Annual Report — Form 10-K Filing Table of Contents
Document/ExhibitDescriptionPagesSize 1: 10-K Annual Report HTML 2.47M
2: EX-4.7.F Ex-4.7.F: Amended and Restated Trust Agreement HTML 242K
3: EX-4.7.G Ex-4.7.G: Amended and Restated Trust Agreement HTML 249K
4: EX-10.9 Ex-10.9: 2001 Stock Option Plan HTML 25K
5: EX-12.1 Ex-12.1: Computation of Ratio of Earnings to Fixed HTML 14K
Charges
6: EX-12.2 Ex-12.2: Computation of Ratio of Earnings to Fixed HTML 15K
Charges and Preferred Stock Dividend
Requirements
7: EX-21.1 Ex-21.1: List of Subsidiaries HTML 107K
8: EX-23.1 Ex-23.1: Consent of Independent Registered Public HTML 13K
Accounting Firm
9: EX-31.1 Ex-31.1: Certification HTML 14K
10: EX-31.2 Ex-31.2: Certification HTML 14K
11: EX-32 Ex-32: Certification HTML 10K
The Indexed Linked Notes, JPMorgan Market Participation Notes, Capped Quarterly Observation Notes, Consumer Price
Indexed Securities and Principal Protected Notes are listed on the American Stock Exchange;
all other securities named above are listed on the New York Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act: none
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. x Yes o No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. o Yes x No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated
filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
x Large accelerated filer o Accelerated filer o Non-accelerated filer
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). o Yes x No
The aggregate market value of JPMorgan Chase & Co. common stock held by non-affiliates of
JPMorgan Chase & Co. on June 30, 2006 was
approximately $144,956,714,582.
Number of shares of common stock outstanding on January 31, 2007: 3,473,349,593
Market for Registrant’s common equity, related stockholder matters and issuer purchases of equity securities
11
Item 6
Selected financial data
11
Item 7
Management’s discussion and analysis of financial condition and results of operations
11
Item 7A
Quantitative and qualitative disclosures about market risk
11
Item 8
Financial statements and supplementary data
12
Item 9
Changes in and disagreements with accountants on accounting and financial disclosure
12
Item 9A
Controls and procedures
12
Item 9B
Other information
12
Part III
Item 10
Directors, executive officers and corporate governance
12
Item 11
Executive compensation
12
Item 12
Security ownership of certain beneficial owners and management and related stockholder matters
12
Item 13
Certain relationships and related transactions, and Director independence
13
Item 14
Principal accounting fees and services
13
Part IV
Item 15
Exhibits, financial statement schedules
13
Part I
Item 1: Business
Overview
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”) 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 $1.4 trillion
in assets, $116 billion in stockholders’ equity and operations worldwide.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank,
National Association (“JPMorgan Chase Bank, N.A.”), a national banking association with branches in 17 states, and Chase Bank USA, National Association
(“Chase Bank USA, N.A.”), a national banking association that is the Firm’s credit
card-issuing bank. JPMorgan Chase’s principal nonbank subsidiary is J.P.
Morgan Securities Inc. (“JPMorgan Securities”), its U.S. investment banking
firm. The bank and nonbank subsidiaries of JPMorgan Chase operate nationally as well as through overseas branches and subsidiaries, representative
offices and subsidiary foreign banks.
On July 1, 2004, Bank One Corporation (“Bank One”) merged with and into
JPMorgan Chase (the “Merger”). 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 heritage JPMorgan Chase only and six months of operations
of the combined Firm; results of operations for all periods prior to 2004
reflect the operations of heritage JPMorgan Chase only.
The Firm’s website is www.jpmorganchase.com. JPMorgan Chase makes
available free of charge, through its website, annual reports on Form
10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
any amendments to those reports filed or furnished pursuant to Section 13(a)
or Section 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after it electronically files such material with, or furnishes such
material to, the Securities and Exchange Commission (the “SEC”). The Firm has
adopted, and posted on its website, a Code of Ethics for its Chairman
and Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer and
other senior financial officers.
Business segments
JPMorgan Chase’s activities are organized, for management reporting purposes,
into six business segments (Investment Bank, Retail Financial Services, Card
Services, Commercial Banking, Treasury & Securities Services and Asset
Management) and Corporate, which includes its Private Equity and Treasury
businesses, as well as corporate support functions. A description of the Firm’s
business segments and the products and services they provide to their respective client bases is provided in the “Business segment results” section of
Management’s discussion and analysis (“MD&A”), beginning on page 34,
and in Note 33 on page 139.
Competition
JPMorgan Chase and its subsidiaries and affiliates operate in a highly
competitive environment. Competitors include other banks, brokerage firms,
investment banking companies, merchant banks, insurance companies, mutual
fund companies, credit card companies, mortgage banking companies, hedge
funds, trust companies, securities processing companies, automobile financing companies, leasing companies,
e-commerce and other Internet-based companies, and a variety of other
financial services and advisory companies. JPMorgan Chase’s businesses compete with these other firms with respect to the quality and range of products
and services offered and the types of clients, customers, industries and geogra-
phies served. With respect to some of its geographies and products, JPMorgan
Chase competes globally; with respect to others, the Firm competes on a
regional basis. JPMorgan Chase’s ability to compete effectively depends upon
the relative performance of its products, the degree to which the
features of its products appeal to customers, and the extent to which the
Firm is able to meet its clients’ objectives or needs. The Firm’s ability to
compete also depends upon its ability to attract and retain its professional
and other personnel, and on its reputation.
The financial services industry has experienced consolidation and convergence
in recent years, as financial institutions involved in a broad range of financial
products and services have merged. This convergence trend is expected
to continue. Consolidation could result in competitors of JPMorgan Chase
gaining greater capital and other resources, such as a broader range of products
and services and geographic diversity. It is possible that competition will
become even more intense as the Firm continues to compete with other
financial institutions that may be larger or better capitalized, or that may
have a stronger local presence in certain geographies. For a discussion of
certain risks relating to the Firm’s competitive environment, see the Risk
factors on page 4.
Supervision and regulation
Permissible business activities: The Firm is subject to regulation under
state and federal law, including the Bank Holding Company Act of 1956, as
amended (the “BHCA”). JPMorgan Chase elected to become a financial
holding company as of March 13, 2000, pursuant to the provisions of the
Gramm-Leach-Bliley Act (“GLBA”).
Under regulations implemented by the Board of Governors of the Federal
Reserve System (the “Federal Reserve Board”), if any depository institution
controlled by a financial holding company ceases to meet certain capital or
management standards, the Federal Reserve Board may impose corrective
capital and/or managerial requirements on the financial holding company
and place limitations on its ability to conduct the broader financial activities
permissible for financial holding companies. In addition, the Federal Reserve
Board may require divestiture of the holding company’s depository institutions
if the deficiencies persist. The regulations also provide that if any depository
institution controlled by a financial holding company fails to maintain a
satisfactory rating under the Community Reinvestment Act (“CRA”), the
Federal Reserve Board must prohibit the financial holding company and its
subsidiaries from engaging in any additional activities other than those
permissible for bank holding companies that are not financial holding
companies. At December 31, 2006, the depository-institution subsidiaries of JPMorgan Chase met the capital, management and CRA
requirements necessary to permit the Firm to conduct the broader activities permitted under GLBA. However, there can be no assurance that
this will continue to be the case in the future.
Regulation by Federal Reserve Board under GLBA: Under GLBA’s
system of “functional regulation,” the Federal Reserve Board acts as an
“umbrella regulator,” and certain of JPMorgan Chase’s subsidiaries are regulated directly by additional authorities based upon the particular activities of
those subsidiaries. JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. are
regulated by the Office of the Comptroller of the Currency
(“OCC”). See “Other Supervision and Regulation”
below for a further description of the regulatory supervision to
which the Firm’s subsidiaries are subject.
1
Part I
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, N.A. and
Chase Bank USA, N.A., is limited to the lesser of the amounts calculated under a “recent
earnings” test and an “undivided profits” test. Under the recent earnings test, a
dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current year’s net income combined with the retained
net income of the two preceding years, unless the national bank obtains the
approval of the OCC. Under the undivided profits test, a dividend may not be paid
in excess of a bank’s “undivided profits.” See Note 25 on page 129 for the
amount of dividends that the Firm’s principal bank subsidiaries could pay, at
January 1, 2007 and 2006, to their respective bank holding companies without the
approval of their banking regulators.
In addition to the dividend restrictions described above, the OCC, the Federal
Reserve Board and the Federal Deposit Insurance Corporation (the “FDIC”) have
authority to prohibit or to limit the payment of dividends by the banking organizations they supervise, including JPMorgan Chase and its bank and bank holding
company subsidiaries, if, in the banking regulator’s opinion, payment of a dividend
would constitute an unsafe or unsound practice in light of the financial condition
of the banking organization.
Capital requirements: Federal banking regulators have adopted risk-based capital
and leverage guidelines that require the Firm’s capital-to-assets ratios to meet
certain minimum standards.
The risk-based capital ratio is determined by allocating assets and specified
off-balance sheet financial instruments into four weighted categories, with higher
levels of capital being required for the categories perceived as representing
greater risk. Under the guidelines, capital is divided into two tiers: Tier 1 capital
and Tier 2 capital. The amount of Tier 2 capital may not exceed the amount of
Tier 1 capital. Total capital is the sum of Tier 1 capital and Tier 2 capital. Under
the guidelines, banking organizations are required to maintain a Total capital
ratio (total capital to risk-weighted assets) of 8% and a Tier 1 capital ratio of 4%.
The federal banking regulators also have established minimum leverage ratio
guidelines. The leverage ratio is defined as Tier 1 capital divided by average total
assets (net of the allowance for loan losses, goodwill and certain
intangible assets). The minimum leverage ratio is 3% for bank holding companies
that are considered “strong” under Federal Reserve Board guidelines or
which have implemented the Federal Reserve Board’s risk-based capital
measure for market risk. Other bank holding companies must have a minimum leverage ratio of 4%. Bank holding companies may be expected to
maintain ratios well above the minimum levels, depending upon their
particular condition, risk profile and growth plans. See Regulatory
capital on page 58 and Note 26 on page 129.
The risk-based capital requirements explicitly identify concentrations of
credit risk, certain risks arising from non-traditional banking activities, and
the management of those risks as important factors to consider in assessing
an institution’s overall capital adequacy. Other factors taken into consideration
by federal regulators include: interest rate exposure; liquidity, funding and
market risk; the quality and level of earnings; the quality of loans and
investments; the effectiveness of loan and investment policies; and
management’s overall ability to monitor and control financial and operational
risks, including the risks presented by concentrations of credit and non-traditional banking activities. In addition, the risk-based capital rules
incorporate a measure for market risk in foreign exchange and commodity
activities and in the trading of debt and equity instruments. The market
risk-based capital
rules require banking organizations with large trading
activities (such as JPMorgan Chase) to maintain capital for market risk in
an amount calculated by using the banking organizations’ own internal
Value-at-Risk models (subject to parameters set by the regulators).
The minimum risk-based capital requirements adopted by the federal banking
agencies follow the Capital Accord of the Basel Committee on Banking
Supervision. The Basel Committee has proposed a revision to the Accord
(“Basel II”). U.S. banking regulators are in the process of incorporating the Basel
II Framework into the existing risk-based capital requirements. JPMorgan
Chase will be required to implement advanced measurement techniques in the
U.S., commencing in 2009, by employing internal estimates of certain key risk
drivers to derive capital requirements. Prior to its implementation of the new
Basel II Framework, JPMorgan Chase will be required to demonstrate to its U.S.
bank supervisors that its internal criteria meet the relevant supervisory standards. JPMorgan Chase expects to be in compliance within the established
timelines with all relevant Basel II rules. During 2007 and 2008, the Firm will
adopt Basel II rules in certain non-U.S. jurisdictions, as required.
FDICIA: The Federal Deposit Insurance Corporation Improvement Act of
1991 (“FDICIA”) provides a framework for regulation of depository institutions and their affiliates,
including parent holding companies, by their federal banking regulators; among other things, it requires the relevant federal
banking regulator to take “prompt corrective action” with respect to a
depository institution if that institution does not meet certain capital adequacy standards.
Supervisory actions by the appropriate federal banking regulator under the
“prompt corrective action” rules generally depend upon an institution’s
classification within five capital categories. The regulations apply only to
banks and not to bank holding companies such as JPMorgan Chase; however, subject to limitations that may be imposed pursuant to GLBA, the
Federal Reserve Board is authorized to take appropriate action at the holding company level, based upon the undercapitalized status of the holding
company’s subsidiary banking institutions. In certain instances relating to
an undercapitalized banking institution, the bank holding company would
be required to guarantee the performance of the undercapitalized subsidiary and might be liable for civil money damages for failure to fulfill its
commitments on that guarantee.
FDIC Insurance Assessments: In November 2006, the FDIC issued final regulations, as required by the Federal Deposit Insurance Reform Act of 2005, by
which the FDIC established a new base rate schedule for the assessment of
deposit insurance premiums and set new assessment rates which became effective in January 2007. Under these regulations, each depository institution is
assigned to a risk category based upon capital and supervisory measures.
Depending upon the risk category to which it is assigned, the depository institution
is then assessed insurance premiums based upon its deposits. Some depository
institutions are entitled to apply against these premiums a credit that
is designed to give effect to premium payments, if any, that the depository
institution may have made in certain prior years. The new assessment
schedule will not have a material adverse effect on the Firm’s earnings or financial condition.
2
Powers of the FDIC upon insolvency of an insured depository institution: An FDIC-insured depository institution can be held liable for any loss
incurred or expected to be incurred by the FDIC in connection with another
FDIC-insured institution under common control with such institution being
“in default” or “in danger of default” (commonly referred to as “cross-guarantee”
liability). An FDIC cross-guarantee claim against a depository institution is
generally superior in right of payment to claims of the holding company and its
affiliates against such depository institution.
If the FDIC is appointed the conservator or receiver of an insured depository
institution upon its insolvency or in certain other events, the FDIC has the
power: (1) to transfer any of the depository institution’s assets and liabilities to
a new obligor without the approval of the depository institution’s creditors; (2)
to enforce the terms of the depository institution’s contracts pursuant to their
terms; or (3) to repudiate or disaffirm any contract or lease to which the depository institution is a party, the performance of which is determined by the FDIC
to be burdensome and the disaffirmation or repudiation of which is determined
by the FDIC to promote the orderly administration of the depository institution.
The above provisions would be applicable to obligations and liabilities of
JPMorgan Chase’s subsidiaries that are insured depository institutions, such as
JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A., including, without limitation,
obligations under senior or subordinated debt issued by those banks to
investors (referenced below as “public noteholders”) in the public markets.
Under federal law, the claims of a receiver of an insured depository institution
for administrative expenses and the claims of holders of U.S. deposit liabilities
(including the FDIC, as subrogee of the depositors) have priority over the
claims of other unsecured creditors of the institution, including public note-holders and depositors in non-U.S. offices, 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 or depositors in non-U.S. offices of any subsidiary of the Firm that is an insured
depository institution, such as JPMorgan Chase Bank, N.A. or Chase Bank USA, N.A., such
persons would be treated differently from, and could receive, if anything, substantially less than the depositors of the depository institution.
The Bank Secrecy Act: The Bank Secrecy Act, which was amended by the
USA Patriot Act of 2001, requires all “financial institutions,” to establish
certain anti-money laundering compliance and due diligence programs. The
Act also 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.”
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 its 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. See Note 25 on page 129.
The Firm’s banks 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, N.A. and
Chase Bank USA, N.A., 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 JPMorgan Securities and
other broker-dealer subsidiaries, all of which are subject to the regulations of
the SEC and the NASD Regulation, Inc. (“NASD”) and other self-regulatory organizations (“SROs”).
JPMorgan Securities 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 Firm has subsidiaries that are members of futures exchanges in
the U.S. and abroad. One subsidiary is registered as a futures commission merchant, and other subsidiaries are registered as commodity pool operators and
commodity trading advisors, all with the Commodity Futures Trading
Commission (“CFTC”). These CFTC-registered subsidiaries are also members of
the National Futures Association. The Firm’s energy business is also subject to
regulation by the Federal Energy Regulatory Commission. The types of activities
in which the non-U.S. branches of JPMorgan Chase Bank, N.A. 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, N.A. and Chase Bank USA, N.A. as consumer
lenders also are subject to regulation under various U.S. federal laws, including the
Truth-in-Lending, Equal Credit Opportunity, Fair Credit Reporting, Fair
Debt Collection Practice and 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.
3
Part I
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 nonpublic
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 nonaffiliates, subject to certain exceptions set
forth in GLBA.
For a discussion of certain risks relating to the Firm’s regulatory environment, see Risk factors below.
Non-U.S. operations
For geographic distributions of total revenue, total expense, income before
income tax expense and net income, see Note 32 on page 138. For information
regarding non-U.S. loans, see Note 12 on page 112 and the sections entitled
“Emerging markets country exposure” in the MD&A on page 72, Loan portfolio on page 154 and
“Cross-border outstandings” on page 155.
Item 1A: Risk factors
The following discussion sets forth some of the more important risk factors that
could affect the Firm’s business and operations. Other factors that could affect
the Firm’s business and operations are discussed in the
“Forward looking statements” section on page 147. However, factors besides those discussed below, in the
MD&A or elsewhere in this or other of the Firm’s reports filed or furnished with
the SEC also could adversely affect the Firm’s business or results. The reader
should not consider any descriptions of such factors to be a complete set of all
potential risks that may face the Firm.
JPMorgan Chase’s results of operations could be adversely affected
by U.S. and international markets and economic conditions.
The Firm’s businesses are affected by conditions in the global financial markets
and economic conditions generally both in the U.S. and internationally. Factors
such as the liquidity of the global financial markets; the level and volatility of
equity prices, interest rates and commodities prices; investor sentiment; inflation; and the availability and cost of credit can affect significantly the activity
level of clients with respect to size, number and timing of transactions involving the Firm’s investment banking business, including its underwriting and
advisory businesses. These factors also may affect the realization of cash
returns from the Firm’s private equity business. A market downturn would likely lead to a decline in the volume of transactions that the Firm executes for its
customers and, therefore, lead to a decline in the revenues it receives from
trading commissions and spreads. In addition, lower market volatility will
reduce trading and arbitrage opportunities, which could lead to lower trading
revenues. Higher interest rates or weakness in the markets also could adversely affect the number or size of underwritings the Firm manages on behalf of
clients and affect the willingness of financial sponsors or investors to participate in loan syndications or underwritings managed by JPMorgan Chase.
The Firm generally maintains large trading portfolios in the fixed income, currency, commodity and equity markets and has significant investment positions,
including merchant banking investments held by its private equity business. The
revenues derived from mark-to-market values of the Firm’s business are affected
by many factors, including its credit standing; its success in
proprietary positioning; volatility in interest rates and equity and debt markets; and other economic and business factors. JPMorgan Chase anticipates that revenues relating to its
trading will experience volatility and there can be no assurance that such
volatility relating to the above factors or other conditions could not materially
adversely affect the Firm’s earnings.
The fees JPMorgan Chase earns for managing third-party assets are also
dependent upon general economic conditions. For example, a higher level of
U.S. or non-U.S. interest rates or a downturn in trading markets could affect the
valuations of the third-party assets managed by the Firm, which, in turn, could
affect the Firm’s revenues. Moreover, even in the absence of a market downturn,
below-market or sub-par performance by JPMorgan Chase’s investment management
businesses could result in outflows of assets under management and supervision
and, therefore, reduce the fees the Firm receives.
The credit
quality of JPMorgan Chase’s on-balance sheet and off-balance sheet
assets may be affected by business conditions. In a poor economic environment
there is a greater likelihood that more of the Firm’s customers or counterparties
could become delinquent on their loans or other obligations to JPMorgan Chase
which, in turn, could result in a higher level of charge-offs and provision for
credit losses, all of which would adversely affect the Firm’s earnings.
The Firm’s consumer businesses are particularly affected by domestic economic
conditions that can materially adversely affect such businesses and the Firm.
Such conditions include U.S. interest rates; the rate of unemployment; the level
of consumer confidence; changes in consumer spending; and the number of
personal bankruptcies, among others. Certain changes to these conditions can
diminish demand for businesses’ products and services, or increase the cost to
provide such products and services. In addition, a deterioration in consumers’
credit quality could lead to an increase in loan delinquencies and higher net
charge-offs, which could adversely affect the Firm’s earnings.
There is increasing competition in the financial services industry which
may adversely affect JPMorgan Chase’s results of operations.
JPMorgan Chase operates in a highly competitive environment and expects
competitive conditions to continue to intensify as continued merger activity in
the financial services industry produces larger, better-capitalized and more
geographically diverse companies that are capable of offering a wider array of
financial products and services at more competitive prices.
The Firm also faces an increasing array of competitors. Competitors include other
banks, brokerage firms, investment banking companies, merchant banks, insurance
companies, mutual fund companies, credit card companies, mortgage banking
companies, hedge funds, trust companies, securities processing
companies, automobile financing companies,
leasing companies, e-commerce and other Internet-based companies, and a
variety of other financial services and advisory companies. Technological
advances and the growth of e-commerce have made it possible for nondepository institutions to offer products and services that traditionally were banking
products, and for financial institutions and other companies to provide electronic
and Internet-based financial solutions, including electronic securities trading.
JPMorgan Chase’s businesses generally compete on the basis of the quality and
variety of its products and services, transaction execution, innovation, technology,
reputation and price. Ongoing or increased competition in any one or all of these
areas may put downward pressure on prices for the Firm’s products and services
or may cause the Firm to lose market share. Increased competition
also may
require the Firm to make additional capital investment in its businesses in order
to remain competitive. These investments may increase expenses or may
require the Firm to extend more of its capital on behalf of clients in order to
execute larger, more competitive transactions. There can be no assurance that
the significant and increasing competition in the financial services industry will
not materially adversely affect JPMorgan Chase’s future results of operations.
4
Part I
JPMorgan Chase’s acquisitions and integration of acquired businesses
may not result in all of the benefits anticipated.
The Firm has in the past and may in the future seek to grow its business by
acquiring other businesses. There can be no assurance that the Firm’s acquisitions
will have the anticipated positive results, including results relating to: the total
cost of integration; the time required to complete the integration; the amount
of longer-term cost savings; or the overall performance of the combined entity.
Integration of an acquired business can be complex and costly, sometimes
including combining relevant accounting and data processing systems and
management controls, as well as managing relevant relationships with
employees, clients,
suppliers and other business partners.
There is no assurance that JPMorgan Chase’s most recent acquisitions or that
any businesses acquired in the future will be successfully integrated and will
result in all of the positive benefits anticipated. If JPMorgan Chase is not able
to integrate successfully its past and any future acquisitions, there is the risk the
Firm’s results of operations could be materially and adversely affected.
JPMorgan Chase relies on its systems, employees and certain
counterparties, and certain failures could materially adversely affect
the Firm’s operations.
The Firm’s businesses are dependent on its ability to process a large number of
increasingly complex transactions. If any of the Firm’s financial, accounting, or
other data processing systems fail or have other significant shortcomings, the
Firm could be materially adversely affected. The Firm is similarly dependent
on its employees. The Firm could be materially adversely affected if a Firm
employee causes a significant operational break down or failure, either as a
result of human error or where an individual purposefully sabotages or fraudulently manipulates the Firm’s operations or systems. Third parties with which
the Firm does business could also be sources of operational risk to the Firm,
including relating to break downs or failures of such parties’ own systems or
employees. Any of these occurrences could result in a diminished ability of
the Firm to operate one or more of its businesses, potential liability to clients,
reputational damage and regulatory intervention, which could materially
adversely affect the Firm.
The Firm also may be subject to disruptions of its operating systems arising
from events that are wholly or partially beyond its control, which may include,
for example, computer viruses or electrical or telecommunications outages or
natural disasters, such as Hurricane Katrina, or events arising from local or
regional politics, including terrorist acts. Such disruptions may give rise to
losses in service to customers and loss or liability to the Firm.
In a firm as large and complex as JPMorgan Chase, lapses or deficiencies
in internal control over financial reporting may occur from time to
time, and there is no assurance that significant deficiencies or material weaknesses in internal controls may not occur in the future.
In addition, there is the risk that the Firm’s controls and procedures as well as
business continuity and data security systems prove to be inadequate. Any
such failure could affect the Firm’s operations and could materially adversely
affect its results of operations by requiring the Firm to expend significant
resources to correct the defect, as well as by exposing the Firm to litigation or
losses not covered by insurance.
JPMorgan Chase’s non-U.S. trading activities and operations are
subject to risk of loss, particularly in emerging markets.
The Firm does business throughout the world, including in developing regions of
the world commonly known as emerging markets. In the past, many emerging
market countries have experienced severe economic and financial disruptions,
including devaluations of their currencies and capital and currency exchange
controls, as well as low or negative economic growth.
JPMorgan Chase’s businesses and revenues derived from non-U.S. operations
are subject to risk of loss from various unfavorable political, economic and legal
developments, including currency fluctuations, social instability, changes in
governmental policies or policies of central banks, expropriation, nationalization,
confiscation of assets and changes in legislation relating to non-U.S. ownership.
The Firm also invests in the securities of corporations located in non-U.S.
jurisdictions, including emerging markets. Revenues from the trading of non-U.S. securities also may be subject to negative fluctuations as a result of the
above considerations. The impact of these fluctuations could be accentuated
as non-U.S. trading markets (particularly in emerging markets) are usually
smaller, less liquid and more volatile than U.S. trading markets. There can be
no assurance the Firm will not suffer losses in the future arising from its non-U.S. trading activities or operations.
If JPMorgan Chase does not successfully handle issues that may arise
in the conduct of its business and operations, its reputation could be
damaged, which could in turn negatively affect its business.
The Firm’s ability to attract and retain customers and transact with its counter-parties could be adversely affected to the extent its reputation is damaged. The
failure of the Firm to deal, or to appear to fail to deal, with various issues that
could give rise to reputational risk could cause harm to the Firm and its business
prospects. These issues include, but are not limited to, appropriately dealing with
potential conflicts of interest, legal and regulatory requirements, ethical issues,
money-laundering, privacy, record-keeping, sales and trading practices, and the
proper identification of the legal, reputational, credit, liquidity and market risks
inherent in its products. The failure to address appropriately these issues could
make the Firm’s clients unwilling to do business with the Firm, which could
adversely affect the Firm’s results.
JPMorgan Chase operates within a highly regulated industry and its
business and results are significantly affected by the regulations to
which it is subject.
JPMorgan Chase operates within a highly regulated environment. The regulations
to which the Firm is subject will continue to have a significant impact on the
Firm’s operations and the degree to which it can grow and be profitable.
Certain regulators to which the Firm is subject have significant power in reviewing
the Firm’s operations and approving its business practices. Particularly in recent
years, the Firm’s businesses have experienced increased regulation and regulatory
scrutiny, often requiring additional Firm resources. In addition, as the Firm
expands its international operations, its activities will become subject to an
increasing range of non-U.S. laws and regulations that likely will impose new
requirements and limitations on certain of the Firm’s operations. There is no
assurance that any change to the current regulatory requirements to which
JPMorgan Chase is subject, or the way in which such regulatory requirements
are interpreted or enforced, will not have a negative effect on the Firm’s ability
to conduct its business or its results of operations.
JPMorgan Chase faces significant legal risks, both from regulatory
investigations and proceedings and from private actions brought
against the Firm.
JPMorgan Chase is named as a defendant or is otherwise involved in
various legal proceedings, including
class actions and other litigation or disputes with third parties, as well as
investigations or proceedings brought by regulatory agencies. These or other
future actions brought against the Firm may result in judgments, settlements,
fines, penalties or other results adverse to the Firm,
5
Part I
which could
materially adversely affect the Firm’s business, financial condition or results of operation,
or cause it serious reputational harm.
JPMorgan Chase’s ability to attract and retain qualified employees
is critical to the success of its business and failure to do so may
materially adversely affect its performance.
The Firm’s employees are its most important resource and, in many areas of the
financial services industry, competition for qualified personnel is intense. If JPMorgan
Chase is unable to continue to retain and attract qualified employees, its performance, including its competitive position, could be materially adversely affected.
Government monetary policies and economic controls may have a
significant adverse affect on JPMorgan Chase’s businesses and results
of operations.
The Firm’s businesses and earnings are affected by the fiscal and other policies
that are adopted by various regulatory authorities of the United States, non-U.S.
governments and international agencies. For example, policies and regulations of
the Federal Reserve Board influence, directly and indirectly, the rate of interest
paid by commercial banks on their interest-bearing deposits and also may affect
the value of financial instruments held by the Firm. The actions of the Federal
Reserve Board also determine to a significant degree the Firm’s cost of funds for
lending and investing. In addition, these policies and conditions can adversely
affect the Firm’s customers and counterparties, both in the United States and
abroad, which may increase the risk that such customers or counterparties
default on their obligations to JPMorgan Chase.
JPMorgan Chase’s framework for managing its risks may not be
effective in mitigating risk and loss to the Firm.
JPMorgan Chase’s risk management framework is made up of various processes
and strategies to manage the Firm’s risk exposure. Types of risk to which the
Firm is subject include liquidity risk, credit risk, market risk, interest rate risk,
operational risk, legal and reputational risk, fiduciary risk and private equity risk,
among others. There can be no assurance that the Firm’s framework to manage
risk, including such framework’s underlying assumptions, will be effective under
all conditions and circumstances.
As the Firm’s businesses grow and the markets in which they operate continue
to evolve, the Firm’s risk management framework may not always keep sufficient
pace with those changes. For example, as the derivatives markets continue to
grow and the Firm’s participation in these markets expands, there is the risk
that the credit and market risks associated with new products may not be appropriately identified, monitored or managed or that the documentation of these
trades by the Firm or its counterparties will not keep up with the increased pace
of settlements. In addition, in the case of credit derivatives that require physical
settlement of transactions, many market participants, including the Firm, do not
always hold the underlying securities or loans relating to such derivatives; if the
Firm is not able to obtain those securities or loans within the required timeframe
for delivery, this could cause the Firm to forfeit payments otherwise due to it.
If the Firm’s risk management framework proves ineffective, whether because it
does not keep pace with changing Firm or market circumstances or otherwise, the
Firm could suffer unexpected losses and could be materially adversely affected.
If JPMorgan Chase does not effectively manage its liquidity, its
business could be negatively affected.
The Firm’s liquidity is critical to its ability to operate its businesses, grow and be
profitable. A compromise to the Firm’s liquidity could therefore have a negative
effect on the Firm. Potential conditions that could negatively affect the Firm’s
liquidity include diminished access to capital markets, unforeseen cash or capital
requirements and an inability to sell assets.
The Firm’s credit ratings are an important part of maintaining its liquidity, and a
reduction in the Firm’s credit ratings would also negatively affect the Firm’s
liquidity. A credit ratings downgrade, depending on its severity, could potentially
increase borrowing costs, limit access to capital markets, require cash payments or
collateral posting, and permit termination of certain contracts to which the Firm is a party.
Future events may be different than those anticipated by JPMorgan
Chase’s management assumptions and estimates, which may cause
unexpected losses in the future.
Pursuant to U.S. GAAP, the Firm is required to use certain estimates in preparing
its financial statements, including accounting estimates to determine loan loss
reserves, reserves related to future litigation, and the fair value of certain assets
and liabilities, among other items. Should the Firm’s determined values for such
items prove substantially inaccurate, the Firm may experience unexpected losses
that could be material.
Item 1B: Unresolved SEC Staff comments
None.
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 10.7 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 4.7 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 (an aggregate 5.8
million square feet); Columbus, Ohio (2.8 million square feet); Phoenix,
Arizona (1.4 million square feet); Jersey City, New Jersey (1.2 million square
feet); and Wilmington, Delaware (1.0 million square feet).
In the United Kingdom, JPMorgan Chase leases approximately 2.3 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 3,079 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 and may determine certain of its premises and facilities are no longer
necessary for its operations. There is no assurance that the Firm will be able to
dispose of any such 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 30.
6
Item 3: Legal proceedings
Enron litigation. JPMorgan Chase and certain of its officers and directors are
involved in a number of lawsuits arising out of its banking relationships with
Enron Corp. and its subsidiaries (“Enron”). Several actions and other proceedings against the Firm have been resolved, including adversary proceedings
brought by Enron’s bankruptcy estate. In addition, as previously reported, the
Firm has reached an agreement to settle the lead class action litigation
brought on behalf of the purchasers of Enron securities, captioned Newby v.
Enron Corp., for $2.2 billion (pretax). On May 24, 2006, the United States
District Court for the Southern District of Texas approved a settlement in the
Newby action, and entered an order of final judgment and dismissal as to the
JPMorgan Chase defendants. Certain plaintiffs have appealed this final judgment to the United States Court of Appeals for the Fifth Circuit, and one such
appeal remains pending. The Newby settlement does not resolve Enron-related
actions filed separately by plaintiffs who opted out of the class action or by
certain plaintiffs who are asserting claims not covered by that action, including
some of the actions described below.
Enron-related actions, other than Newby, include individual actions against the
Firm by plaintiffs who were lenders or claim to be successors-in-interest to
lenders who participated in Enron credit facilities syndicated by the Firm; individual and putative class actions by Enron investors, creditors and counterparties; and third-party actions brought by defendants in Enron-related cases,
alleging federal and state law claims against JPMorgan Chase and many other
defendants. Fact and expert discovery in these actions is complete. Plaintiffs in
two of the bank lender cases have moved for partial summary judgment, and
were subsequently joined in that motion by plaintiffs in the other two cases.
The Firm opposed this motion, briefing has been completed, and the parties
await the court’s ruling.
In addition, in March 2006, two plaintiffs filed complaints in New York
Supreme Court against JPMorgan Chase alleging breach of contract, breach of
implied duty of good faith and fair dealing and breach of fiduciary duty based
upon the Firm’s role as Indenture Trustee in connection with two indenture
agreements between JPMorgan Chase and Enron. The Firm removed both
actions to the United States District Court for the Southern District of New
York. The federal court dismissed one of these cases and remanded the other
to New York State court where it will now proceed.
In a purported, consolidated class action lawsuit by JPMorgan Chase stockholders alleging that the Firm issued false and misleading press releases and
other public documents relating to Enron in violation of Section 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5 thereunder, the United States
District Court for the Southern District of New York dismissed the lawsuit in its
entirety without prejudice in March 2005. Plaintiffs filled an amended complaint in May 2005. The Firm has moved to dismiss the amended complaint,
and the motion has been submitted to the court for decision.
A shareholder derivative action was filed against current and former directors
of JPMorgan Chase asserting that the Board wrongfully refused plaintiff’s
demand that it bring suit against current and former directors and senior officers of the company to recover losses allegedly suffered by JPMorgan Chase
and its affiliates as a result of various alleged activities, including but not limited to Enron. The complaint asserts derivative claims for breach of fiduciary
duty, gross mismanagement, and corporate waste and asserts a violation of
Section 14(a) of the Securities Exchange Act of 1934. On October 11, 2006,
defendants filed a motion to dismiss the complaint, and oral argument on the
motion was held on January 19, 2007. On February 14, 2007, the court granted defendants’ motion to dismiss the complaint without leave to replead.
A putative class action on behalf of JPMorgan Chase employees who participated in the Firm’s 401(k) plan alleged claims under the Employee Retirement
Income Security Act (“ERISA”) for alleged breaches of fiduciary duties and
negligence by JPMorgan Chase, its directors and named officers. In August
2005, the United States District Court for the Southern District of New York
denied plaintiffs’ motion for class certification and ordered some of plaintiffs’
claims dismissed. In September 2005, the Firm moved for summary judgment
seeking dismissal of this ERISA lawsuit in its entirety and, in September 2006,
the court granted summary judgment in part, and ordered plaintiffs to show
cause as to why the remaining claims should not be dismissed. On December27, 2006, the court dismissed the case with prejudice. On December 29,2006, plaintiffs filed a notice of appeal, which is pending.
IPO allocation litigation. Beginning in May 2001, JPMorgan Chase and certain
of its securities subsidiaries were named, along with numerous other firms in
the securities industry, as defendants in a large number of putative class action
lawsuits filed in the United States District Court for the Southern District of
New York. These suits allege improprieties in the allocation of
securities in various
public offerings, including some offerings for which a JPMorgan Chase entity
served as an underwriter. The suits allege violations of securities and antitrust
laws arising from alleged material misstatements and omissions in registration
statements and prospectuses for the initial public offerings (“IPOs”) and
alleged market manipulation with respect to aftermarket transactions in the
offered securities. The securities lawsuits allege, among other things, misrepresentation and market manipulation of the aftermarket trading for these offerings by tying allocations of shares in IPOs to undisclosed excessive commissions
paid to the underwriter defendants, including JPMorgan Securities and to required aftermarket purchase transactions by
customers who received allocations of shares in the respective IPOs, as well as
allegations of misleading analyst reports. The antitrust lawsuits allege an illegal
conspiracy to require customers, in exchange for IPO allocations, to pay undisclosed and excessive commissions and to make aftermarket purchases of the
IPO securities at a price higher than the offering price as a precondition to
receiving allocations. The securities cases were all assigned to one judge for
coordinated pre-trial proceedings, and the antitrust cases were all assigned to
another judge. On February 13, 2003, the Court denied the motions of
JPMorgan Chase and others to dismiss the securities complaints. On October13, 2004, the Court granted in part plaintiffs’ motion to certify classes in six
“focus” cases in the securities litigation. On December 5, 2006, the United
States Court of Appeals for the Second Circuit reversed and vacated the Court’s
class certification ruling. On January 5, 2007, plaintiffs filed a petition for
rehearing en banc in the Second Circuit, which is currently pending.
On February 15, 2005, the Court in the securities cases preliminarily approved
a proposed settlement of plaintiffs’ claims against 298 of the issuer defendants in these cases and a fairness hearing on the proposed settlement was
held on April 24, 2006. Pursuant to the proposed issuer settlement, the insurers for the settling issuer defendants, among other things, (1) agreed to guarantee that the plaintiff classes will recover at least $1 billion from the underwriter defendants in the IPO securities and antitrust cases and to pay any
shortfall, and (2) conditionally assigned to the plaintiffs any claims related to
any “excess compensation” allegedly paid to the underwriters by their customers for allocations of stock in the offerings at issue in the IPO litigation. At
the request of the Court that the parties to the proposed issuer settlement
address the announced preliminary memorandum of understanding (“MOU”)
between plaintiffs and JPMorgan Chase described below, on November 15,
7
Part I
2006, the issuer defendants submitted to the Court a revised proposed order.
On November 29, 2006, the underwriter defendants submitted objections to
the revised proposed order. The Court has not yet approved the proposed
issuer settlement, and the issuer defendants have raised the question with the
Court as to whether the proposed settlement classes can be certified as a
result of the Second Circuit’s December 5, 2006 decision.
Joseph P. LaSala, the trustee designated by plaintiffs to act as assignee of such
issuer excess compensation claims, filed complaints purporting to allege state
law claims on behalf of certain issuers against certain underwriters, including JPMorgan Securities
(the “LaSala Actions”), together with motions to stay proceedings in each case. On August 30, 2005, the Court stayed until resolution of
the proposed issuer settlement the 55 LaSala Actions then pending against
JPMorgan Securities and other underwriter defendants at that time, as well as
all future-filed LaSala Actions pursuant to the parties’ stipulation that the
Court’s decision would govern stay motions in all future LaSala Actions. On
October 12, 2005, the Court granted the underwriter defendants’ motion to
dismiss one LaSala Action, which by stipulation applied to the parallel motions
to dismiss in all other pending and future-filed LaSala Actions. Plaintiffs thereafter filed amended complaints in the lead and other LaSala Actions. On
November 21, 2005, the underwriter defendants moved to dismiss the
amended complaint in the lead LaSala Action and, by virtue of the stipulation
of the parties, thereby moved to dismiss the amended complaints in all other
pending and future-filed LaSala Actions. On February 28, 2006, judgment was
entered by the Court dismissing all pending LaSala Actions. On March 14,2006, plaintiffs filed a motion for reconsideration, alteration or amendment of
the February 28 judgment. On April 28, 2006, the Court denied plaintiffs’
motion for reconsideration.
On April 19, 2006,
counsel for JPMorgan Chase and counsel for the plaintiffs
in the IPO securities and antitrust litigations entered into a preliminary MOU
outlining the general terms of a “proposed settlement” providing that
JPMorgan Securities would pay a sum of $425 million to resolve the claims of
the plaintiffs against JPMorgan Chase and JPMorgan Securities in the securities and
antitrust cases. The MOU specified that the certification of the classes
alleged in the complaints was a condition precedent to any final, binding settlement.
By letter dated December 13, 2006, counsel for JPMorgan Chase
informed counsel for the plaintiffs in the IPO securities and antitrust litigations
that, among other things, due to the Second Circuit’s December 5, 2006, class
certification decision, the proposed settlement classes upon which the preliminary MOU
was conditioned can no longer be certified and, consequently, the
MOU is unenforceable. At a December 14, 2006, conference, the Court stayed
all proceedings in the IPO securities actions pending the Second Circuit’s decision
as to whether to grant plaintiffs’ petition for rehearing en banc.
With respect to the IPO antitrust lawsuits, on November 3, 2003, the Court
granted defendants’ motion to dismiss the claims relating to the IPO allocation
practices in the IPO Allocation Antitrust Litigation. On September 28, 2005,
the United States Court of Appeals for the Second Circuit reversed, vacated
and remanded the district court’s November 3, 2003, dismissal decision.
Defendants thereafter filed a motion for rehearing en banc in the Second
Circuit, which was denied on January 11, 2006. Thereafter, defendants filed a
petition for writ of certiorari in the United States Supreme Court on March 8,2006. The certiorari petition was granted by the Supreme Court on
December 7, 2006, and oral argument will be held in early 2007.
A wholly separate antitrust
class action lawsuit on behalf of purported classes
of IPO issuers and investors alleging that certain underwriters, including JPMorgan Securities,
conspired to fix their underwriting fees in IPOs is in discovery. On
April 18, 2006, the U.S. District Court for the Southern District of New York
denied class certification as to the issuer plaintiffs. The denial of class certification has been appealed to the United States Court of Appeals for the Second
Circuit. Further matters are currently stayed pending resolution of the Second
Circuit appeal.
National Century Financial Enterprises litigation. JPMorgan Chase, JPMorgan
Chase Bank, N.A., JPMorgan Partners, Beacon Group, LLC and three 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. also are named as defendants.
JPMorgan Chase Bank, N.A. and Bank One, N.A. were 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, N.A. 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 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 notes
issued by NCFE. Plaintiffs allege that the trustees violated fiduciary and contractual duties, improperly permitted NCFE and its affiliates to violate the
applicable indentures and violated securities laws by (among other things) failing to disclose the true nature of the NCFE arrangements. Plaintiffs further
allege that the Defendant Employees controlled the Board and audit committees of the NCFE entities; were fully aware, or negligent in not knowing, of NCFE’s
alleged manipulation of its books; and are liable for failing to disclose their
purported knowledge of the alleged fraud to the plaintiffs. Plaintiffs also allege
that Banc One Capital Markets, Inc. is liable for cooperating in the sale of
securities based upon false and misleading statements. Motions to dismiss the
complaints were filed on behalf of the Firm and its affiliates. In October 2006,
the MDL court issued rulings on some of the motions to dismiss, granting the
motions in part and denying the motions in part. Additional motions are still
pending, and limited discovery is underway. The Firm has reached settlements
with several of the plaintiffs: In February 2006, the JPMorgan Chase entities,
the Bank One entities, and the Defendant Employees reached a settlement of
$375 million with the holders of $1.6 billion face value of Notes (the “Arizona
Noteholders”) and reached a separate agreement with the UAT for $50 million; and in June 2006, the JPMorgan entities, the Bank One entities, and the
Defendant Employees reached a settlement of approximately $16 million with
holders of about $89 million face value of Notes (the “New York Pension Fund
8
Noteholders.”) In addition to the lawsuits described above, the SEC has served
subpoenas on JPMorgan Chase Bank, N.A. and Bank One, N.A. and
has interviewed certain current and former employees. On April 25, 2005, the
staff of the Midwest Regional Office of the SEC wrote to advise Bank
One, N.A. that
it is considering recommending that the SEC bring a civil injunctive
action against Bank One, N.A. and a former employee alleging violations of the
securities laws in connection with the role of Banc One, N.A. as indenture trustee for the
NPF XII note program. On July 8, 2005, the staff of the Midwest Regional
Office of the SEC wrote to advise that it is
considering recommending that the SEC bring a civil injunctive action
against two individuals, both former employees of the Firm’s affiliates, alleging
violations of certain securities laws in connection with their role as former
members of NCFE’s board of directors. On July 13, 2005, the staff further
advised that it is considering recommending that the SEC also bring a
civil injunctive action against the Firm in connection with the alleged activities
of the two individuals as alleged agents of the Firm. Lastly, the United States
Department of Justice is also investigating the events surrounding the collapse
of NCFE, and the Firm is cooperating with that investigation.
In re JPMorgan Chase Cash Balance Litigation. In a putative consolidated class
action lawsuit, filed in the District Court for the Southern District of New York,
naming the JPMorgan Chase Retirement Plan (together with the predecessor
plans of the JPMorgan Chase & Co. predecessor companies, the “Plans”) and
the JPMorgan Chase & Co.’s Director of Human Resources as defendants, current and former participants in the Plans allege various claims under the
Employee Retirement Income Security Act (“ERISA”). Plaintiffs’ claims are
based upon alleged violations of ERISA arising from the conversion to and use
of a cash balance formula under the Plans to calculate participants’ pension
benefits. Specifically, plaintiffs allege that: (1) the conversion to and use of a
cash balance formula under the Plans violated ERISA’s proscription against age
discrimination (the “age discrimination claim”); (2) the conversion to a cash
balance formula violated ERISA’s proscriptions against the backloading of pension benefits and created an impermissible forfeiture of accrued benefits (the
“backloading and forfeiture claims”); and (3) defendants failed to adequately
communicate to Plan participants the conversion to a cash balance formula
and in general the nature of the Plan (the “notice claims”). In October 2006,
the United States District Court for the Southern District of New York denied
the Firm’s motion to dismiss the age discrimination and notice claims, but
granted the Firm’s motion to dismiss the backloading and forfeiture claims.
Plaintiffs’ motion for class certification is fully briefed and remains pending
with the Court. Fact discovery is ongoing, but only as to the notice claims.
Discovery as to the age discrimination claims has been temporarily stayed,
pending resolution of a similar case that is now before the United States Court
of Appeals for the Second Circuit.
American Express Litigation. In 1998, the United States Department of Justice
(“DOJ”) commenced an action against VISA U.S.A., Inc., VISA International,
Inc. and MasterCard International Incorporated alleging that VISA
by-law
2.10(e) and MasterCard’s Competitive Programs Policy (the
“Exclusionary Rules”), which
precluded any member of either of the foregoing associations from issuing
payment cards over the Discover or American Express network (or any other
competitive network), violated the antitrust laws and were anticompetitive.
The United States District Court for the Southern District of New York held that
the Exclusionary Rules had an adverse impact on competition and could not be enforced by
the associations. The United States Court of Appeals for the Second Circuit
affirmed, and the United States Supreme Court denied review on October 4,2004, resulting in the repeal of the Exclusionary Rules.
On November 15, 2004, American Express filed a complaint against VISA,
MasterCard, Chase Bank USA, N.A. JPMorgan Chase & Co., as well as certain other
credit card issuing banks, and their respective bank holding companies, in the
United States District Court for the Southern District of New York, alleging that
it suffered damages from the Exclusionary Rules. American Express claims
that, in addition to VISA and MasterCard, member banks were instrumental in
adopting and carrying out the Exclusionary Rules and that the Exclusionary
Rules were restrictions by and for the member banks; and that the member
banks agreed not to compete by means of offering American Express cards.
On August 30, 2005, the Court denied the defendants’ respective motions to
dismiss, finding that the allegations of the complaint satisfied pleading rules
and were therefore sufficient to withstand the motions. The Court also decided that, at this time, the bank defendants, which were not parties to the DOJ
action, are not bound by any of the prior findings and decisions in that case.
Discovery is ongoing.
Interchange Litigation. On June 22, 2005, a group of merchants filed a putative class action complaint in the United States District Court for the District of
Connecticut. The complaint alleges that VISA, MasterCard, Chase Bank
USA, N.A. and JPMorgan Chase & Co., as well as certain other banks, and their respective bank holding companies, conspired to set the price of interchange in violation of Section 1 of the Sherman Act. The complaint further alleges
tying/bundling and exclusive dealing. Since the filing of the Connecticut complaint, other complaints have been filed in different United States District
Courts challenging the setting of interchange, as well the associations’ respective rules. All cases have been consolidated in the Eastern District of New York
for pretrial proceedings. An amended consolidated complaint was filed on
April 24, 2006. Defendants have filed a motion to dismiss all claims that predate January 1, 2004. The motion has not yet been decided.
Plaintiffs subsequently filed a supplemental complaint challenging
MasterCard’s initial public offering in 2006, alleging that the offering violates
the Section 7 of the Clayton Act and that the offering was a fraudulent conveyance. Defendants filed a motion to dismiss both of those claims. The
motion has not yet been decided. Discovery is ongoing.
In addition to the various cases, proceedings and investigations discussed
above, JPMorgan Chase and its subsidiaries are named as defendants or
otherwise involved in a
number of other legal actions and governmental proceedings arising in connection with their businesses. Additional actions, investigations or proceedings
may be initiated 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, penalties or impact related to each pending matter may be. JPMorgan Chase believes, based upon
its current knowledge, after consultation with counsel and after taking into
account its current litigation reserves, that the outcome of the legal actions,
proceedings and investigations currently pending against it should not have a
material, adverse effect on the consolidated financial condition of the Firm.
However, in light of the uncertainties involved in such proceedings, actions
and investigations, there is no assurance that the ultimate resolution of these
matters will not significantly exceed the reserves currently accrued by the Firm;
as a result, the outcome of a particular matter may be material to JPMorgan
Chase’s operating results for a particular period, depending upon, among
other factors, the size of the loss or liability imposed and the level of
JPMorgan Chase’s income for that period.
9
Part I
Item 4: Submission of matters to a vote of security holders
Chairman of the Board since December 31, 2006, and President and Chief Executive Officer
since December 31, 2005. He had been President and Chief Operating Officer from July 1,2004, until December 31, 2005. Prior to the Merger, he had been Chairman and Chief
Executive Officer of Bank One Corporation.
William B. Harrison, Jr.
63
Chairman of the Board from
December 31, 2005, until December 31, 2006,
prior to which he had been Chairman and Chief Executive Officer from November 2001.
Frank Bisignano
47
Chief Administrative Officer since December 2005. Prior to joining JPMorgan Chase, he had
been Chief Executive Officer of Citigroup Inc.’s Global Transaction Services from 2002 until
December 2005 and Chief Administrative Officer of Citigroup Inc.’s Global Corporate and
Investment Bank from 2000 until 2002.
Steven D. Black
54
Co-Chief Executive Officer of the Investment Bank since March 2004, prior to
which he had been Deputy Head of the Investment Bank.
John F. Bradley
46
Director of Human Resources since December 2005. He had been Head of Human
Resources for Europe and Asia regions from April 2003 until December 2005, prior to
which he was Human Resources executive for Technology and Operations since 2002 and
was responsible for human resources integration efforts in 2001.
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, and Treasurer from 2001 until 2003 at Bank One Corporation.
Stephen M. Cutler
45
General Counsel since February 2007. Prior to joining JPMorgan Chase, he was a
partner and co-chair of the Securities Department at the law firm of WilmerHale since October
2005. Prior to joining WilmerHale, he had been Director of the Division of Enforcement at
the U.S. Securities and Exchange Commission since October 2001.
Ina R. Drew
50
Chief Investment Officer since February 2005, prior to which she was Head of Global Treasury.
Samuel Todd Maclin
50
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
44
Head of Strategy and Business Development. Prior to the Merger, he had been Head
of Strategy and Business Development since September 2002 at Bank One Corporation. Prior
to joining Bank One Corporation, he had been Vice Chairman and Chief Executive Officer of
the Private Client Group of Citigroup Inc. subsidiary Salomon Smith Barney.
Heidi Miller
53
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.
Charles W. Scharf
41
Chief Executive Officer 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 at Bank One Corporation.
Richard J. Srednicki
59
Chief Executive Officer of Card Services.
10
Part I
and II
James E. Staley
50
Chief Executive Officer of Asset Management.
William T. Winters
45
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.
Unless otherwise noted, during the five fiscal years ended December 31, 2006, all of JPMorgan
Chase’s above-named executive officers have continuously
held senior-level positions with JPMorgan Chase or its predecessor institution, Bank One
Corporation. There are no family relationships among the foregoing executive officers.
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 143. For
a comparison of the cumulative total return for JPMorgan Chase common
stock with the
S&P 500 Index and the S&P Financial Index
over the five-year period ended December 31, 2006, see
“Five-year performance” on page 22 of this Annual Report. JPMorgan Chase declared quarterly cash
dividends on its common stock in the amount of $0.34 per share for each quarter of 2006, 2005 and 2004. The common dividend payout ratio, based upon
reported net income, was: 34% for 2006; 57% for 2005; and 88% for 2004.
At January 31, 2007, there were 230,273 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 March 21, 2006, the Board of Directors approved a stock repurchase program
that authorizes the repurchase of up to $8 billion of the Firm’s common shares,
superceding a $6 billion stock repurchase program authorized in 2004. The $8 billion authorization includes shares to be purchased to offset issuances under the Firm’s
employee stock-based plans. The actual number of shares purchased is subject to
various factors, including: market conditions; legal considerations affecting the
amount and timing of repurchase activity; the Firm’s capital position (taking into
account goodwill and intangibles); internal capital generation; and alternative
potential investment opportunities. The repurchase program does not include specific price targets or timetables; may be executed through open market purchases
or privately negotiated transactions, or utilizing Rule 10b5-1 programs; and may
be suspended at any time.
The Firm’s repurchases of equity securities during 2006 were as follows:
In addition to the repurchases disclosed above, participants in the Firm’s
stock-based incentive plans may have shares withheld to cover income taxes.
Shares withheld to pay income taxes are repurchased pursuant to the terms
of the applicable plan and not under the Firm’s share repurchase program.
Shares repurchased pursuant to these plans during 2006 were as follows:
For five-year selected financial data, see “Five-year summary of consolidated
financial highlights (unaudited)” on page 22 and "Selected annual financial
data (unaudited)" on page 144.
11
Part II
and III
Item 7:
Management’s discussion and analysis of financial condition
and
results of operations
Management’s discussion and analysis of the financial condition and results
of operations, entitled “Management’s discussion and analysis,” appears on
pages 23 through 87. Such information should be read in conjunction with
the Consolidated financial statements and Notes thereto, which appear on
pages 90 through 142.
Item 7A: Quantitative and qualitative disclosures about market risk
For information related to market risk, see the “Market risk management”
section on pages 77 through 80 and Note 28 on pages 131–132.
Item 8:
Financial statements and supplementary data
The Consolidated financial statements, together with the Notes thereto and
the report of PricewaterhouseCoopers LLP dated February 21, 2007 thereon,
appear on pages 89 through 142.
Supplementary financial data for each full quarter within the two years
ended December 31, 2006, are included on page 143 in the table entitled
“Supplementary information – Selected quarterly financial data (unaudited).”
Also included is a “Glossary of terms’’ on pages
145–146.
Item 9: Changes in and disagreements with accountants on accounting and financial disclosure
None.
Item 9A: Controls and procedures
As of the end of the period covered by this report, an evaluation was carried
out under the supervision and with the participation of the Firm’s management,
including its Chairman and Chief Executive Officer and its Chief Financial Officer, of
the effectiveness of its disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934). Based upon that
evalua-
tion, the Chairman and Chief Executive Officer and the Chief Financial Officer
concluded that these disclosure controls and procedures were effective. See Exhibits
31.1 and 31.2 for the Certification statements issued by the Chairman and Chief
Executive Officer, and Chief Financial Officer.
The Firm is committed to maintaining high standards of internal control over
financial reporting. Nevertheless, because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements.
In addition, in a firm as large and complex as JPMorgan Chase, lapses or
deficiencies in internal controls may 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 88 for Management’s report on internal control over financial
reporting, and page 89 for the Report of independent registered public
accounting firm with respect to management’s assessment of internal control.
There was no change in the Firm’s internal control over financial reporting (as
defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that
occurred during the fourth quarter of 2006 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, executive officers
and corporate governance
See Item 13 below.
Item 11: Executive compensation
See Item 13 below.
Item 12: Security ownership of certain beneficial owners and management and related stockholder matters
For security ownership of certain beneficial owners and management, see
Item 13 below.
The following table details the total number of shares available for issuance under JPMorgan
Chase’s employee stock-based incentive plans (including shares available
for issuance to nonemployee directors). The Firm is not authorized to grant stock-based incentive
awards to nonemployees other than to nonemployee directors.
Employee stock-based incentive plans approved by shareholders
241,004
$ 38.29
207,924
Employee stock-based incentive plans not approved by shareholders
133,907
43.90
—
Total
374,911
$ 40.30
207,924
(a)
(a)
Future shares will be issued under the shareholder-approved 2005 Long-Term Incentive
Plan (“2005 Plan”).
12
Parts
III and IV
Item 13: Certain relationships and related transactions, and Director independence
Information related to JPMorgan Chase’s Executive Officers is included in Part I,
Item 4, on pages 10–11. 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 2007 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 2006 fiscal year.
Item 14: Principal accounting fees and services
See Item 13 above.
Part IV
Item 15: Exhibits, financial statement schedules
Exhibits, financial statement schedules
1.
Financial statements
The Consolidated financial statements, the Notes thereto and
the report thereon listed in Item 8 are set forth commencing on
page 90.
Indenture, dated as of December 1, 1989, between Chemical
Banking Corporation (now known as JPMorgan Chase & Co.) and
The Chase Manhattan Bank (National Association) (succeeded by
Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
4.2(a)
Indenture, dated as of April 1, 1987, as amended and restated as
of December 15, 1992, between Chemical Banking Corporation
(now known as JPMorgan Chase & Co.) and Morgan Guaranty
Trust Company of New York (succeeded by U.S. Bank Trust National
Association), as Trustee (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, 2005).
4.2(b)
Second Supplemental Indenture, dated as of October 8, 1996,
between The Chase Manhattan Corporation (now known as
JPMorgan Chase & Co.) and First Trust of New York, National
Association (succeeded by U.S. Bank Trust National Association),
as Trustee, to the Indenture, dated as of April 1, 1987, as
amended and restated as of December 15, 1992 (incorporated by
reference to Exhibit 4.3(b) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2005).
4.2(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 JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2005).
4.3(a)
Amended and Restated Indenture, dated as of September 1,1993, between The Chase Manhattan Corporation (succeeded
through merger by JPMorgan Chase & Co.) and Chemical Bank
(succeeded by U.S. Bank Trust National Association), as Trustee
(incorporated by reference to Exhibit 4.4(a) to the Annual Report
on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2005).
4.3(b)
First Supplemental Indenture, dated as of March 29, 1996,
among Chemical Banking Corporation (now known as JPMorgan
Chase & Co.), The Chase Manhattan Corporation, (succeeded
through merger by JPMorgan Chase & Co.), Chemical Bank, as
Resigning Trustee, and First Trust of New York, National
Association (succeeded by U.S. Bank Trust National Association),
as Successor Trustee, to the Amended and Restated Indenture,
dated as of September 1, 1993 (incorporated by reference to
Exhibit 4.4(b) to the Annual Report on Form 10-K of JPMorgan
Chase & Co. (File No. 1-5805) for the year ended December 31,2005).
4.3(c)
Second Supplemental Indenture, dated as of October 8, 1996,
between The Chase Manhattan Corporation (now known as
JPMorgan Chase & Co.) and First Trust of New York, National
Association (succeeded by U.S. Bank Trust National Association),
as Trustee, to the Amended and Restated Indenture, dated as of
September 1, 1993 (incorporated by reference to Exhibit 4.4(c) to
the Annual Report on Form 10-K of JPMorgan Chase & Co. (File
No. 1-5805) for the year ended December 31, 2005).
4.3(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 JPMorgan
Chase & Co. (File No. 1-5805) for the year ended December 31,2005).
13
Part IV
4.4(a)
Indenture, dated as of August 15, 1982, between J.P. Morgan &
Co. Incorporated (succeeded through merger by JPMorgan Chase
& Co.) and Manufacturers Hanover Trust Company (succeeded by
U.S. Bank Trust National Association), as Trustee (incorporated by
reference to Exhibit 4.5(a) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2005).
4.4(b)
First Supplemental Indenture, dated as of May 5, 1986, between
J.P. Morgan & Co. Incorporated (succeeded through merger by
JPMorgan Chase & Co.) and Manufacturers Hanover Trust
Company (succeeded by U.S. Bank Trust National Association), as
Trustee, to the Indenture, dated as of August 15, 1982 (incorporated by reference to Exhibit 4.5(b) to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year
ended December 31, 2005).
4.4(c)
Second Supplemental Indenture, dated as of February 27, 1996,
between J.P. Morgan & Co. Incorporated (succeeded through
merger by JPMorgan Chase & Co.) and First Trust of New York,
National Association (succeeded by U.S. Bank Trust National
Association), as Trustee, to the Indenture, dated as of August 15,
1982 (incorporated by reference to Exhibit 4.5(c) to the Annual
Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805)
for the year ended December 31, 2005).
4.4(d)
Third Supplemental Indenture, dated as of January 30, 1997,
between J.P. Morgan & Co. Incorporated (succeeded through
merger by JPMorgan Chase & Co.) and First Trust of New York,
National Association (succeeded by U.S. Bank Trust National
Association), as Trustee, to the Indenture, dated as of August 15,
1982 (incorporated by reference to Exhibit 4.5(d) to the Annual
Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805)
for the year ended December 31, 2005).
4.4(e)
Fourth Supplemental Indenture, dated as of December 29, 2000,
among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation
(now known as JPMorgan Chase & Co.) and U.S. Bank Trust
National Association, as Trustee, to the Indenture, dated as of
August 15, 1982 (incorporated by reference to Exhibit 4.5(e) to
the Annual Report on Form 10-K of JPMorgan Chase & Co. (File
No. 1-5805) for the year ended December 31, 2005).
4.5(a)
Indenture, dated as of March 1, 1993, between J.P. Morgan &
Co. Incorporated (succeeded through merger by JPMorgan Chase
& Co.) and Citibank, N.A. (succeeded by U.S. Bank Trust National
Association), as Trustee (incorporated by reference to Exhibit 4.6(a) to the Annual Report on Form 10-K of JPMorgan Chase &
Co. (File No. 1-5805) for the year ended December 31, 2005).
4.5(b)
First Supplemental Indenture, dated as of December 29, 2000,
among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation
(now known as JPMorgan Chase & Co.) and U.S. Bank Trust
National Association, as Trustee, to the Indenture, dated as of
March 1, 1993 (incorporated by reference to Exhibit 4.6(b) to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2005).
4.6
Indenture, dated as of May 25, 2001, between J.P. Morgan
Chase & Co. and Bankers Trust Company (succeeded by Deutsche
Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4(a)(1) to the amended Registration Statement on
Form S-3 of J.P. Morgan Chase & Co. (File No. 333-52826) filed
June 13, 2001).
4.7(a)
Junior Subordinated Indenture, dated as of December 1, 1996,
between The Chase Manhattan Corporation (now known as
JPMorgan Chase & Co.) and The Bank of New York, as Trustee
(incorporated by reference to Exhibit 4.8(a) to the Annual Report
on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2004).
4.7(b)
Guarantee Agreement, dated as of January 24, 1997, between
The Chase Manhattan Corporation (now known as JPMorgan
Chase & Co.) and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.8(b) to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year
ended December 31, 2004).
4.7(c)
Amended and Restated Trust Agreement, dated as of January 24,1997, among The Chase Manhattan Corporation (now known as
JPMorgan Chase & Co.), The Bank of New York, as Property
Trustee, The Bank of New York (Delaware), as Delaware Trustee,
and the Administrative Trustees named therein (incorporated by
reference to Exhibit 4.8(c) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
4.7(d)
Replacement Capital Covenant, dated as of August 17, 2006,
by JPMorgan Chase & Co. for the benefit of specified debtholders
(incorporated by reference to Exhibit 99.1 to the Current Report on Form 8-K of
JPMorgan Chase & Co. (File No. 1-5805) filed on
August 17, 2006).
4.7(e)
Replacement Capital Covenant, dated as of February 2, 2007, by
JPMorgan Chase & Co. for the benefit of specified debtholders
(incorporated by reference to Exhibit 99.1 to the Current Report on
Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed on
February 2, 2007).
4.7(f)
Amended and Restated Trust Agreement, dated as of
August 17,2006, among JPMorgan Chase & Co., as Depositor, The Bank of New
York, as Property Trustee, The Bank of New York (Delaware), as
Delaware Trustee, and the Administrative Trustees and Holders
specified therein.
4.7(g)
Amended and Restated Trust Agreement, dated as of February 2,2007, among JPMorgan Chase & Co., as Depositor, The Bank of New
York, as Property Trustee, The Bank of New York (Delaware), as
Delaware Trustee, and the Administrative Trustees and Holders
specified therein.
4.8(a)
Indenture, dated as of March 3, 1997, between Banc One
Corporation (succeeded through merger by JPMorgan Chase &
Co.) and The Chase Manhattan Bank (succeeded by Deutsche
Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.9(a) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
14
4.8(b)
First Supplemental Indenture, dated as of October 2, 1998,
between Banc One Corporation (succeeded through merger by
JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by Deutsche Bank Trust Company Americas), as Trustee,
to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.9(b) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
4.8(c)
Form of Second Supplemental Indenture, dated as of July 1,2004, among J.P. Morgan Chase & Co., Bank One Corporation
(succeeded through merger by JPMorgan Chase & Co.),
JPMorgan Chase Bank, N.A. as Resigning Trustee, and Deutsche Bank
Trust Company Americas, as Successor Trustee, to the Indenture,
dated as of March 3, 1997 (incorporated by reference to Exhibit
4.22 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
4.9(a)
Indenture, dated as of March 3, 1997, between Banc One
Corporation (succeeded through merger by JPMorgan Chase &
Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank
Trust National Association), as Trustee (incorporated by reference
to Exhibit 4.10(a) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
4.9(b)
First Supplemental Indenture, dated as of October 2, 1998,
between Banc One Corporation (succeeded through merger by
JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank Trust National Association), as Trustee, to
the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.10(b) to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2004).
4.9(c)
Second Supplemental Indenture, dated as of July 1, 2004, among
J.P. Morgan Chase & Co., Bank One Corporation (succeeded
through merger by JPMorgan Chase & Co.), JPMorgan Chase
Bank, N.A. as Resigning Trustee, and U.S. Bank Trust National
Association, as Successor Trustee, to the Indenture, dated as of
March 3, 1997 (incorporated by reference to Exhibit 4.25 to the
Registration Statement on Form S-3 (File No. 333-116822) of
JPMorgan Chase & Co. filed June 24, 2004).
4.10(a)
Form of Indenture, dated as of July 1, 1995, between Banc One
Corporation (succeeded through merger by JPMorgan Chase &
Co.) and Citibank N.A, as Trustee (incorporated by reference to
Exhibit 4.11(a) to the Annual Report on Form 10-K of JPMorgan
Chase & Co. (File No. 1-5805) for the year ended December 31,2004).
4.10(b)
Form of Supplemental Indenture, dated as of July 1, 2004,
among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.) and Citibank
N.A., as Trustee, to the Indenture, dated as of July 1, 1995
(incorporated by reference to Exhibit 4.31 to the amended
Registration Statement on Form S-3 (File No. 333-116822) of
JPMorgan Chase & Co. filed July 1, 2004).
10.1
Deferred Compensation Plan for Non-Employee Directors of The
Chase Manhattan Corporation (now known as JPMorgan Chase
& Co.) and The Chase Manhattan Bank (now known as
JPMorgan Chase Bank, N.A.), as amended and restated effective
December, 1996 (incorporated by reference to Exhibit 10.1 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2004).
10.2
Post-Retirement Compensation Plan for Non-Employee Directors
of The Chase Manhattan Corporation (now known as JPMorgan
Chase & Co.), as amended and restated effective May 21, 1996
(incorporated by reference to Exhibit 10.2 to the Annual Report
on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2004).
10.3
Deferred Compensation Program of JPMorgan Chase & Co. and
Participating Companies, effective as of January 1, 1996 (incorporated by reference to Exhibit 10.3 to the Annual Report on
Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2004).
JPMorgan Chase & Co. 1996 Long-Term Incentive Plan, as
amended (incorporated by reference to Exhibit 10.6 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2005).
Excess Retirement Plan of The Chase Manhattan Bank and
Participating Companies, restated effective January 1, 2005
(incorporated by reference to Exhibit 10.8 to the Annual Report
on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2005).
10.9
JPMorgan Chase & Co. 2001 Stock Option Plan.
10.10
1995 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as
amended (incorporated by reference to Exhibit 10.12 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2004).
10.11
Executive Retirement Plan of The Chase Manhattan Corporation
and Certain Subsidiaries (incorporated by reference to Exhibit
10.13 to the Annual Report on Form 10-K of JPMorgan Chase &
Co. (File No. 1-5805) for the year ended December 31, 2005).
15
Part IV
10.12
Benefit Equalization Plan of The Chase Manhattan Corporation
and Certain Subsidiaries (incorporated by reference to Exhibit
10.14 to the Annual Report on Form 10-K of JPMorgan Chase &
Co. (File No. 1-5805) for the year ended December 31, 2005).
10.13
Summary of Terms of JPMorgan Chase & Co. Severance Policy
(incorporated by reference to Exhibit 10.15 to the Annual Report
on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the
year ended December 31, 2005).
Summary of Terms of Pension of William B. Harrison, Jr. (incorporated by
reference to Exhibit 10.17 to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2005).
10.16
Bank One Corporation Director Stock Plan, as amended (incorporated by reference to Exhibit 10(B) to the Form 10-K of Bank One
Corporation (File No. 1-15323) for the year ended December 31,2003).
10.17
Summary of Bank One Corporation Director Deferred
Compensation Plan (incorporated by reference to Exhibit 10.19
to the Annual Report on Form 10-K of JPMorgan Chase & Co.
(File No. 1-5805) for the year ended December 31, 2005).
10.18
Bank One Corporation Stock Performance Plan (incorporated by
reference to Exhibit 10(A) to the Form 10-K of Bank One
Corporation (File No. 1-15323) for the year ended December 31,2002).
10.19
Bank One Corporation Supplemental Savings and Investment
Plan, as amended (incorporated by reference to Exhibit 10(E) to
the Form 10-K of Bank One Corporation (File No. 1-15323) for
the year ended December 31, 2003).
10.20
Bank One Corporation Supplemental Personal Pension Account
Plan, as amended (incorporated by reference to Exhibit 10(F) to
the Form 10-K of Bank One Corporation (File No. 1-15323) for
the year ended December 31, 2003).
10.21
Bank One Corporation Investment Option Plan (incorporated by
reference to Exhibit 10.26 to the Annual Report on Form 10-K of
JPMorgan Chase & Co. (File No. 1-5805) for the year ended
December 31, 2005).
10.22
Banc One Corporation Revised and Restated 1989 Stock
Incentive Plan (incorporated by reference to Exhibit 10.30 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2004).
10.23
Banc One Corporation Revised and Restated 1995 Stock
Incentive Plan (incorporated by reference to Exhibit 10.31 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2004).
10.24
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award
Agreement of January 2005 stock appreciation rights
(incorporated by reference to Exhibit 10.31 to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year
ended December 31, 2005).
10.25
JPMorgan Chase & Co. Long-Term Incentive Plan Award
Agreement of January 2005 restricted stock units (incorporated
by reference to Exhibit 10.1 to Form 8-K of JPMorgan Chase &
Co. (File No. 1-5805) filed April 11, 2005).
10.26
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award
Agreement of October 2005 stock appreciation rights
(incorporated by reference to Exhibit 10.33 to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year
ended December 31, 2005).
10.27
Amendment and Restatement of Letter Agreement between
JPMorgan Chase & Co. and Charles W. Scharf, dated December29, 2005 (incorporated by reference to Exhibit 10.34 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2005).
12.1
Computation of ratio of earnings to fixed charges.
12.2
Computation of ratio of earnings to fixed charges and preferred
stock dividend requirements.
Annual Report on Form 11-K of The JPMorgan Chase 401(k)
Savings Plan for the year ended December 31, 2006, (to be filed 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.
32
Certification pursuant to 18 U.S.C. Section 1350, as adopted pur-
suant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certain
instruments defining the rights of securities holders are not
included in Exhibits 4.1 – 4.7 pursuant to Item 601, Section
(b)(4)(iii), of Regulation S-K. JPMorgan Chase hereby agrees to
furnish the instruments not included to the SEC upon its request.
Income from continuing operations before income tax expense
19,886
11,839
5,856
9,773
2,274
Income tax expense
6,237
3,585
1,596
3,209
760
Income from continuing operations
13,649
8,254
4,260
6,564
1,514
Income from discontinued operations(a)
795
229
206
155
149
Net income
$
14,444
$
8,483
$
4,466
$
6,719
$
$1,663
Per common share
Basic earnings per share
Income from continuing operations
$
3.93
$
2.36
$
1.51
$
3.24
$
0.74
Net income
4.16
2.43
1.59
3.32
0.81
Diluted earnings per share
Income from continuing operations
$
3.82
$
2.32
$
1.48
$
3.17
$
0.73
Net income
4.04
2.38
1.55
3.24
0.80
Cash dividends declared per share
1.36
1.36
1.36
1.36
1.36
Book value per share
33.45
30.71
29.61
22.10
20.66
Common shares outstanding
Average: Basic
3,470
3,492
2,780
2,009
1,984
Diluted
3,574
3,557
2,851
2,055
2,009
Common shares at period-end
3,462
3,487
3,556
2,043
1,999
Share price(b)
High
$
49.00
$
40.56
$
43.84
$
38.26
$
$39.68
Low
37.88
32.92
34.62
20.13
15.26
Close
48.30
39.69
39.01
36.73
24.00
Market capitalization
167,199
138,387
138,727
75,025
47,969
Selected ratios
Return on common equity (“ROE”):
Income from continuing operations
12
%
8
%
6
%
15
%
4
%
Net income
13
8
6
16
4
Return on assets (“ROA”):(c)
Income from continuing operations
1.04
0.70
0.44
0.85
0.21
Net income
1.10
0.72
0.46
0.87
0.23
Tier 1 capital ratio
8.7
8.5
8.7
8.5
8.2
Total capital ratio
12.3
12.0
12.2
11.8
12.0
Overhead ratio
62
71
80
66
77
Selected balance sheet data (period-end)
Total assets
$
1,351,520
$
1,198,942
$
1,157,248
$
770,912
$
758,800
Loans
483,127
419,148
402,114
214,766
216,364
Deposits
638,788
554,991
521,456
326,492
304,753
Long-term debt
133,421
108,357
95,422
48,014
39,751
Total stockholders’ equity
115,790
107,211
105,653
46,154
42,306
Headcount
174,360
168,847
160,968
96,367
97,124
(a)
On October 1, 2006, JPMorgan Chase & Co. completed the exchange of selected
corporate trust businesses for the consumer, business banking and middle-market banking
businesses of The Bank of New York Company Inc. The results of operations of these
corporate trust businesses are being reported as discontinued operations for each of the
periods presented.
(b)
JPMorgan Chase’s common stock is listed and traded on the New York Stock
Exchange, the London Stock Exchange Limited and the Tokyo Stock Exchange. The high, low
and closing prices of JPMorgan Chase’s common stock are from The New York Stock Exchange
Composite Transaction Tape.
(c)
Represents Net income divided by Total average assets.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Five-year stock performance
The following table and graph compare the
five-year cumulative total return for JPMorgan
Chase & Co. (“JPMorgan Chase” or the “Firm”) common
stock with the cumulative return of the S&P 500
Stock Index and the S&P Financial Index. The S&P
500 Index is a commonly referenced U.S. equity
benchmark consisting of leading companies from
different economic sectors. The S&P Financial Index
is an index of 88 financial companies, all of which
are within the S&P 500. The Firm is a component of
both published industry indices.
The following table and graph assume $100 invested
on December 31, 2001, in JPMorgan Chase common
stock and $100 invested at that same time in each
of the S&P indices. The comparison assumes that all
dividends are reinvested.
2001
2002
2003
2004
2005
2006
JPMorgan Chase
$
100.00
$
69.29
$
111.06
$
122.13
$
129.15
$
162.21
S&P Financial Index
100.00
85.00
111.38
123.50
131.53
156.82
S&P500
100.00
78.00
100.37
111.29
116.76
135.20
22
JPMorgan Chase & Co. / 2006 Annual Report
Management’s discussion and analysis
JPMorgan Chase & Co.
This section of the Annual Report provides
management’s discussion and analysis (“MD&A”) of
the financial condition and results of operations
for JPMorgan Chase. See the Glossary of terms on
pages 145–146 for definitions of terms used
throughout this Annual Report. The MD&A included in
this Annual Report contains statements that are
forward-looking within the meaning of the Private
Securities Litigation Reform Act of 1995. Such
statements are based upon the current beliefs and
expectations of JPMorgan Chase’s management and are
subject to significant
risks and uncertainties. These risks and
uncertainties could cause JPMorgan Chase’s results
to differ materially from those set forth in such
forward-looking statements. Certain of such risks
and uncertainties are described herein (see
Forward-looking statements on page 147 of this
Annual Report) and in the JPMorgan Chase Annual
Report on Form 10-K for the year ended December 31,2006 (“2006 Form 10-K”), in Part I, Item 1A: Risk
factors, to which reference is hereby made.
INTRODUCTION
JPMorgan Chase & Co., 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 $1.4 trillion in
assets, $115.8 billion in stockholders’ equity and operations worldwide. The
Firm is a leader in investment banking, financial services for consumers and
businesses, financial transaction processing, asset management and private
equity. Under the JPMorgan and Chase brands, the Firm serves millions of customers in the United States and many
of the world’s most prominent corporate, institutional and government clients.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase Bank,
National Association (“JPMorgan Chase Bank, N.A.”), a national banking
association with branches in 17 states; and Chase Bank USA, National
Association (“Chase Bank USA, N.A.”), a national bank that is the Firm’s
credit card issuing bank. JPMorgan Chase’s principal nonbank subsidiary is
J.P. Morgan Securities Inc., the Firm’s U.S. investment banking firm.
JPMorgan Chase’s activities are organized, for management reporting purposes,
into six business segments, as well as Corporate. The Firm’s wholesale businesses comprise the Investment Bank, Commercial Banking, Treasury &
Securities Services and Asset Management segments. The Firm’s consumer
businesses comprise the Retail Financial Services and Card Services segments.
A description of the Firm’s business segments, and the products and services
they provide to their respective client bases, follows.
Investment Bank
JPMorgan is one of the world’s leading investment banks, with deep client
relationships and broad product capabilities. The Investment Bank’s clients are
corporations, financial institutions, governments and institutional investors. The
Firm offers a full range of investment banking products and services in all
major capital markets, including advising on corporate strategy and structure,
capital raising in equity and debt markets, sophisticated risk management,
market-making in cash securities and derivative instruments, and research. The
Investment Bank (“IB”) also commits the Firm’s own capital to proprietary
investing and trading activities.
