<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
J.P. MORGAN & CO. INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 1-5885 13-2625764
(State or other jurisdiction of (Commission (I.R.S. Employer
incorporation or organization) File Number) Identification No.)
60 Wall Street, New York, NY 10260-0060
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 483-2323
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes..X.. No.....
Number of shares outstanding of each of the registrant's classes of common stock
at October 31, 1998:
Common Stock, $2.50 Par Value 174,816,926 Shares
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PART I -- FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
The following financial statement information as of and for the three and nine
months ended September 30, 1998, is set forth within this document on the pages
indicated:
Page(s)
Three month Consolidated statement of income
J.P. Morgan & Co. Incorporated .......................... 3
Nine month Consolidated statement of income
J.P. Morgan & Co. Incorporated .......................... 4
Consolidated balance sheet
J.P. Morgan & Co. Incorporated .......................... 5
Consolidated statement of changes in stockholders' equity
J.P. Morgan & Co. Incorporated .......................... 6
Consolidated statement of cash flows
J.P. Morgan & Co. Incorporated .......................... 7
Consolidated statement of condition
Morgan Guaranty Trust Company of New York ............... 8
Notes to Consolidated financial statements
J.P. Morgan & Co. Incorporated .......................... 9-23
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial highlights .................................... 24
Business sector analysis ................................ 25-29
Financial review ........................................ 30-34
Risk management ......................................... 35-39
Asset-quality analysis .................................. 40-43
Consolidated average balances and net interest earnings . 44-47
PART II -- OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K ..................... 48
SIGNATURES ................................................... 49
2
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PART I
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF INCOME
J.P. Morgan & Co. Incorporated
In millions, except share data
<TABLE>
<CAPTION>
Three months ended
-------------------------------------------------------------------
September 30 September 30 Increase/ June 30 Increase/
1998 1997 (Decrease) 1998 (Decrease)
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET INTEREST REVENUE
Interest revenue $ 3,249 $3,161 $ 88 $3,106 $ 143
Interest expense 2,917 2,689 228 2,816 101
- --------------------------------------------------------------------------------------------------------------
Net interest revenue 332 472 (140) 290 42
NONINTEREST REVENUES
Trading revenue 119 657 (538) 877 (758)
Investment banking revenue 312 320 (8) 362 (50)
Investment management revenue 224 201 23 226 (2)
Fees and commissions 182 164 18 197 (15)
Investment securities revenue 136 67 69 68 68
Other revenue 71 35 36 133 (62)
- --------------------------------------------------------------------------------------------------------------
Total noninterest revenues 1,044 1,444 (400) 1,863 (819)
PROVISION FOR CREDIT LOSSES ($50
related to trading account assets
and $25 related to loans) (75) -- (75) -- (75)
- --------------------------------------------------------------------------------------------------------------
Total revenues, net of interest expense
and provision for credit losses 1,301 1,916 (615) 2,153 (852)
OPERATING EXPENSES
Employee compensation and benefits 567 798 (231) 862 (295)
Net occupancy 84 77 7 78 6
Technology and communications 293 277 16 293 --
Other expenses 155 174 (19) 183 (28)
- --------------------------------------------------------------------------------------------------------------
Total operating expenses 1,099 1,326 (227) 1,416 (317)
Income before income taxes 202 590 (388) 737 (535)
Income taxes 46 194 (148) 256 (210)
- --------------------------------------------------------------------------------------------------------------
Net income 156 396 (240) 481 (325)
PER COMMON SHARE
Net income
Basic $ 0.81 $ 2.10 ($1.29) $ 2.57 ($1.76)
Diluted 0.75 1.96 (1.21) 2.36 (1.61)
Dividends declared 0.95 0.88 0.07 0.95 --
- --------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
3
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CONSOLIDATED STATEMENT OF INCOME
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
In millions, except share data Nine months ended
-------------------------------------------------
September 30 September 30 Increase/
1998 1997 (Decrease)
-------------------------------------------------
<S> <C> <C> <C>
NET INTEREST REVENUE
Interest revenue $9,617 $9,082 $535
Interest expense 8,659 7,665 994
- --------------------------------------------------------------------------------------------
Net interest revenue 958 1,417 (459)
NONINTEREST REVENUES
Trading revenue 1,892 1,831 61
Investment banking revenue 1,020 840 180
Investment management revenue 661 584 77
Fees and commissions 569 468 101
Investment securities revenue 247 242 5
Other revenue 179 158 21
- --------------------------------------------------------------------------------------------
Total noninterest revenues 4,568 4,123 445
PROVISION FOR CREDIT LOSSES ($50 related
to trading account assets and $25
related to loans) (75) - (75)
- ---------------------------------------------------------------------------------------------
Total revenues, net of interest expense
and provision for credit losses 5,451 5,540 (89)
OPERATING EXPENSES
Employee compensation and
benefits 2,432 2,298 134
Net occupancy 313 254 59
Technology and communications 887 720 167
Other expenses 515 486 29
- --------------------------------------------------------------------------------------------
Total operating expenses 4,147 3,758 389
Income before income taxes 1,304 1,782 (478)
Income taxes 430 588 (158)
- ---------------------------------------------------------------------------------------------
Net income 874 1,194 (320)
PER COMMON SHARE
Net income
Basic $4.65 $6.27 ($1.62)
Diluted 4.28 5.85 (1.57)
Dividends declared 2.85 2.64 0.21
- --------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
CONSOLIDATED BALANCE SHEET
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
September 30 December 31
In millions, except share data 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 3,405 $ 1,758
Interest-earning deposits with banks 1,529 2,132
Debt investment securities available-for-sale carried at fair value 25,641 22,768
Equity investment securities 951 1,085
Trading account assets, net of allowance for credit losses of $325 at September 1998 and $350 at
December 1997 128,746 111,854
Securities purchased under agreements to resell 42,985 39,002
Securities borrowed 47,744 38,375
Loans, net of allowance for credit losses of $404 at September 1998 and $546 at December 1997 30,291 31,032
Accrued interest and accounts receivable 6,888 4,962
Premises and equipment, net of accumulated depreciation of $1,339 at September 1998 and
$1,379 at December 1997 1,888 1,838
Other assets 8,446 7,353
- ------------------------------------------------------------------------------------------------------------------------------
Total assets 298,514 262,159
- ------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Noninterest-bearing deposits:
In offices in the U.S. 992 1,482
In offices outside the U.S. 776 744
Interest-bearing deposits:
In offices in the U.S. 3,699 9,232
In offices outside the U.S. 48,885 47,421
- ------------------------------------------------------------------------------------------------------------------------------
Total deposits 54,352 58,879
Trading account liabilities 78,552 71,141
Securities sold under agreements to repurchase ($82,740 at September 1998 and $53,202
at December 1997) and federal funds purchased 83,196 57,804
Commercial paper 12,324 6,622
Other liabilities for borrowed money 13,940 17,176
Accounts payable and accrued expenses 12,547 10,865
Long-term debt not qualifying as risk-based capital 23,284 18,246
Other liabilities, including allowance for credit losses of $185 3,035 4,129
- ------------------------------------------------------------------------------------------------------------------------------
281,230 244,862
Liabilities qualifying as risk-based capital:
Long-term debt 4,615 4,743
Company-obligated mandatorily redeemable preferred securities of subsidiaries 1,150 1,150
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 286,995 250,755
STOCKHOLDERS' EQUITY
Preferred stock (authorized shares: 10,000,000)
Adjustable rate cumulative preferred stock, $100 par value (issued and outstanding: 2,444,300) 244 244
Variable cumulative preferred stock, $1,000 par value (issued and outstanding: 250,000) 250 250
Fixed cumulative preferred stock, $500 par value (issued and outstanding: 400,000) 200 200
Common stock, $2.50 par value (authorized shares: 500,000,000; issued: 200,809,067
at September 1998 and 200,692,673 at December 1997) 502 502
Capital surplus 1,273 1,360
Common stock issuable under stock award plans 1,446 1,185
Retained earnings 9,716 9,398
Accumulated other comprehensive income:
Net unrealized gains on investment securities, net of taxes 292 432
Foreign currency translation, net of taxes (38) (22)
- ------------------------------------------------------------------------------------------------------------------------------
13,885 13,549
Less: treasury stock (25,857,272 shares at September 1998 and 24,374,944 shares
at December 1997) at cost 2,366 2,145
- ------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 11,519 11,404
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity 298,514 262,159
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
5
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CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
1998 1997
------------------------- ------------------------
Compre- Compre-
Stockholders' hensive Stockholders' hensive
In millions: Nine months ended September 30 Equity Income Equity Income
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
PREFERRED STOCK
Adjustable rate cumulative preferred stock balance, January 1 and
September 30 $ 244 $ 244
Variable cumulative preferred stock balance, January 1 and September 30 250 250
Fixed cumulative preferred stock, January 1 and September 30 200 200
- ----------------------------------------------------------------------------------------------------------------------------------
Total preferred stock, September 30 694 694
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, January 1 and September 30 502 502
- ----------------------------------------------------------------------------------------------------------------------------------
CAPITAL SURPLUS
Balance, January 1 1,360 1,446
Shares issued or distributed under dividend reinvestment plan,
various employee benefit plans, and conversion of debentures
and income tax benefits associated with stock options (87) (66)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 1,273 1,380
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ISSUABLE UNDER STOCK AWARD PLANS
Balance, January 1 1,185 838
Deferred stock awards, net 261 249
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 1,446 1,087
- ----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance, January 1 9,398 8,635
Net income 874 $ 874 1,194 $ 1,194
Dividends declared on preferred stock (27) (27)
Dividends declared on common stock (504) (475)
Dividend equivalents on common stock issuable (25) (19)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 9,716 9,308
- ----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Net unrealized gains on investment securities:
Balance, net of taxes, January 1 432 464
------- -------
Net unrealized holding gains arising during the period,
before taxes ($38 in 1998 and $204 in 1997, net of taxes) 67 322
Reclassification adjustment for net gains included in net income,
before taxes ($166 in 1998 and $70 in 1997, net of taxes) (261) (102)
------- -------
Change in net unrealized gains on investment securities, before taxes (194) 220
Deferred income tax benefit/(expense) 54 (86)
------- -------
Change in net unrealized gains on investment securities, net of taxes (140) (140) 134 134
Balance, net of taxes, September 30 292 598
------- -------
Foreign currency translation:
Balance, net of taxes, January 1 (22) (12)
------- -------
Translation adjustment arising during the period, before taxes (26) (8)
Income tax benefit 10 3
------- -------
Translation adjustment arising during the period, net of taxes (16) (16) (5) (5)
------- -------
Balance, net of taxes, September 30 (38) (17)
- ----------------------------------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive income,
net of taxes, September 30 254 581
- ----------------------------------------------------------------------------------------------------------------------------------
LESS: TREASURY STOCK
Balance, January 1 2,145 1,135
Purchases 720 1,191
Shares issued/distributed, primarily related to various employee benefit plans (499) (406)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 2,366 1,920
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 11,519 11,632
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME 718 1,323
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
CONSOLIDATED STATEMENT OF CASH FLOWS
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
In millions Nine months ended
- ----------------------------------------------------------------------------------------------------------------
September 30 September 30
1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
NET INCOME $ 874 $ 1,194
Adjustments to reconcile to cash provided by (used in) operating activities:
Noncash items: provision for credit losses, depreciation, amortization,
deferred income taxes, stock award plans, and write-downs on investment
securities 919 519
Gain on sale of businesses (113) -
Net (increase) decrease in assets:
Trading account assets (16,722) (24,231)
Securities purchased under agreements to resell (3,911) (11,599)
Securities borrowed (9,369) (10,893)
Accrued interest and accounts receivable (1,912) 905
Net increase in liabilities:
Trading account liabilities 7,624 18,828
Securities sold under agreements to repurchase 29,599 12,880
Accounts payable and accrued expenses 1,797 3,408
Other changes in operating assets and liabilities, net (1,362) 2,983
Net investment securities gains included in cash flows from investing
activities (303) (252)
- ----------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 7,121 (6,258)
- ----------------------------------------------------------------------------------------------------------------
Net decrease in interest-earning deposits with banks 608 94
Debt investment securities:
Proceeds from sales 9,715 18,672
Proceeds from maturities, calls, and mandatory redemptions 6,215 2,948
Purchases (19,072) (19,189)
Net decrease in federal funds sold - 32
Net decrease (increase) in loans 794 (3,944)
Payments for premises and equipment (211) (113)
Investment in American Century Companies, Inc. (965) -
Investment in Long-Term Capital Management, L.P. (300) -
Other changes, net 115 (307)
- ----------------------------------------------------------------------------------------------------------------
CASH (USED IN) INVESTING ACTIVITIES (3,101) (1,807)
- ----------------------------------------------------------------------------------------------------------------
Net (decrease) in noninterest-bearing deposits (456) (438)
Net (decrease) increase in interest-bearing deposits (3,920) 3,217
Net (decrease) increase in federal funds purchased (4,146) 152
Net increase in commercial paper 5,703 1,135
Other liabilities for borrowed money proceeds 15,005 14,073
Other liabilities for borrowed money payments (17,685) (18,620)
Long-term debt proceeds 12,103 10,242
Long-term debt payments (7,374) (1,680)
Proceeds from issuance of Company-obligated mandatorily redeemable preferred
securities of subsidiaries - 400
Capital stock issued or distributed 199 210
Capital stock purchased (720) (1,191)
Dividends paid (532) (507)
Other changes, net (560) 1,016
- ----------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (2,383) 8,009
- ----------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and due from banks 10 (37)
- ----------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 1,647 (93)
Cash and due from banks at December 31, 1997 and 1996 1,758 906
- ----------------------------------------------------------------------------------------------------------------
Cash and due from banks at September 30, 1998 and 1997 3,405 813
- ----------------------------------------------------------------------------------------------------------------
Cash disbursements made for:
Interest $ 8,537 $ 7,270
Income taxes 674 806
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
7
<PAGE> 8
CONSOLIDATED STATEMENT OF CONDITION
Morgan Guaranty Trust Company of New York
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
September 30 December 31
In millions, except share data 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 3,344 $ 1,663
Interest-earning deposits with banks 1,500 2,195
Debt investment securities available-for-sale carried at fair value (see note 7) 3,232 20,539
Trading account assets, net of allowance for credit losses of $325 at September 1998
and $350 at December 1997 99,264 88,995
Securities purchased under agreements to resell 37,473 28,045
Securities borrowed 11,923 13,831
Loans, net of allowance for credit losses of $402 at September 1998 and $545 at
December 1997 30,123 30,851
Accrued interest and accounts receivable 5,676 4,534
Premises and equipment, net of accumulated depreciation of $1,153 at September 1998 and
$1,208 at December 1997 1,714 1,669
Other assets 3,563 4,096
- ---------------------------------------------------------------------------------------------------------------------
Total assets 197,812 196,418
- ---------------------------------------------------------------------------------------------------------------------
LIABILITIES
Noninterest-bearing deposits:
In offices in the U.S. 1,012 1,492
In offices outside the U.S. 783 752
Interest-bearing deposits:
In offices in the U.S. 3,721 10,156
In offices outside the U.S. 49,779 48,343
- ---------------------------------------------------------------------------------------------------------------------
Total deposits 55,295 60,743
Trading account liabilities 72,840 61,562
Securities sold under agreements to repurchase and federal funds purchased 28,180 26,017
Other liabilities for borrowed money 8,260 10,433
Accounts payable and accrued expenses 7,351 7,160
Long-term debt not qualifying as risk-based capital (includes $892 at September 1998 and
$1,267 at December 1997 of notes payable to J.P. Morgan) 10,681 14,320
Other liabilities, including allowance for credit losses of $185 1,315 2,713
- ---------------------------------------------------------------------------------------------------------------------
183,922 182,948
Long-term debt qualifying as risk-based capital (includes $3,083 at September 1998 and
$2,878 at December 1997 of notes payable to J.P. Morgan) 3,216 3,037
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities 187,138 185,985
STOCKHOLDER'S EQUITY
Preferred stock, $100 par value (authorized shares: 2,500,000) -- --
Common stock, $25 par value (authorized shares: 11,000,000; issued and
outstanding 10,599,027) 265 265
Surplus 3,305 3,155
Undivided profits 7,016 6,927
Accumulated other comprehensive income:
Net unrealized gains on investment securities, net of taxes 126 108
Foreign currency translation, net of taxes (38) (22)
- ---------------------------------------------------------------------------------------------------------------------
Total stockholder's equity 10,674 10,433
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity 197,812 196,418
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
Member of the Federal Reserve System and the Federal Deposit Insurance
Corporation.
See notes to consolidated financial statements.
8
<PAGE> 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
J.P. Morgan & Co. Incorporated (J.P. Morgan), a global financial services firm,
is the holding company for a group of subsidiaries that provide a range of
financial services, including:
- - advisory
- - underwriting
- - financing
- - market making
- - asset management
- - brokerage
We serve a broad client base that includes corporations, governments,
institutions, and individuals. We also use our expertise and resources to enter
into proprietary transactions for our own account.
J.P. Morgan and our subsidiaries, including Morgan Guaranty Trust Company of New
York (Morgan Guaranty), use accounting and reporting policies and practices that
conform with U.S. generally accepted accounting principles.
Basis of presentation
The consolidated financial statements include the accounts of J.P. Morgan and
subsidiaries. All material intercompany accounts and transactions have been
eliminated in consolidation. The financial information as of and for the periods
ended September 30, 1998 and 1997 is unaudited. All adjustments which, in the
opinion of management, are necessary for a fair presentation have been made and
were of a normal, recurring nature. These unaudited financial statements should
be read in conjunction with the audited financial statements included in J.P.
Morgan's Annual report on Form 10-K for the year ended December 31, 1997, as
well as with information included in J.P. Morgan's unaudited quarterly reports
on Form 10-Q for the periods ended March 31, 1998 and June 30, 1998. The nature
of J.P. Morgan's business is such that the results of any interim period are not
necessarily indicative of results for a full year. Certain prior year amounts
have been reclassified to conform with the current presentation.
The following provides certain supplemental information regarding our accounting
policies.
Aggregate allowance for credit losses
We maintain an aggregate allowance for credit losses to absorb losses inherent
in our extensions of credit that we believe are probable of occurring and that
can be reasonably estimated. Such extensions include:
- - loans and unused loan commitments
- - payments made on behalf of clients (e.g., standby letters of credit and
guarantees)
- - all other credit exposures, including derivatives
The size and adequacy of our aggregate allowance for credit losses is based on
an assessment by the firm's Asset Quality Review (AQR) Committee at each
reporting period of the following components:
- - Specific counterparty allocations - an estimate of probable losses related to
specific counterparties.
- - Specific industry allocations - an estimate of probable losses related to
exposures to counterparties in industries undergoing financial and structural
distress. Industry allocations exclude exposures addressed in specific
counterparty allocations.
