-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WvodZax+cAUkjq3Q1c+8izPXg9GyjRVOAMi4ZK4ciO00Hzki32oTUuTMb2RxoJUg 2n7JFfWI3SzxFvoIyta2RA== 0000950123-00-005113.txt : 20000516 0000950123-00-005113.hdr.sgml : 20000516 ACCESSION NUMBER: 0000950123-00-005113 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MORGAN J P & CO INC CENTRAL INDEX KEY: 0000068100 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 132625764 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05885 FILM NUMBER: 635857 BUSINESS ADDRESS: STREET 1: 60 WALL ST CITY: NEW YORK STATE: NY ZIP: 10260 BUSINESS PHONE: 2124832323 MAIL ADDRESS: STREET 1: 500 STANTON CHRISTIANA RD STREET 2: ATTN RANDY REDCAY CITY: NEWARK STATE: DE ZIP: 19713 10-Q 1 J.P. MORGAN & CO. INCORPORATED 1 ================================================================================ 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 March 31, 2000 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 April 28, 2000: Common Stock, $2.50 Par Value 162,338,748 Shares ================================================================================ 2 PART I -- FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS The following financial statement information as of and for the three months ended March 31, 2000, is set forth within this document on the pages indicated:
Page(s) ------- Three month Consolidated statement of income J.P. Morgan & Co. Incorporated .................................... 3 Consolidated balance sheet J.P. Morgan & Co. Incorporated .................................... 4 Consolidated statement of changes in stockholders' equity J.P. Morgan & Co. Incorporated .................................... 5 Consolidated statement of cash flows J.P. Morgan & Co. Incorporated .................................... 6 Consolidated statement of condition Morgan Guaranty Trust Company of New York ......................... 7 Notes to Consolidated financial statements J.P. Morgan & Co. Incorporated .................................... 8-23 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial highlights .............................................. 24 Segment results .................................................. 24-25 Financial review .................................................. 26 Capital and Risk management ....................................... 27-33 Consolidated average balances and net interest earnings .................... 34-35 Cross-border and local outstandings under the regulatory basis ............. 36 PART II -- OTHER INFORMATION Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............ 37 Item 6. EXHIBITS AND REPORTS ON FORM 8-K ............................... 38 SIGNATURES ............................................................. 39
3 PART I ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENT OF INCOME J.P. Morgan & Co. Incorporated In millions, except share data
Three months ended ----------------------------------------------------------- March 31 March 31 Increase/ December 31 Increase/ 2000 1999 (Decrease) 1999 (Decrease) ----------------------------------------------------------- NET INTEREST REVENUE Interest revenue $3,031 $ 2,757 $ 274 $ 2,717 $314 Interest expense 2,578 2,368 210 2,379 199 - ---------------------------------------------------------------------------------------------------- Net interest revenue 453 389 64 338 115 Provision for loan losses -- -- -- -- -- Reversal of provision for loan losses -- -- -- (25) 25 - ---------------------------------------------------------------------------------------------------- Net interest revenue after loan loss provisions 453 389 64 363 90 NONINTEREST REVENUES Trading revenue 950 1,134 (184) 754 196 Advisory and underwriting fees 543 390 153 385 158 Investment management fees 276 246 30 259 17 Fees and commissions 284 214 70 235 49 Investment securities revenue/(loss) 157 (41) 198 131 26 Other revenue 173 159 14 62 111 - ---------------------------------------------------------------------------------------------------- Total noninterest revenues 2,383 2,102 281 1,826 557 Total revenues, net 2,836 2,491 345 2,189 647 OPERATING EXPENSES Employee compensation and benefits 1,300 1,096 204 937 363 Net occupancy 82 82 -- 55 27 Technology and communications 258 247 11 240 18 Other expenses 215 142 73 185 30 - ---------------------------------------------------------------------------------------------------- Total operating expenses 1,855 1,567 288 1,417 438 Income before income taxes 981 924 57 772 209 Income taxes 353 324 29 263 90 - ---------------------------------------------------------------------------------------------------- Net income 628 600 28 509 119 PER COMMON SHARE Net income: Basic $ 3.62 $ 3.24 $0.38 $ 2.83 $0.79 Diluted 3.37 3.01 0.36 2.63 0.74 Dividends declared 1.00 0.99 0.01 1.00 -- - ----------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 4 CONSOLIDATED BALANCE SHEET J.P. Morgan & Co. Incorporated
March 31 December 31 In millions, except share data 2000 1999 - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 1,901 $ 2,463 Interest-earning deposits with banks 5,198 2,345 Debt investment securities available-for-sale 8,600 14,286 Equity investment securities 1,938 1,734 Trading account assets: U.S. and foreign governments 59,646 42,663 Corporate debt and equity and other securities 32,227 31,271 Derivative receivables 47,194 43,658 - ------------------------------------------------------------------------------------------------------------------------------------ Total trading account assets 139,067 117,592 Securities purchased under agreements to resell ($42,491 at March 2000 and $34,470 at December 1999) and federal funds sold 42,916 35,970 Securities borrowed 33,690 34,716 Loans, net of allowance for loan losses of $290 at March 2000 and $281 at December 1999 26,870 26,568 Accrued interest and accounts receivable 6,979 10,119 Premises and equipment, net of accumulated depreciation of $1,325 at March 2000 and $1,319 at December 1999 2,005 1,997 Other assets 15,398 13,108 - ------------------------------------------------------------------------------------------------------------------------------------ Total assets 284,562 260,898 - ------------------------------------------------------------------------------------------------------------------------------------ LIABILITIES Deposits (including interest-bearing deposits of $45,715 at March 2000 and $43,922 at December 1999) 47,334 45,319 Trading account liabilities: U.S. and foreign governments 25,146 19,378 Corporate debt and equity and other securities 18,514 16,063 Derivative payables 46,235 44,976 - ------------------------------------------------------------------------------------------------------------------------------------ Total trading account liabilities 89,895 80,417 Securities sold under agreements to repurchase ($73,811 at March 2000 and $58,950 at December 1999) and federal funds purchased 74,641 59,693 Commercial paper 8,734 11,854 Other liabilities for borrowed money 10,140 10,258 Accounts payable and accrued expenses 9,977 10,621 Long-term debt not qualifying as risk-based capital 20,126 19,048 Other liabilities, including allowance for credit losses of $126 at March 2000 and $125 at December 1999 5,883 5,897 - ------------------------------------------------------------------------------------------------------------------------------------ 266,730 243,107 Liabilities qualifying as risk-based capital: Long-term debt 5,059 5,202 Company-obligated mandatorily redeemable preferred securities of subsidiaries 1,150 1,150 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 272,939 249,459 STOCKHOLDERS' EQUITY Preferred stock (authorized shares: 10,000,000) Adjustable rate cumulative preferred stock, $100 par value (issued and outstanding: 2,444,300) 244 244 Variable cumulative preferred stock, $1,000 par value (issued and outstanding: 250,000) 250 250 Fixed cumulative preferred stock, $500 par value (issued and outstanding: 400,000) 200 200 Common stock, $2.50 par value (authorized shares: 500,000,000; issued: 200,998,455 at March 2000 and December 1999) 502 502 Capital surplus 1,247 1,249 Common stock issuable under stock award plans 1,951 2,002 Retained earnings 11,354 10,908 Accumulated other comprehensive income: Net unrealized gains on investment securities, net of taxes 119 44 Foreign currency translation, net of taxes (16) (18) - ------------------------------------------------------------------------------------------------------------------------------------ 15,851 15,381 Less: treasury stock (38,495,608 shares at March 2000 and 36,200,897 shares at December 1999) at cost 4,228 3,942 - ------------------------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 11,623 11,439 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity 284,562 260,898 - ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 5 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY J.P. Morgan & Co. Incorporated
2000 1999 ------------------------ ----------------------- Compre- Compre- Stockholders' hensive Stockholders' hensive In millions: Three months ended March 31 Equity Income Equity Income - ------------------------------------------------------------------------------------------------------------------------------------ PREFERRED STOCK Adjustable-rate cumulative preferred stock balance, January 1 and March 31 $ 244 $ 244 Variable cumulative preferred stock balance, January 1 and March 31 250 250 Fixed cumulative preferred stock, January 1 and March 31 200 200 - ------------------------------------------------------------------------------------------------------------------------------------ Total preferred stock, March 31 694 694 - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCK Balance, January 1 and March 31 502 502 - ------------------------------------------------------------------------------------------------------------------------------------ CAPITAL SURPLUS Balance, January 1 1,249 1,252 Shares issued or distributed under dividend reinvestment plan, various employee benefit plans, and income tax benefits associated with stock options (2) (3) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, March 31 1,247 1,249 - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCK ISSUABLE UNDER STOCK AWARD PLANS Balance, January 1 2,002 1,460 Deferred stock awards, net (51) (21) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, March 31 1,951 1,439 - ------------------------------------------------------------------------------------------------------------------------------------ RETAINED EARNINGS Balance, January 1 10,908 9,614 Net income 628 $ 628 600 $ 600 Dividends declared on preferred stock (9) (9) Dividends declared on common stock (163) (175) Dividend equivalents on common stock issuable (10) (8) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, March 31 11,354 10,022 - ------------------------------------------------------------------------------------------------------------------------------------ ACCUMULATED OTHER COMPREHENSIVE INCOME Net unrealized gains on investment securities: Balance, net of taxes, January 1 44 147 ------ ------ Net unrealized gains/(losses) arising during the period, before taxes ($109 in 2000 and ($149) in 1999, net of taxes) 176 (247) Reclassification adjustment for net (gains)/losses included in net income, before taxes ($35 in 2000 and ($15) in 1999, net of taxes) (55) 26 ------ ------ Change in net unrealized gains/(losses) on investment securities, before taxes 121 (221) Income tax (expense)/benefit (46) 84 ------ ------ Change in net unrealized gains/(losses) on investment securities, net of taxes 75 75 (137) (137) Balance, net of taxes, March 31 119 10 ------ ------ Foreign currency translation: Balance, net of taxes, January 1 (18) (46) ------ ------ Translation adjustment arising during the period, before taxes -- -- Income tax benefit/(expense) 2 (1) ------ ------ Translation adjustment arising during the period, net of taxes 2 2 (1) (1) ------ ------ Balance, net of taxes, March 31 (16) (47) - ------------------------------------------------------------------------------------------------------------------------------------ Total accumulated other comprehensive income, net of taxes, March 31 103 (37) - ------------------------------------------------------------------------------------------------------------------------------------ LESS: TREASURY STOCK Balance, January 1 3,942 2,362 Purchases 601 109 Shares issued/distributed, primarily related to various employee benefit plans (315) (232) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, March 31 4,228 2,239 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY 11,623 11,630 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL COMPREHENSIVE INCOME 705 462 - ------------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 6 CONSOLIDATED STATEMENT OF CASH FLOWS J.P. Morgan & Co. Incorporated
- --------------------------------------------------------------------------------------------------------- In millions Three months ended - --------------------------------------------------------------------------------------------------------- March 31 March 31 2000 1999 - --------------------------------------------------------------------------------------------------------- NET INCOME $ 628 $ 600 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 608 452 Net (increase)/decrease in assets: Trading account assets (21,531) (6,045) Securities purchased under agreements to resell (8,029) 3,340 Securities borrowed 1,026 (8,458) Loans held for sale 176 1,090 Accrued interest and accounts receivable 3,138 1,464 Net increase/(decrease) in liabilities: Trading account liabilities 9,434 5,817 Securities sold under agreements to repurchase 14,853 (1,063) Accounts payable and accrued expenses (861) (2,041) Other changes in operating assets and liabilities, net (188) (1,191) Net investment securities losses/(gains), excluding SBICs, included in cash flows from investing activities (58) 18 - --------------------------------------------------------------------------------------------------------- CASH (USED IN) OPERATING ACTIVITIES (804) (6,017) - --------------------------------------------------------------------------------------------------------- Net (increase) decrease in interest-earning deposits with banks (2,857) 181 Debt investment securities: Proceeds from sales 6,040 13,202 Proceeds from maturities, calls, and mandatory redemptions 865 2,762 Purchases (1,155) (12,175) Net decrease (increase) in federal funds sold 1,075 (1,055) Net (increase) in loans (497) (1,879) Payments for premises and equipment (53) (97) Other changes, net (1,415) 204 - --------------------------------------------------------------------------------------------------------- CASH PROVIDED BY INVESTING ACTIVITIES 2,003 1,143 - --------------------------------------------------------------------------------------------------------- Net increase (decrease) in noninterest-bearing deposits 223 (408) Net increase in interest-bearing deposits 1,762 2,131 Net increase (decrease) in federal funds purchased 87 (410) Net (decrease) increase in commercial paper (3,120) 2,896 Other liabilities for borrowed money proceeds 2,201 2,377 Other liabilities for borrowed money payments (3,136) (3,910) Long-term debt proceeds 1,621 3,119 Long-term debt payments (520) (2,194) Capital stock issued or distributed 30 44 Capital stock purchased (601) (109) Dividends paid (176) (182) Other changes, net (128) 1,782 - --------------------------------------------------------------------------------------------------------- CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,757) 5,136 - --------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and due from banks (4) (15) - --------------------------------------------------------------------------------------------------------- (DECREASE) INCREASE IN CASH AND DUE FROM BANKS (562) 247 Cash and due from banks at December 31, 1999 and 1998 2,463 1,203 - --------------------------------------------------------------------------------------------------------- Cash and due from banks at March 31, 2000 and 1999 1,901 1,450 - --------------------------------------------------------------------------------------------------------- Cash disbursements made for: Interest $ 2,860 $ 2,348 Income taxes 193 190 - ---------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 7 CONSOLIDATED STATEMENT OF CONDITION Morgan Guaranty Trust Company of New York
