<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, 1999
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, 1999:
Common Stock, $2.50 Par Value 173,144,984 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, 1999, 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................................ 9-27
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial highlights.......................................... 28
Segment analysis.............................................. 29-31
Financial review.............................................. 31-38
Risk management............................................... 39-43
Consolidated average balances and net interest earnings............ 44-47
Cross-border and local outstandings under the regulatory basis..... 48
PART II -- OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 49
SIGNATURES......................................................... 50
2
<PAGE> 3
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/
1999 1998 (Decrease) 1999 (Decrease)
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET INTEREST REVENUE
Interest revenue $ 2,783 $ 3,249 $ (466) $ 2,713 $ 70
Interest expense 2,394 2,917 (523) 2,288 106
- ----------------------------------------------------------------------------------------------------------------------
Net interest revenue 389 332 57 425 (36)
Provision for loan losses -- 25 (25) -- --
Reversal of provision for loan losses (45) -- (45) (105) 60
- ----------------------------------------------------------------------------------------------------------------------
Net interest revenue after provision /
(reversal of provision) for loan losses 434 307 127 530 (96)
NONINTEREST REVENUES
Trading revenue 424 69 355 803 (379)
Investment banking revenue 398 312 86 457 (59)
Investment management revenue 270 224 46 260 10
Fees and commissions 206 182 24 191 15
Investment securities revenue/(loss) 271 136 135 (29) 300
Other (loss)/revenue (a) (18) 71 (89) (21) 3
- ----------------------------------------------------------------------------------------------------------------------
Total noninterest revenues 1,551 994 557 1,661 (110)
Total revenues, net 1,985 1,301 684 2,191 (206)
OPERATING EXPENSES
Employee compensation and benefits 889 567 322 970 (81)
Net occupancy 82 84 (2) 80 2
Technology and communications 229 293 (64) 231 (2)
Other expenses 141 155 (14) 136 5
- ----------------------------------------------------------------------------------------------------------------------
Total operating expenses 1,341 1,099 242 1,417 (76)
Income before income taxes 644 202 442 774 (130)
Income taxes 202 46 156 270 (68)
- ----------------------------------------------------------------------------------------------------------------------
Net income 442 156 286 504 (62)
PER COMMON SHARE
Net income
Basic $ 2.39 $ 0.81 $ 1.58 $ 2.71 ($ 0.32)
Diluted 2.22 0.75 1.47 2.52 (0.30)
Dividends declared 0.99 0.95 0.04 0.99 --
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Other(loss)/revenue includes a $15 million reversal of provision for credit
losses for the three months ended September 30, 1999 and a $35 million provision
for credit losses for the three months ended June 30, 1999, related to
lending commitments.
See notes to consolidated financial statements.
3
<PAGE> 4
CONSOLIDATED STATEMENT OF INCOME
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
In millions, except share data Nine months ended
-----------------------------------------------
September 30 September 30 Increase/
1999 1998 (Decrease)
-----------------------------------------------
<S> <C> <C> <C>
NET INTEREST REVENUE
Interest revenue $ 8,253 $ 9,617 $(1,364)
Interest expense 7,050 8,659 (1,609)
- -------------------------------------------------------------------------------------------------
Net interest revenue 1,203 958 245
Provision for loan losses -- 25 (25)
Reversal of provision for loan losses (150) -- (150)
- -------------------------------------------------------------------------------------------------
Net interest revenue after provision /
(reversal of provision) for loan losses 1,353 933 420
NONINTEREST REVENUES
Trading revenue 2,361 1,842 519
Investment banking revenue 1,245 1,020 225
Investment management revenue 776 661 115
Fees and commissions 611 569 42
Investment securities revenue 201 247 (46)
Other revenue, including a $20 million net
provision for credit losses in 1999 120 179 (59)
- -------------------------------------------------------------------------------------------------
Total noninterest revenues 5,314 4,518 796
Total revenues, net 6,667 5,451 1,216
OPERATING EXPENSES
Employee compensation and benefits 2,955 2,432 523
Net occupancy 244 313 (69)
Technology and communications 707 887 (180)
Other expenses 419 515 (96)
- -------------------------------------------------------------------------------------------------
Total operating expenses 4,325 4,147 178
Income before income taxes 2,342 1,304 1,038
Income taxes 796 430 366
- -------------------------------------------------------------------------------------------------
Net income 1,546 874 672
PER COMMON SHARE
Net income
Basic $ 8.33 $ 4.65 $ 3.68
Diluted 7.76 4.28 3.48
Dividends declared 2.97 2.85 0.12
- -------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
CONSOLIDATED BALANCE SHEET
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
September 30 June 30 December 31
In millions, except share data 1999 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
Cash and due from banks $ 1,609 $ 2,094 $ 1,203
Interest-earning deposits with banks 2,145 2,058 2,371
Debt investment securities available-for-sale carried at fair value 24,115 26,702 36,232
Equity investment securities 1,528 1,264 1,169
Trading account assets (including derivative receivables of $43,010 at September 1999,
$40,391 at June 1999 and $48,124 at December 1998) 106,510 114,465 113,896
Securities purchased under agreements to resell ($34,705 at September 1999, $32,739 at
June 1999 and $31,056 at December 1998) and federal funds sold 36,755 33,531 31,731
Securities borrowed 35,518 39,977 30,790
Loans, net of allowance for loan losses of $301 at September 1999, $335 at June 1999 and
$470 at December 1998 25,114 28,753 25,025
Accrued interest and accounts receivable 6,826 6,084 7,689
Premises and equipment, net of accumulated depreciation of $1,325 at September 1999,
$1,322 at June 1999 and $1,350 at December 1998 1,995 1,893 1,881
Other assets 12,704 12,573 9,080
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets 254,819 269,394 261,067
- ---------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Noninterest-bearing deposits:
In offices in the U.S. 850 1,222 1,242
In offices outside the U.S. 1,183 778 563
Interest-bearing deposits:
In offices in the U.S. 3,849 6,627 7,724
In offices outside the U.S. 42,941 46,708 45,499
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 48,823 55,335 55,028
Trading account liabilities (including derivative payables of $39,355 at September 1999,
$37,329 at June 1999 and $44,683 at December 1998) 72,043 70,129 70,643
Securities sold under agreements to repurchase ($60,979 at September 1999, $63,460 at
June 1999 and $62,784 at December 1998) and federal funds purchased 61,779 64,554 63,368
Commercial paper 10,327 13,114 6,637
Other liabilities for borrowed money 9,447 10,974 12,515
Accounts payable and accrued expenses 10,507 10,089 9,859
Long-term debt not qualifying as risk-based capital 20,145 22,722 23,037
Other liabilities, including allowance for credit losses of $145 at September 1999, $160
at June 1999 and $125 at December 1998 3,333 4,116 2,999
- ---------------------------------------------------------------------------------------------------------------------------------
236,404 251,033 244,086
Liabilities qualifying as risk-based capital:
Long-term debt 5,257 5,408 4,570
Company-obligated mandatorily redeemable preferred securities of subsidiaries 1,150 1,150 1,150
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 242,811 257,591 249,806
STOCKHOLDERS' EQUITY
Preferred stock (authorized shares: 10,000,000)
Adjustable rate cumulative preferred stock, $100 par value (issued and
outstanding: 2,444,300) 244 244 244
Variable cumulative preferred stock, $1,000 par value (issued and
outstanding: 250,000) 250 250 250
Fixed cumulative preferred stock, $500 par value (issued and outstanding: 400,000) 200 200 200
Common stock, $2.50 par value (authorized shares: 500,000,000; issued: 200,934,737
at September 1999 and June 1999, and 200,873,067 at December 1998) 502 502 502
Capital surplus 1,241 1,245 1,252
Common stock issuable under stock award plans 1,713 1,540 1,460
Retained earnings 10,586 10,334 9,614
Accumulated other comprehensive income:
Net unrealized (losses) / gains on investment securities, net of taxes (108) (52) 147
Foreign currency translation, net of taxes (46) (46) (46)
- ---------------------------------------------------------------------------------------------------------------------------------
14,582 14,217 13,623
Less: treasury stock (26,053,759 shares at September 1999, 24,985,131 at June 1999 and
25,866,786 shares at December 1998) at cost 2,574 2,414 2,362
- ---------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 12,008 11,803 11,261
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity 254,819 269,394 261,067
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
1999 1998
----------------------- -----------------------
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 1,252 1,360
Shares issued or distributed under dividend reinvestment plan,
various employee benefit plans, and conversion of debentures
and income tax benefits associated with stock options (11) (87)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 1,241 1,273
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ISSUABLE UNDER STOCK AWARD PLANS
Balance, January 1 1,460 1,185
Deferred stock awards, net 253 261
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 1,713 1,446
- ----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance, January 1 9,614 9,398
Net income 1,546 $ 1,546 874 $ 874
Dividends declared on preferred stock (25) (27)
Dividends declared on common stock (523) (504)
Dividend equivalents on common stock issuable (26) (25)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 10,586 9,716
- ----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Net unrealized (losses)/gains on investment securities:
Balance, net of taxes, January 1 147 432
-------- --------
Net unrealized (losses)/gains arising during the period,
before taxes (($325) in 1999 and $38 in 1998, net of taxes) (550) 67
Reclassification adjustment for net losses/(gains) included in net income,
before taxes ($69 in 1999 and ($166) in 1998, net of taxes) 118 (261)
-------- --------
Change in net unrealized (losses)/gains on investment securities,
before taxes (432) (194)
Income tax benefit/(expense) 177 54
-------- --------
Change in net unrealized (losses)/gains on investment securities, net
of taxes (255) (255) (140) (140)
Balance, net of taxes, September 30 (108) 292
-------- --------
Foreign currency translation:
Balance, net of taxes, January 1 (46) (22)
-------- --------
Translation adjustment arising during the period, before taxes (7) (26)
Income tax benefit 7 10
-------- --------
Translation adjustment arising during the period, net of taxes -- -- (16) (16)
-------- --------
Balance, net of taxes, September 30 (46) (38)
- ----------------------------------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive income,
net of taxes, September 30 (154) 254
- ----------------------------------------------------------------------------------------------------------------------------------
LESS: TREASURY STOCK
Balance, January 1 2,362 2,145
Purchases 681 720
Shares issued/distributed, primarily related to various employee benefit
plans (469) (499)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30 2,574 2,366
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 12,008 11,519
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME 1,291 718
- ----------------------------------------------------------------------------------------------------------------------------------
</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
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
September 30 September 30
1999 1998
- -----------------------------------------------------------------------------------------------------------
Net income $ 1,546 $ 874
Adjustments to reconcile to cash provided by operating
activities:
Noncash items: provisions for credit losses, depreciation,
amortization, deferred income taxes, stock award plans,
and write-downs on investment securities 1,218 919
Gain on sale of businesses - (113)
Net (increase)/decrease in assets:
Trading account assets 7,259 (16,722)
Securities purchased under agreements to resell (3,668) (3,911)
Securities borrowed (4,728) (9,369)
Loans held for sale 1,485 (177)
Accrued interest and accounts receivable 858 (1,912)
Net increase/(decrease) in liabilities:
Trading account liabilities 1,304 7,624
Securities sold under agreements to repurchase (1,824) 29,599
Accounts payable and accrued expenses 542 1,797
Other changes in operating assets and liabilities, net (2,569) (1,362)
Net investment securities losses/(gains), excluding SBICs, included
in cash flows from investing activities (31) (303)
- -----------------------------------------------------------------------------------------------------------
Cash provided by operating activities 1,392 6,944
- -----------------------------------------------------------------------------------------------------------
Net decrease in interest-earning deposits with banks 222 608
Debt investment securities:
Proceeds from sales 26,498 9,715
Proceeds from maturities, calls, and mandatory redemptions 6,267 6,215
Purchases (21,416) (19,072)
Net (increase) in federal funds sold (1,375) -
Net (increase) decrease in loans (1,508) 971
Payments for premises and equipment (227) (211)
Investment in American Century Companies, Inc. - (965)
Investment in Long-Term Capital Management, L.P. - (300)
Other changes, net (1,821) 115
- -----------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities 6,640 (2,924)
- -----------------------------------------------------------------------------------------------------------
Net increase in noninterest-bearing deposits 227 (456)
Net (decrease) in interest-bearing deposits (6,516) (3,920)
Net increase (decrease) in federal funds purchased 216 (4,146)
Net increase in commercial paper 3,689 5,703
Other liabilities for borrowed money proceeds 8,552 15,005
Other liabilities for borrowed money payments (11,877) (17,685)
Long-term debt proceeds 5,356 12,103
Long-term debt payments (7,389) (7,374)
Capital stock issued or distributed 200 199
Capital stock purchased (669) (720)
Dividends paid (549) (532)
Other changes, net 1,087 (560)
- -----------------------------------------------------------------------------------------------------------
Cash (used in) financing activities (7,673) (2,383)
- -----------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and due from banks 47 10
- -----------------------------------------------------------------------------------------------------------
Increase in cash and due from banks 406 1,647
Cash and due from banks at December 31, 1998 and 1997 1,203 1,758
- -----------------------------------------------------------------------------------------------------------
Cash and due from banks at September 30, 1999 and 1998 1,609 3,405
- -----------------------------------------------------------------------------------------------------------
Cash disbursements made for:
Interest $ 6,884 $ 8,537
Income taxes 764 674
- -----------------------------------------------------------------------------------------------------------
</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 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 1,551 $ 1,147
Interest-earning deposits with banks 2,082 2,372
Debt investment securities available-for-sale carried at fair value 5,146 3,634
Trading account assets 79,220 90,770
Securities purchased under agreements to resell and federal funds sold 18,250 33,316
Securities borrowed 10,016 8,193
Loans, net of allowance for loan losses of $300 at September 1999 and $470 at December 24,604 24,876
1998
Accrued interest and accounts receivable 5,131 3,898
Premises and equipment, net of accumulated depreciation of $1,124 at September 1999 and
$1,160 at December 1998 1,813 1,703
Other assets 12,349 5,337
- --------------------------------------------------------------------------------------------------------------------
Total assets 160,162 175,246
- --------------------------------------------------------------------------------------------------------------------
LIABILITIES
Noninterest-bearing deposits:
In offices in the U.S. 873 1,232
In offices outside the U.S. 1,185 572
Interest-bearing deposits:
In offices in the U.S. 3,881 7,749
In offices outside the U.S. 44,103 46,668
- --------------------------------------------------------------------------------------------------------------------
Total deposits 50,042 56,221
Trading account liabilities 62,404 64,776
Securities sold under agreements to repurchase and federal funds purchased 12,891 14,916
Other liabilities for borrowed money 5,607 8,646
Accounts payable and accrued expenses 6,496 6,123
Long-term debt not qualifying as risk-based capital (includes $704 at September 1999
and $736 at December 1998 of notes payable to J.P. Morgan) 7,340 10,358
Other liabilities, including allowance for credit losses of $145 at September 1999
and $125 at December 1998 1,515 542
- --------------------------------------------------------------------------------------------------------------------
146,295 161,582
Long-term debt qualifying as risk-based capital (includes $2,883 at September 1999 and
$3,058 at December 1998 of notes payable to J.P. Morgan) 2,975 3,186
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 149,270 164,768
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 3,305
Undivided profits 7,303 6,836
Accumulated other comprehensive income:
Net unrealized gains on investment securities, net of taxes 65 118
Foreign currency translation, net of taxes (46) (46)
- --------------------------------------------------------------------------------------------------------------------
Total stockholder's equity 10,892 10,478
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity 160,162 175,246
</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, and 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
Financial information included in the accounts of J.P. Morgan, and the
subsidiaries for which our ownership is more than 50% of the company, is
contained in the consolidated financial statements. All material intercompany
accounts and transactions have been eliminated in consolidation. The financial
information as of and for the periods ended September 30, 1999, September 30,
1998, and June 30,1999 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, 1998, as well as with
information included in J.P. Morgan's unaudited quarterly reports on Form 10-Q
for the three months ended June 30, 1999 and March 31, 1999. 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.
Impaired loans
A loan is impaired when, based on current information and events, it is probable
that we will be unable to collect all amounts due, including principal and
interest, according to the contractual terms of the agreement. We consider the
following in identifying impaired loans:
- - A default has occurred or is expected to occur,
- - The payment of principal and/or interest or other cash flows is greater
than 90 days past due, or
- - Management has serious doubts as to the collectibility of future cash
flows, even if the loan is currently performing.
Once a loan is identified as impaired, management regularly measures impairment
in accordance with Statement of Financial Accounting Standards (SFAS) No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures (collectively with SFAS 114, SFAS No. 114). We measure impairment of
a loan based on the present value of expected future cash flows, an observable
market value, or the fair value of the collateral. If the determined SFAS No.
114 value is less than the recorded investment (book value) in the impaired
loan, an allowance is established or appropriated for the amount deemed
uncollectible; if the impairment is deemed highly certain, the exposure is
charged off against the allowance.