Retail Financial Services
Retail Financial Services (“RFS”), which includes Regional Banking, Mortgage
Banking and Auto Finance reporting segments, helps meet the financial needs
of consumers and businesses. RFS provides convenient consumer banking
through the nation’s fourth-largest branch network and third-largest ATM network. RFS is a top-five mortgage originator and servicer, the second-largest
home equity originator, the largest noncaptive originator of automobile loans
and one of the largest student loan originators.
RFS serves customers through more than 3,000 bank branches, 8,500 ATMs
and 270 mortgage offices, and through relationships with more than 15,000
auto dealerships and 4,300 schools and universities. More than 11,000 branch
salespeople assist customers, across a 17-state footprint from New York to
Arizona, with checking and savings accounts, mortgage, home equity and busi-
ness loans, investments and insurance. Over 1,200 additional mortgage officers provide home loans throughout the country.
Card Services
With more than 154 million cards in circulation and $152.8 billion in managed
loans, Chase Card Services (“CS”) is one of the nation’s largest credit card
issuers. Customers used Chase cards for over $339 billion worth of transactions in 2006.
Chase offers a wide variety of general-purpose cards to satisfy the needs of
individual consumers, small businesses and partner organizations, including
cards issued with AARP, Amazon, Continental Airlines, Marriott, Southwest
Airlines, Sony, United Airlines, Walt Disney Company and many other well-known brands and organizations. Chase also issues private-label cards with
Circuit City, Kohl’s, Sears Canada and BP.
Chase Paymentech Solutions, LLC, a joint venture with JPMorgan Chase and
First Data Corporation, is the largest processor of MasterCard and
Visa payments in the world, having handled over 18 billion transactions in 2006.
Commercial Banking
Commercial Banking (“CB”) serves more than 30,000 clients, including corporations, municipalities, financial institutions and not-for-profit entities. These
clients generally have annual revenues ranging from $10 million to $2 billion.
Commercial bankers serve clients nationally throughout the RFS footprint and
in offices located in other major markets.
Commercial Banking offers its clients industry knowledge, experience, a dedicated service model, comprehensive solutions and local expertise. The Firm’s
broad platform positions CB to deliver extensive product capabilities –
including lending, treasury services, investment banking and asset management – to meet its clients’ U.S. and international financial needs.
Treasury & Securities Services
Treasury & Securities Services (“TSS”) is a global leader in providing transaction, investment and information services to support the needs of institutional
clients worldwide. TSS is one of the largest cash management providers in the
world and a leading global custodian. Treasury Services (“TS”) provides a variety of
cash management products, trade finance and logistics solutions, wholesale card products, and liquidity management capabilities to small and midsized
companies, multinational corporations, financial institutions and government
entities. TS partners with the Commercial Banking, Retail Financial Services
and Asset Management businesses to serve clients firmwide. As a result, certain TS revenues are included in other segments’ results. Worldwide Securities
Services (“WSS”) stores, values, clears and services securities and alternative
investments for investors and broker-dealers; and manages Depositary Receipt
programs globally.
JPMorgan Chase & Co. / 2006 Annual Report
23
Management’s discussion and analysis
JPMorgan Chase & Co.
Asset Management
With assets under supervision of $1.3 trillion,
Asset Management (“AM”) is a global leader in
investment and wealth management. AM clients
include institutions, retail investors and
high-net-worth individuals in every major market
throughout the world. AM offers global investment
management in equities, fixed income, real estate,
hedge funds, private equity and liquidity,
including both money market instruments and bank
deposits. AM also provides trust and estate and
banking services to high-net-worth clients, and
retirement services for corporations and
individuals. The majority of AM’s client assets are
in actively managed portfolios.
Merger with Bank One Corporation
Effective July 1, 2004, Bank One Corporation
(“Bank One”) merged with and into JPMorgan Chase &
Co. (the “Merger”). As a result of the Merger, each
outstanding share of common stock of Bank One was
converted in a stock-for-stock exchange into 1.32
shares of common stock of JPMorgan Chase & Co. The
Merger was accounted for using the purchase method
of accounting. Accordingly, the Firm’s results of
operations for 2004 include six months of heritage
JPMorgan Chase results and six months of the
combined Firm’s results. For additional information
regarding the Merger, see Note 2 on pages 95–96 of
this Annual Report.
2006 Business events
Acquisition of the consumer, business banking
and middle-market banking businesses of The Bank
of New York in exchange for selected corporate
trust businesses, including trustee, paying agent,
loan agency and document management services
On October 1, 2006, JPMorgan Chase completed the
acquisition of The Bank of New York Company, Inc.’s
(“The Bank of New York”) consumer, business banking
and middle-market banking businesses in exchange
for selected corporate trust businesses plus a cash
payment of $150 million. This acquisition added 339
branches and more than 400 ATMs, and it significantly
strengthens RFS’s distribution network in the New
York Tri-state area. The Bank of New York
businesses acquired were valued at a premium of
$2.3 billion; the Firm’s corporate trust businesses
that were transferred (i.e., trustee, paying agent,
loan agency and document management services) were
valued at a premium of $2.2 billion. The Firm also
may make a future payment to The Bank of New York
of up to $50 million depending on certain new
account openings. This transaction included the
acquisition of approximately $7.7 billion in loans
and $12.9 billion in deposits from The Bank of New
York. The Firm also recognized core deposit
intangibles of $485 million which will be amortized
using an accelerated method over a 10 year period.
JPMorgan Chase recorded
an after-tax gain of $622 million related to this
transaction in the fourth quarter of 2006.
JPMorgan Partners management
On August 1, 2006, the buyout and growth equity
professionals of JPMorgan Partners (“JPMP”) formed
an independent firm, CCMP Capital, LLC (“CCMP”),
and the venture professionals separately formed an
independent firm, Panorama Capital, LLC
(“Panorama”). The investment professionals of CCMP
and Panorama continue to manage the former JPMP
investments pursuant to a management agreement with
the Firm.
Sale of insurance underwriting business
On July 1, 2006, JPMorgan Chase completed the sale
of its life insurance and annuity underwriting
businesses to Protective Life Corporation for cash
proceeds of approximately $1.2 billion, consisting
of $900 million of cash received from Protective
Life Corporation and approximately $300 million of
preclosing dividends received from the entities
sold. The after-tax impact of this transaction was
negligible. The sale included both the heritage
Chase insurance business and the insurance business
that Bank One had bought from Zurich Insurance in
2003.
Acquisition
of private-label credit card portfolio from Kohl’s Corporation
On April 21, 2006, JPMorgan Chase completed the
acquisition of $1.6 billion of private-label credit
card receivables and approximately 21 million
accounts from Kohl’s Corporation (“Kohl’s”).
JPMorgan Chase and Kohl’s have also entered into an
agreement under which JPMorgan Chase will offer
private-label credit cards to both new and existing
Kohl’s customers.
Collegiate Funding Services
On March 1, 2006, JPMorgan Chase acquired, for
approximately $663 million, Collegiate Funding
Services, a leader in education loan servicing and
consolidation. This acquisition included $6
billion of education loans and will enable the
Firm to create a comprehensive education finance
business.
Acquisition of certain operations from Paloma Partners
On March 1, 2006, JPMorgan Chase acquired the
middle and back office operations of Paloma
Partners Management Company (“Paloma”), which was
part of a privately owned investment fund
management group. The parties also entered into a
multiyear contract under which JPMorgan Chase will
provide daily operational services to Paloma. The
acquired operations have been combined with
JPMorgan Chase’s current hedge fund administration
unit, JPMorgan Tranaut.
JPMorgan and Fidelity Brokerage Company
On February 28, 2006, the Firm announced a
strategic alliance with Fidelity Brokerage to
become the exclusive provider of new issue equity
securities and the primary provider of fixed income
products to Fidelity’s brokerage clients and retail
customers, effectively expanding the Firm’s
existing distribution platform.
24
JPMorgan Chase & Co. / 2006 Annual Report
EXECUTIVE OVERVIEW
This overview of management’s discussion and analysis highlights selected information and may
not contain all of the information that is important to readers of this Annual Report. For a more
complete understanding of events, trends and uncertainties, as well as the capital, liquidity,
credit and market risks, and the Critical accounting estimates, affecting the Firm and its
various lines of business, this Annual Report should be read in its entirety.
Financial performance of JPMorgan Chase
Year ended December 31,
(in millions, except per share and ratio data)
2006
2005
Change
Selected income statement data
Net revenue
$
61,437
$
53,748
14
%
Provision for credit losses
3,270
3,483
(6
)
Noninterest expense
38,281
38,426
—
Income from continuing operations
13,649
8,254
65
Income from discontinued operations
795
229
247
Net income
14,444
8,483
70
Diluted earnings per share
Income from continuing operations
$
3.82
$
2.32
65
%
Net income
4.04
2.38
70
Return on common equity (“ROE”)
Income from continuing operations
12
%
8
%
Net income
13
8
Business overview
The Firm reported record 2006 net income of
$14.4 billion, or $4.04 per share, compared with
net income of $8.5 billion, or $2.38 per share, for
2005. The return on common equity was 13% compared
with 8% in 2005. Reported results include
discontinued operations related to the exchange of
selected corporate trust businesses for the consumer,
business banking and middle-market banking businesses of
The Bank of New York. Discontinued operations
produced $795 million of net income in 2006
compared with $229 million in the prior year. The
primary driver of the increase was a one-time gain
of $622 million related to the sale of the
corporate trust business (for further information
on discontinued operations see Note 3 on page 97 of
this Annual Report). Income from continuing
operations was a record $13.6 billion, or $3.82 per
share, compared with $8.3 billion, or $2.32 per
share, for 2005. For a detailed discussion of the
Firm’s consolidated results of operations, see
pages 28–31 of this Annual Report.
Effective December 31, 2006, William B. Harrison,
Jr. retired as Chairman of the Board and was
succeeded as Chairman by Chief Executive Officer
James Dimon.
The Firm’s record 2006 results were affected
positively by global economic conditions,
investment in each line of business and the
successful completion of milestones in the
execution of its Merger integration plan. A key
milestone related to the Merger integration was the
New York Tri-state consumer conversion, which
linked the Firm’s more than 2,600 branches in 17
states on a common systems platform (excluding 339
branches acquired from The Bank of New York on
October 1, 2006). The Tri-state conversion, along
with many other merger integration activities,
resulted in continued efficiencies. As a result the
Firm made significant progress toward reaching its
annual merger-related savings target of
approximately $3.0 billion by the end of 2007. The
Firm realized approximately $675 million of
incremental merger savings in 2006, bringing estimated
cumulative savings for 2006 to $2.5 billion, and
the annualized run-rate of savings entering 2007 is
approximately $2.8 billion. In order to achieve
these savings, the Firm expensed Merger costs of
$305 million during the year (including a modest
amount of costs related to The Bank
of New York transaction), bringing the total
cumulative amount expensed since the Merger
announcement to approximately $3.4 billion (including capitalized
costs). Management currently estimates remaining
Merger costs of approximately $400 million, which
are expected to be incurred during 2007 and will
include a modest amount of expense related to the
acquisition of The Bank of New York’s consumer,
business banking and middle-market banking
businesses.
The Firm also continued active management of its
portfolio of businesses during 2006. Actions
included: exchanging selected corporate trust
businesses for the consumer, business banking and
middle-market banking businesses of The Bank of New
York; divesting the insurance underwriting
business; purchasing Collegiate Funding Services to
develop further the education finance business;
acquiring Kohl’s private-label credit card
portfolio; acquiring the middle and back office
operations of Paloma Partners to expand the Firm’s
hedge fund administration capabilities; and
announcing a strategic alliance with Fidelity
Brokerage to provide new issue equity and fixed
income products.
In 2006, the global economy continued to expand,
which supported continued rapid growth in the
emerging market economies. Global gross domestic
product increased by an estimated 5%, with the
European economy gaining momentum, Japan making
steady progress and emerging Asian economies
expanding approximately 8%. The U.S. economy
rebounded early in the year from the prior-year
hurricane disruptions, but weakened in the second
half of the year as home construction declined,
automobile manufacturing weakened and the benefit
of reconstruction from hurricane disruptions
dissipated. The U.S. experienced rising interest
rates during the first half of the year, as the
Federal Reserve Board increased the federal funds
rate from 4.25% to 5.25%. With an anticipated
slowing of economic growth, lower inflation and
stabilizing energy prices, the federal funds rate
was held steady during the second half of the year.
The yield curve subsequently inverted as receding
inflation expectations pushed long-term interest
rates below the federal funds rate. Equity markets,
both domestic and international, reflected positive
performance, with the S&P 500 up 13% on average and
international indices increasing 16% on average
during 2006. Global capital markets activity was
strong during 2006, with debt and equity
underwriting and merger and acquisition activity
surpassing 2005 levels. Demand for wholesale loans
in the U.S. was strong with growth of approximately
14%, while U.S. consumer loans grew an estimated 4%
during 2006. U.S. consumer spending grew at a solid
pace, supported by strong equity markets, low
unemployment and income growth, and lower energy
prices in the second half of the year. This
strength came despite a significant decline in real
estate appreciation.
The 2006 economic environment was a contributing
factor to the performance of the Firm and each of
its businesses. The overall economic expansion,
strong level of capital markets activity and
positive performance in equity markets helped to
drive new business volume and organic growth within
each of the Firm’s businesses while also
contributing to the stable credit quality within
the loan portfolio. However, the interest rate
environment affected negatively wholesale loan
spread and consumer loan and deposit spreads.
Spreads related to wholesale liabilities widened
compared with the prior year, but this benefit
declined over the course of 2006.
JPMorgan Chase & Co. / 2006 Annual Report
25
Management’s discussion and analysis
JPMorgan Chase & Co.
The discussion that follows highlights the
performance of each business segment compared with
the prior year, and discusses results on a managed
basis unless otherwise noted. For more information
about managed basis, See Explanation and
reconciliation of the Firm’s use of non-GAAP
financial measures on pages 32–33 of this Annual
Report.
Investment Bank net income was flat compared with
the prior year, as record revenue was offset by
higher compensation expense and a provision for
credit losses compared with a benefit in the prior
year. Revenue benefited from investments in key
business initiatives, increased market share and
higher global capital markets activity. Record
investment banking fees were driven by record debt
and equity underwriting fees and strong advisory
fees. Fixed income markets revenue set a new record
with strength in credit markets, emerging markets
and currencies. Equity markets revenue was also at
a record level, reflecting strength in cash
equities and equity derivatives. The current-year
Provision for credit losses reflects portfolio
activity; credit quality remained stable. The
increase in expense was primarily the result of
higher performance-based compensation including the
impact of a higher ratio of compensation expense to
revenue and the adoption of SFAS 123R.
Retail Financial Services net income was down from
the prior year as lower results in Mortgage Banking
were offset partially by improved performance in
Regional Banking and Auto Finance. Revenue declined
due to lower revenue in Mortgage Banking, narrower
loan and deposit spreads in Regional Banking and
the sale of the insurance business on July 1, 2006.
Deposit and loan spreads reflected the current
interest rate and competitive environments. These
factors were offset partially by increases in
average deposit and loan balances and higher
deposit-related and branch production fees in
Regional Banking, which benefited from the
continued investment in the retail banking
distribution network and the overall strength of
the U.S. economy. The provision for credit losses
declined from the prior year due to the absence of
a special provision related to Hurricane Katrina in
2005, partially offset by the establishment of
additional allowance for loan losses related to
loans acquired from The Bank of New York. Expense
increased, reflecting the purchase of Collegiate
Funding Services in the first quarter of 2006 and
ongoing investments in the retail banking
distribution network, with the net addition during
the year of 438 branch offices (including 339 from
The Bank of New York), 1,194 ATMs and over 500
personal bankers. Partially offsetting these
increases were the sale of the insurance business
and merger-related and other operating
efficiencies.
Card Services net income was a record, increasing
significantly compared with the prior year,
primarily the result of a lower provision for
credit losses. Net revenue (excluding the impact of
the deconsolidation of Paymentech) declined
slightly from the prior year. Net interest income
was flat as the benefit of an increase in average
managed loan balances, partially due to portfolio
acquisitions as well as marketing initiatives, was
offset by the challenging interest rate and
competitive environments. Noninterest revenue
declined as increased interchange income related to
higher charge volume from increased consumer
spending was more than offset by higher
volume-driven payments to partners, including
Kohl’s, and increased rewards expense. The managed
provision for credit losses benefited from
significantly lower bankruptcy-related credit
losses following the new bankruptcy legislation
that became effective in October 2005. Underlying
credit quality remained strong. Expense (excluding
the impact of the deconsolidation of Paymentech)
increased driven by higher marketing spending and
acquisitions, partially offset by merger savings.
Commercial Banking net income was a record in 2006.
Record revenue benefited from higher liability
balances, higher loan volumes and increased
investment banking revenue, all of which benefited
from increased sales efforts and U.S. economic
growth. Partially offsetting these benefits were
loan spread compression and a shift to
narrower-spread liability products. The provision
for credit losses increased compared with the prior
year reflecting portfolio activity and the
establishment of additional allowances for loan
losses related to loans acquired from The Bank of
New York, partially offset by a release of the
unused portion of the special reserve established
in 2005 for Hurricane Katrina. Credit quality
remained stable. Expense increased due to higher
compensation expense related to the adoption of
SFAS 123R and increased expense related to higher
client usage of Treasury Services’ products.
Treasury & Securities Services net income was a
record and increased significantly over the prior
year. Revenue was at a record level driven by
higher average liability balances, business growth,
increased product usage by clients and higher
assets under custody, all of which benefited from
global economic growth and capital markets
activity. This growth was offset partially by a
shift to narrower-spread liability products.
Expense increased due to higher compensation
related to business growth, investments in new
products and the adoption of SFAS 123R. The expense
increase was offset partially by the absence of a
prior-year charge to terminate a client contract.
Asset Management net income was a record in 2006.
Record revenue benefited from increased assets
under management driven by net asset inflows and
strength in global equity markets, and higher
performance and placement fees. The Provision for
credit losses was a benefit reflecting net loan
recoveries. Expense increased due primarily to
higher performance-based compensation, incremental
expense from the adoption of SFAS 123R, and
increased minority interest expense related to
Highbridge Capital Management, LLC (“Highbridge”),
offset partially by the absence of BrownCo.
Corporate segment reported significantly improved
results (excluding the impact of discontinued
operations, as discussed further, below) driven by
lower expense, improved revenue and the benefit of
tax audit resolutions. Revenue benefited from lower
securities losses, improved net interest spread and
a higher level of available-for-sale securities
partially offset by the absence of the gain on the
sale of BrownCo and lower Private Equity results.
Expense benefited from the absence of prior-year
litigation reserve charges, higher insurance recoveries
relating to certain material litigation, lower
merger-related costs and other operating
efficiencies. These benefits were offset partially
by incremental expense related to the adoption of
SFAS 123R.
On October 1, 2006, the Firm completed the exchange
of selected corporate trust businesses, including
trustee, paying agent, loan agency and document
management services, for the consumer, business
banking and middle-market banking businesses of The
Bank of New York. The corporate trust businesses,
which were previously reported in TSS, were
reported as discontinued operations. The related
balance sheet and income statement activity is
reflected in the Corporate segment for all periods
presented. During 2006, these businesses produced
$795 million of net income compared with net income
of $229 million in the prior year. Net income from
discontinued operations was significantly higher in
2006 due to a one-time after-tax gain of $622
million related to the sale of these businesses. A
modest amount of costs associated with the
acquisition side of this transaction are included
in Merger costs.
26
JPMorgan Chase & Co. / 2006 Annual Report
Credit costs for the Firm were $5.5 billion
compared with $7.3 billion in the prior year. The
$1.8 billion decrease was due primarily to lower
bankruptcy-related losses in Card Services and the
release in the current year of a portion of the
$400 million special provision related to Hurricane
Katrina that was taken in 2005. The decline was partially offset by an increase in the wholesale
provision. The wholesale provision was $321 million
compared with a benefit of $811 million in the
prior year. The increase was due primarily to
portfolio activity, partly offset by a decrease in
nonperforming loans. Credit quality in the
wholesale portfolio was stable. The benefit in 2005
was due to improvement in credit quality, reflected
by significant reductions in criticized exposures
and nonperforming loans. Consumer provision for
credit losses was $5.2 billion compared with $8.1
billion in the prior year. The reduction primarily
reflected the impact of significantly lower
bankruptcy-related credit losses and a special
provision for credit losses in 2005 related to
Hurricane Katrina.
The Firm
had, at year end, total stockholders’
equity of $115.8 billion, and a Tier 1 capital
ratio of 8.7%. The Firm purchased $3.9 billion, or
91 million shares of common stock during the year.
2007 Business outlook
The following forward-looking statements are
based upon the current beliefs and expectations of
JPMorgan Chase’s management and are subject to
significant risks and uncertainties. These risks
and uncertainties could cause JPMorgan Chase’s
results to differ materially from those set forth
in such forward-looking statements.
JPMorgan Chase’s outlook for 2007 should be viewed
against the backdrop of the global economy,
financial markets activity and the geopolitical
environment, all of which are linked integrally.
While the Firm considers outcomes for, and has
contingency plans to respond to, stress
environments, the basic outlook for 2007 is
predicated on the interest rate movements implied
in the forward rate curve for U.S. Treasury
securities, the continuation of favorable U.S. and
international equity markets and continued
expansion of the global economy.
The Investment Bank enters 2007 with a strong
investment banking fee pipeline and remains
focused on developing new products and
capabilities. Asset Management anticipates growth
driven by continued net asset inflows. Commercial
Banking and Treasury & Securities Services expect
growth due to increased business activity and
product sales with some competitive and rate
pressures. However, the performance of the Firm’s
wholesale businesses will be affected by overall
global economic growth and by financial market
movements and activity levels in any given period.
Retail Financial Services anticipates benefiting
from the continued expansion of the branch network
and sales force, including the addition of The Bank
of New York’s 339 branches, and improved sales
productivity and cross-selling in the branches.
Loan and deposit spreads are expected to experience
continued compression due to the interest rate and
competitive environments.
Card Services anticipates growth in managed
receivables and sales volume, both of which are
expected to benefit from marketing initiatives
and new partnerships. Expenditures on marketing
are expected to be lower than the 2006 level.
In the Corporate segment, the revenue outlook for
the Private Equity business is directly related to
the strength of the equity markets and the
performance of the underlying portfolio
investments. If current market conditions persist,
the Firm anticipates continued realization of
private equity gains in 2007, but results can be
volatile from quarter to quarter. Management
believes that the net loss in Treasury and Other
Corporate, on a combined basis, will be
approximately $50 to $100 million per quarter in
2007, reflecting merger savings and other expense
efficiency initiatives, such as less excess real
estate.
The Provision for credit losses in 2007 is
anticipated to be higher than in 2006, primarily
driven by a trend toward a more normal level of
provisioning for credit losses in both the
wholesale and consumer businesses. The consumer
Provision for credit losses should reflect a
higher level of net charge-offs as bankruptcy
filings continue to increase from the
significantly lower than normal levels experienced
in 2006 related to the change in bankruptcy law in
2005.
Firmwide expenses are anticipated to reflect
investments in each business, continued merger
savings and other operating efficiencies. Annual
Merger savings are expected to reach approximately
$3.0 billion by the end of 2007, upon the
completion of the last significant conversion
activity, the wholesale deposit conversion
scheduled for the second half of 2007. Offsetting
merger savings will be continued investment in
distribution enhancements and new product
offerings, and expenses related to recent
acquisitions including The Bank of New York
transaction. Merger costs of approximately $400
million are expected to be incurred during 2007
(including a modest amount related to The Bank of
New York transaction). These additions are expected
to bring total cumulative merger costs to $3.8
billion by the end of 2007.
JPMorgan Chase & Co. / 2006 Annual Report
27
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, 2006. Factors
that are related primarily to a single business
segment are discussed in more detail within that
business segment than they are in this consolidated
section. Total net revenue, Noninterest expense and
Income tax expense have been revised to reflect the
impact of discontinued operations. For a discussion
of the Critical accounting estimates used by the
Firm that affect the Consolidated results of
operations, see pages 83–85 of this Annual Report.
Revenue
Year ended December 31, (in millions)
2006
2005
2004
(a)
Investment banking fees
$
5,520
$
4,088
$
3,536
Principal transactions
10,346
7,669
5,148
Lending & deposit related fees
3,468
3,389
2,672
Asset management, administration
and commissions
11,725
9,891
7,682
Securities gains (losses)
(543
)
(1,336
)
338
Mortgage fees and related income
591
1,054
803
Credit card income
6,913
6,754
4,840
Other income
2,175
2,684
826
Noninterest revenue
40,195
34,193
25,845
Net interest income
21,242
19,555
16,527
Total net revenue
$
61,437
$
53,748
$
42,372
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Total net revenue for 2006 was $61.4 billion, up by
$7.7 billion, or 14%, from the prior year. The
increase was due to higher Principal transactions,
primarily from strong trading revenue results,
record Asset management, administration and
commissions revenue, and record Investment banking
fees. Also contributing to the increase was higher
Net interest income and lower securities portfolio
losses. These improvements were offset partially by
a decline in Other income partly as a result of the
gain recognized in 2005 on the sale of BrownCo, and
lower Mortgage fees and related income.
The increase in Investment banking fees was driven
by record debt and equity underwriting as well as
strong advisory fees. For a further discussion of
Investment banking fees, which are recorded
primarily in the IB, see the IB segment results on
pages 36–37 of this Annual Report.
Principal transactions revenue consists of realized
and unrealized gains and losses from trading
activities, including physical commodities
inventories that are accounted for at the lower of
cost or fair value, primarily in the IB, and
Private equity gains and losses, primarily in the
private equity business of Corporate. Trading
revenue increased compared with 2005 due to record
performance in Equity and Fixed income markets. For
a further discussion of Principal transactions
revenue, see the IB and Corporate segment results
on pages 36–37 and 53–54, respectively, of this
Annual Report.
Lending & deposit related fees rose slightly in
comparison with 2005 as a result of higher fee
income on deposit-related fees and, in part, from
The Bank of New York transaction. For a further
discussion of the change in Lending & deposit
related fees, which are recorded in RFS, see the
RFS segment results on pages 38–42 of this
Annual Report.
The increase in Asset management, administration
and commissions revenue in 2006 was driven by
growth in assets under management in AM, which
exceeded $1 trillion at the end of 2006, higher
equity-related commissions in IB and higher
performance and placement fees. The growth in
assets under management reflected net asset inflows
in the institutional and retail segments. Also
contributing to the increase were higher assets
under custody in TSS driven by market value
appreciation and new business; and growth in
depositary receipts, securities lending and global
clearing, all of which were driven by a combination
of increased product usage by existing clients and
new business. In addition, commissions in the IB
rose as a result of strength across regions, partly
offset by the sale of the insurance business and
BrownCo. For additional information on these fees
and commissions, see the segment discussions for AM
on pages 50–52, TSS on pages 48–49 and RFS on
pages 38–42, of this Annual Report.
The favorable variance in Securities gains (losses)
was due primarily to lower Securities losses in
Treasury in 2006 from portfolio repositioning
activities in connection with the management of the
Firm’s assets and liabilities. For a further
discussion of Securities gains (losses), which are
mostly recorded in the Firm’s Treasury business,
see the Corporate segment discussion on pages
53–54 of this Annual Report.
Mortgage fees and related income declined in
comparison with 2005
reflecting a reduction in net mortgage servicing
revenue and higher losses on mortgage loans
transferred to held-for-sale. These declines were
offset partly by growth in production revenue as a
result of higher volume of loans sales and wider
gain on sale margins. Mortgage fees and related
income exclude the impact of NII and AFS securities
gains related to mortgage activities. For a
discussion of Mortgage fees and related income,
which is recorded primarily in RFS’s Mortgage
Banking business, see the Mortgage Banking
discussion on page 41 of this Annual Report.
Credit card income increased from 2005, primarily
from higher customer charge volume that favorably
impacted interchange income and servicing fees
earned in connection with securitization
activities, which benefited from lower credit
losses incurred on securitized credit card loans.
These increases were offset partially by increases
in volume-driven payments to partners, expenses
related to reward programs, and interest paid to
investors in the securitized loans. Credit card
income also was impacted negatively by the
deconsolida-tion of Paymentech in the fourth
quarter of 2005.
The decrease in Other income compared with the
prior year was due to a $1.3 billion pretax gain
recognized in 2005 on the sale of BrownCo and lower
gains from loan workouts. Partially offsetting
these two items were higher automobile operating
lease revenue; an increase in equity investment
income, in particular, from Chase Paymentech
Solutions, LLC; and a pretax gain of $103 million
on the sale of MasterCard shares in its initial
public offering.
Net interest income rose due largely to improvement
in Treasury’s net interest spread and increases in
wholesale liability balances, wholesale and
consumer loans, available-for-sale securities, and
consumer deposits. Increases in consumer and
wholesale loans and deposits included the impact of
The Bank of New York transaction. These increases
were offset partially by narrower spreads on both
trading-related assets and loans, a shift to
narrower-spread deposit products, RFS’s sale of the
insurance business and the absence of BrownCo in
AM. The Firm’s total average interest-earning
assets for 2006 were $995.5 billion, up 11% from
the prior year, primarily as a result of an
increase in loans and other liquid earning assets,
partially offset by a decline in interests in
purchased receivables as a result of the
restructuring and deconsolidation during the second
quarter of 2006 of certain multi-seller con-
28
JPMorgan Chase & Co. / 2006 Annual Report
duits that the Firm administered. The net yield
on interest-earning assets, on a fully
taxable-equivalent basis, was 2.16%, a decrease of
four basis points from the prior year. For a
further discussion of Net interest income, see the
Business Segment Results section on pages 34–35 of
this Annual Report.
2005 compared with 2004
Total net revenue for 2005 was $53.7 billion, up
27% from 2004, primarily due to the Merger, which
affected every revenue category. The increase from
2004 also was affected by a $1.3 billion gain on
the sale of BrownCo; higher Principal transactions
revenue; and higher Asset management,
administration and commissions, which benefited
from several new investments and growth in Assets
under management and Assets under custody. These
increases were offset partly by available-for-sale
(“AFS”) securities losses as a result of
repositioning of the Firm’s Treasury investment
portfolio. The discussions that follow highlight
factors other than the Merger that affected the
2005 versus 2004 comparison.
The increase in Investment banking fees was driven
by strong growth
in advisory fees resulting in part from the
Cazenove business partnership. For a further
discussion of Investment banking fees, which are
primarily recorded in the IB, see the IB segment
results on pages 36–37 and Note 2 on page 97 of
this Annual Report.
Revenue from Principal transactions increased
compared with 2004, driven by stronger, although
volatile, trading results across commodities,
emerging markets, rate markets and currencies.
Private equity gains were higher due to a
continuation of favorable capital markets
conditions. For a further discussion of Principal
transactions revenue, see the IB and Corporate
segment results on pages 36–37 and 53–54, respectively, of this
Annual Report.
The higher Lending & deposit related fees were
driven by the Merger; absent the effects of the
Merger, the deposit-related fees would have been
lower due to rising interest rates. In a higher
interest rate environment, the value of deposit
balances to a customer is greater, resulting in a
reduction of deposit-related fees. For a further
discussion of liability balances (including
deposits) see the CB and TSS segment discussions on
pages 46–47 and 48–49, respectively, of this
Annual Report.
The increase in Asset management, administration
and commissions revenue was driven by incremental
fees from several new investments, including the
acquisition of a majority interest in Highbridge,
the Cazenove business partnership and the
acquisition of Vastera. Also contributing to the
higher level of revenue was an increase in Assets
under management, reflecting net asset inflows in
equity-related products and global equity market
appreciation. In addition, Assets under custody
were up due to market value appreciation and new
business. Commissions rose as a result of a higher
volume of brokerage transactions. For additional
information on these fees and commissions, see the
segment discussions for IB on pages 36–37, AM on
pages 50–52 and TSS on pages 48–49 of this Annual
Report.
The decline in Securities gains (losses) reflected
$1.3 billion of securities losses, as compared with
$338 million of gains in 2004. The losses were due
to repositioning of the Firm’s Treasury investment
portfolio, to manage exposure to interest rates.
For a further discussion of Securities gains
(losses), which are recorded primarily in the
Firm’s Treasury business, see the Corporate segment
discussion on pages 53–54 of this Annual Report.
Mortgage fees and related income increased due to
improved MSR risk-management results. For a
discussion of Mortgage fees and related income,
which is recorded primarily in RFS’s Mortgage
Banking business, see the segment discussion for
RFS on pages 38–42 of this Annual Report.
Credit card income rose as a result of higher
interchange income associated with the increase in
charge volume. This increase was offset partially
by higher
volume-driven payments to partners and rewards
expense. For a further discussion of Credit card
income, see CS segment results on pages 43–45 of
this Annual Report.
The increase in Other income primarily reflected a
$1.3 billion pretax gain on the sale of BrownCo;
higher gains from loan workouts and loan sales; and
higher automobile operating lease income.
Net interest income rose as a result of higher
average volume of, and wider spreads on, liability
balances. Also contributing to the increase was
higher average volume of wholesale and consumer
loans, in particular, real estate and credit card loans,
which partly reflected a private label portfolio
acquisition by CS. These increases were offset
partially by narrower spreads on consumer and
wholesale loans and on trading-related assets, as
well as the impact of the repositioning of the
Treasury investment portfolio, and the reversal of
revenue related to increased bankruptcies in CS.
The Firm’s total average interest-earning assets in
2005 were $899.1 billion, up 23% from the prior
year. The net interest yield on these assets, on a
fully taxable-equivalent basis, was 2.20%, a
decrease of seven basis points from the prior year.
Provision for credit losses
Year ended December 31,
(in millions)
2006
2005
2004
(a)
Provision for credit losses
$
3,270
$
3,483
$
2,544
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
The Provision for credit losses in 2006 declined
$213 million from the prior year due to a $1.3
billion decrease in the consumer Provision for
credit losses, partly offset by a $1.1 billion
increase in wholesale Provision for credit losses.
The decrease in the consumer provision was driven
by CS, reflecting lower bankruptcy-related losses,
partly offset by higher contractual net
charge-offs. The 2005 consumer provision also
reflected $350 million of a special provision
related to Hurricane Katrina, a portion of which
was released in the current year. The increase in
the wholesale provision was due primarily to
portfolio activity, partly offset by a decrease in
nonperforming loans. The benefit in 2005 was due to
strong credit quality, reflected in significant
reductions in criticized exposure and nonperforming
loans. Credit quality in the wholesale portfolio
was stable. For a more detailed discussion of the
loan portfolio and the Allowance for loan losses,
refer to Credit risk management on pages 64–76 of
this Annual Report.
2005 compared with 2004
The Provision for credit losses was $3.5 billion,
an increase of $939 million, or 37%, from 2004,
reflecting the full-year impact of the Merger. The
wholesale Provision for credit losses was a benefit
of $811 million for the year compared with a
benefit of $716 million in the prior year,
reflecting continued strength in credit quality.
The wholesale loan net recovery rate was 0.06% in
2005, an improvement from a net charge-off rate of
0.18% in the prior year. The total consumer
Provision for credit losses was $4.3 billion, $1.9
billion higher than the prior year, primarily due
to the Merger, higher bankruptcy-related net
charge-offs in Card Services and a $350 million
special provision for Hurricane Katrina. Also
included in 2004 were accounting policy conformity
adjustments as a result of the Merger. Excluding
these items, the consumer portfolio continued to
show strength in credit quality.
JPMorgan Chase & Co. / 2006 Annual Report
29
Management’s discussion and analysis
JPMorgan Chase & Co.
Noninterest expense
Year ended December 31,
(in millions)
2006
2005
2004
(a)
Compensation expense
$
21,191
$
18,065
$
14,291
Occupancy expense
2,335
2,269
2,058
Technology, communications and
equipment expense
3,653
3,602
3,687
Professional & outside services
3,888
4,162
3,788
Marketing
2,209
1,917
1,335
Other expense
3,272
6,199
6,537
Amortization of intangibles
1,428
1,490
911
Merger costs
305
722
1,365
Total noninterest expense
$
38,281
$
38,426
$
33,972
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Total noninterest expense for 2006 was $38.3
billion, down slightly from the prior year. The
decrease was due to material litigation-related insurance
recoveries of $512 million in 2006 compared with a
net charge of $2.6 billion (includes $208 million material
litigation-related insurance recoveries) in 2005, primarily
associated with the settlement of the Enron and
WorldCom class action litigations and for certain
other material legal proceedings. Also contributing
to the decrease were lower Merger costs, the
deconsolidation of Paymentech, the sale of the
insurance business, and merger-related savings and
operating efficiencies. These items were offset
mostly by higher performance-based compensation and
incremental expense of $712 million related to SFAS
123R, the impact of acquisitions and investments in
businesses, as well as higher Marketing
expenditures.
The increase in Compensation expense from 2005 was
primarily a result of higher performance-based
incentives, incremental expense related to SFAS
123R of $712 million for 2006, and additional
headcount in connection with growth in business
volume, acquisitions, and investments in the
businesses. These increases were offset partially
by merger-related savings and other expense
efficiencies throughout the Firm. For a detailed
discussion of the adoption of SFAS 123R and
employee stock-based incentives see Note 8 on pages
105–107 of this Annual Report.
The increase in Occupancy expense from 2005 was due
to ongoing investments in the retail distribution
network, which included the incremental expense
from The Bank of New York branches, partially
offset by merger-related savings and other
operating efficiencies.
The slight increase in Technology, communications
and equipment expense for 2006 was due primarily to
higher depreciation expense on owned automobiles
subject to operating leases and higher technology
investments to support business growth, partially
offset by merger-related savings and operating
efficiencies.
Professional & outside services decreased from
2005 due to merger-related savings and operating
efficiencies, lower legal fees associated with several legal
matters settled in 2005 and the Paymentech
deconsolidation. The decrease was offset partly by
acquisitions and business growth.
Marketing expense was higher compared with 2005,
reflecting the costs of campaigns for credit
cards.
Other expense was lower due to significant
litigation-related charges of $2.8 billion in 2005,
associated with the settlement of the Enron and
WorldCom class action litigations and certain other
material legal proceedings. In addition, the Firm
recognized insurance recoveries of $512 million and
$208 million, in 2006 and 2005, respectively,
pertaining to certain material litigation matters.
For a fur-
ther discussion of litigation, refer to Note 27 on
pages 130–131 of this Annual Report. Also
contributing to the decline from the prior year
were charges of $93 million in connection with the
termination of a client contract in TSS in 2005;
and in RFS, the sale of the insurance business in
the third quarter of 2006. These items were offset
partially by higher charges related to other
litigation, and the impact of growth in business
volume, acquisitions and investments in the
businesses.
For discussion of Amortization of intangibles and
Merger costs, refer to Note 16 and Note 9 on pages
121–123 and 108, respectively, of this Annual
Report.
2005 compared with 2004
Noninterest expense for 2005 was $38.4 billion, up
13% from 2004, primarily due to the full-year
impact of the Merger. Excluding Litigation reserve
charges and Merger costs, Noninterest expense would
have been $35.1 billion, up 22%. In addition to the
Merger, expenses increased as a result of higher
performance-based incentives, continued investment
spending in the Firm’s businesses and incremental
marketing expenses related to launching the new
Chase brand, partially offset by merger-related
savings and operating efficiencies throughout the
Firm. Each category of Noninterest expense was
affected by the Merger. The discussions that follow
highlight factors other than the Merger that
affected the 2005 versus 2004 comparison.
Compensation expense rose as a result of higher
performance-based incentives; additional headcount
due to the insourcing of the Firm’s global
technology infrastructure (effective December 31,2004, when JPMorgan Chase terminated the Firm’s
outsourcing agreement with IBM); the impact of
several investments, including Cazenove, Highbridge
and Vastera; the accelerated vesting of certain
employee stock options; and business growth. The
effect of the termination of the IBM outsourcing
agreement was to shift expenses from Technology and
communications expense to Compensation expense. The
increase in Compensation expense was offset
partially by merger-related savings throughout the
Firm. For a detailed discussion of employee
stock-based incentives, see Note 8 on pages
105–107 of this Annual Report.
The increase in Occupancy expense was due primarily
to the Merger, partially offset by lower charges
for excess real estate and a net release of excess
property tax accruals, as compared with $103
million of charges for excess real estate in 2004.
Technology and communications expense was down
slightly. This reduction reflects the offset of six
months of the combined Firm’s results for 2004
against the full-year 2005 impact from termination
of the JPMorgan Chase outsourcing agreement with
IBM. The reduction in Technology and communications
expense due to the outsourcing agreement
termination is offset mostly by increases in
Compensation expense related to additional
headcount and investments in the Firm’s hardware
and software infrastructure.
Professional and outside services were higher
compared with the prior year as a result of the
insourcing of the Firm’s global technology
infrastructure, upgrades to the Firm’s systems and
technology, and business growth. These expenses
were offset partially by operating efficiencies.
Marketing expense was higher compared with the
prior year, primarily as a result of the Merger and
the cost of advertising campaigns to launch the new
Chase brand.
30
JPMorgan Chase & Co. / 2006 Annual Report
The decrease in Other expense reflected lower
litigation reserve charges for certain material
legal proceedings in 2005: $1.9 billion related to
the settlement of the Enron class action litigation
and for certain other material legal proceedings,
and $900 million for the settlement of the WorldCom
class action litigation; and in 2004, $3.7 billion
to increase litigation reserves. Also contributing
to the decrease were a $208 million insurance
recovery related to certain material litigation,
lower software impairment write-offs,
merger-related savings and operating efficiencies.
These were offset partially by $93 million in
charges taken by TSS to terminate a client contract
and a $40 million charge taken by RFS related to
the dissolution of a student loan joint venture.
For a discussion of Amortization of intangibles
and Merger costs, refer to Note 16 and Note 9 on
pages 121–123 and 108, respectively, of this
Annual Report.
Income tax expense
The Firm’s Income from continuing operations
before income tax expense, Income tax expense
and Effective tax rate were as follows for each
of the periods indicated:
Year ended December 31,
(in millions, except rate)
2006
2005
2004
(a)
Income from continuing operations
before income tax expense
$
19,886
$
11,839
$
5,856
Income tax expense
6,237
3,585
1,596
Effective tax rate
31.4
%
30.3
%
27.3
%
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
The increase in the effective tax rate for 2006, as
compared with the prior year, was primarily the
result of higher reported pretax income combined
with changes in the proportion of income subject to
federal, state and local taxes. Also contributing
to the increase in the effective tax rate were the
litigation charges in 2005 and lower Merger costs,
reflecting a tax benefit at a 38% marginal tax
rate, partially offset by benefits related to tax
audit resolutions of $367 million in 2006.
2005 compared with 2004
The increase in the effective tax rate was
primarily the result of higher reported pretax
income combined with changes in the proportion of
income subject to federal, state and local taxes.
Also contributing to the increase were lower 2005
litigation charges and a gain on the sale of
BrownCo, which were taxed at marginal tax rates of
38% and 40%, respectively. These increases were
offset partially by a tax benefit in 2005 of $55
million recorded in connection with the
repatriation of foreign earnings.
Income from discontinued operations
As a result of the transaction with The Bank of
New York on October 1, 2006, the results of
operations of the selected corporate trust
businesses (i.e., trustee, paying agent, loan
agency and document management services) were
reported as discontinued operations.
The Firm’s Income from discontinued operations
(after-tax) were as follows for each of the periods
indicated:
Year ended December 31,
(in millions)
2006
2005
2004
(a)
Income from discontinued operations
$
795
$
229
$
206
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
The increases from the prior two periods in
Income from discontinued operations were due
primarily to a gain of $622 million from exiting
the corporate trust business in the fourth quarter
of 2006.
JPMorgan Chase & Co. / 2006 Annual Report
31
Management’s discussion and analysis
JPMorgan Chase & Co.
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
90–93 of this Annual Report. That presentation,
which is referred to as “reported basis,” provides
the reader with an understanding of the Firm’s
results that can be tracked consistently from year
to year and enables a comparison of the Firm’s
performance with other companies’ U.S. GAAP
financial statements.
Effective January 1, 2006, JPMorgan Chase’s
presentation of “operating earnings,” which
excluded merger costs and material litigation
reserve charges and recoveries from reported
results, was eliminated. These items had been
excluded previously from operating results because
they were deemed nonrecurring; they are included
now in the Corporate segment’s results. In
addition, trading-related net interest income no
longer is reclassified from Net interest income to
Principal transactions.
In addition to analyzing the Firm’s results on a
reported basis, management reviews the Firm’s and
the lines’ of business results on a “managed”
basis, which is a non-GAAP financial measure. The
Firm’s definition of managed basis starts with the
reported U.S. GAAP results and includes certain
reclassifications that assumes credit card loans
securitized by CS remain on the balance sheet and
presents revenue on a fully taxable-equivalent
(“FTE”) basis. These adjustments do not have any
impact on Net income as reported by the lines of
business or by the Firm as a whole.
The presentation of CS results on a managed basis
assumes that credit card loans that have been
securitized and sold in accordance with SFAS 140
still remain on the balance sheet and that the
earnings on the securitized loans are classified in
the same manner as the earnings on retained loans
recorded on the balance sheet. JPMorgan Chase uses
the concept of managed basis to evaluate the credit
performance and overall financial performance of
the entire
The following summary table provides a reconciliation from the Firm’s reported U.S. GAAP results to managed basis:
Income from continuing operations
before income tax expense
19,886
—
904
20,790
11,839
—
840
12,679
Income tax expense
6,237
—
904
7,141
3,585
—
840
4,425
Income from continuing
operations
13,649
—
—
13,649
8,254
—
—
8,254
Income from discontinued
operations
795
—
—
795
229
—
—
229
Net income
$
14,444
$
—
$
—
$
14,444
$
8,483
$
—
$
—
$
8,483
Income
from continuing operations – diluted
earnings per share
$
3.82
$
—
$
—
$
3.82
$
2.32
$
—
$
—
$
2.32
Return on
common equity (a)
12
%
—
%
—
%
12
%
8
%
—
%
—
%
8
%
Return on
common equity less
goodwill(a)
20
—
—
20
13
—
—
13
Return on
assets (a)
1.04
NM
NM
1.00
0.70
NM
NM
0.67
Overhead
ratio
62
NM
NM
59
71
NM
NM
66
Loans–Period-end
$
483,127
$
66,950
$
—
$
550,077
$
419,148
$
70,527
—
$
489,675
Total assets – average
1,313,794
65,266
—
1,379,060
1,185,066
67,180
—
1,252,246
(a)
Based on Income from continuing operations
(b)
The impact of credit card securitizations affects CS. See pages 43–45 of this
Annual Report for further information.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
32
JPMorgan Chase & Co. / 2006 Annual Report
managed credit card portfolio. Operations are
funded and decisions are made about allocating
resources, such as employees and capital, based
upon managed financial information. In addition,
the same underwriting standards and ongoing risk
monitoring are used for both loans on the balance
sheet and securitized loans. Although
securitizations result in the sale of credit card
receivables to a trust, JPMorgan Chase retains the
ongoing customer relationships, as the customers
may continue to use their credit cards;
accordingly, the customer’s credit performance will
affect both the securitized loans and the loans
retained on the balance sheet. JPMorgan Chase
believes managed basis information is useful to
investors, enabling them to
understand both the credit risks associated with
the loans reported on the balance sheet and the
Firm’s retained interests in securitized loans. For
a reconciliation of reported to managed basis of CS
results, see Card Services segment results on pages
43–45 of this Annual Report. For information
regarding the securitization process, and loans and
residual interests sold and securitized, see Note
14 on pages 114–118 of this Annual Report.
Total net revenue for each of the business
segments and the Firm is presented on an FTE basis.
Accordingly, revenue from tax-exempt securities and
investments that receive tax credits is presented
in the managed results on a basis comparable to
taxable securities and investments. This non-GAAP
financial measure allows management to assess the
comparability of revenues arising from both taxable
and tax-exempt sources. The corresponding income
tax impact related to these items is recorded
within Income tax expense.
Management also uses certain non-GAAP financial
measures at the segment level because it believes
these non-GAAP financial measures provide
information to investors about the underlying
operational performance and trends of the
particular business segment and therefore
facilitate a comparison of the business segment
with the performance of its competitors.
(Table continued from previous page)
2004(c)
Reported
Credit
Tax-equivalent
Managed
results
card
(b)
adjustments
basis
$
3,536
$
—
$
—
$
3,536
5,148
—
—
5,148
2,672
—
—
2,672
7,682
—
—
7,682
338
—
—
338
803
—
—
803
4,840
(2,267
)
—
2,573
826
(86
)
317
1,057
25,845
(2,353
)
317
23,809
16,527
5,251
6
21,784
42,372
2,898
323
45,593
2,544
2,898
—
5,442
33,972
—
—
33,972
5,856
—
323
6,179
1,596
—
323
1,919
4,260
—
—
4,260
206
—
—
206
$
4,466
$
—
$
—
$
4,466
$
1.48
$
—
$
—
$
1.48
6
%
—
%
—
%
6
%
8
—
—
8
0.44
NM
NM
0.43
80
NM
NM
75
$
402,114
$
70,795
—
$
472,909
962,556
51,084
—
1,013,640
Calculation of Certain GAAP and Non-GAAP Metrics
The table below reflects the formulas used to
calculate both the following GAAP and non-GAAP
measures:
Return on common equity
Net income* / Average common stockholders’ equity
Return on common equity less goodwill(a)
Net income* / Average common stockholders’ equity less goodwill
Return on assets
Reported
Net income / Total average assets
Managed
Net income / Total average managed assets (b)
(including average securitized credit card receivables)
Overhead ratio
Total noninterest expense / Total net revenue
* Represents Net income applicable to common stock
(a)
The Firm uses Return on common equity less goodwill, a non-GAAP
financial measure, to evaluate the operating performance of the Firm and to
facilitate comparisons to competitors.
(b)
The Firm uses Return on managed assets, a non-GAAP financial measure, to
evaluate the overall performance of the managed credit card portfolio, including
securitized credit card loans.
JPMorgan Chase & Co. / 2006 Annual Report
33
Management’s discussion and analysis
JPMorgan Chase & Co.
BUSINESS SEGMENT RESULTS
The Firm is managed on a line-of-business
basis. The business segment financial results
presented reflect the current organization of
JPMorgan Chase. There are six major reportable
business segments: the Investment Bank, Retail
Financial Services, Card Services, Commercial
Banking, Treasury & Securities Services and Asset
Management, as well as a Corporate segment. The
seg-
ments are based upon 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 a managed
basis. Segment results for 2004 include six months
of the combined Firm’s results and six months of
heritage JPMorgan Chase only.
Description of business segment reporting methodology
Results of the business segments are intended to
reflect each segment as if it were essentially a
stand-alone business. During 2006, JPMorgan Chase
modified certain of its segment disclosures to
reflect more closely the manner in which the Firm’s
business segments are managed and to provide
improved comparability with competitors. These
financial disclosure modifications are reflected in
this Annual Report and, except as indicated, the
financial information for prior periods has been
revised to reflect the changes as if they had been
in effect throughout all periods reported. A
summary of the changes follows:
•
The presentation of operating earnings in 2005 and 2004 that excluded from reported
results merger costs and material litigation reserve charges and recoveries was eliminated
effective January 1, 2006. These items had been excluded previously from operating results
because they were deemed nonrecurring; they are included now in the Corporate business
segment’s results.
•
Trading-related net interest income is no longer reclassified from Net interest
income to Principal transactions.
•
Various wholesale banking clients, together with the related balance sheet and
income statement items, were transferred among CB, the IB and TSS.
The primary client transfer was corporate mortgage finance from CB to the IB and TSS.
•
TSS firmwide disclosures have been adjusted to reflect a refined set of TSS products
as well as a revised allocation of liability balances and lending- related revenue related
to certain client transfers.
•
As result of the transaction with The Bank of New York, selected corporate rate trust businesses
have been transferred from TSS to the Corporate segment and reported in discontinued operations for all
periods reported.
The management reporting process that derives
business segment results allocates income and
expense using market-based methodologies. The Firm
continues to assess the assumptions, methodologies
and reporting classifications used for segment
reporting, and further refinements may be
implemented in future periods. Segment reporting
methodologies used by the Firm are discussed below.
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. The segment
results reflect these revenue-sharing agreements.
Funds transfer pricing
Funds transfer pricing (“FTP”) is used to allocate
interest income and expense to each business and
transfer the primary interest rate risk exposures
to the Corporate business segment. The allocation
process is unique to each business segment and
considers the interest rate risk, liquidity risk
and regulatory requirements of that segment’s
stand-alone peers. This process is overseen by the
Firm’s Asset-Liability Committee (“ALCO”). Business
segments may retain certain interest rate
exposures, subject to management approval, that
would be expected in the normal operation of a
similar peer business.
34
JPMorgan Chase & Co. / 2006 Annual Report
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 January 1, 2006, the Firm refined its
methodology for allocating capital to the business
segments. As prior periods have not been revised to
reflect the new capital allocations, certain
business metrics, such as ROE, are not comparable
to the current presentations. For a further
discussion of this change, see Capital
management–Line of business equity on page 57 of
this
Annual Report.
Expense allocation
Where business segments use services provided by
support units within the Firm, the costs of those
support units are allocated to the business
segments. Those expenses are allocated based upon
their actual cost or the lower of actual cost or
market, as well as upon usage of the services
provided. In contrast, certain other expenses
related to certain corporate functions, or to cer-
tain technology and operations, are not allocated
to the business segments and are retained in
Corporate. These retained expenses include: parent
company costs that would not be incurred if the
segments were stand-alone businesses; adjustments
to align certain corporate staff, technology and
operations allocations with market prices; and
other one-time items not aligned with the business
segments.
During 2005, the Firm refined cost allocation
methodologies related to certain corporate,
technology and operations expenses in order to
improve transparency, consistency and
accountability with regard to costs allocated
across business segments. Prior periods were not
revised to reflect this methodology change.
Credit reimbursement
TSS reimburses the IB for credit portfolio
exposures managed by the IB on behalf of clients
that the segments share. At the time of the Merger,
the reimbursement methodology was revised to be
based upon pretax earnings, net of the cost of
capital related to those exposures.
Segment results – Managed basis(a)
The following table summarizes the business segment results for the periods indicated:
Year ended December 31,
Total net revenue
Noninterest expense
(in millions, except ratios)
2006
2005
2004
(c)
2006
2005
2004
(c)
Investment Bank
$
18,277
$
14,613
$
12,633
$
12,304
$
9,749
$
8,709
Retail Financial Services
14,825
14,830
10,791
8,927
8,585
6,825
Card Services
14,745
15,366
10,745
5,086
4,999
3,883
Commercial Banking
3,800
3,488
2,278
1,979
1,856
1,326
Treasury & Securities
Services
6,109
5,539
4,198
4,266
4,050
3,726
Asset Management
6,787
5,664
4,179
4,578
3,860
3,133
Corporate(b)
8
(1,136
)
769
1,141
5,327
6,370
Total
$
64,551
$
58,364
$
45,593
$
38,281
$
38,426
$
33,972
Year ended December 31,
Net income (loss)
Return on equity
(in millions, except ratios)
2006
2005
2004
(c)
2006
2005
2004
(c)
Investment Bank
$
3,674
$
3,673
$
2,956
18
%
18
%
17
%
Retail Financial Services
3,213
3,427
2,199
22
26
24
Card Services
3,206
1,907
1,274
23
16
17
Commercial Banking
1,010
951
561
18
28
27
Treasury & Securities
Services
1,090
863
277
48
57
14
Asset Management
1,409
1,216
681
40
51
17
Corporate(b)
842
(3,554
)
(3,482
)
NM
NM
NM
Total
$
14,444
$
8,483
$
4,466
13
%
8
%
6
%
(a)
Represents reported results on a tax-equivalent basis and excludes the impact of
credit card securitizations.
(b)
Net income includes Income from discontinued operations (after-tax) of $795
million, $229 million and $206 million for 2006, 2005 and 2004, respectively.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
35
Management’s discussion and analysis
JPMorgan Chase & Co.
INVESTMENT BANK
JPMorgan is one of the world’s leading
investment banks, with deep client relationships
and broad product capabilities. The Investment
Bank’s clients are corporations, financial
institutions, governments and institutional
investors. The Firm offers a full range of
investment banking products and services in all
major capital markets, including advising on
corporate strategy and structure, capital
raising in equity and debt markets,
sophisticated risk management, market-making in
cash securities and derivative instruments, and
research. The IB also commits the Firm’s own
capital to proprietary investing and trading
activities.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(e)
Revenue
Investment banking fees
$
5,537
$
4,096
$
3,572
Principal transactions
9,086
6,059
3,548
Lending & deposit related fees
517
594
539
Asset management, administration
and commissions
2,110
1,727
1,401
All other income
528
534
277
Noninterest revenue
17,778
13,010
9,337
Net interest income(a)
499
1,603
3,296
Total net revenue(b)
18,277
14,613
12,633
Provision for credit losses
191
(838
)
(640
)
Credit reimbursement from TSS(c)
121
154
90
Noninterest expense
Compensation expense
8,190
5,792
4,896
Noncompensation expense
4,114
3,957
3,813
Total noninterest expense
12,304
9,749
8,709
Income before income tax expense
5,903
5,856
4,654
Income tax expense
2,229
2,183
1,698
Net income
$
3,674
$
3,673
$
2,956
Financial ratios
ROE
18
%
18
%
17
%
ROA
0.57
0.61
0.62
Overhead ratio
67
67
69
Compensation expense as
% of total net revenue(d)
43
40
39
(a)
The decline in net interest income for the periods shown is largely driven by a
decline in trading-related net interest income caused by a higher proportion of
noninterest-bearing net trading assets to total net trading assets, higher funding costs
compared with prior-year periods, and spread compression due to the inverted yield curve
in place for most of the current year.
(b)
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 $802 million, $752 million and $274 million for 2006,
2005 and 2004, respectively.
(c)
TSS is charged a credit reimbursement related to certain exposures managed
within the IB credit portfolio on behalf of clients shared with TSS. For a further
discussion, see Credit reimbursement on page 35 of this Annual Report.
(d)
Beginning in 2006, the Compensation expense to Total net revenue ratio is
adjusted to present this ratio as if SFAS 123R had always been in effect. IB management
believes that adjusting the Compensation expense to Total net revenue ratio for the
incremental impact of adopting SFAS 123R provides a more meaningful measure of IB’s
Compensation expense to Total net revenue ratio.
(e)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income of $3.7 billion was flat, as record
revenue of $18.3 billion was offset largely by
higher compensation expense, including the impact
of SFAS 123R, and a provision for credit losses
compared with a benefit in the prior year.
Total net revenue of $18.3 billion was up $3.7
billion, or 25%, from the prior year. Investment
banking fees of $5.5 billion were a record, up 35%
from the prior year, driven by record debt and
equity underwriting as well as strong advisory
fees, which were the highest since 2000. Advisory
fees of $1.7 billion
The following table provides the IB’s total Net revenue by business segment:
Year ended December 31,
(in millions)
2006
2005
2004
(d)
Revenue by business
Investment banking fees:
Advisory
$
1,659
$
1,263
$
938
Equity underwriting
1,178
864
781
Debt underwriting
2,700
1,969
1,853
Total investment banking fees
5,537
4,096
3,572
Fixed income markets(a)
8,369
7,277
6,342
Equity markets(b)
3,264
1,799
1,491
Credit portfolio(c)
1,107
1,441
1,228
Total net revenue
$
18,277
$
14,613
$
12,633
(a)
Fixed income markets includes client and portfolio management revenue related to
both market-making and proprietary risk-taking across global fixed income markets,
including foreign exchange, interest rate, credit and commodities markets.
(b)
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.
(c)
Credit portfolio revenue includes Net interest income, fees and loan sale
activity, as well as gains or losses on securities received as part of a loan
restructuring, for the IB’s credit portfolio. Credit portfolio revenue also includes the
results of risk management related to the Firm’s lending and derivative activities, and
changes in the credit valuation adjustment (“CVA”), which is the component of the fair
value of a derivative that reflects the credit quality of the counterparty. See pages
70–72 of the Credit risk management section of this Annual Report for further discussion.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
were up 31% over the prior year driven
primarily by strong performance in the Americas.
Debt underwriting fees of $2.7 billion were up 37%
from the prior year driven by record performance in
both loan syndications and bond underwriting.
Equity underwriting fees of
$1.2 billion were up 36% from the prior year driven
by global equity markets. Fixed Income Markets
revenue of $8.4 billion was also a record, up 15%
from the prior year driven by strength in credit
markets, emerging markets and currencies. Record
Equity Markets revenue of $3.3 billion increased
81%, and was driven by strength in cash equities
and equity derivatives. Credit Portfolio revenue of
$1.1 billion was down 23%, primarily reflecting
lower gains from loan workouts.
Provision for credit losses was $191 million
compared with a benefit of $838 million in the
prior year. The current-year provision reflects
portfolio activity; credit quality remained stable.
The prior-year benefit reflected strong credit
quality, a decline in criticized and nonperforming
loans, and a higher level of recoveries.
Total noninterest expense of $12.3 billion was up
by $2.6 billion, or 26%, from the prior year. This
increase was due primarily to higher
performance-based compensation, including the
impact of an increase in the ratio of compensation
expense to total net revenue, as well as the
incremental expense related to SFAS 123R.
Return on equity was 18% on $20.8 billion of
allocated capital compared with 18% on $20.0
billion in 2005.
2005 compared with 2004
Net income of $3.7 billion was up 24%, or $717
million, from the prior year. The increase was
driven by the Merger, higher revenues and an
increased benefit from the Provision for credit
losses. These factors were offset partially by
higher compensation expense. Return on equity was
18%.
Total net revenue of $14.6 billion was up $2.0
billion, or 16%, over the prior year, driven by
strong Fixed Income and Equity Markets and
Investment banking fees. Investment banking fees of
$4.1 billion increased 15% from the prior year
driven by strong growth in advisory fees resulting
in part from the Cazenove business partnership.
Advisory revenues of $1.3 billion were up 35% from
the prior year, reflecting higher market volumes.
Debt underwriting revenues of $2.0
36
JPMorgan Chase & Co. / 2006 Annual Report
billion increased by 6% driven by strong loan
syndication fees. Equity underwriting fees of $864
million were up 11% from the prior year driven by
improved market share. Fixed Income Markets revenue
of $7.3 billion increased 15%, or $935 million,
driven by stronger, although volatile, trading
results across commodities, emerging markets, rate
markets and currencies. Equity Markets revenues
increased 21% to $1.8 billion, primarily due to
increased commissions, which were offset partially
by lower trading results, which also experienced a
high level of volatility. Credit Portfolio revenues
were $1.4 billion, up $213 million from the prior
year due to higher gains from loan workouts and
sales as well as higher trading revenue from credit
risk management activities.
The Provision for credit losses was a benefit of
$838 million compared with a benefit of $640
million in 2004. The increased benefit was due
primarily to the improvement in the credit quality
of the loan portfolio and reflected net recoveries.
Nonperforming assets of $645 million decreased by
46% since the end of 2004.
Total noninterest expense increased 12% to $9.7
billion, largely reflecting higher
performance-based incentive compensation related to
growth in revenue. Noncompensation expense was up
4% from the prior year primarily due to the impact
of the Cazenove business
partnership, while the overhead ratio declined to
67% for 2005, from 69% in 2004.
Selected metrics
Year ended December 31,
(in millions, except headcount and ratio data)
2006
2005
2004
(f)
Revenue by region
Americas
$
9,227
$
8,258
$
6,898
Europe/Middle East/Africa
7,320
4,627
4,082
Asia/Pacific
1,730
1,728
1,653
Total net revenue
$
18,277
$
14,613
$
12,633
Selected average balances
Total assets
$
647,569
$
599,761
$
474,436
Trading assets–debt and
equity instruments
275,077
231,303
190,119
Trading assets–derivative receivables
54,541
55,239
58,735
Loans:
Loans retained(a)
58,846
44,813
37,804
Loans held-for-sale(b)
21,745
11,755
6,124
Total loans
80,591
56,568
43,928
Adjusted assets(c)
527,753
456,920
394,961
Equity
20,753
20,000
17,290
Headcount
23,729
19,802
17,501
Credit data and quality statistics
Net charge-offs (recoveries)
$
(31
)
$
(126
)
$
47
Nonperforming assets:
Nonperforming loans(d)
231
594
954
Other nonperforming assets
38
51
242
Allowance for loan losses
1,052
907
1,547
Allowance for lending related commitments
305
226
305
Net charge-off (recovery) rate(b)
(0.05
)%
(0.28
)%
0.12
%
Allowance for loan losses to average loans(b)
1.79
2.02
4.09
Allowance for loan losses to
nonperforming loans(d)
461
187
163
Nonperforming loans to average loans
0.29
1.05
2.17
Market risk–average trading and
credit portfolio VAR(e)
Trading activities:
Fixed income
$
56
$
67
$
74
Foreign exchange
22
23
17
Equities
31
34
28
Commodities and other
45
21
9
Less: portfolio diversification
(70
)
(59
)
(43
)
Total trading VAR
84
86
85
Credit portfolio VAR
15
14
14
Less: portfolio diversification
(11
)
(12
)
(9
)
Total trading and credit portfolio VAR
$
88
$
88
$
90
(a)
Loans retained include Credit Portfolio, conduit loans, leveraged leases, bridge
loans for underwriting and other accrual loans.
(b)
Loans held-for-sale, which include loan syndications, and warehouse loans held
as part of the IB’s mortgage-backed, asset-backed and other securitization businesses, are
excluded from Total loans for the allowance coverage ratio and net charge-off rate.
(c)
Adjusted assets, a non-GAAP financial measure, equals total average assets minus
(1) securities purchased under resale agreements and securities borrowed less securities
sold, not yet purchased; (2) assets of variable interest entities (VIEs) consolidated
under FIN 46R; (3) cash and securities segregated and on deposit for regulatory and other
purposes; and (4) goodwill and intangibles. The amount of adjusted assets is presented to
assist the reader in comparing the IB’s asset and capital levels to other investment banks in the
securities industry. Asset-to-equity leverage ratios are commonly used as one measure to
assess a company’s capital adequacy. The IB believes an adjusted asset amount that excludes
the assets discussed above, which are considered to have a low risk profile, provides a
more meaningful measure of balance sheet leverage in the securities industry.
(d)
Nonperforming loans include loans held-for-sale of $3 million, $109 million and
$2 million as of December 31, 2006, 2005 and 2004, respectively, which are excluded from
the allowance coverage ratios. Nonperforming loans exclude distressed HFS loans purchased as part of IB’s proprietary activities.
(e)
For a more complete description of VAR, see page 77 of this Annual Report.
(f)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Total average loans of $80.6 billion increased
by $24.0 billion, or 42%, from the prior year.
Average loans retained of $58.8 billion increased
by $14.0 billion, or 31%, from the prior year
driven by higher levels of capital markets
activity. Average loans held-for-sale of $21.7
billion were up by $10.0 billion, or 85%, from the
prior year driven primarily by growth in the IB
securitization businesses.
IB’s average Total trading and credit portfolio VAR
was $88 million for both 2006 and 2005. The
Commodities and other VAR category has increased
from $21 million on average for 2005 to $45 million
on average for 2006, reflecting the build-out of
the IB energy business, which has also increased
the effect of portfolio diversification such that
Total IB Trading VAR was down slightly compared
with the prior year.
According to Thomson Financial, in 2006, the Firm
maintained its #2 position in Global Debt, Equity
and Equity-related, its #1 position in Global
Syndicated Loans, and its #6 position in Global
Equity & Equity-related transactions. The Firm
improved its position in Global Long-term Debt to
#3 from #4.
According to Dealogic, the Firm was ranked #1 in
Investment Banking fees generated during 2006,
based upon revenue.
Market shares and rankings(a)
2006
2005
2004
Market
Market
Market
December 31,
Share
Rankings
Share
Rankings
Share
Rankings
Global debt, equity and
equity-related
7
%
#2
7
%
#2
7
%
#3
Global syndicated loans
14
1
15
1
19
1
Global long-term debt
6
3
6
4
7
2
Global equity and equity-related
7
6
7
6
6
6
Global announced M&A
23
4
23
3
22
3
U.S. debt, equity and
equity-related
9
2
8
3
8
5
U.S. syndicated loans
26
1
28
1
32
1
U.S. long-term debt
12
2
11
2
12
2
U.S. equity and equity-related(b)
8
6
9
6
9
4
U.S. announced M&A
27
3
26
3
28
2
(a)
Source: Thomson Financial Securities data. Global announced M&A is based upon
rank value; all other rankings are based upon proceeds, with full credit to each book
manager/equal if joint. Because of joint assignments, market share of all participants
will add up to more than 100%. The market share and rankings for December 31, 2004 are
presented on a combined basis, as if the merger of JPMorgan Chase and Bank One had been in
effect for the entire period.
(b)
References U.S. domiciled equity and equity-related transactions, per Thomson
Financial.
JPMorgan Chase & Co. / 2006 Annual Report
37
Management’s discussion and analysis
JPMorgan Chase & Co.
RETAIL FINANCIAL SERVICES
Retail Financial Services, which includes
Regional Banking, Mortgage Banking and Auto
Finance reporting segments, helps meet the
financial needs of consumers and businesses. RFS
provides convenient consumer banking through the
nation’s fourth-largest branch network and
third-largest ATM network. RFS is a top-five
mortgage originator and servicer, the
second-largest home equity originator, the
largest noncaptive originator of automobile loans
and one of the largest student loan originators.
RFS serves customers through more than 3,000
bank branches, 8,500 ATMs and 270 mortgage
offices, and through relationships with more
than 15,000 auto dealerships and 4,300 schools
and universities. More than 11,000 branch
salespeople assist customers, across a 17-state
footprint from New York to Arizona, with
checking and savings accounts, mortgage, home
equity and business loans, investments and
insurance. Over 1,200 additional mortgage
officers provide home loans throughout the
country.
During the first quarter of 2006, RFS completed
the purchase of Collegiate Funding Services, which
contributed an education loan servicing capability
and provided an entry into the Federal Family
Education Loan Program consolidation market. On
July 1, 2006, RFS sold its life insurance and
annuity underwriting businesses to Protective Life
Corporation. On October 1, 2006, JPMorgan Chase
completed The Bank of New York transaction,
significantly strengthening RFS’s distribution
network in the New York Tri-state area.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(b)
Revenue
Lending & deposit related fees
$
1,597
$
1,452
$
1,013
Asset management, administration
and commissions
1,422
1,498
1,020
Securities gains (losses)
(57
)
9
(83
)
Mortgage fees and related income
618
1,104
866
Credit card income
523
426
230
Other income
557
136
31
Noninterest revenue
4,660
4,625
3,077
Net interest income
10,165
10,205
7,714
Total net revenue
14,825
14,830
10,791
Provision for credit losses
561
724
449
Noninterest expense
Compensation expense
3,657
3,337
2,621
Noncompensation expense
4,806
4,748
3,937
Amortization of intangibles
464
500
267
Total noninterest expense
8,927
8,585
6,825
Income before income tax expense
5,337
5,521
3,517
Income tax expense
2,124
2,094
1,318
Net income
$
3,213
$
3,427
$
2,199
Financial ratios
ROE
22
%
26
%
24
%
ROA
1.39
1.51
1.18
Overhead ratio
60
58
63
Overhead ratio excluding core
deposit intangibles(a)
57
55
61
(a)
Retail Financial Services uses the overhead ratio (excluding the amortization of
core deposit intangibles (“CDI”)), a non-GAAP financial measure, to evaluate the
underlying expense trends of the business. Including CDI amortization expense in the
overhead ratio calculation
results in a higher overhead ratio in the earlier years and a lower overhead ratio in
later years; this method would result in an improving overhead ratio over time, all things
remaining equal. This non-GAAP ratio excludes Regional Banking’s core deposit intangible
amortization expense related to The Bank of New York transaction and the Bank One merger of
$458 million, $496 million and $264 million for the years ended December 31, 2006, 2005 and
2004, respectively.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income of $3.2 billion was down by $214
million, or 6%, from the prior year. A decline in
Mortgage Banking was offset partially by improved
results in Regional Banking and Auto Finance.
Total net revenue of $14.8 billion was flat
compared with the prior year. Net interest income
of $10.2 billion was down slightly due to narrower
spreads on loans and deposits in Regional Banking,
lower auto loan and lease balances and the sale of
the insurance business. These declines were offset
by the benefit of higher deposit and loan balances
in Regional Banking, wider loan spreads in Auto
Finance and The Bank of New York transaction.
Noninterest revenue of $4.7 billion was up $35
million, or 1%, from the prior year. Results
benefited from increases in deposit-related and
branch production fees, higher automobile operating
lease revenue and The Bank of New York transaction.
This benefit was offset by lower net mortgage
servicing revenue, the sale of the insurance
business and losses related to loans transferred to
held-for-sale. In 2006, losses of $233 million,
compared with losses of $120 million in 2005, were
recognized in Regional Banking related to mortgage
loans transferred to held-for-sale; and losses of
$50 million, compared with losses of $136 million
in the prior year, were recognized in Auto Finance
related to automobile loans transferred to
held-for-sale.
The provision for credit losses of $561 million was
down by $163
million from the prior-year provision due to the
absence of a $250 million special provision for
credit losses related to Hurricane Katrina in the
prior year, partially offset by the establishment
of additional allowance for loan losses related to
loans acquired from The Bank of New York.
Noninterest expense of $8.9 billion was up by $342
million, or 4%, primarily due to The Bank of New
York transaction, the acquisition of Collegiate
Funding Services, investments in the retail
distribution network and higher depreciation
expense on owned automobiles subject to operating
leases. These increases were offset partially by
the sale of the insurance business and
merger-related and other operating efficiencies and
the absence of a $40 million prior-year charge
related to the dissolution of a student loan joint
venture.
2005 compared with 2004
Net income was $3.4 billion, up $1.2 billion from
the prior year. The increase was due largely to the
Merger but also reflected increased deposit
balances and wider spreads, higher home equity and
subprime mortgage balances, and expense savings in
all businesses. These benefits were offset
partially by narrower spreads on retained loan
portfolios, the special provision for Hurricane
Katrina and net losses associated with portfolio
loan sales in Regional Banking and Auto Finance.
Total net revenue increased to $14.8 billion, up
$4.0 billion, or 37%, due primarily to the Merger.
Net interest income of $10.2 billion increased by
$2.5 billion as a result of the Merger, increased
deposit balances and wider spreads, and growth in
retained consumer real estate loans. These benefits
were offset partially by narrower spreads on loan
balances and the absence of loan portfolios sold in
late 2004 and early 2005. Noninterest revenue of
$4.6 billion increased by $1.5 billion due to the
Merger, improved MSR risk management results,
higher automobile operating lease income and
increased
38
JPMorgan Chase & Co. / 2006 Annual Report
deposit-related fees. These benefits were offset in part by losses on portfolio
loan sales in Regional Banking and Auto Finance.
The Provision for credit losses totaled $724 million, up $275 million, or 61%,
from 2004. Results included a special provision in 2005 for Hurricane Katrina
of $250 million and a release in 2004 of $87 million in the Allowance for
loan losses related to the sale of the manufactured home loan portfolio.
Excluding these items, the Provision for credit losses would have been down
$62 million, or 12%. The decline reflected reductions in the Allowance for
loan losses due to improved credit trends in most consumer lending portfolios
and the benefit of certain portfolios in run-off. These reductions were offset
partially by the Merger and higher provision expense related to subprime
mortgage loans retained on the balance sheet.
Total noninterest expense rose to $8.6 billion, an increase of $1.8 billion from
the prior year, due primarily to the Merger. The increase also reflected
continued investment in retail banking distribution and sales, increased depreciation
expense on owned automobiles subject to operating leases and a $40 million
charge related to the dissolution of a student loan joint venture. Expense
savings across all businesses provided a favorable offset.
Selected metrics
Year ended December 31,
(in millions, except headcount and ratios)
2006
2005
2004
(e)
Selected ending balances
Assets
$
237,887
$
224,801
$
226,560
Loans(a)
213,504
197,299
202,473
Deposits
214,081
191,415
182,372
Selected average balances
Assets
$
231,566
$
226,368
$
185,928
Loans(b)
203,882
198,153
162,768
Deposits
201,127
186,811
137,404
Equity
14,629
13,383
9,092
Headcount
65,570
60,998
59,632
Credit data and quality statistics
Net charge-offs(c)
$
576
$
572
$
990
Nonperforming loans(d)
1,677
1,338
1,161
Nonperforming assets
1,902
1,518
1,385
Allowance for loan losses
1,392
1,363
1,228
Net charge-off rate(b)
0.31
%
0.31
%
0.67
%
Allowance for loan losses to
ending loans(a)
0.77
0.75
0.67
Allowance for loan losses to
nonperforming loans(d)
89
104
107
Nonperforming loans to total loans
0.79
0.68
0.57
(a)
Includes loans held-for-sale of $32,744 million, $16,598 million and $18,022 million at
December 31, 2006, 2005 and 2004, respectively. These amounts are not included in the
allowance coverage ratios.
(b)
Average loans include loans held-for-sale of $16,129 million, $15,675 million and $14,736
million for 2006, 2005 and 2004, respectively. These amounts are not included in the net
charge-off rate.
(c)
Includes $406 million of charge-offs related to the manufactured home loan portfolio in 2004.
(d)
Nonperforming loans include loans held-for-sale of $116 million, $27 million and $13 mil-
lion at December 31, 2006, 2005 and 2004, respectively. These amounts are not included in
the allowance coverage ratios.
(e)
2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
Regional Banking
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(b)
Noninterest revenue
$
3,204
$
3,138
$
1,975
Net interest income
8,768
8,531
5,949
Total net revenue
11,972
11,669
7,924
Provision for credit losses
354
512
239
Noninterest expense
6,825
6,675
4,978
Income before income tax expense
4,793
4,482
2,707
Net income
$
2,884
$
2,780
$
1,697
ROE
27
%
31
%
34
%
ROA
1.79
1.84
1.53
Overhead ratio
57
57
63
Overhead ratio excluding core
deposit intangibles(a)
53
53
59
(a)
Regional Banking uses the overhead ratio (excluding the amortization of core
deposit intangibles (“CDI”)), a non-GAAP financial measure, to evaluate the underlying
expense trends of the business. Including CDI amortization expense in the overhead ratio
calculation results in a higher overhead ratio in the earlier years and a lower overhead
ratio in later years; this inclusion would result in an improving overhead ratio over
time, all things remaining equal.
This non-GAAP ratio excludes Regional Banking’s core deposit intangible amortization
expense related to The Bank of New York transaction and the Bank One merger of $458 million, $496 million and $264 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Regional Banking Net income of $2.9 billion was up
by $104 million from the prior year. Total net
revenue of $12.0 billion was up by $303 million, or
3%, including the impact of a $233 million
current-year loss resulting from $13.3 billion of
mortgage loans transferred to held-for-sale and a
prior-year loss of $120 million resulting from $3.3
billion of mortgage loans transferred to
held-for-sale. Results benefited from The Bank of
New York transaction; the acquisition of Collegiate
Funding Services; growth in deposits and home
equity loans; and increases in deposit-related fees
and credit card sales. These benefits were offset
partially by the sale of the insurance business,
narrower spreads on loans, and a shift to
narrower-spread deposit products. The Provision for
credit losses decreased by $158 million, primarily
the result of a $230 million special provision in
the prior year related to Hurricane Katrina, which
was offset partially by additional Allowance for
loan losses related to the acquisition of loans
from The Bank of New York and increased net
charge-offs due to portfolio seasoning and
deterioration in subprime mortgages. Noninterest
expense of $6.8 billion was up by $150 million, or
2%, from the prior year. The increase was due to
investments in the retail distribution network, The
Bank of New York transaction and the acquisition of
Collegiate Funding Services, partially offset by
the sale of the insurance business, merger savings
and operating efficiencies, and the absence of a
$40 million prior-year charge related to the
dissolution of a student loan joint venture.