- - Specific country allocations - an estimate of probable losses resulting from
exposures to counterparties in countries experiencing political and transfer
risk, country-wide economic distress, or issues regarding the legal
enforceability of contracts. Included in this allocation are reserve
requirements, if any, that are mandated by the Federal Reserve Board. Specific
country allocations exclude exposures addressed in specific counterparty
allocations.
- - Expected loss allocations - an estimate based on statistical modeling of the
amount that is probable we will lose over the life of our existing performing
portfolio of traditional credit products, net of recoveries. Our traditional
credit
9
<PAGE> 10
product portfolio includes loans, standby letters of credit, guarantees and
other commitments to extend credit. The expected loss allocation excludes
exposures covered by the specific allocations discussed above, and is intended
to recognize probable losses on a portfolio basis that have not yet been
specifically identified. The expected loss allocation is based on our Annual
Expected Loss calculation which represents the amount of probable losses to
the firm in each year, on average, over the life of our existing portfolio.
- - General allocations - a judgmental assessment of probable losses not
adequately captured by specific allocations or by the expected loss allocation
with regards to our existing portfolio of credit extensions. Probable losses
not specifically identified include those related to our settlement activities
(including situations where the counterparty is unwilling to meet its
obligations). In addition, the allocation attempts to compensate for the
inherent imperfections in our expected loss models, including the fact that
default and recovery statistics are primarily based on U.S. corporate
experience which does not completely match our global book of risk, our view
of future economic trends versus the historical determination of the models,
and the impact of using averages versus actual occurrences.
The firm's AQR process forms the basis for determining the above components
comprising the allowance. The AQR Committee determines, using their judgment and
experience, the appropriate actions (placement on nonperforming status, specific
allocation or charge-off) that should be taken with regard to specific
counterparties, industries and countries. The senior members of the AQR
Committee then consider appropriate actions to be taken in addition to the
specific risk decisions, including a review of the following: expected loss
calculations of the existing performing portfolio; the level and history of
charge-offs and nonperforming assets; the estimated sale prices of certain
exposures; the level of counterparties on the special review list; business and
economic conditions; regulatory requirements; our historical experience;
concentrations of risk by country, industry, product and client; and the
relative size of many of our credit exposures given our wholesale orientation.
Based on this review, each quarter, the senior members of the AQR Committee
recommend the provision, if any, needed to adjust the aggregate allowance, so
that the combination of the general allocation together with the specific and
expected loss allocations remains at an appropriate level.
In accordance with the American Institute of Certified Public Accountants Banks
and Savings Institutions Audit and Accounting Guide, we allocate for financial
reporting purposes our aggregate allowance across balance sheet captions based
upon the nature of the underlying exposure and management's judgment.
Accordingly, we display our aggregate allowance as a reduction of Loans, a
reduction of Trading account assets (relating to derivatives), and as Other
liabilities (relating to off-balance sheet items such as standby letters of
credit, guarantees, and commitments). We expect that portions of the aggregate
allowance may be reclassified from time to time among Loans, Trading account
assets, and Other liabilities due to the global and diverse nature of our
business; expected shifts in the relative level of credit risk among
instruments; and necessary changes in estimates and assumptions needed to
calculate the allocated amounts. Such allowance reclassifications across balance
sheet captions, starting June 30, 1998, are reflected as provisions or reversals
of provisions in the Consolidated statement of income.
2. ACCOUNTING CHANGES AND DEVELOPMENTS
Accounting for transfers of assets and servicing of financial assets and
extinguishments of liabilities
In June 1996, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers of
Assets and Servicing of Financial Assets and Extinguishments of Liabilities,
which provides new accounting and reporting standards for sales,
securitizations, servicing of receivables and other financial assets, and
extinguishments of liabilities. In December 1996, the FASB issued SFAS No. 127,
Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125.
This statement deferred the provisions of SFAS No. 125 for transfers involving
repurchase agreements, securities borrowing/lending transactions, and financial
assets provided as collateral until January 1, 1998. Effective January 1, 1998,
we adopted the provisions of SFAS No. 127. The adoption of this standard did not
have a material impact on our consolidated financial statements.
Reporting comprehensive income
Effective January 1, 1998, we adopted SFAS No. 130, Reporting Comprehensive
Income, which establishes the concept of comprehensive income and provides
standards for reporting it. Comprehensive income is defined as the change in
equity of an entity excluding such transactions with stockholders as the
issuance of common stock or preferred stock, payment of dividends, and purchase
of treasury shares. Comprehensive income has two major components: net income,
as reported in the consolidated statement of income, and other comprehensive
income. Other comprehensive income includes such items as unrealized gains and
losses on available-for-sale securities and foreign currency translation. This
standard is limited to issues of reporting and presentation, and does not
address recognition or measurement. Its adoption, therefore, did not affect our
earnings, liquidity, or capital resources.
10
<PAGE> 11
Disclosures about segments of an enterprise and related information
In 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This standard establishes the criteria for
determining an operating segment and the required financial information to be
disclosed. SFAS No. 131 also establishes standards for disclosing related
information regarding products and services, geographic areas, and major
customers. This standard supersedes SFAS No. 14, Financial Reporting for
Segments of a Business Enterprise. We are required to adopt this standard
starting with our consolidated financial statements for the year ended December
31, 1998. This standard is limited to issues of reporting and presentation and
does not address recognition or measurement. Its adoption, therefore, will not
affect our earnings, liquidity, or capital resources. We are currently in the
process of evaluating SFAS No. 131 and have not yet determined what impact the
adoption of this standard will have on our existing segments which are currently
included in the Business sector analysis section of Management's discussion and
analysis of financial condition and results of operations (MD&A).
Employer's disclosures about pensions and other postretirement benefits
In February 1998, the FASB issued SFAS No. 132, Employer's Disclosures about
Pensions and Other Postretirement Benefits, which revises employer's disclosures
about pensions and other postretirement benefits. This standard supersedes the
disclosure requirements for pension and other benefits of SFAS No. 87,
Employer's Accounting for Pensions; SFAS No.88, Employer's Accounting for
Settlements and Curtailments of Defined Benefit Plans and for Termination
Benefits; and SFAS No. 106, Employer's Accounting for Postretirement Benefits
Other than Pensions. The standard requires additional information on the changes
in the benefit obligations and plan assets and eliminates certain disclosures to
facilitate the financial analysis of these plans. We are required to adopt this
standard starting with our financial statements for the year ended December 31,
1998. This standard is limited to issues of reporting and presentation and does
not address recognition or measurement. Therefore, its adoption will not affect
our earnings, liquidity, or capital resources.
Accounting for the costs of computer software developed or obtained for internal
use
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use (SOP 98-1). SOP 98-1 provides guidance on accounting for the costs of
computer software developed or obtained for internal use and for determining
when specific costs should be capitalized and when they should be expensed. We
are required to adopt SOP 98-1 starting in the first quarter of 1999.
Restatement of financial statements of prior years is not allowed. We are
currently in the process of evaluating SOP 98-1 and have not yet determined the
date or the impact its adoption will have on our earnings or financial position.
Accounting for derivative instruments and hedging activities
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted starting
with our financial statements for the quarter ended March 31, 2000. The standard
permits early adoption as of the beginning of any fiscal quarter after its
issuance. The standard will require us to recognize all derivatives on the
balance sheet at fair value. Derivatives that are not hedges must be adjusted to
fair value through income. If the derivative is a hedge, depending on the nature
of the hedge, changes in the fair value of derivatives will either be offset
against the change in fair value of the hedged assets, liabilities, or firm
commitments through earnings or recognized in other comprehensive income until
the hedged item is recognized in earnings. If the change in fair value of a
derivative designated as a hedge is not effectively offset, as defined, by the
change in value of the item it is hedging, this difference will be immediately
recognized in earnings. We are currently in the process of evaluating SFAS No.
133 and have not yet determined what impact the adoption of the standard will
have on our earnings and financial position.
3. RESTRUCTURING OF BUSINESS ACTIVITIES
The nine months ended September 30, 1998 includes a first quarter 1998 pretax
charge of $215 million ($129 million after tax) incurred in connection with the
restructuring of certain sales and trading functions in Europe, the refocus of
our investment banking and equities business in Asia, and the rationalization of
resources throughout the firm. The charge reflected severance-related costs of
$140 million recorded in Employee compensation and benefits associated with
staff reductions of approximately 900; $70 million in Net occupancy related to
real estate write-offs; and $5 million in Technology and communications, related
to equipment write-offs. As of September 30, 1998, approximately $90 million of
the first quarter charge was accrued in Other liabilities, of which $55 million
related to severance and the remainder primarily related to real estate.
Excluding certain long-term commitments (e.g. real estate leases), this
remaining reserve is expected to be substantially utilized by the end of the
first quarter of 1999.
11
<PAGE> 12
4. INVESTMENTS AND BUSINESS SALES
Investment in American Century Companies, Inc.
In January 1998, we completed the purchase of a 45% economic interest in
American Century Companies, Inc. (American Century) for $965 million. American
Century is a no-load U.S. mutual fund company selling directly to individuals.
The investment is accounted for under the equity method of accounting and
recorded in Other assets. The excess of our investment over our share of equity
(i.e., goodwill) in American Century is approximately $795 million. This amount
is being amortized on a straight-line basis over a period of 25 years. Our share
of equity income or loss in American Century and the amortization of goodwill
related to this investment is recorded in Other revenue.
Sale of global trust and agency services business
In June 1998, we completed the sale of our global trust and agency services
business to Citibank (a wholly owned subsidiary of Citigroup), resulting in a
net gain of $131 million ($79 million after tax) recorded in Other revenue. The
sale will not have a material effect on our ongoing earnings.
Sale of investment management business in Australia
In July 1998, we completed the sale of our investment management business in
Australia to Salomon Smith Barney Asset Management (a subsidiary of Citigroup),
resulting in a net gain of $56 million ($34 million after tax) recorded in Other
revenue. The sale will not have a material effect on our ongoing earnings.
5. INTEREST REVENUE AND EXPENSE
The following table presents an analysis of interest revenue and expense
obtained from on- and off-balance sheet financial instruments. Interest revenue
and expense associated with derivative financial instruments are included with
related balance sheet instruments. These derivative financial instruments are
used as hedges or to modify the interest rate characteristics of assets and
liabilities and include swaps, forwards, futures, options, and debt securities
forwards.
<TABLE>
<CAPTION>
Third quarter Nine months
----------------------------- -----------------------------
In millions 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST REVENUE
Deposits with banks $ 107 $ 51 $ 236 $ 124
Debt investment securities (a) 321 410 1,027 1,209
Trading account assets 1,127 1,032 3,437 3,117
Securities purchased under agreements
to resell and federal funds sold 533 543 1,493 1,502
Securities borrowed 568 457 1,578 1,284
Loans 528 518 1,618 1,477
Other sources, primarily risk adjusting swaps in 1997 65 150 228 369
- --------------------------------------------------------------------------------------------------------------------------
Total interest revenue 3,249 3,161 9,617 9,082
- --------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 645 710 2,138 2,043
Trading account liabilities 386 423 1,218 1,178
Securities sold under agreements to
repurchase and federal funds purchased 1,054 888 2,923 2,617
Other borrowed money 432 365 1,235 1,073
Long-term debt 400 303 1,145 754
- --------------------------------------------------------------------------------------------------------------------------
Total interest expense 2,917 2,689 8,659 7,665
- --------------------------------------------------------------------------------------------------------------------------
Net interest revenue 332 472 958 1,417
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Interest revenue from debt investment securities included taxable revenue
of $291 million and $941 million and revenue exempt from U.S. income taxes of
$30 million and $86 million for the three and nine months ended September 30,
1998, respectively. Interest revenue from debt investment securities included
taxable revenue of $387 million and $1,136 million and revenue exempt from U.S.
income taxes of $23 million and $73 million for the three and nine months ended
September 30, 1997.
Net interest revenue associated with derivatives used for purposes
other-than-trading was approximately $41 million and $112 million for the three
and nine months ended September 30, 1998, respectively, compared with
approximately $50 million and $160 million for the three and nine months ended
September 30, 1997, respectively. At September 30, 1998, approximately $256
million of net deferred losses on closed derivative contracts used for purposes
other-than-trading were recorded on the Consolidated balance sheet. These
amounts are primarily net deferred losses on closed hedge contracts, which are
included in the amortized cost of the debt investment portfolio as of September
30, 1998. The amount of net deferred gains or losses on closed derivative
contracts changes from period to period, primarily due to the amortization of
such amounts to Net interest revenue. These changes are also influenced by the
execution of our investing strategies, which may result in the sale of the
underlying hedged instruments and/or termination of hedge contracts. Net
deferred losses (gains) on closed derivative contracts as of September 30, 1998
of $256 million, are
12
<PAGE> 13
expected to amortize into Net interest revenue as follows: $27 million remainder
of 1998; $100 million in 1999; $90 million in 2000; $46 million in 2001; ($1)
million in 2002; ($3) million in 2003; and approximately ($3) million
thereafter.
6. TRADING REVENUE
We disaggregate trading revenue by principal product grouping across all of our
business sector activities within the following categories:
- - fixed income
- - equities
- - foreign exchange
- - commodities
- - proprietary trading
Our Fixed income trading revenue includes the results of making markets in both
developed and emerging countries in government securities, U.S. government
agency securities, corporate debt securities, money market instruments, interest
rate and currency swaps, and options and other derivatives.
Our Equities trading revenue includes the results of making markets in global
equity securities and equity derivatives such as swaps, options, futures, and
forward contracts.
Our Foreign exchange trading revenue includes the results of making markets in
spot, options, and short-term interest rate products in order to help clients
manage their foreign currency exposure.
Our Commodities trading revenue includes the results from transactions in spot,
forwards, options, and swaps.
Our Proprietary trading revenue reflects results from transactions we enter into
for our own account across all markets. Instruments utilized in our Proprietary
trading activities include fixed income securities, foreign exchange, equity
securities, and related derivatives.
The following table presents trading revenue for the three and nine months ended
September 30, 1998 and 1997. This revenue reflects only a portion of the total
revenues generated by our activities and excludes other important sources of
revenues, including fees and commissions. As a result, this table does not
reflect the integrated nature of our business. Refer to the Business sector
analysis in MD&A for more information.
<TABLE>
<CAPTION>
Third quarter Nine months
----------------- ----------------
In millions 1998 1997 1998 1997
- -------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fixed income ($ 95) $416 $1,078 $1,012
Equities (6) 51 160 332
Foreign exchange 158 78 393 270
Commodities 5 17 55 32
Proprietary trading 57 95 206 185
- -------------------------------------------------------------------
Total trading revenue 119 657 1,892 1,831
- -------------------------------------------------------------------
</TABLE>
7. INVESTMENT SECURITIES
DEBT INVESTMENT SECURITIES
Our debt investment securities portfolio is classified as available-for-sale.
Available-for-sale securities are measured at fair value and unrealized gains or
losses are reported as a net amount within the stockholders' equity account, Net
unrealized gains on investment securities, net of taxes.
The following table presents the gross unrealized gains and losses and a
comparison of the cost, and the fair and carrying value of our
available-for-sale debt investment securities at September 30, 1998. The gross
unrealized gains or losses on each debt investment security include the effects
of any related hedge. See Note 9, Off-balance sheet financial instruments, for
additional detail of gross unrealized gains and losses associated with open
derivative contracts used to hedge debt investment securities.
13
<PAGE> 14
<TABLE>
<CAPTION>
Gross Gross Fair and
unrealized unrealized carrying
In millions: September 30, 1998 Cost gains losses value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury $ 674 $ 167 $ 1 $ 840
U.S. government agency, principally mortgage-backed 20,975 248 85 21,138
U.S. state and political subdivision 2,190 201 11 2,380
U.S. corporate and bank debt 253 1 2 252
Foreign government (a) 376 6 21 361
Foreign corporate and bank debt 647 1 94 554
Other 116 -- -- 116
- ------------------------------------------------------------------------------------------------------------------------------------
Total debt investment securities 25,231 624 214 25,641
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Primarily includes debt of countries that are members of the Organization
for Economic Cooperation and Development
The table below presents gains, losses, and write-downs of debt investment
securities during the three and nine months ended September 30, 1998 and 1997.
These amounts are recorded in Investment securities revenue.
<TABLE>
<CAPTION>
Third quarter Nine months
---------------------- ----------------------
In millions 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross realized gains from sales of securities $ 4 $ 38 $ 62 $ 84
Gross realized losses from sales of securities (27) (31) (111) (64)
Net gains on maturities, calls, and mandatory redemptions 2 3 2 3
Write-downs for other-than-temporary impairments in value - (11) (2) (26)
- -----------------------------------------------------------------------------------------------------------
Net debt investment securities losses (21) (1) (49) (3)
- -----------------------------------------------------------------------------------------------------------
</TABLE>
Morgan Guaranty
In the Morgan Guaranty consolidated statement of condition on page 8, the
balance for Debt investment securities available-for-sale carried at fair value
decreased from $20.5 billion at December 31, 1997 to $3.2 billion at September
30, 1998, reflecting Morgan Guaranty's sale of approximately $18 billion of debt
investment securities to an affiliated J.P. Morgan entity during the first six
months of 1998.
EQUITY INVESTMENT SECURITIES
Equity investment securities include both marketable and nonmarketable
securities.
Marketable available-for-sale equity investment securities
Marketable equity investment securities, which are classified as
available-for-sale, are recorded at fair value. Unrealized gains and losses are
reported as a net amount within the stockholders' equity account, Net unrealized
gains on investment securities, net of taxes. Gross unrealized gains and losses,
as well as a comparison of the cost, and fair and carrying value of marketable
available-for-sale equity investment securities as of September 30, 1998 are
shown in the following table.
<TABLE>
<CAPTION>
In millions: September 30, 1998
- ----------------------------------------------------------------------
<S> <C>
Cost $ 312
- ----------------------------------------------------------------------
Gross unrealized gains 148
Gross unrealized losses (64)
- ----------------------------------------------------------------------
Net unrealized gains(a) 84
- ----------------------------------------------------------------------
Fair and carrying value 396
- ----------------------------------------------------------------------
</TABLE>
(a) Primarily relates to investments in the telecommunications and financial
services industries.
14
<PAGE> 15
Nonmarketable and other equity securities
Nonmarketable equity investment securities are carried at cost on the balance
sheet. Securities held in subsidiaries registered as Small Business Investment
Companies (SBICs) are carried at fair value on the balance sheet, with changes
in fair value recorded currently in Investment securities revenue. The following
table presents the carrying and fair value, as well as the net unrealized gains,
on nonmarketable and other equity securities.
<TABLE>
<CAPTION>
In millions: September 30, 1998
- --------------------------------------------------------------------------------
<S> <C>
Carrying value $ 555
Net unrealized gains on nonmarketable securities(a) 129
- --------------------------------------------------------------------------------
Fair value 684
- --------------------------------------------------------------------------------
</TABLE>
(a) Primarily relates to investments in the telecommunications and
transportation industries.
Realized gains and write-downs
The following table presents gross realized gains and write-downs for
other-than-temporary impairments in value related to our equity investments
portfolio, excluding securities in SBICs, for the three and nine months ended
September 30, 1998 and 1997. These amounts are recorded in Investment securities
revenue.
