DEFA14A 1 0001.txt SCHEDULE 14A (Rule 14a-101) INFORMATION REQUIRED IN PROXY STATEMENT SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant [X] Filed by a Party other than the Registrant [ ] Check the appropriate box: [ ] Preliminary proxy statement. [ ] Confidential, for use of the commission only (as permitted by Rule 14a-6(e)(2)). [ ] Definitive proxy statement. [ ] Definitive additional materials. [X] Soliciting material under Rule 14a-12. J.P. Morgan & Co. Incorporated (Name of Registrant as Specified in Its Charter) N/A (Name of Person(s) Filing Proxy Statement, if Other Than the Registrant) Payment of filing fee (check the appropriate box): [X] No fee required. [ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. (1) Title of each class of securities to which transaction applies: (2) Aggregate number of securities to which transaction applies: (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): (4) Proposed maximum aggregate value of transaction: (5) Total fee paid: [ ] Fee paid previously with preliminary materials. [ ] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the form or schedule and the date of its filing. (1) Amount Previously Paid: (2) Form, Schedule or Registration Statement No.: (3) Filing Party: (4) Date Filed: Date: October 19, 2000 This filing contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements about the benefits of the merger between Chase and J.P. Morgan, including future financial and operating results, Chase's plans, objectives, expectations and intentions and other statements that are not historical facts. Such statements are based upon the current beliefs and expectations of J.P. Morgan's and Chase's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. The following factors, among others, could cause actual results to differ from those set forth in the forward-looking statements: the risk that the businesses of Chase and J.P. Morgan will not be combined successfully; the risk that the growth opportunities and cost savings from the merger may not be fully realized or may take longer to realize than expected; the risk that the integration process may result in the disruption of ongoing business or the loss of key employees or may adversely effect relationships with employees and clients; the risk that stockholder or required regulatory approvals of the merger will not be obtained or that adverse regulatory conditions will be imposed in connection with a regulatory approval of the merger; the risk of adverse impacts from an economic downturn; the risks associated with increased competition, unfavorable political or other developments in foreign markets, adverse governmental or regulatory policies, and volatility in securities markets, interest or foreign exchange rates or indices; or other factors impacting operational plans. Additional factors that could cause Chase's and J.P. Morgan's results to differ materially from those described in the forward-looking statements can be found in the 1999 Annual Reports on Forms 10-K of Chase and J.P. Morgan, filed with the Securities and Exchange Commission and available at the Securities and Exchange Commission's internet site (http://www.sec.gov) and in Chase's Registration Statement on Form S-4 referred to below. Chase has filed a Registration Statement on Form S-4 with the Securities and Exchange Commission containing a preliminary joint proxy statement-prospectus regarding the proposed transaction. Stockholders are urged to read the definitive joint proxy statement-prospectus when it becomes available because it will contain important information. The definitive joint proxy statement-prospectus will be sent to stockholders of Chase and J.P. Morgan seeking their approval of the proposed transaction. Stockholders also will be able to obtain a free copy of the definitive joint proxy statement-prospectus, as well as other filings containing information about Chase and J.P. Morgan, without charge, at the SEC's internet site (http://www.sec.gov). Copies of the definitive joint proxy statement-prospectus and the SEC filings that will be incorporated by reference in the definitive joint proxy statement-prospectus can also be obtained, without charge, by directing a request to The Chase Manhattan Corporation, 270 Park Avenue, New York, NY 10017, Attention: Office of the Corporate Secretary (212-270-6000), or to J.P. Morgan & Co. Incorporated, 60 Wall Street, New York, NY 10260, Attention: Investor Relations (212-483-2323). Information regarding the participants in the proxy solicitation and a description of their direct and indirect interests, by security holdings or otherwise, is contained in the materials filed with the SEC by J.P. Morgan and Chase on September 13, 2000 and September 14, 2000, respectively. [The following is a transcript of a joint meeting and conference for the investment community reviewing third quarter financial results and providing a merger update.] 1 J.P. MORGAN & CO. INCORPORATED THE CHASE MANHATTAN CORPORATION THIRD QUARTER 2000 FINANCIAL RESULTS October 18, 2000 11:00 a.m. 3 MR. SHAPIRO: Good morning, my name is Marc Shapiro, I'm happy to welcome you to the first joint conference between J.P. Morgan and Chase in which we discuss our earnings results. One of us at least has some good results to report. We will be letting David Sidwell go first in that regard. Dina Dublon will then discuss the Chase results, I'll come back up here and talk a little bit about how we see the merger going and really some more discussion about the merger and then we'll all be available, along with a number of our other associates from senior management of both companies, to respond to your questions. Because of the crowded agenda of presentations and because of the number of topics we're going to cover and because of the questions we think we're likely to get, we will probably run a little bit longer than the hour that we normally allot for this. If those of you in the audience need 4 to leave sooner we'll understand that. David, if you will lead off. MR. SIDWELL: Thank you Marc. Let me begin with the obligatory disclosure. If you picked up the materials, you can see it actually on page 2. Obviously this is aimed at making sure that we make you aware that the targets may differ from the actual results and are subject to the risks and uncertainties that we laid out in our annual reports. Let me then turn to page 5, earnings were $514 million, earnings per share of $2.77 cents grew 25 percent from a year ago. Earnings and EPS are down modestly from the second quarter of this year. Return on common equity was 18 percent. After-tax economic value added, or EVA, was $227 million, up $143 million or 170 percent from a year ago. Diversification across markets, products and regions produced solid results for the quarter. Total revenue of $2.3 billion rose 17 percent from a year ago. 5 Core operating expenses of 1.6 billion were up 20 percent. The drivers were higher performance-driven compensation, in line with stronger performance, growth in Investment Banking and Equities as we added people to support the expansion of these businesses, and the continued investment in corporate initiatives, such as LabMorgan and the private banking initiative. The quarter's efficiency ratio was 69 percent, driven by the increase in compensation expense. Let me move onto the segment results, which are on page 6. Looking first at client focused activities. Our businesses delivered solid results in the quarter. Combined EVA was $304 million, revenues increased 19 percent year over year and were flat with the second quarter. Revenues drove the changes in pre-tax income and EVA. Let me drill down into the revenue trend by segments, starting with asset management services. This business 6 reported revenues of $390 million, up $40 million from a year ago, driven primarily by growth in private banking revenues. Revenues from institutional investment management and our equity investment in American Century also increased. Assets under management of $373 billion were up 15 percent from a year ago. The increase