2005 compared with 2004
Regional Banking Net income of $2.8 billion was up
by $1.1 billion from the prior year, including the
impact of the Merger, and a current-year loss of
$120 million resulting from $3.3 billion of
mortgage loans transferred to held-for-sale
compared with a prior-year loss of $52 million
resulting from $5.2 billion of mortgage loans
transferred to held-for-sale. Growth related to the
Merger was offset partially by the impact of a $230
million special provision for credit losses related
to Hurricane Katrina. Total net revenue of $11.7
billion was up by $3.7 billion, benefiting from the
Merger, wider spreads on increased deposit
balances, higher deposit-related fees and increased
loan balances. These benefits were offset partially
by mortgage loan spread compression due
JPMorgan Chase & Co. / 2006 Annual Report
39
Management’s discussion and analysis
JPMorgan Chase & Co.
to rising short-term interest rates and a flat
yield curve, which contributed to accelerated home
equity loan payoffs. The Provision for credit
losses increased by $273 million, primarily the
result of the $230 million special provision
related to Hurricane Katrina, a prior-year $87
million benefit associated with the Firm’s exit of
the manufactured home loan business and the Merger.
These increases were offset partially by the impact
of lower net charge-offs and
improved credit trends. Noninterest expense of $6.7
billion was up by $1.7 billion as a result of the
Merger, the continued investment in branch
distribution and sales, and a $40 million charge
related to the dissolution of a student loan joint
venture, partially offset by merger savings and
operating efficiencies.
Selected metrics
Year ended December 31,
(in millions, except ratios and
where otherwise noted)
2006
2005
2004
(h)
Business metrics (in billions)
Selected ending balances
Home equity origination volume
$
51.9
$
54.1
$
41.8
End-of-period loans owned
Home equity
85.7
73.9
67.6
Mortgage
30.1
44.6
41.4
Business banking
14.1
12.8
12.5
Education
10.3
3.0
3.8
Other loans(a)
2.7
2.6
3.6
Total end of period loans
142.9
136.9
128.9
End-of-period deposits
Checking
68.7
64.9
60.8
Savings
92.4
87.7
86.9
Time and other
43.3
29.7
24.2
Total end-of-period deposits
204.4
182.3
171.9
Average loans owned
Home equity
78.3
69.9
42.9
Mortgage
45.1
45.4
40.6
Business banking
13.2
12.6
7.3
Education
8.3
2.8
2.1
Other loans(a)
2.6
3.1
6.5
Total average loans(b)
147.5
133.8
99.4
Average deposits
Checking
62.8
61.7
43.7
Savings
89.9
87.5
66.5
Time and other
37.5
26.1
16.6
Total average deposits
190.2
175.3
126.8
Average assets
160.8
150.8
110.9
Average equity
10.5
9.1
5.0
Credit data and quality statistics
30+ day delinquency rate(c)(d)
2.02
%
1.68
%
1.47
%
Net charge-offs
Home equity
$
143
$
141
$
79
Mortgage
56
25
19
Business banking
91
101
77
Other loans
48
28
552
Total net charge-offs
338
295
727
Net charge-off rate
Home equity
0.18
%
0.20
%
0.18
%
Mortgage
0.12
0.06
0.05
Business banking
0.69
0.80
1.05
Other loans
0.59
0.93
8.49
Total net charge-off rate(b)
0.23
0.23
0.75
Nonperforming assets(e)(f)(g)
$
1,725
$
1,282
$
1,145
(a)
Includes commercial loans derived from community development activities and,
prior to July 1, 2006, insurance policy loans.
(b)
Average loans include loans held-for-sale of $2.8 billion, $2.9 billion and $3.1
billion for the years ended December 31, 2006, 2005 and 2004, respectively. These amounts
are not
included in the net charge-off rate.
(c)
Excludes delinquencies related to loans eligible for repurchase as well as loans
repurchased from Governmental National Mortgage Association (“GNMA”) pools that are
insured by government agencies of $1.0 billion, $0.9 billion, and $0.9 billion at December31, 2006, 2005 and 2004, respectively. These amounts are excluded as reimbursement is
proceeding normally.
(d)
Excludes loans that are 30 days past due and still accruing, which are insured
by government agencies under the Federal Family Education Loan Program of $0.5 billion at
December 31, 2006. The education loans past due 30 days were insignificant at December 31,2005 and 2004. These amounts are excluded as reimbursement is proceeding normally.
(e)
Excludes nonperforming assets related to loans eligible for repurchase as well
as loans repurchased from GNMA pools that are insured by government agencies of $1.2
billion, $1.1 billion, and $1.5 billion at December 31, 2006, 2005, and 2004,
respectively. These amounts are excluded as reimbursement is proceeding normally.
(f)
Excludes loans that are 90 days past due and still accruing, which are insured
by government agencies under the Federal Family Education Loan Program of $0.2 billion at
December 31, 2006. The Education loans past due 90 days were insignificant at December 31,2005 and 2004. These amounts are excluded as reimbursement is proceeding normally.
(g)
Includes nonperforming loans held-for-sale related to mortgage banking
activities of $11 million, $27 million, and $13 million at December 31, 2006, 2005 and
2004, respectively.
(h)
2004 results include six months of the combined Firm’s results and six months
heritage JPMorgan Chase results.
Retail branch business metrics
Year ended December 31,
(in millions, except
where otherwise noted)
2006
2005
2004
(c)
Investment sales volume
$
14,882
$
11,144
$
7,324
Number of:
Branches
3,079
2,641
2,508
ATMs
8,506
7,312
6,650
Personal bankers(a)
7,573
7,067
5,750
Sales specialists(a)
3,614
3,214
2,638
Active online customers (in thousands)(b)
5,715
4,231
3,359
Checking accounts (in thousands)
9,995
8,793
8,124
(a)
Excludes employees acquired as part of The Bank of New York transaction. Mapping
of the existing Bank of New York acquired base is expected to be completed over the next
year.
(b)
Includes Mortgage Banking and Auto Finance online customers.
(c)
2004 results include six months of the combined Firm’s results and six months
heritage JPMorgan Chase results.
The following is a brief description of
selected terms used by Regional 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.
•
Sales specialists – Retail branch product-specific experts who are licensed or
specifically trained to assist in the sale of investments, mortgages, home equity lines
and loans, and products tailored to small businesses.
40
JPMorgan Chase & Co. / 2006 Annual Report
Mortgage
Banking
Selected income statement data
Year ended December 31, (in millions,
except ratios and where otherwise noted)
2006
2005
2004
(a)
Production revenue
$
833
$
744
$
916
Net mortgage servicing revenue:
Servicing revenue
2,300
2,115
2,070
Changes in MSR asset fair value:
Due to inputs or assumptions in
model
165
770
(248
)
Other changes in fair value
(1,440
)
(1,295
)
(1,309
)
Derivative valuation adjustments
and other
(544
)
(494
)
361
Total net mortgage servicing revenue
481
1,096
874
Total net revenue
1,314
1,840
1,790
Noninterest expense
1,341
1,239
1,364
Income (loss) before income tax expense
(27
)
601
426
Net income (loss)
$
(17
)
$
379
$
269
ROE
NM
24
%
17
%
ROA
NM
1.69
1.10
Business metrics (in billions)
Third-party mortgage loans serviced
(ending)
$
526.7
$
467.5
$
430.9
MSR net carrying value (ending)
7.5
6.5
5.1
Average mortgage loans held-for-sale
12.8
12.1
11.4
Average assets
25.8
22.4
24.4
Average equity
1.7
1.6
1.6
Mortgage origination volume by
channel (in billions)
Retail
$
40.4
$
46.3
$
47.9
Wholesale
32.8
34.2
33.5
Correspondent (including negotiated
transactions)
45.9
48.5
64.2
Total
$
119.1
$
129.0
$
145.6
(a)
2004 results include six months of the combined Firm’s results and six months
heritage JPMorgan Chase results.
2006 compared with 2005
Mortgage Banking Net loss was $17 million compared
with net income of $379 million in the prior year.
Total net revenue of $1.3 billion was down by $526
million from the prior year due to a decline in net
mortgage servicing revenue offset partially by an
increase in production revenue. Production revenue
was $833 million, up by $89 million, reflecting
increased loan sales and wider gain on sale margins
that benefited from a shift in the sales mix. Net
mortgage servicing revenue, which includes loan
servicing revenue, MSR risk management results and
other changes in fair value, was $481 million
compared with $1.1 billion in the prior year. Loan
servicing revenue of $2.3 billion increased by $185
million on a 13% increase in third-party loans
serviced. MSR risk management revenue of negative
$379 million was down by $655 million from the
prior year, including the impact of a $235 million
negative valuation adjustment to the MSR asset in
the third quarter of 2006 due to changes and
refinements to assumptions used in the MSR
valuation model. This result also reflected a fully
hedged position in the current year. Other changes
in fair value of the MSR asset, representing runoff
of the asset against the realization of servicing
cash flows, were negative $1.4 billion. Noninterest
expense was $1.3 billion, up by $102 million, or
8%, due primarily to higher compensation expense
related to an increase in the number of loan
officers.
2005 compared with 2004
Mortgage Banking Net income was $379 million compared
with $269 million in the prior year. Net revenue of
$1.8 billion was up by $50 million from the prior
year. Revenue comprises production revenue and net
mortgage servicing revenue. Production revenue was
$744 million, down by $172 million, due to an 11%
decrease in mortgage originations. Net mortgage
servicing revenue, which includes loan servicing
revenue, MSR risk management results and other
changes in fair value, was $1.1 billion compared with
$874 million in the prior year. Loan servicing
revenue of $2.1 billion increased by $45 million on
an 8% increase in third-party loans serviced. MSR
risk management revenue of $276 million was up by
$163 million from the prior year, reflecting positive
risk management results. Other changes in fair value
of the MSR asset, representing runoff of the asset
against the realization of servicing cash flows, were
negative $1.3 billion. Noninterest expense of $1.2
billion was down by $125 million, or 9%, reflecting
lower production volume and operating efficiencies.
Mortgage Banking origination channels comprise
the following:
Retail – Borrowers who are
buying or refinancing a home work directly with
a mortgage banker employed by the Firm using a
branch office, the Internet or by phone.
Borrowers are frequently referred to a mortgage
banker by real estate brokers, home builders or
other third parties.
Wholesale – A third-party
mortgage broker refers loan applications to a
mortgage banker at the Firm. Brokers are
independent loan originators that specialize in
finding and counseling borrowers but do not
provide funding for loans.
Correspondent – Banks, thrifts, other
mortgage banks and other financial
institutions sell closed loans to the Firm.
Correspondent negotiated transactions (“CNT”) –
Mid- to large-sized mortgage lenders, banks and
bank-owned mortgage companies sell servicing to
the Firm on an as-originated basis. These
transactions supplement traditional production
channels and provide growth opportunities in the
servicing portfolio in stable and rising rate
periods.
Net
Mortgage servicing revenue components:
Production income – Includes net gain or loss
on sales of mortgage loans, and other
production related fees.
Servicing revenue – Represents all revenues
earned from servicing mortgage loans for third
parties, including stated service fees, excess
service fees, late fees, and other ancillary
fees.
Changes in MSR asset fair value due to inputs or
assumptions in model – Represents MSR asset
fair value adjustments due to changes in
market-based inputs, such as interest rates and
volatility, as well as updates to valuation
assumptions used in the valuation model.
Changes in MSR asset fair value due to other
changes – Includes changes in the MSR value due
to servicing portfolio runoff (or time decay).
Effective January 1, 2006, the Firm implemented
SFAS 156, adopting fair value for the MSR asset.
For the years ended December 31, 2005 and 2004,
this amount represents MSR asset amortization
expense calculated in accordance with SFAS 140.
Derivative valuation adjustments and other –
Changes in the fair value of derivative
instruments used to offset the impact of
changes in market-based inputs to the MSR
valuation model.
MSR risk management results – Includes “Changes
in MSR asset fair value due to inputs or
assumptions in model” and “Derivative valuation
adjustments and other.”
JPMorgan Chase & Co. / 2006 Annual Report
41
Management’s discussion and analysis
JPMorgan Chase & Co.
Auto Finance
Selected income statement data
Year ended December 31,
(in millions, except ratios and
where otherwise noted)
2006
2005
2004
(b)
Noninterest revenue
$
368
$
86
$
68
Net interest income
1,171
1,235
1,009
Total net revenue
1,539
1,321
1,077
Provision for credit losses
207
212
210
Noninterest expense
761
671
483
Income before income tax expense
571
438
384
Net income
$
346
$
268
$
233
ROE
14
%
10
%
9
%
ROA
0.77
0.50
0.46
Business metrics (in billions)
Auto originations volume
$
19.3
$
18.1
$
23.5
End-of-period loans and lease related
assets
Loans outstanding
$
39.3
$
41.7
$
50.9
Lease financing receivables
1.7
4.3
8.0
Operating lease assets
1.6
0.9
—
Total end-of-period loans and
lease related assets
42.6
46.9
58.9
Average loans and lease related assets
Loans outstanding(a)
$
39.8
$
45.5
$
42.3
Lease financing receivables
2.9
6.2
9.0
Operating lease assets
1.3
0.4
—
Total average loans and lease
related assets
44.0
52.1
51.3
Average assets
44.9
53.2
52.0
Average equity
2.4
2.7
2.5
Credit quality statistics
30+ day delinquency rate
1.72
%
1.66
%
1.64
%
Net charge-offs
Loans
$
231
$
257
$
219
Lease financing receivables
7
20
44
Total net charge-offs
238
277
263
Net charge-off rate
Loans(a)
0.59
%
0.57
%
0.52
%
Lease financing receivables
0.24
0.32
0.49
Total net charge-off rate(a)
0.56
0.54
0.51
Nonperforming assets
$
177
$
236
$
240
(a)
Average loans include loans held-for-sale of $0.5 billion, $0.7 billion and $0.2
billion for 2006, 2005 and 2004, respectively. These amounts are not included in the net
charge-off rate.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Total net income of $346 million was up by $78
million from the prior year, including the impact
of a $50 million current-year loss and a $136
million prior-year loss related to loans
transferred to held-for-sale. Total net revenue of
$1.5 billion was up by $218 million, or 17%,
reflecting higher automobile operating lease
revenue and wider loan spreads on lower loan and
direct finance lease balances. The provision for
credit losses of $207 million decreased by $5
million from the prior year. Noninterest expense of
$761 million increased by $90 million, or 13%,
driven by increased depreciation expense on owned
automobiles subject to operating leases, partially
offset by operating efficiencies.
2005 compared with 2004
Total net income of $268 million was up by $35
million from the prior year, including the impact
of a $136 million current-year loss related to
loans transferred to held-for-sale. Total net
revenue of $1.3 billion was up by $244 million, or
23%, reflecting higher automobile operating lease
revenue and a benefit of $34 million from the sale
of the $2 billion recreational vehicle loan
portfolio. These increases were offset partially by
narrower spreads. Noninterest expense of $671
million increased by $188, or 39%, driven by
increased depreciation expense on owned automobiles
subject to operating leases, offset partially by
operating efficiencies.
42
JPMorgan Chase & Co. / 2006 Annual Report
CARD SERVICES
With more than 154 million cards in
circulation and $153 billion in managed loans,
Chase Card Services is one of the nation’s
largest credit card issuers. Customers used Chase
cards for over $339 billion worth of transactions
in 2006.
Chase offers a wide variety of general-purpose
cards to satisfy the needs of individual
consumers, small businesses and partner
organizations, including cards issued with AARP,
Amazon, Continental Airlines, Marriott, Southwest
Airlines, Sony, United Airlines, Walt Disney Company and
many other well-known brands and organizations.
Chase also issues private-label cards with
Circuit City, Kohl’s, Sears Canada and BP.
Chase Paymentech Solutions, LLC, a joint venture
with JPMorgan Chase and First Data Corporation,
is the largest processor of MasterCard and Visa
payments in the world, having handled over 18
billion transactions in 2006.
JPMorgan Chase uses the concept of “managed
receivables” to evaluate the credit performance of
its credit card loans, both loans on the balance
sheet and loans that have been securitized. For
further information, see Explanation and
reconciliation of the Firm’s use of non-GAAP
financial measures on pages 32–33 of this Annual
Report. Managed results exclude the impact of
credit card securitizations on Total net revenue,
the Provision for credit losses, net charge-offs
and loan receivables. Securitization does not
change reported Net income; however, it does affect
the classification of items on the Consolidated
statements of income and Consolidated balance
sheets.
Selected income statement data – managed basis
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(c)
Revenue
Credit card income
$
2,587
$
3,351
$
2,179
All other income
357
212
192
Noninterest revenue
2,944
3,563
2,371
Net interest income
11,801
11,803
8,374
Total net revenue(a)
14,745
15,366
10,745
Provision for credit losses(b)
4,598
7,346
4,851
Noninterest expense
Compensation expense
1,003
1,081
893
Noncompensation expense
3,344
3,170
2,485
Amortization of intangibles
739
748
505
Total noninterest expense(a)
5,086
4,999
3,883
Income before income tax expense(a)
5,061
3,021
2,011
Income tax expense
1,855
1,114
737
Net income
$
3,206
$
1,907
$
1,274
Memo: Net securitization gains/
(amortization)
$
82
$
56
$
(8
)
Financial metrics
ROE
23
%
16
%
17
%
Overhead ratio
34
33
36
(a)
As a result of the integration of Chase Merchant Services and Paymentech
merchant processing businesses into a joint venture, beginning in the fourth quarter of
2005, Total net revenue, Total noninterest expense and Income before income tax expense
have been reduced to reflect the deconsolidation of Paymentech. There was no impact to Net
income.
(b)
2005 includes a $100 million special provision related to Hurricane Katrina; the
remaining unused portion was released in 2006.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
To illustrate underlying business trends, the
following discussion of CS’ performance assumes
that the deconsolidation of Paymentech had
occurred as of the beginning of 2004. The effect of
the deconsolidation would have reduced Total net
revenue, primarily in Noninterest revenue, and
Total noninterest expense, but would not have had
any impact on Net income for each period. The
following table presents a reconciliation of CS’
managed basis to an adjusted basis to disclose the
effect of the deconsolidation of Paymentech on CS’
results for the periods presented.
Reconciliation of Card Services’ managed results
to an adjusted basis to disclose the effect of
the Paymentech deconsolidation
Year ended December 31,
(in millions)
2006
2005
2004
(a)
Noninterest revenue
Managed for the period
$
2,944
$
3,563
$
2,371
Adjustment for Paymentech
—
(422
)
(276
)
Adjusted Noninterest revenue
$
2,944
$
3,141
$
2,095
Total net revenue
Managed for the period
$
14,745
$
15,366
$
10,745
Adjustment for Paymentech
—
(435
)
(283
)
Adjusted Total net revenue
$
14,745
$
14,931
$
10,462
Total noninterest expense
Managed for the period
$
5,086
$
4,999
$
3,883
Adjustment for Paymentech
—
(389
)
(252
)
Adjusted Total noninterest expense
$
5,086
$
4,610
$
3,631
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income of $3.2 billion was up by $1.3 billion,
or 68%, from the prior year. Results were driven
by a lower provision for credit losses due to
significantly lower bankruptcy filings.
End-of-period managed loans of $152.8 billion
increased by $10.6 billion, or 7%, from the prior
year. Average managed loans of $141.1 billion
increased by $4.7 billion, or 3%, from the prior
year. Compared with the prior year, both average
managed and end-of-period managed loans continued
to be affected negatively by higher customer
payment rates. Management believes that
contributing to the higher payment rates are the
new minimum payment rules and a higher proportion
of customers in rewards-based programs.
The current year benefited from organic growth and
reflected acquisitions of two loan portfolios. The
first portfolio was the Sears Canada credit card
business, which closed in the fourth quarter of
2005. The Sears Canada portfolio’s average managed
loan balances were $2.1 billion in the current year
and $291 million in the prior year. The second
purchase was the Kohl’s private label portfolio,
which closed in the second quarter of 2006. The
Kohl’s portfolio average and period-end managed
loan balances for 2006 were $1.2 billion and $2.5
billion, respectively.
Total net managed revenue of $14.7 billion was down
by $186 million, or 1% from the prior year. Net
interest income of $11.8 billion was flat to the
prior year. Net interest income benefited from an
increase in average managed loan balances and lower
revenue reversals associated with lower charge-offs. These
increases were offset by attrition of mature,
higher spread balances as a result of higher
payment rates and higher cost of funds on balance
growth in promotional, introductory and transactor
loan balances, which increased due to continued
investment in marketing. Noninterest revenue of
$2.9 billion was down
JPMorgan Chase & Co./2006 Annual Report
43
Management’s discussion and analysis
JPMorgan Chase & Co.
by $197 million, or 6%. Interchange income
increased, benefiting from 12% higher charge
volume, but was more than offset by higher
volume-driven payments to partners, including
Kohl’s, and increased rewards expense (both of
which are netted against interchange income).
The managed provision for credit losses was $4.6
billion, down by $2.7 billion, or 37%, from the
prior year. This benefit was due to a significant
decrease in net charge-offs of $2.4 billion,
reflecting the continued low level of bankruptcy
losses, partially offset by an increase in
contractual net charge-offs. The provision also
benefited from a release in the Allowance for loan
losses in the current year of unused reserves related to Hurricane
Katrina, compared with an increase
in the Allowance for loan losses in the prior year.
The managed net charge-off rate decreased to 3.33%,
down from 5.21% in the prior year. The 30-day
managed delinquency rate was 3.13%, up from 2.79% in
the prior year.
Noninterest expense of $5.1 billion was up $476
million, or 10%, from the prior year due largely
to higher marketing spending and acquisitions
offset partially by merger savings.
2005 compared with 2004
Net income of $1.9 billion was up $633 million, or
50%, from the prior year due to the Merger. In
addition, lower expenses driven by merger savings,
stronger underlying credit quality and higher
revenue from increased loan balances and charge
volume were offset partially by the impact of
increased bankruptcies.
Net managed revenue was $14.9 billion, up $4.5
billion, or 43%. Net interest income was $11.8
billion, up $3.4 billion, or 41%, primarily due to
the Merger, and the acquisition of a private label
portfolio. In addition, higher loan balances were
offset partially by narrower loan spreads and the
reversal of revenue related to increased bankruptcy
losses. Noninterest revenue of $3.1 billion was up
$1.0 billion, or 50%, due to the Merger and higher
interchange income from higher charge volume,
partially offset by higher volume-driven payments to
partners and higher expense related to rewards
programs.
The Provision for credit losses was $7.3 billion, up
$2.5 billion, or 51%, primarily due to the Merger,
and included the acquisition of a private label
portfolio. The provision also increased due to
record bankruptcy-related net charge-offs resulting
from bankruptcy legislation which became effective
on October 17, 2005. Finally, the Allowance for loan
losses was increased in part by the special
Provision for credit losses related to Hurricane
Katrina. These factors were offset partially by
lower contractual net charge-offs. Despite a record
level of bankruptcy losses, the net charge-off rate
improved. The managed net charge-off rate was 5.21%,
down from 5.27% in the prior year. The 30-day
managed delinquency rate was 2.79%, down from 3.70%
in the prior year, driven primarily by accelerated
loss recognition of delinquent accounts as a result
of the bankruptcy reform legislation and strong
underlying credit quality.
Noninterest expense of $4.6 billion increased by
$1.0 billion, or 27%, primarily due to the Merger,
which included the acquisition of a private label
portfolio. Merger savings, including lower
processing and compensation costs were offset
partially by higher spending on marketing.
Selected metrics
Year ended December 31,
(in millions, except headcount, ratios
and where otherwise noted)
2006
2005
2004
(d)
% of average managed outstandings:
Net interest income
8.36
%
8.65
%
9.16
%
Provision for credit losses
3.26
5.39
5.31
Noninterest revenue
2.09
2.61
2.59
Risk adjusted margin(a)
7.19
5.88
6.45
Noninterest expense
3.60
3.67
4.25
Pretax income (ROO)
3.59
2.21
2.20
Net income
2.27
1.40
1.39
Business metrics
Charge volume (in billions)
$
339.6
$
301.9
$
193.6
Net accounts opened (in thousands)(b)
45,869
21,056
7,523
Credit cards issued (in thousands)
154,424
110,439
94,285
Number of registered
Internet customers
22.5
14.6
13.6
Merchant acquiring business(c)
Bank card volume (in billions)
$
660.6
$
563.1
$
396.2
Total transactions
18,171
15,499
9,049
Selected ending balances
Loans:
Loans on balance sheets
$
85,881
$
71,738
$
64,575
Securitized loans
66,950
70,527
70,795
Managed loans
$
152,831
$
142,265
$
135,370
Selected average balances
Managed assets
$
148,153
$
141,933
$
94,741
Loans:
Loans on balance sheets
$
73,740
$
67,334
$
38,842
Securitized loans
67,367
69,055
52,590
Managed loans
$
141,107
$
136,389
$
91,432
Equity
$
14,100
$
11,800
$
7,608
Headcount
18,639
18,629
19,598
Managed credit quality statistics
Managed Net charge-offs
$
4,698
$
7,100
$
4,821
Net charge-off rate
3.33
%
5.21
%
5.27
%
Managed delinquency ratios
30+ days
3.13
%
2.79
%
3.70
%
90+ days
1.50
1.27
1.72
Allowance for loan losses
$
3,176
$
3,274
$
2,994
Allowance for loan losses to
period-end loans
3.70
%
4.56
%
4.64
%
(a)
Represents Total net revenue less Provision for credit losses.
(b)
2006 includes approximately 21 million accounts from the acquisition of the
Kohl’s private label portfolio in the second quarter of 2006 and approximately 9 million
accounts from the acquisition of the BP and Pier 1 Imports, Inc. private label portfolios
in the fourth quarter of 2006. Fourth quarter of 2005 includes approximately 10 million
accounts from the acquisition of the Sears Canada portfolio.
(c)
Represents 100% of the merchant acquiring business.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
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 partner in Chase Paymentech Solutions, LLC.
-
Bank card volume – Represents the dollar amount of transactions processed for merchants.
-
Total transactions – Represents the number of transactions and authorizations processed for merchants.
44
JPMorgan Chase & Co./2006 Annual Report
The financial information presented below reconciles reported basis and managed basis to
disclose the effect of securitizations.
Year ended December 31,
(in millions)
2006
2005
2004
(c)
Income
statement data(a)
Credit card income
Reported basis for the period
$
6,096
$
6,069
$
4,446
Securitization adjustments
(3,509
)
(2,718
)
(2,267
)
Managed credit card income
$
2,587
$
3,351
$
2,179
All other income
Reported basis for the period
$
357
$
212
$
278
Securitization adjustments
—
—
(86
)
Managed All other income
$
357
$
212
$
192
Net interest income
Reported basis for the period
$
6,082
$
5,309
$
3,123
Securitization adjustments
5,719
6,494
5,251
Managed net interest income
$
11,801
$
11,803
$
8,374
Total net revenue
Reported basis for the period
$
12,535
$
11,590
$
7,847
Securitization adjustments
2,210
3,776
2,898
Managed Total net revenue
$
14,745
$
15,366
$
10,745
Provision for credit losses
Reported data for the period(b)
$
2,388
$
3,570
$
1,953
Securitization adjustments
2,210
3,776
2,898
Managed
Provision for credit losses(b)
$
4,598
$
7,346
$
4,851
Balance
sheet – average balances(a)
Total average assets
Reported data for the period
$
82,887
$
74,753
$
43,657
Securitization adjustments
65,266
67,180
51,084
Managed average assets
$
148,153
$
141,933
$
94,741
Credit
quality statistics(a)
Net charge-offs
Reported net charge-offs data for the period
$
2,488
$
3,324
$
1,923
Securitization adjustments
2,210
3,776
2,898
Managed net charge-offs
$
4,698
$
7,100
$
4,821
(a)
For a discussion of managed basis, see the non-GAAP financial measures
discussion on pages 32–33 of this Annual Report.
(b)
2005 includes a $100 million special provision related to Hurricane Katrina,
which was released in 2006.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co./2006 Annual Report
45
Management’s discussion and analysis
JPMorgan Chase & Co.
COMMERCIAL BANKING
Commercial Banking serves more than 30,000
clients, including corporations, municipalities,
financial institutions and not-for-profit
entities. These clients generally have annual
revenues ranging from $10 million to $2 billion.
Commercial bankers serve clients nationally
throughout the RFS footprint and in offices
located in other major markets.
Commercial Banking offers its clients industry
knowledge, experience, a dedicated service model,
comprehensive solutions and local expertise. The
Firm’s broad platform positions CB to deliver
extensive product capabilities – including
lending, treasury services, investment banking
and asset management – to meet its clients’ U.S.
and international financial needs.
On October 1, 2006, JPMorgan Chase completed the
acquisition of The Bank of New York’s consumer,
business banking and middle-market banking
businesses, adding approximately $2.3 billion in
loans and $1.2 billion in deposits.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(c)
Revenue
Lending & deposit related fees
$
589
$
572
$
438
Asset management, administration
and commissions
67
57
30
All other income(a)
417
357
217
Noninterest revenue
1,073
986
685
Net interest income
2,727
2,502
1,593
Total net revenue
3,800
3,488
2,278
Provision for credit losses(b)
160
73
41
Noninterest expense
Compensation expense
740
654
461
Noncompensation expense
1,179
1,137
831
Amortization of intangibles
60
65
34
Total noninterest expense
1,979
1,856
1,326
Income before income tax expense
1,661
1,559
911
Income tax expense
651
608
350
Net income
$
1,010
$
951
$
561
Financial ratios
ROE
18
%
28
%
27
%
ROA
1.75
1.82
1.72
Overhead ratio
52
53
58
(a)
IB-related and commercial card revenues are included in All other income.
(b)
2005 includes a $35 million special provision related to Hurricane Katrina.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Commercial Banking operates in 14 of the top 15
U.S. metropolitan areas and is divided into three
businesses: Middle Market Banking, Mid-Corporate
Banking and Real Estate Banking. General coverage
for corporate clients is provided by Middle Market
Banking, which covers clients with annual revenues
generally ranging between $10 million and $500
million. Mid-Corporate Banking covers clients with
annual revenues generally ranging between $500
million and $2 billion and focuses on clients that
have broader investment-banking needs. The third
segment, Real Estate Banking, serves large regional
and national real estate customers across the
United States. In addition to these three customer
segments, CB offers several products to the Firm’s
entire customer base:
•
Asset-based financing, syndications and collateral analysis through Chase Business
Credit.
•
A variety of equipment finance and leasing products, with specialties in aircraft
finance, public sector, healthcare and information technology through Chase Equipment
Leasing.
•
Alternative capital strategies that provide a broader range of financing options,
such as mezzanine and second lien loans and preferred equity, through Chase Capital
Corporation.
With a large customer base across these segments
and products, management believes the CB loan
portfolio is highly diversified across a broad
range of industries and geographic locations.
2006 compared with 2005
Net income of $1.0 billion increased by $59
million, or 6%, from the prior year due to higher
revenue, partially offset by higher expense and
provision for credit losses.
Record net revenue of $3.8 billion increased 9%, or
$312 million. Net interest income increased to $2.7
billion, primarily driven by higher liability
balances and loan volumes, partially offset by loan
spread compression and a shift to narrower-spread
liability products. Noninterest revenue was $1.1
billion, up $87 million, or 9%, due to record
IB-related revenue and higher commercial card
revenue.
Revenue grew for each CB business compared with the
prior year, driven by increased treasury services,
investment banking and lending revenue. Compared
with the prior year, Middle Market Banking revenue
of $2.5 billion increased by $177 million, or 8%.
Mid-Corporate Banking revenue of $656 million
increased by $105 million, or 19%, and Real Estate
Banking revenue of $458 million increased by $24
million, or 6%.
Provision for credit losses was $160 million, up
from $73 million in the prior year, reflecting
portfolio activity and the establishment of
additional allowance for loan losses related to
loans acquired from The Bank of New York, partially
offset by a release of the unused portion of the
special reserve established in 2005 for Hurricane
Katrina. Net charge-offs were flat compared with
the prior year. Nonperforming loans declined 56%,
to $121 million.
Total noninterest expense of $2.0 billion increased
by $123 million, or 7%, from last year, primarily
related to incremental Compensation expense related
to SFAS 123R and increased expense resulting from
higher client usage of Treasury Services’ products.
2005 compared with 2004
Net income of $951 million was up $390 million,
or 70%, from the prior year, primarily due to
the Merger.
Total net revenue of $3.5 billion increased by $1.2
billion, or 53%, primarily as a result of the
Merger. In addition to the overall increase from
the Merger, Net interest income of $2.5 billion was
positively affected by wider spreads on higher
volume related to liability balances and increased
loan volumes, partially offset by narrower loan
spreads. Noninterest revenue of $986 million was
positively impacted by the Merger and higher IB
revenue, partially offset by lower deposit-related
fees due to higher interest rates.
Each business within CB demonstrated revenue growth
over the prior year, primarily due to the Merger.
Middle Market Banking revenue was $2.4 billion, an
increase of $861 million, or 58%, over the prior
year; Mid-Corporate Banking revenue was $551
million, an increase of $183 million, or 50%; and
46
JPMorgan Chase & Co. / 2006 Annual Report
Real Estate Banking revenue was $434 million,
up $162 million, or 60%. In addition to the
Merger, revenue was higher for each business due
to wider spreads and higher volume related to
liability balances and increased investment
banking revenue, partially offset by narrower loan
spreads.
Provision for credit losses of $73 million
increased by $32 million, primarily due to a
special provision related to Hurricane Katrina,
increased loan balances and refinements in the
data used to estimate the allowance for credit
losses. The credit quality of the portfolio was
strong with net charge-offs of $26 million, down
$35 million from the prior year, and nonperforming
loans of $272 million were down $255 million, or
48%.
Total noninterest expense of $1.9 billion
increased by $530 million, or 40%, primarily due
to the Merger and to an increase in allocated unit
costs for Treasury Services’ products.
Selected metrics
Year ended December 31,
(in millions, except headcount and ratios)
2006
2005
2004
(d)
Revenue by product:
Lending
$
1,344
$
1,215
$
805
Treasury services
2,243
2,062
1,335
Investment banking
253
206
118
Other
(40
)
5
20
Total Commercial Banking revenue
$
3,800
$
3,488
$
2,278
IB revenue, gross(a)
716
552
NA
Revenue by business:
Middle Market Banking
$
2,535
$
2,358
$
1,497
Mid-Corporate Banking
656
551
368
Real Estate Banking
458
434
272
Other
151
145
141
Total Commercial Banking revenue
$
3,800
$
3,488
$
2,278
Selected average balances
Total assets
$
57,754
$
52,358
$
32,547
Loans and leases(b)
53,596
48,117
28,914
Liability balances(c)
73,613
66,055
47,646
Equity
5,702
3,400
2,093
Average loans by business:
Middle Market Banking
$
33,225
$
31,193
$
17,500
Mid-Corporate Banking
8,632
6,388
4,354
Real Estate Banking
7,566
6,909
4,047
Other
4,173
3,627
3,013
Total Commercial Banking loans
$
53,596
$
48,117
$
28,914
Headcount
4,459
4,418
4,527
Credit data and quality statistics:
Net charge-offs
$
27
$
26
$
61
Nonperforming loans
121
272
527
Allowance for loan losses
1,519
1,392
1,322
Allowance for lending-related commitments
187
154
169
Net charge-off rate(b)
0.05
%
0.05
%
0.21
%
Allowance for loan losses to average loans(b)
2.86
2.91
4.57
Allowance for loan losses to
nonperforming loans
1,255
512
251
Nonperforming loans to average loans
0.23
0.57
1.82
(a)
Represents the total revenue related to investment banking products sold to CB
clients.
(b)
Average loans include loans held-for-sale of $442 million and $283 million for
2006 and 2005, respectively. This information is not available for 2004. Loans
held-for-sale amounts are not included in the net charge-off rate or allowance coverage
ratios.
(c)
Liability balances include deposits and deposits swept to on–balance sheet
liabilities.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Commercial Banking revenues comprise the following:
Lending includes a variety of financing
alternatives, which are often provided on a
basis secured by receivables, inventory,
equipment, real estate or other assets.
Products include:
•
Term loans
•
Revolving lines of credit
•
Bridge financing
•
Asset-based structures
•
Leases
Treasury services includes a broad range of
products and services enabling clients to
transfer, invest and manage the receipt and
disbursement of funds, while providing the
related information reporting. These products
and services include:
•
U.S. dollar and multi-currency clearing
•
ACH
•
Lockbox
•
Disbursement and reconciliation services
•
Check deposits
•
Other check and currency-related services
•
Trade finance and logistics solutions
•
Commercial card
•
Deposit products, sweeps and money market mutual funds
Investment banking provides clients with
sophisticated capital-raising alternatives, as
well as balance sheet and risk management
tools, through:
•
Advisory
•
Equity underwriting
•
Loan syndications
•
Investment-grade debt
•
Asset-backed securities
•
Private placements
•
High-yield bonds
•
Derivatives
•
Foreign exchange hedges
•
Securities sales
JPMorgan Chase & Co. / 2006 Annual Report
47
Management’s discussion and analysis
JPMorgan Chase & Co.
TREASURY & SECURITIES SERVICES
Treasury & Securities Services is a global
leader in providing transaction, investment and
information services to support the needs of
institutional clients worldwide. TSS is one of
the largest cash management providers in the
world and a leading global custodian. Treasury
Services provides a variety of cash management
products, trade finance and logistics solutions,
wholesale card products, and short-term liquidity
management capabilities to small and mid-sized
companies, multinational corporations, financial
institutions and government entities. TS partners
with the Commercial Banking, Retail Financial
Services and Asset Management businesses to serve
clients firmwide. As a result, certain TS
revenues are included in other segments’ results.
Worldwide Securities Services stores, values, clears and services securities and
alternative investments for investors and
broker-dealers; and manages Depositary Receipt
programs globally.
As a result of the transaction with The Bank of New
York on October 1, 2006, selected corporate trust
businesses were transferred from TSS to the
Corporate segment and are reported in discontinued
operations for all periods presented.
Selected income statement data
Year ending December 31,
(in millions, except ratios)
2006
2005
2004
(c)
Revenue
Lending & deposit related fees
$
735
$
731
$
649
Asset management, administration
and commissions
2,692
2,409
1,963
All other income
612
519
361
Noninterest revenue
4,039
3,659
2,973
Net interest income
2,070
1,880
1,225
Total net revenue
6,109
5,539
4,198
Provision for credit losses
(1
)
—
7
Credit reimbursement to IB(a)
(121
)
(154
)
(90
)
Noninterest expense
Compensation expense
2,198
1,874
1,414
Noncompensation expense
1,995
2,095
2,254
Amortization of intangibles
73
81
58
Total noninterest expense
4,266
4,050
3,726
Income before income tax expense
1,723
1,335
375
Income tax expense
633
472
98
Net income
$
1,090
$
863
$
277
Financial ratios
ROE
48
%
57
%
14
%
Overhead ratio
70
73
89
Pretax margin ratio(b)
28
24
9
(a)
TSS is charged a credit reimbursement related to certain exposures managed
within the IB credit portfolio on behalf of clients shared with TSS. For a further
discussion, see Credit reimbursement on page 35 of this Annual Report.
(b)
Pretax margin represents Income before income tax expense divided by Total net
revenue, which is a measure of pretax performance and another basis by which management
evaluates its performance and that of its competitors.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income was $1.1 billion, an increase of $227
million, or 26%, from the prior year. Earnings
benefited from increased revenue, and was offset by
higher compensation expense and the absence of
prior-year charges of $58 million (after-tax)
related to the termination of a client contract.
Total net revenue was $6.1 billion, an increase of
$570 million, or 10%. Noninterest revenue was $4.0
billion, up by $380 million, or 10%. The
improvement was due primarily to an increase in
assets under custody to $13.9 trillion, which was
driven by market value appreciation and new business. Also contributing to
the improvement was growth in depositary receipts,
securities lending, and global clearing, all of
which were driven by a combination of increased
product usage by existing clients and new business.
Net interest income was $2.1 billion, an increase
of $190 million, or 10%, benefiting from a 22%
increase in average liability balances, partially
offset by the impact of growth in narrower-spread
liability products.
Treasury Services Total net revenue of $2.8
billion was up 4%. Worldwide Securities Services
Total net revenue of $3.3 billion grew by $473
million, or 17%. TSS firmwide Total net revenue,
which includes Treasury Services Total net revenue
recorded in other lines of business, grew to $8.6
billion, up by $778 million, or 10%. Treasury
Services firmwide Total net revenue grew to $5.2
billion, an increase of $305 million, or 6%.
Total noninterest expense was $4.3 billion, up $216
million, or 5%. The increase was due to higher
compensation expense related to increased client
activity, business growth, investment in new
product platforms and incremental expense related
to SFAS 123R, partially offset by the absence of
prior-year charges of $93 million related to the
termination of a client contract.
2005 compared with 2004
Net income was $863 million, an increase of $586
million, or 212%. Primarily driving the improvement
in revenue were the Merger, business growth, and
widening spreads on and growth in average liability
balances. Noninterest expense increased primarily
due to the Merger and higher compensation expense.
Results for 2005 also included charges of $58
million (after-tax) to terminate a client contract.
Results for 2004 also included software-impairment
charges of $97 million (after-tax) and a gain of
$10 million (after-tax) on the sale of a business.
Total net revenue of $5.5 billion increased $1.3
billion, or 32%. Net interest income grew to $1.9
billion, up $655 million, due to wider spreads on
liability balances, a change in the corporate
deposit pricing methodology in 2004 and growth in
average liability balances. Noninterest revenue of
$3.7 billion increased by $686 million, or 23%, due
to product growth across TSS, the Merger and the
acquisition of Vastera. Leading the product revenue
growth was an increase in assets under custody to
$10.7 trillion, primarily driven by market value
appreciation and new business, along with growth in
wholesale card, securities lending, foreign
exchange, trade, clearing and ACH revenues.
Partially offsetting this growth in noninterest
revenue was a decline in deposit-related fees due
to higher interest rates and the absence, in the
current period, of a gain on the sale of a
business.
48
JPMorgan Chase & Co. / 2006 Annual Report
TS Total net revenue of $2.7 billion grew by
$635 million, and WSS Total net revenue of $2.8
billion grew by $706 million. TSS firmwide Total
net revenue, which includes TS Total net revenue
recorded in other lines of business, grew to $7.8
billion, up $2.1 billion, or 38%. Treasury Services
firmwide Total net revenue grew to $4.9 billion, up
$1.4 billion, or 41%.
Credit reimbursement to the Investment Bank was
$154 million, an increase of $64 million,
primarily as a result of the Merger. TSS is
charged a credit reimbursement related to certain
exposures managed within the Investment Bank
credit portfolio on behalf of clients shared with
TSS.
Total noninterest expense of $4.1 billion was up
$324 million, or 9%, due to the Merger, increased
compensation expense resulting from new business growth and the Vastera acquisition,
and charges of $93 million to terminate a client
contract. Partially offsetting these increases were
higher product unit costs charged to other lines of
business, primarily Commercial Banking, lower
allocations of Corporate segment expenses, merger
savings and business efficiencies. The prior year
included software-impairment charges of $155
million.
Treasury & Securities Services firmwide metrics
include certain TSS product revenues and
liability balances reported in other lines of
business for customers who are also customers of
those lines of business.
Management reviews firmwide metrics such as
liability balances, revenues and overhead ratios
in assessing financial performance for TSS as
such firmwide metrics capture the firmwide
impact of TS’ and TSS’ products and services.
Management believes such firmwide metrics are
necessary in order to understand the aggregate
TSS business.
Selected metrics
Year ending December 31,
(in millions, except headcount, ratio data
and where otherwise noted)
2006
2005
2004
(g)
Revenue by business
Treasury Services
$
2,792
$
2,695
$
2,060
Worldwide Securities Services
3,317
2,844
2,138
Total net revenue
$
6,109
$
5,539
$
4,198
Business metrics
Assets under custody (in billions)
$
13,903
$
10,662
$
9,300
Number of:
US$ ACH transactions originated (in millions)
3,503
2,966
1,994
Total US$ clearing volume (in thousands)
104,846
95,713
81,162
International electronic funds transfer
volume (in thousands)(a)
International electronic funds transfer includes non-US$ ACH and clearing
volume.
(b)
Wholesale cards issued include domestic commercial card, stored value card,
prepaid card, and government electronic benefit card products.
(c)
Liability balances include deposits and deposits swept to on-balance sheet
liabilities.
(d)
Firmwide revenue includes TS revenue recorded in the CB, Regional Banking and AM
lines of business (see below) and excludes FX revenues recorded in the IB for TSS-related
FX activity.
(in millions)
2006
2005
2004
(g)
Treasury Services revenue reported in CB
$
2,243
$
2,062
$
1,335
Treasury Services revenue reported in
other lines of business
207
180
113
TSS firmwide FX revenue, which includes FX revenue recorded in TSS and FX revenue
associated with TSS customers who are FX customers of the IB, was $445 million, $382
million and $320 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
(e)
Overhead ratios have been calculated based upon firmwide revenues and TSS and TS
expenses, respectively, including those allocated to certain other lines of business. FX
revenues and expenses recorded in the IB for TSS-related FX activity are not included in
this ratio.
(f)
Firmwide liability balances include TS’ liability balances recorded in certain
other lines of business. Liability balances associated with TS customers who are also
customers of the CB line of business are not included in TS liability balances.
(g)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
49
Management’s discussion and analysis
JPMorgan Chase & Co.
ASSET MANAGEMENT
With assets under supervision of $1.3
trillion, AM is a global leader in investment and
wealth management. AM clients include
institutions, retail investors and high-net-worth
individuals in every major market throughout the
world. AM offers global investment management in
equities, fixed income, real estate, hedge funds,
private equity and liquidity, including both
money-market instruments and bank deposits. AM
also provides trust and estate and banking
services to high-net-worth clients, and retirement
services for corporations and individuals. The
majority of AM’s client assets are in actively
managed portfolios.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2006
2005
2004
(b)
Revenue
Asset management, administration
and commissions
$
5,295
$
4,189
$
3,140
All other income
521
394
243
Noninterest revenue
5,816
4,583
3,383
Net interest income
971
1,081
796
Total net revenue
6,787
5,664
4,179
Provision for credit losses
(28
)
(56
)
(14
)
Noninterest expense
Compensation expense
2,777
2,179
1,579
Noncompensation expense
1,713
1,582
1,502
Amortization of intangibles
88
99
52
Total noninterest expense
4,578
3,860
3,133
Income before income tax expense
2,237
1,860
1,060
Income tax expense
828
644
379
Net income
$
1,409
$
1,216
$
681
Financial ratios
ROE
40
%
51
%
17
%
Overhead ratio
67
68
75
Pretax margin ratio(a)
33
33
25
(a)
Pretax margin represents Income before income tax expense divided by Total net
revenue, which is a measure of pretax performance and another basis by which management
evaluates its performance and that of its competitors.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income was a record $1.4 billion, up by $193
million, or 16%, from the prior year. Improved
results were driven by increased revenue offset
partially by higher performance-based compensation
expense, incremental expense from the adoption of
SFAS 123R and the absence of a tax credit
recognized in the prior year.
Total net revenue was a record $6.8 billion, up by
$1.1 billion, or 20%, from the prior year.
Noninterest revenue, principally fees and
commissions, of $5.8 billion was up by $1.2
billion, or 27%. This increase was due largely to
increased assets under management and higher
performance and placement fees. Net interest
income was $971 million, down by $110 million, or
10%, from the prior year. The decline was due
primarily to narrower spreads on deposit products
and the absence of BrownCo, partially offset by
higher deposit and loan balances.
Institutional revenue grew 41%, to $2.0 billion,
due to net asset inflows and higher performance
fees. Private Bank revenue grew 13%, to $1.9
billion, due to increased placement activity,
higher asset management fees and higher deposit
balances, partially offset by narrower average
spreads on deposits. Retail revenue grew 22%, to
$1.9 billion, primarily due to net asset inflows,
partially offset by the sale of BrownCo. Private
Client Services revenue decreased 1%, to $1.0
billion, as higher deposit and loan balances were
more than offset by narrower average deposit and
loan spreads.
Provision for credit losses was a benefit of $28
million compared with a benefit of $56 million in
the prior year. The current-year benefit reflects a
high level of recoveries and stable credit quality.
Total noninterest expense of $4.6 billion was up
by $718 million, or 19%, from the prior year. The
increase was due to higher performance-based
compensation, incremental expense related to SFAS
123R, increased salaries and benefits related to
business growth, and higher minority interest
expense related to Highbridge, partially offset by
the absence of BrownCo.
2005 compared with 2004
Net income of $1.2 billion was up $535 million
from the prior year due to the Merger and
increased revenue, partially offset by higher
compensation expense.
Total net revenue was $5.7 billion, up $1.5
billion, or 36%. Noninterest revenue, primarily
fees and commissions, of $4.6 billion was up $1.2
billion, principally due to the Merger, the
acquisition of a majority interest in Highbridge in
2004, net asset inflows and global equity market
appreciation. Net interest income of $1.1 billion
was up $285 million, primarily due to the Merger,
higher deposit and loan balances, partially offset
by narrower deposit spreads.
Private Bank revenue grew 9%, to $1.7 billion.
Retail revenue grew 30%, to $1.5 billion.
Institutional revenue grew 57%, to $1.4 billion,
due to the acquisition of a majority interest in
Highbridge. Private Client Services revenue grew
88%, to $1.0 billion.
Provision for credit losses was a benefit of $56
million, compared with a benefit of $14 million
in the prior year, due to lower net charge-offs
and refinements in the data used to estimate the
allowance for credit losses.
Total noninterest expense of $3.9 billion increased
by $727 million, or 23%, reflecting the Merger, the
acquisition of Highbridge and increased
compensation expense related primarily to higher
performance-based incentives.
50
JPMorgan Chase & Co. / 2006 Annual Report
Selected metrics
Year ended December 31,
(in millions, except headcount, ranking
data, and where otherwise noted)
2006
2005
2004
(e)
Revenue by client segment
Institutional
$
1,972
$
1,395
$
891
Retail
1,885
1,544
1,184
Private Bank
1,907
1,689
1,554
Private Client Services
1,023
1,036
550
Total net revenue
$
6,787
$
5,664
$
4,179
Business metrics
Number of:
Client advisors
1,506
1,484
1,377
Retirement planning services participants
1,362,000
1,299,000
918,000
% of customer assets in 4 & 5 Star
Funds(a)
58
%
46
%
48
%
% of AUM in 1st and 2nd
quartiles:(b)
1 year
83
69
66
3 years
77
68
71
5 years
79
74
68
Selected average balance sheets data
Total assets
$
43,635
$
41,599
$
37,751
Loans(c)
26,507
26,610
21,545
Deposits(c)(d)
50,607
42,123
32,431
Equity
3,500
2,400
3,902
Headcount
13,298
12,127
12,287
Credit data and quality statistics
Net charge-offs (recoveries)
$
(19
)
$
23
$
72
Nonperforming loans
39
104
79
Allowance for loan losses
121
132
216
Allowance for lending-related commitments
6
4
5
Net charge-off (recovery) rate
(0.07
)%
0.09
%
0.33
%
Allowance for loan losses to average loans
0.46
0.50
1.00
Allowance for loan losses to nonperforming loans
310
127
273
Nonperforming loans to average loans
0.15
0.39
0.37
(a)
Derived from Morningstar for the United States; Micropal for the United Kingdom,
Luxembourg, Hong Kong and Taiwan; and Nomura for Japan.
(b)
Quartile rankings sourced from Lipper for the United States and Taiwan; Micropal
for the United Kingdom, Luxembourg, Hong Kong and Taiwan; and Nomura for Japan.
(c)
The sale of BrownCo, which closed on November 30, 2005, included $3.0 billion in
both loans and deposits.
(d)
Reflects the transfer in 2005 of certain consumer deposits from RFS to AM.
(e)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
AM’s client segments comprise the following:
Institutional brings comprehensive global
investment services – including asset
management, pension analytics, asset-liability
management and active risk budgeting strategies
– to corporate and public institutions,
endowments, foundations, not-for-profit
organizations and governments worldwide.
Retail provides worldwide investment management
services and retirement planning and
administration through third-party and direct
distribution of a full range of investment
vehicles.
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.
Private Client Services offers high-net-worth
individuals, families and business owners in the
United States comprehensive wealth management
solutions, including investment management,
capital markets and risk management, tax and
estate planning, banking, and specialty-wealth
advisory services.
JPMorgan Chase & Co. / 2006 Annual Report
51
Management’s discussion and analysis
JPMorgan Chase & Co.
Assets under supervision
2006 compared with 2005
Assets under supervision (“AUS”) were $1.3
trillion, up 17%, or $198 billion, from the prior
year. Assets under management (“AUM”) were $1.0
trillion, up 20%, or $166 billion, from the prior
year. The increase was the result of net asset
inflows in the Retail segment, primarily in
equity-related products, Institutional segment
flows, primarily in liquidity products, and market
appreciation. Custody, brokerage, administration
and deposit balances were $334 billion, up by $32 billion. The Firm also has a 43% interest in
American Century Companies, Inc., whose AUM totaled
$103 billion and $101 billion at December 31, 2006
and 2005, respectively.
2005 compared with 2004
AUS at December 31, 2005, were $1.1 trillion, up
4%, or $43 billion, from the prior year despite a
$33 billion reduction due to the sale of BrownCo.
AUM were $847 billion, up 7%. The increase was
primarily the result of net asset inflows in
equity-related products and global equity market
appreciation. Custody, brokerage, administration,
and deposits were $302 billion, down $13 billion
due to a $33 billion reduction from the sale of
BrownCo. The Firm also has a 43% interest in
American Century Companies, Inc., whose AUM
totaled $101 billion and $98 billion at December31, 2005 and 2004, respectively.
Excludes Assets under management of American Century Companies, Inc.
(b)
2006 data reflects the reclassification of $19 billion of assets under
management into liquidity from other asset classes. Prior period data were not restated.
(c)
In 2006, assets under management of $22 billion from Retirement planning
services has been reclassified from the Institutional client segment to the Retail client
segment in order to be consistent with the revenue by client segment reporting.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(e)
Reflects the Merger with Bank One ($176 billion) and the acquisition of a
majority interest in Highbridge ($7 billion) in 2004.
(f)
Reflects the sale of BrownCo ($33 billion) in 2005, and the Merger with Bank One
($214 billion) and the acquisition of a majority interest in Highbridge ($7 billion) in
2004.
52
JPMorgan Chase & Co. / 2006 Annual Report
CORPORATE
The Corporate sector comprises Private
Equity, Treasury, corporate staff units and
expenses that are centrally managed. Private
Equity includes the JPMorgan Partners and ONE
Equity Partners businesses. Treasury manages the
structural interest rate risk and investment
portfolio for the Firm. The corporate staff units
include Central Technology and Operations,
Internal Audit, Executive Office, Finance, Human
Resources, Marketing & Communications, Office of
the General Counsel, Corporate Real Estate and
General Services, Risk Management, and Strategy
and Development. Other centrally managed expenses
include the Firm’s occupancy and pension-related
expenses, net of allocations to the business.
On August 1, 2006, the buyout and growth equity
professionals of JPMorgan Partners (“JPMP”) formed
an independent firm, CCMP Capital, LLC (“CCMP”), and the venture
professionals separately formed an independent
firm, Panorama Capital, LLC (“Panorama”). The
investment professionals of CCMP and Panorama
continue to manage the former JPMP investments
pursuant to a management agreement with the Firm.
On October 1, 2006, the Firm completed the exchange
of selected corporate trust businesses, including
trustee, paying agent, loan agency and document
management services, for the consumer, business
banking and middle-market banking businesses of The
Bank of New York. These corporate trust businesses,
which were previously reported in TSS, are now
reported as discontinued operations for all periods
presented within Corporate. The related balance
sheet and income statement activity were
transferred to the Corporate segment commencing
with the second quarter of 2006. Periods prior to
the second quarter of 2006 have been revised to
reflect this transfer.
Selected income statement data
Year ended December 31,
(in millions)
2006
2005
2004
(f)
Revenue
Principal transactions
$
1,175
$
1,524
$
1,542
Securities gains (losses)
(608
)
(1,487
)
332
All other income(a)
485
1,583
109
Noninterest revenue
1,052
1,620
1,983
Net interest income
(1,044
)
(2,756
)
(1,214
)
Total net revenue
8
(1,136
)
769
Provision for credit losses(b)
(1
)
10
748
Noninterest expense
Compensation expense
2,626
3,148
2,426
Noncompensation expense(c)
2,351
5,962
7,418
Merger costs
305
722
1,365
Subtotal
5,282
9,832
11,209
Net expenses allocated to other businesses
(4,141
)
(4,505
)
(4,839
)
Total noninterest expense
1,141
5,327
6,370
Income (loss) from continuing operations
before income tax expense
(1,132
)
(6,473
)
(6,349
)
Income tax expense (benefit)(d)
(1,179
)
(2,690
)
(2,661
)
Income (loss) from continuing
operations
47
(3,783
)
(3,688
)
Income from discontinued
operations (e)
795
229
206
Net income (loss)
$
842
$
(3,554
)
$
(3,482
)
(a)
Includes a gain of $103 million in 2006 related to the initial public offering
of Mastercard, and a gain of $1.3 billion on the sale of BrownCo in 2005.
(b)
2004 includes $858 million related to accounting policy conformity adjustments
in connection with the Merger.
(c)
Includes insurance recoveries related to material legal proceedings of $512
million and $208 million in 2006 and 2005, respectively. Includes litigation reserve
charges of $2.8 billion and $3.7 billion in 2005 and 2004, respectively.
(d)
Includes tax benefits recognized upon resolution of tax audits.
(e)
Includes a $622 million gain from exiting the corporate trust business in the
fourth quarter of 2006.
(f)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
2006 compared with 2005
Net income was $842 million compared with a net
loss of $3.6 billion in the prior year. In
comparison with the prior year, Private Equity
earnings was $627 million, down from $821 million;
Treasury net loss was $560 million compared with a
net loss of $2.0 billion; the net loss in Other
Corporate (including Merger costs) was $20 million compared with a net loss
of $2.6 billion; and the Net income from
discontinued operations was $795 million compared
with $229 million.
Total net revenue was $8 million, as compared with
a negative $1.1 billion in the prior year. Net
interest income was a negative $1.0 billion
compared with negative $2.8 billion in the prior
year. Treasury was the primary driver of the
improvement, with Net interest income of negative
$140 million compared with negative $1.7 billion in
the prior year, benefiting primarily from an
improvement in Treasury’s net interest spread and
an increase in available-for-sale securities.
Noninterest revenue was $1.1 billion compared with
$1.6 billion, reflecting the absence of the $1.3
billion gain on the sale of BrownCo last year and
lower Private Equity gains of $1.3 billion compared
with gains of $1.7 billion in the prior year. These
declines were offset by $619 million in securities
losses in Treasury compared with securities losses
of $1.5 billion in the prior year and a gain of
$103 million related to the sale of Mastercard
shares in its initial public offering in the
current year.
Total noninterest expense was $1.1 billion, down by
$4.2 billion from $5.3 billion in the prior year.
Insurance recoveries relating to certain material
litigation were $512 million in the current year,
while the prior-year results included a material
litigation charge of $2.8 billion, and related
insurance recoveries of $208 million. Prior-year
expense included a $145 million cost due to the
accelerated vesting of stock options. Merger costs
were $305 million compared with $722 million in the
prior year.
Discontinued operations include the results of
operations of selected corporate trust businesses
sold to The Bank of New York on October 1, 2006.
Prior to the sale, the selected corporate trust
businesses produced $173 million of Net income in
the current year compared with Net income of $229
million in the prior year. Net income from
discontinued operations for 2006 also included a
one-time gain of $622 million related to the sale
of these businesses.
2005 compared with 2004
Total net revenue was a negative $1.1 billion
compared with Total net revenue of $769 million in
the prior year. Noninterest revenue of $1.6 billion
decreased by $363 million and included securities
losses of $1.5 billion due to the following:
repositioning of the Treasury investment portfolio
to manage exposure to interest rates; the gain on
the sale of BrownCo of $1.3 billion; and the
increase in private equity gains of $262 million.
For further discussion on the sale of BrownCo, see
Note 2 on page 97 of this Annual Report.
JPMorgan Chase & Co. / 2006 Annual Report
53
Management’s discussion and analysis
JPMorgan Chase & Co.
Net interest income was a loss of $2.8
billion compared with a loss of $1.2 billion in
the prior year. Actions and policies adopted in
conjunction with the Merger and the repositioning
of the Treasury investment portfolio were the
main drivers of the increased loss.
Total noninterest expense was $5.3 billion, down
$1.1 billion from $6.4 billion in the prior year. Material litigation
charges were $2.8 billion compared with $3.7
billion in the prior year. Merger costs were $722
million compared with $1.4 billion in the prior
year. These decreases were offset primarily by the
cost of accelerated vesting of certain employee
stock options.
On September 15, 2004, JPMorgan Chase and IBM
announced the Firm’s plans to reintegrate the
portions of its technology infrastructure –
including data centers, help desks, distributed
computing, data networks and voice networks – that
were previously outsourced to IBM. In January 2005,
approximately 3,100 employees and 800 contract
employees were transferred to the Firm.
Selected metrics
Year ended December 31,
(in millions, except headcount)
2006
2005
2004
(e)
Total net revenue
Private equity $
$
1,142
$
1,521
$
1,211
Treasury
(797
)
(3,278
)
81
Corporate other(a)
(337
)
621
(523
)
Total net revenue
$
8
$
(1,136
)
$
769
Net income (loss)
Private equity
$
627
$
821
$
602
Treasury
(560
)
(2,028
)
(106
)
Corporate other(a)(b)(c)
169
(2,128
)
(3,337
)
Merger costs
(189
)
(448
)
(847
)
Income (loss) from continuing operations
47
(3,783
)
(3,688
)
Income from discontinued operations
(d)
795
229
206
Total net income (loss)
$
842
$
(3,554
)
$
(3,482
)
Headcount
23,242
30,666
26,956
(a)
Includes a gain of $64 million ($103 million pretax) in 2006 related to the
initial public offering of Mastercard, and a gain of $752 million ($1.3 billion pretax) on
the sale of BrownCo in 2005.
(b)
Includes insurance recoveries (after-tax) related to material legal proceedings of $317
million and $129 million in 2006 and 2005, respectively. Includes litigation reserve
charges (after-tax) of $1.7 billion and $2.3 billion in 2005 and 2004, respectively.
(c)
Includes tax benefits recognized upon resolution of tax audits.
(d)
Includes a $622 million gain from exiting the corporate trust business in the
fourth quarter of 2006.
(e)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Private equity portfolio
2006 compared with 2005
The carrying value of the private equity portfolio
declined by $95 million to $6.1 billion as of
December 31, 2006. This decline was due primarily
to sales offset partially by new investment activity. The portfolio represented 8.6%
of the Firm’s stockholders’ equity less goodwill
at December 31, 2006, down from 9.7% at December31, 2005.
2005 compared with 2004
The carrying value of the private equity portfolio
declined by $1.3 billion to $6.2 billion as of
December 31, 2005. This decline was primarily the result of sales and recapitalizations
of direct investments. The portfolio represented
9.7% and 12% of JPMorgan Chase’s stockholders’
equity less goodwill at December 31, 2005 and 2004,
respectively.
Selected income statement and balance sheet data
Year ended December 31,
(in millions)
2006
2005
2004
(d)
Treasury
Securities gains (losses)(a)
$
(619
)
$
(1,486
)
$
339
Investment portfolio (average)
63,361
46,520
57,776
Investment portfolio (ending)
82,091
30,741
64,949
Private equity gains (losses)
Realized gains
$
1,223
$
1,969
$
1,423
Write-ups / (write-downs)
(73
)
(72
)
(192
)
Mark-to-market gains (losses)
72
(338
)
164
Total direct investments
1,222
1,559
1,395
Third-party fund investments
77
132
34
Total private equity gains (losses)(b)
1,299
1,691
1,429
Private equity portfolio information(c)
Direct investments
Public securities
Carrying value
$
587
$
479
$
1,170
Cost
451
403
744
Quoted public value
831
683
1,758
Private direct securities
Carrying value
4,692
5,028
5,686
Cost
5,795
6,463
7,178
Third-party fund investments
Carrying value
802
669
641
Cost
1,080
1,003
1,042
Total private equity portfolio
Carrying value
$
6,081
$
6,176
$
7,497
Cost
$
7,326
$
7,869
$
8,964
(a)
Gains/losses reflect repositioning of the Treasury investment securities
portfolio. Excludes gains/losses on securities used to manage risk associated with MSRs.
(b)
Included in Principal transactions.
(c)
For further information on the Firm’s policies regarding the valuation of the
private equity portfolio, see Critical accounting estimates used by the Firm on pages
84–85 and Note 4 on pages 98–99 of this Annual Report, respectively.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
54
JPMorgan Chase & Co. / 2006 Annual Report
BALANCE SHEET ANALYSIS
Selected balance sheet data
December 31, (in millions)
2006
2005
Assets
Cash and due from banks
$
40,412
$
36,670
Deposits with banks
13,547
21,661
Federal funds sold and securities purchased
under resale agreements
140,524
133,981
Securities borrowed
73,688
74,604
Trading assets:
Debt and equity instruments
310,137
248,590
Derivative receivables
55,601
49,787
Securities:
Available-for-sale
91,917
47,523
Held-to-maturity
58
77
Interests in purchased receivables
—
29,740
Loans, net of Allowance for loan losses
475,848
412,058
Other receivables
27,585
27,643
Goodwill
45,186
43,621
Other intangible assets
14,852
14,559
All other assets
62,165
58,428
Total assets
$
1,351,520
$
1,198,942
Liabilities
Deposits
$
638,788
$
554,991
Federal funds purchased and securities sold
under repurchase agreements
162,173
125,925
Commercial paper and other borrowed funds
36,902
24,342
Trading liabilities:
Debt and equity instruments
90,488
94,157
Derivative payables
57,469
51,773
Long-term debt and trust preferred capital debt securities
145,630
119,886
Beneficial interests issued by consolidated VIEs
16,184
42,197
All other liabilities
88,096
78,460
Total liabilities
1,235,730
1,091,731
Stockholders’ equity
115,790
107,211
Total liabilities and stockholders’ equity
$
1,351,520
$
1,198,942
Balance sheet overview
At December 31, 2006, the Firm’s total assets were
$1.4 trillion, an increase of $152.6 billion, or
13%, from December 31, 2005. Total liabilities
were $1.2 trillion, an increase of $144.0 billion,
or 13%, from December 31, 2005. Stockholders’
equity was $115.8 billion, an increase
of $8.6 billion, or 8% from December 31, 2005. The
following is a discussion of the significant
changes in balance sheet items during 2006.
Federal funds sold and securities purchased under
resale agreements; Securities borrowed; Federal
funds purchased and securities sold under
repurchase agreements; and Commercial paper and Other borrowed funds
The Firm utilizes Federal funds sold and securities
purchased under resale agreements, Securities
borrowed, Federal funds purchased and securities
sold under repurchase agreements and Commercial
paper and other borrowed funds as part of its
liquidity management activities, in order to manage
the Firm’s cash positions, risk-based capital
requirements, and to maximize liquidity access and
minimize funding costs. In 2006, Federal funds sold
increased in connection with higher levels of funds
that were available for short-term investments.
Securities sold under repurchase agreements and
Commercial paper and other borrowed funds
increased primarily due to short-term requirements
to fund trading positions and AFS securities
inventory levels, as well as the result of growth
in volume related to sweeps and other cash
management products. For additional information on
the Firm’s Liquidity risk management, see pages
62–63 of this Annual Report.
Trading assets and liabilities – debt and equity instruments
The Firm uses debt and equity trading instruments
for both market-making and proprietary risk-taking
activities. These instruments consist primarily of
fixed income securities (including government and
corporate debt), equity securities and convertible
cash instruments, as well as physical commodities.
The increase in trading assets over December 31,2005, was due primarily to the more favorable
capital markets environment, with growth in
client-driven market-making activities across both
products (such as interest rate, credit and equity
markets) and regions. For additional information,
refer to Note 4 on page 98 of this Annual Report.
Trading assets and liabilities – derivative receivables and payables
The Firm utilizes various interest rate, foreign
exchange, equity, credit and commodity derivatives
for market-making, proprietary risk-taking and
risk-management purposes. The increases in
derivative receivables and payables from December31, 2005, primarily stemmed from an increase in
credit derivatives and equity contracts. For
additional information, refer to Derivative contracts and Note 4 on
pages 69-72 and 98,
respectively, of this Annual Report.
Securities
The Firm’s securities portfolio, almost all of
which is classified as AFS, is used primarily to
manage the Firm’s exposure to interest rate
movements. The AFS portfolio increased by $44.4
billion from the 2005 year end, primarily due to
net purchases in the Treasury investment securities
portfolio, in connection with repositioning the
Firm’s portfolio to manage exposure to interest
rates. For additional information related to
securities, refer to the Corporate segment
discussion and to Note 10 on pages 53–54 and
108–111, respectively, of this Annual Report.
Interests in purchased receivables and Beneficial
interests issued by consolidated VIEs
Interests in purchased receivables and Beneficial
interests issued by consolidated VIEs declined from
December 2005, as a result of the restructuring
during the second quarter of 2006 of
Firm-administered multi-seller conduits. The
restructuring resulted in the deconsolidation of
$29 billion of Interests in purchased receivables,
$3 billion of Loans and $1 billion of AFS
securities, as well as a corresponding decrease in Beneficial interests issued by
consolidated VIEs. For additional information
related to multi-seller conduits, refer to
Off–balance sheet arrangements and contractual
cash obligations on pages 59–60 and Note 15 on
pages 118–120 of this Annual Report.
JPMorgan Chase & Co. / 2006 Annual Report
55
Management’s discussion and analysis
JPMorgan Chase & Co.
Loans
The Firm provides loans to customers of all sizes,
from large corporate clients to individual
consumers. The Firm manages the risk/reward
relationship of each portfolio and discourages the
retention of loan assets that do not generate a
positive return above the cost of risk-adjusted
capital. The $63.8 billion increase in loans, net of the allowance for loan losses, from
December 31, 2005, was due primarily to an increase
of $33.6 billion in the wholesale portfolio, mainly
in the IB, reflecting an increase in capital
markets activity, including financings associated
with client acquisitions, securitizations and loan
syndications. CB loans also increased as a result
of organic growth and The Bank of New York
transaction. The $30.3 billion increase in consumer
loans was due largely to increases in CS
(reflecting strong organic growth, a reduction in
credit card securitization activity, and the
acquisitions of private-label credit card
portfolios), increases in education loans resulting
from the 2006 first-quarter acquisition of
Collegiate Funding Services, and as a result of The
Bank of New York transaction. These increases were
offset partially by a decline in auto loans and
leases. The Allowance for loan losses increased
$189 million, or 3%, from December 31, 2005. For a
more detailed discussion of the loan portfolio and
the Allowance for loan losses, refer to Credit risk
management on pages 64–76 of this Annual Report.
Goodwill
Goodwill arises from business combinations and
represents the excess of the cost of an acquired
entity over the net fair value amounts assigned to
assets acquired and liabilities assumed. The $1.6
billion increase in Goodwill primarily resulted
from the addition of $1.8 billion of goodwill from
The Bank of New York transaction in the 2006
fourth quarter and from the 2006 first-quarter
acquisition of Collegiate Funding Services.
Partially offsetting the increase in Goodwill were
reductions of $402 million resulting from the sale
of selected corporate trust businesses to The Bank
of New York; purchase accounting adjustments
associated with the 2005 fourth-quarter
acquisition of the Sears Canada credit card
business; the 2006 second quarter sale of the
insurance business; and a reduction related to
reclassifying net assets of a subsidiary as
held-for-sale. For additional information, see
Notes 3 and 16 on pages 97 and 121–123 of this
Annual Report.
Other intangible assets
The Firm’s other intangible assets consist of
mortgage servicing rights (“MSRs”), purchased
credit card relationships, other credit
card–related intangibles, core deposit
intangibles, and all other intangibles. The $293
million increase in Other intangible assets
primarily reflects higher MSRs due to growth in the
servicing portfolio, the addition of core deposit
intangibles from The Bank of New York transaction
and purchase accounting adjustments related to the
Sears Canada credit card business. Partially
offsetting these increases were the amortization of
intangibles and a $436 million reduction in Other
intangible assets as a result of the sale of
selected corporate trust businesses to The Bank of
New York. For additional information on MSRs and
other intangible assets, see Notes 3 and 16 on
pages 97 and 121–123 of this Annual Report.
Deposits
The Firm’s deposits represent a liability to
customers, both retail and wholesale, for funds
held on their behalf. Deposits are generally
classified by location (U.S. and non-U.S.), whether
they are interest- or noninterest-bearing, and by
type (demand, money market deposit accounts
(“MMDAs”), savings, time, negotiable order of
withdrawal (“NOW”) accounts), and help provide a
stable and consistent source of funding to the
Firm. Deposits increased by 15% from December 31,2005. Growth in retail deposits reflected The Bank
of New York transaction, new account acquisitions,
and the ongoing expansion of the retail branch
distribution network. Wholesale deposits increased
driven by growth in business volumes. Partially
offsetting the growth in wholesale deposits was a
$24.0 billion decline as a result of the sale of
selected corporate trust businesses to The Bank of
New York. For more information on deposits, refer
to the RFS segment discussion and the Liquidity
risk management discussion on pages 38–42 and
62–63, respectively, of this Annual Report. For
more information on wholesale liability balances,
including deposits, refer to the CB and TSS segment
discussions on pages 46–47 and 48–49,
respectively, of this Annual Report.
Long-term debt and trust preferred capital debt securities
The Firm utilizes Long-term debt and trust
preferred capital debt securities as part of its
liquidity and capital management activities.
Long-term debt and trust preferred capital debt
securities increased by $25.7 billion, or 21%, from
December 31, 2005, primarily due to net new
issuances. Continued strong foreign investor
participation in the global corporate markets
allowed JPMorgan Chase to identify attractive
opportunities globally to further diversify its
funding and capital sources. During 2006, JPMorgan
Chase issued approximately $56.7 billion of
long-term debt and trust preferred capital debt
securities. These issuances were offset partially
by $34.3 billion of long-term debt and trust
preferred capital debt securities that matured or
were redeemed. For additional information on the
Firm’s long-term debt activities, see the Liquidity
risk management discussion on pages 62–63 and Note
19 on pages 124–125 of this Annual Report.
Stockholders’ equity
Total stockholders’ equity increased by $8.6
billion, or 8%, from year-end 2005 to $115.8 billion
at December 31, 2006. The increase was primarily
the result of Net income for 2006 and net shares
issued under the Firm’s employee stock-based
compensation plans, offset partially by the
declaration of cash dividends, stock repurchases, a
charge of $1.1 billion to Accumulated other
comprehensive income (loss) related to the
prospective adoption, as required on December 31,2006, of SFAS 158 for the Firm’s defined benefit
pension and OPEB plans, and the redemption of
preferred stock. For a further discussion of
capital, see the Capital management section that
follows. For a further discussion of SFAS 158, see
Note 7 on pages 100–105 of this Annual Report.
56
JPMorgan Chase & Co. / 2006 Annual Report
CAPITAL MANAGEMENT
The Firm’s capital management framework is
intended to ensure that there is capital sufficient
to support the underlying risks of the Firm’s
business activities, as measured by economic risk
capital, and to maintain “well-capitalized” status
under regulatory requirements. In addition, the
Firm holds capital above these requirements in
amounts deemed appropriate to achieve management’s
regulatory and debt rating objectives. The process
of assigning equity to the lines of business is
integrated into the Firm’s capital framework and is
overseen by ALCO.
Line of business equity
The Firm’s framework for allocating capital is based upon the following objectives:
•
integrate firmwide capital management activities with capital management activities
within each of the lines of business;
•
measure performance consistently across all lines of business; and
•
provide comparability with peer firms for each of the lines of business.
Equity for a line of business represents the amount
the Firm believes the business would require if it
were operating independently, incorporating
sufficient capital to address economic risk
measures, regulatory capital requirements and
capital levels for similarly rated peers. Return on
equity is measured and internal targets for
expected returns are established as a key measure
of a business segment’s performance.
Effective January 1, 2006, the Firm refined its
methodology for allocating capital to the lines of
business. As a result of this refinement, RFS, CS,
CB, TSS and AM had higher amounts of capital
allocated to them commencing in the first quarter
of 2006. The revised methodology considers for each
line of business, among other things, goodwill
associated with such line of business’ acquisitions
since the Merger. In management’s view, the revised
methodology assigns responsibility to the lines of
business to generate returns on the amount of
capital supporting acquisition-related goodwill. As
part of this refinement in the capital allocation
methodology, the Firm assigned to the Corporate
segment an amount of equity capital equal to the
then-current book value of goodwill from and prior
to the Merger. As prior periods have not been
revised to reflect the new capital allocations,
capital allocated to the respective lines of
business for 2006 is not comparable to prior
periods; and certain business metrics, such as ROE,
are not comparable to the current presentation. The
Firm may revise its equity capital-allocation
methodology again in the future.
In accordance with SFAS 142, the lines of business
perform the required goodwill impairment testing.
For a further discussion of goodwill and impairment
testing, see Critical accounting estimates and Note
16 on pages 83–85 and 121–123, respectively, of
this Annual Report.
Line of business equity
Yearly Average
(in billions)
2006
2005
Investment Bank
$
20.8
$
20.0
Retail Financial Services
14.6
13.4
Card Services
14.1
11.8
Commercial Banking
5.7
3.4
Treasury & Securities Services
2.3
1.5
Asset Management
3.5
2.4
Corporate(a)
49.7
53.0
Total common stockholders’ equity
$
110.7
$
105.5
(a)
2006 and 2005 include $41.7 billion and $43.1 billion, respectively, of equity
to offset goodwill and $8.0 billion and $9.9 billion, respectively, 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 risks underlying the Firm’s
business activities, utilizing internal
risk-assessment methodologies. The Firm assigns
economic capital primarily based upon four risk
factors: credit risk, market risk, operational risk
and private equity risk, principally for the Firm’s
private equity business.
Economic risk capital
Yearly Average
(in billions)
2006
2005
Credit risk
$
22.1
$
22.6
Market risk
9.9
9.8
Operational risk
5.7
5.5
Private equity risk
3.4
3.8
Economic risk capital
41.1
41.7
Goodwill
43.9
43.1
Other(a)
25.7
20.7
(b)
Total common stockholders’ equity
$
110.7
$
105.5
(a)
Reflects additional capital required, in management’s view, to meet its
regulatory and debt rating objectives.