<TABLE>
<CAPTION>
Third quarter Nine months
----------------------- -----------------------
In millions 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross realized gains from marketable available-for-sale securities $ 192 $ 15 $ 334 $ 107
Gross realized gains from nonmarketable and other equity securities 5 35 16 122
Write-downs for other-than-temporary impairments in value (48) (13) (82) (25)
- ---------------------------------------------------------------------------------------------------------------------------
Net equity investment securities realized gains 149 37 268 204
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
8. TRADING ACCOUNT ASSETS AND LIABILITIES
Trading account assets and liabilities, including derivative instruments used
for trading purposes, are carried at fair value. The following table presents
the carrying value of trading account assets - before taking into consideration
the allowance for credit losses - and trading account liabilities at September
30, 1998. It also includes the average balance for the three and nine months
ended September 30, 1998.
<TABLE>
<CAPTION>
Carrying Average
value balance
---------------------------------------------------------------
September 30 Third quarter Nine months
In millions: 1998 1998 1998
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
TRADING ACCOUNT ASSETS
U.S. Treasury $ 17,180 $ 10,334 $ 10,612
U.S. government agency 9,098 10,626 10,381
Foreign government 23,615 26,795 30,856
Corporate debt and equity 20,185 22,041 21,983
Other securities 8,925 10,540 9,890
Interest rate and currency swaps 24,549 27,952 23,034
Foreign exchange contracts 3,017 3,228 4,159
Interest rate futures and forwards 441 188 207
Commodity and equity contracts 2,990 5,380 2,692
Purchased option contracts 19,071 10,881 12,611
- -----------------------------------------------------------------------------------------------------
Total trading account assets 129,071 127,965 126,425
- -----------------------------------------------------------------------------------------------------
TRADING ACCOUNT LIABILITIES
U.S. Treasury 7,001 8,155 9,304
Foreign government 10,124 12,163 14,366
Corporate debt and equity 8,710 10,235 9,928
Other securities 2,431 1,899 2,820
Interest rate and currency swaps 23,047 23,591 19,196
Foreign exchange contracts 3,640 2,053 4,148
Interest rate futures and forwards 1,321 806 880
Commodity and equity contracts 2,815 4,711 2,779
Written option contracts 19,463 13,597 12,852
- -----------------------------------------------------------------------------------------------------
Total trading account liabilities 78,552 77,210 76,273
- -----------------------------------------------------------------------------------------------------
</TABLE>
9. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
Derivatives
In general, derivatives are contracts or agreements whose values are derived
from changes in interest rates, foreign exchange rates, prices of securities, or
financial or commodity indices. The timing of cash receipts and payments for
derivatives is generally determined by contractual agreement. Derivatives may be
used for trading or other-than-trading purposes. Other-than-trading purposes are
primarily related to our investing activities.
15
<PAGE> 16
Derivatives used for trading purposes include:
- - interest rate and currency swap contracts
- - interest rate futures, forward rate agreements, and interest rate option
contracts
- - foreign exchange spot, forward, futures and option contracts
- - equity swap, futures and option contracts
- - commodity swap, forward and option contracts
In our investing activities we use derivative instruments including:
- - interest rate and currency swap contracts
- - foreign exchange forward contracts
- - interest rate futures and debt securities forward contracts
- - interest rate and equity option contracts
Interest rate swaps are contractual agreements to exchange periodic interest
payments at specified intervals. The notional amounts of interest rate swaps are
not exchanged; they are used solely to calculate the periodic interest payments.
Currency swaps generally involve exchanging principal (the notional amount) and
periodic interest payments in one currency for principal and periodic interest
payments in another currency.
Foreign exchange contracts involve an agreement to exchange one country's
currency for another at an agreed upon price and settlement date. The contracts
reported in the following table primarily include forward contracts.
Interest rate futures are standardized exchange-traded agreements to receive or
deliver a specific financial instrument at a specific future date and price.
Forward rate agreements provide for the payment or receipt of the difference
between a specified interest rate and a reference rate at a future settlement
date. Debt security forwards include to-be-announced and when-issued securities
contracts.
Commodity and equity swaps, forward, and futures contracts include swaps and
futures in the commodity and equity markets and commodity forward agreements.
Equity swaps are contractual agreements to receive the appreciation or
depreciation in value based on a specific strike price on an equity instrument
in return for paying another rate, which is usually based upon equity index
movements or interest rates. Commodity swaps are contractual commitments to
exchange the fixed price of a commodity for a floating price. Equity and
commodity futures are exchange-traded agreements to receive or deliver a
financial instrument or commodity at a specific future date and price. Equity
and commodity forwards are over-the-counter agreements to purchase or sell a
specific amount of a financial instrument or commodity at an agreed upon price
and settlement date.
An option provides the option purchaser, for a fee, the right - but not the
obligation - to buy or sell a security at a fixed price on or before a specified
date. The option writer is obligated to buy or sell the security if the
purchaser chooses to exercise the option. These options include contracts in the
interest rate, foreign exchange, equity and commodity markets.
Interest rate options include caps and floors.
16
<PAGE> 17
A summary of the on-balance sheet credit exposure, which is represented by the
positive fair value associated with derivatives, is included in the following
table. Our on-balance sheet exposure takes into consideration $101.9 billion of
master netting agreements in effect at September 30, 1998.
<TABLE>
<CAPTION>
In billions: September 30, 1998 Notional amounts Credit exposure
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest rate and currency swaps
Trading $3,195.1
Other-than-trading(a)(b) 75.1
- ----------------------------------------------------------------------------------------------------------
Total interest rate and currency swaps 3,270.2 $24.5
- ----------------------------------------------------------------------------------------------------------
Foreign exchange spot, forward, and futures contracts
Trading 659.5
Other-than-trading(a)(b) 36.8
- ----------------------------------------------------------------------------------------------------------
Total foreign exchange spot, forward, and futures
Contracts 696.3 3.0
- ----------------------------------------------------------------------------------------------------------
Interest rate futures, forward rate agreements,
and debt securities forwards
Trading 1,795.6
Other-than-trading 21.1
- ----------------------------------------------------------------------------------------------------------
Total interest rate futures, forward rate agreements,
and debt securities forwards 1,816.7 0.4
- ----------------------------------------------------------------------------------------------------------
Commodity and equity swaps, forward,
and futures contracts, all trading 94.6 3.0
- ----------------------------------------------------------------------------------------------------------
Purchased options(c)
Trading 1,255.1
Other-than-trading(a) 0.8
- ----------------------------------------------------------------------------------------------------------
Total purchased options 1,255.9 19.1
- ----------------------------------------------------------------------------------------------------------
Written options, all trading(d) 1,493.0
- ----------------------------------------------------------------------------------------------------------
Total on-balance sheet credit exposure 50.0
- ----------------------------------------------------------------------------------------------------------
</TABLE>
(a) The majority of J.P. Morgan's derivatives used for purposes
other-than-trading are transacted with independently managed J.P. Morgan
derivatives dealers who function as intermediaries for credit and administrative
purposes.
(b) The notional amounts of derivative contracts used for purposes
other-than-trading, conducted in the foreign exchange markets, primarily forward
contracts, amounted to $42.0 billion at September 30, 1998, and were primarily
denominated in the following currencies: Italian lira $5.6 billion, British
pound $4.2 billion, German deutsche mark $3.9 billion, French franc $3.8
billion, Japanese yen $3.4 billion, and Swiss franc $3.1 billion.
(c) At September 30, 1998, purchased options used for trading purposes included
$910.6 billion of interest rate options, $245.3 billion of foreign exchange
options, and $99.2 billion of commodity and equity options. Options used for
purposes other-than-trading are primarily interest rate options. Purchased
options executed on an exchange amounted to $337.5 billion and those negotiated
over-the-counter amounted to $918.4 billion at September 30, 1998.
(d) At September 30, 1998, written options included $1,154.9 billion of
interest rate options, $231.8 billion of foreign exchange options, and $106.3
billion of commodity and equity options. Written option contracts executed on an
exchange amounted to $500.2 billion and those negotiated over-the-counter
amounted to $992.8 billion at September 30, 1998.
As part of our other-than-trading activities, we use derivatives to hedge our
exposure to interest rate and currency fluctuations, primarily on or related to
debt investment securities. We also use them to modify the characteristics of
interest rate-related balance sheet instruments such as loans, short-term
borrowings, and long-term debt.
Net unrealized gains associated with open derivative contracts used to hedge or
modify the interest rate characteristics of related balance sheet instruments
amounted to $1.105 billion at September 30, 1998. Such amounts primarily relate
to interest rate and currency swaps used to hedge or modify the interest rate
characteristics of long-term debt and deposits. Gross unrealized gains and gross
unrealized losses associated with open derivative contracts at September 30,
1998, are as follows:
<TABLE>
<CAPTION>
Gross Gross Net
unrealized unrealized unrealized
In millions: September 30, 1998 gains (losses) gains (losses)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Long-term debt $ 793 $(130) $663
Debt investment securities 157 (179) (22)
Deposits 436 (22) 414
Other financial instruments 226 (176) 50
- ---------------------------------------------------------------------------------------
Total 1,612 (507) 1,105
- ---------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 18
Credit-related financial instruments
Credit-related financial instruments include commitments to extend credit,
standby letters of credit and guarantees, and indemnifications related to
securities lending activities. The contractual amounts of these instruments
represent the amount at risk should the contract be fully drawn upon, the client
default, and the value of their collateral become worthless.
The total contractual amount of credit-related financial instruments does not
represent the future liquidity requirements, since we expect a significant
amount of commitments to expire or mature without being drawn. The credit risk
associated with these instruments varies depending on the client's
creditworthiness and the value of any collateral held. Commitments to extend
credit generally require clients to meet certain credit-related terms and
conditions before drawdown. We require collateral in connection with securities
lending indemnifications. Market risk for commitments to extend credit and
standby letters of credit and guarantees, while not significant, may exist as
availability of and access to credit markets change.
The following table summarizes the contractual amount of credit-related
financial instruments as of September 30, 1998.
<TABLE>
<CAPTION>
In billions: September 30, 1998
- --------------------------------------------------------------------------------
<S> <C>
Commitments to extend credit $89.9
Standby letters of credit and guarantees 16.5
Securities lending indemnifications (a) 8.9
- --------------------------------------------------------------------------------
</TABLE>
(a) At September 30, 1998, J.P. Morgan held cash and other collateral in support
of securities lending indemnifications.
Included in Fees and Commissions are credit-related fees of $40 million and $124
million for the three and nine months ended September 30, 1998, respectively,
and $44 million and $121 million for the three and nine months ended
September 30, 1997, respectively. They are primarily earned from commitments to
extend credit, standby letters of credit and guarantees, and securities lending
indemnifications.
Other
Amounts receivable and payable for securities that have not reached their
contractual settlement dates are recorded net in the consolidated balance sheet.
This is consistent with industry practice. Amounts payable for securities
purchased of $38.1 billion was netted against amounts receivable for securities
sold of $35.6 billion. This produced a net trade date payable of $2.5 billion,
recorded in Accounts payable and accrued expenses as of September 30, 1998.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
In accordance with SFAS No. 107, Disclosures about Fair Value of Financial
Instruments, we estimate the fair value of all on-balance sheet and off-balance
sheet financial instruments. At September 30, 1998, we estimate that the SFAS
No. 107 aggregate net fair value of all financial instruments exceeded
associated net carrying values on our consolidated balance sheet by $0.3
billion, compared with an excess of $1.0 billion at December 31, 1997. The
decrease from December 31, 1997 primarily related to net loans as well as
various interest rate-sensitive liabilities.
The SFAS No. 107 fair value of a financial instrument is the current amount that
would be exchanged between willing parties (other than in a forced sale or
liquidation), and is best evidenced by a quoted market price, if one exists.
Where quoted market prices are not available for financial instruments, fair
values are estimated using internal valuation techniques including pricing
models and discounted cash flows which may not be indicative of net realizable
value. Derivative contracts classified as nonperforming are included at their
recorded carrying value in these disclosures. The use of other valuation
techniques may produce results that are different than those obtained under
current fair value methodologies. For example, using the cost of credit
derivatives to hedge loan exposures as a method to estimate the fair value of
loans, rather than discounting loans using current market rates, would result
in fair values that are substantially lower.
18
<PAGE> 19
11. NONPERFORMING ASSETS
Total nonperforming assets - net of charge-offs - at September 30, 1998 are
presented in the following table.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
In millions: September 30, 1998
- --------------------------------------------------------------------------------
<S> <C>
Nonperforming loans:
Commercial and industrial $ 12
Banks and other financial institutions 2
Other 46
- --------------------------------------------------------------------------------
Total nonperforming loans 60
- --------------------------------------------------------------------------------
Other nonperforming assets,
primarily swaps with Asian banking and other financial institutions 533
- --------------------------------------------------------------------------------
Total nonperforming assets 593
- --------------------------------------------------------------------------------
</TABLE>
12. AGGREGATE ALLOWANCE FOR CREDIT LOSSES
We maintain an aggregate allowance for credit losses to absorb losses inherent
in our extensions of credit. Such extensions include loans and unused loan
commitments, payments made on behalf of clients (e.g., standby letters of credit
and guarantees), and all other credit exposures, including derivatives. Refer to
the Credit risk section of Risk management in the 1997 Annual report and Note 1,
Summary of significant accounting policies, in this quarterly report for further
details.
The following tables summarize the activity of the aggregate allowance for
credit losses.
<TABLE>
<CAPTION>
Third quarter
In millions 1998
- ------------------------------------------------------------------------------
<S> <C>
BALANCE, JULY 1 $904
- ------------------------------------------------------------------------------
Provision for credit losses 75
- ------------------------------------------------------------------------------
Recoveries 4
Charge-offs:
Commercial and industrial (6)
Banks and other financial institutions (31)
Losses on sale of loans, primarily banks
and other financial institutions (11)
Other (21)
- ------------------------------------------------------------------------------
Net charge-offs (65)
- ------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30 914
- ------------------------------------------------------------------------------
</TABLE>
For the three months ended September 30, 1998: $50 million of the provision for
credit losses related to trading account assets and the remaining $25 million
related to loans; $52 million of charge-offs related to trading account assets
and the remaining $17 million related to loans; and recoveries of $4 million
related to loans.
<TABLE>
<CAPTION>
Nine months
In millions 1998
- --------------------------------------------------------------------------------
<S> <C>
BALANCE, JANUARY 1 $1,081
- --------------------------------------------------------------------------------
Provision for credit losses 75
- --------------------------------------------------------------------------------
Recoveries 19
Charge-offs:
Commercial and industrial (64)
Banks and other financial institutions (87)
Losses on sale of loans, primarily banks
and other financial institutions (89)
Other (21)
- --------------------------------------------------------------------------------
Net charge-offs (242)
- --------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30 914
- --------------------------------------------------------------------------------
</TABLE>
For the nine months ended September 30, 1998: $50 million of the provision for
credit losses related to trading account assets and the remaining $25 million
related to loans; $131 million of charge-offs related to trading account assets
and the remaining $130 million related to loans; $13 million of recoveries
related to loans and the remaining $6 million related to trading account assets.
13. INVESTMENT BANKING REVENUE
In the third quarter of 1998 and 1997, investment banking revenue of $312
million and $320 million includes $83 million and $132 million, respectively, of
underwriting revenue. For the nine months ended September 30, 1998 and 1997,
investment banking revenue of $1.020 billion and $840 million includes $402
million and $369 million, respectively, of underwriting revenue.
19
<PAGE> 20
14. OTHER REVENUE AND OTHER EXPENSES
Other revenue
In the 1998 third quarter, Other revenue of $71 million includes the $56
million net gain on the sale of the firm's investment management business in
Australia. It also includes losses of approximately $22 million on hedges of
the firm's anticipated foreign currency revenues and expenses. These losses
were partially offset by the impact of exchange rate movements on reported
revenues and expenses in the respective period. In addition to the 1998 third
quarter gain, Other revenue for the first nine months of 1998, includes the
second quarter $131 million net gain on the sale of our global trust and agency
services business and approximately $38 million of losses on hedges of the
firm's anticipated foreign currency revenues and expenses. See Note 4,
Investments and business sales, for additional information.
Other revenue includes $12 million and $85 million for the three and nine months
ended September 30, 1997, respectively, of gains on hedges of anticipated
foreign currency revenues and expenses.
Other expenses
The following table presents the major components of Other expenses.
<TABLE>
<CAPTION>
Third quarter Nine months
-------------------- --------------------
In millions 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Professional services $ 28 $ 33 $ 87 $ 91
Marketing and business development 42 48 131 141
Other 85 93 297 254
- -----------------------------------------------------------------------------------------------------
Total other expenses 155 174 515 486
- -----------------------------------------------------------------------------------------------------
</TABLE>
15. INCOME TAXES
The effective tax rate for the three months ended September 30, 1998 and 1997
was 23% and 33%, respectively. The decrease in the effective tax rate reflects
lower pretax income. For the nine months ended September 30, 1998 and 1997, the
effective tax rate was 33%. Income tax expense related to net realized gains and
write-downs for other-than-temporary impairments in value on debt and equity
investment securities, excluding securities in SBICs, was approximately $47
million and $78 million for the three and nine months ended September 30, 1998,
respectively, and $13 million and $74 million for the three and nine months
ended September 30, 1997, respectively. The applicable tax rate used to compute
the income tax expense related to net gains on debt and equity investment
securities was approximately 36% for the three and nine months ended September
30, 1998. The applicable tax rate used to compute the income tax expense related
to net gains on debt and equity investment securities for the three and nine
months ended September 30, 1997, was approximately 37%.
16. COMMITMENTS AND CONTINGENT LIABILITIES
Excluding mortgaged properties, assets on the consolidated balance sheet of
approximately $113.3 billion at September 30, 1998, were pledged as collateral
for borrowings, to qualify for fiduciary powers, to secure public monies as
required by law, and for other purposes.
17. PERFORMANCE PLAN
In July 1998, the firm adopted the 1998 Performance Plan of J.P. Morgan & Co.
Incorporated and Affiliated Companies ("Performance Plan"). Awards granted
under the Performance Plan will be earned based on the achievement of
firm-wide performance goals (including significantly improved risk-adjusted
returns, earnings growth and expense management) during the 1998-2000
performance period. Unless determined otherwise, the awards, if any, will be
paid in cash in January 2001.
20
<PAGE> 21
18. EARNINGS PER SHARE
Effective December 31, 1997, we adopted SFAS No. 128, Earnings per Share, which
established new standards for computing and presenting earnings per share (EPS).
All EPS amounts have been restated to conform to the new requirements.
Basic EPS is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding, which includes
contingently issuable shares where all necessary conditions for issuance have
been satisfied. Diluted EPS includes the determinants of basic EPS and, in
addition, gives effect to dilutive potential common shares that were outstanding
during the period.
The computation of basic and diluted EPS for the three and nine months ended
September 30, 1998 and 1997 is presented in the following table.
