10-K
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual report pursuant to section 13 or 15(d) of
The Securities Exchange Act of 1934
     
For the fiscal year ended
  Commission file
December 31, 2005
  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, NY
  10017
(Address of principal executive offices)
  (Zip code)
Registrant’s telephone number, including area code: (212) 270-6000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
     
Common stock
  Indexed Linked Notes on the S&P 500® Index due November 26, 2007
Depositary shares representing a one-tenth interest in 65/8%
  JPMorgan Market Participation Notes on the S&P 500® Index due
  cumulative preferred stock (stated value—$500)
    March 12, 2008
61/8% subordinated notes due 2008
  Capped Quarterly Observation Notes Linked to S&P 500® Index due
6.75% subordinated notes due 2008
    September 22, 2008
6.50% subordinated notes due 2009
  Capped Quarterly Observation Notes Linked to S&P 500® Index due
Guarantee of 7.50% Capital Securities, Series I, of J.P. Morgan Chase
    October 30, 2008
  Capital IX
  Capped Quarterly Observation Notes Linked to S&P 500® Index due
Guarantee of 7.00% Capital Securities, Series J, of J.P. Morgan
    January 21, 2009
  Chase Capital X
  JPMorgan Market Participation Notes on the S&P 500® Index due
Guarantee of 57/8% Capital Securities, Series K, of J.P. Morgan Chase
    March 31, 2009
  Capital XI
  Capped Quarterly Observation Notes Linked to S&P 500® Index due
Guarantee of 6.25% Capital Securities, Series L, of J.P. Morgan
    July 7, 2009
  Chase Capital XII
  Capped Quarterly Observation Notes Linked to S&P 500® Index due
Guarantee of 6.20% Capital Securities, Series N, of JPMorgan
    September 21, 2009
  Chase Capital XIV
  Consumer Price Indexed Securities due January 15, 2010
Guarantee of 6.35% Capital Securities, Series P, JPMorgan Chase Capital XVI
  Principal Protected Notes Linked to S&P 500® Index due
Guarantee of 7.20% Preferred Securities of BANK ONE Capital VI
    September 30, 2010
The Indexed Linked Notes, JPMorgan Market Participation Notes, Capped Quarterly Observation Notes, Consumer Price
Indexed Securities and Principal Protected Notes are listed on the American Stock Exchange;
all other securities named above are listed on the New York Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act: none
     Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes o No
     Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No
     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. x Yes o No
     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
     Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): x Large accelerated filer o Accelerated filer o Non-accelerated filer
     Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
     The aggregate market value of JPMorgan Chase & Co. common stock held by non-affiliates of JPMorgan Chase & Co. on June 30, 2005 was approximately $123,459,434,538.
Number of shares of common stock outstanding on January 31, 2006: 3,485,553,836
Documents Incorporated by Reference: Portions of the Registrant’s proxy statement for the annual meeting of stockholders to be held on May 16, 2006, are incorporated by reference in this Form 10-K in response to Items 10, 11, 12, 13 and 14 of Part III.

 


 

Form 10-K Index
                 
Part I   Page  
   
 
           
Item 1  
Business
        1  
   
Overview
        1  
   
Business segments
        1  
   
Competition
        1  
   
Supervision and regulation
        1  
   
Non-U.S. operations
        4  
   
Distribution of assets, liabilities and stockholders’ equity;
interest rates and interest differentials
136–140  
    Return on equity and assets 22, 133, 136–137  
   
Securities portfolio
        141  
    Loan portfolio 64–72, 106–107, 142–144  
    Summary of loan and lending-related commitments loss experience 73–74, 107–108, 145–146  
   
Deposits
        146  
   
Short-term and other borrowed funds
        147  
Item 1A  
Risk factors
        4  
Item 1B  
Unresolved SEC Staff comments
        6  
Item 2  
Properties
        7  
Item 3  
Legal proceedings
        7  
Item 4  
Submission of matters to a vote of security holders
        9  
   
Executive officers of the registrant
        9  
   
 
           
Part II  
 
           
Item 5  
Market for Registrant’s common equity, related stockholder
matters and issuer purchases of equity securities
        11  
Item 6  
Selected financial data
        11  
Item 7  
Management’s discussion and analysis of financial
condition and results of operations
        11  
Item 7A  
Quantitative and qualitative disclosures about market risk
        11  
Item 8  
Financial statements and supplementary data
        11  
Item 9  
Changes in and disagreements with accountants on accounting
and financial disclosure
        11  
Item 9A  
Controls and procedures
        12  
Item 9B  
Other information
        12  
   
 
           
Part III  
 
           
Item 10  
Directors and executive officers of the Registrant
        12  
Item 11  
Executive compensation
        12  
Item 12   Security ownership of certain beneficial owners and management and related stockholder matters   12  
Item 13  
Certain relationships and related transactions
        12  
Item 14  
Principal accounting fees and services
        12  
   
 
           
Part IV  
 
           
Item 15  
Exhibits, financial statement schedules
        12  

 


 

Part I
Item 1: Business
Effective July 1, 2004, Bank One Corporation (“Bank One”) merged with and into JPMorgan Chase & Co. (the “Merger”), pursuant to an Agreement and Plan of Merger dated January 14, 2004. As a result of the Merger, each outstanding share of common stock of Bank One was converted in a stock-for-stock exchange into 1.32 shares of common stock of JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”). The Merger was accounted for using the purchase method of accounting. The purchase price to complete the Merger was $58.5 billion.
Bank One’s results of operations were included in the Firm’s results beginning July 1, 2004. Therefore, the results of operations for the 12 months ended December 31, 2004, reflect six months of operations of the combined Firm and six months of heritage JPMorgan Chase; the results of operations for all other periods prior to 2004 reflect only the operations of heritage JPMorgan Chase.


 
Overview
JPMorgan Chase is a financial holding company incorporated under Delaware law in 1968. JPMorgan Chase is one of the largest banking institutions in the United States, with $1.2 trillion in assets, $107 billion in stockholders’ equity and operations worldwide.
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 (“Chase USA”), a national banking association 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 bank and nonbank subsidiaries of JPMorgan Chase operate nationally as well as through overseas branches and subsidiaries, representative offices and subsidiary foreign banks.
The Firm’s website is www.jpmorganchase.com. JPMorgan Chase makes available free of charge, through its website, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the Securities and Exchange Commission (the “SEC”). The Firm has adopted, and posted on its website, a Code of Ethics for its Chairman, Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and other senior financial officers.
Business segments
JPMorgan Chase’s activities are organized, for management reporting purposes, into six business segments (Investment Bank, Retail Financial Services, Card Services, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management) and Corporate, which includes its Private Equity and Treasury businesses, as well as corporate support functions. A description of the Firm’s business segments and the products and services they provide to their respective client bases is provided in the “Business segment results” section of Management’s discussion and analysis (“MD&A”), beginning on page 34, and in Note 31 on page 130.
Competition
JPMorgan Chase and its subsidiaries and affiliates operate in a highly competitive environment. Competitors include other banks, brokerage firms, investment banking companies, merchant banks, insurance companies, mutual fund companies, credit card companies, mortgage banking companies, hedge funds, trust companies, automobile financing companies, leasing companies,
e-commerce and other Internet-based companies, and a variety of other financial services and advisory companies. JPMorgan Chase’s businesses compete with these other firms with respect to the quality and range of products and services offered and the types of clients, customers, industries and geographies served. With respect to some of its geographies and products, JPMorgan Chase competes globally; with respect to others, the Firm competes on a regional basis. JPMorgan Chase’s ability to compete effectively depends upon the relative performance of its products, the degree to which the features of its products appeal to customers, and the extent to which the Firm is able to meet its clients’ objectives or needs. The Firm’s ability to compete also depends upon its ability to attract and retain its professional and other personnel, and on its reputation.
The financial services industry has experienced consolidation and convergence in recent years, as financial institutions involved in a broad range of financial products and services have merged. This convergence trend is expected to continue. Consolidation could result in competitors of JPMorgan Chase gaining greater capital and other resources, such as a broader range of products and services and geographic diversity. It is possible that competition will become even more intense as the Firm continues to compete with other financial institutions that may be larger or better capitalized, or that may have a stronger local presence in certain geographies. For a discussion of certain risks relating to the Firm’s competitive environment, see the Risk factors on page 4.
Supervision and regulation
Permissible business activities: The Firm is subject to regulation under state and federal law, including the Bank Holding Company Act of 1956, as amended (the “BHCA”). JPMorgan Chase elected to become a financial holding company as of March 13, 2000 pursuant to the provisions of the 1999 Gramm-Leach-Bliley Act (“GLBA”).
Under regulations implemented by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), if any depository institution controlled by a financial holding company ceases to meet certain capital or management standards, the Federal Reserve Board may impose corrective capital and/or managerial requirements on the financial holding company and place limitations on its ability to conduct the broader financial activities permissible for financial holding companies. In addition, the Federal Reserve Board may require divestiture of the holding company’s depository institutions if the deficiencies persist. The regulations also provide that if any depository institution controlled by a financial holding company fails to maintain a satisfactory rating under the Community Reinvestment Act (“CRA”), the Federal Reserve Board must prohibit the financial holding company and its subsidiaries from engaging in any additional activities other than those


1


 

Part I

permissible for bank holding companies that are not financial holding companies. At December 31, 2005, the depository-institution subsidiaries of JPMorgan Chase met the capital, management and CRA requirements necessary to permit the Firm to conduct the broader activities permitted under GLBA. However, there can be no assurance that this will continue to be the case in the future.
Regulation by Federal Reserve Board under GLBA: Under GLBA’s system of “functional regulation,” the Federal Reserve Board acts as an “umbrella regulator,” and certain of JPMorgan Chase’s subsidiaries are regulated directly by additional authorities based upon the particular activities of those subsidiaries. JPMorgan Chase Bank and Chase USA are regulated by the Office of the Comptroller of the Currency (“OCC”). The Firm’s securities and investment advisory activities are regulated by the SEC, and insurance activities are regulated by state insurance commissioners.
Dividend restrictions: Federal law imposes limitations on the payment of dividends by the subsidiaries of JPMorgan Chase that are national banks. Nonbank subsidiaries of JPMorgan Chase are not subject to those limitations. The amount of dividends that may be paid by national banks, such as JPMorgan Chase Bank and Chase USA, is limited to the lesser of the amounts calculated under a “recent earnings” test and an “undivided profits” test. Under the recent earnings test, a dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current year’s net income combined with the retained net income of the two preceding years, unless the national bank obtains the approval of the OCC. Under the undivided profits test, a dividend may not be paid in excess of a bank’s “undivided profits.” See Note 23 on page 121 for the amount of dividends that the Firm’s principal bank subsidiaries could pay, at January 1, 2006 and 2005, to their respective bank holding companies without the approval of their banking regulators.
In addition to the dividend restrictions described above, the OCC, the Federal Reserve Board and the Federal Deposit Insurance Corporation (the “FDIC”) have authority to prohibit or to limit the payment of dividends by the banking organizations they supervise, including JPMorgan Chase and its bank and bank holding company subsidiaries, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking organization.
Capital requirements: Federal banking regulators have adopted risk-based capital and leverage guidelines that require the Firm’s capital-to-assets ratios to meet certain minimum standards.
The risk-based capital ratio is determined by allocating assets and specified off-balance sheet financial instruments into four weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. Under the guidelines, capital is divided into two tiers: Tier 1 capital and Tier 2 capital. The amount of Tier 2 capital may not exceed the amount of Tier 1 capital. Total capital is the sum of Tier 1 capital and Tier 2 capital. Under the guidelines, banking organizations are required to maintain a Total capital ratio (total capital to risk-weighted assets) of 8% and a Tier 1 capital ratio of 4%.
Tier 1 components: Capital surplus, common stock and noncumulative perpetual preferred stock are the most basic components of Tier 1 capital. The Federal Reserve Board also permits cumulative perpetual preferred securities to be included in Tier 1 capital but only up to certain limits. On March 1, 2005, the Federal Reserve Board issued a final rule, which became effective April 11, 2005, that continues the inclusion of trust preferred securities in Tier 1 capital, subject to
stricter quantitative limits and revised qualitative standards, and broadens the definition of restricted core capital elements. The rule provides for a five-year transition period. As an internationally active bank holding company, JPMorgan Chase is subject to the rule’s limitation on restricted core capital elements, including trust preferred securities, to 15% of total core capital elements, net of goodwill less any associated deferred tax liability. At December 31, 2005, JPMorgan Chase’s restricted core capital elements were 16.5% of total core capital elements. JPMorgan Chase expects to be in compliance with the 15% limit by the March 31, 2009, implementation date. Trust preferred securities are generally issued by a special-purpose trust established and owned by JPMorgan Chase. Proceeds from the issuance to the public of the trust preferred securities are lent to the Firm for at least 30 (but not more than 50) years. The intercompany note that evidences this loan provides that the interest payments by JPMorgan Chase on the note may be deferred for up to five years. During the period of any such deferral, no payments of dividends may be made on any outstanding JPMorgan Chase preferred or common stock or on the outstanding trust preferred securities issued to the public. As a result of the Firm’s implementation of Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”), JPMorgan Chase does not consolidate these trusts on its balance sheet.
Tier 2 components: Long-term subordinated debt (generally having an original maturity of 10–12 years) is the primary form of JPMorgan Chase’s Tier 2 capital.
The federal banking regulators also have established minimum leverage ratio guidelines. The leverage ratio is defined as Tier 1 capital divided by average total assets (net of the allowance for loan losses, goodwill and certain intangible assets). The minimum leverage ratio is 3% for bank holding companies that are considered “strong” under Federal Reserve Board guidelines or which have implemented the Federal Reserve Board’s risk-based capital measure for market risk. Other bank holding companies must have a minimum leverage ratio of 4%. Bank holding companies may be expected to maintain ratios well above the minimum levels, depending upon their particular condition, risk profile and growth plans.
The risk-based capital requirements explicitly identify concentrations of credit risk, certain risks arising from non-traditional banking activities, and the management of those risks as important factors to consider in assessing an institution’s overall capital adequacy. Other factors taken into consideration by federal regulators include: interest rate exposure; liquidity, funding and market risk; the quality and level of earnings; the quality of loans and investments; the effectiveness of loan and investment policies; and management’s overall ability to monitor and control financial and operational risks, including the risks presented by concentrations of credit and non-traditional banking activities. In addition, the risk-based capital rules incorporate a measure for market risk in foreign exchange and commodity activities and in the trading of debt and equity instruments. The market risk-based capital rules require banking organizations with large trading activities (such as JPMorgan Chase) to maintain capital for market risk in an amount calculated by using the banking organizations’ own internal Value-at-Risk models (subject to parameters set by the regulators).
The minimum risk-based capital requirements adopted by the federal banking agencies follow the Capital Accord of the Basel Committee on Banking Supervision. The Basel Committee has proposed a revision to the Accord (“Basel II”). U.S. banking regulators are in the process of incorporating the Basel II Framework into the existing risk-based capital requirements.


2


 

JPMorgan Chase will be required to implement advanced measurement techniques in the U.S. by employing internal estimates of certain key risk drivers to derive capital requirements. Prior to implementation of the new Basel II Framework, JPMorgan Chase will be required to demonstrate to its U.S. bank supervisors that internal criteria meet the relevant supervisory standards. JPMorgan Chase expects to be in compliance within the established timelines with all relevant Basel II rules.
FDICIA: The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) provides a framework for regulation of depository institutions and their affiliates, including parent holding companies, by their federal banking regulators; among other things, it requires the relevant federal banking regulator to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards.
Supervisory actions by the appropriate federal banking regulator under the “prompt corrective action” rules generally depend upon an institution’s classification within five capital categories. The regulations apply only to banks and not to bank holding companies such as JPMorgan Chase; however, subject to limitations that may be imposed pursuant to GLBA, the Federal Reserve Board is authorized to take appropriate action at the holding company level, based upon the undercapitalized status of the holding company’s subsidiary banking institutions. In certain instances relating to an undercapitalized banking institution, the bank holding company would be required to guarantee the performance of the undercapitalized subsidiary and might be liable for civil money damages for failure to fulfill its commitments on that guarantee.
FDIC Insurance Assessments: FDICIA also requires the FDIC to establish a risk-based assessment system for FDIC deposit insurance. Under the FDIC’s risk-based insurance premium assessment system, each depository institution is assigned to one of nine risk classifications based upon certain capital and supervisory measures and, depending upon its classification, is assessed insurance premiums on its deposits. In February 2006, a bill intended to reform the deposit insurance system was enacted. This law will generally not be effective until the FDIC issues final regulations implementing the new law. It is not possible to fully assess the impact of the law until such final regulations are promulgated.
Powers of the FDIC upon insolvency of an insured depository institution: An FDIC-insured depository institution can be held liable for any loss incurred or expected to be incurred by the FDIC in connection with another FDIC-insured institution under common control, with such institution being “in default” or “in danger of default” (commonly referred to as “cross-guarantee” liability). An FDIC cross-guarantee claim against a depository institution is generally superior in right of payment to claims of the holding company and its affiliates against such depository institution.
If the FDIC is appointed the conservator or receiver of an insured depository institution upon its insolvency or in certain other events, the FDIC has the power: (1) to transfer any of the depository institution’s assets and liabilities to a new obligor without the approval of the depository institution’s creditors; (2) to enforce the terms of the depository institution’s contracts pursuant to their terms; or (3) to repudiate or disaffirm any contract or lease to which the depository institution is a party, the performance of which is determined by the FDIC to be burdensome and the disaffirmation or repudiation of which is determined by the FDIC to promote the orderly administration of the depository institution. The above provisions would be applicable to obligations and liabilities of JPMorgan Chase’s subsidiaries that are insured depository
institutions, such as JPMorgan Chase Bank and Chase USA, including, without limitation, obligations under senior or subordinated debt issued by those banks to investors (referenced below as “public noteholders”) in the public markets.
Under federal law, the claims of a receiver of an insured depository institution for administrative expenses and the claims of holders of U.S. deposit liabilities (including the FDIC, as subrogee of the depositors) have priority over the claims of other unsecured creditors of the institution, including public note-holders, in the event of the liquidation or other resolution of the institution. As a result, whether or not the FDIC would ever seek to repudiate any obligations held by public noteholders of any subsidiary of the Firm that is an insured depository institution, such as JPMorgan Chase Bank or Chase USA, the public noteholders would be treated differently from, and could receive, if anything, substantially less than the depositors of the depository institution.
The USA PATRIOT Act: The USA Patriot Act of 2001 (“Patriot Act”) substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States; imposes new compliance and due diligence obligations; creates new crimes and penalties; compels the production of documents located both inside and outside the United States, including those of non-U.S. institutions that have a correspondent relationship in the United States; and clarifies the safe harbor from civil liability to customers. The United States Department of the Treasury has issued a number of regulations that further clarify the Patriot Act’s requirements or provide more specific guidance on their application.
The Patriot Act requires all “financial institutions,” as defined, to establish certain anti-money laundering compliance and due diligence programs. The Act requires financial institutions that maintain correspondent accounts for non-U.S. institutions, or persons that are involved in private banking for “non-United States persons” or their representatives, to establish, “appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls that are reasonably designed to detect and report instances of money laundering through those accounts.” JPMorgan Chase believes its programs satisfy the requirements of the Patriot Act. Bank regulators are focusing their examinations on anti-money laundering compliance, and JPMorgan Chase continues to enhance its anti-money laundering compliance programs.
Other supervision and regulation: Under current Federal Reserve Board policy, JPMorgan Chase is expected to act as a source of financial strength to its bank subsidiaries and to commit resources to support the bank subsidiaries in circumstances where it might not do so absent such policy. However, because GLBA provides for functional regulation of financial holding company activities by various regulators, GLBA prohibits the Federal Reserve Board from requiring payment by a holding company or subsidiary to a depository institution if the functional regulator of the payor objects to such payment. In such a case, the Federal Reserve Board could instead require the divestiture of the depository institution and impose operating restrictions pending the divestiture.
Any loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to a priority of payment.


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Part I

The bank subsidiaries of JPMorgan Chase are subject to certain restrictions imposed by federal law on extensions of credit to, and certain other transactions with, the Firm and certain other affiliates, and on investments in stock or securities of JPMorgan Chase and those affiliates. These restrictions prevent JPMorgan Chase and other affiliates from borrowing from a bank subsidiary unless the loans are secured in specified amounts.
The Firm’s bank and certain of its nonbank subsidiaries are subject to direct supervision and regulation by various other federal and state authorities (some of which are considered “functional regulators” under GLBA). JPMorgan Chase’s national bank subsidiaries, such as JPMorgan Chase Bank and Chase USA, are subject to supervision and regulation by the OCC and, in certain matters, by the Federal Reserve Board and the FDIC. Supervision and regulation by the responsible regulatory agency generally includes comprehensive annual reviews of all major aspects of the relevant bank’s business and condition, as well as the imposition of periodic reporting requirements and limitations on investments and other powers. The Firm also conducts securities underwriting, dealing and brokerage activities through JPMSI and other broker-dealer subsidiaries, all of which are subject to the regulations of the SEC and the National Association of Securities Dealers, Inc. (“NASD”). JPMSI is a member of the New York Stock Exchange (“NYSE”). The operations of JPMorgan Chase’s mutual funds also are subject to regulation by the SEC. The types of activities in which the non-U.S. branches of JPMorgan Chase Bank and the international subsidiaries of JPMorgan Chase may engage are subject to various restrictions imposed by the Federal Reserve Board. Those non-U.S. branches and international subsidiaries also are subject to the laws and regulatory authorities of the countries in which they operate.
The activities of JPMorgan Chase Bank and Chase USA as consumer lenders also are subject to regulation under various federal laws, including the Truth-in-Lending, the Equal Credit Opportunity, the Fair Credit Reporting, the Fair Debt Collection Practice and the Electronic Funds Transfer acts, as well as various state laws. These statutes impose requirements on the making, enforcement and collection of consumer loans and on the types of disclosures that need to be made in connection with such loans.
In addition, under the requirements imposed by GLBA, JPMorgan Chase and its subsidiaries are required periodically to disclose to their retail customers the Firm’s policies and practices with respect to (1) the sharing of non-public customer information with JPMorgan Chase affiliates and others; and (2) the confidentiality and security of that information. Under GLBA, retail customers also must be given the opportunity to “opt out” of information-sharing arrangements with non-affiliates, subject to certain exceptions set forth in GLBA.
For a discussion of certain risks relating to the Firm’s regulatory environment, see Risk factors below.
Non-U.S. operations
For geographic distributions of total revenue, total expense, income before income tax expense and net income, see Note 30 on page 129. For a discussion of non-U.S. loans, see Note 11 on page 106 and the sections entitled “Country exposure” in the MD&A on page 70, Loan portfolio on page 142 and “Cross-border outstandings” on page 143.
Item 1A: Risk factors
The following discussion sets forth some of the more important risk factors that could affect the Firm’s business and operations. However, other factors besides those discussed below or elsewhere in this or other of the Firm’s reports filed or furnished with the SEC also could adversely affect the Firm’s business or results. The reader should not consider any descriptions of such factors to be a complete set of all potential risks that may face the Firm.
JPMorgan Chase’s results of operations could be adversely affected by U.S. and international markets and economic conditions.
The Firm’s businesses are affected by conditions in the global financial markets and economic conditions generally both in the U.S. and internationally. Factors such as the liquidity of the global financial markets; the level and volatility of equity prices; interest rates and commodities prices; investor sentiment; inflation; and the availability and cost of credit can significantly affect the activity level of clients with respect to size, number and timing of transactions involving the Firm’s investment banking business, including its underwriting and advisory businesses. These factors also may affect the realization of cash returns from the Firm’s private equity business. A market downturn would likely lead to a decline in the volume of transactions that the Firm executes for its customers and, therefore, lead to a decline in the revenues it receives from trading commissions and spreads. In addition, lower market volatility will reduce trading and arbitrage opportunities, which could lead to lower trading revenues. Higher interest rates or weakness in the markets also could adversely affect the number or size of underwritings the Firm manages on behalf of clients and affect the willingness of financial sponsors or investors to participate in loan syndications or underwritings managed by JPMorgan Chase.
The Firm generally maintains large trading portfolios in the fixed income, currency, commodity and equity markets and has significant investment positions, including merchant banking investments held by its private equity business. The revenues derived from mark-to-market values of the Firm’s business are affected by many factors, including its credit standing; its success in proprietary positioning; volatility in interest rates and equity and debt markets; and other economic and business factors. JPMorgan Chase anticipates that revenues relating to its trading will experience volatility and there can be no assurance that such volatility relating to the above factors or other conditions could not materially adversely affect the Firm’s earnings.
The fees JPMorgan Chase earns for managing third-party assets are also dependent upon general economic conditions. For example, a higher level of U.S. or non-U.S. interest rates or a downturn in trading markets could affect the valuations of the third-party assets managed by the Firm, which, in turn, could affect the Firm’s revenues. Moreover, even in the absence of a market downturn, below-market performance by JPMorgan Chase’s investment management businesses could result in outflows of assets under management and supervision and, therefore, reduce the fees the Firm receives.
The credit quality of JPMorgan Chase’s on-balance sheet and off-balance sheet assets may be affected by business conditions. In a poor economic environment there is a greater likelihood that more of the Firm’s customers or counterparties could become delinquent on their loans or other obligations to JPMorgan Chase which, in turn, could result in a higher level of charge-offs and provision for credit losses, all of which would adversely affect the Firm’s earnings.
The Firm’s consumer businesses are particularly affected by domestic economic conditions which can materially adversely affect such businesses and the Firm.


4


 

Such conditions include U.S. interest rates; the rate of unemployment; the level of consumer confidence; changes in consumer spending; and the number of personal bankruptcies, among others. Certain changes to these conditions can diminish demand for businesses’ products and services, or increase the cost to provide such products and services. In addition, a deterioration in consumers’ credit quality could lead to an increase in loan delinquencies and higher net charge-offs, which could adversely affect the Firm’s earnings.
There is increasing competition in the financial services industry which may adversely affect JPMorgan Chase’s results of operations.
JPMorgan Chase operates in a highly competitive environment and expects competitive conditions to continue to intensify as continued merger activity in the financial services industry produces larger, better-capitalized and more geographically-diverse companies that are capable of offering a wider array of financial products and services at more competitive prices.
The Firm also faces an increasing array of competitors. Competitors include other banks, brokerage firms, investment banking companies, merchant banks, insurance companies, mutual fund companies, credit card companies, mortgage banking companies, hedge funds, trust companies, automobile financing companies, leasing companies, e-commerce and other Internet-based companies, and a variety of other financial services and advisory companies. Technological advances and the growth of e-commerce have made it possible for non-depository institutions to offer products and services that traditionally were banking products, and for financial institutions and other companies to provide electronic and Internet-based financial solutions, including electronic securities trading. JPMorgan Chase’s businesses generally compete on the basis of the quality and variety of its products and services, transaction execution, innovation, technology, reputation and price. Ongoing or increased competition in any one or all of these areas may put downward pressure on prices for the Firm’s products and services or may cause the Firm to lose market share. Increased competition may also require the Firm to make additional capital investment in its businesses in order to remain competitive, which investments may increase expenses, or which may require the Firm to extend more of its capital on behalf of clients in order to execute larger, more competitive transactions. There can be no assurance that the significant and increasing competition in the financial services industry will not materially adversely affect JPMorgan Chase’s future results of operations.
JPMorgan Chase’s acquisitions and integration of acquired businesses may not result in all of the benefits anticipated.
The Firm has in the past and may in the future seek to grow its business by acquiring other businesses. There can be no assurance that the Firm’s acquisitions will have the anticipated positive results, including results relating to: the total cost of integration; the time required to complete the integration; the amount of longer-term cost savings; or the overall performance of the combined entity. Integration of an acquired business can be complex and costly, sometimes including combining relevant accounting and data processing systems and management controls, as well as managing relevant relationships with clients, suppliers and other business partners, as well as with employees.
There is no assurance that JPMorgan Chase’s most recent acquisitions or that any businesses acquired in the future will be successfully integrated and will result in all of the positive benefits anticipated. If JPMorgan Chase is not able to integrate successfully its past and any future acquisitions, there is the risk the Firm’s results of operations could be materially and adversely affected.
JPMorgan Chase relies on its systems, employees and certain counterparties, and certain failures could materially adversely affect the Firm’s operations.
The Firm’s businesses are dependent on its ability to process a large number of increasingly complex transactions. If any of the Firm’s financial, accounting, or other data processing systems fail or have other significant shortcomings, the Firm could be materially adversely affected. The Firm is similarly dependent on its employees. The Firm could be materially adversely affected if a Firm employee causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates the Firm’s operations or systems. Third parties with which the Firm does business could also be sources of operational risk to the Firm, including relating to break-downs or failures of such parties’ own systems or employees. Any of these occurrences could result in a diminished ability of the Firm to operate one or more of its businesses, potential liability to clients, reputational damage and regulatory intervention, which could materially adversely affect the Firm.
The Firm may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control, which may include, for example, computer viruses or electrical or telecommunications outages or natural disasters, such as Hurricane Katrina, or events arising from local or regional politics, including terrorist acts. Such disruptions may give rise to losses in service to customers and loss or liability to the Firm.
In a firm as large and complex as JPMorgan Chase, lapses or deficiencies in internal control over financial reporting are likely to occur from time to time, and there is no assurance that significant deficiencies or material weaknesses in internal controls may not occur in the future.
In addition there is the risk that the Firm’s controls and procedures as well as business continuity and data security systems prove to be inadequate. Any such failure could affect the Firm’s operations and could materially adversely affect its results of operations by requiring the Firm to expend significant resources to correct the defect, as well as by exposing the Firm to litigation or losses not covered by insurance.
JPMorgan Chase’s non-U.S. trading activities and operations are subject to risk of loss, particularly in emerging markets.
The Firm does business throughout the world, including in developing regions of the world commonly known as emerging markets. In the past many emerging market countries have experienced severe economic and financial disruptions, including devaluations of their currencies and capital and currency exchange controls, as well as low or negative economic growth.
JPMorgan Chase’s businesses and revenues derived from non-U.S. operations are subject to risk of loss from various unfavorable political, economic and legal developments, including currency fluctuations, social instability, changes in governmental policies or policies of central banks, expropriation, nationalization, confiscation of assets and changes in legislation relating to non-U.S. ownership.
The Firm also invests in the securities of corporations located in non-U.S. jurisdictions, including emerging markets. Revenues from the trading of non-U.S. securities also may be subject to negative fluctuations as a result of the above considerations. The impact of these fluctuations could be accentuated as non-U.S. trading markets (particularly in emerging markets) are usually smaller, less liquid and more volatile than U.S. trading markets. There can be no assurance the Firm will not suffer losses in the future arising from its non-U.S. trading activities or operations.