Generally, when a loan is recognized as impaired, the accrual of interest is
discontinued and any previously accrued but unpaid interest on the loan is
reversed against the current period's interest revenue. When doubt exists as to
the collectibility of the remaining recorded investment, any interest received
on impaired loans is applied in the following order:
- - against the recorded investment until paid in full
- - as a recovery up to any amounts charged off related to the impaired loan
- - as interest revenue
If it is deemed highly certain we will collect the remaining recorded investment
of the impaired loan, interest revenue is recorded on a cash basis as payments
are received.
9
<PAGE> 10
Allowances for credit losses
We maintain allowances for credit losses to absorb losses inherent in our
traditional extensions of credit that we believe are probable and that can be
reasonably estimated. These allowances include an allowance for loan losses and
an allowance for credit losses on lending commitments which include, commitments
to extend credit, standby letters of credit, and guarantees.
The firm's Asset Quality Review process determines the appropriate allowances
based on an estimate of probable losses by counterparty, industry, or country;
and a statistical model estimate for expected losses on our remaining performing
portfolio, which includes the general component. The general component of our
allowances for credit losses is used to estimate the impact of separately
identified limitations in our expected loss model. Beginning in the second
quarter of 1999, the general component is included as part of the expected loss
component for disclosure purposes since all factors used to derive the general
component relate to the expected loss component. Prior period amounts have been
reclassified.
In March 1999, a Joint Working Group, comprised of banking and securities
regulators, was formed to provide clarification to the banking industry
regarding the appropriate accounting, disclosure, and documentation requirements
for allowances for credit losses. We are in the process of reviewing our model
for estimating credit losses and determining the appropriate level of our
allowances, with the goal of refining it based on our review, which will
incorporate any guidance issued by the Joint Working Group.
2. ACCOUNTING CHANGES AND DEVELOPMENTS
Accounting for derivative instruments and hedging activities
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. 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 earnings. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative will either be offset against the change in fair value of the hedged
asset, liability, or firm commitment through earnings or be 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. While we have not
determined the specific impact of SFAS No. 133 on our earnings and financial
position, we have identified, based on current hedging strategies, our
activities that would be most affected by the new standard. Specifically, the
Proprietary Investing and Trading segment uses derivatives to hedge its
investment portfolio, deposits, and issuance of debt primarily hedges of
interest rate risk. Our credit activities use credit derivatives to hedge credit
risk, and to a lesser extent, use other derivatives to hedge interest rate risk.
Pursuant to SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133, we are
required to adopt the standard effective January 1, 2001. Management is
currently evaluating the impact of SFAS No. 133 on our hedging strategies. The
actual assessment of the impact on the firm's earnings and financial position of
adopting SFAS No. 133 will be made based on our positions at the date of
adoption.
Accounting for the costs of computer software developed or obtained for internal
use
In March 1998, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement requires that we
capitalize certain costs associated with the acquisition or development of
internal use software. Effective January 1, 1999, we adopted SOP 98-1;
restatement of financial statements of previous years is not allowed. As a
result of this adoption we expect to capitalize approximately $130 million in
software costs during 1999, net of expected amortization, of which $103 million
were capitalized in the first nine months of the year. Previously, these costs
would have been expensed as incurred. Once the software is ready for its
intended use, we will begin amortizing capitalized costs on a straight-line
basis over its expected useful life. This period will generally not exceed three
years.
3. RESTRUCTURING OF BUSINESS ACTIVITIES
During the first quarter 1998, the firm announced a plan to restructure certain
sales and trading functions in Europe, refocus our investment banking and
equities businesses in Asia, and rationalize resources throughout the firm. As a
result of this decision, the 1998 first quarter reflected a pretax charge of
$215 million ($129 million after tax) which consisted of the following:
severance-related costs of $140 million recorded in Employee compensation and
benefits associated with staff reductions of approximately 900; $70 million in
Net occupancy, primarily related to lease termination fees, estimated losses on
sublease agreements, and the write-off of various leasehold improvements and
equipment, primarily
10
<PAGE> 11
in Europe; and $5 million in Technology and communications, related to equipment
write-offs. During the fourth quarter 1998, we revised our estimates of
remaining costs under the plan and reduced the liability by $7 million; this
adjustment was recorded in Net occupancy. Excluding certain long-term
commitments, the reserve related to this charge was substantially utilized as of
December 31, 1998.
During the fourth quarter 1998, the firm incurred an additional pretax charge of
$143 million ($86 million after tax) related to cost reduction programs that are
part of its productivity initiatives. The charge reflected severance-related
costs of $101 million recorded in Employee compensation and benefits associated
with staff reductions of approximately 800. It also reflected $42 million (net
of the $7 million adjustment discussed above) in Net occupancy primarily related
to estimated losses on sublease agreements and the write-off of various
leasehold improvements and furniture and fixtures in several European locations.
As of September 30, 1999, approximately $45 million of the fourth-quarter charge
was accrued in Other liabilities, of which $27 million related to severance and
the remainder related to real estate. Excluding certain long-term commitments,
the remainder of this reserve will be substantially utilized by December 31,
1999.
While predominantly impacting the European and North American regions, the
special charges primarily affected all client-focused activities as defined by
our reported segments in note 23, "Segments."
Additional costs associated with these initiatives did not meet the requirement
for inclusion in the first- or fourth-quarter charge. These items were expensed
as incurred and did not have a material impact on the firm. The remaining
reserves relate to future cash outflows, mostly long term in nature, associated
with severance payments, lease termination benefits, and other exit costs. The
payment of these items will not have a material impact on the financial
position or liquidity of the firm.
4. BUSINESS CHANGES AND DEVELOPMENTS
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 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.
Occupancy
On December 23, 1998, the City and State of New York and the New York Stock
Exchange announced an agreement to build a new Exchange on land currently
occupied by J.P. Morgan facilities at 15 Broad Street, 23 Wall Street, and 37
Wall Street in New York City. We do not anticipate any disruption to our
operations, or any material impact to the firm's financial statements, as a
result of this transaction.
Securities portfolio accounting services
On April 22, 1999, J.P. Morgan announced that The Bank of New York has been
appointed to provide securities portfolio accounting and related operational
services for J.P. Morgan's asset management business. We do not anticipate any
disruption to our operations, or any material impact to the firm's financial
statements, as a result of this transaction.
Euroclear
On September 1, 1999, J.P. Morgan and the Boards of Euroclear Clearance System
PLC and Euroclear Clearance System Societe Cooperative announced that they had
signed a letter of intent to create a new, market-owned European bank to operate
all aspects of the Euroclear System. This agreement in principle anticipates the
formation of a European bank in Brussels to succeed J.P. Morgan as operator and
banker for the Euroclear System, facilitating Euroclear's strategy to maintain
its leadership and capitalize on partnership opportunities as market forces
reshape the settlement infrastructure in Europe.
Subject to a definitive agreement being reached, J.P. Morgan will remain as
operator and banker of Euroclear until the successor bank is established and can
take over J.P. Morgan's Euroclear functions, a process which is expected to take
up to 18 months from the signing of the definitive agreement. J.P. Morgan will
play a key role in the formation of the
11
<PAGE> 12
new bank. After that, J.P. Morgan will remain an important participant and
shareholder of Euroclear and retain a seat on its Board. The management and
staff of Euroclear, numbering approximately 1,200 J.P. Morgan employees, will
transfer to the new entity.
Under the existing Operating Agreement, income from clearance and settlement
operations is earned by Euroclear Clearance System Societe Cooperative, while
J.P. Morgan retains earnings from providing banking services to the System's
participants. Under the agreement in principle, J.P. Morgan will continue to
receive pretax banking income for three years following the signing of the
definitive agreement, with a minimum of $195 million and maximum of $295 million
per year, whether the income is earned by J.P. Morgan prior to the changeover to
the new bank or afterward by the new bank. After the new bank becomes
operational, it will also pay J.P. Morgan for certain costs of transition,
assets and know-how that are transferred to it.
Until the new bank becomes operational, J.P. Morgan will continue to record
pre-tax banking income over the period earned. Upon the changeover to the new
bank, J.P. Morgan will recognize as income, on that date, all expected amounts
due over the remaining contract period, plus any gain on assets transferred to
the new bank. This amount will be subsequently adjusted based on the
determination of the final pretax banking income of Euroclear as specified in
the definitive agreement.
Prior to the changeover to the successor bank, all funds due J.P. Morgan under
the agreement in principle will be received as earned. Following the changeover
to the successor bank, fifty percent of all funds due to J.P. Morgan will be
paid as earned. The remaining 50% will be paid in monthly installments over the
period ending six years after the signing of the definitive agreement. The
successor bank will have the option of prepaying its obligation for the
remaining period at the higher of $245 million per year or the average of the
actual annual income (subject to the floor and cap noted above), for the portion
of the three year period preceding the prepayment.
Pretax income from Euroclear-related activities reported by J.P. Morgan was $168
million in the first nine months of 1999; $253 million for the full year 1998;
and $218 million for 1997.
5. INTEREST REVENUE AND EXPENSE
The table below 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 1999 1998 1999 1998
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST REVENUE
Deposits with banks $ 61 $ 107 $ 221 $ 236
Debt investment securities (a) 402 321 1,266 1,027
Trading account assets 970 1,127 2,763 3,437
Securities purchased under agreements to
resell and federal funds sold 407 533 1,188 1,493
Securities borrowed 456 568 1,374 1,578
Loans 415 528 1,249 1,618
Other sources 72 65 192 228
- ------------------------------------------------------------------------------------
Total interest revenue 2,783 3,249 8,253 9,617
- ------------------------------------------------------------------------------------
INTEREST EXPENSE
Deposits 548 645 1,723 2,138
Trading account liabilities 298 386 866 1,218
Securities sold under agreements to
repurchase and federal funds purchased 792 1,054 2,260 2,923
Other borrowed money 376 432 1,070 1,235
Long-term debt 380 400 1,131 1,145
- ------------------------------------------------------------------------------------
Total interest expense 2,394 2,917 7,050 8,659
- ------------------------------------------------------------------------------------
Net interest revenue 389 332 1,203 958
- ------------------------------------------------------------------------------------
</TABLE>
(a) Interest revenue from debt investment securities included taxable revenue of
$378 million and $1,187 million and revenue exempt from U.S. income taxes of $24
million and $79 million for the three and nine months ended September 30, 1999,
respectively. 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.
12
<PAGE> 13
Net interest (expense)/revenue associated with derivatives used for purposes
other-than-trading was approximately ($11) million and $16 million for the three
and nine months ended September 30, 1999, respectively, compared with
approximately $41 million and $112 million for the three and nine months ended
September 30, 1998, respectively. At September 30, 1999, approximately $40
million of net deferred gains on closed derivative contracts used for purposes
other-than-trading were recorded on the "Consolidated balance sheet." These
amounts are primarily net deferred gains on closed hedge contracts, which are
included in the amortized cost of the debt investment portfolio as of September
30, 1999. 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 gains (losses) on closed derivative contracts as of September 30, 1999
of $40 million, are expected to amortize into Net interest revenue as follows:
$(2) million - remainder of 1999; $(7) million in 2000; ($9) million in 2001;
($6) million in 2002; ($6) million in 2003; ($3) million in 2004; and
approximately ($73) million thereafter.
6. TRADING REVENUE
Trading revenue is predominantly generated by our market making activities
included in our Global Finance sector as well as activities in our Proprietary
Investments sector. The following table presents trading revenue by principal
product grouping for the three and nine months ended September 30, 1999 and
1998. Prior period amounts have been restated to reflect the product groupings
as described below.
<TABLE>
<CAPTION>
Third quarter Nine months
------------------ ----------------------
In millions 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fixed income $194 ($123) $1,224 $1,120
Equities 177 2 661 211
Foreign exchange 53 190 476 511
- ------------------------------------------------------------------------------------------------
Total trading revenue 424 69 2,361 1,842
Trading-related net interest revenue 171 78 564 231
- ------------------------------------------------------------------------------------------------
Combined total 595 147 2,925 2,073
- ------------------------------------------------------------------------------------------------
</TABLE>
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. Equities trading
revenue includes the results of making markets in global equity securities,
equity derivatives such as swaps, options, futures, and forward contracts, and
convertible debt securities. 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.
Foreign exchange also includes the results from commodity transactions in spot,
forwards, options, and swaps.
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, along with the fair and carrying value of our
available-for-sale debt investment securities at September 30, 1999. The net
unrealized depreciation on debt investment securities was $274 million at
September 30, 1999, compared with a net unrealized depreciation of $169 million
at June 30, 1999 and a net unrealized appreciation of $125 million at December
31, 1998. The decline from the prior periods primarily related to decreases in
the value of U.S. government and agency securities. The gross unrealized gains
or losses on each debt investment security include the effects of any related
hedge. See note 10, "Derivatives," 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, 1999 Cost gains losses value
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury $ 1,950 $ 40 $ 1 $ 1,989
U.S. government agency, principally mortgage-backed 19,774 24 369 19,429
U.S. state and political subdivision 1,269 150 97 1,322
U.S. corporate and bank debt 84 -- -- 84
Foreign government (a) 857 -- 4 853
Foreign corporate and bank debt 348 3 20 331
Other 107 -- -- 107
- -----------------------------------------------------------------------------------------------------------
Total debt investment securities 24,389 217 491 24,115
- -----------------------------------------------------------------------------------------------------------
</TABLE>
(a) Primarily includes debt of countries that are members of the Organization
for Economic Cooperation and Development.
The table below presents net debt investment securities losses during the three
and nine months ended September 30, 1999 and 1998. These amounts are recorded in
Investment securities revenue.
<TABLE>
<CAPTION>
Third quarter Nine months
---------------------------------------------
In millions 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross realized gains from sales of securities $ 55 $ 4 $ 162 $ 62
Gross realized losses from sales of securities (106) (27) (281) (111)
Write-downs for other-than-temporary impairments in value -- -- -- (2)
Net gains on maturities, calls, and mandatory redemptions -- 2 1 2
- ------------------------------------------------------------------------------------------------------------
Net debt investment securities losses (51) (21) (118) (49)
- ------------------------------------------------------------------------------------------------------------
</TABLE>
EQUITY INVESTMENT 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, 1999 are
shown in the following table.
<TABLE>
<CAPTION>
In millions: September 30, 1999
- -----------------------------------------------------------------
<S> <C>
Cost $ 387
- -----------------------------------------------------------------
Gross unrealized gains 94
Gross unrealized losses (18)
- -----------------------------------------------------------------
Net unrealized gains(a) 76
- -----------------------------------------------------------------
Fair and carrying value 463
- -----------------------------------------------------------------
</TABLE>
(a) Primarily relates to investments in the financial services industries.
Nonmarketable and other equity securities
Nonmarketable equity investment securities are carried at cost on the balance
sheet. The following table presents the carrying and fair value, as well as
the net unrealized gains, on these securities.
<TABLE>
<CAPTION>
In millions: September 30, 1999
- ---------------------------------------------------------------------
<S> <C>
Carrying value $ 550
Net unrealized gains on nonmarketable securities(a) 50
- ---------------------------------------------------------------------
Fair value 600
- ---------------------------------------------------------------------
</TABLE>
(a) Primarily relates to investments in the financial services industries.
Also included in our equity investments are securities held in subsidiaries
registered as Small Business Investment Companies (SBICs). SBICs are carried at
fair value on the balance sheet, with changes in fair value recorded currently
in Investment Securities Revenue. Investments in these securities were
approximately $515 million at September 30, 1999, and primarily relate to
investments in the financial services industries.
14
<PAGE> 15
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, 1999 and 1998. These amounts are recorded in Investment securities
revenue.
<TABLE>
<CAPTION>
Third quarter Nine months
-------------------- -------------------
In millions 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross realized gains from marketable available-for-sale securities $ -- $ 192 $ -- $ 334
Gross realized gains from nonmarketable and other equity securities 141 5 150 16
Write-downs for other-than-temporary impairments in value (112) (48) (150) (82)
- --------------------------------------------------------------------------------------------------------------------------
Net equity investment securities realized gains 29 149 -- 268
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
Gains related to the appreciation of investments in SBICs recorded in
Investment securities revenue were approximately $255 million for the three
and nine months ended September 30, 1999.
8. 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 was approximately $795 million at the time
of purchase. This amount is being amortized on a straight-line basis over a
period of 25 years. At September 30, 1999 and 1998, goodwill totaled $735
million and $768 million, respectively. For the three and nine months ended
September 30, 1999 and 1998, amortization of goodwill was approximately
$8 million and $24 million in each period, respectively. Our share of equity
income in American Century and the amortization of goodwill related to this
investment is recorded in Other revenue. The results of this investment are
included in the Asset Management Services segment.
9. 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 fair and carrying value of trading account assets and trading account
liabilities at September 30, 1999. It also includes the average balances for the
three and nine months ended September 30, 1999.