<TABLE>
<CAPTION>
Third quarter Nine months
----------------------------------- ----------------------------------
Dollars in millions, except share data 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $156 $396 $874 $1,194
Preferred stock dividends and other (9) (10) (27) (27)
- ----------------------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings
per share - income available to
common stockholders $147 $386 $847 $1,167
- ----------------------------------------------------------------------------------------------------------------------------------
Denominator for basic earnings per share -
weighted-average shares 181,663,864 184,046,463 182,309,867 186,130,064
Effect of dilutive securities:
Options (a) 5,387,808(b) 6,655,232 6,445,438(b) 6,533,925
Other stock awards (c) 9,275,066 7,000,957 9,391,115 6,948,737
4.75% convertible debentures 68,747 73,823 69,964 74,940
- ----------------------------------------------------------------------------------------------------------------------------------
14,731,621 13,730,012 15,906,517 13,557,602
- ----------------------------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share -
weighted-average number of common
shares and dilutive potential common
shares 196,395,485 197,776,475 198,216,384 199,687,666
- ----------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $0.81 $2.10 $4.65 $6.27
Diluted earnings per share 0.75 1.96 4.28 5.85
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings per share amounts are based on actual numbers before rounding.
</TABLE>
(a) The dilutive effect of stock options was computed using the treasury stock
method. This method computes the number of incremental shares by assuming the
issuance of outstanding stock options, reduced by the number of shares assumed
to be repurchased from the issuance proceeds, using the average market price of
our common stock for the period. The related tax benefits are also considered.
(b) Options to purchase 5,129,000 shares of our common stock at $130.94 per
share were outstanding at September 30, 1998, but were not included in the
computation of diluted EPS for the three and nine months ended September 30,
1998. The inclusion of such options using the treasury stock method would have
an antidilutive effect on the diluted EPS calculation because the options'
exercise price was greater than the average market price of our common shares
for the three and nine months ended September 30, 1998. These options expire on
July 15, 2008.
(c) Weighted-average incremental shares for other stock awards include
restricted stock and stock bonus awards.
21
<PAGE> 22
19. CAPITAL REQUIREMENTS
J.P. Morgan, our subsidiaries, and certain foreign branches of our bank
subsidiary, Morgan Guaranty Trust Company of New York (Morgan Guaranty), are
subject to regulatory capital requirements of U.S. and foreign regulators. Our
primary federal banking regulator, the Board of Governors of the Federal
Reserve System (Federal Reserve Board), establishes minimum capital
requirements for J.P. Morgan, the consolidated bank holding company, and some
of our subsidiaries, including Morgan Guaranty. These requirements ensure banks
and bank holding companies meet specific guidelines that involve quantitative
measures of assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting principles. Failure to meet these
requirements can result in actions by regulators that could have a direct
material impact on our financial statements. The capital of J.P. Morgan and our
principal subsidiaries, Morgan Guaranty and J.P. Morgan Securities Inc.
(JPMSI), exceeded the minimum requirements set by each regulator at September
30, 1998.
Capital ratios and amounts
The following table indicates the risk-based capital and leverage ratios and
amounts as of September 30, 1998 for J.P. Morgan and Morgan Guaranty under the
Federal Reserve Board's market risk capital guidelines. These guidelines
incorporate a measure of market risk for trading positions. Under the market
risk capital guidelines, the published capital ratios of J.P. Morgan are
calculated including the equity, assets, and off-balance sheet exposures of
JPMSI. In accordance with Federal Reserve Board guidelines, the risk-based
capital and leverage amounts and ratios exclude the effect of SFAS No. 115.
<TABLE>
<CAPTION>
Dollars in millions Amounts Ratios(b)
- --------------------------------------------------------------------------------
<S> <C> <C>
Tier 1 capital(a)
J.P. Morgan $11,320 7.6%
Morgan Guaranty 10,528 8.3
- --------------------------------------------------------------------------------
Total risk-based capital(a)
J.P. Morgan $16,649 11.2%
Morgan Guaranty 14,476 11.4
- --------------------------------------------------------------------------------
Leverage
J.P. Morgan 4.0%
Morgan Guaranty 5.6
- --------------------------------------------------------------------------------
</TABLE>
(a) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required
minimum tier 1 capital of $6.0 billion and $5.1 billion, respectively. For
capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum
total risk-based capital of $11.9 billion and $10.2 billion, respectively.
(b) Pursuant to Federal Reserve Board guidelines, the minimum tier 1 capital,
total risk-based capital, and leverage ratios are 4%, 8%, and 3%, respectively,
for bank holding companies and banks.
Capital categories
Bank regulators use five capital category definitions for regulatory supervision
purposes. The categories range from well capitalized to critically
undercapitalized. A bank is considered well capitalized if it has minimum tier 1
capital, total capital, and leverage ratios of 6%, 10%, and 5%, respectively,
under standards provided by the regulatory framework for prompt corrective
action and the Federal Reserve Board.
Bank holding companies also have guidelines which determine the capital levels
at which they shall be considered well capitalized. Pursuant to these
guidelines, the Federal Reserve Board considers a bank holding company who has
adopted the market risk rules to be well capitalized if it has minimum tier 1
capital, total capital, and leverage ratios of 6%, 10%, and 3%, respectively.
At September 30, 1998, the ratios of J.P. Morgan and Morgan Guaranty exceeded
the minimum standards required for a well capitalized bank holding company and
bank, respectively. Management is aware of no conditions or events that have
occurred since September 30, 1998, that would change J.P. Morgan's and Morgan
Guaranty's well capitalized status.
20. INTERNATIONAL OPERATIONS
For financial reporting purposes, our operations are divided into domestic and
international components. We believe that the method we have chosen to allocate
our results among domestic and international sources, while inexact, is
appropriate.
Because our operations are highly integrated, we need to make estimates and
assumptions to identify revenues and expenses by geographic region. The
following is a summary of these assumptions:
- - Client-focused revenues are assigned to the region managing the client
relationship for a particular product. For finance and advisory products,
this is the client's head office; for most other products, it is the
location where the activity is transacted.
22
<PAGE> 23
- - Market making revenues that cannot be specifically attributed to individual
clients (e.g., gains or losses from positions taken to facilitate client
transactions) are generally allocated based on the proportion of regional
revenues.
- - Revenues from proprietary investing and trading activities are based on the
location of the risk-taker.
- - Expenses are allocated based on the estimated cost associated with servicing
the regions' client base.
- - Earnings on stockholders' equity are mainly allocated based on each region's
proportion of regional revenue, and adjustments are made for differences
between domestic and international tax rates.
- - Provision for credit losses is allocated based on charge-offs in the region
for the respective period.
The results for the three and nine months ended September 30, 1998 and 1997 are
distributed among domestic and international operations, as presented in the
following table.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Income
Client- tax
focused Total Total Pretax expense/ Net
In millions revenues revenues(a) expenses income/(loss) (benefit) income/(loss)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
THIRD QUARTER 1998
Europe(b) $ 209 $ 211 $ 354 ($143) ($57) ($86)
Asia Pacific 170 138(e) 106 32 13 19
Latin America(c) 104 90 42 48 19 29
- ----------------------------------------------------------------------------------------------------------
Total international operations 483 439 502 (63) (25) (38)
Domestic operations(d) 626 862 597 265 71 194
- ----------------------------------------------------------------------------------------------------------
Total 1,109 1,301 1,099 202 46 156
- ----------------------------------------------------------------------------------------------------------
THIRD QUARTER 1997
Europe(b) 493 516 418 98 39 59
Asia Pacific 180 247 138 109 43 66
Latin America(c) 142 164 62 102 41 61
- ----------------------------------------------------------------------------------------------------------
Total international operations 815 927 618 309 123 186
Domestic operations(d) 809 989 708 281 71 210
- ----------------------------------------------------------------------------------------------------------
Total 1,624 1,916 1,326 590 194 396
- ----------------------------------------------------------------------------------------------------------
NINE MONTHS 1998(h)
Europe(b) 1,512 1,602(f) 1,371(g) 231 92 139
Asia Pacific 612 507 396(g) 111 45 66
Latin America(c) 370 389 184 205 82 123
- ----------------------------------------------------------------------------------------------------------
Total international operations 2,494 2,498 1,951 547 219 328
Domestic operations(d) 2,453 2,953 2,196(g) 757 211 546
- ----------------------------------------------------------------------------------------------------------
Total 4,947 5,451 4,147 1,304 430 874
- ----------------------------------------------------------------------------------------------------------
NINE MONTHS 1997
Europe(b) 1,442 1,653 1,152 501 200 301
Asia Pacific 521 623 392 231 92 139
Latin America(c) 450 545 181 364 146 218
- ----------------------------------------------------------------------------------------------------------
Total international operations 2,413 2,821 1,725 1,096 438 658
Domestic operations(d) 2,291 2,719 2,033 686 150 536
- ----------------------------------------------------------------------------------------------------------
Total 4,704 5,540 3,758 1,782 588 1,194
- ----------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes net interest revenue and noninterest revenues.
(b) Includes the Middle East and Africa.
(c) Includes Mexico, Central America, and South America.
(d) Includes the United States, Canada, and the Caribbean. Results relate
substantially to United States operations for both years.
(e) Includes 1998 third quarter net pretax gain of $56 million related to the
sale of our investment management business in Australia. See Note 4, Investments
and business sales.
(f) Includes 1998 second quarter net pretax gain of $131 million related to the
sale of our global trust and agency services business. See Note 4, Investments
and business sales.
(g) Total expenses include a 1998 first quarter $215 million pretax charge
related to the restructuring of business activities which was recorded as
follows: $116 million in Europe, $15 million in Asia Pacific, and $84 million in
Domestic operations.
(h) Expense allocations for prior quarters of 1998 have been reclassified to
conform with the current presentation.
23
<PAGE> 24
PART I
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL HIGHLIGHTS
J.P. Morgan reported third quarter net income of $156 million, down from $396
million in the third quarter of 1997 and $481 million in the 1998 second
quarter. The 1998 third quarter result includes a gain of $56 million ($34
million after tax) related to the sale of a business. Excluding the gain, net
income was $122 million. Earnings per share in the 1998 third quarter were
$0.75, or $0.58 excluding the gain.
The quarter's result reflects the impact of global market upheaval. Markets were
characterized by extreme volatility, widening of credit spreads, lower asset
values, and withdrawal of investors from many markets.
Although client activity has improved from the latter part of the third quarter,
market conditions remain difficult, with illiquidity in certain markets, high
levels of volatility and continued breakdowns in historical market correlations.
In light of market conditions and ongoing productivity initiatives, individual
business units are adjusting their resource levels to reduce core expenses.
These adjustments will result in a fourth quarter charge, consisting mainly of
personnel-related and occupancy costs.
Net income for the first nine months of 1998 was $890 million, excluding
after-tax gains of $113 million on business sales and a $129 million after-tax
restructuring charge taken in the first quarter. This compares with $1.194
billion in the first nine months of 1997. Earnings per share for the 1998 year
to date, excluding special items, were $4.36, versus $5.85 in the same period a
year ago.
OTHER HIGHLIGHTS OF THE QUARTER:
- - Revenues declined 32% from a year ago reflecting unsettled markets globally.
- - Expenses fell 17% from a year ago reflecting lower compensation accruals and
continued progress on productivity initiatives.
- - A $75 million provision brought the allowance for credit losses to $914
million.
- - We continued to reduce emerging market credit exposures: emerging Asian
exposures are down more than 50% from their December 31, 1997 levels; Latin
American exposures are down nearly 40%.
- - We expect to exceed our previously announced savings target of $300-$500
million, reducing core expenses in 1999 by $400 million and reinvesting the
balance of the savings.
THIRD QUARTER RESULTS AT A GLANCE
<TABLE>
<CAPTION>
Second
Third quarter quarter
- -------------------------------------------------------------------------------------------
In millions of dollars, except per share data 1998 1997 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $1,301 $ 1,916 $2,153
Operating expenses (1,099) (1,326) (1,416)
Income taxes (46) (194) (256)
- -------------------------------------------------------------------------------------------
Net income 156 396 481
Net income per share $ 0.75 $ 1.96 $ 2.36
Dividends declared per share $ 0.95 $ 0.88 $ 0.95
- -------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE> 25
BUSINESS SECTOR ANALYSIS
For the purposes of reporting our results, we divide our business activities
into five sectors: Finance and Advisory, Market Making, Asset Management and
Servicing, Equity Investments, and Proprietary Investing and Trading.
The first three sectors - Finance and Advisory, Market Making, and Asset
Management and Servicing - comprise the services we provide to clients. Equity
Investments and Proprietary Investing and Trading represent the activities we
undertake exclusively for our own account. For a complete description of our
business sectors, refer to the J.P. Morgan & Co. Incorporated 1997 Annual
report. Presented below are the summary results for each sector for the three
and nine months ended September 30, 1998 and 1997 and for the three months ended
June 30, 1998.
<TABLE>
<CAPTION>
Asset TOTAL
Finance Management CLIENT- Proprietary TOTAL
and Market and FOCUSED Equity Investing PROPRIETARY Corporate
In millions Advisory Making Servicing ACTIVITIES Investments and Trading ACTIVITIES Items Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
THIRD QUARTER 1998
Total revenues $413 (a) $260 $436 $1,109 $157 $121 $278 ($86) (b) $1,301
Total expenses 281 387 335 1,003 10 40 50 46 1,099
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 132 (127) 101 106 147 81 228 (132) 202
- -----------------------------------------------------------------------------------------------------------------------------------
THIRD QUARTER 1997
Total revenues 548 669 407 1,624 66 241 307 (15) 1,916
Total expenses 343 528 339 1,210 10 49 59 57 1,326
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 205 141 68 414 56 192 248 (72) 590
- -----------------------------------------------------------------------------------------------------------------------------------
INCREASE/(DECREASE), THIRD QUARTER 1998 VS. THIRD
QUARTER 1997
Total revenues (135) (409) 29 (515) 91 (120) (29) (71) (615)
Total expenses (62) (141) (4) (207) -- (9) (9) (11) (227)
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income (73) (268) 33 (308) 91 (111) (20) (60) (388)
- -----------------------------------------------------------------------------------------------------------------------------------
SECOND QUARTER 1998
Total revenues 588 920 445 1,953 108 58 166 34 (c) 2,153
Total expenses 366 565 362 1,293 11 48 59 64 1,416
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 222 355 83 660 97 10 107 (30) 737
- -----------------------------------------------------------------------------------------------------------------------------------
INCREASE/(DECREASE), THIRD QUARTER 1998 VS. SECOND
QUARTER 1998
Total revenues (175) (660) (9) (844) 49 63 112 (120) (852)
Total expenses (85) (178) (27) (290) (1) (8) (9) (18) (317)
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income (90) (482) 18 (554) 50 71 121 (102) (535)
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS 1998
Total revenues 1,565 (a) 2,099 1,283 4,947 290 417 707 (203)(d) 5,451
Total expenses 1,002 1,560 1,040 3,602 28 137 165 380 (e) 4,147
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 563 539 243 1,345 262 280 542 (583) 1,304
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS 1997
Total revenues 1,480 2,050 1,174 4,704 239 633 872 (36) 5,540
Total expenses 996 1,457 959 3,412 28 140 168 178 3,758
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 484 593 215 1,292 211 493 704 (214) 1,782
- -----------------------------------------------------------------------------------------------------------------------------------
INCREASE/(DECREASE), NINE MONTHS 1998 VS. NINE MONTHS 1997
Total revenues 85 49 109 243 51 (216) (165) (167) (89)
Total expenses 6 103 81 190 - (3) (3) 202 389
- -----------------------------------------------------------------------------------------------------------------------------------
Pretax income 79 (54) 28 53 51 (213) (162) (369) (478)
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes a third quarter 1998 provision for credit losses of $75 million.
(b) Includes a third quarter 1998 pretax gain of $56 million related to the sale
of the firm's investment management business in Australia.
(c) Includes a second quarter 1998 pretax gain of $131 million related to the
sale of the firm's global trust and agency services business.
(d) Includes 1998 pretax gains of $187 million related to business sales (see
notes b and c).
(e) Includes a first quarter 1998 pretax charge of $215 million related to the
restructuring of business activities.
METHODOLOGY:
The firm's management reporting system and policies were used to determine the
revenues and expenses directly attributable to each business sector. Earnings on
stockholders' equity were allocated based on management's assessment of the
inherent risk of the components of each sector. In addition, certain overhead
expenses not allocated for management reporting purposes were allocated to each
business sector. Overhead expenses were allocated based primarily on staff
levels and represent costs associated with various support functions that exist
for the benefit of the firm as a whole.
25
<PAGE> 26
The following table summarizes revenues by major activity included within each
of our business sectors for the three and nine months ended September 30, 1998
and 1997 and the three months ended June 30, 1998.
<TABLE>
<CAPTION>
Third Third Second Nine Nine
Quarter Quarter Increase/ Quarter Increase/ Months Months Increase/
In millions 1998 1997 (Decrease) 1998 (Decrease) 1998 1997 (Decrease)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES
Advisory & Underwriting $ 268 $ 328 ($ 60) $ 334 ($ 66) $ 942 $ 804 $ 138
Global Credit 145 (a) 220 (75) 254 (109) 623 (a) 676 (53)
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCE AND ADVISORY 413 548 (135) 588 (175) 1,565 1,480 85
- ------------------------------------------------------------------------------------------------------------------------------------
Fixed Income 56 333 (277) 377 (321) 893 864 29
Emerging Markets (56) 111 (167) 149 (205) 330 420 (90)
Equities 119 106 13 205 (86) 440 416 24
Foreign Exchange 138 99 39 147 (9) 377 302 75
Commodities 3 20 (17) 42 (39) 59 48 11
- ------------------------------------------------------------------------------------------------------------------------------------
MARKET MAKING 260 669 (409) 920 (660) 2,099 2,050 49
- ------------------------------------------------------------------------------------------------------------------------------------
Asset Management Services 270 259 11 277 (7) 798 758 40
Securities and Futures Services 166 148 18 168 (2) 485 416 69
- ------------------------------------------------------------------------------------------------------------------------------------
ASSET MANAGEMENT AND SERVICING 436 407 29 445 (9) 1,283 1,174 109
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CLIENT-FOCUSED REVENUES 1,109 1,624 (515) 1,953 (844) 4,947 4,704 243
- ------------------------------------------------------------------------------------------------------------------------------------
EQUITY INVESTMENTS 157 66 91 108 49 290 239 51
- ------------------------------------------------------------------------------------------------------------------------------------
PROPRIETARY INVESTING AND TRADING 121 241 (120) 58 63 417 633 (216)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROPRIETARY REVENUES 278 307 (29) 166 112 707 872 (165)
- ------------------------------------------------------------------------------------------------------------------------------------
CORPORATE ITEMS (86) (b) (15) (71) 34 (c) (120) (203) (d) (36) (167)
- ------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED REVENUES 1,301 1,916 (615) 2,153 (852) 5,451 5,540 (89)
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes a third quarter 1998 provision for credit losses of $75 million.