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Part I

If JPMorgan Chase does not successfully handle issues that may arise in the conduct of its business and operations its reputation could be damaged, which could in turn negatively affect its business.
The Firm’s ability to attract and retain customers and transact with its counter-parties could be adversely affected to the extent its reputation is damaged. The failure of the Firm to deal, or to appear to fail to deal, with various issues that could give rise to reputational risk could cause harm to the Firm and its business prospects. These issues include, but are not limited to, appropriately dealing with potential conflicts of interest, legal and regulatory requirements, ethical issues, money-laundering, privacy, record-keeping, sales and trading practices, and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in its products. The failure to address appropriately these issues could make the Firm’s clients unwilling to do business with the Firm, which could adversely affect the Firm’s results.
JPMorgan Chase operates within a highly regulated industry and its business and results are significantly affected by the regulations to which it is subject.
JPMorgan Chase operates within a highly regulated environment. The regulations to which the Firm is subject will continue to have a significant impact on the Firm’s operations and the degree to which it can grow and be profitable.
Certain regulators to which the Firm is subject have significant power in reviewing the Firm’s operations and approving its business practices. Particularly in recent years, the Firm’s businesses have experienced increased regulation and regulatory scrutiny, often requiring additional Firm resources. In addition, as the Firm expands its international operations, its activities will become subject to an increasing range of non-U.S. laws and regulations that will likely impose new requirements and limitations on certain of the Firm’s operations. There is no assurance that any change to the current regulatory requirements to which JPMorgan Chase is subject, or the way in which such regulatory requirements are interpreted or enforced, will not have a negative affect on the Firm’s ability to conduct its business and its results of operations.
JPMorgan Chase faces significant legal risks, both from regulatory investigations and proceedings and from private actions brought against the Firm.
JPMorgan Chase is named as a defendant in various legal actions, including class actions and other litigation or disputes with third parties, as well as investigations or proceedings brought by regulatory agencies. These or other future actions brought against the Firm may result in judgments, settlements, fines, penalties or other results adverse to the Firm which could materially adversely affect the Firm’s business, financial condition or results of operation, or cause it serious reputational harm.
JPMorgan Chase’s ability to attract and retain qualified employees is critical to the success of its business and failure to do so may materially adversely affect its performance.
The Firm’s employees are its most important resource and, in many areas of the financial services industry, competition for qualified personnel is intense. If JPMorgan Chase is unable to continue to retain and attract qualified employees, its performance, including its competitive position, could be materially adversely affected.
Government monetary policies and economic controls may have a significant adverse affect on JPMorgan Chase’s businesses and results of operations.
The Firm’s businesses and earnings are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States, non-U.S. governments and international agencies. For example, policies and regulations of the Federal Reserve Board influence, directly and indirectly, the rate of interest paid by commercial banks on their interest-bearing deposits and also may affect the value of financial instruments held by the Firm. The actions of the Federal Reserve Board also determine to a significant degree the Firm’s cost of funds for lending and investing. In addition, these policies and conditions can adversely affect the Firm’s customers and counterparties, both in the United States and abroad, which may increase the risk that such customers or counterparties default on their obligations to JPMorgan Chase.
JPMorgan Chase’s framework for managing its risks may not be effective in mitigating risk and loss to the Firm.
JPMorgan Chase’s risk management framework is made up of various processes and strategies to manage the Firm’s risk exposure. Types of risk to which the Firm is subject include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal and reputation risk, fiduciary risk and private equity risk, among others. There can be no assurance that the Firm’s framework to manage risk, including such framework’s underlying assumptions, will be effective under all conditions and circumstances. If the Firm’s risk management framework proves ineffective, the Firm could suffer unexpected losses and could be materially adversely affected.
If JPMorgan Chase does not effectively manage its liquidity, its business could be negatively impacted.
The Firm’s liquidity is critical to its ability to operate its businesses, grow and be profitable. A compromise to the Firm’s liquidity could therefore have a negative effect on the Firm. Potential conditions that could negatively affect the Firm’s liquidity include diminished access to capital markets, unforeseen cash or capital requirements and an inability to sell assets.
The Firm’s credit ratings are an important part of maintaining its liquidity, as a reduction in the Firm’s credit ratings would also negatively affect the Firm’s liquidity. A credit ratings downgrade, depending on its severity, could potentially increase borrowing costs, limit access to capital markets, require cash payments or collateral posting, and permit termination of certain contracts material to the Firm.
Future events may be different than those anticipated by JPMorgan Chase’s management assumptions and estimates, which may cause unexpected losses in the future.
Pursuant to U.S. GAAP, the Firm is required to use certain estimates in preparing its financial statements, including accounting estimates to determine loan loss reserves, reserves related to future litigation, and the fair value of certain assets and liabilities, among other items. Should the Firm’s determined values for such items prove substantially inaccurate the Firm may experience unexpected losses which could be material.
Item 1B: Unresolved SEC Staff comments
None.


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Item 2: Properties
The headquarters of JPMorgan Chase is located in New York City at 270 Park Avenue, which is a 50-story bank and office building owned by JPMorgan Chase. This location contains approximately 1.3 million square feet of space. In total, JPMorgan Chase owns or leases approximately 12.3 million square feet of commercial office space and retail space in New York City.
JPMorgan Chase and its subsidiaries also own or lease significant administrative and operational facilities in Chicago, Illinois (5.1 million square feet), Houston and Dallas, Texas (6.8 million square feet), Columbus, Ohio (2.9 million square feet), Newark and Wilmington, Delaware (2.2 million square feet), Phoenix, Arizona (1.4 million square feet), Tampa, Florida (1.0 million square feet), Jersey City, New Jersey (1.2 million square feet), and Indianapolis, Indiana (900 thousand square feet).
Outside the United States, JPMorgan Chase owns or leases facilities in the United Kingdom (2.7 million square feet) and in other countries (2.6 million square feet).
In addition, JPMorgan Chase and its subsidiaries occupy offices and other administrative and operational facilities throughout the world under various types of ownership and leasehold agreements, including 2,641 retail branches in the United States. The properties occupied by JPMorgan Chase are used across all of the Firm’s business segments and for corporate purposes.
JPMorgan Chase continues to evaluate its current and projected space requirements. There is no assurance that the Firm will be able to dispose of its excess premises or that it will not incur charges in connection with such dispositions. Such disposition costs may be material to the Firm’s results of operations in a given period. For a discussion of occupancy expense, see the Consolidated results of operations discussion on pages 29–30.
Item 3: Legal proceedings
Enron litigation. JPMorgan Chase and certain of its officers and directors are involved in a number of lawsuits arising out of its banking relationships with Enron Corp. and its subsidiaries (“Enron”). Several actions and other proceedings, against the Firm, have been resolved, including adversary proceedings brought by Enron’s bankruptcy estate. In addition, as previously reported, the Firm has reached an agreement to settle the lead class action litigation brought on behalf of the purchasers of Enron securities, captioned Newby v. Enron Corp., for $2.2 billion (pretax). The settlement is subject to approval by the United States District Court for the Southern District of Texas. The Newby settlement does not resolve Enron-related actions filed separately by plaintiffs who opt out of the class action, or by certain plaintiffs who are asserting claims not covered by that action.
The remaining Enron-related actions include individual actions against the Firm by plaintiffs who were lenders or claim to be successors-in-interest to lenders who participated in Enron credit facilities syndicated by the Firm; individual and putative class actions by Enron investors, creditors and counterparties; and third-party actions brought by defendants in Enron-related cases, alleging federal and state law claims against JPMorgan Chase and many other defendants. Fact discovery in these actions is mostly complete. Plaintiffs in two of the bank lender cases have moved for partial summary judgment, which the Firm will oppose.
In a purported, consolidated class action lawsuit by JPMorgan Chase stockholders alleging that the Firm issued false and misleading press releases and other public documents relating to Enron in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the United States District Court for the Southern District of New York dismissed the lawsuit in its entirety without prejudice in March 2005. Plaintiffs filed an amended complaint in May 2005. The Firm has moved to dismiss the amended complaint, and the motion has been submitted to the court for decision.
In a putative class action on behalf of JPMorgan Chase employees who participated in the Firm’s 401(k) plan are alleging claims under the Employee Retirement Income Security Act (“ERISA”) for alleged breaches of fiduciary duties and negligence by JPMorgan Chase, its directors and named officers. In August 2005, the United States District Court for the Southern District of New York denied plaintiffs’ motion for class certification and ordered some of plaintiffs’ claims dismissed. A petition has been filed by the plaintiffs seeking review of the denial of class certification in the United States Court of Appeals for the Second Circuit, which petition remains pending. The Firm has also moved for summary judgment seeking dismissal of this ERISA lawsuit in its entirety.
IPO allocation litigation. Beginning in May 2001, JPMorgan Chase and certain of its securities subsidiaries were named, along with numerous other firms in the securities industry, as defendants in a large number of putative class action lawsuits filed in the United States District Court for the Southern District of New York. These suits allege improprieties in the allocation of stock in various public offerings, including some offerings for which a JPMorgan Chase entity served as an underwriter. The suits allege violations of securities and antitrust laws arising from alleged material misstatements and omissions in registration statements and prospectuses for the initial public offerings (“IPOs”) and alleged market manipulation with respect to aftermarket transactions in the offered securities. The securities lawsuits allege, among other things, misrepresentation and market manipulation of the aftermarket trading for these offerings by tying allocations of shares in IPOs to undisclosed excessive commissions paid to JPMorgan Chase and to required aftermarket purchase transactions by customers who received allocations of shares in the respective IPOs, as well as allegations of misleading analyst reports. The antitrust lawsuits allege an illegal conspiracy to require customers, in exchange for IPO allocations, to pay undisclosed and excessive commissions and to make aftermarket purchases of the IPO securities at a price higher than the offering price as a precondition to receiving allocations. The securities cases were all assigned to one judge for coordinated pre-trial proceedings, and the antitrust cases were all assigned to another judge. On February 13, 2003, the Court denied the motions of JPMorgan Chase and others to dismiss the securities complaints. On October 13, 2004, the Court granted in part plaintiffs’ motion to certify classes in six “focus” cases in the securities litigation. On June 30, 2005, the United States Court of Appeals for the Second Circuit granted the underwriter defendants’ petition for permission to appeal the district court’s class certification decision, and the appeal currently is being briefed. The Second Circuit likely will hear oral argument sometime during the first half of 2006.
In addition, on February 15, 2005, the Court in the securities cases preliminarily approved a proposed settlement of plaintiffs’ claims against 298 of the issuer defendants in these cases and a fairness hearing on the proposed settlement is now scheduled for April 24, 2006. Pursuant to the proposed issuer settlement, the insurers for the settling issuer defendants, among other things, (1) agreed to guarantee that the plaintiff classes will recover at least $1 billion from the underwriter defendants in the IPO securities and antitrust


7


 

Part I

cases and to pay any shortfall, and (2) conditionally assigned to the plaintiffs any claims related to any “excess compensation” allegedly paid to the underwriters by their customers for allocations of stock in the offerings at issue in the IPO litigation. Joseph P. Lasala, the trustee designated by plaintiffs to act as assignee of such issuer excess compensation claims, filed complaints purporting to allege state law claims on behalf of certain issuers against JPMSI and other underwriters (the “LaSala Actions”), together with motions to stay proceedings in each case. To date, JPMSI is a defendant in more than half of the approximately 100 pending LaSala Actions. On August 30, 2005, the Court stayed until resolution of the proposed issuer settlement the LaSala Actions then pending against JPMSI and other underwriter defendants at that time, as well as all future-filed LaSala Actions pursuant to the parties’ stipulation that the Court’s decision would govern stay motions in all future LaSala Actions. On October 12, 2005, the Court granted the underwriter defendants’ motion to dismiss one LaSala Action, which by stipulation applied to the parallel motions to dismiss in all other pending and future-filed LaSala Actions. The Court did, however, grant Plaintiffs leave to replead and noted that the stay of the LaSala Actions remains in effect. Plaintiffs thereafter filed amended complaints in the lead and other LaSala Actions in which Plaintiffs are purportedly seeking equitable restitution on a breach of fiduciary duty claim — a claim that sought damages in the initial LaSala complaints and was dismissed on the ground that it was time-barred. On November 21, 2005, the underwriter defendants moved to dismiss the amended complaint in the lead LaSala Action and — by virtue of the stipulation of the parties — thereby moved to dismiss the amended complaints in all other pending and future-filed LaSala Actions. The motion currently is being briefed.
With respect to the IPO antitrust lawsuits, on November 3, 2003, the Court granted defendants’ motion to dismiss the claims relating to the IPO allocation practices in the IPO Allocation Antitrust Litigation. On September 28, 2005, the United States Court of Appeals for the Second Circuit reversed, vacated and remanded the district court’s November 3, 2003, dismissal decision. Defendants’ motion for rehearing en banc in the Second Circuit was denied on January 11, 2006.
A wholly separate antitrust class action lawsuit on behalf of a class of IPO issuers alleging that JPMSI and other underwriters conspired to fix their underwriting fees in IPOs is in discovery.
National Century Financial Enterprises litigation. JPMorgan Chase, JPMorgan Chase Bank, JPMorgan Partners, Beacon Group, LLC and three current or former Firm employees have been named as defendants in more than a dozen actions filed in or transferred to the United States District Court for the Southern District of Ohio (the “MDL Litigation”). In the majority of these actions, Bank One, Bank One, N.A., and Banc One Capital Markets, Inc. are also named as defendants. JPMorgan Chase Bank and Bank One, N.A. are also defendants in an action brought by The Unencumbered Assets Trust (“UAT”), a trust created for the benefit of the creditors of National Century Financial Enterprises, Inc. (“NCFE”) as a result of NCFE’s Plan of Liquidation in bankruptcy. These actions arose out of the November 2002 bankruptcy of NCFE. Prior to bankruptcy, NCFE provided financing to various healthcare providers through wholly-owned special-purpose vehicles, including NPF VI and NPF XII, which purchased discounted accounts receivable to be paid under third-party insurance programs. NPF VI and NPF XII financed the purchases of such receivables, primarily through private placements of notes (“Notes”) to institutional investors and pledged the receivables for, among other things, the repayment of the Notes. In the MDL Litigation, JPMorgan Chase Bank is sued in its role as indenture trustee for NPF VI, which issued
approximately $1 billion in Notes. Bank One, N.A. is sued in its role as indenture trustee for NPF XII, which issued approximately $2 billion in Notes. The three current or former Firm employees are sued in their roles as former members of NCFE’s board of directors (the “Defendant Employees”). JPMorgan Chase, JPMorgan Partners and Beacon Group, LLC, are claimed to be vicariously liable for the alleged actions of the Defendant Employees. Banc One Capital Markets, Inc. is sued in its role as co-manager for three note offerings made by NPF XII. Other defendants include the founders and key executives of NCFE, its auditors and outside counsel, and rating agencies and placement agents that were involved with the issuance of the Notes. Plaintiffs in these actions include institutional investors who purchased more than $2.7 billion in original face amount of asset-backed securities issued by NCFE. Plaintiffs allege that the trustees violated fiduciary and contractual duties, improperly permitted NCFE and its affiliates to violate the applicable indentures and violated securities laws by (among other things) failing to disclose the true nature of the NCFE arrangements. Plaintiffs further allege that the Defendant Employees controlled the Board and audit committees of the NCFE entities; were fully aware or negligent in not knowing of NCFE’s alleged manipulation of its books; and are liable for failing to disclose their purported knowledge of the alleged fraud to the plaintiffs. Plaintiffs also allege that Banc One Capital Markets, Inc. is liable for cooperating in the sale of securities based upon false and misleading statements. Motions to dismiss on behalf of the JPMorgan Chase entities, the Bank One entities and the Defendant Employees are currently pending. In the UAT action, JPMorgan Chase Bank and Bank One are sued in their roles as indenture trustees. Claims are asserted under the Federal Racketeer Influenced and Corrupt Organizations Act (“RICO”), the Ohio Corrupt Practices Act and various common-law claims. On March 31, 2005, motions to dismiss the UAT action were filed on behalf of JPMorgan Chase Bank. These motions are currently pending. On February 22, 2006, the JPMorgan Chase entities, the Bank One entities and the Defendant Employees reached a settlement with the holders of $1.6 billion face value of Notes (the “Arizona Noteholders”), and reached a separate agreement with the UAT. The settlements are contingent upon the entry of certain orders by the MDL court and bankruptcy courts. Assuming the contingencies are met, the Firm has agreed to pay the Arizona Noteholders the sum of $375 million for all claims and potential claims held by them and has agreed to pay the UAT the sum of $50 million for all claims or potential claims held by it.
In addition, the Securities and Exchange Commission has served subpoenas on JPMorgan Chase Bank and Bank One, N.A. (“Bank One”) and has interviewed certain current and former employees. On April 25, 2005, the staff of the Midwest Regional Office of the SEC wrote to advise Bank One that it is considering recommending that the Commission bring a civil injunctive action against Bank One and a former employee alleging violations of the securities laws in connection with Bank One’s role as indenture trustee for the NPF XII note program. On July 8, 2005, the staff of the Midwest Regional Office of the Securities and Exchange Commission wrote to advise that it is considering recommending that the Commission bring a civil injunctive action against two individuals, one present and one former employee of the Firm’s affiliates, alleging violations of certain securities laws in connection with their role as former members of NCFE’s board of directors. On July 13, 2005, the staff further advised that it is considering recommending that the Commission also bring a civil injunctive action against the Firm in connection with the alleged activities of the two individuals as alleged agents of the Firm. Lastly, the United States Department of Justice is also investigating the events surrounding the collapse of NCFE, and the Firm is cooperating with that investigation.


8


 

In addition to the various cases, proceedings and investigations discussed above, JPMorgan Chase and its subsidiaries are named as defendants in a number of other legal actions and governmental proceedings arising in connection with their businesses. Additional actions, investigations or proceedings may be brought from time to time in the future. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in early stages of discovery, the Firm cannot state with confidence what the eventual outcome of these pending matters will be, what the timing of the ultimate resolution of these matters will be or what the eventual loss, fines or penalties related to each pending matter may be. JPMorgan Chase believes, based upon its current
knowledge, after consultation with counsel and after taking into account its current litigation reserves, that the outcome of the legal actions, proceedings and investigations currently pending against it should not have a material, adverse effect on the consolidated financial condition of the Firm. However, in light of the uncertainties involved in such proceedings, actions and investigations, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by the Firm; as a result, the outcome of a particular matter may be material to JPMorgan Chase’s operating results for a particular period, depending upon, among other factors, the size of the loss or liability imposed and the level of JPMorgan Chase’s income for that period.


Item 4: Submission of matters to a vote of security holders
None.
Executive officers of the registrant
             
Name
 
  Age
(at December 31, 2005)
  Positions and offices held with JPMorgan Chase
 
 
           
William B. Harrison, Jr.
    62     Chairman of the Board since December 31, 2005, prior to which he was Chairman and Chief Executive Officer from November 2001. He was President and Chief Executive Officer from December 2000 until November 2001 and Chairman and Chief Executive Officer from January through December 2000.
 
           
James Dimon
    49     President and Chief Executive Officer since December 31, 2005, prior to which he was President and Chief Operating Officer. Prior to the Merger, he had been Chairman and Chief Executive Officer of Bank One Corporation since March 2000. Before joining Bank One Corporation, he had been a private investor from November 1998 until March 2000, prior to which he held various senior executive positions at Citigroup Inc., its subsidiary, Salomon Smith Barney, and its predecessor company, Travelers Group, Inc.
 
           
Austin A. Adams
    62     Chief Information Officer. Prior to the Merger, he had been Chief Information Officer of Bank One Corporation since March 2001. Before joining Bank One Corporation, he had been Chief Information Officer at First Union Corporation (now known as Wachovia Corp.).
 
           
Frank Bisignano
    46     Chief Administrative Officer since December 2005. Prior to joining JPMorgan Chase, he had been Chief Executive Officer of Citigroup Inc.’s Global Transaction Services from 2002 until December 2005 and Chief Administrative Officer of Citigroup Inc.’s Global Corporate and Investment Bank from 2000 until 2002.
 
           
Steven D. Black
    53     Co-Chief Executive Officer of the Investment Bank since March 2004, prior to which he had been Deputy Head of the Investment Bank since January 2001 and Head of Institutional Equities business since 2000. Prior to joining JPMorgan Chase in 2000, he had been Vice Chairman of Citigroup Inc. subsidiary, Salomon Smith Barney.
 
           
John F. Bradley
    45     Director of Human Resources since December 2005. He had been Head of Human Resources for Europe and Asia regions from April 2003 until December 2005, prior to which he was Human Resources executive for Technology and Operations since 2002 and was responsible for human resources integration efforts in 2001. He had been Co-Head of Global Human Resources at J.P. Morgan & Co. Incorporated.
 
           
Michael J. Cavanagh
    39     Chief Financial Officer since September 2004, prior to which he had been Head of Middle Market Banking. Prior to the Merger, he had been Chief Administrative Officer of Commercial Banking from February 2003, Chief Operating Officer for Middle Market Banking from August 2003, Treasurer from 2001 until 2003, and Head of Strategy and Planning from May 2000 until 2001 at Bank One Corporation.

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Part I
             
Ina R. Drew
    49     Chief Investment Officer since February 2005, prior to which she was Head of Global Treasury.
 
           
Joan Guggenheimer
    53     Co-General Counsel since July 2004. Prior to the Merger, she had been Chief Legal Officer and Corporate Secretary at Bank One Corporation since May 2003. She had served in various positions with Citigroup Inc. and its predecessor entities from 1985 until 2003, and immediately prior to joining Bank One Corporation was General Counsel of the Global Corporate and Investment Bank and also served as Co-General Counsel of Citigroup Inc.
 
           
Samuel Todd Maclin
    49     Head of Commercial Banking since July 2004, prior to which he had been Chairman and CEO of the Texas Region and Head of Middle Market Banking.
 
           
Jay Mandelbaum
    43     Head of Strategy and Business Development. Prior to the Merger, he had been Head of Strategy and Business Development since September 2002 at Bank One Corporation. Prior to joining Bank One Corporation, he had been Vice Chairman and Chief Executive Officer of the Private Client Group of Citigroup Inc. subsidiary Salomon Smith Barney from September 2000 until August 2002, prior to which he had been Senior Executive Vice President of Private Client Sales and Marketing at Salomon Smith Barney.
 
           
William H. McDavid
    59     Co-General Counsel since July 2004. Prior to the Merger, he had been General Counsel.
 
           
Heidi Miller
    52     Chief Executive Officer of Treasury & Securities Services. Prior to the Merger, she had been Chief Financial Officer at Bank One Corporation since March 2002. Prior to joining Bank One Corporation, she had been Vice Chairman of Marsh, Inc. from January 2001 until March 2002, prior to which she had held several executive positions at Priceline.com and at Citigroup Inc., including Chief Financial Officer.
 
           
Charles W. Scharf
    40     Head of Retail Financial Services. Prior to the Merger, he had been Head of Retail Banking from May 2002, prior to which he was Chief Financial Officer from June 2000 at Bank One Corporation. Prior to joining Bank One Corporation, he had been Chief Financial Officer at Citigroup Global Corporate and Investment Bank.
 
           
Richard J. Srednicki
    58     Chief Executive Officer of Card Services from July 2004, prior to which he was Executive Vice President of Chase Cardmember Services.
 
           
James E. Staley
    49     Global Head of Asset & Wealth Management since 2001, prior to which he had been Head of the Private Bank at J.P. Morgan & Co. Incorporated.
 
           
Don M. Wilson III
    57     Chief Risk Officer. He had been Co-Head of Credit & Rate Markets from 2001 until July 2003, prior to which he headed the Global Trading Division.
 
           
William T. Winters
    44     Co-Chief Executive Officer of the Investment Bank since March 2004, prior to which he had been Deputy Head of the Investment Bank and Head of Credit & Rate Markets. He had been Head of Global Markets at J.P. Morgan & Co. Incorporated.
Unless otherwise noted, during the five fiscal years ended December 31, 2005, all of JPMorgan Chase’s above-named executive officers have continuously held senior-level positions with JPMorgan Chase or its predecessor institution, Bank One Corporation. There are no family relationships among the foregoing executive officers.

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Part II

Item 5: Market for registrant’s common equity, related stockholder matters and issuer purchases of equity securities
The outstanding shares of JPMorgan Chase’s common stock are listed and traded on the New York Stock Exchange, the London Stock Exchange Limited and the Tokyo Stock Exchange. For the quarterly high and low prices of JPMorgan Chase’s common stock on the New York Stock Exchange for the last two years, see the section entitled “Supplementary information — selected quarterly financial data (unaudited)” on page 133. JPMorgan Chase declared quarterly cash dividends on its common stock in the amount of $0.34 per share for each quarter of 2005, 2004 and 2003. The common dividend payout ratio, based upon reported net income, was: 57% for 2005; 88% for 2004; and 43% for 2003. At January 31, 2006, there were 225,105 holders of record of JPMorgan Chase’s common stock. For information regarding securities authorized for issuance under the Firm’s employee stock-based compensation plans, see Item 12 on page 12.
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 is 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. The stock repurchase program has no set expiration date.
The Firm’s repurchases of equity securities during 2005 were as follows:
                         
    Total open   Average   Dollar value of
For the year ended   market shares   price paid   remaining authorized
December 31, 2005   repurchased   per share(a)   repurchase program
 
First quarter
    35,972,000       $ 36.57       $ 3,946  
Second quarter
    16,807,465       35.32       3,352  
Third quarter
    14,445,300       34.61       2,853  
 
October
    5,964,000       35.77       2,640  
November
    8,428,600       37.90       2,321  
December
    11,913,900       39.29       1,853  
 
Fourth quarter
    26,306,500       38.05       1,853  
 
Total for 2005
    93,531,265       $ 36.46       $ 1,853  
 
(a)   Excludes commission costs.
In addition to the repurchases disclosed above, participants in the Firm’s stock-based incentive plans may have shares withheld to cover income taxes. Shares withheld to pay income taxes are repurchased pursuant to the terms of the applicable Plan and not under the Firm’s share repurchase program. Shares repurchased pursuant to these plans were as follows for 2005:
                    
For the year ended   Total shares     Average price  
December 31, 2005   repurchased     paid per share  
 
First quarter
    6,993,164       $ 37.22  
Second quarter
    680,851       35.10  
Third quarter
    386,526       34.90  
 
October
    67,885       33.99  
November
    31,110       37.77  
December
    19,362       39.09  
 
Fourth quarter
    118,357       35.82  
 
Total for 2005
    8,178,898       $ 36.91  
 
Item 6: Selected financial data
For five-year selected financial data, see “Five-year summary of consolidated financial highlights (unaudited)” on page 22.
Item 7: Management’s discussion and analysis of financial condition and results of operations
Management’s discussion and analysis of the financial condition and results of operations, entitled “Management’s discussion and analysis,” appears on pages 23 through 84. Such information should be read in conjunction with the Consolidated financial statements and Notes thereto, which appear on pages 87 through 132.
Item 7A: Quantitative and qualitative disclosures about market risk
For information related to market risk, see the “Market risk management” section on pages 75 through 78 and Note 26 on page 123.
Item 8: Financial statements and supplementary data
The Consolidated financial statements, together with the Notes thereto and the report of PricewaterhouseCoopers LLP dated February 24, 2006 thereon, appear on pages 86 through 132.
Supplementary financial data for each full quarter within the two years ended December 31, 2005, are included on page 133 in the table entitled “Supplementary information – selected quarterly financial data (unaudited).” Also included is a “Glossary of terms’’ on page 134.
Item 9: Changes in and disagreements with accountants on accounting and financial disclosure
None.


11


 

Parts II, III & IV

Item 9A: Controls and procedures
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Firm’s management, including its Chairman, Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chairman, Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective. See Exhibits 31.1, 31.2 and 31.3 for the Certification statements issued by the Chairman, Chief Executive Officer and Chief Financial Officer.
The Firm is committed to maintaining high standards of internal control over financial reporting. Nevertheless, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, in a firm as large and complex as JPMorgan Chase, lapses or deficiencies in internal controls are likely to occur from time to time, and there can be no assurance that any such deficiencies will not result in significant deficiencies – or even material weaknesses – in internal controls in the future. See page 85 for Management’s report on internal control over financial reporting, and page 86 for the Report of independent registered public accounting firm with respect to management’s assessment of internal control. There was no change in the Firm’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fourth quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the Firm’s internal control over financial reporting.
Item 9B: Other information
None.

