10-K 1 y05475e10vk.htm FORM 10-K FORM 10-K
Table of Contents

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
December 31, 2004
  Commission file
number 1-5805

JPMorgan Chase & Co.

(Exact name of registrant as specified in its charter)
     
Delaware   13-2624428
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
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
   
Depositary shares representing a one-tenth interest in 6 5/8% cumulative preferred stock (stated value—$500)
   
6.50% subordinated notes due 2005
   
6.25% subordinated notes due 2006
   
6 1/8% subordinated notes due 2008
   
6.75% subordinated notes due 2008
   
6.50% subordinated notes due 2009
   
Guarantee of 8.25% Capital Securities, Series H, of Chase Capital VIII
   
Guarantee of 7.50% Capital Securities, Series I, of J.P. Morgan Chase Capital IX
   
Guarantee of 7.00% Capital Securities, Series J, of J.P. Morgan Chase Capital X
   
Guarantee of 5 7/8% Capital Securities, Series K, of J.P. Morgan Chase Capital XI
   
Guarantee of 6.25% Capital Securities, Series L, of J.P. Morgan Chase Capital XII
   
Guarantee of 6.20% Capital Securities, Series N, of JPMorgan Chase Capital XIV
   
Guarantee of 8.50% Preferred Securities of BANK ONE Capital II
   
     
Guarantee of 8.00% Preferred Securities of BANK ONE Capital V
   
Guarantee of 7.20% Preferred Securities of BANK ONE Capital VI
   
Indexed Linked Notes on the S&P 500® Index due November 26, 2007
   
JPMorgan Market Participation Notes on the S&P 500® Index due March 12, 2008
   
Capped Quarterly Observation Notes Linked to S&P 500® Index due September 22, 2008
   
Capped Quarterly Observation Notes Linked to S&P 500® Index due October 30, 2008
   
Capped Quarterly Observation Notes Linked to S&P 500® Index due January 21, 2009
   
JPMorgan Market Participation Notes on the S&P 500® Index due March 31, 2009
   
Capped Quarterly Observation Notes Linked to S&P 500® Index due July 7, 2009
   
Capped Quarterly Observation Notes Linked to S&P 500® Index due September 21, 2009
   
Consumer Price Indexed Securities due January 15, 2010
   
Principal Protected Notes Linked to S&P 500® Index due 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
Number of shares of common stock outstanding on January 31, 2005: 3,553,701,118

      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ..X.. No.....

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ..X.. No.....

      The aggregate market value of JPMorgan Chase & Co. common stock held by non-affiliates of JPMorgan Chase & Co. on June 30, 2004 was approximately $80,330,277,311.

Document Incorporated by Reference: Portions of Registrant’s proxy statement for the annual meeting of stockholders to be held on May 17, 2005, 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      1
       1
       1
       1
       1
       4
       6
       132-136
       129-130, 132-133
       137
       59-67, 101-102, 138-140
       68-69, 102-103, 141-142
       142
       143
Item 2      6
Item 3      6
Item 4      9
       9
Part II  
 
   
Item 5      11
Item 6      12
Item 7      12
Item 7A      12
Item 8      12
Item 9      12
Item 9A      12
Item 9B      12
Part III  
 
   
Item 10      12
Item 11      12
Item 12      12
Item 13      13
Item 14      13
Part IV  
 
   
Item 15      13
 EX-3.1: RESTATED CERTIFICATE OF INCORPORATION
 EX-3.2: BY-LAWS
 INDENTURE
 JUNIOR SUBORDINATED INDENTURE
 GUARANTEE AGREEMENT
 AMENDED AND RESTATED TRUST AGREEMENT
 INDENTURE
 FIRST SUPPLEMENTAL INDENTURE
 INDENTURE
 FIRST SUPPLEMENTAL INDENTURE
 FORM OF INDENTURE
 FORM OF INDENTURE
 DEFERRED COMPENSATION PLAN FOR NON-EMPLOYEE DIRECTORS
 POST-RETIREMENT COMPENSATION PLAN FOR NON-EMPLOYEE DIRECTORS
 DEFERRED COMPENSATION PROGRAM
 1994 LONG-TERM INCENTIVE PLAN
 AMENDMENT TO THE 1994 LONG-TERM INCENTIVE PLAN
 LONG-TERM STOCK INCENTIVE PLAN
 FORM OF STOCK OPTION AWARD
 1992 STOCK INCENTIVE PLAN
 1984 STOCK INCENTIVE PLAN
 1995 STOCK INCENTIVE PLAN
 1998 PERFORMANCE PLAN
 EX-10.16: SUMMARY OF TERMS OF SEVERANCE POLICY
 STOCK INCENTIVE PLAN
 PERFORMANCE INCENTIVE PLAN
 REVISED AND RESTATED 1989 STOCK INCENTIVE PLAN
 REVISED AND RESTATED 1995 STOCK INCENTIVE PLAN
 EX-12.1: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
 EX-12.2: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
 EX-21.1: LIST OF SUBSIDIARIES
 EX-23.1: CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 CERTIFICATION
 CERTIFICATION
 CERTIFICATION
 CERTIFICATION

 


Table of Contents

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, $106 billion in stockholders’ equity and operations in more than 50 countries.

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 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 affiliated 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 Chief Executive Officer, President and Chief Operating 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 28, and in Note 31 on page 126.

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, 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 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 on 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 on 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, as demonstrated by the merger of JPMorgan Chase and Bank One Corporation on July 1, 2004. 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.

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”).

Under the 1999 Gramm-Leach-Bliley Act (“GLBA”), bank holding companies meeting certain eligibility criteria may elect to become “financial holding companies,” which may engage in activities that have been approved by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the United States Department of the Treasury (“U.S. Treasury Department”). JPMorgan Chase elected to become a financial holding company as of March 13, 2000.

Under regulations implemented by 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



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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 permissible for bank holding companies that are not financial holding companies. At December 31, 2004, 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 on the particular activities of those subsidiaries (e.g., the lead bank is regulated by the Office of the Comptroller of the Currency (“OCC”), 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 Comptroller of the Currency. Under the undivided profits test, a dividend may not be paid in excess of a bank’s “undivided profits.” See Note 23 on page 116 for the amount of dividends that the Firm’s principal bank subsidiaries could pay, at January 1, 2005 and 2004, to their respective bank holding companies without the approval of the relevant banking regulators.

In addition to the dividend restrictions described above, the Comptroller of the Currency, 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 and common stock remain the most important forms of capital at JPMorgan Chase. Because common equity has no maturity date, and because dividends on common stock are paid only

when and if declared by the Board of Directors, common equity is available to absorb losses over long periods of time. Noncumulative perpetual preferred stock is similar to common stock in its ability to absorb losses. If the Board of Directors does not declare a dividend on noncumulative perpetual preferred stock in any dividend period, the holders of the instrument are never entitled to receive that dividend payment. JPMorgan Chase’s outstanding noncumulative perpetual preferred stock is a type commonly referenced as a “FRAP”: a fixed-rate/ adjustable preferred stock. Because the interest rate on FRAPs may increase (up to a predetermined ceiling), the Federal Reserve Board treats the Firm’s noncumulative FRAPs in a manner similar to cumulative perpetual preferred securities. The Federal Reserve Board permits cumulative perpetual preferred securities to be included in Tier 1 capital but only up to certain limits, as these financial instruments do not provide as strong protection against losses as common equity and noncumulative, non-FRAP securities. Cumulative perpetual preferred stock does not have a maturity date, similar to other forms of Tier 1 capital. However, any dividends not declared on cumulative perpetual preferred stock accumulate and thus continue to be due to the holder of the instrument until all arrearages are satisfied. On March 1, 2005, the Federal Reserve Board issued a final rule that continues the inclusion of trust preferred securities in Tier 1 capital, subject to stricter quantitative limits. The rule provides for a five-year transition period. The Firm is currently assessing the impact of the final rule. The effective date of the final rule is dependent on the date of publication in the Federal Register. 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 security 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. During 2003, the Firm implemented Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”), which addresses the consolidation rules to be applied to entities defined in FIN 46 as “variable interest entities.” Prior to FIN 46, trusts that issued trust preferred securities were consolidated subsidiaries of their respective parents. As a result of FIN 46, JPMorgan Chase is no longer permitted to consolidate these trusts. 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. Subordinated debt is deemed a form of regulatory capital, because payments on the debt are subordinated to other creditors of JPMorgan Chase, including holders of senior and medium long-term debt and counterparties on derivative contracts.

The federal banking regulators have also 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.



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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”). JPMorgan Chase is actively pursuing implementation of the Basel II framework in accordance with the criteria of the U.S. banking regulators, which will require JPMorgan Chase to use “advanced measurement techniques,” employing its internal estimates of certain key risk drivers to derive capital requirements. Implementation of Basel II by U.S. regulators is expected as of January 1, 2008, with certain transitional implementation arrangements.

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, as described below, the Federal Reserve Board is authorized to take appropriate action at the holding company level, based on 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.

As of December 31, 2004, the Firm and its primary banking subsidiaries were “well-capitalized.”

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.

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 those 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 noteholders, 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: On October 26, 2001, President Bush signed into law The USA PATRIOT Act of 2001 (the “Act”).

The 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 Act mandates the U.S. Treasury Department to issue a number of regulations to further clarify the Act’s requirements or provide more specific guidance on their application.

The 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.”



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JPMorgan Chase believes its programs satisfy the requirements of the 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.

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.

Important factors that may affect future results

From time to time, the Firm has made and will make forward-looking statements. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as “anticipate,” “target,” “expect,” “estimate,” “intend,” “plan,” “goal,” “believe” or other words of similar meaning. Forward-looking statements provide JPMorgan Chase’s current expectations or forecasts of future events, circumstances or results. JPMorgan Chase’s disclosures in this report, including in the MD&A section, contain forward-looking statements. The Firm also may make forward-looking statements in its other documents filed with the SEC and in other written materials. In addition, the Firm’s senior management may make forward-looking statements orally to analysts, investors, representatives of the media and others.

Any forward-looking statements made by or on behalf of the Firm speak only as of the date they are made. JPMorgan Chase does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made. The reader should, however, consult any further disclosures of a forward-looking nature JPMorgan Chase may make in its Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q and its Current Reports on Form 8-K.

All forward-looking statements, by their nature, are subject to risks and uncertainties. JPMorgan Chase’s actual future results may differ materially from those set forth in its forward-looking statements. Factors that might cause the Firm’s future financial performance to vary from that described in its forward-looking statements include the credit, market, operational, liquidity, interest rate and other risks discussed in the MD&A section of this report and in other periodic reports filed with the SEC. In addition, the following discussion sets forth certain risks and uncertainties that the Firm believes could cause its actual future results to differ materially from expected results. However, other factors besides those listed below or discussed in JPMorgan Chase’s reports to the SEC also could adversely affect the Firm’s results, and the reader should not consider any such list of factors to be a complete set of all potential risks or uncertainties. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

Merger of JPMorgan Chase and Bank One. There are significant risks and uncertainties associated with the Firm’s merger with Bank One. For example, JPMorgan Chase may fail to realize the growth opportunities and cost savings anticipated to be derived from the merger. In addition, it is possible that the integration process could result in the loss of



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key employees, or that the disruption of ongoing business from the Merger could adversely affect JPMorgan Chase’s ability to maintain relationships with clients or suppliers.

Business conditions and general economy. The profitability of JPMorgan Chase’s businesses could be affected by general economic conditions in the United States or abroad. In 2004 both the U.S. and global economies continued to strengthen overall. While the outlook for the Firm for 2005 continues to be cautiously optimistic, there can be no assurances that the economic recovery that began in 2003 will continue throughout 2005.

Factors such as the liquidity of the global financial markets, the level and volatility of equity prices and interest rates, investor sentiment, inflation, and the availability and cost of credit could 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 recurrence of 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. Higher interest rates or continued weakness in the market also could affect the willingness of financial 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 in equity and debt markets; and the economic, political and business factors described below. JPMorgan Chase anticipates that these revenues will fluctuate over time.

The fees JPMorgan Chase earns for managing 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 mutual funds 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 mutual funds could result in outflows of assets under management 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 levels 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, including U.S. interest rates, the rate of unemployment, the level of consumer confidence, changes in consumer spending and the number of personal bankruptcies, as these factors will affect the level of consumer loans and credit quality.

Competition. JPMorgan Chase operates in a highly competitive environment and expects various factors to cause competitive conditions to continue to intensify. The Firm expects competition to intensify as continued merger activity in the financial services industry produces larger,

better-capitalized companies that are capable of offering a wider array of financial products and services, and at more competitive prices. In addition, 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 to compete with technology companies in providing electronic and Internet-based financial solutions.

Non-U.S. operations; trading in non-U.S. securities. The Firm does business throughout the world, including in developing regions of the world commonly known as emerging markets. JPMorgan Chase’s businesses and revenues derived from non-U.S. operations are subject to risk of loss from unfavorable political and diplomatic developments, 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. JPMorgan Chase 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 factors. The impact of these fluctuations could be accentuated, because generally, non-U.S. trading markets, particularly in emerging market countries, are smaller, less liquid and more volatile than U.S. trading markets.

Operational risk. JPMorgan Chase, like all large corporations, is exposed to many types of operational risk, including the risk of fraud by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Given the high volume of transactions at JPMorgan Chase, certain errors may be repeated or compounded before they are discovered and successfully rectified. In addition, the Firm’s necessary dependence upon automated systems to record and process its transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. The Firm may also be subject to disruptions of its operating systems, arising from events that are wholly or partially beyond its control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to loss or liability to the Firm. The Firm is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligation to the Firm (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Firm), and to the risk that the Firm’s (or its vendors’) business continuity and data security systems prove not to be sufficiently adequate. The Firm also faces the risk that the design of its controls and procedures prove inadequate or are circumvented, thereby causing delays in detection or errors in information. Although the Firm maintains a system of controls designed to keep operational risk at appropriate levels, there can be no assurance that JPMorgan Chase will not suffer losses from operational risks in the future that may be material in amount.

Government monetary policies and economic controls. JPMorgan Chase’s businesses and earnings are affected by general economic conditions, both domestic and international. The Firm’s businesses and earnings also 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



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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. The nature and impact of future changes in economic and market conditions and fiscal policies are uncertain and are beyond the Firm’s control. In addition, these policies and conditions can 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.

Reputational and legal risk. The Firm’s ability to attract and retain customers and employees 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. Failure to address appropriately these issues could also give rise to additional legal risk to the Firm, which, in turn, could increase the size and number of litigation claims and damages asserted against the Firm or subject the Firm to enforcement actions, fines and penalties.

Credit, market, liquidity and private equity risk. JPMorgan Chase’s revenues also are dependent upon the extent to which management can successfully achieve its business strategies within a disciplined risk environment. JPMorgan Chase’s ability to grow its businesses is affected by pricing and competitive pressures, as well as by the costs associated with the introduction of new products and services and the expansion and development of new distribution channels. To the extent any of the instruments and strategies the Firm uses to hedge or otherwise manage its exposure to market, credit and private equity risk are not effective, the Firm may not be able to mitigate effectively its risk exposures in particular market environments or against particular types of risk. The Firm’s balance sheet growth will be dependent upon the economic conditions described above, as well as on its determination to securitize, sell, purchase or syndicate particular loans or loan portfolios. The Firm’s trading revenues and interest rate risk are dependent upon its ability to identify properly, and mark to market, changes in the value of its financial instruments caused by changes in market prices or rates. The Firm’s earnings will also be dependent upon how effectively its critical accounting estimates, including those used in its private equity valuations, prove accurate and upon how effectively it determines and assesses the cost of credit and manages its risk concentrations. To the extent its assessments of migrations in credit quality and of risk concentrations, or its assumptions or estimates used in establishing valuation models for the fair value of assets and liabilities or for loan loss reserves, prove inaccurate or not predictive of actual results, the Firm could suffer higher-than-anticipated losses. The successful management of credit, market, operational and private equity risk is an important consideration in managing the Firm’s liquidity risk, as evaluation by rating agencies of the management of these risks affects their determinations as to the Firm’s credit ratings and, therefore, its cost of funds.

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 125. For a discussion of non-U.S. loans, see Note 11 on page 101 and the sections entitled “Country exposure” in the MD&A on page 65 and “Cross-border outstandings” on page 139.

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.

Prior to the merger with Bank One on July 1, 2004, the headquarters of Bank One was located in Chicago at 10 South Dearborn, which continues to be used as an administrative and operational facility. This location is owned by the Firm and contains approximately 2.0 million square feet of space. In total, JPMorgan Chase owns or leases approximately 5.2 million square feet of commercial office and retail space in Chicago.

JPMorgan Chase and its subsidiaries also own or lease significant administrative and operational facilities in Houston and Dallas, Texas (6.8 million square feet); Columbus, Ohio (3 million square feet); Phoenix, Arizona (1.5 million square feet); Tampa, Florida (1.1 million square feet); Jersey City, New Jersey (1.1 million square feet); and in Indianapolis, Indiana (1 million square feet).

In the United Kingdom, JPMorgan Chase leases approximately 2.4 million square feet of office space and owns a 350,000 square-foot
operations center.

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 2,508 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, particularly in light of the merger with Bank One. 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 page 22.

Item 3: Legal proceedings

Enron litigation. JPMorgan Chase is involved in a number of lawsuits and investigations arising out of its banking relationships with Enron Corp. and its subsidiaries (“Enron”). A lawsuit in London by the Firm against Westdeutsche Landesbank Girozentrale (“WLB”) sought to compel payment of $165 million under an Enron-related letter of credit issued by WLB. WLB resisted payment on the grounds that the underlying pre-pay transaction, and its predecessors, were “disguised loans” and part of a



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“fraudulent scheme to hide Enron’s debt.” The trial of that action was conducted in June and July 2004, and on August 3, 2004, the Court issued its decision in favor of JPMorgan Chase, finding that the Firm did not commit fraud and ordering WLB to pay the letter of credit in full. That order has become final.

Other actions involving Enron have been initiated by parties against JPMorgan Chase, its directors and certain of its officers. These lawsuits include a series of purported class actions brought on behalf of shareholders of Enron, including the lead action captioned Newby v. Enron Corp. The consolidated complaint filed in Newby names as defendants, among others, JPMorgan Chase; several other investment banking firms; a number of law firms; Enron’s former accountants and affiliated entities and individuals; and other individual defendants, including present and former officers and directors of Enron. It asserts claims against JPMorgan Chase and the other defendants under federal and state securities laws. The Newby trial is scheduled to commence in October 2006.

Additional actions include: 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; putative class actions on behalf of JPMorgan Chase employees who participated in the Firm’s employee stock ownership plans 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; shareholder derivative actions alleging breaches of fiduciary duties and alleged failures to exercise due care and diligence by the Firm’s directors and named officers in the management of JPMorgan Chase; individual and putative class actions in various courts by Enron investors, creditors and holders of participating interests related to syndicated credit facilities; third-party actions brought by defendants in Enron-related cases, alleging federal and state law claims against JPMorgan Chase and many other defendants; investigations by governmental agencies with which the Firm is cooperating; and several bankruptcy actions, including an adversary proceeding brought by Enron in bankruptcy court seeking damages for alleged aiding and abetting of breaches of fiduciary duty by Enron insiders, return of alleged fraudulent conveyances and preferences, and equitable subordination of JPMorgan Chase’s claims in the Enron bankruptcy.

WorldCom litigation. J.P. Morgan Securities Inc. (“JPMSI”) and JPMorgan Chase were named as defendants in more than 50 actions that were filed in U.S. District Courts, in state courts in more than 20 states, and in one arbitral panel beginning in July 2002, arising out of alleged accounting irregularities in the books and records of WorldCom Inc. Plaintiffs in these actions are individual and institutional investors, including state pension funds, who purchased debt securities issued by WorldCom pursuant to public offerings in 1997, 1998, 2000 and 2001. JPMSI acted as an underwriter of the 1998, 2000 and 2001 offerings. In addition to JPMSI, JPMorgan Chase and, in two actions, J.P. Morgan Securities Ltd. (“JPMSL”), in its capacity as one of the underwriters of the international tranche of the 2001 offering, the defendants in various of the actions include other underwriters, certain executives and directors of WorldCom, and WorldCom’s auditors. In the actions, plaintiffs allege that defendants knew, or were reckless or negligent in not knowing, that the securities were sold to plaintiffs on the basis of misrepresentations and omissions of material facts concerning the financial condition and business of WorldCom. The complaints against JPMorgan Chase, JPMSI and JPMSL assert claims under federal and state securities laws, under other state statutes and

under common-law theories of fraud and negligent misrepresentation. In the class action pending in the U.S. District Court for the Southern District of New York, which involves claims on approximately $15 billion of Worldcom bonds, the court denied summary judgment with respect to the alleged financial misrepresentation and certain alleged omissions claims, and trial is presently scheduled to commence in late March 2005.

Commercial Financial Services litigation. JPMSI (formerly known as Chase Securities Inc.) has been named as a defendant in several actions that were filed in or transferred to the U.S. District Court for the Northern District of Oklahoma in 1999, arising from the failure of Commercial Financial Services, Inc. (“CFS”). Plaintiffs in these actions are institutional investors who purchased approximately $1.3 billion (original face amount) of asset-backed securities issued by CFS. The securities were backed by charged-off credit card receivables. In addition to JPMSI, the defendants in various of the actions are the founders and key executives of CFS, as well as its auditors and outside counsel. JPMSI is alleged to have been the investment banker to CFS and to have acted as an initial purchaser and placement agent in connection with the issuance of certain of the securities. Plaintiffs allege that defendants knew, or were reckless or negligent in not knowing, that the securities were sold to plaintiffs on the basis of misleading misrepresentations and omissions of material facts. The complaints against JPMSI assert claims under the Securities Exchange Act of 1934, under the Oklahoma Securities Act and under common-law theories of fraud and negligent misrepresentation. Plaintiffs seek damages in the amount of approximately $1.8 billion, plus punitive damages and additional interest that continues to accrue, and attorney’s fees. CFS has commenced an action against JPMSI in Oklahoma state court and has asserted claims against JPMSI for professional negligence and breach of fiduciary duty. CFS alleges that JPMSI failed to detect and prevent its insolvency. CFS seeks damages of approximately $1.3 billion. CFS also has commenced, in its bankruptcy case, an adversary proceeding against JPMSI and its credit card affiliate, Chase Manhattan Bank USA, N.A., alleging that certain payments, aggregating $78.4 million, made in connection with CFS’s purchase or securitization of charged-off credit card receivables were constructive fraudulent conveyances, and it seeks to recover such payments and interest. A trial date on the adversary proceeding has been set for May 2005. The federal securities actions have been set for trial in July 2005.

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 U.S. District Court for the Southern District of New York. These suits purport to challenge alleged improprieties in the allocation of stock in various public offerings, including some offerings for which a JPMorgan Chase entity served as an underwriter. The suits allege violations of securities and antitrust laws arising from alleged material misstatements and omissions in registration statements and prospectuses for the initial public offerings (“IPOs”) and alleged market manipulation with respect to aftermarket transactions in the offered securities. The securities claims 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 claims allege an illegal conspiracy to require customers, in exchange for IPO allocations, to pay undisclosed and excessive



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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, and the underwriter defendants have petitioned to appeal that decision. On February 15, 2005, the Court preliminarily approved a proposed settlement of plaintiffs’ claims against the issuer defendants in these cases. With respect to the antitrust claims, on November 3, 2003, the Court granted defendants’ motion to dismiss the claims relating to the IPO allocation practices, and that decision is on appeal. A separate antitrust claim alleging that JPMSI and the other underwriters conspired to fix their underwriting fees is in discovery.

Research analyst conflicts. JPMSI has been named as a co-defendant with nine other broker-dealers in a putative class action filed in federal court in Colorado, seeking an unspecified amount of money damages for alleged violations of federal securities laws related to analyst independence issues; and an action filed in West Virginia state court by West Virginia’s Attorney General, seeking recovery from the defendants in the aggregate of $5,000 for each of what are alleged to be hundreds of thousands of violations of the state’s consumer protection statute. On August 8, 2003, the plaintiffs in the Colorado action dismissed the complaint without prejudice. In West Virginia, the court denied defendants’ motion to dismiss, and defendants are pursuing an interlocutory appeal to the State Supreme court.