(b) Includes a third quarter 1998 pretax gain of $56 million related to the sale
of the firm's investment management business in Australia.
(c) Includes a second quarter 1998 pretax gain of $131 million related to the
sale of the firm's global trust and agency services business.
(d) Includes 1998 pretax gains of $187 million related to business sales (see
notes b and c).
The activities of our Fixed Income, Emerging Markets, and Equities businesses
are reflected across several sectors. Aggregate revenues for these businesses
for the nine months ended September 30 follows: Fixed Income - (1998) $1,284
million and (1997) $1,214 million; Emerging Markets - (1998) $301 million and
(1997) $508 million; and, Equities - (1998) $700 million and (1997) $647
million.
Private clients accounted for revenues of approximately $175 million and $520
million for the three and nine months ended September 30, 1998, respectively. Of
this amount, $44 million and $144 million were recorded in the Finance and
Advisory and Market Making sectors for the three and nine months ended September
30, 1998, respectively. Private clients accounted for revenues of approximately
$160 million and $438 million for the three and nine months ended September 30,
1997, respectively. Of this amount, $51 million and $136 million were recorded
in the Finance and Advisory and Market Making sectors for the three and nine
months ended September 30, 1997, respectively.
REVENUES in the third quarter of 1998 were $1.301 billion, down 32% from last
year and 40% from the 1998 second quarter, reflecting the global market
upheaval.
Revenues from client-focused activities, reported in the Finance and Advisory,
Market Making, and Asset Management and Servicing sectors, were $1.109 billion,
compared with $1.624 billion last year and $1.953 billion in the second quarter.
Revenues from Equity Investments and Proprietary Investing and Trading
activities were $278 million, versus $307 million in 1997.
26
<PAGE> 27
FINANCE AND ADVISORY
The Finance and Advisory sector includes results of our advisory, debt and
equity underwriting, and credit activities. Revenues were $413 million, down
from $548 million in the third quarter of last year and $588 million in the
second quarter of 1998.
Advisory and underwriting revenues were $268 million, $60 million lower than in
the 1997 third quarter. Advisory fees increased but underwriting revenues fell
as issuance activity across markets worldwide slowed significantly in the latter
half of the quarter. For the first nine months of 1998, Securities Data Co.
ranked us sixth in announced mergers and acquisitions worldwide. In completed
transactions Morgan ranked eighth, and market share advanced to 12.7% from 10.7%
last year. Morgan ranked ninth in U.S. equity lead underwriting with a market
share of 4.4%, up from 2.9% last year.
Revenues from credit activities in the quarter were $145 million and included a
provision for credit losses of $75 million. Excluding the provision, credit
revenues were flat compared with last year's quarter.
Finance and Advisory expenses in the third quarter of 1998 were $281 million
compared with $343 million in the third quarter of 1997 and $366 million in the
second quarter of 1998. The decrease primarily relates to lower compensation
accruals. This sector includes all the costs associated with our global network
of client relationship managers who market the full spectrum of our capabilities
and provide the link between our clients' needs and our capital raising,
advisory, asset management, market making, and risk management products and
services.
The Finance and Advisory sector recorded pretax income of $132 million in the
third quarter of 1998 compared with $205 million a year ago and $222 million in
the second quarter of 1998.
Revenues for the first nine months of 1998 increased to $1.565 billion from
$1.480 billion in 1997. Expenses for the same period were $1.002 billion versus
$996 million in the nine months ended September 30, 1997. Year-to-date pretax
income was $563 million in 1998, as compared to $484 million for the first nine
months of 1997.
MARKET MAKING
The Market Making sector includes results of our fixed income, emerging markets,
equities, foreign exchange, and commodities activities. Revenues totaled $260
million in the third quarter, compared with $669 million in the third quarter of
1997 and $920 million in the second quarter of this year. Results across
developed and emerging markets were affected by widening credit spreads,
illiquidity and price declines in many instruments, increases in market
volatility, and the breakdown of historical price relationships across markets.
Fixed income revenues declined to $56 million from $333 million in the 1997
quarter. The results included losses in corporate securities activities and
lower derivatives revenues. Emerging markets recorded a loss of $56 million
compared with revenues of $111 million in the 1997 quarter. The decline
primarily related to losses of approximately $130 million on Russian trading
account positions. Equities market making revenues increased $13 million to $119
million on strong commission volumes. Foreign exchange revenues of $138 million
were $39 million higher than in the third quarter of 1997. Strong client demand
and related trading in emerging market and G-7 currencies contributed to this
improvement.
Market making expenses were $387 million, a 27% decrease from the third quarter
of 1997 and a 32% decrease from the second quarter of 1998. The decrease
primarily relates to lower compensation accruals.
The Market Making sector recorded a pretax loss of $127 million in the third
quarter of 1998, compared with $141 million of pretax income in the third
quarter of 1997 and $355 million of pretax income in the second quarter of 1998.
Revenues for the nine month period were $2.099 billion compared with $2.050
billion a year earlier. Expenses for the same period were $1.560 billion
compared to $1.457 billion in the nine months ended September 30, 1997.
Year-to-date pretax income was $539 million in 1998, as compared to $593 million
for the first nine months of 1997.
ASSET MANAGEMENT AND SERVICING
The Asset Management and Servicing sector includes results of institutional
investment management and mutual funds, services for private clients, and
securities and futures services activities. Revenues were up 7% to $436 million
in the third quarter from a year ago and essentially unchanged from the 1998
second quarter.
Revenues from asset management increased $23 million or 9% from a year ago,
excluding the effect of our partnership with American Century, driven by growth
in investment management fees of 11%. Including American Century, asset
management revenues were $270 million, up $11 million. Assets
27
<PAGE> 28
under management were $278 billion at September 30, 1998, compared with $244
billion at September 30, 1997, and $302 billion at June 30, 1998. The decline
from the previous quarter was principally caused by the worldwide weakness in
equity prices.
Revenues from private client services across our business sectors rose 9% to
$175 million from the 1997 quarter. Despite the turbulent market environment,
investment management and liquidity management revenues rose, while brokerage
commissions remained stable.
On October 1, 1998, J.P. Morgan and the Dai-Ichi Kangyo Bank, Limited agreed to
form an integrated joint venture to offer investment trusts (i.e., mutual funds)
to retail customers in Japan.
Revenues from securities and futures services rose nearly 20% to $166 million,
excluding prior year revenues of the global trust and agency services business,
which was sold in June 1998. The increase included record results in futures and
options brokerage.
Asset Management and Servicing expenses were $335 million in the third quarter
of 1998, compared with $339 million in the third quarter of 1997 and $362
million in the second quarter of 1998.
The Asset Management and Servicing sector recorded pretax income of $101 million
in the third quarter of 1998, compared with $68 million in the year-earlier
period and $83 million in the second quarter of 1998.
Revenues for the nine month period increased to $1.283 billion from $1.174
billion a year earlier. Expenses for the same period were $1.040 billion versus
$959 million for the nine months ended September 30, 1997. Year-to-date pretax
income was $243 million, as compared to $215 million for the first nine months
of 1997.
EQUITY INVESTMENTS
The Equity Investments sector includes results from our proprietary equity
investments portfolio management activities. Reported revenues were $157 million
in the third quarter, compared with $66 million a year ago and $108 million in
the 1998 second quarter. Gains of $197 million this quarter primarily related to
an investment in the insurance industry. Offsetting these gains were write-downs
of $48 million mostly related to investments in Latin America. Equity
investments recorded pretax income of $147 million in the third quarter of 1998,
compared with $56 million in the third quarter of 1997 and $97 million in the
second quarter of 1998.
Revenues for the nine month period were $290 million, as compared with $239
million a year earlier. Year-to-date pretax income was $262 million in 1998, as
compared to $211 million for the first nine months of 1997.
The downturn in equity markets caused total return - reported revenues and the
change in net unrealized appreciation - to be negative $90 million compared with
$176 million in the 1997 third quarter and negative $48 million last quarter.
Total return for the nine months ended September 30, 1998 was negative $53
million compared with $363 million for the nine months ended September 30, 1997.
PROPRIETARY INVESTING AND TRADING
The Proprietary Investing and Trading sector includes results from our market
and credit risk positioning and capital and liquidity management activities.
Revenues were $121 million in the 1998 third quarter, compared with $241 million
a year ago and $58 million in the 1998 second quarter. The Proprietary Investing
and Trading sector recorded pretax income of $81 million in the third quarter of
1998, compared with $192 million in the same period a year ago and $10 million
in the 1998 second quarter.
Revenues for the nine months of 1998 were $417 million as compared to $633
million a year earlier. Year-to-date pretax income was $280 million in 1998, as
compared to $493 million for the first nine months of 1997.
Total return - reported revenues and the change in net unrealized appreciation -
for the 1998 third quarter was $141 million, compared with $173 million last
year and $69 million for the 1998 second quarter. Total return for the nine
month period ended September 30, 1998 was $390 million, as compared to $597
million for the nine months ended September 30, 1997.
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<PAGE> 29
CORPORATE ITEMS
Corporate Items includes revenues and expenses not allocated to business
sectors, intercompany eliminations, equity in earnings of certain affiliates,
taxable-equivalent adjustments, and results of sold or discontinued businesses.
For the third quarter of 1998, Corporate Items includes the $56 million pretax
net gain on the sale of the firm's investment management business in Australia.
In addition to the third quarter gain, Corporate Items, for the first nine
months of 1998, includes the second quarter $131 million pretax net gain on the
sale of our global trust and agency services business and the first quarter
pretax charge of $215 million related to the restructuring of business
activities.
Corporate items for the nine months of 1997 includes $80 million of gains on
hedges of anticpated foreign currency revenues and expenses. These gains were
partially offset by the impact of exchange rate movements on reported revenues
and expenses in the year-to-date period. Corporate items in 1997 also includes
a charge of $28 million incurred in connection with the renovation of office
space in New York.
29
<PAGE> 30
FINANCIAL REVIEW
REVENUES
Revenues were $1.301 billion in the third quarter of 1998, compared with $1.916
billion in the year ago quarter and $2.153 billion in the second quarter of
1998. For the nine months ended September 30, 1998, revenues were $5.451 billion
versus $5.540 billion in the same period a year ago.
Net interest revenue, the aggregate of interest revenue and expense generated
from the firm's client-focused and proprietary activities using a variety of
asset, liability, and off-balance sheet instruments, decreased 30% to $332
million from the third quarter of 1997. This decrease resulted from lower net
interest revenue from our market-making activities and proprietary investing
positions. Net interest revenue increased 15% from $290 million in the second
quarter of 1998. For the first nine months of 1998, net interest revenue
decreased 32% to $958 million from the corresponding 1997 period.
Trading revenue, excluding trading-related net interest revenue, decreased to
$119 million in the third quarter of 1998 from $657 million a year ago and $877
million in the second quarter of this year. Year-to-date trading revenue
increased to $1.892 billion from $1.831 billion for the first nine months of
1997. The following table presents trading revenue, disaggregated by principal
product groupings across all of our business sector activities, and total
trading-related net interest revenue. This revenue reflects only a portion of
the total revenues generated by our activities, and excludes other important
sources of revenue, including fees and commissions. As a result, this table does
not reflect the integrated nature of our business as described in Business
Sector Analysis (see pages 25-29).
<TABLE>
<CAPTION>
Total Net
Fixed Foreign Commod- Proprietary Trading Interest Combined
In millions Income Equities Exchange ities Trading Revenue Revenue Total
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Third quarter 1998 ($95) ($6) $158 $5 $57 $119 $92 $211
Third quarter 1997 416 51 78 17 95 657 118 775
- -----------------------------------------------------------------------------------------------------------------------------
Second quarter 1998 532 109 170 40 26 877 74 951
- -----------------------------------------------------------------------------------------------------------------------------
Nine months 1998 1,078 160 393 55 206 1,892 275 2,167
Nine months 1997 1,012 332 270 32 185 1,831 399 2,230
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Fixed income trading revenue was a $95 million loss in the 1998 third quarter,
compared with $416 million of revenue a year earlier and $532 million of revenue
in the 1998 second quarter. The loss reflects lower revenues in corporate
securities and derivatives in our activities in developed markets, and losses in
emerging markets activities, primarily related to Russia. Trading revenue from
equities was a $6 million loss in the current quarter compared with $51 million
of revenue a year ago and $109 million of revenue in the second quarter of 1998.
The decline reflects lower positioning results in both secondary and derivative
market making activities. Foreign exchange trading revenue was $158 million in
the current quarter, compared with $78 million of revenue a year ago. Strong
client demand and related trading in emerging and G-7 currencies contributed to
this improvement. Foreign exchange trading revenue was $170 million in the
second quarter of 1998. Trading revenue from commodities decreased to $5 million
from $17 million in the year-earlier quarter and $40 million last quarter.
Proprietary trading revenue was $57 million, $95 million, and $26 million for
the three months ended September 30, 1998, September 30, 1997, and June 30,
1998, respectively.
Investment banking revenue was $312 million, $8 million lower than in the 1997
third quarter and $50 million lower than in the 1998 second quarter.
Underwriting revenue fell to $83 million from $132 million in the year-earlier
quarter and $164 million in the 1998 second quarter as issuance activity across
markets worldwide slowed significantly in the latter half of the third quarter.
Advisory and syndication fees rose to $229 million from $188 million a year ago
and $198 million in the 1998 second quarter. Investment banking revenue for the
first nine months of 1998 was $1.020 billion, compared with $840 million for the
first nine months of 1997. Underwriting revenue for the first nine months of
1998 was $402 million, versus $369 million for the same 1997 period. Advisory
and syndication fees for the first nine months of 1998 were $618 million,
compared to $471 million for the same period of 1997.
30
<PAGE> 31
Investment management revenue increased 11% to $224 million in the 1998 third
quarter from a year ago and was essentially unchanged with the 1998 second
quarter. Assets under management were $278 billion at September 30, 1998,
compared with $244 billion a year ago and $302 billion at June 30, 1998. The
decline from the second quarter of 1998 was principally caused by the worldwide
weakness in equity prices. Investment management revenue for the first nine
months of 1998 increased 13% to $661 million, over the same 1997 period.
Fees and commissions were $182 million, up 11% from $164 million in the year-ago
quarter and down 8% from last quarter. The increase from last year primarily
reflects higher equity commissions and very strong results in futures and
options brokerage, offset by fees of $28 million paid to credit derivative
providers as part of our credit exposure reduction initiatives. Results were
down from the second quarter primarily as a result of such fees paid to credit
derivative providers. For the first nine months of 1998, fees and commissions
revenue was $569 million compared to $468 million in the same 1997 period.
Investment securities revenue was $136 million in the third quarter of 1998
compared to $67 million in the prior year quarter and $68 million in the second
quarter of 1998. Gains from positions associated with our Equity Investment
activities, including securities in Small Business Investment Companies, were
$197 million in the current quarter and primarily related to the sale of an
investment in the insurance industry. Offsetting these gains were write-downs
of $48 million mostly related to investments in Latin America. Net gains were
$38 million a year ago and $108 million last quarter. Also included in
investment securities revenue in the current quarter were net realized losses
on sales of debt investment securities of $21 million. This compares with net
realized losses of $1 million and $43 million in the year-ago quarter and 1998
second quarter, respectively. For the current nine month period, investment
securities revenue was $247 million, versus $242 million for the first nine
months of 1997.
Other revenue was $71 million in the third quarter, compared with $35 million a
year earlier and $133 million last quarter. For the third quarter of 1998, Other
revenue included the $56 million net pretax gain on the sale of the firm's
investment management business in Australia. Other revenue for the first nine
months of 1998 was $179 million, compared with $158 million for the first nine
months of 1997. In addition to the third quarter gain, the nine months of 1998
include a second quarter net pretax gain of $131 million on the sale of the
firm's global trust and agency services business.
OPERATING EXPENSES
Operating expenses were $1.099 billion in the third quarter, down 17% from a
year ago and down 22% from last quarter. Compensation costs declined nearly 30%
from the prior year, mostly because of lower compensation accruals.
Non-compensation costs were flat versus the year-ago period and down 4% from the
second quarter of 1998. Costs to prepare for the Year 2000 ($27 million) and
European Economic and Monetary Union ($18 million) totaled $45 million in the
quarter, up from $28 million a year ago (see pages 37-39). For the nine months
ended September 30, 1998, operating expenses were $4.147 billion, including the
first quarter 1998 pretax charge of $215 million related to the restructuring of
business activities. This compares to $3.758 billion of operating expenses for
the first nine months of 1997. Costs to prepare for the Year 2000 and European
Economic and Monetary Union totaled $155 million for the nine months ended
September 30, 1998, up from $44 million a year ago.
We have intensified the productivity initiative announced earlier this year. We
expect to exceed our previously disclosed target of $300 million to $500 million
in annualized savings, reducing core expenses in 1999 by $400 million and
reinvesting the balance of the savings. In light of market conditions and
ongoing productivity initiatives, individual business units are adjusting their
resource levels. These adjustments will result in a fourth quarter charge,
consisting mainly of personnel-related and occupancy costs.
At September 30, 1998, staff totaled 16,155 employees, compared with 16,045 at
June 30, 1998, 16,943 at December 31, 1997, and 16,525 employees at September
30, 1997.
Income-tax expense in the third quarter totaled $46 million, based on an
effective tax rate of 23%, compared with an effective rate of 33% in the
year-earlier quarter and 35% in the second quarter of 1998. The decrease in the
effective tax rate reflects lower pretax income. The effective tax rate was 33%
for the nine months ended September 30, 1998 and September 30, 1997.
ASSETS
Total assets were $299 billion at September 30, 1998, compared with $281 billion
at June 30, 1998 and $262 billion at December 31, 1997.
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<PAGE> 32
CREDIT-RELATED ITEMS
Market dislocations in the third quarter evidence a significant shift in the
global risk environment. We have responded by closely managing our credit
exposures and selectively reducing risk concentrations.
Exposures to key emerging markets reduced 45% year-to-date
We continued to manage down exposures to key emerging markets to reflect the
increased risk associated with these assets. Asian exposures (excluding Japan)
at September 30, 1998, were down more than 50% from December 31, 1997. Latin
American exposures declined nearly 40%. At quarter end, cross-border exposures
to Asia and Latin America based upon management's view of exposure were $4.5
billion and $5.0 billion respectively; local exposures were $0.1 billion and
$2.1 billion. These exposures consist of loans and commitments to lend as well
as the fair values of derivatives, securities in trading accounts, and debt
investment securities. In addition, we charged off our Russian credit and
settlement counterparty exposure of $50 million. Remaining Russian government
exposure as of September 30 consisted of approximately $65 million of net
trading assets. See page 42 for further information on exposures to certain
emerging markets based upon management's view of total exposure as of September
30, 1998.