Part III
Item 10: Directors and
executive officers of the Registrant
See Item 13 below.
Item 11: Executive compensation
See Item 13 below.
Item 12: Security ownership of certain beneficial owners and management and related stockholder matters
For security ownership of certain beneficial owners and management, see Item 13 below.


The following table details the total number of shares available for issuance under JPMorgan Chase’s employee stock-based incentive plans (including shares available for issuance to nonemployee directors). The Firm is not authorized to grant stock-based incentive awards to nonemployees other than to nonemployee directors.
                         
    Number of shares to be     Weighted-average     Number of shares remaining  
December 31, 2005   issued upon exercise of     exercise price of     available for future issuance under  
(Shares in thousands)   outstanding options/SARs     outstanding options/SARs     stock compensation plans  
 
Employee stock-based incentive plans approved by shareholders
    292,248       36.64       260,367  
Employee stock-based incentive plans not approved by shareholders
    150,452       42.37        
 
Total
    442,700       38.59       260,367 (a)
 
(a)   Future shares will be issued out of the shareholder-approved 2005 Long-Term Incentive Plan (“2005 Plan”). The 2005 Plan replaces three existing stock compensation plans – the 1996 Long-Term Incentive Plan, as amended, and two nonshareholder approved plans – all of which expired in May 2005.

Item 13: Certain relationships and
related transactions
Information related to JPMorgan Chase’s Executive Officers is included on pages 9–10. Pursuant to Instruction G(3) to Form 10-K, the remainder of the information to be provided in Items 10, 11, 12, 13 and 14 of Form 10-K (other than information pursuant to Rule 402 (i), (k) and (l) of Regulation S-K) is incorporated by reference to JPMorgan Chase’s definitive proxy statement for the 2006 annual meeting of stockholders, which proxy statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days of the close of JPMorgan Chase’s 2005 fiscal year.
Item 14: Principal accounting fees and services
See Item 13 above.
Part IV
Item 15: Exhibits, financial statement schedules
    Exhibits, financial statement schedules
 
1.   Financial statements
 
    The Consolidated financial statements, the Notes thereto and the report thereon listed in Item 8 are set forth commencing on page 87.
 
2.   Financial statement schedules
 
    Financial statement schedules are omitted since the required information is either not applicable, not deemed material, or is shown in the respective Consolidated financial statements or in the Notes thereto.


12


 

Part IV

     
3.
  Exhibits
 
   
3.1
  Restated Certificate of Incorporation of JPMorgan Chase & Co. (incorporated by reference to Exhibit 3.1 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
3.2
  By-laws of JPMorgan Chase & Co., effective December 31, 2005.
 
   
4.1
  Deposit Agreement, dated as of February 8, 1996, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Morgan Guaranty Trust Company of New York (succeeded through merger by JPMorgan Chase Bank), as Depository (incorporated by reference to Exhibit 4.7 to the Registration Statement on Form 8A (File No. 1-5805) of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) filed December 20, 2000).
 
   
4.2
  Indenture, dated as of December 1, 1989, between Chemical Banking Corporation (now known as JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association) (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.3(a)
  Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992, between Chemical Banking Corporation (now known as JPMorgan Chase & Co.) and Morgan Guaranty Trust Company of New York (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.3(b)
  Second Supplemental Indenture, dated as of October 8, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992.
 
   
4.3(c)
  Third Supplemental Indenture, dated as of December 29, 2000, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992.
 
   
4.4(a)
  Amended and Restated Indenture, dated as of September 1, 1993, between The Chase Manhattan Corporation (succeeded through merger by JPMorgan Chase & Co.) and Chemical Bank (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.4(b)
  First Supplemental Indenture, dated as of March 29, 1996, among Chemical Banking Corporation (now known as JPMorgan Chase & Co.), The Chase Manhattan Corporation, (succeeded through merger by JPMorgan Chase & Co.), Chemical Bank, as Resigning Trustee, and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Successor Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
4.4(c)
  Second Supplemental Indenture, dated as of October 8, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
4.4(d)
  Third Supplemental Indenture, dated as of December 29, 2000, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
     
4.5(a)
  Indenture, dated as of August 15, 1982, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Manufacturers Hanover Trust Company (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.5(b)
  First Supplemental Indenture, dated as of May 5, 1986, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Manufacturers Hanover Trust Company (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(c)
  Second Supplemental Indenture, dated as of February 27, 1996, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(d)
  Third Supplemental Indenture, dated as of January 30, 1997, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(e)
  Fourth Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.6(a)
  Indenture, dated as of March 1, 1993, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Citibank, N.A. (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.6(b)
  First Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of March 1, 1993.
 
   
4.7
  Indenture, dated as of May 25, 2001, between J.P. Morgan Chase & Co. and Bankers Trust Company (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4(a)(1) to the amended Registration Statement on Form S-3 (File No. 333-52826) of J.P. Morgan Chase & Co. filed June 13, 2001).
 
   
4.8(a)
  Junior Subordinated Indenture, dated as of December 1, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.8(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.8(b)
  Guarantee Agreement, dated as of January 24, 1997, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.8(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.8(c)
  Amended and Restated Trust Agreement, dated as of January 24, 1997, among The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.), The Bank of New York, as Property Trustee, The Bank of New York (Delaware), as Delaware Trustee, and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.8(c) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).


13


 

Part IV

     
4.9(a)
  Indenture, dated as of March 3, 1997, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.9(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.9(b)
  First Supplemental Indenture, dated as of October 2, 1998, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by Deutsche Bank Trust Company Americas), as Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.9(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.9(c)
  Form of Second Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and Deutsche Bank Trust Company Americas, as Successor Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.22 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
4.10(a)
  Indenture, dated as of March 3, 1997, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank Trust National Association), as Trustee (incorporated by reference to Exhibit 4.10(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.10(b)
  First Supplemental Indenture, dated as of October 2, 1998, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.10(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.10(c)
  Second Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and U.S. Bank Trust National Association, as Successor Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.25 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
4.11(a)
  Form of Indenture, dated as of July 1, 1995, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and Citibank N.A, as Trustee (incorporated by reference to Exhibit 4.11(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.11(b)
  Form of Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.) and Citibank N.A., as Trustee, to the Indenture, dated as of July 1, 1995 (incorporated by reference to Exhibit 4.31 to the amended Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed July 1, 2004).
     
4.12(a)
  Form of Indenture, dated as of December 1, 1995, between First Chicago NBC Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association) (succeeded by U.S. Bank Trust National Association), as Trustee (incorporated by reference to Exhibit 4.12(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.12(b)
  Form of Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and U.S. Bank Trust National Association, as Successor Trustee, to the Indenture, dated as of December 1, 1995 (incorporated by reference to Exhibit 4.29 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
10.1
  Deferred Compensation Plan for Non-Employee Directors of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Chase Manhattan Bank (now known as JPMorgan Chase Bank, N.A.), as amended and restated effective December, 1996 (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.2
  Post-Retirement Compensation Plan for Non-Employee Directors of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.), as amended and restated effective May 21, 1996 (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.3
  Deferred Compensation Program of JPMorgan Chase & Co. and Participating Companies, effective as of January 1, 1996 (incorporated by reference to Exhibit 10.3 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.4
  2005 Deferred Compensation Program of JPMorgan Chase & Co., effective December 31, 2005.
 
   
10.5
  JPMorgan Chase & Co. 2005 Long-Term Incentive Plan (incorporated by reference to Appendix C of Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805) filed April 4, 2005).
 
   
10.6
  The Chase Manhattan Corporation 1996 Long-Term Incentive Plan.
 
   
10.7
  Key Executive Performance Plan of JPMorgan Chase & Co., as restated as of January 1, 2005.
 
   
10.8
  Excess Retirement Plan of The Chase Manhattan Bank and Participating Companies, restated effective January 1, 2005.
 
   
10.9
  1984 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.11 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.10
  1992 J.P. Morgan & Co. Incorporated and Affiliated Companies Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.10 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.11
  1995 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.12 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).


14


 

     
10.12
  1998 J.P. Morgan & Co. Incorporated and Affiliated Companies Performance Plan (incorporated by reference to Exhibit 10.13 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.13
  Executive Retirement Plan of The Chase Manhattan Corporation and Certain Subsidiaries.
 
   
10.14
  Benefit Equalization Plan of The Chase Manhattan Corporation and Certain Subsidiaries.
 
   
10.15
  Summary of Terms of JPMorgan Chase & Co. Severance Policy.
 
   
10.16
  Employment Agreement between J.P. Morgan Chase & Co. and James Dimon dated January 14, 2004 (incorporated by reference to Exhibit 10.1 of the Registration Statement on Form S-4 of J.P. Morgan Chase & Co. (File No. 333-112967) filed February 20, 2004).
 
   
10.17
  Summary of Terms of Pension of William B. Harrison, Jr. (incorporated by reference to Form 8-K Item 1.01 of JPMorgan Chase & Co. filed February 28, 2005 (File No. 1-5805)).
 
   
10.18
  Bank One Corporation Director Stock Plan, as amended (incorporated by reference to Exhibit 10(B) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.19
  Summary of Bank One Corporation Director Deferred Compensation Plan.
 
   
10.20
  Bank One Corporation Stock Performance Plan (incorporated by reference to Exhibit 10(A) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2002).
 
   
10.21
  Bank One Corporation Deferred Compensation Plan.
 
   
10.22
  Bank One Corporation Supplemental Savings and Investment Plan, as amended (incorporated by reference to Exhibit 10(E) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.23
  Bank One Corporation Supplemental Personal Pension Account Plan, as amended (incorporated by reference to Exhibit 10(F) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.24
  Bank One Corporation Key Executive Change of Control Plan, as amended (incorporated by reference to Exhibit 10(G) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.25
  Bank One Corporation Planning Group Annual Incentive Plan, as amended (incorporated by reference to Exhibit 10(H) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.26
  Bank One Corporation Investment Option Plan.
 
   
10.27
  First Chicago Corporation Stock Incentive Plan (incorporated by reference to Exhibit 10.28 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.28
  NBD Bancorp, Inc. Performance Incentive Plan, as amended (incorporated by reference to Exhibit 10.29 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
     
10.29
  Bank One Corporation Revised and Restated 1989 Stock Incentive Plan (incorporated by reference to Exhibit 10.30 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.30
  Bank One Corporation Revised and Restated 1995 Stock Incentive Plan (incorporated by reference to Exhibit 10.31 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.31
  Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 2005 stock appreciation rights.
 
   
10.32
  JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 2005 restricted stock units (incorporated by reference to Exhibit 10.1 to Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 11, 2005).
 
   
10.33
  Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of October 2005 stock appreciation rights.
 
   
10.34
  Amendment and Restatement of Letter Agreement between JPMorgan Chase & Co. and Charles W. Scharf, dated December 29, 2005.
 
   
12.1
  Computation of ratio of earnings to fixed charges.
 
   
12.2
  Computation of ratio of earnings to fixed charges and preferred stock dividend requirements.
 
   
21.1
  List of Subsidiaries of JPMorgan Chase & Co.
 
   
22.1
  Annual Report on Form 11-K of the JPMorgan Chase 401(k) Savings Plan (to be filed by amendment pursuant to Rule 15d-21 under the Securities Exchange Act of 1934).
 
   
23.1
  Consent of independent registered public accounting firm.
 
   
31.1
  Certification.
 
   
31.2
  Certification.
 
   
31.3
  Certification.
 
   
32
  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
JPMorgan Chase hereby agrees to furnish to the Securities and Exchange Commission, upon request, copies of instruments defining the rights of holders for the outstanding nonregistered long-term debt of JPMorgan Chase and its subsidiaries and certain other long-term debt issued by predecessor institutions of JPMorgan Chase and assumed by virtue of the mergers with those respective institutions. These instruments have not been filed as exhibits hereto by reason that the total amount of each issue of such securities does not exceed 10% of the total assets of JPMorgan Chase and its subsidiaries on a consolidated basis. In addition, JPMorgan Chase hereby agrees to file with the Securities and Exchange Commission, upon request, the Junior Subordinated Indentures, the Guarantees and the Amended and Restated Trust Agreements for each Delaware business trust subsidiary that has issued Capital Securities, the guarantees for which have been assumed by JPMorgan Chase & Co. by virtue of the mergers of the respective predecessor institutions that originally issued such securities. The provisions of such agreements differ from the documents constituting Exhibits 4.8(a), (b) and (c) to this report only with respect to the pricing terms of each series of capital securities; these pricing terms are disclosed in Note 17 on page 117.


15


 

 
 
 
 
 
Pages 16-20 not used
 
 
 
 
 

16


 

Table of contents

Financial:
22   Five-year summary of consolidated financial highlights
Management’s discussion and analysis:
23   Introduction
 
25   Executive overview
 
27   Consolidated results of operations
 
31   Explanation and reconciliation of the Firm’s
use of non-GAAP financial measures
 
34   Business segment results
 
55   Balance sheet analysis
 
56   Capital management
 
58   Off-balance sheet arrangements and
contractual cash obligations
 
60   Risk management
 
61   Liquidity risk management
 
63   Credit risk management
 
75   Market risk management
 
79   Operational risk management
 
80   Reputation and fiduciary risk management
 
80   Private equity risk management
 
81   Critical accounting estimates used by the Firm
 
83   Accounting and reporting developments
 
84   Nonexchange-traded commodity derivative contracts at fair value
Audited financial statements:
85   Management’s report on internal control
over financial reporting
 
86   Report of independent registered public accounting firm
 
87   Consolidated financial statements
 
91   Notes to consolidated financial statements
Supplementary information:
133   Selected quarterly financial data
 
134   Glossary of terms
 
135   Forward-looking statements


Merger with Bank One Corporation
Effective July 1, 2004, Bank One Corporation (“Bank One”) merged with and into JPMorgan Chase & Co. (the “Merger”). As a result of the Merger, each outstanding share of common stock of Bank One was converted in a stock-for-stock exchange into 1.32 shares of common stock of JPMorgan Chase & Co. (“JPMorgan Chase”). The Merger was accounted for using the purchase method of accounting. Accordingly, the Firm’s results of operations for 2004 include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results only and 2003 results of operations reflect the results of heritage JPMorgan Chase only. For additional information regarding the Merger, see Note 2 on page 92 of this Annual Report.
     
JPMorgan Chase & Co. / 2005 Annual Report   21

 


 

Five-year summary of consolidated financial highlights
JPMorgan Chase & Co.
                                         
(unaudited)                      
(in millions, except per share, headcount and ratio data)
 
                  Heritage JPMorgan Chase only  
As of or for the year ended December 31,   2005     2004 (e)   2003     2002     2001  
 
Selected income statement data
                                       
Noninterest revenue
  $ 34,702     $ 26,336     $ 20,419     $ 17,436     $ 17,943  
Net interest income
    19,831       16,761       12,965       12,178       11,401  
 
Total net revenue
    54,533       43,097       33,384       29,614       29,344  
Provision for credit losses
    3,483       2,544       1,540       4,331       3,182  
Noninterest expense before Merger costs and Litigation reserve charge
    35,549       29,294       21,716       20,254       21,073  
Merger and restructuring costs
    722       1,365             1,210       2,523  
Litigation reserve charge
    2,564       3,700       100       1,300        
 
Total noninterest expense
    38,835       34,359       21,816       22,764       23,596  
 
Income before income tax expense and effect of accounting change
    12,215       6,194       10,028       2,519       2,566  
Income tax expense
    3,732       1,728       3,309       856       847  
 
Income before effect of accounting change
    8,483       4,466       6,719       1,663       1,719  
Cumulative effect of change in accounting principle (net of tax)
                            (25 )
 
Net income
  $ 8,483     $ 4,466     $ 6,719     $ 1,663     $ 1,694  
 
Per common share
                                       
Net income per share: Basic
  $ 2.43     $ 1.59     $ 3.32     $ 0.81     $ 0.83 (f)
Diluted
    2.38       1.55       3.24       0.80       0.80 (f)
Cash dividends declared per share
    1.36       1.36       1.36       1.36       1.36  
Book value per share
    30.71       29.61       22.10       20.66       20.32  
 
                                       
Common shares outstanding
                                       
Average: Basic
    3,492       2,780       2,009       1,984       1,972  
Diluted
    3,557       2,851       2,055       2,009       2,024  
Common shares at period-end
    3,487       3,556       2,043       1,999       1,973  
 
                                       
Selected ratios
                                       
Return on common equity (“ROE”)
    8 %     6 %     16 %     4 %     4 %
Return on assets (“ROA”)(a)
    0.72       0.46       0.87       0.23       0.23  
Tier 1 capital ratio
    8.5       8.7       8.5       8.2       8.3  
Total capital ratio
    12.0       12.2       11.8       12.0       11.9  
Tier 1 leverage ratio
    6.3       6.2       5.6       5.1       5.2  
Selected balance sheet data (period-end)
                                       
Total assets
  $ 1,198,942     $ 1,157,248     $ 770,912     $ 758,800     $ 693,575  
Securities
    47,600       94,512       60,244       84,463       59,760  
Loans
    419,148       402,114       214,766       216,364       217,444  
Deposits
    554,991       521,456       326,492       304,753       293,650  
Long-term debt
    108,357       95,422       48,014       39,751       39,183  
Common stockholders’ equity
    107,072       105,314       45,145       41,297       40,090  
Total stockholders’ equity
    107,211       105,653       46,154       42,306       41,099  
 
                                       
Credit quality metrics
                                       
Allowance for credit losses
  $ 7,490     $ 7,812     $ 4,847     $ 5,713     $ 4,806  
Nonperforming assets(b)
    2,590       3,231       3,161       4,821       4,037  
Allowance for loan losses to total loans(c)
    1.84 %     1.94 %     2.33 %     2.80 %     2.25 %
Net charge-offs
  $ 3,819     $ 3,099     $ 2,272     $ 3,676     $ 2,335  
Net charge-off rate(c)
    1.00 %     1.08 %     1.19 %     1.90 %     1.13 %
 
                                       
Headcount
    168,847       160,968       96,367       97,124       95,812 (g)
Share price (d)
                                       
High
  $ 40.56     $ 43.84     $ 38.26     $ 39.68     $ 59.19  
Low
    32.92       34.62       20.13       15.26       29.04  
Close
    39.69       39.01       36.73       24.00       36.35  
 
(a)   Represents Net income divided by Total average assets.
(b)   Excludes wholesale purchased held-for-sale (“HFS”) loans purchased as part of the Investment Bank’s proprietary activities.
(c)   Excluded from the allowance coverage ratios were end-of-period loans held-for-sale; and excluded from the net charge-off rates were average loans held-for-sale.
(d)   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.
(e)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
(f)   Basic and diluted earnings per share were each reduced by $0.01 in 2001 because of the impact of the adoption of SFAS 133 relating to the accounting for derivative instruments and hedging activities.
(g)   Represents full-time equivalent employees, as headcount data is unavailable.
     
22   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

This section of the Annual Report provides management’s discussion and analysis (“MD&A”) of the financial condition and results of operations for JPMorgan Chase. See the Glossary of terms on pages 134–135 for definitions of terms used throughout this Annual Report. The MD&A included in this Annual Report 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. These risks and uncertainties could cause JPMorgan Chase’s results to differ materially from those set forth in such forward-looking statements. Certain of such risks and uncertainties are described herein (see Forward-looking statements on page 135 of this Annual Report) and in the JPMorgan Chase Annual Report on Form 10–K (“Form 10–K”) for the year ended December 31, 2005, in Part I, Item 1A: Risk factors, to which reference is hereby made.
 


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, $107 billion in stockholders’ equity and operations worldwide. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, asset and wealth management and private equity. Under the JPMorgan, Chase and Bank One brands, the Firm serves millions of customers in the United States and many of the world’s most prominent corporate, institutional and government clients.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank”), a national banking association with branches in 17 states; and Chase Bank USA, National Association, a national bank that is the Firm’s credit card issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan Securities Inc. (“JPMSI”), the Firm’s U.S. investment banking firm.
JPMorgan Chase’s activities are organized, for management reporting purposes, into six business segments, as well as Corporate. The Firm’s wholesale businesses comprise the Investment Bank, Commercial Banking, Treasury & Securities Services, and Asset & Wealth Management. The Firm’s consumer businesses comprise 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 the Investment Bank 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 Investment Bank 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 2,641 branches and 7,312 automated teller machines (“ATMs”). Auto & Education Finance is
the largest noncaptive 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 one of the largest issuers of credit cards in the United States, with more than 110 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.
Commercial Banking
Commercial Banking (“CB”) serves more than 25,000 clients, including corporations, municipalities, financial institutions and not-for-profit entities with annual revenues generally ranging from $10 million to $2 billion. While most Middle Market clients are within the Retail Financial Services footprint, CB also covers larger corporations, as well as local governments and financial institutions on a national basis. CB is a market leader with superior client penetration across the businesses it serves. Local market presence, coupled with industry expertise and excellent client service and risk management, enable CB to offer superior financial advice. Partnership with other JPMorgan Chase businesses positions CB to deliver broad product capabilities – including lending, treasury services, investment banking, and asset and wealth management – and meet its clients’ financial 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 one of the largest cash management providers in the world and a leading global custodian. The Treasury Services (“TS”) business provides a variety of cash management products, trade finance and logistics solutions, wholesale card products, and short-term liquidity management tools. The Investor Services (“IS”) business provides custody, fund 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. TS partners with the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management businesses to serve clients firmwide. As a result, certain TS revenues are included in other segments’ results. TSS combined the management of the IS and ITS businesses under the name Worldwide Securities Services (“WSS”) to create an integrated franchise which provides custody and investor services as well as securities clearance and trust services to clients globally. Beginning January 1, 2006, TSS will report results for two divisions: TS and WSS.


     
JPMorgan Chase & Co. / 2005 Annual Report   23

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Asset & Wealth Management
Asset & Wealth Management (“AWM”) provides investment advice and management for institutions and individuals. With Assets under supervision of $1.1 trillion, AWM is one of the largest asset and wealth managers in the world. AWM serves four distinct client groups through three businesses: institutions through JPMorgan Asset Management; ultra-high-net-worth clients through the Private Bank; high-net-worth clients through Private Client Services; and retail clients through JPMorgan Asset Management. The majority of AWM’s client assets are in actively managed portfolios. AWM has global investment expertise in equities, fixed income, real estate, hedge funds, private equity and liquidity, including both money market instruments and bank deposits. AWM also provides trust and estate services to ultra-high-net-worth and high-net-worth clients, and retirement services for corporations and individuals.
2005 Business events
Collegiate Funding Services
On March 1, 2006, JPMorgan Chase acquired, for approximately $663 million, Collegiate Funding Services, a leader in student loan servicing and consolidation. This acquisition will enable the Firm to create a comprehensive education finance business.
BrownCo
On November 30, 2005, JPMorgan Chase sold BrownCo, an on-line deep-discount brokerage business, to E*TRADE Financial for a cash purchase price of $1.6 billion. JPMorgan Chase recognized an after-tax gain of $752 million.
Sears Canada credit card business
On November 15, 2005, JPMorgan Chase purchased Sears Canada Inc.’s credit card operation, including both the private-label card accounts and the co-branded Sears MasterCard® accounts. The credit card operation includes approximately 10 million accounts with $2.2 billion (CAD$2.5 billion) in managed loans. Sears Canada and JPMorgan Chase entered into an ongoing arrangement under which JPMorgan Chase will offer private-label and co-branded credit cards to both new and existing customers of Sears Canada.
Chase Merchant Services, Paymentech integration
On October 5, 2005, JPMorgan Chase and First Data Corp. completed the integration of the companies’ jointly owned Chase Merchant Services and Paymentech merchant businesses, to be operated under the name of Chase Paymentech Solutions, LLC. The joint venture is the largest financial transaction processor in the U.S. for businesses accepting credit card payments via traditional point of sale, Internet, catalog and recurring billing. As a result of the integration into a joint venture, Paymentech has been deconsolidated and JPMorgan Chase’s ownership interest in this joint venture is accounted for in accordance with the equity method of accounting.
Neovest Holdings, Inc.
On September 1, 2005, JPMorgan Chase completed its acquisition of Neovest Holdings, Inc., a provider of high-performance trading technology and direct market access. This transaction will enable the Investment Bank to offer a leading, broker-neutral trading platform across asset classes to institutional investors, asset managers and hedge funds.
Enron litigation settlement
On June 14, 2005, JPMorgan Chase announced that it had reached an agreement in principle to settle, for $2.2 billion, the Enron class action litigation captioned Newby v. Enron Corp. The Firm also recorded a nonoperating charge of $1.9 billion (pre-tax) to cover the settlement and to increase its reserves for certain other remaining material legal matters.
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’ Treasury Services unit. Vastera automates trade management processes associated with the physical movement of goods internationally; the acquisition enables TS to offer management of information and processes in support of physical goods movement, together with financial settlement.
WorldCom litigation settlement
On March 17, 2005, JPMorgan Chase settled, for $2.0 billion, the WorldCom, Inc. class action litigation. In connection with the settlement, JPMorgan Chase increased the Firm’s Litigation reserve by $900 million.
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 buyout and growth equity professionals of JPMorgan Partners will form a new independent firm, CCMP Capital, LLC, and the venture professionals will separately form a new independent firm, Panorama Capital, LLC. JPMorgan Chase has committed to invest the lesser of $875 million or 24.9% of the limited partnership interests in the fund to be raised by CCMP Capital, and has committed to invest the lesser of $50 million or 24.9% of the limited partnership interests in the fund to be raised by Panorama Capital. The investment professionals of CCMP and Panorama will continue to manage the JPMP investments pursuant to a management agreement with the Firm.
Cazenove
On February 28, 2005, JPMorgan Chase and Cazenove Group plc (“Cazenove”) formed a business partnership which combined Cazenove’s investment banking business and JPMorgan Chase’s U.K.-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.
Subsequent events
Sale of insurance underwriting business
On February 7, 2006, JPMorgan Chase announced that the Firm has agreed to sell its life insurance and annuity underwriting businesses to Protective Life Corporation for a cash purchase price of approximately $1.2 billion. The sale, which includes both the heritage Chase insurance business and the life business that Bank One had bought from Zurich Insurance in 2003, is subject to normal regulatory approvals and is expected to close in the third quarter of 2006. JPMorgan Chase anticipates the transaction will have no material impact on earnings.