equally divided between net new business and market depreciation. In addition, there were $114 billion of assets under management in American Century, our investment in American Century as you remember is 45 percent. Investment Banking revenues were $426 million. All activities -- advisory, debt and equity capital raising and derivatives origination activities -- contributed to the $60 million increase from a year ago. Revenues were flat with the second quarter as an increase in derivatives origination offset a modest decline in advisory. Our year-to-date market share and 7 worldwide completed M&A was 16 percent. While our completed advisory activity slowed this quarter from a record level in the second quarter, we saw a meaningful pickup in our global advisory pipeline. It is currently as strong as it has ever been. Conditions in the debt markets improved, resulting in higher underwriting revenues compared to the second quarter. Equity underwriting revenues, however, were flat with the last quarter. As you know, our strength is executing large, global transactions. Several deals were postponed during the quarter because of issuer-specific strategic decisions. We continue to have a healthy pipeline, although obviously execution will depend on the market environment. For the nine months we ranked sixth in the U.S. in lead equity underwritings. Equities reported revenues of $448 million. While down modestly from the second quarter, equity derivative revenues were the main contributor and continued 8 this year's trend of very strong results. Cash equities revenues were up modestly versus the second quarter, driven by volume growth in North America. Compared to a year ago, cash equities were up significantly as we continued to reap the benefits of our investment in this business, both in the U.S. and Europe. Interest rate and currency markets reported $426 million in revenues. Derivatives were the story, with the increase driven by trading gains which more than offset weaker client demand from issuers and investors. Finally, credit markets revenues of $346 million were flat with the second quarter. Higher revenues from debt syndication, and structured finance activities, as well as trading, were offset by approximately $100 million in mark to market losses recorded on an equity position taken in a debt restructuring of a U.S. retail distribution company. Our credit portfolio revenues were unchanged. 9 Let me turn now to our proprietary segment which is on page 7. We had divergent trends in the two businesses. Equity Investments revenues were $14 million, substantially lower than previous quarters. Realized gains of $118 million were offset by losses from mark-to-market depreciation on an investment in the telecommunications industry. Fair value for our investment securities portfolio at quarter-end was $1.6 billion, including approximately $280 million in net unrealized gains. The proprietary positioning business posted very strong results for the third straight quarter, reporting revenues at $310 million. These results were driven by excellent performance in fixed income and equity relative value portfolios both here in the U.S. and Europe. As we have stated before, this business activity was restructured late last year to focus more on relative value strategies and to reduce capital dedicated to significant 10 directional risk positions. Required capital for this segment was reduced in late 1999; it averaged about $350 million in this quarter, compared to $1.5 billion in the prior year's quarter. Let me say a few words about year-to-date, which is on page 8 in the book. After-tax EVA rose 49 percent to $843 million. EPS was $9.05 per share, up 17 percent. Return on equity was 20 percent, with an efficiency ratio of 67 percent. Revenues were up 15 percent to $7.6 billion on strength in Equities, Investment Banking, Asset Management and Proprietary. Expenses of $5.1 billion increased 18 percent on similar trends as in the quarter-higher compensation expenses driven by stronger performance and the addition of personnel in Investment Banking and Equities and the corporate e-finance initiatives. The tax rate in the quarter was 28 11 percent, which was necessary to bring our effective rate for the year to 33 percent, which is our current estimate of the full year 2000 rate. Let me finish with a few comments on credit quality. Overall, the credit quality in the portfolio was relatively stable through the second quarter, non-investment grade credit risk being less than 10 percent of the total credit portfolio. You can see the split on the slide between derivatives and loans and commitments. Charge-offs on loans were $18 million, primarily to one U.S. health care industry name. Non-performing loans declined by $12 million to $128 million. Finally we had a negative provision for credit losses of $36 million in the quarter. MS. DUBLON: Our story is a little bit longer and it's a little bit longer because it's not as good. As you know, the more complicated, the longer it takes to 12 explain it. This was a disappointing quarter for us and we luckily do not have many of those. The key drivers behind earnings this quarter is private equity, where we had large unrealized mark-to- market write-downs of $560 million. In Investment Banking we had expense growth that significantly exceeded revenue growth. The issue, however, is expenses, it's not market or credit risk. All other businesses had very good results, Wealth Management, Operating Services and Consumer. Over the last year we have taken many and significant actions to reposition the company for a long-term competitive advantage and higher growth rates. This quarter's results should not overshadow this progress. Private equity first. Realized cash gains have grown and are significant. For the quarter, $538 million, and year-to-date, $1.2 billion. However, unrealized gains have clearly been volatile over recent 13 quarters. $560 million negative this quarter and, not on this slide, almost $1 billion in the fourth quarter of last year. This is not a business for the faint hearted or for those obsessed with quarterly accounting results. If we had the option of available-for- sale accounting here, as we have for our investment securities portfolio, we would have had close to $600 million more in pre-tax income or another 30 cents a share. The unrealized pre-tax write-down of $560 million would be taken against equity and offset almost dollar-for-dollar the $550 million improvement in the value of the investment securities portfolio this quarter. How many of you have noticed that improvement? In any event, it's a very different report card on exactly the same facts. Accounting does matter. It definitely seemed to matter in terms of perceptions. For this business, however, reported earnings are not a good gauge for value 14 creation. So is it a good business for our shareholders. The point that seems so difficult to get across is that the quoted market value of the public securities portfolio is still, after the price declines, almost four times the cost of the investments we made. We carry these investments at a $1 billion discount from the quoted market value because of our restrictions on our ability to sell. Let me be more specific with an example, an example that was in the media this morning. The cost basis for Triton and Telecorp in our public securities portfolio is $58 million, that's the money we put in. Let me round it to $60 million. The market value of those two securities at September 30 was rounded to $600 million. On June 30 it was $1.2 billion. So this quarter we reported a large unrealized loss, most of the decline that you see in our private equity business. Are these good investments? We have written them up and we have written them 15 down. We haven't sold, but to date it looks pretty good. The public securities portfolio is only 20 percent of the total. It gets more attention than the other 80 percent that is generally carried at cost and is really where most of the value of the business resides. You have seen this slide