- ----------------------------------------------------------------------------------------------------------------------- March 31 December 31 In millions, except share data 2000 1999 - ----------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,769 $ 2,382 Interest-earning deposits with banks 5,094 2,266 Debt investment securities available-for-sale 2,503 4,992 Trading account assets 97,091 84,786 Securities purchased under agreements to resell and federal funds sold 18,803 19,094 Securities borrowed 10,188 9,700 Loans, net of allowance for loan losses of $289 at March 2000 and $280 at December 1999 25,126 26,072 Accrued interest and accounts receivable 5,728 4,426 Premises and equipment, net of accumulated depreciation of $1,125 at March 2000 and $1,113 at December 1999 1,785 1,810 Other assets 14,885 12,138 - ----------------------------------------------------------------------------------------------------------------------- Total assets 182,972 167,666 - ----------------------------------------------------------------------------------------------------------------------- LIABILITIES Noninterest-bearing deposits: In offices in the U.S. 912 907 In offices outside the U.S. 721 501 Interest-bearing deposits: In offices in the U.S. 3,010 4,256 In offices outside the U.S. 44,476 42,052 - ----------------------------------------------------------------------------------------------------------------------- Total deposits 49,119 47,716 Trading account liabilities 79,141 72,066 Securities sold under agreements to repurchase and federal funds purchased 18,198 13,610 Other liabilities for borrowed money 7,214 5,482 Accounts payable and accrued expenses 6,787 6,310 Long-term debt not qualifying as risk-based capital (includes $954 at March 2000 and $727 at December 1999 of notes payable to J.P. Morgan) 6,050 6,224 Other liabilities, including allowance for credit losses of $126 at March 2000 and $125 at December 1999 2,913 2,719 - ----------------------------------------------------------------------------------------------------------------------- 169,422 154,127 Long-term debt qualifying as risk-based capital (includes $2,853 at March 2000 and December 1999 of notes payable to J.P. Morgan) 2,891 2,944 - ----------------------------------------------------------------------------------------------------------------------- Total liabilities 172,313 157,071 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 7,069 6,975 Accumulated other comprehensive income: Net unrealized gains on investment securities, net of taxes 35 67 Foreign currency translation, net of taxes (15) (17) - ----------------------------------------------------------------------------------------------------------------------- Total stockholder's equity 10,659 10,595 - ----------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholder's equity 182,972 167,666 - -----------------------------------------------------------------------------------------------------------------------
Member of the Federal Reserve System and the Federal Deposit Insurance Corporation. See notes to consolidated financial statements. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES J.P. Morgan & Co. Incorporated (J.P. Morgan) is the holding company for a group of subsidiaries that provide a range of financial services. We serve a broad client base that includes corporations, governments, institutions, and individuals. We also enter into transactions for our own account. J.P. Morgan and its subsidiaries use accounting and reporting policies and practices that conform with U.S. generally accepted accounting principles. Basis of presentation Our consolidated financial statements include the accounts of J.P. Morgan and of subsidiaries in which we have more than 50% ownership. All material intercompany accounts and transactions are eliminated during consolidation. For companies in which we have significant influence over operating and financing decisions (generally defined as owning a voting or economic interest of 20% to 50%), we use the equity method of accounting. These investments are included in Other assets, and our share of income or loss is included in Other revenue, with the exception of such investments held in our Equity Investments segment, where our share of income or loss is recorded in Investment securities revenue. Assets that we hold in an agency or fiduciary capacity are not assets of J.P. Morgan. They are therefore not included in our "Consolidated balance sheet." The financial information as of and for the periods ended March 31, 2000 and 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, 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. Accounting developments Accounting for derivative instruments and hedging activities In June 1998 the FASB issued SFAS No. 133, which 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 affects earnings. If the change in fair value or cash flows of a derivative designated as a hedge is not effectively offset, as defined, by the change in value or cash flows of the item it is hedging, this difference will be immediately recognized in earnings. Based on our current hedging strategies, the activities that would be most affected by the new standard would be those of our Proprietary Investing and Trading segment, which uses derivatives to hedge its investment portfolio, deposits, and issuance of debt, as well as those in our Credit Portfolio segment, which uses credit derivatives to hedge credit risk, and to a lesser extent, other derivatives to hedge interest rate risk. Pursuant to SFAS No. 137, we are required to adopt SFAS No. 133 effective January 1, 2001. At the time these financial statements were issued, the FASB was preparing to issue an amendment to SFAS No. 133. A final amendment is not expected to be issued until June 2000. As such, we cannot estimate the impact of SFAS No. 133 on our earnings and financial position until the final rules are available. 9 2. FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying value and fair value of J.P. Morgan's financial instruments as of March 31, 2000 and December 31, 1999 in accordance with SFAS No. 107. Accordingly, certain amounts which are not considered financial instruments, including premises and equipment as well as investments under the equity method of accounting, are excluded from the table. Refer to note 1, "Summary of significant accounting policies," of our 1999 Annual report for detailed information on how we estimate the fair value of financial instruments.
March 31, December 31, 2000 1999 ---------------------------------- ------------------------------------- Carrying Fair Appreciation / Carrying Fair Appreciation / In billions value value (Depreciation) value value (Depreciation) - ------------------------------------------------------------------------------------------------------------------------------------ FAIR VALUE THROUGH EARNINGS Financial assets: Trading account assets: Cash securities $91.9 $91.9 $ -- $73.9 $73.9 $ -- Derivative receivables 47.2 47.2 -- 43.7 43.7 -- Equity investments - SBICs 0.7 0.7 -- 0.6 0.6 -- Financial liabilities: Trading account liabilities: Cash securities 43.7 43.7 -- 35.4 35.4 -- Derivative payables 46.2 46.2 -- 45.0 45.0 -- FAIR VALUE THROUGH EQUITY Financial assets: Debt investment securities 8.6 8.6 -- 14.3 14.3 -- Equity investments - marketable securities 0.6 0.6 -- 0.6 0.6 -- CARRIED AT COST (APPROXIMATES FAIR VALUE) Financial assets: Securities purchased under agreements to resell and federal funds sold 42.9 42.9 -- 36.0 36.0 -- Securities borrowed 33.7 33.7 -- 34.7 34.7 -- Loans, net 8.4 8.4 -- 8.2 8.2 -- Other financial assets, including cash and due from banks, accrued interest and accounts receivable, and other assets 15.2 15.2 -- 17.8 17.8 -- Financial liabilities: Noninterest-bearing deposits 1.6 1.6 -- 1.4 1.4 -- Securities sold under agreements to repurchase and federal funds purchased 74.6 74.6 -- 59.7 59.7 -- Other financial liabilities, including securities lent, accounts payable and other liabilities 18.7 18.7 -- 18.7 18.7 -- CARRIED AT COST Financial assets: Interest-earnings deposits with banks 5.2 5.2 -- 2.3 2.3 -- Loans, net 18.5 18.6 0.1 18.3 18.4 0.1 Related derivatives -- -- -- -- 0.1 0.1 Equity investments - nonmarketable securities 0.7 0.8 0.1 0.5 0.6 0.1 Other financial assets 7.6 7.6 -- 6.4 6.4 -- Financial liabilities: Interest-bearing deposits 45.7 45.9 (0.2) 43.9 44.2 (0.3) Related derivatives -- (0.2) 0.2 -- (0.1) 0.1 Commercial paper 8.7 8.7 -- 11.9 11.9 -- Other liabilities for borrowed money 6.9 6.9 -- 7.2 7.2 -- Long-term debt 25.2 25.0 0.2 24.3 24.1 0.2 Related derivatives -- 0.3 (0.3) -- 0.3 (0.3) Other financial liabilities -- -- -- 0.7 0.7 -- Allowance - lending commitments 0.1 -- 0.1 0.1 -- 0.1 Company-obligated mandatorily redeemable preferred securities of subsidiaries 1.2 1.1 0.1 1.2 1.1 0.1 Related derivatives -- 0.1 (0.1) -- 0.1 (0.1) Lending commitments -- (0.2) (0.2) -- (0.2) (0.2) - ------------------------------------------------------------------------------------------------------------------------------------ Net depreciation before considering income taxes -- (0.1) - ------------------------------------------------------------------------------------------------------------------------------------
10 3. SEGMENTS Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in assessing performance. In accordance with SFAS No. 131, we have presented results based on the segments 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 defined by the products and services it provides globally to our clients or the activities it undertakes 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 comprises the following separately managed investments: a proprietary emerging markets portfolio, a credit investment securities portfolio, and our investment in Long-Term Capital Management, L.P. - the first two of these have been discontinued and our remaining investment in Long-Term Capital Management, L.P. was substantially repaid in the quarter. The assessment of segment performance by senior management includes a review for each segment of pretax economic value added, pretax income, revenues, and expenses, as well as related trends among these items. We define economic value added (EVA) as operating income, adjusted to reflect certain segments on a total return basis, less preferred stock dividends and a charge for the cost of equity capital. At the business level, EVA is currently evaluated on a pretax basis, while at the firm level EVA is assessed after the impact of taxes. To arrive at the charge for equity capital for each segment, we multiply its allocated required economic capital by its market-based cost of equity (or hurdle rate), with the exception of our Credit Portfolio segment whose cost of equity is based on market pricing for credit risk. The cost of equity for each business activity is separately determined from observable market returns of publicly held investments. To arrive at the charge for equity capital for J.P. Morgan consolidated, we multiply the firm's equity by its market-based cost of equity, which is currently estimated at 10.5%. Our management reporting system and policies were used to determine income (revenues minus expenses) attributable to each segment. Earnings on stockholders' equity were allocated based on management's estimate of the economic capital of each segment. Overhead, which represents costs associated with various support functions that exist for the benefit of the firm as a whole, is allocated to each segment based on that segment's expenses. Transactions between segments are recorded within segment results as if conducted with a third party and are 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 1999 Annual report, except for management reporting policies related to the tax-equivalent adjustment and reporting certain segments on a total return basis. For purposes of comparability, segment results include an adjustment to gross-up tax-exempt revenue to a taxable basis; this adjustment is eliminated in consolidation. In addition, in arriving at pretax EVA an adjustment is made to record certain segments on a total return basis; the Proprietary Investing and Trading segment is the only segment significantly affected by this adjustment (see footnote d to the segment results table below.) Our economic capital allocation model estimates the amount of equity required by each business activity and the firm as a whole. Business economic capital is estimated as if each activity were conducted as a standalone operating entity. This estimate is based, to the extent possible, on observations of the capital structures and risk profiles of public companies or benchmarks. In particular, for our markets and asset management activities, required economic capital is based on the revenue volatility and fixed expenses of public U.S. investment banks and asset management companies, respectively; for Credit Portfolio, capital is based on a simulation of unexpected credit losses; and, for Equity Investments, capital is equal to the carrying value of the portfolio. Diversification of Morgan's portfolio of businesses is reflected as a reduction to the consolidated level of required equity and is a factor in assessing the appropriate level of capitalization of the firm. The benefit of diversification is not allocated to the segments. The following table presents segment results for the three months ended March 31, 2000 and 1999, respectively. 11