<TABLE>
<CAPTION>
Carrying Average
value Balance
------------ -------------------------------
September 30, Third quarter Nine months
In millions: 1999 1999 1999
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
TRADING ACCOUNT ASSETS
U.S. Treasury $ 7,908 $ 9,212 $ 9,871
U.S. government agency 12,780 15,525 13,676
Foreign government 17,304 16,603 19,011
Corporate debt and equity 18,479 18,453 19,239
Other securities 7,029 5,764 6,414
Interest rate and currency swaps 16,335 15,696 16,675
Credit derivatives 51 294 1,230
Foreign exchange contracts 1,945 2,568 3,110
Interest rate futures and forwards 74 36 53
Commodity and equity contracts 7,264 5,913 4,312
Purchased option contracts 17,341 19,018 19,809
- -----------------------------------------------------------------------------------------
Total trading account assets 106,510 109,082 113,400
- -----------------------------------------------------------------------------------------
TRADING ACCOUNT LIABILITIES
U.S. Treasury 8,125 5,054 5,908
Foreign government 11,327 13,654 12,557
Corporate debt and equity 9,104 8,496 9,110
Other securities 4,132 1,322 2,602
Interest rate and currency swaps 12,975 12,092 13,649
Credit derivatives 514 154 1,027
Foreign exchange contracts 1,963 2,503 3,611
Interest rate futures and forwards 94 703 923
Commodity and equity contracts 5,690 4,458 3,303
Written option contracts 18,119 20,988 19,697
- -----------------------------------------------------------------------------------------
Total trading account liabilities 72,043 69,424 72,387
- -----------------------------------------------------------------------------------------
</TABLE>
15
<PAGE> 16
At September 30, 1999, trading account assets include the fair value of certain
disputed swap contracts with South Korean counterparties. The gross derivative
receivables related to these contracts, before fair value adjustments made by
management, were $534 million. In October 1999, J.P. Morgan settled
approximately $344 million of the gross derivative receivables under dispute.
J.P. Morgan received a consideration primarily consisting of cash and, to a
lesser extent, an equity interest in a South Korean financial services company.
The fair value of the consideration approximated the recorded fair value of the
receivables included in the settlement.
Trade date receivables/payables
Amounts receivable and payable for securities that have not reached their
contractual settlement dates are recorded net in the "Consolidated balance
sheet." Amounts receivable for securities sold of $36.0 billion were netted
against amounts payable for securities purchased of $35.2 billion. This produced
a net trade date receivable of $0.8 billion, recorded in Accrued interest and
accounts receivable, at September 30, 1999.
10. 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 are
either standardized contracts executed on an exchange or negotiated
over-the-counter contracts. Futures and options contracts are examples of
standard exchange-traded derivatives. Forwards, swaps, and option contracts are
examples of over-the-counter derivatives. Over-the-counter derivatives are
generally not traded like securities. In the normal course of business, however,
they may be terminated or assigned to another counterparty if the original
holder agrees.
Derivatives may be used for trading or other-than-trading purposes.
Other-than-trading purposes are primarily related to our investing activities.
Derivatives used for trading purposes include:
- - interest rate and currency swap contracts
- - credit derivatives
- - 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
- - credit derivatives
- - 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.
Credit derivatives include credit default swaps and related swap and option
contracts. Credit default swaps are contractual agreements that provide
insurance against a credit event of one or more referenced credits. The nature
of the credit event is established by the protection buyer and seller at the
inception of the transaction, and includes events such as bankruptcy,
insolvency, and failure to meet payment obligations when due. The protection
buyer pays a periodic fee in return for a contingent payment by the protection
seller following a credit event. The contingent payment is typically the loss-
the difference between the notional and the recovery amount - incurred by the
creditor of the reference credit as a result of the event.
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.
16
<PAGE> 17
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 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 on 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.
The following table presents notional amounts for trading and other-than-trading
derivatives, based on management's intent and ongoing usage. A summary of the
on-balance-sheet credit exposure, which is represented by the net positive fair
value associated with trading derivatives and recorded in Trading account
assets, is also included in the following table. Our on-balance-sheet credit
exposure takes into consideration $84.6 billion of master netting agreements in
effect at September 30, 1999.
<TABLE>
<CAPTION>
On-balance-sheet
In billions: September 30, 1999 Notional amounts credit exposure
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest rate and currency swaps
Trading $4,239.2
Other-than-trading(a)(b) 65.0
- -------------------------------------------------------------------------------------------------
Total interest rate and currency swaps 4,304.2 ( $16.3)
- -------------------------------------------------------------------------------------------------
Credit derivatives
Trading 114.4
Other-than-trading (a) 19.0
- -------------------------------------------------------------------------------------------------
Total credit derivatives 133.4 0.1
- -------------------------------------------------------------------------------------------------
Foreign exchange spot, forward, and futures contracts
Trading 497.7
Other-than-trading(a)(b) 20.7
- -------------------------------------------------------------------------------------------------
Total foreign exchange spot, forward, and futures contracts 518.4 2.0
- -------------------------------------------------------------------------------------------------
Interest rate futures, forward rate agreements, and debt
securities forwards
Trading 1,140.7
Other-than-trading (a) 38.4
- -------------------------------------------------------------------------------------------------
Total interest rate futures, forward rate agreements,
and debt securities forwards 1,179.1 --
- -------------------------------------------------------------------------------------------------
Commodity and equity swaps, forward, and futures contracts, 89.6 7.3
all trading
- -------------------------------------------------------------------------------------------------
Purchased options(c)
Trading 1,297.2
Other-than-trading(a) 11.8
- -------------------------------------------------------------------------------------------------
Total purchased options 1,309.0 17.3
- -------------------------------------------------------------------------------------------------
Written options, all trading(d) 1,538.2
- -------------------------------------------------------------------------------------------------
Total on-balance-sheet credit exposure 43.0
- -------------------------------------------------------------------------------------------------
</TABLE>
(a) Derivatives used as hedges of other-than-trading positions may be transacted
with third parties through independently managed J.P. Morgan derivative dealers
that function as intermediaries for credit and administrative purposes. In such
cases, the terms of the third-party transaction - notional, duration, currency,
etc. - are matched with the terms of the internal trade to ensure the hedged
risk has been offset with a third party. If such terms are not matched or a
third-party trade is not transacted, the intercompany trade is eliminated in
consolidation.
(b) The notional amounts of derivative contracts used for purposes
other-than-trading, conducted in the foreign exchange markets, primarily forward
contracts, amounted to $26.4 billion at September 30, 1999, and were primarily
denominated in the following currencies: Euro $6.2 billion, Japanese yen $5.7
billion, British pound $2.6 billion, Canadian dollar $2.5 billion and Swiss
franc $2.4 billion.
(c) At September 30, 1999, purchased options used for trading purposes included
$946.8 billion of interest rate options, $198.6 billion of foreign exchange
options, and $151.8 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 $228.1 billion and those negotiated
over-the-counter amounted to $1,080.9 billion at September 30,1999.
17
<PAGE> 18
(d) At September 30, 1999, written options included $1,177.1 billion of interest
rate options, $211.6 billion of foreign exchange options, and $149.5 billion of
commodity and equity options. Written option contracts executed on an exchange
amounted to $217.1 billion and those negotiated over-the-counter amounted to
$1,321.1 billion at September 30, 1999.
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 losses associated with open derivative contracts used to hedge or
modify the interest rate characteristics of related balance sheet instruments
amounted to $110 million at September 30, 1999. Gross unrealized gains and gross
unrealized losses associated with open derivative contracts at September 30,
1999, are as follows:
<TABLE>
<CAPTION>
Gross Gross Net
unrealized unrealized unrealized
In millions: September 30, 1999 gains (losses) gains (losses)
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Long-term debt $412 ($580) ($168)
Debt investment securities 31 (3) 28
Deposits 137 (36) 101
Other financial instruments 107 (178) (71)
- -------------------------------------------------------------------------------------
Total 687 (797) (110)
- -------------------------------------------------------------------------------------
</TABLE>
11. LOANS
Included in Loans are loans held for sale of approximately $1.3 billion at
September 30, 1999. These loans are recorded on the balance sheet at lower of
cost or fair value and are primarily to borrowers in the U.S. in various
industries.
12. OTHER CREDIT-RELATED PRODUCTS
Lending commitments include commitments to extend credit, standby letters of
credit, 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 the collateral become worthless.
The following table summarizes the contractual amount of lending commitments.
<TABLE>
<CAPTION>
In billions: September 30, 1999
- ---------------------------------------------------------
<S> <C>
Commitments to extend credit $64.7
Standby letters of credit and guarantees 14.5
Securities lending indemnifications (a) 7.2
- ---------------------------------------------------------
</TABLE>
(a) At September 30, 1999, J.P. Morgan held cash and other collateral in full
support of securities lending indemnifications.
Included in Fees and Commissions are credit-related fees of $47 million and
$45 million for the three months ended September 30, 1999 and 1998,
respectively. Credit-related fees were $125 million and $132 million for the
nine months ended September 30, 1999 and 1998, respectively. They are primarily
earned from commitments to extend credit, standby letters of credit and
guarantees, and securities lending indemnifications. Also included in Fees and
Commissions are amounts paid to credit derivative providers of $12 million and
$33 million for the three months ended September 30, 1999 and 1998,
respectively. Amounts paid to credit derivative providers were $35 million and
$48 million for the nine months ended September 30, 1999 and 1998,
respectively.
18
<PAGE> 19
13. IMPAIRED LOANS
Total impaired loans, organized by the location of the counterparty - net of
charge-offs - at September 30, 1999 and 1998 are presented in the following
table.
<TABLE>
<CAPTION>
In millions: September 30 1999 1998 (a)
- ---------------------------------------------------------------
<S> <C> <C>
COUNTERPARTIES IN THE U.S.
Commercial and industrial $ 19 $ 23
Other 25 18
- -----------------------------------------------------------
44 41
- -----------------------------------------------------------
COUNTERPARTIES OUTSIDE THE U.S.
Commercial and industrial 112 5
Other, primarily individuals 13 14
- -----------------------------------------------------------
125 19
- -----------------------------------------------------------
TOTAL IMPAIRED LOANS 169 60
- -----------------------------------------------------------
Allowance for impaired loans 32 14
- -----------------------------------------------------------
</TABLE>
(a) Certain reclassifications were made to conform with the categorization used
in Bank regulatory filings.
Impaired loans for which no SFAS No. 114 reserve was deemed necessary were $37
million and $20 million as of September 30, 1999 and 1998, respectively.
The following table presents an analysis of the changes in impaired loans.
<TABLE>
<CAPTION>
Third Third Nine Nine
quarter quarter months months
In millions 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IMPAIRED LOANS, BEGINNING PERIOD $ 67 $ 55 $ 122 $ 113
- -----------------------------------------------------------------------------------------------------------
Additions to impaired loans 109(b) 36 139 162
Less:
Repayments of principal, net of
additional advances (1) (11) (43) (36)
Impaired loans returning to
accrual status -- -- (2) (39)
Charge-offs (a):
Commercial and industrial (6) (6) (16) (40)
Banks -- (5) (1) (66)
Other, primarily other financial institutions -- (6) (25) (24)
Interest and other credits -- (3) (5) (10)
- -----------------------------------------------------------------------------------------------------------
IMPAIRED LOANS, SEPTEMBER 30 169 60 169 60
- -----------------------------------------------------------------------------------------------------------
</TABLE>
(a) Charge-offs include losses on loan sales of $3 million and $11 million for
the three months ended September 30, 1999 and 1998, respectively. Charge-offs
include losses on loan sales, primarily banks and other financial institutions
of $33 million and $89 million for the nine months ended September 30, 1999 and
1998, respectively.
(b) Primarily relates to loans to the Latin American steel industry.
For the three months ended September 30, 1999 and 1998, the average recorded
investments in impaired loans was $109 million and $53 million, respectively.
For the nine months ended September 30, 1999 and 1998, the average recorded
investments in impaired loans was $102 million and $78 million, respectively.
An analysis of the effect of impaired loans - net of charge-offs - on interest
revenue for the three and nine months ended September 30, 1999 and 1998 is
presented in the following table.
<TABLE>
<CAPTION>
Third Third Nine Nine
quarter quarter months months
In millions 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest revenue that would have been recorded if accruing $4 $- $8 $4
Net interest revenue recorded related to the current period - - - 4
- --------------------------------------------------------------------------------------------------------------
Negative impact of impaired loans on interest revenue 4 - 8 -
- --------------------------------------------------------------------------------------------------------------
</TABLE>
19
<PAGE> 20
14. ALLOWANCES FOR CREDIT LOSSES
The following table summarizes the activity of our allowance for loan losses.
<TABLE>
<CAPTION>
Third Third Nine Nine
quarter quarter months months
In millions 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BEGINNING BALANCE $ 335 $ 392 $ 470 $ 546
- -------------------------------------------------------------------------------------------------------------------------
(Reversal of provision)/provision for loan losses in the U.S. 19 (14) (46) 14
(Reversal of provision)/provision for loan losses outside the U.S. (64) (11) (104) 11
- -------------------------------------------------------------------------------------------------------------------------
(45) 25 (150) 25
- -------------------------------------------------------------------------------------------------------------------------
Reclassifications in the U.S. -- -- -- 6
Reclassifications outside the U.S. -- -- -- (56)
- -------------------------------------------------------------------------------------------------------------------------
-- -- -- (50)(a)
- -------------------------------------------------------------------------------------------------------------------------
Recoveries:
Counterparties in the U.S. 2 4 3 8
Counterparties outside the U.S. 15 -- 20 5
- -------------------------------------------------------------------------------------------------------------------------
17 4 23 13
- -------------------------------------------------------------------------------------------------------------------------
Charge-offs:
Counterparties in the U.S., primarily other financial
institutions in 1999 (3) (2) (38) (4)
Counterparties outside the U.S.:
Commercial and industrial (3) (6) (3) (38)
Banks -- (5) (1) (66)
Other -- (4) -- (22)
- -------------------------------------------------------------------------------------------------------------------------
Net recoveries/(charge-offs) 11 (13) (19) (117)
- -------------------------------------------------------------------------------------------------------------------------
ENDING BALANCE, SEPTEMBER 30 301 404 301 404
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across
balance sheet reserve or allowance captions - which included an adjustment for
trading derivatives needed to determine fair value, an allowance for loan
losses, and an allowance for credit losses on lending commitments which include
commitments to extend credit, standby letters of credit, and guarantees - were
shown as reclassifications. Reclassifications had no impact on net income and,
accordingly, were not shown on the income statement. Subsequent to July 1, 1998,
reclassifications across balance sheet captions for allowances are reflected as
provisions and reversals of provisions in the "Consolidated statement of
income." If reclassifications prior to July 1, 1998 were included in the
"Consolidated statement of income," the captions on the income statement for the
nine months ended September 30, 1999 would change with no impact on net income
as follows: Provision for loan losses would be a negative (income) $50 million
and Trading revenue would decrease by $50 million.
The following table displays our allowance for loan losses by component as of
September 30.
<TABLE>
<CAPTION>
In millions: September 30 1999 1998
- -----------------------------------------------------------------------------
<S> <C> <C>
Specific counterparty components in the U.S. $ 9 $ 36
Specific counterparty components outside the U.S. 23 5
- -----------------------------------------------------------------------------
Total specific counterparty 32 41
- -----------------------------------------------------------------------------
Specific country 24 77
Expected loss (b) 245 286
- -----------------------------------------------------------------------------
Total 301 404
- -----------------------------------------------------------------------------
</TABLE>
The following table summarizes the activity of our allowance for credit losses
on lending commitments.
<TABLE>
<CAPTION>
Third Third Nine Nine
quarter quarter months months
In millions 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BEGINNING BALANCE $ 160 $ 185 $ 125 $ 185
- -------------------------------------------------------------------------------------------------------------------------
(Reversal of provision)/provision for credit losses in the U.S. (2) -- 49 --
(Reversal of provision)/provision for credit losses outside the U.S. (13) -- (29) --
- -------------------------------------------------------------------------------------------------------------------------
(15) -- 20 --
- -------------------------------------------------------------------------------------------------------------------------
ENDING BALANCE, SEPTEMBER 30 145 185 145 185
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE> 21
The following table displays our allowance for credit losses on lending
commitments by component as of September 30.
<TABLE>
<CAPTION>
In millions: September 30 1999 1998
- -------------------------------------------------------------------------
<S> <C> <C>
Specific counterparty components in the U.S. $ 20 $ 1
Specific counterparty components outside the U.S. 3 2
- -------------------------------------------------------------------------
Total specific counterparty 23 3
- -------------------------------------------------------------------------
Specific country 1 7
Expected loss (b) 121 175
- -------------------------------------------------------------------------
Total 145 185
- -------------------------------------------------------------------------
</TABLE>
(b) The general component of our allowances for credit losses is used to
estimate the impact of separately identified limitations in our expected loss
model. Beginning in the second quarter of 1999, the general component is
included as part of the expected loss component for disclosure purposes since
all factors used to derive the general component relate to the expected loss
component. Prior period amounts have been reclassified.