JPMSI was served by the SEC, NASD and NYSE on or about May 30, 2003, with subpoenas or document requests seeking information regarding certain present and former officers and employees in connection with an investigation focusing on whether particular individuals properly performed supervisory functions regarding domestic equity research. The regulators also raised issues regarding JPMSI’s document retention procedures and policies and pursued a books-and-records charge against it concerning e-mail that its heritage entities could not retrieve for the period prior to July 2001. JPMSI has negotiated an agreement that has been accepted by all of the regulators to settle this matter for a payment of a $2.1 million penalty without admitting or denying any allegations.

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 on 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. Responsive pleadings in the UAT action have not been filed.

Mutual fund Litigation: On June 29, 2004, Banc One Investment Advisors (“BOIA”) entered into a settlement with the New York Attorney General and the SEC related to alleged market timing in the One Group mutual funds. Under the settlement, BOIA paid $10 million in restitution and fee disgorgement plus a civil penalty of $40 million. BOIA also agreed to reduce fees over a five-year period in the amount of $8 million per year, consented to a cease-and-desist order and a censure, and agreed to undertake certain compliance and mutual fund governance reforms. Additionally, JPMorgan Chase, Bank One, and certain subsidiaries and officers have been named, along with numerous other entities related to the mutual fund industry, as defendants in private-party litigation arising out of alleged late trading and market timing in mutual funds. The actions have been filed in or transferred to U.S. District Court in Baltimore, Maryland. Certain plaintiffs allege that BOIA and related entities and officers allowed favored investors to market time and late trade in the One Group mutual funds. These complaints include a purported class action on behalf of One Group shareholders alleging claims under federal securities laws and common law; a purported derivative suit on behalf of the One Group funds under the Investment Company Act, the Investment Advisers Act and common law; and a purported class action on behalf of participants and beneficiaries of the Bank One Corporation 401(k) plan, alleging claims under the Employee Retirement Income Security Act. On September 29, 2004, certain other plaintiffs in the federal action in Baltimore, Maryland filed amended complaints which included JPMorgan Chase and JPMSI as defendants. The amended complaints allege that JPMorgan Chase and JPMSI, with several co-defendants including Bank of America,



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Bank of America Securities, Canadian Imperial Commerce Bank, Bear Stearns and CFSB, provided financing to Canary Capital which was used to engage in the market timing and late trading. JPMorgan Chase and JPMSI are alleged to have financed knowingly the market timing and late trading by Canary Capital and Edward Stern, and knowingly to have created short-position equity baskets to allow Canary Capital to profit from trading in a falling market. On February 25, 2005, BOIA, JPMorgan Chase, JPMSI and other defendants filed motions to dismiss these actions.

Certain JPMorgan Chase subsidiaries have also received various subpoenas and information requests relating to market timing and late trading in mutual funds from various governmental and other agencies, including the SEC, the NASD, the U.S. Department of Labor, the Attorneys General of New York, West Virginia and Vermont, and regulators in the United Kingdom, Luxembourg, the Republic of Ireland, Chile and Hong Kong. The Firm is fully cooperating with these investigations.

On January 12, 2005, Bank One Securities Corporation (“BOSC”) entered into a settlement with the NASD pursuant to which BOSC was censured and agreed to pay a $400,000 fine for its alleged failure to implement adequate supervisory systems and written procedures designed to detect and prevent late trading of mutual funds, and for inaccurately recording the entry time for customer orders.

Bank One Securities Litigation. Bank One and several former officers and directors are defendants in three class actions and one individual action arising out of the mergers between Banc One Corporation (“Banc One”) and First Commerce Corporation (“First Commerce”), and Banc One Corporation and First Chicago NBD Corporation (“FCNBD”). These actions were filed in 2000 and are pending in the United States District Court for the Northern District of Illinois in Chicago under the general caption, In re Bank One Securities Litigation. The cases were filed after Bank One’s earnings announcements in August and November 1999 that lowered Bank One’s earnings expectations for the third and fourth quarters of 1999. Following the announcements, Bank One’s stock price had dropped by 37.7% as of November 10, 1999.

Two of these class actions were brought by representatives of FCNBD shareholders and Banc One shareholders, respectively, alleging certain misrepresentations and omissions of material fact made in connection with the merger between FCNBD and Banc One, which was completed in October 1998. There is also an individual lawsuit proceeding

in connection with that same merger. A third class action was filed by another individual plaintiff representing shareholders of First Commerce, alleging certain misrepresentations and omissions of material fact made in connection with the merger between Banc One and First Commerce, which was completed in June 1998. All of these plaintiff groups claim that as a result of various misstatements or omissions regarding payment processing issues at First USA Bank, N.A., a wholly-owned subsidiary of Banc One, and as a result of the use of various accounting practices, the price of Banc One common stock was artificially inflated, causing their shareholders to acquire shares of the Bank One’s common stock in the merger at an exchange rate that was artificially deflated. The complaints against Bank One and the individual defendants assert claims under federal securities laws. Fact discovery, with limited exceptions, closed in December 2003. The parties are in the middle of expert discovery, which is scheduled to close in the spring of 2005.

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 respective 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 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   Positions and offices held with JPMorgan Chase
    (at December 31, 2004)    
 
           
William B. Harrison, Jr.
    61     Chairman and Chief Executive Officer since November 2001, prior to which he was President and Chief Executive Officer from December 2000. He was Chairman and Chief Executive Officer from January through December 2000 and President and Chief Executive Officer from June through December 1999.

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James Dimon
    48     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; President of Citigroup Inc. and Chairman and Co-Chief Executive Officer of Citigroup Inc. subsidiary Salomon Smith Barney Holdings, Inc. from October to November 1998; President and Chief Operating Officer of Travelers Group from November 1993 until October 1998.
 
           
Austin A. Adams
    61     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.) from 1985 until February 2001.
 
           
Steven B. Black
    52     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, Global Equities, Tax Exempt Securities and Securities Lending of Citigroup Inc. subsidiary, Salomon Smith Barney Inc.
 
           
William I. Campbell
    60     Chairman of Card Services. Prior to the Merger, he had been Head of Card Services with Bank One Corporation since July 2003. He had been Senior Partner with Sanoch Management, LLC from January 2000 until July 2003, prior to which he had been Co-Chief Executive Officer of Global Consumer Business of Citigroup Inc. from January 1996 until December 1999.
 
           
Michael J. Cavanagh
    38     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. Prior to joining Bank One Corporation, he held executive positions at Citigroup Inc. and its predecessor entities.
 
           
David A. Coulter
    57     Chairman of West Coast Region since January 2005 and Head of Private Equity since March 2004. He had been Chairman of the Investment Bank and Head of Asset & Wealth Management from June 2002 until December 2004, prior to which he had been Head of Chase Financial Services from 2000 until 2002. Prior to joining JPMorgan Chase in 2000, he led the West Coast operations of The Beacon Group, prior to which he was Chairman and Chief Executive Officer of BankAmerica Corporation and Bank of America NT & SA.
 
           
John J. Farrell
    52     Director Human Resources and Head of Security since September 2001.
 
           
Joan Guggenheimer
    52     Co-General Counsel. 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 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.
 
           
Frederick W. Hill
    54     Director of Corporate Marketing and Communications.
 
           
Samuel Todd Maclin
    48     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
    42     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. He had been Vice Chairman and Chief Executive Officer of the Private Client Group of Citigroup Inc. subsidiary Salomon Smith Barney, Inc. from September 2000 until August 2002 and Senior Executive Vice President of Private Client Sales and Marketing at Salomon Smith Barney, Inc. from August 1997 until August 2000.
 
           
William H. McDavid
    58     Co-General Counsel. Prior to the Merger, he had been General Counsel.
 
           
Heidi Miller
    51     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

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          March 2002; Senior Executive Vice President, Chief Financial Officer and Head of Strategic Planning at Priceline.com from March until November 2000; Chief Financial Officer at Citigroup Inc. from 1998 until March 2000.
 
           
Charles W. Scharf
    39     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 from 1998 until 2000.
 
           
Richard J. Srednicki
    57     Chief Executive Officer of Card Services from July 2004 prior to which he was Executive Vice President of Chase Cardmember Services from 1999 until 2004.
 
           
James E. Staley
    48     Global Head of Asset & Wealth Management since 2001. He had been Head of the Private Bank at J.P. Morgan & Co. Incorporated.
 
           
Don M. Wilson III
    56     Chief Risk Officer. He had been Co-Head of Credit & Rates Markets from 2001 until July 2003, prior to which he headed the Global Trading Division.
 
           
William T. Winters
    43     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, 2004, all of JPMorgan Chase’s above-named executive officers have continuously held senior-level positions with JPMorgan Chase or its predecessor institutions, Bank One Corporation, J.P. Morgan & Co. Incorporated and The Chase Manhattan Corporation. There are no family relationships among the foregoing executive officers.

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 129. JPMorgan Chase declared quarterly cash dividends on its common stock in the amount of $0.34 per share for each quarter of 2004 and 2003. The common dividend payout ratio based on reported net income was 88% for 2004, 43% for 2003 and 171% for 2002. At January 31, 2005, there were 233,239 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 equity-based plans. The actual amount of shares repurchased will be subject to various factors, including market conditions; legal considerations affecting the amount and timing of repurchase activity; the Firm’s capital position (taking into account purchase accounting adjustments); internal capital generation; and alternative potential investment opportunities. The stock repurchase program has no set expiration or termination date.

The Firm’s repurchases of equity securities were as follows:

                         
    Total open     Average     Dollar value of  
For the year ended   market shares     price paid     remaining authorized  
December 31, 2004   repurchased     per share(a)     repurchase program  
 
Third quarter
    3,497,700     $ 39.42     $ 5,862  
 
October
    4,187,000       37.60       5,704  
November
    5,827,700       38.12       5,482  
December
    5,766,800       38.19       5,262  
 
Fourth quarter
    15,781,500       38.01       5,262  
 
Total for 2004
    19,279,200     $ 38.27     $ 5,262  
 
(a)  
Excludes commission costs.

In addition to the repurchases disclosed above, participants in the Long-term Incentive Plan and Stock Option Plan 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 publicly announced share repurchase program. Shares repurchased were as follows for the year ended December 31, 2004: first quarter— 3,625,236 shares at an average price per share of $39.47; second quarter—669,247 shares at an average price per share of $36.23; third quarter—995,686 shares at an average price per share of $38.17; October—107,795 shares at an average price per share of $39.48; November—216,254 shares at an average price per share of $38.79; December—95,026 shares at an average price per share of $37.96; fourth quarter—419,075 shares at an average price per share of $38.78; 2004 Total—5,709,244 shares at an average price per share of $38.82.



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Parts II & III

Item 6: Selected financial data

For five-year selected financial data, see “Five-year summary of consolidated financial highlights (unaudited)” on page 130.

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 18 through 81. Such information should be read in conjunction with the Consolidated financial statements and Notes thereto, which appear on pages 84 through 128.

Item 7A: Quantitative and qualitative
disclosures about market risk

For information related to market risk, see the “Market risk management” section on pages 70 through 74 and Note 26 on pages 118-119.

Item 8: Financial statements
and supplementary data

The Consolidated financial statements, together with the Notes thereto and the report of PricewaterhouseCoopers LLP dated February 22, 2005 thereon, appear on pages 83 through 128.

Supplementary financial data for each full quarter within the two years ended December 31, 2004 are included on page 129 in the table entitled “Supplementary information — selected quarterly financial data (unaudited).” Also included is a “Glossary of terms” on page 131.

Item 9: Changes in and disagreements
with accountants on accounting and
financial disclosure

None.

Item 9A: Controls and procedures

Within the 75-day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of the Firm’s management, including its Chief Executive Officer, Chief Operating Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). See Exhibits 31.1,

31.2 and 31.3 for the Certification statements issued by the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective.

The work undertaken by the Firm to comply with Section 404 of the Sarbanes-Oxley Act of 2002 involved the identification, documentation, assessment and testing of the Firm’s internal control over financial reporting in order to evaluate the effectiveness of such controls. The evaluation included key controls of Bank One Corporation from the date of its acquisition on July 1, 2004.

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 82 for Management’s report on internal control over financial reporting, and page 83 for the Report of the Firm’s 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 2004 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 on page 13.

Item 11: Executive compensation

See Item 13 on page 13.

Item 12: Security ownership of certain
beneficial owners and management

For security ownership of certain beneficial owners and management, see Item 13 on page 13.



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Parts III & IV

The following table details the total number of shares available for issuance under JPMorgan Chase 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, 2004   issued upon exercise of     exercise price of     available for future issuance under  
(Shares in thousands)   outstanding options     outstanding options     equity compensation plans  
 
Employee stock-based incentive plans approved by shareholders
    314,814     $ 35.76       188,580 (a)(b)
Employee stock-based incentive plans not approved by shareholders
    172,448       40.12       54,000 (c)
 
Total
    487,262     $ 37.30       242,580  
 
(a)  
Includes 35 million shares of restricted stock/restricted stock units available for grant in lieu of cash under our shareholder approved plan. The shareholder approved 1996 Long-Term Incentive Plan, as amended in May 2000, expires in May 2005.
(b)  
In January 2005, approximately 35.5 million restricted stock units and 2.0 million stock appreciation rights (“SARs”) (settled only in shares) and stock options were granted under the Firm’s shareholder approved plan as part of employee annual incentive compensation. Other than these grants, the Firm does not anticipate making any significant grants to employees under the 1996 Long-Term Incentive Plan before this plan expires in May 2005. A new equity plan will be presented for approval by shareholders at the annual meeting in May 2005. For the new equity plan, management will not be requesting the remaining shares available for future issuance under the shareholder approved 1996 Long-Term Incentive Plan — anticipated to be about 150 million shares — be made available under the new equity plan.
(c)  
Management has determined that there will be no grants in 2005 under either the Stock Option Plan (under which options and SARs were last awarded in 2002) and the Value Sharing Plan (6.3 million options and SARs were granted in 2004). Both of these non-shareholder approved plans will expire in May 2005. Management will not be requesting that the 54 million shares available for future issuance be carried over to the new equity plan.

Item 13: Certain relationships and
related transactions

Information related to JPMorgan Chase’s Executive Officers is included on pages 9-11. 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 2005 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 2004 fiscal year.

Item 14: Principal accounting fees and
services

See Item 13 above.

Part IV

Item 15: Exhibits, financial statement
schedules

Exhibits, financial statements and 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 83.
 
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.

3.  
Exhibits
 
3.1  
Restated Certificate of Incorporation of JPMorgan Chase & Co.
 
3.2  
By-laws of JPMorgan Chase & Co. as amended by the Board of Directors on March 16, 2004, effective July 20, 2004.
 
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 8-A of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) File No. 1-5805), 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), as succeeded to by Bankers Trust Company (now known as Deutsche Bank Trust Company Americas), as Trustee.
 
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 (now known as JPMorgan Chase Bank), as succeeded to by U.S. Bank Trust National Association, as Trustee (incorporated by reference to Exhibit 4.3(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
4.3(b)  
Second Supplemental Indenture, dated as of October 8, 1996, 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 (incorporated by reference to Exhibit 4.3(b) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).



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Part IV

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 (incorporated by reference to Exhibit 4.3(c) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
4.4(a)  
Amended and Restated Indenture, dated as of September 1, 1993, between The Chase Manhattan Corporation (as assumed by JPMorgan Chase & Co.) and Chemical Bank (succeeded through the merger by JPMorgan Chase Bank), as Trustee (incorporated by reference to Exhibit 4.4(a) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
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, Chemical Bank, as resigning Trustee, and U.S. Bank Trust National Association, as successor Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993 (incorporated by reference to Exhibit 4.4(b) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
4.4(c)  
Second Supplemental Indenture, dated as of October 8, 1996, 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 (incorporated by reference to Exhibit 4.4(c) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
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 (incorporated by reference to Exhibit 4.4(d) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
4.5(a)  
Indenture dated as of August 15, 1982, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee (incorporated by reference to Exhibit 4.5(a) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
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 U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of August 15, 1982 (incorporated by reference to Exhibit 4.5(b) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).

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 U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of August 15, 1982 (incorporated by reference to Exhibit 4.5(c) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
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 U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of August 15, 1982 (incorporated by reference to Exhibit 4.5(d) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
4.5(e)  
Fourth Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated, 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 (incorporated by reference to Exhibit 4.5(e) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
4.6(a)  
Indenture dated as of March 1, 1993, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee (incorporated by reference to Exhibit 4.7(a) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
4.6(b)  
First Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated, 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 (incorporated by reference to Exhibit 4.7(b) to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
4.7  
Indenture dated May 25, 2001, between J.P. Morgan Chase & Co. (now known as JPMorgan Chase & Co.) and Deutsche Bank Trust Company Americas (previously known as Bankers Trust Company), as Trustee (incorporated by reference to Exhibit 4(a)(1) to the Registration Statement on Form S-3 (File No. 333-52826) of J.P. Morgan Chase & Co., File No. 1-5805).
 
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 Debenture Trustee.
 
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.
 
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.



14


Table of Contents

4.9(a)  
Indenture relating to senior debt securities, dated March 3, 1997, between Banc One Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank, as Trustee.
 
4.9(b)  
First Supplemental Indenture relating to senior debt securities, dated as of October 2, 1998, between Banc One Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank, as Trustee.
 
4.9(c)  
Form of Second Supplemental Indenture relating to senior debt securities, dated as of July 1, 2004, among J.P. Morgan Chase & Co. (now known as JPMorgan Chase & Co.), Bank One Corporation, 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 dated July 1, 2004. (File No. 333-116822) of JPMorgan Chase & Co.)
 
4.10(a)  
Indenture relating to subordinated debt securities, dated March 3, 1997, between Banc One Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank, as Trustee.
 
4.10(b)  
First Supplemental Indenture relating to subordinated debt securities dated October 2, 1998, between Banc One Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank, as Trustee.
4.10(c)  
Second Supplemental Indenture relating to subordinated debt securities, dated July 1, 2004, among J.P. Morgan Chase & Co. (now known as JPMorgan Chase & Co.), Bank One Corporation, 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 dated July 1, 2004. (File No. 333-116822) of JPMorgan Chase & Co.)
 
4.11(a)  
Form of Indenture, dated July 1, 1995, between Banc One Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and Citibank N.A, as Trustee.
 
4.11(b)  
Form of Supplemental Indenture, dated July 1, 2004, among J.P. Morgan Chase & Co. (now known as JPMorgan Chase & Co.), Bank One Corporation, and Citibank N.A. as resigning Trustee, and U.S. Bank Trust National Association, as successor Trustee, to the Indenture, dated as of July 1, 1995 (incorporated by reference to Exhibit 4.27 to the Registration Statement on Form S-3 dated July 1, 2004. (File No. 333-116822) of JPMorgan Chase & Co.)
 
4.12(a)  
Form of Indenture, dated December 1, 1995, between First Chicago NBC Corporation (a predecessor to Bank One Corporation) (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association), as Trustee.

4.12(b)  
Form of Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co. (now known as JPMorgan Chase & Co.), Bank One Corporation, JPMorgan Chase Bank (as successor to The Chase Manhattan Bank (National Association), 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 dated July 1, 2004. (File No. 333-116822) of JPMorgan Chase & Co.)
 
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.
 
10.2  
Post-Retirement Compensation Plan for Non-Employee Directors, as amended and restated as of May 21, 1996.
 
10.3  
Deferred Compensation Program of JPMorgan Chase & Co. and Participating Companies, effective as of January 1, 1996.
 
10.4  
Amended and Restated 1996 Long-Term Incentive Plan of The Chase Manhattan Corporation (incorporated by reference to Schedule 14A, filed on April 5, 2000, of The Chase Manhattan Corporation, File No. 1-5805).
10.5(a)  
The Chase Manhattan 1994 Long-Term Incentive Plan.
 
10.5(b)  
Amendment to The Chase Manhattan 1994 Long-Term Incentive Plan.
 
10.6  
Chemical Banking Corporation Long-Term Stock Incentive Plan, as amended and restated as of May 19, 1992.
 
10.7  
Key Executive Performance Plan of JPMorgan Chase & Co., as amended and restated January 1, 1999 (incorporated by reference to Proposal 4 of the Joint Proxy Statement, dated April 19, 2004, of J.P. Morgan Chase & Co. and Bank One Corporation).
 
10.8  
Excess Retirement Plan of The Chase Manhattan Bank and Participating Companies, restated effective January 1, 1997 (incorporated by reference to Exhibit 10.14 to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
10.9  
Form of J.P. Morgan & Co. Incorporated Stock Option Award.
 
10.10  
1992 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended.
 
10.11  
1984 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended.
 
10.12  
1995 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended.
 
10.13  
1998 J.P. Morgan & Co. Incorporated Performance Plan.
 
10.14  
Executive Retirement Plan of The Chase Manhattan Corporation and Certain Subsidiaries (incorporated by reference to Exhibit 10.25 to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).



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Part IV

10.15  
Benefit Equalization Plan of The Chase Manhattan Corporation and Certain Subsidiaries (incorporated by reference to Exhibit 10.26 to the Annual Report on Form 10-K of J.P. Morgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2000).
 
10.16  
Summary of Terms of JPMorgan Chase & Co. Severance Policy.
 
10.17  
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 dated as of July 1, 2004 of J.P. Morgan Chase & Co. (File No. 333-112967)).
 
10.18  
Summary of Terms of Pension – William B. Harrison, Jr. (incorporated by reference to Form 8-K of JPMorgan Chase & Co. dated February 28, 2005).
 
10.19  
Bank One Corporation Director Stock Plan, as amended (incorporated by reference to Exhibit 10(B) to the Form 10-K of Bank One Corporation for the year ended December 31, 2003).
 
10.20  
Summary of Bank One Corporation Director Deferred Compensation Plan (incorporated by reference to Exhibit 10(M) to the Form 10-K of Bank One Corporation for the year ended December 31, 2000).
 
10.21  
Bank One Corporation Stock Performance Plan (incorporated by reference to Exhibit 10(A) to the Form 10-K of Bank One Corporation for the year ended December 31, 2002).
 
10.22  
Bank One Corporation Deferred Compensation Plan, as amended (incorporated by reference to Exhibit 10(D) to the Form 10-K of Bank One Corporation for the year ended December 31, 2000).
 
10.23  
Bank One Corporation Supplement Savings and Investment Plan, as amended (incorporated by reference to Exhibit 10(E) to the Form 10-K of Bank One Corporation for the year ended December 31, 2003).
 
10.24  
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 for the year ended December 31, 2003).
 
10.25  
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 for the year ended December 31, 2003).
 
10.26  
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 for the year ended December 31, 2003).
 
10.27  
Bank One Corporation Investment Option Plan (incorporated by reference to Exhibit 10(I) to the Form 10-K of Bank One Corporation for the year ended December 31, 2003).
 
10.28  
First Chicago Corporation Stock Incentive Plan.
 
10.29  
NBD Bancorp, Inc. Performance Incentive Plan, as amended.

10.30  
Bank One Corporation Revised and Restated 1989 Stock Incentive Plan.
 
10.31  
Bank One Corporation Revised and Restated 1995 Stock Incentive Plan.
 
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 112.  



16


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Table of contents

Financial:

     
Management’s discussion and analysis:
     
18  
Introduction
     
20  
Executive overview
     
22  
Consolidated results of operations
     
25  
Explanation and reconciliation of the Firm’s use of non-GAAP financial measures
     
28  
Business segment results
     
49  
Balance sheet analysis
     
50  
Capital management
     
52  
Off-balance sheet arrangements and contractual cash obligations
     
54  
Risk management
     
55  
Liquidity risk management
     
57  
Credit risk management
     
70  
Market risk management
     
75  
Operational risk management
     
76  
Reputation and fiduciary risk management
     
76  
Private equity risk management
     
77  
Critical accounting estimates used by the Firm
     
80  
Nonexchange-traded commodity contracts at fair value
     
80  
Accounting and reporting developments
     
Audited financial statements:
     
82  
Management’s report on internal control over financial reporting
     
83  
Report of independent registered public accounting firm
     
84  
Consolidated financial statements
     
88  
Notes to consolidated financial statements
     
Supplementary information:
     
129  
Selected quarterly financial data
     
130  
Five-year summary of consolidated financial highlights
     
131  
Glossary of terms


     
JPMorgan Chase & Co. / 2004 Annual Report   17

 


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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 page 131 for a definition 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. Such risks and uncertainties are described herein and in Part I, Item 1: Business, Important factors that may affect future results, in the JPMorgan Chase Annual Report on Form 10-K for the year ended December 31, 2004, filed with the Securities and Exchange Commission and available at the Commission’s website (www.sec.gov), 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, $106 billion in stockholders’ equity and operations in more than 50 countries. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, investment management, private banking and private equity. JPMorgan Chase serves more than 90 million customers, including consumers nationwide and many of the world’s most prominent wholesale clients.