Interest Rate Asset Invest- and Foreign Manage- ment Exchange Credit Credit ment In millions Banking Equities Markets Markets Portfolio Services - -------------------------------------------------------------------------------------------------------- MARCH 31, 2000 Net interest revenues $ 3 $ 45 $ 140 $ 56 $ 99(b) $ 40 - -------------------------------------------------------------------------------------------------------- Trading revenue 63 301 247 193 74 17 Advisory and underwriting fees 300 95 12 114 8 15 Investment management fees 2 -- -- -- -- 275 Fees and commissions (8) 173 43 7 20 33 Investment securities revenue -- -- -- 12 -- -- Other revenue 4 22 47 5 (2) 27 - -------------------------------------------------------------------------------------------------------- Total noninterest revenues 361 591 349 331 100 367 - -------------------------------------------------------------------------------------------------------- Total revenues 364 636 489 387 199 407 - -------------------------------------------------------------------------------------------------------- Total operating expenses 294 347 334 253 38 303 - -------------------------------------------------------------------------------------------------------- Total pretax income 70 289 155 134 161 104 - -------------------------------------------------------------------------------------------------------- Pretax EVA 52 243 32 65 97 83 - -------------------------------------------------------------------------------------------------------- Total assets at period end (in billions) -- 28 103 26 59 11 - -------------------------------------------------------------------------------------------------------- Avg. required economic capital 486 821 1,732 1,249 2,516 576 - -------------------------------------------------------------------------------------------------------- MARCH 31, 1999 Net interest revenues 1 16 79 106 103(b) 26 - -------------------------------------------------------------------------------------------------------- Trading revenue 39 113 490 471 18 7 Advisory and underwriting fees 219 37 10 118 -- 6 Investment management fees -- -- -- -- -- 240 Fees and commissions (1) 107 42 -- 35 22 Investment securities revenue -- -- 2 2 -- -- Other revenue -- 14 26 7 1 8 - -------------------------------------------------------------------------------------------------------- Total noninterest revenues 257 271 570 598 54 283 - -------------------------------------------------------------------------------------------------------- Total revenues 258 287 649 704(a) 157 309 - -------------------------------------------------------------------------------------------------------- Total operating expenses 210 230 359 258 45 257 - -------------------------------------------------------------------------------------------------------- Total pretax income 48 57 290 446 112 52 - -------------------------------------------------------------------------------------------------------- Pretax EVA 34 23 185 389 (22) 35 - -------------------------------------------------------------------------------------------------------- Total assets at period end (in billions) -- 25 84 23 67 8 - -------------------------------------------------------------------------------------------------------- Avg. required economic capital 358 601 2,098 1,119 3,666 545 - --------------------------------------------------------------------------------------------------------
Proprietary Equity Investing Invest- and Consol- In millions ments Trading Corporate idated - ------------------------------------------------------------------------------------------ MARCH 31, 2000 Net interest revenues $ (5) $ 48(c) $ 27 $ 453 - ------------------------------------------------------------------------------------------ Trading revenue (8) 49 14 950 Advisory and underwriting fees (1) -- -- 543 Investment management fees 2 -- (3) 276 Fees and commissions 2 1 13 284 Investment securities revenue 161 (19) 3 157 Other revenue 2 109 (41) 173 - ------------------------------------------------------------------------------------------ Total noninterest revenues 158 140 (14) 2,383 - ------------------------------------------------------------------------------------------ Total revenues 153 188(d) 13 2,836 - ------------------------------------------------------------------------------------------ Total operating expenses 45 56 185 1,855 - ------------------------------------------------------------------------------------------ Total pretax income 108 132 (172)(e) 981 - ------------------------------------------------------------------------------------------ Pretax EVA 78 150 (240)(f) 560 - ------------------------------------------------------------------------------------------ Total assets at period end (in billions) 2 41 15 285 - ------------------------------------------------------------------------------------------ Avg. required economic capital 1,882 496 (1,244)(g) 8,514 - ------------------------------------------------------------------------------------------ MARCH 31, 1999 Net interest revenues (4) 84(c) (22) 389 - ------------------------------------------------------------------------------------------ Trading revenue 1 3 (8) 1,134 Advisory and underwriting fees -- -- -- 390 Investment management fees 7 -- (1) 246 Fees and commissions -- 1 8 214 Investment securities revenue (17) (37) 9 (41) Other revenue (1) 76 28 159 - ------------------------------------------------------------------------------------------ Total noninterest revenues (10) 43 36 2,102 - ------------------------------------------------------------------------------------------ Total revenues (14) 127(d) 14 2,491 - ------------------------------------------------------------------------------------------ Total operating expenses 14 32 162 1,567 - ------------------------------------------------------------------------------------------ Total pretax income (28) 95 (148)(e) 924 - ------------------------------------------------------------------------------------------ Pretax EVA (59) (93) (46)(f) 446 - ------------------------------------------------------------------------------------------ Total assets at period end (in billions) 1 48 13 269 - ------------------------------------------------------------------------------------------ Avg. required economic capital 1,278 3,595 (1,592)(g) 11,668 - ------------------------------------------------------------------------------------------
(a) Revenues related to the structuring of tax-advantaged loans and structured credit products for Credit Portfolio was $18 million for the three months ended March 31, 1999. (b) The adjustment to gross up Credit Portfolio's revenue to a taxable basis was $8 million and $6 million for the three months ended March 31, 2000 and 1999, respectively. These amounts are eliminated in consolidation. (c) The adjustment to gross up Proprietary Investing and Trading's tax-exempt revenues to a taxable basis was $75 million and $36 million for the three months ended March 31, 2000 and 1999, respectively. (d) Total return revenues, which combine reported revenues and the change in net unrealized appreciation/depreciation, were $235 million and $91 million for the three months ended March 31, 2000 and 1999, respectively. (e) We classify the revenues and expenses of Corporate into three broad categories: - Corporate research and development initiatives that involve strategic investments in new client segments or services, but are managed separately from existing business lines. Expenses related to this area totaled $48 million for the three months ended March 31, 2000. - Other corporate revenues and expenses that are recurring but unallocated to the business segments, including but not limited to: the results of hedging anticipated net foreign currency revenues and expenses across all business segments; corporate-owned life insurance; certain equity earnings in affiliates; and consolidation and management reporting offsets to certain revenues and expenses recorded in the business segments. Excluding consolidation and management reporting offsets, recurring revenues were $22 million and $23 million for the three months ended March 31, 2000 and 1999, respectively. Consolidating and management reporting offsets - which comprises offsets to certain amounts recorded in the segments, including the allocation of earnings on equity out of Corporate into the segments, adjustments to bring segments to a tax-equivalent basis, and other management accounting adjustments - were ($87) million and ($70) million for the three months ended March 31, 2000 and 1999, respectively. - Nonrecurring items not allocated to segments - including gains on the sale of businesses, revenues and expenses associated with businesses that have been sold or are in the process of being discontinued, including revenues and expenses related to Euroclear activities, special charges, and other one-time corporate items. Nonrecurring revenues were $3 million and ($6) million for the three months ended March 31, 2000 and 1999, respectively. Corporate includes revenues, expenses and pretax income related to Euroclear activities for the three months ended March 31, 2000 and 1999, respectively, as follows: revenues - $76 million and $65 million; expenses - $9 million and $9 million; and pretax income - $67 million and $56 million. (f) Pretax EVA for Corporate includes the cost of equity adjustment related to the following items, among others: assets and investments not allocated to the segments [note (g)1], the diversification effect, and excess/shortfall capital. (g) The following table provides a reconciliation of average common equity to required capital for the three months ended March 31, 2000 and 1999, respectively.
- ------------------------------------------------------------------------------- In millions March 31, 2000 March 31, 1999 - ------------------------------------------------------------------------------- Average common equity $10,631 $10,756 Trust preferred securities 1,150 1,150 Fixed and adjustable preferred stock 444 444 Other adjustments (49) (164) - ------------------------------------------------------------------------------- Total available capital 12,176 12,186 - ------------------------------------------------------------------------------- Total required capital of business segments 9,758 13,260 Corporate (1) 1,292 1,477 Diversification (2,536) (3,069) - ------------------------------------------------------------------------------- Total required capital 8,514 11,668 - ------------------------------------------------------------------------------- Excess available capital 3,662 518 - -------------------------------------------------------------------------------
(1) Includes capital related to goodwill, Euroclear, retirement plans and other corporate assets. 12 4. BUSINESS CHANGES AND DEVELOPMENTS Euroclear Effective January 1, 2000, J.P. Morgan and the Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe Cooperative executed a definitive agreement to create a new, market-owned European bank to operate all aspects of the Euroclear system. This agreement anticipates the formation of a bank, based in Brussels and to be known as Euroclear Bank, to succeed J.P. Morgan as operator and banker for the Euroclear System. J.P. Morgan will remain as operator and banker of Euroclear until the successor bank is established and is ready to take over the operations from J.P. Morgan, a process that is expected to take from 12 to 18 months from January 1, 2000. The management and staff of Euroclear, comprising 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 definitive agreement, J.P. Morgan will continue to receive pretax banking income for three years from January 1, 2000, 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 thereafter by the new bank. After the new bank becomes operational, it will also pay J.P. Morgan for certain assets and know-how transferred to it. Until the new bank becomes operational, J.P. Morgan will continue to record pretax banking income over the period during which it is 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 part of the three-year 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 banking income due to J.P. Morgan under the agreement will be received as earned. Following the changeover, 50% of all banking income due to J.P. Morgan will be paid as earned and the remaining 50% will be paid in monthly installments over the period starting the next succeeding year and ending December 31, 2005. The successor bank will have the option of prepaying its obligation for the remaining portion of the three-year contract 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. Pre-tax income from Euroclear-related activities reported by J.P. Morgan was $67 million for the first three months of 2000, $216 million for the full year 1999, and $261 million for 1998. 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. 13
First quarter ----------------------------- In millions 2000 1999 - -------------------------------------------------------------------------------- INTEREST REVENUE Deposits with banks $78 $ 81 Debt investment securities (a) 219 459 Trading account assets 1,101 861 Securities purchased under agreements to Resell and federal funds sold 517 426 Securities borrowed 513 448 Loans 461 430 Other sources 142 52 - -------------------------------------------------------------------------------- Total interest revenue 3,031 2,757 - -------------------------------------------------------------------------------- INTEREST EXPENSE Deposits 542 616 Trading account liabilities 394 274 Securities sold under agreements to Repurchase and federal funds purchased 808 743 Other borrowed money 453 355 Long-term debt 381 380 - -------------------------------------------------------------------------------- Total interest expense 2,578 2,368 - -------------------------------------------------------------------------------- Net interest revenue 453 389 - --------------------------------------------------------------------------------
(a) Interest revenue from debt investment securities included taxable revenue of $197 million and $429 million and revenue exempt from U.S. income taxes of $22 million and $30 million for the three months ended March 31, 2000 and 1999, respectively. Net interest (expense) revenue associated with derivatives used for purposes other-than-trading was approximately ($6) million for the three months ended March 31, 2000, compared with approximately $26 million for the three months ended March 31, 1999. As of March 31, 2000, approximately $42 million of net deferred gains on closed derivative contracts used for purposes other-than-trading were recorded on the "Consolidated balance sheet." These amounts primarily relate to closed hedge contracts included in the amortized cost of the debt investment portfolio as of March 31, 2000. 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 on closed derivative contracts as of March 31, 2000, are expected to amortize into Net interest revenue as follows: $1 million - remainder of 2000; $1 million in 2001; $4 million in 2002; $4 million in 2003; $5 million in 2004; and approximately $27 million thereafter. 6. TRADING REVENUE The following table presents trading revenue by principal product grouping for the three months ended March 31, 2000 and 1999.