15. INVESTMENT BANKING REVENUE
<TABLE>
<CAPTION>
Third quarter Nine months
----------------------- ----------------------
In millions 1999 1998 1999 1998
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Advisory and syndication fees $ 258 $ 229 $ 737 $ 618
Underwriting revenue 140 83 508 402
- ---------------------------------------------------------------------------------------------
Total 398 312 1,245 1,020
- ---------------------------------------------------------------------------------------------
</TABLE>
Advisory and syndication fees include revenues earned from; advising clients on
corporate strategy including mergers, acquisitions, privatizations, and changes
in capital structures and; fees earned from the arrangement and syndication of
credit facilities. Underwriting revenue includes both fees from debt and equity
underwriting.
16. OTHER REVENUE AND OTHER EXPENSES
Other revenue
For the three months ended September 30, 1999, Other revenue of negative (loss)
$18 million includes $45 million of losses 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. Other revenue also includes a $15 million reversal of
provision for credit losses (income) related to the allowance for credit losses
on lending commitments.
For the nine months ended September 30, 1999, Other revenue of $120 million
includes $85 million of gains on hedges of the firm's anticipated foreign
currency revenues and expenses and a $20 million net provision for credit losses
related to the allowance for credit losses on lending commitments.
In the 1998 third quarter, Other revenue of $71 million included the $56 million
net gain on the sale of the firm's investment management business in Australia.
It also included losses of approximately $22 million on hedges of the firm's
anticipated foreign currency revenues and expenses. In addition to the 1998
third quarter gain, Other revenue for the first nine months of 1998, included
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,
Business Changes and Developments, for additional information.
Other expenses
The following table presents the major components of Other expenses.
<TABLE>
<CAPTION>
Third quarter Nine months
------------------- --------------------
In millions 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Professional services $ 32 $ 28 $ 83 $ 87
Marketing and business development 51 42 136 131
Other 58 85 200 297
- ------------------------------------------------------------------------------------------
Total other expenses 141 155 419 515
- ------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE> 22
17. INCOME TAXES
The effective tax rate for the three months ended September 30, 1999 and 1998
was 31% and 23%, respectively. The increase in the effective tax rate reflects
higher pretax income over the prior year quarter. For the nine months ended
September 30, 1999 and 1998, the effective tax rate was 34% and 33%,
respectively. The income tax benefit related to net realized losses and
write-downs for other-than-temporary impairments in value on debt and equity
investment securities, excluding securities in SBICs, was approximately $9
million and $48 million for the three and nine months ended September 30, 1999,
compared to an income tax expense related to net realized gains of $47 million
and $78 million for the three and nine months ended September 30, 1998.
The applicable tax rate used to compute the income tax benefit related to net
losses on debt and equity investment securities for the three and nine months
ended September 30, 1999 was approximately 41%. 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 was
approximately 36%.
18. 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, 1999.
Capital ratios and amounts
The following table indicates the risk-based capital and leverage ratios and
amounts as of September 30, 1999 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.
Dollars in millions Amounts Ratios(b)
- -------------------------------------------------------------------
Tier 1 capital(a)
J.P. Morgan $12,243 9.1%
Morgan Guaranty $10,807 9.1%
- -------------------------------------------------------------------
Total risk-based capital(a)
J.P. Morgan $17,825 13.2%
Morgan Guaranty $14,281 12.1%
- -------------------------------------------------------------------
Leverage
J.P. Morgan 4.8%
Morgan Guaranty 6.6%
- -------------------------------------------------------------------
(a) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required
minimum tier 1 capital of $5.4 billion and $4.7 billion, respectively. For
capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum
total risk-based capital of $10.8 billion and $9.5 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.
22
<PAGE> 23
At September 30, 1999, 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, 1999, that would change J.P. Morgan's and Morgan
Guaranty's well capitalized status.
19. STOCK OPTIONS AND OTHER AWARD PLANS
J.P. Morgan's stock option and stock award plans provide for the grant of
stock-related awards to key employees.
To satisfy awards granted under stock option and stock award plans, we may make
common stock available from authorized but unissued shares. We also may purchase
shares in the open market at various times during the year. Shares available for
future grants under stock incentive plans totaled 9,493,000 as of July 31, 1999.
A portion of these shares may be made available from treasury shares. Shares
authorized for future grants under the Stock Bonus Plan are 6.5% of outstanding
shares. All shares authorized under the Stock Bonus Plan are required to be
settled in treasury shares.
In July 1999 we granted stock option awards totaling 6,088,000 with an average
exercise price of $135.72.
20. EARNINGS PER SHARE
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, 1999 and 1998 is presented in the following table.
<TABLE>
<CAPTION>
Third quarter Nine months
--------------------------------- ----------------------------------
Dollars in millions, except share data 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 442 $ 156 $ 1,546 $ 874
Preferred stock dividends and other (9) (9) (27) (27)
- ------------------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings
per share - income available to
common stockholders $ 433 $ 147 $ 1,519 $ 847
- ------------------------------------------------------------------------------------------------------------------------------
Denominator for basic earnings per share-
weighted-average shares 181,511,850 181,663,864 182,405,166 182,309,867
Effect of dilutive securities:
Options (a) 5,191,290(b) 5,387,808(b) 5,207,112(b) 6,445,438(b)
Other stock awards (c) 7,968,493 9,275,066 8,252,293 9,391,115
4.75% convertible debentures -- 68,747 -- 69,964
- ------------------------------------------------------------------------------------------------------------------------------
13,159,783 14,731,621 13,459,405 15,906,517
- ------------------------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share-
weighted-average number of common
shares and dilutive potential common shares 194,671,633 196,395,485 195,864,571 198,216,384
- ------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 2.39 $ 0.81 $ 8.33 $ 4.65
Diluted earnings per share 2.22 0.75 7.76 4.28
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Earnings per share amounts are based on actual numbers before rounding.
(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) The following options to purchase shares of our common stock were
outstanding at September 30, 1999, but were not included in the computation of
diluted EPS:
For the three months ended September 30, 1999: 4,830,000 shares at $130.94 per
share expiring July 15, 2008 and 6,074,000 shares at $135.72 per share expiring
July 15, 2009. For the nine months ended September 30, 1999: 6,074,000 shares at
$135.72 per share expiring July 15, 2009. For the three and nine months ended
September 30, 1998: 5,129,000 shares at $130.94 per share expiring July 15,
2008.
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
respective period.
(c) Weighted-average incremental shares for other stock awards include
restricted stock and stock bonus awards. The related tax benefits are also
considered.
23
<PAGE> 24
21. COMMITMENTS AND CONTINGENT LIABILITIES
Excluding mortgaged properties, assets on our "Consolidated balance sheet" of
approximately $115.2 billion at September 30, 1999, were pledged as collateral
for borrowings, to qualify for fiduciary powers, to secure public monies as
required by law, and for other purposes.
At September 30, 1999 we had commitments to enter into future resale and
repurchase agreements totaling $5.4 billion and $4.2 billion, respectively.
22. 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- and off-balance-sheet
financial instruments. At September 30, 1999, the SFAS No. 107 aggregate net
fair value for all financial instruments approximated the net carrying values on
our "Consolidated balance sheet". At June 30, 1999, the aggregate net fair value
for all financial instruments exceeded the associated net carrying values on our
"Consolidated balance sheet" by $0.5 billion. The decrease from June 30, 1999
primarily related to long-term debt and our traditional credit products.
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 that may not be indicative of net realizable
value. Beginning June 30, 1999, we refined the valuation technique used to
estimate the fair value of our traditional credit products, which includes
loans, commitments to extend credit, standby letters of credit, and guarantees,
to better reflect how we currently manage these exposures. The revised technique
utilizes a discounted cash flows approach which uses rates based on credit
spreads in various markets including credit derivatives, asset swaps and bonds.
Previously, we estimated the fair value of these products based on secondary
loan spreads.
23. SEGMENTS
We present our results based on the segments or activities as reviewed
separately by the chief operating decision maker, our Chairman and Chief
Executive Officer, as well as other members of senior management. Each segment
is organized based on similar products and services we provide globally to our
clients or activities we undertake solely for our own account.
J.P. Morgan's segments or activities are: Investment Banking, Equities, Interest
Rate and Foreign Exchange Markets, Credit Markets, Credit Portfolio, Asset
Management Services, Equity Investments, and Proprietary Investing and Trading.
In addition to the activities of our proprietary positioning group, the
Proprietary Investing and Trading segment is comprised of a separately managed
credit investment securities portfolio and our investment in Long-Term Capital
Management, L.P. For purposes of presentation, we have grouped these segments
into the sectors Global Finance, Asset Management Services, and Proprietary
Investments.
In connection with the signed letter of intent between J.P. Morgan and the
Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe
Cooperative, Morgan will end its role as operator and banker for the Euroclear
system upon the formation of a successor bank to be owned by Euroclear (See note
4, "Business changes and developments"). Accordingly, segment results have been
restated to reflect Euroclear-related revenues and expenses in Corporate Items.
Previously, results related to our Asset Management and Euroclear activities
were included in the sector titled Asset Management and Servicing. In addition,
Credit Portfolio's results were restated in the second quarter of 1999 to
reflect the segment's responsibility for managing the firm's allowances for
credit losses as follows: provisions for credit losses, previously included in
Corporate Items, are included in the segment, and the intercompany credit loss
charge previously paid to Corporate Items in lieu of recording provisions, has
been eliminated. All amounts in the following tables below have been restated to
reflect our current reporting structure and policies.
The assessment of segment performance by senior management includes a review of
pretax income for each of the segments. Our management reporting system and
policies were used to determine revenues and expenses attributable to each
segment. Earnings on stockholders' equity were allocated based on management's
estimate of the economic capital of each segment; economic capital levels are
derived principally from an estimate of risk inherent in each segment. Overhead
was applied based on management's estimate of overhead usage by each segment.
Transactions between
24
<PAGE> 25
segments are recorded within segment results as if conducted with a third party
and eliminated in consolidation. The accounting policies of our segments are, in
all material respects, consistent with those described in note 1, "Summary of
Significant Accounting Policies," of our 1998 Annual report except for
management reporting policies related to the tax-equivalent adjustment.
The following table presents segment pretax income for the three months ended
September 30, 1999, September 30, 1998 and June 30, 1999; and the nine months
ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
SUMMARY OF SEGMENT RESULTS
- ------------------------------------------------------------------------------------------------------------------
Asset
Interest Manage-
Investment Rate and Credit Credit Global ment Equity
In millions Banking Equities FX Markets Markets Portfolio Finance Services Investments
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
THIRD QUARTER 1999
Total Revenues $310 $289 $331 $186(a) $269(b)(f) $1,385 $353 $341
Total Expenses 209 214 288 156 34 901 296 53
- -----------------------------------------------------------------------------------------------------------------
Pretax Income 101 75 43 30 235 484 57 288
- -----------------------------------------------------------------------------------------------------------------
THIRD QUARTER 1998
Total Revenues 238 141 348 (140)(a) 50(b)(g) 637 300 160
Total Expenses 166 162 280 77 42 727 272 15
- -----------------------------------------------------------------------------------------------------------------
Pretax Income 72 (21) 68 (217) 8 (90) 28 145
- -----------------------------------------------------------------------------------------------------------------
SECOND QUARTER 1999
Total Revenues 320 427 555 361(a) 152(b)(f) 1,815 343 13
Total Expenses 228 236 321 210 41 1,036 276 13
- -----------------------------------------------------------------------------------------------------------------
Pretax Income 92 191 234 151 111 779 67 -
- -----------------------------------------------------------------------------------------------------------------
NINE MONTHS 1999
Total Revenues 888 1,004 1,548 1,243(a) 575(b)(h) 5,258 1,005 332
Total Expenses 647 680 968 625 120 3,040 836 80
- -----------------------------------------------------------------------------------------------------------------
Pretax Income 241 324 580 618 455 2,218 169 252
- -----------------------------------------------------------------------------------------------------------------
NINE MONTHS 1998
Total Revenues 736 520 1,583 462(a) 339(b)(g) 3,640 901 288
Total Expenses 526 578 971 537 109 2,721 833 39
- -----------------------------------------------------------------------------------------------------------------
Pretax Income 210 (58) 612 (75) 230 919 68 249
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
Proprietary
Investing Proprietary Corporate Consol-
In millions Trading Investments Items(e) idated
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
THIRD QUARTER 1999
Total Revenues ($14)(c)(d) $327 ($80) $1,985
Total Expenses 37 90 54 1,341
- ----------------------------------------------------------------------
Pretax Income (51) 237 (134) 644
- ----------------------------------------------------------------------
THIRD QUARTER 1998
Total Revenues 147(c)(d) 307 57 1,301
Total Expenses 35 50 50 1,099
- ----------------------------------------------------------------------
Pretax Income 112 257 7 202
- ----------------------------------------------------------------------
SECOND QUARTER 1999
Total Revenues 44(c)(d) 57 (24) 2,191
Total Expenses 42 55 50 1,417
- ----------------------------------------------------------------------
Pretax Income 2 2 (74) 774
- ----------------------------------------------------------------------
NINE MONTHS 1999
Total Revenues 149(c)(d) 481 (77) 6,667
Total Expenses 112 192 257 4,325
- ----------------------------------------------------------------------
Pretax Income 37 289 (334) 2,342
- ----------------------------------------------------------------------
NINE MONTHS 1998
Total Revenues 514(c)(d) 802 108 5,451
Total Expenses 114 153 440 4,147
- ----------------------------------------------------------------------
Pretax Income 400 649 (332) 1,304
- ----------------------------------------------------------------------
</TABLE>
(a) Revenues related to the structuring of tax-advantaged loans and
structured credit products for Credit Portfolio were $5 million and $11
million for the three months ended September 30, 1999 and 1998,
respectively, and $22 million for the three months ended June 30, 1999.
For the nine months ended September 30, 1999 and 1998 these revenues
were $45 million and $19 million, respectively. These amounts are
eliminated in consolidation.
(b) The adjustment to gross-up Credit Portfolio's revenue to a taxable
basis was $7 million and $6 million for the three months ended
September 30, 1999 and 1998, respectively, and $7 million for the three
months ended June 30, 1999. These revenues were $20 million for each of
the nine months ended September 30, 1999 and 1998, respectively. These
amounts are eliminated in consolidation.
(c) The adjustment to gross up the Proprietary Investing and Trading
segment tax-exempt revenues to a taxable basis was $37 million and $33
million for the three months ended September 30, 1999 and 1998,
respectively, and $30 million for the three months ended June 30, 1999.
For the nine months ended September 30, 1999 and 1998 the adjustment
was $105 million and $85 million, respectively. These amounts are
eliminated in consolidation.
(d) Total return revenues, which combine reported revenues and the change
in net unrealized appreciation/depreciation, were ($110) million and
$167 million for the three months ended September 30, 1999 and 1998,
respectively, and $26 million for the three months ended June 30, 1999.
Total return for the nine months ended September 30, 1999 and 1998 was
($1) million and $455 million, respectively.
(e) We classify the revenues and expenses of Corporate Items into three
broad categories:
Recurring items not allocated to the segments - including recurring
corporate items, unallocated net interest revenue, results of
hedging anticipated net foreign currency revenues and expenses
across all segments, corporate-owned life insurance, and equity
earnings of certain affiliates. Recurring items included in revenues
were ($97) million and ($18) million for the three months ended
September 30, 1999 and 1998, respectively, ($30) million for the
three months ended June 30, 1999, and ($86) million and ($190)
million for the nine months ended September 30, 1999 and 1998,
respectively.
Nonrecurring items not allocated to the segments - includes gains on
sales of businesses, revenues and expenses associated with
businesses that have been sold or discontinued including revenues
and expenses related to Euroclear activities, special charges, and
other one-time corporate items. Nonrecurring revenues were $64
million and $130 million for the three months ended September 30,
1999 and 1998, respectively and $79 million for the three months
ended June 30, 1999. Nonrecurring revenues were $199 million and
$443 million for the nine months ended September 30, 1999 and 1998,
respectively. Significant nonrecurring revenue items include the
following: third quarter of 1998 pretax gain of $56 million related
to the sale of the firm's investment management business in
Australia; second quarter of 1998 pretax gain of $131 million
related to the sale of the firm's global trust and agency services
business. Nonrecurring expenses in the first quarter of 1998 include
a charge of $215 million in connection with restructuring
initiatives. Corporate items includes in revenues and expenses
related to Euroclear activities as follows:
<TABLE>
<CAPTION>
Third quarter Second quarter Nine months
1999 1998 1999 1999 1998
---------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total revenues $58 $83 $67 $187 $237
Total expenses 8 12 3 19 41
---------------------------------------------------
Pretax income 50 71 64 168 196
</TABLE>
25
<PAGE> 26
Consolidation and management reporting offsets - comprises offsets
to certain amounts recorded in the segments, including the
allocation of earnings on equity out of corporate items and into the
segments, adjustments to bring segments to a tax-equivalent basis,
and other management accounting adjustments. Consolidation and
management reporting offset revenues were ($47) million and ($55)
million for the three months ended September 30, 1999 and 1998,
respectively, ($73) million for the three months ended June 30,
1999, and ($190) million and ($145) million for the nine months
ended September 30, 1999 and 1998, respectively.