Exposures to hedge funds substantially collateralized
The net amount owed J.P. Morgan by hedge funds under derivative and foreign
exchange contracts on a mark-to-market basis was approximately $0.9 billion as
of September 30, 1998. Substantially all of this amount is secured by cash and
U.S. Treasury and agency securities, under daily mark-to-market collateral
agreements. We also finance trading positions for hedge funds through reverse
repurchase agreements. The net amount of collateral owed the firm under
derivative and foreign exchange contracts and short-term financing agreements
was approximately $100 million. In addition, we have unsecured loans and
commitments to lend of approximately $40 million.
J.P. Morgan also made a $300 million equity investment on September 28, 1998 in
Long-Term Capital Management, L.P., as part of the consortium of firms
recapitalizing that entity. This investment is being accounted for under the
equity method of accounting.
Provision for credit losses of $75 million
We recorded a provision for credit losses of $75 million in the quarter,
bringing the aggregate allowance for credit losses after net charge-offs to $914
million, compared with $904 million at June 30, 1998 and $1.081 billion at
December 31, 1997. Net charge-offs for the three months ended September 30, 1998
were $65 million and primarily related to exposures in Russia. The allowance
reflects our quantitative and qualitative assessment of expected credit losses.
It includes allocations to specific counterparties and countries, primarily in
Asia. It also includes allocations that reflect the risks inherent in our
overall portfolio, including increased risks in emerging markets outside Asia.
However, the entire allowance remains available to absorb any losses inherent in
our extensions of credit.
Nonperforming assets at September 30, 1998, were $593 million, versus $588
million at June 30, 1998 and $659 million at December 31, 1997. Assets newly
classified as nonperforming during the quarter were nearly offset by a
combination of charge-offs and repayments. Nonperforming assets consist
primarily of swaps with certain Asian countries.
32
<PAGE> 33
CAPITAL
STOCKHOLDERS' EQUITY
Total stockholders' equity was approximately $11.5 billion at September 30,
1998. Stockholders' equity included approximately $292 million of net unrealized
appreciation on debt investment securities and marketable equity investment
securities, net the related deferred tax liability of $202 million. The net
unrealized appreciation on debt investment securities was $410 million at
September 30, 1998. The net unrealized appreciation on marketable equity
investment securities was $84 million at September 30, 1998. Included in the
table below are selected ratios based upon stockholders' equity.
<TABLE>
<CAPTION>
September 30 December 31 September 30
Dollars in billions, except share data 1998 1997 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Total stockholders' equity $ 11.5 $ 11.4 $ 11.6
Annualized rate of return on average common stockholders'
equity (a)(b) 5.3%(c) 9.7% 14.3%
As percent of period-end total assets:
Common equity 3.6% 4.1% 4.1%
Total equity 3.9% 4.4% 4.3%
Book value per common share (d) $ 56.22 $ 55.99 $ 56.83
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Represents the annualized rate of return on average common stockholders'
equity for the three months ended September 30, 1998, December 31, 1997, and
September 30, 1997. Excluding the impact of SFAS No. 115, the annualized rate of
return on average common stockholders' equity would have been 5.4%, 10.2%, and
15.0% for the three months ended September 30, 1998, December 31, 1997, and
September 30, 1997, respectively.
(b) The annualized rate of return on average common stockholders' equity for the
nine months ended September 30, 1998 and 1997 was 10.3% and 14.7% (including the
impact of SFAS No. 115), respectively, and 10.8% and 15.4% (excluding the impact
of SFAS No. 115), respectively. Excluding the 1998 third quarter after tax gain
of $34 million ($56 million before tax) related to the sale of the firm's
investment management business in Australia; excluding the 1998 second quarter
after tax gain of $79 million ($131 million before tax) related to the sale of
the firm's global trust and agency services business; and excluding the 1998
first quarter after tax charge of $129 million ($215 million before tax) related
to the restructuring of business activities, the annualized rate of return on
average common stockholders' equity was 10.5% (including the impact of SFAS No.
115) and 11.0% (excluding the impact of SFAS No. 115) for the nine months ended
September 30, 1998.
(c) Excluding the 1998 third quarter after tax gain of $34 million ($56 million
before tax) related to the sale of the firm's investment management business in
Australia, the annualized rate of return on average common stockholders' equity
was 4.0% (including the impact of SFAS No. 115) and 4.2% (excluding the impact
of SFAS No. 115) for the three months ended September 30, 1998.
(d) Excluding the impact of SFAS No. 115, the book value per common share would
have been $54.70, $53.74, and $53.73 at September 30, 1998, December 31, 1997,
and September 30, 1997, respectively.
During the third quarter, the firm purchased approximately 2.6 million shares of
its common stock for a total of 6.3 million shares in the year to date. These
purchases are pursuant to the Board of Directors' December 1997 authorization to
purchase up to 7 million shares of J.P. Morgan common stock, to lessen the
dilutive impact on earnings per share of the firm's employee benefit plans.
These purchases may be made in 1998 or beyond in the open market or through
privately negotiated transactions.
REGULATORY CAPITAL REQUIREMENTS
The capital of J.P. Morgan and Morgan Guaranty Trust Company of New York (Morgan
Guaranty) remained well above the minimum standards set by regulators at
September 30, 1998. Further, the capital ratios of J.P. Morgan and Morgan
Guaranty exceeded the minimum standards for a well capitalized bank holding
company and bank, respectively, at September 30, 1998.
At September 30, 1998, under the Federal Reserve Board market risk capital
guidelines for calculation of risk-based capital ratios, J.P. Morgan's tier 1
and total risk-based capital ratios were 7.6% and 11.2%, respectively; the
leverage ratio was 4.0%. At December 31, 1997, J.P. Morgan's tier 1 and total
risk-based capital ratios were 8.0% and 11.9%, respectively, and the leverage
ratio was 4.4%. Refer to note 19, Capital Requirements, for further information.
Risk-adjusted assets represent the total of all on- and off- balance sheet
exposures adjusted for risk-based factors as prescribed by the Federal Reserve
Board. J.P. Morgan's risk-adjusted assets as of September 30, 1998 were $148.9
billion, compared with $148.9 billion at June 30, 1998. At December 31, 1997,
risk-adjusted assets were $148.5 billion.
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<PAGE> 34
FORWARD-LOOKING STATEMENTS
Certain sections of our Form 10-Q contain forward-looking statements. We use
words such as "expects," "believe," "anticipates," "estimates" or similar
expressions to identify these statements. In particular, disclosures made in
Financial Highlights, The Year 2000 initiative, and Economic and Monetary Union
in Europe contain forward-looking statements. Such forward looking statements
are based on our current expectations and are subject to various risks and
uncertainties as discussed in the Business environment and other information
and Risk Management sections of our 1997 Annual Report. J.P. Morgan claims the
protection afforded by the safe harbor for forward-looking statements contained
in the Private Securities Litigation Reform Act of 1995. Actual results could
differ materially from those currently anticipated due to a number of factors
in addition to those discussed elsewhere in this document and in the firm's
other public filings, press releases and discussions with management,
including:
- economic and market conditions (including the liquidity of secondary
markets)
- volatility of market prices, rates, and indices
- timing and volume of market activity
- availability of capital
- inflation
- political events (including legislative, regulatory, and other
developments)
- competitive forces (including the ability to attract and retain highly
skilled individuals)
- the ability to develop and support technology and information systems
- investor sentiment
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<PAGE> 35
RISK MANAGEMENT
The major risks associated with our business are:
- - Market risk - the risk of loss due to movements in market prices and rates
- - Liquidity risk - the risk of being unable to fund our portfolio of assets
at reasonable rates and to appropriate maturities
- - Credit risk - represents the probability that corporations, non-bank
financial institutions, governments, banks, and individuals (collectively
referred to as counterparties) will default on their obligations to us
- - Operating risk - the potential for loss arising from breakdowns in our
policies and controls for ensuring the proper functioning of our people,
systems, and facilities
We have developed comprehensive risk management processes to facilitate,
control, and monitor risk taking. These processes are built on a foundation of
early identification and measurement. They continually evolve as our business
activities change in response to market, credit, product, and other
developments. We constantly seek to strengthen our risk monitoring process.
Periodic reviews by internal auditors, regulators, and independent accountants
subject our practices to additional scrutiny and further strengthen our process.
Please refer to our 1997 Annual report for a detailed discussion of how we
manage risk.
MARKET RISK
Market risk profiles
Market risk arises from trading and investing activities undertaken by both
client-related and proprietary businesses. Our primary tool for measuring and
monitoring market risk is referred to as Daily Earnings at Risk (DEaR). DEaR is
an estimate, at a 95% confidence level, of the worst expected loss in the value
of our portfolios over a one-day time horizon. The DEaR measure takes into
account numerous variables that may cause a change in the value of our
portfolios, including interest rates, foreign exchange rates, securities and
commodities prices, and their volatilities, as well as correlations among these
variables.
The measurement of DEaR is only one element of market risk management.
Particularly when markets experience extreme conditions, as in the third
quarter, the management of risks calls for a proactive hands-on approach, with
special sensitivity to the impact that extreme changes in volatility and market
correlations can have on what, in normal markets, are low risk positions. Market
conditions in the third quarter - including extreme increases in volatility and
widespread breakdowns in historical market correlations - more closely
approximated those simulated in our stress testing than those used in our normal
DEaR estimates. While such conditions caused the actual volatility of trading
results to exceed our estimates in terms of our value at risk measures,
quantitative measures are only part of our risk management process. Judgment and
experience, as always, play a crucial role in allowing us to assess on a daily
basis that our level of market risk is consistent with our tolerance for that
risk.
The following presents the market risk profiles for the firm. The level of
market risk, which is measured on a diversified basis, will vary with market
factors, the level of client activity, and price and market movements.
Quarterly market risk profile
Aggregate DEaR, which presents the market risk profile for firmwide trading and
investing activities combined, rose to $68 million at the end of the third
quarter compared with $35 million at June 30, 1998. DEaR in our trading
activities increased from $34 million at the end of June to $43 million at
September 30, 1998 as increased volatility more than offset reductions in the
size of positions. DEaR for our investing activities was $39 million at
September 30, 1998, up from $13 million on June 30, 1998 reflecting increased
holdings of U.S. government agency mortgage-backed securities in our investment
securities portfolio. Unprecedented market volatilities during the
August-September period caused actual results to be more volatile than
estimates predicted by our DEaR models during the quarter.
Twelve-month market risk profile
Aggregate DEaR
Aggregate DEaR averaged $40 million for the twelve months ended
September 30, 1998 and ranged from $25 million to $72 million. For the twelve
months ended December 31, 1997, average aggregate DEaR was $29 million and
ranged from $22 million to $37 million. At September 30, 1998, aggregate DEaR
was $68 million versus $31 million at December 31, 1997. The increase in
aggregate DEaR primarily reflects increased holdings in our investment portfolio
of U.S. government agency mortgage-backed securities.
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<PAGE> 36
DEaR for trading activities
Average DEaR for trading activities was $36 million and ranged from $23 million
to $55 million for the twelve months ended September 30, 1998. For the twelve
months ended December 31, 1997, average DEaR for trading activities was $23
million and ranged from $15 million to $35 million. This increase reflects
higher market volatilities, partially offset by the reductions of the size of
our positions. The twelve month average and period-end DEaR for September 30,
1998 and December 31, 1997, segregated by type of market risk exposure
associated with our trading activities, is presented in the table below.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
Twelve months ended Period-end
----------------------------- -----------------------------
September 30 December 31
1998 1997 September 30 December 31
In millions Average Average 1998 1997
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate risk $ 27 $ 20 $ 35 $ 26
Foreign exchange risk 19 7 15 12
Equity price risk 12 8 14 13
Commodity price risk 3 3 3 4
Diversification effects (25) (15) (24) (27)
- -------------------------------------------------------------------------------------------
Total 36 23 43 28
- -------------------------------------------------------------------------------------------
</TABLE>
Our primary market risk exposures related to the above risks are as follows:
Interest rate risk
Interest rate risk is the risk that changes in interest rates will affect the
value of financial instruments. Our primary risk exposures to interest rates
from trading activities originate in sovereign and corporate bond markets across
North America, Europe, Asia and Latin America; mortgage-backed security markets
in the U.S.; and interest rate derivatives. They also include yield curve, vega,
and basis risk primarily concentrated in our European and American trading
activities. Instruments such as interest rate swaps, options, U.S. government
securities, and future and forward contracts are used, in connection with
diversification management strategies, to manage our exposure to interest rate
risk.
Foreign exchange rate risk
Foreign exchange rate risk represents the possibility that fluctuations in
foreign exchange rates will impact the value of our financial instruments. Our
primary risk exposures to foreign exchange rate risk arises from transactions
and activities denominated in currencies other than the U.S. dollar, in
particular the currencies of G-7 countries. We execute transactions in foreign
currencies in all major countries and most minor currencies throughout North
America, Europe, Latin America and Asia. We manage the risk arising from foreign
currency transactions primarily through the use of currency swaps, options, and
future and forward contracts.
Equity price risk
Equity price risk arises from the possibility that equity security prices will
fluctuate, affecting the value of equity securities and other instruments that
derive their value from a particular stock, a defined basket of stocks, or a
stock index. Our primary risk exposure to equity price risk arises from our
activities in our equity derivative portfolios. We manage the risk of loss, due
to unexpected price fluctuations, primarily through the use of equity option
contracts.
Given the nature of our business, we expect frequent changes to our primary risk
exposures over the course of a year. Our approach to managing market risk
considers this expectation.
We evaluate the reasonableness of DEaR for our trading activities by comparing
DEaR to actual trading results. During the twelve month period, there was a
greater number of occurences where actual daily revenue fell short of average
daily revenue by amounts larger than related DEaR estimates than was consistent
with statistical expectations. This resulted from unprecedented increases in
market volatilities, primarily in the third quarter, which caused actual trading
results to be more volatile than estimates predicted by our DEaR models.
DEaR for proprietary investing activities
Average DEaR for our proprietary investing activities for the twelve months
ended September 30, 1998 was $17 million, and ranged from $8 million to $40
million. This compares with average DEaR of $16 million and a range from $10
36
<PAGE> 37
million to $25 million for the twelve months ended December 31, 1997. At
September 30, 1998 and December 31, 1997, DEaR for our proprietary investing
activities was $39 million and $15 million, respectively. The increase in DEaR
reflects increased holdings of U.S. government agency mortgage-backed securities
in our investing portfolio.
The primary sources of market risk associated with our proprietary investing
activities relate to interest rate risk associated with fixed income securities
and spread risk associated with our mortgage-backed securities portfolio. Spread
risk is the possibility that changes in credit spreads will affect the value of
our financial instruments.
Due to the longer-term nature of our investing activities, we use a weekly time
horizon to evaluate our risk estimates relative to total return. For the twelve
month period ended September 30, 1998, the number of times weekly total return
fell short of expected weekly results by amounts greater than related weekly
risk estimates was consistent with statistical expectations.
OPERATING RISK
The Year 2000 initiative
With the new millennium approaching, organizations are examining their computer
systems to ensure they are Year 2000 compliant. The issue, in simple terms, is
that many existing computer systems use only two numbers to identify a year in
the date field with the assumption that the first two digits are always 19. As
the century is implied in the date, on January 1, 2000, computers that are not
Year 2000 compliant will assume the year is 1900. Systems that calculate,
compare, or sort using the incorrect date will cause erroneous results, ranging
from system malfunctions to incorrect or incomplete transaction processing. If
not remedied, potential risks include business interruption or shutdown,
financial loss, reputation loss, regulatory actions and/or legal liability.
J.P. Morgan has undertaken a firmwide initiative to address the Year 2000 issue
and has developed a comprehensive remediation plan to mitigate the internal and
external risks to the firm. The internal components of the initiative address
applications, technology products and facilities; the external components
address credit and operating risk. Each line of business has taken
responsibility for remediating within its own area of operation, for addressing
all interdependencies within the firm, and for identifying and managing risk
posed by external entities, including suppliers, clients, non-client
counterparties and utilities. A multidisciplinary team of internal and external
experts supports the business teams by providing direction and firmwide
coordination.
The remediation plan for applications consists of the following five phases:
- - The awareness phase includes launching a firmwide awareness campaign;
developing and implementing an organizational model; setting up a
management oversight committee; and establishing a risk model.
- - The inventory/assessment phase includes conducting a firmwide inventory of
information technology (IT) and non-IT (i.e., telecommunications, power,
facilities, etc.) applications and products; documenting business
processes; and identifying external interfaces and dependencies (agencies,
counterparties, correspondents, exchanges, etc.). This phase also includes
assessing the potential impact on these inventories; prioritizing
renovation activities; developing renovation plans; and determining the
compliance status of vendor supplied applications.
- - The renovation/replacement phase includes identifying "replace vs.
renovate" opportunities; renovating applications and products; and
documenting code and system changes.
- - The testing phase includes establishing a consistent testing methodology;
conducting unit and system tests; and receiving certification sign-off from
senior business managers.
- - The implementation phase includes implementing critical updated
applications and products and conducting final compliance certification.
Working together, the business and multidisciplinary teams completed the
awareness phase in the first quarter of 1997 and inventory/assessment in the
second quarter of 1997. We expect to substantially complete the renovation and
testing of high criticality applications and technology products by the end of
1998. However, competing business priorities, particularly the Economic and
Monetary Union in Europe (EMU), could delay achievement of this goal into 1999.
The remaining exceptions, as well as our non-key systems, are scheduled to be
completed and substantially implemented into production by June 30, 1999. We
have championed and participated successfully in industry-wide testing
including the Securities Industry Association- sponsored Equities Beta Test and
Futures Industry Association-sponsored Futures and Options Beta Test.
37
<PAGE> 38
We have commenced work on assessment and mitigation of external risks.
Assessment of the readiness of clients is underway, and we are developing
scenario plans to track the impact and likelihood of key events occurring which
will impact our ability to conduct business. The plans identify trigger points
to action contingencies which will mitigate risk on a timely basis.
Based on currently available information, management does not believe that the
Year 2000 issue related to our internal systems will have a material adverse
impact on the firm's financial condition or overall trends in results of
operations. With regards to external dependencies, there can be no assurance
that the failure to ensure Year 2000 capability by a third party would not have
a material adverse effect on the firm. To date we have not received sufficient
information from certain parties and international markets to complete our
external assessment. The failure of external parties to resolve their own Year
2000 issues in a timely manner could expose J.P. Morgan to the potential for
loss, impairment of business processes and activities, and disruption of
financial markets. We are working with key external parties, including clients,
counterparties, vendors, exchanges, depositories, utilities, suppliers, agents
and regulatory agencies, to stem the potential risks the Year 2000 problem poses
to us and to the global financial community.
For potential failure scenarios where the risk to the firm is deemed significant
and where such risk is considered to have a higher probability of occurrence, we
will develop business recovery/contingency plans. These plans, which will be
developed in the first half of 1999, will define the infrastructure that should
be put in place for managing a failure during the millennium event itself.
Costs to prepare the firm for Year 2000 are estimated at $300 million, up from
the $250 million previously disclosed. The increase provides for additional
tasks necessary to address risk due to external failures, over and above the
effort which was previously estimated for this work; this reflects our
increasing concern over lack of external readiness.