First quarter -------------------- In millions 2000 1999 - -------------------------------------------------------------------------------- Fixed income $ 552 $ 561 Equities 363 160 Foreign exchange 35 413 - -------------------------------------------------------------------------------- Total trading revenue 950 1,134 Trading-related net interest revenue 200 215 - -------------------------------------------------------------------------------- Combined total 1,150 1,349 - --------------------------------------------------------------------------------
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, forward, and option contracts, and in 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, forward, and option contracts, and in swaps. 14 7. ADVISORY AND UNDERWRITING FEES
First quarter ------------------ In millions 2000 1999 - ----------------------------------------------------------------------------- Advisory fees $236 $173 Underwriting revenue and syndication fees 307 217 - ----------------------------------------------------------------------------- Total 543 390 - -----------------------------------------------------------------------------
Advisory fees include revenues earned from advising clients on such corporate strategies as mergers and acquisitions, privatizations, and changes in capital structures. Underwriting revenue includes fees from both debt and equity underwriting. Syndication fees include revenue earned from the arrangement and syndication of credit facilities. 8. INVESTMENT SECURITIES REVENUE
First quarter ----------------- In millions 2000 1999 - ------------------------------------------------------------------------------------------ DEBT INVESTMENT SECURITIES Gross realized gains from sales of securities $ 70 $ 34 Gross realized losses from sales of securities (87) (60) - ------------------------------------------------------------------------------------------ Net debt investment securities (loss) (17) (26) - ------------------------------------------------------------------------------------------ EQUITY INVESTMENT SECURITIES Gross realized gains from marketable available-for-sale securities 72 - Gross realized gains from nonmarketable securities 3 8 Net appreciation in SBIC securities 103 10 Write-downs for other-than-temporary impairments in value (12) (38) Dividend and other income 8 5 - ------------------------------------------------------------------------------------------ Net equity investment securities revenue (loss) 174 (15) - ------------------------------------------------------------------------------------------ Total investment securities revenue (loss) 157 (41) - ------------------------------------------------------------------------------------------
9. OTHER REVENUE AND OTHER EXPENSES Other revenue
First quarter ------------------ In millions 2000 1999 - --------------------------------------------------------------------------------------------------- Foreign currency hedging gains (a) $65 $93 Equity earnings in certain affiliates, including related goodwill amortization 22 46 Provision for credit losses (1) -- Other 87 20 - --------------------------------------------------------------------------------------------------- Total other revenue 173 159 - ---------------------------------------------------------------------------------------------------
(a) Includes gains and losses on hedges of anticipated foreign currency revenues and expenses. These gains and losses are partially offset by the impact of exchange rate movements on reported revenues and expenses over the year. Other expenses
First quarter ------------------ In millions 2000 1999 - ---------------------------------------------------------------------------- Professional services $ 43 $ 28 Marketing and business development 70 40 Other outside services 58 39 Other 44 35 - ---------------------------------------------------------------------------- Total other expenses 215 142 - ----------------------------------------------------------------------------
10. 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 resulting in annual amortization expense of approximately $32 million. As of March 31, 2000 and 1999, goodwill totaled $723 million and $751 million, 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. 15 11. INVESTMENT SECURITIES DEBT INVESTMENT SECURITIES 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 as of March 31, 2000. The gross unrealized gains or losses on each debt investment security include the effects of any related hedge. See note 13 for additional detail of gross unrealized gains and losses associated with open derivative contracts used to hedge debt investment securities.
Gross Gross Fair and unrealized unrealized carrying In millions: March 31, 2000 Cost gains losses value - --------------------------------------------------------------------------------------------------------------- U.S. Treasury $ 546 $ 12 $ 1 $ 557 U.S. government agency, principally mortgage-backed 6,605 30 194 6,441 U.S. state and political subdivision 1,152 134 63 1,223 U.S. corporate and bank debt 69 -- -- 69 Foreign government 187 -- -- 187 Foreign corporate and bank debt 5 -- -- 5 Other 108 10 -- 118 - --------------------------------------------------------------------------------------------------------------- Total debt investment 8,672 186 258 8,600 securities - ---------------------------------------------------------------------------------------------------------------
EQUITY INVESTMENT SECURITIES Equity investment securities are generally owned by J.P. Morgan Capital Corporation, a wholly owned nonbank subsidiary of J.P. Morgan. Many of these equity investment securities are subject to legal, regulatory, and contractual restrictions that limit our ability to dispose of them freely. The following table shows gross unrealized gains and losses, a comparison of the cost, fair value and carrying value of marketable, nonmarketable, and SBIC securities portfolios of J.P. Morgan consolidated. A substantial portion of these are included in our Equity Investments segment.
In millions: March 31, 2000 Marketable Nonmarketable SBIC securities - ----------------------------------------------------------------------------------------------------------------- Accounting (a) Fair value through equity Cost Fair value through earnings - ----------------------------------------------------------------------------------------------------------------- Cost $340 $664 $290 - ----------------------------------------------------------------------------------------------------------------- Gross unrealized gains 205 97 444 Gross unrealized losses (5) (5) -- - ----------------------------------------------------------------------------------------------------------------- Net unrealized gains 200 (b) 92 (c) 444 (d) - ----------------------------------------------------------------------------------------------------------------- Fair value 540 756 734 - ----------------------------------------------------------------------------------------------------------------- Carrying value on balance sheet 540 664 734 - -----------------------------------------------------------------------------------------------------------------
(a) See note 1, "Summary of Significant Accounting Policies," of our 1999 Annual Report. (b) Primarily relates to investments in the telecommunications and financial services industries. (c) Primarily relates to investments in the financial services and basic industries. (d) Primarily relates to investments in the telecommunications industry. 16 12. TRADING ACCOUNT ASSETS AND LIABILITIES The following table presents the fair and carrying value of trading account assets and trading account liabilities as of March 31, 2000. It also includes the average balances for the three months ended March 31, 2000.
Carrying Average value balance ------------ ------------- March 31 First quarter In millions: 2000 2000 - ------------------------------------------------------------------------------ TRADING ACCOUNT ASSETS U.S. Treasury $ 9,602 $ 6,713 U.S. government agency 19,703 15,936 Foreign government 30,341 23,132 Corporate debt and equity 24,357 22,704 Other securities 7,870 8,243 Interest rate and currency swaps 17,944 15,670 Credit derivatives 560 638 Foreign exchange contracts 2,767 2,280 Interest rate futures and forwards (11) 37 Equity and commodity contracts 5,585 6,369 Purchased option contracts 20,349 19,117 - ------------------------------------------------------------------------------ 139,067 120,839 - ------------------------------------------------------------------------------ TRADING ACCOUNT LIABILITIES U.S. Treasury 8,203 7,914 Foreign government 16,943 13,021 Corporate debt and equity 14,059 10,675 Other securities 4,455 5,292 Interest rate and currency swaps 16,233 14,874 Credit derivatives 836 617 Foreign exchange contracts 2,203 1,955 Interest rate futures and forwards 47 13 Equity and commodity contracts 4,525 4,606 Written option contracts 22,391 21,313 - ------------------------------------------------------------------------------ 89,895 80,280 - ------------------------------------------------------------------------------
Trade date receivables/payables Amounts receivable and payable for securities that have not reached their contractual settlement dates in our trading and investing activities are recorded net in the "Consolidated balance sheet." Amounts receivable for securities sold of $24.9 billion were netted against amounts payable for securities purchased of $23.5 billion. This produced a net trade date receivable of $1.4 billion, recorded in Accrued interest and accounts receivable as of March 31, 2000. 13. DERIVATIVES In general, derivatives are contracts or agreements whose values are derived from changes in interest rates, foreign exchange rates, credit spreads, 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 privately negotiated contracts. Futures and option contracts are examples of standard exchange-traded derivatives. Forward, swap, and option contracts are examples of privately negotiated derivatives. Privately negotiated 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. We use derivatives for trading or other-than-trading purposes. Other-than-trading purposes are primarily related to our investing activities. 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. Events include 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. Most of the contracts reported in the following table are forward contracts. 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. Equity and commodity contracts include swaps and futures in the equity and commodity 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 privately negotiated 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 $89.6 billion of master netting agreements in effect as of March 31, 2000.
On-balance-sheet In billions: March 31, 2000 Notional amounts credit exposure - ------------------------------------------------------------------------------------------------------------------- Interest rate and currency swaps: Trading $4,707.2 Other-than-trading (a)(b) 55.0 - ------------------------------------------------------------------------------------------------------------------- Total interest rate and currency swaps 4,762.2 $ 17.9 - ------------------------------------------------------------------------------------------------------------------- Credit derivatives: Trading 154.2 Other-than-trading (a) 21.6 - ------------------------------------------------------------------------------------------------------------------- Total credit derivatives 175.8 0.6 - ------------------------------------------------------------------------------------------------------------------- Foreign exchange spot, forward, and futures contracts: Trading 553.0 Other-than-trading (a) 19.4 - ------------------------------------------------------------------------------------------------------------------- Total foreign exchange spot, forward, and futures contracts 572.4 2.8 - ------------------------------------------------------------------------------------------------------------------- Interest rate futures, forward rate agreements, and debt securities forwards: Trading 944.3 Other-than-trading 13.1 - ------------------------------------------------------------------------------------------------------------------- Total interest rate futures, forward rate agreements, and debt securities forwards 957.4 -- - ------------------------------------------------------------------------------------------------------------------- Equity and commodity swaps, forward and futures contracts, all trading 110.6 5.6 - ------------------------------------------------------------------------------------------------------------------- Purchased options: (c) Trading 1,299.6 Other-than-trading (a) 3.6 - ------------------------------------------------------------------------------------------------------------------- Total purchased options 1,303.2 20.3 - ------------------------------------------------------------------------------------------------------------------- Written options, all trading (d) 1,522.0 -- - ------------------------------------------------------------------------------------------------------------------- Total on-balance-sheet credit exposure 47.2 - -------------------------------------------------------------------------------------------------------------------
(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 $25.3 billion at March 31, 2000, and were primarily denominated in the following currencies: Japanese yen $7.9 billion, Euro $6.0 billion, Canadian dollar $2.7 billion, Swiss franc $2.5 billion, British pound $2.0 billion, and Australian dollar $1.3 billion. (c) At March 31, 2000, purchased options used for trading purposes included $981.8 billion of interest rate options, $121.6 billion of foreign exchange options, and $196.2 billion of commodity and equity options. Options used for purposes other-than-trading are primarily interest rate options. Purchased options executed on an exchange amounted to $217.2 billion and those negotiated over-the-counter amounted to $1,086.0 billion at March 31, 2000. 18 (d) At March 31, 2000, written options included $1,171.2 billion of interest rate options, $150.6 billion of foreign exchange options, and $200.2 billion of commodity and equity options. Written option contracts executed on an exchange amounted to $201.1 billion and those negotiated over-the-counter amounted to $1,320.9 billion at March 31, 2000. Derivatives are used to hedge or modify the interest rate characteristics of debt investment securities, loans, deposits, other liabilities for borrowed money, long-term debt, and other financial assets and liabilities. Net unrealized losses associated with such derivatives contracts amounted to $146 million as of March 31, 2000. Gross unrealized gains and gross unrealized losses associated with open derivatives contracts used for these purposes as of March 31, 2000, are presented in the following table. Such amounts primarily relate to interest rate and currency swaps used to hedge or modify the interest rate characteristics of long-term debt; debt investment securities, principally mortgage-backed securities; deposits; and other financial instruments.
Gross Gross Net unrealized unrealized unrealized In millions: March 31, 2000 gains (losses) gains (losses) - -------------------------------------------------------------------------------- Long-term debt $ 277 $ (595) $ (318) Debt investment securities 138 (53) 85 Deposits 189 (43) 146 Other financial instruments 292 (351) (59) - -------------------------------------------------------------------------------- Total 896 (1,042) (146) - --------------------------------------------------------------------------------
14. LOANS Included in Loans are loans held for sale of approximately $3.0 billion at March 31, 2000. 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. During the first quarter of 2000, we revised the terms of a $77 million loan to a Latin American steel company under a troubled debt restructuring. At March 31, 2000, this loan was considered performing. 15. OTHER CREDIT-RELATED PRODUCTS Lending commitments include commitments to extend credit, standby letters of credit and guarantees. 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 total contractual amount of credit-related financial instruments does not represent the future liquidity requirements, since we expect a significant amount of commitments to expire or mature without being drawn. The credit risk associated with these instruments varies according to each client's creditworthiness and the value of any collateral held. Commitments to extend credit generally require clients to meet certain credit-related terms and conditions before drawdown. Market risk for commitments to extend credit, standby letters of credit, and guarantees, while not significant, may arise as availability of and access to credit markets change. The following table summarizes the contractual amount of credit-related instruments as of March 31. In billions: March 31, 2000 - -------------------------------------------------------- Commitments to extend credit $66.8 Standby letters of credit and guarantees 16.8 - -------------------------------------------------------- Total lending commitments 83.6 - --------------------------------------------------------
We also have securities lending indemnifications associated with our Euroclear-related activities of $8.8 billion as of March 31, 2000. As of March 31, 2000, J.P. Morgan held cash and other collateral in full support of these securities lending indemnifications. PURCHASE OF CREDIT PROTECTION Since December 1997, we have entered into three Synthetic Collateralized Loan Obligations that has allowed us to reduce the credit risk on a portfolio of counterparties totaling approximately $20 billion in notional amount. This was accomplished using credit default swaps, whereby the credit risk is transferred into the capital markets via a special purpose entity, without us having to sell the assets or change their composition. The structures provide protection at the counterparty level, that is, protection is provided on all exposures to a referenced counterparty versus on a specific loan, commitment or derivative transaction to that counterparty. We have retained the first risk of loss equity tranche in these transactions totaling $224 million. As a result of these structures, we were able to reduce economic capital by approximately $428 million as of March 31, 2000. These structures have also allowed us to reduce our risk-adjusted assets 19 by approximately $2.8 billion as of March 31, 2000, thereby increasing our Tier I and Total risk-based capital ratios by 18 basis points (0.18%) and 26 basis points (0.26 %), respectively. In particular, these transactions have allowed us to convert the credit risk associated with $20 billion of diversified exposure on our balance sheet - as described in the following table - from various lower credit ratings to that we believe is equivalent to a AAA+ counterparty.