(f) Includes a third quarter 1999 reversal of provision for credit losses of
($60) million.
(g) Includes a third quarter 1998 provision for credit losses of $75 million.
(h) Includes a third quarter 1999 reversal of provision for credit losses
of ($60) million, and a second quarter 1999 net reversal of provision for
credit losses of ($70) million.
The following table presents segment assets at period end, as well as average
period assets, for the nine months ended September 30, 1999, for the six months
ended June 30, 1999, and for the year ended December 31, 1998.
<TABLE>
<CAPTION>
Assets (a)
- ------------------------------------------------------------------------------------------------
Asset
Interest Manage-
Rate and Credit Credit Global Ment Equity
In billions Equities FX Markets Markets Portfolio Finance Services Investments
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999
At September 30 $31 $122 $22 $15 $190 $9 $2
Average 35 123 26 16 200 10 1
1999
At June 30 34 126 26 16 202 10 1
Average 35 123 28 17 203 9 1
1998
At December 31 28 123 22 17 190 7 1
Average 31 137 31 21 220 7 1
- ------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
Propriet- Propriet-
ary- ary
Investing Invest- Corporate
In billions and Trading ments Items Total
- -----------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999
At September 30 $41 $43 $13 $255
Average 46 47 7 264
1999
At June 30 47 48 9 269
Average 47 48 8 268
1998
At December 31 57 58 6 261
Average 51 52 4 283
- -----------------------------------------------------------------------
</TABLE>
(a) The unrealized gains and losses related to derivatives contracts are
reflected in the total assets of each respective business; however, the
credit risks related to these exposures are primarily managed centrally by
Credit Portfolio.
24. 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 investment banking
activities, this is the client's head office; for most other products,
it is the location where the activity is transacted.
- - Market making revenues that cannot be specifically attributed to
individual clients (for examples, 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.
26
<PAGE> 27
The results for the three and nine months ended September 30, 1999 and 1998 were
distributed among domestic and international operations, as presented in the
following table.
<TABLE>
<CAPTION>
Income
Pretax tax Net
Total Total income/ expense/ income/
In millions revenues(a,j) expenses (loss) (benefit) (loss)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
THIRD QUARTER 1999
Europe(b) $ 595(h) $ 437 $ 158 $ 63 $ 95
Asia Pacific 85(h) 145 (60) (24) (36)
Latin America(c) 102(h) 35 67 27 40
- -----------------------------------------------------------------------------------------------------------------------
Total international operations 782 617 165 66 99
Domestic operations(d) 1,203(h) 724 479 136 343
- -----------------------------------------------------------------------------------------------------------------------
Total 1,985 1,341 644 202 442
- -----------------------------------------------------------------------------------------------------------------------
THIRD QUARTER 1998
Europe(b) 211 354 (143) (57) (86)
Asia Pacific 138(e) 106 32 13 19
Latin America(c) 90 42 48 19 29
- -----------------------------------------------------------------------------------------------------------------------
Total international operations 439 502 (63) (25) (38)
Domestic operations(d) 862 597 265 71 194
- -----------------------------------------------------------------------------------------------------------------------
Total 1,301 1,099 202 46 156
- -----------------------------------------------------------------------------------------------------------------------
NINE MONTHS 1999
Europe(b) 2,110(i) 1,317 793 318 475
Asia Pacific 408(i) 427 (19) (7) (12)
Latin America(c) 751(i) 152 599 239 360
- -----------------------------------------------------------------------------------------------------------------------
Total international operations 3,269 1,896 1,373 550 823
Domestic operations(d) 3,398(i) 2,429 969 246 723
- -----------------------------------------------------------------------------------------------------------------------
Total 6,667 4,325 2,342 796 1,546
- -----------------------------------------------------------------------------------------------------------------------
NINE MONTHS 1998
Europe(b) 1,602(f) 1,371(g) 231 92 139
Asia Pacific 507(e) 396(g) 111 45 66
Latin America(c) 389 184 205 82 123
- -----------------------------------------------------------------------------------------------------------------------
Total international operations 2,498 1,951 547 219 328
Domestic operations(d) 2,953 2,196(g) 757 211 546
- -----------------------------------------------------------------------------------------------------------------------
Total 5,451 4,147 1,304 430 874
- -----------------------------------------------------------------------------------------------------------------------
</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.
(f) Includes 1998 second quarter net pretax gain of $131 million related to
the sale of our global trust and agency services business.
(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) Includes 1999 third quarter reversal of provision for credit losses of
($60) million, which was recorded as follows: ($32) million in Europe,
($33) million in Asia Pacific, ($12) million in Latin America, and $17
million in Domestic operations.
(i) Includes 1999 net reversal of provision for credit losses of ($130)
million, which was recorded as follows: $(21) million in Europe, ($71)
million in Asia Pacific, ($41) million in Latin America, and $3 million
in Domestic operations.
(j) Includes 1998 provisions for credit losses of $75 million, which was
recorded as follows: $27 million in Europe, $6 million in Asia Pacific, $6
million in Latin America, and $36 million in Domestic operations.
27
<PAGE> 28
PART I
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL HIGHLIGHTS
J.P. Morgan today reported third quarter net income of $442 million, or $2.22
per share, up from $156 million, or $0.75 per share, in the third quarter of
1998. Return on equity was 15.6% in the quarter. Net income for the first nine
months was $1.546 billion compared with $874 million in the first nine months of
1998. Earnings per share were $7.76 versus $4.28 a year ago. Year-to-date return
on equity was 18.6%.
The Board of Directors of J.P. Morgan also approved the purchase of up to $3
billion of J.P. Morgan common stock and announced its intention to increase the
quarterly common stock dividend to $1.00 from $0.99 per share when it meets
again in December. These actions reflect J.P. Morgan's strong business momentum
and a significant improvement in capital productivity. Over the past seven
quarters we have reduced by 50% the risk and capital needs of our credit
portfolio, improved risk-taking efficiency in our markets activities, and
implemented a wide-ranging productivity initiative. At the same time, our
investment banking and equities activities have turned solidly profitable and
the contribution of our asset management services business continues to grow. We
remain committed to J.P. Morgan's strong capitalization and retain ample capital
to pursue the numerous growth opportunities in our target markets.
OTHER HIGHLIGHTS FOR THE THIRD QUARTER:
- - Operating revenues of $1.985 billion were 59% ahead of last year
- - Global Finance revenues of $1.385 billion reflect growth in advisory
services and strong results in equities, while fixed income trading
results were weaker
- - Proprietary Investments revenues of $327 million were driven by results in
Equity Investments
- - Assets under management increased 18% from a year ago, to $323 billion
- - Core expenses before bonuses for the nine months of 1999 were down by more
than $330 million
THIRD QUARTER RESULTS AT A GLANCE
<TABLE>
<CAPTION>
Third quarter Second quarter
- ----------------------------------------------------------------------------------------------------
In millions of dollars, except per share data 1999 1998 1999
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $ 1,985 $ 1,301(a) $ 2,191
Operating expenses (1,341) (1,099) (1,417)
Income taxes (202) (46) (270)
- ----------------------------------------------------------------------------------------------------
Net income 442 156 504
Net income per share $ 2.22 $ 0.75 $ 2.52
Dividends declared per share $ 0.99 $ 0.95 $ 0.99
- ----------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes a gain of $56 million related to the sale of the firm's
investment management business in Australia.
OTHER DEVELOPMENTS
Euroclear
On September 1, 1999 J.P. Morgan and the Boards of Euroclear Clearance System
PLC and Euroclear Clearance System Societe Cooperative announced the signing of
a letter of intent to create a new, market-owned European bank to operate all
aspects of the Euroclear System, the leading clearance and settlement system for
internationally traded securities. Subject to a definitive agreement being
reached, J.P. Morgan will remain operator of Euroclear until the successor bank
is established, which is expected to take up to 18 months. After that, Morgan
will remain an important participant and shareholder of Euroclear and retain a
seat on its Board. The management and staff of Euroclear, numbering
approximately 1,200 Morgan employees, will transfer to the new entity.
Under the agreement in principle Morgan will continue to receive pretax banking
income from Euroclear for three years following the signing of a definitive
agreement. This income is subject to a minimum of $195 million and maximum of
$295 million per year, whether it is earned by Morgan prior to the formation of
the new bank or afterward by the new bank. After the new bank is formed, it will
also pay Morgan for certain transition costs and for assets and know-how that
are transferred to it.
28
<PAGE> 29
SEGMENT ANALYSIS
For the purposes of reporting our results, we divide our business segments or
activities into three sectors: Global Finance, Asset Management Services, and
Proprietary Investments. Reporting by sector helps simplify the presentation of
complex, interrelated activities conducted in over thirty countries by over
15,000 people.
The first two sectors - Global Finance and Asset Management Services - comprise
the services we provide to clients. Proprietary Investments represent the
activities we undertake exclusively for our own account. For a description of
our business sectors and activities within each sector, refer to the J.P. Morgan
& Co. Incorporated 1998 Annual report. Certain information and amounts have been
restated to reflect management's current reporting structure - refer to note 23,
"Segments," for more details. Presented below are the summary results for each
sector for the three and nine months ended September 30, 1999 and 1998, and the
three months ended June 30, 1999.
SUMMARY OF SECTOR RESULTS
<TABLE>
<CAPTION>
Interest
Investment Rate and Credit Credit GLOBAL
In millions Banking Equities FX Markets Markets Portfolio FINANCE
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
THIRD QUARTER 1999
Total Revenues $ 310 $ 289 $ 331 $ 186 $269 (a) $ 1,385
Total Expenses 209 214 288 156 34 901
- --------------------------------------------------------------------------------------------------------------
Pretax Income 101 75 43 30 235 484
- --------------------------------------------------------------------------------------------------------------
THIRD QUARTER 1998
Total Revenues 238 141 348 (140) 50 (b) 637
Total Expenses 166 162 280 77 42 727
- --------------------------------------------------------------------------------------------------------------
Pretax Income 72 (21) 68 (217) 8 (90)
- --------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
ASSET
MANAGE- Proprietary
MENT Equity Investing PROPRIETARY CORPORATE CONSOL-
In millions SERVICES Investments and Trading INVESTMENTS ITEMS (h) IDATED
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
THIRD QUARTER 1999
Total Revenues $ 353 $ 341 ($ 14) $ 327 ($ 80) $ 1,985
Total Expenses 296 53 37 90 54 1,341
- ---------------------------------------------------------------------------------------------------------
Pretax Income 57 288 (51) 237 (134) 644
- ---------------------------------------------------------------------------------------------------------
THIRD QUARTER 1998
Total Revenues 300 160 147 307 57 (c) 1,301
Total Expenses 272 15 35 50 50 1,099
- ---------------------------------------------------------------------------------------------------------
Pretax Income 28 145 112 257 7 202
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
INCREASE / (DECREASE), THIRD QUARTER 1999 VS THIRD QUARTER 1998
<S> <C> <C> <C> <C> <C> <C>
Total Revenues 72 148 (17) 326 219 748
Total Expenses 43 52 8 79 (8) 174
- ---------------------------------------------------------------------------------------------------------------
Pretax Income 29 96 (25) 247 227 574
- ---------------------------------------------------------------------------------------------------------------
SECOND QUARTER 1999
Total Revenues 320 427 555 361 152 (d) 1,815
Total Expenses 228 236 321 210 41 1,036
- ---------------------------------------------------------------------------------------------------------------
Pretax Income 92 191 234 151 111 779
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Total Revenues 53 181 (161) 20 (137) 684
Total Expenses 24 38 2 40 4 242
- ---------------------------------------------------------------------------------------------------------
Pretax Income 29 143 (163) (20) (141) 442
- ---------------------------------------------------------------------------------------------------------
SECOND QUARTER 1999
Total Revenues 343 13 44 57 (24) 2,191
Total Expenses 276 13 42 55 50 1,417
- ---------------------------------------------------------------------------------------------------------
Pretax Income 67 -- 2 2 (74) 774
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
INCREASE / (DECREASE), THIRD QUARTER 1999 VS SECOND QUARTER 1999
<S> <C> <C> <C> <C> <C> <C>
Total Revenues (10) (138) (224) (175) 117 (430)
Total Expenses (19) (22) (33) (54) (7) (135)
- ---------------------------------------------------------------------------------------------------------------
Pretax Income 9 (116) (191) (121) 124 (295)
- ---------------------------------------------------------------------------------------------------------------
NINE MONTHS 1999
Total Revenues 888 1,004 1,548 1,243 575 (e) 5,258
Total Expenses 647 680 968 625 120 3,040
- ---------------------------------------------------------------------------------------------------------------
Pretax Income 241 324 580 618 455 2,218
- ---------------------------------------------------------------------------------------------------------------
NINE MONTHS 1998
Total Revenues 736 520 1,583 462 339 (b) 3,640
Total Expenses 526 578 971 537 109 2,721
- ---------------------------------------------------------------------------------------------------------------
Pretax Income 210 (58) 612 (75) 230 919
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Total Revenues 10 328 (58) 270 (56) (206)
Total Expenses 20 40 (5) 35 4 (76)
- ----------------------------------------------------------------------------------------------------------
Pretax Income (10) 288 (53) 235 (60) (130)
- ----------------------------------------------------------------------------------------------------------
NINE MONTHS 1999
Total Revenues 1,005 332 149 481 (77) 6,667
Total Expenses 836 80 112 192 257 4,325
- ----------------------------------------------------------------------------------------------------------
Pretax Income 169 252 37 289 (334) 2,342
- ----------------------------------------------------------------------------------------------------------
NINE MONTHS 1998
Total Revenues 901 288 514 802 108 (f) 5,451
Total Expenses 833 39 114 153 440 (g) 4,147
- ----------------------------------------------------------------------------------------------------------
Pretax Income 68 249 400 649 (332) 1,304
- ----------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
INCREASE / (DECREASE), NINE MONTHS 1999 VS NINE MONTHS 1998
<S> <C> <C> <C> <C> <C> <C>
Total Revenues 152 484 (35) 781 236 1,618
Total Expenses 121 102 (3) 88 11 319
- -------------------------------------------------------------------------------------------------------------
Pretax Income 31 382 (32) 693 225 1,299
- -------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Total Revenues 104 44 (365) (321) (185) 1,216
Total Expenses 3 41 (2) 39 (183) 178
- -------------------------------------------------------------------------------------------------------
Pretax Income 101 3 (363) (360) (2) 1,038
- -------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE> 30
(a) Includes a third quarter 1999 reversal of provision for credit losses
of ($60) million.
(b) Includes a third quarter 1998 provision for credit losses of $75 million.
(c) Includes a third quarter 1998 pretax gain of $56 million related to the
sale of the firm's investment management business in Australia.
(d) Includes a second quarter 1999 net reversal of provision for credit
losses of ($70) million.
(e) Includes a third quarter 1999 reversal of provision for credit losses
of ($60) million, and a second quarter 1999 net reversal of provision for
credit losses of ($70) million.
(f) Includes a third quarter 1998 pretax gain of $56 million related to the
sale of the firm's investment management business in Australia, and a
second quarter 1998 pretax gain of $131 million related to the sale of the
firm's global trust and agency services business.
(g) Includes a first quarter 1998 pretax charge of $215 million related to
restructuring of business activities.
(h) Corporate Items includes revenues and expenses related to Euroclear
activities, as follows:
<TABLE>
<CAPTION>
Third Qtr. Third Qtr. Second Qtr. Nine Months Nine Months
1999 1998 1999 1999 1998
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total revenues $ 58 $ 83 $ 67 $187 $237
Total expenses 8 12 3 19 41
- ------------------------------------------------------------------------------------
Pretax income 50 71 64 168 196
- ------------------------------------------------------------------------------------
</TABLE>
SECTOR RESULTS
Revenues were $1.985 billion in the third quarter of 1999, up 59% from the 1998
period, excluding last year's $56 million gain on the sale of our Australian
investment management business. Revenues from client-focused activities,
reported in the Global Finance and Asset Management Services sectors, increased
85% to $1.738 billion. Revenues from Proprietary Investments were $327 million
versus $307 million a year ago.
GLOBAL FINANCE revenues of $1.385 billion more than doubled over the third
quarter of 1998, which was affected by extreme market dislocations.
- - Investment Banking revenues of $310 million were up 30% from last year's
quarter. Advisory services, equity capital markets services, and
derivative origination activities continued to expand with clients across
a diverse range of industries. Advisory revenues surpassed both last
year's quarter and the second quarter of 1999. For the first nine months
of 1999, Thomson Financial Securities Data Corporation ranked J.P. Morgan
6th in completed mergers and acquisitions volume worldwide with a 13.1%
market share.
- - Equities revenues of $289 million increased $148 million from last year.