     
24   JPMorgan Chase & Co. / 2005 Annual Report

 


 

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 Annual Report. For a more complete understanding of events, trends and uncertainties, as well as the liquidity, capital, credit and market risks, and the critical accounting estimates, affecting the Firm and the lines of business, this Annual Report should be read in its entirety.
Financial performance of JPMorgan Chase
                         
As of or for the year ended December 31,                  
(in millions, except per share and ratio data)   2005     2004 (a)   Change  
 
Total net revenue
  $ 54,533     $ 43,097       27 %
Provision for credit losses
    3,483       2,544       37  
Total noninterest expense
    38,835       34,359       13  
Net income
    8,483       4,466       90  
Net income per share – diluted
    2.38       1.55       54  
Average common equity
    105,507       75,641       39  
Return on common equity (“ROE”)
    8 %     6 %        
 
Loans
  $ 419,148     $ 402,114       4 %
Total assets
    1,198,942       1,157,248       4  
Deposits
    554,991       521,456       6  
 
Tier 1 capital ratio
    8.5 %     8.7 %        
Total capital ratio
    12.0       12.2          
 
(a)   Includes six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
Business overview
2005 represented the Firm’s first full year as a merged company; 2004 included six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. Therefore, comparisons between the two years are significantly affected by the Merger. In addition, other key factors affecting 2005 results included litigation charges to settle the Enron and Worldcom class actions, a special provision for credit losses related to Hurricane Katrina, the impact of the new bankruptcy legislation on credit card charge-offs and the sale of BrownCo, as well as the global economic and market environments.
In 2005, the Firm successfully completed a number of milestones in the execution of its Merger integration plan. Key accomplishments included: launching a national advertising campaign that introduced a modernized Chase brand; the conversion of 1,400 Bank One branches, 3,400 ATMs and millions of Bank One credit cards to the Chase brand; completing the operating platform conversion in Card Services; and executing a major systems conversion in Texas that united 400 Chase and Bank One branches and over 800 ATMs under common systems and branding. These accomplishments resulted in continued efficiencies from the Merger, and the Firm made significant progress toward reaching the merger-related savings target of approximately $3.0 billion by the end of 2007. The Firm realized approximately $1.5 billion of merger savings in 2005, bringing estimated cumulative savings to $1.9 billion, and the annualized run-rate of savings entering 2006 is approximately $2.2 billion. In order to achieve these savings, the Firm expensed merger-related costs of $722 million during the year, bringing the total cumulative amount expensed since the Merger announcement to $2.1 billion. Management continues to estimate remaining Merger costs of approximately $0.9 billion to $1.4 billion, which are expected to be expensed over the next two years.
The Board of Directors announced in the fourth quarter that James Dimon, President and Chief Operating Officer, would succeed Chairman and Chief Executive Officer William B. Harrison, Jr. as Chief Executive Officer on December 31, 2005. Mr. Harrison remains Chairman of the Board.
The Firm reported 2005 net income of $8.5 billion, or $2.38 per share, compared with net income of $4.5 billion, or $1.55 per share, for 2004. The return on common equity was 8% compared with 6% in 2004.
Results included $2.0 billion in after-tax charges, or $0.57 per share, which included nonoperating litigation charges of $1.6 billion and Merger costs of $448 million. Excluding these charges, operating earnings were $10.5 billion, or $2.95 per share, and return on common equity was 10%. Operating earnings represent business results without merger-related costs, nonoperating litigation-related charges and recoveries, and costs related to conformance of accounting policies.
In 2005, both the U.S. and global economies continued to expand. Gross domestic product increased by an estimated 3.0% globally with the U.S. economy growing at a slightly faster pace. The U.S. economy experienced continued rising short-term interest rates, which were driven by Federal Reserve Board actions during the course of the year. The federal funds rate increased from 2.25% to 4.25% during the year, and the yield curve flattened as long term interest rates remained broadly steady. Equity markets, both domestic and international, reflected positive performance, with the S&P 500 up 3% and international indices increasing over 20%. Capital markets activity was very strong during 2005, with debt and equity underwriting and merger and acquisition activity surpassing 2004 levels. The U.S. consumer sector showed continued strength buoyed by overall economic strength, which benefited from good levels of employment and retail sales that increased versus the prior year. This strength came despite slowing mortgage origination and refinance activity as well as significantly higher bankruptcy filings due to the new bankruptcy legislation which became effective in October 2005.
The 2005 economic environment was a contributing factor to the performance of the Firm and each of its businesses. The overall economic expansion and strong level of capital markets activity helped to drive new business volume and sales growth within each business. The interest rate environment negatively affected both wholesale and consumer loan spreads, though wholesale liability spreads widened over the course of the year, benefiting Treasury & Securities Services and Commercial Banking. Additionally, the credit quality of the loan portfolio continued to remain strong, reflecting the beneficial economic environment, despite the impacts of accelerated bankruptcy filings and Hurricane Katrina.
The discussion that follows highlights, on an operating basis and excluding the impact of the Merger, the performance of each of the Firm’s lines of business.
Investment Bank operating earnings benefited from higher revenue and a continued benefit from the Provision for credit losses, which were offset by increased compensation expense. Revenue growth was driven by higher, although volatile, fixed income trading results, stronger equity commissions and improved investment banking fees, all of which benefited from strength in global capital markets activity. Investment banking fees had particular strength in advisory, reflecting in part the benefit of the business partnership with Cazenove, which was formed in February of 2005. As in 2004, the


     
JPMorgan Chase & Co. / 2005 Annual Report   25

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Provision for credit losses in 2005 was a benefit to earnings, mainly due to continued improvement in the credit quality of the loan portfolio. The increase in expense was primarily the result of higher performance-based incentive compensation due to increased revenues.
Retail Financial Services operating earnings benefited from the overall strength of the U.S. economy, which led to increased deposit, home equity and mortgage balances. In addition to the benefit from higher balances, revenues increased due to improved mortgage servicing rights (“MSRs”) risk management results. Expenses declined, reflecting ongoing efficiency improvements across all businesses even as investments continued in retail banking distribution and sales, with the net addition during the year of 133 branch offices, 662 ATMs and over 1,300 personal bankers. These benefits were offset partially by narrower spreads on loans due to the interest rate environment and net losses associated with loan portfolio sale activity. The provision for credit losses benefited from improved credit trends in most consumer lending portfolios and from loan portfolio sales, but was affected negatively by a special provision related to Hurricane Katrina.
Card Services operating earnings benefited from lower expenses driven by merger savings and greater efficiencies from the operating platform conversion, which resulted in lower processing and compensation costs. Revenue benefited from higher loan balances and customer charge volume resulting from marketing initiatives and increased consumer spending. Partially offsetting this growth were narrower spreads on loan balances due to an increase in accounts in their introductory rate period and higher interest rates. The managed provision for credit losses increased due to record levels of bankruptcy-related charge-offs related to the new bankruptcy legislation that became effective in October 2005 and a special provision related to Hurricane Katrina. Despite these events, underlying credit quality remained strong, with a managed net charge-off ratio of 5.21%, down from 5.27% in 2004.
Commercial Banking operating earnings benefited from wider spreads and higher volumes related to liability balances and increased loan balances. Partially offsetting these benefits were narrower loan spreads related to competitive pressures in some markets and lower deposit-related fees due to higher interest rates. The provision for credit losses increased due to a special provision related to Hurricane Katrina, increased loan balances and refinements in the data used to estimate the allowance for credit losses. However, the underlying credit quality in the portfolio was strong throughout the year, as evidenced by lower net charge-offs and nonperforming loans compared with 2004.
Treasury & Securities Services operating earnings grew significantly in 2005. Revenue growth resulted from business growth and widening spreads on, and growth in, liability balances, all of which benefited from global economic strength and capital market activity. Partially offsetting this growth were lower deposit-related fees due to higher interest rates. Expenses decreased due to lower software impairment charges, partially offset by higher compensation expense resulting from new business growth, the Vastera acquisition completed in April, and by charges taken in the second quarter to terminate a client contract.
Asset & Wealth Management operating earnings benefited from net asset inflows and asset appreciation, both the result of favorable capital markets and improved investment performance, which resulted in an increased level of Assets under management. Results also benefited from the acquisition of a majority interest in Highbridge Capital Management in the fourth quarter of
2004 and growth in deposit and loan balances. Expenses increased due primarily to the acquisition of Highbridge and higher performance-based incentive compensation related to increased revenue.
Corporate segment operating earnings were affected negatively by repositioning of the Treasury Investment portfolio. This decline was offset partially by the gain on the sale of BrownCo of $1.3 billion (pre-tax) and improved Private Equity results.
The Firm had, at year-end, total stockholders’ equity of $107 billion, and a Tier 1 capital ratio of 8.5%. The Firm purchased $3.4 billion, or 93.5 million shares of common stock during the year.
2006 Business outlook
The following forward-looking statements are based upon the current beliefs and expectations of JPMorgan Chase’s management and are subject to significant risks and uncertainties. These risks and uncertainties could cause JPMorgan Chase’s results to differ materially from those set forth in such forward-looking statements.
JPMorgan Chase’s outlook for 2006 should be viewed against the backdrop of the global economy, financial markets and the geopolitical environment, all of which are integrally linked. While the Firm considers outcomes for, and has contingency plans to respond to, stress environments, the basic outlook for 2006 is predicated on the interest rate movements implied in the forward rate curve for U.S. treasuries, the continuation of favorable U.S. and international equity markets and continued expansion of the global economy.
The performance of the Firm’s capital markets and wholesale businesses are affected by overall global economic growth and by financial market movements and activity levels. The Investment Bank enters 2006 with a strong investment banking fee pipeline and continues to focus on new product expansion initiatives, such as commodities and securitized products, which are intended to benefit growth and reduce volatility in trading results over time. Compared with 2005, the Investment Bank anticipates lower credit portfolio revenues due to reduced gains from loan workouts. Asset & Wealth Management anticipates continued growth driven by continued net inflows to Assets under supervision. Treasury & Securities Services and Commercial Banking expect growth due to increased business activity and product sales.
Retail Financial Services anticipates benefiting from the expanded branch network and salesforce, and improved sales productivity and cross-selling in the branches, partially offset by pressure on loan and deposit spreads due to the higher interest rate environment. The acquisition of Collegiate Funding Services is expected to contribute modestly to earnings in 2006.
Card Services anticipates that managed receivables will grow in line with the overall credit card industry, benefiting from marketing initiatives, new partnerships and the acquisition of the Sears Canada credit card business. Revenues and expenses also will reflect the full-year impact of the Paymentech deconsolidation and the acquisition of the Sears Canada credit card business.
The Corporate segment includes Private Equity, Treasury and other corporate support units. The revenue outlook for the Private Equity business is directly related to the strength of the equity markets and the performance of the underlying portfolio investments. If current market conditions persist, the Firm anticipates continued realization of private equity gains in 2006, but results can be volatile from quarter to quarter. It is anticipated that Treasury net interest


     
26   JPMorgan Chase & Co. / 2005 Annual Report

 


 

income will gradually improve and that the net loss in Other Corporate will be reduced as merger savings and other expense reduction initiatives, such as less excess real estate, are realized.
The Provision for credit losses in 2006 is anticipated to be higher than in 2005, primarily driven by a trend toward a more normal level of provisioning for credit losses in the wholesale businesses. The consumer Provision for credit losses in 2006 should reflect generally stable underlying asset quality. However, it is anticipated that the first half of 2006 will experience lower credit card net charge-offs, as the record level of bankruptcy filings in the fourth quarter of 2005 are believed to have included bankruptcy filings that would otherwise have occurred in 2006. The second half of 2006 is expected
to include increased credit card delinquencies and net charge-offs as a result of implementation of new FFIEC minimum payment rules.
Firmwide expenses are anticipated to benefit as the run rate of merger savings is expected to reach approximately $2.8 billion by the end of 2006 driven by activities such as the tri-state retail conversion and data center upgrades. Offsetting the merger savings will be continued investment in distribution enhancements and new product offerings; extensive merger integration activities and upgrading of technology; and expenses related to recent acquisitions, such as the Sears Canada credit card business and Collegiate Funding Services.
 
 
 


Consolidated results of operations
 
The following section provides a comparative discussion of JPMorgan Chase’s consolidated results of operations on a reported basis for the three-year period ended December 31, 2005. Factors that are related primarily to a single business segment are discussed in more detail within that business segment than they are in this consolidated section. For a discussion of the Critical accounting estimates used by the Firm that affect the Consolidated results of operations, see pages 81–83 of this Annual Report.
Revenue
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Investment banking fees
  $ 4,088     $ 3,537     $ 2,890  
Trading revenue
    5,860       3,612       4,427  
Lending & deposit related fees
    3,389       2,672       1,727  
Asset management, administration and commissions
    10,390       8,165       6,039  
Securities/private equity gains
    473       1,874       1,479  
Mortgage fees and related income
    1,054       806       790  
Credit card income
    6,754       4,840       2,466  
Other income
    2,694       830       601  
 
Noninterest revenue
    34,702       26,336       20,419  
Net interest income
    19,831       16,761       12,965  
 
Total net revenue
  $ 54,533     $ 43,097     $ 33,384  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
Total net revenue for 2005 was $54.5 billion, up 27% from 2004, primarily due to the Merger, which affected every revenue category. The increase from the prior year also was affected by a $1.3 billion gain on the sale of BrownCo; higher Trading revenue; and higher Asset management, administration and commissions, which benefited from several new investments and growth in
Assets under management and assets under custody. These increases were offset partly by available-for-sale (“AFS”) securities losses as a result of repositioning of the Firm’s Treasury investment portfolio. The discussions that follow highlight factors other than the Merger that affected the 2005 versus 2004 comparison.
The increase in Investment banking fees reflected continued strength in advisory, equity and debt underwriting, with particular growth in Europe, which benefited from the business partnership with Cazenove. Trading revenue increased from 2004, reflecting strength in fixed income, equities and commodities. 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 36–38 of this Annual Report.
The higher Lending & deposit-related fees were driven by the Merger; absent the effects of the Merger, the deposit-related fees would have been lower due to rising interest rates. In a higher interest-rate environment, the value of deposit balances to a customer is greater, resulting in a reduction of deposit-related fees. For a further discussion of liability balances (including deposits) see the CB and TSS segment discussions on pages 47–48 and 49–50, respectively, of this Annual Report.
The increase in Asset management, administration and commissions revenue was driven by incremental fees from several new investments, including a majority interest in Highbridge Capital Management, LLC, the business partnership with Cazenove and the acquisition of Vastera. Also contributing to the higher level of revenue was an increase in Assets under management, reflecting net asset inflows, mainly in equity-related products, and global equity market appreciation. In addition, Assets under custody were up due to market value appreciation and new business. Commissions rose as a result of a higher volume of brokerage transactions. For additional information on these fees and commissions, see the segment discussions for IB on pages 36–38, AWM on pages 51–52 and TSS on pages 49–50 of this Annual Report.


     
JPMorgan Chase & Co. / 2005 Annual Report   27

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

The decline in Securities/private equity gains reflected $1.3 billion of securities losses, as compared with $338 million of gains in 2004. The losses resulted primarily from repositioning the Firm’s Treasury investment portfolio in response to rising interest rates. The securities losses were offset partly by higher private equity gains due to a continuation of favorable capital markets conditions. For a further discussion of Securities/private equity gains, which are recorded primarily in the Firm’s Treasury and Private Equity businesses, see the Corporate segment discussion on pages 53–54 of this Annual Report.
Mortgage fees and related income increased due to improvements in risk management results related to MSR assets. Mortgage fees and related income exclude the impact of NII and AFS securities gains related to home mortgage activities. For a discussion of Mortgage fees and related income, which is recorded primarily in RFS’s Home Finance business, see the segment discussion for RFS on pages 39–44 of this Annual Report.
Credit card income rose as a result of higher interchange income associated with the increase in charge volume. This increase was offset partially by higher volume-driven payments to partners; rewards expense; and the impact of the deconsolidation of Paymentech, which was deconsolidated upon completion of the integration of Chase Merchant Services and the Paymentech merchant processing businesses in 2005. For a further discussion of Credit card income, see CS segment results on pages 45–46 of this Annual Report.
The increase in Other income primarily reflected a $1.3 billion pre-tax gain on the sale of BrownCo to E*TRADE Financial; higher gains from loan workouts and loan sales; and higher revenues as a result of a shift from financing leases to operating leases in the auto business. These gains were offset partly by write-downs on auto loans that were transferred to held-for-sale and a one-time gain in 2004 on the sale of an investment.
Net interest income rose as a result of higher average volume of, and wider spreads on, liability balances. Also contributing to the increase was higher average volume of wholesale and consumer loans, in particular, home equity and credit card loans. These increases were offset partially by narrower spreads on consumer and wholesale loans and on trading assets, as well as reduced Treasury investment portfolio levels. The Firm’s total average interest-earning assets in 2005 were $916 billion, up 23% from the prior year. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.19%, a decrease of six basis points from the prior year.
2004 compared with 2003
Total net revenues, at $43.1 billion, rose by $9.7 billion, or 29%, primarily due to the Merger, which affected every category of Total net revenue. The discussion that follows highlights factors other than the Merger that affected the 2004 versus 2003 comparison.
The increase in Investment banking fees was driven by significant gains in underwriting and advisory activities as a result of increased global market volumes and market share gains. Trading revenue declined by 18%, primarily due to lower portfolio management results in fixed income and equities.
Lending & deposit related fees were up from 2003 due to the Merger. The rise was offset partially by lower deposit-related fees, as clients paid for services with deposits versus fees due to rising interest rates. Throughout 2004, deposit balances grew in response to rising interest rates.
The increase in Asset management, administration and commissions was driven also by the full-year impact of other acquisitions – such as EFS in January 2004, Bank One’s Corporate Trust business in November 2003 and JPMorgan Retirement Plan Services in June 2003 – as well as the effect of global equity market appreciation, net asset inflows and a better product mix. In addition, a more active market for trading activities in 2004 resulted in higher brokerage commissions.
Securities/private equity gains for 2004 rose from the prior year, primarily fueled by the improvement in the Firm’s private equity investment results. This change was offset by lower securities gains on the Treasury investment portfolio as a result of lower volumes of securities sold, and lower gains realized on sales due to higher interest rates. Additionally, RFS’s Home Finance business reported losses in 2004 on AFS securities, as compared with gains in 2003. For a further discussion of securities gains, see the RFS and Corporate segment discussions on pages 39–44 and 53–54, respectively, of this Annual Report.
Mortgage fees and related income rose as a result of higher servicing revenue; this improvement was offset partially by lower MSR risk management results and prime mortgage production revenue, and by lower gains from sales and securitizations of subprime loans as a result of management’s decision in 2004 to retain these loans. Mortgage fees and related income exclude the impact of NII and securities gains related to home mortgage activities.
Credit card income increased from 2003 as a result of higher customer charge volume, which resulted in increased interchange income, and higher credit card servicing fees associated with an increase of $19.4 billion in average securitized loans. The increases were offset partially by higher volume-driven payments to partners and rewards expense.
The increase in Other income from 2003 reflected gains on leveraged lease transactions, the sale of an investment in 2004 and higher net results from corporate- and bank-owned life insurance policies. These positive factors in 2004 were offset partially by gains on sales of several nonstrategic businesses and real estate properties in 2003.
Net interest income rose from 2003 as growth in volumes of consumer loans and deposits, as well as wider spreads on deposits, contributed to higher net interest income. These positive factors were offset partially by lower wholesale loan balances in the IB and tighter spreads on loans, investment securities and trading assets stemming from the rise in interest rates. The Firm’s total average interest-earning assets for 2004 were $744 billion, up $154 billion from 2003. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.25% in 2004, an increase of four basis points from the prior year.


     
28   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Provision for credit losses
2005 compared with 2004
The Provision for credit losses was $3.5 billion, an increase of $939 million, or 37%, from 2004, reflecting the full-year impact of the Merger. The wholesale Provision for credit losses was a benefit of $811 million for the year compared with a benefit of $716 million in the prior year, reflecting continued strength in credit quality. The wholesale loan net recovery rate was 0.06% in 2005, an improvement from a net charge-off rate of 0.18% in the prior year. The total consumer Provision for credit losses was $4.3 billion, $1.9 billion higher than the prior year, primarily due to the Merger, higher bankruptcy-related net charge-offs in Card Services and a $350 million special provision for Hurricane Katrina. 2004 included accounting policy conformity adjustments as a result of the Merger. Excluding these items, the consumer portfolio continued to show strength in credit quality.
The Firm had total nonperforming assets of $2.6 billion at December 31, 2005, a decline of $641 million, or 20%, from the 2004 level of $3.2 billion. 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 63–74 of this Annual Report.
2004 compared with 2003
The Provision for credit losses of $2.5 billion was up $1.0 billion, or 65%, compared with 2003. The impact of the Merger and accounting policy conformity charges of $858 million were offset partially by releases in the allowance for credit losses related to the wholesale loan portfolio, primarily due to improved credit quality in the IB, and the sale of the manufactured home loan portfolio in RFS.
Noninterest expense
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Compensation expense
  $ 18,255     $ 14,506     $ 11,387  
Occupancy expense
    2,299       2,084       1,912  
Technology and communications expense
    3,624       3,702       2,844  
Professional & outside services
    4,224       3,862       2,875  
Marketing
    1,917       1,335       710  
Other expense
    3,705       2,859       1,694  
Amortization of intangibles
    1,525       946       294  
Merger costs
    722       1,365        
Litigation reserve charge
    2,564       3,700       100  
 
Total noninterest expense
  $ 38,835     $ 34,359     $ 21,816  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
Noninterest expense was $38.8 billion, up 13% from the prior year, primarily due to the full-year impact of the Merger. Excluding Litigation reserve charges and Merger costs, Noninterest expense would have been $35.5 billion, up 21%. In addition to the Merger, expenses increased as a result of higher performance-based incentives, continued investment spending in the Firm’s businesses and incremental marketing expenses related to launching the new Chase brand, partially offset by merger-related savings and other efficiencies throughout the Firm. Each category of Noninterest expense was affected by the Merger. The discussions that follow highlight factors other than the Merger that affected the 2005 versus 2004 comparison.
Compensation expense rose as a result of higher performance-based incentives; additional headcount due to the insourcing of the Firm’s global technology infrastructure (effective December 31, 2004, when JPMorgan Chase terminated the Firm’s outsourcing agreement with IBM); the impact of several investments, including Cazenove, Highbridge and Vastera; the accelerated vesting of certain employee stock options; and business growth. The effect of the termination of the IBM outsourcing agreement was to shift expenses from Technology and communications expense to Compensation expense. The increase in Compensation expense was offset partially by merger-related savings throughout the Firm. For a detailed discussion of employee stock-based incentives, see Note 7 on pages 100–102 of this Annual Report.
The increase in Occupancy expense was primarily due to the Merger, partially offset by lower charges for excess real estate and a net release of excess property tax accruals, compared with $103 million of charges for excess real estate in 2004.
Technology and communications expense was down only slightly. This reduction reflects the offset of six months of the combined Firm’s results for 2004 against the full-year 2005 impact from termination of the JPMorgan Chase outsourcing agreement with IBM. The reduction in Technology and communications expense due to the outsourcing agreement termination is mostly offset by increases in Compensation expense related to additional headcount and investments in the Firm’s hardware and software infrastructure.
Professional and outside services were higher compared with the prior year as a result of the insourcing of the Firm’s global technology infrastructure, upgrades to the Firm’s systems and technology, and business growth. These expenses were offset partially by expense-management initiatives.
Marketing expense was higher compared with the prior year, primarily as a result of the Merger and the cost of advertising campaigns to launch the new Chase brand.
The increase in Other expense reflected incremental expenses related to investments made in 2005, as well as an increase in operating charges for legal matters. Also contributing to the increase was a $93 million charge taken by TSS to terminate a client contract and a $40 million charge taken by RFS related to the dissolution of a student loan joint venture. These items were offset partially by lower software impairment write-offs, merger-related savings and other efficiencies.
For a discussion of Amortization of intangibles and Merger costs, refer to Note 15 and Note 8 on pages 114–116 and 103, respectively, of this Annual Report.
The 2005 nonoperating Litigation reserve charges that were recorded by the Firm were as follows: a $1.9 billion charge related to the settlement of the Enron class action litigation and for certain other material legal proceedings and a $900 million charge for the settlement costs of the WorldCom class action litigation; these were partially offset by a $208 million insurance recovery related to certain material litigation. In comparison, 2004 included a $3.7 billion nonoperating charge to increase litigation reserves. For a further discussion of litigation, refer to Note 25 on page 123 of this Annual Report.


     
JPMorgan Chase & Co. / 2005 Annual Report   29

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

2004 compared with 2003
Noninterest expense was $34.4 billion in 2004, up $12.5 billion, or 57%, primarily due to the Merger. Excluding $1.4 billion of Merger costs, and Litigation reserve charges, Noninterest expense would have been $29.3 billion, up 35%. The discussion that follows highlights other factors affecting the 2004 versus 2003 comparison.
Compensation expense was up from 2003, primarily due to strategic investments in the IB and continuing expansion in RFS. These factors were offset partially by ongoing efficiency improvements and merger-related savings throughout the Firm, and by a reduction in pension costs. The decline in pension costs was attributable mainly to the increase in the expected return on plan assets resulting from a discretionary $1.1 billion contribution to the Firm’s pension plan in April 2004, partially offset by changes in actuarial assumptions for 2004 compared with 2003.
The increase in Occupancy expense was offset partly by lower charges for excess real estate, which were $103 million in 2004 compared with $270 million in 2003.
Technology and communications expense was higher than in the prior year as a result of higher costs associated with greater use of outside vendors, primarily IBM, to support the global infrastructure requirements of the Firm. For a further discussion regarding the IBM outsourcing agreement, see the Corporate segment discussion on page 53 of this Annual Report.
Professional & outside services rose due to higher legal costs associated with litigation matters, as well as outside services stemming from recent acquisitions – primarily Electronic Financial Services (“EFS”), and growth in business at TSS and CS.
Marketing expense rose as CS initiated a more robust marketing campaign during 2004.
Other expense was up due to software impairment write-offs of $224 million, primarily in TSS and Corporate, compared with $60 million in 2003; higher operating charges for legal matters; and growth in business volume. These expenses were offset partly by a $57 million settlement related to the Enron surety bond litigation.
For a discussion of Amortization of intangibles and Merger costs, refer to Note 15 and Note 8 on pages 114–116 and 103, respectively.
In June of 2004, JPMorgan Chase recorded a $3.7 billion addition to the Litigation reserve. By comparison, 2003 included a charge of $100 million for Enron-related litigation.
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:
                         
Year ended December 31,(a)                  
(in millions, except rate)   2005     2004     2003  
 
Income before income tax expense
  $ 12,215     $ 6,194     $ 10,028  
Income tax expense
    3,732       1,728       3,309  
Effective tax rate
    30.6 %     27.9 %     33.0 %
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
The increase in the effective tax rate was primarily the result of higher reported pre-tax income combined with changes in the proportion of income subject to federal, state and local taxes. Also contributing to the increase were lower 2005 nonoperating charges and a gain on the sale of BrownCo, which were taxed at marginal tax rates of 38% and 40%, respectively. These increases were offset partially by a tax benefit of $55 million recorded in connection with the repatriation of foreign earnings.
2004 compared with 2003
The reduction in the effective tax rate for 2004, as compared with 2003, was the result of various factors, including lower reported pre-tax income, a higher level of business tax credits, and changes in the proportion of income subject to federal, state and local taxes, partially offset by purchase accounting adjustments related to leveraged lease transactions. The Merger costs and accounting policy conformity adjustments recorded in 2004, and the Litigation reserve charge recorded in the second quarter of 2004, reflected a tax benefit at a 38% marginal tax rate, contributing to the reduction in the effective tax rate compared with 2003.


     
30   JPMorgan Chase & Co. / 2005 Annual Report

 


 

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 87–90 of this Annual Report. That presentation, which is referred to as “reported basis,” provides the reader with an understanding of the Firm’s results that can be tracked consistently from year to year and enables a comparison of the Firm’s performance with other companies’ U.S. GAAP financial statements.
In addition to analyzing the Firm’s results on a reported basis, management reviews the Firm’s and the lines’ of business results on an operating basis, which is a non-GAAP financial measure. The Firm’s definition of operating basis starts with the reported U.S. GAAP results. Operating basis excludes: (i) merger costs, (ii) the nonoperating litigation charges taken and insurance recoveries received with respect to certain of the Firm’s material litigation; and (iii) costs related to the conformance of certain accounting policies as a result of the Merger. Management believes these items are not part of the Firm’s normal daily business operations and, therefore, not indicative of trends, as they do not provide meaningful comparisons with other periods. For additional detail on nonoperating litigation charges, see the Glossary of terms on page 134 of this Annual Report.
In addition, the Firm manages its lines of business on an operating basis. In the case of the Investment Bank, noninterest revenue on an operating basis includes, in trading-related 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. The impact of changes in market interest rates will either be recorded in Trading revenue or Net interest income depending on whether the trading position is a cash security or a derivative. Combining both the trading revenue and related net interest income allows management to evaluate the economic results of the Investment Bank’s trading activities, which for GAAP purposes are reported in both Trading revenue and Net interest income. In management’s view, this presentation also facilitates operating comparisons to competitors. For a discussion of trading-related revenue, see the IB on pages 36–38 of this Annual Report.
In the case of Card Services, operating basis is also referred to as “managed basis,” and excludes the impact of credit card securitizations on total net revenue, the provision for credit losses, net charge-offs and loan receivables. This presentation is provided to facilitate operating comparisons to competitors. 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 the receivables to a trust, and the sale of undivided interests to investors that entitle the investors to specific cash flows generated from the credit card receivables. The Firm retains the remaining undivided interests as seller’s interests, which are recorded in Loans on the Consolidated balance sheets. 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 statements of income as interest income, certain fee revenue, recoveries in excess of interest paid to the investors, gross credit losses and other trust expenses related to the securitized receivables are all reclassified into credit card income. For a reconciliation of reported to managed basis of Card Services results, see page 46 of this Annual Report. For information regarding loans and residual interests sold and securitized, see Note 13 on pages 108–111 of this Annual Report. 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, Card Services operations are funded, operating results are evaluated, and decisions are made about allocating resources such as employees and capital based upon managed financial information.
Finally, commencing with the first quarter of 2005, 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 non-GAAP financial measure 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. The Corporate sector’s and the Firm’s operating revenue and income tax expense for the periods prior to the first quarter of 2005 have been restated to be similarly presented on a tax-equivalent basis. 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 because it 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.