Counterparty rating Notional exposure - ------------------------------------------ AAA $ 669 AA 3 167 A 9 507 BBB 4 726 BB 888 B 260 CCC and below 994 - ------------------------------------------ Total 20 211 - ------------------------------------------
The notional exposures in the above table are diversified by counterparty in the following industries: banks - $2,733 million; nonbank financial institutions - $2,898 million; governments - $855 million; commercial and industrial - $5,213 million; cyclical $4,593 million; and non-cyclical - $3,919 million. 16. IMPAIRED LOANS Total impaired loans, organized by the location of the counterparty - net of charge-offs - at March 31, 2000 are presented in the following table. - --------------------------------------------------- In millions: March 31 - --------------------------------------------------- COUNTERPARTIES IN THE U.S. Commercial and industrial $ 26 Other 13 - --------------------------------------------------- 39 - --------------------------------------------------- COUNTERPARTIES OUTSIDE THE U.S. Commercial and industrial 91 Other 10 - --------------------------------------------------- 101 - --------------------------------------------------- TOTAL IMPAIRED LOANS 140 - --------------------------------------------------- Allowance for impaired loans 46 - ---------------------------------------------------
Impaired loans for which no SFAS No. 114 reserve was deemed necessary were $22 million as of March 31, 2000. As of March 31, 2000, approximately 65% of impaired loans were measured using the fair value of collateral, 30% of impaired loans were measured for impairment using observable market prices, and the remainder using the present value of future cash flows. The following table presents an analysis of the changes in impaired loans.
- ---------------------------------------------------------------------------- First Quarter In millions 2000 - ---------------------------------------------------------------------------- IMPAIRED LOANS, BEGINNING PERIOD $ 77 - ---------------------------------------------------------------------------- Additions to impaired loans 66 Less: Repayments of principal, net of additional advances (2) Impaired loans returning to accrual status - Charge-offs: Commercial and industrial - Banks - Other - Interest and other credits (1) - ---------------------------------------------------------------------------- IMPAIRED LOANS, MARCH 31 140 - ----------------------------------------------------------------------------
20 An analysis of the effect of impaired loans - net of charge-offs - on interest revenue for the three months ended March 31, 2000 is presented in the following table.
- ----------------------------------------------------------------------------- First Quarter In millions 2000 - ----------------------------------------------------------------------------- Interest revenue that would have been recorded if accruing $3 Net interest revenue recorded related to the current period - - ----------------------------------------------------------------------------- Negative impact of impaired loans on interest revenue 3 - -----------------------------------------------------------------------------
For the three months ended March 31, 2000, the average recorded investments in impaired loans was $92 million. As of March 31, 2000, loans of $20 million were over 90 days past due (principal or interest) and still accruing interest, but not considered impaired. Lending commitments to counterparties considered impaired totaled $56 million at March 31, 2000. 17. ALLOWANCES FOR CREDIT LOSSES The following table summarizes the activity of our allowance for loan losses.
- ---------------------------------------------------------------------------- First Quarter In millions 2000 - ---------------------------------------------------------------------------- BEGINNING BALANCE $281 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- Provision for loan losses in the U.S. 18 (Reversal of provision) for loan losses outside the U.S. (18) - ---------------------------------------------------------------------------- - - ---------------------------------------------------------------------------- Recoveries: Counterparties in the U.S. - Counterparties outside the U.S. 9 - ---------------------------------------------------------------------------- 9 - ---------------------------------------------------------------------------- Charge-offs: Counterparties in the U.S., primarily other financial institutions - Counterparties outside the U.S.: Commercial and industrial - Banks - Other - - ---------------------------------------------------------------------------- Net recoveries 9 - ---------------------------------------------------------------------------- ENDING BALANCE, MARCH 31 290 - ----------------------------------------------------------------------------
The following table displays our allowance for loan losses by component as of March 31, 2000. In millions - ------------------------------------------------------------- Specific counterparty components in the U.S. $ 13 Specific counterparty components outside the U.S. 33 - ------------------------------------------------------------- Total specific counterparty 46 Expected loss 244 - ------------------------------------------------------------- Total 290 - -------------------------------------------------------------
The following table summarizes the activity of our allowance for credit losses on lending commitments.
- ------------------------------------------------------------------------- First Quarter In millions 2000 - ------------------------------------------------------------------------- BEGINNING BALANCE $125 - ------------------------------------------------------------------------- - ------------------------------------------------------------------------- (Reversal of provision) for credit losses in the U.S. (5) Provision for credit losses outside the U.S. 6 - ------------------------------------------------------------------------- 1 - ------------------------------------------------------------------------- ENDING BALANCE, MARCH 31 126 - -------------------------------------------------------------------------
21 The following table displays our allowance for credit losses on lending commitments by component as of March 31, 2000. In millions - ------------------------------------------------------------- Specific counterparty components in the U.S. $ 19 Specific counterparty components outside the U.S. 4 - ------------------------------------------------------------- Total specific counterparty 23 Expected loss 103 - ------------------------------------------------------------- Total 126 - -------------------------------------------------------------
18. INCOME TAXES The effective tax rate for the three months ended March 31, 2000 and 1999 was 36% and 35%, respectively. The increase in the effective tax rate reflects higher pretax income over the prior year quarter. The income tax expense / (benefit) related to net realized gains / (losses) and write-downs for other-than-temporary impairments in value on debt and equity investment securities, excluding securities in SBICs, was approximately $16 million for the three months ended March 31, 2000, compared to ($22) million for the three months ended March 31, 1999. The applicable tax rate used to compute the income tax expense / (benefit) related to net gains / (losses) on debt and equity investment securities for the three months ended March 31, 2000 and 1999 was approximately 35% and 39%, respectively. 19. CAPITAL REQUIREMENTS J.P. Morgan, its subsidiaries, and certain foreign branches of its bank subsidiary Morgan Guaranty Trust Company of New York 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 that banks and bank holding companies meet specific guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under generally accepted 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 as of March 31, 2000. J.P. Morgan's risk-based capital ratios are calculated in accordance with the Federal Reserve Board's market risk capital guidelines. These guidelines require our risk-based capital ratios to take into account general market risk and specific issuer risk of our debt and equity trading portfolios, as well as general market risk associated with all trading and nontrading foreign exchange and commodity positions. The guidelines, however, continue to exclude the effect of SFAS No. 115. The calculation of risk-based capital ratios for J.P. Morgan, the bank holding company, includes the capital and assets of JPMSI, our U.S. broker-dealer. Capital ratios and amounts The following tables show the risk-based capital and leverage ratios and amounts for J.P. Morgan and Morgan Guaranty as of March 31, 2000.
Dollars in millions Amounts Ratios(b) - ------------------------------------------------------------- Tier 1 capital(a) J.P. Morgan $11,644 8.3% Morgan Guaranty 10,604 8.7 - ------------------------------------------------------------- Total risk-based capital(a) J.P. Morgan $16,842 12.0% Morgan Guaranty 13,914 11.4 - ------------------------------------------------------------- Leverage J.P. Morgan 4.5% Morgan Guaranty 6.4 - -------------------------------------------------------------
(a) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum tier 1 capital of $5.6 billion and $4.9 billion, respectively. For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum total risk-based capital of $11.2 billion and $9.8 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. 22 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 that determine the capital levels at which they shall be considered well capitalized. According to these guidelines, a bank holding company is considered well capitalized if it has minimum tier 1 capital, total capital, and leverage ratios of 6%, 10%, and 3%, respectively. At March 31, 2000, 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 March 31, 2000, that would change J.P. Morgan's and Morgan Guaranty's well capitalized status. 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 for which all necessary conditions for issuance have been satisfied. Diluted EPS includes the determinants of basic EPS and, in addition, takes into account dilutive potential common shares that were outstanding during the period. The following table presents the computation of basic and diluted EPS for the three months ended March 31, 2000 and 1999.
First quarter ------------------------------------ Dollars in millions, except share data 2000 1999 - --------------------------------------------------------------------------------------------- Net income $ 628 $ 600 Preferred stock dividends and other (9) (9) - --------------------------------------------------------------------------------------------- Numerator for basic and diluted earnings per share - income available to common stockholders $619 $591 - --------------------------------------------------------------------------------------------- Denominator for basic earnings per share - weighted-average shares 170,854,461 182,740,896 Effect of dilutive securities: Options (a) 3,853,844(b) 4,663,826(c) Other stock awards (d) 8,881,595 8,978,013 - --------------------------------------------------------------------------------------------- 12,735,439 13,641,839 - --------------------------------------------------------------------------------------------- Denominator for diluted earnings per share - weighted-average number of common shares and dilutive potential common shares 183,589,900 196,382,735 - --------------------------------------------------------------------------------------------- Basic earnings per share $ 3.62 $ 3.24 Diluted earnings per share 3.37 3.01 - ---------------------------------------------------------------------------------------------
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 March 31, 2000, but were not included in the computation of diluted EPS: For the three months ended March 31, 2000: 4,699,078 shares at $130.94 per share expiring July 15, 2008; 100,000 shares at $128.21 per share expiring January 20, 2009; 75,000 shares at $134.88 per share expiring December 12, 2009; 5,959,000 shares at $135.72 per share expiring July 19, 2009; 188,475 shares at $123.28 per share expiring January 18, 2010; and 100,000 shares at $145.28 per share expiring January 18, 2010. 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) Options to purchase 5,003,500 and 100,000 shares of our common stock at $130.94 and $128.21, respectively, per share were outstanding at March 31, 1999, but were not included in the computation of diluted EPS. 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. These options expire on July 15, 2008 and January 19, 2009, respectively. (d) Weighted-average incremental shares for other stock awards include restricted stock and stock bonus awards. The related tax benefits are also considered. 23 21. COMMITMENTS AND CONTINGENT LIABILITIES Excluding mortgaged properties, assets on our "Consolidated balance sheet" of approximately $123.9 billion at March 31, 2000, were pledged as collateral for borrowings, to qualify for fiduciary powers, to secure public monies as required by law, and for other purposes. At March 31, 2000 we had commitments to enter into future resale and repurchase agreements totaling $5.5 billion and $0.8 billion, respectively. 22. INTERNATIONAL OPERATIONS For financial reporting purposes, we divide our operations into domestic and international components. As these operations are highly integrated, estimates and subjective assumptions have been made to apportion revenue and expense between domestic and international components. In 1999, we changed our estimates and assumptions to be consistent with the allocations used for our business segments as reported in note 3. Prior period amounts have been restated to reflect this allocation methodology. Revenues and expenses - - Client-focused revenues are allocated between the regions responsible for managing the client relationship and the regions responsible for product execution and risk management - - Revenues from proprietary investing and trading activities and equity investments are allocated based on the location of the risk taker - - Expenses are allocated based on the estimated cost associated with servicing each region's client base. Corporate revenues and expenses are allocated primarily to the region in which they are recorded. Certain centrally managed expenses are allocated based on the underlying activity. The results for the three months ended March 31, 2000 and 1999 were distributed among domestic and international operations, as presented in the following table.