(b)
Includes $2.1 billion of capital previously reported as business risk capital.
Credit risk capital
Credit risk capital is estimated separately for
the wholesale businesses (IB, CB, TSS and AM) and
consumer businesses (RFS and CS).
Credit risk capital for the overall wholesale
credit portfolio is defined in terms of unexpected
credit losses, both from defaults and declines in
market value due to credit deterioration, measured
over a one-year period at a confidence level
consistent with the level of capitalization
necessary to achieve a targeted ‘AA’ solvency
standard. Unexpected losses are in excess of those
for which provisions for credit losses are
maintained. In addition to maturity and
correlations, capital allocation is based upon
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 exposure in an over-the-counter derivative
transaction is represented by the expected positive exposure based upon potential
movements of underlying market rates. The loan-equivalent amount for unused revolving
credit facilities represents the portion of the unused commitment or other contingent
exposure that is expected, based upon average portfolio historical experience, to become
outstanding in the event of a default by an obligor.
•
Default likelihood is based upon current market conditions for all Investment Bank
clients by referencing equity and credit derivatives markets, as well as certain other
publicly traded entities that are not IB clients. This methodology facilitates, in the Firm’s view, more active risk management by utilizing
a dynamic, forward-looking measure of credit. This measure changes with the credit cycle
over time, impacting the level of credit risk capital. For privately held firms and
individuals in the Commercial Bank and Asset Management, default likelihood is based upon
longer-term averages through the credit cycles.
•
Loss severity of exposure is based upon the Firm’s average historical experience
during workouts, with adjustments to account for collateral or subordination.
Credit risk capital for the consumer portfolio is
based upon product and other relevant risk
segmentation. Actual segment level default and
severity experience are used to estimate unexpected
losses for a one-year horizon at a confidence level
equivalent to the ‘AA’ solvency standard.
Statistical results for certain segments or
JPMorgan Chase & Co. / 2006 Annual Report
57
Management’s discussion and analysis
JPMorgan Chase & Co.
portfolios are adjusted to ensure that capital
is consistent with external benchmarks, such as
subordination levels on market transactions or
capital held at representative monoline
competitors, where appropriate.
Market risk capital
The Firm calculates market risk capital guided by
the principle that capital should reflect the risk
of loss in the value of portfolios and financial
instruments caused by adverse movements in market
variables, such as interest and foreign exchange
rates, credit spreads, securities prices and
commodities prices. Daily Value-at-Risk (“VAR”),
monthly stress-test results and other factors are
used to determine appropriate capital levels. The
Firm allocates market risk capital to each business
segment according to a formula that weights that
segment’s VAR and stress-test exposures. See Market
risk management on pages 77–80 of this Annual
Report for more information about these market risk
measures.
Operational risk capital
Capital is allocated to the lines of business for
operational risk using a risk-based capital
allocation methodology which estimates operational
risk on a bottom-up basis. The operational risk
capital model is based upon actual losses and
potential scenario-based stress losses, with
adjustments to the capital calculation to reflect
changes in the quality of the control environment
or the 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.
Private equity risk capital
Capital is allocated to privately- and
publicly-held securities, third-party fund
investments and commitments in the Private Equity
portfolio to cover the potential loss associated
with a decline in equity markets and related asset
devaluations.
Regulatory capital
The Firm’s federal banking regulator, the
Federal Reserve Board, 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, N.A. and Chase Bank USA, N.A.
On December 14, 2006, the federal banking
regulatory agencies announced an interim decision
that SFAS 158 will not impact regulatory capital.
Until further guidance is issued, any amounts
included in Accumulated other comprehensive income
(loss) within Stockholders’ equity related to the
adoption of SFAS 158 will be excluded from
regulatory capital. For further discussion of SFAS
158, refer to Note 7 on pages 100–105 of this
Annual Report.
In the first quarter of 2006, the federal banking
regulatory agencies issued a final rule that
provides regulatory capital relief for certain cash-collateralized, securities-borrowed
transactions. The final rule, which became
effective February 22, 2006, also broadens the
types of transactions qualifying for regulatory
capital relief under the interim rule. Adoption of
the rule did not have a material effect on the
Firm’s capital ratios.
On March 1, 2005, the Federal Reserve Board issued
a final rule, which became effective April 11,2005, that continues the inclusion of trust
preferred capital debt securities in Tier 1 capital, subject to
stricter quantitative limits and revised
qualitative standards, and broadens the definition
of restricted core capital elements. The rule
provides for a five-year transition period. As an
internationally active bank holding company,
JPMorgan Chase is subject to the rule’s limitation
on restricted core capital elements, including
trust preferred capital debt securities, to 15% of total core
capital elements, net of goodwill less any
associated deferred tax liability. At December 31,2006, JPMorgan Chase’s restricted core capital
elements were 15.1% of total core capital elements.
The following tables show that JPMorgan Chase
maintained a well-capitalized position based upon
Tier 1 and Total capital ratios at December 31, 2006
and 2005.
Tier 1 capital was $81.1 billion at December31, 2006, compared with $72.5 billion at December31, 2005, an increase of $8.6 billion. The increase
was due primarily to Net income of $14.4 billion,
net issuances of common stock under the Firm’s
employee stock based compensation plans of $3.8
billion and $873 million of additional qualifying
trust preferred capital debt securities. Partially offsetting
these increases were changes in stockholders' equity net of
Accumulated other comprehensive income (loss) due
to dividends declared of $4.9 billion, common share
repurchases of $3.9 billion, the redemption of
preferred stock of $139 million, a $1.2 billion
increase in the deduction for goodwill and other
nonqualifying intangibles and a $563 million
reduction in qualifying minority interests.
Additional information regarding the Firm’s capital
ratios and the federal regulatory capital standards
to which it is subject is presented in Note 26 on
pages 129–130 of this Annual Report.
Basel II
The Basel Committee on Banking Supervision
published the new Basel II Framework in 2004 in an
effort to update the original international bank
capital accord (“Basel I”), which has been in
effect since 1988. The goal of the Basel II
Framework is to make regulatory capital more risk-sensitive, and promote enhanced
risk management practices among large,
internationally active banking organizations.
U.S. banking regulators are in the process of
incorporating the Basel II Framework into the
existing risk-based capital requirements. JPMorgan
Chase will be required to implement advanced
measurement techniques in the U.S., commencing in
2009, by employing internal estimates of certain
key risk drivers to derive capital requirements.
Prior to its implementation of the new Basel II
Framework, JPMorgan Chase will be required to
demonstrate to its U.S. bank supervisors that its
internal criteria meet the relevant supervisory
standards. JPMorgan Chase expects to be in
compliance within the established timelines with
all relevant Basel II rules. During 2007 and 2008,
the Firm will adopt Basel II rules in certain
non-U.S. jurisdictions, as required.
Dividends
The Firm’s common stock dividend policy
reflects JPMorgan Chase’s earnings outlook, desired
dividend payout ratios, need to maintain an
adequate capital level and alternative investment
opportunities. In 2006, JPMorgan Chase declared
quarterly cash dividends on its common stock of
$0.34 per share. The Firm continues to target a
dividend payout ratio of 30-40% of net income over
time.
58
JPMorgan Chase & Co. / 2006 Annual Report
The following table shows the common
dividend payout ratio based upon reported Net
income:
For information regarding restrictions on
JPMorgan Chase’s ability to pay dividends, see
Note 25 on page 129 of this Annual Report.
Stock repurchases
On March 21, 2006, the Board of Directors
approved a stock repurchase program that authorizes
the repurchase of up to $8 billion of the Firm’s
common shares, which supercedes a $6 billion stock
repurchase program approved in 2004. The $8 billion
authorization includes shares to be repurchased to
offset issuances under the Firm’s employee
stock-based plans. The actual number of shares
repurchased is subject to various factors,
including: market conditions; legal considerations
affecting the amount and timing of repurchase
activity; the Firm’s capital position (taking into
account goodwill and intangibles); internal capital
generation; and alternative potential investment
opportunities. The repurchase program does not
include specific price targets or timetables; may
be executed through open market purchases or
privately negotiated transactions, or utilizing
Rule 10b5-1 programs; and may be suspended at any
time.
For the year ended December 31, 2006, under the
respective stock repurchase programs then in
effect, the Firm repurchased a total of 91 million
shares for $3.9 billion at an average price per
share of $43.41. Under the original $6 billion
stock repurchase program, during 2005, the Firm
repurchased 94 million shares for $3.4 billion at
an average price per share of $36.46.
As of December 31, 2006, $5.2 billion of authorized
repurchase capacity remained under the current stock
repurchase program.
The Firm has determined that it may, from time to
time, enter into written trading plans under Rule
10b5-1 of the Securities Exchange Act of 1934 to
facilitate the repurchase of common stock in
accordance with the repurchase program. A Rule
10b5-1 repurchase plan would allow the Firm to
repurchase shares during periods when it would not
otherwise be repurchasing common stock – for
example, during internal trading “black-out
periods.” All purchases under a Rule 10b5-1 plan
must be made according to a predefined plan that is
established when the Firm is not aware of material
nonpublic information.
For additional information regarding repurchases
of the Firm’s equity securities, see Part II, Item
5, Market for registrant’s common equity, related
stockholder matters and issuer purchases of equity
securities, on page 11 of JPMorgan Chase’s 2006
Form 10-K.
OFF–BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS
Special-purpose entities
JPMorgan Chase is involved with several types
of off–balance sheet arrangements, including
special purpose entities (“SPEs”), lines of credit
and loan commitments. The principal uses of SPEs
are to obtain sources of liquidity for JPMorgan
Chase and its clients by securitizing financial
assets, and to create other investment products for
clients. These arrangements are an important part
of the financial markets, providing market
liquidity by facilitating investors’ access to
specific portfolios of assets and risks. For
example, SPEs are integral to the markets for
mortgage-backed securities, commercial paper and
other asset-backed securities.
The basic SPE structure involves a company selling
assets to the SPE. The SPE funds the purchase of
those assets by issuing securities to investors. To
insulate investors from creditors of other
entities, including the seller of assets, SPEs are
generally structured to be bankruptcy-remote.
JPMorgan Chase is involved with SPEs in three broad
categories: loan securitizations, multi-seller
conduits and client intermediation. Capital is
held, as deemed appropriate, against all
SPE-related transactions and related exposures,
such as derivative transactions and lending-related
commitments. For further discussion of SPEs and the
Firm’s accounting for these types of exposures, see
Note 1 on page 94, Note 15 on pages 118–120 and
Note 16 on pages 121–123 of this Annual Report.
The Firm has no commitments to issue its own stock
to support any SPE transaction, and its policies
require that transactions with SPEs be conducted at
arm’s length and reflect market pricing. Consistent
with this policy, no JPMorgan Chase employee is
permitted to invest in SPEs with which the Firm is
involved where such investment would violate the
Firm’s Code of Conduct. These rules prohibit
employees from self-dealing and 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
short-term credit rating of JPMorgan Chase Bank,
N.A. 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 $74.4 billion and
$71.3 billion at December 31, 2006 and 2005, respectively. Alternatively, if JPMorgan Chase
Bank, N.A. were downgraded, the Firm could be
replaced by another liquidity provider in lieu of
providing funding
under the liquidity commitment, or, in certain
circumstances, could facilitate the sale or
refinancing of the assets in the SPE in order to
provide liquidity.
Of the $74.4 billion in liquidity commitments to
SPEs at December 31, 2006, $74.0 billion was
included in the Firm’s other unfunded commitments
to extend credit and asset purchase agreements, as
shown in the table on the following page. Of the $71.3 billion
of liquidity commitments to SPEs at December 31,2005, $38.9 billion was included in the Firm’s
other unfunded commitments to extend credit and
asset purchase agreements. Of these commitments,
$356 million and $32.4 billion have been excluded
from the table at December 31, 2006 and 2005,
respectively, as the underlying assets of the SPEs
have been included on the Firm’s Consolidated
balance sheets due to the consolidation of certain
multi-seller conduits as required under FIN 46R.
The decrease from the 2005 year end is due to the
deconsolidation during the 2006 second quarter of
several multi-seller conduits administrated by the
Firm. For further information, refer to Note 15 on
pages 118–120 of this Annual Report.
The Firm also has exposure to certain SPEs
arising from derivative transactions; these
transactions are recorded at fair value on the
Firm’s Consolidated balance sheets with changes
in fair value (i.e., mark-to-market (“MTM”) gains
and losses) recorded in Principal transactions.
Such MTM gains and losses are not included in the
revenue amounts reported in the following table.
The following table summarizes certain revenue
information related to consolidated and
nonconsolidated variable interest entities (“VIEs”)
with which the Firm has significant involvement,
and qualifying SPEs (“QSPEs”). The revenue reported
in the table below primarily represents servicing
and credit fee income. For further discussion of
VIEs and QSPEs, see Note 1, Note 14 and Note 15, on
pages 94, 114–118 and 118–120, respectively, of
this Annual Report.
Revenue from VIEs and QSPEs
Year ended December 31,
(in millions)
VIEs
(c)
QSPEs
Total
2006
$
209
$
3,183
$
3,392
2005(a)
222
2,940
3,162
2004(a)(b)
154
2,732
2,886
(a)
Prior-period results have been restated to reflect current methodology.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(c)
Includes VIE-related revenue (i.e., revenue associated with consolidated and
significant nonconsolidated VIEs).
JPMorgan Chase & Co. / 2006 Annual Report
59
Management’s discussion and analysis
JPMorgan Chase & Co.
Off–balance sheet lending-related financial instruments and guarantees
JPMorgan Chase utilizes lending-related
financial instruments (e.g., commitments and
guarantees) to meet the financing needs of its
customers. The contractual amount of these
financial instruments represents the maximum
possible credit risk should the counterparty draw
down the commitment or the Firm be required to
fulfill its obligation under the guarantee, and the
counterparty subsequently fail to perform according to the terms of the contract.
Most of these commitments and guarantees expire
without a default occurring or without being drawn.
As a result, the total contractual amount of these
instruments is not, in the Firm’s view,
representative of its actual future credit exposure
or funding requirements. Further, certain
commitments, primarily related to consumer
financings, are cancelable, upon notice, at the
option of the Firm. For further discussion of
lending-related commitments and guarantees and the
Firm’s accounting for them, see Credit risk
management on pages 64–76 and Note 29 on pages
132–134 of this Annual Report.
Contractual cash obligations
In the normal course of business, the Firm
enters into various contractual obligations that
may require future cash payments. Commitments for
future cash expenditures primarily include
contracts to purchase future services and capital
expenditures related to real estate–related
obligations and equipment.
The accompanying table summarizes, by remaining
maturity, JPMorgan Chase’s off–balance sheet
lending-related financial instruments and
significant contractual cash obligations at
December 31, 2006. Contractual purchases and
capital expenditures in the table below reflect the
minimum contractual obligation under legally
enforceable contracts with 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;
Derivative payables; and certain purchases of
instruments that resulted in settlement failures.
For discussion regarding Long-term debt and trust
preferred capital securities, see Note 19 on pages
124–125 of this Annual Report. For discussion
regarding operating leases, see Note 27 on page 130
of this Annual Report.
Off-balance sheet lending-related financial instruments and guarantees
2006
By remaining maturity at December 31,
Under
1–<3
3–5
Over
2005
(in millions)
1 year
years
years
5 years
Total
Total
Lending-related
Consumer(a)
$
677,784
$
3,807
$
3,604
$
62,340
$
747,535
$
655,596
Wholesale:
Other unfunded commitments to extend
credit(b)(c)(d)
92,829
52,465
67,250
16,660
229,204
208,469
Asset purchase agreements(e)
20,847
38,071
7,186
1,425
67,529
31,095
Standby letters of credit and
guarantees(c)(f)(g)
23,264
21,286
38,812
5,770
89,132
77,199
Other letters of credit(c)
4,628
823
101
7
5,559
4,346
Total wholesale
141,568
112,645
113,349
23,862
391,424
321,109
Total lending-related
$
819,352
$
116,452
$
116,953
$
86,202
$
1,138,959
$
976,705
Other guarantees
Securities lending guarantees(h)
$
318,095
$
—
$
—
$
—
$
318,095
$
244,316
Derivatives qualifying as guarantees(i)
13,542
10,656
24,414
22,919
71,531
61,759
Contractual cash obligations
Time deposits
$
195,187
$
5,314
$
2,329
$
1,519
$
204,349
$
147,381
Long-term debt
28,272
41,015
28,189
35,945
133,421
108,357
Trust preferred capital debt securities
—
—
—
12,209
12,209
11,529
FIN 46R long-term beneficial interests(j)
70
63
413
7,790
8,336
2,354
Operating leases(k)
1,058
1,995
1,656
6,320
11,029
9,734
Contractual purchases and capital expenditures
770
524
154
136
1,584
2,324
Obligations under affinity and co-brand programs
1,262
2,050
1,906
897
6,115
6,877
Other liabilities(l)
638
718
769
3,177
5,302
11,646
Total
$
227,257
$
51,679
$
35,416
$
67,993
$
382,345
$
300,202
(a)
Includes Credit card lending-related commitments of $657 billion and $579
billion at December 31, 2006 and 2005, respectively, that represent the total available
credit to the Firm’s cardholders. The Firm has not experienced, and does not anticipate,
that all of its cardholders will utilize their entire available lines of credit at the
same time. The Firm can reduce or cancel a credit card commitment by providing the
cardholder prior notice or, in some cases, without notice as permitted by law.
(b)
Includes unused advised lines of credit totaling $39.0 billion and $28.3 billion
at December 31, 2006 and 2005, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve Board, unused advised lines are not reportable.
(c)
Represents contractual amount net of risk participations totaling $32.8 billion
and $29.3 billion at December 31, 2006 and 2005, respectively.
(d)
Excludes unfunded commitments to private third-party equity funds of $589
million and $242 million at December 31, 2006 and 2005, respectively.
(e)
The maturity is based upon the weighted-average life of the underlying assets in
the SPE, which are primarily multi-seller asset-backed commercial paper conduits.
Represents asset purchase agreements with the Firm’s administered multi-seller
asset-backed commercial paper conduits, which excludes $356 million and $32.4 billion at
December 31, 2006 and 2005, respectively, related to conduits that were consolidated in
accordance with FIN 46R, as the underlying assets of the conduits are reported in the
Firm’s Consolidated balance sheets. It also includes $1.4 billion and $1.3 billion of
asset purchase agreements to other third-party entities at December 31, 2006 and 2005,
respectively. Certain of the Firm’s administered multi-seller conduits were deconsolidated
as of June 2006; the assets deconsolidated were approximately $33 billion.
(f)
JPMorgan Chase held collateral relating to $13.5 billion and $9.0 billion of
these arrangements at December 31, 2006 and 2005, respectively.
(g)
Includes unused commitments to issue standby letters of credit of $45.7 billion
and $37.5 billion at December 31, 2006 and 2005, respectively.
(h)
Collateral held by the Firm in support of securities lending indemnification
agreements was $317.9 billion and $245.0 billion at December 31, 2006 and 2005,
respectively.
(i)
Represents notional amounts of derivatives qualifying as guarantees. For further
discussion of guarantees, see Note 29 on pages 132–134 of this Annual Report.
(j)
Included on the Consolidated balance sheets in Beneficial interests issued by
consolidated VIEs.
(k)
Excludes benefit of noncancelable sublease rentals of $1.2 billion and $1.3
billion at December 31, 2006 and 2005, respectively.
(l)
Includes deferred annuity contracts. Excludes contributions for pension and other
postretirement benefits plans, if any, as these contributions are
not reasonably estimatable at this time.
60
JPMorgan Chase & Co. / 2006 Annual Report
RISK MANAGEMENT
Risk is an inherent part of JPMorgan Chase’s
business activities. The Firm’s risk management
framework and governance structure are intended to
provide comprehensive controls and ongoing
management of the major risks inherent in its
business activities. The Firm’s ability to
properly identify, measure, monitor and report
risk is critical to both its soundness and
profitability.
•
Risk identification: The Firm’s exposure to risk through its daily business
dealings, including lending, trading and capital markets activities, is identified and
aggregated through the Firm’s risk management infrastructure.
•
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 with the goal of ensuring that the Firm’s risk
estimates are reasonable and reflect underlying positions.
•
Risk monitoring/control: The Firm’s risk management policies and procedures
incorporate risk mitigation strategies and include approval limits by customer, product,
industry, country and business. These limits are monitored on a daily, weekly and monthly
basis, as appropriate.
•
Risk reporting: Risk reporting is executed on a line of business and consolidated
basis. This information is reported to management on a daily, weekly and monthly basis, as
appropriate.
There are eight major risk types identified in the
business activities of the Firm: liquidity risk,
credit risk, market risk, interest rate risk,
private equity risk, operational risk, legal and
reputation risk, and fiduciary risk.
Risk governance
The Firm’s risk governance structure starts with
each line of business being responsible for
managing its own risk. Each line of business
works closely with Risk Management of the Firm,
through its own risk committee and, in most
cases, its own chief risk officer. Each risk
committee is responsible for decisions regarding
the business’ risk strategy, policies and
controls.
Overlaying the line of business risk management
are five corporate functions with risk
management–related responsibilities, including
the Asset-Liability Committee, Treasury, Chief
Investment Office, Office of the General Counsel
and Risk Management.
The Asset-Liability Committee is responsible for
approving the Firm’s liquidity policy, including
contingency funding planning and exposure to SPEs
(and any required liquidity support by the Firm of
such SPEs). The committee also oversees the Firm’s
capital management and funds transfer pricing
policy (through which lines of business “transfer”
interest and foreign exchange risk to Treasury in
the Corporate segment). The Committee is composed
of the Firm’s Chief Financial Officer, Chief Risk
Officer, Chief Investment Officer, Corporate
Treasurer and the Chief Financial Officers of each
line of business.
Treasury and the Chief Investment Office are
responsible for measuring, monitoring, reporting
and managing the Firm’s liquidity, interest rate
and foreign exchange risk.
The Office of the General Counsel has oversight
for legal and reputation and fiduciary risks.
Risk Management is responsible for providing a
firmwide function of risk management and controls.
Within Risk Management are units responsible for
credit risk, market risk, operational risk and
private equity risk, as well as Risk Management
Services and Risk Technology and Operations. Risk
Management Services is responsible for risk policy
and methodology, risk reporting and risk education;
and Risk Technology and Operations is responsible
for building the information technology
infrastructure used to monitor and manage risk.
Risk Management is headed by the Firm’s Chief Risk
Officer, who is a member of the Operating Committee
and reports to the Chief Executive Officer and the
Board of Directors, primarily through the Board’s
Risk Policy Committee and Audit Committee. The
person who filled the position of Chief Risk
Officer during 2006 retired at the end of the year.
Until his replacement is named, the Firm’s Chief
Executive Officer is acting as the interim Chief
Risk Officer.
In addition to the risk committees of the lines of
business and the above-referenced corporate
functions, the Firm also has an Investment
Committee, which oversees global merger and
acquisition activities undertaken by JPMorgan
Chase for its own investment account, that fall
outside the scope of the Firm’s private equity and
other principal finance activities.
JPMorgan Chase & Co. / 2006 Annual Report
61
Management’s discussion and analysis
JPMorgan Chase & Co.
The Board of Directors exercises its oversight
of risk management, principally through the Board’s
Risk Policy Committee and Audit Committee. The Risk
Policy Committee oversees senior management
risk-related responsibilities, including reviewing
management policies and performance against these
policies and related benchmarks. The Audit
Committee is responsible for oversight
of guidelines and policies that 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.
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 access
enables the Firm to replace maturing obligations
when due and fund assets at appropriate maturities
and rates. To accomplish this, management uses a
variety of measures to mitigate liquidity and
related risks, taking into consideration market
conditions, prevailing interest rates, liquidity
needs and the desired maturity profile of
liabilities, among other factors.
The three primary measures of the Firm’s liquidity position include the following:
•
Holding company short-term position: Holding company short-term position measures
the parent holding company’s ability to repay all obligations with a maturity of less than
one year at a time when the ability of the Firm’s subsidiaries to pay dividends to the
parent company is constrained.
•
Cash capital position: Cash capital position is a measure intended to ensure the
illiquid portion of the balance sheet can be funded by equity, long-term debt, trust
preferred capital debt securities and deposits the Firm believes to be core.
•
Basic surplus: Basic surplus measures the 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.
Liquidity is managed so that, based upon the
measures described above, management believes
there is sufficient surplus liquidity.
An extension of liquidity management is the Firm’s
contingency funding plan. The goal of the plan is
to ensure appropriate liquidity during normal and
stress periods. The plan considers numerous
temporary and long-term stress scenarios where
access to unsecured funding is severely limited or
nonexistent, taking into account both on– and
off–balance sheet exposures, separately evaluating
access to funds by the parent holding company,
JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A.
Part of the Firm’s contingency funding plan is its
ratings downgrade analysis. For this analysis, the
impact of numerous rating agency downgrade
scenarios are considered.
The various analytics used to manage the Firm’s
liquidity and related risks rely on management’s
judgment regarding JPMorgan Chase’s ability to
liquidate assets or use assets as collateral for
borrowings and take into account historical data on
the funding of loan commitments (for example,
commercial paper back-up facilities), liquidity
commitments to SPEs, commitments with rating
triggers and collateral posting requirements.
Governance
The Firm’s Asset-Liability Committee approves the
Firm’s liquidity policy and oversees the policy’s
execution. Treasury is responsible for measuring,
monitoring, reporting and managing the Firm’s
liquidity risk profile. Treasury formulates the
Firm’s liquidity targets and strategies; monitors
the Firm’s on– and off–balance sheet liquidity
obligations; maintains contingency planning,
including ratings downgrade stress testing; and
identifies and measures internal and external
liquidity warning signals to permit early detection
of liquidity issues.
Funding
Sources of funds
Consistent with its liquidity management policy,
the Firm has raised funds at the parent holding
company sufficient to cover its obligations and
those of its nonbank subsidiaries that mature over
the next 12 months.
As of December 31, 2006, the Firm’s liquidity
position remained strong based upon its liquidity
metrics. JPMorgan Chase’s long-dated funding,
including core liabilities, exceeded illiquid
assets, and the Firm believes its obligations can
be met even if access to funding is impaired.
The diversity of the Firm’s funding sources
enhances financial flexibility and limits
dependence on any one source, thereby minimizing
the cost of funds. The deposits held by the RFS,
CB, TSS and AM lines of business are generally a
stable and consistent source of funding for
JPMorgan Chase Bank, N.A. As of December 31, 2006,
total deposits for the Firm were $639 billion. A
significant portion of the Firm’s deposits
are retail deposits, which are less sensitive to interest rate changes and
therefore are considered more stable than
market-based (i.e., wholesale) deposits. In
addition to these deposits, the Firm benefits from
substantial liability balances originated by RFS,
CB, TSS and AM through the normal course of
business. These franchise-generated liability
balances are also a stable and consistent source of
funding due to the nature of the businesses from
which they are generated. For a further discussion
of deposit and liability balance trends, see
Business Segment Results and Balance Sheet Analysis
on pages 36–52 and 55–56, respectively, of this
Annual Report.
Additional sources of funds include a variety of
both short- and long-term instruments, including
federal funds purchased, commercial paper, bank
notes, long-term debt, and trust preferred capital
debt securities. This funding is managed centrally,
using regional expertise and local market access,
to ensure active participation by the Firm in the
global financial markets while maintaining
consistent global pricing. These markets serve as a
cost-effective and diversified 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 upon
relative costs, general market conditions,
prospective views of balance sheet growth and a
targeted liquidity profile.
Finally, funding flexibility is provided by the
Firm’s ability to access the repurchase and asset
securitization markets. These markets 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 upon the credit quality and yields of the
assets securitized and are generally not dependent
upon the credit ratings of the issuing entity.
Transactions between the Firm and its
securitization structures are reflected in JPMorgan Chase’s consolidated
financial statements and notes to the consolidated
financial statements; these relationships include
retained interests in securitization trusts,
liquidity facilities and derivative transactions.
For further details, see Off–balance sheet
arrangements and contractual cash obligations and
Notes 14 and 29 on pages 59–60, 114–118 and
132–134, respectively, of this Annual Report.
62
JPMorgan Chase & Co. / 2006 Annual Report
Issuance
Continued strong foreign investor participation in
the global corporate markets allowed JPMorgan Chase
to identify attractive opportunities globally to
further diversify its funding and capital sources.
During 2006, JPMorgan Chase issued approximately
$56.7 billion of long-term debt and trust preferred
capital debt securities. These issuances were
offset partially by $34.3 billion of long-term debt
and trust preferred capital debt securities that
matured or were redeemed, and by the Firm’s
redemption of $139 million of preferred stock. In
addition, in 2006 the Firm securitized
approximately $16.8 billion of residential mortgage
loans and $9.7 billion of credit card loans,
resulting in pretax gains on securitizations of $85
million and $67 million, respectively. In addition,
the Firm securitized approximately $2.4 billion of
automobile loans resulting in an insignificant
gain. For a further discussion of loan
securitizations, see Note 14 on pages 114–118 of
this Annual Report.
In
connection with the issuance of certain of its trust preferred
capital debt securities, the Firm has entered into Replacement
Capital Covenants (“RCCs”) granting certain rights to the
holder of “covered debt,” as defined in the RCCs, that
prohibit the repayment, redemption or purchase of the trust preferred
capital debt securities except, with limited exceptions, to the extent
that JPMorgan Chase has received specified amounts of proceeds from
the sale of certain qualifying securities. Currently the Firm’s
covered debt is its 5.875% Junior Subordinated Deferrable Interest
Debentures, Series O, due 2035. For more information regarding
these covenants, see the Forms 8-K filed by the Firm on
August 17, 2006, September 28, 2006 and February 2,2007.
Cash Flows
Cash Flows from Operating Activities
For the years ended December 31, 2006 and 2005, net
cash used in operating activities was $49.6 billion
and $30.2 billion, respectively. Net cash was used
to support the Firm’s lending and capital markets
activities, as well as to support loans originated
or purchased with an initial intent to sell.
JPMorgan Chase’s operating assets and liabilities
vary significantly in the normal course of business
due to the amount and timing of cash flows.
Management believes cash flows from operations,
available cash balances and short- and long-term
borrowings will be sufficient to fund the Firm’s
operating liquidity needs.
Cash Flows from Investing Activities
The Firm’s investing activities primarily include
originating loans to be held to maturity, other
receivables, and the available-for-sale investment
portfolio. For the year ended December 31, 2006,
net cash of $99.6 billion was used in investing
activities, primarily due to increased loans in the
wholesale portfolio, mainly in the IB, reflecting
an increase in capital markets activity, as well as
organic growth in CB. On the consumer side,
increases in CS loans reflected strong organic
growth, the acquisitions of private-label credit
card portfolios and the 2006 first-quarter acquisition of
Collegiate Funding Services, offset partially by
credit card securitization activity and a decline
in auto loans and leases. Cash also was used to
fund the increase in the Treasury investment
securities portfolio, primarily in connection with
repositioning of the Firm’s portfolio to manage
exposure to interest rates.
For the year ended December 31, 2005, net cash of
$12.9 billion was used in investing activities,
primarily attributable to growth in consumer loans,
primarily home equity and in CS, reflecting growth
in new account originations and the acquisition of
the Sears Canada credit card business, offset
partially by securitization activity and a decline
in auto loans reflecting a difficult auto lending
market. Net cash was generated by the Treasury
investment securities portfolio primarily from
maturities of securities, as purchases and sales of
securities essentially offset each other.
Cash Flows from Financing Activities
The Firm’s financing activities primarily include
the issuance of debt and receipt of customer
deposits. JPMorgan Chase pays quarterly dividends
on its common stock and has an ongoing stock
repurchase program. In 2006, net cash provided by
financing activities was $152.7 billion due to
growth in deposits, reflecting the ongoing
expansion of the retail branch distribution network
and higher wholesale business volumes; and net new
issuances of Long-term debt and trust preferred
capital debt securities, offset partially by the
payment of cash dividends and stock repurchases.
In 2005, net cash provided by financing activities
was $45.1 billion due to growth in deposits,
reflecting, on the retail side, new account
acquisitions and the ongoing expansion of the
branch distribution network, and higher wholesale
business volumes; and net new issuances of
Long-term debt and trust preferred capital debt
securities, offset partially by the payment of cash
dividends and stock repurchases.
Credit ratings
The credit ratings of JPMorgan Chase’s parent holding company and each of its significant
banking subsidiaries, as of December 31, 2006, 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+
On February 14, 2007, S&P raised the senior
long-term debt ratings on JPMorgan Chase & Co. and
the operating bank subsidiaries to AA- and AA,
respectively. Additionally, S&P raised the
short-term debt rating of JPMorgan Chase & Co. to
A-1+. Similarly, on February 16, 2007, Fitch raised the
senior long-term debt rating on JPMorgan Chase & Co. and
operating bank subsidiaries to AA-. Fitch also raised the
short-term debt rating of JPMorgan Chase & Co. to F1+. The cost and availability of unsecured
financing are influenced by credit ratings. A
reduction in these ratings could have an adverse
affect on 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 disciplined liquidity monitoring procedures.
If the Firm’s ratings were downgraded by one notch,
the Firm estimates the incremental cost of funds
and the potential loss of funding to be negligible.
Additionally, the Firm estimates the additional funding requirements for VIEs and other
third-party commitments would not be material. In
the current environment, the Firm believes a
downgrade is unlikely. For additional information
on the impact of a credit ratings downgrade on the
funding requirements for VIEs, and on derivatives
and collateral agreements, see Special-purpose
entities on page 59 and Ratings profile of
derivative receivables mark-to-market (“MTM”) on
page 71, of this Annual Report.
JPMorgan Chase & Co. / 2006 Annual Report
63
Management’s discussion and analysis
JPMorgan Chase & Co.
CREDIT RISK MANAGEMENT
Credit risk is the risk of loss from obligor or
counterparty default. The Firm provides credit (for
example, through loans, lending-related commitments
and derivatives) to customers of all sizes, from
large corporate clients to the individual consumer.
The Firm manages the risk/reward relationship of
each credit and discourages the retention of assets
that do not generate a positive return above the
cost of risk-adjusted capital. The majority of the
Firm’s wholesale syndicated loan originations
(primarily to IB clients) continues to be
distributed into the marketplace, with residual
holds by the Firm averaging less than 10%.
Wholesale loans generated by CB and AM are
generally retained on the balance sheet. With
regard to the consumer credit market, the Firm
focuses on creating a portfolio that is diversified
from both a product and a geographic perspective.
Within the mortgage business, originated loans are
retained on the balance sheet as well as
securitized and sold selectively to U.S. government
agencies and U.S. government-sponsored enterprises;
the latter category of loans is routinely
classified as held-for-sale.
Credit risk organization
Credit risk management is overseen by the Chief
Risk Officer. The Firm’s credit risk management
governance consists of the following primary
functions:
•
establishing a comprehensive credit risk policy framework
•
calculating the allowance for credit losses and ensuring appropriate credit risk-based capital management
•
assigning and managing credit authorities in connection with the approval of all credit exposure
•
monitoring and managing credit risk across all portfolio segments
•
managing criticized exposures
Risk identification
The Firm is exposed to credit risk through lending
and capital markets activities. Credit risk
management works in partnership with the business
segments in identifying and aggregating exposures
across all lines of business.
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 on a portfolio basis. 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 upon the
amount of exposure should the obligor or the
counterparty default, the probability of default
and the loss severity given a default event. Based
upon 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, primarily are based upon statistical
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
57–59 of this Annual Report for a further
discussion of the credit risk capital methodology.)
Risk measurement for the wholesale portfolio is
assessed primarily on a risk-
rated basis; for the consumer portfolio, it is
assessed primarily on a credit-scored basis.
Risk-rated exposure
For portfolios that are risk-rated, probable and
unexpected loss calculations are based upon
estimates of probability of default and loss given
default. Probability of default is the expected
default calculated on an obligor basis. Loss given
default is an estimate of losses that are based
upon collateral and structural support for each
credit facility. Calculations and assumptions are
based upon management information systems and
methodologies which are 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 profiles and the related collateral
and structural positions.
Credit-scored exposure
For credit-scored portfolios (generally held in RFS
and CS), probable loss is based upon 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 assessed accurately, approved properly,
monitored regularly and managed actively at both
the transaction and portfolio levels. The policy
framework establishes credit approval authorities,
concentration limits, risk-rating methodologies,
portfolio-review parameters and guidelines for
management of distressed exposure. Wholesale credit
risk is monitored regularly 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 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 management of
the Firm’s exposure is accomplished through loan
syndication and participations, loan sales,
securitizations, credit derivatives, use of master
netting agreements and collateral 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 regularly to senior
credit risk management. 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 at least on a
quarterly basis. Through the risk reporting and
governance structure, credit risk trends and limit
exceptions are provided regularly to, and discussed
with, the Operating Committee.
64
JPMorgan Chase & Co. / 2005 Annual Report
2006 Credit risk overview
The wholesale portfolio exhibited credit
stability during 2006. There was substantial growth
in wholesale lending as a result of increased
capital markets–related activity, offset by
decreases in nonperforming loans and criticized
exposure of $601 million and $591 million,
respectively. In 2006, the Firm also made
significant strides in its multiyear initiative to
reengineer its wholesale credit risk systems
infrastructure. Several enhancements were
incorporated into the Firm’s operating
infrastructure in 2006. Overall, the initiative has
enhanced management of credit risk; timeliness and
accuracy of reporting; support of client
relationships; allocation of economic capital; and
compliance with Basel II initiatives. The Firm is
on target to substantially complete the initiative
by year-end 2007.
Consumer credit performance generally was stable in
2006. CS adopted the FFIEC higher minimum payment
requirements, which initially resulted in higher
payment rates than historically experienced, albeit
with losses less severe than initially anticipated.
Loans impacted by Hurricane Katrina generally have
performed better than initially projected, but have
experienced longer resolution timeframes,
especially where real estate and business banking
assets are
involved. The Allowance for loan losses related
to Hurricane Katrina was reduced by $121 million in
2006 as a result of the better than anticipated
performance. Bankruptcy reform legislation became
effective on October 17, 2005. This legislation
prompted a “rush to file” effect that resulted in a
spike in bankruptcy filings and increased 2005
credit losses, predominantly in CS. As expected,
following this spike in filings the Firm
experienced lower credit card net charge-offs in
2006, as the record levels of bankruptcy filings in
the fourth quarter of 2005 are believed to have
included bankruptcy filings that would have
occurred in 2006.
In 2006, management of the consumer segment
continued to focus on portfolios providing the most
appropriate risk/reward relationship while keeping
within the Firm’s desired risk tolerance. During
the past year, the majority of the new sub-prime
mortgage production was sold or classified as
held-for-sale. In addition, a portion of the
subprime mortgage portfolio was transferred into
the held-for-sale account. The Firm also continued a de-emphasis of vehicle
finance leasing. The Firm experienced growth in
many core consumer lending products including home
equity, credit cards, education, and business
banking reflecting a focus on the prime credit
quality segment of the market.
CREDIT PORTFOLIO
The following table presents JPMorgan Chase’s
credit portfolio as of December 31, 2006 and 2005.
Total credit exposure at December 31, 2006,
increased by $198.7 billion from December 31,2005, reflecting an increase of $80.0 billion in
the wholesale credit portfolio and $118.7 billion
in the consumer credit portfolio as further
described in the following pages.
In the table below, reported loans include all HFS
loans, which are carried at the lower of cost or
fair value with changes in value recorded in
Noninterest revenue. However, these HFS loans are
excluded from the average loan balances used for
the net charge-off rate calculations.
Total credit portfolio
Nonperforming
Average annual
As of or for the year ended December 31,
Credit exposure
assets(i)
Net charge-offs
net charge-off rate
(in millions, except ratios)
2006
2005
2006
2005
2006
2005
2006
2005
Total credit portfolio
Loans – reported(a)
$
483,127
$
419,148
$
2,077
(j)
$
2,343
(j)
$
3,042
$
3,819
0.73
%
1.00
%
Loans – securitized(b)
66,950
70,527
—
—
2,210
3,776
3.28
5.47
Total managed loans(c)
550,077
489,675
2,077
2,343
5,252
7,595
1.09
1.68
Derivative receivables
55,601
49,787
36
50
NA
NA
NA
NA
Interests in purchased receivables(d)
—
29,740
—
—
NA
NA
NA
NA
Total managed credit-related
assets
605,678
569,202
2,113
2,393
5,252
7,595
1.09
1.68
Lending-related commitments(d)(e)
1,138,959
976,705
NA
NA
NA
NA
NA
NA
Assets acquired in loan satisfactions
NA
NA
228
197
NA
NA
NA
NA
Total credit portfolio
$
1,744,637
$
1,545,907
$
2,341
$
2,590
$
5,252
$
7,595
1.09
%
1.68
%
Net credit derivative hedges notional(f)
$
(50,733
)
$
(29,882
)
$
(16
)
$
(17
)
NA
NA
NA
NA
Collateral held against derivatives(g)
(6,591
)
(6,000
)
NA
NA
NA
NA
NA
NA
Held-for-sale
Total average HFS loans
$
38,316
$
27,713
$
87
$
95
NA
NA
NA
NA
Nonperforming – purchased(h)
251
341
NA
NA
NA
NA
NA
NA
(a)
Loans are presented net of unearned income and net deferred loan fees of $2.3
billion and $3.0 billion at December 31, 2006 and 2005, respectively.
(b)
Represents securitized credit card receivables. For further discussion of credit
card securitizations, see Card Services on pages 43–45 of this Annual Report.
(c)
Past-due 90 days and over and accruing includes credit card receivables of $1.3
billion and $1.1 billion, and related credit card securitizations of $962 million and $730
million at December 31, 2006 and 2005, respectively.
(d)
As a result of restructuring certain multi-seller conduits the Firm administers,
JPMorgan Chase deconsolidated $29 billion of Interests in purchased receivables, $3
billion of Loans and $1 billion of Securities, and recorded a related increase of $33
billion of lending-related commitments during the second quarter of 2006.
(e)
Includes wholesale unused advised lines of credit totaling $39.0 billion and
$28.3 billion at December 31, 2006 and 2005, respectively, which are not legally binding.
In regulatory filings with the Federal Reserve Board, unused advised lines are not
reportable. Credit card lending-related commitments of $657 billion and $579 billion at
December 31, 2006 and 2005, respectively, represent the total available credit to its
cardholders. The Firm has not experienced, and does not anticipate, that all of its
cardholders will utilize their entire available lines of credit at the same time. The Firm
can reduce or cancel a credit card commitment by providing the cardholder prior notice or,
in some cases, without notice as permitted by law.
(f)
Represents the net notional amount of protection purchased and sold of
single-name and portfolio credit derivatives used to manage the credit exposures; these
derivatives do not qualify for hedge accounting under SFAS 133.
(g)
Represents other liquid securities collateral held by the Firm as of December31, 2006 and 2005, respectively.
(h)
Represents distressed HFS wholesale loans purchased as part of IB’s proprietary
activities, which are excluded from nonperforming assets.
(i)
Includes nonperforming HFS loans of $120 million and $136 million as of December31, 2006 and 2005, respectively.
(j)
Excludes nonperforming assets related to (1) loans eligible for repurchase as
well as loans repurchased from GNMA pools that are insured by U.S. government agencies and
U.S. government sponsored enterprises of $1.2 billion and $1.1 billion at December 31,2006 and 2005, respectively, and (2) education loans that are 90 days past due and still
accruing, which are insured by government agencies under the Federal Family Education Loan
Program, of $0.2 billion at December 31, 2006. These amounts for GNMA and education loans
are excluded, as reimbursement is proceeding normally.
JPMorgan Chase & Co. / 2006 Annual Report
65
Management’s discussion and analysis
JPMorgan Chase & Co.
WHOLESALE CREDIT PORTFOLIO
As of December 31, 2006, wholesale exposure
(IB, CB, TSS and AM) increased by $80.0 billion
from December 31, 2005, due to increases in
lending-related commitments of $70.3 billion, Loans
of $33.6 billion, and Derivative receivables of
$5.8 billion, partially offset by a decrease of
$29.7 billion in Interests in purchased
receivables. During the second quarter of 2006,
certain multi-seller conduits that the Firm
administers were deconsolidated, resulting in a
decrease of $29 billion in Interests in purchased
receivables, offset by a related increase of $33
billion in lending-related commitments. For a more
detailed discussion of the deconsolidation, refer
to Note 15 on pages 118–120 of this Annual Report.
The remainder of the increase in Loans and
lending-related commitments was primarily in the
IB, reflecting an increase in capital
markets–related activity, including financings
associated with client acquisitions,
securitizations and loan syndications.
Wholesale
As of or for the year ended December 31,
Credit exposure
Nonperforming assets(f)
(in millions)
2006
2005
2006
2005
Loans – reported(a)
$
183,742
$
150,111
$
391
$
992
Derivative receivables
55,601
49,787
36
50
Interests in purchased receivables
—
29,740
—
—
Total wholesale credit-related assets
239,343
229,638
427
1,042
Lending-related commitments(b)
391,424
321,109
NA
NA
Assets acquired in loan satisfactions
NA
NA
3
17
Total wholesale credit exposure
$
630,767
$
550,747
$
430
$
1,059
Net credit derivative hedges notional(c)
$
(50,733
)
$
(29,882
)
$
(16
)
$
(17
)
Collateral held against derivatives(d)
(6,591
)
(6,000
)
NA
NA
Held-for-sale
Total average HFS loans
$
22,187
$
12,038
$
58
$
74
Nonperforming – purchased(e)
251
341
NA
NA
(a)
Includes loans greater or equal to 90 days past due that continue to accrue
interest. The principal balance of these loans totaled $29 million and $50 million at
December 31, 2006 and 2005, respectively. Also see Note 12 on pages 112–113 of this
Annual Report.
(b)
Includes unused advised lines of credit totaling $39.0 billion and $28.3 billion
at December 31, 2006 and 2005, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve Board, unused advised lines are not reportable.
(c)
Represents the net notional amount of protection purchased and sold of
single-name and portfolio credit derivatives used to manage the credit risk of credit
exposures; these derivatives do not qualify for hedge accounting under SFAS 133. Also see
credit derivatives positions on page 71 of this Annual Report.
(d)
Represents other liquid securities collateral held by the Firm as of December31, 2006 and 2005, respectively.
(e)
Represents distressed HFS loans purchased as part of IB’s proprietary
activities, which are excluded from nonperforming assets.
(f)
Includes nonperforming HFS loans of $4 million and $109 million as of December31, 2006 and 2005, respectively.
66
JPMorgan Chase & Co. / 2006 Annual Report
Net charge-offs/recoveries
Wholesale
Year ended December 31,
(in millions, except ratios)
2006
2005
Loans – reported
Net recoveries
$
22
$
77
Average annual net recovery rate(a)
0.01
%
0.06
%
(a)
Excludes average loans HFS of $22 billion
and $12 billion for the years ended December 31,2006 and 2005, respectively.
During both 2006 and 2005, there were no net
charge-offs for Derivative receivables, Interests
in purchased receivables or lending-related
commitments.
Net recoveries do not include gains from sales of
nonperforming loans that were sold from the credit
portfolio (as shown in the following table). Gains
from these sales during 2006 and 2005 were $72
million and $67 million, respectively, and are
reflected in Noninterest revenue.
Nonperforming loan activity
Wholesale
Year ended December 31,
(in millions)
2006
2005
Beginning balance
$
992
$
1,574
Additions
480
581
Reductions:
Paydowns and other
(578
)
(520
)
Charge-offs
(186
)
(255
)
Returned to performing
(133
)
(204
)
Sales
(184
)
(184
)
Total reductions
(1,081
)
(1,163
)
Net additions (reductions)
(601
)
(582
)
Ending balance
$
391
$
992
The following table presents summaries of the maturity and ratings profiles of the wholesale
portfolio as of December 31, 2006 and 2005. The ratings scale is based upon the Firm’s internal
risk ratings and is presented on an S&P-equivalent basis.
As a result of restructuring certain multi-seller conduits the Firm administers,
JPMorgan Chase deconsolidated $29 billion of Interests in purchased receivables, $3
billion of Loans and $1 billion of Securities, and recorded a related increase of $33
billion of lending-related commitments during the second quarter of 2006.
(b)
HFS loans relate primarily to securitization and syndication activities.
(c)
Ratings are based upon the underlying referenced assets.
(d)
The maturity profile of Loans and lending-related commitments is based upon the
remaining contractual maturity. The maturity profile of Derivative receivables is based
upon the maturity profile of Average exposure. See page 70 of this Annual Report for a
further discussion of Average exposure.
JPMorgan Chase & Co. / 2006 Annual Report
67
Management’s discussion and analysis
JPMorgan Chase & Co.
Wholesale credit exposure – selected industry concentration
The Firm focuses on the management and the
diversification of its industry concentrations. At
December 31, 2006, the top 10 industries remained
unchanged from December 31, 2005. The increase in
Banks and finance compa-
nies, Utilities, Asset managers, and Securities
firms and exchanges reflects the overall growth
in wholesale exposure. Below are summaries of the
top 10 industry concentrations as of December 31,2006 and 2005.
Wholesale credit exposure – selected industry concentration
HFS loans primarily relate to securitization and syndication activities.
(c)
Credit exposure is net of risk participations and excludes the benefit of credit
derivative hedges and collateral held against Derivative receivables or Loans.
(d)
Represents notional amounts only; these credit derivatives do not qualify for
hedge accounting under SFAS 133.
(e)
Represents other liquid securities collateral held by the Firm as of December31, 2006 and 2005, respectively.
68
JPMorgan Chase & Co. / 2006 Annual Report
Wholesale criticized exposure
Exposures deemed criticized generally represent a
ratings profile similar to a rating of CCC+/Caa1
and lower, as defined by Standard & Poor’s/Moody’s.
The criticized component of the portfolio decreased
to $5.7 billion at December 31, 2006, from $6.2
billion at year-end 2005. The decline resulted from
upgrades, repayments and reductions in wholesale
nonperforming loans as shown on page 67 of this
Annual Report.
At December 31, 2006, Healthcare, Agriculture/paper
manufacturing, Business services, and
Chemicals/plastics moved into the top 10 of
wholesale criticized exposure, replacing Telecom
services, Airlines, Machinery and equipment
manufacturing, and Building materials/construction.
Wholesale criticized exposure – industry concentrations
2006
2005
December 31,
Credit
% of
Credit
% of
(in millions, except ratios)
exposure
portfolio
exposure
portfolio
Automotive
$
1,442
29
%
$
643
12
%
Media
392
8
684
13
Consumer products
383
7
590
11
Healthcare
284
6
243
5
Retail and consumer services
278
5
288
6
Real estate
243
5
276
5
Agriculture/paper
manufacturing
239
5
178
3
Business services
222
4
250
5
Utilities
183
4
295
6
Chemicals/plastics
159
3
188
4
All other
1,201
24
1,537
30
Total excluding HFS
$
5,026
100
%
$
5,172
100
%
Held-for-sale(a)
624
1,069
Total
$
5,650
$
6,241
(a)
HFS loans primarily relate to securitization and syndication activities;
excludes purchased nonperforming HFS loans.
Wholesale selected industry discussion
Presented below is a discussion of several
industries to which the Firm has significant
exposure, as well as industries the Firm
continues to monitor because of actual or
potential credit concerns. For additional
information, refer to the tables above and on the
preceding page.
•
Banks and finance companies: This industry group, primarily consisting of exposure
to commercial banks, is the largest
segment of the Firm’s wholesale credit portfolio. Credit quality is high, as 84% of the
exposure in this category is rated investment-grade.
•
Real estate: This industry, as the second largest segment of the Firm’s wholesale
credit portfolio, continued to grow in 2006, primarily due to improving market
fundamentals and increased capital demand for the asset class supported by the relatively
low interest rate environment. Real estate exposure is well-diversified by client,
transaction type, geography, and property type. Approximately half of this exposure is to
large public and rated real estate companies and institutions (e.g., REITS), as well as
real estate loans originated for sale into the commercial mortgage-backed securities
market. The remaining exposure is primarily to professional real estate developers,
owners, or service providers and generally involves real estate leased to third-party
tenants.
•
Automotive: Automotive Original Equipment Manufacturers and suppliers based in North
America continued to be impacted negatively by a challenging operating environment in
2006. As a result, criticized exposures grew in 2006, primarily as a result of downgrades
to select names within the portfolio. Though larger in the aggregate, most of the
criticized exposure remained undrawn, was performing and substantially secured.
•
Media: Media no longer represents the largest percentage of criticized exposure
since its criticized exposures decreased significantly in 2006. This decrease was due primarily to the maturation of short-term financing arrangements,
repayments, and the planned sale to reduce select exposures.
•
All other: All other in the wholesale credit exposure concentration table on page 68
of this Annual Report at December 31, 2006, excluding HFS,
included $317.5 billion of credit
exposure to 22 industry segments. Exposures related to SPEs and high-net-worth individuals were 31% and 13%, respectively, of
this category. SPEs provide secured financing (generally backed by receivables, loans or
bonds on a bankruptcy-remote, non- recourse or limited-recourse basis) originated by a
diverse group of companies in industries that are not highly correlated. The remaining All
other exposure is well-diversified across industries other than those related to SPEs and
high-net-worth individuals; none comprise more than 3% of total exposure.
In the normal course of business, the Firm uses
derivative instruments to meet the needs of
customers; to generate revenues through trading
activities; to manage exposure to fluctuations in
interest rates, currencies and other markets; and
to manage the Firm’s credit exposure. For further
discussion of derivative contracts, see Note 28 on
pages 131–132 of this Annual Report.
JPMorgan Chase & Co. / 2006 Annual Report
69
Management’s discussion and analysis
JPMorgan Chase & Co.
The following table summarizes the aggregate notional amounts and the net derivative
receivables MTM for the periods presented.
Notional amounts and derivative receivables marked to market
(“MTM”)
Notional amounts(b)
Derivative receivables MTM(c)
December 31,
(in billions)
2006
2005
2006
2005
Interest rate
$
50,201
$
38,493
$
29
$
28
Foreign exchange
2,520
2,136
4
3
Equity
809
458
6
6
Credit derivatives
4,619
2,241
6
3
Commodity
507
265
11
10
Total, net of cash collateral(a)
$
58,656
$
43,593
56
50
Liquid securities collateral
held against derivative
receivables
NA
NA
(7
)
(6
)
Total, net of all collateral
NA
NA
$
49
$
44
(a)
Collateral is only applicable to Derivative receivables MTM amounts.
(b)
Represents the sum of gross long and gross short third-party notional derivative
contracts, excluding written options and foreign exchange spot contracts.
(c)
2005 has been adjusted to reflect more appropriate product classification of
certain balances.
The amount of Derivative receivables reported on the Consolidated
balance sheets of $56 billion and $50 billion at
December 31, 2006 and 2005, respectively, is the amount of the
mark-to-market (“MTM”) or fair value of the derivative
contracts after giving effect to legally enforceable master netting
agreements and cash collateral held by the Firm and represents the
cost to the Firm to replace the contracts at current market rates
should the counterparty default. However, in Management’s view,
the appropriate measure of current credit risk should also reflect
additional liquid securities held as collateral by the Firm of
$7 billion and $6 billion at December 31, 2006 and
2005, respectively, resulting in total exposure, net of all
collateral, of $49 billion and $44 billion at
December 31, 2006 and 2005, respectively.
The Firm also holds additional collateral delivered by clients at the
initiation of transactions, but this collateral does not reduce the
credit risk of the derivative receivables in the table above. This
additional collateral secures potential exposure that could arise in
the derivatives portfolio should the MTM of the client’s
transactions move in the Firm’s favor. As of December 31,2006 and 2005, the Firm held $12 billion and $10 billion,
respectively, of this additional collateral. The derivative
receivables MTM, net of all collateral, also does not include other
credit enhancements in the forms of letters of credit and surety
receivables.
While useful as a current view of credit exposure,
the net MTM value of the derivative receivables
does not capture the potential future variability
of that credit exposure. To capture the potential
future variability of credit exposure, the Firm
calculates, on a client-by-client basis, three
measures of potential derivatives-related credit
loss: Peak, Derivative Risk Equivalent (“DRE”) and
Average exposure (“AVG”). These measures all
incorporate netting and collateral benefits, where
applicable.
Peak exposure to a counterparty is an extreme
measure of exposure calculated at a 97.5%
confidence level. However, the total potential
future credit risk embedded in the Firm’s
derivatives portfolio is not the simple sum of all
Peak client credit risks. This is because, at the
portfolio level, credit risk is reduced by the fact
that when offsetting transactions are done with
separate counter-parties, only one of the two
trades can generate a credit loss, even if both
counterparties were to default simultaneously. The
Firm refers to this effect as market
diversification, and the Market-Diversified Peak
(“MDP”) measure is a portfolio aggregation of
counterparty Peak measures, representing the
maximum losses at the 97.5% confidence level that
would occur if all counterparties defaulted under
any one given market scenario and time frame.
Derivative Risk Equivalent exposure is a
measure that expresses the riskiness of derivative
exposure on a basis intended to be equivalent to
the riskiness of loan exposures. The measurement is
done by equating the unexpected loss in a
derivative counterparty exposure (which takes into
consideration both the loss volatility and the
credit rating of the counterparty) with the
unexpected loss in a loan exposure (which takes
into consideration only the credit rating of the
counterparty). DRE is a less extreme measure of
potential credit loss than Peak and is the primary
measure used by the Firm for credit approval of
derivative transactions.
Finally, AVG is a measure of
the expected MTM value of the Firm’s derivative
receivables at future time periods, including the
benefit of collateral. AVG exposure over the total
life of the derivative contract is used as the
primary metric for pricing
purposes and is used to calculate credit capital
and the Credit Valuation Adjustment (“CVA”), as
further described below. Average exposure was $36
billion at both December 31, 2006 and 2005,
compared with derivative receivables MTM, net of
all collateral, of $49 billion and $44 billion at
December 31, 2006 and 2005, respectively.
The graph below shows exposure profiles to
derivatives over the next 10 years as calculated
by the MDP, DRE and AVG metrics. All three
measures generally show declining exposure after
the first year, if no new trades were added to the
portfolio.
Exposure profile of derivatives measures
70
JPMorgan Chase & Co. / 2006 Annual Report
The MTM value of the Firm’s derivative
receivables incorporates an adjustment, the CVA, to
reflect the credit quality of counterparties. The
CVA is based upon the Firm’s AVG to a counterparty
and the counterparty’s credit spread in the credit
derivatives market. The primary components of
changes in CVA are credit spreads, new deal
activity or unwinds, and changes in the underlying
market environment. The Firm believes that active
risk management is essential to controlling the
dynamic credit risk in the derivatives portfolio.
The Firm risk manages exposure to changes in CVA by
entering into credit derivative transactions, as
well as interest rate, foreign exchange, equity and
commodity derivative transactions.
The following table summarizes the ratings profile of the Firm’s Derivative receivables MTM, net of
other liquid securities collateral, for the dates indicated:
Ratings profile of
derivative receivables MTM
Rating equivalent
2006
2005
December 31,
Exposure net of
% of exposure net
Exposure net of
% of exposure net
(in millions, except ratios)
all collateral
of all collateral
all collateral
of all collateral
AAA to AA-(a)
$
28,150
58
%
$
20,735
48
%
A+ to A-
7,588
15
8,074
18
BBB+ to BBB-
8,044
16
8,243
19
BB+ to B-
5,150
11
6,580
15
CCC+ and below
78
—
155
—
Total
$
49,010
100
%
$
43,787
100
%
(a)
The increase in AAA to AA- was due primarily to exchange-traded commodity activities.
The Firm actively pursues the use of collateral
agreements to mitigate counterparty credit risk in
derivatives. The percentage of the Firm’s
derivatives transactions subject to collateral
agreements decreased slightly, to 80% as of
December 31, 2006, from 81% at December 31, 2005.
The Firm posted $27 billion of collateral as of
both December 31, 2006 and 2005. Certain derivative
and collateral agreements include provisions that
require the counterparty and/or the Firm, upon
specified downgrades in their respective credit
ratings, to post collateral for the benefit of the
other party. As of December 31, 2006, the impact of
a single-notch ratings downgrade to JPMorgan Chase
Bank, N.A., from its rating of AA- to A+ at
December 31, 2006, would have required $1.1 billion
of additional collateral to be posted by the Firm;
the impact of a six-notch ratings downgrade (from
AA- to BBB-) would have required $3.1 billion of
additional collateral.
Certain derivative contracts also provide for
termination of the contract, generally upon a
downgrade of either the Firm or the counterparty,
at the then-existing MTM value of the derivative
contracts.
Credit derivatives
The following table presents the Firm’s
notional amounts of credit derivatives protection
purchased and sold by the respective businesses as
of December 31, 2006 and 2005:
Credit derivatives positions
Notional amount
Credit portfolio
Dealer/client
December 31,
Protection
Protection
Protection
Protection
(in billions)
purchased
sold
purchased
sold
Total
2006
$
52
(a)
$
1
$
2,277
$
2,289
$
4,619
2005
31
1
1,096
1,113
2,241
(a)
Includes $23 billion which represents the notional amount for structured
portfolio protection; the Firm retains the first risk of loss on this portfolio.
In managing wholesale credit exposure, the Firm
purchases single-name and portfolio credit
derivatives; this activity does not reduce the
reported level of assets on the balance sheet or
the level of reported off–balance sheet
commitments. The Firm also diversifies exposures by
providing (i.e., selling) credit protection, which
increases exposure to industries or clients where
the Firm has little or no client-related exposure.
This activity is not material to the Firm’s overall
credit exposure.
JPMorgan Chase & Co. / 2006 Annual Report
71
Management’s discussion and analysis
JPMorgan Chase & Co.
JPMorgan Chase has limited counterparty
exposure as a result of credit derivatives
transactions. Of the $55.6 billion of total
Derivative receivables MTM at December 31, 2006,
approximately $5.7 billion, or 10%, was associated
with credit derivatives, before the benefit of
liquid securities collateral.
Dealer/client
At December 31, 2006, the total notional amount
of protection purchased and sold in the
dealer/client business increased $2.4 trillion from
year-end 2005 as a result of increased trade volume
in the market. This business has a mismatch between
the total notional amounts of protection purchased
and sold. However, in the Firm’s view, the risk
positions are largely matched when securities used
to risk-manage certain derivative positions are
taken into consideration and the notional amounts
are adjusted to a duration-based equivalent basis
or to reflect different degrees of subordination in
tranched structures.
Credit portfolio management activities
Use of single-name and portfolio credit derivatives
December 31,
Notional amount of protection purchased
(in millions)
2006
2005
Credit derivatives used to manage:
Loans and lending-related commitments
$
40,755
$
18,926
Derivative receivables
11,229
12,088
Total
$
51,984
(a)
$
31,014
(a)
Includes $23 billion which represents the notional amount for structured
portfolio protection; the Firm retains the first loss on this portfolio.
The credit derivatives used by JPMorgan Chase
for credit portfolio management activities do not
qualify for hedge accounting under SFAS 133, and
therefore, effectiveness testing under SFAS 133 is
not performed. These derivatives are reported at
fair value, with gains and losses recognized in
Principal transactions. The MTM value incorporates
both the cost of credit derivative premiums and
changes in value due to movement in spreads and
credit events; in contrast, the loans and
lending-related commitments being risk-managed are
accounted for on an accrual basis. Loan interest
and fees are generally recognized in Net interest
income, and impairment is recognized in the
Provision for credit losses. This asymmetry in
accounting treatment, between loans and
lending-related commitments and the credit
derivatives utilized in portfolio management
activities, causes earnings volatility that is not
representative, in the Firm’s view, of the true
changes in value of the Firm’s overall credit
exposure. The MTM related to the Firm’s credit
derivatives used for managing credit exposure, as
well as the MTM related to the CVA, which reflects
the credit quality of derivatives counterparty
exposure, are included in the table below. These
results can vary from year to year due to market
conditions that impact specific positions in the
portfolio.
Year ended December 31,
(in millions)
2006
2005
2004
(c)
Hedges of lending-related commitments(a)
$
(246
)
$
24
$
(234
)
CVA and hedges of CVA(a)
133
84
188
Net gains (losses)(b)
$
(113
)
$
108
$
(46
)
(a)
These hedges do not qualify for hedge accounting under SFAS 133.
(b)
Excludes gains of $56 million, $8 million and $52 million for the years ended
December 31, 2006, 2005 and 2004, respectively, of other
Principal transactions revenues
that are not associated with hedging activities.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
The Firm also actively manages wholesale credit
exposure through loan and commitment sales. During
2006, 2005 and 2004, the Firm sold $3.1 billion,
$4.0 billion and $5.9 billion of loans and
commitments, respectively, recognizing gains
(losses) of $73 million, $76 million and ($8)
million in 2006, 2005 and 2004, respectively. The
gains include gains on sales of nonperforming loans
as discussed on page 67 of this Annual Report.
These activities are not related to the Firm’s
securitization activities, which are undertaken for
liquidity and balance sheet management purposes.
For a further discussion of securitization
activity, see Liquidity Risk Management and Note 14
on pages 62–63 and 114–118, respectively, of this
Annual Report.
Lending-related commitments
The contractual amount of wholesale
lending-related commitments was $391.4 billion at
December 31, 2006, compared with $321.1 billion at
December 31, 2005. See page 66 of this Annual
Report for an explanation of the increase in
exposure. In the Firm’s view, the total contractual
amount of these instruments is not representative
of the
Firm’s actual credit risk exposure or funding
requirements. In determining the amount of credit
risk exposure the Firm has to wholesale
lending-related commitments, which is used as the
basis for allocating credit risk capital to these
instruments, the Firm has established a
“loan-equivalent” amount for each commitment; this
amount represents the portion of the unused
commitment or other contingent exposure that is
expected, based upon average portfolio historical
experience, to become outstanding in the event of a
default by an obligor. The loan-equivalent amount
of the Firm’s lending-related commitments was $212
billion and $178 billion as of December 31, 2006
and 2005, respectively.
Emerging
markets country exposure
The Firm has a comprehensive
internal process for measuring and managing exposures and risk in
emerging markets countries – defined as those countries
potentially vulnerable to sovereign events. As of December 31,2006, based upon its internal methodology,
the Firm’s exposure to any individual emerging-markets country was not
significant, in that total exposure to any such country did not
exceed 0.75% of the Firm’s total assets. In evaluating and
managing its exposures to emerging markets countries, the Firm takes
into consideration all credit-related lending, trading, and
investment activities, whether cross-border or locally funded.
Exposure amounts are then adjusted for credit enhancements (e.g.,
guarantees and letters of credit) provided by third parties located
outside the country, if the enhancements fully cover the country risk
as well as the credit risk. For information regarding the
Firm’s cross-border exposure, based upon guidelines of the Federal
Financial Institutions Examination Council (“FFIEC”),
see Part 1, Item 1,
Loan portfolio, Cross-border outstandings, on page 155, of the
Firm’s Annual Report on Form 10-K for the year ended
December 31, 2006.
72
JPMorgan Chase & Co. / 2006 Annual Report
CONSUMER CREDIT PORTFOLIO
JPMorgan Chase’s consumer portfolio consists
primarily of residential mortgages, home equity
loans, credit cards, auto loans and leases,
education loans and business banking loans and
reflects the benefit of diversification from both a
product and a geographic perspective. The primary
focus is serving the prime consumer credit market.
There are no products in the real estate portfolios
that result in
negative amortization. However, RFS offers Home
Equity lines of credit and Mortgage loans with
interest-only payment options to predominantly
prime borrowers. The Firm actively manages its
consumer credit operation. Ongoing efforts include
continual review and enhancement of credit
underwriting criteria and refinement of pricing and
risk management models.
The following table presents managed consumer credit–related information for the dates indicated:
Consumer portfolio
Credit
Nonperforming
Average annual
As of or for the year ended December 31,
exposure
assets(e)
Net charge-offs
net charge-off rate(g)
(in millions, except ratios)
2006
2005
2006
2005
2006
2005
2006
2005
Retail Financial Services
Home equity
$
85,730
$
73,866
$
454
$
422
$
143
$
141
0.18
%
0.20
%
Mortgage
59,668
58,959
769
442
56
25
0.12
0.06
Auto loans and leases(a)
41,009
46,081
132
193
238
277
0.56
0.54
All other loans
27,097
18,393
322
281
139
129
0.65
0.83
Card Services – reported(b)
85,881
71,738
9
13
2,488
3,324
3.37
4.94
Total consumer loans – reported
299,385
269,037
1,686
(f)
1,351
(f)
3,064
3,896
1.17
1.56
Card Services – securitizations(b)(c)
66,950
70,527
—
—
2,210
3,776
3.28
5.47
Total consumer loans –
managed(b)
366,335
339,564
1,686
1,351
5,274
7,672
1.60
2.41
Assets acquired in loan satisfactions
NA
NA
225
180
NA
NA
NA
NA
Total consumer related assets – managed
366,335
339,564
1,911
1,531
5,274
7,672
1.60
2.41
Consumer lending–related commitments:
Home equity
69,559
58,281
NA
NA
NA
NA
NA
NA
Mortgage
6,618
5,944
NA
NA
NA
NA
NA
NA
Auto loans and leases
7,874
5,665
NA
NA
NA
NA
NA
NA
All other loans
6,375
6,385
NA
NA
NA
NA
NA
NA
Card Services(d)
657,109
579,321
NA
NA
NA
NA
NA
NA
Total lending-related commitments
747,535
655,596
NA
NA
NA
NA
NA
NA
Total consumer credit portfolio
$
1,113,870
$
995,160
$
1,911
$
1,531
$
5,274
$
7,672
1.60
%
2.41
%
Total average HFS loans
$
16,129
$
15,675
$
29
$
21
NA
NA
NA
NA
Memo: Credit card – managed
152,831
142,265
9
13
$
4,698
$
7,100
3.33
%
5.21
%
(a)
Excludes operating lease–related assets of $1.6 billion and $858 million at
December 31, 2006 and 2005, respectively.
(b)
Past-due loans 90 days and over and accruing includes credit card receivables of
$1.3 billion and $1.1 billion at December 31, 2006 and 2005, and related credit card
securitizations of $962 million and $730 million at December 31, 2006 and 2005,
respectively.
(c)
Represents securitized credit card receivables. For a further discussion of
credit card securitizations, see Card Services on pages 43–45 of this Annual Report.
(d)
The credit card lending–related commitments represent the total available
credit to the Firm’s cardholders. The Firm has not experienced, and does not anticipate,
that all of its cardholders will utilize their entire available lines of credit at the
same time. The Firm can reduce or cancel a credit card commitment by providing the
cardholder prior notice or, in some cases, without notice as permitted by law.
(e)
Includes nonperforming HFS loans of $116 million and $27 million at December 31,2006 and 2005, respectively.
(f)
Excludes nonperforming assets related to (1) loans eligible for repurchase as
well as loans repurchased from GNMA pools that are insured by U.S. government agencies and
U.S. government-sponsored enterprises of $1.2 billion and $1.1 billion for December 31,2006 and 2005, respectively, and (2) education loans that are 90 days past due and still
accruing, which are insured by U.S. government agencies under the Federal Family Education
Loan Program of $0.2 billion at December 31, 2006. These amounts for GNMA and education
loans are excluded, as reimbursement is proceeding normally.
(g)
Net charge-off rates exclude average loans HFS of $16 billion for the years
ended December 31, 2006 and 2005.
Total managed consumer loans as of December31, 2006, were $366.3 billion, up from $339.6
billion at year-end 2005 reflecting growth in most
consumer portfolios. Consumer lending-related
commitments increased by 14%, to $747.5 billion at
December 31, 2006, primarily reflecting growth in
credit cards and home equity lines of credit. The
following discussion relates to the specific loan
and lending-related categories within the consumer
portfolio.
Retail Financial Services:
Average RFS loan balances for 2006 were $203.9
billion. The net charge-off rate for retail loans
in 2006 was 0.31%, which was flat compared with
the prior year, reflecting stable credit trends in
most consumer lending portfolios. New loans
originated in 2006 primarily reflect high credit
quality consistent
with management’s focus on prime and near-prime
credit market segmentation. The Firm regularly
evaluates market conditions and the overall
economic returns of new originations and makes an
initial determination of whether to classify
specific new originations as held-for-investment or
held-for-sale. The Firm also periodically evaluates
the overall economic returns of its
held-for-investment loan portfolio under prevailing
market conditions to determine whether to retain or
sell loans in the portfolio. When it is determined
that a loan that was previously classified as
held-for-investment will be sold it is transferred
into a held-for-sale account. Held-for-sale loans
are
accounted for at the lower of cost or fair value,
with changes in value recorded in Noninterest
revenue.
JPMorgan Chase & Co. / 2006 Annual Report
73
Management’s discussion and analysis
JPMorgan Chase & Co.
Home equity: Home equity loans at December 31,2006, were $85.7 billion, an increase of $11.9
billion from year-end 2005. Growth in the portfolio
reflected organic growth, as well as The Bank of
New York transaction. The geographic distribution
is well-diversified as shown in the table below.
Mortgage: Mortgage loans at December 31, 2006,
were $59.7 billion. Mortgage receivables as of
December 31, 2006, reflected an increase of $709
million from the prior year. Although the Firm
provides mortgage loans
to the full spectrum of credit borrowers, more
than 75% of RFS’ mortgage loans on the balance
sheet are to prime borrowers. In addition, the
Firm sells or securitizes virtually all fixed-rate
mortgage originations, as well as a portion of its
adjustable rate originations. As a result, the
portfolio of residential mortgage loans
held-for-investment consists primarily of
adjustable rate products. The geographic
distribution is well-diversified as shown in the
table below.
Consumer real estate loans by geographic location
Year ended December 31,
Home equity
(in billions, except ratios)
2006
2005
California
$
12.9
15
%
$
10.5
14
%
New York
12.2
14
10.2
14
Illinois
6.2
7
5.5
7
Texas
5.8
7
5.3
7
Arizona
5.4
6
4.5
6
Ohio
5.3
6
5.2
7
Florida
4.4
5
3.5
5
Michigan
3.8
4
3.7
5
New Jersey
3.5
4
2.6
4
Indiana
2.6
3
2.6
4
All other
23.6
29
20.3
27
Total
$
85.7
100
%
$
73.9
100
%
Year ended December 31,
Mortgage
(in billions, except ratios)
2006
2005
California
$
14.5
24
%
$
13.8
23
%
New York
8.9
15
9.2
16
Florida
7.1
12
6.8
12
New Jersey
2.6
4
2.6
4
Illinois
2.4
4
2.2
4
Texas
2.1
4
2.3
4
Virginia
1.5
3
1.7
3
Michigan
1.5
3
1.5
3
Arizona
1.5
3
1.2
2
Maryland
1.4
2
1.5
3
All other
16.2
26
16.2
26
Total
$
59.7
100
%
$
59.0
100
%
Auto loans and leases: As of December 31, 2006,
Auto loans and leases decreased to $41.0 billion
from $46.1 billion at year-end 2005. The decrease
in outstanding loans was caused primarily by the
de-emphasis of vehicle finance leasing, which
comprised $1.7 billion of outstanding loans as of
December 31, 2006, down from $4.3 billion in the
prior year. The Auto loan portfolio reflects a high
concentration of prime and near-prime quality
credits.
All other loans: All other loans primarily include
business banking loans (which are highly
collateralized loans, often with personal loan
guarantees), Education loans and community
development loans. As of December 31, 2006, Other
loans increased to $27.1 billion compared with
$18.4 billion at year-end 2005. This increase is
due primarily to an increase in education loans as
a result of the acquisition of Collegiate Funding
Services. Loan balances also increased in Business
banking primarily as a result of The Bank of New
York transaction.
Card Services
JPMorgan Chase analyzes its credit card portfolio
on a managed basis, which includes credit card
receivables on the consolidated balance sheet and
those receivables sold to investors through
securitization. Managed credit card receivables
were $152.8 billion at December 31, 2006, an
increase of $10.6 billion from year-end 2005,
reflecting organic growth and acquisitions,
partially offset by higher customer payment rates.
The managed credit card net charge-off rate
decreased to 3.33% for 2006, from 5.21% in 2005.
This decrease was due primarily to lower
bankruptcy-related net charge-offs. The 30-day
delinquency rates increased to 3.13% at December31, 2006, from 2.79% at December 31, 2005,
primarily driven by accelerated loss recognition of
delinquent accounts in 2005, as a result of the
2005 bankruptcy reform legislation. The managed
credit card portfolio continues to reflect a
well-seasoned portfolio that has good U.S.
geographic diversification.
74
JPMorgan Chase & Co. / 2006 Annual Report
ALLOWANCE FOR CREDIT LOSSES
JPMorgan Chase’s allowance for credit losses is
intended to cover probable credit losses, including
losses where the asset is not specifically
identified or the size of the loss has not been
fully determined. At least quarterly, the allowance
for credit losses is reviewed by the Chief Risk
Officer, the Chief Financial Officer and the
Controller of the Firm, and discussed with the Risk
Policy and Audit Committees of the Board of
Directors of the Firm. The allowance is reviewed
relative to the risk profile of the Firm’s credit
portfolio and current economic conditions and is
adjusted if, in management’s judgment, changes are
warranted. The allowance includes an asset-specific
com-
ponent and a formula-based component, the latter of
which consists of a statistical calculation and
adjustments to the statistical calculation. For
further discussion of the components of the
allowance for credit losses, see Critical
accounting estimates used by the Firm on page 83
and Note 13 on pages 113–114 of this Annual
Report. At December 31, 2006, management deemed the
allowance for credit losses to be appropriate
(i.e., sufficient to absorb losses that are
inherent in the portfolio, including losses that
are not specifically identified or for which the
size of the loss has not yet been fully
determined).
Summary of changes in the allowance for credit losses
2006 includes a $157 million release of Allowance for loan losses related to
Hurricane Katrina. 2005 includes $400 million of allowance related to Hurricane Katrina.
(b)
The ratio of the wholesale allowance for loan losses to total wholesale loans
was 1.68% and 1.85%, excluding wholesale HFS loans of $22.5 billion and $17.6 billion at
December 31, 2006 and 2005, respectively.
(c)
The ratio of the consumer allowance for loan losses to total consumer loans was
1.71% and 1.84%, excluding consumer HFS loans of $32.7 billion and $16.6 billion at
December 31, 2006 and 2005, respectively.
(d)
Primarily relates to loans acquired in The Bank of New York transaction in the
fourth quarter of 2006.
JPMorgan Chase & Co. / 2006 Annual Report
75
Management’s discussion and analysis
JPMorgan Chase & Co.
The Allowance for credit losses increased by
$313 million from December 31, 2005, primarily due
to activity in the wholesale portfolio. New lending
activity in IB and CB was offset partially by lower
wholesale nonperforming loans. Additionally, there
was a release of $157 million of Allowance for loan
losses related to Hurricane Katrina in the consumer
and wholesale portfolios.
Excluding held-for-sale loans, the Allowance for
loan losses represented 1.70% of loans at December31, 2006, compared with 1.84% at December 31,2005. The wholesale component of the allowance
increased to $2.7 billion as of December 31, 2006,
from $2.5 billion at year-end 2005, due to loan
growth in the IB and CB, including the acquisition
of The Bank of New York loan portfolio. The
consumer allowance decreased $69 million, which
included a release of $98 million in CS, partially
offset by a $29 million build in RFS. The Allowance release by
CS was primarily the result of
releasing the remaining Allowance for loan loss
related to Hurricane Katrina established in
2005. Excluding the allowance release for
Hurricane Katrina, CS’ Allowance for loan losses
remained constant as improved credit quality
offset the increase of $14.1 billion in loan
receivables subject to the Allowance. The RFS
build was primarily the result of loans acquired
in The Bank of New York transaction.