before, it shows cash on cash returns on liquidated investments by crop year, the year in which investments were made. Over the whole period we have 43 percent compound annual cash on cash return. Management are partners in the investments we make. They are compensated on the basis of cash returns, not on accounting and unrealized gains. There is no incentive to accelerate sales. We continue to be very positive on the potential for good cash returns going forward. In Investment Banking- revenues are up 16 percent, earnings are down 9 percent. We have a higher overhead ratio, lower return on equity and lower shareholder 16 value added, reflecting higher equity allocation to support the acquisition planning. Expenses are too high, we know it is unsustainable and are committed to return to more disciplined spending. We have, however, made huge progress this past year in building the platform for execution in the TMT (technology, media and telecomm) sector, M&A advisory, as well as in Asia. With the merger we will be addressing the expense issue in a broader context. I want to use a quote from Sandy Warner to our board yesterday. What he said was "Together we are ready and committed to move from a transform to a perform stage." Revenues were softer than the second quarter. Trading revenues were flat its last year and under the second quarter, reflecting lower market volatility, lower volume and client spreads in effect in derivatives, yet we had no unusual activity in trading, we had zero days this quarter--I repeat, zero days--with trading loss, better 17 performance than in the prior four quarters. Syndication fees and high yield underwriting, in total about 30 percent of our Investment Banking fees, are close to 40 percent lower than last year because markets are slower, not because we lost share. Advisory, equity underwriting, high grade bonds, project finance, private placements are all significantly higher, reflecting the progress we have made. Flemings had a good two months in Investment Banking. Their expense ratio is higher, but they are not the key contributor to the expense imbalance you see this quarter. The deal pipeline, as David commented on Morgan, is very strong; we are looking for stronger Investment Banking fees in the fourth quarter. A few comments about the Morgan pro forma results. Combined for the third quarter we will have, we do have $1.5 18 billion in trading revenues and $1 billion in Investment Banking fees. In both cases just number 3, behind Goldman and Morgan Stanley, so this is where we are on the scale front. Two, we had a more diversified earnings stream, being able to better counterbalance slower leveraged finance markets with equity and equity derivatives. Our pro forma decline from the second quarter is more moderate and the growth from last year more pronounced than most of our competitors. We will have higher revenue growth without the necessity to spend to build capabilities we each don't have on our own. You cannot yet see the impact of lower spending or the impact of the combined capabilities and clients on the revenues. Clients though are requesting and embracing joint pitches. Marc will elaborate on that later. Our credit philosophy and practices have held us in good stead, commercial charge-offs are low 19 this quarter as well as year-to-date. We continue to be comfortable with the lower end of our expected loan loss range of 40 to 60 basis points. Non performers, both commercial and consumer, are down. The absolute level and percentage to assets is low. We can see fluctuations quarter to quarter, but don't expect significant changes from the level we are at. Pro forma for Morgan, our credit exposure and credit revenues are a much smaller percentage of capital assets or revenues. It's more biased toward investment grade and, as we have said before, should continue to decline. Wealth Management includes our Global Private Banking and Asset Management businesses. It includes two months of Flemings results. Private banking had a great quarter, with over 30 percent revenue growth. The momentum is strong. The bottom line reflects large investments in technology, internet and talent. We have kept here a better pay-as-you-go expense 20 discipline than we have in the Investment Bank. Total assets under management are over $300 billion. For mutual fund and institutional assets under management, of $180 billion, we had net cash inflows of $4.6 billion over the period. Operating cash income is up, but will be burdened this and next year by amortization of retention bonuses. Equity against goodwill is up on average $2.7 billion for the business, lowering return on equity and shareholder value added. With pro forma assets under management of approximately $750 billion, we will be a formidable competitor. Global operating services had record earnings. Revenue growth in our trustee and custody businesses are double digits for the quarter and year-to-date. Revenues from cash management services are low single digits, as they have been for the whole year. The focus on operating leverage has fueled over 20 percent growth 21 in the bottom line for all three businesses for the quarter and year-to-date. This roughly $3.5 billion revenue franchise should continue to see double-digit revenue growth, improved efficiency and growing market share in a consolidating environment. It is a gem. We have many opportunities for synergies here as well between the equity derivatives business that Morgan brings and our custody business. For the consumer businesses, bottom line results were strong across the board. Let me pick up on just two of them. Credit cards - revenues are flat year over year, but we have 6 percent revenue growth from the second quarter. In the quarter we have acquired record new accounts and now have three-month sequential growth in card outstandings, reflecting the benefit, among other things, of the new management. In Chase Home Finance we have mixed trends. In the quarter we had significantly higher servicing fees. 22 mortgage originations, however, were 20 percent below last year and we realized gains on securities that were hedging our mortgage servicing rights. In total for the consumer businesses, revenue growth was anemic with income growth of 13 percent, driven by declining credit costs and expense management. Shareholder value added is up, and you can see both from the overhead ratio and return on equity, that the franchise is very, very profitable--24 percent return on equity. We have been judiciously taking actions to rationalize the business by divesting where we cannot sustain competitive advantage and investing where we believe we can. Over the last twelve months we have sold some upstate branches, our business in Beaumont, Texas, Panama and we announced exit from Hong Kong. At the same time we have acquired portfolios in credit card and mortgage businesses. We have invested in our electronic brokerage of Brown & Company 23 and see opportunities to leverage Flemings asset management, as well as Morgan on-line content with affluent consumers. We continue aggressively with our Chase.com initiatives. Mortgage banking may introduce some volatility from quarter to quarter, but the momentum here is very good and David Coulter is confident we can grow the bottom line and maintain a very high profitability level in the business. How does it all sum up? This is not an easy quarter. We had the volatility of Capital Partners, as well as acquisitions for which investors and analysts don't have a good history. Operating earnings per share of 68 cents is 24 cents lower than last year. That's the starting point and it is disappointing. Chase Capital Partners unrealized write-downs cost us 23 cents over last year. The rationale for separating earnings from Capital Partners is that earnings are not an adequate means to value the business. 