-----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, LV1pD7M2lBimxeGwNFaHydQjG8z2nURdgTCcJwuOstctT4rOy/eqFzoDLzVVKoRY FgR9XJDUE28trpur6r83ZQ== 0000950123-99-010280.txt : 19991117 0000950123-99-010280.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950123-99-010280 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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: 99756603 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 September 30, 1999 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 J.P. MORGAN & CO. INCORPORATED (Exact name of registrant as specified in its charter) Delaware 1-5885 13-2625764 (State or other jurisdiction of (Commission (I.R.S. Employer incorporation or organization) File Number) Identification No.) 60 Wall Street, New York, NY 10260-0060 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 483-2323 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes..X.. No..... Number of shares outstanding of each of the registrant's classes of common stock at October 31, 1999: Common Stock, $2.50 Par Value 173,144,984 Shares ================================================================================ 2 PART I -- FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS The following financial statement information as of and for the three and nine months ended September 30, 1999, is set forth within this document on the pages indicated: Page(s) Three month Consolidated statement of income J.P. Morgan & Co. Incorporated................................ 3 Nine month Consolidated statement of income J.P. Morgan & Co. Incorporated................................ 4 Consolidated balance sheet J.P. Morgan & Co. Incorporated................................ 5 Consolidated statement of changes in stockholders' equity J.P. Morgan & Co. Incorporated................................ 6 Consolidated statement of cash flows J.P. Morgan & Co. Incorporated................................ 7 Consolidated statement of condition Morgan Guaranty Trust Company of New York..................... 8 Notes to Consolidated financial statements J.P. Morgan & Co. Incorporated................................ 9-27 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial highlights.......................................... 28 Segment analysis.............................................. 29-31 Financial review.............................................. 31-38 Risk management............................................... 39-43 Consolidated average balances and net interest earnings............ 44-47 Cross-border and local outstandings under the regulatory basis..... 48 PART II -- OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 49 SIGNATURES......................................................... 50 2 3 PART I ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENT OF INCOME J.P. Morgan & Co. Incorporated In millions, except share data
Three months ended ---------------------------------------------------------------------- September 30 September 30 Increase/ June 30 Increase/ 1999 1998 (Decrease) 1999 (Decrease) ---------------------------------------------------------------------- NET INTEREST REVENUE Interest revenue $ 2,783 $ 3,249 $ (466) $ 2,713 $ 70 Interest expense 2,394 2,917 (523) 2,288 106 - ---------------------------------------------------------------------------------------------------------------------- Net interest revenue 389 332 57 425 (36) Provision for loan losses -- 25 (25) -- -- Reversal of provision for loan losses (45) -- (45) (105) 60 - ---------------------------------------------------------------------------------------------------------------------- Net interest revenue after provision / (reversal of provision) for loan losses 434 307 127 530 (96) NONINTEREST REVENUES Trading revenue 424 69 355 803 (379) Investment banking revenue 398 312 86 457 (59) Investment management revenue 270 224 46 260 10 Fees and commissions 206 182 24 191 15 Investment securities revenue/(loss) 271 136 135 (29) 300 Other (loss)/revenue (a) (18) 71 (89) (21) 3 - ---------------------------------------------------------------------------------------------------------------------- Total noninterest revenues 1,551 994 557 1,661 (110) Total revenues, net 1,985 1,301 684 2,191 (206) OPERATING EXPENSES Employee compensation and benefits 889 567 322 970 (81) Net occupancy 82 84 (2) 80 2 Technology and communications 229 293 (64) 231 (2) Other expenses 141 155 (14) 136 5 - ---------------------------------------------------------------------------------------------------------------------- Total operating expenses 1,341 1,099 242 1,417 (76) Income before income taxes 644 202 442 774 (130) Income taxes 202 46 156 270 (68) - ---------------------------------------------------------------------------------------------------------------------- Net income 442 156 286 504 (62) PER COMMON SHARE Net income Basic $ 2.39 $ 0.81 $ 1.58 $ 2.71 ($ 0.32) Diluted 2.22 0.75 1.47 2.52 (0.30) Dividends declared 0.99 0.95 0.04 0.99 -- - ----------------------------------------------------------------------------------------------------------------------