Costs incurred relating to this project are funded through operating cash flow
and expensed during the period in which they are incurred. The firm's
expectations about future costs associated with the Year 2000 are subject to
uncertainties that could cause actual results to differ materially from those
anticipated. Through September 30, 1998, costs incurred approximated $207
million ($95 million in 1997; $112 million in nine months ended September 30,
1998).
Economic and Monetary Union in Europe
EMU refers to the movement towards economic and monetary union in Europe with
the ultimate goal of introducing a single currency called the euro. Monetary
union will have profound financial and political implications. It removes the
existence of different currencies, monetary policies, and, to some degree,
fiscal policies from Europe's financial markets. It effectively brings about a
merger of the capital markets of the EMU participants. In the second quarter,
financial ministers of the European Union certified 11 states to launch the
single currency. The countries joining EMU in the first wave are: Austria,
Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands,
Portugal, and Spain. The remaining four EU members are Britain, Greece, Sweden
and Denmark. While the movement toward the euro has reduced client demand for
certain transactions, which has impacted our foreign exchange and fixed income
activities in Europe, we anticipate new opportunities in Europe will be created
through an expansion of activities in both the investment grade and high yield
debt capital markets. Overall, management anticipates that the formation of EMU
will not materially affect the trend of earnings of the firm.
J.P. Morgan has been actively involved in preparing for EMU and has developed a
firmwide remediation plan to enable a successful transition to the euro. J.P.
Morgan is committed to having all areas of the firm prepared for EMU before the
scheduled start date of January 1, 1999. A dedicated cross-functional team has
been assigned to assess the impact on the firm's global infrastructure and to
drive the implementation of the changeover across the firm. Many areas of the
firm will be affected by the introduction of the single currency. As with the
Year 2000 issue, EMU poses various operating risks. EMU requires many changes to
our operations and technology, including currency conversions, modifications of
payment and settlement systems, and the redenomination of securities. Our
remediation plan consists of the following five phases:
- - The impact assessment phase includes identifying the key systems,
operations and requirements that need to change as a result of EMU. This
phase also consists of establishing general cost estimates for conversion
of each business within the firm.
38
<PAGE> 39
- - The analysis phase includes a detailed analysis and process redesign based
upon the requirements of the impact assessment and the changes needed to
accommodate new products and business strategies.
- - The implementation planning phase includes creating detailed plans for the
conversion process over the conversion weekend.
- - The testing phase includes testing all systems and operations at every
level of the firm. We intend to do a series of "dry run" tests for the
conversion weekend and are also participating in national systems testing
with France, Germany and Italy.
- - The conversion weekend phase includes switching over all of our systems
and operations so that business can resume on January 4, 1999.
We completed the impact assessment phase in July, 1997; the analysis phase in
February, 1998; and the implementation planning phase in May, 1998. We commenced
the testing phase in September, 1998 and expect to be substantially completed in
November, 1998. We are now directing our efforts toward planning the conversion
weekend (January 1-3, 1999). As part of our conversion weekend phase, we are
establishing detailed contingency plans. The contingency plans will provide
mechanisms to assess and communicate the impact of any delays, and to resolve as
quickly as possible any deviation from the conversion plan using an established
chain-of-command. We will have a Central Conversion Center (CCC) based in London
to oversee the conversion process at a firmwide level. The CCC will include
members of senior management who will be able to make critical decisions if we
experience any operational delays over the conversion weekend. We will also have
Business Conversion Centers and Location Control Centers to coordinate
activities within each of our product areas and in key locations.
Costs to prepare for EMU in 1998 are expected to be approximately $65 million,
of which $43 million has been incurred in the first nine months of 1998.
The above section on The Year 2000 initiative and Economic and Monetary Union
in Europe contains forward-looking statements including, without limitation,
statements relating to the firm's plans, expectations, intentions, and adequate
resources, that are made pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. Estimates are based on
assumptions of future events, including the availability of resources,
third-party renovation plans and other factors. However, there can be no
guarantee that our estimates will be achieved, or that there will not be a
delay in, or increased costs. Specific factors that could cause actual results
to differ materially from our estimates include, but are not limited to, the
availability and cost of resources, the ability to locate and correct all
relevant non-compliant systems, timely responses to and renovations by
third-parties, and similar uncertainties. Refer to page 34 for more information
on forward-looking statements.
39
<PAGE> 40
ASSET-QUALITY ANALYSIS
NONPERFORMING ASSETS
The following table presents nonperforming assets - net of charge-offs -
organized by the location of the counterparty. Approximately $526 million in
banks and other financial institutions at September 30, 1998 relate primarily to
swaps with certain Asian counterparties; the remainder of the amounts included
in the table primarily represent nonperforming loans.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
In millions: September 30 1998
- --------------------------------------------------------------------------------
<S> <C>
COUNTERPARTIES IN THE U.S.
Commercial and industrial $ 7
Other 34
- --------------------------------------------------------------------------------
41
- --------------------------------------------------------------------------------
COUNTERPARTIES OUTSIDE THE U.S.
Commercial and industrial 12
Banks and other financial institutions 528
Other 12
- --------------------------------------------------------------------------------
552
- --------------------------------------------------------------------------------
TOTAL NONPERFORMING ASSETS 593
- --------------------------------------------------------------------------------
</TABLE>
The following table presents an analysis of the changes in nonperforming assets.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Third quarter Nine months
In millions 1998 1998
- ----------------------------------------------------------------------------------------
<S> <C> <C>
NONPERFORMING ASSETS, BEGINNING BALANCE $ 588 $ 659
- ----------------------------------------------------------------------------------------
Additions to nonperforming assets 88 312
Less:
Repayments of principal, net of
additional advances (11) (45)
Nonperforming assets returning to
accrual status -- (50)
Charge-offs:
Commercial and industrial (6) (64)
Banks and other financial institutions (31) (87)
Losses on sales of loans, primarily banks and
other financial institutions (11) (89)
Other (21) (21)
Interest and other credits (3) (22)
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
NONPERFORMING ASSETS, SEPTEMBER 30 593 593
- ----------------------------------------------------------------------------------------
</TABLE>
AGGREGATE ALLOWANCE FOR CREDIT LOSSES
We maintain an aggregate allowance for credit losses to absorb losses inherent
in our extensions of credit. Such extensions include loans and unused loan
commitments, payments made on behalf of clients (e.g., standby letters of credit
and guarantees), and all other credit exposures, including derivatives.
40
<PAGE> 41
The following table summarizes the activity of the aggregate allowance for
credit losses.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Third quarter Nine months
In millions 1998 1998
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BEGINNING BALANCE $ 904 $ 1,081
- --------------------------------------------------------------------------------------------------------------
Recoveries:
Counterparties in the U.S. 4 14
Counterparties outside the U.S., primarily commercial and industrial -- 5
- --------------------------------------------------------------------------------------------------------------
4 19
- --------------------------------------------------------------------------------------------------------------
Charge-offs:
Counterparties in the U.S.:
Commercial and industrial -- (2)
Losses on sale of loans in the U.S. (5) (5)
Counterparties outside the U.S.:
Commercial and industrial (6) (62)
Banks and other financial institutions (31) (87)
Losses on sale of loans, primarily banks and
other financial institutions (6) (84)
Other (21) (21)
- --------------------------------------------------------------------------------------------------------------
(69) (261)
- --------------------------------------------------------------------------------------------------------------
Net charge-offs (65) (242)
- --------------------------------------------------------------------------------------------------------------
Provision for credit losses 75 75
- --------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30 914 914
- --------------------------------------------------------------------------------------------------------------
</TABLE>
COMPONENTS OF THE AGGREGATE ALLOWANCE FOR CREDIT LOSSES
Our aggregate allowance for credit losses is based on an assessment at each
reporting period of the following components: specific counterparty allocations,
specific industry allocations, specific country allocations, expected loss
allocations, and general allocations. Refer to Note 1, Summary of significant
accounting policies, for additional information regarding the allocation of the
aggregate allowance for credit losses.
The following table displays how the aggregate allowance for credit losses is
allocated between the specific, expected loss, and general allocation components
as of September 30, 1998.
<TABLE>
<CAPTION>
In millions: September 30 1998
- --------------------------------------------------------------------------------
<S> <C>
Specific counterparty allocations in the U.S. $ 38
Specific counterparty allocations outside the U.S. 229
- --------------------------------------------------------------------------------
Total specific counterparty allocations 267
- --------------------------------------------------------------------------------
Specific industry/country allocations 178
Expected loss allocations 304
General allocations 165
- --------------------------------------------------------------------------------
Total aggregate allowance for credit losses 914
- --------------------------------------------------------------------------------
</TABLE>
41
<PAGE> 42
SELECTED COUNTRY EXPOSURES
Exposures to certain emerging markets
The following tables present exposures to certain emerging markets based upon
management's view of total exposure as of September 30, 1998.
The management view includes the following cross-border and local exposures: the
notional or contract value of loans, commitments to extend credit, securities
purchased under agreements to resell, interest earning deposits with banks; the
fair values of trading account assets (cash securities and derivatives) and
investment securities; and other monetary assets. It also includes the impact of
credit derivatives, at their notional or contract value, where we have bought or
sold credit protection outside of the respective country. Trading assets reflect
the net of long and short positions of the same issuer. Management's view
differs from bank regulatory rules, which are established by the Federal
Financial Institutions Examination Council (FFIEC), because the FFIEC view
excludes credit derivatives and trading account short positions, as well as uses
the cost versus the fair value of investment securities. In addition, management
does not net local funding or liabilities against any local exposures as allowed
by the FFIEC. See page 43 for cross-border and local outstandings under the
regulatory basis.
<TABLE>
<CAPTION>
By type of financial instrument
- ------------------------------------------------------------------------------------------------------------------------------
Credit
In billions Deriva- Other out- deriva- Commit- Local Total
September 30, 1998 Loans tives standings tives ments exposure exposure
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
China $ -- $0.2 $ -- $ -- $ -- $ -- $0.2
Hong Kong 0.8 -- 0.2 (0.1) 0.2 0.1 1.2
Indonesia 0.1 -- -- -- 0.1 -- 0.2
Malaysia -- -- 0.1 -- -- -- 0.1
Philippines 0.1 0.1 -- -- -- -- 0.2
Singapore -- -- 0.2 -- -- -- 0.2
South Korea 0.5 1.2 0.5 (0.5) -- -- 1.7
Taiwan -- -- -- -- 0.1 -- 0.1
Thailand 0.1 0.2 0.1 -- -- -- 0.4
Other -- 0.1 0.2 -- -- -- 0.3
- ------------------------------------------------------------------------------------------------------------------------------
Total Asia, excluding Japan(a) 1.6 1.8 1.3 (0.6) 0.4 0.1 4.6
- ------------------------------------------------------------------------------------------------------------------------------
Argentina 0.3 0.4 0.6 (0.5) -- 0.3 1.1
Brazil 0.8 0.1 0.5 (0.3) -- 1.1 2.2
Chile 0.6 0.1 0.1 (0.1) -- -- 0.7
Colombia 0.2 0.1 0.4 -- -- -- 0.7
Mexico 0.5 0.3 0.4 (0.3) -- 0.7 1.6
Other 0.4 -- 0.3 -- 0.1 -- 0.8
- ------------------------------------------------------------------------------------------------------------------------------
Total Latin America, excluding the
Caribbean 2.8 1.0 2.3 (1.2) 0.1 2.1 7.1
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
By type of counterparty
- --------------------------------------------------------------------------------------
In billions Govern-
September 30, 1998 Banks ments Other Total
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
China $0.1 $0.1 $ -- $0.2
Hong Kong 0.1 -- 1.1 1.2
Indonesia -- -- 0.2 0.2
Malaysia 0.1 -- -- 0.1
Philippines 0.1 -- 0.1 0.2
Singapore 0.1 -- 0.1 0.2
South Korea 1.0 0.6 0.1 1.7
Taiwan 0.1 -- -- 0.1
Thailand 0.3 -- 0.1 0.4
Other -- -- 0.3 0.3
- --------------------------------------------------------------------------------------
Total Asia, excluding Japan(a) 1.9 0.7 2.0 4.6
- --------------------------------------------------------------------------------------
Argentina -- 0.4 0.7 1.1
Brazil 0.2 0.8 1.2 2.2
Chile -- -- 0.7 0.7
Colombia -- 0.1 0.6 0.7
Mexico 0.1 0.4 1.1 1.6
Other 0.2 -- 0.6 0.8
- --------------------------------------------------------------------------------------
Total Latin America, excluding the
Caribbean 0.5 1.7 4.9 7.1
- --------------------------------------------------------------------------------------
</TABLE>
(a) Total exposures to Japan, based upon management's view, were $6.8 billion
at September 30, 1998.
Total exposures to South Africa, based upon management's view, were $1.6
billion at September 30, 1998.
42
<PAGE> 43
Cross-border and local outstandings under the regulatory basis
For financial reporting purposes only, the following table presents our
cross-border and local outstandings under the regulatory basis established by
the Federal Financial Institutions Examination Council (FFIEC). The FFIEC
approach excludes certain items which management believes should be considered
in determining exposure. Refer to page 42 for a detailed description of the
management view, as well as total exposures to certain emerging markets under
the management view.
In accordance with the FFIEC, cross-border outstandings include, regardless of
currency:
- - all claims of our U.S. offices against foreign residents
- - all claims of our foreign offices against residents of other foreign countries
Local outstandings include all claims of our foreign offices with residents of
the same foreign country, net of local funding.
All outstandings are based on the location of the counterparty. In most cases
where collateral or a formal guarantee exists, the location of the counterparty
presented is determined by the location where the collateral is held and
realizable, or the location of the guarantor. Cross-border and local
outstandings include the following: interest-earning deposits with banks;
investment securities; trading account assets including derivatives; securities
purchased under agreements to resell; loans; accrued interest; investments in
affiliates; and other monetary assets. Commitments include all cross-border
commitments to extend credit, standby letters of credit, guarantees, and
securities lending indemnifications.
The following table shows each country where cross-border and local
outstandings, net of funding, exceed 0.75% of total assets, as of September 30,
1998, under the regulatory basis established by the FFIEC.
<TABLE>
<CAPTION>
Total out-
Local out- standings
standings, Total % of and
In millions Govern- net of Out- Total Commit- commit-
September 30, 1998 Banks ments Other(a) funding standings assets ments ments
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Germany $12,281 $4,127 $1,068 $ -- $17,476 5.85% $1,223 $18,699
Japan(b) 2,774 5,883 2,098 -- 10,755 3.60 90 10,845
United Kingdom 2,779 126 6,938 -- 9,843 3.30 1,272 11,115
France 5,507 1,965 1,852 -- 9,324 3.12 2,142 11,466
Netherlands 6,310 673 2,123 -- 9,106 3.05 246 9,352
Cayman Islands 170 -- 7,897 -- 8,067 2.70 299 8,366
Italy 1,808 4,371 464 -- 6,643 2.23 76 6,719
Spain 1,712 3,042 1,374 219 6,347 2.13 566 6,913
Switzerland 3,295 331 1,668 -- 5,294 1.77 726 6,020
Belgium 1,968 1,456 1,503 -- 4,927 1.65 8,570 13,497
Canada 1,584 1,798 371 -- 3,753 1.26 1,833 5,586
Hong Kong(b) 981 491 1,171 -- 2,643 0.89 196 2,839
South Korea(b) 957 776 739 -- 2,472 0.83 54 2,526
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes nonbank financial institutions and commercial and industrial
entities.
(b) See page 42 for exposures to these countries under the management view.
43
<PAGE> 44
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
Dollars in millions,
Interest and average rates
On a taxable-equivalent basis
<TABLE>
<CAPTION>
Three months ended
-------------------------------------------------------------------------------
September 30, 1998 September 30, 1997
-------------------------------------------------------------------------------
Average Average Average Average
balance Interest rate balance Interest rate
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning deposits with banks,
mainly in offices outside the U.S. $ 1,925 $ 107 22.05% $ 1,896 $ 51 10.67%
Debt investment securities in
offices in the U.S. (a):
U.S. Treasury 673 16 9.43 1,259 23 7.25
U.S. state and political subdivision 1,695 43 10.06 1,187 35 11.70
Other 18,500 259 5.55 18,274 290 6.30
Debt investment securities in offices
outside the U.S. (a) 1,357 22 6.43 3,753 75 7.93
Trading account assets:
In offices in the U.S. 30,750 473 6.10 25,364 389 6.08
In offices outside the U.S. 35,056 655 7.41 38,516 644 6.63
Securities purchased under agreements
to resell,
In offices in the U.S. 15,372 226 5.83 15,970 225 5.59
In offices outside the U.S. 24,330 307 5.01 25,457 318 4.96
Securities borrowed,
mainly in offices in the U.S. 40,796 568 5.52 37,589 457 4.82
Loans:
In offices in the U.S. 6,496 124 7.57 5,046 90 7.08
In offices outside the U.S. 23,666 404 6.77 26,155 431 6.54
Other interest-earning assets (b):
In offices in the U.S. 3,318 34 * 732 69 *
In offices outside the U.S. 790 31 * 525 81 *
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 204,724 3,269 6.34 201,723 3,178 6.25
Allowance for credit losses (751) (918)
Cash and due from banks 1,495 453
Other noninterest-earning assets 79,169 60,856
- -----------------------------------------------------------------------------------------------------------------------------
Total assets 284,637 262,114
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest and average rates applying to the following asset categories have been
adjusted to a taxable-equivalent basis: Debt investment securities in offices in
the U.S.; Trading account assets in offices in the U.S.; and Loans in offices in
the U.S. The applicable tax rate used to determine these adjustments was
approximately 41% for the three months ended September 1998 and 1997.
(a) For the three months ended September 30, 1998 and 1997, average debt
investment securities are computed based on historical amortized cost, excluding
the effects of SFAS No. 115 adjustments.
(b) Interest revenue includes the effect of certain off-balance sheet
transactions.