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

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

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

Investment Bank

JPMorgan Chase is one of the world’s leading investment banks, as evidenced by the breadth of its client relationships and product capabilities. The Investment Bank (“IB”) has extensive relationships with corporations, financial institutions, governments and institutional investors worldwide. The Firm provides a full range of investment banking products and services, 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 in all major capital markets. The IB also commits the Firm’s own capital to proprietary investing and trading activities.

Retail Financial Services

Retail Financial Services (“RFS”) includes Home Finance, Consumer & Small Business Banking, Auto & Education Finance and Insurance. Through this group of businesses, the Firm provides consumers and small businesses with a broad range of financial products and services including deposits, investments, loans and insurance. Home Finance is a leading provider of consumer real estate loan products and is one of the largest originators and servicers of

home mortgages. Consumer & Small Business Banking offers one of the largest branch networks in the United States, covering 17 states with 2,508 branches and 6,650 automated teller machines. Auto & Education Finance is the largest bank originator of automobile loans as well as a top provider of loans for college students. Through its Insurance operations, the Firm sells and underwrites an extensive range of financial protection products and investment alternatives, including life insurance, annuities and debt protection products.

Card Services

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

Commercial Banking

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

Treasury & Securities Services

Treasury & Securities Services (“TSS”) is a global leader in providing transaction, investment and information services to support the needs of corporations, issuers and institutional investors worldwide. TSS is the largest cash management provider in the world and one of the top three global custodians. The Treasury Services business provides clients with a broad range of capabilities, including U.S. dollar and multi-currency clearing, ACH, trade, and short-term liquidity and working capital tools. The Investor Services business provides a wide range of capabilities, including custody, funds services, securities lending, and performance measurement and execution products. The Institutional Trust Services business provides trustee, depository and administrative services for debt and equity issuers. Treasury Services partners with the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management segments to serve clients firmwide. As a result, certain Treasury Services revenues are included in other segments’ results.

Asset & Wealth Management

Asset & Wealth Management (“AWM”) provides investment management to retail and institutional investors, financial intermediaries and high-net-worth families and individuals globally. For retail investors, AWM provides investment management products and services, including a global mutual fund franchise, retirement plan administration, and consultation and brokerage


     
18   JPMorgan Chase & Co./2004 Annual Report

 


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services. AWM delivers investment management to institutional investors across all asset classes. The Private bank and Private client services businesses provide integrated wealth management services to ultra-high-net-worth and high-net-worth clients, respectively.

Merger with Bank One Corporation

Effective July 1, 2004, Bank One Corporation (“Bank One”) merged with and into JPMorgan Chase (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. The Merger was accounted for using the purchase method of accounting. The purchase price to complete the Merger was $58.5 billion. Key objectives of the Merger were to provide the Firm with a more balanced business mix and greater geographic diversification.

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.

It is expected that cost savings of approximately $3.0 billion (pre-tax) will be achieved by the end of 2007; approximately two-thirds of the savings are anticipated to be realized by the end of 2005. Total 2004 Merger savings were approximately $400 million. Merger costs to combine the operations of JPMorgan Chase and Bank One are expected to range from approximately $4.0 billion to $4.5 billion (pre-tax). Of these costs, approximately $1.0 billion, specifically related to Bank One, were accounted for as purchase accounting adjustments and were recorded as an increase to goodwill in 2004. Of the approximately $3.0 billion to $3.5 billion in remaining Merger-related costs, $1.4 billion (pre-tax) were incurred in 2004 and have been charged to income, $1.4 billion (pre-tax) are expected to be incurred in 2005, and the remaining costs are expected to be incurred in 2006. These estimated Merger-related charges will result from actions taken with respect to both JPMorgan Chase’s and Bank One’s operations, facilities and employees. The charges will be recorded based on the nature and timing of these integration actions.

As part of the Merger, certain accounting policies and practices were conformed, which resulted in $976 million (pre-tax) of charges in 2004. The significant components of the conformity charges were comprised of a $1.4 billion (pre-tax) charge related to the decertification of the seller’s interest in credit card securitizations, and the benefit of a $584 million reduction in the allowance for credit losses as a result of conforming the wholesale and consumer credit provision methodologies.

Other business events

Electronic Financial Services

On January 5, 2004, JPMorgan Chase acquired Electronic Financial Services (“EFS”), a leading provider of government-issued benefits payments and prepaid stored value cards used by state and federal government agencies and private institutions. The acquisition further strengthened JPMorgan Chase’s position as a leading provider of wholesale payment services.

Cazenove

On November 5, 2004, JPMorgan Chase and Cazenove Group plc (“Cazenove”) announced an agreement to combine Cazenove’s investment banking business and JPMorgan Chase’s United Kingdom-based investment banking business into a new entity to be jointly owned. The partnership will provide investment banking services in the United Kingdom and Ireland. The transaction closed on February 28, 2005, and the new company is called JPMorgan Cazenove Holdings.

Highbridge

On December 13, 2004, JPMorgan Chase formed a strategic partnership with and acquired a majority interest in Highbridge Capital Management (“Highbridge”), a New York-based multi-strategy hedge fund manager, with seven discrete strategy groups and more than $7 billion of assets under management. Highbridge has offices in New York, London and Hong Kong. Including Highbridge, JPMorgan Chase now manages more than $40 billion of absolute-return products (e.g., hedge funds, private equity and real estate investments).

Vastera

On January 7, 2005, JPMorgan Chase agreed to acquire Vastera, a provider of global trade management solutions, for approximately $129 million. Vastera’s business will be combined with the Logistics and Trade Services businesses of TSS’s Treasury Services unit. The transaction is expected to close in the first half of 2005. Vastera automates trade management processes associated with the physical movement of goods internationally; the acquisition will enable Treasury Services to offer management of information and processes in support of physical goods movement, together with financial settlement.


     
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Management’s discussion and analysis

JPMorgan Chase & Co.

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. This overview discusses the economic or industry-wide factors that affected JPMorgan Chase, the factors that drove business performance, and the factors that management monitors in setting policy. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, this entire Annual Report should be read carefully.

Financial performance of JPMorgan Chase

                         
As of or for the year ended December 31, (a)                  
(in millions, except per share and ratio data)   2004     2003     Change  
 
Total net revenue
  $ 43,097     $ 33,384       29 %
Provision for credit losses
    2,544       1,540       65  
Noninterest expense
    34,359       21,816       57  
Net income
    4,466       6,719       (34 )
Net income per share — diluted
    1.55       3.24       (52 )
Average common equity
    75,641       42,988       76  
Return on average common equity(“ROCE”)
    6 %     16 %   (1,000 )bp
 
Loans
  $ 402,114     $ 214,766       87 %
Total assets
    1,157,248       770,912       50  
Deposits
    521,456       326,492       60  
 
Tier 1 capital ratio
    8.7 %     8.5 %   20 bp
Total capital ratio
    12.2       11.8       40  
 
(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.

Business overview

The Firm’s results in 2004 were affected by many factors, but the most significant of these were the Merger, the litigation charge taken in the second quarter of the year and global economic growth.

The Firm reported 2004 net income of $4.5 billion, or $1.55 per share, compared with net income of $6.7 billion, or $3.24 per share, for 2003. The return on common equity was 6%, compared with 16% in 2003. Results included $3.7 billion in after-tax charges, or $1.31 per share, comprised of: Merger costs of $846 million; charges to conform accounting policies as a result of the Merger of $605 million; and a charge of $2.3 billion to increase litigation reserves. Excluding these charges, operating earnings would have been $8.2 billion, or $2.86 per share, and return on common equity would have been 11%. Operating earnings represent business results without the merger-related costs and the significant litigation charges.

During the course of the year, the Firm developed a comprehensive plan of Merger integration and began to execute on the plan. Significant milestones during the year included: branding decisions for all businesses; merger of the holding companies, lead banks and credit card banks; conversion of the Bank One credit card portfolio to a new processing platform; announcement of insourcing of major technology operations; and consolidation and standardization of human resource policies and benefit plans. As part of the Merger, the Firm announced that it had targeted reducing operating expenses by $3.0 billion (pre-tax) by the end of 2007. In order to accomplish the cost reductions, the Firm announced that it expects to incur Merger costs of approximately $4.0 billion to $4.5 billion and reduce its workforce by approximately 12,000 over the same time period.

In 2004, both the U.S. and global economies continued to strengthen overall, even though momentum slowed during the second half of the year due to rising oil prices. Gross domestic product increased by 3.9% globally and 4.4% in the U.S., both up from 2003. The U.S. economy experienced rising short-term interest rates, driven by Federal Reserve Board (“FRB”) actions during the course of the year. The federal funds rate increased from 1.00% to 2.25% during the year and the yield curve flattened, as long-term interest rates were relatively stable. Equity markets, both domestic and international, enjoyed strong results, with the S&P 500 up 9% and international indices increasing in similar fashion. Capital markets activity during 2004 was healthy, debt underwriting was consistent with the strong levels experienced in 2003, and equity underwriting enjoyed strong and consistent activity during the year. The U.S. consumer sector showed continued strength buoyed by the overall economic strength, despite slowing mortgage origination and refinance activity. Retail sales were up over the prior year, and bankruptcy filings were down significantly from 2003.

On an operating basis, net income in each of the Firm’s lines of business was affected primarily by the Merger. The discussion that follows highlights other factors which affected operating results in each business.

Despite the relatively beneficial capital markets environment, results for the Investment Bank were under pressure during the year. This was primarily due to a decline in trading revenue related to lower fixed income trading, driven by weaker portfolio management results, and a reduction in net interest income, stemming primarily from lower loan balances. This was partially offset by increased investment banking fees, the result of continued strength in debt underwriting, and higher advisory fees. The Investment Bank benefited from a reduction in the allowance for credit losses, primarily due to the improved credit quality of the loan portfolio, as evidenced by the significant drop in nonperforming loans and, to a lesser extent, recoveries of previously charged-off loans. Expenses rose, primarily due to higher compensation expenses.

Retail Financial Services benefited from better spreads earned on deposits and growth in retained residential mortgage and home equity loan balances. Mortgage fees and related income was also up, reflecting higher mortgage servicing revenue, partially offset by significantly lower prime mortgage production income related to the slower mortgage origination activity. The Provision for credit losses benefited from improved credit quality in nearly all portfolios and a reduction in the allowance for credit losses related to the sale of a $4 billion manufactured home loan portfolio. Higher compensation expenses were due to continued expansion of the branch office network, including 130 new locations (106 net additional branches) opened during 2004 for the combined Firm, and expansion of the sales force, partially offset by ongoing efficiency improvements.

Card Services revenue benefited from higher loan balances and customer charge volume, which increased net interest income and higher net interchange income, respectively. Expenses increased due to higher marketing spending and higher volume-based processing expenses.

Commercial Banking revenues benefited from strong deposit growth and higher investment banking fees. These benefits were partially offset by lower service charges on deposits, which often decline when interest rates rise. Credit quality continued to improve, resulting in lower net charge-offs and nonperforming loans.



     
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Treasury & Securities Services revenues benefited from strong growth in assets under custody and average deposits, along with deposit spreads, which improved due to the relatively low interest rate environment for deposits. These benefits were offset by lower service charges on deposits, which often decline when interest rates rise. Revenues and expenses also were affected by acquisitions, divestitures and growth in business volume. Expenses also increased due to software impairment charges, and legal and technology-related expenses.

Asset & Wealth Management results were positively affected by the strength of global equity markets, an improved product mix, better investment performance and net asset inflows. Results also benefited from deposit and loan growth.

The Corporate segment performance was negatively affected by a repositioning of the investment securities portfolio and tighter spreads. This was partially offset by improved Private Equity results due to an improved climate for investment sales.

The Firm’s balance sheet was likewise significantly affected by the Merger. Aside from the Merger, the Firm took a number of actions during the year to strengthen the balance sheet. Notably, the Treasury investment portfolio was repositioned to reduce exposure to rising interest rates; auto leasing was de-emphasized, and lease receivables were reduced by 16% to $8 billion; the $4 billion manufactured home loan portfolio was sold; the $2 billion recreational vehicle portfolio was sold subsequent to year-end; a significant portion of third-party private equity investments have been sold; and the Firm increased its litigation reserves. The Firm’s capital base was also significantly enhanced following the Merger. As of year-end, total stockholders’ equity was $106 billion, and the Tier 1 capital ratio was 8.7%. The capital position allowed the Firm to begin repurchasing common stock during the second half of the year, with more than $700 million, or 19.3 million common shares, repurchased during the year.

2005 business outlook

JPMorgan Chase’s outlook for 2005 should be viewed against the backdrop of the global economy, financial markets and the geopolitical environment, all of which are integrally linked together. While the Firm considers outcomes for, and has contingency plans to respond to, stress environments, its basic outlook for 2005 is predicated on the interest rate movements implied in the forward rate curve for U.S. Treasuries, the continuation of the favorable U.S. and international equity markets and continued expansion of the global economy.

The performance of the Firm’s capital markets businesses is highly correlated to overall global economic growth. The Investment Bank enters 2005 with a strong pipeline for advisory and underwriting business, and it continues to focus on growing its client-driven trading business. Compared with 2004, the Investment Bank expects a reduction in credit portfolio revenues, as both net interest income on loans and gains from workouts are likely to decrease. Financial market movements and activity levels also affect Asset & Wealth Management and Treasury & Securities Services. Asset & Wealth Management anticipates revenue growth, driven by net inflows to Assets under supervision and by the Highbridge acquisition, as well as deposit and loan growth. Treasury & Securities Services anticipates modest revenue growth, due to wider spreads on deposits, as well as increased business volume and activity in the custody, trade, commercial card, American Depositary Receipt and Collateralized Debt Obligation businesses. Commercial Banking anticipates that net revenues will benefit from growth in treasury services and investment banking fees, offset by margin compression on loans.

The business outlook varies for the respective consumer businesses. Card Services anticipates modest growth in consumer spending and in card outstandings. For RFS, Home Finance earnings are likely to weaken given a market-driven decline in mortgage originations, neutralizing the expected earnings increase in Consumer & Small Business Banking. The drop in revenue at Home Finance should be mitigated by ongoing efforts to bring expenses in line with lower expected origination volumes. Growth is expected to continue in Consumer & Small Business Banking, with increases in core deposits and associated revenue partially offset by ongoing investments in the branch distribution network. New branch openings should continue at a pace consistent with or slightly above those of 2004. At the heritage Chase branches, expanded hours and realigned compensation plans that tie incentives to branch performance are expected to provide improvements in productivity and incremental net revenue growth. Earnings in Auto & Education Finance are expected to remain under pressure, given the current competitive operating environment. Across all RFS businesses, credit quality trends remain stable, with a slight increase in credit costs likely in 2005.

The Corporate sector includes Private Equity, Treasury and the corporate support units. The revenue outlook for the Private Equity business is directly related to the strength of equity market conditions in 2005. If current market conditions persist, the Firm anticipates continued realization of private equity gains; the Firm is not anticipating investment securities gains from the Treasury portfolio in 2005.

The Provision for credit losses in 2005 is anticipated to be higher than in 2004, driven primarily by a return to a more normal level of provisioning for credit losses in the wholesale businesses over time. The consumer Provision for credit losses in 2005 should reflect increased balances, with generally stable credit quality. The Firm plans to implement higher minimum-payment requirements in the Card Services business in the third quarter of 2005; it is anticipated that this will increase delinquency and net charge-off rates, but the magnitude of the impact is currently being assessed.

The Firm’s 2005 expenses should reflect the realization of $1.5 billion in merger savings. These savings are expected to be offset by a projected $1.1 billion of incremental spending related to firmwide technology infrastructure, distribution enhancement, and product improvement and expansion in Retail Financial Services, the Investment Bank and Asset & Wealth Management. In addition, expenses will increase as a result of recent acquisitions, such as Highbridge and Cazenove.

Management will seek to continue to strengthen the Firm’s balance sheet through rigorous financial and risk discipline. Any capital generated in excess of the Firm’s capital targets, and beyond that required to support anticipated modest growth in assets and the underlying risks of the Firm’s businesses, including litigation risk, will create capital flexibility in 2005 with respect to common stock repurchases and further investments in the Firm’s businesses.



     
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Management’s discussion and analysis

JPMorgan Chase & Co.

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, 2004. Factors that are primarily related 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 77-79 of this Annual Report.

Revenue

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Investment banking fees
  $ 3,537     $ 2,890     $ 2,763  
Trading revenue
    3,612       4,427       2,675  
Lending & deposit related fees
    2,672       1,727       1,674  
Asset management, administration and commissions
    7,967       5,906       5,754  
Securities/private equity gains
    1,874       1,479       817  
Mortgage fees and related income
    1,004       923       988  
Credit card income
    4,840       2,466       2,307  
Other income
    830       601       458  
 
Noninterest revenue
    26,336       20,419       17,436  
Net interest income
    16,761       12,965       12,178  
 
Total net revenue
  $ 43,097     $ 33,384     $ 29,614  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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. Additional factors contributing to the revenue growth were higher consumer demand for credit products and higher credit card charge volume, as well as strong retail and wholesale deposit growth. Investment banking revenues increased as a result of growth in global market volumes and market share gains. Revenue also benefited from acquisitions and growth in assets under custody, under management and under supervision, the result of global equity market appreciation and net asset inflows. Private equity gains were higher due to an improved climate for investment sales. 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. 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 30-32 of this Annual Report.

Lending & deposit related fees were up from 2003 due to the Merger. The rise was partially offset by lower service charges on deposits, 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 also driven 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. For additional information on these fees and commissions, see the segment discussions for AWM on pages 45-46, TSS on pages 43-44 and RFS on pages 33-38 of this Annual Report.

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 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 available-for-sale (“AFS”) securities, as compared with gains in 2003. For a further discussion of securities gains, see the RFS and Corporate segment discussions on pages 33-38 and 47-48, respectively, of this Annual Report. For a further discussion of Private equity gains, which are primarily recorded in the Firm’s Private Equity business, see the Corporate segment discussion on pages 47-48 of this Annual Report.

Mortgage fees and related income rose as a result of higher servicing revenue; this improvement was partially offset by lower mortgage servicing rights (“MSRs”) asset risk management results and prime mortgage production revenue, and 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 excludes the impact of NII and securities gains related to home mortgage activities. For a discussion of Mortgage fees and related income, which is primarily recorded in RFS’s Home Finance business, see the Home Finance discussion on pages 34-36 of this Annual Report.

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 the increase of $19.4 billion in average securitized loans. The increases were partially offset by higher volume-driven payments to partners and rewards expense. For a further discussion of Credit card income, see CS’s segment results on pages 39-40 of this Annual Report.

The increase in Other income from 2003 reflected gains on leveraged lease transactions and higher net results from corporate and bank-owned life insurance policies. These positive factors in 2004 were partially offset 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 were partially offset 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 $744.1 billion, up $154.2 billion from 2003. Growth was also driven by higher levels of consumer loans. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.27% in 2004, an increase of 6 basis points from the prior year.

2003 compared with 2002

Total revenue for 2003 was $33.4 billion, up 13% from 2002. All businesses benefited from improved economic conditions in 2003. In particular, the low-interest rate environment drove robust fixed income markets and an unprecedented mortgage refinancing boom, which drove the growth in revenue.


     
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Investment banking fees increased by $127 million, primarily due to growth in IB’s equity underwriting, which was up 49%, reflecting increases in market share and underwriting volumes. This increase was partially offset by lower advisory fees reflecting depressed levels of M&A activity. Trading revenue was up $1.8 billion, or 65%, primarily due to strong client and portfolio management revenue growth in fixed income and equity markets as a result of the low-interest rate environment, improvement in equity markets and volatility in credit markets. For a further discussion of Investment banking fees and Trading revenue, which are primarily recorded in the Investment Bank, see the IB segment results on pages 30-32 of this Annual Report.

Lending & deposit related fees rose, the result of higher fees on standby letters of credit, due to growth in transaction volume, and higher service charges on deposits. These charges were driven by an increase in the payment of services with fees, versus deposits, due to lower interest rates.

The increase in Asset management, administration and commissions was attributable to a more favorable environment for debt and equity activities, resulting in higher fees for the custody, institutional trust, brokerage and other processing-related businesses. Fees for investment management activities also increased as a result of acquisitions in AWM, but these increases were partially offset by institutional net fund outflows, which resulted in lower average assets under management.

Securities/private equity gains increased to $1.5 billion from $817 million in 2002, reflecting significant improvement in private equity gains. These gains were partially offset by lower gains realized from the sale of securities in Treasury and of AFS securities in RFS’s Home Finance business, driven by increasing interest rates beginning in the third quarter of 2003. For a further discussion of private equity gains (losses), see the Corporate segment discussion on pages 47-48 of this Annual Report.

Mortgage fees and related income declined by 7% in 2003, primarily due to a decline in revenue associated with risk management of the MSR asset, mortgage pipeline and mortgage warehouse; these were partially offset by higher fees from origination and sales activity and other fees derived from volume and market-share growth. For a discussion of Mortgage fees and related income, which is primarily recorded in RFS’s Home Finance business, see the Home Finance discussion on pages 34-36 of this Annual Report.

Credit card income rose as a result of higher credit card servicing fees associated with the $6.7 billion growth in average securitized credit card receivables. For a further discussion of Credit card income, see CS’s segment results on pages 39-40 of this Annual Report.

Other income rose, primarily from $200 million in gains on sales of securities acquired in loan workouts (compared with $26 million in 2002), as well as gains on the sale of several nonstrategic businesses and real estate properties; these were partly offset by lower net results from corporate and bank-owned life insurance policies. In addition, 2002 included $73 million of write-downs for several Latin American investments.

The increase in Net interest income reflected the positive impact of lower interest rates on consumer loan originations, such as mortgages and automobile loans and leases and related funding costs. Net interest income was partially reduced by a lower volume of wholesale loans and lower spreads on investment securities. The Firm’s total average interest-earning assets in 2003 were $590 billion, up 6% from the prior year. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.21%, the same as in the prior year.

Provision for credit losses

2004 compared with 2003

The Provision for credit losses of $2.5 billion was up $1.0 billion, or 65%, compared with the prior year. The impact of the Merger, and of accounting policy conformity charges of $858 million, were partially offset by releases in the allowance for credit losses related to the wholesale loan portfolio, primarily due to improved credit quality in the IB. Wholesale nonperforming loans decreased by 21% even after the inclusion of Bank One’s loan portfolio. RFS’s Provision for credit losses benefited from a reduction in the allowance for credit losses related to the sale of the $4 billion manufactured home loan portfolio and continued positive credit quality trends in the home and auto finance businesses. The provision related to the credit card portfolio grew by $919 million, principally due to the Merger. 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 57-69 of this Annual Report.

2003 compared with 2002

The 2003 Provision for credit losses was $2.8 billion lower than in 2002, primarily reflecting continued improvement in the quality of the wholesale loan portfolio and a higher volume of credit card securitizations.

Noninterest expense

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Compensation expense
  $ 14,506     $ 11,387     $ 10,693  
Occupancy expense
    2,084       1,912       1,606  
Technology and communications expense
    3,702       2,844       2,554  
Professional & outside services
    3,862       2,875       2,587  
Marketing
    1,335       710       689  
Other expense
    2,859       1,694       1,802  
Amortization of intangibles
    946       294       323  
 
Total noninterest expense before merger costs and litigation reserve charge
    29,294       21,716       20,254  
Merger costs
    1,365             1,210  
Litigation reserve charge
    3,700       100       1,300  
 
Total noninterest expense
  $ 34,359     $ 21,816     $ 22,764  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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 expenses would have been $29.3 billion, up 35%. In addition to the Merger and litigation charges, expenses increased due to reinvestment in the lines of business, partially offset by merger-related savings throughout the Firm. Each category of Noninterest expense was affected by the Merger. The discussion that follows highlights other factors which affected 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 partially offset by ongoing efficiency improvements and merger-related savings throughout the Firm, and a reduction in pension costs. The decline in pension costs was mainly attributable to the increase in the expected return on plan assets from a discretionary $1.1 billion contribution to the Firm’s pension



     
JPMorgan Chase & Co./2004 Annual Report   23

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

plan in April 2004, partially offset by changes in actuarial assumptions for 2004 compared with 2003. For a detailed discussion of pension and other postretirement benefit costs, see Note 6 on pages 92-95 of this Annual Report.