To provide for the risk of loss inherent in the
Firm’s process of extending credit, management also
computes an asset-specific component and a
formula-based component for wholesale
lending-related commitments. These components are
computed using a methodology similar to that used
for the wholesale loan portfolio, modified for
expected maturities and probabilities of drawdown.
This allowance, which is reported in Other
liabilities, was $524 million and $400 million at
December 31, 2006 and 2005, respectively. The
increase reflected increased lending-related
commitments and updates to inputs used in the
calculation.
Provision for credit losses
For a discussion of the reported Provision for credit losses, see page 29 of this Annual
Report. The managed provision for credit losses includes credit card securitizations. For the year
ended December 31, 2006, securitized credit card losses were lower compared with the prior-year
periods, primarily as a result of lower bankruptcy-related charge-offs. At December 31, 2006,
securitized credit card outstandings were $3.6 billion lower compared with the prior year end.
Provision for
Year ended December 31,
Provision for loan losses
lending-related commitments
Total provision for credit losses(c)
(in millions)
2006
2005
2004
(b)
2006
2005
2004
(b)
2006
(a)
2005
(a)
2004
(b)
Investment Bank
$
112
$
(757
)
$
(525
)
$
79
$
(81
)
$
(115
)
$
191
$
(838
)
$
(640
)
Commercial Banking
133
87
35
27
(14
)
6
160
73
41
Treasury & Securities
Services
(1
)
(1
)
7
—
1
—
(1
)
—
7
Asset Management
(30
)
(55
)
(12
)
2
(1
)
(2
)
(28
)
(56
)
(14
)
Corporate
(1
)
10
975
—
—
(227
)
(1
)
10
748
Total Wholesale
213
(716
)
480
108
(95
)
(338
)
321
(811
)
142
Retail Financial Services
552
721
450
9
3
(1
)
561
724
449
Card Services
2,388
3,570
1,953
—
—
—
2,388
3,570
1,953
Total Consumer
2,940
4,291
2,403
9
3
(1
)
2,949
4,294
2,402
Total provision for credit
losses
3,153
(a)
3,575
(a)
2,883
117
(92
)
(339
)
3,270
3,483
2,544
Credit card securitization
2,210
3,776
2,898
—
—
—
2,210
3,776
2,898
Total managed provision for credit losses
$
5,363
$
7,351
$
5,781
$
117
$
(92
)
$
(339
)
$
5,480
$
7,259
$
5,442
(a)
2006 includes a $157 million release of Allowance for loan losses related to
Hurricane Katrina. 2005 includes $400 million of allowance related to Hurricane Katrina.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(c)
The 2004 provision for loan losses includes an increase of approximately $1.4
billion as a result of the decertification of heritage Bank One seller’s interest in
credit card securitizations, partially offset by a reduction of $357 million to conform
provision methodologies. The 2004 provision for lending-related commitments reflects a
reduction of $227 million to conform provision methodologies in the wholesale portfolio.
76
JPMorgan Chase & Co. / 2006 Annual Report
MARKET RISK MANAGEMENT
Market risk is the exposure to an adverse
change in the market value of portfolios and
financial instruments caused by a change in market
prices or rates.
Market risk management
Market risk is identified, measured, monitored, and
controlled by an independent corporate risk
governance function. Market risk management seeks
to facilitate efficient risk/return decisions,
reduce volatility in operating performance and make
the Firm’s market risk profile transparent to
senior management, the Board of Directors and
regulators. Market risk management is overseen by
the Chief Risk Officer and performs the following
primary functions:
•
Establishment of a comprehensive market risk policy framework
•
Independent measurement, monitoring and control of business segment market risk
•
Definition, approval and monitoring of limits
•
Performance of stress testing and qualitative risk assessments
The Firm’s business segments also have valuation
teams whose functions are to provide independent oversight of the accuracy of the
valuations of positions that expose the Firm to
market risk. These valuation functions reside
within the market risk management area and have a
reporting line into Finance.
Risk identification and classification
The market risk management group works in
partnership with the business segments to identify
market risks throughout the Firm and to refine and
monitor market risk policies and procedures. All
business segments are responsible for comprehensive
identification and verification of market risks
within their units. Risk-taking businesses have
functions that act independently from trading
personnel and are responsible for verifying risk
exposures that the business takes. In addition to
providing independent oversight for market risk
arising from the business segments, Market risk
management also is responsible for identifying
exposures which may not be large within individual
business segments, but which may be large for the
Firm in aggregate. Regular meetings are held
between Market risk management and the heads of
risk-taking businesses to discuss and decide on
risk exposures in the context of the market
environment and client flows.
Positions that expose the Firm to market risk can
be classified into two categories: trading and
nontrading risk. Trading risk includes positions
that are held by the Firm as part of a business
segment or unit whose main business strategy is to
trade or make markets. Unrealized gains and losses
in these positions are generally reported in
Principal transactions revenue. Nontrading risk
includes securities and other assets held for
longer-term investment, mortgage servicing rights,
and securities and derivatives used to manage the
Firm’s asset/liability exposures. Unrealized gains
and losses in these positions are generally not
reported in Principal transactions revenue.
Trading risk
Fixed income risk (which includes interest rate
risk and credit spread risk), foreign exchange,
equities and commodities and other trading risks
involve the potential decline in Net income or
financial condition due to adverse changes in
market rates, whether arising from client
activities or proprietary positions taken by the
Firm.
Nontrading risk
Nontrading risk arises from execution of the
Firm’s core business
strategies, the delivery of products and services
to its customers, and the discretionary positions
the Firm undertakes to risk-manage exposures.
These exposures can result from a variety of
factors, including differences in the timing among
the maturity or repricing of assets, liabilities
and off–balance sheet instruments. Changes in the
level and shape of market interest rate curves also
may create interest rate risk, since the repricing
characteristics of the Firm’s assets do not
necessarily match those of its liabilities. The
Firm also is exposed to basis risk, which is the
difference in repricing characteristics of two
floating-rate indices, such as the prime rate and
3-month LIBOR. In addition, some of the Firm’s
products have embedded optionality that impact
pricing and balances.
The Firm’s mortgage banking activities also give
rise to complex interest rate risks. The interest
rate exposure from the Firm’s mortgage banking
activities is a result of changes in the level of
interest rates, as well as option and basis risk.
Option risk arises primarily from prepayment
options embedded in mortgages and changes in the
probability of newly originated mortgage
commitments actually closing. Basis risk results
from different relative movements between mortgage
rates and other interest rates.
Risk measurement
Tools used to measure risk
Because no single measure can reflect all
aspects of market risk, the Firm uses various
metrics, both statistical and nonstatistical,
including:
•
Nonstatistical risk measures
•
Value-at-risk (“VAR”)
•
Loss advisories
•
Economic value stress testing
•
Earnings-at-risk stress testing
•
Risk identification for large exposures (“RIFLE”)
Nonstatistical risk measures
Nonstatistical risk measures other than stress
testing include net open positions, basis point
values, option sensitivities, market values,
position concentrations and position turnover.
These measures provide granular information on the
Firm’s market risk exposure. They are aggregated by
line of business and by risk type, and are used for
monitoring limits, one-off approvals and tactical
control.
Value-at-risk
JPMorgan Chase’s primary statistical risk measure,
VAR, estimates the potential loss from adverse
market moves in an ordinary market environment and
provides a consistent cross-business measure of
risk profiles and levels of diversification. VAR is
used for comparing risks across businesses,
monitoring limits, one-off approvals, and as an
input to economic capital calculations. VAR
provides risk transparency in a normal trading
environment. Each business day the Firm undertakes
a comprehensive VAR calculation that includes both
its trading and its nontrading risks. VAR for
nontrading risk measures the amount of potential
change in the fair values of the exposures related
to these risks; however, for such risks, VAR is not
a measure of reported revenue since nontrading
activities are generally not marked to market
through earnings.
JPMorgan Chase & Co. / 2006 Annual Report
77
Management’s discussion and analysis
JPMorgan Chase & Co.
To calculate VAR, the Firm uses historical
simulation, which measures risk across instruments
and portfolios in a consistent and comparable way.
This approach assumes that historical changes in
market values are representative of future changes.
The simulation is based upon data for the previous
twelve
months. The Firm calculates VAR using a one-day
time horizon and an expected tail-loss methodology,
which approximates a 99% confidence level. This
means the Firm would expect to incur losses greater
than that predicted by VAR estimates only once in
every 100 trading days, or about two to three times
a year.
IB Trading and Credit Portfolio VAR
IB trading VAR by risk type and credit portfolio VAR
2006
2005
As of or for the year ended
Average
Minimum
Maximum
Average
Minimum
Maximum
At December 31,
December 31, (in millions)
VAR
VAR
VAR
VAR
VAR
VAR
2006
2005
By risk type:
Fixed income
$
56
$
35
$
94
$
67
$
37
$
110
$
44
$
89
Foreign exchange
22
14
42
23
16
32
27
19
Equities
31
18
50
34
15
65
49
24
Commodities and other
45
22
128
21
7
50
41
34
Less: portfolio diversification
(70
)(c)
NM
(d)
NM
(d)
(59
)(c)
NM
(d)
NM
(d)
(62
)(c)
(63
)(c)
Trading VAR(a)
84
55
137
86
53
130
99
103
Credit portfolio VAR(b)
15
12
19
14
11
17
15
15
Less: portfolio diversification
(11
)(c)
NM
(d)
NM
(d)
(12
)(c)
NM
(d)
NM
(d)
(10
)(c)
(10
)(c)
Total trading and credit
portfolio VAR
$
88
$
61
$
138
$
88
$
57
$
130
$
104
$
108
(a)
Trading VAR does not include VAR related to the MSR portfolio or VAR related to
other corporate functions, such as Treasury and Private Equity. For a discussion of MSRs
and the corporate functions, see pages 53–54 and Note 16 on pages 121–122 of this Annual
Report, respectively. Trading VAR includes substantially all trading activities in IB;
however, particular risk parameters of certain products are not fully captured, for
example, correlation risk.
(b)
Includes VAR on derivative credit valuation adjustments, hedges of the credit
valuation adjustment and mark-to-market hedges of the accrual loan portfolio, which are
all reported in Principal trans- actions revenue. This VAR does not include the accrual
loan portfolio, which is not marked to market.
(c)
Average and period-end VARs are less than the sum of the VARs of its market risk
components, which is due to risk offsets resulting from portfolio diversification. The
diversification effect reflects the fact that the risks are not perfectly correlated. The
risk of a portfolio of positions is therefore usually less than the sum of the risks of
the positions themselves.
(d)
Designated as not meaningful (“NM”) because the minimum and maximum may occur on
different days for different risk components, and hence it is not meaningful to compute a
portfolio diversification effect.
Investment Bank’s average Total Trading and
Credit Portfolio VAR was $88 million for both 2006
and 2005. Commodities and other VAR increased due
to continued expansion of the energy trading
business, while Fixed income VAR decreased due to
reduced risk positions, as well as to lower market
volatility compared with 2005. These changes also
led to an increase in portfolio diversification, as
Average Trading VAR diversification increased to
$70 million, or 45% of the sum of the components,
during 2006; from $59 million, or 41% of the sum of
the components, during 2005. In general, over the
course of the year, VAR exposures can vary
significantly as positions change, market
volatility fluctuates and diversification benefits
change.
VAR back-testing
To evaluate the soundness of its VAR model, the
Firm conducts daily back-testing of VAR against
daily IB market risk-related revenue, which is
defined as the change in value of Principal
transactions revenue less Private Equity
gains/losses plus any trading-related net interest
income, brokerage commissions, underwriting fees or
other revenue. The following histogram illustrates
the daily market risk-related gains and losses for
IB trading businesses for the year ended December31, 2006. The chart shows that IB posted market
risk-related gains on 227 out of 260 days in this
period, with 29 days exceeding $100 million. The
inset graph looks at those days on which IB
experienced losses and depicts the amount by which
VAR exceeded the actual loss on each of those days.
Losses were sustained on 33 days, with no loss
greater than $100 million, and with no loss
exceeding the VAR measure.
78
JPMorgan Chase & Co. / 2006 Annual Report
Loss advisories
Loss advisories are tools used to highlight to
senior management trading losses above certain
levels and are used to initiate discussion of
remedies.
Economic value stress testing
While VAR reflects the risk of loss due to adverse
changes in normal markets, stress testing captures
the Firm’s exposure to unlikely but plausible
events in abnormal markets. The Firm conducts
economic-value stress tests for both its trading
and its nontrading activities at least once a month
using multiple scenarios that assume credit spreads
widen significantly, equity prices decline and
interest rates rise in the major currencies.
Additional scenarios focus on the risks predominant
in individual business segments and include
scenarios that focus on the potential for adverse
moves in complex portfolios. Periodically,
scenarios are reviewed and updated to reflect
changes in the Firm’s risk profile and economic
events. Along with VAR, stress testing is important
in measuring and controlling risk. Stress testing
enhances the understanding of the Firm’s risk
profile and loss potential, and stress losses are
monitored against limits. Stress testing is also
utilized in one-off approvals and cross-business
risk measurement, as well as an input to economic
capital allocation. Stress-test results, trends and
explanations are provided each month to the Firm’s
senior management and to the lines of business to
help them better measure and manage risks and to
understand event risk-sensitive positions.
Earnings-at-risk stress testing
The VAR and stress-test measures described above
illustrate the total economic sensitivity of the
Firm’s balance sheet to changes in market
variables. The effect of interest rate exposure on
reported Net income also is critical. Interest rate
risk exposure in the Firm’s core nontrading
business activities (i.e., asset/liability
management positions) results from on– and
off–balance sheet positions. The Firm conducts
simulations of changes in NII from its nontrading
activities under a variety of interest rate
scenarios. Earnings-at-risk tests measure the
potential change in the Firm’s Net interest income
over the next 12 months and highlight exposures to
various rate-sensitive factors, such as the rates
themselves (e.g., the prime lending rate), pricing
strategies on deposits, optionality and changes in
product mix. The tests include forecasted balance
sheet changes, such as asset sales and
securitizations, as well as prepayment and
reinvestment behavior.
Earnings-at-risk also can result from changes in
the slope of the yield curve, because the Firm has
the ability to lend at fixed rates and borrow at
variable or short-term fixed rates. Based upon
these scenarios, the Firm’s earnings would be
affected negatively by a sudden and unanticipated
increase in short-term rates without a
corresponding increase in long-term rates.
Conversely, higher long-term rates generally are
beneficial to earnings, particularly when the
increase is not accompanied by rising short-term
rates.
JPMorgan Chase & Co. / 2006 Annual Report
79
Management’s
discussion and analysis
JPMorgan Chase & Co.
Immediate changes in interest rates present a
limited view of risk, and so a number of
alternative scenarios also are reviewed. These
scenarios include the implied forward curve,
nonparallel rate shifts and severe interest rate
shocks on selected key rates. These scenarios are
intended to provide a comprehensive view of
JPMorgan Chase’s earnings-at-risk over a wide range
of outcomes.
JPMorgan Chase’s 12-month pretax earnings
sensitivity profile as of December 31, 2006
and 2005, were as follows:
The primary change in earnings-at-risk from
December 31, 2005, reflects a higher level of AFS
securities and other repositioning. The Firm is
exposed to both rising and falling rates. The
Firm’s risk to rising rates is largely the result
of increased funding costs. In contrast, the
exposure to falling rates is the result of higher
anticipated levels of loan and securities
prepayments.
Risk identification for large exposures (“RIFLE”)
Individuals who manage risk positions, particularly
those that are complex, are responsible for
identifying potential losses that could arise from
specific, unusual events, such as a potential tax
change, and estimating the probabilities of losses
arising from such events. This information is
entered into the Firm’s RIFLE database. Trading
management has access to RIFLE, thereby permitting
the Firm to monitor further earnings vulnerability
not adequately covered by standard risk measures.
Risk monitoring and control
Limits
Market risk is controlled primarily through a
series of limits. Limits reflect the Firm’s risk
appetite in the context of the market environment
and business strategy. In setting limits, the Firm
takes into consideration factors such as market
volatility, product liquidity, business trends and
management experience.
Market risk management regularly reviews and
updates risk limits. Senior management, including
the Firm’s Chief Executive Officer and Chief Risk
Officer, is responsible for reviewing and approving
risk limits at least once a year. Market risk
management further controls the Firm’s exposure by
specifically designating approved financial
instruments and tenors, known as instrument
authorities, for each business segment.
The Firm maintains different levels of limits.
Corporate-level limits include VAR and stress.
Similarly, line-of-business limits include VAR and
stress limits and may be supplemented by loss
advisories, nonstatistical measurements and
instrument authorities. Businesses are responsible
for adhering to established limits, against which
exposures are monitored and reported. Limit
breaches are reported in a timely manner to senior
management, and the affected business segment is
required either to reduce trading positions or
consult with senior management on the appropriate
action.
Qualitative review
The market risk management group also performs
periodic reviews as necessary of both businesses
and products with exposure to market risk in order
to assess the ability of the businesses to control
their market risk. Strategies, market conditions,
product details and risk controls are reviewed, and
specific recommendations for improvements are made
to management.
Model review
Some of the Firm’s financial instruments cannot be
valued based upon quoted market prices but are
instead valued using pricing models. Such models
are used for management of risk positions, such as
reporting against limits, as well as for valuation.
The Model Risk Group, independent of the businesses
and market risk management, reviews the models the
Firm uses and assesses model appropriateness and
consistency. The model reviews consider a number of
factors about the model’s suitability for valuation
and risk management of a particular product,
including whether it accurately reflects the
characteristics of the transaction and its
significant risks, the suitability and convergence
properties of numerical algorithms, reliability of
data sources, consistency of the treatment with
models for similar products, and sensitivity to
input parameters and assumptions that cannot be
priced from the market.
Reviews are conducted of new or changed models, as
well as previously accepted models, to assess
whether there have been any changes in the product
or market that may impact the model’s validity and
whether there are theoretical or competitive
developments that may require reassessment of the
model’s adequacy. For a summary of valuations
based upon models, see Critical Accounting
Estimates used by the Firm on pages 83–85 of this
Annual Report.
Risk reporting
Nonstatistical exposures, value-at-risk, loss
advisories and limit excesses are reported daily
for each trading and nontrading business. Market
risk exposure trends, value-at-risk trends, profit
and loss changes, and portfolio concentrations are
reported weekly. Stress-test results are reported
monthly to business and senior management.
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PRIVATE EQUITY RISK MANAGEMENT
Risk management
The Firm makes direct principal investments in
private equity. The illiquid nature and long-term
holding period associated with these investments
differentiates private equity risk from the risk of
positions
held in the trading portfolios. The Firm’s approach
to managing private equity risk is consistent with
the Firm’s general risk governance structure.
Controls are in place establishing target levels
for total and annual investment in order to control
the overall size of the portfolio. Industry and
geographic concentration limits are in place and
intended to ensure diversification of the
portfolio; and periodic reviews
are performed on the portfolio to substantiate
the valuations of the investments. The valuation
function within Market risk management that reports
into Finance is responsible for reviewing the
accuracy of the carrying values of private equity
investments held by Private Equity. At December 31,2006, the carrying value of the private equity
businesses was $6.1 billion, of which $587 million
represented positions traded in the public market.
OPERATIONAL RISK MANAGEMENT
Operational risk is the risk of loss resulting from
inadequate or failed processes or systems, human
factors or external events.
Overview
Operational risk is inherent in each of the Firm’s
businesses and support activities. Operational risk
can manifest itself in various ways, including
errors, fraudulent acts, business interruptions,
inappropriate behavior of employees or vendors that
do not perform in accordance with outsourcing
arrangements. These events could result in
financial losses and other damage to the Firm,
including reputational harm.
To monitor and control operational risk, the Firm
maintains a system of comprehensive policies and a
control framework designed to provide a sound and
well-controlled operational environment. The goal
is to keep operational risk at appropriate levels,
in light of the Firm’s financial strength, the
characteristics of its businesses, the markets in
which it operates, and the competitive and
regulatory environment to which it is subject.
Notwithstanding these control measures, the Firm
incurs operational losses.
The Firm’s approach to operational risk management
is intended to mitigate such losses by
supplementing traditional control-based approaches
to operational risk with risk measures, tools and
disciplines that are risk-specific, consistently
applied and utilized firmwide. Key themes are
transparency of information, escalation of key
issues and accountability for issue resolution.
The Firm’s operational risk framework is supported
by Phoenix, an internally designed operational
risk software tool. Phoenix integrates the
individual components of the operational risk
management framework into a unified, web-based
tool. Phoenix enhances the capture, reporting and
analysis of operational risk data by enabling risk
identification, measurement, monitoring, reporting
and analysis to be done in an integrated manner,
thereby enabling efficiencies in the Firm’s
monitoring and management of its operational risk.
For purposes of identification, monitoring,
reporting and analysis, the Firm categorizes
operational risk events as follows:
•
Client service and selection
•
Business practices
•
Fraud, theft and malice
•
Execution, delivery and process management
•
Employee disputes
•
Disasters and public safety
•
Technology and infrastructure failures
Risk identification and measurement
Risk identification is the recognition of the
operational risk events that management
believes may give rise to operational losses.
All businesses utilize the Firm’s newly redesigned
firmwide self-assessment process and supporting
architecture as a dynamic risk management tool. The
goal of the self-assessment process is for each
business to identify the key operational risks
specific to its environment and assess the degree
to which it maintains appropriate controls. Action
plans are developed for control issues identified,
and businesses are held accountable for tracking
and resolving these issues on a timely basis.
Risk monitoring
The Firm has a process for monitoring operational
risk-event data, permitting analysis of errors and
losses as well as trends. Such analysis, performed
both at a line-of-business level and by risk-event
type, enables identification of the causes
associated with risk events faced by the
businesses. Where available, the internal data can
be supplemented with external data for comparative
analysis with industry patterns. The data reported
enables the Firm to back-test against
self-assessment results. The Firm is a founding
member of the Operational Risk Data Exchange, a
not-for-profit industry association formed for the
purpose of collecting operational loss data and
sharing data in an anonymous form and benchmarking
results back to members. Such information
supplements the Firm’s ongoing operational risk
analysis.
Risk reporting and analysis
Operational risk management reports provide timely
and accurate information, including information
about actual operational loss levels and
self-assessment results, to the lines of business
and senior management. The purpose of these reports
is to enable management to maintain operational
risk at appropriate levels within each line of
business, to escalate issues and to provide
consistent data aggregation across the Firm’s
businesses and support areas.
Audit alignment
Internal Audit utilizes a risk-based program of
audit coverage to provide an independent assessment
of the design and effectiveness of key controls
over the Firm’s operations, regulatory compliance
and reporting. Audit partners with business
management and members of the control community in
providing guidance on the operational risk
framework and reviewing the effectiveness and accuracy of the
business self-assessment process as part of its business unit audits.
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81
Management’s discussion and analysis
JPMorgan Chase & Co.
REPUTATION AND FIDUCIARY RISK MANAGEMENT
A firm’s success depends not only on its
prudent management of the liquidity, credit, market
and operational risks that are part of its
business risks, but equally on the maintenance
among many constituents – clients, investors,
regulators, as well as the general public – of a
reputation for business practices of the highest
quality. Attention to reputation always has been a
key aspect of the Firm’s practices, and maintenance
of reputation is the responsibility of everyone at
the Firm. JPMorgan Chase bolsters this individual
responsibility in many ways, including through the
Firm’s Code of Conduct, training, maintaining
adherence to policies and procedures, and oversight
functions that approve transactions. These
oversight functions include a Conflicts Office,
which examines wholesale transactions with the
potential to create conflicts of interest for the
Firm, and a Policy Review Office that reviews
certain transactions with clients, especially
complex derivatives and structured finance
transactions that have the potential to affect
adversely the Firm’s reputation.
Policy Review Office
The Policy Review Office is the most senior
approval level for client transactions involving
reputation risk issues. The mandate of the Policy
Review Office is to opine on specific transactions
brought by the Regional Reputation Risk Review
Committees and consider changes in policies or
practices relating to reputation risk. The head of
the Policy Review Office consults with the Firm’s
most senior executives on specific topics and
provides regular updates. The Policy Review Office
reinforces the Firm’s procedures for examining
transactions in terms of appropriateness, ethical
issues and reputation risk. It focuses on the
purpose and effect of its transactions from the
client’s point of view, with the goal that these
transactions are not used to mislead investors or
others.
Primary responsibility for adherence to the
policies and procedures designed to address
reputation risk lies with the business units
conducting the transactions in question. The Firm’s
transaction approval process requires review from,
among others, internal legal/compliance, conflicts,
tax and accounting groups. Transactions involving
an SPE established by the Firm receive particular
scrutiny intended to ensure that every such entity
is properly approved, documented, monitored and
controlled.
Business units also are required to submit to
regional Reputation Risk Review Committees proposed
transactions that may give rise to heightened
reputation risk. The committees may approve, reject
or require further clarification on or changes to
the transactions. The members of these committees
are senior representatives of the business and
support units in the region. The committees may
escalate transaction review to the Policy Review
Office.
Fiduciary risk management
The risk management committees within each line of
business include in their mandate the oversight of
the legal, reputational and, where appropriate,
fiduciary risks in their businesses that may
produce significant losses or reputational damage.
The Fiduciary Risk Management function works with
the relevant line-of-business risk committees with
the goal of ensuring that businesses providing
investment or risk management products or services
that give rise to fiduciary duties to clients
perform at the appropriate standard relative to
their fiduciary relationship with a client. Of
particular focus are the policies and practices
that address a business’ responsibilities to a
client, including client suitability determination,
disclosure obligations and communications, and
performance expectations with respect to risk
management products or services being provided by
the Firm, that give rise to such fiduciary duties.
In this way, the relevant line-of-business risk
committees, together with the Fiduciary Risk
Management function, provide oversight of the
Firm’s efforts to monitor, measure and control the
risks that may arise in the delivery of
the products or services to clients that give rise
to such duties, as well as those stemming from any
of the Firm’s fiduciary responsibilities to
employees under the Firm’s various employee benefit
plans.
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JPMorgan Chase & Co. / 2006 Annual Report
CRITICAL ACCOUNTING ESTIMATES USED BY THE FIRM
JPMorgan Chase’s accounting policies and use of
estimates are integral to understanding its
reported results. The Firm’s most complex
accounting estimates require management’s judgment
to ascertain the valuation of assets and
liabilities. The Firm has established detailed
policies and control procedures intended to ensure
that valuation methods, including any judgments
made as part of such methods, are well-controlled,
independently reviewed and applied consistently
from period to period. In addition, the policies
and procedures are intended to ensure that the
process for changing methodologies occurs in an
appropriate manner. The Firm believes its estimates
for determining the valuation of its assets and
liabilities are appropriate. The following is a
brief description of the Firm’s critical accounting
estimates involving significant valuation
judgments.
Allowance for credit losses
JPMorgan Chase’s allowance for credit losses covers
the wholesale and consumer loan portfolios as well
as the Firm’s portfolio of wholesale
lending-related commitments. The Allowance for
credit losses is intended to adjust the value of
the Firm’s loan assets for probable credit losses
as of the balance sheet date. For further
discussion of the methodologies used in
establishing the Firm’s Allowance for credit
losses, see Note 13 on pages 113–114 of this
Annual Report.
Wholesale loans and lending-related commitments
The methodology for calculating both the Allowance
for loan losses and the Allowance for
lending-related commitments involves significant
judgment. First and foremost, it involves the early
identification of credits that are deteriorating.
Second, it involves judgment in establishing the
inputs used to estimate the allowances. Third, it
involves management judgment to evaluate certain
macroeconomic factors, underwriting standards, and
other relevant internal and external factors
affecting the credit quality of the current
portfolio and to refine loss factors to better
reflect these conditions.
The Firm uses a risk rating system to determine the
credit quality of its wholesale loans. Wholesale
loans are reviewed for information affecting the
obligor’s ability to fulfill its obligations. In
assessing the risk rating of a particular loan,
among the factors considered are the obligor’s debt
capacity and financial flexibility, the level of
the obligor’s earnings, the amount and sources for
repayment, the level and nature of contingencies,
management strength, and the industry and geography
in which the obligor operates. These factors are
based upon an evaluation of historical and current
information, and involve subjective assessment and
interpretation. Emphasizing one factor over another
or considering additional factors could impact the
risk rating assigned by the Firm to that loan.
The Firm applies its judgment to establish loss
factors used in calculating the allowances.
Wherever possible, the Firm uses independent,
verifiable data or the Firm’s own historical loss
experience in its models for estimating the
allowances. Many factors can affect estimates of
loss, including volatility of loss given default,
probability of default and rating migrations.
Consideration is given as to whether the loss
estimates should be calculated as an average over
the entire credit cycle or at a particular point in
the credit cycle, as well as to which external data
should be used and when they should be used.
Choosing data that are not reflective of the Firm’s
specific loan portfolio characteristics could also
affect loss estimates. The application of different
inputs would change the amount of the allowance for
credit losses determined appropriate by the Firm.
Management also applies its judgment to adjust the
loss factors derived, taking into consideration
model imprecision, external factors and economic
events that have occurred but are not yet reflected
in the loss factors. The resultant adjustments to
the statistical calculation on the performing
portfolio are determined by creating estimated
ranges using historical experience of both loss
given default and probability of default. Factors
related to concentrated and deteriorating
industries also are incorporated where relevant.
The estimated ranges and the determination of the
appropriate point within the range are based upon
management’s view of uncertainties that relate to
current macroeconomic and political conditions,
quality of underwriting standards and other
relevant internal and external factors affecting
the credit quality of the current portfolio. The
adjustment to the statistical calculation for the
wholesale loan portfolio for the period ended
December 31, 2006, was $903 million based upon
management’s assessment of current economic
conditions.
Consumer loans
For scored loans in the consumer lines of business,
loss is determined primarily by applying
statistical loss factors and other risk indicators
to pools of loans by asset type. These loss
estimates are sensitive to changes in delinquency
status, credit bureau scores, the realizable value
of collateral and other risk factors.
Adjustments to the statistical calculation are
accomplished in part by analyzing the historical
loss experience for each major product segment.
Management analyzes the range of credit loss
experienced for each major portfolio segment,
taking into account economic cycles, portfolio
seasoning and underwriting criteria, and then
formulates a range that incorporates relevant risk
factors that impact overall credit performance. The
recorded adjustment to the statistical calculation
for the period ended December 31, 2006, was $1.2
billion based upon management’s assessment of
current economic conditions.
Fair value of financial instruments, MSRs and commodities inventory
A portion of JPMorgan Chase’s assets and
liabilities are carried at fair value, including
trading assets and liabilities, AFS securities,
private equity investments and mortgage servicing
rights (“MSRs”). Held-for-sale loans and physical
commodities are carried at the lower of fair value
or cost. At December 31, 2006, approximately $526.8
billion of the Firm’s assets were recorded at fair
value.
The fair value of a financial instrument is defined
as the amount at which the instrument could be
exchanged in a current transaction between willing
parties, other than in a forced or liquidation
sale. The majority of the Firm’s assets reported at
fair value are based upon quoted market prices or
upon internally developed models that utilize
independently sourced market parameters, including
interest rate yield curves, option volatilities and
currency rates.
The degree of management judgment involved in
determining the fair value of a financial
instrument is dependent upon the availability of
quoted market prices or observable market
parameters. For financial instruments that are
traded actively and have quoted market prices or
parameters readily available, there is little-to-no
subjectivity in determining fair value. When
observable market prices and parameters do not
exist, management judgment is necessary to estimate
fair value. The valuation process takes into consideration
JPMorgan Chase & Co. / 2006 Annual Report
83
Management’s discussion and analysis
JPMorgan Chase & Co.
factors such as liquidity and concentration
concerns and, for the derivatives portfolio,
counterparty credit risk (For a discussion of CVA, see Derivative
contracts
on pages 69–72 of this Annual Report). For example,
there is often limited market data to rely on when
estimating the fair value of a large or aged
position. Similarly, judgment must be applied in
estimating prices for less readily observable
external parameters. Finally, other factors such as
model assumptions, market dislocations and
unexpected correlations can affect estimates of
fair value. Imprecision in estimating these factors
can impact the amount of revenue or loss recorded
for a particular position.
Trading and available-for-sale portfolios
The majority of the Firm’s securities held for
trading and investment purposes (“long” positions)
and securities that the Firm has sold to other
parties but does not own (“short” positions) are
valued based upon quoted market prices. However,
certain securities are traded less actively and,
therefore, are not always able to be valued based
upon quoted market prices. The determination of
their fair value requires management judgment, as
this determination may require benchmarking to
similar instruments or analyzing default and
recovery rates. Examples include certain
collateralized mortgage and debt obligations and
high-yield debt securities.
As few derivative contracts are listed on an
exchange, the majority of the Firm’s derivative
positions are valued using internally developed
models that use as their basis readily observable
market parameters – that is, parameters that are
actively quoted and can be validated to external
sources, including industry-pricing services.
Certain derivatives, however, are valued based upon
models with significant unobservable market
parameters – that is, parameters that must be
estimated and are, therefore, subject to management
judgment to substantiate the model valuation. These
instruments are normally either traded less
actively or trade activity is one way. Examples
include long-dated interest rate or currency swaps,
where swap rates may be unobservable for longer
maturities, and certain credit products, where
correlation and recovery rates are unobservable.
Due to the lack of observable market data, the Firm
defers the initial trading profit for these
financial instruments. The deferred profit is
recognized in Principal transactions revenue on a
systematic basis (typically straight-line
amortization over the life of the instruments) when
observable market data becomes available.
Management’s judgment includes recording fair value
adjustments (i.e., reductions) to model valuations
to account for parameter uncertainty when valuing
complex or less actively traded derivative
transactions. The following table summarizes the
Firm’s trading and available-for-sale portfolios by
valuation methodology at December 31, 2006:
Internal models with significant
observable market parameters
13
96
3
95
3
Internal models with significant
unobservable market parameters
4
1
—
2
—
Total
100
%
100
%
100
%
100
%
100
%
(a)
Reflected as debt and equity instruments on the Firm’s Consolidated balance
sheets.
(b)
Based upon gross mark-to-market valuations of the Firm’s derivatives portfolio
prior to netting positions pursuant to FIN 39, as cross-product netting is not relevant to
an analysis based upon valuation methodologies.
To ensure that the valuations are appropriate,
the Firm has various controls in place. These
include: an independent review and approval of
valuation models; detailed review and explanation
for profit and loss analyzed daily and over time;
decomposing the model valuations for certain
structured derivative instruments into their
components and benchmarking valuations, where
possible, to similar products; and validating
valuation estimates through actual cash settlement.
As markets and products develop and the pricing for
certain derivative products becomes more
transparent, the Firm continues to refine its
valuation methodologies.
For further discussion of market risk management,
including the model review process, see Market risk
management on pages 77–80 of this Annual Report.
For further details regarding the Firm’s valuation
methodologies, see Note 31 on pages 135–137 of
this Annual Report.
Loans held-for-sale
The fair value of loans in the held-for-sale
portfolio generally is based upon observable market
prices of similar instruments, including bonds,
credit derivatives and loans with similar
characteristics. If market prices are not
available, fair value is based upon the estimated
cash flows adjusted for credit risk that is
discounted using an interest rate appropriate for
the maturity of the applicable loans.
Commodities inventory
The majority of commodities inventory includes
bullion and base metals where fair value is
determined by reference to prices in highly active
and liquid markets. The fair value of other
commodities inventory is determined primarily using
prices and data derived from the markets on which
the underlying commodities are traded. Market
prices used may be adjusted for liquidity.
Private equity investments
Valuation of private investments held primarily by
the Private Equity business within Corporate
requires significant management judgment due to the
absence of quoted market prices, inherent lack of
liquidity and the long-term nature of such assets.
Private equity investments are valued initially
based upon cost. The carrying values of private
equity investments are adjusted from cost to
reflect both positive and negative changes
evidenced by financing events with third-party
capital providers. In addition, these investments
are subject to ongoing impairment reviews by
Private Equity’s senior investment professionals. A
variety of factors are reviewed and monitored to
assess impairment including, but not limited to,
operating performance and future expectations of
the particular portfolio investment, industry
valuations of comparable public companies, changes
in market outlook and the third-party financing
environment over time.
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JPMorgan Chase & Co. / 2006 Annual Report
For a
discussion of the accounting for Private
equity investments, see
Note 4 on pages 98–99 of this Annual Report.
MSRs and certain other retained interests in securitizations
MSRs and certain other retained interests from
securitization activities do not trade in an
active, open market with readily observable prices.
For example, sales of MSRs do occur, but the
precise terms and conditions typically are not
readily available. Accordingly, the Firm estimates
the fair value of MSRs and certain other retained
interests in securitizations using discounted
future cash flow (DCF) models.
For MSRs, the Firm uses an option adjusted spread
(“OAS”) valuation model in conjunction with the
Firm’s proprietary prepayment model to project MSR
cash flows over multiple interest rate scenarios,
which are then discounted at risk-adjusted rates to
estimate an expected fair value of the MSRs. The
OAS model considers portfolio characteristics,
contractually specified servicing fees, prepayment
assumptions, delinquency rates, late charges, other
ancillary revenues, costs to service and other
economic factors.
For certain other retained interests in
securitizations (such as interest-only strips), a
single interest rate path DCF model is used and
generally includes assumptions based upon
projected finance charges related to the
securitized assets, estimated net credit losses,
prepayment assumptions, and contractual interest
paid to third-party investors. Changes in the
assumptions used may have a significant impact on
the Firm’s valuation of retained interests.
For both MSRs and certain other retained interests
in securitizations, the Firm compares its fair
value estimates and assumptions to observable
market data where available and to recent market
activity and actual portfolio experience.
For further discussion of the most significant
assumptions used to value retained interests in
securitizations and MSRs, as well as the applicable
stress tests for those assumptions, see Notes 14
and 16 on pages 114–118 and 121–122,
respectively, of this Annual Report.
Goodwill impairment
Under SFAS 142, goodwill must be allocated to
reporting units and tested for impairment. The Firm
tests goodwill for impairment at least annually,
and more frequently if events or circumstances,
such as adverse changes in the business climate,
indicate that there may be justification for
conducting an interim test. Impairment testing is
performed at the reporting-unit level (which is
generally one level below the six major business
segments identified in Note 33 on pages 139–141 of
this Annual Report, plus Private Equity which is
included in Corporate). The first part of the test
is a comparison, at the reporting unit level, of
the fair value of each reporting unit to its
carrying amount, including goodwill. If the fair
value is less than the carrying value, then the
second part of the test is needed to measure the
amount of potential goodwill impairment. The
implied fair value of the reporting unit goodwill
is calculated and compared with the carrying amount
of goodwill recorded in the Firm’s financial
records. If the carrying value of reporting unit
goodwill exceeds the implied fair value of that
goodwill, then the Firm would recognize an
impairment loss in the amount of the difference,
which would be recorded as a charge against Net
income.
The fair values of the reporting units are
determined using discounted cash flow models based
upon each reporting unit’s internal forecasts. In
addition, analysis using market-based trading and
transaction multiples, where available, are used to
assess the reasonableness of the valuations derived
from the discounted cash flow models.
ACCOUNTING AND REPORTING DEVELOPMENTS
Accounting for share-based payments
Effective January 1, 2006, the Firm adopted SFAS
123R and all related interpretations using the
modified prospective transition method. SFAS 123R
requires all share-based payments to employees,
including employee stock options and stock-settled
stock appreciation right (“SARs”), to be measured
at their grant date fair values. For additional
information related to SFAS 123R, see Note 8 on
pages 105–107 of this Annual Report.
Accounting for certain hybrid financial
instruments – an amendment of FASB Statements
No. 133 and 140
In February 2006, the FASB issued SFAS 155, which
applies to certain “hybrid financial instruments”
which are defined as financial instruments that
contain embedded derivatives. The new standard
establishes a requirement to evaluate beneficial
interests in securitized financial assets to
determine if the interests represent freestanding
derivatives or are hybrid financial instruments
containing embedded derivatives requiring
bifurcation. It
also permits an irrevocable election for fair value
remeasurement of any hybrid financial instrument
containing an embedded derivative that otherwise
would require bifurcation under SFAS 133. The Firm
adopted this standard effective January 1, 2006.
For additional information related to SFAS 155, see
Note 1 on page 95 of this Annual Report.
Accounting for servicing of financial assets
In March 2006, the FASB issued SFAS 156, which is
effective as of the beginning of the first fiscal
year beginning after September 15, 2006, with early
adoption permitted. JPMorgan Chase elected to adopt
the standard effective January 1, 2006. The
standard permits an entity a one-time irrevocable
election to adopt fair value accounting for a class
of servicing assets. The Firm has defined MSRs as
one class of servicing assets for this election.
For additional information related to the Firm’s
adoption of SFAS 156 with respect to MSRs, see Note
16 on pages 121–122 of this Annual Report.
JPMorgan Chase & Co. / 2006 Annual Report
85
Management’s discussion and analysis
JPMorgan Chase & Co.
Postretirement benefit plans
In September 2006, the FASB issued SFAS 158, which
requires recognition in the Consolidated balance
sheets of the overfunded or underfunded status of
defined benefit postretirement plans, measured as
the difference between the fair value of plan
assets and the amount of the benefit obligation.
The Firm adopted SFAS 158 on a prospective basis on
December 31, 2006. SFAS 158 has no impact either on
the measurement of the Firm’s plan assets or
benefit obligations, or on how the Firm determines
its net periodic benefit costs. For additional
information related to SFAS 158, see Note 7 on
pages 100–105 of this Annual Report.
Accounting
for uncertainty in income taxes and changes in timing of cash
flows related to income taxes generated by a leveraged
lease
In July 2006, the FASB issued two pronouncements:
FIN 48, which clarifies the accounting for uncertainty in
income taxes recognized under SFAS 109, and the related
FSP FAS 13-2. FIN 48 addresses the recognition and
measurement of tax positions taken or expected to be taken, and
also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, and
disclosure. FSP FAS 13-2 requires the recalculation of
returns on leveraged leases if there is a change or projected
change in the timing of cash flows relating to income taxes
generated by a leveraged lease. The Firm will apply FIN 48
to all of its income tax positions at the required effective
date of January 1, 2007 under the transition provisions of
the Interpretation. JPMorgan Chase currently estimates that the
cumulative effect adjustment to implement FIN 48 will
increase the January 1, 2007 balance of Retained earnings
by approximately $400 million. However, the standard
continues to be interpreted and the FASB is expected to issue
additional guidance on FIN 48, which could affect this
estimate. Accordingly, JPMorgan Chase will continue its
assessment of the impact of FIN 48 on its financial
condition and results of operations. The guidance in FSP
FAS 13-2 will also be effective for the Firm on
January 1, 2007. Implementation of FSP FAS 13-2
is expected to result in immaterial adjustments.
Fair value measurements
In September 2006, the FASB issued SFAS 157, which is
effective for fiscal years beginning after November 15,2007, with early adoption permitted. SFAS 157 defines fair
value, establishes a framework for measuring fair value, and
expands disclosures about assets and liabilities measured at
fair value. The new standard provides a consistent definition of
fair value which focuses on exit price and prioritizes, within a
measurement of fair value, the use of market-based inputs over
entity-specific inputs. The standard also establishes a
three-level hierarchy for fair value measurements based on the
transparency of inputs to the valuation of an asset or liability
as of the measurement date. SFAS 157 nullifies the guidance
in EITF 02-3 which required the deferral of profit at inception
of a transaction involving a derivative financial instrument in
the absence of observable data supporting the valuation
technique. The standard also eliminates large position discounts
for financial instruments quoted in active markets and requires
consideration of nonperformance risk when valuing liabilities.
Currently, the fair value of the Firm’s derivative payables
does not incorporate a valuation adjustment to reflect JPMorgan
Chase’s credit quality.
The Firm intends to early adopt SFAS 157 effective
January 1, 2007, and expects to record a cumulative
effect after-tax increase to retained earnings of
approximately $250 million related to the release of profit
previously deferred in accordance with EITF 02-3. In order
to determine the amount of this transition adjustment and to
confirm that the Firm’s valuation policies are consistent
with exit price as prescribed by SFAS 157, the Firm
reviewed its derivative valuations in consideration of all
available evidence including recent transactions in the
marketplace, indicative pricing services and the results of back-testing similar transaction types. In addition, the Firm expects
to record adjustments to earnings related to the incorporation
of the Firm’s nonperformance risk in the valuation of
liabilities recorded at fair value and for private equity
investments where there is significant market evidence to
support an increase in value but there has been no third-party
market transaction related to the capital structure of the
investment. The application of SFAS 157 involves judgement
and interpretation. The Firm continues to monitor and evaluate
the developing interpretations.
Fair
value option for financial assets and financial
liabilities
In February 2007, the FASB issued SFAS 159, which is
effective for the fiscal years beginning after November 15,2007, with early adoption permitted. SFAS 159 provides an
option for companies to elect fair value as an alternative
measurement for selected financial assets, financial
liabilities, unrecognized firm commitments, and written loan
commitments. Under SFAS 159, fair value would be used for
both the initial and subsequent measurement of the designated
assets, liabilities and commitments, with the changes in value
recognized in earnings. The Firm is reviewing the recently
released standard and assessing what elections it may make as
part of an early adoption effective January 1, 2007.
86
JPMorgan Chase & Co. / 2006 Annual Report
NON EXCHANGE-TRADED COMMODITY DERIVATIVE CONTRACTS AT FAIR VALUE
In the normal course of business, JPMorgan
Chase trades nonexchange-traded commodity
derivative contracts. To determine the fair value
of these contracts, the Firm uses various fair
value estimation techniques, which are primarily
based upon internal models with significant
observable market parameters. The Firm’s
nonexchange-traded commodity derivative contracts
are primarily energy-related contracts. The
following table summarizes the changes in fair
value for nonexchange-traded commodity derivative
contracts for the year ended December 31, 2006:
Management’s report on internal control over financial reporting
JPMorgan Chase & Co.
Management of JPMorgan Chase & Co. is
responsible for establishing and maintaining
adequate internal control over financial reporting.
Internal control over financial reporting is a
process designed by, or under the supervision of,
the Firm’s principal executive and principal
financial officers, or persons performing similar
functions, and effected by JPMorgan Chase’s Board
of Directors, management and other personnel, to
provide reasonable assurance regarding the
reliability of financial reporting and the
preparation of financial statements for external
purposes in accordance with accounting principles
generally accepted in the United States of America.
JPMorgan Chase’s internal control over financial
reporting includes those policies and procedures
that (1) pertain to the maintenance of records,
that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the
Firm’s assets; (2) provide reasonable assurance
that transactions are recorded as necessary to
permit preparation of financial statements in
accordance with generally accepted accounting
principles, and that receipts and expenditures of
the Firm are being made only in accordance with
authorizations of JPMorgan Chase’s management and
directors; and (3) provide reasonable assurance
regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the
Firm’s assets that could have a material effect on
the financial statements.
Because of its inherent limitations, internal
control over financial reporting may not prevent
or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies or
procedures may deteriorate.
Management has completed an assessment of the
effectiveness of the Firm’s internal control over
financial reporting as of December 31, 2006. In
making the assessment, management used the
framework in “Internal Control –Integrated
Framework” promulgated by the Committee of
Sponsoring Organizations of the Treadway
Commission, commonly referred to as the “COSO”
criteria.
Based upon the assessment performed, management
concluded that as of December 31, 2006, JPMorgan
Chase’s internal control over financial reporting
was effective based upon the COSO criteria.
Additionally, based upon management’s assessment,
the Firm determined that there were no material
weaknesses in its internal control over financial
reporting as of December 31, 2006.
Management’s assessment of the effectiveness of the
Firm’s internal control over financial reporting as
of December 31, 2006, has been audited by
PricewaterhouseCoopers LLP, JPMorgan Chase’s
independent registered public accounting firm, who
also audited the Firm’s financial statements as of
and for the year ended December 31, 2006, as stated
in their report which is included herein.
Report of independent registered public accounting firm
JPMorgan Chase & Co.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of JPMorgan Chase & Co.:
We have completed integrated audits of JPMorgan
Chase & Co.’s consolidated financial statements and
of its internal control over financial reporting as
of December 31, 2006, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States). Our opinions,
based on our audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated
balance sheets and the related consolidated
statements of income, changes in stockholders’
equity and comprehensive income, and cash flows
present fairly, in all material respects, the
financial position of JPMorgan Chase & Co. and its
subsidiaries (the “Company”) at December 31, 2006
and 2005, and the results of their operations and
their cash flows for each of the three years in the
period ended December 31, 2006 in conformity with
accounting principles generally accepted in the
United States of America. These financial
statements are the responsibility of the Company’s
management. Our responsibility is to express an
opinion on these financial statements based on our
audits. We conducted our audits of these statements
in accordance with the standards of the Public
Company Accounting Oversight Board (United States).
Those standards require that we plan and perform
the audit to obtain reasonable assurance about
whether the financial statements are free of
material misstatement. An audit of financial
statements includes examining, on a test basis,
evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting
principles used and significant estimates made by
management, and evaluating the overall financial
statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment,
included in the accompanying “Management’s report
on internal control over financial reporting”, that
the Company maintained effective internal control
over financial reporting as of December 31, 2006
based on criteria established in Internal Control
- Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission
(COSO), is fairly stated, in all material respects,
based on those criteria. Furthermore, in our
opinion, the Company maintained, in all material
respects, effective internal control over financial
reporting as of December 31, 2006, based on
criteria established in Internal Control -
Integrated Framework issued by the COSO. The
Company’s management is responsible for maintaining
effective internal control
over financial reporting and for its assessment of
the effectiveness of internal control over
financial reporting. Our responsibility is to
express opinions on management’s assessment and on
the effectiveness of the Company’s internal control
over financial reporting based on our audit. We
conducted our audit of internal control over
financial reporting in accordance with the
standards of the Public
Company Accounting Oversight Board (United
States). Those standards require that we plan and
perform the audit to obtain reasonable assurance
about whether effective internal control over
financial reporting was maintained in all material
respects. An audit of internal control over
financial reporting includes obtaining an
understanding of internal control over financial
reporting, evaluating management’s assessment,
testing and evaluating the design and operating
effectiveness of internal control, and performing
such other procedures as we consider necessary in
the circumstances. We believe that our audit
provides a reasonable basis for our opinions.
A company’s internal control over financial
reporting is a process designed to provide
reasonable assurance regarding the reliability of
financial reporting and the preparation of
financial statements for external purposes in
accordance with generally accepted accounting
principles. A company’s internal control over
financial reporting includes those policies and
procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of
the assets of the company; (ii) provide reasonable
assurance that transactions are recorded as
necessary to permit preparation of financial
statements in accordance with generally accepted
accounting principles, and that receipts and
expenditures of the company are being made only in
accordance with authorizations of management and
directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal
control over financial reporting may not prevent
or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies or
procedures may deteriorate.
Federal funds purchased and securities sold under repurchase agreements
162,173
125,925
Commercial paper
18,849
13,863
Other borrowed funds
18,053
10,479
Trading liabilities
147,957
145,930
Accounts payable, accrued expenses and other liabilities (including the Allowance for
lending-related
commitments of $524 at December 31, 2006, and $400 at December 31, 2005)
88,096
78,460
Beneficial interests issued by consolidated variable interest entities
16,184
42,197
Long-term debt (including structured notes accounted for at fair value of $25,370 at December 31,2006)
133,421
108,357
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital
debt securities
12,209
11,529
Total liabilities
1,235,730
1,091,731
Commitments and contingencies (see Note 27 on pages 130–131 of this Annual Report)
Stockholders’ equity
Preferred stock ($1 par value; authorized 200,000,000 shares at December 31, 2006 and 2005;
issued 0 shares and 280,433 shares at December 31, 2006 and 2005, respectively)
—
139
Common stock ($1 par value; authorized 9,000,000,000 shares at December 31, 2006 and 2005;
issued 3,657,786,282 shares and 3,618,189,597 shares at December 31, 2006 and 2005,
respectively)
3,658
3,618
Capital surplus
77,807
74,994
Retained earnings
43,600
33,848
Accumulated other comprehensive income (loss)
(1,557
)
(626
)
Treasury stock, at cost (196,102,381 shares and 131,500,350 shares at December 31, 2006 and 2005,
respectively)
(7,718
)
(4,762
)
Total stockholders’ equity
115,790
107,211
Total liabilities and stockholders’ equity
$
1,351,520
$
1,198,942
The Notes to consolidated financial statements are an integral part of these statements.
JPMorgan Chase & Co. / 2006 Annual Report
91
Consolidated statements of changes in stockholders’ equity and comprehensive income
JPMorgan Chase & Co.
Year ended December 31, (in millions, except per share data)
2006
2005
2004
(a)
Preferred stock
Balance at beginning of year
$
139
$
339
$
1,009
Redemption of preferred stock
(139
)
(200
)
(670
)
Balance at end of year
—
139
339
Common stock
Balance at beginning of year
3,618
3,585
2,044
Issuance of common stock
40
33
72
Issuance of common stock for purchase accounting acquisitions
—
—
1,469
Balance at end of year
3,658
3,618
3,585
Capital surplus
Balance at beginning of year
74,994
72,801
13,512
Issuance of common stock and options for purchase accounting
acquisitions
—
—
55,867
Shares issued and commitments to issue common stock for employee stock-based
compensation awards and related tax effects
2,813
2,193
3,422
Balance at end of year
77,807
74,994
72,801
Retained earnings
Balance at beginning of year
33,848
30,209
29,681
Cumulative effect of change in accounting principles
172
—
—
Balance at beginning of year, adjusted
34,020
30,209
29,681
Net income
14,444
8,483
4,466
Cash dividends declared:
Preferred stock
(4
)
(13
)
(52
)
Common stock ($1.36 per share each year)
(4,860
)
(4,831
)
(3,886
)
Balance at end of year
43,600
33,848
30,209
Accumulated other comprehensive income (loss)
Balance at beginning of year
(626
)
(208
)
(30
)
Other comprehensive income (loss)
171
(418
)
(178
)
Adjustment to initially apply SFAS 158
(1,102
)
—
—
Balance at end of year
(1,557
)
(626
)
(208
)
Treasury stock, at cost
Balance at beginning of year
(4,762
)
(1,073
)
(62
)
Purchase of treasury stock
(3,938
)
(3,412
)
(738
)
Reissuance from treasury stock
1,334
—
—
Share
repurchases related to employee stock-based compensation awards
(352
)
(277
)
(273
)
Balance at end of year
(7,718
)
(4,762
)
(1,073
)
Total stockholders’ equity
$
115,790
$
107,211
$
105,653
Comprehensive income
Net income
$
14,444
$
8,483
$
4,466
Other comprehensive income (loss)
171
(418
)
(178
)
Comprehensive income
$
14,615
$
8,065
$
4,288
(a)
2004 results include six months of the combined Firm’s results and six
months of heritage JPMorgan Chase results.
The Notes to consolidated financial statements are an integral part of
these statements.
92
JPMorgan Chase & Co. / 2006 Annual Report
Consolidated statements of cash flows
JPMorgan Chase & Co.
Year ended December 31, (in millions)
2006
2005
2004
(a)
Operating activities
Net income
$
14,444
$
8,483
$
4,466
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for credit losses
3,270
3,483
2,544
Depreciation and amortization
2,149
2,828
2,924
Amortization of intangibles
1,428
1,490
911
Deferred tax benefit
(1,810
)
(1,791
)
(827
)
Investment securities (gains) losses
543
1,336
(338
)
Private equity unrealized (gains) losses
(404
)
55
(766
)
Gains on disposition of businesses
(1,136
)
(1,254
)
(17
)
Stock based compensation
2,368
1,563
1,296
Originations and purchases of loans held-for-sale
(178,355
)
(108,611
)
(89,315
)
Proceeds from sales and securitizations of loans held-for-sale
170,874
102,602
95,973
Net change in:
Trading assets
(61,664
)
(3,845
)
(48,703
)
Securities borrowed
916
(27,290
)
(4,816
)
Accrued interest and accounts receivable
(1,170
)
(1,934
)
(2,391
)
Other assets
(7,208
)
(9
)
(17,588
)
Trading liabilities
(4,521
)
(12,578
)
29,764
Accounts payable, accrued expenses and other liabilities
7,815
5,532
13,277
Other operating adjustments
2,882
(296
)
(1,541
)
Net cash used in operating activities
(49,579
)
(30,236
)
(15,147
)
Investing activities
Net change in:
Deposits with banks
8,168
104
(4,196
)
Federal funds sold and securities purchased under resale agreements
(6,939
)
(32,469
)
(13,101
)
Held-to-maturity securities:
Proceeds
19
33
66
Available-for-sale securities:
Proceeds from maturities
24,909
31,053
45,197
Proceeds from sales
123,750
82,902
134,534
Purchases
(201,530
)
(81,749
)
(173,745
)
Proceeds from sales and securitizations of loans held-for-investment
20,809
23,861
12,854
Originations and other changes in loans, net
(70,837
)
(40,436
)
(47,726
)
Net cash received (used) in business dispositions or acquisitions
185
(1,039
)
13,864
All other investing activities, net
1,839
4,796
2,519
Net cash used in investing activities
(99,627
)
(12,944
)
(29,734
)
Financing activities
Net change in:
Deposits
82,105
31,415
52,082
Federal funds purchased and securities sold under repurchase agreements
36,248
(1,862
)
7,065
Commercial paper and other borrowed funds
12,657
2,618
(4,343
)
Proceeds from the issuance of long-term debt and capital debt securities
56,721
43,721
25,344
Repayments of long-term debt and capital debt securities
(34,267
)
(26,883
)
(16,039
)
Net proceeds from the issuance of stock and stock-related awards
1,659
682
848
Excess tax benefits related to stock-based compensation
302
—
—
Redemption of preferred stock
(139
)
(200
)
(670
)
Treasury stock purchased
(3,938
)
(3,412
)
(738
)
Cash dividends paid
(4,846
)
(4,878
)
(3,927
)
All other financing activities, net
6,247
3,868
(26
)
Net cash provided by financing activities
152,749
45,069
59,596
Effect of exchange rate changes on cash and due from banks
199
(387
)
185
Net increase in cash and due from banks
3,742
1,502
14,900
Cash and due from banks at the beginning of the year
36,670
35,168
20,268
Cash and due from banks at the end of the year
$
40,412
$
36,670
$
35,168
Cash interest paid
$
36,415
$
24,583
$
13,384
Cash income taxes paid
$
5,563
$
4,758
$
1,477
Note:
In 2006, the Firm exchanged selected corporate trust businesses for The Bank of New
York’s consumer, business banking and middle-market banking businesses. The fair values of the
noncash assets exchanged was $2.15 billion. In 2004, the fair values of noncash assets acquired and
liabilities assumed in the merger with Bank One were $320.9 billion and $277.0 billion,
respectively, and approximately 1,469 million shares of common stock, valued at approximately $57.3
billion, were issued in connection with the merger with Bank One.
(a)
2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
The Notes to consolidated financial statements are an integral part of these statements.
JPMorgan Chase & Co. / 2006 Annual Report
93
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 1 – Basis of presentation
JPMorgan Chase & Co. (“JPMorgan Chase” or the
“Firm”), a financial holding company incorporated
under Delaware law in 1968, is a leading global
financial services firm and one of the largest
banking institutions in the United States, with
operations worldwide. The Firm is a leader in
investment banking, financial services for
consumers and businesses, financial transaction
processing, asset management and private equity.
For a discussion of the Firm’s business segment
information, see Note 33 on pages 139–141 of this
Annual Report.
The accounting and financial reporting policies
of JPMorgan Chase and its subsidiaries conform to
accounting principles generally accepted in the
United States of America (“U.S. GAAP”).
Additionally, where applicable, the policies
conform to the accounting and reporting
guidelines prescribed by bank regulatory
authorities.
Certain amounts in the prior periods have been
reclassified to conform to the current
presentation.
Consolidation
The consolidated financial statements include the
accounts of JPMorgan Chase and other entities in
which the Firm has a controlling financial
interest. All material intercompany balances and
transactions have been eliminated.
The most usual condition for a controlling
financial interest is the ownership of a majority
of the voting interests of the entity. However, a
controlling financial interest also may be deemed
to exist with respect to entities, such as special
purpose entities (“SPEs”), through arrangements
that do not involve controlling voting interests.
SPEs are an important part of the financial
markets, providing market liquidity by facilitating
investors’ access to specific portfolios of assets
and risks. For example, they are critical to the
functioning of the mortgage- and asset-backed
securities and commercial paper markets. SPEs may
be organized as trusts, partnerships or
corporations and are typically set up for a single,
discrete purpose. SPEs are not typically operating
entities and usually have a limited life and no
employees. 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. The legal documents that govern the
transaction describe how the cash earned on the
assets must be allocated to the SPE’s investors and
other parties that have rights to those cash flows.
SPEs can be structured to be bankruptcy-remote,
thereby insulating investors from the impact of the
creditors of other entities, including the seller
of the assets.
There are two different accounting frameworks
applicable to SPEs: the qualifying SPE (“QSPE”)
framework under SFAS 140; and the variable interest
entity (“VIE”) framework under FIN 46R. The
applicable framework depends on the nature of the
entity and the Firm’s relation to that entity. The
QSPE framework is applicable when an entity
transfers (sells) financial assets to an SPE
meeting certain criteria defined in SFAS 140. These
criteria are designed to ensure that the activities
of the entity are essentially predetermined at the
inception of the vehicle and that the transferor of
the financial assets cannot exercise control over
the entity and the assets therein.
Entities meeting these criteria are not
consolidated by the transferor or other
counterparties, as long as they do not have the
unilateral ability to liquidate or to cause the
entity no longer to meet the QSPE criteria. The
Firm primarily follows the QSPE model for
securitizations of its residential and commercial
mortgages, credit card loans and automobile loans.
For further details, see Note 14 on pages 114–118
of this Annual Report.
When the SPE does not meet the QSPE criteria,
consolidation is assessed pursuant to FIN 46R.
Under FIN 46R, a VIE is defined as an entity that:
(1) lacks enough equity investment at risk to
permit the entity to finance its activities without
additional subordinated financial support from
other parties; (2) has equity owners that lack the
right to make significant decisions affecting the
entity’s operations; and/or (3) has equity owners
that do not have an obligation to absorb the
entity’s losses or the right to receive the
entity’s returns.
FIN 46R requires a variable interest holder (i.e.,
a counterparty to a VIE) to consolidate the VIE if
that party will absorb a majority of the expected
losses of the VIE, receive the majority of the
expected residual returns of the VIE, or both. This
party is considered the primary beneficiary. In
making this determination, the Firm thoroughly
evaluates the VIE’s design, capital structure and
relationships among variable interest holders. When
the primary beneficiary cannot be identified
through a qualitative analysis, the Firm performs a
quantitative analysis, which computes and allocates
expected losses or residual returns to variable
interest holders. The allocation of expected cash
flows in this analysis is based upon the relative
contractual rights and preferences of each interest
holder in the VIE’s capital structure. For further
details, see Note 15 on pages 118–120 of this
Annual Report.
Investments in companies that are considered to
be voting-interest entities under FIN 46R in
which the Firm has significant influence over
operating and financing decisions are accounted
for in accordance with the equity method of
accounting. These investments are generally
included in Other assets, and the Firm’s share of
income or loss is included in Other income.
All retained interests and significant
transactions between the Firm, QSPEs and
nonconsolidated VIEs are reflected on JPMorgan
Chase’s Consolidated balance sheets or in the
Notes to consolidated financial statements.
For a discussion of the accounting for private
equity investments, see Note 4 on pages 98–99 of
this Annual Report.
Assets held for clients in an agency or
fiduciary capacity by the Firm are not assets of
JPMorgan Chase and are not included in the
Consolidated balance sheets.
Use of estimates in the preparation of
consolidated financial statements
The preparation of consolidated financial
statements requires management to make estimates
and assumptions that affect the reported amounts
of assets and liabilities, of revenue and
expenses, and of disclosures of contingent assets
and liabilities. Actual results could be different
from these estimates. For discussion of critical
accounting estimates used by the Firm, see pages
83–85 of this Annual Report.
Foreign currency translation
JPMorgan Chase revalues assets, liabilities,
revenues and expenses
denominated in foreign (i.e., non-U.S.)
currencies into U.S. dollars using applicable
exchange rates.
Gains and losses relating to translating functional
currency financial statements for U.S. reporting
are included in Other comprehensive income (loss)
within Stockholders’ equity. Gains and losses
relating to nonfunctional currency transactions,
including non-U.S. operations where the functional
currency is the U.S. dollar, are reported in the
Consolidated statements of income.
Statements of cash flows
For JPMorgan Chase’s Consolidated statements of
cash flows, cash is defined as those amounts
included in Cash and due from banks.
94
JPMorgan Chase & Co. / 2006 Annual Report
Accounting for certain hybrid financial instruments
SFAS 155 applies to certain “hybrid financial
instruments” which are financial instruments that
contain embedded derivatives. The standard
establishes a requirement to evaluate beneficial
interests in securitized financial assets to
determine if the interests represent freestanding
derivatives or are hybrid financial instruments
containing embedded derivatives requiring
bifurcation. SFAS 155 also permits an irrevocable
election for fair value measurement of any hybrid
financial instrument containing an embedded
derivative that otherwise would require bifurcation
under SFAS 133. The fair value election can be
applied to existing instruments on an
instrument-by-instrument basis at the date of
adoption and can be applied to new instruments on a
prospective basis.
The Firm adopted SFAS 155 effective January 1,2006. The Firm has elected to fair value all
instruments issued, acquired or modified after
December 31, 2005, that are required to be
bifurcated under SFAS 133, as amended by SFAS 138,
SFAS 149 and SFAS 155. In addition, the Firm
elected to fair value certain structured notes
existing as of December 31, 2005, resulting in a
$22 million cumulative effect increase to Retained
earnings. The cumulative effect adjustment includes
gross unrealized gains of $29 million and gross
unrealized losses of $7 million.
The substantial majority of the structured notes to
which the fair-value election has been applied are
classified in Long-term debt on the Consolidated
balance sheets. The change in fair value associated
with structured notes is classified within
Principal transactions revenue on the Consolidated
statements of income. For a discussion of Principal
transactions and Long-term debt, see Notes 4 and 19
on pages 98–99 and 124–125, respectively, of this
Annual Report.
Significant accounting policies
The following table identifies JPMorgan Chase’s
other significant accounting policies and the Note
and page where a detailed description of each
policy can be found:
Business changes and developments
Note
2
Page
95
Principal transactions activities
Note
4
Page
98
Other noninterest revenue
Note
5
Page
99
Pension and other postretirement employee
benefit plans
Note
7
Page
100
Employee stock-based incentives
Note
8
Page
105
Noninterest expense
Note
9
Page
108
Securities
Note
10
Page
108
Securities financing activities
Note
11
Page
111
Loans
Note
12
Page
112
Allowance for credit losses
Note
13
Page
113
Loan securitizations
Note
14
Page
114
Variable interest entities
Note
15
Page
118
Goodwill and other intangible assets
Note
16
Page
121
Premises and equipment
Note
17
Page
123
Income taxes
Note
24
Page
128
Accounting for derivative instruments
and hedging activities
Note
28
Page
131
Off–balance sheet lending-related financial
instruments and guarantees
Note
29
Page
132
Fair value of financial instruments
Note
31
Page
135
Note 2 – Business changes and developments
Merger with Bank One Corporation
Bank One Corporation merged with and into JPMorgan Chase (the
“Merger”) on July 1, 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. JPMorgan Chase stockholders kept
their shares, which remained outstanding and
unchanged as shares of JPMorgan Chase following the
Merger. Key objectives of the Merger were to
provide the Firm with a more balanced business mix
and greater geographic diversification. The Merger
was accounted for using the purchase method of
accounting, which requires that the assets and
liabilities of Bank One be fair valued as of July1, 2004. The purchase price to complete the Merger
was $58.5 billion.
As part of the Merger, certain accounting policies
and practices were conformed, which resulted in
$976 million of charges in 2004. The significant
components of the conformity charges were a $1.4
billion 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.
JPMorgan Chase & Co. / 2006 Annual Report
95
Notes to consolidated financial statements
JPMorgan Chase & Co.
The final purchase price of the Merger was
allocated to the assets acquired and liabilities
assumed using their fair values as of the Merger
date. The computation of the purchase price and the
allocation of the purchase price to the net assets
of Bank One – based upon their respective fair
values as of July 1, 2004 – and the resulting
goodwill are presented below.
Average purchase price per
JPMorgan Chase common share(a)
$
39.02
$
57,336
Fair value of employee stock awards and
direct acquisition costs
1,210
Total purchase price
58,546
Net assets acquired:
Bank One stockholders’ equity
$
24,156
Bank One goodwill and other intangible assets
(2,754
)
Subtotal
21,402
Adjustments to reflect assets
acquired at fair value:
Loans and leases
(2,261
)
Private equity investments
(72
)
Identified intangible assets
8,665
Pension plan assets
(778
)
Premises and equipment
(417
)
Other assets
(267
)
Amounts to reflect liabilities
assumed at fair value:
Deposits
(373
)
Deferred income taxes
932
Other postretirement benefit plan liabilities
(49
)
Other liabilities
(1,162
)
Long-term debt
(1,234
)
24,386
Goodwill resulting from Merger(b)
$
34,160
(a)
The value of the Firm’s common stock exchanged with Bank One shareholders was
based upon the average closing prices of the Firm’s common stock for the two days prior
to, and the two days following, the announcement of the Merger on January 14, 2004.
(b)
Goodwill resulting from the Merger reflects adjustments of the allocation of the
purchase price to the net assets acquired through June 30, 2005.
Condensed statement of net assets acquired
The following condensed statement of net
assets acquired reflects the fair value of Bank
One net assets as of July 1, 2004.
Components of the fair value of acquired,
identified intangible assets as of July 1, 2004,
were as follows:
Fair value
Weighted-average
Useful life
(in millions)
life (in years)
(in years)
Core deposit intangibles
$
3,650
5.1
Up to 10
Purchased credit card relationships
3,340
4.6
Up to 10
Other credit card–related intangibles
295
4.6
Up to 10
Other customer relationship intangibles
870
4.6–10.5
Up to 20
Subtotal
8,155
5.1
Up to 20
Indefinite-lived asset management
intangibles
510
NA
NA
Total
$
8,665
Unaudited pro forma condensed combined financial information
The following unaudited pro forma condensed
combined financial information presents the results
of operations of the Firm had the Merger taken
place at January 1, 2004.
Year ended December 31, (in millions, except per share data)
2004
Noninterest revenue
$
30,684
Net interest income
21,132
Total net revenue
51,816
Provision for credit losses
2,727
Noninterest expense
40,117
Income from continuing operations
before income tax expense
8,972
Income from continuing operations
6,338
Income from discontinued operations
206
Net income
$
6,544
Net income per common share:
Basic
Income from continuing operations
$
1.79
Net income
1.85
Diluted
Income from continuing operations
1.75
Net income
1.81
Average common shares outstanding:
Basic
3,510
Diluted
3,593
Other business events
Acquisition of the consumer, business banking
and middle-market banking businesses of The Bank
of New York in exchange for selected corporate
trust businesses, including trustee, paying agent,
loan agency and document management services
On October 1, 2006, JPMorgan Chase completed the
acquisition of The Bank of New York Company, Inc.’s
(“The Bank of New York”) consumer, business banking
and middle-market banking businesses in exchange
for selected corporate trust businesses plus a cash
payment of $150 million. This acquisition added 339
branches and more than 400 ATMs, and it
significantly strengthens Retail Financial
Services’ distribution network in the New York
Tri-state area. The Bank of New York businesses
acquired were valued at a premium of $2.3 billion;
the Firm’s corporate trust businesses that were
transferred (i.e., trustee, paying agent, loan
agency and document management services) were
valued at a premium of $2.2 billion. The Firm also
may make a future payment to The Bank of New York
of up to $50 million depending on certain new
account openings. This transaction included the
acquisition of approximately $7.7 billion in loans
net of Allowance for loan losses and $12.9 billion
in deposits from The Bank of New York. The Firm
also recognized core deposit
96
JPMorgan Chase & Co. / 2006 Annual Report
intangibles of $485 million which will be
amortized using an accelerated method over a 10
year period. JPMorgan Chase recorded an after-tax
gain of $622 million related to this transaction in
the fourth quarter of 2006.
JPMorgan Partners management
On August 1, 2006, the buyout and growth equity
professionals of JPMorgan Partners (“JPMP”) formed
an independent firm, CCMP Capital, LLC (“CCMP”),
and the venture professionals separately formed an
independent firm, Panorama Capital, LLC
(“Panorama”). The investment professionals of CCMP
and Panorama continue to manage the former JPMP
investments pursuant to a management agreement with
the Firm.
Sale of insurance underwriting business
On July 1, 2006, JPMorgan Chase completed the sale
of its life insurance and annuity underwriting
businesses to Protective Life Corporation for cash
proceeds of approximately $1.2 billion, consisting
of $900 million of cash received from Protective
Life Corporation and approximately $300 million of
preclosing dividends received from the entities
sold. The after-tax impact of this transaction was
negligible. The sale included both the heritage
Chase insurance business and the insurance business
that Bank One had bought from Zurich Insurance in
2003.
Acquisition of private-label credit card
portfolio from Kohl’s Corporation
On April 21, 2006, JPMorgan Chase completed the
acquisition of $1.6 billion of private-label credit
card receivables and approximately 21 million
accounts from Kohl’s Corporation (“Kohl’s”).
JPMorgan Chase and Kohl’s have also entered into an
agreement under which JPMorgan Chase will offer
private-label credit cards to both new and existing
Kohl’s customers.
Collegiate Funding Services
On March 1, 2006, JPMorgan Chase acquired, for
approximately $663 million, Collegiate Funding
Services, a leader in education loan servicing and
consolidation. This acquisition included $6
billion of education loans and will enable the
Firm to create a comprehensive education finance
business.
BrownCo
On November 30, 2005, JPMorgan Chase sold BrownCo,
an on-line deep-discount brokerage business, to
E*TRADE Financial for a cash purchase price of
$1.6 billion. JPMorgan Chase recognized an
after-tax gain of $752 million on the sale.
BrownCo’s results of operations were reported in
the Asset Management business segment; however,
the gain on the sale, which was recorded in Other
income in the Consolidated statements of income,
was reported in the Corporate business segment.
Sears Canada credit card business
On November 15, 2005, JPMorgan Chase purchased
Sears Canada Inc.’s credit card operation,
including both private-label card accounts and
co-branded Sears MasterCard®accounts,
aggregating approximately 10 million accounts with
$2.2 billion (CAD$2.5 billion) in managed loans.
Sears Canada and JPMorgan Chase entered into an
ongoing arrangement under which JPMorgan Chase will
offer private-label and co-branded credit cards to
both new and existing customers of Sears Canada.
Chase Merchant Services, Paymentech integration
On October 5, 2005, JPMorgan Chase and First Data
Corp. completed the integration of the companies’
jointly owned Chase Merchant Services and
Paymentech merchant businesses, to be operated
under the name Chase Paymentech Solutions, LLC. The
joint venture is the largest financial transaction
processor in the U.S. for businesses accepting
credit card payments via traditional point of sale,
Internet, catalog and recurring billing. As a
result of the integration
into a joint venture, Paymentech has been
deconsolidated and JPMorgan Chase’s ownership
interest in this joint venture is accounted for in
accordance with the equity method of accounting.
Cazenove
On February 28, 2005, JPMorgan Chase and Cazenove
Group plc (“Cazenove”) formed a business
partnership which combined Cazenove’s investment
banking business and JPMorgan Chase’s U.K.-based
investment banking business in order to provide
investment banking services in the United Kingdom
and Ireland. The new company is called JPMorgan
Cazenove Holdings.
Other acquisitions
During 2004, JPMorgan Chase purchased the
Electronic Financial Services (“EFS”) business
from Citigroup and acquired a majority interest
in hedge fund manager Highbridge Capital
Management, LLC (“Highbridge”).
Note 3 – Discontinued operations
The transfer of selected corporate trust
businesses to The Bank of
New York (see Note 2 above) includes the trustee,
paying agent, loan agency and document management
services businesses. JPMorgan Chase recognized an
after-tax gain of $622 million on this transaction.
The results of operations of these corporate trust
businesses were transferred from the Treasury &
Securities Services (“TSS”) segment to the
Corporate segment effective with the second quarter
of 2006, and reported as discontinued operations.
Condensed financial information of the corporate
trust business follows:
Selected income statements data
Year ended December 31, (in millions)
2006
2005
2004
(a)
Other noninterest revenue
$
407
$
509
$
491
Net interest income
264
276
234
Gain on sale of discontinued operations
1,081
—
—
Total net revenue
1,752
785
725
Noninterest expense
385
409
387
Income from discontinued operations
before income taxes
1,367
376
338
Income tax expense
572
147
132
Income from discontinued
operations
$
795
$
229
$
206
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
The following is a summary of the assets and
liabilities associated with the selected corporate
trust businesses related to The Bank of New York
transaction that closed on October 1, 2006.
JPMorgan Chase will provide certain transitional
services to The Bank of New York for a defined
period of time after the closing date. The Bank of
New York will compensate JPMorgan Chase for these
transitional services.
JPMorgan Chase & Co. / 2006 Annual Report
97
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 4 – Principal transactions
Principal transactions is a new caption,
effective January 1, 2006, in the Consolidated
statements of income. Principal transactions
revenue consists of: realized and unrealized gains
and losses from trading activities (including
physical commodities inventories that are accounted
for at the lower of cost or fair value); changes in
fair value
associated with structured notes to which the SFAS
155 fair value election has been applied, and
Private equity gains and losses. The prior-period
presentation of Trading revenue and Private equity
gains (losses) has been reclassified to this new
caption. The following table presents Principal
transactions revenue:
Year ended December 31, (in millions)
2006
2005
2004
(a)
Trading revenue
$
8,986
$
5,860
$
3,612
Private equity gains
1,360
1,809
1,536
Principal transactions
$
10,346
$
7,669
$
5,148
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Trading assets and liabilities
Trading assets include debt and equity
securities held for trading purposes that JPMorgan
Chase owns (“long” positions). Trading liabilities
include debt and equity securities that the Firm
has sold to other parties but does not own (“short”
positions). The Firm is obligated to purchase
securities at a future date to cover the short
positions. Included in Trading assets and Trading
liabilities are the reported receivables
(unrealized gains) and payables (unrealized losses)
related to derivatives. Loans are classified as
trading where positions are bought and sold to make
profits from short-term movements in price. Trading
positions are carried at fair value on the
Consolidated balance sheets.