24 With the acquisitions, amortization of intangibles has more than doubled to 11 cents this quarter. Flemings is in our numbers as I said for two months. The deal was non-dilutive to cash earnings per share in the quarter. Flemings earned for the two months $52 million in after-tax cash income after absorbing $48 million in retention bonuses, but before goodwill. This is an annualized rate -- all I'm doing is multiplying it by 6 -- this is an annualized rate of $500 million before retention bonuses and $310 million net of the retention bonuses. Cash operating results, excluding Capital Partners, were 88 cents or 4 cents higher than last year. 5 percent growth is not great, it is disappointing to management, to all of us, but it is also not as terrible as the first impression. Our long-term business outlook is unchanged. Nothing in this quarter points to a fundamental impairment of our business franchise. Over the last twelve months, as 25 I have pointed out, we have significantly repositioned the company. Marc will address where we are and the progress we are making with Morgan. Thank you. MR. SHAPIRO: Thank you Dina. I would like to turn my attention for a moment to the merger transaction, because I think it is one of the most important things affecting both of our companies and our valuation of our stock. I would like to talk about it focusing on three issues. One is price, because there have been a lot of commentary and questions about price and I want to address that issue. The second is synergies, because I think that has a lot to do with whether the deal pays off or not. Finally, some comments on execution and where we are in the transaction right now. Let me start with price. Many people have asked whether in pricing this transaction we have gone away from our focus on SVA and capital discipline. Let me 26 tell you how I feel about that. I do not believe that SVA is a good method for valuing transactions of this type. Why did we develop SVA and why do we use it as a concept? The reason really was so that units of the company can make the same trade-off that we can at a corporate level about the use of capital and the earnings on that capital. We can make the trade-off at the corporate level because we have a measure called earnings per share and we can affect earnings per share by re-buying stock. Units of our business don't have that option. SVA is a means to an end and there is only one end for any corporate business and that's increasing valuation. I believe that increasing valuation is driven by increasing cash flow per share and earnings per share. That is the means to the end. SVA is a way of apportioning that decision-making process out among units of a business, so that they can make 27 appropriate trade offs between investment of capital and the return on that capital, and that's what we use it for. I think it works well for small acquisitions where we can assign the good- will to the unit that's doing it and make sure that they have to have an earnings requirement on that goodwill, so it works well for small acquisitions. But when you get to a large corporate acquisition with a lot of shares, the issue really for me is what do those shares do in terms of the growth rate in earnings per share and the discount rate on the uncertainty that you apply to that future growth rate. So I start with the simple proposition--which is one way to measure that is dilution to earnings per share. This slide is a little bit different than the one you have in the book because we had used a different consensus EPS, the one we should have used and the one we are using now is before the transaction with Morgan, so not reflecting any potential dilution. 28 On that basis and on the shares that we have to issue in the transaction, we would need to cover synergies of about $.9 billion, a little bit less than a billion dollars. What we said in our earlier estimate was a conservative belief on an after-tax basis that we can get to $1.2 billion. The way we got to that number was simply on a conservative estimate of could we cover the dilution. We can and we will and I'm going to go into greater detail on that point later. The real point is if we can cover the dilution, then what we will have within 18 months is a company that has as strong earnings per share as we had before, a higher growth rate potential on that earnings per share, less risk because of the greater diversification of risk and therefore, in my mind, a lower discount rate applied to that future growth rate and earnings per share. Finally, we won't have to wait very long to find out if we're right or wrong 29 about this. This is not a deal that depends on 10 year growth rates to equalize. We will know the answer to this question in a year and I predict that the answer will be very positive. The third element that I want to talk about on price is premium. Some people say well, it's a great deal, but you paid too much over the market. Well, the observation I would make about that is we looked at exchange ratios. Exchange ratios vary a great deal from point to point in time and the market has its own way of valuing things, and then we're trying to look more intrinsically at what long-term values are. It is not clear to me that if we had the hypothetical alternative of paying no premium for another securities firm that was trading at a higher price-earnings ratio than the price-earnings ratio we actually paid for this securities firm, that we would have had a better transaction. It might have looked better 30 because there was no premium, but in our view, the degree of synergies that we would have had to overcome would have been greater and our ability to execute on developing those synergies would have been more difficult. So I'm very comfortable with the pricing here because we believe it works out to the benefit of our stockholders. Finally, there is this question about timing. The accusation that whether it's with H&Q, with Flemings or with Morgan, that we are buying at the top of the securities market. Well, in the first place I don't exactly know where the top is, I have to confess to that and those of you who do, I wish you would stand up so we can talk about it. What I do know is that we take a long-term view of markets. We believe that the markets for new economy securities, that the markets for Asian securities and that the markets for equity securities more broadly in the U.S. and in Europe are fast 31 growing markets and will be for the next ten to twenty years. Having a broad-based platform to participate in those markets we think is a good business proposition. We don't know exactly where the top is, but we do believe that we've covered our risk to some degree by pricing the bigger transactions with shares that fluctuate in value, depending upon how the market fluctuates, and we believe that over the long term we will be rewarded with these transactions. Let me talk about synergy, because I think that's an important part of the immediate reward. Synergy falls into two categories, expenses and revenue. On the expense side, what we have been doing is looking over the last three weeks, since really the merger planning began, at doing a much more careful detail of where the expense synergies were coming from -- try to map one unit against another comparable unit, assign them to managers -- we have many managers now in place for the combined 32 units -- say let's get a much more careful handle on what the synergy could be. We haven't completed that process, when we do we will probably come back and tell you what we think it shows, but it is quite clear that it will show that the numbers that we have given you so far are very conservative. Let me give you two examples that I think illustrate the point. In the back office processing units of all of our securities systems and all of our heavy transactional flow businesses, generally speaking, one or the other of us has a much higher volume than the other, yet we all have to process all the transactions. In one particular back office processing unit for Morgan that does a lot of their processing volume, expense is about $30 million. Our view is that we can add that on incrementally to the platform we have at Chase for about $3 to $5 million. We can apply that kind of logic across a whole range of back office 33 processing. I'm not suggesting they will all be 90 percent, but I do think there will be significant back office savings. On the front office, if you looked at the two companies combined, to take one other example, we have 600 M&A bankers, we do not need 600 M&A bankers to have a first class, top tier, number one M&A practice. There are significant opportunities for savings and we have a management group that is committed to finding those savings. On the other hand, we also think that there is huge revenue opportunity. The revenue opportunity comes in several forms. Many of you I think do judge a securities firm on the basis of M&A and on the basis of the equity platform. On that we're already a fully formed company. In M&A, depending on how you measure it, the combined companies are No. 4 in terms of the value of announced transactions, No. 2 in number of transactions and No. 3, I believe, in the fee revenue that are derived from those transactions. That's where we already are today. 