(a) Other(loss)/revenue includes a $15 million reversal of provision for credit losses for the three months ended September 30, 1999 and a $35 million provision for credit losses for the three months ended June 30, 1999, related to lending commitments. See notes to consolidated financial statements. 3 4 CONSOLIDATED STATEMENT OF INCOME J.P. Morgan & Co. Incorporated
- ------------------------------------------------------------------------------------------------- In millions, except share data Nine months ended ----------------------------------------------- September 30 September 30 Increase/ 1999 1998 (Decrease) ----------------------------------------------- NET INTEREST REVENUE Interest revenue $ 8,253 $ 9,617 $(1,364) Interest expense 7,050 8,659 (1,609) - ------------------------------------------------------------------------------------------------- Net interest revenue 1,203 958 245 Provision for loan losses -- 25 (25) Reversal of provision for loan losses (150) -- (150) - ------------------------------------------------------------------------------------------------- Net interest revenue after provision / (reversal of provision) for loan losses 1,353 933 420 NONINTEREST REVENUES Trading revenue 2,361 1,842 519 Investment banking revenue 1,245 1,020 225 Investment management revenue 776 661 115 Fees and commissions 611 569 42 Investment securities revenue 201 247 (46) Other revenue, including a $20 million net provision for credit losses in 1999 120 179 (59) - ------------------------------------------------------------------------------------------------- Total noninterest revenues 5,314 4,518 796 Total revenues, net 6,667 5,451 1,216 OPERATING EXPENSES Employee compensation and benefits 2,955 2,432 523 Net occupancy 244 313 (69) Technology and communications 707 887 (180) Other expenses 419 515 (96) - ------------------------------------------------------------------------------------------------- Total operating expenses 4,325 4,147 178 Income before income taxes 2,342 1,304 1,038 Income taxes 796 430 366 - ------------------------------------------------------------------------------------------------- Net income 1,546 874 672 PER COMMON SHARE Net income Basic $ 8.33 $ 4.65 $ 3.68 Diluted 7.76 4.28 3.48 Dividends declared 2.97 2.85 0.12 - -------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 4 5 CONSOLIDATED BALANCE SHEET J.P. Morgan & Co. Incorporated
- --------------------------------------------------------------------------------------------------------------------------------- September 30 June 30 December 31 In millions, except share data 1999 1999 1998 - --------------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,609 $ 2,094 $ 1,203 Interest-earning deposits with banks 2,145 2,058 2,371 Debt investment securities available-for-sale carried at fair value 24,115 26,702 36,232 Equity investment securities 1,528 1,264 1,169 Trading account assets (including derivative receivables of $43,010 at September 1999, $40,391 at June 1999 and $48,124 at December 1998) 106,510 114,465 113,896 Securities purchased under agreements to resell ($34,705 at September 1999, $32,739 at June 1999 and $31,056 at December 1998) and federal funds sold 36,755 33,531 31,731 Securities borrowed 35,518 39,977 30,790 Loans, net of allowance for loan losses of $301 at September 1999, $335 at June 1999 and $470 at December 1998 25,114 28,753 25,025 Accrued interest and accounts receivable 6,826 6,084 7,689 Premises and equipment, net of accumulated depreciation of $1,325 at September 1999, $1,322 at June 1999 and $1,350 at December 1998 1,995 1,893 1,881 Other assets 12,704 12,573 9,080 - --------------------------------------------------------------------------------------------------------------------------------- Total assets 254,819 269,394 261,067 - --------------------------------------------------------------------------------------------------------------------------------- LIABILITIES Noninterest-bearing deposits: In offices in the U.S. 850 1,222 1,242 In offices outside the U.S. 1,183 778 563 Interest-bearing deposits: In offices in the U.S. 3,849 6,627 7,724 In offices outside the U.S. 42,941 46,708 45,499 - --------------------------------------------------------------------------------------------------------------------------------- Total deposits 48,823 55,335 55,028 Trading account liabilities (including derivative payables of $39,355 at September 1999, $37,329 at June 1999 and $44,683 at December 1998) 72,043 70,129 70,643 Securities sold under agreements to repurchase ($60,979 at September 1999, $63,460 at June 1999 and $62,784 at December 1998) and federal funds purchased 61,779 64,554 63,368 Commercial paper 10,327 13,114 6,637 Other liabilities for borrowed money 9,447 10,974 12,515 