The following table
presents the fair value of Trading assets and
Trading liabilities for the dates indicated:
December 31, (in millions)
2006
2005
Trading assets
Debt and equity instruments:
U.S. government and federal agency obligations
$
17,358
$
16,283
U.S. government-sponsored enterprise obligations
28,544
24,172
Obligations of state and political subdivisions
9,569
9,887
Certificates of deposit, bankers’ acceptances
and commercial paper
8,204
5,652
Debt securities issued by non-U.S. governments
58,387
48,671
Corporate securities and other
188,075
143,925
Total debt and equity instruments
310,137
248,590
Derivative receivables:(a)(b)
Interest rate
28,932
28,113
Foreign exchange
4,260
2,855
Equity
6,246
5,575
Credit derivatives
5,732
3,464
Commodity
10,431
9,780
Total derivative receivables
55,601
49,787
Total trading assets
$
365,738
$
298,377
December 31, (in millions)
2006
2005
Trading liabilities
Debt and equity instruments(c)
$
90,488
$
94,157
Derivative payables:(a)(b)
Interest rate
22,738
26,930
Foreign exchange
4,820
3,453
Equity
16,579
11,539
Credit derivatives
6,003
2,445
Commodity
7,329
7,406
Total derivative payables
57,469
51,773
Total trading liabilities
$
147,957
$
145,930
(a)
2005 has been adjusted to reflect more appropriate product classifications of
certain balances.
(b)
Included in Trading assets and Trading liabilities are the reported receivables
(unrealized gains) and payables (unrealized losses) related to derivatives. These amounts
are reported net of cash received and paid of $23.0 billion and $18.8 billion,
respectively, at December 31, 2006, and $26.7 billion and $18.9 billion, respectively, at
December 31, 2005, under legally enforceable master netting agreements.
(c)
Primarily represents securities sold, not yet purchased.
Average Trading assets and liabilities were as follows for the periods indicated:
Year ended December 31, (in millions)
2006
2005
2004
(b)
Trading assets – debt and
equity instruments
$
280,079
$
237,073
$
200,389
Trading assets – derivative receivables
57,368
57,365
59,522
Trading liabilities – debt and
equity instruments(a)
$
102,794
$
93,102
$
82,204
Trading liabilities – derivative payables
57,938
55,723
52,761
(a)
Primarily represents securities sold, not yet purchased.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Private equity
The following table presents the carrying value and cost of the Private equity
investment portfolio for the dates indicated:
Private equity investments are held primarily
by the Private equity business within Corporate
(which includes investments made by JPMorgan
Partners and ONE Equity Partners). The Private
Equity business invests in buyouts, growth equity
and venture opportunities. These investments are
accounted for under investment company guidelines.
Accordingly, these investments, irrespective of the
percentage of equity ownership interest held by
Private equity, are carried on the Consolidated
balance sheets at fair value. Realized and
unrealized gains and losses arising from changes in
value are reported in Principal transactions
revenue in the Consolidated statements of income in
the period that the gains or losses occur.
Privately held investments are initially valued
based upon cost. The carrying values of privately
held investments are adjusted from cost to reflect
both positive and negative changes evidenced by
financing events with third-party capital
providers. In addition, these investments are
subject to ongoing impairment reviews by Private
equity senior
investment professionals. A variety of factors are
reviewed and monitored to assess impairment
including, but not limited to, operating
performance of, and future expectations regarding,
the particular portfolio investment; industry
valuations of comparable public companies; changes
in market outlook; and the third-party financing
environment over time.
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JPMorgan Chase & Co. / 2006 Annual Report
Private equity also holds publicly held equity
investments, generally obtained through the initial
public offering of privately held equity
investments. Publicly held investments are
marked-to-market at the quoted public value. To
determine the carrying values of these investments,
Private equity incorporates the use of discounts to
take into account the fact that it cannot
immediately realize the quoted public values as a
result of regulatory and/or contractual sales
restrictions imposed on these holdings.
Note 5 – Other noninterest revenue
Investment banking fees
This revenue category includes advisory and equity
and debt underwriting fees. Advisory fees are
recognized as revenue when the related services
have been performed. Underwriting fees are
recognized as revenue when the Firm has rendered
all services to the issuer and is entitled to
collect the fee from the issuer, as long as there
are no other contingencies associated with the fee
(e.g., the fee is not contingent upon the customer
obtaining financing). Underwriting fees are net of
syndicate expenses. The Firm recognizes credit
arrangement and syndication fees as revenue after
satisfying certain retention, timing and yield
criteria.
The following table presents the components of Investment banking fees:
Year ended December 31, (in millions)
2006
2005
2004
(a)
Underwriting:
Equity
$
1,179
$
864
$
780
Debt
2,703
1,969
1,858
Total Underwriting
3,882
2,833
2,638
Advisory
1,638
1,255
898
Total
$
5,520
$
4,088
$
3,536
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Lending & deposit related fees
This revenue category includes fees from loan
commitments, standby letters of credit, financial
guarantees, deposit-related fees in lieu of
compensating balances, cash management-related
activities or transactions, deposit accounts, and
other loan servicing activities. These fees are
recognized over the period in which the related
service is provided.
Asset management, administration and commissions
This revenue category includes fees from investment
management and related services, custody, brokerage
services, insurance premiums and commissions and
other products. These fees are recognized over the
period in which the related service is provided.
Performance-based fees, which are earned based upon
exceeding certain benchmarks or other performance
targets, are accrued and recognized at the end of
the performance period in which the target is met.
Mortgage fees and related income
This revenue category includes fees and income
derived from mortgage origination, sales and
servicing, and includes the effect of risk
management activities associated with the mortgage
pipeline, warehouse and the mortgage servicing
rights (“MSRs”) asset (excluding gains and losses
on the sale of Available-for-sale (“AFS”)
securities). Origination fees and gains or losses
on loan sales are recognized in income upon sale.
Mortgage servicing fees are recognized over the
period the related service is provided. Valuation
changes in the mortgage pipeline, warehouse, MSR
asset and corresponding risk management instruments
are recognized in earnings as these changes occur.
Net interest income and securities gains and losses
on AFS securities used in mortgage-related risk
management activities are not included in Mortgage
fees and related income. For a further discussion
of MSRs, see Note 16 on pages 121–122 of this
Annual Report.
Credit card income
This revenue category includes interchange income
from credit and debit cards and servicing fees earned
in connection with securitization activities.
Volume-related payments to partners and expenses for
rewards programs are netted against interchange
income. Expenses related to rewards programs are
recorded when the rewards are earned by the customer.
Other Fee revenues are recognized as earned, except
for annual fees, which are deferred with direct loan
origination costs and recognized on a straight-line
basis over the 12-month period to which they pertain.
Credit card revenue sharing agreements
The Firm has contractual agreements with numerous
affinity organizations and co-brand partners, which
grant to the Firm exclusive rights to market to
their members or customers. These organizations and
partners endorse the credit card programs and
provide their mailing lists to the Firm, and they
may also conduct marketing activities and provide
awards under the various credit card programs. The
terms of these agreements generally range from 3 to
10 years. The economic incentives the Firm pays to
the endorsing organizations and partners typically
include payments based upon new account
originations, charge volumes, and the cost of the
endorsing organizations’ or partners’ marketing
activities and awards.
The Firm recognizes the payments made to the
affinity organizations and co-brand partners based
upon new account originations as direct loan
origination costs. Payments based upon charge
volumes are considered by the Firm as revenue
sharing with the affinity organizations and co-brand
partners, which are deducted from Credit card income
as the related revenue is earned. Payments based
upon marketing efforts undertaken by the endorsing
organization or partner are expensed by the Firm as
incurred. These costs are recorded within
Noninterest expense.
Note 6 – Interest income and Interest expense
Details of Interest income and Interest expense were as follows:
Year ended December 31, (in millions)
2006
2005
(b)
2004
(b)(c)
Interest income
Loans
$
33,121
$
26,056
$
16,768
Securities
4,147
3,129
3,377
Trading assets
10,942
9,117
7,527
Federal funds sold and securities
purchased under resale agreements
5,578
3,562
1,380
Securities borrowed
3,402
1,618
578
Deposits with banks
1,265
660
539
Interests in purchased receivables(a)
652
933
291
Total interest income
59,107
45,075
30,460
Interest expense
Interest-bearing deposits
17,042
9,986
4,515
Short-term and other liabilities
14,086
10,002
6,474
Long-term debt
5,503
4,160
2,466
Beneficial interests issued by
consolidated VIEs
1,234
1,372
478
Total interest expense
37,865
25,520
13,933
Net interest income
21,242
19,555
16,527
Provision for credit losses
3,270
3,483
2,544
Net interest income after Provision
for credit losses
$
17,972
$
16,072
$
13,983
(a)
As a result of restructuring certain multi-seller conduits the Firm administers,
JPMorgan Chase deconsolidated $29 billion of Interests in purchased receivables, $3
billion of Loans and $1 billion of Securities, and recorded $33 billion of lending-related
commitments during the second quarter of 2006.
(b)
Prior periods have been adjusted to reflect the reclassification of certain
amounts to more appropriate Interest income and Interest expense lines.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
99
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 7 – Pension and other postretirement
employee benefit plans
The Firm’s defined benefit pension plans are
accounted for in accordance with SFAS 87 and SFAS
88, and its other postretirement employee benefit
(“OPEB”) plans are accounted for in accordance with
SFAS 106. In September 2006, the FASB issued SFAS
158, which requires companies to recognize on their
Consolidated balance sheets the overfunded or
underfunded status of their defined benefit
postretirement plans, measured as the difference
between the fair value of plan assets and the
benefit obligation. SFAS 158 requires unrecognized
amounts (e.g., net actuarial loss and prior service
costs) to be recognized in Accumulated other
comprehensive income (“AOCI”) and that these
amounts be adjusted as they are subsequently
recognized as components of net periodic benefit
cost based upon the current amortization and
recognition requirements of SFAS 87 and SFAS 106.
The Firm prospectively adopted SFAS 158 as required
on December 31, 2006, which resulted in a charge to
AOCI of $1.1 billion.
SFAS 158 also eliminates the provisions of SFAS 87
and SFAS 106 that allow plan assets and
obligations to be measured as of a date not more
than three months prior to the reporting entity’s
balance sheet date. The Firm uses a measurement
date of December 31 for its defined benefit
pension and OPEB plans; therefore, this provision
of SFAS 158 will have no effect on the Firm’s
financial statements.
For the Firm’s defined benefit pension plans, fair
value is used to determine the expected return on
plan assets. For the Firm’s OPEB plans, a
calculated value that recognizes changes in fair
value over a five-year period is used to determine
the expected return on plan assets. Amortization of
net actuarial gains and losses is included in
annual net periodic benefit cost if, as of the
beginning of the year, the net actuarial gain or
loss exceeds 10 percent of the greater of the
projected benefit obligation or the fair value of
the plan assets. Any excess, as well as prior
service costs, are amortized over the average
future service period of defined benefit pension
plan participants, which for the U.S. defined
benefit pension plan is currently 10 years. For
OPEB plans, any excess net actuarial gains and
losses also are amortized over the average future
service period, which is currently seven years;
however, prior service costs are amortized over the
average years of service remaining to full
eligibility age, which is currently five years.
Defined benefit pension plans
The Firm has a qualified noncontributory U.S.
defined benefit pension plan that provides benefits
to substantially all U.S. employees. The U.S. plan
employs a cash balance formula, in the form of pay
and interest credits, to determine the benefits to
be provided at retirement, based upon eligible
compensation and years of service. Employees begin
to accrue plan benefits after completing one year
of service, and benefits generally vest after five
years of service. The Firm also offers benefits
through defined benefit pension plans to qualifying
employees in certain non-U.S. locations based upon
factors such as eligible compensation, age and/or
years of service.
It is the Firm’s policy to fund the pension plans
in amounts sufficient to meet the requirements
under applicable employee benefit and local tax
laws. As a result of the enactment of the Pension
Protection Act in August 2006, which increased the
maximum amount allowable for tax deduction, the
Firm is reviewing 2007 U.S. and non-U.S. defined
benefit pension plan contribution alternatives. The
amount of potential 2007 contributions, if any, is
not reasonably estimable at this time.
JPMorgan Chase has a number of other defined
benefit pension plans (i.e., U.S. plans not subject
to Title IV of the Employee Retirement Income
Security Act). The most significant of these plans
is the Excess Retirement Plan, pursuant to which
certain employees earn pay and interest credits on
compensation amounts above the maximum stipulated
by law under a qualified plan. The Excess
Retirement Plan is a nonqualified, noncontributory
U.S. pension plan with an unfunded projected
benefit obligation at December 31, 2006 and 2005,
in the amount of $301 million and $273 million,
respectively. In the current year, this plan has
been incorporated into certain of this Note’s
tables for which it had not been included in prior
years.
Defined contribution plans
JPMorgan Chase offers several defined contribution
plans in the U.S. and in certain non-U.S.
locations, all of which are administered in
accordance with applicable local laws and
regulations. The most significant of these plans is
The JPMorgan Chase 401(k) Savings Plan (the “401(k)
Savings Plan”), which covers substantially all U.S.
employees. The 401(k) Savings Plan allows employees
to make pretax contributions to tax-deferred
investment portfolios. The JPMorgan
Chase Common Stock Fund, which is an investment
option under the 401(k) Savings Plan, is a
nonleveraged employee stock ownership plan. The
Firm matches eligible employee contributions up to
a certain percentage of benefits-eligible
compensation per pay period, subject to plan and
legal limits. Employees begin to receive matching
contributions after completing a one-year service
requirement and are immediately vested in the
Firm’s contributions when made. Employees with
total annual cash compensation of $250,000 or more
are not eligible for matching contributions. The
401(k) Savings Plan also permits discretionary
profit-sharing contributions by participating
companies for certain employees, subject to a
specified vesting schedule.
OPEB plans
JPMorgan Chase offers postretirement medical and
life insurance benefits to certain retirees and
qualifying U.S. employees. These benefits vary with
length of service and date of hire and provide for
limits on the Firm’s share of covered medical
benefits. The medical benefits are contributory,
while the life insurance benefits are
noncontributory. As of August 1, 2005, the
eligibility requirements for U.S. employees to
qualify for subsidized retiree medical coverage
were revised, and life insurance coverage was
eliminated for active employees retiring after
2005. Postretirement medical benefits also are
offered to qualifying U.K. employees.
JPMorgan Chase’s U.S. OPEB obligation is funded
with corporate-owned life insurance (“COLI”)
purchased on the lives of eligible employees and
retirees. While the Firm owns the COLI policies,
COLI proceeds (death benefits, withdrawals and
other distributions) may be used only to reimburse
the Firm for its net postretirement benefit claim
payments and related administrative expenses. The
U.K. OPEB plan is unfunded.
The following tables present the funded status,
changes in the benefit obligations and plan assets,
accumulated benefit obligations, and AOCI amounts
reported on the Consolidated balance sheets for the
Firm’s U.S. and non-U.S. defined benefit pension
and OPEB plans:
100
JPMorgan Chase & Co. / 2006 Annual Report
Defined benefit pension plans
As of or for the year ended December 31,
U.S.
Non-U.S.
OPEB plans(g)
(in millions)
2006
2005
(e)
2006
2005
2006
2005
(h)
Change in benefit obligation
Benefit obligation, beginning of year
$
(8,054
)
$
(7,980
)
$
(2,378
)
$
(1,969
)
$
(1,395
)
$
(1,577
)
Cazenove business partnership
—
—
—
(291
)
—
—
Benefits earned during the year
(281
)
(293
)
(37
)
(25
)
(9
)
(13
)
Interest cost on benefit obligations
(452
)
(453
)
(120
)
(104
)
(78
)
(81
)
Plan amendments
—
—
2
—
—
117
Liabilities of newly material plans(a)
—
—
(154
)
—
—
—
Employee contributions
NA
NA
(2
)
—
(50
)
(44
)
Actuarial gain (loss)
(200
)
(123
)
(23
)
(310
)
(55
)
21
Benefits paid
856
766
68
66
177
187
Expected Medicare Part D subsidy receipts
NA
NA
NA
NA
(13
)
NA
Curtailments
33
29
2
—
(12
)
(9
)
Settlements
—
—
37
—
—
—
Special termination benefits
—
—
(1
)
—
(2
)
(1
)
Foreign exchange impact and other
—
—
(311
)
255
(6
)
5
Benefit obligation, end of year
$
(8,098
)
$
(8,054
)
$
(2,917
)
$
(2,378
)
$
(1,443
)
$
(1,395
)
Change in plan assets
Fair value of plan assets, beginning of year
$
9,617
$
9,637
$
2,223
$
1,889
$
1,329
$
1,302
Cazenove business partnership
—
—
—
252
—
—
Actual return on plan assets
1,151
703
94
308
120
43
Firm contributions
43
43
241
78
2
3
Employee contributions
—
—
2
—
—
—
Assets of newly material plans(a)
—
—
67
—
—
—
Benefits paid
(856
)
(766
)
(68
)
(66
)
(100
)
(19
)
Settlements
—
—
(37
)
—
—
—
Foreign exchange impact and other
—
—
291
(238
)
—
—
Fair value of plan assets, end of year
$
9,955
(c)
$
9,617
(c)
$
2,813
$
2,223
$
1,351
$
1,329
Funded (unfunded) status
$
1,857
$
1,563
$
(104
)
$
(155
)
$
(92
)
$
(66
)
Unrecognized amounts:
Net actuarial loss
NA
(d)
1,087
NA
(d)
599
NA
(d)
335
Prior service cost (credit)
NA
(d)
43
NA
(d)
3
NA
(d)
(105
)
Net amount recognized in the
Consolidated balance sheets(b)
$
1,857
$
2,693
$
(104
)
$
447
(f)
$
(92
)
$
164
Accumulated benefit obligation, end of year
$
(7,679
)
$
(7,647
)
$
(2,849
)
$
(2,303
)
NA
NA
(a)
Reflects adjustments related to pension plans in Germany and Switzerland, which
have defined benefit pension obligations that were not previously measured under SFAS 87
due to immateriality.
(b)
Net amount recognized is recorded in Other assets for prepaid pension costs or
in Accounts payable, accrued expenses and other liabilities for accrued pension costs.
(c)
At December 31, 2006 and 2005, approximately $282 million and $405 million,
respectively, of U.S. plan assets related to participation rights under participating
annuity contracts.
(d)
Under SFAS 158, and as noted in the following table, amounts that were
previously reported as part of prepaid or accrued pension costs are now reported within
AOCI.
(e)
Revised primarily to incorporate amounts related to the U.S. defined benefit
pension plans not subject to Title IV of the Employee Retirement Income Security Act of
1974 (e.g., Excess Retirement Plan).
(f)
At December 31, 2005, Accrued pension costs related to non-U.S. defined benefit
pension plans that JPMorgan Chase elected not to prefund fully totaled $164 million.
(g)
Includes accumulated postretirement benefit obligation of $52 million and $44
million and postretirement benefit liability (included in Accrued expenses) of $52 million
and $50 million, at December 31, 2006 and 2005, respectively, for the U.K. plan, which is
unfunded.
(h)
The U.S. OPEB plan was remeasured as of August 1, 2005, to reflect a midyear
plan amendment and the final Medicare Part D regulations that were issued on January 21,2005; as a result, the benefit obligation was reduced by $116 million.
Amounts recognized in Accumulated other comprehensive income
Total recognized in Accumulated other
comprehensive income
$
819
$
325
$
494
$
669
$
266
$
403
$
258
$
53
$
205
(a)
For defined benefit pension plans, the net actuarial loss is primarily the
result of declines in discount rates in recent years, partially offset by asset gains.
Other factors that contribute to this net actuarial loss include demographic experience,
which differs from expectations, and changes in other actuarial assumptions. For OPEB
plans, the primary drivers of the cumulative actuarial loss were the decline in the
discount rate in recent years and in the medical cost trend rate, which was higher than
expected. These losses have been offset partially by the recognition of future savings
attributable to Medicare Part D subsidy receipts.
JPMorgan Chase & Co. / 2006 Annual Report
101
Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents the incremental effect of applying SFAS 158 on individual line
items on the Consolidated balance sheets:
Accounts payable, accrued expenses and other
liabilities
88,557
(461
)
88,096
(b)
Total liabilities
1,236,191
(461
)
1,235,730
Accumulated other comprehensive income (loss)
(455
)
(1,102
)
(1,557
)
Total liabilities and stockholders’ equity
1,353,083
(1,563
)
1,351,520
(a)
Includes overfunded defined benefit pension and OPEB plans of $2.3 billion.
(b)
Includes underfunded defined benefit pension and OPEB plans of $596 million.
The following tables present the components of net periodic benefit costs reported in the
Consolidated statements of income for the Firm’s U.S. and non-U.S. defined benefit pension and OPEB
plans:
Defined benefit pension plans
Year ended December 31,
U.S.
Non-U.S.
OPEB plans(e)
(in millions)
2006
2005
(b)
2004
(b)(c)(d)
2006
2005
2004
(c)(d)
2006
2005
2004
(c)(d)
Components of net periodic benefit cost
Benefits earned during the period
$
281
$
293
$
271
$
37
$
25
$
17
$
9
$
13
$
15
Interest cost on benefit obligations
452
453
368
120
104
87
78
81
81
Expected return on plan assets
(692
)
(694
)
(556
)
(122
)
(109
)
(90
)
(93
)
(90
)
(86
)
Amortization:
Net actuarial loss
12
4
24
45
38
44
29
12
—
Prior service cost (credit)
5
5
14
—
1
1
(19
)
(10
)
—
Curtailment (gain) loss
2
3
8
1
—
—
2
(17
)
8
Settlement (gain) loss
—
—
—
4
—
(1
)
—
—
—
Special termination benefits
—
—
—
1
—
11
2
1
2
Subtotal
60
64
129
86
59
69
8
(10
)
20
Other defined benefit pension plans
(a)
2
3
1
36
39
24
NA
NA
NA
Total defined benefit
plans
62
67
130
122
98
93
NA
NA
NA
Total defined contribution plans
254
237
187
199
155
130
NA
NA
NA
Total pension and OPEB cost included in
Compensation expense
$
316
$
304
$
317
$
321
$
253
$
223
$
8
$
(10
)
$
20
(a)
Includes immaterial non-U.S. defined benefit pension plans.
(b)
Revised primarily to incorporate amounts related to the U.S. defined benefit
pension plans not subject to Title IV of the Employee Retirement Income Security Act of
1974 (e.g., Excess Retirement Plan).
(c)
Effective July 1, 2004, the Firm assumed the obligations of heritage Bank One’s
pension and OPEB plans. These plans were similar to those of heritage JPMorgan Chase. The
heritage Bank One plans were merged into the JPMorgan Chase plans effective December 31,2004.
(d)
2004 results include six months of the combined Firm’s results and six months of
the heritage JPMorgan Chase results.
(e)
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
resulted in a reduction of $32 million, $15 million and $5 million in 2006, 2005 and 2004,
respectively, in net periodic benefit cost. The impact on 2006 and 2005 costs were higher
as a result of the final Medicare Part D regulations issued on January 21, 2005, which
were reflected beginning as of August 1, 2005, the next measurement date for the plan.
The estimated amounts that will be amortized from AOCI into net periodic benefit cost,
before tax, in 2007 are as follows:
Plan assumptions
JPMorgan Chase’s expected long-term rate of return
for U.S. defined benefit pension and OPEB plan
assets is a blended average of the investment
advisor’s projected long-term (10 years or more)
returns for the various asset classes, weighted by
the portfolio allocation. Returns on asset classes
are developed using a forward-looking
building-block approach and are not strictly based
upon historical returns. Equity returns are
generally developed as the sum of inflation,
expected real earnings growth and expected
long-term dividend yield. Bond returns are
generally developed as the sum of inflation, real
bond yield and risk spread (as appropriate),
adjusted for the expected effect on returns from
changing yields. Other asset-class returns are
derived from their relationship to the equity and
bond markets.
For the U.K. defined benefit pension plan, which
represents the most significant of the non-U.S.
defined benefit pension plans, procedures similar
to those in the U.S. are used to develop the
expected long-term rate of return on defined
benefit pension plan assets, taking into
consideration local market conditions and the
specific allocation of plan assets. The expected
long-term rate of return on U.K. plan assets is an
average of projected long-term returns for each
asset class, selected by reference to the yield on
long-term U.K. government bonds and AA-rated
long-term corporate bonds, plus an equity risk
premium above the risk-free rate.
In 2006 and 2005, the discount rate used in
determining the benefit obligation under the U.S.
defined benefit pension and OPEB plans was selected
by reference to the yield on a portfolio of bonds
with redemption dates and coupons that closely
match each of the plan’s projected cash flows; such
portfolio is derived from a broad-based universe of
high-quality corporate bonds as of the measurement
date. In years in which this hypothetical bond
portfolio generates excess
cash, such excess is assumed to be reinvested at
the one-year forward rates implied by the Citigroup
Pension Discount Curve published as of the
measurement date. Prior to 2005, discount rates
were selected by reference to the year-end Moody’s
corporate AA rate, as well as other high-quality
indices with a duration that was similar to that of
the respective plan’s benefit obligations. The
discount rates for the U.K. defined benefit pension
and OPEB plans represent rates from the yield curve
of the year-end iBoxx Ł corporate AA 15-year-plus
bond index with durations corresponding to those of
the underlying benefit obligations.
The following tables present the weighted-average
annualized actuarial assumptions for the projected
and accumulated benefit obligations and the
components of net periodic benefit costs for the
Firm’s U.S. and non-U.S. defined benefit pension
and OPEB plans, as of and for the periods
indicated:
In 2005 the expected long-term rate of return on plan assets for the Firm’s OPEB
plan was revised to show the aggregate expected return for the heritage Bank One and
JPMorgan Chase plans.
JPMorgan Chase & Co. / 2006 Annual Report
103
Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents the effect of a
one-percentage-point change in the assumed health
care cost trend rate on JPMorgan Chase’s total
service and interest cost and accumulated
postretirement benefit obligation:
At December 31, 2006, the Firm increased the
discount rates used to determine its benefit
obligations for the U.S. defined benefit pension
and OPEB plans based upon current market interest
rates, which will result in a decrease in expense
of approximately $23 million for 2007. The 2007
expected long-term rate of return on U.S. pension
plan assets remained at 7.50%. The 2007 expected
long-term rate of return on the Firm’s U.S. OPEB
plan assets increased from 6.84% to 7.00%. The Firm
maintained the health care benefit obligation trend
assumption at 10% for 2007, declining to an
ultimate rate of 5% in 2014. The interest crediting
rate assumption at December 31, 2006, used to
determine pension benefits changed primarily due to
changes in market interest rates, which will result
in additional expense of $10 million for 2007. The
assumed rate of compensation increase remained at
4.00% as of December 31, 2006. The most significant
change to the assumptions used to determine net
periodic benefit costs in 2006 from the prior year
were lower discount rates for the Firm’s non-U.S.
plans, both defined benefit pension and OPEB, due
to lower market interest rates, resulting in $23
million higher compensation expense in 2006
compared with 2005.
JPMorgan Chase’s U.S. defined benefit pension and
OPEB plan expenses are most sensitive to the
expected long-term rate of return on plan assets.
With all other assumptions held constant, a
25-basis point decline in the expected long-term
rate of return on U.S. plan assets would result in
an increase of approximately $27 million in 2007
U.S. defined benefit pension and OPEB plan
expenses. A 25-basis point decline in the discount
rate for the U.S. plans would result in an increase
in 2007 U.S. defined benefit pension and OPEB plan
expenses of approximately $3 million and an
increase in the related projected benefit
obligations of approximately $217 million. A
25-basis point decline in the discount rates for
the non-U.S. plans would result in an increase in
the
2007 non-U.S. defined benefit pension and OPEB plan
expenses of approximately $19 million. A 25-basis
point increase in the interest crediting rate for
the U.S. defined benefit pension plan would result
in an increase in 2007 U.S. defined benefit pension
expense of approximately $10 million and an
increase in the related projected benefit
obligations of approximately $82 million.
Investment strategy and asset allocation
The investment policy for the Firm’s postretirement
employee benefit plan assets is to optimize the
risk-return relationship as appropriate to the
respective plan’s needs and goals, using a global
portfolio of various asset classes diversified by
market segment, economic sector, and issuer.
Specifically, the goal is to optimize the asset mix
for future benefit obligations, while managing
various risk factors and each plan’s investment
return objectives. For example, long-duration fixed
income securities are included in the U.S.
qualified pension plan’s asset allocation, in
recognition of its long-duration obligations. Plan
assets are managed by a combination of internal and
external investment managers and are rebalanced to
within approved ranges, to the extent economically
practical.
The Firm’s U.S. defined benefit pension plan assets
are held in various trusts and are invested in a
well-diversified portfolio of equities (including
U.S. large and small capitalization and
international equities), fixed income (including
corporate and government bonds), Treasury
inflation-indexed and high-yield securities, real
estate, cash equivalents, and alternative
investments. Non-U.S. defined benefit pension plan
assets are held in various trusts and are similarly
invested in well-diversified portfolios of equity,
fixed income and other securities. Assets of the
Firm’s COLI policies, which are used to fund
partially the U.S. OPEB plan, are held in separate
accounts with an insurance company and are invested
in equity and fixed income index funds. In
addition, tax-exempt municipal debt securities,
held in a trust, were used to fund the U.S. OPEB
plan in prior periods; as of December 31, 2006,
there are no remaining assets in the trust. As of
December 31, 2006, the assets used to fund the
Firm’s U.S. and non-U.S. defined benefit pension
and OPEB plans do not include JPMorgan Chase common
stock, except in connection with investments in
third-party stock-index funds.
The following table presents the weighted-average asset allocation at December 31 for the years
indicated, and the respective approved range/target allocation by asset category, for the Firm’s
U.S. and non-U.S. defined benefit pension and OPEB plans:
Defined benefit pension plans
U.S.
Non-U.S.(a)
OPEB plans(b)
Target
% of plan assets
Target
% of plan assets
Target
% of plan assets
December 31,
Allocation
2006
2005
Allocation
2006
2005
Allocation
2006
2005
Asset category
Debt securities
10-30
%
31
%
33
%
73
%
70
%
75
%
50
%
50
%
54
%
Equity securities
25-60
55
57
26
26
24
50
50
46
Real estate
5-20
8
6
—
1
1
—
—
—
Alternatives
15-50
6
4
1
3
—
—
—
—
Total
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
(a)
Represents the U.K. defined benefit pension plan only, as plans outside the U.K.
are not significant.
(b)
Represents the U.S. OPEB plan only, as the U.K. OPEB plan is unfunded.
104
JPMorgan Chase & Co. / 2006 Annual Report
The following table presents JPMorgan Chase’s actual rate of return on plan assets for the U.S. and non-U.S. defined benefit pension and
OPEB plans:
Estimated future benefit payments
The following table presents benefit payments expected to be paid, which include the effect of
expected future service, for the years indicated. The OPEB medical and life insurance payments are
net of expected retiree contributions:
U.S.
Non-U.S.
Year ended December 31,
defined benefit
defined benefit
OPEB before
Medicare
(in millions)
pension plans
pension plans
Medicare Part D subsidy
Part D subsidy
2007
$
561
$
83
$
130
$
15
2008
563
81
132
16
2009
583
88
133
18
2010
602
93
135
19
2011
623
97
137
20
Years
2012–2016
3,417
533
657
121
Note 8 — Employee stock-based incentives
Effective January 1, 2006, the Firm adopted
SFAS 123R and all related interpretations using
the modified prospective transition method. SFAS
123R requires all share-based payments to
employees, including employee stock options and
stock appreciation rights (“SARs”), to be measured at their grant date fair
values. Results for prior periods have not been
restated. The Firm also adopted the transition
election provided by FSP FAS 123(R)-3.
JPMorgan Chase had previously adopted SFAS 123,
effective January 1, 2003, using the prospective
transition method. Under SFAS 123, the Firm
accounted for its stock-based compensation awards
at fair value, similar to the SFAS 123R
requirements. However, under the prospective
transition method, JPMorgan Chase continued to
account for unmodified stock options that were
outstanding as of December 31, 2002, using the APB
25 intrinsic value method. Under this method, no
expense was recognized for stock options granted at
an exercise price equal to the stock price on the
grant date, since such options have no intrinsic
value.
Upon adopting SFAS 123R, the Firm began to
recognize in the Consolidated statements of income
compensation expense for unvested stock options
previously accounted for under APB 25.
Additionally, JPMorgan Chase recognized as
compensation expense an immaterial cumulative
effect adjustment resulting from the SFAS 123R
requirement to estimate forfeitures at the grant
date instead of recognizing them as incurred.
Finally, the Firm revised its accounting policies
for share-based payments granted to
retirement-eligible employees under SFAS 123R.
Prior to adopting SFAS 123R, the Firm’s accounting
policy for share-based payment awards granted to
retirement-eligible employees was to recognize
compensation cost over the award’s stated service
period. For awards granted to retirement-eligible
employees in 2006, JPMorgan Chase recognized
compensation expense on the grant date without
giving consideration to the impact of post
employment restrictions. In the first quarter of
2006, the Firm also began to accrue the estimated
cost of stock awards granted to retirement-eligible
employees in January 2007.
Employee stock-based awards
The Firm has granted restricted stock, restricted
stock units (“RSUs”), stock options, and
stock-settled SARs to
certain of its employees.
In 2006, JPMorgan Chase granted long-term
stock-based awards under the 2005 Long-Term
Incentive Plan (the “2005 Plan”). In 2005,
JPMorgan Chase granted long-term stock-based awards
under the 1996 Long-Term Incentive Plan as amended
(the “1996 plan”) until May 2005 and under the 2005
Plan thereafter to certain key employees. These two
plans, plus prior Firm plans and plans assumed as
the result of acquisitions, constitute the Firm’s
stock-based compensation plans (“LTI Plans”). The
2005 Plan became effective on May 17, 2005, after
approval by shareholders at the 2005 annual
meeting. The 2005 Plan replaced three existing
stock-based compensation plans – the 1996 Plan and
two nonshareholder-approved plans – all of which
expired in May 2005. Under the terms of the 2005
Plan, 275 million shares of common stock are
available for issuance during its five-year term.
The 2005 Plan is the only active plan under which
the Firm is currently granting stock-based
incentive awards.
Restricted stock and RSUs are granted by JPMorgan
Chase at no cost to the recipient. These awards are
subject to forfeiture until certain restrictions
have lapsed, including continued employment for a
specified period. The recipient of a share of
restricted stock is entitled to voting rights and
dividends on the common stock. An RSU entitles the
recipient to receive a share of common stock after
the applicable restrictions lapse; the recipient is
entitled to receive cash payments equivalent to any
dividends paid on the underlying common stock
during the period the RSU is outstanding. Effective
January 2005, the equity portion of the Firm’s
annual incentive awards were granted primarily in
the form of RSUs. The Firm also periodically grants
discretionary share-based payment awards, primarily
in the form of both employee stock options and
SARs.
Under the LTI Plans, stock options and SARs have
been granted with an exercise price equal to
JPMorgan Chase’s common stock price on the grant
date. Generally, options and SARs cannot be
exercised until at least one year after the grant
date and become exercisable over various periods
as determined at the time of the grant. These
awards generally expire 10 years after the grant
date. The Firm’s share-based compensation awards
generally vest in multiple tranches.
JPMorgan Chase & Co. / 2006 Annual Report
105
Notes to consolidated financial statements
JPMorgan Chase & Co.
The Firm separately recognizes compensation
expense for each tranche of each award as if it
were a separate award with its own vesting date.
For each tranche granted (other than grants to
employees who are retirement eligible at the grant
date), compensation expense is recognized on a
straight-line basis from the grant date until the
vesting date of the respective tranche, provided
that the employees will not become retirement
eligible during the vesting period. For each
tranche granted to employees who will become
retirement eligible during the vesting period,
compensation expense is recognized on a
straight-line basis from the grant date until the
earlier of the employee’s retirement eligibility
date or the vesting date of the respective tranche.
The Firm’s policy for issuing shares upon
settlement of employee share-based payment awards
is to issue either new shares of common stock or
treasury shares. During 2006, the Firm issued new
shares of common stock from January 1 through May31, 2006, and treasury shares from June 1 through
December 31, 2006.
On March 21, 2006, the Board of Directors approved
a stock repurchase program that authorizes the
repurchase of up to $8 billion of the Firm’s common
shares, which supersedes a $6 billion stock
repurchase program approved in 2004. The $8 billion
authorization includes shares to be repurchased to
offset issuances under the Firm’s employee
stock-based plans. The actual number of shares
repurchased is subject to various factors,
including: market conditions; legal
considerations affecting the amount and timing of
repurchase activity; the Firm’s capital position
(taking into account goodwill and intangibles);
internal capital generation; and alternative
potential investment opportunities. The repurchase
program does not include specific price targets or
timetables; may be executed through open market
purchases or privately negotiated transactions, or
utilizing Rule 10b5-1 programs; and may be
suspended at any time.
In December 2005, the Firm accelerated the vesting
of approximately 41 million unvested,
out-of-the-money employee stock options granted in
2001 under the Growth and Performance Incentive
Program (“GPIP”), which were scheduled to vest in
January 2007. These options were not modified other
than to accelerate vesting. The related expense was
approximately $145 million, and was recognized as
compensation expense in the fourth quarter of 2005.
The Firm believed that at the time the options were
accelerated they had limited economic value since
the exercise price of the accelerated options
was $51.22 and the closing price of the Firm’s
common stock on the effective date of the
acceleration was $39.69.
Restricted stock and RSU activity
Compensation expense for restricted stock and RSUs
is measured based upon the number of shares granted
multiplied by the stock price at the grant date,
and is recognized in Net income as previously
described. The following table summarizes JPMorgan
Chase’s restricted stock and RSU activity for 2006:
Lapsed awards represent awards granted in prior years for which, in the case of
restricted stock, restrictions have lapsed; and, in the case of RSUs, the awards have been
converted into common stock.
The total fair value of shares that vested
during the years ended December 31, 2006, 2005 and
2004, was $1.3 billion, $1.1 billion and $1.7
billion, respectively.
The vesting of certain restricted stock and RSU
awards issued prior to 2002 was conditioned upon
certain service requirements being met and JPMorgan
Chase’s common stock reaching and sustaining target
prices within a five-year performance period.
During 2002, it was determined that it was no
longer probable that the target stock prices
related to forfeitable awards granted in 1999,
2000, and 2001 would be achieved within their
respective performance periods, and accordingly,
previously accrued expenses were reversed. The
target
stock prices for these awards ranged from $73.33 to
$85.00. These awards were forfeited as follows: 1.2
million shares granted in 1999 were forfeited in
January 2004; 1.2 million shares granted in 2000
were forfeited in January 2005; and 1.2 million
shares granted in 2001 were forfeited in January
2006.
Employee stock option and SARs activity
Compensation expense, which is measured at the grant date as the fair value of employee stock
options and SARs, is recognized in Net income as described above. The following table summarizes
JPMorgan Chase’s employee stock option and SARs activity for the year ended December 31, 2006,
including awards granted to key employees and awards granted in prior years under broad-based
plans:
The
weighted-average grant date per share fair value of stock options and SARs granted during the years
ended December 31, 2006, 2005 and 2004, was $10.99, $10.44 and $13.77, respectively. The total
intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 was
$994 million, $364 million and $520 million, respectively.
106
JPMorgan Chase & Co. / 2006 Annual Report
Impact of adoption of SFAS 123R
During 2006, the incremental expense related to the
Firm’s adoption of SFAS 123R was $712 million. This
amount represents an accelerated noncash
recognition of costs that would otherwise have been
incurred in future periods. Also as a result of
adopting SFAS 123R, the Firm’s Income from
continuing operations (pretax) for the year ended
December 31, 2006,was lower by $712 million, and
Income from continuing operations (after-tax), as
well as Net income, for the year ended December 31,2006, was lower by $442 million, than if the Firm
had continued to account for share-based
compensation under APB 25 and SFAS 123. Basic and
diluted earnings per share from continuing
operations, as well as basic and diluted Net income
per share, for the year ended December 31, 2006
were $0.13 and $0.12 lower, respectively, than if
the Firm had not adopted SFAS 123R.
The Firm recognized noncash compensation expense
related to its various employee stock-based
incentive awards of $2.4 billion (including the
$712 million incremental impact of adopting SFAS
123R), $1.6 billion and $1.3 billion for the years
ended December 31, 2006, 2005 and 2004,
respectively, in its Consolidated statements of
income. At December 31, 2006, approximately $1.0
billion (pretax) of compensation cost related to
unvested awards has not yet been charged to Net
income. That cost is expected to be amortized into
compensation expense over a weighted-average period
of 1.2 years. The Firm does not capitalize any
compensation cost related to share-based
compensation awards to employees.
Cash flows and tax benefits
The total income tax benefit related to
stock-based compensation arrangements recognized
in the Firm’s Consolidated statements of income
for the years ended December 31, 2006, 2005 and
2004, was $947 million, $625 million and $519
million, respectively.
Prior to adopting SFAS 123R, the Firm presented
all tax benefits of deductions resulting from
share-based compensation awards as operating cash
flows in its Consolidated statements of cash
flows. SFAS 123R requires the cash flows resulting
from the tax benefits of tax deductions in excess
of the compensation expense recognized for those
share-based compensation awards (i.e., excess tax
benefits) to be classified as financing cash
flows. The $302 million of excess tax benefits
classified as a financing cash inflow during 2006
would have been classified as an operating cash
inflow if the Firm had not adopted SFAS 123R.
The following table sets forth the cash received
from the exercise of stock options under all
share-based compensation arrangements and the
actual tax benefit realized related to the tax
deduction from the exercise of stock options.
Year ended December 31, (in millions)
2006
2005
2004
Cash received for options exercised
$
1,924
$
635
$
764
Tax benefit realized
211
65
204
Comparison of the fair and intrinsic value measurement methods
The following table presents Net income and basic
and diluted earnings per share as reported, and as
if all 2005 and 2004 share-based payment awards
were accounted for at fair value. All 2006 awards
were accounted for at fair value.
Year ended December 31,
(in millions, except per share data)
2005
2004
(a)
Net income as reported
$
8,483
$
4,466
Add:
Employee stock-based compensation expense included in reported Net income, net of related tax effects
938
778
Deduct:
Employee stock-based compensation expense determined under the fair value method for all awards, net of related tax effects
(1,015
)
(960
)
Pro forma Net income
$
8,406
$
4,284
Earnings per share:
Basic:
As reported
$
2.43
$
1.59
Pro forma
2.40
1.52
Diluted:
As reported
$
2.38
$
1.55
Pro forma
2.36
1.48
(a)
2004 results include six months of the
combined Firm’s results and six months of heritage
JPMorgan Chase results.
The following table presents the assumptions
used to value employee stock options and SARs
granted during the period under the Black-Scholes valuation model:
Prior to the adoption of SFAS 123R, the Firm
used the historical volatility of its common stock
price as the expected volatility assumption in
valuing options. The Firm completed a review of its
expected volatility assumption in 2006. Effective
October 1, 2006, JPMorgan Chase began to value its
employee stock options granted or modified after
that date using an expected volatility assumption
derived from the implied volatility of its publicly
traded stock options.
The expected life assumption is an estimate of the
length of time that an employee might hold an
option or SAR before it is exercised or cancelled.
The expected life assumption was developed using
historic experience.
JPMorgan Chase & Co. / 2006 Annual Report
107
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 9 – Noninterest expense
Merger costs
Costs associated with the Merger and The Bank of
New York transaction are reflected in the Merger
costs caption of the Consolidated statements of
income. A summary of such costs, by expense
category, is shown in the following table for
2006, 2005 and 2004.
Year ended December 31, (in millions)
2006
2005
2004
(c)
Expense category
Compensation
$
26
$
238
$
467
Occupancy
25
(77
)
448
Technology and communications and other
239
561
450
Bank of New York transaction(a)
15
—
—
Total(b)
$
305
(b)
$
722
$
1,365
(a)
Represents Compensation and Technology and communications and other.
(b)
With the exception of occupancy-related write-offs, all of the costs in the table require the
expenditure of cash.
(c)
2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
The table below shows the change in the
liability balance related to the costs associated
with the Merger.
Year ended December 31, (in millions)
2006
2005(b)
2004
(c)
Liability balance,
beginning of period
$
311
$
952
$
—
Recorded as merger costs
290
722
1,365
Recorded as goodwill
—
(460
)
1,028
Liability utilized
(446
)
(903
)
(1,441
)
Liability
balance, end of period
$
155
(a)
$
311
$
952
(a)
Excludes $21 million related to The Bank of New York transaction.
(b)
2005 has been revised to reflect the current
presentation.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Note 10 – Securities
Securities are classified as AFS,
Held-to-maturity (“HTM”) or Trading. Trading
securities are discussed in Note 4 on page 98 of
this Annual Report. Securities are classified
primarily as AFS when purchased as part of the
Firm’s management of its structural interest rate
risk. AFS securities are carried at fair value on
the Consolidated balance sheets. Unrealized gains
and losses after SFAS 133 valuation adjustments are
reported as net increases or decreases to
Accumulated other comprehensive income (loss). The
specific identification method is used to determine
realized gains and losses on AFS securities, which
are included in Securities gains (losses) on the
Consolidated statements of income. Securities that
the Firm has the positive intent and ability to
hold to maturity are classified as HTM and are
carried at amortized cost on the Consolidated
balance sheets. The Firm has not classified new
purchases of securities as HTM for the past several
years.
The following table presents realized gains and losses from AFS securities:
Year ended December 31,
(in millions)
2006
2005
2004
(b)
Realized gains
$
399
$
302
$
576
Realized losses
(942
)
(1,638
)
(238
)
Net realized Securities
gains (losses)(a)
$
(543
)
$
(1,336
)
$
338
(a)
Proceeds from securities sold were generally within 2% of amortized cost.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
108
JPMorgan Chase & Co. / 2006 Annual Report
The amortized cost and estimated fair value of AFS and HTM securities were as follows for the dates indicated:
2006
2005
Gross
Gross
Gross
Gross
Amortized
unrealized
unrealized
Fair
Amortized
unrealized
unrealized
Fair
December 31, (in millions)
cost
gains
losses
value
cost
gains
losses
value
Available-for-sale securities
U.S. government and federal agency obligations:
U.S. treasuries
$
2,398
$
—
$
23
$
2,375
$
4,245
$
24
$
2
$
4,267
Mortgage-backed securities
32
2
1
33
80
3
—
83
Agency obligations
78
8
—
86
165
16
—
181
Collateralized mortgage obligations
—
—
—
—
4
—
—
4
U.S. government-sponsored enterprise obligations
75,434
334
460
75,308
22,604
9
596
22,017
Obligations of state and political subdivisions
637
17
4
650
712
21
7
726
Debt securities issued by non-U.S. governments
6,150
7
52
6,105
5,512
12
18
5,506
Corporate debt securities
611
1
3
609
5,754
39
74
5,719
Equity securities
3,689
125
1
3,813
3,179
110
7
3,282
Other, primarily asset-backed
securities(a)
2,890
50
2
2,938
5,738
23
23
5,738
Total available-for-sale securities
$
91,919
$
544
$
546
$
91,917
$
47,993
$
257
$
727
$
47,523
Held-to-maturity securities(b)
Total held-to-maturity securities
$
58
$
2
$
—
$
60
$
77
$
3
$
—
$
80
(a)
Includes collateralized mortgage obligations of private issuers.
(b)
Consists primarily of mortgage-backed securities issued by U.S.
government-sponsored entities.
JPMorgan Chase & Co. / 2006 Annual Report
109
Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents the fair value and gross unrealized losses for AFS securities by
aging category at December 31:
Securities with gross unrealized losses
Less than 12 months
12 months or more
Total
Gross
Gross
Total
Gross
Fair
unrealized
Fair
unrealized
Fair
unrealized
2006 (in millions)
value
losses
value
losses
value
losses
Available-for-sale securities
U.S. government and federal agency obligations:
U.S. treasuries
$
2,268
$
23
$
—
$
—
$
2,268
$
23
Mortgage-backed securities
8
1
—
—
8
1
Agency obligations
—
—
—
—
—
—
Collateralized mortgage obligations
—
—
—
—
—
—
U.S. government-sponsored enterprise obligations
17,877
262
6,946
198
24,823
460
Obligations of state and political subdivisions
—
—
180
4
180
4
Debt securities issued by non-U.S. governments
3,141
13
2,354
39
5,495
52
Corporate debt securities
387
3
—
—
387
3
Equity securities
17
1
—
—
17
1
Other, primarily asset-backed securities
1,556
1
82
1
1,638
2
Total securities with gross unrealized losses
$
25,254
$
304
$
9,562
$
242
$
34,816
$
546
Securities with gross unrealized losses
Less than 12 months
12 months or more
Total
Gross
Gross
Total
Gross
Fair
unrealized
Fair
unrealized
Fair
unrealized
2005 (in millions)
value
losses
value
losses
value
losses
Available-for-sale securities
U.S. government and federal agency obligations:
U.S. treasuries
$
3,789
$
1
$
85
$
1
$
3,874
$
2
Mortgage-backed securities
—
—
47
—
47
—
Agency obligations
7
—
13
—
20
—
Collateralized mortgage obligations
15
—
30
—
45
—
U.S. government-sponsored enterprise obligations
10,607
242
11,007
354
21,614
596
Obligations of state and political subdivisions
237
3
107
4
344
7
Debt securities issued by non-U.S. governments
2,380
17
71
1
2,451
18
Corporate debt securities
3,076
52
678
22
3,754
74
Equity securities
1,838
7
2
—
1,840
7
Other, primarily asset-backed securities
778
14
370
9
1,148
23
Total securities with gross unrealized losses
$
22,727
$
336
$
12,410
$
391
$
35,137
$
727
Impairment of AFS securities is evaluated
considering numerous factors, and their relative
significance varies case-by-case. Factors
considered include the length of time and extent to
which the market value has been less than cost; the
financial condition and near-term prospects of the
issuer of a security; and the Firm’s intent and
ability to retain the security in order to allow
for an anticipated recovery in fair value. If,
based upon an analysis of each of the above
factors, it is determined that the impairment is
other-than-temporary, the carrying value of the
security is written down to fair value, and a loss
is recognized through earnings.
Included in the $546 million of gross unrealized
losses on AFS securities at December 31, 2006, was
$242 million of unrealized losses that have existed
for a period greater than 12 months. These
securities are predominately rated AAA and the
unrealized losses primarily are due to overall
increases in market interest rates and not concerns
regarding the underlying credit of the issuers. The
majority of the securities with unrealized losses
aged greater than 12 months are obligations of U.S.
government-sponsored enterprises and have a fair
value at December 31, 2006, that is within 3% of
their amortized cost basis.
110
JPMorgan Chase & Co. / 2006 Annual Report
The following table presents the amortized cost, estimated fair value and average yield at
December 31, 2006, of JPMorgan Chase’s AFS and HTM securities by contractual maturity:
Includes securities with no stated maturity. Substantially all of the Firm’s
MBSs and CMOs are due in 10 years or more based upon contractual maturity. The estimated
duration, which reflects anticipated future prepayments based upon a consensus of dealers
in the market, is approximately four years for MBSs and CMOs.
(b)
The average yield is based upon amortized cost balances at year end. Yields are
derived by dividing interest income by total amortized cost. Taxable-equivalent yields are
used where applicable.
Note 11 – Securities financing activities
JPMorgan Chase enters into resale agreements,
repurchase agreements, securities borrowed
transactions and securities loaned transactions,
primarily to finance the Firm’s inventory
positions, acquire securities to cover short
positions and settle other securities obligations.
The Firm also enters into these transactions to
accommodate customers’ needs.
Securities purchased under resale agreements
(“resale agreements”) and securities sold under
repurchase agreements (“repurchase agreements”) are
generally treated as collateralized financing
transactions and are carried on the Consolidated
balance sheets at the amounts the securities will
be subsequently sold or repurchased, plus accrued
interest. Where appropriate, resale and repurchase
agreements with the same counterparty are reported
on a net basis in accordance with FIN 41. JPMorgan
Chase takes possession of securities purchased
under resale agreements. On a daily basis, JPMorgan
Chase monitors the market value of the underlying
collateral, primarily U.S. and non-U.S. government
and agency securities that it has received from its
counterparties, and requests additional collateral
when necessary.
Transactions similar to financing activities that
do not meet the SFAS 140 definition of a repurchase
agreement are accounted for as “buys” and “sells”
rather than financing transactions. These
transactions are accounted for as a purchase (sale)
of the underlying securities with a forward
obligation to sell (purchase) the securities. The
forward purchase (sale) obligation, a derivative,
is recorded on the Consolidated balance sheets at
its fair value, with changes in fair value recorded
in Principal transactions revenue.
Securities borrowed and securities lent are
recorded at the amount of cash collateral advanced
or received. Securities borrowed consist primarily
of government and equity securities. JPMorgan Chase
monitors the market value of the securities
borrowed and lent on a daily basis and calls for
additional collateral when appropriate. Fees
received or paid are recorded in Interest income or
Interest expense.
December 31, (in millions)
2006
2005
Securities purchased under resale agreements
$
122,479
$
129,570
Securities borrowed
73,688
74,604
Securities sold under repurchase agreements
$
143,253
$
103,052
Securities loaned
8,637
14,072
JPMorgan Chase pledges certain financial
instruments it owns to collateralize repurchase
agreements and other securities financings. Pledged
securities that can be sold or repledged by the
secured party are identified as financial
instruments owned (pledged to various parties) on
the Consolidated balance sheets.
At December 31, 2006, the Firm had received
securities as collateral that could be repledged,
delivered or otherwise used with a fair value of
approximately $317 billion. This collateral was
generally obtained under resale or
securities-borrowing agreements. Of these
securities, approximately $291 billion were
repledged, delivered or otherwise used, generally
as collateral under repurchase agreements,
securities lending agreements or to cover short
sales.
JPMorgan Chase & Co. / 2006 Annual Report
111
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 12 – Loans
Loans that are originated or purchased by the
Firm and that management has the intent and ability
to hold for the foreseeable future are reported at
the principal amount outstanding, net of the
Allowance for loan losses, unearned income and any
net deferred loan fees. Loans that are either
originated or purchased by the Firm and that
management intends to sell or to securitize are
classified as held-for-sale and are carried at the
lower of cost or fair value, with valuation changes
recorded in Noninterest revenue. Gains or losses on
held-for-sale loans are also recorded in
Noninterest revenue. Interest income is recognized
using the interest method, or on a basis
approximating a level rate of return over the term
of the loan.
Loans are transferred from the retained portfolio
to the held-for-sale portfolio when management
decides to sell the loan. Transfers to
held-for-sale are recorded at the lower of cost or
fair value on the date of transfer; losses
attributed to credit losses are charged off to the
Allowance for loan losses and losses due to
interest rates, or exchange rates, are recognized
in Noninterest revenue.
Nonaccrual loans are those on which the accrual of
interest is discontinued. Loans (other than certain
consumer loans discussed below) are placed on
nonaccrual status immediately if, in the opinion of
management, full payment of principal or interest
is in doubt, or when principal or interest is 90
days or more past due and collateral, if any, is
insufficient to cover principal and interest.
Interest accrued but not collected at the date a
loan is placed on nonaccrual status is reversed
against Interest income. In addition, the
amortization of net deferred loan fees is
suspended. Interest income on nonaccrual loans is
recognized only to the extent it is received in
cash. However, where there is doubt regarding the
ultimate collectibility of loan principal, all cash
thereafter received is applied to reduce the
carrying value of such loans. Loans are restored to
accrual status only when interest and principal
payments are brought current and future payments
are reasonably assured. Loans are charged off to
the Allowance for loan losses when it is highly
certain that a loss has been realized.
Consumer loans are generally charged to the
Allowance for loan losses upon reaching specified
stages of delinquency, in accordance with the
Federal Financial Institutions Examination Council
(“FFIEC”) policy. For example, credit card loans
are charged off by the end of the month in which
the account becomes 180 days past due or within 60
days from receiving notification of the filing of
bankruptcy, whichever is earlier. Residential
mortgage products are generally charged off to net
realizable value at 180 days past due. Other
consumer products, if collateralized, are generally
charged off to net realizable value at 120 days
past due. Accrued interest on residential mortgage
products, automobile financings, education
financings and certain other consumer loans are
accounted for in accordance with the nonaccrual
loan policy discussed in the preceding paragraph.
Interest and fees related to credit card loans
continue to accrue until the loan is charged off or
paid in full. Accrued interest on all other
consumer loans is generally reversed against
Interest income when the loan is charged off. A
collateralized loan is considered an in-substance
foreclosure and is reclassified to assets acquired
in loan satisfactions, within Other assets, only
when JPMorgan Chase has taken physical possession
of the collateral, regardless of whether formal
foreclosure proceedings have taken place.
The composition of the loan portfolio at each of
the dates indicated was as follows:
December 31, (in millions)
2006
2005
U.S. wholesale loans:
Commercial and industrial
$
77,788
$
70,233
Real estate
14,237
13,612
Financial institutions
14,103
11,100
Lease financing receivables
2,608
2,621
Other
9,950
14,499
Total U.S. wholesale loans
118,686
112,065
Non-U.S. wholesale loans:
Commercial and industrial
43,428
27,452
Real estate
1,146
1,475
Financial institutions
19,163
7,975
Lease financing receivables
1,174
1,144
Other
145
—
Total non-U.S. wholesale loans
65,056
38,046
Total wholesale loans:(a)
Commercial and industrial
121,216
97,685
Real estate(b)
15,383
15,087
Financial institutions
33,266
19,075
Lease financing receivables
3,782
3,765
Other
10,095
14,499
Total wholesale loans
183,742
150,111
Total consumer loans:(c)
Home equity
85,730
73,866
Mortgage
59,668
58,959
Auto loans and leases
41,009
46,081
All other loans
27,097
18,393
Credit card receivables(d)
85,881
71,738
Total consumer loans
299,385
269,037
Total loans(e)(f)
$
483,127
$
419,148
(a)
Includes Investment Bank, Commercial
Banking, Treasury & Securities Services and Asset
Management.
(b)
Represents credits extended for real
estate–related purposes to borrowers who are
primarily in the real estate development or
investment businesses and for which the primary
repayment is from the sale, lease, management,
operations or refinancing of the property.
(c)
Includes Retail Financial Services and Card Services.
(d)
Includes billed finance charges and fees net of
an allowance for uncollectible amounts.
(e)
Loans are presented net of unearned income and net
deferred loan fees of $2.3 billion and $3.0 billion
at December 31, 2006 and 2005, respectively.
(f)
Includes loans held-for-sale (primarily
related to securitization and syndication
activities) of $55.2 billion and $34.2 billion at
December 31, 2006 and 2005, respectively.
The following table reflects information about
the Firm’s loan sales:
Year ended December 31, (in millions)
2006
2005
(a)
2004
(a)(b)
Net gains on
sales of loans (including lower of cost or fair
value adjustments)
$
568
$
365
$
459
(a)
Prior periods have been revised to reflect the current
presentation.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
112
JPMorgan Chase & Co. / 2006 Annual Report
Impaired loans
JPMorgan Chase accounts for and discloses
nonaccrual loans as impaired loans and recognizes
their interest income as discussed previously for
nonaccrual loans. The following are excluded from
impaired loans: small-balance, homogeneous consumer
loans; loans carried at fair value or the lower of
cost or fair value; debt securities; and leases.
The table below sets forth information about
JPMorgan Chase’s impaired loans. The Firm
primarily uses the discounted cash flow method
for valuing impaired loans:
December 31, (in millions)
2006
2005
Impaired loans with an allowance
$
623
$
1,095
Impaired loans without an allowance(a)
66
80
Total impaired loans
$
689
$
1,175
Allowance for impaired loans under SFAS 114(b)
153
257
(a)
When the discounted cash flows, collateral value or market price equals or exceeds the
carrying value of the loan, then the loan does not require an allowance under SFAS 114.
(b)
The allowance for impaired loans under SFAS 114 is included in JPMorgan Chase’s
Allowance for loan losses.
Year ended December 31,
(in millions)
2006
2005
2004
Average balance of impaired
loans during the year
$
990
$
1,478
$
1,883
Interest income recognized on
impaired loans during the year
2
5
8
Note 13 – Allowance for credit losses
JPMorgan Chase’s Allowance for loan losses
covers the wholesale (risk-rated) and consumer
(scored) loan portfolios and represents
management’s estimate of probable credit losses
inherent in the Firm’s loan portfolio as of
December 31, 2006, 2005 and 2004. Management also
computes an allowance for wholesale lending-related
commitments using a methodology similar to that
used for the wholesale loans.
The table below summarizes the Firm’s reporting of
its allowance for credit losses:
Reported in:
Allowance for
credit losses on:
Balance sheet
Income statement
Loans
Allowance for loan losses
Provision for credit losses
Lending-related commitments
Other liabilities
Provision for credit losses
The Allowance for loan losses includes an
asset-specific component and a formula-based
component. Within the formula-based component is a
statistical calculation and an adjustment to the
statistical calculation.
The asset-specific component relates to provisions
for losses on loans considered impaired and
measured pursuant to SFAS 114. An allowance is
established when the discounted cash flows (or
collateral value or observable market price) of the
loan is lower than the carrying value of that loan.
To compute the asset-specific component of the
allowance, larger impaired loans are evaluated
individually, and smaller impaired loans are
evaluated as a pool using historical loss
experience for the respective class of assets.
The formula-based component covers performing
wholesale and consumer loans and is the product of
a statistical calculation, as well as adjustments
to such calculation. These adjustments take into
consideration model imprecision, external factors
and economic events that have occurred but are not
yet reflected in the factors used to derive the
statistical calculation.
The statistical calculation is the product of
probability of default and loss given default. For
risk-rated loans (generally loans originated by the
wholesale lines of
business), these factors are differentiated by risk
rating and maturity. For scored loans (generally
loans originated by the consumer lines of
business), loss is primarily determined by applying
statistical loss factors and other risk indicators
to pools of loans by asset type. Adjustments to the
statistical calculation for the risk-rated
portfolios are determined by creating estimated
ranges using historical experience of both
probability of default and loss given default.
Factors related to concentrated and deteriorating
industries are also incorporated into the
calculation where relevant. Adjustments to the
statistical calculation for the scored loan
portfolios are accomplished in part by analyzing
the historical loss experience for each major
product segment. The estimated ranges and the
determination of the appropriate point within the
range are based upon management’s view of
uncertainties that relate to current macroeconomic
and political conditions, quality of underwriting
standards, and other relevant internal and external
factors affecting the credit quality of the
portfolio.
The Allowance for lending-related commitments
represents management’s estimate of probable credit
losses inherent in the Firm’s process of extending
credit as of December 31, 2006, 2005 and 2004.
Management establishes an asset-specific allowance
for lending-related commitments that are considered
impaired and computes a formula-based allowance for
performing wholesale lending-related commitments.
These are computed using a methodology similar to
that used for the wholesale loan portfolio,
modified for expected maturities and probabilities
of drawdown.
At least
quarterly, the allowance for credit losses is reviewed by the Chief
Risk Officer, the Chief Financial Officer and the Controller of the
Firm and discussed with the Risk Policy and Audit Committees
of the Board of Directors of the Firm. As of
December 31, 2006, JPMorgan Chase deemed the
allowance for credit losses to be appropriate
(i.e., sufficient to absorb losses that are
inherent in the portfolio, including those not yet
identifiable).
The table below summarizes the changes in the Allowance for loan losses:
Primarily relates to loans acquired in The Bank of New York transaction in the
fourth quarter of 2006.
(b)
Includes $51 million of asset-specific and $7.2 billion of formula-based
allowance. Included within the formula-based allowance was $5.1 billion related to a
statistical calculation and an adjustment to the statistical calculation of $2.1 billion.
(c)
Includes $203 million of asset-specific and $6.9 billion of formula-based
allowance. Included within the formula-based allowance was $5.1 billion related to a
statistical calculation (including $400 million related to Hurricane Katrina), and an
adjustment to a statistical calculation of $1.8 billion.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(e)
Includes $406 million related to the Manufactured Home Loan portfolio in the
fourth quarter of 2004.
(f)
Primarily represents the transfer of the allowance for accrued interest and fees
on reported and securitized credit card loans.
(g)
Includes $469 million of asset-specific and $6.8 billion of formula-based
allowance. Included within the formula-based allowance was $4.8 billion related to a
statistical calculation and an adjustment to the statistical calculation of $2.0 billion.
JPMorgan Chase & Co. / 2006 Annual Report
113
Notes to consolidated financial statements
JPMorgan Chase & Co.
The table below summarizes the changes in the
Allowance for lending-related commitments:
Year ended December 31, (in millions)
2006
2005
2004
(c)
Allowance for lending-related
commitments at January 1
Allowance for lending-related
commitments at December 31(b)
$
524
$
400
$
492
(a)
2006 amount relates to The Bank of New York transaction.
(b)
2006 includes $33 million of asset-specific and $491 million of formula-based
allowance. 2005 includes $60 million of asset-specific and $340 million of formula-based
allowance. 2004 includes $130 million of asset-specific and $362 million of formula-based
allowance. The formula-based allowance for lending-related commitments is based upon a
statistical calculation.
There is no adjustment to the statistical calculation for lending-related commitments.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(d)
Represents a reduction of $227 million to conform provision methodologies in the
whole- sale portfolio.
Note 14 – Loan securitizations
JPMorgan Chase securitizes and sells a variety
of its consumer and wholesale loans. Consumer
activities include securitizations of residential
real estate, credit card and automobile loans that
are originated or purchased by Retail Financial
Services (“RFS”), and Card Services (“CS”). Wholesale activities
include securitizations of purchased residential
real estate loans and commercial loans (primarily
real estate–related) originated by the Investment
Bank (“IB”).
JPMorgan Chase–sponsored securitizations utilize
SPEs as part of the securitization process. These
SPEs are structured to meet the definition of a
QSPE (as discussed in Note 1 on page 94 of this
Annual Report); accordingly, the assets and
liabilities of securitization-related QSPEs are not
reflected in the Firm’s Consolidated balance sheets
(except for retained interests, as described below)
but are included on the balance sheet of the QSPE
purchasing the assets. Assets held by
securitization-related QSPEs as of December 31,2006 and 2005, were as follows:
December 31, (in billions)
2006
2005
Consumer activities
Credit card receivables
$
86.4
$
96.0
Automobile loans
4.9
5.5
Residential mortgage receivables
40.7
29.8
Wholesale activities
Residential mortgages
43.8
11.1
Commercial and other(a)(b)
87.1
61.8
Total
$
262.9
$
204.2
(a)
Cosponsored securitizations include non-JPMorgan originated assets
(b)
Commercial and other consists of commercial loans (primarily real estate) and
non-mortgage consumer receivables purchased from third parties.
The Firm records a loan securitization as a
sale when the accounting criteria for a sale are
met. Those criteria are: (1) the transferred assets
are legally isolated from the Firm’s creditors; (2)
the entity can pledge or exchange the financial
assets or, if the entity is a QSPE, its investors
can pledge or exchange their interests; and (3) the
Firm does not maintain effective control via an
agreement to repurchase the transferred assets
before their maturity or have the ability to
unilaterally cause the holder to return the
transferred assets.
For loan securitizations that meet the accounting
sales criteria, the gains or losses recorded
depend, in part, on the carrying amount of the
loans sold and are allocated between the loans sold
and the retained interests, based upon their
relative fair values at the date of sale. Gains on
securitizations are reported in Noninterest
revenue. When quoted market prices for the retained
interests are not available, the Firm estimates the
fair value for these retained interests by
determining the
present value of future expected cash flows using
modeling techniques. Such models incorporate
management’s best estimates of key variables, such
as expected credit losses, prepayment speeds and
the discount rates appropriate for the risks
involved.
Interests in the securitized loans may be retained
by the Firm in the form of senior or subordinated
interest-only strips, senior and subordinated
tranches, and escrow accounts. The classification
of retained interests is dependent upon several
factors, including the type of interest (e.g.,
whether the retained interest is represented by a
security certificate) and when it was retained, due
to the adoption of SFAS 155. The Firm has elected
to fair value all interests in securitized loans
retained after December 31, 2005, that have an
embedded derivative required to be bifurcated under
SFAS 155; these retained interests are classified
primarily as Trading assets. Retained interests
from wholesale activities are classified as Trading
assets. For consumer activities, senior and
subordinated retained interests represented by a
security certificate are classified as AFS.
Retained interests not represented by a security
certificate are classified in Other assets. For
those retained interests that are subject to
prepayment risk (such that JPMorgan Chase may not
recover substantially all of its investment) but
are not required to be bifurcated under SFAS 155,
the retained interests are recorded at fair value;
subsequent adjustments are reflected in earnings or
in Other comprehensive income (loss). Retained
interests classified as AFS are subject to the
impairment provisions of EITF 99-20.
Credit card securitization trusts require the Firm
to maintain a minimum undivided interest in the
trusts, representing the Firm’s interests in the
receivables transferred to the trust that have not
been securitized. These seller’s interests are not
represented by security certificates. The Firm’s
undivided interests are carried at historical cost
and are classified in Loans.
114
JPMorgan Chase & Co. / 2006 Annual Report
2006, 2005 and 2004 Securitization activity
The following table summarizes new
securitization transactions that were completed
during 2006, 2005 and 2004; the resulting gains
arising from
such securitizations; certain cash flows received
from such securitizations; and the key economic
assumptions used in measuring the retained
interests, as of the dates of such sales:
Expected credit losses for prime residential mortgage and certain wholesale
securitizations are minimal and are incorporated into other assumptions.
(c)
The auto securitization gain of $9 million does not include the write-down of
loans transferred to held-for-sale in 2005 and risk management activities intended to
protect the economic value of the loans while held-for-sale.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(e)
Delineation between Residential mortgage and Commercial and other is not
available for 2004.
JPMorgan Chase & Co. / 2006 Annual Report
115
Notes to consolidated financial statements
JPMorgan Chase & Co.
At both December 31, 2006 and 2005, the Firm
had, with respect to its credit card master trusts,
$19.3 billion and $24.8 billion, respectively,
related to undivided interests, and $2.5 billion
and $2.2 billion, respectively, related to
subordinated interests in accrued interest and fees
on the securitized receivables, net of an allowance
for uncollectible amounts. Credit card
securitization trusts require the Firm to maintain
a minimum undivided interest of 4% to 12% of the
principal receivables in the trusts. The Firm
maintained an average undivided interest in
principal receivables in the trusts of
approximately 21% for 2006 and 23% for 2005.
The Firm also maintains escrow accounts up to
predetermined limits for some credit card and
automobile securitizations, to cover the unlikely
event of deficiencies in cash flows owed to
investors. The amounts available in such escrow
accounts are recorded in Other assets and, as of
December 31, 2006, amounted to $153 million and $56
million for credit card and automobile
securitizations, respectively; as of December 31,2005, these amounts were $754 million and $76
million for credit card and automobile
securitizations, respectively.
JPMorgan Chase retains servicing responsibilities
for all originated and for certain purchased
residential mortgage, credit card and automobile
loan securitizations and for certain commercial
activity securitizations it sponsors, and receives
servicing fees based upon the securitized loan
balance plus certain ancillary fees. The Firm also
retains the right to service the residential
mortgage loans it sells in connection with
mortgage-backed securities transactions with the
Government National Mortgage Association (“GNMA”),
Federal National Mortgage Association (“FNMA”) and
Federal Home Loan Mortgage Corporation (“Freddie
Mac”). For a discussion of mortgage servicing
rights, see Note 16 on pages 121–122 of this
Annual report.
In addition to the amounts reported for
securitization activity on the previous page, the
Firm sold residential mortgage loans totaling
$53.7 billion, $52.5 billion and $65.7 billion
during 2006, 2005 and 2004, respectively,
primarily as GNMA, FNMA and Freddie Mac
mortgage-backed securities; these sales resulted
in pretax gains of $251 million, $293 million and
$58 million, respectively.
The table below summarizes other retained
securitization interests, which are primarily
subordinated or residual interests, and are carried
at fair value on the Firm’s Consolidated balance
sheets:
December 31, (in millions)
2006
2005
Consumer activities
Credit card(a)(b)
$
833
$
808
Automobile(a)(c)
168
150
Residential mortgage(a)
155
182
Wholesale activities(d)
Residential mortgages
1,032
245
Commercial and other
117
20
Total
$
2,305
$
1,405
(a)
Pretax unrealized gains recorded in Stockholders’ equity that relate to retained
securitization interests on consumer activities totaled $3 million and $6 million for
credit card; $4 million and $5 million for automobile and $51 million and $60 million for
residential mortgage at December 31, 2006 and 2005, respectively.
(b)
The credit card retained interest amount noted above includes subordinated
securities retained by the Firm totaling $301 million and $357 million at December 31,2006 and 2005, respectively, that are classified as AFS securities. The securities are
valued using quoted market prices and therefore are not included in the key economic
assumptions and sensitivities table that follows.
(c)
In addition to the automobile retained interest amounts noted above, the Firm
also retained senior securities totaling $188 million and $490 million at December 31,2006 and 2005, respectively, that are classified as AFS securities. These securities are
valued using quoted market prices and therefore are not included in the key economic
assumption and sensitivities table that follows.
(d)
In addition to the wholesale retained interest amounts noted above, the Firm
also retained subordinated securities totaling $23 million and $51 million at December 31,2006 and 2005, respectively, predominately from resecuritizations activities that are
classified as Trading assets. These securities are valued using quoted market prices and
therefore are not included in the key assumptions and sensitivities table that follows.
The table below outlines the key economic
assumptions used to determine the fair value of the
Firm’s retained interests in its securitizations at
December 31, 2006 and 2005, respectively; and it
outlines the sensitivities of those fair values to
immediate 10% and 20% adverse changes in those
assumptions:
(in millions, except rates and where otherwise noted)
Credit card
Automobile
Mortgage
mortgage
and other
Weighted-average life (in years)
0.4–0.7
1.2
0.5-3.5
2.6
0.2–4.1
Prepayment rate
11.9–20.8
%
1.5
%
20.1–43.7
%
22.0–46.6
%
0.0–50.0
%(c)
PPR
ABS
CPR
CPR
CPR
Impact of 10% adverse change
$
(44
)
$
—
$
(3
)
$
(4
)
$
(1
)
Impact of 20% adverse change
(88
)
(2
)
(5
)
(4
)
(2
)
Loss assumption
3.2–8.1
%
0.7
%
0.0–5.2
%(a)
0.6–2.0
%
0.0
%
Impact of 10% adverse change
$
(77
)
$
(4
)
$
(10
)
$
(6
)
$
—
Impact of 20% adverse change
(153
)
(9
)
(19
)
(11
)
—
Discount rate
6.9–12.0
%
7.2
%
12.7–30.0
%(b)
16.0–18.5
%
0.2–4.7
%
Impact of 10% adverse change
$
(2
)
$
(1
)
$
(4
)
$
(6
)
$
—
Impact of 20% adverse change
(4
)
(3
)
(8
)
(12
)
—
(a)
Expected credit losses for prime residential mortgage are minimal and are
incorporated into other assumptions.
(b)
The Firm sold certain residual interests from subprime mortgage securitizations
via Net Interest Margin (“NIM”) securitizations and retains residual interests in these
NIM transactions, which are valued using a 30% discount rate.
(c)
Prepayment risk on certain wholesale retained interests for commercial and other
are minimal and are incorporated into other assumptions.
The sensitivity analysis in the preceding table
is hypothetical. Changes in fair value based upon a
10% or 20% variation in assumptions generally
cannot be extrapolated easily because the
relationship of the change in the assumptions to
the change in fair value may not be linear. Also,
in the table, the
effect that a change in a particular assumption
may have on the fair value is calculated without
changing any other assumption. In reality, changes
in one factor may result in changes in another,
which might counteract or magnify the
sensitivities.
Expected static-pool net credit losses include actual incurred losses plus projected net credit
losses, divided by the original balance of the outstandings comprising the securitization pool. The
table below displays the expected static-pool net credit losses for 2006, 2005 and 2004, based upon
securitizations occurring in that year:
Static-pool losses are not applicable to credit card securitizations due to
their revolving nature.
(b)
Primarily includes subprime residential mortgages securitized in 2006 and 2005
as part of wholesale activities. Expected losses for prime residential mortgage
securitizations are minimal for consumer activities.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
117
Notes to consolidated financial statements
JPMorgan Chase & Co.
The table below presents information about delinquencies, net charge-offs (recoveries) and
components of reported and securitized financial assets at December 31, 2006 and 2005:
Nonaccrual and 90 days or
Net loan charge-offs
Total Loans
more past due(d)
(recoveries) Year ended
December 31, (in millions)
2006
2005
2006
2005
2006
2005
Home Equity
$
85,730
$
73,866
$
454
$
422
$
143
$
141
Mortgage
59,668
58,959
769
442
56
25
Auto loans and leases
41,009
46,081
132
193
238
277
All other loans
27,097
18,393
322
281
139
129
Credit card receivables
85,881
71,738
1,344
1,091
2,488
3,324
Total consumer loans
299,385
269,037
3,021
(e)
2,429
(e)
3,064
3,896
Total wholesale loans
183,742
150,111
420
1,042
(22
)
(77
)
Total loans reported
483,127
419,148
3,441
3,471
3,042
3,819
Securitized consumer loans:
Residential mortgage(a)
7,995
8,061
191
370
57
105
Automobile
4,878
5,439
10
11
15
15
Credit card
66,950
70,527
962
730
2,210
3,776
Total consumer loans securitized
79,823
84,027
1,163
1,111
2,282
3,896
Securitized wholesale activities
Residential mortgage(a)
27,275
4,787
544
4
13
—
Commercial and other
13,756
4,262
6
—
3
—
Total securitized wholesale activities
41,031
9,049
550
4
16
—
Total loans securitized(b)
120,854
93,076
1,713
1,115
2,298
3,896
Total loans reported and securitized(c)
$
603,981
$
512,224
$
5,154
$
4,586
$
5,340
$
7,715
(a)
Includes $18.6 billion and $11.9 billion of outstanding principal balances on
securitized subprime 1–4 family residential mortgage loans as of December 31, 2006 and
2005, respectively.
(b)
Total assets held in securitization-related SPEs were $262.9 billion and $204.2
billion at December 31, 2006 and 2005, respectively. The $120.9 billion and $93.1 billion
of loans securitized at December 31, 2006 and 2005, respectively, excludes: $122.5 billion
and $85.6 billion of securitized loans, in which the Firm’s only continuing involvement is
the servicing of the assets; $19.3 billion and $24.8 billion of seller’s interests in
credit card master trusts; and $0.2 billion and $0.7 billion of escrow accounts and other
assets, respectively.
(c)
Represents both loans on the Consolidated balance sheets and loans that have
been securitized, but excludes loans for which the Firm’s only continuing involvement is
servicing of the assets.
(d)
Includes nonperforming HFS loans of $120 million and $136 million at December31, 2006 and 2005, respectively.
(e)
Excludes nonperforming assets related to (i) loans eligible for repurchase as
well as loans repurchased from GNMA pools that are insured by U.S. government agencies and
U.S. government-sponsored enterprises of $1.2 billion and $1.1 billion for December 31,2006 and 2005, respectively, and (ii) education loans that are 90 days past due and still
accruing, which are insured by U.S. government agencies under the Federal Family Education
Loan Program of $0.2 billion at December 31, 2006. These amounts for GNMA and education
loans are excluded, as reimbursement is proceeding normally.
Note 15 – Variable interest entities
Refer to Note 1 on page 94 of this Annual
Report for a further description of JPMorgan
Chase’s policies regarding consolidation of
variable interest entities.