The increase in Occupancy expense was partly offset 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. After the Merger, JPMorgan Chase decided to terminate its outsourcing agreement with IBM, effective December 31, 2004. For a further discussion regarding the IBM outsourcing agreement, see the Corporate segment discussion on page 47 of this Annual Report.

Professional & outside services rose due to higher legal costs associated with pending litigation matters, as well as outside services stemming from recent acquisitions, primarily 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 accruals for non-Enron-related litigation cases; and the impact of growth in business volume. These were partly offset 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 109-111 and 98, respectively.

In June of 2004, JPMorgan Chase recorded a $3.7 billion (pre-tax) addition to the Litigation reserve. While the outcome of litigation is inherently uncertain, the addition reflected management’s assessment of the appropriate reserve level in light of all then-known information. By comparison, 2003 included a charge of $100 million for Enron-related litigation.

2003 compared with 2002

Total Noninterest expense was $21.8 billion, down 4% from the prior year. In 2002, the Firm recorded $1.3 billion of charges, principally for Enron-related litigation, and $1.2 billion for merger and restructuring costs related to programs announced prior to January 1, 2002. Excluding these costs, expenses rose by 8% in 2003, reflecting higher performance-related incentives, increased costs related to stock-based compensation and pension and other postretirement expenses; and higher occupancy expenses. The Firm began expensing stock options in 2003.

The increase in Compensation expense principally reflected higher performance-related incentives, as well as higher pension and other postretirement benefit costs, primarily as a result of changes in actuarial assumptions. The increase pertaining to incentives included $266 million as a result of adopting SFAS 123, and $120 million from the reversal in 2002 of previously accrued expenses for certain forfeitable key employee stock awards. Total compensation expenses declined as a result of the transfer, beginning April 1, 2003, of 2,800 employees to IBM in connection with the aforementioned technology outsourcing agreement.

The increase in Occupancy expense reflected costs of additional leased space in midtown Manhattan and in the South and Southwest regions of the United States, higher real estate taxes in New York City and the cost of enhanced

safety measures. Also contributing to the increase were charges for unoccupied excess real estate of $270 million; this compared with $120 million in 2002.

Technology and communications expense increased primarily due to a shift in expenses: costs that were previously associated with Compensation and Other expenses shifted, upon the commencement of the IBM outsourcing agreement, to Technology and communications expense. Also contributing to the increase were higher costs related to software amortization. For a further discussion of the IBM outsourcing agreement, see Corporate on page 47 of this Annual Report.

Professional & outside services rose, reflecting greater utilization of third-party vendors for processing activities and higher legal costs associated with various litigation and business-related matters.

Higher Marketing expense was driven by more robust campaigns for the Home Finance business.

The decrease in Other expense was due partly to expense management initiatives, such as reduced allowances to expatriates and recruitment costs.

There were no Merger costs in 2003. In 2002, merger and restructuring costs of $1.2 billion were for programs announced prior to January 1, 2002.

The Firm added $100 million to the Enron-related litigation reserve in 2003 to supplement a $1.3 billion reserve initially recorded in 2002. The 2002 reserve was established to cover Enron-related matters, as well as certain other material litigation, proceedings and investigations in which the Firm is involved.

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)   2004     2003     2002  
 
Income before income tax expense
  $ 6,194     $ 10,028     $ 2,519  
Income tax expense
    1,728       3,309       856  
Effective tax rate
    27.9 %     33.0 %     34.0 %
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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.

2003 compared with 2002

The effective tax rate decline was principally attributable to changes in the proportion of income subject to state and local taxes.


     
24   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

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 84-87 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 consistently tracked from year to year and enables a comparison of the Firm’s performance with other companies’ U.S. GAAP financial statements.

In addition to analyzing the Firm’s results on a reported basis, management reviews line-of-business results on an “operating basis,” which is a non-GAAP financial measure. The definition of operating basis starts with the reported U.S. GAAP results. In the case of the IB, operating basis noninterest revenue includes, in Trading revenue, net interest income related to trading activities. Trading activities generate revenues, which are recorded for U.S. GAAP purposes in two line items on the income statement: Trading revenue, which includes the mark-to-market gains or losses on trading positions, and Net interest income, which includes the interest income or expense related to those positions. Combining both the trading revenue and related net interest income enables management to evaluate the IB’s trading activities, by considering all revenue related to these activities, and facilitates operating comparisons to other competitors. The following table reclassifies the Firm’s trading-related Net interest income to Trading revenue.

Trading-related Net interest income reclassification

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Net interest income – reported
  $ 16,761     $ 12,965     $ 12,178  
Trading-related NII
    (1,950 )     (2,129 )     (1,880 )
 
Net interest income – adjusted
  $ 14,811     $ 10,836     $ 10,298  
 
Trading revenue – reported (b)
  $ 3,612     $ 4,427     $ 2,675  
Trading-related NII
    1,950       2,129       1,880  
 
Trading revenue – adjusted (b)
  $ 5,562     $ 6,556     $ 4,555  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Reflects Trading revenue at the Firm level. The majority of Trading revenue is recorded in the Investment Bank.

In addition, segment results reflect revenues on a tax-equivalent basis. The tax-equivalent gross-up for each business segment is based upon the level, type and tax jurisdiction of the earnings and assets within each business segment. Operating revenue for the Investment Bank includes tax-equivalent adjustments for income tax credits primarily related to affordable housing investments as well as tax-exempt income from municipal bond investments. Information prior to the Merger has not been restated to conform with this new presentation. The amount of the tax-equivalent gross-up for each business segment is eliminated within the Corporate segment. For a further discussion of trading-related revenue and tax-equivalent adjustments made to operating revenue, see the IB on pages 30-32 of this Annual Report.

In the case of Card Services, operating or managed basis excludes the impact of credit card securitizations on revenue, the Provision for credit losses, net charge-offs and loan receivables. Through securitization the Firm transforms a portion of its credit card receivables into securities, which are sold to investors. The credit card receivables are removed from the consolidated balance sheet through the transfer of principal credit card receivables to a trust, and the sale of undivided interests 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 sheet. A gain or loss on the sale of credit card receivables to investors is recorded in Other income. Securitization also affects the Firm’s consolidated income statement by reclassifying as credit card income, interest income, certain fee revenue, and recoveries in excess of interest paid to the investors, gross credit losses and other trust expenses related to the securitized receivables. For a reconciliation of reported to managed basis of Card Services results, see page 40 of this Annual Report. For information regarding loans and residual interests sold and securitized, see Note 13 on pages 103-106 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 about allocating resources such as employees and capital are based on managed financial information.

Finally, operating basis excludes Merger costs, the Litigation reserve charge and accounting policy conformity adjustments related to the Merger, as management believes these items are not part of the Firm’s normal daily business operations (and, therefore, are not indicative of trends) and do not provide meaningful comparisons with other periods.

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



     
JPMorgan Chase & Co./2004 Annual Report   25

 


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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)   2004   2003
(in millions, except   Reported     Credit     Special     Operating     Reported     Credit     Special     Operating  
per share and ratio data)   results     card (b)     items     basis     results     card (b)     items     basis  
                 
Revenue
                                                               
Investment banking fees
  $ 3,537     $     $     $ 3,537     $ 2,890     $     $     $ 2,890  
Trading revenue(c)
    5,562                   5,562       6,556                   6,556  
Lending & deposit related fees
    2,672                   2,672       1,727                   1,727  
Asset management, administration and commissions
    7,967                   7,967       5,906                   5,906  
Securities/private equity gains
    1,874                   1,874       1,479                   1,479  
Mortgage fees and related income
    1,004                   1,004       923                   923  
Credit card income
    4,840       (2,267 )           2,573       2,466       (1,379 )           1,087  
Other income
    830       (86 )     118 (1)     862       601       (71 )           530  
                 
Noninterest revenue(c)
    28,286       (2,353 )     118       26,051       22,548       (1,450 )           21,098  
Net interest income(c)
    14,811       5,251             20,062       10,836       3,320             14,156  
                 
Total net revenue
    43,097       2,898       118       46,113       33,384       1,870             35,254  
Provision for credit losses
    2,544       2,898       (858) (2)     4,584       1,540       1,870             3,410  
Noninterest expense
                                                               
Merger costs
    1,365             (1,365) (3)                              
Litigation reserve charge
    3,700             (3,700) (4)           100                   100  
All other noninterest expense
    29,294                   29,294       21,716                   21,716  
                 
Total noninterest expense
    34,359             (5,065 )     29,294       21,816                   21,816  
                 
Income before income tax expense
    6,194             6,041       12,235       10,028                   10,028  
Income tax expense
    1,728             2,296 (6)     4,024       3,309                   3,309  
                 
Net income
  $ 4,466     $     $ 3,745     $ 8,211     $ 6,719     $     $     $ 6,719  
                 
Earnings per share — diluted
  $ 1.55     $     $ 1.31     $ 2.86     $ 3.24     $     $     $ 3.24  
                 
Return on common equity
    6 %           5 %     11 %     16 %                 16 %
Return on equity — goodwill(d)
    9             7       16       19                   19  
                 
Return on assets
    0.46     NM   NM     0.81       0.87     NM   NM     0.83  
                 
Overhead ratio
    80 %   NM   NM     64 %     65 %   NM   NM     62 %
                 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
The impact of credit card securitizations affects CS. See pages 39-40 of this Annual Report for further information.
(c)  
Includes the reclassification of trading-related Net interest income to Trading revenue. See page 25 of this Annual Report for further information.
(d)  
Net income applicable to common stock/Total average common equity (net of goodwill). The Firm uses return on equity less goodwill, a non-GAAP financial measure, to evaluate the operating performance of the Firm. The Firm utilizes this measure to facilitate operating comparisons to other competitors.
                                                 
Year ended December 31,(e)   2004   2003
(in millions)   Reported     Securitized     Managed     Reported     Securitized     Managed  
     
Loans — Period-end
  $ 402,114     $ 70,795     $ 472,909     $ 214,766     $ 34,856     $ 249,622  
Total assets — average
    962,556       51,084       1,013,640       775,978       32,365       808,343  
     
(e)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
     
26   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

(Table continued from previous page)

                           
2002
Reported   Credit     Special     Operating  
results   card (b)     items     basis  
   
$
2,763
  $     $     $ 2,763  
 
4,555
                4,555  
 
1,674
                1,674  
 
5,754
                5,754  
 
817
                817  
 
988
                988  
 
2,307
    (1,341 )           966  
 
458
    (36 )           422  
   
 
19,316
    (1,377 )           17,939  
 
10,298
    2,816             13,114  
   
 
29,614
    1,439             31,053  
 
4,331
    1,439             5,770  
 
1,210
          (1,210 )(3)      
 
1,300
          (1,300 )(4)      
 
20,254
          (98 )(5)     20,156  
   
 
22,764
          (2,608 )     20,156  
   
 
2,519
          2,608       5,127  
 
856
          887 (6)     1,743  
   
$
1,663
  $     $ 1,721     $ 3,384  
   
$
0.80
  $     $ 0.86     $ 1.66  
   
 
4
%         4 %     8 %
 
5
          5       10  
   
 
0.23
    NM       NM       0.45  
   
 
77
%   NM       NM       65 %
   
                   
2002  
Reported   Securitized     Managed  
 
$
216,364
  $ 30,722     $ 247,086  
 
733,357
    26,519       759,876  
 

Special Items

The reconciliation of the Firm’s reported results to operating results in the accompanying table sets forth the impact of several special items incurred by the Firm in 2002 and 2004. These special items are excluded from Operating earnings, as management believes these items are not part of the Firm’s normal daily business operations and, therefore, are not indicative of trends and do not provide meaningful comparisons with other periods. These items include Merger costs, significant litigation charges, charges to conform accounting policies and other items, each of which is described below:

(1)  
Other income in 2004 reflects $118 million of other accounting policy conformity adjustments.
 
(2)  
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.
 
(3)  
Merger costs of $1.4 billion in 2004 reflect costs associated with the Merger; the $1.2 billion of charges in 2002 reflect merger and restructuring costs associated with programs announced prior to January 1, 2002.
 
(4)  
Significant litigation charges of $3.7 billion and $1.3 billion were taken in 2004 and 2002, respectively.
 
(5)  
All Other noninterest expense in 2002 reflects a $98 million charge for excess real estate capacity related to facilities in the West Coast region of the United States.
 
(6)  
Income tax expense in 2004 and 2002 of $2.3 billion and $887 mil lion, respectively, represents the tax effect of the above items.

Formula Definitions for 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 - goodwill
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



     
JPMorgan Chase & Co./2004 Annual Report   27

 


Table of Contents

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 reportable business segments: the Investment Bank, Retail Financial Services, Card Services, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management, as well as a Corporate segment.

The segments are based on the products and services provided, or the type of customer served, and they reflect the manner in which financial information is currently evaluated by management. Results of these lines of business are presented on an operating basis.



(BUSINESS SEGMENT RESULTS)
JPMorgan is the brand name. JPMorgan Chase Chase is the brand name. Retail Treasury &Asset & Investment Card Commercial Financial Securities Wealth Bank Services Banking Services Services Management Product types: Businesses: Businesses: Businesses: Businesses: Businesses: •Investment banking:• Home Finance• Credit Card• Middle Market• Treasury Services• Investment Banking• Investor Services Management — Advisory• Consumer & Small• Merchant Acquiring — Debt and equity Business Banking• Corporate Banking- Institutional • Institutional Trust underwriting• Auto & Education• Commercial RealServices- Retail •Market-makingFinanceEstate• Private Banking and trading:• Insurance• Business Credit • Private Client — Fixed income • Equipment LeasingServices — Equities — Credit •Corporate lending

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 Middle Market moved into Commercial Banking, and Chase Cardmember Services is now its own segment called Card Services. TSS remains unchanged. Investment Management & Private Banking has been renamed Asset &

Wealth Management. JPMorgan Partners, which formerly was a stand-alone business segment, was moved into Corporate. Corporate is currently comprised of Private Equity (JPMorgan Partners and ONE Equity Partners), Treasury, as well as corporate support areas, which include Central Technology and Operations, Internal Audit, Executive Office, Finance, General Services, Human Resources, Marketing & Communications, Office of the General Counsel, Real Estate and Business Services, Risk Management and Strategy and Development.

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)   2004     2003     Change     2004     2003     Change  
 
Investment Bank
  $ 12,605     $ 12,684       (1 )%   $ 8,696     $ 8,302       5 %
Retail Financial Services
    10,791       7,428       45       6,825       4,471       53  
Card Services
    10,745       6,144       75       3,883       2,178       78  
Commercial Banking
    2,374       1,352       76       1,343       822       63  
Treasury & Securities Services
    4,857       3,608       35       4,113       3,028       36  
Asset & Wealth Management
    4,179       2,970       41       3,133       2,486       26  
Corporate
    562       1,068       (47 )     1,301       529       146  
 
Total
  $ 46,113     $ 35,254       31 %   $ 29,294     $ 21,816       34 %
 
(a)  
Represents the reported results excluding the impact of credit card securitizations and, in 2004, Merger costs, the significant litigation reserve charges 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. 2003 reflects the results of heritage JPMorgan Chase only.
(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.
     
28   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

Description of business segment reporting methodology

Results of the business segments are intended to reflect each segment as if it were essentially a stand-alone business. The management reporting process that derives these results allocates income and expense using market-based methodologies. At the time of the Merger, several of the allocation methodologies were revised, as noted below. The changes became effective July 1, 2004. 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 intends to continue to assess the assumptions, methodologies and reporting reclassifications used for segment reporting, and it is anticipated that further refinements may be implemented in future periods.

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 businesses.

Funds transfer pricing

Funds transfer pricing (“FTP”) is used to allocate interest income and interest expense to each line of business and also serves to transfer interest rate risk to Corporate. While business segments may periodically retain interest rate exposures related to customer pricing or other business-specific risks, the balance of the Firm’s overall interest rate risk exposure is included and managed in Corporate. 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 on 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.

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. Effective with the third quarter of 2004, new methodologies were implemented to calculate the amount of capital allocated to each segment. As part of the new methodology, goodwill, as well as the associated capital, is allocated solely to Corporate. Although U.S. GAAP requires the allocation of goodwill to the business segments for impairment testing (see Note 15 on page 109 of this Annual Report), the Firm has elected not to include goodwill or the related capital in each of the business segments for management reporting purposes. See the Capital management section on page 50 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 on pre-tax earnings, net of the cost of capital related to those exposures. Prior to the Merger, the credit reimbursement was based on pre-tax earnings, plus the allocated capital associated with the shared clients.

Tax-equivalent adjustments

Segment results reflect revenues on a tax-equivalent basis for segment reporting purposes. Refer to page 25 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)   2004     2003     Change     2004     2003  
 
Investment Bank
  $ 2,948     $ 2,805       5 %     17 %     15 %
Retail Financial Services
    2,199       1,547       42       24       37  
Card Services
    1,274       683       87       17       20  
Commercial Banking
    608       307       98       29       29  
Treasury & Securities Services
    440       422       4       17       15  
Asset & Wealth Management
    681       287       137       17       5  
Corporate
    61       668       (91 )     NM       NM  
 
Total
  $ 8,211     $ 6,719       22 %     16 %     19 %
 
     
JPMorgan Chase & Co./2004 Annual Report   29

 


Table of Contents

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, 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 in all major capital markets. The Investment Bank also commits the Firm’s own capital to proprietary investing and trading activities.

As a result of the Merger, the Treasury business has been transferred to the Corporate sector, and prior periods have been restated to reflect the reorganization.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Investment banking fees:
                       
Advisory
  $ 938     $ 640     $ 743  
Equity underwriting
    781       699       470  
Debt underwriting
    1,853       1,532       1,494  
 
Total investment banking fees
    3,572       2,871       2,707  
Trading-related revenue:(b)
                       
Fixed income and other
    5,008       6,016       4,607  
Equities
    427       556       20  
Credit portfolio
    6       (186 )     (143 )
 
Total trading-related revenue
    5,441       6,386       4,484  
Lending & deposit related fees
    539       440       394  
Asset management, administration and commissions
    1,400       1,217       1,244  
Other income
    328       103       (125 )
 
Noninterest revenue
    11,280       11,017       8,704  
Net interest income(b)
    1,325       1,667       1,978  
 
Total net revenue(c)
    12,605       12,684       10,682  
 
                       
Provision for credit losses
    (640 )     (181 )     2,392  
Credit reimbursement from (to) TSS(d)
    90       (36 )     (82 )
 
                       
Noninterest expense
                       
Compensation expense
    4,893       4,462       4,298  
Noncompensation expense
    3,803       3,840       3,500  
 
Total noninterest expense
    8,696       8,302       7,798  
 
Operating earnings before income tax expense
    4,639       4,527       410  
Income tax expense (benefit)
    1,691       1,722       (3 )
 
Operating earnings
  $ 2,948     $ 2,805     $ 413  
 
Financial ratios
                       
ROE
    17 %     15 %     2 %
ROA
    0.62       0.64       0.10  
Overhead ratio
    69       65       73  
Compensation expense as % of total net revenue
    39       35       40  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect 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 $1.9 billion, $2.1 billion and $1.9 billion for 2004, 2003 and 2002, respectively.
(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 $274 million, $117 million and $112 million for 2004, 2003, and 2002, respectively.
(d)  
TSS is charged a credit reimbursement related to certain exposures managed within the IB credit portfolio on behalf of clients shared with TSS. For a further discussion, see Credit reimbursement on page 29 of this Annual Report.

2004 compared with 2003
In 2004, Operating earnings of $2.9 billion were up 5% from the prior year. Increases in Investment banking fees, a reduction 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%.

Total net revenue of $12.6 billion was relatively flat from the prior year, primarily due to lower Fixed income markets revenues and total 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. Total credit portfolio revenues were down due to lower net interest income and lending fees, primarily driven by lower loan balances; these 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 additional information, see Credit risk management on pages 57-69 of this Annual Report.

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, including strategic investments and the impact of the Merger.

2003 compared with 2002
Operating earnings of $2.8 billion were up significantly over 2002. The increase in earnings was driven by a significant decline in the Provision for credit losses, coupled with strong growth in fixed income and equity markets revenues.

Total net revenue was $12.7 billion, an increase of $2.0 billion from the prior year. The low interest rate environment, improvement in equity markets and volatility in credit markets produced increased client and portfolio management revenue in fixed income and equities. Market share gains in equity underwriting contributed to the increase in Investment banking fees over 2002.

The Provision for credit losses was a benefit of $181 million in 2003, compared with a cost of $2.4 billion in 2002, reflecting improvement in the overall credit quality of the wholesale portfolio and the restructuring of several nonperforming wholesale loans.

Noninterest expense increased by 6% from 2002, reflecting higher incentives related to improved financial performance and the impact of expensing stock options. Noncompensation expenses were up 10% from the prior year due to increases in technology and occupancy costs.



     
30   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2004     2003     2002  
 
Revenue by business
                       
Investment banking fees
  $ 3,572     $ 2,871     $ 2,707  
Fixed income markets
    6,314       6,987       5,450  
Equities markets
    1,491       1,406       1,018  
Credit portfolio
    1,228       1,420       1,507  
 
Total net revenue
  $ 12,605     $ 12,684     $ 10,682  
 
                       
Revenue by region
                       
Americas
  $ 6,870     $ 7,250     $ 6,360  
Europe/Middle East/Africa
    4,082       4,331       3,215  
Asia/Pacific
    1,653       1,103       1,107  
 
Total net revenue
  $ 12,605     $ 12,684     $ 10,682  
 
                       
Selected balance sheet (average)
                       
Total assets
  $ 473,121     $ 436,488     $ 429,866  
Trading assets – debt and equity instruments
    173,086       156,408       134,191  
Trading assets – derivatives receivables
    58,735       83,361       70,831  
Loans(b)
    42,618       45,037       55,998  
Adjusted assets(c)
    393,646       370,776       359,324  
Equity
    17,290       18,350       19,134  
 
                       
Headcount
    17,478       14,691       15,012  
 
                       
Credit data and quality statistics
                       
Net charge-offs
  $ 47     $ 680     $ 1,627  
Nonperforming assets:
                       
Nonperforming loans(d)(e)
    954       1,708       3,328  
Other nonperforming assets
    242       370       408  
Allowance for loan losses
    1,547       1,055       1,878  
Allowance for lending related commitments
    305       242       324  
Net charge-off rate(b)
    0.13 %     1.65 %     3.15 %
Allowance for loan losses to average loans(b)
    4.27       2.56       3.64  
Allowance for loan losses to nonperforming loans(d)
    163       63       57  
Nonperforming loans to average loans
    2.24       3.79       5.94  
 
                       
Market risk-average trading and credit portfolio VAR
                       
Trading activities:
                       
Fixed income(f)
  $ 74     $ 61     NA
Foreign exchange
    17       17     NA
Equities
    28       18     NA
Commodities and other
    9       8     NA
Diversification
    (43 )     (39 )   NA
 
Total trading VAR
    85       65     NA
 
                       
Credit portfolio VAR(g)
    14       18     NA
Diversification
    (9 )     (14 )   NA
 
Total trading and credit portfolio VAR
  $ 90     $ 69     NA
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
The year-to-date average loans held for sale are $6.4 billion, $3.8 billion and $4.3 billion for 2004, 2003 and 2002, respectively. These amounts are not included in the allowance coverage ratios and net charge-off rates. The 2002 net charge-offs and net charge-off rate exclude charge-offs of $212 million taken on lending-related commitments.
(c)  
Adjusted assets equals total average assets minus (1) securities purchased under resale agreements and securities borrowed less securities sold, not yet purchased; (2) assets of variable interest entities (VIEs) consolidated under FIN 46R; (3) cash and securities segregated and on deposit for regulatory and other purposes; and (4) goodwill and intangibles.
   
The amount of adjusted assets is presented to assist the reader in comparing the IB’s asset and capital levels to other investment banks in the securities industry. Asset-to-equity leverage ratios are commonly used as one measure to assess a company’s capital adequacy. The IB believes an adjusted asset amount, which excludes certain assets considered to have a low risk profile, provides a more meaningful measure of balance sheet leverage in the securities industry. See Capital management on pages 50-52 of this Annual Report for a discussion of the Firm’s overall capital adequacy and capital management.
(d)  
Nonperforming loans include loans held for sale of $2 million, $30 million and $16 million as of December 31, 2004, 2003 and 2002, respectively. These amounts are not included in the allowance coverage ratios.
(e)  
Nonperforming loans exclude loans held for sale of $351 million, $22 million and $2 million as of December 31, 2004, 2003, and 2002, respectively, that were purchased as part of the IB’s proprietary investing activities.
(f)  
Includes all mark-to-market trading activities, plus available-for-sale securities held for IB investing purposes.
(g)  
Includes VAR on derivative credit valuation adjustments, credit valuation adjustment hedges and mark-to-market loan hedges, which are reported in Trading revenue. This VAR does not include the accrual loan portfolio, which is not marked to market.
NA – Data for 2002 is not available on a comparable basis.