Accounts payable and accrued expenses 10,507 10,089 9,859 Long-term debt not qualifying as risk-based capital 20,145 22,722 23,037 Other liabilities, including allowance for credit losses of $145 at September 1999, $160 at June 1999 and $125 at December 1998 3,333 4,116 2,999 - --------------------------------------------------------------------------------------------------------------------------------- 236,404 251,033 244,086 Liabilities qualifying as risk-based capital: Long-term debt 5,257 5,408 4,570 Company-obligated mandatorily redeemable preferred securities of subsidiaries 1,150 1,150 1,150 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 242,811 257,591 249,806 STOCKHOLDERS' EQUITY Preferred stock (authorized shares: 10,000,000) Adjustable rate cumulative preferred stock, $100 par value (issued and outstanding: 2,444,300) 244 244 244 Variable cumulative preferred stock, $1,000 par value (issued and outstanding: 250,000) 250 250 250 Fixed cumulative preferred stock, $500 par value (issued and outstanding: 400,000) 200 200 200 Common stock, $2.50 par value (authorized shares: 500,000,000; issued: 200,934,737 at September 1999 and June 1999, and 200,873,067 at December 1998) 502 502 502 Capital surplus 1,241 1,245 1,252 Common stock issuable under stock award plans 1,713 1,540 1,460 Retained earnings 10,586 10,334 9,614 Accumulated other comprehensive income: Net unrealized (losses) / gains on investment securities, net of taxes (108) (52) 147 Foreign currency translation, net of taxes (46) (46) (46) - --------------------------------------------------------------------------------------------------------------------------------- 14,582 14,217 13,623 Less: treasury stock (26,053,759 shares at September 1999, 24,985,131 at June 1999 and 25,866,786 shares at December 1998) at cost 2,574 2,414 2,362 - --------------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 12,008 11,803 11,261 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity 254,819 269,394 261,067 - ---------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 5 6 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY J.P. Morgan & Co. Incorporated
1999 1998 ----------------------- ----------------------- Compre- Compre- Stockholders' hensive Stockholders' hensive In millions: Nine months ended September 30 Equity Income Equity Income - ---------------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCK Adjustable-rate cumulative preferred stock balance, January 1 and September 30 $ 244 $ 244 Variable cumulative preferred stock balance, January 1 and September 30 250 250 Fixed cumulative preferred stock, January 1 and September 30 200 200 - ---------------------------------------------------------------------------------------------------------------------------------- Total preferred stock, September 30 694 694 - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCK - ---------------------------------------------------------------------------------------------------------------------------------- Balance, January 1 and September 30 502 502 - ---------------------------------------------------------------------------------------------------------------------------------- CAPITAL SURPLUS Balance, January 1 1,252 1,360 Shares issued or distributed under dividend reinvestment plan, various employee benefit plans, and conversion of debentures and income tax benefits associated with stock options (11) (87) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, September 30 1,241 1,273 - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCK ISSUABLE UNDER STOCK AWARD PLANS Balance, January 1 1,460 1,185 Deferred stock awards, net 253 261 - ---------------------------------------------------------------------------------------------------------------------------------- Balance, September 30 1,713 1,446 - ---------------------------------------------------------------------------------------------------------------------------------- RETAINED EARNINGS Balance, January 1 9,614 9,398 Net income 1,546 $ 1,546 874 $ 874 Dividends declared on preferred stock (25) (27) Dividends declared on common stock (523) (504) Dividend equivalents on common stock issuable (26) (25) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, September 30 10,586 9,716 - ---------------------------------------------------------------------------------------------------------------------------------- ACCUMULATED OTHER COMPREHENSIVE INCOME Net unrealized (losses)/gains on investment securities: Balance, net of taxes, January 1 147 432 -------- -------- Net unrealized (losses)/gains arising during the period, before taxes (($325) in 1999 and $38 in 1998, net of taxes) (550) 67 Reclassification adjustment for net losses/(gains) included in net income, before taxes ($69 in 1999 and ($166) in 1998, net of taxes) 118 (261) -------- -------- Change in net unrealized (losses)/gains on investment securities, before taxes (432) (194) Income