Both cash and equity derivative results increased. Equity underwriting
revenues increased as we continued to grow market share - J.P. Morgan
ranked 6th in U.S. equity lead underwriting with a 5.5% market share for
1999 and commission revenues were more than 20% above last year on higher
market share. Equity derivative revenues more than doubled from a year ago
when results were affected by sharp increases in volatility and illiquid
markets, but were down from the second quarter.
- - Interest Rate and Foreign Exchange Markets revenues of $331 million
reflect very strong derivative client activity across all regions,
combined with weaker trading results. Interest Rate Markets revenues rose
over last year as we continued to expand our derivative client franchise,
but declined from the second quarter 1999 due to weaker trading results
primarily associated with illiquid European markets early in the quarter.
Foreign Exchange revenues, while stable through 1999, were down from a
very strong third quarter a year ago.
- - Credit Markets revenues of $186 million were achieved in a difficult
environment that reflected concerns over interest rate increases and
widening spreads, especially for lower-rated securities. Lower issuer and
investor demand for most instruments reduced overall volumes meaningfully
in the quarter, which led to a 48% decline in revenues versus the second
quarter. In last year's quarter, severe market dislocations resulted in
losses of $140 million.
- - Credit Portfolio had revenues of $269 million compared to $152 million in
the previous quarter and $50 million in the same quarter a year ago.
Improving credit default swap spreads on higher-rated counterparties and
continuing refinements in measuring and managing credit risk associated
with derivative exposures contributed to revenues during the quarter.
Ongoing improvement in credit markets and the lowering of certain emerging
markets exposures in our traditional credit portfolio resulted in a $60
million reduction (i.e., income) in the allowances for credit losses after
charge-offs and recoveries. The economic capital requirement of our credit
portfolio has declined by 50% from December 31, 1997, in line with our
previously announced target.
30
<PAGE> 31
ASSET MANAGEMENT SERVICES revenues increased 18% to $353 million versus last
year, reflecting asset growth, a shift towards higher-fee alternative investment
disciplines, and performance fees. Assets under management rose 18% to $323
billion, driven by market appreciation and new business from defined benefit
plans and private clients. Assets under management from private clients
increased 16% to $72 billion.
PROPRIETARY INVESTMENTS revenues were $327 million, up 7%.
- - Equity Investments, which represents equity portfolio management for
Morgan's own account, reported revenues of $341 million in the third
quarter, compared with $160 million a year ago. The increase was mostly
attributable to investments in the cable television and telecommunications
industries, partially offset by write-downs that primarily related to an
investment in the insurance industry.
- - Proprietary Investing and Trading reported a loss of $14 million compared
to a gain of $147 million last year. Total return - reported revenues and
the change in net unrealized value - was a loss of $110 million compared
with a gain of $167 million. The lower results were driven primarily by
our U.S. government agency investment portfolio and our positioning
activities in Asia.
CORPORATE ITEMS had negative revenues of $80 million, including $58 million of
positive revenues from activities related to Euroclear. Revenues are $56 million
lower than the second quarter and $137 million lower than last year, mainly due
to the change in the value of hedges of the firm's anticipated net foreign
currency revenues and expenses. These hedging results are partially offset by
the impact of exchange rate movements on revenues and expenses reported in the
business segments. Additionally, in the third quarter of 1998, we recognized a
$56 million gain on the sale of our investment management business in Australia.
FINANCIAL REVIEW
REVENUES
Revenues were $1.985 billion in the third quarter of 1999, up 59% from the 1998
period, excluding last year's $56 million gain on the sale of our Australian
investment management business. Revenues were down 10% or $206 million from the
second quarter of 1999. Excluding gains on business sales (See note 4, Business
changes and developments), revenues for the first nine months of 1999 were
$6.667 billion up 27% over the same period a year ago.
Net interest revenue represents 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. Excluding loan
loss provisions/reversals, third quarter 1999 net interest revenue was $389
million compared to $332 million in the year ago quarter. This increase resulted
primarily from higher net interest revenue from activities in our Interest Rate
and Foreign Exchange Markets, Credit Markets and Credit Portfolio segments.
Third quarter 1999 included a $45 million negative provision to reduce the
allowance for loan losses reflecting ongoing improvements in credit markets and
the lowering of certain emerging markets exposures in our traditional
credit portfolio. This compares to a $25 million provision to increase the
allowance in the prior year quarter. Excluding loan loss provisions/reversals,
net interest revenue for the first nine months of 1999 was $1.203 billion,
compared with $958 million for the first nine months of 1998. Year to date
September 30, 1999 included negative provisions to reduce the allowance for
loan losses of $150 million, versus a provision for loan losses of $25 million
in the same period a year ago.
Total trading revenue was $424 million in the third quarter of 1999 versus only
$69 million in the third quarter of 1998, which was impacted by severe market
dislocations. The increase was driven by higher trading revenues in our Global
Finance sector primarily in our Equities, Credit Markets and Credit Portfolio
segments. These results were partially offset by lower revenue in our
Proprietary Investments sector. Compared to the second quarter of 1999, total
trading revenue declined 47% or $379 million on lower results, primarily in our
Interest Rate and Foreign Exchange Markets, Credit Markets and Equities
segments. Year-to-date trading revenues increased to $2.361 billion from $1.842
billion for the first nine months of 1999.
31
<PAGE> 32
Investment banking revenue grew 28% to $398 million in the third quarter of 1999
from $312 million in the third quarter of 1998, reflecting growth with clients
across a diverse range of industries. Underwriting revenue grew 69% to $140
million, and advisory and syndication fees rose 13% to $258 million. For the
first nine months of 1999, Thomson Financial Securities Data Company Inc. ranked
J.P. Morgan sixth in completed merger and acquisitions worldwide, with a market
share of 13.1%. Investment banking revenue for the first nine months of 1999
increased 22% to $1.245 billion, over the same 1998 period.
Investment management revenue increased 21% to $270 million in the 1999 third
quarter from a year ago. Assets under management were $323 billion at September
30, 1999, compared with $274 billion a year ago; the increase reflected net new
business and market appreciation. For the first nine months of 1999, investment
management revenue was $776 million, an increase of 17% over the prior year
period.
Fees and commissions were $206 million, up 13% from $182 million in the year-ago
quarter, driven by lower fees paid to credit derivative providers and to a
lesser extent higher equity commissions. For the year to date, fees and
commissions were $611 million compared to $569 million in the same 1998 period.
Investment securities revenue was $271 million in the third quarter of 1999,
compared to $136 million in the third quarter of 1998 and a loss of $29 million
in the second quarter of 1999. This increase reflects gains from investments in
the cable television and telecommunications industries, partially offset by
write-downs that primarily related to an investment in the insurance industry.
For the current nine-month period, investment securities revenue was $201
million versus $247 million for the first nine months of 1998.
Other revenue was negative (loss) $18 million in the third quarter of 1999,
compared with revenue of $71 million a year earlier. For the third quarter of
1999, other revenue includes $45 million of losses on hedges of anticipated
foreign currency revenues. These losses were partially offset by the impact of
exchange rate movements on reported revenues and expenses in the respective
period. Other revenue also included a $15 million negative provision to reduce
the allowance for credit losses on lending commitments. For the three months
ended September 30, 1998, other revenue includes a $56 million net gain on the
sale of the firm's investment management business in Australia. Other revenue
for the first nine months of 1999 was $120 million, compared with $179 million
for the first nine months of 1998.
OPERATING EXPENSES
Operating expenses were $1.341 billion, an increase of 22% from the same period
a year ago. Non-compensation operating expenses were 15% lower this quarter as
we continued our focus on productivity. Compensation expenses rose as a result
of increased bonus accruals. The firm's efficiency ratio was 68% in the third
quarter.
Costs associated with preparation for the Year 2000 were $9 million for the
third quarter, down from $45 million last year, which also included preparation
for European Economic and Monetary Union. For the first nine months of 1999,
costs of preparation for the Year 2000 and European Economic and Monetary Union
were $47 million, down from $155 million a year ago. Third quarter 1999 software
costs of $37 million were capitalized rather than recorded as expenses because
of a change in accounting rules and are not included in the 1999 expenses. For
the nine months ended September 30, 1999, $103 million of software costs were
capitalized.
Operating expenses for the first nine months of 1999 were $4.325 billion. Before
bonus accruals and excluding the effect of software capitalization, this
represents a reduction of more than $330 million compared with the first nine
months of last year.
At September 30, 1999, staff totaled 15,287 employees, compared with 14,902 at
June 30, 1999, 15,674 at December 31, 1998 and 16,155 employees at September 30,
1998.
Income-tax expense in the third quarter totaled $202 million, based on an
effective tax rate of 31%, compared with $46 million in the year-earlier
quarter. The increase in expense reflects higher pretax income.
ASSETS
Total assets were $255 billion at September 30, 1999, compared with $269 billion
at June 30, 1999 and $261 billion at December 31, 1998.
32
<PAGE> 33
ASSET QUALITY
IMPAIRED LOANS
<TABLE>
<CAPTION>
September 30, June 30, December 31,
In millions: 1999 1999 1998 (a)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial and industrial $ 131 $ 38 $ 25
Other 38 29 97
- ------------------------------------------------------------------------------------
Total impaired loans 169 67 122
- ------------------------------------------------------------------------------------
</TABLE>
(a) Certain reclassifications were made to conform with the categorization used
in Bank regulatory filings.
Impaired loans were $169 million at September 30, 1999 versus $67 million at
June 30, 1999. The increase in "Commercial and industrial" impaired loans during
the third quarter of 1999 primarily relates to newly classified loans in the
Latin American steel industry.
ALLOWANCES FOR CREDIT LOSSES
We maintain allowances for credit losses to absorb losses inherent in our
traditional extensions of credit that we believe are probable and that can be
reasonably estimated. These allowances include an allowance for loan losses and
an allowance for credit losses on lending commitments, which include commitments
to extend credit, standby letters of credit, and guarantees.
In determining the appropriate size of our allowances, we make use of our
historical experience over the course of past credit cycles. We believe our use
of past credit cycle experience is appropriate because our current portfolio is
similar to that of the past: institutionally based, with significant emerging
market exposures. Our experience has shown that credit losses, when they occur,
are significant and highly correlated, particularly across emerging markets. The
actual amount of credit losses realized may vary from estimated losses at each
period end, due to improved economic conditions or successful management of our
credit exposures, resulting in lower net charge-offs than expected. Our process
includes procedures to limit differences between estimated and actual credit
losses, which include detailed quarterly assessments by senior management and
model adjustments to reflect current market indicators of credit quality.
In March 1999, a Joint Working Group, comprised of banking and securities
regulators, was formed to provide clarification to the banking industry
regarding the appropriate accounting, disclosure, and documentation requirements
for allowances for credit losses. We are in the process of reviewing our model
for estimating credit losses and determining the appropriate level of our
allowances, with the goal of refining it based on our review, which will
incorporate any guidance issued by the Joint Working Group.
The following table summarizes the activity of our allowances for credit losses
for the three and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON
LOAN LOSSES LENDING COMMITMENTS
- --------------------------------------------------------------------------------------------------------------
Third Third Third Third
quarter quarter quarter quarter
In millions 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BEGINNING BALANCE, JULY 1 $ 335 $ 392 $ 160 $ 185
- -------------------------------------------------------------------------------------------------------
Provision for credit losses -- 25 -- --
Reversal of provision for credit losses (45) -- (15) --
- -------------------------------------------------------------------------------------------------------
Recoveries: 17 4 -- --
Charge-offs:
Commercial and industrial (6) (6) -- --
Banks -- (5) -- --
Other -- (6) -- --
- -------------------------------------------------------------------------------------------------------
Net recoveries/(charge-offs) 11 (13) -- --
- -------------------------------------------------------------------------------------------------------
ENDING BALANCE, SEPTEMBER 30 301 404 145 185
- -------------------------------------------------------------------------------------------------------
</TABLE>
33
<PAGE> 34
<TABLE>
<CAPTION>
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON
LOAN LOSSES LENDING COMMITMENTS
- ------------------------------------------------------------------------------------------------------------------
Nine months Nine months Nine months Nine months
In millions 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
BEGINNING BALANCE, JANUARY 1 $ 470 $ 546 $ 125 $ 185
- ------------------------------------------------------------------------------------------------------------
Provision for credit losses -- 25 35 --
Reversal of provision for credit losses (150) -- (15) --
- ------------------------------------------------------------------------------------------------------------
Reclassifications (a) -- (50) -- --
- ------------------------------------------------------------------------------------------------------------
Recoveries: 23 13 -- --
Charge-offs:
Commercial and industrial (16) (40) -- --
Banks (1) (66) -- --
Other, primarily financial institutions in 1999 (25) (24) -- --
- ------------------------------------------------------------------------------------------------------------
Net charge-offs (19) (117) -- --
- ------------------------------------------------------------------------------------------------------------
ENDING BALANCE, SEPTEMBER 30 301 404 145 185
- ------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to July 1, 1998, changes, excluding charge-offs and recoveries,
across balance sheet reserve or allowance captions - which included an
adjustment for trading derivatives needed to determine fair value, an
allowance for loan losses, and an allowance for credit losses which
include commitments to extend credit, standby letters of credit, and
guarantees - were shown as reclassifications. Reclassifications had no
impact on net income and, accordingly, were not shown on the income
statement. Subsequent to July 1, 1998, reclassifications across balance
sheet captions for allowances are reflected as provisions and reversals of
provisions in the "Consolidated statement of income."
The following table displays our allowances for credit losses by component at
September 30, 1999, June 30, 1999, and December 31, 1998.
<TABLE>
<CAPTION>
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON LENDING
LOAN LOSSES COMMITMENTS
- -------------------------------------------------------------------------------------------------------------------
September 30, June 30, December 31, September 30, June 30, December 31,
In millions: 1999 1999 1998 1999 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Specific counterparty $ 32 $ 14 $ 34 $ 23 $ 20 $ 3
Specific country 24 32 93 1 3 30
Expected loss (b) 245 289 343 121 137 92
- ---------------------------------------------------------------------------------------------------------------
Total 301 335 470 145 160 125
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(b) The general component of our allowances for credit losses is used to
estimate the impact of separately identified limitations in our expected
loss model. Beginning in the second quarter of 1999, the general component
is included as part of the expected loss component for disclosure purposes
since all factors used to derive the general component relate to the
expected loss component. Prior period amounts have been reclassified.
Ongoing improvements in credit markets and the lowering of certain emerging
markets exposures in our traditional credit portfolio resulted in a $60 million
reduction in the allowances for credit losses, before net recoveries of $11
million during the third quarter of 1999. The negative provision (revenue) of
$60 million included negative provisions of $45 million for loan losses and $15
million for credit losses on lending commitments. The allowance for loan losses
was $301 million at September 30, 1999, compared with $335 million at June 30,
1999. The allowance for credit losses on lending commitments was $145 million at
September 30, 1999, compared to $160 million at June 30, 1999, respectively.
The specific counterparty component of the allowance for loan losses, which
represents the SFAS No. 114 impairment reserve, was $32 million and $14 million
at September 30, 1999 and June 30, 1999, respectively. The increase in the
specific counterparty component from the prior quarter primarily reflects the
addition of counterparty allocations in the Latin American steel industry. The
specific counterparty component of the allowance for credit losses on lending
commitments was $23 million at September 30, 1999, compared with $20 million at
June 30, 1999.
The specific country component focuses on countries experiencing financial
stress. The loss estimates for each country were determined by management by
applying a percentage loss estimate on a "tiering of risk basis" (e.g. different
loss estimates based on whether exposures are sovereigns versus corporates or
cross-border versus local). To determine these estimates, management utilized
historical loss experience and secondary market data, where applicable. The
specific country component of the allowance for loan losses decreased to $24
million at September 30, 1999 from $32 million at
34
<PAGE> 35
June 30, 1999. Countries included in the specific country component of the
allowance for loan losses at September 30, 1999 were Brazil and Indonesia -
consistent with June 30, 1999. The decrease in the specific country component of
the allowance for loan losses reflects continued improvement in Brazil's credit
market conditions, as well as a reduction in loan exposures. The specific
country allocation of the allowance for credit losses on lending commitments
represents an allocation for Indonesia at both September 30, 1999 and June 30,
1999.
The expected loss component, which includes the general component, is an
estimate, based on statistical modeling, of the probable loss inherent in our
existing performing portfolio of traditional credit products, net of recoveries.
The general component of our allowances for credit losses is used to estimate
the impact of separately identified limitations in our expected loss model.
Beginning in the second quarter of 1999, the general component is included as
part of the expected loss component for disclosure purposes since all factors
used to derive the general component relate to the expected loss component.
Prior period amounts have been reclassified to conform with this presentation.