According to Thomson Financial, in 2004, the Firm improved its ranking in U.S. announced M&A from #8 to #1, and Global announced M&A from #4 to #2, while increasing its market share significantly. The Firm’s U.S. initial public offerings ranking improved from #16 to #4, with the Firm moving to #6 from #4 in the U.S. Equity & Equity-related category. The Firm maintained its #1 ranking in U.S. syndicated loans, with a 32% market share, and its #3 position in Global Debt, Equity and Equity-related.

Market shares and rankings(a)

                                                 
    2004     2003     2002  
    Market             Market             Market        
December 31,   Share     Rankings     Share     Rankings     Share     Rankings  
 
Global debt, equity and equity-related
    7 %     # 3       8 %     # 3       8 %     #3  
Global syndicated loans
    20       # 1       20       # 1       26       #1  
Global long-term debt
    7       # 2       8       # 2       8       #2  
Global equity and equity-related
    6       # 6       8       # 4       4       #8  
Global announced M&A
    26       # 2       16       # 4       14       #5  
U.S. debt, equity and equity-related
    8       # 5       9       # 3       10       #2  
U.S. syndicated loans
    32       # 1       35       # 1       39       #1  
U.S. long-term debt
    12       # 2       10       # 3       13       #2  
U.S. equity and equity-related
    8       # 6       11       # 4       6       #6  
U.S. announced M&A
    33       # 1       13       # 8       14       #7  
 
(a)  
Sourced from Thomson Financial Securities data. Global announced M&A is based on rank value; all other rankings are based on proceeds, with full credit to each book manager/equal if joint. Because of joint assignments, market share of all participants will add up to more than 100%. Market share and rankings are presented on a combined basis for all periods presented, reflecting the merger of JPMorgan Chase and Bank One.


     
JPMorgan Chase & Co. / 2004 Annual Report   31

 


Table of Contents

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             Total net  
(in millions)   banking fees     revenue     related fees     and commissions     income     NII     revenue  
 
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  
 
2002
                                                       
Investment banking fees
  $ 2,707     $     $     $     $     $     $ 2,707  
Fixed income markets
          4,607       75       295       (20 )     493       5,450  
Equities markets
          20             911       (53 )     140       1,018  
Credit portfolio
          (143 )     319       38       (52 )     1,345       1,507  
 
Total
  $ 2,707     $ 4,484     $ 394     $ 1,244     $ (125 )   $ 1,978     $ 10,682  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

 

IB’s revenues are comprised of 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 for IB’s credit portfolio. Credit portfolio revenue also includes gains or losses on securities received as part of a loan restructuring, 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 page 63 of the Credit risk management section of this Annual Report for a further discussion of the CVA. Credit portfolio revenue also includes the results of risk management related to the Firm’s lending and derivative activities. See pages 64-65 of the Credit risk management section of this Annual Report for a further discussion on credit derivatives.

     
32   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

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 2,508 branches and 6,650 automated teller machines (“ATMs”). Auto & Education Finance is the largest bank originator of automobile loans as well as a top provider of loans for college students. Through its Insurance operations, the Firm sells and underwrites an extensive range of financial protection products and investment alternatives, including life insurance, annuities and debt protection products.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Lending & deposit related fees
  $ 1,013     $ 486     $ 509  
Asset management, administration and commissions
    849       357       368  
Securities/private equity gains (losses)
    (83 )     381       493  
Mortgage fees and related income
    1,037       905       982  
Credit card income
    230       107       91  
Other income
    31       (28 )     82  
 
Noninterest revenue
    3,077       2,208       2,525  
Net interest income
    7,714       5,220       3,823  
 
Total net revenue
    10,791       7,428       6,348  
 
                       
Provision for credit losses
    449       521       334  
 
                       
Noninterest expense
                       
Compensation expense
    2,621       1,695       1,496  
Noncompensation expense
    3,937       2,773       2,234  
Amortization of intangibles
    267       3       3  
 
Total noninterest expense
    6,825       4,471       3,733  
 
Operating earnings before income tax expense
    3,517       2,436       2,281  
Income tax expense
    1,318       889       849  
 
Operating earnings
  $ 2,199     $ 1,547     $ 1,432  
 
Financial ratios
                       
ROE
    24 %     37 %     37 %
ROA
    1.18       1.05       1.25  
Overhead ratio
    63       60       59  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

2004 compared with 2003
Operating earnings were $2.2 billion, up from $1.5 billion a year ago. The increase was largely due 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 influence 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 investments to expand the branch network. Partially offsetting the increase were merger-related expense savings in all businesses.

2003 compared with 2002
Total net revenue was $7.4 billion in 2003, an increase of 17% over 2002. Net interest income increased by 37% to $5.2 billion, reflecting the positive impact of the low interest rate environment on consumer loan originations, particularly in Home Finance, and on spreads earned on retained loans.

The Provision for credit losses of $521 million increased by 56% compared with the prior year due to continued growth in the retained loan portfolios. Credit quality remained stable in 2003, as charge-offs decreased slightly, to $381 million.

Noninterest expense rose 20% to $4.5 billion. The increase reflected higher business volumes and compensation costs.



     
JPMorgan Chase & Co. / 2004 Annual Report   33

 


Table of Contents

Management’s discussion and analysis
JPMorgan Chase & Co.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2004     2003     2002  
 
Selected balance sheet (ending)
                       
Total assets
  $ 226,560     $ 139,316     NA
Loans(b)
    202,473       121,921     NA
Core deposits(c)
    157,256       75,850     NA
Total deposits
    182,765       86,162     NA
 
                       
Selected balance sheet (average)
                       
Total assets
  $ 185,928     $ 147,435     $ 114,248  
Loans(d)
    162,768       120,750       93,125  
Core deposits(c)
    121,121       80,116       68,551  
Total deposits
    137,796       89,793       79,348  
Equity
    9,092       4,220       3,907  
 
                       
Headcount
    59,632       32,278       29,096  
 
                       
Credit data and quality statistics
                       
Net charge-offs(e)
  $ 990     $ 381     $ 382  
Nonperforming loans(f)
    1,161       569       554  
Nonperforming assets
    1,385       775       730  
Allowance for loan losses
    1,228       1,094       955  
 
                       
Net charge-off rate
    0.67 %     0.40 %     0.48 %
Allowance for loan losses to ending loans(b)
    0.67       1.04     NA
Allowance for loan losses to nonperforming loans(f)
    107       209       181  
 
                       
Nonperforming loans to total loans
    0.57       0.47     NA
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
End-of-period loans include loans held for sale of $18,022 million, $17,105 million and $19,948 million at December 31, 2004, 2003 and 2002, respectively. Those amounts are not included in the allowance coverage ratios.
(c)  
Includes demand and savings deposits.
(d)  
Average loans include loans held for sale of $14,736 million, $25,293 million and $13,500 million for 2004, 2003 and 2002, 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 the fourth quarter of 2004.
(f)  
Nonperforming loans include loans held for sale of $13 million, $45 million and $25 million at December 31, 2004, 2003 and 2002, respectively. These amounts are not included in the allowance coverage ratios.
NA – Data for 2002 is not available on a comparable basis.

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 at the end of the year.

Selected income statement data by business

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Prime production and servicing
                       
Production
  $ 728     $ 1,339     $ 1,052  
Servicing:
                       
Mortgage servicing revenue, net of amortization
    651       453       486  
MSR risk management results
    113       784       670  
 
Total net revenue
    1,492       2,576       2,208  
Noninterest expense
    1,115       1,124       921  
Operating earnings
    240       918       821  
 
                       
Consumer real estate lending
                       
Total net revenue
    2,376       1,473       712  
Provision for credit losses
    74       240       191  
Noninterest expense
    922       606       417  
Operating earnings
    881       414       81  
 
                       
Total Home Finance
                       
Total net revenue
    3,868       4,049       2,920  
Provision for credit losses
    74       240       191  
Noninterest expense
    2,037       1,730       1,338  
Operating earnings
    1,121       1,332       902  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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 impacted 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 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.



     
34   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

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. 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 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.

2003 compared with 2002
Home Finance achieved record financial performance in 2003, as operating earnings of $1.3 billion increased by 48% from 2002.

Total net revenue of $4.0 billion increased by 39% over 2002, given record production revenue, improved margins and higher home equity revenue.

The provision for credit losses of $240 million for 2003 increased by 26% over 2002, primarily due to higher retained loan balances. Credit quality continued to be strong relative to 2002, as evidenced by a lower net charge-off ratio and reduced delinquencies.

Noninterest expense of $1.7 billion increased by 29% from 2002, primarily a result of growth in origination volume. The increase in expenses was also a result of higher performance-related incentives and strategic investments made to further expand certain distribution channels. These were partially offset by production-related expense reduction efforts initiated in the fourth quarter of 2003.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except ratios and where otherwise noted)   2004     2003     2002  
 
Origination volume by channel (in billions)
                       
Retail
  $ 74.2     $ 90.8     $ 56.3  
Wholesale
    48.5       65.6       36.2  
Correspondent
    22.8       44.5       20.6  
Correspondent negotiated transactions
    41.5       83.3       42.6  
 
Total
    187.0       284.2       155.7  
Origination volume by business (in billions)
                       
Mortgage
  $ 144.6     $ 259.5     $ 141.8  
Home equity
    42.4       24.7       13.9  
 
Total
    187.0       284.2       155.7  
Business metrics (in billions)
                       
Loans serviced (ending)
  $ 562.0     $ 470.0     $ 426.0  
MSR net carrying value (ending)
    5.1       4.8       3.2  
End of period loans owned
                       
Mortgage loans held for sale
    14.2       15.9       18.8  
Mortgage loans retained
    42.6       34.5       26.9  
Home equity and other loans
    67.9       24.1       18.5  
 
Total end of period loans owned
    124.7       74.5       64.2  
Average loans owned
                       
Mortgage loans held for sale
    12.1       23.5       12.0  
Mortgage loans retained
    40.7       32.0       27.7  
Home equity and other loans
    47.0       19.4       17.2  
 
Total average loans owned
    99.8       74.9       56.9  
Overhead ratio
    53 %     43 %     46 %
Credit quality statistics
                       
30+ day delinquency rate
    1.27 %     1.81 %     3.07 %
Net charge-offs
                       
Mortgage
  $ 19     $ 26     $ 50  
Home equity and other loans(b)
    554       109       93  
 
Total net charge-offs
    573       135       143  
Net charge-off rate
                       
Mortgage
    0.05 %     0.08 %     0.18 %
Home equity and other loans
    1.18       0.56       0.53  
Total net charge-off rate(c)
    0.65       0.26       0.32  
Nonperforming assets
  $ 844     $ 546     $ 518  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Includes $406 million of charge-offs related to the manufactured home loan portfolio in the fourth quarter of 2004.
(c)  
Excludes mortgage loans held for sale.


Home Finance’s origination channels are comprised of the following:

Retail - A mortgage banker employed by the Firm directly contacts borrowers who are buying or refinancing a home through a branch office, through 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 loans 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.

     
JPMorgan Chase & Co. / 2004 Annual Report   35

 


Table of Contents

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 statement 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)   2004     2003     2002     2004     2003     2002     2004     2003     2002  
 
Net interest income
  $ 700     $ 1,556     $ 727     $ 2,245     $ 1,226     $ 712     $ 2,945     $ 2,782     $ 1,439  
Securities / private equity gains (losses)
    (89 )     359       498                         (89 )     359       498  
Mortgage fees and related income(b)
    881       661       983       131       247             1,012       908       983  
 
Total
  $ 1,492     $ 2,576     $ 2,208     $ 2,376     $ 1,473     $ 712     $ 3,868     $ 4,049     $ 2,920  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect 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)   2004     2003     2002  
 
Reported amounts:
                       
MSR valuation adjustments(b)
  $ (248 )   $ (253 )   $ (4,040 )
Derivative valuation adjustments and other risk management gains (losses)(c)
    361       1,037       4,710  
 
MSR risk management results
  $ 113     $ 784     $ 670  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Excludes subprime loan MSR activity of $(2) million and $(13) million in 2004 and 2002, 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.

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 related risk management instruments. The type and amount of hedging instruments used in this risk management activity change over time as market conditions and approach dictate.

During 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. In 2003, negative MSR valuation adjustments of $253 million were more than offset by $1.0 billion of aggregate risk management gains, including net interest earned on AFS securities. Unrealized gains/(losses) on AFS securities were $(3) million, $(144) million and $377 million at December 31, 2004, 2003 and 2002, respectively. For a further discussion of MSRs, see Critical accounting estimates on page 79 and Note 15 on pages 109-111 of this Annual Report.

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 (generally with annual sales less than $10 million). This segment also includes community development loans.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Total net revenue
  $ 5,385     $ 2,422     $ 2,648  
Provision for credit losses
    165       76       (31 )
Noninterest expense
    3,981       2,358       2,055  
Operating earnings
    760       (4 )     361  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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 is 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 investments in the branch distribution network was also a contributing factor.

2003 compared with 2002
Total net revenue of $2.4 billion decreased by 9% compared with 2002. Net interest income declined by 10% to $1.6 billion, primarily due to the low-interest rate environment. Noninterest revenue decreased by 5% to $828 million given lower deposit fee income, decreased debit card fees and one-time gains in 2002.

Noninterest expense of $2.4 billion increased by 15% from 2002. The increase was largely due to investments in technology within the branch network and higher compensation expenses related to increased staff levels.

The Provision for credit losses of $76 million increased by $107 million compared with 2002. This reflected a reduction in the allowance for loan losses in 2002.



     
36   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except ratios and where otherwise noted)   2004     2003     2002  
 
Business metrics (in billions)
                       
End-of-period balances
                       
Small business loans
  $ 12.5     $ 2.2     NA
Consumer and other loans(b)
    2.2       2.0     NA
 
Total loans
    14.7       4.2     NA
Core deposits(c)
    146.7       66.4     NA
Total deposits
    172.2       76.7     NA
 
                       
Average balances
                       
Small business loans
  $ 7.3     $ 2.1     $ 1.9  
Consumer and other loans(b)
    2.1       2.0       2.6  
 
Total loans
    9.4       4.1       4.5  
Core deposits(c)
    110.0       64.8       57.9  
Total deposits
    126.6       74.4       68.7  
 
                       
Number of:
                       
Branches
    2,508       561       560  
ATMs
    6,650       1,931       1,876  
Personal bankers
    5,324       1,820       1,587  
Personal checking accounts (in thousands)
    7,286       1,984       2,037  
Business checking accounts (in thousands)
    894       347       345  
Online customers (in thousands)
    6,587     NA   NA
Debit cards issued (in thousands)
    8,392       2,380       2,352  
 
                       
Overhead ratio
    74 %     97 %     78 %
Retail brokerage business metrics
                       
Investment sales volume
  $ 7,324     $ 3,579     NA
Number of dedicated investment sales representatives
    1,364       349       291  
 
                       
Credit quality statistics
                       
Net charge-offs
                       
Small business
  $ 77     $ 35     $ 24  
Consumer and other loans
    77       40       51  
 
Total net charge-offs
    154       75       75  
Net charge-off rate
                       
Small business
    1.05 %     1.67 %     1.26 %
Consumer and other loans
    3.67       2.00       1.96  
Total net charge-off rate
    1.64       1.83       1.67  
Nonperforming assets
  $ 299     $ 72     $ 94  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Primarily community development loans.
(c)  
Includes demand and savings deposits.
NA – Data is not available on a comparable basis.

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 also offers loans to students via colleges and universities across the United States.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Total net revenue
  $ 1,145     $ 842     $ 683  
Provision for credit losses
    210       205       174  
Noninterest expense
    490       291       247  
Operating earnings
    270       206       166  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

2004 compared with 2003
Operating earnings totaled $270 million, up 31% from the prior year. While the increase was reflective of the Merger, performance for the year was moderated by narrower spreads and reduced origination volumes arising from a competitive operating environment.

Total net revenue increased by 36% to $1.1 billion from the prior year. This increase reflected the Merger but included a decline in net interest income, given the competitive operating environment in 2004 and incremental charges associated with the Firm’s lease residual exposure.

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.



The following is a brief description of selected business metrics within 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. / 2004 Annual Report   37

 


Table of Contents

Management’s discussion and analysis
JPMorgan Chase & Co.

2003 compared with 2002
In 2003, operating earnings were $206 million, 24% higher than in 2002. Total net revenue grew by 23% to $842 million. Net interest income grew by 33% in comparison to 2002, driven by higher average loans and leases outstanding and wider spreads.

The Provision for credit losses increased by 18% to $205 million, primarily reflecting a 32% increase in average loan and lease receivables. Credit quality continued to be strong relative to 2002, as evidenced by a lower net charge-off ratio and a reduced delinquency rate.

Noninterest expense of $291 million increased by 18% compared with 2002. The increase in expenses was driven by higher origination volume and higher performance-based incentives.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except ratios and where otherwise noted)   2004     2003     2002  
 
Business metrics (in billions)
                       
End of period loans and lease receivables
                       
Loans receivables
  $ 54.6     $ 33.7     $ 28.0  
Lease receivables
    8.0       9.5       9.4  
 
Total end-of-period loans and lease receivables
    62.6       43.2       37.4  
Average loans and lease receivables
                       
Loans outstanding (average)(b)
  $ 44.3     $ 32.0     $ 23.3  
Lease receivables (average)
    9.0       9.7       8.4  
 
Total average loans and lease receivables(b)
    53.3       41.7       31.7  
 
                       
Overhead ratio
    43 %     35 %     36 %
 
                       
Credit quality statistics
                       
30+ day delinquency rate
    1.55 %     1.42 %     1.49 %
Net charge-offs
                       
Loans
  $ 219     $ 130     $ 126  
Lease receivables
    44       41       38  
 
Total net charge-offs
    263       171       164  
Net charge off rate
                       
Loans(b)
    0.52 %     0.43 %     0.58 %
Lease receivables
    0.49       0.42       0.45  
Total net charge-off rate(b)
    0.52       0.43       0.54  
Nonperforming assets
  $ 242     $ 157     $ 118  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Average loans include loans held for sale of $2.3 billion, $1.8 billion and $1.5 billion for, 2004, 2003 and 2002, respectively. 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.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Total net revenue
  $ 393     $ 115     $ 97  
Noninterest expense
    317       92       93  
Operating earnings
    48       13       3  
Memo: Consolidated gross insurance-related revenue(b)
    1,191       611       536  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Includes revenue reported in the results of other businesses.

2004 compared with 2003
Insurance 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 almost entirely due to the Merger.

2003 compared with 2002
Operating earnings in 2003 reflected a 19% increase in Total net revenue, while expenses were essentially flat.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except where otherwise noted)   2004     2003     2002  
 
Business metrics — ending balances
                       
Invested assets
  $ 7,368     $ 1,559     $ 919  
Policy loans
    397              
Insurance policy and claims reserves
    7,279       1,096       535  
Term premiums — first year annualized
    28              
Proprietary annuity sales
    208       548       490  
Number of policies in force — direct/assumed (in thousands)
    2,611       631     NA
Insurance in force — direct/assumed
  $ 277,827     $ 31,992     NA
Insurance in force — retained
    80,691       31,992     NA
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. All other periods reflect the results of heritage JPMorgan Chase only.
NA — Data for 2002 is not available on a comparable basis.


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.

     
38   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Card Services

 

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

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)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Asset management, administration and commissions
  $ 75     $ 108     $ 126  
Credit card income
    2,179       930       826  
Other income
    117       54       31  
 
Noninterest revenue
    2,371       1,092       983  
Net interest income
    8,374       5,052       4,930  
 
Total net revenue
    10,745       6,144       5,913  
 
Provision for credit losses
    4,851       2,904       2,751  
 
Noninterest expense
                       
Compensation expense
    893       582       523  
Noncompensation expense
    2,485       1,336       1,320  
Amortization of intangibles
    505       260       286  
 
Total noninterest expense
    3,883       2,178       2,129  
 
Operating earnings before income tax expense
    2,011       1,062       1,033  
Income tax expense
    737       379       369  
 
Operating earnings
  $ 1,274     $ 683     $ 664  
 
Financial metrics
                       
ROE
    17 %     20 %     19 %
Overhead ratio
    36       35       36  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

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 higher charge volume, which generated increased interchange income. This was 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.

2003 compared with 2002
Operating earnings of $683 million increased by $19 million or 3% compared with the prior year. Earnings benefited from higher revenue, partially offset by a higher provision for credit losses and expenses.

Total net revenue of $6.1 billion increased by 4%. Net interest income of $5.1 billion increased by 2% due to higher spread and loan balances. Noninterest revenue of $1.1 billion increased by 11% due to higher charge volume, which generated increased interchange income. This was partially offset by higher rewards expense.

The Provision for credit losses was $2.9 billion, an increase of 6%, primarily due to the higher provision for credit losses and higher losses due to loan growth. Conservative risk management and rigorous collection practices contributed to stable credit quality.

Noninterest expense was $2.2 billion, an increase of 2%, due to volume-based processing expenses, partially offset by disciplined expense management.



     
JPMorgan Chase & Co./2004 Annual Report   39

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount, ratios                  
and where otherwise noted)   2004     2003     2002  
 
Memo: Net securitization gains (amortization)
  $ (8 )   $ 1     $ 16  
 
% of average managed outstandings:
                       
Net interest income
    9.16 %     9.95 %     10.08 %
Provision for credit losses
    5.31       5.72       5.62  
Noninterest revenue
    2.59       2.15       2.01  
Risk adjusted margin(b)
    6.45       6.38       6.46  
Noninterest expense
    4.25       4.29       4.35  
Pre-tax income
    2.20       2.09       2.11  
Operating earnings
    1.39       1.35       1.36  
 
Business metrics
                       
Charge volume (in billions)
  $ 193.6     $ 88.2     $ 79.0  
Net accounts opened (in thousands)
    7,523       4,177       3,680  
Credit cards issued (in thousands)
    94,285       35,103       33,488  
Number of registered internet customers (in millions)
    13.6       3.7       2.2  
Merchant acquiring business
                       
Bank card volume (in billions)
  $ 396.2     $ 261.2     $ 226.1  
Total transactions (in millions)
    12,066       7,154       6,509  
 
Selected ending balances
                       
Loans:
                       
Loans on balance sheet
  $ 64,575     $ 17,426     $ 20,101  
Securitized loans
    70,795       34,856       30,722  
 
Managed loans
  $ 135,370     $ 52,282     $ 50,823  
 
Selected average balances
                       
Managed assets
  $ 94,741     $ 51,406     $ 49,648  
Loans:
                       
Loans on balance sheet
  $ 38,842     $ 17,604     $ 22,410  
Securitized loans
    52,590       33,169       26,519  
 
Managed loans
  $ 91,432     $ 50,773     $ 48,929  
 
Equity
    7,608       3,440       3,444  
 
Headcount
    19,598       10,612       10,885  
 
Credit quality statistics – managed
                       
Net charge-offs
  $ 4,821     $ 2,996     $ 2,887  
Net charge-off rate
    5.27 %     5.90 %     5.90 %
 
Delinquency ratios – managed
                       
30+ days
    3.70 %     4.68 %     4.69 %
90+ days
    1.72       2.19       2.16  
 
Allowance for loan losses
  $ 2,994     $ 1,225     $ 1,459  
Allowance for loan losses to period-end loans
    4.64 %     7.03 %     7.26 %
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Represents Total net revenue less Provision for credit losses.