- ------------------------------------------------------------------------------------------- Income Pretax tax Net Total Total income/ expense/ income/ In millions revenues(a) expenses (loss) (benefit) (loss) - ------------------------------------------------------------------------------------------- FIRST QUARTER 2000 Europe (b) $ 997 $ 518 $ 479 $ 194 $ 285 Asia-Pacific 209 153 56 23 33 Latin America (c) 112 55 57 23 34 - ------------------------------------------------------------------------------------------- Total international operations 1,318 726 592 240 352 Domestic operations (d) 1,518 1,129 389 113 276 - ------------------------------------------------------------------------------------------- Total 2,836(e) 1,855 981 353 628 - ------------------------------------------------------------------------------------------- FIRST QUARTER 1999 Europe (b) 940 492 448 181 267 Asia-Pacific 181 148 33 14 19 Latin America (c) 443 92 351 142 209 - ------------------------------------------------------------------------------------------- Total international operations 1,564 732 832 337 495 Domestic operations (d) 927 835 92 (13) 105 - ------------------------------------------------------------------------------------------- Total 2,491 1,567 924 324 600 - -------------------------------------------------------------------------------------------
(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. Total revenues and expenses relate substantially to United States operations. (e) Includes March, 2000 provision for credit losses of $1 million, which was recorded in Europe. 24 PART I ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL HIGHLIGHTS J.P. Morgan reported record quarterly net income of $628 million for the first quarter of 2000, up from $600 million in the first quarter of 1999. Earnings per share were $3.37, an increase of 12% from $3.01 a year ago. Return on common equity was 23% in the quarter, compared with 22% in the first quarter of 1999. OTHER HIGHLIGHTS FOR THE FIRST QUARTER: - - Economic value added (EVA) rose 26% to $358 million from a year ago - - Revenues of $2.836 billion were up 14% from a very strong first quarter in 1999 - - Strong momentum in Equities, Investment Banking, and Asset Management Services fueled top-line growth - - Expenses increased 18% because of higher performance-driven compensation accruals and investment in the expansion of key client activities - - The efficiency ratio (expenses divided by revenues) was 65%, within our target range ACCELERATION OF FIRMWIDE E-FINANCE INITIATIVES During the quarter we significantly accelerated efforts to launch digital, commercial applications of Morgan capabilities and technologies, frequently partnering with firms that are leaders in their industries. To that end, we established LabMorgan, a new e-finance unit that aims to be a destination of choice for entrepreneurs and a hub for innovation within the firm. These initiatives have important benefits: They provide our clients and us with improved service and extend our client reach by capturing scale and drawing on the resources of partner companies. They also unlock equity value from leading-edge technologies that we have developed to support existing business activities. Major initiatives in the quarter included: - Launch of Morgan OnLine, comprehensive, integrated wealth management advice and services delivered to affluent individuals via the Internet - Participation in Sony Net Bank, a new consumer e-banking venture in Japan that will utilize J.P. Morgan's on-line private banking expertise - Formation of Arcordia, an Internet-based derivative operations and settlement company - Participation in Securities.Hub, an e-commerce company that will host a series of on-line portals linking securities firms and dealers with institutional investors worldwide - Formation of Market Axess, a multi-dealer fixed income transaction platform providing on-line access to research, new-issue, and secondary markets - Creation of Cygnifi, an independent, Internet-based derivatives services company delivering market, credit, and collateral risk management expertise Since the beginning of April we have announced three additional initiatives: - Formation of TransactPlus, an independent firm that allows companies to identify, validate, and connect with each other in a 24x7, secure, globally available environment - Creation of SwapsWire, a network and protocol for on-line trading and negotiation of interest rate derivative transactions - Creation of Gold Avenue, an independent company that will be the first to offer a comprehensive range of products and services to the gold market over the Internet. SEGMENT RESULTS Total revenues were $2.836 billion in the first quarter of 2000, up 14% from the same period a year ago. 25 Investment Banking revenues rose 41% to $364 million in the first quarter. The increase was fueled by robust advisory results and record revenues from equity underwriting and derivatives. Revenues from European clients and the technology and biotechnology sectors were particularly strong. For the first quarter, Thompson Financial Securities Data Corporation ranked J.P. Morgan fifth worldwide in completed mergers and acquisitions, with a market share of 18%. This includes strong gains in the United States, where we ranked third with a similar market share. Equities revenues increased more than twofold to $636 million over the prior year. Equity derivative revenues were sharply higher, reflecting increased client demand and significant trading gains. Results from equity underwriting more than doubled as we maintained our top-three lead manager ranking for transactions larger than $500 million and gained share overall. We ranked fifth among lead underwriters of U.S. transactions with a market share of 8.9%, compared with seventh and a market share of 5.6% for all of 1999. Brokerage commission revenues also increased sharply as a result of higher volumes and market share gains, particularly in Europe. Interest Rate and Foreign Exchange Markets revenues declined 25% to $489 million from the first quarter of 1999, primarily due to lower trading results and client activity in interest rate derivatives. Less investor demand for yield-enhancing transactions in the rising interest rate environment globally, combined with a shift in interest toward equities, depressed client flows. Government securities revenues were strong in the quarter, although down from a year ago when results in Asia were exceptional. Foreign exchange activities were in line with last year's quarter. Credit Markets revenues were $387 million in the first quarter. This compares with revenues of $704 million a year ago, which included significant gains on hedges of our economic exposures to Brazil. This quarter saw continued momentum in structured finance and benefited from improved emerging market conditions in both underwriting and trading. Credit Portfolio revenues increased 27% to $199 million while overall risk in our credit portfolio was flat compared with the fourth quarter and significantly down from the first quarter of 1999. The increase in revenues reflected higher mark-to-market values of credit derivatives used as economic hedges of our exposures. It also resulted from an increase in the value of our derivatives portfolio brought about by narrower credit spreads. Income associated with our traditional loan portfolio rose as the proportion of higher-yielding assets increased. The allowances for credit losses totaled $416 million at March 31, 2000, consistent with year-end levels. Impaired loans rose from $77 million to $140 million, which was primarily accounted for by a single industrial counterparty in Europe. Reflecting overall risk levels in the portfolio, average economic capital for the segment was $2.5 billion in both the first quarter of 2000 and the fourth quarter of 1999, down approximately 30% from $3.7 billion in last year's first quarter. Asset Management Services revenues increased 32% to $407 million compared with a year ago. The increase included significant growth in revenues in our private banking activities. It also included a rise in investment management fees, reflecting asset growth and a shift in asset mix towards higher-fee alternative investment disciplines. Assets under management increased 17% from a year ago to approximately $370 billion at March 31, 2000. Earnings from our equity investment in American Century also rose. Equity Investments reported revenues of $153 million in the first quarter, primarily reflecting gains in investments in the telecommunications industry. Gains of $68 million were realized through sales, with the remainder due to appreciation in fair value. Deal flow was strong as we invested approximately $120 million, two-thirds of which was committed to the rapidly expanding technology and e-commerce sectors. Equity investments recorded a loss of $14 million in the first quarter of 1999, primarily reflecting write-downs of Brazilian investments. Proprietary Investing and Trading revenues were $188 million in the quarter, up from $127 million a year ago. Total return - reported revenues and the change in net unrealized value - was $235 million in the quarter compared with $91 million a year ago. The increases were achieved on significantly lower market risk levels. Reported revenues and total return in the first quarter of 2000 reflected strong results across our U.S. portfolios. This compares with the year-ago period, which reflected very strong results in our European portfolio and losses in our investment securities and Asian portfolios. Average economic capital for the segment declined from $3.6 billion last year to $0.5 billion in this quarter. Corporate revenues were $13 million in the first quarter, essentially unchanged from the 1999 period. They included $76 million and $65 million of revenues from activities related to Euroclear in this year's and last year's quarter, respectively. 26 FINANCIAL REVIEW REVENUES Revenues were $2.836 billion in the first quarter of 2000, up 14% from the 1999 period. Net interest revenue in the first quarter of 2000 was $453 million compared to $389 million in the year ago quarter. This increase primarily reflected higher net interest revenue from our interest rate markets activities and increased equities securities borrowing, partially offset by a decrease in higher yielding positions in local markets in Latin America. Total trading revenue was $950 million in the first quarter of 2000. This compares with revenue of $1,134 million a year ago, which included significant gains on positions in Brazil taken in association with hedging our economic exposures. This quarter reflected strong results in equity derivatives and trading for our own account, partially offset by lower results in the interest rate markets. Advisory and underwriting fees grew 39% to $543 million in the first quarter of 2000 from $390 million in the first quarter of 1999. Advisory fees grew 36% to $236 million, reflecting robust activity, particularly with European clients. For the first three months of 2000, Thompson Financial Securities Data Company, Inc. ranked J.P. Morgan fifth in completed mergers and acquisitions worldwide, with a market share of 18%. Underwriting revenue and syndication fees rose 41% to $307 million driven by record revenues from equity underwriting. Investment management fees increased 12% to $276 million in the 2000 first quarter from a year ago, reflecting asset growth and a shift in asset mix towards higher-fee alternative investment disciplines. Assets under management were $370 billion at March 31, 2000, compared with $315 billion a year ago. Fees and commissions were $284 million, up 33% from $214 million in the year-ago quarter. The increase reflects higher equities brokerage commissions related to higher volumes and market share gains, particularly in Europe. Investment securities revenue was $157 million in the first quarter of 2000. This reflects gains of $178 million from equity investments primarily in the telecommunications industry of which $80 million were realized through sales, with the remainder due to appreciation in fair value. These gains were offset by write-downs of $12 million primarily related to equity investments in the consumer/retail industry and net losses of $17 million on the sale of debt investment securities. The current quarter results compares with negative (loss) investment securities revenue of $41 million in the first quarter of 1999. The loss reflected write-downs of $38 million primarily on Brazilian equity investments, and net losses of $26 million on the sale of debt investment securities. These losses were partially offset by gains of $10 million related to our equity investments portfolio. Other revenue was $173 million in the first quarter of 2000, compared with $159 million a year earlier. OPERATING EXPENSES Operating expenses were $1.855 billion in the first quarter, an increase of 18% from the year-ago quarter. The rise reflected higher performance-driven compensation as well as investments to expand capacity in our investment banking and equity businesses. We also invested in corporate e-commerce initiatives, particularly Morgan OnLine and LabMorgan. The firm's efficiency ratio was 65% in the first quarter of 2000, consistent with the full year of 1999 and our corporate target. At March 31, 2000, staff totaled 15,622 employees, compared with 15,512 at December 31, 1999 and 15,100 employees at March 31, 1999. Income-tax expense in the first quarter totaled $353 million, based on an effective tax rate of 36%, compared with $324 million in the year-earlier quarter. The increase in expense reflects higher pretax income. 27 CAPITAL AND RISK MANAGEMENT We seek to increase shareholder value through a firmwide discipline that links capital allocation, risk management, performance measurement, investment decisions, and incentive compensation into one integrated framework. This framework buttresses our day-to-day operations at all levels of the firm and employs consistent economic value added (EVA) and capital allocation methodologies. EVA integrates traditional operating earnings with capital and risk management by subtracting from income a charge for the equity used in support of our business. Please refer to our 1999 Annual report filed on Form 10-K for a detailed discussion of capital and risk management. CAPITAL Our economic capital allocation model estimates the amount of equity required by each business activity and the firm as a whole. Business economic capital is estimated as if each activity were conducted as a standalone entity. This estimate is based, to the extent possible, on observations of the capital structures and risk profiles of public companies or benchmarks. Diversification of Morgan's portfolio of businesses lowers the consolidated level of required equity and is a factor in assessing the appropriate level of capitalization of the firm. The benefit of diversification is not allocated to the businesses. The related cost of equity for each business activity is based on observable market returns of publicly held investments, with the exception of our Credit Portfolio segment, whose cost of equity is based on market pricing for credit risk. To arrive at the charge for equity capital for each segment, we multiply its allocated required economic capital by its market-based cost of equity (or hurdle rate). To arrive at the consolidated charge for equity capital for J.P. Morgan, we multiply the firm's common equity by its market-based cost of equity, which currently is estimated at 10.5%. Required versus available capital J.P. Morgan's total required economic capital is compared with available capital to evaluate overall capital utilization. It is our policy to maintain an appropriate excess of capital to provide for growth and as additional protection against losses. The following table compares average required versus available capital for the periods ended March 31, 2000 and December 31, 1999, respectively.