tax benefit/(expense) 177 54 -------- -------- Change in net unrealized (losses)/gains on investment securities, net of taxes (255) (255) (140) (140) Balance, net of taxes, September 30 (108) 292 -------- -------- Foreign currency translation: Balance, net of taxes, January 1 (46) (22) -------- -------- Translation adjustment arising during the period, before taxes (7) (26) Income tax benefit 7 10 -------- -------- Translation adjustment arising during the period, net of taxes -- -- (16) (16) -------- -------- Balance, net of taxes, September 30 (46) (38) - ---------------------------------------------------------------------------------------------------------------------------------- Total accumulated other comprehensive income, net of taxes, September 30 (154) 254 - ---------------------------------------------------------------------------------------------------------------------------------- LESS: TREASURY STOCK Balance, January 1 2,362 2,145 Purchases 681 720 Shares issued/distributed, primarily related to various employee benefit plans (469) (499) - ---------------------------------------------------------------------------------------------------------------------------------- Balance, September 30 2,574 2,366 - ---------------------------------------------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 12,008 11,519 - ---------------------------------------------------------------------------------------------------------------------------------- TOTAL COMPREHENSIVE INCOME 1,291 718 - ----------------------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 6 7 CONSOLIDATED STATEMENT OF CASH FLOWS J.P. Morgan & Co. Incorporated
- ----------------------------------------------------------------------------------------------------------- In millions Nine months ended - ----------------------------------------------------------------------------------------------------------- September 30 September 30 1999 1998 - ----------------------------------------------------------------------------------------------------------- Net income $ 1,546 $ 874 Adjustments to reconcile to cash provided by operating activities: Noncash items: provisions for credit losses, depreciation, amortization, deferred income taxes, stock award plans, and write-downs on investment securities 1,218 919 Gain on sale of businesses - (113) Net (increase)/decrease in assets: Trading account assets 7,259 (16,722) Securities purchased under agreements to resell (3,668) (3,911) Securities borrowed (4,728) (9,369) Loans held for sale 1,485 (177) Accrued interest and accounts receivable 858 (1,912) Net increase/(decrease) in liabilities: Trading account liabilities 1,304 7,624 Securities sold under agreements to repurchase (1,824) 29,599 Accounts payable and accrued expenses 542 1,797 Other changes in operating assets and liabilities, net (2,569) (1,362) Net investment securities losses/(gains), excluding SBICs, included in cash flows from investing activities (31) (303) - ----------------------------------------------------------------------------------------------------------- Cash provided by operating activities 1,392 6,944 - ----------------------------------------------------------------------------------------------------------- Net decrease in interest-earning deposits with banks 222 608 Debt investment securities: Proceeds from sales 26,498 9,715 Proceeds from maturities, calls, and mandatory redemptions 6,267 6,215 Purchases (21,416) (19,072) Net (increase) in federal funds sold (1,375) - Net (increase) decrease in loans (1,508) 971 Payments for premises and equipment (227) (211) Investment in American Century Companies, Inc. - (965) Investment in Long-Term Capital Management, L.P. - (300) Other changes, net (1,821) 115 - ----------------------------------------------------------------------------------------------------------- Cash provided by (used in) investing activities 6,640 (2,924) - ----------------------------------------------------------------------------------------------------------- Net increase in noninterest-bearing deposits 227 (456) Net (decrease) in interest-bearing deposits (6,516) (3,920) Net increase (decrease) in federal funds purchased 216 (4,146) Net increase in commercial paper 3,689 5,703 Other liabilities for borrowed money proceeds 8,552 15,005 Other liabilities for borrowed money payments (11,877) (17,685) Long-term debt proceeds 5,356 12,103 Long-term debt payments (7,389) (7,374) Capital stock issued or distributed 200 199 Capital stock purchased (669) (720) Dividends paid (549) (532) Other changes, net 1,087 (560) - ----------------------------------------------------------------------------------------------------------- Cash (used in) financing activities (7,673) (2,383) - ----------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and due from banks 47 10 - ----------------------------------------------------------------------------------------------------------- Increase in cash and due from banks 406 1,647 Cash and due from banks at December 31, 1998 and 1997 1,203 1,758 - ----------------------------------------------------------------------------------------------------------- Cash and due from banks at September 30, 1999 and 1998 1,609 3,405 - ----------------------------------------------------------------------------------------------------------- Cash disbursements made for: Interest $ 6,884 $ 8,537 Income taxes 764 674 - -----------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements 7 8 CONSOLIDATED STATEMENT OF CONDITION Morgan Guaranty Trust Company of New York