34 In September, of the fifteen largest transactions announced worldwide, we advised on one side or the other on eight of those. Of the six of those that were outside of the United States we advised on five of those. We have a fully formed practice that is producing today at a very high level in M&A. On equity platform it's harder to see because we put together a lot of pieces recently--Flemings and Morgan and H&Q all coming together. Together we have over 700 salespeople, we have over 500 equity research analysts, we cover almost 5,000 companies. We have a big business today. It is not as strong as M&A on the league tables today, but that's because none of these businesses have had the advantage of having the platform that we have against a large client base that we now have together. It's my prediction that within a year you will see significant improvement in league table standings. Despite the fact of the importance of 35 M&A and equities, the real juice in this merger is selling products that one company has to the other's clients, and a lot of those products, to use a simple example, are going to be selling structured derivative products to everybody at Chase that takes out a syndicated loan, because in one way or another, most of those people have a need. We have found very little client overlap. As a matter of fact, we looked at 2400 of our core clients in the United States and we found that the overlap among those 2400 was about 10 percent, and this shows the different industry groupings that we have, but generally across the board it runs about 10 percent. In Asia we looked at our top 20 clients on each side and we have one overlap. There is very little overlap here and the real juice in this merger is going to come from the product strengths of one company and the clients of the other -- that is going to produce a lot of synergies. 36 We know that because the reaction from clients is already very strong. Where we have a client that knows that we have these joint capabilities or the capabilities of the other firm and they request us, we can make a joint pitch already to those clients. In the three weeks since we started working together we made 54 joint pitches, we have won 19 of those -- that's a higher batting average than either of us would have had on our own. Many of those deals we would not have won on our own. We would estimate that the incremental fees that are associated with just those transactions, over and above what we could have done on our own, is in excess of $50 million. We have 75 more pitches scheduled in the next three weeks. This is a huge value adding transaction and we haven't even merged yet. There is going to be a lot of revenue produced. We see similar opportunities already in the private banking activity where together we are the largest private 37 bank in the United States. Finally a word on execution. It is helpful to have done these before. They are very large and very complex and knowing what's coming and knowing how to get it organized is a big assist. We have a team in place that's fully staffed across each of our business units. We have an overall coordinating team in place. We have filed all of our regulatory applications. We are expecting to close in the first quarter, but we are preparing ourselves to close by year-end if we are able to get approvals to do that. We have made a lot of progress on naming jobs. The 35 top jobs in this company were named on the first day of announcement. Since then we have named about the same number of jobs in many of our key staff areas. We expect this week to announce over 250 jobs in the Investment Bank and in the Private Bank -- most of the key headline of reports. We have moved faster in this merger than we have in any of the others, because we understand 38 the importance of speed and because we think that helps us execute in a much crisper manner. We are extremely positive about this merger. Before I close I would like to say one other word to our investors and to those of you who have recommended our stock. We understand that you put a great deal of trust in us by your actions in doing that and we also understand that at least as of today that has not worked out as well as we would like for many of us. We are not a management that is not mindful of the responsibility you have placed with us and we understand the importance of it. It is our view that there will be a time when everybody who has invested in our stock at whatever price they have invested, will view it as a good investment. We can't control the market, but we can control our performance and what we do about it and we are very committed to performing at a top tier level that will justify the confidence of the market and 39 justify your confidence in us. With that I would like to close and throw it open for questions, both to those in the room and those on the telephone. I am joined by a number of senior associates here from both J.P. Morgan and from Chase and I will properly deflect all the difficult questions. QUESTIONER: First, in terms of possible revenue losses that you have looked at up front in the merger, and whether there is any update in terms of overlap there. Secondly, you alluded to or you referenced I think an ability to slow underlying -- investments of Chase going forward, I wonder if you can give us some thoughts of how that's going to influence the expense growth rate. I'm curious where J.P. Morgan stands today in terms of targeted proprietary revenues versus total. That number has been coming down for a long time and now we have three quarters of high proprietary profits. What is a normalized way to think about proprietary income on the Morgan side? MR. SHAPIRO: My problem is always 40 remembering all these questions that you asked, so if I forget one along the way I will start over. I'm going to answer the second one and let Don Layton answer the first. Most of the concerns about revenue losses have been focused on the trading side and that's where it is so I'll let Don comment. In terms of expenses, I think it's clear that there is an awful lot of expenses that we can avoid. One small example, as it happens, is that we both occupy the same building in Tokyo. We were preparing to build an equity trading floor on the 13th floor and Morgan was preparing to build one on the 14th floor. I think we can only build one now. Another example is the significant amount of money that we were committed to spend to build up our equity derivatives business and to build up our platform more broadly in Europe. In both cases, Morgan brings world class capabilities and we won't need to spend that money. I think it will be difficult to 41 track exactly the slowdown in expense growth that comes from expense avoidance as we get to the new firm, because we're only going to be showing combined results and you're also going to be getting the benefit of synergies and I don't know quite how to plug it in the models. I will say if we had not done this merger we would have slowed the growth rate in expenses, because we are committed