     
JPMorgan Chase & Co. / 2005 Annual Report   31

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.
The following summary table provides a reconciliation from the firm’s reported GAAP results to operating results:
(Table continues on next page)
                                                                                 
Year ended December 31,(a)   2005     2004  
     
(in millions, except   Reported     Credit     Nonoperating     Tax-equivalent     Operating     Reported     Credit     Nonoperating     Tax-equivalent     Operating  
per share and ratio data)   results     card(b)     items     adjustments     basis     results     card(b)     items     adjustments     basis  
     
Revenue
                                                                               
Investment banking fees
  $ 4,088     $     $     $     $ 4,088     $ 3,537     $     $     $     $ 3,537  
Trading revenue(c)
    6,019                         6,019       5,562                         5,562  
Lending & deposit related fees
    3,389                         3,389       2,672                         2,672  
Asset management, administration and commissions
    10,390                         10,390       8,165                         8,165  
Securities/private equity gains
    473                         473       1,874                         1,874  
Mortgage fees and related income
    1,054                         1,054       806                         806  
Credit card income
    6,754       (2,718 )                 4,036       4,840       (2,267 )                 2,573  
Other income
    2,694                   571       3,265       830       (86 )     118 (3)     317       1,179  
     
Noninterest revenue(c)
    34,861       (2,718 )           571       32,714       28,286       (2,353 )     118       317       26,368  
 
                                                                               
Net interest income(c)
    19,672       6,494             269       26,435       14,811       5,251             6       20,068  
     
Total net revenue
    54,533       3,776             840       59,149       43,097       2,898       118       323       46,436  
 
                                                                               
Provision for credit losses
    3,483       3,776                   7,259       2,544       2,898       (858 )(4)           4,584  
 
                                                                               
Noninterest expense
                                                                               
Merger costs
    722             (722 )(1)                 1,365             (1,365 )(1)            
Litigation reserve charge
    2,564             (2,564 )(2)                 3,700             (3,700 )(2)            
All other noninterest expense
    35,549                         35,549       29,294                         29,294  
     
Total noninterest expense
    38,835             (3,286 )           35,549       34,359             (5,065 )           29,294  
     
Income before income tax expense
    12,215             3,286       840       16,341       6,194             6,041       323       12,558  
 
                                                                               
Income tax expense
    3,732             1,248       840       5,820       1,728             2,296       323       4,347  
     
Net income
  $ 8,483     $     $ 2,038     $     $ 10,521     $ 4,466     $     $ 3,745     $     $ 8,211  
     
Earnings per share – diluted
  $ 2.38     $     $ 0.57     $     $ 2.95     $ 1.55     $     $ 1.31     $     $ 2.86  
     
Return on common equity
    8 %     %     2 %     %     10 %     6 %     %     5 %     %     11 %
 
                                                                               
Return on equity less goodwill
    14             3             17       9             7             16  
     
Return on assets
    0.72       NM       NM       NM       0.84       0.46       NM       NM       NM       0.81  
     
Overhead ratio
    71       NM       NM       NM       60       80       NM       NM       NM       63  
     
Effective income tax rate
    31       NM       38       NM       36       28       NM       38       NM       35  
     
Loans–Period-end
  $ 419,148     $ 70,527                 $ 489,675     $ 402,114     $ 70,795                 $ 472,909  
Total assets – average
    1,185,066       67,180                   1,252,246       962,556 (a)     51,084 (a)                 1,013,640 (a)
     
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   The impact of credit card securitizations affects CS. See pages 45–46 of this Annual Report for further information.
(c)   Trading-related net interest income reclassification
                                 
Year ended December 31,(a) (in millions)   2005     2004     2003        
         
Trading revenue – reported (d)
  $ 5,860     $ 3,612     $ 4,427          
Trading-related NII
    159       1,950       2,129          
         
Trading revenue – adjusted (d)
  $ 6,019     $ 5,562     $ 6,556          
         
Net interest income – reported
  $ 19,831     $ 16,761     $ 12,965          
Trading-related NII
    (159 )     (1,950 )     (2,129 )        
         
Net interest income – adjusted
  $ 19,672     $ 14,811     $ 10,836          
         
(d)   Reflects Trading revenue at the Firm level. The majority of Trading revenue is recorded in the Investment Bank.
     
32   JPMorgan Chase & Co. / 2005 Annual Report

 


 

(Table continued from previous page)

                                     
2003
Reported     Credit     Nonoperating     Tax-equivalent     Operating  
results     card (b)     items     adjustments     basis  
 
                                     
$ 2,890     $     $     $     $ 2,890  
  6,556                         6,556  
                                     
  1,727                         1,727  
                                     
                                     
  6,039                         6,039  
                                     
  1,479                         1,479  
                                     
  790                         790  
  2,466       (1,379 )                 1,087  
  601       (71 )           89       619  
 
  22,548       (1,450 )           89       21,187  
                                     
  10,836       3,320             44       14,200  
 
  33,384       1,870             133       35,387  
                                     
  1,540       1,870                   3,410  
                                     
                                     
                           
  100                         100  
                                     
  21,716                         21,716  
 
                                     
  21,816                         21,816  
 
                                     
  10,028                   133       10,161  
  3,309                   133       3,442  
 
$ 6,719     $     $     $     $ 6,719  
 
                                     
$ 3.24     $     $     $     $ 3.24  
 
  16 %     %     %     %     16 %
                                     
                                     
  19                         19  
 
  0.87       NM       NM       NM       0.83  
 
  65       NM       NM       NM       62  
 
  33       NM       NM       NM       34  
 
$ 214,766     $ 34,856                 $ 249,622  
                                     
  775,978       32,365                   808,343  
 

Nonoperating Items
The reconciliation of the Firm’s reported results to operating results in the accompanying table sets forth the impact of several nonoperating items incurred by the Firm in 2005 and 2004. These nonoperating items are excluded from Operating earnings, as management believes these items are not part of the Firm’s normal daily business operations and, therefore, not indicative of trends as they do not provide meaningful comparisons with other periods. These items include Merger costs, nonoperating litigation charges and insurance recoveries, and charges to conform accounting policies, each of which is described below:
(1)   Merger costs of $722 million in 2005 and $1.4 billion in 2004 reflect costs associated with the Merger.
 
(2)   Net nonoperating litigation charges of $2.6 billion and $3.7 billion were taken in 2005 and 2004, respectively.
 
(3)   Other income in 2004 reflects $118 million of other accounting policy conformity adjustments.
 
(4)   The Provision for credit losses in 2004 reflects $858 million of accounting policy conformity adjustments, consisting of a $1.4 billion charge related to the decertification of the seller’s interest in credit card securitizations, partially offset by a benefit of $584 million related to conforming wholesale and consumer credit provision methodologies for the combined Firm.
 
 

Calculation of Certain GAAP and Non-GAAP Metrics
The table below reflects the formulas used to calculate both the following GAAP and non-GAAP measures:
Return on common equity
     
 
   
Reported
  Net income* / Average common equity
Operating
  Operating earnings* / Average common equity
Return on equity less goodwill(a)
     
 
   
Reported
  Net income* / Average common equity less goodwill
Operating
  Operating earnings*/ Average common equity less goodwill
Return on assets
     
 
   
Reported
  Net income / Average assets
Operating
  Operating earnings / Average managed assets
Overhead ratio
     
 
   
Reported
  Total noninterest expense / Total net revenue
Operating
  Total noninterest expense / Total net revenue
*   Represents earnings applicable to common stock
(a)   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 competitors.


     
JPMorgan Chase & Co. / 2005 Annual Report   33

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.
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 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 upon the products and services provided, or the type of customer served, and reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on an operating basis.


(JPMORGAN FLOW CHART)

In connection with the Merger, business segment reporting was realigned to reflect the new business structure of the combined Firm. Treasury was transferred from the IB into Corporate. The segment formerly known as Chase Financial Services had been comprised of Chase Home Finance, Chase Cardmember Services, Chase Auto Finance, Chase Regional Banking and Chase Middle Market; as a result of the Merger, this segment is now called Retail Financial Services and is comprised of Home Finance, Auto & Education Finance, Consumer & Small Business Banking and Insurance. Chase Cardmember Services is now its own segment called Card Services, and Chase Middle Market moved into Commercial Banking. Investment Management & Private Banking was renamed Asset & Wealth Management. JPMorgan Partners, which formerly was a stand-alone business segment, was moved into
Corporate. Corporate currently comprises Private Equity (JPMorgan Partners and ONE Equity Partners) and Treasury, and the corporate support areas, which include Central Technology and Operations, Audit, Executive Office, Finance, Human Resources, Marketing & Communications, Office of the General Counsel, Corporate Real Estate and General Services, Risk Management, and Strategy and Development. Beginning January 1, 2006, TSS will report results for two divisions: TS and WSS. WSS was formed by consolidating IS and ITS.
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.


Segment results – Operating basis(a)(b)
(Table continues on next page)
                                                 
Year ended December 31,   Total net revenue     Noninterest expense  
(in millions, except ratios)   2005     2004     Change     2005     2004     Change  
 
Investment Bank
  $ 14,578     $ 12,605       16 %   $ 9,739     $ 8,696       12 %
Retail Financial Services
    14,830       10,791       37       8,585       6,825       26  
Card Services
    15,366       10,745       43       4,999       3,883       29  
Commercial Banking
    3,596       2,374       51       1,872       1,343       39  
Treasury & Securities Services
    6,241       4,857       28       4,470       4,113       9  
Asset & Wealth Management
    5,664       4,179       36       3,860       3,133       23  
Corporate
    (1,126 )     885     NM       2,024       1,301       56  
 
Total
  $ 59,149     $ 46,436       27 %   $ 35,549     $ 29,294       21 %
 
(a)   Represents reported results on a tax-equivalent basis and excludes the impact of credit card securitizations; Merger costs, litigation reserve charges and insurance recoveries deemed nonoperating; and accounting policy conformity adjustments related to the Merger.
 
(b)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(c)   As a result of the Merger, new capital allocation methodologies were implemented during the third quarter of 2004. The capital allocated to each line of business considers several factors: stand-alone peer comparables, economic risk measures and regulatory capital requirements. In addition, effective with the third quarter of 2004, goodwill, as well as the associated capital, is only allocated to the Corporate line of business. Prior periods have not been revised to reflect these new methodologies and are not comparable to the presentation beginning in the third quarter of 2004.
     
34   JPMorgan Chase & Co. / 2005 Annual Report

 


 

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. Effective with the Merger on July 1, 2004, several of the allocation methodologies were revised, as noted below. As prior periods have not been revised to reflect these new methodologies, they are not comparable to the presentation of periods beginning with the third quarter of 2004. Further, the Firm continues to assess the assumptions, methodologies and reporting reclassifications used for segment reporting, and further refinements may be implemented in future periods.
Revenue sharing
When business segments join efforts to sell products and services to the Firm’s clients, the participating business segments agree to share revenues from those transactions. These revenue-sharing agreements were revised on the Merger date to provide consistency across the lines of business.
Funds transfer pricing
Funds transfer pricing (“FTP”) is used to allocate interest income and expense to each business and transfer the primary interest rate risk exposures to Corporate. The allocation process is unique to each business and considers the interest rate risk, liquidity risk and regulatory requirements of its stand-alone peers. Business segments may retain certain interest rate exposures, subject to management approval, that would be expected in the normal operation of a similar peer business. In the third quarter of 2004, FTP was revised to conform the policies of the combined firms.
Expense allocation
Where business segments use services provided by support units within the Firm, the costs of those support units are allocated to the business segments. Those expenses are allocated based upon their actual cost, or the lower of actual cost or market cost, as well as upon usage of the services provided. Effective with the third quarter of 2004, the cost allocation methodologies of the heritage firms were aligned to provide consistency across the business segments. In addition, expenses related to certain corporate functions, technology and operations ceased to be allocated to the business segments
and are retained in Corporate. These retained expenses include parent company costs that would not be incurred if the segments were stand-alone businesses; adjustments to align certain corporate staff, technology and operations allocations with market prices; and other one-time items not aligned with the business segments. During 2005, the Firm refined cost allocation methodologies related to certain corporate functions, technology and operations expenses in order to improve transparency, consistency and accountability with regard to costs allocated across business segments. Prior periods have not been revised to reflect these new cost allocation methodologies.
Capital allocation
Each business segment is allocated capital by taking into consideration stand-alone peer comparisons, economic risk measures and regulatory capital requirements. The amount of capital assigned to each business is referred to as equity. At the time of the Merger, goodwill, as well as the associated capital, was allocated solely to Corporate. Effective January 2006, the Firm expects to refine its methodology for allocating capital to the business segments to include any goodwill associated with line of business-directed acquisitions since the Merger. U.S. GAAP requires the allocation of goodwill to the business segments for impairment testing (see Critical accounting estimates used by the Firm and Note 15 on pages 81–83 and 114–116, respectively, of this Annual Report). See the Capital management section on page 56 of this Annual Report for a discussion of the equity framework.
Credit reimbursement
TSS reimburses the IB for credit portfolio exposures the IB manages on behalf of clients the segments share. At the time of the Merger, the reimbursement methodology was revised to be based upon pre-tax earnings, net of the cost of capital related to those exposures. Prior to the Merger, the credit reimbursement was based upon pre-tax earnings, plus the allocated capital associated with the shared clients.
Tax-equivalent adjustments
Segment and Firm results reflect revenues on a tax-equivalent basis for segment reporting purposes. Refer to Explanation and reconciliation of the Firm’s non-GAAP financial measures on page 31 of this Annual Report for additional details.


Segment results – Operating basis(a)(b)
(Table continued from previous page)
                                         
Year ended December 31,   Operating earnings     Return on common equity – goodwill(c)  
(in millions, except ratios)   2005     2004     Change     2005     2004  
 
Investment Bank
  $ 3,658     $ 2,948       24 %     18 %     17 %
Retail Financial Services
    3,427       2,199       56       26       24  
Card Services
    1,907       1,274       50       16       17  
Commercial Banking
    1,007       608       66       30       29  
Treasury & Securities Services
    1,037       440       136       55       17  
Asset & Wealth Management
    1,216       681       79       51       17  
Corporate
    (1,731 )     61     NM     NM     NM  
 
Total
  $ 10,521     $ 8,211       28 %     17 %     16 %
 
     
JPMorgan Chase & Co. / 2005 Annual Report   35

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.
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 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 Investment Bank also commits the Firm’s own capital to proprietary investing and trading activities.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Investment banking fees:
                       
Advisory
  $ 1,263     $ 938     $ 640  
Equity underwriting
    864       781       699  
Debt underwriting
    1,969       1,853       1,532  
 
Total investment banking fees
    4,096       3,572       2,871  
Trading-related revenue:
                       
Fixed income and other
    5,673       5,008       6,016  
Equities
    350       427       556  
Credit portfolio
    116       6       (186 )
 
Total trading-related revenue(b)
    6,139       5,441       6,386  
Lending & deposit related fees
    594       539       440  
Asset management, administration and commissions
    1,724       1,400       1,217  
Other income
    615       328       103  
 
Noninterest revenue
    13,168       11,280       11,017  
Net interest income(b)
    1,410       1,325       1,667  
 
Total net revenue(c)
    14,578       12,605       12,684  
Provision for credit losses
    (838 )     (640 )     (181 )
Credit reimbursement from (to) TSS(d)
    154       90       (36 )
Noninterest expense
                       
Compensation expense
    5,785       4,893       4,462  
Noncompensation expense
    3,954       3,803       3,840  
 
Total noninterest expense
    9,739       8,696       8,302  
 
Operating earnings before income tax expense
    5,831       4,639       4,527  
Income tax expense
    2,173       1,691       1,722  
 
Operating earnings
  $ 3,658     $ 2,948     $ 2,805  
 
Financial ratios
                       
ROE
    18 %     17 %     15 %
ROA
    0.61       0.62       0.64  
Overhead ratio
    67       69       65  
Compensation expense as % of total net revenue
    40       39       35  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Trading revenue, on a reported basis, excludes the impact of Net interest income related to IB’s trading activities; this income is recorded in Net interest income. However, in this presentation, to assess the profitability of IB’s trading business, the Firm combines these revenues for segment reporting purposes. The amount reclassified from Net interest income to Trading revenue was $0.2 billion, $1.9 billion and $2.1 billion for 2005, 2004 and 2003, respectively. The decline from prior years is due to tightening spreads as short-term funding rates have risen sharply and also, to a lesser extent, increased funding costs from growth in noninterest-bearing trading assets.
 
(c)   Total net revenue includes tax-equivalent adjustments, primarily due to tax-exempt income from municipal bond investments and income tax credits related to affordable housing investments, of $752 million, $274 million and $117 million for 2005, 2004 and 2003, 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 35 of this Annual Report.

The following table provides the IB’s total net revenue by business segment:
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Revenue by business
                       
Investment banking fees
  $ 4,096     $ 3,572     $ 2,871  
Fixed income markets
    7,242       6,314       6,987  
Equities markets
    1,799       1,491       1,406  
Credit portfolio
    1,441       1,228       1,420  
 
Total net revenue
  $ 14,578     $ 12,605     $ 12,684  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
Operating earnings of $3.7 billion were up 24%, or $710 million, from the prior year. The increase was driven by the Merger, higher revenues and an increased benefit from the Provision for credit losses. These factors were partially offset by higher compensation expense. Return on equity was 18%.
Net revenue of $14.6 billion was up $2.0 billion, or 16%, over the prior year, representing the IB’s highest annual revenue since 2000, driven by strong Fixed Income and Equity Markets and Investment banking fees. Investment banking fees of $4.1 billion increased 15% from the prior year driven by strong growth in advisory fees resulting in part from the Cazenove business partnership. Advisory revenues of $1.3 billion were up 35% from the prior year, reflecting higher market volumes. Debt underwriting revenues of $2.0 billion increased by 6% driven by strong loan syndication fees. Equity underwriting fees of $864 million were up 11% from the prior year driven by improved market share. Fixed Income Markets revenue of $7.2 billion increased 15%, or $928 million, driven by stronger, although volatile, trading results across commodities, emerging markets, rate markets and currencies. Equities Markets revenues increased 21% to $1.8 billion, primarily due to increased commissions, which were offset partially by lower trading results, which also experienced a high level of volatility. Credit Portfolio revenues were $1.4 billion, up $213 million from the prior year due to higher gains from loan workouts and sales as well as higher trading revenue from credit risk management activities.
The Provision for credit losses was a benefit of $838 million compared with a benefit of $640 million in 2004. The increased benefit was due primarily to the improvement in the credit quality of the loan portfolio and reflected net recoveries. Nonperforming assets of $645 million decreased by 46% since the end of 2004.
Noninterest expense increased 12% to $9.7 billion, largely reflecting higher performance-based incentive compensation related to growth in revenue. Noncompensation expense was up 4% from the prior year primarily due to the impact of the Cazenove business partnership, while the overhead ratio declined to 67% for 2005, from 69% in 2004.
2004 compared with 2003
In 2004, Operating earnings of $2.9 billion were up 5% from the prior year. Increases in Investment banking fees, the improvement in the Provision for credit losses and the impact of the Merger were partially offset by decreases in trading revenues and net interest income. Return on equity was 17% for 2004.
Total net revenue of $12.6 billion was relatively flat from the prior year, primarily due to lower Fixed income markets revenues and Credit portfolio revenues, offset by increases in Investment banking fees and the impact of the Merger. The decline in revenue from Fixed income markets was driven by weaker portfolio management trading results, mainly in the interest rate markets business. Credit portfolio revenues were down due to lower net interest income,


     
36   JPMorgan Chase & Co. / 2005 Annual Report

 


 

primarily driven by lower loan balances; these factors were partially offset by higher trading revenue due to more severe credit spread tightening in 2003 relative to 2004. Investment banking fees increased by 24% over the prior year, driven by significant gains in advisory and debt underwriting. The advisory gains were a result of increased global market volumes and market share, while the higher underwriting fees were due to stronger client activity.
The Provision for credit losses was a benefit of $640 million, compared with a benefit of $181 million in 2003. The improvement in the provision was the result of a $633 million decline in net charge-offs, partially offset by lower reductions in the allowance for credit losses in 2004 relative to 2003.
For the year ended December 31, 2004, Noninterest expense was up 5% from the prior year. The increase from 2003 was driven by higher Compensation expense, resulting from strategic investments and the impact of the Merger.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount and ratio data)   2005     2004     2003  
 
Revenue by region
                       
Americas
  $ 8,223     $ 6,870     $ 7,250  
Europe/Middle East/Africa
    4,627       4,082       4,331  
Asia/Pacific
    1,728       1,653       1,103  
 
Total net revenue
  $ 14,578     $ 12,605     $ 12,684  
 
Selected average balances
                       
Total assets
  $  598,118     $  473,121     $  436,488  
Trading assets–debt and equity instruments
    231,303       173,086       156,408  
Trading assets–derivatives receivables
    55,239       58,735       83,361  
Loans:
                       
Loans retained(b)
    42,918       36,494       40,240  
Loans held-for-sale(c)
    12,014       6,124       4,797  
 
Total loans
    54,932       42,618       45,037  
Adjusted assets(d)
    455,277       393,646       370,776  
Equity(e)
    20,000       17,290       18,350  
 
                       
Headcount
    19,769       17,478       14,691  
 
                       
Credit data and quality statistics
                       
Net charge-offs (recoveries)
  $ (126 )   $ 47     $ 680  
Nonperforming assets:
                       
Nonperforming loans(f)
    594       954       1,708  
Other nonperforming assets
    51       242       370  
Allowance for loan losses
    907       1,547       1,055  
Allowance for lending related commitments
    226       305       242  
 
                       
Net charge-off (recovery) rate(c)
    (0.29 )%     0.13 %     1.69 %
Allowance for loan losses to average loans(c)
    2.11       4.24       2.56  
Allowance for loan losses to nonperforming loans(f)
    187       163       63  
Nonperforming loans to average loans
    1.08       2.24       3.79  
Market risk–average trading and credit portfolio VAR(g)(h)(i)
                       
Trading activities:
                       
Fixed income(g)
  $ 67     $ 74     $ 61  
Foreign exchange
    23       17       17  
Equities
    34       28       18  
Commodities and other
    21       9       8  
Diversification(i)
    (59 )     (43 )     (39 )
 
Total trading VAR
    86       85       65  
Credit portfolio VAR(h)
    14       14       18  
Diversification(i)
    (12 )     (9 )     (14 )
 
Total trading and credit portfolio VAR
  $ 88     $ 90     $ 69  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Loans retained include Credit Portfolio, Conduit loans, leverage leases, bridge loans for underwriting and other accrual loans.
 
(c)   Loans held-for-sale, which include warehouse loans held as part of the IB’s mortgage-backed, asset-backed and other securitization businesses, are excluded from Total loans for the allowance coverage ratio and net charge-off rate.
 
(d)   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.
 
(e)   Equity includes $15.0 billion, $15.0 billion and $14.6 billion of economic risk capital assigned to the IB for the years ended 2005, 2004 and 2003 respectively.
 
(f)   Nonperforming loans include loans held-for-sale of $109 million, $2 million and $30 million as of December 31, 2005, 2004 and 2003, respectively. These amounts are not included in the allowance coverage ratios.
 
(g)   Includes all fixed income mark-to-market trading activities, plus available-for-sale securities held for proprietary purposes.
 
(h)   Includes VAR on derivative credit valuation adjustments, credit valuation adjustment hedges and mark-to-market hedges of the accrual loan portfolio, which are all reported in Trading revenue. This VAR does not include the accrual loan portfolio, which is not marked to market.
(i)   Average VARs are less than the sum of the VARs of its market risk components, due to risk offsets resulting from portfolio diversification. The diversification effect reflects the fact that the risks are not perfectly correlated. The risk of a portfolio of positions is therefore usually less than the sum of the risks of the positions themselves.
According to Thomson Financial, in 2005, the Firm improved its ranking in U.S. Debt, Equity and Equity-related from #5 in 2004 to #4 and in U.S. Equity and Equity-related from #6 in 2004 to #5. The Firm maintained its #3 position in Global Announced M&A with 24% market share and its #1 position in Global Syndicated Loans. The Firm maintained its #2 ranking in U.S. Long-Term Debt, but dropped from #2 to #4 in Global Long-Term Debt.
According to Dealogic, the Firm was ranked #2 in Investment Banking fees generated during 2005.
Market shares and rankings(a)
                                                 
    2005     2004     2003  
    Market             Market             Market        
December 31,   Share     Rankings     Share     Rankings     Share     Rankings  
 
Global debt, equity and equity-related
    6 %     #4       7 %     #3       8 %     #3  
Global syndicated loans
    16       #1       19       #1       20       #1  
Global long-term debt
    6       #4       7       #2       8       #2  
Global equity and equity-related
    7       #6       6       #6       8       #4  
Global announced M&A
    24       #3       24       #3       16       #4  
U.S. debt, equity and equity-related
    8       #4       8       #5       9       #3  
U.S. syndicated loans
    28       #1       32       #1       34       #1  
U.S. long-term debt
    11       #2       12       #2       12       #2  
U.S. equity and equity-related
    9       #5       8       #6       11       #4  
U.S. announced M&A
    24       #3       31       #2       14       #7  
 
(a)   Source: Thomson Financial Securities data. Global announced M&A is based on rank value; all other rankings are based upon 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 years ended December 31, 2004 and 2003 are presented on a combined basis, as if the merger of JPMorgan Chase and Bank One had been in effect during the periods.


     
JPMorgan Chase & Co. / 2005 Annual Report   37

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.
Composition of revenue
                                                         
                            Asset                    
Year ended           Trading-     Lending &     management,                    
December 31,(a)   Investment     related     deposit     administration     Other     Net interest     Total net  
(in millions)   banking fees     revenue     related fees     and commissions     income     income     revenue  
 
2005
                                                       
Investment banking fees
  $ 4,096     $     $     $     $     $     $ 4,096  
Fixed income markets
          5,673       251       219       365       734       7,242  
Equities markets
          350             1,462       (88 )     75       1,799  
Credit portfolio
          116       343       43       338       601       1,441  
 
Total
  $ 4,096     $ 6,139     $ 594     $ 1,724     $ 615     $ 1,410     $ 14,578  
 
 
                                                       
2004
                                                       
Investment banking fees
  $ 3,572     $     $     $     $     $     $ 3,572  
Fixed income markets
          5,008       191       287       304       524       6,314  
Equities markets
          427             1,076       (95 )     83       1,491  
Credit portfolio
          6       348       37       119       718       1,228  
 
Total
  $ 3,572     $ 5,441     $ 539     $ 1,400     $ 328     $ 1,325     $ 12,605  
 
 
                                                       
2003
                                                       
Investment banking fees
  $ 2,871     $     $     $     $     $     $ 2,871  
Fixed income markets
          6,016       107       331       84       449       6,987  
Equities markets
          556             851       (85 )     84       1,406  
Credit portfolio
          (186 )     333       35       104       1,134       1,420  
 
Total
  $ 2,871     $ 6,386     $ 440     $ 1,217     $ 103     $ 1,667     $ 12,684  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.

IB revenues comprise the following:
Investment banking fees includes advisory, equity underwriting, bond underwriting and loan syndication fees.
Fixed income markets includes client and portfolio management revenue related to both market-making and proprietary risk-taking across global fixed income markets, including government and corporate debt, foreign exchange, interest rate and commodities markets.
Equities markets includes client and portfolio management revenue related to market-making and proprietary risk-taking across global equity products, including cash instruments, derivatives and convertibles.
Credit portfolio revenue includes Net interest income, fees and loan sale activity, as well as gains or losses on securities received as part of a loan restructuring, for IB’s credit portfolio. Credit portfolio revenue also includes the results of risk management related to the Firm’s lending and derivative activities, and changes in the credit valuation adjustment (“CVA”), which is the component of the fair value of a derivative that reflects the credit quality of the counterparty. See pages 69–70 of the Credit risk management section of this Annual Report for a further discussion.
     
38   JPMorgan Chase & Co. / 2005 Annual Report

 


 

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 2,641 branches and 7,312 automated teller machines (“ATMs”). Auto & Education Finance is the largest noncaptive 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.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Lending & deposit related fees
  $ 1,452     $ 1,013     $ 486  
Asset management, administration and commissions
    1,498       1,020       459  
Securities / private equity gains (losses)
    9       (83 )     381  
Mortgage fees and related income
    1,104       866       803  
Credit card income
    426       230       107  
Other income
    136       31       (28 )
 
Noninterest revenue
    4,625       3,077       2,208  
Net interest income
    10,205       7,714       5,220  
 
Total net revenue
    14,830       10,791       7,428  
 
                       
Provision for credit losses(b)
    724       449       521  
 
                       
Noninterest expense
                       
Compensation expense
    3,337       2,621       1,695  
Noncompensation expense
    4,748       3,937       2,773  
Amortization of intangibles
    500       267       3  
 
Total noninterest expense
    8,585       6,825       4,471  
 
Operating earnings before income tax expense
    5,521       3,517       2,436  
Income tax expense
    2,094       1,318       889  
 
Operating earnings
  $ 3,427     $ 2,199     $ 1,547  
 
Financial ratios
                       
ROE
    26 %     24 %     37 %
ROA
    1.51       1.18       1.05  
Overhead ratio
    58       63       60  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   2005 includes a $250 million special provision related to Hurricane Katrina allocated as follows: $140 million in Consumer Real Estate Lending, $90 million in Consumer & Small Business Banking and $20 million in Auto & Education Finance.
2005 compared with 2004
Operating earnings were $3.4 billion, up $1.2 billion from the prior year. The increase was due largely to the Merger but also reflected increased deposit balances and wider spreads, higher home equity and subprime mortgage balances, and expense savings in all businesses. These benefits were partially
offset by narrower spreads on retained loan portfolios, the special provision for Hurricane Katrina and net losses associated with portfolio loan sales in the Home Finance and Auto businesses.
Net revenue increased to $14.8 billion, up $4.0 billion, or 37%, due primarily to the Merger. Net interest income of $10.2 billion increased by $2.5 billion as a result of the Merger, increased deposit balances and wider spreads, and growth in retained consumer real estate loans. These benefits were offset partially by narrower spreads on loan balances and the absence of loan portfolios sold in late 2004 and early 2005. Noninterest revenue of $4.6 billion increased by $1.5 billion due to the Merger, improved MSR risk management results, higher automobile operating lease income and increased banking fees. These benefits were offset in part by losses on portfolio loan sales in the Home Finance and Auto businesses.
The Provision for credit losses totaled $724 million, up $275 million, or 61%, from 2004. Results included a special provision in 2005 for Hurricane Katrina of $250 million and a release in 2004 of $87 million in the Allowance for loan losses related to the sale of the manufactured home loan portfolio. Excluding these items, the Provision for credit losses would have been down $62 million, or 12%. The decline reflected reductions in the Allowance for loan losses due to improved credit trends in most consumer lending portfolios and the benefit of certain portfolios in run-off. These reductions were partially offset by the Merger and higher provision expense related to the decision to retain subprime mortgage loans.
Noninterest expense rose to $8.6 billion, an increase of $1.8 billion from the prior year, due primarily to the Merger. The increase also reflected continued investment in retail banking distribution and sales, increased depreciation expense on owned automobiles subject to operating leases and a $40 million charge related to the dissolution of a student loan joint venture. Expense savings across all businesses provided a favorable offset.
2004 compared with 2003
Operating earnings were $2.2 billion, up from $1.5 billion a year ago. The increase was due largely to the Merger. Excluding the benefit of the Merger, earnings declined as lower MSR risk management results and reduced prime mortgage production revenue offset the benefits of growth in loan balances, wider spreads on deposit products and improvement in credit costs.
Total net revenue increased to $10.8 billion, up 45% from the prior year. Net interest income increased by 48% to $7.7 billion, primarily due to the Merger, growth in retained loan balances and wider spreads on deposit products. Noninterest revenue increased to $3.1 billion, up 39%, due to the Merger and higher mortgage servicing income. Both components of total revenue included declines associated with risk managing the MSR asset and lower prime mortgage originations.
The Provision for credit losses was down 14% to $449 million despite the impact of the Merger. The effect of the Merger was offset by a reduction in the Allowance for loan losses resulting from the sale of the manufactured home loan portfolio, and continued positive credit quality trends in the consumer lending businesses.
Noninterest expense totaled $6.8 billion, up 53% from the prior year, primarily due to the Merger and continued investment to expand the branch network. Partially offsetting the increase were merger-related expense savings in all businesses.