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

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Income statement data
                       
Credit card income
                       
Reported data for the period
  $ 4,446     $ 2,309     $ 2,167  
Securitization adjustments
    (2,267 )     (1,379 )     (1,341 )
 
Managed credit card income
  $ 2,179     $ 930     $ 826  
 
Other income
                       
Reported data for the period
  $ 203     $ 125     $ 67  
Securitization adjustments
    (86 )     (71 )     (36 )
 
Managed other income
  $ 117     $ 54     $ 31  
 
Net interest income
                       
Reported data for the period
  $ 3,123     $ 1,732     $ 2,114  
Securitization adjustments
    5,251       3,320       2,816  
 
Managed net interest income
  $ 8,374     $ 5,052     $ 4,930  
 
Total net revenue(b)
                       
Reported data for the period
  $ 7,847     $ 4,274     $ 4,474  
Securitization adjustments
    2,898       1,870       1,439  
 
Managed total net revenue
  $ 10,745     $ 6,144     $ 5,913  
 
Provision for credit losses
                       
Reported data for the period
  $ 1,953     $ 1,034     $ 1,312  
Securitization adjustments
    2,898       1,870       1,439  
 
Managed provision for credit losses
  $ 4,851     $ 2,904     $ 2,751  
 
Balance sheet – average balances
                       
Total average assets
                       
Reported data for the period
  $ 43,657     $ 19,041     $ 23,129  
Securitization adjustments
    51,084       32,365       26,519  
 
Managed average assets
  $ 94,741     $ 51,406     $ 49,648  
 
Credit quality statistics
                       
Net charge-offs
                       
Reported net charge-offs data for the period
  $ 1,923     $ 1,126     $ 1,448  
Securitization adjustments
    2,898       1,870       1,439  
 
Managed net charge-offs
  $ 4,821     $ 2,996     $ 2,887  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Includes Credit card income, Other income and Net interest income.


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, purchases and sales.
 
 
Merchant acquiring business – Represents an entity that processes payments for merchants. JPMorgan Chase is a majority owner of Paymentech, Inc. and a 50% owner of Chase Merchant Services.
 
 
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.

     
40   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

Commercial Banking

 

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

Commercial Banking operates in 10 of the top 15 major U.S. metropolitan areas. Within this network, Commercial Banking is divided into three customer coverage segments. General coverage for corporate clients is done by Middle Market Banking, which generally covers clients up to $500 million, and Corporate Banking, which generally covers clients over $500 million. Corporate Banking typically focuses on clients that have broader investment banking needs. The third segment, Commercial Real Estate, serves investors in and developers of for-sale housing, multifamily rental, retail, office and industrial properties. In addition to these three customer groupings, Commercial Banking offers several products to the Firm’s entire customer base. Chase Business Credit is a leading national provider of highly structured asset-based financing, syndications and collateral analysis. Chase Equipment Leasing finances a variety of equipment types and offers vendor programs for leading capital and technology equipment manufacturers. 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.

Commercial Banking was known prior to the Merger as Chase Middle Market and was a business within the former Chase Financial Services.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Lending & deposit related fees
  $ 441     $ 301     $ 285  
Asset management, administration and commissions
    32       19       16  
Other income(b)
    209       73       65  
 
Noninterest revenue
    682       393       366  
Net interest income
    1,692       959       999  
 
Total net revenue
    2,374       1,352       1,365  
 
Provision for credit losses
    41       6       72  
 
Noninterest expense
                       
Compensation expense
    465       285       237  
Noncompensation expense
    843       534       565  
Amortization of intangibles
    35       3       7  
 
Total noninterest expense
    1,343       822       809  
 
Operating earnings before income tax expense
    990       524       484  
Income tax expense
    382       217       201  
 
Operating earnings
  $ 608     $ 307     $ 283  
 
Financial ratios
                       
ROE
    29 %     29 %     24 %
ROA
    1.67       1.87       1.77  
Overhead ratio
    57       61       59  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
IB-related and commercial card revenues are included in Other income.

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 deposit 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 service charges on deposits, 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 lower reductions in the Allowance for credit losses in 2004 relative to 2003.

Noninterest expense was $1.3 billion, an increase of $521 million, or 63%, primarily related to the Merger.



     
JPMorgan Chase & Co./2004 Annual Report   41

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

2003 compared with 2002
Operating earnings were $307 million, an increase of 8% compared with 2002.

Total net revenue of $1.4 billion decreased by 1% compared with 2002. Net interest income of $1.0 billion decreased by 4% compared with the prior year, primarily due to lower deposit and loan spreads, partially offset by higher deposit and loan balances. Noninterest revenue was $393 million, an increase of 7%, primarily reflecting higher service charges on deposits and investment banking fees.

The Provision for credit losses was $6 million, a decrease of $66 million, which resulted from a larger reduction in the Allowance for credit losses and lower net charge-offs in 2003, reflecting an improvement in credit quality.

Noninterest expense was $822 million, an increase of 2% compared with 2002. The increase was the result of higher severance costs and performance-based incentives, partially offset by a decrease in other expenses.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2004     2003     2002  
 
Revenue by product:
                       
Lending
  $ 764     $ 396     $ 414  
Treasury services
    1,467       896       925  
Investment banking
    120       66       51  
Other
    23       (6 )     (25 )
Total Commercial Banking revenue
    2,374       1,352       1,365  
 
Selected balance sheet (average)
                       
Total assets
  $ 36,435     $ 16,460     $ 15,973  
Loans and leases
    32,417       14,049       13,642  
Deposits
    51,620       32,880       29,403  
Equity
    2,093       1,059       1,199  
 
Headcount
    4,555       1,730       1,807  
 
Credit data and quality statistics:
                       
Net charge-offs
  $ 61     $ 76     $ 107  
Nonperforming loans
    527       123       198  
Allowance for loan losses
    1,322       122       182  
Allowance for lending-related commitments(b)
    169       26        
 
Net charge-off rate
    0.19 %     0.54 %     0.78 %
Allowance for loan losses to average loans
    4.08       0.87       1.33  
Allowance for loan losses to nonperforming loans
    251       99       92  
Nonperforming loans to average loans
    1.63       0.88       1.45  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
In 2002, the Allowance for lending-related commitments was allocated to the IB. Had the amount been allocated to CB, the allowance would have been $24 million.


Commercial Banking revenues are comprised of the following:

Lending incorporates a variety of financing alternatives, such as term loans, revolving lines of credit and asset-based structures and leases, which are often secured by receivables, inventory, equipment or real estate.

Treasury services incorporates a broad range of products and services to help clients manage short-term liquidity through deposits and sweeps, and longer-term investment needs through money market accounts, certificates of deposit and mutual funds; manage working capital through lockbox, global trade, global clearing and commercial card products; and have ready access to information to manage their business through online reporting tools.

Investment banking products provide clients with more sophisticated capital-raising alternatives, through loan syndications, investment-grade debt, asset-backed securities, private placements, high-yield bonds and equity underwriting, and balance sheet and risk management tools through foreign exchange, derivatives, M&A and advisory services.

     
42   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

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 the largest cash management provider in the world and one of the top three global custodians. The Treasury Services business provides clients with a broad range of capabilities, including U.S. dollar and multi-currency clearing, ACH, trade, and short-term liquidity and working capital tools. The Investor Services business provides a wide range of capabilities, including custody, funds services, securities lending, and performance measurement and execution products. The Institutional Trust Services business provides trustee, depository and administrative services for debt and equity issuers. Treasury Services partners with the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management segments to serve clients firmwide. As a result, certain Treasury Services revenues are included in other segments’ results.

Selected income statement data

                         
Year ending December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Lending & deposit related fees
  $ 647     $ 470     $ 445  
Asset management, administration and commissions
    2,445       1,903       1,800  
Other income
    382       288       328  
 
Noninterest revenue
    3,474       2,661       2,573  
Net interest income
    1,383       947       962  
 
Total net revenue
    4,857       3,608       3,535  
 
                       
Provision for credit losses
    7       1       3  
Credit reimbursement (to) from IB(b)
    (90 )     36       82  
 
                       
Noninterest expense
                       
Compensation expense
    1,629       1,257       1,131  
Noncompensation expense
    2,391       1,745       1,616  
Amortization of intangibles
    93       26       24  
 
Total noninterest expense
    4,113       3,028       2,771  
 
Operating earnings before income tax expense
    647       615       843  
Income tax expense
    207       193       294  
 
Operating earnings
  $ 440     $ 422     $ 549  
 
Financial ratios
                       
ROE
    17 %     15 %     20 %
Overhead ratio
    85       84       78  
 
                       
Memo
                       
Treasury Services firmwide overhead ratios(c)
    62       62       62  
Treasury & Securities Services firmwide overhead ratio(c)
    74       76       72  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect 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 29 of this Annual Report.
(c)  
TSS and TS firmwide overhead ratios have been calculated based on the firmwide revenues described in footnote (b) on page 44 of this Annual Report and TSS or TS expenses, respectively, including those allocated to certain other lines of business.

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 Investor Services business. Prior-year results include an after-tax gain of $22 million on the sale of an Institutional Trust Services business. Excluding these one-time gains, operating earnings 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 EFS in January 2004.

TSS net revenue improved by 35% to $4.9 billion. This revenue growth reflected the benefit of the Merger and 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 deposit balance growth of 44%, to $128 billion, a change in the corporate deposit pricing methodology in 2004 and wider deposit spreads. Growth in fees and commissions was driven by a 20% increase in assets under custody to $9.1 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 service charges on deposits, which often decline as interest rates rise, and a soft municipal bond market.

Treasury Services (“TS”) net revenue grew to $2.0 billion, Investor Services (“IS”) to $1.7 billion and Institutional Trust Services (“ITS”) to $1.2 billion. TSS firmwide net revenue grew 41% to $6.5 billion. TSS firmwide net revenues include Treasury Services 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 and 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.

On January 7, 2005, JPMorgan Chase agreed to acquire Vastera, a provider of global trade management solutions, for a total transaction value of approximately $129 million. Vastera’s business will be combined with the Logistics and Trade Services businesses of the Treasury Services unit. The transaction is expected to close in the first half of 2005.

2003 compared with 2002

TSS operating earnings decreased by 23% from 2002 while delivering a return on allocated capital of 15%. A 9% increase in Noninterest expense and a lower credit reimbursement contributed to the lower earnings.

Total net revenue increased by 2%, with growth at ITS of 11%. ITS revenue growth was the result of debt product lines, increased volume in asset servicing, a pre-tax gain of $36 million on the sale of an Institutional Trust Services business in 2003, and the result of acquisitions which generated $29 million of new revenue in 2003. TS’s revenue rose by 8% on higher trade and commercial payment card revenue and increased balance-related earnings, including



     
JPMorgan Chase & Co. / 2004 Annual Report   43

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

higher balance-deficiency fees resulting from the lower interest rate environment. IS’s revenue contracted by 7%, the result of lower NII due to lower interest rates, lower foreign exchange and securities lending revenue, and a pre-tax gain of $50 million on the sale of the Firm’s interest in a non-U.S. securities clearing firm in 2002.

Noninterest expense increased by 9%, attributable to higher severance, the impact of acquisitions, the cost associated with expensing of options, increased pension costs and charges to provide for losses on subletting unoccupied excess real estate.

TSS was assigned a credit reimbursement of pre-tax earnings and the associated capital related to certain credit exposures managed within IB’s credit portfolio on behalf of clients shared with TSS. For 2003, the impact to TSS was to increase pre-tax operating earnings by $36 million and average allocated capital by $712 million.

Treasury & Securities Services firmwide metrics include certain TSS product revenues and deposits reported in other lines of business for customers who are also customers of those lines of business. In order to capture the firmwide impact of TS and TSS products and revenues, management reviews firmwide metrics such as firmwide deposits, firmwide revenue and firmwide overhead ratios in assessing financial performance for TSS. Firmwide metrics are necessary in order to understand the aggregate TSS business.

Selected metrics

                         
Year ending December 31,(a)                  
(in millions, except headcount and where                  
otherwise noted)   2004     2003     2002  
 
Revenue by business
                       
Treasury Services(b)
  $ 1,994     $ 1,200     $ 1,111  
Investor Services
    1,709       1,448       1,561  
Institutional Trust Services
    1,154       960       863  
 
Total net revenue
  $ 4,857     $ 3,608     $ 3,535  
 
Memo
                       
Treasury Services firmwide revenue(b)
  $ 3,665     $ 2,214     $ 2,125  
Treasury & Securities Services firmwide revenue(b)
    6,528       4,622       4,549  
 
                       
Business metrics
                       
Assets under custody (in billions)
  $ 9,137     $ 7,597     $ 6,336  
Corporate trust securities under administration (in billions)(c)
    6,676       6,127     NA  
 
                       
Selected balance sheet (average)
                       
Total assets
  $ 23,430     $ 18,379     $ 17,239  
Loans
    7,849       6,009       5,972  
Deposits
                       
U.S. deposits
    82,928       54,116     $ 32,698  
Non-U.S. deposits
    45,022       34,518       34,919  
 
Total deposits
    127,950       88,634       67,617  
Equity
    2,544       2,738       2,700  
 
                       
Memo
                       
Treasury Services firmwide deposits(d)
  $ 99,587     $ 65,194     $ 41,508  
Treasury & Securities Services firmwide deposits(d)
    175,327       119,245       88,865  
 
                       
Headcount
    22,612       15,145       14,810  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
TSS and Treasury Services firmwide revenues include TS revenues recorded in certain other lines of business. Revenue associated with Treasury Services customers who are also customers of the Commercial Banking, Consumer & Small Business Banking and Asset & Wealth Management lines of business are reported in these other lines of business and are excluded from Treasury Services, as follows:
                         
(in millions)   2004     2003     2002  
 
Treasury Services revenue reported in Commercial Banking
  $ 1,467     $ 896     $ 925  
Treasury Services revenue reported in other lines of business
    204       118       89  
 
   
Note: Foreign exchange revenues are apportioned between TSS and the IB, and only TSS’s share is included in TSS firmwide revenue.
   
 
(c)  
Corporate trust securities under administration include debt held in trust on behalf of third parties and debt serviced as agent.
(d)  
TSS and TS firmwide deposits include TS’s deposits recorded in certain other lines of business. Deposits associated with Treasury Services customers who are also customers of the Commercial Banking line of business are reported in that line of business and are excluded from Treasury Services.
NA
Data for 2002 is not available on a comparable basis.


     
44   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Asset & Wealth Management

 

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

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Revenue
                       
Lending & deposit related fees
  $ 28     $ 19     $ 21  
Asset management, administration and commissions
    3,140       2,258       2,228  
Other income
    215       205       216  
 
Noninterest revenue
    3,383       2,482       2,465  
Net interest income
    796       488       467  
 
Total net revenue
    4,179       2,970       2,932  
 
                       
Provision for credit losses
    (14 )     35       85  
 
                       
Noninterest expense
                       
Compensation expense
    1,579       1,213       1,141  
Noncompensation expense
    1,502       1,265       1,261  
Amortization of intangibles
    52       8       6  
 
Total noninterest expense
    3,133       2,486       2,408  
 
Operating earnings before income tax expense
    1,060       449       439  
Income tax expense
    379       162       161  
 
Operating earnings
  $ 681     $ 287     $ 278  
 
Financial ratios
                       
ROE
    17 %     5 %     5 %
Overhead ratio
    75       84       82  
Pre-tax margin ratio(b)
    25       15       15  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Pre-tax margin represents Operating earnings before income taxes / 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.

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 the second quarter of 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 as well as increased Compensation expense and the impact of increased technology and marketing initiatives.

2003 compared with 2002

Operating earnings were $287 million, up 3% from the prior year, reflecting an improved credit portfolio, the benefit of slightly higher revenues. During the second quarter of 2003, the Firm acquired American Century Retirement Plan Services Inc., a provider of defined contribution recordkeeping services, as part of its strategy to grow its U.S. retail investment management business. The business was renamed JPMorgan Retirement Plan Services (“RPS”).

Total net revenue was $3.0 billion, up 1% from the prior year. The increase in fees and commissions reflected the acquisition of RPS and increased average equity market valuations in client portfolios, partly offset by institutional net outflows. Net interest income increased due to higher brokerage account balances and spreads. The decline in Other income primarily reflected non-recurring items in 2002.

The Provision for credit losses decreased by 59%, due to an improvement in credit quality and recoveries.

Noninterest expense was $2.5 billion, up $78 million from 2002, reflecting the acquisition of RPS, higher Compensation expense, and real estate and software write-offs, partly offset by the continued impact of expense-management programs.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount and ratios)   2004     2003     2002  
 
Revenue by client segment
                       
Private bank
  $ 1,554     $ 1,437     $ 1,467  
Retail
    1,081       732       695  
Institutional
    994       723       688  
Private client services
    550       78       82  
 
Total net revenue
  $ 4,179     $ 2,970     $ 2,932  
 
                       
Business metrics
                       
Number of:
                       
Client advisors
    1,226       615       673  
Brown Co. average daily trades
    29,901       27,150       24,584  
Retirement Plan Services participants
    918,000       756,000        
 
                       
Star rankings(b)
                       
% of customer assets in funds ranked 4 or better
    48 %     48 %   NA  
% of customer assets in funds ranked 3 or better
    81       69     NA  
 
                       
Selected balance sheet (average)
                       
Total assets
  $ 37,751     $ 33,780     $ 35,813  
Loans
    21,545       16,678       18,926  
Deposits
    32,039       20,249       19,329  
Equity
    3,902       5,507       5,649  
 
                       
Headcount
    12,287       8,520       8,546  
 


     
JPMorgan Chase & Co. / 2004 Annual Report   45

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

                         
Year ended December 31,(a)                  
(in millions, except ratios)   2004     2003     2002  
 
Credit data and quality statistics
                       
Net charge-offs
  $ 72     $ 9     $ 112  
Nonperforming loans
    79       173       139  
Allowance for loan losses
    216       130       97  
Allowance for lending-related commitments
    5       4        
Net charge-off rate
    0.33 %     0.05 %     0.59 %
Allowance for loan losses to average loans
    1.00       0.78       0.51  
Allowance for loan losses to nonperforming loans
    273       75       70  
Nonperforming loans to average loans
    0.37       1.04       0.73  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
Derived from Morningstar for the United States; Micropal for the United Kingdom, Luxembourg, Hong Kong and Taiwan; and Nomura for Japan.
NA-Data for 2002 is not available on a comparable basis.

AWM’s client segments are comprised of the following:

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 more than 2 million customers worldwide with investment management, retirement planning and administration, and brokerage services through third-party and direct distribution channels.

Institutional serves more than 3,000 large and mid-size corporate and public institutions, endowments and foundations, and governments globally. AWM offers institutions comprehensive global investment services, including investment management across asset classes, pension analytics, asset-liability management, active risk budgeting and overlay strategies.

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

2004 compared with 2003

Assets under supervision (“AUS”) at December 31, 2004 were $1.3 trillion, up 66% from 2003, and Assets under management (“AUM”) 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 $478 billion, up 135%, primarily due to the Merger, as well as market appreciation and net inflows across all products.

2003 compared with 2002

AUS at December 31, 2003, totaled $764 billion, up 19% from the prior year-end. AUM totaled $561 billion, up 9%, and custody, brokerage, administration and deposit accounts were $203 billion, up 54%. The increase in AUM was driven by higher equity market valuations in client portfolios, partly offset by institutional net outflows. Custody, brokerage, administration and deposits grew by $70 billion, driven by the acquisition of RPS ($41 billion), higher equity market valuations in client portfolios and net inflows from Private bank clients.

The diversification of AUS across product classes, client segments and geographic regions helped to mitigate the impact of market volatility on revenue. The Firm also had a 44% interest in American Century Companies, Inc., whose AUM totaled $87 billion and $72 billion at December 31, 2003 and 2002, respectively.

                 
Assets under supervision(a)(b)            
(in billions)   2004     2003  
 
Asset class
               
Liquidity
  $ 232     $ 156  
Fixed income
    171       118  
Equities, balanced and other
    388       287  
 
Assets under management
    791       561  
Custody/brokerage/administration/deposits
    478       203  
 
Total Assets under supervision
  $ 1,269     $ 764  
 
Client segment
               
Private bank
               
Assets under management
  $ 139     $ 138  
Custody/brokerage/administration/deposits
    165       128  
 
Assets under supervision
    304       266  
Retail
               
Assets under management
    133       93  
Custody/brokerage/administration/deposits
    88       71  
 
Assets under supervision
    221       164  
Institutional
               
Assets under management
    466       322  
Custody/brokerage/administration/deposits
    184        
 
Assets under supervision
    650       322  
Private client services
               
Assets under management
    53       8  
Custody/brokerage/administration/deposits
    41       4  
 
Assets under supervision
    94       12  
 
Total Assets under supervision
  $ 1,269     $ 764  
 
Geographic region
               
Americas
               
Assets under management
  $ 562     $ 365  
Custody/brokerage/administration/deposits
    444       168  
 
Assets under supervision
    1,006       533  
International
               
Assets under management
    229       196  
Custody/brokerage/administration/deposits
    34       35  
 
Assets under supervision
    263       231  
 
Total Assets under supervision
  $ 1,269     $ 764  
 
Memo:
               
Mutual fund assets:
               
Liquidity
  $ 183     $ 103  
Fixed income
    41       27  
Equity, balanced and other
    104       83  
 
Total mutual funds assets
  $ 328     $ 213  
 
Assets under supervision rollforward(b)
               
Beginning balance
  $ 764     $ 642  
Net asset flows
    25       (16 )
Acquisitions(c)
    383       41  
Market/other impact
    97       97  
 
Ending balance
  $ 1,269     $ 764  
 
(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. 2003 reflects the results of heritage JPMorgan Chase only.
(c)  
Reflects the Merger with Bank One ($376 billion) in the third quarter of 2004, the acquisition of a majority interest in Highbridge Capital Management ($7 billion) in the fourth quarter of 2004 and the acquisition of RPS in the second quarter of 2003.


     
46   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Corporate

 

The Corporate sector is comprised of Private Equity, Treasury, and corporate staff and other centrally managed expenses. Private Equity includes JPMorgan Partners and ONE Equity Partners businesses. Treasury manages the structural interest rate risk and investment portfolio for the Firm. The corporate staff areas include Central Technology and Operations, Internal Audit, Executive Office, Finance, General Services, Human Resources, Marketing & Communications, Office of the General Counsel, Real Estate and Business Services, Risk Management, and Strategy and Development. Other centrally managed expenses include items such as the Firm’s occupancy and pension expense, net of allocations to the business.

Selected income statement data

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Revenue
                       
Securities / private equity gains
  $ 1,786     $ 1,031     $ 334  
Other income
    (2 )     214       (11 )
 
Noninterest revenue
    1,784       1,245       323  
Net interest income
    (1,222 )     (177 )     (45 )
 
Total net revenue
    562       1,068       278  
 
                       
Provision for credit losses
    (110 )     124       133  
 
                       
Noninterest expense
                       
Compensation expense
    2,426       1,893       1,867  
Noncompensation expense
    4,088       3,216       2,711  
Net expenses allocated to other businesses
    (5,213 )     (4,580 )     (4,070 )
 
Total noninterest expense
    1,301       529       508  
 
Operating earnings before income tax expense
    (629 )     415       (363 )
Income tax expense (benefit)
    (690 )     (253 )     (128 )
 
Operating earnings
  $ 61     $ 668     $ (235 )
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.

2004 compared with 2003

Operating earnings were $61 million, down from earnings of $668 million in the prior year.

Noninterest revenue was $1.8 billion, up 43% 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 negative $1.2 billion, compared with a negative $177 million in the prior year. The decline 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, which were partially offset by higher allocation of these expenses to the businesses. Incremental allocations to the businesses were lower than the gross expense increase due to certain policies adopted in conjunction with the Merger. These policies retain overhead costs that would not be incurred by the lines of business if operated on a stand-alone basis, as well as costs in excess of the market price for services provided by the corporate staff and technology and operations areas.

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.

2003 compared with 2002

For 2003, Corporate had operating earnings of $668 million, compared with an operating loss of $235 million in 2002, driven primarily by higher gains in the Private Equity portfolio and income tax benefits not allocated to the business segments.

Selected metrics

                         
Year ended December 31,(a)                  
(in millions, except headcount)   2004     2003     2002  
 
Selected average balance sheet
                       
Short-term investments(b)
  $ 14,590     $ 4,076     $ 7,691  
Investment portfolio(c)
    63,475       63,506       61,816  
Goodwill(d)
    21,773       293       1,166  
Total assets
    162,234       104,395       97,089  
 
                       
Headcount
    24,806       13,391       16,960  
 
                       
Treasury
                       
Securities gains (losses)(e)
  $ 347     $ 999     $ 1,073  
Investment portfolio (average)
    57,776       56,299       54,197  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect 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 changed the allocation methodology of goodwill to retain all goodwill in Corporate.
(e)  
Excludes gains/losses on securities used to manage risk associated with MSRs.