to a long-term balance between revenue growth and expense growth. Don, if you want to comment on the revenue loss risk, especially in the trading areas. MR. LAYTON: Let me give you some background I embarrassed myself in our first two mergers because when we did our planning I predicted that trading revenues would drop before they went up again, because of issues of counterparty credit and overlap and such, and was proved wrong in both cases as revenues took off, because any of those negative impacts were quite modest versus the strategic benefit of being able to handle more size, be a bigger factor in the market, capture more of the bid-offer spread, as you have higher volumes coming 42 through the same trading organization. I'm very reluctant at this merger to talk about revenue loss, even internally or externally and any kind of anecdotes I've heard about it are all relatively modest, so I don't think it's a material item to put in the planning at all. MR. SHAPIRO: With regard to proprietary trading. MR. SIDWELL: Obviously I think we have been very pleased with the results that we have seen in this business, particularly in light of the repositioning we have talked about as we moved from a business that has a large element of outright directional positioning to one which is based more on relative value strategies and maximizing returns at the corporate level. I think we have also achieved something which was important, which was a re-sizing, in light of the risks being taken of capital allocated to our business. Obviously this tends to be a more 43 volatile aspect of our business than some of the more client focused activities and our last two quarters will probably be a little further above trend. However, we think this is an important part of the business going forward and expect to see over time good results in this activity. QUESTIONER: Dina suggested Investment Banking fees should pick up again in the fourth quarter. I'm curious what the foundation of that thinking is. More specifically, I think we have a very odd market, capital market environment to look forward to. I know the standard answer is if high yield is stuck and liquidity isn't back, one way out of it is to go back to lending. In this instance do you feel comfortable doing that considering what the examiners have done? Secondly, if you could discuss a little bit more about where the merger integration process is going? MR. SHAPIRO: Jeff. MR. BOISI: On the revenue side of the fourth quarter we are expecting a very 44 significant pickup in each category. If we just closed every transaction that we have a current commitment on, we would have a very significant pickup off where we are, so it's across the board. If you look at our merger business, this past quarter it's grown 87 percent year-to-year in terms of the numbers of transactions. It's almost 150 percent up from last year. This is just Chase alone. We see very significant increases both domestically and internationally in terms of our positioning in the merger business. Our backlog of equity transactions is very robust and that has been growing at very high rates as well. Our issue has been syndicated finance business and, more specifically, the leveraged portion of that and the high yield business. We have maintained the market share positions that we have had in the syndicated finance business overall, our number one position. The leverage finance business through the lessening of LBO activity has hurt us in 45 this past quarter. However, on the basic bread and butter business it seems there's a backlog of business that looks quite good there. The high yield business is the area that has been difficult for us and I think we have dropped both in terms of the overall volume of that business, but also slightly our position in that business, which we are heavily focused on. I would tell you that based on the backlog that we have now of committed transactions, we expect to see a significant pickup. I will say, I do want to add to what Dina and Marc have said so that you hear it directly from Don Layton and myself. On the expense side, you have to remember I have been here for three and a half months and we have had a fair number of changes. I want to assure all of you that we are exceedingly focused on this expense issue. We have been in the growth mode here 46 for a number of years. As you know, there is a severe war on talent going on. We have been protecting our people, but we have been growing our businesses aggressively all over the world, in every theater of the world in almost every significant area. We were doing that on our own book, building it person by person, group by group. Now with the J.P. Morgan transaction we have completed that all in one fell swoop. Now, I will tell you in the three and a half months that we have been here, even though we were growing it on a person-by-person basis, we had not had the chance--even though I can guarantee you, that the entire management team in the Investment Bank has been spending countless hours focused on how we reposition our expense base in order to fund that growth. But we are doing that, we have done it day in and day out now. Unfortunately it's going to take a quarter or two to start to see the benefits of that. I guarantee you you will see the benefits of that. 47 MR. SHAPIRO: Just one last addendum. Part of your question said do you go back to old-fashioned lending, we are not and J.P. Morgan is not interested in growing revenue from lending. We grow revenue from the syndication business, but neither of us believes that holding long-term corporate loans is a great revenue producer and a great return or any return on capital and therefore, both of us in our different ways, have been trying to work that part of our business down and will continue to do so. QUESTIONER: Marc, in the page you had when you were talking about pricing, you were looking at reported earnings. I was wondering if that means you're downplaying cash earnings, because if I looked at that on a cash earnings basis, that absorbs most of the gap that you had in the chart that you showed between the synergies and the amount that you would need from Morgan; so does that mean that cash earnings aren't so important? 48 MR. SHAPIRO: That's a good question and that's a good observation, because we do believe that cash earnings are the most important thing and it does take the synergy requirement up a little bit higher. It is still a dilution element that we think will be comfortably covered by the conservative revenue and expense estimates that we have here. As I said, I am increasingly coming to the opinion that those numbers will be increased. QUESTIONER: When I look at the coverage that's needed in the out years when the synergies are fully phased in, when I do that math they basically match, more or less; so that implies to me that to more than cover and to accertive, if you see already more benefits than what you're seeing right now. I was wondering if you could give us some quantification to what you really expect as opposed to the numbers you have out there? MR. SHAPIRO: I would prefer not to quantify it until we have completed the 49 more detailed work. It is our gut feeling going in that those were conservative numbers, I feel more strongly that those are conservative numbers. We would be best served by waiting to complete the detailed work that we have done and I would expect at some point to come back to you with a better estimate of what it is. I hope I provided a conviction about where I think that number is going to go. QUESTIONER: Two questions, one for Don Layton. Morgan has been quite enamored with its prop. trading activity, you have been more interested in market making. Could you talk about how you feel about that activity going forward within the entire mix of global markets? Secondly, for Bob Strong, could you discuss Chase's feeling about the TMT area, specifically Telecomm, and how that looks across both the loan book, as well as your counter-parties on the derivative side? MR. LAYTON: Chase has emphasized the market making, which was a historic 50 strength. In all cases, companies build on their historic strengths and do what they do well. I've always talk about proprietary trading as being kept to a proportionate size so it doesn't tend to dominate the total. In the new bank, because it will be so much larger, I think you will find proprietary trading will in fact fit that policy because you have a big denominator basically. The second thing is -- and I have had a talk with the gentleman downtown who runs this unit -- calling it proprietary positioning is a bit of a misnomer. I don't know if there's been a word invented to cover what they do. While there is some moderate amount of classic proprietary trading in there, David did mention it's more relative value oriented, but there are a lot of transactions which are using market transactions to create value. For example, tax synergies for the company, which shows up in the P&L for that unit, which is considered proprietary. But this unit is far away from your classic long, short, any fund depending on your view, kind of unit that swings around. 