Three months Twelve months ended ended December 31, Average (billions) March 31, 2000 1999 - ----------------------------------------------------------------------------- Common stockholder's equity $10.6 $11.0 Preferred stock, excluding variable 0.4 0.4 Trust preferred securities 1.2 1.2 Other adjustments - (0.1) - ----------------------------------------------------------------------------- Total available capital 12.2 12.5 - ----------------------------------------------------------------------------- Required economic capital: Credit Portfolio 2.5 3.0 Equity Investments 1.9 1.5 Interest Rate Markets and FX 1.7 2.0 Credit Markets 1.2 1.1 Equities 0.8 0.7 Asset Management Services 0.6 0.6 Proprietary Investing and Trading 0.5 1.8 Investment Banking 0.5 0.4 - ----------------------------------------------------------------------------- Total business segments 9.7 11.1 Corporate 1.3 1.5 Diversification (2.5) (2.7) - ----------------------------------------------------------------------------- Total required economic capital 8.5 9.9 - ----------------------------------------------------------------------------- Excess available capital 3.7 2.6 - -----------------------------------------------------------------------------
It is our policy to maintain an appropriate excess of capital to provide for growth and as additional protection against losses. Excess available capital averaged $3.7 billion in the quarter compared with $2.6 billion for the 1999 full year, primarily reflecting lower economic capital requirements in our Proprietary Investing and Trading and Credit Portfolio segments as we continued to reduce risk. This decrease was partially offset by higher average economic capital requirements of our Equity Investments segment reflecting net new investments and appreciation. 28 RISK MANAGEMENT Risk is inherent in our business, and sound risk management is key to our success. The major types of risks to which we are exposed are market, credit, liquidity, and operating risk. We have developed and implemented comprehensive policies and procedures to identify, mitigate, and monitor risk across the firm. DAILY EARNINGS AT RISK Our tool for the systematic measuring and monitoring of market and credit risk is the daily earnings at risk (DEaR) calculation. DEaR for each business is a key input to our EVA calculation and capital allocation. DEaR is a statistical measure used to estimate the firm's exposure in non-stressed markets to market risk and credit risk in our trading derivatives portfolio. DEaR is an upperband estimate of the potential loss in the value of our portfolios, at a 95% confidence level, over a one-day time horizon. The firm's DEaR measure is based on a model that uses historical simulations. It 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. STRESS TESTING We regularly supplement our DEaR calculations with stress testing at both the firmwide and business-specific levels. Stress testing measures the impact of abnormal movements on the firm's portfolios. Some of the stress test assumptions are very specific to businesses' specialized risks, while others are conducted in conformity with firmwide stress scenarios that are distributed by our Corporate Risk Management group. This provides senior management with an analysis of the potential impact on the firm's revenue. VULNERABILITY IDENTIFICATION In 1999 we introduced vulnerability identification (VID) as a discipline to highlight material risks which may or may not be captured by measures such as DEaR. The discipline systemically captures potential "worst-case" losses identified by traders and other risk takers. Once identified, these losses - or VIDs - may be quantified through specific stress tests and assist senior management in focusing on specific risks. MARKET RISK PROFILES DeaR - --------------------------------------------------------------------------------
Trading Investing Aggregate ------------------------ ----------------------- ------------------------ March 31 December 31 March 31 December 31 March 31 December 31 In millions 2000 1999 2000 1999 2000 1999 - --------------------------------------------- ------------------------ ------------------------- Period end $27(a) $29(a) $ 7 $ 9 $32 $26 - --------------------------------------------- ------------------------ ------------------------- 12 month average 24(b) 29(b) 18 26 $33(b) $42(b) - --------------------------------------------- ------------------------ -------------------------
(a) This reflects, before diversification benefits, market risk DEaR of $24 million at March 31, 2000 ($26 million at December 31, 1999), and derivatives credit risk DEaR of $13 million at March 31, 2000 ($12 million at December 31, 1999). (b) The averages for the twelve month periods ended March 31, 2000 and December 31, 1999 do not include derivative credit risk DEaR because we only began to incorporate derivative credit risk into our DEaR measurement as of June 30, 1999. 29 CREDIT EXPOSURES The following section provides detailed information regarding the firm's significant credit exposures. Credit exposure and related economic capital - --------------------------------------------------------------------------------
Mar. 31, 2000 Dec. 31, 1999 Economic capital -------------------- ---------------------- -------------------- Carrying Fair Carrying Fair Mar. 31 Dec. 31 IN BILLIONS value Value value value 2000 1999 - ---------------------------------------------------- ---------------------- -------------------- Derivatives $47.2(a) $47.2 $43.7(a) $43.7 $1.0 $0.9 Loans and lending commitments 26.8(b) 26.8 26.4(b) 26.5 2.1 1.8 - ---------------------------------------------------- ---------------------- -------------------- Total credit exposures(c) 74.0 74.0 70.1 70.2 3.1 2.7 - ---------------------------------------------------- ---------------------- --------------------
(a) Carried at fair value on the balance sheet with changes in fair value recorded in the income statement. Includes credit valuation adjustment as of March 31, 2000 and December 31, 1999 of $667 million and $670 million, respectively. (b) Amount net of allowances for credit losses of $416 million as of March 31, 2000 and $406 million as of December 31, 1999. Carrying value excludes the notional value of lending commitments, which are off-balance-sheet instruments. (c) Substantially all credit risk related to derivatives, loans, and lending commitment exposures are managed by the Credit Portfolio segment. Economic capital includes the impact of purchased credit protection and other credit risk hedges. Credit exposure before and after collateral - --------------------------------------------------------------------------------
Mar. 31, 2000 Dec. 31, 1999 ---------------------------- ---------------------------- Net exposure Net exposure Gross after Gross after IN BILLIONS exposure collateral(b) exposure collateral(b) - ----------------------------------------------------------- -------------------------- Derivatives $47.2(a) $42.2(a) $43.7(a) $37.7(a) Loans 27.2 20.0 26.8 18.9 Lending commitments(c) 83.6 82.5 83.1 82.3 - ------------------------------------------------------------------------------------------
(a) Includes the benefit of master netting agreements of $89.6 billion and $94.0 billion as of March 31, 2000 and December 31, 1999, respectively. (b) Collateral held consisting of highly rated liquid securities (U.S. government securities) and cash was as follows: derivatives - $5 billion (March 2000) and $6 billion (December 1999); loans - $7.2 billion (March 2000) and $7.9 billion (December 1999); and lending commitments - $1.1 billion (March 2000) and $0.8 billion (December 1999). (c) Before allowance for credit losses. TRADITIONAL CREDIT PRODUCTS The majority of credit risk from traditional credit products relates to exposures managed by our Credit Portfolio segment. Exposures not managed by this segment, primarily associated with our private banking activities, are largely secured. The maximum credit risk for our traditional credit products is measured by their contractual amounts, net of collateral. For example, the risk of a loan is the amount of money lent to the client. For lending commitments, the risk is the amount that would be owed should the contract be drawn upon, the client default, and the collateral becomes worthless. A significant number of our commitments expire, however, without being drawn upon. Moreover, commitments usually include financial covenants and/or material adverse change clauses that, if triggered, enable us to withdraw from the obligation to lend. IMPAIRED LOANS The following table presents impaired loans, net of charge-offs, as of March 31, 2000 and December 31, 1999. Impaired loans - ----------------------------------------------------------
March 31, December 31, In millions 2000 1999 - ------------------------------------------- ------------ Commercial and industrial $117 $54 Other 23 23 - ---------------------------------------------------------- Total impaired loans 140 77 - ----------------------------------------------------------
Impaired loans were $140 million as of March 31, 2000, compared with $77 million as of December 31, 1999. The increase in commercial and industrial loans was primarily due to the addition of one European counterparty. 30 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 can be reasonably estimated. We determine the appropriateness of our allowances on a quarterly basis. This review is performed separately for each allowance classification - loans and lending commitments. The actual amount of credit losses or charge-offs, when they occur, may vary from estimated losses at each period end, due to changing economic conditions or exposure management decisions. Our process includes procedures to limit differences between estimated and actual credit losses, which include detailed quarterly assessments by senior management and model inputs that reflect current market indicators of credit quality. The following table summarizes the activity of our allowances for credit losses for the three months ended March 31, 2000 and 1999, respectively.
=============================================================================-========================================== ALLOWANCE FOR CREDIT LOSSES ON ALLOWANCE FOR LOAN LOSSES LENDING COMMITMENTS - ------------------------------------------------------------------------------------------------------------------------ First First First First Quarter Quarter Quarter Quarter In millions 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------------------------------------ Balance, January 1 $ 281 $ 470 $ 125 $ 125 - ------------------------------------------------------------------------------------------------------------------------ Provision for credit losses -- -- 1 -- Reversal of provision for credit losses -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------ Recoveries 9 5 -- -- Charge-offs: Commercial and industrial -- (3) -- -- Banks -- -- -- -- Other, primarily financial institutions in 1999 -- (25) -- -- - ------------------------------------------------------------------------------------------------------------------------ Net recoveries/(charge-offs) 9 (23) -- -- - ------------------------------------------------------------------------------------------------------------------------ Balance, March 31 290 447 126 125 =============================================================================-==========================================
The following table summarizes the period-end information of our allowances for credit losses as of March 31, 2000 and December 31, 1999, respectively.
=============================================================================-============ ALLOWANCE FOR CREDIT LOSSES ON ALLOWANCE FOR LOAN LOSSES LENDING COMMITMENTS - ------------------------------------------------------------------------------------------ March 31 December 31 March 31 December 31 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------ Components: Specific counterparty $ 46 $ 24 $ 23 $ 22 Expected loss 244 257 103 103 - ------------------------------------------------------------------------------------------ Total allowance 290 281 126 125 =============================================================================-============
The allowance for loan losses increased to $290 million at March 31, 2000 from $281 million at December 31, 1999. The specific counterparty component of the allowance for loan losses was $46 million and $24 million at March 31, 2000 and December 31, 1999, respectively. The increase in the specific counterparty component from the prior quarter primarily reflects a new allocation to an industrial counterparty in Europe. The expected loss component of the allowance for loan losses decreased 5% to $244 million as of March 31, 2000, primarily reflecting improved market spreads globally which are used as a current indicator of credit quality. The allowance for credit losses on lending commitments was $126 million essentially unchanged from December 31, 1999. 31 CAPITAL STOCKHOLDERS' EQUITY At March 31, 2000, stockholders' equity of $11.6 billion included $119 million of net unrealized appreciation on investment securities, net of the related tax liability of $58 million. This compares with $44 million of net unrealized appreciation at December 31, 1999, net of the related tax liability of $12 million. The net unrealized depreciation on debt investment securities was $72 million at March 31, 2000 compared with a net unrealized depreciation of $129 million at December 31, 1999. The decrease primarily related to the realization of losses on sales of investment securities during the quarter. The net unrealized appreciation on marketable equity investment securities was $200 million at March 31, 2000, and $169 million at December 31, 1999. The net unrealized appreciation on investment securities held by unconsolidated affiliates was $49 million and $16 million, respectively. Included in the table below are selected ratios based upon stockholders' equity.