     
JPMorgan Chase & Co. / 2004 Annual Report   47

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

Selected income statement and
balance sheet data – Private equity

                         
Year ended December 31,(a)                  
(in millions)   2004     2003     2002  
 
Private equity gains (losses)
                       
Direct investments
                       
Realized gains
  $ 1,423     $ 535     $ 452  
Write-ups / write-downs
    (192 )     (404 )     (825 )
Mark-to-market gains (losses)
    164       215       (210 )
 
Total direct investments
    1,395       346       (583 )
Third-party fund investments
    34       (319 )     (150 )
 
Total private equity gains (losses)
    1,429       27       (733 )
Other income
    53       47       59  
Net interest income
    (271 )     (264 )     (302 )
 
Total net revenue
    1,211       (190 )     (976 )
Total noninterest expense
    288       268       296  
 
Operating earnings (loss) before income tax expense
    923       (458 )     (1,272 )
Income tax expense (benefit)
    321       (168 )     (466 )
 
Operating earnings (losses)
  $ 602     $ (290 )   $ (806 )
 
Private equity portfolio information(b)
                       
Direct investments
                       
Public securities
                       
Carrying value
  $ 1,170     $ 643     $ 520  
Cost
    744       451       663  
Quoted public value
    1,758       994       761  
 
                       
Private direct securities
                       
Carrying value
    5,686       5,508       5,865  
Cost
    7,178       6,960       7,316  
 
                       
Third-party fund investments(c)
                       
Carrying value
    641       1,099       1,843  
Cost
    1,042       1,736       2,333  
 
                       
Total private equity portfolio
                       
Carrying value
  $ 7,497     $ 7,250     $ 8,228  
Cost
  $ 8,964     $ 9,147     $ 10,312  
 
(a)  
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. All other periods reflect the results of heritage JPMorgan Chase only.
(b)  
For further information on the Firm’s policies regarding the valuation of the private equity portfolio, see Note 9 on pages 98–100 of this Annual Report.
(c)  
Unfunded commitments to private third-party equity funds were $563 million, $1.3 billion and $2.0 billion at December 31, 2004, 2003 and 2002, respectively.

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 $535 million in 2003. Net write-downs on direct investments were $192 million in 2004, compared with $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 Merger. Otherwise, the portfolio declined as a result of sales of investments, 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.

2003 compared with 2002

The private equity portfolio recognized negative Total net revenue of $190 million and operating losses of $290 million in 2003. Opportunities to realize value through sales, recapitalizations and initial public offerings (“IPOs”) of investments, although limited, improved during the year as the M&A and IPO markets started to recover.

Private equity gains totaled $27 million in 2003, compared with losses of $733 million in 2002. Private equity recognized gains of $346 million on direct investments and losses of $319 million on sales and writedowns of private third-party fund investments.



     
48   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

Balance sheet analysis

 

Selected balance sheet data

                 
December 31, (in millions)   2004     2003(a)  
 
Assets
               
Trading assets – debt and equity instruments
  $ 222,832     $ 169,120  
Trading assets – derivative receivables
    65,982       83,751  
Securities:
               
Available-for-sale
    94,402       60,068  
Held-to-maturity
    110       176  
Loans, net of allowance
    394,794       210,243  
Goodwill and other intangible assets
    57,887       14,991  
All other assets
    321,241       232,563  
 
Total assets
  $ 1,157,248     $ 770,912  
 
Liabilities
               
Deposits
  $ 521,456     $ 326,492  
Trading liabilities – debt and equity instruments
    87,942       78,222  
Trading liabilities – derivative payables
    63,265       71,226  
Long-term debt
    95,422       48,014  
All other liabilities
    283,510       200,804  
 
Total liabilities
    1,051,595       724,758  
Stockholders’ equity
    105,653       46,154  
 
Total liabilities and stockholders’ equity
  $ 1,157,248     $ 770,912  
 
(a)  
Heritage JPMorgan Chase only.

Balance sheet overview

At December 31, 2004, the Firm’s total assets were $1.2 trillion, an increase of $386 billion, or 50%, from the prior year, primarily as a result of the Merger. Merger-related growth in assets was primarily in: Available-for-sale securities; interests in purchased receivables related to Bank One’s conduit business; wholesale and consumer loans; and goodwill and other intangibles, which was primarily the result of the purchase accounting impact of the Merger. Nonmerger-related growth was primarily due to the IB’s increased trading activity, which is reflected in securities purchased under resale agreements and securities borrowed, as well as trading assets.

At December 31, 2004, the Firm’s total liabilities were $1.1 trillion, an increase of $327 billion, or 45%, from the prior year, again primarily as a result of the Merger. Merger-related growth in liabilities was primarily in interest-bearing U.S. deposits, long-term debt, trust preferred securities and beneficial interests issued by consolidated variable interest entities. Nonmerger-related growth in liabilities was primarily driven by increases in noninterest-bearing U.S. deposits and the IB’s trading activity, which is reflected in securities sold under repurchase agreements, partially offset by reductions in federal funds purchased.

Trading assets – debt and equity instruments

The Firm’s debt and equity trading assets consist primarily of fixed income (including government and corporate debt) and cash equity and convertible instruments used for both market-making and proprietary risk-taking activities. The increase over 2003 was primarily due to growth in client-driven market-making activities across interest rate, credit and equity markets, as well as an increase in proprietary trading activities.

Trading assets and liabilities – derivative receivables and payables

The Firm uses various interest rate, foreign exchange, equity, credit and commodity derivatives for market-making, proprietary risk-taking and risk management purposes. The decline from 2003 was primarily due to the Firm’s election, effective January 1, 2004, to report the fair value of derivative assets and liabilities net of cash received and paid, respectively, under legally enforceable master netting agreements. For additional information, refer to Credit risk management and Note 3 on pages 57–69 and 90–91, respectively, of this Annual Report.

Securities

AFS securities include fixed income (e.g., U.S. Government agency and asset-backed securities, as well as non-U.S. government and corporate debt) and equity instruments. The Firm uses AFS securities primarily to manage interest rate risk. The AFS portfolio grew by $34.3 billion from the 2003 year-end primarily due to the Merger. Partially offsetting the increase were net sales in the Treasury portfolio since the second quarter of 2004. In anticipation of the Merger, both heritage firms reduced the level of their AFS securities to reposition the combined firm. For additional information related to securities, refer to Note 9 on pages 98–100 of this Annual Report.

Loans

Loans, net of allowance, were $394.8 billion at December 31, 2004, an increase of 88% from the prior year, primarily due to the Merger. Also contributing to the increase was growth in both the RFS and CS loan portfolios, partially offset by lower wholesale loans in the IB. For a more detailed discussion of the loan portfolio and allowance for credit losses, refer to Credit risk management on pages 57–69 of this Annual Report.

Goodwill and other intangible assets

The $42.9 billion increase in Goodwill and other intangible assets from the prior year was primarily the result of the Merger and, to a lesser extent, the Firm’s other acquisitions such as EFS and the majority stake in Highbridge. For additional information, see Note 15 on pages 109–111 of this Annual Report.

Deposits

Deposits are a key source of funding. The stability of this funding source is affected by such factors as returns available to customers on alternative investments, the quality of customer service levels and competitive forces. Deposits increased by 60% from December 31, 2003, primarily the result of the Merger and growth in deposits in TSS. For more information, refer to the TSS segment discussion and the Liquidity risk management discussion on pages 43–44 and 55–56, respectively, of this Annual Report.

Long-term debt

Long-term debt increased by 99% from the prior year, primarily due to the Merger and net new debt issuances. For additional information on the Firm’s long-term debt activity, see the Liquidity risk management discussion on pages 55–56 of this Annual Report.

Stockholders’ equity

Total stockholders’ equity increased by 129% to $105.7 billion, primarily as a result of the Merger. For a further discussion of capital, see Capital management on pages 50–52 of this Annual Report.


     
JPMorgan Chase & Co. / 2004 Annual Report   49

 


Table of Contents

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

Line of business equity

The Firm’s framework for allocating capital is based on the following objectives:

 
Integrate firmwide capital management activities with capital management activities within each of the lines of business.
 
 
Measure performance in each business segment 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 primary measure of a business segment’s performance.

For performance management purposes, the Firm does not allocate goodwill to the lines of business because it believes that the accounting-driven allocation of goodwill could distort assessment of relative returns. In management’s view, this approach fosters better comparison of line of business returns with other internal business segments, as well as with peers. The Firm assigns an amount of equity capital equal to the then current book value of its goodwill to the Corporate segment. The return on invested capital related to the Firm’s goodwill assets is managed within this segment. In accordance with SFAS 142, the Firm allocates goodwill to the lines of business based on the underlying fair values of the businesses and then performs the required impairment testing. For a further discussion of goodwill and impairment testing, see Critical accounting estimates and Note 15 on pages 77–79 and 109–111 respectively, of this Annual Report.

This integrated approach to assigning equity to the lines of business is a new methodology resulting from the Merger. Therefore, current year 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 table below for 2004 was primarily attributable to the Merger.

                         
(in billions)   Yearly Average  
Line of business equity(a)   2004           2003  
 
Investment Bank
  $ 17.3             $ 18.4  
Retail Financial Services
    9.1               4.2  
Card Services
    7.6               3.4  
Commercial Banking
    2.1               1.1  
Treasury & Securities Services
    2.5               2.7  
Asset & Wealth Management
    3.9               5.5  
Corporate(b)
    33.1               7.7  
 
Total common stockholders’ equity
  $ 75.6             $ 43.0  
 
(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.
(b)  
2004 includes $25.9 billion of equity to offset goodwill and $7.2 billion of equity primarily related to Treasury, Private Equity and the Corporate Pension Plan.

Economic risk capital

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

                         
(in billions)   Yearly Average
Economic risk capital(a)   2004           2003  
 
Credit risk
  $ 16.5             $ 13.1  
Market risk
    7.5               4.5  
Operational risk
    4.5               3.5  
Business risk
    1.9               1.7  
Private equity risk
    4.5               5.4  
 
Economic risk capital
    34.9               28.2  
Goodwill
    25.9               8.1  
Other(b)
    14.8               6.7  
 
Total common stockholders’ equity
  $ 75.6             $ 43.0  
 
(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.
(b)  
Additional capital required to meet internal regulatory/debt rating objectives.

Credit risk capital

Credit risk capital is estimated separately for the wholesale businesses (Investment Bank, Commercial Banking, Asset & Wealth Management and Treasury & Securities Services) 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, from both 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 on potential movements of underlying market rates. Loan equivalents for unused revolving credit facilities represent the portion of an unused commitment likely, based on the Firm’s average portfolio historical experience, to become outstanding in the event an obligor defaults.
 
 
Default likelihood is closely aligned with current market conditions for all publicly traded names or investment banking clients, yielding a forward-looking measure of credit risk. This facilitates more active risk management by utilizing the growing market in credit derivatives and secondary market loan sales. For privately-held firms in the commercial banking portfolio, default likelihood is based on longer term averages over an entire credit cycle.
 
 
Loss severity of exposure is based on 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.



     
50   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

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 on 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 allocates market risk capital guided by the principle that capital should reflect the extent to which risks are present in businesses. Daily VAR, monthly stress-test results and other factors determine appropriate capital charges for major business segments. See Market risk management on pages 70–74 of this Annual Report for more information about these market risk measures. The Firm allocates market risk capital to each business segment according to a formula that weights that segment’s VAR and stress test exposures.

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 bottoms-up basis. The operational risk capital model is based on actual losses and potential scenario-based stress losses, with adjustments to the capital calculation to reflect changes in the quality of the control environment and with a potential offset for 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 on 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 publicly- and privately-held securities and 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. In addition to negative market fluctuations, potential losses in private equity investment portfolios can be magnified by liquidity risk. The capital allocation for the Private Equity portfolio is based upon measurement of the loss experience suffered by the Firm and other market participants over a prolonged period of adverse equity market conditions.

Regulatory capital

The Firm’s federal banking regulator, the FRB, establishes capital requirements, including well-capitalized standards for the consolidated financial holding company. The Office of the Comptroller of the Currency (“OCC”) establishes similar capital requirements and standards for the Firm’s national

banks, including JPMorgan Chase Bank, National Association (“JPMorgan Chase Bank”) and Chase Bank USA, National Association.

On March 1, 2005, the FRB issued a final rule that continues the inclusion of trust preferred securities in Tier 1 capital, subject to stricter quantitative limits. The rule provides for a five-year transition period. The Firm is currently assessing the impact of the final rule. The effective date of the final rule is dependent on the date of publication in the Federal Register.

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

The following tables show that JPMorgan Chase maintained a well-capitalized position based on Tier 1 and Total capital ratios at December 31, 2004 and 2003.

Capital ratios

                         
                    Well-
                    capitalized
December 31,   2004     2003(a)     ratios
 
Tier 1 capital ratio
    8.7 %     8.5 %     6.0 %
Total capital ratio
    12.2       11.8       10.0  
Tier 1 leverage ratio
    6.2       5.6     NA  
Total stockholders’ equity to assets
    9.1       6.0     NA  
 
(a)  
Heritage JPMorgan Chase only.

Risk-based capital components and assets

                         
December 31, (in millions)   2004           2003 (a)
 
Total Tier 1 capital
  $ 68,621             $ 43,167  
Total Tier 2 capital
    28,186               16,649  
 
Total capital
  $ 96,807             $ 59,816  
 
Risk-weighted assets
  $ 791,373             $ 507,456  
Total adjusted average assets
    1,102,456               765,910  
 
(a)  
Heritage JPMorgan Chase only.

Tier 1 capital was $68.6 billion at December 31, 2004, compared with $43.2 billion at December 31, 2003, an increase of $25.4 billion. The increase was due to an increase in common stockholders’ equity of $60.2 billion, primarily driven by stock issued in connection with the Merger of $57.3 billion and net income of $4.5 billion; these were partially offset by dividends paid of $3.9 billion and common share repurchases of $738 million. The Merger added Tier 1 components such as $3.0 billion of additional qualifying trust preferred securities and $493 million of minority interests in consolidated subsidiaries; Tier 1 deductions resulting from the Merger included $34.1 billion of merger-related goodwill, and $3.4 billion of nonqualifying intangibles.

Additional information regarding the Firm’s capital ratios and the associated components and assets, and a more detailed discussion of federal regulatory capital standards are presented in Note 24 on pages 116–117 of this Annual Report.



     
JPMorgan Chase & Co. / 2004 Annual Report   51

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

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 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 employing its 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 the FRB that its internal criteria meet the relevant supervisory standards. The Basel II Framework will be fully effective in January 2008. JPMorgan Chase expects to implement the Basel II Framework within this timeframe.

JPMorgan Chase is currently analyzing local Basel II requirements in major jurisdictions outside the U.S. where it operates. Based on the results of this analysis, different approaches may be implemented in various jurisdictions.

Dividends

The Firm’s common stock dividend policy reflects its earnings outlook, desired payout ratios, the need to maintain an adequate capital level and alternative investment opportunities. In 2004, JPMorgan Chase declared a quarterly cash dividend on its common stock of $0.34 per share. The Firm anticipates a dividend payout ratio in 2005 of 30-40% of operating earnings.

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 equity-based plans. The actual amount of shares repurchased will be subject to various factors, including market conditions; legal considerations affecting the amount and timing of repurchase activity; the Firm’s capital position (taking into account purchase accounting adjustments); internal capital generation; and alternative potential investment opportunities. During 2004, under the stock repurchase program, the Firm repurchased 19.3 million shares for $738 million at an average price per share of $38.27. The Firm did not repurchase any shares of its common stock during 2003.



Off–balance sheet arrangements and contractual cash obligations

 

Special-purpose entities

JPMorgan Chase is involved with several types of off-balance sheet arrangements including special purpose entities (“SPEs”), lines of credit and loan commitments. The principal uses of SPEs are to obtain sources of liquidity for JPMorgan Chase and its clients by securitizing their financial assets, and to create 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 are often structured to be bankruptcy-remote.

JPMorgan Chase is involved with SPEs in three broad categories of transactions: loan securitizations, multi-seller conduits and client intermediation. Capital is held, as appropriate, against all SPE-related transactions and related exposures, such as derivative transactions and lending-related commitments. For a further discussion of SPEs and the Firm’s accounting for them, see Note 1 on page 88, Note 13 on pages 103–106 and Note 14 on pages 106–109 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 Worldwide Rules

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 $79.4 billion and $34.0 billion at December 31, 2004 and 2003, respectively. Alternatively, if JPMorgan Chase Bank were downgraded, the Firm could be replaced by another liquidity provider in lieu of funding under the liquidity commitment, or, in certain circumstances, could facilitate the sale or refinancing of the assets in the SPE in order to provide liquidity.

Of its $79.4 billion in liquidity commitments to SPEs at December 31, 2004, $47.7 billion is included in the Firm’s total other unfunded commitments to extend credit, included in the table below (compared with $27.7 billion at December 31, 2003). As a result of the Firm’s consolidation of multi-seller conduits in accordance with FIN 46R, $31.7 billion of these commitments are excluded from the table (compared with $6.3 billion at December 31, 2003), as the underlying assets of the SPEs have been included on the Firm’s Consolidated balance sheets.

The revenue reported in the table below primarily represents servicing and custodial fee income. The Firm also has exposure to certain SPEs arising from derivative transactions; these transactions are recorded at fair value on the Firm’s Consolidated balance sheets with changes in fair value (i.e., 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.



     
52   JPMorgan Chase & Co. / 2004 Annual Report

 


Table of Contents

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

Revenue from VIEs and QSPEs

                         
Year ended December 31,(a)                  
(in millions)   VIEs(b)     QSPEs     Total  
 
2004
  $ 154     $ 1,438     $ 1,592  
2003
    79       979       1,058  
 
(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 VIE-related revenue (i.e., revenue associated with consolidated and significant nonconsolidated VIEs).

Contractual cash obligations

In the normal course of business, the Firm enters into various contractual obligations that may require future cash payments. The accompanying table summarizes JPMorgan Chase’s off–balance sheet lending-related financial

instruments and significant contractual cash obligations, by remaining maturity, at December 31, 2004. For a discussion regarding Long-term debt and trust preferred capital securities, see Note 17 on pages 112–113 of this Annual Report. For a discussion regarding operating leases, see Note 25 on page 117 of this Annual Report.

Contractual purchases include commitments for future cash expenditures, primarily related to services. Capital expenditures primarily represent future cash payments for real estate–related obligations and equipment. Contractual purchases and capital expenditures at December 31, 2004, reflect the minimum contractual obligation under legally enforceable contracts with contract terms that are both fixed and determinable. Excluded from the following table are a number of obligations to be settled in cash, primarily in under one year. These obligations are reflected on the Firm’s Consolidated balance sheets and include Federal funds purchased and securities sold under repurchase agreements; Other borrowed funds; purchases of Debt and equity instruments that settle within standard market timeframes (e.g., regular-way); Derivative payables that do not require physical delivery of the underlying instrument; and certain purchases of instruments that resulted in settlement failures.



Off–balance sheet lending-related financial instruments

                                         
By remaining maturity at December 31, 2004   Under   1–3   3–5   After    
(in millions)   1 year   years   years   5 years   Total
 
Consumer
  $ 552,748     $ 3,603     $ 2,799     $ 42,046     $ 601,196  
Wholesale:
                                       
Other unfunded commitments to extend credit(a)(b)
    114,555       57,183       48,987       4,427       225,152  
Standby letters of credit and guarantees(a)
    22,785       30,805       21,387       3,107       78,084  
Other letters of credit(a)
    4,631       1,297       190       45       6,163  
 
Total wholesale
    141,971       89,285       70,564       7,579       309,399  
 
Total lending-related commitments
  $ 694,719     $ 92,888     $ 73,363     $ 49,625     $ 910,595  
 
 
                                       
Contractual cash obligations
                                       
By remaining maturity at December 31, 2004 (in millions)
                                       
 
Certificates of deposit of $100,000 and over
  $ 38,946     $ 7,941     $ 1,176     $ 1,221     $ 49,284  
Long-term debt
    15,833       30,890       23,527       25,172       95,422  
Trust preferred capital securities
                      10,296       10,296  
FIN 46R long-term beneficial interests(c)
    3,072       708       203       2,410       6,393  
Operating leases(d)
    1,060       1,878       1,614       5,301       9,853  
Contractual purchases and capital expenditures
    1,791       518       252       181       2,742  
Obligations under affinity and co-brand programs
    868       2,442       1,086       6       4,402  
Other liabilities(e)
    968       1,567       1,885       6,546       10,966  
 
Total
  $ 62,538     $ 45,944     $ 29,743     $ 51,133     $ 189,358  
 
(a)  
Represents contractual amount net of risk participations totaling $26 billion at December 31, 2004.
(b)  
Includes unused advised lines of credit totaling $23 billion at December 31, 2004, which are not legally binding. In regulatory filings with the FRB, unused advised lines are not reportable.
(c)  
Included on the Consolidated balance sheets in Beneficial interests issued by consolidated variable interest entities.
(d)  
Excludes benefit of noncancelable sublease rentals of $689 million at December 31, 2004.
(e)  
Includes deferred annuity contracts and expected funding for pension and other postretirement benefits for 2005. Funding requirements for pension and postretirement benefits after 2005 are
excluded due to the significant variability in the assumptions required to project the timing of future cash payments.
     
JPMorgan Chase & Co. / 2004 Annual Report   53

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

Risk management

 

Risk is an inherent part of JPMorgan Chase’s business activities. The Firm’s risk management framework and governance structure is intended to provide comprehensive controls and ongoing management of its major risks. In addition, this framework recognizes the diversity among the Firm’s core businesses, which helps reduce the impact of volatility in any particular area on its operating results as a whole.

The Firm’s ability to properly identify, measure, monitor and report risk is critical to its soundness and profitability.

 
Risk identification: The Firm identifies risk by dynamically assessing the potential impact of internal and external factors on transactions and positions. Business and risk professionals develop appropriate mitigation strategies for the identified risks.

 
Risk measurement: The Firm measures risk using a variety of methodologies, including calculating probable loss, unexpected loss and value-at-risk, and by conducting stress tests and making comparisons to external benchmarks. Measurement models and related assumptions are routinely reviewed to ensure that the Firm’s risk estimates are reasonable and reflective of underlying positions.

 
Risk monitoring/Control: The Firm establishes risk management policies and procedures. These policies contain approved limits by customer, product and business that are monitored on a daily, weekly and monthly basis as appropriate.

 
Risk reporting: Risk reporting covers all lines of business and is provided to management on a daily, weekly and monthly basis as appropriate.

Risk governance

The Firm’s risk governance structure is built upon the premise that each line of business is responsible for managing the risks inherent in its business activity. There are seven major risk types identified in the business activities of the Firm: liquidity risk, credit risk, market risk, operational risk, legal and reputation risk, fiduciary risk and principal risk. As part of the risk management structure, each line of business has a Risk Committee responsible for decisions relating to risk strategy, policies and control. Where appropriate, the Risk Committees escalate risk issues to the Firm’s Operating Committee, comprised of senior officers of the Firm, or to the Risk Working Group, a subgroup of the Operating Committee.

In addition to the Risk Committees, there is an Asset & Liability Committee (“ALCO”), which oversees structural interest rate and liquidity risk as well as the Firm’s funds transfer pricing policy, through which lines of business transfer market-hedgable interest rate risk to Treasury. Treasury also has responsibility for decisions relating to its risk strategy, policies and control. There is also an Investment Committee, which reviews key aspects of the Firm’s global M&A activities that are undertaken for its own account and that fall outside the scope of established private equity and other principal finance activities.



(FLOW CHART)

Overlaying risk management within the lines of business is the corporate function of Risk Management which, under the direction of the Chief Risk Officer reporting to the President and Chief Operating Officer, provides an independent firmwide function for control and management of risk. Within

Risk Management are those units responsible for credit risk, market risk, operational risk, fiduciary risk, principal risk, and risk technology and operations, as well as Risk Management Services, which is responsible for credit risk policy and methodology, risk reporting and risk education.



(FLOW CHART)

 

54   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

The Board of Directors exercises oversight of risk management as a whole and through the Board’s Audit Committee and the Risk Policy Committee. The Audit Committee is responsible for oversight of guidelines and policies to govern the process by which risk assessment and management is undertaken. In addition, the Audit Committee reviews with management the system of internal controls and financial reporting that is relied upon to provide reasonable assurance of compliance with the Firm’s operational risk management processes. The Risk Policy Committee is responsible for oversight of management’s

responsibilities to assess and manage the Firm’s credit risk, market risk, interest rate risk, investment risk and liquidity risk, and is also responsible for review of the Firm’s fiduciary and asset management activities. Both committees are responsible for oversight of reputational risk. The Chief Risk Officer and other management report on the risks of the Firm to the Board of Directors, particularly through the Board’s Audit Committee and Risk Policy Committee.