September 30 December 31 In millions, except share data 1999 1998 - ----------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 1,551 $ 1,147 Interest-earning deposits with banks 2,082 2,372 Debt investment securities available-for-sale carried at fair value 5,146 3,634 Trading account assets 79,220 90,770 Securities purchased under agreements to resell and federal funds sold 18,250 33,316 Securities borrowed 10,016 8,193 Loans, net of allowance for loan losses of $300 at September 1999 and $470 at December 24,604 24,876 1998 Accrued interest and accounts receivable 5,131 3,898 Premises and equipment, net of accumulated depreciation of $1,124 at September 1999 and $1,160 at December 1998 1,813 1,703 Other assets 12,349 5,337 - -------------------------------------------------------------------------------------------------------------------- Total assets 160,162 175,246 - -------------------------------------------------------------------------------------------------------------------- LIABILITIES Noninterest-bearing deposits: In offices in the U.S. 873 1,232 In offices outside the U.S. 1,185 572 Interest-bearing deposits: In offices in the U.S. 3,881 7,749 In offices outside the U.S. 44,103 46,668 - -------------------------------------------------------------------------------------------------------------------- Total deposits 50,042 56,221 Trading account liabilities 62,404 64,776 Securities sold under agreements to repurchase and federal funds purchased 12,891 14,916 Other liabilities for borrowed money 5,607 8,646 Accounts payable and accrued expenses 6,496 6,123 Long-term debt not qualifying as risk-based capital (includes $704 at September 1999 and $736 at December 1998 of notes payable to J.P. Morgan) 7,340 10,358 Other liabilities, including allowance for credit losses of $145 at September 1999 and $125 at December 1998 1,515 542 - -------------------------------------------------------------------------------------------------------------------- 146,295 161,582 Long-term debt qualifying as risk-based capital (includes $2,883 at September 1999 and $3,058 at December 1998 of notes payable to J.P. Morgan) 2,975 3,186 - -------------------------------------------------------------------------------------------------------------------- Total liabilities 149,270 164,768 STOCKHOLDER'S EQUITY Preferred stock, $100 par value (authorized shares: 2,500,000) -- -- Common stock, $25 par value (authorized shares: 11,000,000; issued and outstanding 10,599,027) 265 265 Surplus 3,305 3,305 Undivided profits 7,303 6,836 Accumulated other comprehensive income: Net unrealized gains on investment securities, net of taxes 65 118 Foreign currency translation, net of taxes (46) (46) - -------------------------------------------------------------------------------------------------------------------- Total stockholder's equity 10,892 10,478 - -------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholder's equity 160,162 175,246
Member of the Federal Reserve System and the Federal Deposit Insurance Corporation. See notes to consolidated financial statements. 8 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES J.P. Morgan & Co. Incorporated (J.P. Morgan), a global financial services firm, is the holding company for a group of subsidiaries that provide a range of financial services, including: advisory, underwriting, financing, market making, asset management, and brokerage. We serve a broad client base that includes corporations, governments, institutions, and individuals. We also use our expertise and resources to enter into proprietary transactions for our own account. J.P. Morgan and our subsidiaries, including Morgan Guaranty Trust Company of New York (Morgan Guaranty), use accounting and reporting policies and practices that conform with U.S. generally accepted accounting principles. Basis of presentation Financial information included in the accounts of J.P. Morgan, and the subsidiaries for which our ownership is more than 50% of the company, is contained in the consolidated financial statements. All material intercompany accounts and transactions have been eliminated in consolidation. The financial information as of and for the periods ended September 30, 1999, September 30, 1998, and June 30,1999 is unaudited. All adjustments which, in the