March 31, December 31, March 31, Dollars in billions, except share data 2000 1999 1999 - ------------------------------------------------------------------------------------------ Total stockholders' equity $11.6 $11.4 $11.6 Rate of return on average common stockholders' equity 23.4% 18.1% 22.3% As percent of period-end total assets: Common equity 3.8% 4.1% 4.1% Total equity 4.1% 4.4% 4.3% Book value per common share $59.82 $57.83 $56.66 - ------------------------------------------------ -----------------------------------------
During the first quarter of 2000, the firm purchased approximately $600 million of its common stock or 5.2 million shares under its October 1999 authorization to repurchase up to $3 billion of common stock. As of March 31, 2000, $2 billion of this authorization had been utilized; we intend to use the remaining $1 billion over the next nine to 12 months, subject to market conditions, business considerations, and other factors. REGULATORY CAPITAL REQUIREMENTS At March 31, 2000, 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 March 31, 2000. At March 31, 2000, 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 8.3% and 12.0%, respectively; the leverage ratio was 4.5%. At December 31, 1999, J.P. Morgan's tier 1 and total risk-based capital ratios were 8.8% and 12.9%, respectively, and the leverage ratio was 4.7%. Refer to note 19, Capital Requirements, for further information. Risk-adjusted assets represent the total of all on- and off-balance sheet exposures adjusted for risk-based factors as prescribed by the Federal Reserve Board. J.P. Morgan's risk-adjusted assets as of March 31, 2000 were $140.1 billion, compared with $131.4 billion at December 31, 1999. 32 EXPOSURES TO EMERGING COUNTRIES The following tables present exposures to certain emerging markets based on management's view of total exposure as of March 31, 2000. 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 =============================================================================-============================================== Credit Total In billions Deriva- Other out- deriva- Commit- cross- Local Total March 2000 Loans tives standings tives ments border exposure exposure - ---------------------------------------------------------------------------------------------------------------------------- China $ - $ 0.1 $ 0.1 ($0.2) $ - $ - $ - $ - Hong Kong 0.1 0.2 0.1 (0.1) 0.1 0.4 0.1 0.5 Indonesia 0.1 - 0.1 - - 0.2 - 0.2 Malaysia - - 0.2 - - 0.2 - 0.2 Philippines - - 0.2 - - 0.2 - 0.2 Singapore - 0.5 0.1 - - 0.6 0.1 0.7 South Korea 0.2 0.2 1.0 (0.3) - 1.1 0.7 1.8 Taiwan - - 0.1 - - 0.1 - 0.1 Thailand - 0.2 0.1 - - 0.3 - 0.3 Other - - - - - - 0.1 0.1 - ---------------------------------------------------------------------------------------------------------------------------- Total Asia, excluding Japan 0.4 1.2 2.0 (0.6) 0.1 3.1 1.0 4.1 - ---------------------------------------------------------------------------------------------------------------------------- Argentina 0.1 0.2 1.2 (0.3) - 1.2 0.3 1.5 Brazil 0.1 - 0.1 0.1 - 0.3 1.0 1.3 Chile 0.4 - 0.1 (0.1) - 0.4 - 0.4 Colombia 0.2 - 0.1 - - 0.3 - 0.3 Mexico 0.4 0.1 0.5 (0.4) - 0.6 1.4 2.0 Other 0.2 - 0.3 (0.1) - 0.4 - 0.4 - ---------------------------------------------------------------------------------------------------------------------------- Total Latin America, excluding the Caribbean 1.4 0.3 2.3 (0.8) - 3.2 2.7 5.9 - ----------------------------------------------------------------------------------------------------------------------------
33 FORWARD-LOOKING STATEMENTS J.P. Morgan and its subsidiaries operate in an intensely competitive industry. We compete globally with investment banks, commercial banks, and a wide range of nonbank financial institutions. Our non-U.S. competitors may have advantages in their home markets. We have also seen new competitors such as insurance companies and Internet companies compete with us for clients, market share, and people. We anticipate further competitive pressures from industry consolidation, which we expect to accelerate in the wake of the November 1999 passage of the Gramm-Leach-Bliley Act. In addition to a competitive marketplace, we also operate in an unpredictable global market environment. Our results are directly affected by factors outside our control, including general economic and market conditions; volatility of market prices, rates, and indices; and legislative and regulatory developments. They are also dependent on our ability to attract and retain skilled individuals and our ability to develop and support technology and information systems that are critical to our operations. Consequently, our results may vary significantly from period to period, and we may not be able to achieve our strategic objectives. Certain sections of our Form 10-Q contain forward-looking statements. We use words such as expect, believe, anticipate, and estimate to identify these statements. In particular, disclosures made in the sections "Financial Highlights" and "Financial Review," contain forward-looking statements. Such statements are based on our current expectations and are subject to the risks and uncertainties discussed above, which could cause actual results to differ materially from those currently anticipated. 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. 34 CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated
Dollars in millions, Three months ended Interest and average rates ------------------------------------------------------------------------ on a taxable-equivalent basis March 31, 2000 March 31, 1999 ------------------------------------------------------------------------ Average Average Average Average balance Interest rate balance Interest rate ------------------------------------------------------------------------ ASSETS Interest-earning deposits with banks, mainly in offices outside the U.S. $ 3,527 $ 78 8.89% $ 2,937 $ 81 11.18% Debt investment securities in offices in the U.S. (a): U.S. Treasury 327 7 8.61 619 13 8.52 U.S. state and political subdivision 1,206 40 13.34 1,653 47 11.53 Other 9,356 170 7.31 29,056 387 5.40 Debt investment securities in offices outside the U.S. (a) 1,795 18 4.03 2,504 31 5.02 Trading account assets: In offices in the U.S. 36,204 643 7.14 29,704 393 5.37 In offices outside the U.S. 26,501 458 6.95 28,649 469 6.64 Securities purchased under agreements to resell: In offices in the U.S. 27,742 381 5.52 22,016 265 4.88 In offices outside the U.S. 12,003 136 4.56 13,240 161 4.93 Securities borrowed, mainly in offices in the U.S. 34,891 513 5.91 36,948 448 4.92 Loans: In offices in the U.S. 15,387 295 7.71 5,766 104 7.31 In offices outside the U.S. 11,267 167 5.96 21,747 327 6.10 Other interest-earning assets (b): In offices in the U.S. 4,465 85 * 1,430 20 * In offices outside the U.S. 890 57 * 974 32 * - ----------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 185,561 3,048 6.61 197,243 2,778 5.71 Cash and due from banks 615 2,156 Other noninterest-earning assets 74,282 70,764 - ----------------------------------------------------------------------------------------------------------------------------- Total assets 260,458 270,163 - -----------------------------------------------------------------------------------------------------------------------------
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 March 31, 2000 and 1999. (a) For the three months ended March 31, 2000 and 1999, 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 35 CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated
Dollars in millions, Three months ended Interest and average rates ----------------------------------------------------------------- on a taxable-equivalent basis March 31, 2000 March 31, 1999 ----------------------------------------------------------------- Average Average Average Average balance Interest rate balance Interest rate ----------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits: In offices in the U.S. $ 3,530 $ 59 6.72% $ 9,018 $ 110 4.95% In offices outside the U.S. 40,037 483 4.85 47,617 506 4.31 Trading account liabilities: In offices in the U.S. 11,884 214 7.24 6,650 113 6.89 In offices outside the U.S. 12,322 180 5.88 12,840 161 5.09 Securities sold under agreements to repurchase and federal funds purchased, mainly in offices in the U.S. 62,421 808 5.21 61,171 743 4.93 Commercial paper, mainly in offices in the U.S. 11,923 177 5.97 9,661 121 5.08 Other interest-bearing liabilities: In offices in the U.S. 6,511 191 11.79 10,917 185 6.87 In offices outside the U.S. 3,396 85 10.07 3,994 49 4.98 Long-term debt, mainly in offices in the U.S. 24,280 381 6.31 28,548 380 5.40 - ------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 176,304 2,578 5.88 190,416 2,368 5.04 Noninterest-bearing deposits: In offices in the U.S. 951 882 In offices outside the U.S. 510 812 Other noninterest-bearing liabilities 71,368 66,603 - ------------------------------------------------------------------------------------------------------- Total liabilities 249,133 258,713 Stockholders' equity 11,325 11,450 - ------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity 260,458 270,163 Net yield on interest-earning assets 1.02 0.84 - ------------------------------------------------------------------------------------------------------- Net interest earnings 470 410 - -------------------------------------------------------------------------------------------------------
36 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 32 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 primarily 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 March 31, 2000.
Total out- standings Net local Total % of and In millions Govern- out- out- total Commit- commit- March 31, 2000 Banks ments Other(a) standings standings assets ments ments - ---------------------------------------------------------------------------------------------------------------- Germany $7,554 $11,345 $3,574 $- $22,473 7.90% $2,656 $25,129 Italy 3,156 9,272 1,916 - 14,344 5.04 284 14,628 Netherlands 3,671 2,715 3,777 - 10,163 3.57 1,350 11,513 United Kingdom 4,754 366 3,124 - 8,244 2.90 1,678 9,922 France 2,772 2,076 2,347 - 7,195 2.53 1,193 8,388 Japan 2,402 1,803 2,266 - 6,471 2.27 903 7,374 Switzerland 1,750 240 1,612 147 3,749 1.32 747 4,496 Spain 766 1,419 1,187 193 3,565 1.25 426 3,991 Belgium 666 1,313 757 - 2,736 0.96 813 3,549 Mexico (b) 74 1,512 848 - 2,434 0.86 100 2,534 South Africa 173 1,303 278 388 2,142 0.75 67 2,209 - ----------------------------------------------------------------------------------------------------------------
(a) Includes nonbank financial institutions and commercial and industrial entities. (b) See page 32 for exposure to this country under the management view. 37 Part II ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS SUMMARY OF J.P. MORGAN'S ANNUAL MEETING The 2000 annual meeting of stockholders of J.P. Morgan & Co. Incorporated was held on Wednesday, April 12, 2000 at the company's 60 Wall Street headquarters; 83.84% of the 164,265,059 shares of common stock outstanding and eligible to be voted was represented either in person or by proxy, constituting a quorum. Douglas A. Warner III, Chairman of the Board, presided. The stockholders took the following actions: 1. Elected all 15 nominees to one-year terms as members of the Board of Directors. The directors are:
Percent of Shares Percent of Director Shares in favor shares voting withheld shares voting - ---------------------------------------------------------------------------------------------------------- Douglas A. Warner III * 134,494,654 97.66% 3,217,110 2.34% Paul A. Allaire 134,526,682 97.69% 3,185,082 2.31% Riley P. Bechtel 134,458,657 97.64% 3,253,107 2.36% Lawrence A. Bossidy 134,559,381 97.71% 3,152,383 2.29% Martin Feldstein 134,549,711 97.70% 3,162,053 2.30% Ellen V. Futter 134,473,143 97.65% 3,238,621 2.35% Hanna H. Gray 134,444,573 97.63% 3,267,191 2.37% Walter A. Gubert ** 134,551,151 97.71% 3,160,613 2.29% James R. Houghton 134,499,462 97.67% 3,212,302 2.33% James L. Ketelsen 134,440,213 97.62% 3,271,551 2.38% John A. Krol 134,496,854 97.67% 3,214,910 2.33% Michael E. Patterson ** 134,538,498 97.70% 3,173,266 2.30% Lee R. Raymond 134,472,441 97.65% 3,239,323 2.35% Lloyd D. Ward 134,542,696 97.70% 3,169,068 2.30% Douglas C. Yearley 134,516,708 97.68% 3,195,056 2.32%
* Chairman of the Board ** Vice Chairman of the Board 2. Approved the appointment of PricewaterhouseCoopers LLP as independent accountants to perform auditing functions during 2000. There were 136,071,592 shares in favor, or 98.81% of shares voting; 293,937 shares against, or 0.21% of shares voting; 1,346,235 shares abstained; and no shares reflecting broker nonvotes. 3. Defeated the stockholder proposal relating to director share ownership. There were 95,006,156 shares against, or 84.27% of shares voting; 12,726,869 shares for, or 11.29% of shares voting; 5,013,953 shares abstained; and 24,964,786 shares reflecting broker nonvotes. 38 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 April 6, 2000) 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 March 31, 2000: March 30, 2000 (Items 5 and 7) Reported the issuance of a press release announcing its partnership with Sony and Sakura Bank with the purpose of establishing an Internet bank in Japan. Reported the issuance of a press release announcing the launching, in partnership with EDS, of Arcordia, the world's first independent internet-based derivative management and settlement company. Arcordia will provide transaction management and settlement services via the Internet for derivative products to financial institutions and corporations worldwide. March 13, 2000 (Items 5 and 7) Reported the issuance of a press release announcing the introduction of Morgan OnLine, a new Internet service delivering the firm's trusted private client services to today's growing number of millionaire clients. Reported the issuance of a press release announcing that continued momentum in a robust business environment produced strong performance in the first two months of 2000. March 9, 2000 (Items 5 and 7) Reported the issuance of a press release announcing the introduction of LabMorgan, the firm's new e-finance unit. J.P. Morgan intends to commit up to $1 billion to electronic business initiatives in 2000, the majority of which will be invested as capital in promising ventures. January 18, 2000 (Items 5 and 7) Reported the issuance by J.P. Morgan of a press release announcing its earnings for the three and twelve month periods ended December 31, 1999. Disclosed the statement of consolidated average balances and net interest earnings for the three and twelve-month periods ended December 31, 1999. 39 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: May 15, 2000 EX-27 2 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CURRENT REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND DISCLOSURES. 1,000,000 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 1,901 5,198 42,916 139,067 8,600 0 0 27,160 290 284,562 47,334 93,515 106,905 25,185 0 694 502 10,427 284,562 461 219 2,351 3,031 542 2,578 453 0 157 1,855 981 628 0 0 628 3.62 3.37 1.02 140 20 0 0 406 0 9 416 32 37 347 INCLUDES SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND/OR FEDERAL FUNDS SOLD. INCLUDES SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED, COMMERCIAL PAPER, AND OTHER LIABILITIES FOR BORROWED MONEY. INCLUDES TRADING ACCOUNT LIABILITIES, ACCOUNTS PAYABLE AND ACCRUED EXPENSES, OTHER LIABILITIES, AND COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES. INCLUDES GAIN AND LOSSES ON DEBT AND EQUITY INVESTMENT SECURITIES, OTHER-THAN-TEMPORARY IMPAIRMENTS OR WRITE-DOWNS IN VALUE, AND RELATED DIVIDEND INCOME. INCLUDES EMPLOYEE COMPENSATION AND BENEFITS, NET OCCUPANCY, TECHNOLOGY AND COMMUNICATIONS, AND OTHER EXPENSES. 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 REPRESENTS OUR STATISTICAL ESTIMATE OF PROBABLE LOSS INHERENT IN OUR PERFORMING PORTFOLIO OF TRADITIONAL CREDIT PRODUCTS, NET OF RECOVERIES, DETERMINED IN ACCORDANCE WITH SFAS NO. 5 (OUR EXPECTED LOSS COMPONENT). THE ALLOCATED 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.
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