The major risk types identified by the Firm are discussed in the following sections.



Liquidity risk management

 

Liquidity risk arises from the general funding needs of the Firm’s activities and in the management of its assets and liabilities. JPMorgan Chase’s liquidity management framework is intended to maximize liquidity access and minimize funding costs. Through active liquidity management, the Firm seeks to preserve stable, reliable and cost-effective sources of funding. This enables the Firm to replace maturing obligations when due and fund assets at appropriate maturities and rates in all market environments. To accomplish this, management uses a variety of liquidity risk measures that take into consideration market conditions, prevailing interest rates, liquidity needs and the desired maturity profile of liabilities.

Risk identification and measurement

Treasury is responsible for setting the Firm’s liquidity strategy and targets, understanding the Firm’s on- and off-balance sheet liquidity obligations, providing policy guidance, overseeing policy adherence, and maintaining contingency planning and stress testing. In addition, it identifies and measures internal and external liquidity warning signals, such as the unusual widening of spreads, to permit early detection of liquidity issues.

The Firm’s three primary measures of liquidity are:

 
Holding company short-term position: Measures the parent holding company’s ability to repay all obligations with a maturity less than one year at a time when the ability of the Firm’s banks to pay dividends to the parent holding company is constrained.
 
 
Cash capital surplus: Measures the Firm’s ability to fund assets on a fully collateralized basis, assuming access to unsecured funding is lost.
 
 
Basic surplus: Measures JPMorgan Chase Bank’s ability to sustain a 90-day stress event that is specific to the Firm where no new funding can be raised to meet obligations as they come due.

All three primary liquidity measures are managed to provide sufficient surplus in the Firm’s liquidity position.

Risk monitoring and reporting

Treasury is responsible for measuring, monitoring, reporting and managing the liquidity profile of the Firm through both normal and stress periods. Treasury analyzes reports to monitor the diversity and maturity structure of the Firm’s sources of funding, and to assess downgrade impact scenarios, contingent funding needs, and overall collateral availability and pledging status. A contingency funding plan is in place, intended to help the Firm manage through periods when access to funding is temporarily impaired. A downgrade analysis considers the potential impact of a one- and two-notch

downgrade at both the parent and bank level, and calculates the estimated loss of funding as well as the increase in annual funding costs in both scenarios. A trigger-risk funding analysis considers the impact of a bank downgrade below A-1/P-1, including the funding requirements that would be required if such an event were to occur. These liquidity analytics rely on management’s judgment about JPMorgan Chase’s ability to liquidate assets or use them as collateral for borrowings and take into account credit risk management’s historical data on the funding of loan commitments (e.g., commercial paper back-up facilities), liquidity commitments to SPEs, commitments with rating triggers and collateral posting requirements. For a further discussion of SPEs and other off-balance sheet arrangements, see Off-balance sheet arrangements and contractual cash obligations on pages 52-53, as well as Note 1, Note 13, Note 14 and Note 27 on pages 88, 103-106, 106-109, and 119-120, respectively, of this Annual Report.

Funding

Sources of funds

The diversity of the Firm’s funding sources enhances financial flexibility and limits dependence on any one source, thereby minimizing the cost of funds. A major source of liquidity for JPMorgan Chase Bank is provided by its large core deposit base. Core deposits include all U.S. deposits insured by the FDIC, up to the legal limit of $100,000 per depositor. In 2004, core bank deposits grew approximately 116% from 2003 year-end levels, primarily the result of the Merger, as well as growth within RFS and TSS. In addition to core deposits, the Firm benefits from substantial, stable deposit balances originated by TSS, Commercial Banking and the IB through the normal course of their businesses.

Additional funding flexibility is provided by the Firm’s ability to access the repurchase and asset securitization markets. At December 31, 2004, $72 billion of securities were available for repurchase agreements, and $36 billion of credit card, automobile and mortgage loans were available for securitizations. These alternatives are evaluated on an ongoing basis to achieve an appropriate balance of secured and unsecured funding. The ability to securitize loans, and the associated gains on those securitizations, are principally dependent on the credit quality and yields of the assets securitized and are generally not dependent on the credit ratings of the issuing entity. Transactions between the Firm and its securitization structures are reflected in JPMorgan Chase’s consolidated financial statements; these relationships include retained interests in securitization trusts, liquidity facilities and derivative transactions. For further details, see Notes 13 and 14 on pages 103-106 and 106-109, respectively, of this Annual Report.



JPMorgan Chase & Co./2004 Annual Report   55

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

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

Issuance

Corporate credit spreads narrowed in 2004 across most industries and sectors, reflecting the market perception that credit risks were improving, as the number of downgrades declined, corporate balance sheet cash positions increased, and corporate profits exceeded expectations. JPMorgan Chase’s credit spreads performed in line with peer spreads in 2004. The Firm took advantage of narrowing credit spreads globally by opportunistically issuing long-term debt and capital securities throughout the year. Consistent with its liquidity management policy, the Firm has raised funds at the parent holding

company sufficient to cover maturing obligations over the next 12 months and to support the less liquid assets on its balance sheet. High 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 decreasing funding costs and lengthening maturities.

During 2004, JPMorgan Chase issued approximately $25.3 billion of long-term debt and capital securities. These issuances were partially offset by $ 16.0 billion of long-term debt and capital securities that matured or were redeemed, and the Firm’s redemption of $670 million of preferred stock. In addition, in 2004 the Firm securitized approximately $6.5 billion of residential mortgage loans, $8.9 billion of credit card loans and $1.6 billion of automobile loans, resulting in pre-tax gains (losses) on securitizations of $47 million, $52 million and $(3) million, respectively. For a further discussion of loan securitizations, see Note 13 on pages 103-106 of this Annual Report.



Credit ratings

The credit ratings of JPMorgan Chase’s parent holding company and each of its significant banking subsidiaries, as of December 31, 2004, were as follows:

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

The Firm’s principal insurance subsidiaries had the following financial strength ratings as of December 31, 2004:

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

In connection with the Merger, Moody’s upgraded the ratings of the Firm by one notch, moving the parent holding company’s senior long-term debt rating to Aa3 and JPMorgan Chase Bank’s senior long-term debt rating to Aa2; and changed its outlook to stable. Also at that time, Fitch affirmed its ratings and changed its outlook to positive, while S&P affirmed all its ratings and kept its outlook stable.

The cost and availability of unsecured financing are influenced by credit ratings. A reduction in these ratings could adversely affect the Firm’s access to

liquidity sources, increase the cost of funds, trigger additional collateral requirements and decrease the number of investors and counterparties willing to lend. Critical factors in maintaining high credit ratings include a stable and diverse earnings stream; strong capital ratios; strong credit quality and risk management controls; diverse funding sources; and strong liquidity monitoring procedures.

If the Firm’s ratings were downgraded by one notch, the Firm estimates the incremental cost of funds and the potential loss of funding to be negligible. Additionally, the Firm estimates the additional funding requirements for VIEs and other third-party commitments would not be material. In the current environment, the Firm believes a downgrade is unlikely. For additional information on the impact of a credit ratings downgrade on funding requirements for VIEs, and on derivatives and collateral agreements, see Off-balance Sheet Arrangements on pages 52-53 and Ratings profile of derivative receivables mark-to-market (“MTM”) on page 64, of this Annual Report.



56   JPMorgan Chase & Co./2004 Annual Report

 


Table of Contents

Credit risk management

 

Credit risk is the risk of loss from obligor or counterparty default. The Firm provides credit to customers of all sizes, from large corporate clients to loans for the individual consumer. Management manages the risk/reward relationship of each portfolio, discouraging the retention of loan assets that do not generate a positive return above the cost of risk-adjusted capital. The Firm’s business strategy for its large corporate wholesale loan portfolio remains primarily one of origination for distribution; the majority of the Firm’s wholesale

loan originations (primarily to IB clients) continue to be distributed into the marketplace, with residual holds by the Firm averaging less than 10%. With regard to the prime consumer credit market, the Firm focuses on creating a portfolio that is diversified from both a product and a geographical perspective.

The Firm’s credit risk management governance structure consists of the primary functions as described in the organizational chart below.



Credit risk organization

(ORGANIZATIONAL CHART)

 

JPMorgan Chase & Co./2004 Annual Report   57

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

In 2004, the Firm continued to enhance its risk management discipline, managing wholesale single-name and industry concentration through its threshold and limit structure and using credit derivatives and loan sales in its portfolio management activity. The Firm manages wholesale exposure concentrations by obligor, risk rating, industry and geography. In addition, the Firm continued to make progress under its multi-year initiative to reengineer specific components of the credit risk infrastructure. The goal is to enhance the Firm’s ability to provide immediate and accurate risk and exposure information; actively manage credit risk in the retained portfolio; support client relationships; more quickly manage the allocation of economic capital; and comply with Basel II initiatives.

In 2004, the Firm continued to grow its consumer loan portfolio, focusing on businesses providing the most appropriate risk/reward relationship while keeping within the Firm’s desired risk tolerance. During the past year, the Firm also completed a strategic review of all consumer lending portfolio segments. This action resulted in the sale of the $4 billion manufactured home loan portfolio, de-emphasizing vehicle leasing and, subsequent to year-end 2004, the sale of a $2 billion recreational vehicle portfolio. Continued growth in the core consumer lending product set (residential real estate, auto and education finance, credit cards and small business) reflected a focus on the prime credit quality segment of the market.

Risk identification

The Firm is exposed to credit risk through its lending (e.g., loans and lending-related commitments), derivatives trading and capital markets activities. Credit risk also arises due to country or sovereign exposure, as well as indirectly through the issuance of guarantees.

Risk measurement

To measure credit risk, the Firm employs several methodologies for estimating the likelihood of obligor or counterparty default. Losses generated by consumer loans are more predictable than wholesale losses but are subject to cyclical and seasonal factors. Although the frequency of loss is higher on consumer loans than on wholesale loans, the severity of loss is typically lower and more manageable. As a result of these differences, methodologies vary depending on certain factors, including type of asset (e.g., consumer installment versus wholesale loan), risk measurement parameters (e.g., delinquency status and credit bureau score versus wholesale risk rating) and risk management and collection processes (e.g., retail collection center versus centrally managed workout groups).

Credit risk measurement is based on the amount of exposure should the obligor or the counterparty default, and the loss severity given a default event. Based on these factors and related market-based inputs, the Firm estimates both probable and unexpected losses for the wholesale and consumer portfolios. Probable losses, reflected in the Provision for credit losses, are statistically-based estimates of credit losses over time, anticipated as a result of obligor or counterparty default. However, probable losses are not the sole indicators of risk. If losses were entirely predictable, the probable loss rate could be factored into pricing and covered as a normal and recurring cost of doing business. Unexpected losses, reflected in the allocation of credit risk capital, represent the potential volatility of actual losses relative to the probable level of losses (refer to Capital management on pages 50-51 of this Annual Report for a further discussion of the credit risk capital methodology). Risk measurement for the wholesale portfolio is primarily based on risk-rated exposure; and for the consumer portfolio it is based on credit-scored exposure.

Risk-rated exposure

For portfolios that are risk-rated, probable and unexpected loss calculations are based on estimates of probability of default and loss given default. Probability of default is expected default calculated on an obligor basis. Loss given default is an estimate of losses that are based on collateral and structural support for each credit facility. Calculations and assumptions are based on management information systems and methodologies under continual review. Risk ratings are assigned and reviewed on an ongoing basis by Credit Risk Management and revised, if needed, to reflect the borrowers’ current risk profile and the related collateral and structural position.

Credit-scored exposure

For credit-scored portfolios (generally Retail Financial Services and Card Services), probable loss is based on a statistical analysis of inherent losses over discrete periods of time. Probable losses are estimated using sophisticated portfolio modeling, credit scoring and decision-support tools to project credit risks and establish underwriting standards. In addition, common measures of credit quality derived from historical loss experience are used to predict consumer losses. Other risk characteristics evaluated include recent loss experience in the portfolios, changes in origination sources, portfolio seasoning, loss severity and underlying credit practices, including charge-off policies. These analyses are applied to the Firm’s current portfolios in order to forecast delinquencies and severity of losses, which determine the amount of probable losses. These factors and analyses are updated on a quarterly basis.

Risk monitoring

The Firm has developed policies and practices that are designed to preserve the independence and integrity of decision-making and ensure credit risks are accurately assessed, properly approved, continually monitored and actively managed at both the transaction and portfolio levels. The policy framework establishes credit approval authorities, credit limits, risk-rating methodologies, portfolio-review parameters and problem-loan management. Wholesale credit risk is continually monitored on both an aggregate portfolio level and on an individual customer basis. For consumer credit risk, the key focus items are trends and concentrations at the portfolio level, where potential problems can be remedied through changes in underwriting policies and portfolio guidelines. Consumer Credit Risk Management monitors trends against business expectations and industry benchmarks.

In order to meet its credit risk management objectives, the Firm seeks to maintain a risk profile that is diverse in terms of borrower, product type, industry and geographic concentration. Additional diversification of the Firm’s exposure is accomplished through syndication of credits, participations, loan sales, securitizations, credit derivatives and other risk-reduction techniques.

Risk reporting

To enable monitoring of credit risk and decision-making, aggregate credit exposure, credit metric forecasts, hold-limit exceptions and risk profile changes are reported to senior credit risk management regularly. Detailed portfolio reporting of industry, customer and geographic concentrations occurs monthly, and the appropriateness of the allowance for credit losses is reviewed by senior management on a quarterly basis. Through the risk governance structure, credit risk trends and limit exceptions are regularly provided to, and discussed with, the Operating Committee.


58   JPMorgan Chase & Co./2004 Annual Report

 


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Credit portfolio

 
The following table presents JPMorgan Chase’s credit portfolio as of December 31, 2004 and 2003. Total wholesale credit exposure increased by $167 billion, and total consumer exposure increased by $584 billion, at year-end 2004 from year-end 2003. This increase in total exposure (including $71 billion of securitized credit cards) was primarily the result of the Merger.

Wholesale and consumer credit portfolio

                                                                 
As of or for the                                            
year ended                   Nonperforming                     Average annual  
December 31,(a)   Credit exposure     assets(t)(u)     Net charge-offs     net charge-off rate  
(in millions, except ratios)   2004     2003     2004     2003     2004     2003     2004     2003  
 
Wholesale(b)(c)(d)
                                                               
Loans – reported(e)
  $ 135,067     $ 75,419     $ 1,574     $ 2,004     $ 186     $ 765       0.19 %     0.97 %
Derivative receivables(f)(g)
    65,982       83,751       241       253     NA     NA     NA     NA
Interests in purchased receivables
    31,722       4,752                 NA     NA     NA     NA
Other receivables
          108             108     NA     NA     NA     NA
 
Total wholesale credit-related assets(e)
    232,771       164,030       1,815       2,365       186       765       0.19       0.97  
Lending-related commitments(h)(i)
    309,399       211,483     NA     NA     NA     NA     NA     NA
 
Total wholesale credit exposure(e)(j)
  $ 542,170     $ 375,513     $ 1,815     $ 2,365     $ 186     $ 765       0.19 %     0.97 %
 
Consumer(c)(k)(l)
                                                               
Loans – reported(m)
  $ 267,047     $ 139,347     $ 1,169     $ 580     $ 2,913     $ 1,507       1.56 %     1.33 %
Loans – securitized(m)(n)
    70,795       34,856                   2,898       1,870       5.51       5.64  
 
Total managed consumer loans(m)
  $ 337,842     $ 174,203     $ 1,169     $ 580     $ 5,811     $ 3,377       2.43 %     2.31 %
Lending-related commitments
    601,196       181,198     NA     NA     NA     NA     NA     NA
 
Total consumer credit exposure(o)
  $ 939,038     $ 355,401     $ 1,169     $ 580     $ 5,811     $ 3,377       2.43 %     2.31 %
 
Total credit portfolio
                                                               
Loans – reported
  $ 402,114     $ 214,766     $ 2,743     $ 2,584     $ 3,099     $ 2,272       1.08 %     1.19 %
Loans – securitized(n)
    70,795       34,856                   2,898       1,870       5.51       5.64  
 
Total managed loans
    472,909       249,622       2,743       2,584       5,997       4,142       1.76       1.84  
Derivative receivables(f)(g)
    65,982       83,751       241       253     NA     NA     NA     NA
Interests in purchased receivables
    31,722       4,752                 NA     NA     NA     NA
Other receivables
          108             108     NA     NA     NA     NA
 
Total managed credit-related assets
    570,613       338,233       2,984       2,945       5,997       4,142       1.76       1.84  
Wholesale lending-related commitments(h)(i)
    309,399       211,483     NA     NA     NA     NA     NA     NA
Consumer lending-related commitments
    601,196       181,198     NA     NA     NA     NA     NA     NA
Assets acquired in loan satisfactions(p)
  NA     NA       247       216     NA     NA     NA     NA
 
Total credit portfolio(q)
  $ 1,481,208     $ 730,914     $ 3,231     $ 3,161     $ 5,997     $ 4,142       1.76 %     1.84 %
 
Purchased held-for-sale wholesale loans(r)
  $ 351     $ 22     $ 351     $ 22     NA     NA     NA     NA  
Credit derivative hedges notional(s)
    (37,200 )     (37,282 )     (15 )     (123 )   NA     NA     NA     NA  
Collateral held against derivatives
    (9,301 )     (36,214 )   NA     NA     NA     NA     NA     NA  
 
   
 
(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 Investment Bank, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management.
(c)  
Amounts are presented gross of the Allowance for loan losses.
(d)  
Net charge-off rates exclude year-to-date average wholesale loans HFS of $6.4 billion and $3.8 billion for 2004 and 2003, respectively.
(e)  
Wholesale loans past-due 90 days and over and accruing were $8 million and $42 million at December 31, 2004 and 2003, respectively.
(f)  
The 2004 amount includes the effect of legally enforceable master netting agreements. Effective January 1, 2004, the Firm elected to report the fair value of derivative assets and liabilities net of cash received and paid, respectively, under legally enforceable master netting agreements. As of December 31, 2004, derivative receivables were $98 billion before netting of $32 billion of cash collateral held.
(g)  
The Firm also views its credit exposure on an economic basis. For derivative receivables, economic credit exposure is the three-year averages of a measure known as Average exposure (which is the expected MTM value of derivative receivables at future time periods, including the benefit of collateral). Average exposure was $38 billion and $34 billion at December 31, 2004 and December 31, 2003, respectively. See pages 62-64 of this Annual Report for a further discussion of the Firm’s derivative receivables.
(h)  
The Firm also views its credit exposure on an economic basis. For lending-related commitments, economic credit exposure is represented by a “loan equivalent,” which is the portion of the unused commitments or other contingent exposure that is expected, based on average portfolio historical experience, to become outstanding in the event of a default by the obligor. Loan equivalents were $162 billion and $104 billion at December 31, 2004 and 2003, respectively. See page 65 of this Annual Report for a further discussion of this measure.
(i)  
Includes unused advised lines of credit totaling $23 billion and $19 billion at December 31, 2004 and 2003, respectively, which are not legally binding. In regulatory filings with the FRB, unused advised lines are not reportable.
(j)  
Represents Total wholesale loans, Derivative receivables, Interests in purchased receivables, Other receivables and Wholesale lending-related commitments.
(k)  
Net charge-off rates exclude year-to-date average HFS consumer loans (excluding Card) in the amount of $14.7 billion and $25.3 billion for 2004 and 2003, respectively.
(l)  
Includes Retail Financial Services and Card Services.
(m)  
Past-due loans 90 days and over and accruing includes credit card receivables of $998 million and $273 million, and related credit card securitizations of $1.3 billion and $879 million, at December 31, 2004 and 2003, respectively.
(n)  
Represents securitized credit cards. For a further discussion of credit card securitizations, see Card Services on pages 39-40 of this Annual Report.
(o)  
Represents Total consumer loans, Credit card securitizations and Consumer lending-related commitments.
(p)  
At December 31, 2004 and 2003, includes $23 million and $10 million, respectively, of wholesale assets acquired in loan satisfactions, and $224 million and $206 million, respectively, of consumer assets acquired in loan satisfactions.
(q)  
At December 31, 2004 and 2003, excludes $1.5 billion and $2.3 billion, respectively, of residential mortgage receivables in foreclosure status that are insured by government agencies. These amounts are excluded as reimbursement is proceeding normally.
(r)  
Represents distressed wholesale loans purchased as part of IB’s proprietary investing activities.
(s)  
Represents the notional amount of single-name and portfolio credit derivatives used to manage the credit risk of wholesale credit exposure; these derivatives do not qualify for hedge accounting under SFAS 133.
(t)  
Excludes purchased held-for-sale (“HFS”) wholesale loans.
(u)  
Nonperforming assets include wholesale HFS loans of $2 million and $30 million for 2004 and 2003, respectively, and consumer HFS loans of $13 million and $45 million for 2004 and 2003, respectively. HFS loans are carried at the lower of cost or market, and declines in value are recorded in Other income.
NA — Not applicable.
 
JPMorgan Chase & Co./2004 Annual Report   59

 


Table of Contents

Management’s discussion and analysis

JPMorgan Chase & Co.

Wholesale credit portfolio

 

The increase in total wholesale exposure was almost entirely due to the Merger. Derivative receivables declined by $18 billion, primarily because, effective January 1, 2004, the Firm elected to report the fair value of derivative assets and liabilities net of cash received and paid, respectively, under legally enforceable master netting agreements. Loans, lending-related commitments

and interests in purchased receivables increased by $60 billion, $98 billion and $27 billion, respectively, primarily as a result of the Merger.

Below are summaries of the maturity and ratings profiles of the wholesale portfolio as of December 31, 2004 and 2003. The ratings scale is based on the Firm’s internal risk ratings and is presented on an S&P-equivalent basis.



                                                                                         
Wholesale exposure   Maturity profile(a)     Ratings profile
                                    Investment-grade ("IG")     Noninvestment-grade                
At December 31, 2004         AAA     A+     BBB+     BB+     CCC+             Total %  
(in billions, except ratios)   <1 year     1-5 years     > 5 years     Total     to AA-     to A-     to BBB     to B-     & below     Total     of IG  
 
Loans
    43 %     43 %     14 %     100 %   $ 31     $ 20     $ 36     $ 43     $ 5     $ 135       64 %
Derivative receivables(b)
    19       39       42       100       34       12       11       9             66       86  
Interests in purchased receivables
    37       61       2       100       3       24       5                   32       100  
Lending-related commitments(b)(c)
    46       52       2       100       124       68       74       40       3       309       86  
 
Total exposure(d)
    42 %     49 %     9 %     100 %   $ 192     $ 124     $ 126     $ 92       8     $ 542       82 %
 
Credit derivative hedges notional(e)
    18 %     77 %     5 %     100 %   $ (11 )   $ (11 )   $ (13 )   $ (2 )   $     $ (37 )     95 %
 
                                                                                         
    Maturity profile(a)     Ratings profile  
                                    Investment-grade ("IG")     Noninvestment-grade                
At December 31, 2003(f)         AAA     A+     BBB+     BB+     CCC+             Total %  
(in billions, except ratios)   <1 year     1-5 years     > 5 years     Total     to AA-     to A-     to BBB     to B-     & below     Total     of IG  
 
Loans
    50 %     35 %     15 %     100 %   $ 14     $ 13     $ 20     $ 22     $ 6     $ 75       63 %
Derivative receivables(b)
    20       41       39       100       47       15       12       9       1       84       88  
Interests in purchased receivables
    27       71       2       100       5                               5       100  
Lending-related commitments(b)(c)
    52       45       3       100       79       57       48       26       2       212       87  
 
Total exposure(d)
    44 %     43 %     13 %     100 %   $ 145     $ 85     $ 80     $ 57     $ 9     $ 376       83 %
 
Credit derivative hedges notional(e)
    16 %     74 %     10 %     100 %   $ (10 )   $ (12 )   $ (12 )   $ (12 )   $ (1 )   $ (37 )     92 %
 
   
 
(a)  
The maturity profile of loans and lending-related commitments is based upon the remaining contractual maturity. The maturity profile of derivative receivables is based upon the maturity profile of Avera