51 It's been rebuilt substantially in the last four to eight quarters. In our due diligence we determined this and on that basis I'm even more comfortable that the underlying true proprietary in there of the company is going to be perfectly fine as a percentage of the corporate earnings, so there is not a swing factor, and so it does not come to dominate earnings overall or trading earnings. MR. SHAPIRO: Bob. MR. STRONG: In terms of Telecomm and our total exposure, Telecomm is one of our larger industry groups and represents about 5 percent of our total exposure. It has grown over the last year. However, our growth has been centered on the investment grade section of Telecomm. As a result, our risk profile of our portfolio has improved quite a bit in the course of the year. We have no meaningful problems in 52 that portfolio, we have one minor $125 million nonperforming loan, but fundamentally we are very comfortable with where we are in Telecomm. Our focus continues to be to focus on the higher end to try to provide a market view of what will sell in the market and to distribute that out and that has held us in good stead. MR. SHAPIRO: Everything that we have in syndication is doing fine. I think we will take a question on the phone. MS. MERIDIAN: Diane Meridian of Morgan Stanley Dean Witter. The question I have is with respect to Chase Capital Partners. If you decide that it is in effect raising your cost of equity for the entire company, then really Chase Capital Partners has to earn an additional amount of income to offset that. If you look at the sum of common equity of the five businesses this quarter you have about $31 billion worth of equity on which these five operations have to earn a return; if you raise the cost of capital 53 a hundred basis points, that is an extra $310 million that you need to earn at Chase Capital Partners to cover it--which compared to last year's strong earnings is about a 22 percent hike over the base. Is it your sense that it raises the cost of capital, is there a point at which you try to think about how to keep the value of this company, but separate it in such a way that you don't end up paying for it in terms of the company overall? MR. SHAPIRO: I think we said at the beginning of the year that we really wanted to spend the year evaluating the best way to deal with Chase Capital Partners. We think it is a fabulous business and a business system that has proven to be effective a long period of time. It clearly has a significant effect on our reported earnings and we know that that's an issue that we have to deal with in one way or another. We have talked about the possibility of splitting it off. That has a number of negative things that are associated with 54 it, because it also happens to be very integrated into our business model for the Investment Bank. This quarter we are trying to provide more detail to clearly split apart the complete income statement for Chase Capital Partners and also what the remainder of Chase looks like, because we think in many ways the two entities are valued in completely separate ways. How the best way is to capture that for our stockholders--capture that value for our stockholders--is an issue that we are still withholding judgment on. We have probably changed opinions almost every month since the first of the year as markets have moved. So I would say by putting in place at least the holding period of a year has probably been a wise thing to do. We now have the context of a much larger company to look at it in that context and I think when we put all those pieces together we will try to come to some conclusion at the year-end, but I don't 55 think we're there yet. QUESTIONER: Is there an option that we're not aware of, aside from giving us really good disclosure on the entire income statement as you did this quarter and splitting it off that we haven't talked about or haven't heard you speak out loud about? MR. SHAPIRO: There are some other permutations that we have looked at, but I don't think we are in a position to discuss those until we get to a position to tell you where we think we're going. Is there a second question on the phone? MR. DIXON: Question on Flemings, Give us a sense for how they affected the revenue side, it looks like they added $350 billion in revenue. I'm wondering when that came in. Of the increase in amortization, how much was tied to the retention pool and what was the other addition in terms of expenses? MR. SHAPIRO: Your revenue number is roughly right; the expense number is lower than that, but it depends on the amortization of goodwill and the 56 retention bonuses. When you factor both of those elements in then you get expenses that are roughly equal to the revenue. Before that you get positive returns in terms of cash earnings and before the restricted--or the retention bonuses you get earnings which are more or less consistent with where they were performing before. Their trends are pretty good on the Investment Banking side. On the Asset Management side, their revenue has been affected by the decline in the Asian stock market in particular and the values there where they are receiving most of their revenue on a percentage of assets under management. They continue to have positive cash inflows into their funds and have had almost every month this year and we continue to see that as a positive value adding transaction. MR. DIXON: In terms of the revenue lines that Flemings affected, it would have been Trust Investment Management and Investment Banking spread income? MR. SHAPIRO: Right, it would be 57 asset management, some spread income and some investment banking fees and some small amount of trading revenue. They have a lot of fee income that comes from their brokerage business, equity brokerage business, which is reported in fee income. Next question. QUESTIONER: Marc, at the merger announcement meeting I believe you mentioned that the National Consumer business is one that you are evaluating as to its strategic position in the merged company. From the numbers today it would seem that that business is strongly, positively contributing to SVA and to earnings per share and I would argue probably increases the valuation. How is your thought process coming about that? MR. SHAPIRO: David Coulter is the number one thinker on the subject. David, would you like to respond? MR. COULTER: Marc, I'd like to say thank you to my long lost relative in the audience. First of all, this is a perspective of about a month and a half, so it's formed that well. What I have 58 observed over the last month and a half is that Don Boudreau and his team have done a good job, a very tough job of merging three franchises together over the last five years, approximately, and that's tough. Having done it on the West Coast I understand it. As I look at the retail franchise, I think there is real possibility for continuing to take that shareholder value number we saw up there today--and I don't think it's an