     
JPMorgan Chase & Co. / 2005 Annual Report   39

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2005     2004     2003  
 
Selected ending balances
                       
Total assets
  $  224,801     $  226,560     $  139,316  
Loans(b)
    197,299       202,473       121,921  
Core deposits(c)
    161,666       156,885       75,850  
Total deposits
    191,415       182,372       86,162  
 
                       
Selected average balances
                       
Total assets
  $ 226,368     $ 185,928     $ 147,435  
Loans(d)
    198,153       162,768       120,750  
Core deposits(c)
    160,641       120,758       80,116  
Total deposits
    186,811       137,404       89,793  
Equity
    13,383       9,092       4,220  
 
                       
Headcount
    60,998       59,632       32,278  
 
                       
Credit data and quality statistics
                       
Net charge-offs(e)
  $ 572     $ 990     $ 381  
Nonperforming loans(f)
    1,338       1,161       569  
Nonperforming assets
    1,518       1,385       775  
Allowance for loan losses
    1,363       1,228       1,094  
 
                       
Net charge-off rate(d)
    0.31 %     0.67 %     0.40 %
Allowance for loan losses to ending loans(b)
    0.75       0.67       1.04  
Allowance for loan losses to nonperforming loans(f)
    104       107       209  
Nonperforming loans to total loans
    0.68       0.57       0.47  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Includes loans held for sale of $16,598 million, $18,022 million and $17,105 million at December 31, 2005, 2004 and 2003, respectively. These amounts are not included in the allowance coverage ratios.
 
(c)   Includes demand and savings deposits.
 
(d)   Average loans include loans held for sale of $15,675 million, $14,736 million and $25,293 million for 2005, 2004 and 2003, respectively. These amounts are not included in the net charge-off rate.
 
(e)   Includes $406 million of charge-offs related to the manufactured home loan portfolio in 2004.
 
(f)   Nonperforming loans include loans held for sale of $27 million, $13 million and $45 million at December 31, 2005, 2004 and 2003, respectively. These amounts are not included in the allowance coverage ratios.
Home Finance
Home Finance is comprised of two key business segments: Prime Production & Servicing and Consumer Real Estate Lending. The Prime Production & Servicing segment includes the operating results associated with the origination, sale and servicing of prime mortgages. Consumer Real Estate Lending reflects the operating results of consumer loans that are secured by real estate, retained by the Firm and held in the portfolio. This portfolio includes prime and subprime first mortgages, home equity lines and loans, and manufactured home loans. The Firm stopped originating manufactured home loans early in 2004 and sold substantially all of its remaining portfolio in 2004.
Selected income statement data by business
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Prime production and servicing
                       
Production
  $   692     $   728     $  1,339  
Servicing:
                       
Mortgage servicing revenue, net of amortization
    635       651       453  
MSR risk management results(b)
    283       113       784  
 
Total net revenue
    1,610       1,492       2,576  
Noninterest expense
    943       1,115       1,124  
Operating earnings
    422       240       918  
 
                       
Consumer real estate lending
                       
Total net revenue
    2,704       2,376       1,473  
Provision for credit losses
    298       74       240  
Noninterest expense
    940       922       606  
Operating earnings
    935       881       414  
 
                       
Total Home Finance
                       
Total net revenue
    4,314       3,868       4,049  
Provision for credit losses
    298       74       240  
Noninterest expense
    1,883       2,037       1,730  
Operating earnings
    1,357       1,121       1,332  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   For additional information, see page 42 of this Annual Report.
2005 compared with 2004
Operating earnings were $1.4 billion, up $236 million from the prior year, primarily due to the Merger, higher loan balances, reduced expenses and improved MSR risk management results.
Operating earnings for the Prime Production & Servicing segment totaled $422 million, up $182 million from the prior year. Net revenue of $1.6 billion increased by $118 million, reflecting improved MSR risk management results. The increase in MSR risk management results was due in part to the absence of prior-year securities losses on repositioning of the risk management asset. Decreased mortgage production revenue attributable to lower volume partially offset this benefit. Noninterest expense of $943 million decreased by $172 million, reflecting lower production volume and operating efficiencies.
Operating earnings for the Consumer Real Estate Lending segment increased by $54 million to $935 million. The current year included a loss of $120 million associated with the transfer of $3.3 billion of mortgage loans to held-for-sale, and a $140 million special provision related to Hurricane Katrina. Prior-year results included a $95 million net benefit associated with the sale of a $4.0 billion manufactured home loan portfolio and a $52 million charge related to a transfer of adjustable rate mortgage loans to held-for-sale. Excluding the after-tax impact of these items, earnings would have been up $242 million, reflecting the Merger, higher loan balances and lower expenses, partially offset by loan spread compression due to rising short-term interest rates and a flat yield curve, which contributed to accelerated home equity loan payoffs.
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 instruments used in this risk management activity change over time as market conditions and approach dictate.


     
40   JPMorgan Chase & Co. / 2005 Annual Report

 


 

During 2005, positive MSR valuation adjustments of $777 million were partially offset by losses of $494 million on risk management instruments, including net interest earned on AFS securities. In 2004, negative MSR valuation adjustments of $248 million were more than offset by $361 million of aggregate risk management gains, including net interest earned on AFS securities. Unrealized losses on AFS securities were $174 million, $3 million and $144 million at December 31, 2005, 2004 and 2003, respectively. For a further discussion of MSRs, see Critical accounting estimates on page 83 and Note 15 on pages 114–116 of this Annual Report.
2004 compared with 2003
Operating earnings in the Prime Production & Servicing segment dropped to $240 million from $918 million in the prior year. Results reflected a decrease in prime mortgage production revenue, to $728 million from $1.3 billion, due to a decline in mortgage originations. Operating earnings were also adversely affected by a drop in MSR risk management revenue, to $113 million from $784 million in the prior year. Results in 2004 included realized losses of $89 million on the sale of AFS securities associated with the risk management of the MSR asset, compared with securities gains of $359 million in the prior year. Noninterest expense was relatively flat at $1.1 billion.
Operating earnings for the Consumer Real Estate Lending segment more than doubled to $881 million from $414 million in the prior year. The increase was largely due to the addition of the Bank One home equity lending business but also reflected growth in retained loan balances and a $95 million net benefit associated with the sale of the $4 billion manufactured home loan portfolio; partially offsetting these increases were lower subprime mortgage securitization gains as a result of management’s decision in 2004 to retain these loans. These factors contributed to total net revenue rising 61% to $2.4 billion. The provision for credit losses, at $74 million, decreased by 69% from a year ago. This improvement was the result of an $87 million reduction in the allowance for loan losses associated with the manufactured home loan portfolio sale, improved credit quality and lower delinquencies, partially offset by the Merger. Noninterest expense totaled $922 million, up 52% from the year-ago period, largely due to the Merger.

Home Finance’s origination channels are comprised of the following:
Retail – Borrowers who are buying or refinancing a home are directly contacted by a mortgage banker employed by the Firm using a branch office, the Internet or by phone. Borrowers are frequently referred to a mortgage banker by real estate brokers, home builders or other third parties.
Wholesale – A third-party mortgage broker refers loan applications to a mortgage banker at the Firm. Brokers are independent loan originators that specialize in finding and counseling borrowers but do not provide funding for loans.
Correspondent – Banks, thrifts, other mortgage banks and other financial institutions sell closed loans to the Firm.
Correspondent negotiated transactions (“CNT”) – Mid- to large-sized mortgage lenders, banks and bank-owned mortgage companies sell servicing to the Firm on an as-originated basis. These transactions supplement traditional production channels and provide growth opportunities in the servicing portfolio in stable and rising-rate periods.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except ratios and                  
where otherwise noted)   2005     2004     2003  
 
Origination volume by channel (in billions)
                       
Retail
  $ 83.9     $ 74.2     $ 90.8  
Wholesale
    50.4       48.5       65.6  
Correspondent
    14.0       22.8       44.5  
Correspondent negotiated transactions
    34.5       41.5       83.3  
 
Total
    182.8       187.0       284.2  
Origination volume by business (in billions)
                       
Mortgage
  $  128.7     $  144.6     $  259.5  
Home equity
    54.1       42.4       24.7  
 
Total
    182.8       187.0       284.2  
 
                       
Business metrics (in billions)
                       
Third-party mortgage loans serviced (ending)(b)
  $ 467.5     $ 430.9     $ 393.7  
MSR net carrying value (ending)
    6.5       5.1       4.8  
End-of-period loans owned
                       
Mortgage loans held-for-sale
    13.7       14.2       15.9  
Mortgage loans retained
    43.0       42.6       34.5  
Home equity and other loans
    76.8       67.9       24.1  
 
Total end of period loans owned
    133.5       124.7       74.5  
Average loans owned
                       
Mortgage loans held-for-sale
    12.1       12.1       23.5  
Mortgage loans retained
    46.4       40.7       32.0  
Home equity and other loans
    70.2       47.0       19.4  
 
Total average loans owned
    128.7       99.8       74.9  
Overhead ratio
    44 %     53 %     43 %
 
                       
Credit data and quality statistics
                       
30+ day delinquency rate(c)
    1.61 %     1.27 %     1.81 %
Net charge-offs
                       
Mortgage
  $ 25     $ 19     $ 26  
Home equity and other loans(d)
    129       554       109  
 
Total net charge-offs
    154       573       135  
Net charge-off rate
                       
Mortgage
    0.05 %     0.05 %     0.08 %
Home equity and other loans
    0.18       1.18       0.56  
Total net charge-off rate(e)
    0.13       0.65       0.26  
Nonperforming assets(f)
  $ 998     $ 844     $ 546  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Includes prime first mortgage loans and subprime loans.
 
(c)   Excludes delinquencies related to loans eligible for repurchase as well as loans repurchased from GNMA pools that are insured by government agencies of $0.9 billion, $0.9 billion and $0.1 billion, for December 31, 2005, 2004 and 2003, respectively. These amounts are excluded as reimbursement is proceeding normally.
 
(d)   Includes $406 million of charge-offs related to the manufactured home loan portfolio in 2004.
 
(e)   Excludes mortgage loans held for sale.
 
(f)   Excludes nonperforming assets related to loans eligible for repurchase as well as loans repurchased from GNMA pools that are insured by government agencies of $1.1 billion, $1.5 billion and $2.3 billion for December 31, 2005, 2004 and 2003, respectively. These amounts are excluded as reimbursement is proceeding normally.


     
JPMorgan Chase & Co. / 2005 Annual Report   41

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.
The table below reconciles management’s disclosure of Home Finance’s revenue into the reported U.S. GAAP line items shown on the Consolidated statements of income and in the related Notes to Consolidated financial statements:
                                                                         
Year ended December 31,(a)   Prime production and servicing     Consumer real estate lending     Total revenue  
(in millions)   2005     2004     2003     2005     2004     2003     2005     2004     2003  
 
Net interest income
  $ 426     $ 700     $ 1,556     $ 2,672     $ 2,245     $ 1,226     $ 3,098     $ 2,945     $ 2,782  
Securities / private equity gains (losses)
    3       (89 )     359                         3       (89 )     359  
Mortgage fees and related income(b)
    1,181       881       661       32       131       247       1,213       1,012       908  
 
Total
  $ 1,610     $ 1,492     $ 2,576     $ 2,704     $ 2,376     $ 1,473     $ 4,314     $ 3,868     $ 4,049  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 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
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Reported amounts:
                       
MSR valuation adjustments(b)
  $   777     $   (248 )   $   (253 )
Derivative valuation adjustments and other risk management gains (losses)(c)
    (494 )     361       1,037  
 
MSR risk management results
  $ 283     $ 113     $ 784  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Excludes subprime loan MSR activity of $(7) million and $(2) million in 2005 and 2004, respectively. There was no subprime loan MSR activity in 2003.
 
(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.
Consumer & Small Business Banking
Consumer & Small Business Banking offers a full array of financial services through a branch network spanning 17 states as well as through the Internet. Product offerings include checking and savings accounts, mutual funds and annuities, credit cards, mortgages and home equity loans, and loans for small business customers (customers with annual sales generally less than $10 million).
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Noninterest revenue
  $  2,929     $  1,864     $ 828  
Net interest income
    5,476       3,521        1,594  
 
Total net revenue
    8,405       5,385       2,422  
Provision for credit losses
    214       165       76  
Noninterest expense
    5,431       3,981       2,358  
Operating earnings (loss)
    1,684       760       (4 )
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
Operating earnings totaled $1.7 billion, up $924 million from the prior year. While growth largely reflected the Merger, results also included increased deposit balances and wider spreads, as well as higher debit card and other banking fees. These factors contributed to net revenue increasing to $8.4 billion from $5.4 billion in the prior year. The Provision for credit losses of $214 million increased by $49 million; excluding the special provision of $90 million related to Hurricane Katrina, the Provision would have decreased by $41 million from the prior year, reflecting lower net charge-offs and improved credit quality trends. Noninterest expense increased by $1.5 billion to $5.4 billion, as a result of the Merger and continued investment in branch distribution and sales, partially offset by merger efficiencies.
2004 compared with 2003
Operating earnings totaled $760 million, up from a loss of $4 million in the prior-year period. The increase was largely due to the Merger but also reflected wider spreads on deposits and lower expenses. These benefits were partially offset by a higher Provision for credit losses.
Total net revenue was $5.4 billion, compared with $2.4 billion in the prior year. While the increase was primarily attributable to the Merger, total net revenue also benefited from wider spreads on deposits.
The Provision for credit losses increased to $165 million from $76 million in the prior year. The increase was in part due to the Merger but also reflected an increase in the allowance for credit losses to cover high-risk portfolio segments.
The increase in Noninterest expense to $4.0 billion was largely attributable to the Merger. Incremental expense from investment in the branch distribution network was also a contributing factor.


     
42   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except ratios and                  
where otherwise noted)   2005     2004     2003  
 
Business metrics (in billions)
                       
Selected ending balances
                       
Small business loans
  $ 12.7     $ 12.5     $ 2.2  
Consumer and other loans(b)
    1.7       2.2       2.0  
 
Total loans
    14.4       14.7       4.2  
Core deposits(c)
    152.3       146.3       66.4  
Total deposits
    181.9       171.8       76.7  
 
                       
Selected average balances
                       
Small business loans
  $ 12.4     $ 7.3     $ 2.1  
Consumer and other loans(b)
    2.0       2.1       2.0  
 
Total loans
    14.4       9.4       4.1  
Core deposits(c)
    149.0       109.6       64.8  
Total deposits
    175.1       126.2       74.4  
 
                       
Number of:
                       
Branches
    2,641       2,508       561  
ATMs
    7,312       6,650       1,931  
Personal bankers
    7,067       5,750       1,820  
Personal checking accounts (in thousands)(d)
    7,869       7,235       1,984  
Business checking accounts (in thousands)(d)
    924       889       347  
Active online customers (in thousands)
    4,231       3,359     NA  
Debit cards issued (in thousands)
    9,266       8,392       2,380  
Overhead ratio
    65 %     74 %     97 %
 
                       
Retail brokerage business metrics
                       
Investment sales volume
  $  11,144     $    7,324     $    3,579  
Number of dedicated investment sales representatives
    1,449       1,364       349  
 
                       
Credit data and quality statistics
                       
Net charge-offs
                       
Small business
  $ 101     $ 77     $ 35  
Consumer and other loans
    40       77       40  
 
Total net charge-offs
    141       154       75  
Net charge-off rate
                       
Small business
    0.81 %     1.05 %     1.67 %
Consumer and other loans
    2.00       3.67       2.00  
Total net charge-off rate
    0.98       1.64       1.83  
Nonperforming assets
  $ 283     $ 299     $ 72  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Primarily community development loans.
 
(c)   Includes demand and savings deposits.
 
(d)   Prior periods amounts have been restated to reflect inactive accounts that should have been closed during those periods.
Auto & Education Finance
Auto & Education Finance provides automobile loans and leases to consumers and loans to commercial clients, primarily through a national network of automotive dealers. The segment is also a top provider of loans to students at colleges and universities across the United States.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Total net revenue
  $  1,467     $  1,145     $     842  
Provision for credit losses
    212       210       205  
Noninterest expense
    751       490       291  
Operating earnings
    307       270       206  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
2005 compared with 2004
Operating earnings were $307 million, up $37 million from the prior year. The current year included a net loss of $83 million associated with a $2.3 billion auto loan securitization; a net loss of $42 million associated with a $1.5 billion auto loan securitization; a $40 million charge related to the dissolution of a student loan joint venture; a benefit of $34 million from the sale of a $2 billion recreational vehicle loan portfolio; and the $20 million special provision for credit losses related to Hurricane Katrina. The prior-year results included charges of $65 million related to auto lease residuals. Excluding the after-tax impact of these items, operating earnings would have increased by $90 million over the prior year, primarily due to the Merger and improved credit quality. Results continued to reflect lower production volumes and narrower spreads.
2004 compared with 2003
Operating earnings totaled $270 million, up 31% from the prior year. The increase was due to the Merger, offset by narrower spreads and reduced origination volumes reflecting a competitive operating environment.
Total net revenue increased by 36% to $1.1 billion from the prior year. This increase was due to the Merger, which more than offset a decline in net interest income, reflecting the competitive operating environment in 2004, and incremental charges associated with the Firm’s auto lease residual exposure.


The following is a brief description of selected terms used by Consumer & Small Business Banking.
  Personal bankers – Retail branch office personnel who acquire, retain and expand new and existing customer relationships by assessing customer needs and recommending and selling appropriate banking products and services.
 
  Investment sales representatives – Licensed retail branch sales personnel, assigned to support several branches, who assist with the sale of investment products including college planning accounts, mutual funds, annuities and retirement accounts.
     
JPMorgan Chase & Co. / 2005 Annual Report   43

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

The Provision for credit losses totaled $210 million, up 2% from the prior year. The increase was due to the Merger but was largely offset by a lower Provision for credit losses, reflecting favorable credit trends.
Noninterest expense increased by 68% to $490 million, largely due to the Merger.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except ratios and                  
  where otherwise noted)   2005     2004     2003  
 
Business metrics (in billions)
                       
End-of-period loans and lease related assets
Loans outstanding
  $ 44.7     $ 54.6     $ 33.7  
Lease related assets(b)
    5.2       8.0       9.5  
 
Total end-of-period loans and lease related assets
    49.9       62.6       43.2  
Average loans and lease related assets
                       
Loans outstanding(c)
  $ 48.5     $ 44.3     $ 32.0  
Lease related assets(d)
    6.6       9.0       9.7  
 
Total average loans and lease related assets(c)(d)
    55.1       53.3       41.7  
 
                       
Overhead ratio
    51 %     43 %     35 %
 
                       
Credit quality statistics
                       
30+ day delinquency rate
    1.65 %     1.55 %     1.42 %
Net charge-offs
                       
Loans
  $ 257     $ 219     $ 130  
Lease receivables(d)
    20       44       41  
 
Total net charge-offs
    277       263       171  
Net charge-off rate
                       
Loans(c)
    0.57 %     0.52 %     0.43 %
Lease receivables
    0.32       0.49       0.42  
Total net charge-off rate(c)
    0.54       0.52       0.43  
Nonperforming assets
  $ 237     $ 242     $ 157  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   Includes operating lease-related assets of $0.9 billion for 2005. Balances prior to January 1, 2005, were insignificant.
(c)   Average loans include loans held for sale of $3.5 billion, $2.3 billion and $1.8 billion for, 2005, 2004 and 2003, respectively. These are not included in the net charge-off rate.
(d)   Includes operating lease-related assets of $0.4 billion for 2005. Balances prior to January 1, 2005, were insignificant. These are not included in the net charge-off rate.
Insurance
Insurance is a provider of financial protection products and services, including life insurance, annuities and debt protection. Products and services are distributed through both internal lines of business and external markets. On February 7, 2006, the Firm signed a definitive agreement to sell its life insurance and annuity underwriting business.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Total net revenue
  $ 644     $ 393     $ 115  
Noninterest expense
    520       317       92  
Operating earnings
    79       48       13  
Memo: Consolidated gross
insurance-related revenue(b)
    1,642       1,191          611  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   Includes revenue reported in the results of other businesses.
2005 compared with 2004
Operating earnings totaled $79 million, an increase of $31 million from the prior year, on net revenues of $644 million. The increase was due primarily to the Merger. Results also reflected an increase in proprietary annuity sales commissions paid and lower expenses from merger savings and other efficiencies.
2004 compared with 2003
Operating earnings totaled $48 million on Total net revenue of $393 million in 2004. The increases in Total net revenue and Noninterest expense over the prior year were due almost entirely to the Merger.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except where otherwise noted)   2005     2004     2003  
 
Business metrics – ending balances
                       
Invested assets
  $ 7,767     $ 7,368     $ 1,559  
Policy loans
    388       397        
Insurance policy and claims reserves
    7,774       7,279       1,096  
Term life sales – first year annualized premiums
    60       28        
Term life premium revenues
    477       234        
Proprietary annuity sales
    706       208       548  
Number of policies in force – direct/assumed (in thousands)
    2,441       2,611       631  
Insurance in force – direct/assumed
  $ 282,903     $ 277,827     $ 31,992  
Insurance in force – retained
    87,753       80,691       31,992  
A.M. Best rating
    A       A       A  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.


The following is a brief description of selected business metrics within Insurance.
  Proprietary annuity sales represent annuity contracts marketed through and issued by subsidiaries of the Firm.
 
  Insurance in force – direct/assumed includes the aggregate face amount of insurance policies directly underwritten and assumed through reinsurance.
 
  Insurance in force – retained includes the aggregate face amounts of insurance policies directly underwritten and assumed through reinsurance, after reduction for face amounts ceded to reinsurers.
     
44   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Card Services
 

Card Services is one of the largest issuers of credit cards in the United States, with more than 110 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.
JPMorgan Chase uses the concept of “managed receivables” to evaluate the credit 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 receivables sold under SFAS 140 and those not sold. Thus, in its disclosures regarding managed 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.
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
                         
Year ended December 31,(a)(b)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Asset management, administration and commissions
  $     $ 75     $ 108  
Credit card income
    3,351       2,179       930  
Other income
    212       117       54  
 
Noninterest revenue
    3,563       2,371       1,092  
Net interest income
    11,803       8,374       5,052  
 
Total net revenue
    15,366       10,745       6,144  
 
                       
Provision for credit losses(c)
    7,346       4,851       2,904  
 
                       
Noninterest expense
                       
Compensation expense
    1,081       893       582  
Noncompensation expense
    3,170       2,485       1,336  
Amortization of intangibles
    748       505       260  
 
Total noninterest expense
    4,999       3,883       2,178  
 
Operating earnings before income tax expense
    3,021       2,011       1,062  
Income tax expense
    1,114       737       379  
 
Operating earnings
  $ 1,907     $ 1,274     $ 683  
 
Memo: Net securitization gains (amortization)
  $ 56     $ (8 )   $ 1  
Financial metrics
                       
ROE
    16 %     17 %     20 %
Overhead ratio
    33       36       35  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   As a result of the integration of Chase Merchant Services and Paymentech merchant processing businesses into a joint venture, beginning in the fourth quarter of 2005, Total net revenue, Noninterest expense and pre-tax earnings have been reduced to reflect the deconsolidation of Paymentech. There is no impact to operating earnings.
(c)   2005 includes a $100 million special provision related to Hurricane Katrina.
2005 compared with 2004
Operating earnings of $1.9 billion were up $633 million, or 50%, from the prior year due to the Merger. In addition, lower expenses driven by merger savings, stronger underlying credit quality and higher revenue from increased loan balances and charge volume were partially offset by the impact of increased bankruptcies.
Net revenue was $15.4 billion, up $4.6 billion, or 43%. Net interest income was $11.8 billion, up $3.4 billion, or 41%, primarily due to the Merger, and the acquisition of a private label portfolio. In addition, higher loan balances were partially offset by narrower loan spreads and the reversal of revenue related to increased bankruptcies. Noninterest revenue of $3.6 billion was up $1.2 billion, or 50%, due to the Merger and higher interchange income from higher charge volume, partially offset by higher volume-driven payments to partners, higher expense related to rewards programs and the impact of the deconsolidation of Paymentech.
The Provision for credit losses was $7.3 billion, up $2.5 billion, or 51%, primarily due to the Merger, and included the acquisition of a private label portfolio. The provision also increased due to record bankruptcy-related net charge-offs resulting from the new bankruptcy legislation, which became effective on October 17, 2005. Finally, the Allowance for loan losses was increased in part by the special provision for credit losses related to Hurricane Katrina. These factors were partially offset by lower contractual net charge-offs. Despite a record level of bankruptcy losses, the net charge-off rate improved. The managed net charge-off rate was 5.21%, down from 5.27% in the prior year. The 30-day managed delinquency rate was 2.79%, down from 3.70% in the prior year, driven primarily by accelerated loss recognition of delinquent accounts as a result of the bankruptcy reform legislation and strong underlying credit quality.
Noninterest expense of $5.0 billion increased by $1.1 billion, or 29%, primarily due to the Merger, which included the acquisition of a private label portfolio. Merger savings, including lower processing and compensation costs and the impact of the deconsolidation of Paymentech, were partially offset by higher spending on marketing.
2004 compared with 2003
Operating earnings of $1.3 billion increased by $591 million compared with the prior year, primarily due to the Merger. In addition, earnings benefited from higher loan balances and charge volume, partially offset by a higher Provision for credit losses and higher expenses.
Total net revenue of $10.7 billion increased by $4.6 billion. Net interest income of $8.4 billion increased by $3.3 billion, primarily due to the Merger and higher loan balances. Noninterest revenue of $2.4 billion increased by $1.3 billion, primarily due to the Merger and increased interchange income resulting from higher charge-off volume. These factors were partially offset by higher volume-driven payments to partners, reflecting the sharing of income and increased rewards expense.
The Provision for credit losses of $4.9 billion increased by $1.9 billion, primarily due to the Merger and growth in credit card receivables. Credit ratios remained strong, benefiting from reduced contractual and bankruptcy charge-offs. The net charge-off ratio was 5.27%. The 30-day delinquency ratio was 3.70%.
Noninterest expense of $3.9 billion increased by $1.7 billion, primarily related to the Merger. In addition, expenses increased due to higher marketing expenses and volume-based processing expenses, partially offset by lower compensation expenses.