* Not meaningful
44
<PAGE> 45
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
- --------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
On a taxable-equivalent basis
<TABLE>
<CAPTION>
Three months ended
----------------------------------------------------------------------------
September 30, 1998 September 30, 1997
----------------------------------------------------------------------------
Average Average Average Average
balance Interest Rate balance Interest rate
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
In offices in the U.S. $ 4,421 $ 67 6.01% $ 9,818 $ 140 5.66%
In offices outside the U.S. 48,196 578 4.76 46,755 570 4.84
Trading account liabilities:
In offices in the U.S. 9,204 159 6.86 11,813 199 6.68
In offices outside the U.S. 13,014 227 6.92 14,834 224 5.99
Securities sold under agreements to
repurchase and federal funds
purchased, mainly in offices in
the U.S. 73,845 1,054 5.66 66,932 888 5.26
Commercial paper, mainly in offices
in the U.S. 10,221 145 5.63 5,461 71 5.16
Other interest-bearing liabilities:
In offices in the U.S. 10,976 214 7.74 15,184 233 5.99
In offices outside the U.S. 4,540 73 6.38 5,515 61 4.39
Long-term debt,
mainly in offices in the U.S. 27,136 400 5.85 19,959 303 6.02
- -----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 201,553 2,917 5.74 196,271 2,689 5.44
Noninterest-bearing deposits:
In offices in the U.S. 717 926
In offices outside the U.S. 791 589
Other noninterest-bearing
liabilities 69,780 52,888
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities 272,841 250,674
Stockholders' equity 11,796 11,440
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity 284,637 262,114
Net yield on interest-earning assets 0.68 0.96
- -----------------------------------------------------------------------------------------------------------------------
Net interest earnings 352 489
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
45
<PAGE> 46
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
- --------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
<TABLE>
<CAPTION>
Nine months ended
-------------------------------------------------------------------------------------
September 30, 1998 September 30, 1997
-------------------------------------------------------------------------------------
Average Average Average Average
balance Interest rate balance Interest rate
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest-earning deposits with banks,
mainly in offices outside the U.S. $ 1,946 $ 236 16.21% $ 1,944 $ 124 8.53%
Debt investment securities in
offices in the U.S. (a):
U.S. Treasury 743 46 8.28 1,321 73 7.39
U.S. state and political
subdivision 1,407 117 11.12 1,295 114 11.77
Other 19,257 815 5.66 17,699 848 6.41
Debt investment securities in offices
outside the U.S. (a) 1,737 95 7.31 3,972 216 7.27
Trading account assets:
In offices in the U.S. 30,015 1,418 6.32 23,544 1,103 6.26
In offices outside the U.S. 38,286 2,021 7.06 39,850 2,017 6.77
Securities purchased under agreements
to resell and federal funds sold,
In offices in the U.S. 15,075 617 5.47 15,757 648 5.50
In offices outside the U.S. 23,495 876 4.98 24,137 854 4.73
Securities borrowed,
mainly in offices in the U.S. 40,641 1,578 5.19 34,625 1,284 4.96
Loans:
In offices in the U.S. 6,628 357 7.20 4,955 281 7.58
In offices outside the U.S. 25,116 1,264 6.73 24,833 1,206 6.49
Other interest-earning assets (b):
In offices in the U.S. 2,269 109 * 717 131 *
In offices outside the U.S. 1,001 119 * 753 238 *
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 207,616 9,668 6.23 195,402 9,137 6.25
Allowance for credit losses (800) (915)
Cash and due from banks 1,358 804
Other noninterest-earning assets 73,897 51,943
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets 282,071 247,234
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest and average rates applying to the following asset categories have been
adjusted to a taxable-equivalent basis: Debt investment securities in offices in
the U.S.; Trading account assets in offices in the U.S.; and Loans in offices in
the U.S. The applicable tax rate used to determine these adjustments was
approximately 41% for the nine months ended September 1998 and 1997.
(a) For the nine months ended September 30, 1998 and 1997, average debt
investment securities are computed based on historical amortized cost, excluding
the effects of SFAS No. 115 adjustments.
(b) Interest revenue includes the effect of certain off-balance sheet
transactions.
* Not meaningful
46
<PAGE> 47
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
- --------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
<TABLE>
<CAPTION>
Nine months ended
----------------------------------------------------------------------------
September 30, 1998 September 30, 1997
----------------------------------------------------------------------------
Average Average Average Average
balance Interest Rate Balance Interest Rate
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
In offices in the U.S. $ 7,318 $ 306 5.59% $ 9,600 $ 401 5.58%
In offices outside the U.S. 50,053 1,832 4.89 45,793 1,642 4.79
Trading account liabilities:
In offices in the U.S. 9,972 553 7.41 10,800 549 6.80
In offices outside the U.S. 14,527 665 6.12 13,665 629 6.15
Securities sold under agreements to
repurchase and federal funds
purchased, mainly in offices in
the U.S. 70,551 2,923 5.54 66,703 2,617 5.25
Commercial paper, mainly in offices
in the U.S. 9,363 395 5.64 4,444 178 5.36
Other interest-bearing liabilities:
In offices in the U.S. 12,947 635 6.56 15,990 724 6.05
In offices outside the U.S. 3,934 205 6.97 4,332 171 5.28
Long-term debt, mainly in offices in the U.S. 25,748 1,145 5.95 16,657 754 6.05
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 204,413 8,659 5.66 187,984 7,665 5.45
Noninterest-bearing deposits:
In offices in the U.S. 880 1,035
In offices outside the U.S. 858 403
Other noninterest-bearing
liabilities 64,275 46,498
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities 270,426 235,920
Stockholders' equity 11,645 11,314
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity 282,071 247,234
Net yield on interest-earning assets 0.65 1.01
- --------------------------------------------------------------------------------------------------------------------------------
Net interest earnings 1,009 1,472
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE> 48
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10. Material contracts
12. Statement re computation of ratios (incorporated by reference to
exhibit 12 to J.P. Morgan's report on Form 8-K, dated October 19,
1998)
27. Financial data schedule
(b) Reports on Form 8-K
The following reports on Form 8-K were filed with the Securities and
Exchange Commission during the quarter ended June 30, 1998:
July 14, 1998 (Items 5 and 7)
Reported the issuance by J.P. Morgan of a press release announcing its
earnings for the three and six-month periods ended June 30, 1998.
August 28, 1998 (Items 5 and 7)
Reported the issuance by J.P. Morgan of a press release disclosing
Russian exposure and approximate trading revenue for the quarter to
date period.
48
<PAGE> 49
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
J.P. MORGAN & CO. INCORPORATED
------------------------------
(Registrant)
/s/ DAVID H. SIDWELL
-----------------------------------
NAME: DAVID H. SIDWELL
TITLE: MANAGING DIRECTOR AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
DATE: November 16, 1998
49
<PAGE> 50
EXHIBIT INDEX
10. Material contracts
12. Statement re computation of ratios (incorporated by reference to
exhibit 12 to J.P. Morgan's report on Form 8-K, dated October 19,
1998)
27. Financial data schedule
<PAGE> 1
EXHIBIT 10
1998 PERFORMANCE PLAN OF
J.P. MORGAN & CO. INCORPORATED AND AFFILIATED COMPANIES
ARTICLE I
PURPOSE OF PLAN
The purpose of the Plan is to promote the success of J.P. Morgan & Co.
Incorporated and encourage certain employees to remain in its employ by
providing compensation to such employees.
ARTICLE II
DEFINITIONS
The following words and phrases herein shall have the following meanings unless
a different meaning is plainly required by the context.
2.1 "Award" shall mean any award granted under the Plan.
2.1 "Company" shall mean J.P. Morgan & Co. Incorporated or any successor
to it in ownership of all or substantially all of its assets.
2.3 "Board of Directors" shall mean the Board of Directors of the
Company.
2.4 "Participating Company" shall mean the Company, and any subsidiary or
other affiliated entity (whether or not incorporated).
2.5 "Code" shall mean the Internal Revenue Code of 1986, as amended from
time to time.
2.6 "Employee" shall mean any executive employed by one or more
Participating Companies who is selected by the Committee to receive an Award
under the Plan.
2.7 "Plan" shall mean the 1998 Performance Plan of J.P. Morgan & Co.
Incorporated and Affiliated Companies, as amended from time to time.
2.8 "Committee" shall mean the Committee established to administer the Plan
in accordance with Section 3.1.
1
<PAGE> 2
2.9 "Stock Incentive Plan" shall mean the 1995 Stock Incentive Plan of J.P.
Morgan & Co. Incorporated and Affiliated Companies, as the same may be amended
from time to time, and any successor plan thereto.
2.10 "Stock Plans" shall mean equity-based compensation plans of the
Company, including but not limited to, the Stock Incentive Plan.
ARTICLE III
ADMINISTRATION OF THE PLAN
3.1. The Committee. The Plan shall be administered by a Committee consisting
of at least three persons chosen by the Board of Directors from among those
members of the Board of Directors who (i) are not eligible to participate in the
Plan and (ii) are not employees of a Participating Company. The Committee may
consult with management but shall have the responsibility of determining the
Employees who are to receive Awards under the Plan and the amount of such Awards
and shall otherwise be responsible for the administration of the Plan. The
Committee also shall construe and interpret the Plan and adopt rules and
regulations governing administration of the Plan, and exercise the remaining
duties and powers conferred on it by the Plan, provided, however, the Committee
may delegate to senior officers of the Company the power to act for the
Committee as the Committee shall specify.
ARTICLE IV
AWARDS UNDER THE PLAN
4.1. Grant of Awards under the Plan. The Committee is hereby authorized to
grant Awards to participants. Subject to the terms of the Plan and any
applicable Award agreement, an Award granted under the Plan (i) may be
denominated or payable in cash, shares of Common Stock of the Company
(including, without limitation, grants or awards under the Stock Plans), other
securities, other awards, or other property, or any combination thereof, and
(ii) shall confer on the holder thereof rights valued as determined by the
Committee and payable to, or exercisable by, the holder of the Award, based, in
whole or in part, upon the Committee's assessment of the level of achievement of
such performance or other goals during such performance or vesting periods as
the Committee shall establish. Subject to the terms of the Plan and any
applicable Award agreement, the performance or other goals for any performance
or vesting period, the length of any performance or vesting period, the amount
of any Award granted, and the amount of any payment or transfer to be made
pursuant to any Award shall be determined by the Committee. Except as otherwise
determined by the Committee, an Award shall be
2
<PAGE> 3
forfeited if the Employee's employment terminates for any reason prior to the
end of the applicable performance or vesting period established by the
Committee.
4.2. Payment. (a) An Award shall be deemed "earned" if and to the extent the
Committee so determines following the close of the applicable performance or
vesting period. Except as provided in Section 4.2(b), Awards earned under the
Plan shall be paid as promptly as practicable after the close of the applicable
year, or after such further vesting or performance period as may be imposed by
the Committee in its sole discretion.
(b) The Committee shall have the right to require that payment of all or any
portion of an earned Award be deferred until such time or times as the
Committee, in its sole discretion, shall determine. In addition, the Committee
may provide that an Employee may elect to defer the payment of any Award earned
under the Plan. Deferral elections shall be made at such time and in such manner
as the Committee shall prescribe. The Committee shall establish such terms,
conditions, rules and regulations as it shall deem necessary and advisable with
respect to deferred Awards including, but not limited to, the time of payment
(including acceleration), the method of determining additional amounts, if any,
to be credited with respect to a deferred Award, the applicable methods of
payment of deferred Awards, and any special rules that may apply in the event of
termination of employment for any reason.
ARTICLE V
GENERAL PROVISIONS
5.1. No Right of Continued Employment. Neither the establishment of the Plan
nor the payment of any benefits hereunder nor any action of any Participating
Company or of the Board of Directors or of the Committee shall be held or
construed to confer upon any person any legal right to be continued in the
employ of a Participating Company and each Participating Company expressly
reserves the right to discharge an Employee whenever the interest of any such
company in its sole discretion may so require without liability to such
Participating Company, the Board of Directors or the Committee except as to any
rights which may be expressly conferred upon such Employee under the Plan.
5.2. Discretion of the Company, Board of Directors and Committee. Any
decision made or action taken by the Company, the Board of Directors or by the
Committee arising out of or in connection with the construction, administration,
interpretation and effect of the Plan shall lie within the absolute discretion
of the Company, the Board of Directors or the Committee, as the case may be, and
shall be conclusive and binding upon all persons.
5.3. Absence of Liability. No member of the Board of Directors or of the
Committee or officer of any Participating Company shall be liable for any act or
action hereunder,
3
<PAGE> 4
whether of commission or omission, taken by any other member, or by an officer,
agent, or employee, or, except in circumstances involving his bad faith, for
anything done or omitted to be done by himself.
5.4. No Segregation of Cash or Shares. (a) The Company shall not be required
to segregate any cash or any other assets which may at any time be represented
by Awards credited to an Employee and the Plan shall constitute an "unfunded"
plan of the Company.
(b) The Company shall not, by any provisions of this Plan, be deemed to be a
trustee of any property, and the liabilities of the Company to any Employee
pursuant to the Plan shall be those of a debtor pursuant to such contract
obligations as are created by or pursuant to the Plan, and the rights of any
Employee, former Employee or beneficiary shall be limited to those of an
unsecured creditor of the Company. In its sole discretion, the Board of
Directors may authorize the creation of trusts or other arrangements to meet the
obligations of the Participating Companies under the Plan, provided, however,
that the existence of such trusts or arrangements is consistent with the
unfunded status of the Plan.
5.5. Inalienability of Benefits and Interests. (a) Except as expressly
provided by the Committee and subsection (b) hereof, no Award, nor any benefit
payable under or interest in the Plan, shall be subject in any manner to
anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or
charge, and any such attempted action shall be void and no such benefit or
interest shall be in any manner liable for or subject to debts, contracts,
liabilities, engagements or torts of any Employee, or former Employee.
(b) The provisions of subsection (a) hereof shall not apply to an assignment by
the Employee's legal representative or beneficiary of a payment due after the
death of the Employee if such assignment is made for the purposes of settling
the affairs of such deceased Employee nor to a beneficiary designation made by
an Employee to the extent authorized by the Committee.
5.6. New York Law to Govern. All questions pertaining to the construction,
regulation, validity and effect of the provisions of the Plan shall be
determined in accordance with the laws of the State of New York.
5.7. Payment of Awards. Payment of Awards shall be by or for the account of
the Participating Companies and the Company and the Participating Companies may
make such arrangements as they may deem appropriate with respect thereto.
5.8. Cancellation of Awards. (a) Prior to the occurrence of a Change in
Control, but not thereafter, the Committee may, in its sole discretion and with
or without cause, cancel any Award in whole or in part to the extent it has not
theretofore become vested. Such cancellation shall be effective as of the date
specified by the Committee.
4
<PAGE> 5
(b) Notwithstanding subsection (a) above, prior to payment of any Award, the
Committee may, in its sole discretion, in cases involving a serious breach of
conduct by an Employee or former Employee, or activity of a former Employee in
competition with the business of a Participating Company, cancel any Award,
whether or not vested, in whole or in part. Such cancellation shall be effective
as of the date specified by the Committee. The determination of whether an
Employee or former Employee has engaged in a serious breach of conduct or
activity in competition with the business of a Participating Company shall be
determined by the Committee in good faith and in its sole discretion.
5.9. Change in Control. (a) In the event of a Change in Control, the payment
of all outstanding Awards (whether or not vested, earned, deferred or subject to
attainment of further goals) shall (unless the Committee otherwise determines)
be made as soon as practicable and the Committee shall, in its discretion,
determine the terms of such payments, if any, including but not limited to, the
amount and form of such payments.
(b) For purposes of this Section 5.9, a Change in Control shall have the same
meaning as specified in Section 10.1(c) of the Stock Incentive Plan. In
addition, any determination made by the Committee under Section 5.9(a) shall be
made in cases covered by a Change in Control as defined in Section 10.1(c)(i) or
(ii) of the Stock Incentive Plan prior to or as soon as practicable after the
occurrence of such event and in cases covered by a Change in Control as defined
in Section 10.1(c)(iii) and (iv) of the Stock Incentive Plan prior to the
occurrence of such event.
ARTICLE VI
AMENDMENT, SUSPENSION OR TERMINATION OF PLAN
The Board of Directors or the Committee may from time to time amend, suspend or
terminate the Plan in whole or in part, and if suspended or terminated, may
reinstate any or all of the provisions of the Plan, except that without the
consent of the Employee no amendment, suspension or termination of the Plan
shall adversely affect the rights of any Employee with respect to an Award
previously made to such Employee.
5
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CURRENT
REPORT ON FORM 10-Q FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND
ACCOMPANYING DISCLOSURES.
</LEGEND>
<MULTIPLIER> 1,000,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 3,405
<INT-BEARING-DEPOSITS> 1,529
<FED-FUNDS-SOLD> 42,985<F1>
<TRADING-ASSETS> 128,746
<INVESTMENTS-HELD-FOR-SALE> 26,037
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 30,291
<ALLOWANCE> 404
<TOTAL-ASSETS> 298,514
<DEPOSITS> 54,352
<SHORT-TERM> 109,460<F2>
<LIABILITIES-OTHER> 95,284<F3>
<LONG-TERM> 27,899
0
694
<COMMON> 502
<OTHER-SE> 10,323
<TOTAL-LIABILITIES-AND-EQUITY> 298,514
<INTEREST-LOAN> 1,618
<INTEREST-INVEST> 1,027
<INTEREST-OTHER> 6,972
<INTEREST-TOTAL> 9,617
<INTEREST-DEPOSIT> 2,138
<INTEREST-EXPENSE> 8,659
<INTEREST-INCOME-NET> 958
<LOAN-LOSSES> 75<F4>
<SECURITIES-GAINS> 247<F5>
<EXPENSE-OTHER> 4,147<F6>
<INCOME-PRETAX> 1,304
<INCOME-PRE-EXTRAORDINARY> 874
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 874
<EPS-PRIMARY> 4.65<F7>
<EPS-DILUTED> 4.28<F7>
<YIELD-ACTUAL> 0.65
<LOANS-NON> 593<F8>
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,081<F9>
<CHARGE-OFFS> 261<F9>
<RECOVERIES> 19<F9>
<ALLOWANCE-CLOSE> 914<F9>
<ALLOWANCE-DOMESTIC> 38<F9>
<ALLOWANCE-FOREIGN> 229<F9>
<ALLOWANCE-UNALLOCATED> 647<F9>
<FN>
<F1>INCLUDES SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND/OR FEDERAL FUNDS
SOLD.
<F2>INCLUDES SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS
PURCHASED, COMMERCIAL PAPER, AND OTHER LIABILITIES FOR BORROWED MONEY.
<F3>INCLUDES TRADING ACCOUNT LIABILITIES, ACCOUNTS PAYABLE AND ACCRUED EXPENSES,
OTHER LIABILITIES, AND COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF SUBSIDIARIES.
<F4>$50 MILLION OF THE PROVISION FOR CREDIT LOSSES RELATE TO TRADING ACCOUNT
ASSETS AND THE REMAINING $25 MILLION RELATE TO LOANS.
<F5>INCLUDES GAINS AND LOSSES ON DEBT AND EQUITY INVESTMENT SECURITIES,
OTHER-THAN-TEMPORARY IMPAIRMENTS OR WRITE-DOWNS IN VALUE, AND RELATED DIVIDEND
INCOME.
<F6>INCLUDES EMPLOYEE COMPENSATION AND BENEFITS, NET OCCUPANCY, TECHNOLOGY AND
COMMUNICATIONS, AND OTHER EXPENSES.
<F7>PRIMARY EPS REPRESENTS BASIC EPS UNDER STATEMENT OF FINANCIAL ACCOUNTING
STANDARDS NO. 128, EARNINGS PER SHARE.
<F8>INCLUDES NONPERFORMING LOANS AND OTHER NONPERFORMING ASSETS.
<F9>AMOUNTS RELATE TO THE FIRM'S AGGREGATE ALLOWANCE FOR CREDIT LOSSES.
</FN>
</TABLE>