In determining the appropriate level of the general component, loss estimates
related to our emerging market exposures, excluding Brazil and Indonesia which
are covered by the specific country component, were adjusted to reflect the
credit pricing inherent in bond spreads in emerging markets, as well as regional
estimates of recovery. This adjustment was made to compensate for the fact that
our expected loss model utilizes default and recovery statistics that are based
on U.S. corporate experience, which do not match the risks associated with
exposures in emerging markets. In addition, the general component is needed to
adjust the results produced by our expected loss model to reflect facility
draw-down percentages upon default that we believe are more reflective of
historical and industry experience. The expected loss component of the allowance
for loan losses decreased to $245 million at September 30, 1999 from $289
million at June 30, 1999. The expected loss component of the allowance for
credit losses on lending commitments was $121 million at September 30, 1999,
compared with $137 million at June 30, 1999. The decrease in the expected loss
component in the allowances primarily reflects improved credit conditions
during the year in emerging markets as indicated by an overall improvement
in bond spreads in these regions.
35
<PAGE> 36
EXPOSURES TO EMERGING COUNTRIES
The following tables present exposures to certain emerging markets based on
management's view of total exposure as of September 30, 1999.
The management view takes into account 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, excluding any collateral we hold to offset these exposures) and
investment securities; and other monetary assets. It also considers 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 of its treatment of
credit derivatives, trading account short positions, and the use of fair values
versus cost of investment securities. In addition, management does not net local
funding or liabilities against local exposures as allowed by the FFIEC.
By type of financial instrument
<TABLE>
<CAPTION>
Credit Total
In billions Deriva- Other out- deriva- Commit- cross- Local Total
September 30, 1999 Loans tives standings tives ments border exposure exposure
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
China $ -- $0.1 $ -- ($0.1) $ -- $ -- $ -- $ --
Hong Kong 0.2 0.5 0.4 ( 0.2) 0.2 1.1 0.3 1.4
Indonesia 0.1 -- -- -- 0.1 0.2 -- 0.2
Malaysia -- -- -- 0.1 -- 0.1 -- 0.1
Philippines -- -- 0.1 -- -- 0.1 -- 0.1
Singapore -- 0.4 0.1 (0.1) -- 0.4 0.1 0.5
South Korea 0.2 0.8 0.4 (0.3) -- 1.1 0.5 1.6
Taiwan -- -- -- -- -- -- -- --
Thailand -- 0.1 0.1 0.1 -- 0.3 -- 0.3
Other -- -- -- -- -- -- 0.2 0.2
- ---------------------------------------------------------------------------------------------------------------------------------
Total Asia, excluding Japan(a) 0.5 1.9 1.1 (0.5) 0.3 3.3 1.1 4.4
- ---------------------------------------------------------------------------------------------------------------------------------
Argentina 0.1 0.1 0.8 (0.5) -- 0.5 0.4 0.9
Brazil 0.2 -- 0.3 -- -- 0.5 1.1 1.6
Chile 0.4 -- -- -- -- 0.4 -- 0.4
Colombia 0.2 -- 0.1 -- -- 0.3 -- 0.3
Mexico 0.4 0.4 0.4 (0.3) -- 0.9 0.3 1.2
Other 0.2 -- 0.3 -- 0.1 0.6 -- 0.6
- ---------------------------------------------------------------------------------------------------------------------------------
Total Latin America, 1.5 0.5 1.9 (0.8) 0.1 3.2 1.8 5.0
excluding the Caribbean
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
By type of counterparty
<TABLE>
<CAPTION>
In billions Govern-
September 30, 1999 Banks ments Other Total
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
China $ -- $ -- $ -- $ --
Hong Kong 0.6 0.2 0.6 1.4
Indonesia -- -- 0.2 0.2
Malaysia 0.1 -- -- 0.1
Philippines -- -- 0.1 0.1
Singapore 0.4 -- 0.1 0.5
South Korea 0.4 0.9 0.3 1.6
Taiwan -- -- -- --
Thailand 0.2 -- 0.1 0.3
Other -- 0.2 -- 0.2
- -----------------------------------------------------------------------------------------
Total Asia, excluding Japan(a) 1.7 1.3 1.4 4.4
- -----------------------------------------------------------------------------------------
Argentina -- 0.4 0.5 0.9
Brazil 0.4 0.9 0.3 1.6
Chile -- -- 0.4 0.4
Colombia -- 0.1 0.2 0.3
Mexico -- 0.4 0.8 1.2
Other -- 0.2 0.4 0.6
- -----------------------------------------------------------------------------------------
Total Latin America, excluding the 0.4 2.0 2.6 5.0
Caribbean
- -----------------------------------------------------------------------------------------
</TABLE>
(a) Total exposures to Japan, based upon management's view, were $3.8 billion
at September 30, 1999.
Total exposures to South Africa, based upon management's view, were $1.9 billion
at September 30, 1999.
36
<PAGE> 37
CAPITAL
STOCKHOLDERS' EQUITY
Total stockholders' equity was approximately $12.0 billion at September 30,
1999. Stockholders' equity included approximately $108 million of net unrealized
depreciation on debt investment securities and marketable equity investment
securities, net the related deferred tax benefit of $89 million. This compares
with $52 million of net unrealized depreciation at June 30, 1999, net of the
related tax benefit of $49 million. The net unrealized depreciation on debt
investment securities was $274 million at September 30, 1999, compared with a
net unrealized depreciation of $169 million at June 30, 1999. The decline in
debt investment securities primarily related to decreases in the value of U.S.
government and agency securities reflecting the negative effect of a rise in
Treasury yields. The net unrealized appreciation on marketable equity
investment securities was $76 million at September 30, 1999, and $68 million at
June 30, 1999. Included in the table below are selected ratios based upon
stockholders' equity.
<TABLE>
<CAPTION>
September 30, June 30, December 31, September 30,
Dollars in billions, except share data 1999 1999 1998 1998
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total stockholders' equity $ 12.0 $ 11.8 $ 11.3 $ 11.5
- ----------------------------------------------------------------------------------------------------------------------------
Rate of return on average common stockholders'
equity (a) 18.6% 20.1% 8.6% 10.3%(b)
- ----------------------------------------------------------------------------------------------------------------------------
As percent of period-end total assets:
Common equity 4.4% 4.1% 4.0% 3.6%
Total equity 4.7% 4.4% 4.3% 3.9%
Book value per common share (c) $58.42 $57.60 $55.01 $56.22
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Represents the rate of return on average common stockholders' equity
annualized based on the year-to-date results for the nine months ended September
30, 1999, six months ended June 30, 1999, year ended December 31, 1998, and
nine months ended September 30, 1998. Excluding the impact of SFAS No. 115, the
annualized rate of return on average common stockholders' equity would have
been 18.6%, 20.2%, 8.8%, and 10.8% for the nine months ended September 30,
1999, six months ended June 30, 1999, twelve months ended December 31, 1998,
and nine months ended September 30, 1998, respectively.
(b) Excluding the 1998 second quarter after tax gain of $79 million related to
the sale of the firm's global trust and agency securities business, the 1998
third quarter after tax gain of $34 million related to the sale of the firm's
investment management business in Australia, and the 1998 first quarter after
tax charge of $129 million 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 impact of SFAS No. 115, the book value per common share would
have been $58.99, $57.87, $54.24, and $54.70 at September 30, 1999, June 30,
1999, December 31, 1998, and September 30, 1998, respectively.
During the third quarter of 1999, the firm purchased approximately $235 million
shares of its common stock or 1.9 million shares, for a total of $682 million or
5.3 million shares in the first nine months of 1999. These purchases are part of
the December 1998 authorization to repurchase $750 million of common stock
subject to market conditions and other factors. These purchases may be made
periodically in 1999 or beyond in the open market or through privately
negotiated transactions.
As previously mentioned, the Board of Directors approved the purchase of up to
$3 billion of J.P. Morgan common stock and announced its intention to increase
the quarterly common stock dividend to $1.00 from $0.99 per share when it meets
again in December. Refer to Financial Highlights for further information.
REGULATORY CAPITAL REQUIREMENTS
At September 30, 1999, 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. 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, 1999.
At September 30, 1999, 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 9.1% and 13.2%, respectively; the
leverage ratio was 4.8%. At June 30, 1999, J.P. Morgan's tier 1 and total
risk-based capital ratios were 8.4% and 12.5%, respectively, and the leverage
ratio was 4.5%. At December 31, 1998, J.P. Morgan's tier 1 and total risk-based
capital ratios were 8.0% and 11.7%, respectively, and the leverage ratio was
3.9%. Refer to note 18, Capital Requirements, for further information.
37
<PAGE> 38
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, 1999 were $134.9
billion, compared with $142.5 billion at June 30, 1999. At December 31, 1998,
risk-adjusted assets were $140.2 billion.
FORWARD-LOOKING STATEMENTS
Certain sections of our Form 10-Q contain forward-looking statements. We use
words such as "expects," "believe," "anticipate," and "estimate" to identify
these statements. In particular, disclosures made in Financial Highlights,
Financial Review and The year 2000 initiative contain forward-looking
statements. Such 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 1998
Annual report. Actual results could differ materially from those currently
anticipated due to a number of variables 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.
As a result of these variables, revenues and net income in any particular period
may:
- - not be indicative of full-year results
- - vary from year to year
- - impact the firm's ability to achieve its strategic objectives
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.
38
<PAGE> 39
RISK MANAGEMENT
Risk is inherent in our business, and sound risk management is key to our
success. We have developed and implemented comprehensive policies and procedures
to identify, mitigate, and monitor risk across the firm. These practices rely on
constant communication, judgment, and knowledge of products and markets by the
professionals closest to them, combined with regular oversight by a central risk
management group and senior management.
The major types of risk to which we are exposed are:
- - Market risk: the possibility of loss due to changes in market prices and
rates, the correlations among them, and their levels of volatility
- - Credit risk: the possibility of loss due to changes in the quality of
counterparties, the correlations among them, and the market prices for
credit risk assets. We are subject to credit risk in our lending
activities, sales and trading activities, and derivative activities and
when we act as an intermediary on behalf of clients and other third
parties.
- - Liquidity risk: the risk of being unable to fund our portfolio of assets
at reasonable rates and to appropriate maturities
- - Operating risk: the potential for loss arising from breakdowns in policies
and controls for ensuring the proper functioning of people, contracts,
systems, and facilities
Our risk management processes are built on a foundation of early identification
and measurement. They are regularly reviewed and modified as our business
changes in response to market, credit, product, and other developments. We
constantly seek to strengthen our risk management process. Further, we mitigate
our exposure to losses from unexpected events by diversifying our activities
across instruments, markets, clients and geographic regions. Please refer to our
1998 Annual report for a detailed discussion of how we manage risk.
MARKET RISK
Market risk arises from trading and investing in both our client-focused and
proprietary activities. Our ability to estimate potential losses that could
arise from adverse changes in market conditions is a key element of managing
market risk. While quantitative measures are integral to our process, judgment
and experience are crucial in assessing whether our level of market risk is
acceptable. In particular when markets experience extreme conditions, we
continue to use our tools to quantify our risks but rely on management's
judgment to interpret and gauge the impact that extreme changes in volatility
and market correlations can have on positions that, in normal markets, are
estimated to be low-risk.
Our primary tool for the systematic measuring and monitoring of market risk is
the Daily Earnings at Risk (DEaR) calculation. 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 makes assumptions about market behavior
and takes into account numerous variables that may cause a change in the value
of our portfolios, including interest rates, foreign exchange rates, equity and
commodity prices and their volatilities, and correlations among these variables.
Effective June 30, 1999, we enhanced our measurement of DEaR to incorporate
credit risk related to counterparty exposure in our trading derivatives
portfolio. We began to measure the credit risk embedded in derivative trading
exposures based on market prices for credit risk. Previously, these exposures
were measured using a combination of historical default experience derived from
credit rating agencies and other fair value adjustments. We continue to refine
our risk measurement and reporting methodology. Prior period amounts have not
been restated due to data limitations. As a result, DEaR for the twelve months
ended September 30, 1999 has been presented in accordance with our previous risk
measurement methodology. 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 trading and proprietary investing DEaR
Firm-wide market and credit risk DEaR for our trading activities approximated
$33 million at September 30, 1999 versus $45 million at June 30, 1999. This
reflects, before diversification benefits, market risk DEaR of $26 million at
September 30, 1999 ($27 million at June 30, 1999) and derivative credit risk
DEaR of approximately $20 million at September 30, 1999 ($35 million at June 30,
1999). The decrease in credit risk DEaR reflects greater use of credit
derivatives to reduce overall portfolio risk levels, as well as methodology
enhancements.
DEaR for our proprietary investing activities, which consists largely of U.S.
government agency securities, was $24 million at September 30, 1999, versus $30
million at June 30, 1999.
39
<PAGE> 40
Twelve-month market risk profile
DEaR for trading activities
Average DEaR for our trading activities, excluding credit risk related to
derivative counterparty exposure as previously discussed, was $32 million and
ranged from $19 million to $48 million for the twelve months ended September 30,
1999. For the twelve months ended December 31, 1998, average DEaR for trading
activities was $38 million and ranged from $27 million to $55 million. We
evaluate the reasonableness of DEaR for our trading activities by comparing
actual daily revenue to estimates predicted by our models. During the twelve
months ended September 30, 1999, daily revenue fell short of the downside DEaR
band (average daily revenue less the DEaR estimate) by more than the expected
frequency or greater than 5% of the time. This primarily resulted from a
combination of extreme market conditions experienced in the latter half of 1998
and higher average trading revenue in 1999.
Our primary market risk exposures in our trading activities:
The twelve month average and period-end DEaR for September 30, 1999 and December
31, 1998, 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
(Average)
------------------------------------ ---------------- -----------------------
September 30, December 31, September 30, December 31,
In millions 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate risk $27 $30 $20 $31
Foreign exchange rate risk 9 18 7 11
Equity price risk 8 12 2 12
Commodity price risk 2 3 - 3
Diversification effects (14) (25) (3) (22)
- ----------------------------------------------------------------------------------------------------------------------
Total 32 38 26 35
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
Interest rate risk
Interest rate risk is the possibility that changes in interest rates will affect
the value of financial instruments. Our primary risk exposures to interest rates
from trading activities are 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 spread, volatility, and
basis risk. We use instruments such as interest rate swaps, options, U.S.
government securities, and futures and forward contracts 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 rates arise from transactions in all
major countries and most minor countries throughout Europe, Latin America, and
Asia. We manage the risk arising from foreign currency transactions primarily
through currency swaps; options; and spot, futures and forward contracts.
Equity price risk
Equity price risk is 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 derivatives portfolio. We manage the risk of loss through the use of
equity cash, future, swap, and option instruments.
Given the nature of our business, we expect frequent changes to our primary risk
exposures over the course of a year. Our integrated approach to managing market
risk considers this expectation and facilitates a dynamic and proactive
adjustment of the risk profile across all our trading activities as needed.
DEaR for proprietary investing activities
Average DEaR for our proprietary investing activities for the twelve months
ended September 30, 1999 was $42 million, and ranged from $19 million to $109
million. This compares with average DEaR of $33 million and a range from $8
million to $109 million for the twelve months ended December 31, 1998.
40
<PAGE> 41
The primary sources of market risk associated with our proprietary investing
activities are spread risk in our mortgage-backed securities portfolio and
interest rate risk associated with fixed income securities. Spread risk is the
possibility that changes in credit spreads will affect the value of our
financial instruments.
In estimating risk for our investing activities, we have measured the risk in
this portfolio using the same one-day horizon and 95% confidence interval used
for trading, in order to facilitate aggregation with our trading risk
activities. This approach to risk estimation does not, however, fit well with
the longer horizon or with other risk features of these nontrading activities.
For this reason, we also track risk in our investing portfolio using a one-week
value-at-risk measure to evaluate our risk estimates relative to total return.
For the twelve months ended September 30, 1999, weekly total return fell short
of expected weekly results by amounts greater than related weekly risk estimates
on more times than the expected frequency. This resulted primarily from the
extreme market conditions experienced in the latter half of 1998.
Aggregate DEaR
Aggregate DEaR, excluding derivative credit risk DEaR, averaged $57 million for
the twelve months ended September 30, 1999 and ranged from $26 million to $120
million. For the twelve months ended December 31, 1998, average aggregate DEaR
was $55 million and ranged from $33 million to $120 million.
OPERATING RISK
The year 2000 initiative
With the new millennium approaching, organizations are examining their computer
systems to ensure that they are year 2000 compliant. The issue, in simple terms,
is that many existing computer systems fail to properly identify dates after
December 31, 1999. 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 systems are not updated, potential
risks include business interruption or shutdown, financial loss, reputation
loss, regulatory actions, and/or legal liability. J.P. Morgan uses computers in
all aspects of its business including processing of transactions from inception
through to settlement.
We have undertaken a firmwide initiative to address the year 2000 issue and
developed a comprehensive plan to mitigate the internal and external risks. The
internal components of the initiative address software applications, technology
products and facilities; the external components address credit and operating
risk and fiduciary responsibilities. Each business line is responsible for
remediating within its operating area, addressing all interdependencies within
the firm, and identifying and managing risk posed by external entities,
including clients, counterparties, vendors, exchanges, depositories, utilities,
suppliers, agents, and regulatory agencies. A multidisciplinary team of internal
and external experts supports the business teams by providing direction and
firmwide coordination.