opinion of management, are necessary for a fair presentation have been made and were of a normal, recurring nature. These unaudited financial statements should be read in conjunction with the audited financial statements included in J.P. Morgan's Annual report on Form 10-K for the year ended December 31, 1998, as well as with information included in J.P. Morgan's unaudited quarterly reports on Form 10-Q for the three months ended June 30, 1999 and March 31, 1999. The nature of J.P. Morgan's business is such that the results of any interim period are not necessarily indicative of results for a full year. Certain prior year amounts have been reclassified to conform with the current presentation. The following provides certain supplemental information regarding our accounting policies. Impaired loans A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the agreement. We consider the following in identifying impaired loans: - - A default has occurred or is expected to occur, - - The payment of principal and/or interest or other cash flows is greater than 90 days past due, or - - Management has serious doubts as to the collectibility of future cash flows, even if the loan is currently performing. Once a loan is identified as impaired, management regularly measures impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures (collectively with SFAS 114, SFAS No. 114). We measure impairment of a loan based on the present value of expected future cash flows, an observable market value, or the fair value of the collateral. If the determined SFAS No. 114 value is less than the recorded investment (book value) in the impaired loan, an allowance is established or appropriated for the amount deemed uncollectible; if the impairment is deemed highly certain, the exposure is charged off against the allowance. Generally, when a loan is recognized as impaired, the accrual of interest is discontinued and any previously accrued but unpaid interest on the loan is reversed against the current period's interest revenue. When doubt exists as to the collectibility of the remaining recorded investment, any interest received on impaired loans is applied in the following order: - - against the recorded investment until paid in full - - as a recovery up to any amounts charged off related to the impaired loan - - as interest revenue If it is deemed highly certain we will collect the remaining recorded investment of the impaired loan, interest revenue is recorded on a cash basis as payments are received. 9 10 Allowances for credit losses We maintain allowances for credit losses to absorb losses inherent in our traditional extensions of credit that we believe are probable and that can be reasonably estimated. These allowances include an allowance for loan losses and an allowance for credit losses on lending commitments which include, commitments to extend credit, standby letters of credit, and guarantees. The firm's Asset Quality Review process determines the appropriate allowances based on an estimate of probable losses by counterparty, industry, or country; and a statistical model estimate for expected losses on our remaining performing portfolio, which includes the general component. The general component of our allowances for credit losses is used to estimate the impact of separately identified limitations in our expected loss model. Beginning in the second quarter of 1999, the general component is included as part of the expected loss component for disclosure purposes since all factors used to derive the general component relate to the expected loss component. Prior period amounts have been reclassified. In March 1999, a Joint Working Group, comprised of banking and securities regulators, was formed to provide clarification to the banking industry regarding the appropriate accounting, disclosure, and documentation requirements for allowances for credit losses. We are in the process of reviewing our model for estimating credit losses and determining the appropriate level of our allowances, with the goal of refining it based on our review, which will incorporate any guidance issued by the Joint Working Group. 2. ACCOUNTING CHANGES AND DEVELOPMENTS Accounting for derivative instruments and hedging activities In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The standard will require us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings or be recognized in other comprehensive income until the hedged item is recognized in earnings. If the change in fair value of a derivative designated as a hedge is not effectively offset, as defined, by the change in value of the item it is hedging, this difference will be immediately recognized in earnings. While we have not determined the specific impact of SFAS No. 133 on our earnings and financial position, we have identified, based on current hedging strategies, our activities that would be most affected by the new standard. Specifically, the Proprietary