     
JPMorgan Chase & Co. / 2005 Annual Report   45

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount, ratios                  
and where otherwise noted)   2005     2004     2003  
 
% of average managed outstandings:
                       
Net interest income
    8.65 %     9.16 %     9.95 %
Provision for credit losses
    5.39       5.31       5.72  
Noninterest revenue
    2.61       2.59       2.15  
Risk adjusted margin(b)
    5.88       6.45       6.38  
Noninterest expense
    3.67       4.25       4.29  
Pre-tax income (ROO)
    2.21       2.20       2.09  
Operating earnings
    1.40       1.39       1.35  
 
                       
Business metrics
                       
Charge volume (in billions)
  $ 301.9     $ 193.6     $ 88.2  
Net accounts opened (in thousands)
    21,056       7,523       4,177  
Credit cards issued (in thousands)
    110,439       94,285       35,103  
Number of registered Internet customers
(in millions)
    14.6       13.6       3.7  
Merchant acquiring business(c)
Bank card volume (in billions)
  $ 563.1     $ 396.2     $ 261.2  
Total transactions (in millions)(d)
    15,499       9,049       4,254  
 
                       
Selected ending balances
                       
Loans:
                       
Loans on balance sheets
  $ 71,738     $ 64,575     $   17,426  
Securitized loans
    70,527       70,795       34,856  
 
Managed loans
  $ 142,265     $ 135,370     $ 52,282  
 
Selected average balances
                       
Managed assets
  $ 141,933     $ 94,741     $ 51,406  
Loans:
                       
Loans on balance sheets
  $ 67,334     $ 38,842     $ 17,604  
Securitized loans
    69,055       52,590       33,169  
 
Managed loans
  $ 136,389     $ 91,432     $ 50,773  
 
Equity
    11,800       7,608       3,440  
 
                       
Headcount
    18,629       19,598       10,612  
 
                       
Credit quality statistics
                       
Net charge-offs
  $ 7,100     $ 4,821     $ 2,996  
Managed net charge-off rate
    5.21 %     5.27 %     5.90 %
 
                       
Delinquency ratios
                       
30+ days
    2.79 %     3.70 %     4.68 %
90+ days
    1.27       1.72       2.19  
Allowance for loan losses
  $ 3,274     $ 2,994     $ 1,225  
Allowance for loan losses to period-end loans
    4.56 %     4.64 %     7.03 %
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   Represents Total net revenue less Provision for credit losses.
(c)   Represents 100% of the merchant acquiring business.
(d)   Prior periods have been restated to conform methodologies following the integration of Chase Merchant Services and Paymentech merchant processing businesses.
The financial information presented below reconciles reported basis and managed basis to disclose the effect of securitizations.
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Income statement data
                       
Credit card income
                       
Reported data for the period
  $ 6,069     $ 4,446     $ 2,309  
Securitization adjustments
    (2,718 )     (2,267 )     (1,379 )
 
Managed credit card income
  $ 3,351     $ 2,179     $ 930  
 
Other income
Reported data for the period
  $ 212     $ 203     $ 125  
Securitization adjustments
          (86 )     (71 )
 
Managed other income
  $ 212     $ 117     $ 54  
 
Net interest income
                       
Reported data for the period
  $ 5,309     $ 3,123     $ 1,732  
Securitization adjustments
    6,494       5,251       3,320  
 
Managed net interest income
  $ 11,803     $ 8,374     $ 5,052  
 
Total net revenue(b)
                       
Reported data for the period
  $ 11,590     $ 7,847     $ 4,274  
Securitization adjustments
    3,776       2,898       1,870  
 
Managed total net revenue
  $ 15,366     $ 10,745     $ 6,144  
 
Provision for credit losses
                       
Reported data for the period(c)
  $ 3,570     $ 1,953     $ 1,034  
Securitization adjustments
    3,776       2,898       1,870  
 
Managed provision for credit losses
  $ 7,346     $ 4,851     $ 2,904  
 
Balance sheet – average balances
                       
Total average assets
                       
Reported data for the period
  $ 74,753     $ 43,657     $ 19,041  
Securitization adjustments
    67,180       51,084       32,365  
 
Managed average assets
  $ 141,933     $ 94,741     $ 51,406  
 
Credit quality statistics
                       
Net charge-offs
                       
Reported net charge-offs data for the period
  $ 3,324     $ 1,923     $ 1,126  
Securitization adjustments
    3,776       2,898       1,870  
 
Managed net charge-offs
  $ 7,100     $ 4,821     $ 2,996  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   Includes noninterest revenue and Net interest income.
(c)   2005 includes a $100 million special provision related to Hurricane Katrina.

The following is a brief description of selected business metrics within Card Services.
  Charge volume – Represents the dollar amount of cardmember purchases, balance transfers and cash advance activity.
 
  Net accounts opened – Includes originations, portfolio purchases and sales.
 
  Merchant acquiring business – Represents an entity that processes payments for merchants. JPMorgan Chase is a partner in Chase Paymentech Solutions, LLC.
 
  Bank card volume – Represents the dollar amount of transactions processed for the merchants.
 
  Total transactions — Represents the number of transactions and authorizations processed for the merchants.


     
46   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Commercial Banking
 

Commercial Banking serves more than 25,000 clients, including corporations, municipalities, financial institutions and not-for-profit entities with annual revenues generally ranging from $10 million to $2 billion. While most Middle Market clients are within the Retail Financial Services footprint, CB also covers larger corporations, as well as local governments and financial institutions on a national basis. CB is a market leader with superior client penetration across the businesses it serves. Local market presence, coupled with industry expertise and excellent client service and risk management, enable CB to offer superior financial advice. Partnership with other JPMorgan Chase businesses positions CB to deliver broad product capabilities – including lending, treasury services, investment banking, and asset and wealth management – and meet its clients’ financial needs.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Lending & deposit related fees
  $ 575     $ 441     $ 301  
Asset management, administration and commissions
    60       32       19  
Other income(b)
    351       209       73  
 
Noninterest revenue
    986       682       393  
Net interest income
    2,610       1,692       959  
 
Total net revenue
    3,596       2,374       1,352  
 
                       
Provision for credit losses(c)
    73       41       6  
 
                       
Noninterest expense
                       
Compensation expense
    661       465       285  
Noncompensation expense
    1,146       843       534  
Amortization of intangibles
    65       35       3  
 
Total noninterest expense
    1,872       1,343       822  
 
Operating earnings before income tax expense
    1,651       990       524  
Income tax expense
    644       382       217  
 
Operating earnings
  $ 1,007     $ 608     $ 307  
 
Financial ratios
                       
ROE
    30 %     29 %     29 %
ROA
    1.78       1.67       1.87  
Overhead ratio
    52       57       61  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   IB-related and commercial card revenues are included in Other income.
(c)   2005 includes a $35 million special provision related to Hurricane Katrina.
Commercial Banking operates in 10 of the top 15 major U.S. metropolitan areas and is divided into three customer segments: Middle Market Banking, Mid-Corporate Banking and Real Estate. General coverage for corporate clients is provided by Middle Market Banking, which covers clients with annual revenues generally up to $500 million. Mid-Corporate Banking covers clients with annual revenues generally ranging between $500 million and $2 billion and focuses on clients that have broader investment banking needs. The third segment, Real Estate, serves investors in, and developers of, for-sale housing, multifamily rental, retail, office, and industrial properties. In addition to these
three customer segments, Commercial Banking offers several products to the Firm’s entire customer base: Chase Business Credit, the #1 asset-based lender for 2005, provides asset-based financing, syndications, and collateral analysis, and Chase Equipment Leasing offers a variety of equipment finance and leasing products, with specialties in aircraft finance, public sector, and information technology. Given this structure, Commercial Banking manages a customer base and loan portfolio that is highly diversified across a broad range of industries and geographic locations.
2005 compared with 2004
Operating earnings of $1.0 billion were up $399 million from the prior year, primarily due to the Merger.
Net revenue of $3.6 billion increased by $1.2 billion, or 51%, primarily as a result of the Merger. In addition to the overall increase from the Merger, Net interest income of $2.6 billion was positively affected by wider spreads on higher volume related to liability balances and increased loans, partially offset by narrower loan spreads. Noninterest revenue of $986 million was lower due to a decline in deposit-related fees due to higher interest rates, partially offset by increased investment banking revenue.
Each business within Commercial Banking demonstrated revenue growth over the prior year, primarily due to the Merger. Middle Market revenue was $2.4 billion, an increase of $870 million over the prior year; Mid-Corporate Banking revenue was $548 million, an increase of $181 million; and Real Estate revenue was $534 million, up $166 million. In addition to the Merger, revenue was higher for each business due to wider spreads and higher volume related to liability balances and increased investment banking revenue, partially offset by narrower loan spreads.
Provision for credit losses of $73 million increased by $32 million, primarily due to a special provision related to Hurricane Katrina, increased loan balances and refinements in the data used to estimate the allowance for credit losses. The credit quality of the portfolio was strong with net charge-offs of $26 million, down $35 million from the prior year, and nonperforming loans of $272 million, down $255 million.
Noninterest expense of $1.9 billion increased by $529 million, or 39%, primarily due to the Merger and to an increase in allocated unit costs for Treasury Services products.
2004 compared with 2003
Operating earnings were $608 million, an increase of 98%, primarily due to the Merger.
Total net revenue was $2.4 billion, an increase of 76%, primarily due to the Merger. In addition to the overall increase related to the Merger, Net interest income of $1.7 billion was positively affected by higher liability balances, partially offset by lower lending-related revenue. Noninterest revenue of $682 million was positively affected by higher investment banking fees and higher gains on the sale of loans and securities acquired in satisfaction of debt, partially offset by lower deposit-related fees, which often decline as interest rates rise.
The Provision for credit losses was $41 million, an increase of $35 million, primarily due to the Merger. Excluding the impact of the Merger, the provision was higher in 2004. Lower net charge-offs in 2004 were partially offset by smaller reductions in the allowance for credit losses in 2004 relative to 2003.


     
JPMorgan Chase & Co. / 2005 Annual Report   47

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Noninterest expense was $1.3 billion, an increase of $521 million, or 63%, primarily related to the Merger.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2005     2004     2003  
 
Revenue by product:
                       
Lending
  $ 1,076     $ 764     $ 396  
Treasury services
    2,299       1,467       896  
Investment banking
    213       120       66  
Other
    8       23       (6 )
 
Total Commercial Banking revenue
    3,596       2,374       1,352  
 
                       
Revenue by business:
                       
Middle Market Banking
  $ 2,369     $ 1,499     $ 772  
Mid-Corporate Banking
    548       367       194  
Real Estate
    534       368       206  
Other
    145       140       180  
 
Total Commercial Banking revenue
    3,596       2,374       1,352  
 
                       
Selected average balances
                       
Total assets
  $ 56,561     $ 36,435     $ 16,460  
Loans and leases
    51,797       32,417       14,049  
Liability balances(b)
    73,395       52,824       32,880  
Equity
    3,400       2,093       1,059  
 
Average loans by business:
                       
Middle market
  $ 31,156     $ 17,471     $ 5,609  
Mid-corporate banking
    6,375       4,348       2,880  
Real estate
    10,639       7,586       2,831  
Other
    3,627       3,012       2,729  
 
Total Commercial Banking loans
    51,797       32,417       14,049  
 
                       
Headcount
    4,456       4,555       1,730  
 
                       
Credit data and quality statistics:
                       
Net charge-offs
  $ 26     $ 61     $ 76  
Nonperforming loans
    272       527       123  
Allowance for loan losses
    1,392       1,322       122  
Allowance for lending-related commitments
    154       169       26  
 
                       
Net charge-off rate
    0.05 %     0.19 %     0.54 %
Allowance for loan losses to average loans
    2.69       4.08       0.87  
Allowance for loan losses to nonperforming loans
    512       251       99  
Nonperforming loans to average loans
    0.53       1.63       0.88  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   Liability balances include deposits and deposits swept to on-balance sheet liabilities.

Commercial Banking revenues are comprised of the following:
Lending includes a variety of financing alternatives, which are often provided on a basis secured by receivables, inventory, equipment, real estate or other assets. Products include:
  Term loans
 
  Revolving lines of credit
 
  Bridge financing
 
  Asset-based structures
 
  Leases
Treasury services includes a broad range of products and services enabling clients to transfer, invest and manage the receipt and disbursement of funds, while providing the related information reporting. These products and services include:
  U.S. dollar and multi-currency clearing
 
  ACH
 
  Lockbox
 
  Disbursement and reconciliation services
 
  Check deposits
 
  Other check and currency-related services
 
  Trade finance and logistics solutions
 
  Commercial card
 
  Deposit products, sweeps and money market mutual funds
Investment banking products provide clients with sophisticated capital-raising alternatives, as well as balance sheet and risk management tools, through:
  Loan syndications
 
  Investment-grade debt
 
  Asset-backed securities
 
  Private placements
 
  High-yield bonds
 
  Equity underwriting
 
  Advisory
 
  Interest rate derivatives
 
  Foreign exchange hedges


     
48   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Treasury & Securities Services
 

Treasury & Securities Services is a global leader in providing transaction, investment and information services to support the needs of corporations, issuers and institutional investors worldwide. TSS is one of the largest cash management providers in the world and a leading global custodian. The TS business provides a variety of cash management products, trade finance and logistics solutions, wholesale card products, and short-term liquidity management tools. The IS business provides custody, fund services, securities lending, and performance measurement and execution products. The ITS business provides trustee, depository and administrative services for debt and equity issuers. TS partners with the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management businesses to serve clients firmwide. As a result, certain TS revenues are included in other segments’ results. TSS combined the management of the IS and ITS businesses under the name WSS to create an integrated franchise which provides custody and investor services as well as securities clearance and trust services to clients globally. Beginning January 1, 2006, TSS will report results for two divisions: TS and WSS.
Selected income statement data
                         
Year ending December 31,(a)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Lending & deposit related fees
  $ 728     $ 647     $ 470  
Asset management, administration and commissions
    2,908       2,445       1,903  
Other income
    543       382       288  
 
Noninterest revenue
    4,179       3,474       2,661  
Net interest income
    2,062       1,383       947  
 
Total net revenue
    6,241       4,857       3,608  
 
                       
Provision for credit losses
          7       1  
Credit reimbursement (to) from IB(b)
    (154 )     (90 )     36  
 
                       
Noninterest expense
                       
Compensation expense
    2,061       1,629       1,257  
Noncompensation expense
    2,293       2,391       1,745  
Amortization of intangibles
    116       93       26  
 
Total noninterest expense
    4,470       4,113       3,028  
 
Operating earnings before income tax expense
    1,617       647       615  
Income tax expense
    580       207       193  
 
Operating earnings
  $ 1,037     $ 440     $ 422  
 
Financial ratios
                       
ROE
    55 %     17 %     15 %
Overhead ratio
    72       85       84  
Pre-tax margin ratio(c)
    26       13       17  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(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 35 of this Annual Report.
(c)   Pre-tax margin represents Operating earnings before income tax expense 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’ earnings, after all operating costs are taken into consideration.
2005 compared with 2004
Operating earnings were $1.0 billion, an increase of $597 million, or 136%. Primarily driving the improvement in revenue were the Merger, business growth, and widening spreads on and growth in average liability balances. Noninterest expense increased primarily due to the Merger and higher compensation expense. Results for 2005 also included charges of $58 million (after-tax) to terminate a client contract. Results for 2004 also included software-impairment charges of $97 million (after-tax) and a gain of $10 million (after-tax) on the sale of a business.
TSS net revenue of $6.2 billion increased $1.4 billion, or 28%. Net interest income grew to $2.1 billion, up $679 million, due to wider spreads on liability balances, a change in the corporate deposit pricing methodology in 2004 and growth in average liability balances. Noninterest revenue of $4.2 billion increased by $705 million, or 20%, due to product growth across TSS, the Merger and the acquisition of Vastera. Leading the product revenue growth was an increase in assets under custody to $11.2 trillion, primarily driven by market value appreciation and new business, along with growth in wholesale card, securities lending, foreign exchange, trust product, trade, clearing and ACH revenues. Partially offsetting this growth in noninterest revenue was a decline in deposit-related fees due to higher interest rates and the absence, in the current period, of a gain on the sale of a business.
TS net revenue of $2.6 billion grew by $628 million, Investor Services net revenue of $2.2 billion grew by $446 million, and Institutional Trust Services net revenue of $1.5 billion grew by $310 million. TSS firmwide net revenue, which includes TS net revenue recorded in other lines of business, grew to $8.8 billion, up $2.3 billion, or 35%. Treasury Services firmwide net revenue grew to $5.2 billion, up $1.6 billion, or 43%.
Credit reimbursement to the Investment Bank was $154 million, an increase of $64 million, primarily as a result of the Merger. 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 $4.5 billion was up $357 million, or 9%, due to the Merger, increased compensation expense resulting from new business growth and the Vastera acquisition, and charges of $93 million to terminate a client contract. Partially offsetting these increases were higher product unit costs charged to other lines of business, primarily Commercial Banking, lower allocations of Corporate segment expenses, merger savings and business efficiencies. The prior year included software-impairment charges of $155 million.
2004 compared with 2003
Operating earnings for the year were $440 million, an increase of $18 million, or 4%. Results in 2004 include an after-tax gain of $10 million on the sale of an IS business. Prior-year results include an after-tax gain of $22 million on the sale of an ITS business. Excluding these one-time gains, operating earnings would have increased by $30 million, or 8%. Both net revenue and Noninterest expense increased primarily as a result of the Merger, the acquisition of Bank One’s Corporate Trust business in November 2003 and the acquisition of Electronic Financial Services (“EFS”) in January 2004.


     
JPMorgan Chase & Co. / 2005 Annual Report   49

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

TSS net revenue improved by 35% to $4.9 billion. This revenue growth reflected the benefit of the Merger, the acquisitions noted above, and improved product revenues across TSS. Net interest income grew to $1.4 billion from $947 million as a result of average liability balance growth of 46%, to $126 billion, a change in the corporate deposit pricing methodology in 2004 and wider deposit spreads. Growth in fees and commissions was driven by a 22% increase in assets under custody to $9.3 trillion as well as new business growth in trade, commercial card, global equity products, securities lending, fund services, clearing and ACH. Partially offsetting these improvements were lower deposit-related fees, which often decline as interest rates rise, and a soft municipal bond market.
TS net revenue grew to $2.0 billion, IS to $1.7 billion and ITS to $1.2 billion. TSS firmwide net revenue grew by 41% to $6.5 billion. TSS firmwide net revenues include TS net revenues recorded in other lines of business.
Credit reimbursement to the Investment Bank was $90 million, compared with a credit from the Investment Bank of $36 million in the prior year, principally due to the Merger and a 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 totaled $4.1 billion, up from $3.0 billion, reflecting the Merger, the acquisitions noted above, $155 million of software impairment charges, upfront transition expenses related to on-boarding new custody and fund accounting clients, and legal and technology-related expenses.
 

Treasury & Securities Services firmwide metrics include certain TSS product revenues and liability balances reported in other lines of business related to customers who are also customers of those other lines of business. In order to capture the firmwide impact of TS and TSS products and revenues, management reviews firmwide metrics such as liability balances, revenues and overhead ratios in assessing financial performance for TSS. Firmwide metrics are necessary, in management’s view, in order to understand the aggregate TSS business.
Selected metrics
                         
Year ending December 31,(a)                  
(in millions, except headcount and where                  
otherwise noted)   2005     2004     2003  
 
Revenue by business
                       
Treasury Services
  $ 2,622     $ 1,994     $ 1,200  
Investor Services
    2,155       1,709       1,448  
Institutional Trust Services
    1,464       1,154       960  
 
Total net revenue
  $ 6,241     $ 4,857     $ 3,608  
 
                       
Business metrics
                       
Assets under custody (in billions)(b)
  $ 11,249     $ 9,300     $ 7,597  
Corporate trust securities under administration (in billions)(c)
    6,818       6,676       6,127  
Number of:
                       
US$ ACH transactions originated (in millions)
    2,966       1,994     NA
Total US$ clearing volume (in thousands)
    95,713       81,162     NA
International electronic funds transfer volume (in thousands)(d)
    89,537       45,654     NA
Wholesale check volume (in millions)
    3,856     NA     NA
Wholesale cards issued (in thousands)(e)
    13,206       11,787     NA
Selected average balances
                       
Total assets
  $ 26,947     $ 23,430     $ 18,379  
Loans
    10,430       7,849       6,009  
Liability balances(f)
    164,305       125,712       85,994  
Equity
    1,900       2,544       2,738  
 
                       
Headcount
    24,484       22,612       15,145  
 
                       
TSS firmwide metrics
                       
Treasury Services firmwide revenue(g)
  $ 5,224     $ 3,665     $ 2,214  
Treasury & Securities Services firmwide revenue(g)
    8,843       6,528       4,622  
Treasury Services firmwide overhead ratio(h)
    55 %     62 %     62 %
Treasury & Securities Services firmwide overhead ratio(h)
    62       74       76  
Treasury Services firmwide liability balances(i)
  $ 139,579     $ 102,785     $ 64,819  
Treasury & Securities Services firmwide liability balances(i)
    237,699       178,536       118,873  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
(b)   2005 assets under custody include approximately $530 billion of ITS assets under custody that have not been included previously. At December 31, 2005, approximately 5% of total assets under custody were trust-related.
(c)   Corporate trust securities under administration include debt held in trust on behalf of third parties and debt serviced as agent.
(d)   International electronic funds transfer includes non-US$ ACH and clearing volume.
(e)   Wholesale cards issued include domestic commercial card, stored value card, prepaid card, and government electronic benefit card products.
(f)   Liability balances include deposits and deposits swept to on-balance sheet liabilities.
(g)   Firmwide revenue includes TS revenue recorded in the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management businesses (see below) and excludes FX revenues recorded in the IB for TSS-related FX activity. TSS firmwide FX revenue, which includes FX revenue recorded in TSS and FX revenue associated with TSS customers who are FX customers of the IB, was $382 million, $320 million and $256 million for the years ended December 31, 2005, 2004 and 2003, respectively.
(h)   Overhead ratios have been calculated based on firmwide revenues and TSS and TS expenses, respectively, including those allocated to certain other lines of business. FX revenues and expenses recorded in the IB for TSS-related FX activity are not included in this ratio.
(i)   Firmwide liability balances include TS’ liability balances recorded in certain lines of business. Liability balances associated with TS customers who are also customers of the Commercial Banking line of business are not included in TS liability balances.
                         
(in millions)(a)   2005     2004     2003  
 
Treasury Services revenue reported in Commercial Banking
  $ 2,299     $ 1,467     $ 896  
Treasury Services revenue reported in other lines of business
    303       204       118  
 


     
50   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Asset & Wealth Management
 

Asset & Wealth Management provides investment advice and management for institutions and individuals. With Assets under supervision of $1.1 trillion, AWM is one of the largest asset and wealth managers in the world. AWM serves four distinct client groups through three businesses: institutions through JPMorgan Asset Management; ultra-high-net-worth clients through the Private Bank; high-net-worth clients through Private Client Services; and retail clients through JPMorgan Asset Management. The majority of AWM’s client assets are in actively managed portfolios. AWM has global investment expertise in equities, fixed income, real estate, hedge funds, private equity and liquidity, including both money market instruments and bank deposits. AWM also provides trust and estate services to ultra-high-net-worth and high-net-worth clients, and retirement services for corporations and individuals.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions, except ratios)   2005     2004     2003  
 
Revenue
                       
Asset management, administration and commissions
  $ 4,189     $ 3,140     $ 2,258  
Other income
    394       243       224  
 
Noninterest revenue
    4,583       3,383       2,482  
Net interest income
    1,081       796       488  
 
Total net revenue
    5,664       4,179       2,970  
 
                       
Provision for credit losses(b)
    (56 )     (14 )     35  
 
                       
Noninterest expense
                       
Compensation expense
    2,179       1,579       1,213  
Noncompensation expense
    1,582       1,502       1,265  
Amortization of intangibles
    99       52       8  
 
Total noninterest expense
    3,860       3,133       2,486  
 
Operating earnings before income tax expense
    1,860       1,060       449  
Income tax expense
    644       379       162  
 
Operating earnings
  $ 1,216     $ 681     $ 287  
 
Financial ratios
                       
ROE
    51 %     17 %     5 %
Overhead ratio
    68       75       84  
Pre-tax margin ratio(c)
    33       25       15  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   2005 includes a $3 million special provision related to Hurricane Katrina.
 
(c)   Pre-tax margin represents Operating earnings before income tax expense 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 costs are taken into consideration.
2005 compared with 2004
Operating earnings of $1.2 billion were up $535 million from the prior year due to the Merger and increased revenue, partially offset by higher compensation expense.
Net revenue was $5.7 billion, up $1.5 billion, or 36%. Noninterest revenue, primarily fees and commissions, of $4.6 billion was up $1.2 billion, principally due to the Merger, the acquisition of a majority interest in Highbridge Capital Management in 2004, net asset inflows and global equity market appreciation. Net interest income of $1.1 billion was up $285 million, primarily due to the Merger, higher deposit and loan balances, partially offset by narrower deposit spreads.
Private Bank client segment revenue of $1.7 billion increased by $135 million. Retail client segment revenue of $1.5 billion increased by $360 million. Institutional client segment revenue was up $504 million to $1.4 billion due to the acquisition of a majority interest in Highbridge Capital Management. Private Client Services client segment revenue grew by $486 million, to $1.0 billion.
Provision for credit losses was a benefit of $56 million, compared with a benefit of $14 million in the prior year, due to lower net charge-offs and refinements in the data used to estimate the allowance for credit losses.
Noninterest expense of $3.9 billion increased by $727 million, or 23%, reflecting the Merger, the acquisition of Highbridge and increased compensation expense related primarily to higher performance-based incentives.
2004 compared with 2003
Operating earnings were $681 million, up 137% from the prior year, due largely to the Merger but also driven by increased revenue and a decrease in the Provision for credit losses; these were partially offset by higher Compensation expense.
Total net revenue was $4.2 billion, up 41%, primarily due to the Merger. Additionally, fees and commissions increased due to global equity market appreciation, net asset inflows and the acquisition of JPMorgan Retirement Plan Services (“RPS”) in 2003. Fees and commissions also increased due to an improved product mix, with an increased percentage of assets in higher-yielding products. Net interest income increased due to deposit and loan growth.
The Provision for credit losses was a benefit of $14 million, a decrease of $49 million, due to an improvement in credit quality.
Noninterest expense was $3.1 billion, up 26%, due to the Merger, increased Compensation expense and increased technology and marketing initiatives.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount and ranking                  
data, and where otherwise noted)   2005     2004     2003  
 
Revenue by client segment
                       
Private bank
  $ 1,689     $ 1,554     $ 1,437  
Retail
    1,544       1,184       774  
Institutional
    1,395       891       681  
Private client services
    1,036       550       78  
 
Total net revenue
  $ 5,664     $ 4,179     $ 2,970  
 
                       
Business metrics
                       
Number of:
                       
Client advisors
    1,430       1,333       651  
Retirement Plan Services participants
    1,299,000       918,000       756,000  
 
                       
% of customer assets in 4 & 5 Star Funds(b)
    46 %     48 %     48 %
% of AUM in 1st and 2nd quartiles:(c)
                       
1 year
    69       66       57  
3 years
    68       71       69  
5 years
    74       68       65  
 
                       
Selected average balances
                       
Total assets
  $ 41,599     $ 37,751     $ 33,780  
Loans
    26,610       21,545       16,678  
Deposits(d)
    42,123       32,431       20,576  
Equity
    2,400       3,902       5,507  
 
                       
Headcount
    12,127       12,287       8,520  
 


     
JPMorgan Chase & Co. / 2005 Annual Report   51

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

                         
Credit data and quality statistics
                       
Net charge-offs
  $ 23     $ 72     $ 9  
Nonperforming loans
    104       79       173  
Allowance for loan losses
    132       216       130  
Allowance for lending-related commitments
    4       5       4  
                         
Net charge-off rate
    0.09 %     0.33 %     0.05 %
Allowance for loan losses to average loans
    0.50       1.00       0.78  
Allowance for loan losses to nonperforming loans
    127       273       75  
Nonperforming loans to average loans
    0.39       0.37       1.04  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Star rankings derived from Morningstar and Standard & Poor’s.
 
(c)   Quartile rankings sourced from Lipper and Standard & Poor’s.
 
(d)   Reflects the transfer in 2005 of certain consumer deposits from Retail Financial Services to Asset & Wealth Management.

AWM’s client segments are comprised of the following:
Institutional serves large and mid-size corporate and public institutions, endowments and foundations, and governments globally. AWM offers these institutions comprehensive global investment services, including investment management across asset classes, pension analytics, asset-liability management, active risk budgeting and overlay strategies.
The Private Bank addresses every facet of wealth management for ultra-high-net-worth individuals and families worldwide, including investment management, capital markets and risk management, tax and estate planning, banking, capital raising and specialty wealth advisory services.
Retail provides worldwide investment management services and retirement planning and administration through third-party and direct distribution channels.
Private Client Services offers high-net-worth individuals, families and business owners comprehensive wealth management solutions that include financial planning, personal trust, investment and banking products and services.
Assets under supervision
2005 compared with 2004
Assets under supervision (“AUS”) at December 31, 2005, were $1.1 trillion, up 4%, or $43 billion, from the prior year despite a $33 billion reduction due to the sale of BrownCo. Assets under management (“AUM”) were $847 billion, up 7%. The increase was primarily the result of net asset inflows in equity-related products and global equity market appreciation. The Firm also has a 43% interest in American Century Companies, Inc., whose AUM totaled $101 billion and $98 billion at December 31, 2005 and 2004, respectively. Custody, brokerage, administration, and deposits were $302 billion, down $13 billion due to a $33 billion reduction from the sale of BrownCo.
2004 compared with 2003
Assets under supervision at December 31, 2004, were $1.1 trillion, up 45% from 2003, and Assets under management were $791 billion, up 41% from the prior year. The increases were primarily the result of the Merger, as well as market appreciation, net asset inflows 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 $98 billion and $87 billion at December 31, 2004 and 2003, respectively. Custody, brokerage, administration, and deposits were $315 billion, up 55%, due to market appreciation, the Merger and net inflows across all products.
                 