JPMorgan Chase’s principal involvement with VIEs
occurs in the following business segments:
•
Investment Bank: Utilizes VIEs to assist clients in accessing the financial
markets in a cost-efficient manner by providing flexibility relating to price, yield and
desired risk. There are two broad categories of transactions involving VIEs in the IB: (1)
multi-seller conduits and (2) client inter- mediation; both are discussed below. The IB
also securitizes loans through QSPEs, to create asset-backed securities, as further
discussed in Note 14 on pages 114–118 of this Annual Report.
•
Asset Management (“AM”): Provides investment management services to a limited number
of the Firm’s mutual funds deemed VIEs. AM earns a fixed fee based upon assets managed;
the fee varies with each fund’s investment objective and is competitively priced. For the
limited number of funds that qualify as VIEs, AM’s relationships with such funds are not
considered significant variable interests under FIN 46R.
•
Treasury & Securities Services: Provides services to a number of VIEs. These
services are similar to those provided to non-VIEs. TSS earns market-based
fees for services provided. Such relationships are not considered significant variable
interests under FIN 46R.
•
Commercial Banking: Utilizes VIEs to assist clients in accessing the financial
markets in a cost-efficient manner. This is often accomplished through the use of products
similar to those offered in the Investment Bank.
Commercial Banking may assist in the structuring and/or on-going administration of these
VIEs and may provide
liquidity, letters of credit and/or derivative instruments in support of the VIE. Such
relationships are not considered significant variable interests under FIN 46R.
•
The Private Equity business, included in Corporate, may be involved with entities
that could be deemed VIEs. Private equity activities are accounted for in accordance with
the Investment Company Audit Guide (“Audit Guide”). The FASB deferred adoption of FIN 46R
for nonregistered investment companies that apply the Audit Guide until the proposed
Statement of Position on the clarification of the scope of the Audit Guide is finalized. The Firm continues to apply this deferral provision; had FIN 46R been applied to VIEs
subject to this deferral, the impact would have had an insignificant impact on the Firm’s
Consolidated financial statements as of December 31, 2006.
As noted above, there are two broad categories of
transactions involving VIEs with which the IB is
involved: multi-seller conduits and client
intermediation.
118
JPMorgan Chase & Co. / 2006 Annual Report
Multi-seller conduits
The Firm is an active participant in the
asset-backed securities business, helping meet
customers’ financing needs by providing access to
the commercial paper markets through VIEs known as
multi-seller conduits. These companies are separate
bankruptcy-remote companies in the business of
purchasing interests in, and making loans secured
by, receivable pools and other financial assets
pursuant to agreements with customers. The
companies fund their purchases and loans through
the issuance of highly rated commercial paper. The
primary source of repayment of the commercial paper
is the cash flow from the pools of assets.
JPMorgan Chase serves as the administrator and
provides contingent liquidity support and limited
credit enhancement for several multi-seller
conduits. The commercial paper issued by the
conduits is backed by collateral, credit
enhancements and commitments to provide liquidity
sufficient to enable the conduit to receive a
liquidity rating of at least A-1, P-1 and, in
certain cases, F1.
As a means of ensuring timely repayment of the
commercial paper, each asset pool financed by the
conduits has a minimum 100% deal-specific liquidity
facility associated with it. The liquidity
facilities are typically in the form of asset
purchase agreements and are generally structured
such that the liquidity is provided by the Firm
purchasing, or lending against, a pool of
nondefaulted, performing assets. Deal-specific
liquidity facilities are the primary source of
liquidity support for the conduits.
The Firm also provides vehicles with program-wide
liquidity, in the form of revolving and short-term
lending commitments, in the event of short-term
disruptions in the commercial paper market.
Deal-specific credit enhancement that supports the
commercial paper issued by the conduits is
generally structured to cover a multiple of
historical losses expected on the pool of assets
and is provided primarily by customers (i.e.,
sellers) or other third parties. The deal-specific
credit enhancement is typically in the form of
overcollateralization provided by the seller but
also may include any combination of the following:
recourse to the seller or originator, cash
collateral accounts, letters of credit, excess
spread, retention of subordinated interests or
third-party guarantees. In certain instances, the
Firm provides limited credit enhancement in the
form of standby letters of credit.
In June 2006, the Firm restructured four
multi-seller conduits that it administers: each
conduit issued a capital note that was acquired by
an independent third-party investor who absorbs the
majority of the expected losses of the respective
conduit whose note it had purchased. In determining
the primary beneficiary of the conduits, the Firm
used a Monte Carlo–based model to size the expected
losses and considered the relative rights and
obligations of each of the variable interest
holders. As a result of the restructuring, the Firm
deconsolidated approximately $33 billion of assets
and liabilities as of June 30, 2006. The following
table summarizes the Firm’s involvement with
Firm-administered multi-seller conduits:
Consolidated
Nonconsolidated
Total
December 31, (in billions)
2006
2005
2006
2005
2006
2005
Total commercial paper issued by conduits
$
3.4
$
35.2
$
44.1
$
8.9
$
47.5
$
44.1
Commitments
Asset-purchase agreements
$
0.5
$
47.9
$
66.0
$
14.3
$
66.5
$
62.2
Program-wide liquidity commitments
1.0
5.0
4.0
1.0
5.0
6.0
Program-wide limited credit enhancements
—
1.3
1.6
1.0
1.6
2.3
Maximum exposure to loss(a)
1.0
48.4
67.0
14.8
68.0
63.2
(a)
The Firm’s maximum exposure to loss is limited to the amount of drawn
commitments (i.e., sellers’ assets held by the multi-seller conduits for which the Firm
provides liquidity support) of $43.9 billion and $41.6 billion at December 31, 2006 and
2005, respectively, plus contractual but undrawn commitments of $24.1 billion and $21.6
billion at December 31, 2006 and 2005, respectively.
Certain of the Firm’s administered multi-seller conduits were deconsolidated as of June 30,2006; the assets deconsolidated were approximately $33 billion. Since the Firm provides
credit enhancement and liquidity to Firm administered multi-seller conduits, the maximum
exposure is not adjusted to exclude exposure that would be absorbed by third-party
liquidity providers.
The Firm views its credit exposure to
multi-seller conduit transactions as limited. This
is because, for the most part, the Firm is not
required to fund under the liquidity facilities if
the assets in the VIE are in default. Additionally,
the Firm’s obligations under the letters of credit
are secondary to the risk of first loss provided by
the customer or other third parties – for example,
by the overcollateralization of the VIE with the
assets sold to it or notes subordinated to the
Firm’s liquidity facilities.
Client intermediation
As a financial intermediary, the Firm is involved
in structuring VIE transactions to meet investor
and client needs. The Firm intermediates various
types of risks (including fixed income, equity and
credit), typically using derivative instruments as
further discussed below. In certain circumstances,
the Firm also provides liquidity and other support
to the VIEs to facilitate the transaction. The
Firm’s current exposure to nonconsolidated VIEs is
reflected in its Consolidated balance sheets or in
the Notes to consolidated financial statements. The
risks inherent in derivative instruments or
liquidity commitments are managed similarly to
other credit, market and liquidity risks to which
the Firm is exposed. The Firm intermediates
principally with the following types of VIEs:
credit-linked note vehicles and municipal bond
vehicles.
JPMorgan Chase & Co. / 2006 Annual Report
119
Notes to consolidated financial statements
JPMorgan Chase & Co.
The Firm structures credit-linked notes in
which the VIE purchases highly rated assets (such
as asset-backed securities) and enters into a
credit derivative contract with the Firm to obtain
exposure to a referenced credit not held by the
VIE. Credit-linked notes are issued by the VIE to
transfer the risk of the referenced credit to the
investors in the VIE. Clients and investors often
prefer a VIE structure, since the credit-linked
notes generally carry a higher credit rating than
they would if issued directly by JPMorgan Chase.
The Firm is involved with municipal bond vehicles
for the purpose of creating a series of secondary market trusts that
allow tax-exempt investors to finance their
investments at short-term tax-exempt rates. The VIE
purchases fixed-rate, longer-term highly rated
municipal bonds by issuing puttable floating-rate
certificates and inverse floating-rate
certificates; the investors that purchase the
inverse floating-rate certificates are exposed to
the residual losses of the VIE (the “residual
interests”). For vehicles in which the Firm owns
the residual interests, the Firm consolidates the
VIE. In vehicles in which third-party investors own
the residual interests, the Firm’s exposure is
limited because of the high credit quality of the
underlying municipal bonds, the unwind triggers
based upon the market value of the underlying
collateral and the residual interests held by third
parties. The Firm often serves as remarketing agent
for the VIE and provides liquidity to support the
remarketing.
Assets held by credit-linked and municipal bond
vehicles at December 31, 2006 and 2005, were as
follows:
December 31, (in billions)
2006
2005
Credit-linked note vehicles(a)
$
20.2
$
13.5
Municipal bond vehicles(b)
16.9
13.7
(a)
Assets of $1.8 billion reported in the table above were recorded on the Firm’s
Consolidated balance sheets at December 31, 2006 and 2005, due to contractual
relationships held by the Firm that relate to collateral held by the VIE.
(b)
Total amounts consolidated due to the Firm owning residual interests were $4.7
billion and $4.9 billion at December 31, 2006 and 2005, respectively, and are reported in
the table.
Total liquidity commitments were $10.2 billion and $5.8 billion at December 31, 2006 and
2005, respectively. The Firm’s maximum credit exposure to all municipal bond vehicles was
$14.9 billion and $10.7 billion at December 31, 2006 and 2005, respectively.
The Firm may enter into transactions with VIEs
structured by other parties. These transactions can
include, for example, acting as a derivative
counterparty, liquidity provider, investor,
underwriter, placement agent, trustee or custodian.
These transactions are conducted at arm’s length,
and individual credit decisions are based upon the
analysis of the specific VIE, taking into
consideration the quality of the underlying assets.
Where these activities do not cause JPMorgan Chase
to absorb a majority of the expected losses of the
VIEs or to receive a majority of the residual
returns of the VIE, JPMorgan Chase records and
reports these positions similarly to any other
third-party transaction. These transactions are not
considered significant for disclosure purposes.
Consolidated VIE assets
The following table summarizes the Firm’s total
consolidated VIE assets, by classification, on the
Consolidated balance sheets, as of December 31,2006 and 2005:
December 31, (in billions)
2006(d)
2005
Consolidated VIE assets(a)
Securities purchased under resale agreements(b)
$
8.0
$
2.6
Trading assets(c)
9.8
9.3
Investment securities
0.2
1.9
Interests in purchased receivables
—
29.6
Loans(b)
15.9
8.1
Other assets
2.9
0.4
Total consolidated assets
$
36.8
$
51.9
(a)
The Firm also holds $3.5 billion and $3.9 billion of assets, at December 31,2006 and 2005, respectively, primarily as a seller’s interest, in certain
consumer securitizations in a segregated entity, as part of a two-step securitization
transaction. This interest is included in the securitization activities disclosed in Note
14 on pages 114–118 of this Annual Report.
(b)
Includes activity conducted by the Firm in a principal capacity, primarily in
the IB.
(c)
Includes the fair value of securities and derivative receivables.
(d)
Certain multi-seller conduits administered by the Firm were deconsolidated as of
June 30, 2006; the assets deconsolidated consisted of $29 billion of Interests in
purchased receivables, $3 billion of Loans and $1 billion of investment securities.
Interests in purchased receivables included
interests in receivables purchased by
Firm-administered conduits, which had been
consolidated in accordance with FIN 46R. Interests
in purchased receivables were carried at cost and
reviewed to determine whether an
other-than-temporary impairment existed.
The interest-bearing beneficial interest
liabilities issued by consolidated VIEs are
classified in the line item titled, “Beneficial
interests issued by consolidated variable interest
entities” on the Consolidated balance sheets. The
holders of these beneficial interests do not have
recourse to the general credit of JPMorgan Chase.
See Note 19 on page 124 of this Annual Report for
the maturity profile of FIN 46 long-term beneficial
interests.
FIN 46(R)-6 Transition
In April 2006, the FASB issued FSP FIN 46(R)-6,
which requires an analysis of the design of a VIE
in determining the variability to be considered in
the application of FIN 46(R). The Firm adopted the
guidance in FSP FIN 46(R)-6 prospectively on July1, 2006. The adoption of FSP FIN 46(R)-6 did not
significantly change the way in which the Firm
evaluated its interests in VIEs under FIN 46(R);
thus, it had an immaterial impact on the Firm’s
consolidated financial statements.
120
JPMorgan Chase & Co. / 2006 Annual Report
Note 16 – Goodwill and other intangible assets
Goodwill is not amortized. It is instead tested
for impairment in accordance with SFAS 142 at the
reporting-unit segment, which is generally one
level below the six major reportable business
segments (as described in Note 33 on pages 139–141
of this Annual Report); plus Private Equity (which
is included in Corporate). Goodwill is tested
annually (during the fourth quarter) or more often
if events or circumstances, such as adverse changes
in the business climate, indicate there may be
impairment. Intangible assets determined to have
indefinite lives are not amortized but instead are
tested for impairment at least annually, or more
frequently if events or changes in circumstances
indicate that the asset might be impaired. The
impairment test compares the fair value of the
indefinite-lived intangible asset to its carrying
amount. Other acquired intangible assets determined
to have finite lives, such as core deposits and
credit card relationships, are amortized over their
estimated useful lives in a manner that best
reflects the economic benefits of the intangible
asset. In addition, impairment testing is performed
periodically on these amortizing intangible assets.
Goodwill and other intangible assets consist of the following:
December 31, (in millions)
2006
2005
Goodwill
$
45,186
$
43,621
Mortgage servicing rights
7,546
6,452
Purchased credit card relationships
2,935
3,275
All other intangibles:
Other credit card–related intangibles
$
302
$
124
Core deposit intangibles
2,623
2,705
Other intangibles
1,446
2,003
Total All other intangible assets
$
4,371
$
4,832
Goodwill
As of December 31, 2006, Goodwill increased by $1.6
billion compared with December 31, 2005. The
increase is due principally to the $1.8 billion of
goodwill resulting from the acquisition of the
consumer, business banking and middle-market
banking businesses of The Bank of New York, as well
as $510 million of goodwill resulting from the
acquisition of Collegiate Funding Services. The
increase from acquisitions was offset partially by
a reduction to Goodwill: of $402 million due to the
sale of selected corporate trust businesses to The
Bank of New York; resulting from purchase
accounting adjustments related to the acquisition
of the Sears Canada credit card business; of $111
million due to the sale of the insurance business;
and of $70 million related to reclassifying net
assets of a subsidiary as held-for-sale.
Goodwill attributed to the business segments was as follows:
December 31, (in millions)
2006
2005
Investment Bank
$
3,526
$
3,531
Retail Financial Services
16,955
14,991
Card Services
12,712
12,984
Commercial Banking
2,901
2,651
Treasury & Securities Services
1,605
2,062
Asset Management
7,110
7,025
Corporate (Private Equity)
377
377
Total Goodwill
$
45,186
$
43,621
Mortgage servicing rights
JPMorgan Chase recognizes as intangible assets
mortgage servicing rights, which represent the
right to perform specified residential mortgage
servicing activities for others. MSRs are either
purchased from third parties or retained upon sale
or securitization of mortgage loans. Servicing
activities include collecting principal, interest,
and escrow payments from borrowers; making tax and
insurance payments on behalf of the borrowers;
monitoring delinquencies and executing foreclosure
proceedings; and accounting for and remitting
principal and interest payments to the investors of
the mortgage-backed securities.
The amount initially capitalized as MSRs represents
the amount paid to third parties to acquire MSRs or
is the estimate of fair value, if retained upon the
sale or securitization of mortgage loans. The Firm
estimates the fair value of MSRs for initial
capitalization and ongoing valuation using an
option-adjusted spread (“OAS”) model, which
projects MSR cash flows over multiple interest rate
scenarios in conjunction with the Firm’s
proprietary prepayment model, and then discounts
these cash flows at risk-adjusted rates. The model
considers portfolio characteristics, contractually
specified servicing fees, prepayment assumptions,
delinquency rates, late charges, other ancillary
revenues, and costs to service, and other economic
factors. The Firm compares fair value estimates and
assumptions to observable market data where available and to
recent market activity and actual portfolio
experience.
The fair value of MSRs is sensitive to changes in
interest rates, including their effect on
prepayment speeds. JPMorgan Chase uses or has used
combinations of derivatives, AFS securities and
trading instruments to manage changes in the fair
value of MSRs. The intent is to offset any changes
in the fair value of MSRs with changes in the fair
value of the related risk management instruments.
MSRs decrease in value when interest rates decline.
Conversely, securities (such as mortgage-backed
securities), principal-only certificates and
certain derivatives (when the Firm receives
fixed-rate interest payments) increase in value
when interest rates decline.
In March 2006, the FASB issued SFAS 156, which
permits an entity a one-time irrevocable election to
adopt fair value accounting for a class of
servicing assets. JPMorgan Chase elected to adopt
the standard effective January 1, 2006, and defined
MSRs as one class of servicing assets for this
election. At the transition date, the fair value of
the MSRs exceeded their carrying amount, net of any
related valuation allowance, by $150 million net of
taxes. This amount was recorded as a
cumulative-effect adjustment to retained earnings
as of January 1, 2006. MSRs are recognized in the
Consolidated balance sheet at fair value, and
changes in their fair value are recorded in
current-period earnings. During 2006, as in prior
years, revenue amounts related to MSRs and the
financial instruments used to manage the risk of
MSRs are recorded in Mortgage fees and related
income.
For the years ended December 31, 2005 and 2004,
MSRs were accounted for under SFAS 140, using a
lower of cost or fair value approach. Under this
approach, MSRs were amortized as a reduction of the
actual servicing income received in proportion to,
and over the period of, the estimated future net
servicing income stream of the underlying mortgage
loans. For purposes of evaluating and measuring
impairment of MSRs, the Firm stratified the
portfolio on the basis of the predominant risk
characteristics, which are loan type and interest
rate. Any indicated impairment was recognized as a
reduction in revenue through a valuation allowance,
which represented the extent to which the carrying
value of an individual stratum exceeded its
estimated fair value. Any gross carrying value and
related valuation allowance amounts which were
not expected to be recovered in the foreseeable
future, based upon the interest rate scenario, were
considered to be other-than-temporary.
JPMorgan Chase & Co. / 2006 Annual Report
121
Notes to consolidated financial statements
JPMorgan Chase & Co.
Prior to the adoption of SFAS 156, the Firm
designated certain derivatives used to risk manage
MSRs (e.g., a combination of swaps, swaptions and
floors) as SFAS 133 fair value hedges of benchmark
interest rate risk. SFAS 133 hedge accounting
allowed the carrying value of the hedged MSRs to be
adjusted through earnings in the same period that
the change in value of the hedging derivatives was
recognized through earnings. The designated hedge
period was daily. In designating the benchmark
interest rate, the Firm considered the impact that
the change in the benchmark rate had on the
prepayment speed estimates in determining the fair
value of the MSRs. Hedge effectiveness was assessed
using a regression analysis of the change in fair
value of the MSRs as a result of changes in
benchmark interest rates and of the change in the
fair value of the designated derivatives. The
valuation adjustments to both the MSRs and SFAS 133
derivatives were recorded in Mortgage fees and
related income. With the election to apply fair
value accounting to the MSRs under SFAS 156, SFAS
133 hedge accounting is no longer necessary. For a
further discussion on derivative instruments and
hedging activities, see Note 28 on pages 131–132 of this Annual Report.
The following table summarizes MSR activity,
certain key assumptions, and the sensitivity of the
fair value of MSRs to adverse changes in those key
assumptions for the year ended December 31, 2006,
during which MSRs were accounted for under SFAS
156.
Year ended December 31,
(in millions, except rates and where otherwise noted)
2006
Balance at beginning of period after valuation allowance
$
6,452
Cumulative effect of change in accounting principle
230
Fair value at beginning of period
6,682
Originations of MSRs
1,512
Purchase of MSRs
627
Total additions
2,139
Sales
—
Change in valuation due to inputs and assumptions(a)
Contractual service fees, late fees and other ancillary fees
included in Mortgage fees and related income
$
2,038
Third-party Mortgage loans serviced at December 31 (in billions)
$
527
CPR: Constant prepayment rate.
(a)
Represents MSR asset fair value adjustments due to changes in inputs, such as
interest rates and volatility, as well as updates to assumptions used in the valuation
model.
(b)
Includes changes in the MSR value due to servicing portfolio runoff (or time
decay).
The sensitivity analysis in the preceding table
is hypothetical and should be used with caution.
Changes in fair value based upon a 10% and 20%
variation in assumptions generally cannot be easily
extrapolated because the relationship of the change
in the assumptions to the change in fair value may
not be linear. Also, in this table, the effect that
a change in a particular assumption may have on the
fair value is calculated without changing any other
assumption. In reality, changes in one factor may
result in changes in another, which might magnify
or counteract the sensitivities.
The following table summarizes MSR activity for the
years ended December 31, 2005 and 2004, during
which MSRs were accounted for under SFAS 140.
Year ended December 31,
(in millions, except rates and where otherwise noted)
Contractual service fees, late fees and other ancillary
fees included in Mortgage fees and related income
$
1,769
$
1,721
Third-party Mortgage loans serviced
at December 31 (in billions)
$
468
$
431
(a)
The valuation allowance in the preceding table at December 31, 2005 and 2004,
represent- ed the extent to which the carrying value of MSRs exceeded the estimated fair
value for its applicable SFAS 140 strata. Changes in the valuation allowance were the
result of the recognition of impairment or the recovery of previously recognized
impairment charges due to changes in market conditions during the period.
(b)
The Firm recorded an other-than-temporary impairment of its MSRs of $1 million
and $149 million in 2005 and 2004, respectively, which permanently reduced the gross
carrying value of the MSRs and the related valuation allowance. The permanent reduction
precluded subsequent reversals. This write-down had no impact on the results of
operations or financial condition of the Firm.
(c)
During the fourth quarter of 2005, the Firm began valuing MSRs using an
option-adjusted spread (“OAS”) valuation model. Prior to the fourth quarter of 2005, MSRs
were valued using cash flows and discount rates determined by a “static” or single
interest rate path valuation model.
(d)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
CPR: Constant prepayment rate
122
JPMorgan Chase & Co. / 2006 Annual Report
Purchased credit card relationships and All other intangible assets
During 2006, Purchased credit card relationship
intangibles decreased by $340 million as a result
of $731 million in amortization expense, partially
offset by increases from various acquisitions of
private-label portfolios and purchase accounting
adjustments related to the November 2005
acquisition of the Sears Canada credit card
business. During 2006, all other intangible assets
declined $461 million, primarily as a result of
amortization expense and a reduction of $436
million related to the transfer of selected
corporate trust businesses to The Bank of New
York, partially offset by an increase in
core deposit intangibles of $485 million resulting
from the acquisition of The Bank of New York’s
consumer, business banking and middle-market banking
businesses, and further purchase accounting
adjustments related to the acquisition of the Sears
Canada credit card business. Except for $513
million of indefinite-lived intangibles related to
asset management advisory contracts that are not
amortized but instead are tested for impairment at
least annually, the remainder of the Firm’s other
acquired intangible assets are subject to
amortization.
The components of credit card relationships, core deposits and other intangible assets were as follows:
2006
2005
Net
Net
Gross
Accumulated
carrying
Gross
Accumulated
carrying
December 31, (in millions)
amount
amortization
value
amount
amortization
value
Purchased credit card relationships
$
5,716
$
2,781
$
2,935
$
5,325
$
2,050
$
3,275
All other intangibles:
Other credit card–related intangibles
367
65
302
183
59
124
Core deposit intangibles
4,283
1,660
2,623
3,797
1,092
2,705
Other intangibles(a)
1,961
515
(b)
1,446
2,582
579
(b)
2,003
(a)
Amounts at December 31, 2006, exclude, and amounts at December 31,2005, include,
other intangibles and related accumulated amortization of selected corporate trust
businesses related to the transaction with The Bank of New York.
(b)
Includes $11 million and $14 million of amortization expense related to
servicing assets on securitized automobile loans for the years ended December 31, 2006 and
2005, respectively.
Amortization expense
The following table
presents amortization expense related to credit card relationships,
core deposits and All other intangible assets:
Year ended December 31, (in millions)
2006
2005
2004
(b)
Purchased credit card relationships
$
731
$
703
$
476
All other intangibles:
Other credit card–related intangibles
6
36
23
Core deposit intangibles
568
623
330
Other intangibles(a)
123
128
82
Total amortization expense
$
1,428
$
1,490
$
911
(a)
Amortization expense related to the aforementioned selected corporate trust
businesses were reported in Income from discontinued operations for all periods presented.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Future amortization expense
The following table presents estimated future amortization expense related to credit card
relationships, core deposits and All other intangible assets at December 31, 2006:
Other credit
Purchased credit
card-related
Core deposit
All other
Year ended December 31, (in millions)
card relationships
intangibles
intangibles
intangible assets
Total
2007
$
700
$
10
$
555
$
109
$
1,374
2008
580
17
479
100
1,176
2009
428
23
397
92
940
2010
358
30
336
81
805
2011
289
35
293
73
690
Note 17 – Premises and equipment
Premises and equipment, including leasehold
improvements, are carried at cost less accumulated
depreciation and amortization. JPMorgan Chase
computes depreciation using the straight-line
method over the estimated useful life of an asset.
For leasehold improvements, the Firm uses the
straight-line method computed over the lesser of
the remaining term of the leased facility or 10 years.
JPMorgan Chase has recorded immaterial asset
retirement obligations related to asbestos
remediation under SFAS 143 and FIN 47 in those
cases where it has sufficient information to
estimate the obligations’ fair value.
JPMorgan Chase capitalizes certain costs
associated with the acquisition or development of
internal-use software under SOP 98-1. Once the
software is ready for its intended use, these
costs are amortized on a straight-line basis over
the software’s expected useful life, and reviewed
for impairment on an ongoing basis.
JPMorgan Chase & Co. / 2006 Annual Report
123
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 18 – Deposits
At December 31, 2006 and 2005, time
deposits in denominations of $100,000 or
more were as follows:
December 31, (in millions)
2006
2005
U.S.
$
110,812
$
80,861
Non-U.S.
51,138
34,912
Total
$
161,950
$
115,773
At December 31, 2006, the maturities of time deposits were as follows:
JPMorgan Chase issues long-term debt denominated in various currencies, although predominantly
U.S. dollars, with both fixed and variable interest rates. The following table is a summary of
long-term debt carrying values (including unamortized original issue discount, SFAS 133 valuation
adjustments and fair value adjustments, where applicable) by contractual maturity for the current
year.
Included are various equity-linked or other indexed instruments. Embedded
derivatives separated from hybrid securities in accordance with SFAS 133 are reported at
fair value and shown net with the host contract on the Consolidated balance sheets.
Changes in fair value of separated derivatives are recorded in Principal transactions
revenue. Hybrid securities which the Firm has elected to measure at fair value in
accordance with SFAS 155 are classified in the line item of the host contract on
the Consolidated balance sheets; changes in fair values are recorded in Principal transactions
revenue in the Consolidated statements of income.
(b)
The interest rates shown are the range of contractual rates in effect at year
end, including non-U.S. dollar-fixed- and variable-rate issuances, which excludes the
effects of the associated derivative instruments used in SFAS 133 hedge accounting
relationships if applicable. The use of these derivative instruments modifies the Firm’s
exposure to the contractual interest rates disclosed in the table above. Including the
effects of the SFAS 133 hedge accounting derivatives, the range of modified rates in
effect at December 31, 2006, for total long-term debt was 0.11% to 17.00%, versus the
contractual range of 0.75% to 17.00% presented in the table above.
(c)
Included on the Consolidated balance sheets in Beneficial interests issued by
consolidated variable interest entities.
(d)
At December 31, 2006, long-term debt aggregating $27.3 billion was redeemable at
the option of JPMorgan Chase, in whole or in part, prior to maturity, based upon the terms
specified in the respective notes.
(e)
The aggregate principal amount of debt that matures in each of the five years
subsequent to 2006 is $28.3 billion in 2007, $22.9 billion in 2008, $18.1 billion in 2009,
$10.6 billion in 2010 and $17.6 billion in 2011.
(f)
Includes $3.0 billion of outstanding zero-coupon notes at December 31, 2006. The
aggregate principal amount of these notes at their respective maturities was $6.8 billion.
(g)
Includes $25.4 billion of outstanding structured notes accounted for at fair
value under SFAS 155.
124
JPMorgan Chase & Co. / 2006 Annual Report
The weighted-average contractual interest rate
for total Long-term debt was 4.89% and 4.62% as of
December 31, 2006 and 2005, respectively. In order
to modify exposure to interest rate and currency
exchange rate movements, JPMorgan Chase utilizes
derivative instruments, primarily interest rate and
cross-currency interest rate swaps, in conjunction
with some of its debt issues. The use of these
instruments modifies the Firm’s interest expense on
the associated debt. The modified weighted-average
interest rate for total long-term debt, including
the effects of related derivative instruments, was
4.99% and 4.65% as of December 31, 2006 and 2005,
respectively.
JPMorgan Chase & Co. (Parent Company) has
guaranteed certain debt of its subsidiaries,
including both long-term debt and structured notes
sold as part of the Firm’s trading activities.
These guarantees rank on a parity with all of the
Firm’s other unsecured and unsubordinated
indebtedness. Guaranteed liabilities totaled $30
million and $170 million at December 31, 2006 and
2005, respectively.
Junior subordinated deferrable interest debentures
held by trusts that issued guaranteed capital debt
securities
At December 31, 2006, the Firm had established 22
wholly owned Delaware statutory business trusts
(“issuer trusts”) that had issued guaranteed
capital debt securities.
The junior subordinated deferrable interest
debentures issued by the Firm to the issuer
trusts, totaling $12.2 billion and $11.5 billion
at December 31, 2006 and 2005, respectively, were
reflected in the Firm’s Consolidated balance
sheets in the Liabilities section under the
caption “Junior subordinated deferrable interest
debentures held by trusts that issued guaranteed
capital debt securities” (i.e., trust preferred capital debt
securities). The Firm also records
the common capital securities issued by the issuer
trusts in Other assets in its Consolidated balance
sheets at December 31, 2006 and 2005.
The debentures issued to the issuer trusts by the Firm, less the common capital securities of the
issuer trusts, qualify as Tier 1 capital. The following is a summary of the outstanding capital
debt securities, including unamortized original issue discount, issued by each trust and the junior
subordinated deferrable interest debenture issued by JPMorgan Chase to each trust as of December31, 2006:
Represents the amount of capital securities issued to the public by each trust,
including unamortized original issue discount.
(b)
Represents the principal amount of JPMorgan Chase debentures issued to each
trust, including unamortized original issue discount. The principal amount of debentures
issued to the trusts includes the impact of hedging and purchase accounting fair value
adjustments that were recorded on the Firm’s Consolidated financial statements.
Note 20 – Preferred stock
JPMorgan Chase is authorized to issue 200
million shares of preferred stock, in one or more
series, with a par value of $1 per share. There
was no outstanding preferred stock at December 31,2006. Outstanding preferred
stock at
December 31, 2005, was 280,433 shares. On
March 31, 2006, JPMorgan Chase redeemed all 280,433
shares of its 6.63% Series H cumulative preferred
stock. Dividends on shares of the Series H
preferred stock were payable quarterly.
JPMorgan Chase & Co. / 2006 Annual Report
125
Notes to consolidated financial statements
JPMorgan Chase & Co.
The following is a summary of JPMorgan Chase’s preferred stock outstanding as of December 31:
Stated value and
Rate in effect at
(in millions, except
redemption
Shares
Outstanding at December 31,
Earliest
December 31,
per share amounts and rates)
price per share (b)
2006
2005
2006
2005
redemption date
2006
6.63% Series H cumulative(a)
$
500.00
—
0.28
$
—
$
139
NA
NA
Total preferred stock
—
0.28
$
—
$
139
(a)
Represented by depositary shares.
(b)
Redemption price includes amount shown in the table plus any accrued but unpaid dividends.
Note 21 – Common stock
At December 31, 2006, JPMorgan Chase was
authorized to issue 9.0 billion shares of common
stock with a $1 par value per share. Common shares
issued (newly issued or distributed from treasury)
by JPMorgan Chase during 2006, 2005 and 2004 were
as follows:
December 31, (in millions)
2006
2005
2004
(b)
Issued – balance at January 1
3,618.2
3,584.8
2,044.4
Newly issued:
Employee benefits and
compensation plans
39.3
34.0
69.0
Employee stock purchase plans
0.6
1.4
3.1
Purchase accounting acquisitions
and other
—
—
1,469.4
Total newly issued
39.9
35.4
1,541.5
Cancelled shares
(0.3
)
(2.0
)
(1.1
)
Total issued – balance at December 31
3,657.8
3,618.2
3,584.8
Treasury – balance at January 1
(131.5
)
(28.6
)
(1.8
)
Purchase of treasury stock
(90.7
)
(93.5
)
(19.3
)
Share repurchases related to employee
stock-based awards(a)
(8.8
)
(9.4
)
(7.5
)
Issued from treasury:
Employee benefits and
compensation plans
34.4
—
—
Employee stock purchase plans
0.5
—
—
Total issued from treasury
34.9
—
—
Total treasury – balance at December 31
(196.1
)
(131.5
)
(28.6
)
Outstanding
3,461.7
3,486.7
3,556.2
(a)
Participants in the Firm’s stock-based incentive plans may have shares withheld
to cover income taxes. The shares withheld amounted to 8.1 million, 8.2 million and 5.7
million for 2006, 2005 and 2004, respectively.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
During 2006, 2005 and 2004, the Firm
repurchased 91 million shares, 94 million shares
and 19 million shares, respectively, of common
stock under stock repurchase programs approved by
the Board of Directors.
As of December 31, 2006, approximately 464 million
unissued shares of common stock were reserved for
issuance under various employee or director
incentive, compensation, option and stock purchase
plans.
Note 22 – Earnings per share
SFAS 128 requires the presentation of basic and
diluted earnings per share (“EPS”) in the
Consolidated statement of income. Basic EPS is
computed by dividing net income applicable to
common stock by the weighted-average number of
common shares outstanding for the period. Diluted
EPS is computed using the same method as basic EPS
but, in the denominator, the number of common
shares reflect, in addition to outstanding shares,
the potential dilution that could occur if
convertible securities or other contracts to issue
common stock were converted or exercised into
common stock. Net income available for common stock
is the same for basic EPS and diluted EPS, as
JPMorgan Chase had no convertible securities, and
therefore, no adjustments to Net income available
for common stock were necessary. The following
table presents the calculation of basic and diluted
EPS for 2006, 2005 and 2004:
Year ended December 31,
(in millions, except per share amounts)
2006
2005
2004(b)
Basic earnings per share
Income from continuing operations
$
13,649
$
8,254
$
4,260
Discontinued operations
795
229
206
Net income
14,444
8,483
4,466
Less: preferred stock dividends
4
13
52
Net income applicable to
common stock
$
14,440
$
8,470
$
4,414
Weighted-average basic
shares outstanding
3,470.1
3,491.7
2,779.9
Income from continuing operations
per share
$
3.93
$
2.36
$
1.51
Discontinued operations per share
0.23
0.07
0.08
Net income per share
$
4.16
$
2.43
$
1.59
Diluted earnings per share
Net income applicable to
common stock
$
14,440
$
8,470
$
4,414
Weighted-average basic
shares outstanding
3,470.1
3,491.7
2,779.9
Add: Employee restricted stock,
RSUs, stock options and SARs
103.8
65.6
70.7
Weighted-average diluted
shares outstanding(a)
3,573.9
3,557.3
2,850.6
Income from continuing operations
per share
$
3.82
$
2.32
$
1.48
Discontinued operations per share
0.22
0.06
0.07
Net income per share
$
4.04
$
2.38
$
1.55
(a)
Options issued under employee stock-based incentive plans to purchase 150
million, 280 million and 300 million shares of common stock were outstanding for the years
ended 2006, 2005 and 2004, respectively, but were not included in the computation of
diluted EPS because the options were antidilutive.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
126
JPMorgan Chase & Co. / 2006 Annual Report
Note 23 – Accumulated other comprehensive income (loss)
Accumulated other comprehensive income (loss) includes the after-tax change in unrealized gains
and losses on AFS securities, foreign currency translation adjustments (including the impact of
related derivatives), cash flow hedging activities and the net actuarial loss and prior service
cost related to the Firm’s defined benefit pension and OPEB plans.
Balance at December 31, 2003 reflects heritage JPMorgan Chase only. 2004 results
include six months of the combined Firm’s results and six months of heritage JPMorgan
Chase results.
(b)
Represents the after-tax difference between the fair value and amortized cost of
the AFS securities portfolio and retained interests in securitizations recorded in Other
assets.
(c)
The net change during 2004 was due primarily to higher interest rates and
recognition of unrealized gains from securities sales.
(d)
The net change during 2005 was due primarily to higher interest rates, partially
offset by the reversal of unrealized losses from securities sales.
(e)
The net change during 2006 was due primarily to the reversal of unrealized
losses from securities sales.
(f)
For further discussion of SFAS 158, see Note 7 on pages 100–105 of this Annual Report.
The following table presents the after-tax changes in net unrealized holdings gains (losses),
reclassification adjustments for realized gains and losses on AFS securities and cash flow hedges,
and changes resulting from foreign currency translation adjustments (including the impact of
related derivatives). The table also reflects the adjustment to Accumulated other comprehensive
income (loss) resulting from the initial application of SFAS 158 to the Firm’s defined benefit
pension and OPEB plans. Reclassification adjustments include amounts recognized in Net income
during the current year that had been recorded previously in Other comprehensive income (loss).
2006
2005
2004(b)
Before
Tax
After
Before
Tax
After
Before
Tax
After
Year ended December 31, (in millions)
tax
effect
tax
tax
effect
tax
tax
effect
tax
Unrealized gains (losses) on AFS securities:
Net unrealized holdings gains (losses) arising
during the period
$
(403)
$
144
$
(259
)
$
(1,706
)
$
648
$
(1,058
)
$
68
$
(27
)
$
41
Reclassification adjustment for realized (gains)
losses included in Net income
797
(285
)
512
1,443
(548
)
895
(200
)
79
(121
)
Net change
394
(141
)
253
(263
)
100
(163
)
(132
)
52
(80
)
Translation adjustments:
Translation
590
(236
)
354
(584
)
233
(351
)
474
(194
)
280
Hedges
(563
)
222
(341
)
584
(233
)
351
(478
)
196
(282
)
Net change
27
(14
)
13
—
—
—
(4
)
2
(2
)
Cash flow hedges:
Net unrealized holdings gains (losses) arising
during the period
(250
)
98
(152
)
(470
)
187
(283
)
57
(23
)
34
Reclassification adjustment for realized (gains)
losses included in Net income
93
(36
)
57
46
(18
)
28
(216
)
86
(130
)
Net change
(157
)
62
(95
)
(424
)
169
(255
)
(159
)
63
(96
)
Total Other comprehensive income
$
264
$
(93
)
$
171
$
(687
)
$
269
$
(418
)
$
(295
)
$
117
$
(178
)
Net actuarial loss and prior service cost (credit)
of defined benefit pension and OPEB plans:
Adjustments to initially apply
SFAS 158(a)
$
(1,746
)
$
644
$
(1,102
)
NA
NA
NA
NA
NA
NA
(a)
For further discussion of SFAS 158, see Note 7 on pages 100–105 of this Annual Report.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
127
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 24 – Income taxes
JPMorgan Chase and eligible subsidiaries file a
consolidated U.S. federal income tax return.
JPMorgan Chase uses the asset-and-liability method
required by SFAS 109 to provide income taxes on all
transactions recorded in the Consolidated financial
statements. This method requires that income taxes
reflect the expected future tax consequences of
temporary differences between the carrying amounts
of assets or liabilities for book and tax purposes.
Accordingly, a deferred tax liability or asset for
each temporary difference is determined based upon
the tax rates that the Firm expects to be in effect
when the underlying items of income and expense are
realized. JPMorgan Chase’s expense for income taxes
includes the current and deferred portions of that
expense. A valuation allowance is established to
reduce deferred tax assets to the amount the Firm
expects to realize.
Due to the inherent complexities arising from the
nature of the Firm’s businesses, and from
conducting business and being taxed in a
substantial number of jurisdictions, significant
judgments and estimates are required to be made.
Agreement of tax liabilities between JPMorgan Chase
and the many tax jurisdictions in which the Firm
files tax returns may not be finalized for several
years. Thus, the Firm’s final tax-related assets
and liabilities may ultimately be different than
those currently reported.
Deferred income tax expense (benefit) results from
differences between assets and liabilities measured
for financial reporting and for income-tax return
purposes. The significant components of deferred
tax assets and liabilities are reflected in the
following table:
December 31, (in millions)
2006
2005
Deferred tax assets
Employee benefits
$
5,175
$
3,381
Allowance for other than loan losses
3,533
3,554
Allowance for loan losses
2,910
2,745
Non-U.S. operations
566
807
Fair value adjustments
427
531
Gross deferred tax assets
$
12,611
$
11,018
Deferred tax liabilities
Depreciation and amortization
$
3,668
$
3,683
Leasing transactions
2,675
3,158
Non-U.S. operations
1,435
1,297
Fee income
1,216
1,396
Other, net
78
149
Gross deferred tax liabilities
$
9,072
$
9,683
Valuation allowance
$
210
$
110
Net deferred tax asset
$
3,329
$
1,225
A valuation allowance has been recorded in
accordance with SFAS 109, primarily relating to
capital losses associated with certain portfolio
investments.
The components of income tax expense included in
the Consolidated statements of income were as
follows:
Year ended December 31, (in millions)
2006
2005
2004
(a)
Current income tax expense
U.S. federal
$
5,512
$
4,178
$
1,613
Non-U.S.
1,656
887
653
U.S. state and local
879
311
157
Total current income tax
expense
8,047
5,376
2,423
Deferred income tax (benefit) expense
U.S. federal
(1,628
)
(2,063
)
(382
)
Non-U.S.
194
316
(322
)
U.S. state and local
(376
)
(44
)
(123
)
Total deferred income tax
(benefit) expense
(1,810
)
(1,791
)
(827
)
Total income tax expense
from continuing operations
6,237
3,585
1,596
Total income tax expense
from discontinued operations
572
147
132
Total income tax expense
$
6,809
$
3,732
$
1,728
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Total income tax expense includes $367
million of tax benefits recorded in 2006 as a
result of tax audit resolutions.
The preceding table does not reflect the tax
effects of SFAS 52 foreign currency translation
adjustments, SFAS 115 unrealized gains and losses
on AFS securities, SFAS 133 hedge transactions and
certain tax benefits associated with the Firm’s
employee stock-based compensation plans. Also not
reflected are the cumulative tax effects of
implementing in 2006, SFAS 155, which applies to
certain hybrid financial instruments; SFAS 156,
which accounts for servicing financial assets; and
SFAS 158, which applies to defined benefit pension
and OPEB plans. The tax effect of all items
recorded directly in Stockholders’ equity was an
increase of $885 million, $425 million and $431
million in 2006, 2005 and 2004, respectively.
U.S. federal income taxes have not been provided on
the undistributed earnings of certain non-U.S.
subsidiaries, to the extent that such earnings have
been reinvested abroad for an indefinite period of
time. For 2006, such earnings approximated $423
million on a pretax basis. At December 31, 2006,
the cumulative amount of undistributed pretax
earnings in these subsidiaries approximated $1.9
billion. It is not practicable at this time to
determine the income tax liability that would
result upon repatriation of these earnings.
On October 22, 2004, the American Jobs Creation Act
of 2004 (the “Act”) was signed into law. The Act
created a temporary incentive for U.S. companies to
repatriate accumulated foreign earnings at a
substantially reduced U.S. effective tax rate by
providing a dividends received deduction on the
repatriation of certain foreign earnings to the
U.S. taxpayer (the “repatriation provision”). The
deduction was subject to a number of limitations
and requirements. In the fourth quarter of 2005,
the Firm applied the repatriation provision to $1.9
billion of cash from foreign earnings, resulting in
a net tax benefit of $55 million. The $1.9 billion
of cash was invested in accordance with the Firm’s
domestic reinvestment plan pursuant to the
guidelines set forth in the Act.
128
JPMorgan Chase & Co. / 2006 Annual Report
The tax expense (benefit) applicable to
securities gains and losses for the years 2006, 2005
and 2004 was $(219) million, $(536) million and $126
million, respectively.
A reconciliation of the applicable statutory U.S.
income tax rate to the effective tax rate for
continuing operations for the past three years is
shown in the following table:
U.S. state and local income taxes, net of
federal income tax benefit
2.1
1.4
0.2
Tax-exempt income
(2.2
)
(3.1
)
(4.2
)
Non-U.S. subsidiary earnings
(0.5
)
(1.4
)
(1.4
)
Business tax credits
(2.5
)
(3.7
)
(4.3
)
Other, net
(0.5
)
2.1
2.0
Effective tax rate
31.4
%
30.3
%
27.3
%
(a)
2004 results include six months of the
combined Firm’s results and six months of heritage
JPMorgan Chase results.
The following table presents the U.S. and
non-U.S. components of Income from continuing operations before income tax
expense:
Year ended December 31, (in millions)
2006
2005
2004
(b)
U.S.
$
12,934
$
8,683
$
3,566
Non-U.S.(a)
6,952
3,156
2,290
Income
from continuing operations before income tax expense
$
19,886
$
11,839
$
5,856
(a)
For purposes of this table, non-U.S. income is defined as income generated from
operations located outside the United States of America.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Note 25 – Restrictions on cash and
intercompany funds transfers
JPMorgan Chase Bank, N.A.’s business is subject
to examination and regulation by the Office of the
Comptroller of the Currency (“OCC”).
The Bank is a member of the U.S. Federal Reserve
System and its deposits are insured by the Federal
Deposit Insurance Corporation (“FDIC”).
The Federal Reserve Board requires depository
institutions to maintain cash reserves with a
Federal Reserve Bank. The average amount of reserve
balances deposited by the Firm’s bank subsidiaries
with various Federal Reserve Banks was
approximately $2.2 billion in 2006 and $2.7 billion
in 2005.
Restrictions imposed by U.S. federal law prohibit
JPMorgan Chase and certain of its affiliates from
borrowing from banking subsidiaries unless the
loans are secured in specified amounts. Such
secured loans to the Firm or to other affiliates
are generally limited to 10% of the banking
subsidiary’s total capital, as determined by the
risk-based capital guidelines; the aggregate amount
of all such loans is limited to 20% of the banking
subsidiary’s total capital.
The principal sources of JPMorgan Chase’s income
(on a parent company-only basis) are dividends and
interest from JPMorgan Chase Bank, N.A. and the
other banking and nonbanking subsidiaries of
JPMorgan Chase. In addition to dividend
restrictions set forth in statutes and regulations,
the Federal Reserve Board, the OCC and the FDIC
have authority under the Financial Institutions
Supervisory Act to prohibit or to limit the payment
of dividends by the banking organizations they
supervise, including JPMorgan Chase and its
subsidiaries that are banks or bank holding
companies, 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.
At January 1, 2007 and 2006, JPMorgan Chase’s
banking subsidiaries could pay, in the aggregate,
$14.3 billion and $7.4 billion, respectively, in
dividends to their respective bank holding
companies without prior approval of their relevant
banking regulators. The capacity to pay dividends
in 2007 will be supplemented by the banking
subsidiaries’ earnings during the year.
In compliance with rules and regulations
established by U.S. and non-U.S. regulators, as
of December 31, 2006 and 2005, cash in the amount
of $8.6 billion and $6.4 billion, respectively,
and securities with a fair value of $2.1 billion
and $2.1 billion, respectively, were segregated
in special bank accounts for the benefit of
securities and futures brokerage customers.
Note 26 – Capital
There are two categories of risk-based capital:
Tier 1 capital and Tier 2 capital. Tier 1 capital
includes common stockholders’ equity, qualifying
preferred stock and minority interest less goodwill
and other adjustments. Tier 2 capital consists of
preferred stock not qualifying as Tier 1,
subordinated long-term debt and other instruments
qualifying as Tier 2, and the aggregate allowance
for credit losses up to a certain percentage of
risk-weighted assets. Total regulatory capital is
subject to deductions for investments in certain
subsidiaries. Under the risk-based capital
guidelines of the Federal Reserve Board, JPMorgan
Chase is required to maintain minimum ratios of
Tier 1 and Total (Tier 1 plus Tier 2) capital to
risk weighted assets, as well as minimum leverage
ratios (which are defined as Tier 1 capital to
average adjusted on-balance sheet assets). Failure
to meet these minimum requirements could cause the
Federal Reserve Board to take action. Banking
subsidiaries also are subject to these capital
requirements by their respective primary
regulators. As of December 31, 2006 and 2005,
JPMorgan Chase and all of its banking subsidiaries
were well-capitalized and met all capital
requirements to which each was subject.
Asset and capital amounts for JPMorgan Chase’s banking subsidiaries reflect
intercompany transactions, whereas the respective amounts for JPMorgan Chase reflect the
elimination of intercompany transactions.
(b)
As defined by the regulations issued by the Federal Reserve Board, OCC and FDIC.
(c)
Includes off–balance sheet risk-weighted assets in the amounts of $305.3
billion, $290.1 billion and $12.7 billion, respectively, at December 31, 2006, and $279.2
billion, $260.0 billion and $15.5 billion, respectively, at December 31, 2005, for
JPMorgan Chase and its significant banking subsidiaries.
(d)
Average adjusted assets for purposes of calculating the leverage ratio include
total average assets adjusted for unrealized gains/losses on securities, less deductions
for disallowed goodwill and other intangible assets, investments in subsidiaries and the
total adjusted carrying value of nonfinancial equity investments that are subject to
deductions from Tier 1 capital.
(e)
Represents requirements for banking subsidiaries pursuant to regulations issued
under the Federal Deposit Insurance Corporation Improvement Act. There is no Tier 1
leverage component in the definition of a well-capitalized bank holding company.
(f)
The minimum Tier 1 leverage ratio for bank holding companies and banks is 3% or
4% depending on factors specified in regulations issued by the Federal Reserve Board and
OCC.
The following table shows the components of the Firm’s Tier 1 and Total capital:
December 31, (in millions)
2006
2005
Tier 1 capital
Total stockholders’ equity
$
115,790
$
107,211
Effect of certain items in Accumulated other
comprehensive income (loss)
excluded from Tier 1 capital(a)
Long-term debt and other instruments
qualifying as Tier 2
$
26,613
$
22,733
Qualifying allowance for credit losses
7,803
7,490
Less: Investments in certain subsidiaries
and other
206
260
Tier 2 capital
$
34,210
$
29,963
Total qualifying capital
$
115,265
$
102,437
(a)
Includes the effect of net unrealized gains (losses) on AFS securities, cash
flow hedging activities and, at December 31, 2006, unrecognized amounts related to the
Firm’s pension and OPEB plans.
(b)
Primarily includes trust preferred securities of certain business trusts.
Note 27 – Commitments and contingencies
At December 31, 2006, JPMorgan Chase and its
subsidiaries were obligated under a number of
noncancelable operating leases for premises and
equipment used primarily for banking purposes.
Certain leases contain renewal options or
escalation clauses providing for increased rental
payments based upon maintenance, utility and tax
increases or require the Firm to perform
restoration work on leased premises. No lease
agreement imposes restrictions on the Firm’s
ability to pay dividends, engage in debt or equity
financing transactions or enter into further lease
agreements.
The following table presents required future
minimum rental payments under operating leases
with noncancelable lease terms that expire after
December 31, 2006:
Year ended December 31, (in millions)
2007
$
1,058
2008
1,033
2009
962
2010
865
2011
791
After 2011
6,320
Total minimum payments required(a)
11,029
Less: Sublease rentals under noncancelable subleases
(1,177
)
Net minimum payment required
$
9,852
(a)
Lease restoration obligations are accrued
in accordance with SFAS 13, and are not reported as
a required minimum lease payment.
Total rental
expense was as
follows:
Year ended December 31, (in millions)
2006
2005
2004
(a)
Gross rental expense
$
1,266
$
1,239
$
1,161
Sublease rental income
(194
)
(192
)
(158
)
Net rental expense
$
1,072
$
1,047
$
1,003
(a)
2004 results include six months of the
combined Firm’s results and six months of heritage
JPMorgan Chase results.
At December 31, 2006, assets were pledged to
secure public deposits and for other purposes. The
significant components of the assets pledged were
as follows:
The Firm maintains litigation reserves for certain
of its outstanding litigation. In accordance with
the provisions of SFAS 5, JPMorgan Chase accrues
for a litigation-related liability when it is
probable that such a liability has been incurred
and the amount of the loss can be reasonably
estimated. While the outcome of litigation is
inherently uncertain, management believes, in light
of all information known to it at December 31,2006, the Firm’s litigation reserves were adequate
at such date. Management reviews litigation
reserves periodically, and the reserves may be
increased or decreased in the future to reflect
further litigation developments. The Firm believes
it has meritorious defenses to claims asserted
against it in its currently outstanding litigation
and, with respect to such litigation, intends to
continue to defend itself vigorously, litigating or
settling cases according to management’s judgment
as to what is in the best interests of
stockholders.
Insurance recoveries related to certain material
legal proceedings were $512 million and $208
million in 2006 and 2005, respectively. Charges
related to certain material legal proceedings were
$2.8 billion and $3.7 billion in 2005 and 2004,
respectively. There were no charges in 2006 related
to material legal proceedings.
Note 28 – Accounting for derivative
instruments and hedging activities
Derivative instruments enable end users to
increase, reduce or alter exposure to credit or
market risks. The value of a derivative is derived
from its reference to an underlying variable or
combination of variables such as equity, foreign
exchange, credit, commodity or interest rate prices
or indices. JPMorgan Chase makes markets in
derivatives for customers and also is an end-user
of derivatives in order to hedge market exposures,
modify the interest rate characteristics of related
balance sheet instruments or meet longer-term
investment objectives. The majority of the Firm’s
derivatives are entered into for trading purposes.
Both trading and end-user derivatives are recorded
at fair value in Trading assets and Trading
liabilities as set forth in Note 4 on pages 98–99
of this Annual Report.
SFAS 133, as amended by SFAS 138, SFAS 149, and
SFAS 155, establishes accounting and reporting
standards for derivative instruments, including
those used for trading and hedging activities, and
derivative instruments embedded in other contracts.
All free-standing derivatives, whether designated
for hedging relationships or not, are required to
be recorded on the Consolidated balance sheets at
fair value. The accounting for changes in value of
a derivative depends on whether the contract is for
trading purposes or has been designated and
qualifies for hedge accounting.
In order to qualify for hedge accounting, a
derivative must be considered highly effective at
reducing the risk associated with the exposure
being hedged. In order for a derivative to be
designated as a
hedge, there must be documentation of the risk
management objective and strategy, including
identification of the hedging instrument, the
hedged item and the risk exposure, and how
effectiveness is to be assessed prospectively and
retrospectively. To assess effectiveness, the Firm
uses statistical methods such as regression
analysis, as well as nonstatistical methods
including dollar value comparisons of the change in
the fair value of the derivative to the change in
the fair value or cash flows of the hedged item.
The extent to which a hedging instrument has been
and is expected to continue to be effective at
achieving offsetting changes in fair value or cash
flows must be assessed and documented at least
quarterly. Any ineffectiveness must be reported in
current-period earnings. If it is determined that a
derivative is not highly effective at hedging the
designated exposure, hedge accounting is
discontinued.
For qualifying fair value hedges, all changes in
the fair value of the derivative and in the fair
value of the hedged item for the risk being hedged
are recognized in earnings. If the hedge
relationship is terminated, then the fair value
adjustment to the hedged item continues to be
reported as part of the basis of the item and
continues to be amortized to earnings as a yield
adjustment. For qualifying cash flow hedges, the
effective portion of the change in the fair value
of the derivative is recorded in Other
comprehensive income and recognized in the
Consolidated statement of income when the hedged
cash flows affect earnings. The ineffective
portions of cash flow hedges are immediately
recognized in earnings. If the hedge relationship
is terminated, then the change in fair value of the
derivative recorded in Other comprehensive income
is recognized when the cash flows that were hedged
occur, consistent with the original hedge strategy.
For hedge relationships discontinued because the
forecasted transaction is not expected to occur
according to the original strategy, any related
derivative amounts recorded in Other comprehensive
income are immediately recognized in earnings. For
qualifying net investment hedges, changes in the
fair value of the derivative or the revaluation of
the foreign currency–denominated debt instrument
are recorded in the translation adjustments account
within Other comprehensive income.
JPMorgan Chase’s fair value hedges primarily
include hedges of fixed-rate long-term debt, loans,
AFS securities and MSRs. Interest rate swaps are
the most common type of derivative contract used to
modify exposure to interest rate risk, converting
fixed-rate assets and liabilities to a floating
rate. Prior to the adoption of SFAS 156, interest
rate options, swaptions and forwards were also used
in combination with interest rate swaps to hedge
the fair value of the Firm’s MSRs in SFAS 133 hedge
relationships. For a further discussion of MSR risk
management activities, see Note 16 on pages
121–122 of this Annual Report. All amounts have
been included in earnings consistent with the
classification of the hedged item, primarily Net
interest income, Mortgage fees and related income,
and Other income. The Firm did not recognize any
gains or losses during 2006, 2005 or 2004 on firm
commitments that no longer qualify as fair value
hedges.
JPMorgan Chase also enters into derivative
contracts to hedge exposure to variability in cash
flows from floating-rate financial instruments and
forecasted transactions, primarily the rollover of
short-term assets and liabilities, and foreign
currency–denominated revenues and expenses.
Interest rate swaps, futures and forward contracts
are the most common instruments used to reduce the
impact of interest rate and foreign exchange rate
changes on future earnings. All amounts affecting
earnings have been recognized consistent with the
classification of the hedged item, primarily Net
interest income.
The Firm uses forward foreign exchange contracts
and foreign currency–denominated debt instruments
to protect the value of net investments in
subsidiaries whose functional currency is not the
U.S. dollar. The portion of the hedging instruments
excluded from the assessment of hedge effectiveness
(forward points) is recorded in Net interest
income.
The following table presents derivative instrument
hedging-related activities for the periods
indicated:
Year ended December 31, (in millions)
2006
2005
2004(b)
Fair value hedge ineffective net gains/(losses)(a)
$
51
$
(58
)
$
199
Cash flow hedge ineffective net gains/(losses)(a)
2
(2
)
—
Cash flow hedging gains/(losses) on forecasted
transactions that failed to occur
—
—
1
(a)
Includes ineffectiveness and the components of hedging instruments that have
been excluded from the assessment of hedge effectiveness.
(b)
2004 results include six months of the combined Firm’s
results and six months of heritage JPMorgan Chase results.
JPMorgan Chase & Co. / 2006 Annual Report
131
Notes to consolidated financial statements
JPMorgan Chase & Co.
Over the next 12 months, it is expected that
$67 million (after-tax) of net losses recorded in
Other comprehensive income at December 31, 2006,
will be recognized in earnings. The maximum length
of time over which forecasted transactions are
hedged is 10 years, and such transactions primarily
relate to core lending and borrowing activities.
JPMorgan Chase does not seek to apply hedge
accounting to all of the Firm’s economic hedges.
For example, the Firm does not apply hedge
accounting to standard credit derivatives used to
manage the credit risk of loans and commitments
because of the difficulties in qualifying such
contracts as hedges under SFAS 133. Similarly, the
Firm does not apply hedge accounting to certain
interest rate derivatives used as economic hedges.
Note 29 – Off–balance sheet
lending-related financial instruments and
guarantees
JPMorgan Chase utilizes lending-related
financial instruments (e.g., commitments and
guarantees) to meet the financing needs of its
customers. The contractual amount of these
financial instruments represents the maximum
possible credit risk should the counterparty draw
down the commitment or the Firm fulfill its
obligation under the guarantee, and the
counterparty subsequently fail to perform according
to the terms of the contract. Most of these
commitments and guarantees expire without a default
occurring or without being drawn. As a result, the
total contractual amount of these instruments is
not, in the Firm’s view, representative of its
actual future credit exposure or funding
requirements. Further, certain commitments,
primarily related to consumer financings, are
cancelable, upon notice, at the option of the Firm.
To provide for the risk of loss inherent in
wholesale-related contracts, an allowance for
credit losses on lending-related commitments is
maintained. See Note 13 on pages 113–114 of this
Annual Report for further discussion of the
allowance for credit losses on lending-related
commitments.
The following table summarizes the contractual
amounts of off–balance sheet lending-related
financial instruments and guarantees and the
related allowance for credit losses on
lending-related commitments at December 31, 2006
and 2005:
Off–balance sheet lending-related financial
instruments and guarantees
Allowance for
Contractual
lending-related
amount
commitments
December 31, (in millions)
2006
2005
2006
2005
Lending-related
Consumer(a)
$
747,535
$
655,596
$
25
$
15
Wholesale:
Other unfunded commitments
to extend credit(b)(c)(d)
229,204
208,469
305
208
Asset purchase agreements(e)
67,529
31,095
6
3
Standby letters of credit
and guarantees(c)(f)(g)
89,132
77,199
187
173
Other letters of credit(c)
5,559
4,346
1
1
Total wholesale
391,424
321,109
499
385
Total lending-related
$
1,138,959
$
976,705
$
524
$
400
Other guarantees
Securities lending guarantees(h)
$
318,095
$
244,316
NA
NA
Derivatives qualifying as
guarantees
71,531
61,759
NA
NA
(a)
Includes Credit card lending-related commitments of $657 billion at December 31,2006, and $579 billion at December 31, 2005, which represent the total available credit to
the Firm’s cardholders. The Firm has not experienced, and does not anticipate, that all of
its cardholders will utilize their entire available lines of credit at the same time. The
Firm can reduce or cancel a credit card commitment by providing the cardholder prior
notice or, in some cases, without notice as permitted by law.
(b)
Includes unused advised lines of credit totaling $39.0 billion and $28.3 billion
at December 31, 2006 and 2005, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve Board, unused advised lines are not reportable.
(c)
Represents contractual amount net of risk participations totaling $32.8 billion
and $29.3 billion at December 31, 2006 and 2005, respectively.
(d)
Excludes unfunded commitments to private third-party equity funds of $589
million and $242 million at December 31, 2006, and December 31, 2005, respectively.
(e)
Represents asset purchase agreements with the Firm’s administered multi-seller
asset- backed commercial paper conduits, which excludes
$356 million and $32.4 billion at
December 31, 2006 and 2005, respectively, related to conduits that were consolidated in
accordance with FIN 46R, as the underlying assets of the conduits are reported in the
Firm’s Consolidated balance sheets. It also includes $1.4 billion and $1.3 billion of
asset purchase agreements to other third-party entities at December 31, 2006 and 2005,
respectively. Certain of the Firm’s administered multi-seller conduits were deconsolidated as of June
2006; the assets deconsolidated were approximately $33 billion.
(f)
JPMorgan Chase held collateral relating to $13.5 billion and $9.0 billion of
these arrangements at December 31, 2006 and 2005, respectively.
(g)
Includes unused commitments to issue standby letters of credit of $45.7 billion
and $37.5 billion at December 31, 2006 and 2005, respectively.
(h)
Collateral held by the Firm in support of securities lending indemnification
agreements was $317.9 billion and $245.0 billion at December 31, 2006 and 2005,
respectively.
Other unfunded commitments to extend credit
Unfunded commitments to extend credit are
agreements to lend only when a customer has
complied with predetermined conditions, and they
generally expire on fixed dates.
FIN 45 establishes accounting and disclosure
requirements for guarantees, requiring that a
guarantor recognize, at the inception of a
guarantee, a liability in an amount equal to the
fair value of the obligation undertaken in issuing
the guarantee. FIN 45 defines a guarantee as a
contract that contingently requires the guarantor
to pay a guaranteed party, based upon: (a) changes
in an underlying asset, liability or equity
security of the guaranteed party; or (b) a third
party’s failure to perform under a specified
agreement. The Firm considers the following
off–balance sheet lending arrangements to be
guarantees under FIN 45: certain asset purchase
agreements, standby letters of credit and financial
guarantees, securities lending indemnifications,
certain indemnification agreements included within
third-party contractual arrangements and certain
derivative contracts. These guarantees are
described in further detail below.
The fair value at inception of the obligation
undertaken when issuing the guarantees and
commitments that qualify under FIN 45 is typically
equal to the net present value of the future amount
of premium receivable under the contract. The Firm
has recorded this amount in Other Liabilities with
an offsetting entry recorded in Other Assets. As
cash is received under the contract, it is applied
to the premium receivable recorded in Other Assets,
and the fair value of the liability recorded at
inception is amortized into income as Lending &
deposit related fees over the life of the guarantee
contract. The amount of the liability related to
FIN 45 guarantees recorded at December 31, 2006 and
2005, excluding the allowance for credit losses on
lending-related commitments and derivative
contracts discussed below, was approximately $297
million and $313 million, respectively.
Asset purchase agreements
The majority of the Firm’s unfunded commitments are
not guarantees as defined in FIN 45, except for
certain asset purchase agreements that are
principally used as a mechanism to provide
liquidity to SPEs, primarily multi-seller conduits,
as described in Note 15 on pages 118–120 of this
Annual Report. Some of these asset purchase
agreements can be exercised at any time by the
SPE’s administrator, while others require a
triggering event to occur. Triggering events
include, but are not limited to, a need for
liquidity, a decline
132
JPMorgan Chase & Co. / 2006 Annual Report
in market value of the assets or a downgrade in
the rating of JPMorgan Chase Bank, N.A. These
agreements may cause the Firm to purchase an asset
from the SPE at an amount above the asset’s fair
value, in effect providing a guarantee of the
initial value of the reference asset as of the date
of the agreement. In most instances, third-party
credit enhancements of the SPE mitigate the Firm’s
potential losses on these agreements.
Standby letters of credit and financial guarantees
Standby letters of credit and financial guarantees
are conditional lending commitments issued by
JPMorgan Chase to guarantee the performance of a
customer to a third party under certain
arrangements, such as commercial paper facilities,
bond financings, acquisition financings, trade and
similar transactions. Approximately 50% of these
arrangements mature within three years. The Firm
typically has recourse to recover from the
customer any amounts paid under these guarantees;
in addition, the Firm may hold cash or other
highly liquid collateral to support these
guarantees.
Securities lending indemnification
Through the Firm’s securities lending program,
customers’ securities, via custodial and
non-custodial arrangements, may be lent to third
parties. As part of this program, the Firm issues
securities lending indemnification agreements to
the lender which protects it principally against
the failure of the third-party borrower to return
the lent securities. To support these
indemnification agreements, the Firm obtains cash
or other highly liquid collateral with a market
value exceeding 100% of the value of the securities
on loan from the borrower. Collateral is marked to market daily to
help assure that collateralization is adequate. Additional collateral is
called from the borrower if a shortfall exists or released to the
borrower in the event of overcollateralization. If
an indemnifiable default by a borrower occurs, the
Firm would expect to use the collateral held to purchase
replacement securities in the market or to credit
the lending customer with the cash equivalent
thereof.
Also as part of this program, the
Firm invests cash collateral received from the
borrower in accordance with approved guidelines.
On an exceptional basis the Firm may indemnify the
lender against this investment risk when certain
types of investments are made.
Based upon historical experience, management
believes that these risks of loss are remote.
Indemnification agreements – general
In connection with issuing securities to investors,
the Firm may enter into contractual arrangements
with third parties that may require the Firm to
make a payment to them in the event of a change in
tax law or an adverse interpretation of tax law. In
certain cases, the contract also may include a
termination clause, which would allow the Firm to
settle the contract at its fair value; thus, such a
clause would not require the Firm to make a payment
under the indemnification agreement. Even without
the termination clause, management does not expect
such indemnification agreements to have a material
adverse effect on the consolidated financial
condition of JPMorgan Chase. The Firm may also
enter into indemnification clauses when it sells a
business or assets to a third party, pursuant to
which it indemnifies that third party for losses it
may incur due to actions taken by the Firm prior to
the sale. See below for more information regarding
the Firm’s loan securitization activities. It is
difficult to estimate the Firm’s maximum exposure
under these indemnification arrangements, since
this would require an assessment of future changes
in tax law and future claims that may be made
against the Firm that have not yet occurred.
However, based upon historical experience,
management expects the risk of loss to be remote.
Securitization-related indemnifications
As part of the Firm’s loan securitization
activities, as described in Note 14 on pages
114–118 of this Annual Report, the Firm provides
representations and warranties that certain
securitized loans meet specific requirements. The
Firm may be required to repurchase the loans and/or
indemnify the purchaser of the loans against losses
due to any breaches of such representations or
warranties. Generally, the maximum amount of future
payments the Firm would be required to make under
such repurchase and/or indemnification provisions
would be equal to the current amount of assets held
by such securitization-related SPEs as of December31, 2006, plus, in certain circumstances, accrued
and unpaid interest on such loans and certain
expenses. The potential loss due to such repurchase
and/or indemnity is mitigated by the due diligence
the Firm performs before the sale to ensure that
the assets comply with the requirements set forth
in the representations and warranties.
Historically, losses incurred on such repurchases
and/or indemnifications have been insignificant,
and therefore management expects the risk of
material loss to be remote.
Credit card charge-backs
The Firm is a partner with one of the leading
companies in electronic payment services in a joint
venture operating under the name of Chase
Paymentech Solutions, LLC (the “joint venture”).
The joint venture was formed in October 2005, as a
result of an agreement by the Firm and First Data
Corporation, its joint venture partner, to
integrate the companies’ jointly owned Chase
Merchant Services (“CMS”) and Paymentech merchant
businesses. The joint venture provides merchant
processing services in the United States and
Canada. Under the rules of Visa USA, Inc. and
Mastercard International, JPMorgan Chase Bank,
N.A., is liable primarily for the amount of each
processed credit card sales transaction that is the
subject of a dispute between a cardmember and a
merchant. The joint venture is contractually liable
to JPMorgan Chase Bank, N.A. for these disputed
transactions. If a dispute is resolved in the
cardmember’s favor, the joint venture will (through
the cardmember’s issuing bank) credit or refund the
amount to the cardmember and will charge back the
transaction to the merchant. If the joint venture
is unable to collect the amount from the merchant,
the joint venture will bear the loss for the amount
credited or refunded to the cardmember. The joint
venture mitigates this risk by withholding future
settlements, retaining cash reserve accounts or by
obtaining other security. However, in the unlikely
event that: (1) a merchant ceases operations and is
unable to deliver products, services or a refund;
(2) the joint venture does not have sufficient
collateral from the merchant to provide customer
refunds; and (3) the joint venture does not have
sufficient financial resources to provide customer
refunds, JPMorgan Chase Bank, N.A. would be liable
for the amount of the transaction, although it
would have a contractual right to recover from its
joint venture partner an amount proportionate to
such partner’s equity interest in the joint
venture. For the year ended December 31, 2006, the
joint venture incurred aggregate credit losses of
$9 million on $661 billion of aggregate volume
processed. At December 31, 2006, the joint venture
held $893 million of collateral. For the year ended
December 31, 2005, the CMS and Paymentech ventures incurred
aggregate credit losses of $11 million on $563
billion of aggregate volume processed. At December31, 2005, the joint venture held $909 million of
collateral. The Firm believes that, based upon
historical experience and the collateral held by
the joint venture, the fair value of the Firm’s
chargeback-related obligations would not be
different materially from the credit loss allowance
recorded by the joint venture; therefore, the Firm
has not recorded any allowance for losses in excess
of the allowance recorded by the joint venture.
JPMorgan Chase & Co. / 2006 Annual Report
133
Notes to consolidated financial statements
JPMorgan Chase & Co.
Exchange and clearinghouse guarantees
The Firm is a member of several securities and
futures exchanges and clearing-houses, both in the
United States and other countries. Membership in
some of these organizations requires the Firm to
pay a pro rata share of the losses incurred by the
organization as a result of the default of another
member. Such obligations vary with different
organizations. These obligations may be limited to
members who dealt with the defaulting member or to
the amount (or a multiple of the amount) of the
Firm’s contribution to a members’ guaranty fund,
or, in a few cases, it may be unlimited. It is
difficult to estimate the Firm’s maximum exposure
under these membership agreements, since this would
require an assessment of future claims that may be
made against the Firm that have not yet occurred.
However, based upon historical experience,
management expects the risk of loss to be remote.
Derivative guarantees
In addition to the contracts described above, there
are certain derivative contracts to which the Firm
is a counterparty that meet the characteristics of
a guarantee under FIN 45. These derivatives are
recorded on the Consolidated balance sheets at fair
value. These contracts include written put options
that require the Firm to purchase assets from the
option holder at a specified price by a specified
date in the future, as well as derivatives that
effectively guarantee the return on a
counterparty’s reference portfolio of assets. The
total notional value of the derivatives that the
Firm deems to be guarantees was $72 billion and $62
billion at December 31, 2006 and 2005,
respectively. The Firm reduces exposures to these
contracts by entering into offsetting transactions
or by entering into contracts that hedge the market
risk related to these contracts. The fair value
related to these contracts was a derivative
receivable of $230 million and $198 million, and a
derivative payable of $987 million and $767 million
at December 31, 2006 and 2005, respectively.
Finally, certain written put options and credit
derivatives permit cash settlement and do not
require the option holder or the buyer of credit
protection to own the reference asset. The Firm
does not consider these contracts to be guarantees
under FIN 45.
Note 30 – Credit risk concentrations
Concentrations of credit risk arise when a
number of customers are engaged in similar business
activities or activities in the same geographic
region, or when they have similar economic features
that would cause their ability to meet contractual
obligations to be similarly affected by changes in
economic conditions.
JPMorgan Chase regularly monitors various segments
of the credit risk portfolio to assess potential
concentration risks and to obtain collateral when
deemed necessary. In the Firm’s wholesale
portfolio, risk concentrations are evaluated
primarily by industry and by geographic region. In
the consumer portfolio, concentrations are
evaluated primarily by product and by U.S.
geographic region.
The Firm does not believe exposure to any one loan
product with varying terms (e.g., interest-only
payments for an introductory period) or exposure to
loans with high loan-to-value ratios would result
in a significant concentration of credit risk.
Terms of loan products and collateral coverage are
included in the Firm’s assessment when extending
credit and establishing its Allowance for loan
losses.
For further information regarding on–balance sheet
credit concentrations by major product and
geography, see Note 12 on pages 112–113 of this
Annual Report. For information regarding
concentrations of off–balance sheet
lending-related financial instruments by major
product, see Note 29 on page 132 of this Annual
Report. More information about concentrations can
be found in the following tables or discussion in
the MD&A:
Credit
risk management – risk monitoring
Wholesale exposure
Wholesale selected industry concentrations
Emerging markets country exposure
Consumer real estate loan portfolio by geographic location
Page 64
Page 67
Page 68
Page 72
Page 74
The table below presents both on–balance sheet and off–balance sheet wholesale- and
consumer-related credit exposure as of December 31, 2006 and 2005:
2006
2005
Credit
On-balance
Off-balance
Credit
On-balance
Off-balance
December 31, (in billions)
exposure (b)
sheet (b)(c)
sheet (d)
exposure (b)
sheet (b)(c)
sheet (d)
Wholesale-related:
Banks and finance companies
$
63.6
$
28.1
$
35.5
$
51.1
$
20.3
$
30.8
Real estate
35.9
21.6
14.3
32.5
19.0
13.5
Healthcare
30.1
6.1
24.0
25.5
4.7
20.8
State and municipal governments
27.5
6.9
20.6
25.3
6.1
19.2
Consumer products
27.1
9.1
18.0
26.7
10.0
16.7
All other wholesale
446.6
167.6
279.0
389.6
169.5
220.1
Total wholesale-related
630.8
239.4
391.4
550.7
229.6
321.1
Consumer-related:
Home equity
155.2
85.7
69.5
132.2
73.9
58.3
Mortgage
66.3
59.7
6.6
64.8
58.9
5.9
Auto loans and leases
48.9
41.0
7.9
51.8
46.1
5.7
All other loans
33.5
27.1
6.4
24.8
18.4
6.4
Card Services-reported (a)
743.0
85.9
657.1
651.0
71.7
579.3
Total consumer–related
1,046.9
299.4
747.5
924.6
269.0
655.6
Total exposure
$
1,677.7
$
538.8
$
1,138.9
$
1,475.3
$
498.6
$
976.7
(a)
Excludes $67.0 billion and $70.5 billion of securitized credit card receivables
at December 31, 2006 and 2005, respectively.
(b)
Includes HFS loans.
(c)
Represents loans, derivative receivables and interests in purchased receivables.
(d)
Represents lending-related financial instruments.
134
JPMorgan Chase & Co. / 2006 Annual Report
Note 31 – Fair value of financial instruments
The fair value of a financial instrument is the
amount at which the instrument could be exchanged
in a current transaction between willing parties,
other than in a forced or liquidation sale.
The accounting for an asset or liability may
differ based upon the type of instrument and/or
its use in a trading or investing strategy.
Generally, the measurement framework in the
consolidated financial statements is one of the
following:
•
at fair value on the Consolidated balance sheets, with changes in fair value
recorded each period in the Consolidated statements of income;
•
at fair value on the Consolidated balance sheets, with changes in fair value
recorded each period in the Accumulated other comprehensive income component of
Stockholders’ equity and as part of Other comprehensive income;
•
at cost (less other-than-temporary impairments), with changes in fair value not
recorded in the consolidated financial statements but disclosed in the notes thereto; or
•
at the lower of cost or fair value.
Determination of fair value
The Firm has an established and well-documented
process for determining fair values. Fair value is
based upon quoted market prices, where available.
If listed prices or quotes are not available, fair
value is based upon internally developed models
that primarily use market-based or independent
information as inputs to the valuation model.
Valuation adjustments may be necessary to ensure
that financial instruments are recorded at fair
value. These adjustments include amounts to reflect
counterparty credit quality, liquidity and
concentration concerns and are based upon defined
methodologies that are applied consistently over
time.
•
Credit valuation adjustments are necessary when the market price (or parameter) is
not indicative of the credit quality of the counterparty. As few derivative contracts are
listed on an exchange, the majority of derivative positions are valued using internally
developed models that use as their basis observable market parameters. Market practice is
to quote parameters equivalent to a AA credit rating; thus, all counterparties are assumed
to have the same credit quality. An adjustment is therefore necessary to reflect the
credit quality of each derivative counterparty and to arrive at fair value.
•
Liquidity adjustments are necessary when the Firm may not be able to observe a
recent market price for a financial instrument that trades in inactive (or less active)
markets. Thus, valuation adjustments for the risk of loss due to a lack of liquidity are
applied to those positions to arrive at fair value. The Firm tries to ascertain the amount of uncertainty in the initial valuation based upon
the degree of liquidity or illiquidity, as the case may be, of the market in which the
instrument trades and makes liquidity adjustments to the financial instruments. The Firm
measures the liquidity adjustment based upon the following factors: (1) the amount of time
since the last relevant pricing point; (2) whether there was an actual trade or relevant
external quote; and (3) the volatility of the principal component of the financial
instrument.
•
Concentration valuation adjustments are necessary to reflect the cost of unwinding
larger-than-normal market-size risk positions. The cost is deter- mined based upon the
size of the adverse market move that is likely to
occur during the extended period required to bring
a position down to a nonconcentrated level. An
estimate of the period needed to reduce, without
market disruption, a position to a nonconcentrated
level is generally based upon the relationship of
the position to the average daily trading volume
of that position. Without these adjustments,
larger positions would be valued at a price
greater than the price at which the Firm could
exit the positions.