Investing and Trading segment uses derivatives to hedge its investment portfolio, deposits, and issuance of debt primarily hedges of interest rate risk. Our credit activities use credit derivatives to hedge credit risk, and to a lesser extent, use other derivatives to hedge interest rate risk. Pursuant to SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, we are required to adopt the standard effective January 1, 2001. Management is currently evaluating the impact of SFAS No. 133 on our hedging strategies. The actual assessment of the impact on the firm's earnings and financial position of adopting SFAS No. 133 will be made based on our positions at the date of adoption. Accounting for the costs of computer software developed or obtained for internal use In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This statement requires that we capitalize certain costs associated with the acquisition or development of internal use software. Effective January 1, 1999, we adopted SOP 98-1; restatement of financial statements of previous years is not allowed. As a result of this adoption we expect to capitalize approximately $130 million in software costs during 1999, net of expected amortization, of which $103 million were capitalized in the first nine months of the year. Previously, these costs would have been expensed as incurred. Once the software is ready for its intended use, we will begin amortizing capitalized costs on a straight-line basis over its expected useful life. This period will generally not exceed three years. 3. RESTRUCTURING OF BUSINESS ACTIVITIES During the first quarter 1998, the firm announced a plan to restructure certain sales and trading functions in Europe, refocus our investment banking and equities businesses in Asia, and rationalize resources throughout the firm. As a result of this decision, the 1998 first quarter reflected a pretax charge of $215 million ($129 million after tax) which consisted of the following: severance-related costs of $140 million recorded in Employee compensation and benefits associated with staff reductions of approximately 900; $70 million in Net occupancy, primarily related to lease termination fees, estimated losses on sublease agreements, and the write-off of various leasehold improvements and equipment, primarily 10 11 in Europe; and $5 million in Technology and communications, related to equipment write-offs. During the fourth quarter 1998, we revised our estimates of remaining costs under the plan and reduced the liability by $7 million; this adjustment was recorded in Net occupancy. Excluding certain long-term commitments, the reserve related to this charge was substantially utilized as of December 31, 1998. During the fourth quarter 1998, the firm incurred an additional pretax charge of $143 million ($86 million after tax) related to cost reduction programs that are part of its productivity initiatives. The charge reflected severance-related costs of $101 million recorded in Employee compensation and benefits associated with staff reductions of approximately 800. It also reflected $42 million (net of the $7 million adjustment discussed above) in Net occupancy primarily related to estimated losses on sublease agreements and the write-off of various leasehold improvements and furniture and fixtures in several European locations. As of September 30, 1999, approximately $45 million of the fourth-quarter charge was accrued in Other liabilities, of which $27 million related to severance and the remainder related to real estate. Excluding certain long-term commitments, the remainder of this reserve will be substantially utilized by December 31, 1999. While predominantly impacting the European and North American regions, the special charges primarily affected all client-focused activities as defined by our reported segments in note 23, "Segments." Additional costs associated with these initiatives did not meet the requirement for inclusion in the first- or fourth-quarter charge. These items were expensed as incurred and did not have a material impact on the firm. The remaining reserves relate to future cash outflows, mostly long term in nature, associated with severance payments, lease termination benefits, and other exit costs. The payment of these items will not have a material impact on the financial position or liquidity of the firm. 4. BUSINESS CHANGES AND DEVELOPMENTS Sale of global trust and agency services business In June 1998, we completed the sale of our global trust and agency services business to Citibank ( a subsidiary of Citigroup), resulting in a net gain of $131 million ($79 million after tax) recorded in Other revenue. The sale will not have a material effect on our ongoing earnings. Sale of investment management business in Australia In July 1998, we completed the sale of our investment management business in Australia to Salomon Smith Barney Asset Management (a subsidiary of Citigroup), resulting in a net gain