Assets under supervision(a) (in billions)            
As of or for the year ended December 31,   2005     2004  
 
Assets by asset class
               
Liquidity
  $ 238     $ 232  
Fixed income
    165       171  
Equities & balanced
    370       326  
Alternatives
    74       62  
 
Total Assets under management
    847       791  
Custody/brokerage/administration/deposits
    302       315  
 
Total Assets under supervision
  $ 1,149     $ 1,106  
 
 
               
Assets by client segment
               
Institutional
  $ 481     $ 466  
Private Bank
    145       139  
Retail
    169       133  
Private Client Services
    52       53  
 
Total Assets under management
  $ 847     $ 791  
 
Institutional
  $ 484     $ 487  
Private Bank
    318       304  
Retail
    245       221  
Private Client Services
    102       94  
 
Total Assets under supervision
  $ 1,149     $ 1,106  
 
 
               
Assets by geographic region
               
U.S./Canada
  $ 562     $ 554  
International
    285       237  
 
Total Assets under management
  $ 847     $ 791  
 
U.S./Canada
  $ 805     $ 815  
International
    344       291  
 
Total Assets under supervision
  $ 1,149     $ 1,106  
 
 
               
Mutual fund assets by asset class
               
Liquidity
  $ 182     $ 183  
Fixed income
    45       41  
Equity
    150       104  
 
Total mutual fund assets
  $ 377     $ 328  
 
 
               
Assets under management rollforward(b)
               
Beginning balance, January 1
  $ 791     $ 561  
Flows:
               
Liquidity
    8       3  
Fixed income
          (8 )
Equity, balanced and alternative
    24       14  
Acquisitions /divestitures(c)
          183  
Market/performance/other impacts(d)
    24       38  
 
Ending balance, December 31
  $ 847     $ 791  
 
Assets under supervision rollforward(b)
               
Beginning balance, January 1
  $ 1,106     $ 764  
Net asset flows
    49       42  
Acquisitions /divestitures(e)
    (33 )     221  
Market/performance/other impacts(d)
    27       79  
 
Ending balance, December 31
  $ 1,149     $ 1,106  
 
(a)   Excludes Assets under management of American Century.
 
(b)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(c)   Reflects the Merger with Bank One ($176 billion) and the acquisition of a majority interest in Highbridge Capital Management ($7 billion) in 2004.
 
(d)   Includes AWM’s strategic decision to exit the Institutional fiduciary business ($12 billion) in 2005.
 
(e)   Reflects the Merger with Bank One ($214 billion) and the acquisition of a majority interest in Highbridge Capital Management ($7 billion) in 2004, and the sale of BrownCo ($33 billion) in 2005.


     
52   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Corporate
 

The Corporate sector is comprised of Private Equity, Treasury, corporate staff units and expenses that are centrally managed. Private Equity includes the JPMorgan Partners and ONE Equity Partners businesses. Treasury manages the structural interest rate risk and investment portfolio for the Firm. The corporate staff units include Central Technology and Operations, Audit, Executive Office, Finance, Human Resources, Marketing & Communications, Office of the General Counsel, Corporate Real Estate and General Services, Risk Management, and Strategy and Development. Other centrally managed expenses include the Firm’s occupancy and pension-related expenses, net of allocations to the business.
Selected income statement data
                         
Year ended December 31,(a)                  
(in millions)   2005     2004 (d)   2003 (d)
 
Revenue
                       
Securities / private equity gains
  $ 200     $ 1,786     $ 1,031  
Other income(b)
    1,410       315       303  
 
Noninterest revenue
    1,610       2,101       1,334  
Net interest income
    (2,736 )     (1,216 )     (133 )
 
Total net revenue
    (1,126 )     885       1,201  
 
                       
Provision for credit losses(c)
    10       (110 )     124  
 
                       
Noninterest expense
                       
Compensation expense
    3,151       2,426       1,893  
Noncompensation expense
    4,216       4,088       3,216  
 
Subtotal
    7,367       6,514       5,109  
Net expenses allocated to other businesses
    (5,343 )     (5,213 )     (4,580 )
 
Total noninterest expense
    2,024       1,301       529  
 
Operating earnings before income tax expense
    (3,160 )     (306 )     548  
Income tax expense (benefit)
    (1,429 )     (367 )     (120 )
 
Operating earnings (loss)
  $ (1,731 )   $ 61     $ 668  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Includes $1.3 billion (pre-tax) gain on the sale of BrownCo in 2005.
 
(c)   2005 includes a $12 million special provision related to Hurricane Katrina.
 
(d)   In 2005, the Corporate sector’s and the Firm’s operating results were presented on a tax-equivalent basis. Prior period results have been restated. This restatement had no impact on the Corporate sector’s or the Firm’s operating earnings.
2005 compared with 2004
Operating loss of $1.7 billion declined from earnings of $61 million in the prior year.
Net revenue was a loss of $1.1 billion compared with revenue of $885 million in the prior year. Noninterest revenue of $1.6 billion decreased by $491 million and included securities losses of $1.5 billion due to the repositioning of the Treasury investment portfolio, to manage exposure to interest rates, the gain on the sale of BrownCo of $1.3 billion and the increase in private equity gains of $262 million. For a further discussion on the sale of BrownCo, see Note 2 on page 93 of this Annual Report.
Net interest income was a loss of $2.7 billion compared with a loss of $1.2 billion in the prior year. Actions and policies adopted in conjunction with the Merger and the repositioning of the Treasury investment portfolio were the main drivers of the increased loss.
Noninterest expense was $2.0 billion, up $723 million, or 56%, from the prior year, primarily due to the Merger and the cost of the accelerated vesting of certain employee stock options. These increases were offset partially by merger-related savings and other expense efficiencies.
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.
2004 compared with 2003
Operating earnings were $61 million, down from earnings of $668 million in the prior year.
Noninterest revenue was $2.1 billion, up 57% from the prior year. The primary component of noninterest revenue is Securities/private equity gains, which totaled $1.8 billion, up 73% from the prior year. The increase was a result of net gains in the Private Equity portfolio of $1.4 billion in 2004 compared with $27 million in net gains in 2003. Partially offsetting these gains were lower investment securities gains in Treasury.
Net interest income was a loss of $1.2 billion compared with a loss of $133 million in the prior year. The increased loss was driven primarily by actions and policies adopted in conjunction with the Merger.
Noninterest expense of $1.3 billion was up $772 million from the prior year due to the Merger. The Merger resulted in higher gross compensation and noncompensation expenses. Allocations of compensation and noncompensation expenses to the businesses were lower than the gross expense increase due to certain policies adopted in conjunction with the Merger, which retain in Corporate overhead costs that would not be incurred by the lines of business if operated on a stand-alone basis, and costs in excess of the market price for services provided by the corporate staff and technology and operations areas.
Selected metrics
                         
Year ended December 31,(a)                  
(in millions, except headcount)   2005     2004     2003  
 
Selected average balances
                       
Short-term investments(b)
  $ 16,808     $ 14,590     $ 4,076  
Investment portfolio(c)
    54,481       65,985       65,113  
Goodwill(d)
    43,475       21,773       293  
Total assets
    160,720       162,234       104,395  
 
Headcount
    28,384       24,806       13,391  
 
Treasury
                       
Securities gains (losses)
  $ (1,502 )   $ 347     $ 999  
Investment portfolio (average)
    46,520       57,776       56,299  
Investment portfolio (ending)
    30,741       64,949       45,811  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 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)   As of July 1, 2004, the Firm revised the goodwill allocation methodology to retain all goodwill in Corporate. Effective with the first quarter of 2006, the Firm will refine its methodology to allocate goodwill to the lines of business.


     
JPMorgan Chase & Co. / 2005 Annual Report   53

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

Private equity
2005 compared with 2004
Private Equity’s operating earnings for the year were $821 million compared with $602 million in the prior year. This improvement in earnings reflected an increase of $262 million in private equity gains to $1.7 billion, a 15% reduction in noninterest expenses and a $62 million decline in net funding costs of carrying portfolio investments. Private equity gains benefited from continued favorable markets for investment sales and recapitalizations, resulting in nearly $2 billion of realized gains. The carrying value of the private equity portfolio declined by $1.3 billion to $6.2 billion as of December 31, 2005. This decline was primarily the result of sales and recapitalizations of direct investments.
2004 compared with 2003
Private Equity’s operating earnings for the year totaled $602 million compared with a loss of $290 million in 2003. This improvement reflected a $1.4 billion increase in total private equity gains. In 2004, markets improved for investment sales, resulting in $1.4 billion of realized gains on direct investments, compared with realized gains of $535 million in 2003. Net write-downs on direct investments were $192 million in 2004 compared with net write-downs of $404 million in 2003, as valuations continued to stabilize amid positive market conditions.
The carrying value of the Private Equity portfolio at December 31, 2004, was $7.5 billion, an increase of $247 million from December 31, 2003. The increase was primarily the result of the acquisition of ONE Equity Partners as a result of the Merger. Excluding ONE Equity Partners, the portfolio declined as a result of sales of investments, which was consistent with management’s intention to reduce over time the capital committed to private equity. Sales of third-party fund investments resulted in a decrease in carrying value of $458 million, to $641 million at December 31, 2004, compared with $1.1 billion at December 31, 2003.
Selected income statement and
balance sheet data – Private equity
                         
Year ended December 31,(a)                  
(in millions)   2005     2004     2003  
 
Private equity gains (losses)
                       
Direct investments
Realized gains
  $ 1,969     $ 1,423     $ 535  
Write-ups / (write-downs)
    (72 )     (192 )     (404 )
Mark-to-market gains (losses)
    (338 )     164       215  
 
Total direct investments
    1,559       1,395       346  
Third-party fund investments
    132       34       (319 )
 
Total private equity gains (losses)
    1,691       1,429       27  
Other income
    40       53       47  
Net interest income
    (209 )     (271 )     (264 )
 
Total net revenue
    1,522       1,211       (190 )
Total noninterest expense
    244       288       268  
 
Operating earnings (loss) before income tax expense
    1,278       923       (458 )
Income tax expense
    457       321       (168 )
 
Operating earnings (loss)
  $ 821     $ 602     $ (290 )
 
Private equity portfolio information(b)
                       
Direct investments
                       
Public securities
                       
Carrying value
  $ 479     $ 1,170     $ 643  
Cost
    403       744       451  
Quoted public value
    683       1,758       994  
 
                       
Private direct securities
                       
Carrying value
    5,028       5,686       5,508  
Cost
    6,463       7,178       6,960  
 
                       
Third-party fund investments
                       
Carrying value
    669       641       1,099  
Cost
    1,003       1,042       1,736  
 
                       
Total private equity portfolio
                       
Carrying value
  $ 6,176     $ 7,497     $ 7,250  
Cost
  $ 7,869     $ 8,964     $ 9,147  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 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 103–105 of this Annual Report.


     
54   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Balance sheet analysis
 
Selected balance sheet data
                 
December 31, (in millions)   2005     2004  
 
Assets
               
Cash and due from banks
  $ 36,670     $ 35,168  
Deposits with banks and Federal funds sold
    26,072       28,958  
Securities purchased under resale agreements and Securities borrowed
    204,174       141,504  
Trading assets – debt and equity instruments
    248,590       222,832  
Trading assets – derivative receivables
    49,787       65,982  
Securities:
               
Available-for-sale
    47,523       94,402  
Held-to-maturity
    77       110  
Loans, net of allowance for loan losses
    412,058       394,794  
Other receivables
    27,643       31,086  
Goodwill and other intangible assets
    58,180       57,887  
All other assets
    88,168       84,525  
 
Total assets
  $ 1,198,942     $ 1,157,248  
 
Liabilities
               
Deposits
  $ 554,991     $ 521,456  
Securities sold under repurchase agreements and securities lent
    117,124       112,347  
Trading liabilities – debt and equity instruments
    94,157       87,942  
Trading liabilities – derivative payables
    51,773       63,265  
Long-term debt and capital debt securities
    119,886       105,718  
All other liabilities
    153,800       160,867  
 
Total liabilities
    1,091,731       1,051,595  
Stockholders’ equity
    107,211       105,653  
 
Total liabilities and stockholders’ equity
  $ 1,198,942     $ 1,157,248  
 
Securities purchased under resale agreements and Securities sold under repurchase agreements
The increase in Securities purchased under resale agreements was due primarily to growth in client-driven financing activities in North America and Europe.
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 equity and convertible cash 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. For additional information, refer to Note 3 on page 94 of this Annual Report.
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 December 31, 2004, was primarily due to the appreciation of the U.S. dollar and, to a lesser extent, higher interest rates, partially offset by increased commodity trading activity and rising commodity prices. For additional information, refer to Credit risk management and Note 3 on pages 63–74 and 94, respectively, of this Annual Report.
Securities
The AFS portfolio declined by $46.9 billion from December 31, 2004, primarily due to securities sales (as a result of management’s decision to reposition the Treasury investment portfolio to manage exposure to interest rates) and maturities, which more than offset purchases. For additional information related to securities, refer to the Corporate segment discussion and to Note 9 on pages 53–54 and 103–105, respectively, of this Annual Report.
Loans
The $17 billion increase in gross loans was due primarily to an increase of $15 billion in the wholesale portfolio, primarily from the IB, reflecting higher balances of loans held-for-sale (“HFS”) related to securitization and syndication activities, and growth in the IB Credit Portfolio. Wholesale HFS loans were $18 billion as of December 31, 2005, compared with $6 billion as of December 31, 2004. For consumer loans, growth in consumer real estate (primarily home equity loans) and credit card loans was offset largely by a decline in the auto portfolio. The increase in credit card loans primarily reflected growth from new account originations and the acquisition of $1.5 billion of Sears Canada loans on the balance sheet. The decline in the auto portfolio primarily reflected a difficult auto lending market in 2005, $3.8 billion of securitizations and was also the result of a strategic review of the portfolio in 2004 that led to the decisions to de-emphasize vehicle leasing and sell a $2 billion recreational vehicle portfolio. For a more detailed discussion of the loan portfolio and the Allowance for loan losses, refer to Credit risk management on pages 63–74 of this Annual Report.
Goodwill and Other intangible assets
The $293 million increase in Goodwill and Other intangible assets primarily resulted from higher MSRs due to growth in the servicing portfolio as well as an overall increase in the valuation from improved market conditions; the business partnership with Cazenove; the acquisition of the Sears Canada credit card business; and the Neovest and Vastera acquisitions. Partially offsetting the increase were declines from the amortization of purchased credit card relationships and core deposit intangibles and the deconsolidation of Paymentech. For additional information, see Note 15 on pages 114–116 of this Annual Report.
Deposits
Deposits increased by 6% from December 31, 2004. Retail deposits increased, reflecting growth from new account acquisitions and the ongoing expansion of the retail 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 39–44 and 61–62, respectively, of this Annual Report. For more information on liability balances, refer to the CB and TSS segment discussions on pages 47–48 and 49–50, respectively, of this Annual Report.
Long-term debt and capital debt securities
Long-term debt and capital debt securities increased by $14.2 billion, or 13%, from December 31, 2004, primarily due to net new issuances of long-term debt and capital debt securities. The Firm took advantage of narrow credit spreads globally to issue opportunistically long-term debt and capital debt securities throughout 2005. Consistent with its liquidity management policy, the Firm raised funds sufficient to cover maturing obligations over the next 12 months and to support the less liquid assets on its balance sheet. Large investor cash positions and increased foreign investor participation in the corporate markets allowed JPMorgan Chase to diversify further its funding across the global markets while lengthening maturities. For additional information on the Firm’s long-term debt activity, see the Liquidity risk management discussion on pages 61–62 of this Annual Report.
Stockholders’ equity
Total stockholders’ equity increased by $1.6 billion from year-end 2004 to $107.2 billion at December 31, 2005. The increase was the result of net income for 2005 and common stock issued under employee plans, partially offset by cash dividends, stock repurchases, the redemption of $200 million of preferred stock and net unrealized losses in Accumulated other comprehensive income. For a further discussion of capital, see the Capital management section that follows.


     
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Management’s discussion and analysis
JPMorgan Chase & Co.
Capital management
 
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, as 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 regulatory and debt rating objectives. The Firm’s capital framework is integrated into the process of assigning equity to the lines of business.
Line of business equity
The Firm’s framework for allocating capital is based upon the following objectives:
  Integrate firmwide capital management activities with capital management activities within each of the lines of business.
 
  Measure performance consistently across all lines of business.
 
  Provide comparability with peer firms for each of the lines of business.
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 key measure of a business segment’s performance.
For performance management purposes, the Firm initiated a methodology at the time of the Merger for allocating goodwill. Under this methodology, in the last half of 2004 and all of 2005, goodwill from the Merger and from any business acquisition by either heritage firm prior to the Merger was allocated to Corporate, as was any associated equity. Therefore, 2005 line of business equity is not comparable to equity assigned to the lines of business in prior years. The increase in average common equity in the following table for 2005 was attributable primarily to the Merger.
                 
(in billions)   Yearly Average  
Line of business equity   2005     2004 (a)
 
Investment Bank
  $ 20.0     $ 17.3  
Retail Financial Services
    13.4       9.1  
Card Services
    11.8       7.6  
Commercial Banking
    3.4       2.1  
Treasury & Securities Services
    1.9       2.5  
Asset & Wealth Management
    2.4       3.9  
Corporate(b)
    52.6       33.1  
 
Total common stockholders’ equity
  $ 105.5     $ 75.6  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   2005 includes $43.5 billion of equity to offset goodwill and $9.1 billion of equity, primarily related to Treasury, Private Equity and the Corporate Pension Plan.
Effective January 1, 2006, the Firm expects to refine its methodology for allocating capital to the lines of business, and may continue to refine this methodology. The revised methodology, among other things, considers for each line of business goodwill associated with such line of business’ acquisitions since the Merger. As a result of this refinement, Retail Financial Services, Card Services, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management will have higher amounts of capital allocated in 2006, while the amount of capital allocated to the Investment Bank will remain unchanged. In management’s view, the revised methodology assigns responsibility to the lines of business to generate returns on the amount of capital supporting acquisition-related goodwill. As part of this refinement in the capital allocation methodology, the Firm will assign to the Corporate segment an
amount of equity capital equal to the then-current book value of goodwill from and prior to the Merger. In accordance with SFAS 142, the lines of business will continue to perform the required goodwill impairment testing. For a further discussion of goodwill and impairment testing, see Critical accounting estimates and Note 15 on pages 81–83 and 114–116, respectively, of this Annual Report.
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 upon 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)   Yearly Average  
Economic risk capital   2005     2004 (a)
 
Credit risk
  $ 22.6     $ 16.5  
Market risk
    9.8       7.5  
Operational risk
    5.5       4.5  
Business risk
    2.1       1.9  
Private equity risk
    3.8       4.5  
 
Economic risk capital
    43.8       34.9  
Goodwill
    43.5       25.9  
Other(b)
    18.2       14.8  
 
Total common stockholders’ equity
  $ 105.5     $ 75.6  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   Additional capital required to meet internal debt and regulatory rating objectives.
Credit risk capital
Credit risk capital is estimated separately for the wholesale businesses (Investment Bank, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management) and consumer businesses (Retail Financial Services and Card Services).
Credit risk capital for the overall wholesale credit portfolio is defined in terms of unexpected credit losses, both from defaults and declines in market value due to credit deterioration, measured over a one-year period at a confidence level consistent with the level of capitalization necessary to achieve a targeted ‘AA’ solvency standard. Unexpected losses are in excess of those for which provisions for credit losses are maintained. In addition to maturity and correlations, capital allocation is differentiated by several principal drivers of credit risk: exposure at default (or loan equivalent amount), likelihood of default, loss severity, and market credit spread.
  Loan equivalent amount for counterparty exposures in an over-the-counter derivative transaction is represented by the expected positive exposure based upon potential movements of underlying market rates. Loan equivalents for unused revolving credit facilities represent the portion of an unused commitment likely, based upon the Firm’s average portfolio historical experience, to become outstanding in the event an obligor defaults.
 
  Default likelihood is based upon current market conditions for all publicly traded names and investment banking clients, by referencing the growing market in credit derivatives and secondary market loan sales. This methodology produces, in the Firm’s view, more active risk management by utilizing a forward-looking measure of credit risk. This dynamic measure captures current market conditions and will change with the credit cycle over time impacting the level of credit risk capital. For privately-held firms in the commercial banking portfolio, default likelihood is based upon longer term averages over an entire credit cycle.


     
56   JPMorgan Chase & Co. / 2005 Annual Report

 


 

  Loss severity of exposure is based upon the Firm’s average historical experience during workouts, with adjustments to account for collateral or subordination.
 
  Market credit spreads are used in the evaluation of changes in exposure value due to credit deterioration.
Credit risk capital for the consumer portfolio is intended to represent a capital level sufficient to support an ‘AA’ rating, and its allocation is based upon product and other relevant risk segmentation. Actual segment level default and severity experience are used to estimate unexpected losses for a one-year horizon at a confidence level equivalent to the ‘AA’ solvency standard. Statistical results for certain segments or portfolios are adjusted upward to ensure that capital is consistent with external benchmarks, including subordination levels on market transactions and capital held at representative monoline competitors, where appropriate.
Market risk capital
The Firm calculates market risk capital guided by the principle that capital should reflect the risk of loss in the value of portfolios and financial instruments caused by adverse movements in market variables, such as interest and foreign exchange rates, credit spreads, securities prices and commodities prices. Daily VAR, monthly stress-test results and other factors are used to determine appropriate capital levels. The Firm allocates market risk capital to each business segment according to a formula that weights that segment’s VAR and stress test exposures. See Market risk management on pages 75–78 of this Annual Report for more information about these market risk measures.
Operational risk capital
Capital is allocated to the lines of business for operational risk using a risk-based capital allocation methodology which estimates operational risk on a bottom-up basis. The operational risk capital model is based upon actual losses and potential scenario-based stress losses, with adjustments to the capital calculation to reflect changes in the quality of the control environment or the potential offset as a result of the use of risk-transfer products. The Firm believes the model is consistent with the new Basel II Framework and expects to propose it eventually for qualification under the advanced measurement approach for operational risk.
Business risk capital
Business risk is defined as the risk associated with volatility in the Firm’s earnings due to factors not captured by other parts of its economic-capital framework. Such volatility can arise from ineffective design or execution of business strategies, volatile economic or financial market activity, changing client expectations and demands, and restructuring to adjust for changes in the competitive environment. For business risk, capital is allocated to each business based upon historical revenue volatility and measures of fixed and variable expenses. Earnings volatility arising from other risk factors, such as credit, market, or operational risk, is excluded from the measurement of business risk capital, as those factors are captured under their respective risk capital models.
Private equity risk capital
Capital is allocated to privately- and publicly-held securities, third-party fund investments and commitments in the Private Equity portfolio to cover the potential loss associated with a decline in equity markets and related asset devaluations.
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 and Chase Bank USA, National Association.
The federal banking regulatory agencies issued a final rule that makes permanent an interim rule issued in 2000 that provides regulatory capital relief for certain cash-collateralized securities borrowed transactions, effective February 22, 2006. The final rule also broadens the types of transactions qualifying for regulatory capital relief under the interim rule. Adoption of the rule is not expected to have a material effect on the Firm’s capital ratios.
On March 1, 2005, the FRB issued a final rule, which became effective April 11, 2005, that continues the inclusion of trust preferred securities in Tier 1 capital, subject to stricter quantitative limits and revised qualitative standards, and broadens the definition of restricted core capital elements. The rule provides for a five-year transition period. As an internationally active bank holding company, JPMorgan Chase is subject to the rule’s limitation on restricted core capital elements, including trust preferred securities, to 15% of total core capital elements, net of goodwill less any associated deferred tax liability. At December 31, 2005, JPMorgan Chase’s restricted core capital elements were 16.5% of total core capital elements. JPMorgan Chase expects to be in compliance with the 15% limit by the March 31, 2009, implementation date.
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. In addition, both short- and long-term liquidity facilities are subject to certain asset quality tests effective September 30, 2005. Adoption of the rule did not have a material effect on the capital ratios of the Firm.
The following tables show that JPMorgan Chase maintained a well-capitalized position based upon Tier 1 and Total capital ratios at December 31, 2005 and 2004.
                         
Capital ratios                   Well-capitalized  
December 31,   2005     2004     ratios  
 
Tier 1 capital ratio
    8.5 %     8.7 %     6.0 %
Total capital ratio
    12.0       12.2       10.0  
Tier 1 leverage ratio
    6.3       6.2     NA  
Total stockholders’ equity to assets
    8.9       9.1     NA  
 
Risk-based capital components and assets
                 
December 31, (in millions)   2005     2004  
 
Total Tier 1 capital
  $ 72,474     $ 68,621  
Total Tier 2 capital
    29,963       28,186  
 
Total capital
  $ 102,437     $ 96,807  
 
Risk-weighted assets
  $ 850,643     $ 791,373  
Total adjusted average assets
    1,152,546       1,102,456  
 
Tier 1 capital was $72.5 billion at December 31, 2005, compared with $68.6 billion at December 31, 2004, an increase of $3.9 billion. The increase was due primarily to net income of $8.5 billion, net common stock issued under employee plans of $1.9 billion, $1.3 billion of additional qualifying trust preferred securities and a decline of $716 million in the deduction for nonqualifying intangible assets as a result of amortization. Offsetting these increases were dividends declared of $4.8 billion, common share repurchases of $3.4 billion, an increase in the deduction for goodwill of $418 million and the redemption of $200 million of preferred stock. Additional information regarding the Firm’s capital ratios and the federal regulatory capital standards to which it is subject is presented in Note 24 on pages 121–122 of this Annual Report.
Basel II
The Basel Committee on Banking Supervision published the new Basel II Framework in 2004 in an effort to update the original international bank capital


     
JPMorgan Chase & Co. / 2005 Annual Report   57

 


 

Management’s discussion and analysis
JPMorgan Chase & Co.

accord (“Basel I”), in effect since 1988. The goal of the Basel II Framework is to improve the consistency of capital requirements internationally, make regulatory capital more risk-sensitive, and promote enhanced risk management practices among large, internationally active banking organizations. JPMorgan Chase supports the overall objectives of the Basel II Framework.
U.S. banking regulators are in the process of incorporating the Basel II Framework into the existing risk-based capital requirements. JPMorgan Chase will be required to implement advanced measurement techniques in the U.S. by employing internal estimates of certain key risk drivers to derive capital requirements. Prior to implementation of the new Basel II Framework, JPMorgan Chase will be required to demonstrate to its U.S. bank supervisors that its internal criteria meet the relevant supervisory standards. JPMorgan Chase expects to be in compliance within the established timelines with all relevant Basel II rules.
Dividends
The Firm’s common stock dividend policy reflects JPMorgan Chase’s earnings outlook, desired payout ratios, need to maintain an adequate capital level and alternative investment opportunities. In 2005, JPMorgan Chase declared a quarterly cash dividend on its common stock of $0.34 per share. The Firm continues to target a dividend payout ratio of 30-40% of 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 is 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. Under the stock repurchase program, during 2005, the Firm repurchased 93.5 million shares for $3.4 billion at an average price per share of $36.46. During 2004, the Firm repurchased 19.3 million shares for $738 million at an average price per share of $38.27. As of December 31, 2005, $1.9 billion of authorized repurchase capacity remained.
The Firm has determined that it may, from time to time, enter into written trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate the repurchase of common stock in accordance with the repurchase program. A Rule 10b5-1 repurchase plan would allow the Firm to repurchase shares during periods when it would not otherwise be repurchasing common stock – for example, during internal trading “black-out periods.” All purchases under a Rule 10b5-1 plan must be made according to a predefined plan that is established when the Firm is not aware of material nonpublic information.
For additional information regarding repurchases of the Firm’s equity securities, see Part II, Item 5, Market for registrant’s common equity, related stockholder matters and issuer purchases of equity securities, on page 11 of JPMorgan Chase’s 2005 Form 10-K.


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 financial assets, and to create other 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. For example, SPEs are integral to the markets for mortgage-backed securities, commercial paper, and other asset-backed securities.
The basic SPE structure involves a company selling assets to the SPE. The SPE funds the purchase of those assets by issuing securities to investors. To insulate investors from creditors of other entities, including the seller of assets, SPEs can be structured to be bankruptcy-remote.
JPMorgan Chase is involved with SPEs in three broad categories: loan securitizations, multi-seller conduits and client intermediation. Capital is held, as deemed 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 1 on page 91, Note 13 on pages 108–111 and Note 14 on pages 111–113 of this Annual Report.
The Firm has no commitments to issue its own stock to support any SPE transaction, and its policies require that transactions with SPEs be conducted at arm’s length and reflect market pricing. Consistent with this policy, no JPMorgan Chase employee is permitted to invest in SPEs with which the Firm is involved where such investment would violate the Firm’s Code of Conduct. These rules prohibit employees from self-dealing and prohibit employees from acting on behalf of the Firm in transactions with which they or their family have any significant financial interest.
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 $71.3 billion and $79.4 billion at December 31, 2005 and 2004, respectively. Alternatively, if JPMorgan Chase Bank were downgraded, the Firm could be replaced by another liquidity provider in lieu of providing 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 its $71.3 billion in liquidity commitments to SPEs at December 31, 2005, $38.9 billion was included in the Firm’s other unfunded commitments to extend credit and asset purchase agreements, included in the following table. Of the $79.4 billion of liquidity commitments to SPEs at December 31, 2004, $47.7 billion was included in the Firm’s other unfunded commitments to extend credit and asset purchase agreements. As a result of the Firm’s consolidation of multi-seller conduits in accordance with FIN 46R, $32.4 billion of these commitments, compared with $31.7 billion at December 31, 2004, are excluded from the following table, as the underlying assets of the SPEs have been included on the Firm’s Consolidated balance sheets.
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., MTM gains and losses) recorded in Trading revenue. Such MTM gains and losses are not included in the revenue amounts reported in the table below.
The following table summarizes certain revenue information related to variable interest entities (“VIEs”) with which the Firm has significant involvement, and qualifying SPEs (“QSPEs”). The revenue reported in the table below primarily represents servicing and custodial fee income. For a further discussion of VIEs and QSPEs, see Note 1, Note 13 and Note 14, on pages 91, 108–111 and 111–113, respectively, of this Annual Report.


     
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Revenue from VIEs and QSPEs
                         
Year ended December 31,(a)                  
(in millions)   VIEs (b)   QSPEs     Total