anomaly--and I think there is a real possibility to continue to provide the type of growth off that shareholder value number that's attractive. I'm not quite sure what all the details of that will take. There will probably be some businesses that we decide to get out of, there may be or there will be some businesses that we decide to add on to. It's strictly the shareholder value metric and I do see an upside of that. QUESTIONER: As you look at the business, do you see and compare it with 59 all the consolidation that's going on, is it big enough? MR. COULTER: That question probably applies to the physical footprint, is it big enough. On the product side, for instance, if you take mortgage, I think, although the numbers continue to move around, at the end of the third quarter we're probably the number one servicer, number one originator on the mortgage side. The physical footprint in this market and in the Texas market--certainly in this market--has a real critical mass. In Texas, Marc will probably talk more about that than myself, we are a number 4, and probably a somewhat distant No. 4. With the way that the market is moving in terms of what's the retail market of the future, I'm not sure that the lack of physical footprint we see throughout the rest of the U.S. is necessarily a disadvantage. Clearly you need some physical presence to continue to open up accounts, 60 but I don't think you need the physical presence of some of the other competitors out there. The trick is can you twist your mind around turning that lack of footprint into a bit of an advantage if you have other ways to provide just enough physical presence to open new accounts. You certainly don't need it to service accounts -- as Schwab shows. MR. SHAPIRO: Yes. QUESTIONER: The question is this, Chase Capital has been stepping up its pace of investments pretty dramatically over the last couple of years; it seems this year in particular pace of investments is up from last year. Obviously we have lived through some changes in market values for certain sectors of its portfolio. Without thinking about the relationship with Chase to Chase Capital Partners, just thinking about the Capital Partners business itself, have there been any changes in terms of thinking about the pace of investments, the nature of the investments that have been made. 61 There have been press stories about possibly selling off some of the third party investments using other people's money, as well as Chase's. Is there an evolution about how you are thinking about Capital Partners? MR. SHAPIRO: Sure. If Jeff were here he would say that the opportunity to invest has never been better, partly because of the better equilibrium in the market, but more so because of the continued evolution of the deal flow and of the network that he has put in place over a long period of time and the interaction of that with the Investment Bank. Morgan's capabilities will add importantly to that. We have been increasing the pace of investment. Last year we invested about $2 billion directly and about another $800 million in funds; this year it will be probably closer to $2.5 billion directly and about a billion dollars in funds. We have thought that it would be prudent to cut back on that total and in particular, 62 on the fund part of it, because our returns on those funds are lower than on our direct investments. We do get ancillary benefits from those investments in terms of our relationships and our financing, but we are working to create more of a secondary market in those funds and I think that is the sale that has been discussed in the papers. The pace of that investment over the future I think will be more stable or possibly even slightly below, depending on where we come out on the form of Chase Capital Partners. We are raising a large third-party fund for the first time in the history of Chase Capital Partners and that is all because we believe that the opportunities are greater now even than our capacity to invest in them and we want to see how much we can calibrate what we invest. We do believe in the business, we think it is a business that has 63 demonstrated the capacity to create extraordinary value and we want to find a way to capture the full benefit of that for our stockholders. QUESTIONER: Is there any change in the regulatory view on this? MR. SHAPIRO: No, with regard to regulatory views the Fed has proposed some more capital stringent rulings. We commented on those saying we didn't think they were such a great idea. Most of the other commentators were along the same lines. The Fed has not come forward with any conclusions that they have drawn from their original proposal and the comments they received. Is there a next question on the phone? A VOICE: Two questions, I was wondering if J.P. Morgan could provide some comments on their backlog and, to the extent that some of this backlog can't get monetized in the fourth quarter, how much flexibility do both companies have in managing the compensation expense line down. 64 MR. SHAPIRO: I will ask Walter Gubert to comment on the Morgan line. What I will say on the compensation is we both have incentive systems that are tied to actual performance and we do have some flexibility with adjusting those in line with performance. Walter, you might want to comment on how you see the backlog and possibly also on how you see the merger coming together and the opportunities we have. MR. GUBERT: The very simple answer is that the backlog is very strong. It is across the board in terms of products; it is across the geography and we feel, if anything, it is strengthened by the combination. Several of my colleagues talked about the dynamics in terms of pitches, common pitches and success rate and clearly that is the positive momentum in terms of our pipeline, it's very, very strong. In terms of more broadly, I can say that the reason the pitch rate is this good is because there is already remarkable clarity in terms of how to approach 65 clients, in terms of who has to work with whom on specific deal situations. I can tell you that clarity is a lot better than what I would have expected. In my enormous experience in being involved in mergers myself--this is the first one. I can tell you that is enormously energizing for our people and it translates into bottom line results quickly. So I'm very optimistic and I think our teams are very optimistic about what we can do together. Because of the complementarity in terms of clients and products--that is true in North America, in Latin America, in Asia and in Europe--the combination of ours is to take advantage of the growth potential much better than otherwise. Thank you. MR. SHAPIRO: Thank you, we will take one more question on the phone and then one more question in the audience. First on the phone. MR. EISMAN: Could you give us an idea of what type of expense controls or 66 expense savings you could realize in the fourth quarter of this year? MR. SHAPIRO: No, not specifically Steve. I think it is true that many of the projects that we might have had in mind before the merger would be postponed, plus the additional focus that Jeff emphasized so clearly in the Investment Bank on the expense issues that are there. It is worth noting that in our other businesses we do have improved efficiency rates. In Consumer I think it is notable that expenses were up only 1 percent last year. In Operating Services we continued to have increased efficiency. In Wealth Management it's harder to see because of the impact of the merger, but I can tell you on a stand-alone basis we would have increased efficiency. The issue really has been built up in Investment Banking and I think you can tell from Jeff's answer that he is extremely focused on that issue. Is there a last question in the 67 audience? If not I'll take a last question on the phone. If not, thank you very much for coming. I want to emphasize again how committed the entire management team that you see here from both organizations is in making this transaction a great success and rewarding our stockholders. Thank you very much.