We divided our remediation plan into five phases:
- - Awareness: To begin, we launched a firmwide awareness campaign, developed
and implemented an organizational model, set up a management oversight
committee, and established a risk model. Status: complete.
- - Inventory/assessment: We conducted a firmwide inventory of information
technology (IT) and non-IT (e.g., telecommunications, power, facilities
applications, and products), documented business processes, and identified
external interfaces and dependencies. In this phase we assessed the
potential impact on these inventories, prioritized renovation activities,
developed renovation plans, and determined the compliance status of
third-party products and services. Status: complete.
- - Renovation/replacement: We set about to identify "replace vs. renovate"
opportunities, renovate applications and products, and document code and
system changes. Status: complete.
- - Testing: We established a consistent testing methodology, conducted unit
and system tests, and received certification sign-off from senior business
managers. Status: complete.
- - Implementation: This final phase entailed the implementation of critical
updated applications and products and conducting final compliance
certification. Status: complete.
The awareness and inventory/assessment phases were completed in 1997. The
renovation/replacement and testing phases are now fully complete. As of
September 30th, we met all Federal Financial Institutions Examination Council
(FFIEC) and Federal Reserve requirements. We have also successfully participated
in several industry tests including (i) the Securities Industry
Association-sponsored Equities Beta Test (July 1998), Market Data Beta Test
(February 1999) and Industry-wide Street Test (March-April 1999), (ii) the
Futures Industry Association-sponsored Futures and Options Beta
41
<PAGE> 42
Test (September 1998), (iii) the New York Clearing House's Global Payments
Systems Test (September 1999), (iv) various non-US industry tests in such
countries as the United Kingdom, Germany, Japan, Singapore, Argentina, and (v)
point to point testing with major financial clearing entities.
Based on currently available information, management does not believe that the
year 2000 issue as it relates to our internal systems will have a material
adverse impact on the firm's financial condition. However, the failure of
external parties to resolve their own year 2000 issues could expose J.P. Morgan
to potential losses, impairment of business processes and activities, and
financial markets disruption. We are working with key external parties to stem
the potential risks the year 2000 problem poses to us and the global financial
community.
As such, the focus of the program is now concentrated on the assessment and
mitigation of external risks. The overall goal of our Risk Mitigation Delivery
Model is to identify year 2000 risks and institute plans to mitigate these
risks. The following steps have been, or are being, taken:
- - Identify and address the year 2000 program risks which would prevent the
completion of work to achieve year 2000 compliance for all high
critical/high risk functions - Status: complete;
- - Deploy mitigation strategies prior to the millennium event in order to
reduce the probability of business disruption at the millennium change -
Status: complete;
- - Develop business recovery plans for high likelihood and impact risk areas
in the event of post-millennium failure - Status: complete;
- - Develop an overall command center (crisis management) framework for
successfully responding to potential business disruptions as they occur,
caused either by internal or external failures - Status: complete;
- - Establish risk committees within each line of business to monitor risk
sources and oversee the implementation of the above mitigation - Status:
complete;
- - Validate command center framework and perform "dress rehearsals" of
business recovery plans - Status: A global, firmwide test of our command
center framework was conducted in October 1999. The test included all
businesses in all regions and involved all levels of staff including senior
business managers and decision makers. Additional tests will be conducted
in November and December.
To date, we have completed readiness assessments of the key clients who, in
aggregate, represent the majority of our credit exposure. A process is in place
to monitor readiness on an ongoing basis and take credit action where
appropriate. We have also assessed the readiness of important non-client
counterparties and individual countries; in the latter case we have done so in
conjunction with the Global 2000 Coordinating Group, an industry group formed to
facilitate the readiness of the global financial community for the year 2000
date change. These assessments are updated on an ongoing basis, in particular
with respect to counterparties and countries who fall into the "high risk, high
impact" category. We have developed scenario and contingency plans that identify
and track the impact and likelihood of key events that could impact our ability
to conduct business as usual. These plans identify trigger points to actions
that will mitigate risk on a timely basis, prior to the millennium. During the
first half of 1999, business recovery plans were developed to manage both
internal and external failures that may take place over and after the millennium
changeover, including February 29, 2000. Validation and "dress rehearsals" of
the business recovery plans have occurred and will continue throughout the year.
Additionally, general uncertainty about the outcome of the millennium change may
cause market participants to temporarily reduce the level of their market
activities. Consequently, there may be a downturn in client and general market
activity for a period of time before and after January 1, 2000. If this occurs,
our net revenues may be adversely affected depending on the length of the
reduction in activity and how broadly it affects the markets.
Costs to prepare the firm for year 2000 are estimated at $300 million, including
$265 million incurred through September 1999 ($225 million through December 31,
1998; $40 million in the nine months ended September 30, 1999). 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 spending to differ materially from that anticipated.
The above section on the year 2000 initiative 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
42
<PAGE> 43
future events, including the availability of resources, third-party renovation
plans and other factors. There can be no guarantee, however, that our estimates
will be achieved, or that there will not be a delay in achieving our plans.
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 noncompliant systems,
and timely responses to and renovations by third-parties, and similar
uncertainties. Refer to page 38 for more information on forward-looking
statements.
43
<PAGE> 44
- -------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
Three months ended
----------------------------------------------------------------------------
September 30, 1999 September 30, 1998
----------------------------------------------------------------------------
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. $ 2,520 $ 61 9.60% $ 1,925 $ 107 22.05%
Debt investment securities in
offices in the U.S. (a):
U.S. Treasury 455 10 8.72 673 16 9.43
U.S. state and political subdivision 1,322 40 12.00 1,695 43 10.06
Other 23,349 341 5.81 18,500 259 5.55
Debt investment securities in offices
outside the U.S. (a) 2,190 27 4.89 1,357 22 6.43
Trading account assets:
In offices in the U.S. 34,276 587 6.79 30,750 473 6.10
In offices outside the U.S. 23,957 383 6.34 35,056 655 7.41
Securities purchased under agreements to resell:
In offices in the U.S. 22,184 290 5.19 15,372 226 5.83
In offices outside the U.S. 13,013 117 3.57 24,330 307 5.01
Securities borrowed,
mainly in offices in the U.S. 37,037 456 4.88 40,796 568 5.52
Loans:
In offices in the U.S. 8,062 131 6.45 6,496 124 7.57
In offices outside the U.S. 17,964 284 6.27 23,666 404 6.77
Other interest-earning assets (b):
In offices in the U.S. 2,953 39 * 3,318 34 *
In offices outside the U.S. 896 33 * 790 31 *
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 190,178 2,799 5.84 204,724 3,269 6.34
Cash and due from banks 1,141 1,495
Other noninterest-earning assets 64,590 78,418
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets 255,909 284,637
- -----------------------------------------------------------------------------------------------------------------------------------
</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 30, 1999 and 1998.
(a) For the three months ended September 30, 1999 and 1998, 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
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
Three months ended
----------------------------------------------------------------------------
September 30, 1999 September 30, 1998
----------------------------------------------------------------------------
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. $ 4,785 $ 68 5.64% $ 4,421 $ 67 6.01%
In offices outside the U.S. 43,704 480 4.36 48,196 578 4.76
Trading account liabilities:
In offices in the U.S. 7,320 123 6.67 9,204 159 6.85
In offices outside the U.S. 14,400 175 4.82 13,014 227 6.92
Securities sold under agreements to
repurchase and federal funds
purchased, mainly in offices in
the U.S. 62,583 792 5.02 73,845 1,054 5.66
Commercial paper, mainly in offices
in the U.S. 12,437 164 5.23 10,221 145 5.63
Other interest-bearing liabilities:
In offices in the U.S. 7,758 156 7.98 10,976 214 7.74
In offices outside the U.S. 2,726 56 8.15 4,540 73 6.38
Long-term debt,
mainly in offices in the U.S. 27,441 380 5.49 27,136 400 5.85
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 183,154 2,394 5.19 201,553 2,917 5.74
Noninterest-bearing deposits:
In offices in the U.S. 899 717
In offices outside the U.S. 570 791
Other noninterest-bearing
liabilities 59,518 69,780
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 244,141 272,841
Stockholders' equity 11,768 11,796
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity 255,909 284,637
Net yield on interest-earning assets 0.84 0.68
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest earnings 405 352
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
45
<PAGE> 46
- -------------------------------------------------------------------------------
CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
Nine months ended
----------------------------------------------------------------------------
September 30, 1999 September 30, 1998
----------------------------------------------------------------------------
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. $ 2,574 $ 221 11.48% $ 1,946 $ 236 16.21%
Debt investment securities in
offices in the U.S. (a):
U.S. Treasury 555 35 8.43 743 46 8.28
U.S. state and political subdivision 1,483 130 11.72 1,407 117 11.12
Other 25,579 1,062 5.56 19,257 815 5.66
Debt investment securities in offices
outside the U.S. (a) 2,579 93 4.82 1,737 95 7.31
Trading account assets:
In offices in the U.S. 31,930 1,482 6.21 30,015 1,418 6.32
In offices outside the U.S. 27,055 1,282 6.34 38,286 2,021 7.06
Securities purchased under agreements
to resell and federal funds sold,
In offices in the U.S. 20,793 769 4.94 15,075 617 5.47
In offices outside the U.S. 13,415 419 4.18 23,495 876 4.98
Securities borrowed,
mainly in offices in the U.S. 37,889 1,374 4.85 40,641 1,578 5.19
Loans:
In offices in the U.S. 6,829 345 6.75 6,628 357 7.20
In offices outside the U.S. 19,529 906 6.20 25,116 1,264 6.73
Other interest-earning assets (b):
In offices in the U.S. 2,061 82 * 2,269 109 *
In offices outside the U.S. 946 110 * 1,001 119 *
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 193,217 8,310 5.75 207,616 9,668 6.23
Cash and due from banks 1,411 1,358
Other noninterest-earning assets 69,381 73,097
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets 264,009 282,071
- -----------------------------------------------------------------------------------------------------------------------------------
</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 30, 1999 and 1998.
(a) For the nine months ended September 30, 1999 and 1998, 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
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Dollars in millions,
Interest and average rates
on a taxable-equivalent basis
Nine months ended
----------------------------------------------------------------------------
September 30, 1999 September 30, 1998
----------------------------------------------------------------------------
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. $ 7,137 $ 269 5.04% $ 7,318 $ 306 5.59%
In offices outside the U.S. 45,695 1,454 4.25 50,053 1,832 4.89
Trading account liabilities:
In offices in the U.S. 6,870 351 6.83 9,972 553 7.41
In offices outside the U.S. 13,949 515 4.94 14,527 665 6.12
Securities sold under agreements to
repurchase and federal funds
purchased, mainly in offices in
the U.S. 62,322 2,260 4.85 70,551 2,923 5.54
Commercial paper, mainly in offices
in the U.S. 10,962 418 5.10 9,363 395 5.64
Other interest-bearing liabilities:
In offices in the U.S. 8,954 502 7.50 12,947 635 6.56
In offices outside the U.S. 3,595 150 5.58 3,934 205 6.97
Long-term debt,
mainly in offices in the U.S. 28,038 1,131 5.39 25,748 1,145 5.95
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 187,522 7,050 5.03 204,413 8,659 5.66
Noninterest-bearing deposits:
In offices in the U.S. 896 880
In offices outside the U.S. 601 858
Other noninterest-bearing
liabilities 63,350 64,275
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 252,369 270,426
Stockholders' equity 11,640 11,645
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders'
equity 264,009 282,071
Net yield on interest-earning assets 0.87 0.65
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest earnings 1,260 1,009
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE> 48
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). Bank regulatory
rules differ from management's view in the treatment of credit derivatives,
trading account short positions, and the use of fair value versus cost of
investment securities. In addition, management does not net local funding or
liabilities against any local exposures as allowed by the FFIEC. Refer to page
36 for more information on exposures based on the management view.
In accordance with the regulatory rules, 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 ultimate counterparty; that
is, if collateral or a formal guarantee exists, the country 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, and guarantees, and securities lending
indemnifications.
The following table shows each country where cross-border and local outstandings
exceed 0.75% of total assets, as of September 30, 1999.
<TABLE>
<CAPTION>
Total out-
standings
Net local Total % of and
In millions Govern- out- out- Total Commit- commit-
September 30, 1999 Banks ments Other(a) Standings standings assets ments ments
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Germany $11,412 $3,103 $1,513 $- $16,028 6.29% $958 $16,986
United Kingdom 6,952 718 2,484 - 10,154 3.98 1,080 11,234
Netherlands 4,989 1,218 3,680 - 9,887 3.88 552 10,439
Italy 1,848 3,931 1,287 - 7,066 2.77 41 7,107
France 2,849 1,325 2,815 - 6,989 2.74 815 7,804
Spain 2,129 1,738 1,537 - 5,404 2.12 313 5,717
Switzerland 2,046 388 1,079 - 3,513 1.38 575 4,088
Japan (b) 1,520 486 1,010 - 3,016 1.18 1,068 4,084
Luxembourg 331 19 2,440 - 2,790 1.09 40 2,830
Mexico (b) 52 1,775 729 163 2,719 1.07 9 2,728
Cayman Islands 7 - 2,474 - 2,481 0.97 1,168 3,649
Argentina (b) 154 1,799 330 - 2,283 0.90 - 2,283
Brazil (b) 55 1,366 340 295 2,056 0.81 - 2,056
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes nonbank financial institutions and commercial and industrial
entities.
(b) See page 36 for exposures to these countries under the management view.
<PAGE> 49
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
12. Statement re computation of ratios (incorporated by reference
to exhibit 12 to J.P. Morgan's report on Form 8-K, dated
October 18, 1999)
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 September 30, 1999:
July 19, 1999 (Items 5 and 7)
Reported the issuance by J.P. Morgan of a press release announcing
its earnings for the three-month period ended June 30, 1999.
September 1, 1999 (Items 5 and 7)
Reported the issuance by J.P. Morgan of a joint press release
announcing that it and the Boards of Euroclear Clearance System PLC
and Euroclear Clearance System Societe Cooperative (the "Boards")
have signed a letter of intent to create a new Euroclear bank that
will take over J.P. Morgan's operating and banking roles to the
Euroclear system once the successor bank is established.
September 8, 1999 (Items 5 and 7)
Reported the issuance by J.P. Morgan of two separate press releases
announcing that Lloyd D. Ward, Chairman and Chief Executive Officer
of Maytag Corporation, has been elected to the Board of Directors
(release dated September 8, 1999), and that the firm held a planned
update for the investment community covering the firm's progress on
strategic initiatives (release dated September 9, 1999)
49
<PAGE> 50
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 15, 1999
50
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE CURRENT REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED SEPTEMBER 30,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS AND DISCLOSURES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH
</LEGEND>
<MULTIPLIER> 1,000,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 1,609
<INT-BEARING-DEPOSITS> 2,145
<FED-FUNDS-SOLD> 36,755<F1>
<TRADING-ASSETS> 106,510
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 25,415
<ALLOWANCE> 301
<TOTAL-ASSETS> 254,819
<DEPOSITS> 48,823
<SHORT-TERM> 81,553<F2>
<LIABILITIES-OTHER> 87,033<F3>
<LONG-TERM> 25,402
0
694
<COMMON> 502
<OTHER-SE> 10,812
<TOTAL-LIABILITIES-AND-EQUITY> 254,819
<INTEREST-LOAN> 1,249
<INTEREST-INVEST> 1,266
<INTEREST-OTHER> 5,738
<INTEREST-TOTAL> 8,253
<INTEREST-DEPOSIT> 1,723
<INTEREST-EXPENSE> 7,050
<INTEREST-INCOME-NET> 1,203
<LOAN-LOSSES> (130)<F4>
<SECURITIES-GAINS> 201<F5>
<EXPENSE-OTHER> 4,325<F6>
<INCOME-PRETAX> 2,342
<INCOME-PRE-EXTRAORDINARY> 2,342
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,546
<EPS-BASIC> 8.33
<EPS-DILUTED> 7.76
<YIELD-ACTUAL> 0.87
<LOANS-NON> 169
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 595<F7>
<CHARGE-OFFS> (42)<F7>
<RECOVERIES> 23<F7>
<ALLOWANCE-CLOSE> 446<F7>
<ALLOWANCE-DOMESTIC> 29<F7>
<ALLOWANCE-FOREIGN> 26<F7>
<ALLOWANCE-UNALLOCATED> 391<F7>
<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>Includes a reversal of provision for loan losses of ($150) million, and a
provision for credit losses on lending commitments of $20 million, recorded in
Other revenue.
<F5>Includes gain 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>Amounts relate to the firm's allowance for loan losses and allowance for
credit losses on lending commitments, such as commitments, standby letter of
credit, and guarantees. The unallocated allowance includes the specific country
and expected loss components of our allowances for credit losses. The
unallocated amounts represent our allowances to specific counterparties
determined in accordance with SFAS No. 114 and SFAS No. 5, for loans and
off-balance-sheet credit instruments, respectively.
</FN>
</TABLE>