Valuation adjustments are determined based upon
established policies and are controlled by a price
verification group, which is independent of the
risk-taking function. Economic substantiation of
models, prices, market inputs and revenue through
price/input testing, as well as back-testing, is
done to validate the appropriateness of the
valuation methodology. Any changes to the valuation
methodology are reviewed by management to ensure
the changes are justified.
The methods described above may produce a fair
value calculation that may not be indicative of
net realizable value or reflective of future fair
values. Furthermore, the use of different
methodologies to determine the fair value of
certain financial instruments could result in a
different estimate of fair value at the reporting
date.
Certain financial instruments and all nonfinancial
instruments are excluded from the scope of SFAS
107. Accordingly, the fair value disclosures
required by SFAS 107 provide only a partial
estimate of the fair value of JPMorgan Chase. For
example, the Firm has developed long-term
relationships with its customers through its
deposit base and credit card accounts, commonly
referred to as core deposit intangibles and credit
card relationships. In the opinion of management,
these items, in the aggregate, add significant
value to JPMorgan Chase, but their fair value is
not disclosed in this Note.
The following items describe the methodologies
and assumptions used, by financial instrument, to
determine fair value.
Financial assets
Assets for which fair value approximates carrying value
The Firm considers fair values of certain financial
assets carried at cost – including cash and due
from banks, deposits with banks, securities
borrowed, short-term receivables and accrued
interest receivable – to approximate their
respective carrying values, due to their short-term
nature and generally negligible credit risk.
Federal funds sold and securities purchased under resale agreements
Federal funds sold and securities purchased under
resale agreements are typically short-term in
nature and, as such, for a significant
majority of the Firm’s transactions, cost
approximates carrying value. This balance sheet
item also includes structured resale agreements
and similar products with long-dated maturities.
To estimate the fair value of these instruments,
cash flows are discounted using the appropriate
market rates for the applicable maturity.
Trading debt and equity instruments
The Firm’s debt and equity trading instruments are
carried at their estimated fair value. Quoted
market prices, when available, are used to
determine the fair value of trading instruments. If
quoted market prices are not available, then fair
values are estimated by using pricing models,
quoted prices of instruments with similar
characteristics, or discounted cash flows.
Securities
Fair values of actively traded securities are
determined by quoted external dealer prices, while
the fair values for nonactively traded securities
are based upon independent broker quotations.
JPMorgan Chase & Co. / 2006 Annual Report
135
Notes to consolidated financial statements
JPMorgan Chase & Co.
Derivatives
Fair value for derivatives is determined based upon the following:
•
position valuation, principally based upon liquid market pricing as evidenced by
exchange-traded prices, broker-dealer quotations or related input parameters, which assume
all counterparties have the same credit rating;
•
credit valuation adjustments to the resulting portfolio valuation, to reflect the
credit quality of individual counterparties; and
•
other fair value adjustments to take into consideration liquidity, concentration and
other factors.
For those derivatives valued based upon models with
significant unobservable market parameters, the
Firm defers the initial trading profit for these
financial instruments. The deferred profit is
recognized in Trading revenue on a systematic basis
(typically straight-line amortization over the life
of the instruments) and when observable market data
becomes available.
The fair value of derivative payables does not
incorporate a valuation adjustment to reflect
JPMorgan Chase’s credit quality.
Interests in purchased receivables
The fair value of variable-rate interests in
purchased receivables approximate their respective
carrying amounts due to their variable interest
terms and negligible credit risk. The estimated
fair values for fixed-rate interests in purchased
receivables are determined using a discounted cash
flow analysis using appropriate market rates for
similar instruments.
Loans
Fair value for loans is determined using
methodologies suitable for each type of loan:
•
Fair value for the wholesale loan portfolio is estimated, primarily using the cost
of credit derivatives, which is adjusted to account for the differences in recovery rates
between bonds, upon which the cost of credit derivatives is based, and loans.
•
Fair values for consumer installment loans (including automobile financings) and
consumer real estate, for which market rates for comparable loans are readily available,
are based upon discounted cash flows adjusted for prepayments. The discount rates used for
consumer installment loans are current rates offered by commercial banks. For consumer
real estate, secondary market yields for comparable mortgage-backed securities, adjusted
for risk, are used.
•
Fair value for credit card receivables is based upon discounted expected cash flows.
The discount rates used for credit card receivables incorporate only the effects of
interest rate changes, since the expected cash flows already reflect an adjustment for
credit risk.
•
The fair value of loans in the held-for-sale and trading portfolios is generally
based upon observable market prices and upon prices of similar instruments, including
bonds, credit derivatives and loans with similar characteristics. If market prices are not
available, the fair value is based upon the estimated cash flows adjusted for credit risk;
that risk is discounted, using a rate appropriate for each maturity.
Other
Commodities inventory is carried at the lower of
cost or fair value. For the majority of commodities
inventory, fair value is determined by reference to
prices in highly active and liquid markets. The
fair value for other commodities inventory is
determined primarily using pricing and data derived
from the markets on which the underlying
commodities are traded. Market prices used may be
adjusted for liquidity. This caption also includes
Private equity investments and MSRs. For discussion
of the fair value methodology for Private equity
investments, see Note 4 on pages 98–99 of this
Annual Report.
For discussion of the fair value methodology
for retained interests related to securitizations,
see Note 14 on pages 114–118 of this Annual
Report.
For discussion of the fair value methodology for
MSRs, see Note 16 on pages 121–122 of this Annual
Report.
Financial liabilities
Liabilities for which fair value approximates carrying value
SFAS 107 requires that the fair value for deposit
liabilities with no stated maturity (i.e., demand,
savings and certain money market deposits) be
equal to their carrying value. SFAS 107 does not
allow for the recognition of the inherent funding
value of these instruments.
Fair value of commercial paper, other borrowed
funds, accounts payable and accrued liabilities is
considered to approximate their respective carrying
values due to their short-term nature.
Interest-bearing deposits
Fair values of interest-bearing deposits are
estimated by discounting cash flows using the
appropriate market rates for the applicable
maturity.
Federal funds purchased and securities sold
under repurchase agreements
Federal funds purchased and securities sold under
repurchase agreements are typically short-term in
nature; as such, for a significant majority of
these transactions, cost approximates carrying
value. This balance sheet item also includes
structured repurchase agreements and similar
products with long-dated maturities. To estimate
the fair value of these instruments, the cash flows
are discounted using the appropriate market rates
for the applicable maturity.
Trading liabilities
For a discussion of the fair value methodology for
trading debt and equity instruments and
derivatives, see the related discussions in the
Financial assets section of this Note.
Beneficial interests issued by consolidated VIEs
Beneficial interests issued by consolidated VIEs
(“beneficial interests”) are generally short-term
in nature and, as such, for a significant
majority of the Firm’s transactions, cost
approximates carrying value. The Consolidated
balance sheets also include beneficial interests
with long-dated maturities. The fair value of
these instruments is based upon current market
rates.
Long-term debt-related instruments
Fair value for long-term debt, including the junior
subordinated deferrable interest debentures held by
trusts that issued guaranteed capital debt
securities, is based upon current market rates and
is adjusted for JPMorgan Chase’s credit quality.
Lending-related commitments
Although there is no liquid secondary market for
wholesale commitments, the Firm estimates the fair
value of its wholesale lending-related commitments
primarily using the cost of credit derivatives
(which is adjusted to account for the difference in
recovery rates between bonds, upon which the cost
of credit derivatives is based, and loans) and loan
equivalents (which represent the portion of an
unused commitment expected, based upon the Firm’s
average portfolio historical experience, to become
outstanding in the event an obligor defaults). The
Firm estimates the fair value of its consumer
commitments to extend credit based upon the primary
market prices to originate new commitments. It is
the change in current primary market prices that
provides the estimate of the fair value of these
commitments. On this basis, at December 31, 2006,
the estimated fair value of the Firm’s
lending-related commitments was a liability of $0.2
billion, compared with $0.5 billion at December 31,2005.
136
JPMorgan Chase & Co. / 2006 Annual Report
The following table presents the carrying value and estimated fair value of financial assets
and liabilities valued under SFAS 107; accordingly, certain assets and liabilities that are not
considered financial instruments are excluded from the table.
2006
2005
Carrying
Estimated
Appreciation/
Carrying
Estimated
Appreciation/
December 31, (in billions)
value
fair value
(depreciation)
value
fair value
(depreciation)
Financial assets
Assets for which fair value approximates carrying value
$
150.5
$
150.5
$
—
$
155.4
$
155.4
$
—
Federal funds sold and securities purchased under resale
agreements
140.5
140.5
—
134.0
134.3
0.3
Trading assets
365.7
365.7
—
298.4
298.4
—
Securities
92.0
92.0
—
47.6
47.6
—
Loans: Wholesale, net of Allowance for loan losses
181.0
184.6
3.6
147.7
150.2
2.5
Consumer, net of Allowance for loan losses
294.8
294.8
—
264.4
262.7
(1.7
)
Interests in purchased receivables
—
—
—
29.7
29.7
—
Other
61.8
62.4
0.6
53.4
54.7
1.3
Total financial assets
$
1,286.3
$
1,290.5
$
4.2
$
1,130.6
$
1,133.0
$
2.4
Financial liabilities
Liabilities for which fair value approximates carrying value
$
259.9
$
259.9
$
—
$
241.0
$
241.0
$
—
Interest-bearing deposits
498.3
498.4
(0.1
)
411.9
411.7
0.2
Federal funds purchased and securities sold under repurchase
agreements
162.2
162.2
—
125.9
125.9
—
Trading liabilities
148.0
148.0
—
145.9
145.9
—
Beneficial interests issued by consolidated VIEs
16.2
16.2
—
42.2
42.1
0.1
Long-term debt-related instruments
145.6
147.1
(1.5
)
119.9
120.6
(0.7
)
Total financial liabilities
$
1,230.2
$
1,231.8
$
(1.6
)
$
1,086.8
$
1,087.2
$
(0.4
)
Net appreciation
$
2.6
$
2.0
JPMorgan Chase & Co. / 2006 Annual Report
137
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 32 – International operations
The following table presents income statement
information of JPMorgan Chase by major geographic
area. The Firm defines international activities as
business transactions that involve customers
residing outside of the U.S., and the information
presented below is based primarily upon the
domicile of the customer or the location from which
the customer relationship is managed. However, many
of the Firm’s U.S. operations serve international
businesses.
As the Firm’s operations are highly integrated,
estimates and subjective assumptions have been
made to apportion revenue and expense between
U.S. and international operations. These
estimates and assumptions are consistent with the
allocations used for the Firm’s segment reporting
as set forth in Note 33 on pages 139–141 of this
Annual Report.
The Firm’s long-lived assets for the periods
presented are not considered by management to be
significant in relation to total assets. The
majority of the Firm’s long-lived assets are
located in the U.S.
Income from
continuing
operations before
Year ended December 31, (in millions)
Revenue
(b)
Expense
(c)
income taxes
Net income
2006
Europe/Middle East and Africa
$
11,238
$
7,367
$
3,871
$
2,774
Asia and Pacific
3,144
2,566
578
400
Latin America and the Caribbean
1,328
806
522
333
Other
381
240
141
90
Total international
16,091
10,979
5,112
3,597
Total U.S.
45,346
30,572
14,774
10,847
Total
$
61,437
$
41,551
$
19,886
$
14,444
2005
Europe/Middle East and Africa
$
7,549
$
5,379
$
2,170
$
1,547
Asia and Pacific
2,806
2,024
782
509
Latin America and the Caribbean
960
493
467
285
Other
165
89
76
44
Total international
11,480
7,985
3,495
2,385
Total U.S.
42,268
33,924
8,344
6,098
Total
$
53,748
$
41,909
$
11,839
$
8,483
2004(a)
Europe/Middle East and Africa
$
6,439
$
4,587
$
1,852
$
1,305
Asia and Pacific
2,597
1,742
855
547
Latin America and the Caribbean
812
405
407
255
Other
112
77
35
25
Total international
9,960
6,811
3,149
2,132
Total U.S.
32,412
29,705
2,707
2,334
Total
$
42,372
$
36,516
$
5,856
$
4,466
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(b)
Revenue is composed of Net interest income and Noninterest revenue.
(c)
Expense is composed of Noninterest expense and Provision for credit losses.
138
JPMorgan Chase & Co. / 2006 Annual Report
Note 33 – Business segments
JPMorgan Chase is organized into six major
reportable business segments —Investment Bank,
Retail Financial Services, Card Services,
Commercial Banking (“CB”), Treasury & Securities
Services and Asset Management, as well as a
Corporate segment. The segments are based upon 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 a managed basis. For a definition
of managed basis, see Explanation and Reconciliation of the
Firm’s use of non-GAAP financial measures, on pages 32–33 of this Annual
Report. For a further discussion concerning
JPMorgan Chase’s business segments, see Business
segment results on pages 34–35 of this Annual
Report.
Business segment financial disclosures
Effective January 1, 2006, JPMorgan Chase modified
certain of its financial disclosures to reflect
more closely the manner in which the Firm’s
business segments are managed and to provide
improved comparability with competitors. These
financial disclosure revisions are reflected in
this Annual Report, and the financial information
for prior periods has been revised to reflect the
disclosure changes as if they had been in effect
throughout all periods reported. A summary of the
changes are described below.
Reported versus Operating Basis Changes
The presentation of operating earnings that excluded
merger costs and material litigation reserve charges
and recoveries from reported results has been
eliminated. These items had been excluded previously
from operating results because they were deemed
nonrecurring; they are now included in the Corporate business segment’s
results. In addition, trading-related net interest
income is no longer reclassified from Net interest
income to trading revenue. As a result of these
changes, effective January 1, 2006, management has
discontinued reporting on an “operating” basis.
Business Segment Disclosures
Various wholesale banking clients, together with
the related balance sheet and income statement
items, were transferred among CB, IB and TSS. The
primary client transfer was corporate mortgage
finance from CB to IB and TSS.
Capital allocation changes
Effective January 1, 2006, the Firm refined its
methodology for allocating capital (i.e., equity)
to the business segments. As a result of this
refinement, RFS, CS, CB, TSS and AM have higher
amounts of capital allocated to them, commencing in
the first quarter of 2006. The revised methodology
considers for each line of business, among other
things, goodwill associated with such business
segment’s acquisitions since the Merger. In
management’s view, the revised methodology assigns
responsibility to the lines of business to generate
returns on the amount of capital supporting
acquisition-related goodwill. As part of this
refinement in the capital allocation methodology,
the Firm assigned to the Corporate segment an
amount of equity capital equal to the then-current
book value of goodwill from and prior to the
Merger. As prior periods have not been revised to
reflect the new capital allocations, capital
allocated to the respective lines of business for
2006 is not comparable to prior periods and certain
business metrics, such as ROE, are not comparable
to the current presentation. The Firm may revise
its equity capital allocation methodology again in
the future.
Discontinued operations
As a result of the transaction with The Bank of
New York, selected corporate trust businesses have
been transferred from TSS to the Corporate segment
and reported in discontinued operations for all
periods reported.
JPMorgan Chase & Co. / 2006 Annual Report
139
Notes to consolidated financial statements
JPMorgan Chase & Co.
Segment results
The following table provides a summary of the
Firm’s segment results for 2006, 2005 and 2004 on a
managed basis. The impact of credit card
securitizations and tax-equivalent adjustments have
been included in Reconciling items so that the
total Firm results are on a reported basis. The
first six
months of 2004 reflect heritage JPMorgan
Chase–only results and have been restated to
reflect the current business segment organization
and reporting classifications.
Segment results and reconciliation(a) (table continued on next page)
Year ended December 31,(b)
Investment Bank
Retail Financial Services(e)
Card Services(f)
Commercial Banking
(in millions, except ratios)
2006
2005
2004
2006
2005
2004
2006
2005
2004
2006
2005
2004
Noninterest revenue
$
17,778
$
13,010
$
9,337
$
4,660
$
4,625
$
3,077
$
2,944
$
3,563
$
2,371
$
1,073
$
986
$
685
Net interest income
499
1,603
3,296
10,165
10,205
7,714
11,801
11,803
8,374
2,727
2,502
1,593
Total net revenue
18,277
14,613
12,633
14,825
14,830
10,791
14,745
15,366
10,745
3,800
3,488
2,278
Provision for credit losses
191
(838
)
(640
)
561
724
449
4,598
7,346
4,851
160
73
41
Credit reimbursement
(to)/from TSS(c)
121
154
90
—
—
—
—
—
—
—
—
—
Noninterest expense(d)
12,304
9,749
8,709
8,927
8,585
6,825
5,086
4,999
3,883
1,979
1,856
1,326
Income (loss) from
continuing operations
before income tax expense
5,903
5,856
4,654
5,337
5,521
3,517
5,061
3,021
2,011
1,661
1,559
911
Income tax expense (benefit)
2,229
2,183
1,698
2,124
2,094
1,318
1,855
1,114
737
651
608
350
Income (loss) from
continuing operations
3,674
3,673
2,956
3,213
3,427
2,199
3,206
1,907
1,274
1,010
951
561
Income (loss) from
discontinued operations
—
—
—
—
—
—
—
—
—
—
—
—
Net income (loss)
$
3,674
$
3,673
$
2,956
$
3,213
$
3,427
$
2,199
$
3,206
$
1,907
$
1,274
$
1,010
$
951
$
561
Average equity
$
20,753
$
20,000
$
17,290
$
14,629
$
13,383
$
9,092
$
14,100
$
11,800
$
7,608
$
5,702
$
3,400
$
2,093
Average assets
647,569
599,761
474,436
231,566
226,368
185,928
148,153
141,933
94,741
57,754
52,358
32,547
Return on average equity
18
%
18
%
17
%
22
%
26
%
24
%
23
%
16
%
17
%
18
%
28
%
27
%
Overhead ratio
67
67
69
60
58
63
34
33
36
52
53
58
(a)
In addition to analyzing the Firm’s results on a reported basis, management
reviews the Firm’s lines’ of business results on a “managed basis,” which is a non-GAAP
financial measure. The Firm’s definition of managed basis starts with the reported U.S.
GAAP results and includes certain reclassifications that do not have any impact on Net
income as reported by the lines of business or by the Firm as a whole.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
(c)
TSS reimburses the IB for credit portfolio exposures the IB manages on behalf of
clients the segments share. At the time of the Merger, the reimbursement methodology was
revised to be based upon pretax earnings, net of the cost of capital related to those
exposures. Prior to the Merger, the credit reimbursement was based upon pretax earnings,
plus the allocated capital associated with the shared clients.
(d)
Includes Merger costs which are reported in the Corporate segment. Merger costs
attributed to the business segments for 2006, 2005 and 2004 were as follows:
Year ended December 31, (in millions)
2006
2005
2004
(b)
Investment Bank
$
2
$
32
$
74
Retail Financial Services
24
133
201
Card Services
29
222
79
Commercial Banking
1
3
23
Treasury & Securities Services
117
95
68
Asset Management
23
60
31
Corporate
109
177
889
(e)
Effective January 1, 2006, RFS was reorganized into three businesses: Regional
Banking, Mortgage Banking and Auto Finance.
(f)
Managed results for CS exclude the impact of credit card securitizations on
Total net revenue, Provision for credit losses and Average assets, as JPMorgan Chase
treats the sold receivables as if they were still on the balance sheet in evaluating
credit performance and the overall performance of CS’ entire managed credit card portfolio
as operations are funded, and decisions are made about allocating resources such as
employees and capital, based upon managed information. These adjustments are eliminated in
Reconciling items to arrive at the Firm’s reported U.S. GAAP results. The related
securitization adjustments were as follows:
Year ended December 31, (in millions)
2006
2005
2004
(b)
Noninterest revenue
$
(3,509
)
$
(2,718
)
$
(2,353
)
Net interest income
5,719
6,494
5,251
Provision for credit losses
2,210
3,776
2,898
Average assets
65,266
67,180
51,084
140
JPMorgan Chase & Co. / 2006 Annual Report
(table continued from previous page)
Treasury &
Asset
Reconciling
Securities Services
Management
Corporate
items(f)(h)
Total
2006
2005
2004
2006
2005
2004
2006
2005
2004
2006
2005
2004
2006
2005
2004
$
4,039
$
3,659
$
2,973
$
5,816
$
4,583
$
3,383
$
1,052
$
1,620
$
1,983
$
2,833
$
2,147
$
2,036
$
40,195
$
34,193
$
25,845
2,070
1,880
1,225
971
1,081
796
(1,044
)
(2,756
)
(1,214
)
(5,947
)
(6,763
)
(5,257
)
21,242
19,555
16,527
6,109
5,539
4,198
6,787
5,664
4,179
8
(1,136
)
769
(3,114
)
(4,616
)
(3,221
)
61,437
53,748
42,372
(1
)
—
7
(28
)
(56
)
(14
)
(1
)
10
748
(g)
(2,210
)
(3,776
)
(2,898
)
3,270
3,483
2,544
(121
)
(154
)
(90
)
—
—
—
—
—
—
—
—
—
—
—
—
4,266
4,050
3,726
4,578
3,860
3,133
1,141
5,327
6,370
—
—
—
38,281
38,426
33,972
1,723
1,335
375
2,237
1,860
1,060
(1,132
)
(6,473
)
(6,349
)
(904
)
(840
)
(323
)
19,886
11,839
5,856
633
472
98
828
644
379
(1,179
)
(2,690
)
(2,661
)
(904
)
(840
)
(323
)
6,237
3,585
1,596
1,090
863
277
1,409
1,216
681
47
(3,783
)
(3,688
)
—
—
—
13,649
8,254
4,260
—
—
—
—
—
—
795
229
206
—
—
—
795
229
206
$
1,090
$
863
$
277
$
1,409
$
1,216
$
681
$
842
$
(3,554
)
$
(3,482
)
$
—
$
—
$
—
$
14,444
$
8,483
$
4,466
$
2,285
$
1,525
$
1,989
$
3,500
$
2,400
$
3,902
$
49,728
$
52,999
$
33,667
$
—
$
—
$
—
$
110,697
$
105,507
$
75,641
31,760
28,206
24,815
43,635
41,599
37,751
218,623
162,021
163,422
(65,266
)
(67,180
)
(51,084
)
1,313,794
1,185,066
962,556
48
%
57
%
14
%
40
%
51
%
17
%
NM
NM
NM
NM
NM
NM
13
%
8
%
6
%
70
73
89
67
68
75
NM
NM
NM
NM
NM
NM
62
71
80
(g)
Includes $858 million of accounting policy conformity adjustments consisting of
approximately $1.4 billion related to the decertification of the seller’s retained
interest in credit card securitizations, partially offset by a benefit of $584 million
related to conforming wholesale and consumer provision methodologies for the combined
Firm.
(h)
Segment managed results reflect revenues on a tax-equivalent basis with the
corresponding income tax impact recorded within Income tax expense. These adjustments are
eliminated in Reconciling items to arrive at the Firm’s reported U.S. GAAP
results. Tax-equivalent adjustments were as follows for the years ended December 31, 2006,
2005 and 2004:
Year ended December 31, (in millions)
2006
2005
2004
(b)
Noninterest income
$
676
$
571
$
317
Net interest income
228
269
6
Income tax expense
904
840
323
JPMorgan Chase & Co. / 2006 Annual Report
141
Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 34 – Parent company
Parent company – statements of income
Year ended December 31, (in millions)
2006
2005
2004
(c)
Income
Dividends from bank and bank
holding company subsidiaries
Net proceeds from the issuance of stock
and stock-related awards
1,659
682
848
Excess tax benefits related to
stock-based compensation
302
—
—
Redemption of preferred stock
(139
)
(200
)
(670
)
Treasury stock purchased
(3,938
)
(3,412
)
(738
)
Cash dividends paid
(4,846
)
(4,878
)
(3,927
)
Net cash
provided by financing activities
8,642
261
1,611
Net increase
(decrease) in cash and due from banks
295
(52
)
365
Cash and due
from banks
at the beginning of the year, primarily
with bank subsidiaries
461
513
148
Cash and
due from banks at the end of the year,
primarily with bank subsidiaries
$
756
$
461
$
513
Cash interest paid
$
5,485
$
3,838
$
2,383
Cash income taxes paid
$
3,599
$
3,426
$
701
(a)
Subsidiaries include trusts that issued guaranteed capital debt securities (“issuer trusts”).
As a result of FIN 46R, the Parent deconsolidated these trusts in 2003. The Parent received
dividends of $23 million, $21 million and $15 million
from the issuer trusts in 2006, 2005 and 2004, respectively. For further discussion on these issuer trusts, see Note 19 on page 125 of this Annual
Report.
(b)
At December 31, 2006, debt that contractually matures in 2007 through 2011 totaled
$10.6 billion, $12.4 billion, $13.7 billion, $4.3 billion and $13.5 billion, respectively.
(c)
2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results. For further discussion of the Merger, see Note 2 on pages 95–96
of this Annual Report.
142
JPMorgan Chase & Co. / 2006 Annual Report
Supplementary information
Selected quarterly financial data (unaudited)
(in millions, except per share, ratio and headcount data)
2006
2005
As of or for the period ended
4th
3rd
2nd
1st
4th
3rd
2nd
1st
Selected income statement data
Noninterest revenue
$
10,362
$
10,021
$
9,762
$
10,050
$
8,804
$
9,482
$
7,616
$
8,291
Net interest income
5,692
5,379
5,178
4,993
4,678
4,783
4,932
5,162
Total net revenue
16,054
15,400
14,940
15,043
13,482
14,265
12,548
13,453
Provision for credit losses
1,134
812
493
831
1,224
1,245
587
427
Total noninterest expense
9,746
9,651
9,236
9,648
8,430
9,359
10,798
9,839
Income from continuing operations before income tax
expense
5,174
4,937
5,211
4,564
3,828
3,661
1,163
3,187
Income tax expense
1,268
1,705
1,727
1,537
1,186
1,192
226
981
Income from continuing operations (after-tax)
3,906
3,232
3,484
3,027
2,642
2,469
937
2,206
Income from discontinued operations
(after-tax)(a)
620
65
56
54
56
58
57
58
Net income
$
4,526
$
3,297
$
3,540
$
3,081
$
2,698
$
2,527
$
994
$
2,264
Per common share
Basic earnings per share
Income from continuing operations
$
1.13
$
0.93
$
1.00
$
0.87
$
0.76
$
0.71
$
0.27
$
0.63
Net income
1.31
0.95
1.02
0.89
0.78
0.72
0.28
0.64
Diluted earnings per share
Income from continuing operations
1.09
0.90
0.98
0.85
0.74
0.70
0.26
0.62
Net income
1.26
0.92
0.99
0.86
0.76
0.71
0.28
0.63
Cash dividends declared per share
0.34
0.34
0.34
0.34
0.34
0.34
0.34
0.34
Book value per share
33.45
32.75
31.89
31.19
30.71
30.26
29.95
29.78
Common shares outstanding
Average: Basic
3,465
3,469
3,474
3,473
3,472
3,485
3,493
3,518
Diluted
3,579
3,574
3,572
3,571
3,564
3,548
3,548
3,570
Common shares at period end
3,462
3,468
3,471
3,473
3,487
3,503
3,514
3,525
Selected ratios
Return on common equity (“ROE”)
Income from continuing operations
14
%
11
%
13
%
11
%
10
%
9
%
4
%
8
%
Net income
16
12
13
12
10
9
4
9
Return on assets (“ROA”)
Income from continuing operations
1.14
0.98
1.05
0.98
0.87
0.82
0.32
0.77
Net income
1.32
1.00
1.06
1.00
0.89
0.84
0.34
0.79
Tier 1 capital ratio
8.7
8.6
8.5
8.5
8.5
8.2
8.2
8.6
Total capital ratio
12.3
12.1
12.0
12.1
12.0
11.3
11.3
11.9
Tier 1 leverage ratio
6.2
6.3
5.8
6.1
6.3
6.2
6.2
6.3
Overhead ratio
61
63
62
64
63
66
86
73
Selected balance sheet data (period-end)
Total assets
$
1,351,520
$
1,338,029
$
1,328,001
$
1,273,282
$
1,198,942
$
1,203,033
$
1,171,283
$
1,178,305
Securities
91,975
86,548
78,022
67,126
47,600
68,697
58,573
75,251
Loans
483,127
463,544
455,104
432,081
419,148
420,504
416,025
402,669
Deposits
638,788
582,115
593,716
584,465
554,991
535,123
534,640
531,379
Long-term debt
133,421
126,619
125,280
112,133
108,357
101,853
101,182
99,329
Total stockholders’ equity
115,790
113,561
110,684
108,337
107,211
106,135
105,385
105,340
Credit quality metrics
Allowance for credit losses
$
7,803
$
7,524
$
7,500
$
7,659
$
7,490
$
7,615
$
7,233
$
7,423
Nonperforming assets(b)
2,341
2,300
2,384
2,348
2,590
2,839
2,832
2,949
Allowance
for loan losses to total loans(c)
1.70
%
1.65
%
1.69
%
1.83
%
1.84
%
1.86
%
1.76
%
1.82
%
Net charge-offs
$
930
$
790
$
654
$
668
$
1,360
$
870
$
773
$
816
Net
charge-off rate(c)
0.84
%
0.74
%
0.64
%
0.69
%
1.39
%
0.89
%
0.82
%
0.88
%
Wholesale
net charge-off (recovery) rate(c)
0.07
(0.03
)
(0.05
)
(0.06
)
0.07
(0.12
)
(0.16
)
(0.03
)
Managed Card
net charge-off rate(c)
3.45
3.58
3.28
2.99
6.39
4.70
4.87
4.83
Headcount
174,360
171,589
172,423
170,787
168,847
168,955
168,708
164,381
Share
price(d)
High
$
49.00
$
47.49
$
46.80
$
42.43
$
40.56
$
35.95
$
36.50
$
39.69
Low
45.51
40.40
39.33
37.88
32.92
33.31
33.35
34.32
Close
48.30
46.96
42.00
41.64
39.69
33.93
35.32
34.60
Market capitalization
167,199
162,835
145,764
144,614
138,387
118,871
124,112
121,975
(a)
On October 1, 2006, the Firm completed the exchange of selected corporate trust
businesses including trustee, paying agent, loan agency and document management services
for the consumer, business banking and middle-market banking businesses of The Bank of New
York. The results of operations of these corporate trust businesses are being reported as
discontinued operations for each of the periods presented.
(b)
Excludes wholesale held-for-sale (“HFS”) loans purchased as part of the Investment
Bank’s proprietary activities.
(c)
Excluded from the allowance coverage ratios were end-of-period loans
held-for-sale; and excluded from the net charge-off rates were average loans
held-for-sale.
(d)
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange,
the London Stock Exchange Limited and the Tokyo Stock Exchange. The high, low and closing
prices of JPMorgan Chase’s common stock are from The New York Stock Exchange Composite
Transaction Tape.
JPMorgan Chase & Co. / 2006 Annual Report
143
Supplementary information
Selected annual financial data (unaudited)
(in millions, except per share, headcount and ratio data)
Income from continuing operations before income tax expense
19,886
11,839
5,856
9,773
2,274
Income tax expense
6,237
3,585
1,596
3,209
760
Income from continuing operations
13,649
8,254
4,260
6,564
1,514
Income from discontinued operations(a)
795
229
206
155
149
Net income
$
14,444
$
8,483
$
4,466
$
6,719
$
1,663
Per common share
Basic earnings per share
Income from continuing operations
$
3.93
$
2.36
$
1.51
$
3.24
$
0.74
Net income
4.16
2.43
1.59
3.32
0.81
Diluted earnings per share
Income from continuing operations
$
3.82
$
2.32
$
1.48
$
3.17
$
0.73
Net income
4.04
2.38
1.55
3.24
0.80
Cash dividends declared per share
1.36
1.36
1.36
1.36
1.36
Book value per share
33.45
30.71
29.61
22.10
20.66
Common shares outstanding
Average: Basic
3,470
3,492
2,780
2,009
1,984
Diluted
3,574
3,557
2,851
2,055
2,009
Common shares at period-end
3,462
3,487
3,556
2,043
1,999
Selected ratios
Return on common equity (“ROE”):
Income from continuing operations
12
%
8
%
6
%
15
%
4
%
Net income
13
8
6
16
4
Return on assets (“ROA”):
Income from continuing operations
1.04
0.70
0.44
0.85
0.21
Net income
1.10
0.72
0.46
0.87
0.23
Tier 1 capital ratio
8.7
8.5
8.7
8.5
8.2
Total capital ratio
12.3
12.0
12.2
11.8
12.0
Overhead ratio
62
71
80
66
77
Selected balance sheet data (period-end)
Total assets
$
1,351,520
$
1,198,942
$
1,157,248
$
770,912
$
758,800
Securities
91,975
47,600
94,512
60,244
84,463
Loans
483,127
419,148
402,114
214,766
216,364
Deposits
638,788
554,991
521,456
326,492
304,753
Long-term debt
133,421
108,357
95,422
48,014
39,751
Common stockholders’ equity
115,790
107,072
105,314
45,145
41,297
Total stockholders’ equity
115,790
107,211
105,653
46,154
42,306
Credit quality metrics
Allowance for credit losses
$
7,803
$
7,490
$
7,812
$
4,847
$
5,713
Nonperforming assets(b)
2,341
2,590
3,231
3,161
4,821
Allowance for loan losses to total loans(c)
1.70
%
1.84
%
1.94
%
2.33
%
2.80
%
Net charge-offs
$
3,042
$
3,819
$
3,099
$
2,272
$
3,676
Net charge-off rate(c)
0.73
%
1.00
%
1.08
%
1.19
%
1.90
%
Wholesale net charge-off (recovery) rate(c)
(0.01
)
(0.06
)
0.18
0.97
NA
Managed Card net charge-off rate
3.33
5.21
5.27
5.90
5.90
Headcount
174,360
168,847
160,968
96,367
97,124
Share price(d)
High
$
49.00
$
40.56
$
43.84
$
38.26
$
39.68
Low
37.88
32.92
34.62
20.13
15.26
Close
48.30
39.69
39.01
36.73
24.00
Market capitalization
167,199
138,387
138,727
75,025
47,969
(a)
On October 1, 2006, the Firm completed the exchange of selected corporate trust
businesses including trustee, paying agent, loan agency and document management services
for the consumer, business banking and middle-market banking businesses of The Bank of New
York. The results of operations of these corporate trust businesses are being reported as
discontinued operations for each of the periods presented.
(b)
Excludes wholesale held-for-sale (“HFS”) loans purchased as part of the Investment
Bank’s proprietary activities.
(c)
Excluded from the allowance coverage ratios were end-of-period loans
held-for-sale; and excluded from the net charge-off rates were average loans
held-for-sale.
(d)
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange,
the London Stock Exchange Limited and the Tokyo Stock Exchange. The high, low and closing
prices of JPMorgan Chase’s common stock are from The New York Stock Exchange Composite
Transaction Tape.
(e)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
NA – Data for 2002 is not available on a comparable basis.
144
JPMorgan Chase & Co. / 2006 Annual Report
Glossary of terms
JPMorgan Chase & Co.
ACH: Automated Clearing House.
APB 25: Accounting Principles Board Opinion No.
25. “Accounting for Stock Issued to Employees.”
Assets under management: Represent assets actively
managed by Asset Management on behalf of
institutional, private banking, private client
services and retail clients. Excludes assets
managed by American Century Companies, Inc., in
which the Firm has a 43% ownership interest.
Assets under supervision: Represent assets under
management as well as custody, brokerage,
administration and deposit accounts.
Average managed assets: Refers to total assets
on the Firm’s balance sheet plus credit card
receivables that have been securitized.
Beneficial interest issued by consolidated VIEs:
Represents the interest of third-party holders of
debt/equity securities, or other obligations,
issued by VIEs that JPMorgan Chase consolidates
under FIN 46R. The underlying obligations of the
VIEs consist of short-term borrowings, commercial
paper and long-term debt. The related assets
consist of trading assets, available-for-sale
securities, loans and other assets.
Benefit obligation: Refers to the projected
benefit obligation for pension plans and the
accumulated postretirement benefit obligation for
OPEB plans.
Contractual credit card charge-off: In accordance
with the Federal Financial Institutions Examination
Council policy, credit card loans are charged off
by the end of the month in which the account
becomes 180 days past due or within 60 days from
receiving notification of the filing of bankruptcy,
whichever is earlier.
Credit derivatives: Contractual agreements that
provide protection against a credit event of one or
more referenced credits. The nature of a credit
event is established by the protection buyer and
protection seller at the inception of a
transaction, and such events include bankruptcy,
insolvency or failure to meet payment obligations
when due. The buyer of the credit derivative pays a
periodic fee in return for a payment by the
protection seller upon the occurrence, if any, of a
credit event.
Credit cycle: A period of time over which credit
quality improves, deteriorates and then improves
again. The duration of a credit cycle can vary from
a couple of years to several years.
Discontinued operations: A component of an entity
that is classified as held-for-sale or that has
been disposed of from ongoing operations in its
entirety or piecemeal, and for which the entity
will not have any significant, continuing
involvement. A discontinued operation may be a
separate major business segment, a component of a
major business segment or a geographical area of
operations of the entity that can be separately
distinguished operationally and for financial
reporting purposes.
EITF: Emerging Issues Task Force.
EITF Issue 02-3: “Issues Involved in Accounting
for Derivative Contracts Held for Trading Purposes
and Contracts Involved in Energy Trading and Risk
Management Activities.”
EITF Issue 99-20: “Recognition of Interest Income
and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial
Assets.”
FASB: Financial Accounting Standards Board.
FIN 39: FASB Interpretation No. 39, “Offsetting
of Amounts Related to Certain Contracts — an
interpretation of APB Opinion No. 10 and FASB Statement
No. 105.”
FIN 41: FASB Interpretation No. 41, “Offsetting
of Amounts Related to Certain Repurchase and
Reverse Repurchase Agreements — an interpretation of
APB Opinion No. 10 and a modification of FASB Interpretation
No. 39.”
FIN 45: FASB Interpretation No. 45,
“Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others — an
interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34.”
FIN 46R: FASB Interpretation No. 46 (revised December 2003),
“Consolidation of Variable Interest Entities — an
interpretation of ARB
No. 51.”
FIN 47: FASB Interpretation No. 47, “Accounting
for Conditional Asset Retirement Obligations –
an interpretation of FASB Statement No. 143.”
FIN 48: FASB Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes — an
interpretation of FASB Statement No. 109.”
Forward
points: Represents the interest rate differential between two
currencies, which is either added to or subtracted from the current
exchange rate (i.e., “spot rate”) to determine the forward
exchange rate.
FSP:
FASB Staff Position.
FSP FIN 46(R)-6: “Determining the Variability to
Be Considered in Applying FASB Interpretation No.
46(R).”
FSP FAS 123(R)-3: “Transition Election Related to
Accounting for the Tax Effects of Share-Based
Payment Awards.”
FSP FAS 13-2: “Accounting for a Change or Projected
Change in the Timing of Cash Flows Relating to
Income Taxes Generated by a Leveraged Lease
Transaction.”
Interchange income: A fee that is paid to a credit
card issuer in the clearing and settlement of a
sales or cash advance transaction.
Interests in purchased receivables: Represent an
ownership interest in cash flows of an underlying
pool of receivables transferred by a third-party
seller into a bankruptcy-remote entity, generally
a trust.
Investment-grade: An indication of credit quality
based upon JPMorgan Chase’s internal risk
assessment system. “Investment-grade” generally
represents a risk profile similar to a rating of
a BBB-/Baa3 or better, as defined by independent
rating agencies.
Managed basis: A non-GAAP presentation of
financial results that includes reclassifications
related to credit card securitizations and taxable
equivalents. Management uses this non-GAAP
financial measure at the segment level because it
believes this provides information to investors in
understanding the underlying operational
performance and trends of the particular business
segment and facilitates a comparison of the
business segment with the performance of
competitors.
Managed credit card receivables: Refers to credit
card receivables on the Firm’s balance sheet plus
credit card receivables that have been
securitized.
Mark-to-market exposure: A measure, at a point in
time, of the value of a derivative or foreign
exchange contract in the open market. When the
mark-to-market value is positive, it indicates the
counterparty owes JPMorgan Chase and, therefore,
creates a repayment risk for the Firm. When the
mark-to-market value is negative, JPMorgan Chase
owes the counterparty. In this situation, the Firm
does not have repayment risk.
Master netting agreement: An agreement between two
counterparties that have multiple derivative
contracts with each other that provides for the net
settlement of all contracts through a single
payment, in a single currency, in the event of
default on or termination of any one contract. See
FIN 39.
MSR risk management revenue: Includes changes in
MSR asset fair value due to inputs or assumptions
in model and derivative valuation adjustments.
JPMorgan Chase & Co. / 2006 Annual Report
145
Glossary of terms
JPMorgan Chase & Co.
Material legal proceedings: Refers to certain
specific litigation originally discussed in the
section “Legal Proceedings” in the Firm’s Annual
Report on Form 10-K for the year ended December31, 2002. Of such legal proceedings, some lawsuits
related to Enron, WorldCom and the IPO allocation
allegations remain outstanding as of the date of
this Annual Report, as discussed in Part I, Item 3, Legal
proceedings in the Firm’s Annual Report on Form 10-K for
the year ended December 31, 2006, to which reference is hearby
made; other such legal proceedings have been
resolved.
NA: Data is not applicable or available for the period presented.
Net yield on interest-earning assets: The
average rate for interest-earning assets less
the average rate paid for all sources of funds.
NM: Not meaningful.
OPEB: Other postretirement employee benefits.
Overhead ratio: Noninterest expense as a percentage of Total net revenue.
Principal transactions: Represents Trading revenue
(which includes physical commodities carried at the
lower of cost or fair value), primarily in the IB,
plus Private equity gains (losses), primarily in
the Private Equity business of Corporate.
Reported basis: Financial statements prepared under
accounting principles generally accepted in the
United States of America (“U.S. GAAP”). The
reported basis includes the impact of credit card
securitizations, but excludes the impact of
taxable-equivalent adjustments.
Return on common equity less goodwill: Represents
net income applicable to common stock divided by
total average common equity (net of goodwill). The
Firm uses return on equity less goodwill, a
non-GAAP financial measure, to evaluate the
operating performance of the Firm. The Firm also
utilizes this measure to facilitate operating
comparisons to other competitors.
SFAS: Statement of Financial Accounting Standards.
SFAS 5: “Accounting for Contingencies.”
SFAS 13: “Accounting for Leases.”
SFAS 52: “Foreign Currency Translation.”
SFAS 87: “Employers’ Accounting for Pensions.”
SFAS 88: “Employers’ Accounting for
Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination
Benefits.”
SFAS 106: “Employers’ Accounting for
Postretirement Benefits Other Than
Pensions.”
SFAS 107: “Disclosures about Fair Value of
Financial Instruments.”
SFAS 109:“Accounting for Income Taxes.”
SFAS 114:“Accounting by Creditors for Impairment of a
Loan – An amendment of FASB Statements No. 5 and 15.”
SFAS 115: “Accounting for Certain Investments in Debt and Equity Securities.”
SFAS 123: “Accounting for Stock-Based Compensation.”
SFAS 123R: “Share-Based Payment.”
SFAS 128: “Earnings per Share.”
SFAS 133: “Accounting for Derivative Instruments and Hedging Activities.”
SFAS 138: “Accounting for Certain Derivative
Instruments and Certain Hedging Activities –
an amendment of FASB Statement No. 133.”
SFAS 140: “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of
Liabilities – a replacement of FASB Statement No.
125.”
SFAS 142: “Goodwill and Other Intangible Assets.”
SFAS 143: “Accounting for Asset Retirement Obligations.”
SFAS 149: “Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities.”
SFAS 155: “Accounting for Certain Hybrid Financial
Instruments – an amendment of FASB Statements No.
133 and 140.”
SFAS 156: “Accounting for Servicing of Financial
Assets – an amendment of FASB Statement No. 140.”
SFAS 157: “Fair Value Measurements.”
SFAS 158: “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans –
an amendment of FASB Statements No. 87, 88, 106,
and 132(R).”
SFAS
159: “The Fair Value Option for Financial Assets and
Financial Liabilities — Including an Amendment of FASB Statement
No. 115.”
Staff Accounting Bulletin (“SAB”) 107: “Application
of Statement of Financial Accounting Standards No.
123 (revised 2004), Share-Based Payment.”
Statement of Position (“SOP”) 98-1:“Accounting for the
Costs of Computer Software Developed or
Obtained for Internal Use.”
Stress testing: A scenario that measures market
risk under unlikely but plausible events in
abnormal markets.
Transactor loan: Loan in which the outstanding
balance is paid in full by payment due date.
Unaudited: The financial statements and
information included throughout this document,
which are labeled unaudited, have not been
subjected to auditing procedures sufficient to
permit an independent certified public accountant
to express an opinion thereon.
U.S. GAAP: Accounting principles generally
accepted in the United States of America.
U.S. government and federal agency obligations: Obligations of the
U.S. government or an instrumentality of the U.S. government whose
obligations are fully and explicitly guaranteed as to the
timely payment of principal and interest by the
full faith and credit of the U.S. government.
U.S. government-sponsored enterprise obligations:
Obligations of agencies originally established or
chartered by the U.S. government to serve public
purposes as specified by the U.S. Congress; these
obligations are not explicitly guaranteed as to the
timely payment of principal and interest by the
full faith and credit of the U.S. government.
Value-at-risk (“VAR”): A measure of the dollar
amount of potential loss from adverse market
moves in an ordinary market environment.
146
JPMorgan Chase & Co. / 2006 Annual Report
Forward-looking statements
JPMorgan Chase & Co.
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, results
or aspirations. JPMorgan Chase’s disclosures in
this report contain forward-looking statements
within the meaning of the Private Securities
Litigation Reform Act of 1995. The Firm also may
make forward-looking statements in its other
documents filed or furnished with the Securities
and Exchange Commission (“SEC”). In addition, the
Firm’s senior management may make forward-looking
statements orally to analysts, investors,
representatives of the media and others.
All forward-looking statements are, by their
nature, 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 could
cause this difference – many of which are beyond
the Firm’s control – include the following: local,
regional and
international business, political or economic
conditions; changes in trade, monetary and fiscal
policies and laws; technological changes instituted
by the Firm and by other entities which may affect
the Firm’s business; mergers and acquisitions,
including the Firm’s ability to integrate
acquisitions; ability of the Firm to develop new
products and services;
acceptance of new products and services and the
ability of the Firm to increase market share; the
ability of the Firm to control expenses;
competitive pressures; changes in laws and
regulatory requirements; changes in applicable
accounting policies; costs, outcomes and effects of
litigation and regulatory investigations; changes
in the credit quality of the Firm’s customers; and
adequacy of the Firm’s risk management framework.
Additional factors that may cause future results
to differ materially from forward-looking
statements are discussed in Part I, Item 1A: Risk
Factors in the Firm’s Annual Report on Form 10-K
for the year ended December 31, 2006, to which
reference is hereby made. There is no assurance
that any list of risks and uncertainties or risk
factors is complete.
Any forward-looking statements made by or on behalf
of the Firm speak only as of the date they are made
and 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 the Firm may make in any
subsequent Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, or Current Reports on Form
8-K.
JPMorgan Chase & Co. / 2006 Annual Report
147
Distribution of assets, liabilities and stockholders’ equity;
interest rates and interest differentials
Consolidated average balance sheet, interest and rates
Provided below is a summary of JPMorgan Chase’s
consolidated average balances, interest rates and
interest differentials on a taxable-equivalent
basis for the years 2004 through 2006. Income
computed on a taxable-equivalent basis is the
income reported in the Consolidated statements of
income,
adjusted to make income and earnings yields on
assets exempt from income taxes (primarily federal
taxes) comparable with other taxable income. The
incremental tax rate used for calculating the
taxable-equivalent adjustment was approximately
40% in 2006, 2005 and 2004. A substantial portion
of JPMorgan Chase’s securities are taxable.
(Table continued on next page)
2006
Year ended December 31,
Average
Average
(Taxable-equivalent interest and rates; in millions, except rates)
balance
Interest
rate
Assets
Deposits with banks
$
27,730
$
1,265
4.56
%
Federal funds sold and securities purchased under resale agreements
132,118
5,578
4.22
Securities borrowed
83,831
3,402
4.06
Trading assets – debt instruments
205,506
11,120
5.41
Securities:
Available-for-sale
77,776
4,299
5.53
(e)
Held-to-maturity
69
5
6.57
Interests in purchased receivables
13,941
652
4.68
Loans
454,535
33,014
(d)
7.26
Total interest-earning assets
995,506
59,335
5.96
Allowance for loan losses
(7,165
)
Cash and due from banks
31,171
Trading assets – equity instruments
74,573
Trading assets – derivative receivables
57,368
Goodwill
43,872
Other Intangible Assets
Mortgage servicing rights
7,484
Purchased credit card relationships
3,113
All other intangibles
4,307
All other assets
87,068
Assets of discontinued operations held-for-sale(a)
16,497
Total assets
$
1,313,794
Liabilities
Interest-bearing deposits
$
452,323
$
17,042
3.77
%
Federal funds purchased and securities sold under repurchase
agreements
183,783
8,187
4.45
Commercial paper
17,710
794
4.49
Other borrowings(b)
102,147
5,105
5.00
Beneficial interests issued by consolidated VIEs
28,652
1,234
4.31
Long-term debt
129,667
5,503
4.24
Total interest-bearing liabilities
914,282
37,865
4.14
Noninterest-bearing deposits
124,550
Trading liabilities – derivative payables
57,938
All other liabilities, including the allowance for lending-related
commitments
90,506
Liabilities of discontinued operations held-for-sale(a)
15,787
Total liabilities
1,203,063
Stockholders’ equity
Preferred stock
34
Common stockholders’ equity
110,697
Total stockholders’ equity
110,731
(c)
Total liabilities, preferred stock of subsidiary and stockholders’
equity
$
1,313,794
Interest rate spread
1.82
%
Net interest income and net yield on interest-earning assets
$
21,470
2.16
(a)
For purposes of the consolidated average balance sheet for assets and
liabilities transferred to discontinued operations, JPMorgan Chase used Federal funds sold
interest income as a reasonable estimate of the earnings on corporate trust deposits;
therefore, JPMorgan Chase transferred to Assets of discontinued operations held-for-sale
average Federal funds sold, along with the related interest income earned, and transferred
to Liabilities of discontinued operations held-for-sale average corporate trust deposits.
(b)
Includes securities sold but not yet purchased.
(c)
The ratio of average stockholders’ equity to average assets was 8.4% for 2006,
8.9% for 2005 and 8.0% for 2004. The return on average stockholders’ equity was 13.0% for
2006, 8.0% for 2005 and 5.8% for 2004.
(d)
Fees and commissions on loans included in loan interest amounted to $1.3 billion
in 2006, $1.2 billion in 2005 and $1.4 billion for 2004.
(e)
The annualized rate for available-for-sale securities based on amortized cost
was 5.49% in 2006, 4.56% in 2005, and 4.38% in 2004, and does not give effect to changes
in fair value that are reflected in Accumulated other comprehensive
income (loss).
(f)
Prior periods have been adjusted to reflect the reclassificaiton of certain
balances to more appropriate income statement and balance sheet line items.
(g)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
148
Within the Consolidated average balance sheets, interest and rates summary,
the principal amounts of nonaccrual loans have been included in
the average loan balances used to determine the average interest rate
earned on loans. For additional information on nonaccrual loans,
including interest accrued, see Note 12 on pages 112 and 113.
(Continuation of table)
2005(f)
2004(f)(g)
Average
Average
Average
Average
balance
Interest
rate
balance
Interest
rate
$
15,203
$
660
4.34
%
$
28,625
$
539
1.88
%
123,233
3,562
2.89
78,612
1,380
1.76
63,023
1,618
2.57
49,387
578
1.17
187,615
9,312
4.96
169,125
7,535
4.46
71,542
3,276
4.58
(e)
78,689
3,471
4.41
(e)
95
10
10.42
172
11
6.50
28,397
933
3.29
15,564
291
1.87
409,988
25,973
(d)
6.34
308,249
16,661
(d)
5.40
899,096
45,344
5.04
728,423
30,466
4.18
(7,074
)
(5,951
)
30,635
25,258
49,458
31,264
57,365
59,522
43,074
25,494
5,523
5,064
3,524
2,511
4,820
2,870
80,219
71,113
18,426
16,988
$
1,185,066
$
962,556
$
383,259
$
9,986
2.61
%
$
297,721
$
4,515
1.52
%
154,818
4,728
3.05
155,665
2,526
1.62
14,450
407
2.81
12,699
131
1.03
93,765
4,867
5.19
78,355
3,817
4.87
44,675
1,372
3.07
26,815
478
1.78
112,370
4,160
3.70
79,193
2,466
3.11
803,337
25,520
3.18
650,448
13,933
2.14
125,002
97,926
55,723
52,761
78,141
69,117
17,149
15,656
1,079,352
885,908
207
1,007
105,507
75,641
105,714
(c)
76,648
(c)
$
1,185,066
$
962,556
1.86
%
2.04
%
$
19,824
2.20
$
16,533
2.27
149
Interest rates and interest differential analysis of net interest income –
U.S. and non-U.S.
Presented below is a summary of interest rates
and interest differentials segregated between U.S.
and non-U.S. operations for the years 2004 through
2006. The segregation of U.S. and non-U.S.
components is based on the location of the office
recording the transaction. Intracompany funding
generally
comprises dollar-denominated deposits originated
in various locations that are centrally managed by
JPMorgan Chase’s Treasury unit. U.S. Net interest
income was $19.4 billion in 2006, an increase of
$1.2 billion from the prior
(Table continued on next page)
2006
Year ended December 31,
Average
Average
(Taxable-equivalent interest and rates; in millions, except rates)
balance
Interest
rate
Interest-earning assets:
Deposits with banks, primarily non-U.S.
$
27,730
$
1,265
4.56
%
Federal funds sold and securities purchased under resale agreements:
U.S.
66,627
3,647
5.47
Non-U.S.
65,491
1,931
2.95
Securities borrowed, primarily U.S.
83,831
3,402
4.06
Trading assets – debt instruments:
U.S.
88,492
5,471
6.18
Non-U.S.
117,014
5,649
4.83
Securities:
U.S.
68,477
3,951
5.77
Non-U.S.
9,368
353
3.77
Interests in purchased receivables, primarily U.S.
13,941
652
4.68
Loans:
U.S.
402,295
29,475
7.33
Non-U.S.
52,240
3,539
6.77
Total interest-earning assets
995,506
59,335
5.96
Interest-bearing liabilities:
Interest-bearing deposits:
U.S.
313,835
11,551
3.68
Non-U.S.
138,488
5,491
3.96
Federal funds purchased and securities sold under repurchase agreements:
U.S.
137,439
6,729
4.90
Non-U.S.
46,344
1,458
3.15
Other borrowed funds:
U.S.
55,300
3,368
6.09
Non-U.S.
64,557
2,531
3.92
Beneficial interests issued by consolidated VIEs, primarily U.S.
28,652
1,234
4.31
Long-term debt, primarily U.S.
129,667
5,503
4.24
Intracompany funding:
U.S.
(49,972
)
(2,088
)
—
Non-U.S.
49,972
2,088
—
Total interest-bearing liabilities
914,282
37,865
4.14
Noninterest-bearing liabilities(a)
81,224
Total investable funds
$
995,506
$
37,865
3.80
%
Net interest income and net yield:
$
21,470
2.16
%
U.S.
19,430
2.87
Non-U.S.
2,040
0.64
Percentage of total assets and liabilities attributable
to non-U.S. operations:
Assets
35.3
Liabilities
31.8
(a)
Represents the amount of noninterest-bearing liabilities funding
interest-earning assets.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
150
year. Net interest income from non-U.S. operations was $2.0 billion for 2006,
an increase of $0.4 billion when compared with $1.6 billion in 2005.
For further information, see the “Net interest income” discussion in Consolidated results of operations on pages 28–29.
(Continuation of table)
2005
2004(b)
Average
Average
Average
Average
balance
Interest
rate
balance
Interest
rate
$
15,203
$
660
4.34
%
$
28,625
$
539
1.88
%
84,713
2,587
3.05
56,061
873
1.56
38,520
975
2.53
22,551
507
2.25
63,023
1,618
2.57
49,387
578
1.17
97,943
4,861
4.96
100,658
4,361
4.33
89,672
4,451
4.96
68,467
3,174
4.63
54,434
2,705
4.97
65,845
3,053
4.63
17,203
581
3.38
13,016
429
3.29
28,397
933
3.29
15,564
291
1.87
372,912
24,928
6.68
275,713
15,672
5.68
37,076
1,045
2.82
32,536
989
3.04
899,096
45,344
5.04
728,423
30,466
4.18
266,335
6,497
2.44
193,320
2,639
1.37
116,924
3,489
2.98
104,401
1,876
1.80
113,348
3,685
3.25
122,760
1,830
1.49
41,470
1,043
2.52
32,905
696
2.12
64,765
2,837
4.38
61,685
2,138
3.47
43,450
2,437
5.61
29,369
1,810
6.16
44,675
1,372
3.07
26,815
478
1.78
112,370
4,160
3.70
79,193
2,466
3.11
28,800
789
—
26,687
207
—
(28,800
)
(789
)
—
(26,687
)
(207
)
—
803,337
25,520
3.18
650,448
13,933
2.14
95,759
77,975
$
899,096
$
25,520
2.84
%
$
728,423
$
13,933
1.91
%
$
19,824
2.20
%
$
16,533
2.27
%
18,220
2.72
14,990
2.76
1,604
0.70
1,543
0.83
29.4
29.7
29.3
30.6
151
Changes in net interest income, volume and rate analysis
The table below presents an analysis of the effect on net interest income of volume and rate
changes for the periods 2006 versus 2005 and 2005 versus 2004. In this analysis, the change due to
the volume/rate variance has been allocated to volume.
2006 versus 2005
2005 versus 2004(a)
(On a taxable-equivalent basis;
Increase (decrease) due to change in:
Net
Increase (decrease) due to change in:
Net
in millions)
Volume
Rate
change
Volume
Rate
change
Interest-earning assets
Deposits with banks, primarily non-U.S.
$
572
$
33
$
605
$
(583
)
$
704
$
121
Federal funds sold and securities
purchased under resale
agreements:
U.S.
(990
)
2,050
1,060
879
835
1,714
Non-U.S.
794
162
956
405
63
468
Securities borrowed, primarily U.S.
845
939
1,784
349
691
1,040
Trading assets – debt instruments:
U.S.
(585
)
1,195
610
(134
)
634
500
Non-U.S.
1,315
(117
)
1,198
1,051
226
1,277
Securities:
U.S.
811
435
1,246
(572
)
224
(348
)
Non-U.S.
(295
)
67
(228
)
140
12
152
Interests in purchased receivables, primarily
U.S.
(676
)
395
(281
)
421
221
642
Loans:
U.S.
2,123
2,424
4,547
6,499
2,757
9,256
Non-U.S.
1,029
1,465
2,494
128
(72
)
56
Change in interest income
4,943
9,048
13,991
8,583
6,295
14,878
Interest-bearing liabilities
Interest-bearing deposits:
U.S.
1,751
3,303
5,054
1,789
2,069
3,858
Non-U.S.
856
1,146
2,002
381
1,232
1,613
Federal funds purchased and securities
sold under repurchase agreements:
U.S.
1,174
1,870
3,044
(306
)
2,161
1,855
Non-U.S.
154
261
415
215
132
347
Other borrowed funds:
U.S.
(576
)
1,107
531
138
561
699
Non-U.S.
828
(734
)
94
789
(162
)
627
Beneficial interests issued by consolidated
VIEs, primarily U.S.
(692
)
554
(138
)
548
346
894
Long-term debt, primarily U.S.
736
607
1,343
1,227
467
1,694
Intracompany funding:
U.S.
(3,292
)
415
(2,877
)
59
523
582
Non-U.S.
3,292
(415
)
2,877
(59
)
(523
)
(582
)
Change in interest expense
4,231
8,114
12,345
4,781
6,806
11,587
Change in net interest income
$
712
$
934
$
1,646
$
3,802
$
(511
)
$
3,291
(a)
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan
Chase results.
152
Securities portfolio
The table below presents the amortized cost, estimated fair value and average yield (including
the impact of related derivatives) of JPMorgan Chase’s securities by contractual maturity range and
type of security.
Maturity schedule of available-for-sale and held-to-maturity securities
Due in 1
Due after 1
Due after 5
Due after
December 31, 2006 (in millions, rates on a taxable-equivalent basis)
year or less
through 5 years
through 10 years
10 years
(d)
Total
U.S. government and federal agency obligations:
Amortized cost
$
885
$
573
$
953
$
97
$
2,508
Fair value
884
567
936
107
2,494
Average yield(a)
4.42
%
4.51
%
4.66
%
7.35
%
4.64
%
U.S. government-sponsored enterprise obligations:
Amortized cost
$
4
$
20
$
22
$
75,388
$
75,434
Fair value
4
20
22
75,262
75,308
Average yield(a)
3.53
%
4.62
%
4.90
%
5.80
%
5.80
%
Other:(b)
Amortized cost
$
6,178
$
3,414
$
249
$
4,136
$
13,977
Fair value
6,175
3,420
253
4,267
14,115
Average yield(a)
2.58
%
3.85
%
5.00
%
1.53
%
2.62
%
Total available-for-sale securities:(c)
Amortized cost
$
7,067
$
4,007
$
1,224
$
79,621
$
91,919
Fair value
7,063
4,007
1,211
79,636
91,917
Average yield(a)
2.81
%
3.95
%
4.73
%
5.58
%
5.28
%
Total held-to-maturity securities:(c)
Amortized cost
$
—
$
—
$
44
$
14
$
58
Fair value
—
—
46
14
60
Average yield(a)
—
%
—
%
6.91
%
6.61
%
6.84
%
(a)
The average yield was based on amortized cost balances at the end of the year, and
does not give effect to changes in fair value that are reflected in Accumulated other
comprehensive income (loss). Yields are derived by dividing interest income (including the
effect of related derivatives on available-for-sale securities and the amortization of
premiums and accretion of discounts) by total amortized cost. Taxable-equivalent yields
are used where applicable.
(b)
Includes obligations of state and political subdivisions, debt securities issued
by non-U.S. governments, corporate debt securities, CMOs of private issuers and other debt
and equity securities.
(c)
For the amortized cost of the above categories of securities at December 31, 2005,
see Note 10 on page 109. At December 31, 2004, the amortized cost of U.S. government and
federal agency obligations was $16,109 million, U.S. government-sponsored enterprise
obligations was $46,143 million and other available-for-sale securities was $32,569 million.
At December 31, 2004, the amortized cost of U.S. government and federal agency
obligations and U.S. government-sponsored enterprise obligations held-to-maturity
securities was $110 million. There were no other held-to-maturity securities at December31, 2004.
(d)
Securities with no stated maturity are included with securities with a contractual
maturity of 10 years or more. Substantially all of JPMorgan Chase’s mortgaged-backed
securities (“MBSs”) and collateralized mortgage obligations (“CMOs”) are due in 10 years
or more based on contractual maturity. The estimated duration, which reflects anticipated
future prepayments based on a consensus of dealers in the market, is approximately four
years for MBSs and CMOs.
U.S. government-sponsored enterprises were the only issuers whose securities
exceeded 10% of JPMorgan Chase’s total stockholders’ equity at December31, 2006.
For a further discussion of JPMorgan Chase’s securities portfolios, see Note
10 on pages 108–111.
153
Loan portfolio
The table below presents loans based on customer and collateral type compared with the line
of business approach that is presented in Credit risk management on pages 65, 66 and 73, and in
Note 12 on page 112:
December 31, (in millions)
2006
2005
2004
2003
(a)
2002
(a)
U.S.
loans:
Commercial and industrial
$
96,897
$
84,597
$
76,890
$
38,879
$
49,205
Commercial real estate – commercial
mortgage(b)
17,877
16,074
15,323
3,182
3,176
Commercial real estate –
construction(b)
4,832
4,143
4,612
589
516
Financial institutions
15,217
13,259
12,664
4,622
3,770
Consumer
288,572
261,361
255,073
136,393
124,687
Total U.S. loans
423,395
379,434
364,562
183,665
181,354
Non-U.S.
loans:
Commercial and industrial
40,287
28,969
27,293
24,618
31,446
Commercial real estate(b)
469
311
929
79
381
Financial institutions
12,793
7,468
6,494
5,671
2,438
Non-U.S. governments
2,532
1,295
2,778
705
616
Consumer
3,651
1,671
58
28
129
Total non-U.S. loans
59,732
39,714
37,552
31,101
35,010
Total loans(c)
$
483,127
$
419,148
$
402,114
$
214,766
$
216,364
(a)
Heritage JPMorgan Chase only.
(b)
Represents loans secured by commercial real estate.
(c)
Loans are presented net of unearned income and net deferred loan fees of $2.3
billion, $3.0 billion, $4.1 billion, $1.3 billion and $1.9 billion at December 31, 2006,
2005, 2004, 2003 and 2002, respectively.
Maturities and sensitivity to changes in interest rates
The table below shows, at December 31, 2006, commercial loan maturity and distribution between
fixed and floating interest rates based upon the stated terms of the commercial loan agreements.
The table does not include the impact of derivative instruments.
Cross-border disclosure is based upon the
Federal Financial Institutions Examination
Council’s (“FFIEC”) guidelines governing the
determination of cross-border risk. Based on new rules from the
FFIEC, beginning in 2006 securities purchased under resale agreements
are now allocated to a country based upon the domicile of the
counterparty; previously they were based upon the domicile of the
underlying security’s issuer. Additionally, local foreign office
commitments are now included in commitments; previously they were
excluded from commitments. Prior period data were not revised.
The following table lists all countries in which
JPMorgan Chase’s cross-border outstandings exceed
0.75% of consolidated assets as of any of the dates
specified. The disclosure includes certain
exposures that are not required under the
disclosure requirements of the SEC. The most
significant differences between the FFIEC and SEC
methodologies relate to the treatments of local country exposure
and to foreign exchange and derivatives.
For a further discussion of JPMorgan Chase’s
emerging markets cross-border exposure, see Emerging markets country exposure on page
72.
Cross-border outstandings exceeding 0.75% of total assets
Net local
Total
country
cross-border
Total
(in millions)
December 31,
Governments
Banks
Other
(a)
assets
outstandings
(b)
Commitments
(c)
exposure
U.K.
2006
$
507
$
13,116
$
11,594
$
—
$
25,217
$
306,565
$
331,782
2005
1,108
16,782
9,893
—
27,783
146,854
174,637
2004
1,531
23,421
24,357
—
49,309
102,770
152,079
Germany
2006
$
9,361
$
16,384
$
16,091
$
—
$
41,836
$
186,875
$
228,711
2005
26,959
8,462
10,579
—
46,000
89,112
135,112
2004
28,114
10,547
9,759
509
48,929
47,268
96,197
France
2006
$
5,218
$
7,760
$
12,747
$
575
$
26,300
$
171,407
$
197,707
2005
8,346
7,890
7,717
305
24,258
75,577
99,835
2004
3,315
15,178
11,790
2,082
32,365
33,724
66,089
Italy
2006
$
6,395
$
3,004
$
6,328
$
364
$
16,091
$
84,054
$
100,145
2005
14,193
4,053
5,264
308
23,818
36,688
60,506
2004
12,431
5,589
6,911
180
25,111
14,895
40,006
Netherlands
2006
$
1,776
$
9,699
$
17,878
$
—
$
29,353
$
80,337
$
109,690
2005
2,918
2,330
11,410
—
16,658
36,584
53,242
2004
1,563
4,656
13,302
—
19,521
16,985
36,506
Spain
2006
$
722
$
3,715
$
5,766
$
1,136
$
11,339
$
55,517
$
66,856
2005
2,876
3,108
2,455
733
9,172
24,000
33,172
2004
4,224
3,781
5,276
659
13,940
11,087
25,027
Japan
2006
$
6,758
$
8,158
$
8,588
$
—
$
23,504
$
32,781
$
56,285
2005
2,474
3,008
1,167
—
6,649
20,801
27,450
2004
25,349
3,869
5,765
—
34,983
23,582
58,565
Switzerland
2006
$
372
$
5,512
$
3,076
$
—
$
8,960
$
43,184
$
52,144
2005
207
2,873
3,471
—
6,551
18,794
25,345
2004
327
4,131
5,184
311
9,953
7,807
17,760
Luxembourg
2006
$
1,396
$
1,860
$
8,592
$
—
$
11,848
$
15,667
$
27,515
2005
1,326
2,484
9,082
—
12,892
7,625
20,517
2004
397
5,000
9,690
—
15,087
1,721
16,808
Belgium
2006
$
1,132
$
1,671
$
1,180
$
—
$
3,983
$
2,798
$
6,781
2005
2,350
1,268
1,893
—
5,511
1,481
6,992
2004
2,899
3,177
3,075
—
9,151
1,254
10,405
Cayman Islands
2006
$
20
$
125
$
21,492
$
—
$
21,637
$
10,626
$
32,263
2005
606
193
5,746
—
6,545
10,508
17,053
2004
—
142
2,837
2,995
5,974
2,455
8,429
(a)
Consists primarily of commercial and industrial.
(b)
Outstandings includes loans and accrued interest receivable, interest-bearing deposits
with banks, acceptances, resale agreements, other monetary assets, cross-border trading
debt and equity instruments, mark-to-market exposure of foreign exchange and derivative
contracts and local country assets, net of local country liabilities. The amounts
associated with foreign exchange and derivative contracts are presented after taking into
account the impact of legally enforceable master netting agreements.
(c)
Commitments include outstanding letters of credit, undrawn commitments to extend
credit and credit derivatives.
JPMorgan Chase’s total cross-border exposure tends to fluctuate greatly, and the amount of
exposure at year-end tends to be a function of timing rather than representing a consistent trend.
155
Risk elements
The following table sets forth nonperforming assets and
contractually past-due assets at the dates indicated:
December 31, (in millions)
2006
2005
2004
2003
(d)
2002
(d)
Nonperforming assets
U.S. nonperforming loans:(a)
Commercial and industrial
$
429
$
818
$
1,175
$
1,060
$
1,769
Commercial real estate
188
234
326
31
48
Financial institutions
—
1
1
1
258
Consumer
1,379
1,117
895
542
544
Total U.S. nonperforming loans
1,996
2,170
2,397
1,634
2,619
Non-U.S. nonperforming loans:(a)
Commercial and industrial
47
135
288
909
1,566
Commercial real estate
13
12
13
13
11
Financial institutions
20
25
43
25
36
Non-U.S. governments
—
—
—
—
—
Consumer
1
1
2
3
2
Total non-U.S. nonperforming loans
81
173
346
950
1,615
Total nonperforming loans
2,077
2,343
2,743
2,584
4,234
Derivative receivables
36
50
241
253
289
Other receivables
—
—
—
108
108
Assets acquired in loan satisfactions
228
197
247
216
190
Total nonperforming assets(b)
$
2,341
$
2,590
$
3,231
$
3,161
$
4,821
Contractually
past-due assets:(c)
U.S. loans:
Commercial and industrial
$
84
$
75
$
34
$
41
$
57
Commercial real estate
1
7
—
—
—
Consumer
1,279
1,046
970
269
473
Total U.S. loans
1,364
1,128
1,004
310
530
Non-U.S. loans
Commercial and industrial
—
—
2
5
—
Consumer
—
—
—
—
—
Total non-U.S. loans
—
—
2
5
—
Total
$
1,364
$
1,128
$
1,006
$
315
$
530
(a)
All nonperforming loans are accounted for on a nonaccrual basis. There were no
nonperforming renegotiated loans. Renegotiated loans are those for which concessions, such
as the reduction of interest rates or the deferral of interest or principal payments, have
been granted as a result of a deterioration in the borrowers’ financial condition.
(b)
Excludes wholesale purchased held-for-sale (“HFS”) loans purchased as part of the
Investment Bank’s proprietary activities.
(c)
Represents accruing loans past-due 90 days or more as to principal and interest,
which are not characterized as nonperforming loans.
(d)
Heritage JPMorgan Chase only.
For a discussion of nonperforming loans and past-due loan accounting policies, see Credit risk
management on pages 64–76, and Note 12 on pages 112–113.
Impact of nonperforming loans on interest income
The negative impact on interest income from nonperforming loans represents the difference
between the amount of interest income that would have been recorded on nonperforming loans
according to contractual terms and the amount of interest that actually was recognized on a cash
basis. The following table sets forth this data for the years specified.
Year ended December 31, (in millions)
2006
2005
2004
(a)
U.S.:
Gross amount of interest that would have
been recorded at the original rate
$
156
$
170
$
124
Interest that was recognized in income
(26
)
(30
)
(8
)
Negative impact – U.S.
130
140
116
Non-U.S.:
Gross amount of interest that would have
been recorded at the original rate
5
11
36
Interest that was recognized in income
—
(4
)
—
Negative impact – non-U.S.
5
7
36
Total negative impact on interest income
$
135
$
147
$
152
(a)
2004 results include six months of the combined
Firm’s results and six months of heritage JPMorgan Chase
results.
156
Summary of loan and lending-related commitments loss experience
The tables below summarize the changes in the Allowance for loan losses and the Allowance for
lending-related commitments, respectively, during the periods indicated. For a further discussion,
see Allowance for credit losses on pages 75–76, and Note 13 on pages 113–114.
Primarily relates to the transfer of the allowance for accrued interest and fees
on reported and securitized credit card loans in 2004 and 2003.
(b)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results. 2003 and 2002 reflect the results of heritage JPMorgan
Chase only.
2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
2003 and 2002 reflect the results of heritage JPMorgan Chase only.
157
Loan loss analysis
Year ended December 31, (in millions, except ratios)
2006
2005
2004
(c)
2003
(c)
2002
(c)
Balances
Loans – average
$
454,535
$
409,988
$
308,249
$
220,585
$
211,432
Loans – year-end
483,127
419,148
402,114
214,766
216,364
Net charge-offs(a)
3,042
3,819
3,099
2,272
3,676
Allowance for loan losses:
U.S.
6,654
6,642
6,617
3,677
4,122
Non-U.S.
625
448
703
846
1,228
Total allowance for loan losses
7,279
7,090
7,320
4,523
5,350
Nonperforming loans
2,077
2,343
2,743
2,584
4,234
Ratios
Net charge-offs to:
Loans – average(b)
0.73
%
1.00
%
1.08
%
1.19
%
1.90
%
Allowance for loan losses
41.79
53.86
42.34
50.23
68.71
Allowance for loan losses to:
Loans – year-end(b)
1.70
1.84
1.94
2.33
2.80
Nonperforming loans(b)
372
321
268
180
128
(a)
Excludes net charge-offs (recoveries) on lending-related commitments of $212
million in 2002. There were no net charge-offs (recoveries) on lending-related commitments
in 2006, 2005, 2004 or 2003.
(b)
Excludes loans held for sale.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results. 2003 and 2002 reflect the results of heritage JPMorgan
Chase only.
Deposits
The following table provides a summary of the average balances and average interest rates of
JPMorgan Chase’s various deposits for the years indicated:
Average balances
Average interest rates
(in millions, except interest rates)
2006
2005
2004
(a)
2006
2005
2004
(a)
U.S.:
Noninterest-bearing demand
$
36,099
$
39,714
$
27,876
—
%
—
%
—
%
Interest-bearing demand
8,036
13,612
11,040
2.73
2.69
1.31
Savings
260,645
239,375
176,607
2.52
1.57
0.80
Time
126,927
92,739
69,245
3.75
2.57
1.55
Total U.S. deposits
431,707
385,440
284,768
2.68
1.69
0.93
Non-U.S.:
Noninterest-bearing demand
6,645
5,874
6,268
—
—
—
Interest-bearing demand
77,624
63,748
50,326
4.35
3.08
1.73
Savings
513
549
746
0.53
0.36
0.11
Time
60,384
52,650
53,539
3.50
2.89
1.88
Total non-U.S. deposits
145,166
122,821
110,879
3.78
2.84
1.69
Total deposits
$
576,873
$
508,261
$
395,647
2.95
%
1.96
%
1.14
%
(a)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
At December 31, 2006, other U.S. time deposits
in denominations of $100,000 or more totaled $80.9 billion, substantially all of which mature in three months or less. In addition, the table below
presents the maturities for U.S. time certificates of deposit in denominations of $100,000 or more:
U.S. time
certificates of
deposit ($100,000
or more)
$
19,171
$
5,127
$
3,842
$
1,748
$
29,888
158
Short-term and other borrowed funds
The following table provides a summary of JPMorgan Chase’s short-term and other
borrowed funds for the years indicated:
(in millions, except rates)
2006
2005
2004
(c)
Federal funds purchased and securities
sold under repurchase agreements:
Balance at year-end
$
162,173
$
125,925
$
127,787
Average daily balance during the year
183,783
154,818
155,665
Maximum month-end balance
204,879
177,144
168,257
Weighted-average rate at December 31
5.05
%
3.63
%
2.39
%
Weighted-average rate during the year
4.45
3.05
1.62
Commercial paper:
Balance at year-end
$
18,849
$
13,863
$
12,605
Average daily balance during the year
17,710
14,450
12,699
Maximum month-end balance
20,980
18,077
15,300
Weighted-average rate at December 31
4.80
%
3.62
%
1.98
%
Weighted-average rate during the year
4.49
2.81
1.03
Other borrowed funds:(a)
Balance at year-end
$
108,541
$
104,636
$
96,981
Average daily balance during the year
102,147
93,765
78,355
Maximum month-end balance
132,367
120,051
99,689
Weighted-average rate at December 31
5.56
%
5.21
%
4.18
%
Weighted-average rate during the year
5.00
5.19
4.87
FIN 46 short-term beneficial interests: (b)
Commercial paper:
Balance at year-end
$
3,351
$
35,161
$
38,519
Average daily balance during the year
17,851
34,439
19,472
Maximum month-end balance
35,757
35,676
38,519
Weighted-average rate at December 31
4.67
%
2.69
%
2.23
%
Weighted-average rate during the year
4.53
3.07
1.80
Other borrowed funds:
Balance at year-end
$
4,497
$
4,682
$
3,149
Average daily balance during the year
5,267
3,569
3,219
Maximum month-end balance
9,078
5,568
3,447
Weighted-average rate at December 31
1.99
%
1.92
%
1.93
%
Weighted-average rate during the year
1.61
2.13
1.10
(a)
Includes securities sold but not yet purchased.
(b)
Included on the Consolidated balance sheets in Beneficial interests issued by
consolidated variable interest entities. VIEs had unfunded commitments to borrow an
additional $4.2 billion, $4.1 billion and $4.2 billion at December 31, 2006, 2005 and
2004, respectively, from other third parties, for general liquidity purposes.
(c)
2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Federal funds purchased represents overnight
funds. Securities sold under repurchase agreements
generally mature between one day and three months.
Commercial paper generally is issued in amounts not
less than $100,000 and with maturities of 270 days
or less. Other borrowed funds consist of demand
notes, term federal funds purchased and
various other borrowings that generally have
maturities of one year or less. At December31, 2006, JPMorgan Chase had no lines of
credit for general corporate purposes.
159
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on behalf of the undersigned, thereunto
duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacity and on the
date indicated. JPMorgan Chase does not exercise the power of attorney to sign on behalf of any
Director.