGES AND DEVELOPMENTS

Merger with Bank One Corporation
Refer to Note 2 on pages 89-90 of JPMorgan Chase’s 2004 Annual Report for a discussion of JPMorgan Chase’s merger with Bank One Corporation (the “Merger”) on July 1, 2004, including its purchase price allocation and goodwill, Unaudited condensed statement of net assets acquired, and Acquired, identifiable intangible assets.

Bank One merged with and into JPMorgan Chase. The Merger was accounted for using the purchase method of accounting, which requires that the assets and liabilities of Bank One be fair valued as of July 1, 2004. The purchase price to complete the Merger was $58.5 billion.

Pro forma condensed combined financial information
The following pro forma condensed combined financial information presents the results of operations of the Firm, for the three months ended March 31, 2004, had the Merger taken place at January 1, 2004.

         
Three months ended March 31, (in millions, except per share data)   2004  
 
Noninterest revenue
  $ 8,496  
Net interest income
    5,311  
 
Total net revenue
    13,807  
Provision for credit losses
    153  
Noninterest expense
    9,112  
 
Income before income tax expense
    4,542  
Net income
  $ 3,027  
 
Net income per common share:
       
Basic
  $ 0.86  
Diluted
    0.84  
Average common shares outstanding:
       
Basic
    3,503.7  
Diluted
    3,590.4  
 

59


 

Other business events
On February 28, 2005, JPMorgan Chase and Cazenove Group plc (“Cazenove”) formed a joint venture partnership which combined Cazenove’s investment banking business and JPMorgan Chase’s United Kingdom-based investment banking business to provide investment banking services in the United Kingdom and Ireland. The new company is called JPMorgan Cazenove Holdings.

NOTE 3—TRADING ASSETS AND LIABILITIES
For a discussion of the accounting policies related to trading assets and liabilities, see Note 3 on pages 90-91 of JPMorgan Chase’s 2004 Annual Report. The following table presents Trading assets and Trading liabilities for the dates indicated:

                 
    March 31,     December 31,  
(in millions)   2005     2004  
 
Trading assets
               
Debt and equity instruments:
               
U.S. government, federal agencies/corporations obligations and municipal securities
  $ 55,377     $ 43,866  
Certificates of deposit, bankers’ acceptances and commercial paper
    5,780       7,341  
Debt securities issued by non-U.S. governments
    54,202       50,699  
Corporate securities and other
    115,366       120,926  
 
Total debt and equity instruments
    230,725       222,832  
 
Derivative receivables(a)
               
Interest rate
    41,290       45,892  
Foreign exchange
    4,712       7,939  
Equity
    7,059       6,120  
Credit derivatives
    2,762       2,945  
Commodity
    4,565       3,086  
 
Total derivative receivables
    60,388       65,982  
 
Total trading assets
  $ 291,113     $ 288,814  
 
Trading liabilities
               
Debt and equity instruments(b)
  $ 96,090     $ 87,942  
 
Derivative payables:(a)
               
Interest rate
    38,396       41,075  
Foreign exchange
    4,988       8,969  
Equity
    9,284       9,096  
Credit derivatives
    1,904       2,499  
Commodity
    3,054       1,626  
 
Total derivative payables
    57,626       63,265  
 
Total trading liabilities
  $ 153,716     $ 151,207  
 
 
(a)  
Included in Trading assets and Trading liabilities are the reported receivables (unrealized gains) and payables (unrealized losses) related to derivatives. These amounts include the effect of legally enforceable master netting agreements, including cash paid and received.
(b)  
Primarily represents securities sold, not yet purchased.

60


 

NOTE 4 — INTEREST INCOME AND INTEREST EXPENSE
Details of Interest income and Interest expense were as follows:

                 
Three months ended March 31,(a) (in millions)   2005     2004  
 
Interest income
               
Loans
  $ 6,034     $ 2,667  
Securities
    1,078       661  
Trading assets
    2,232       1,799  
Federal funds sold and securities purchased under resale agreements
    727       307  
Securities borrowed
    221       94  
Deposits with banks
    154       87  
Interests in purchased receivables
    186       11  
 
Total interest income
    10,632       5,626  
Interest expense
               
Interest-bearing deposits
    1,985       814  
Short-term and other liabilities
    2,226       1,384  
Long-term debt
    924       403  
Beneficial interests issued by consolidated VIEs
    272       39  
 
Total interest expense
    5,407       2,640  
 
Net interest income
    5,225       2,986  
Provision for credit losses
    427       15  
 
Net interest income after provision for credit losses
  $ 4,798     $ 2,971  
 
 
(a)  
2005 reflects the combined Firm’s results, while 2004 reflects the results of heritage JPMorgan Chase only.

NOTE 5 — PENSION AND OTHER POSTRETIREMENT EMPLOYEE BENEFIT PLANS
For a discussion of JPMorgan Chase’s pension and other postretirement employee benefit plans, see Note 6 on pages 92-95 of JPMorgan Chase’s 2004 Annual Report. The following table presents the components of net periodic benefit costs reported in the Consolidated statements of income for the U.S. and non-U.S. defined benefit pension and other postretirement benefit plans of the Firm.

                                                 
                                    Other  
    Pension plans     Postretirement  
    U.S.     Non-U.S.     benefit plans  
Three months ended March 31,(a) (in millions)   2005     2004     2005     2004     2005     2004  
 
Components of net periodic benefit costs
                                               
Defined benefit plans:
                                               
Benefits earned during the period
  $ 75     $ 49     $ 5     $ 5     $ 4     $ 5  
Interest cost on benefit obligations
    108       67       26       22       21       19  
Expected return on plan assets
    (173 )     (85 )     (27 )     (22 )     (22 )     (21 )
Amortization of unrecognized amounts:
                                               
Prior service cost
    2       4                   1        
Net actuarial loss
          8       10       14              
Settlement loss
                      6              
 
Subtotal
    12       43       14       25       4       3  
Other defined benefit pension plans(b)
    7       9       9       6              
 
Total defined benefit pension plans
    19       52       23       31       4       3  
Defined contribution plans
    61       36       45