of $56 million ($34 million after tax) recorded in Other revenue. The sale will not have a material effect on our ongoing earnings. Occupancy On December 23, 1998, the City and State of New York and the New York Stock Exchange announced an agreement to build a new Exchange on land currently occupied by J.P. Morgan facilities at 15 Broad Street, 23 Wall Street, and 37 Wall Street in New York City. We do not anticipate any disruption to our operations, or any material impact to the firm's financial statements, as a result of this transaction. Securities portfolio accounting services On April 22, 1999, J.P. Morgan announced that The Bank of New York has been appointed to provide securities portfolio accounting and related operational services for J.P. Morgan's asset management business. We do not anticipate any disruption to our operations, or any material impact to the firm's financial statements, as a result of this transaction. Euroclear On September 1, 1999, J.P. Morgan and the Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe Cooperative announced that they had signed a letter of intent to create a new, market-owned European bank to operate all aspects of the Euroclear System. This agreement in principle anticipates the formation of a European bank in Brussels to succeed J.P. Morgan as operator and banker for the Euroclear System, facilitating Euroclear's strategy to maintain its leadership and capitalize on partnership opportunities as market forces reshape the settlement infrastructure in Europe. Subject to a definitive agreement being reached, J.P. Morgan will remain as operator and banker of Euroclear until the successor bank is established and can take over J.P. Morgan's Euroclear functions, a process which is expected to take up to 18 months from the signing of the definitive agreement. J.P. Morgan will play a key role in the formation of the 11 12 new bank. After that, J.P. Morgan will remain an important participant and shareholder of Euroclear and retain a seat on its Board. The management and staff of Euroclear, numbering approximately 1,200 J.P. Morgan employees, will transfer to the new entity. Under the existing Operating Agreement, income from clearance and settlement operations is earned by Euroclear Clearance System Societe Cooperative, while J.P. Morgan retains earnings from providing banking services to the System's participants. Under the agreement in principle, J.P. Morgan will continue to receive pretax banking income for three years following the signing of the definitive agreement, with a minimum of $195 million and maximum of $295 million per year, whether the income is earned by J.P. Morgan prior to the changeover to the new bank or afterward by the new bank. After the new bank becomes operational, it will also pay J.P. Morgan for certain costs of transition, assets and know-how that are transferred to it. Until the new bank becomes operational, J.P. Morgan will continue to record pre-tax banking income over the period earned. Upon the changeover to the new bank, J.P. Morgan will recognize as income, on that date, all expected amounts due over the remaining contract period, plus any gain on assets transferred to the new bank. This amount will be subsequently adjusted based on the determination of the final pretax banking income of Euroclear as specified in the definitive agreement. Prior to the changeover to the successor bank, all funds due J.P. Morgan under the agreement in principle will be received as earned. Following the changeover to the successor bank, fifty percent of all funds due to J.P. Morgan will be paid as earned. The remaining 50% will be paid in monthly installments over the period ending six years after the signing of the definitive agreement. The successor bank will have the option of prepaying its obligation for the remaining period at the higher of $245 million per year or the average of the actual annual income (subject to the floor and cap noted above), for the portion of the three year period preceding the prepayment. Pretax income from Euroclear-related activities reported by J.P. Morgan was $168 million in the first nine months of 1999; $253 million for the full year 1998; and $218 million for 1997. 5. INTEREST REVENUE AND EXPENSE The table below presents an analysis of interest revenue and expense obtained from on- and off-balance-sheet financial instruments. Interest revenue and expense associated with derivative financial instruments are included with related balance sheet instruments. These derivative financial instruments are used as hedges or to modify the interest rate characteristics of assets and liabilities and include swaps, forwards, futures, options, and debt securities forwards.
Third quarter Nine months --------------------------------------- In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------ INTEREST REVENUE Deposits with banks $ 61 $ 107 $ 221 $ 236 Debt investment securities (a) 402 321 1,266 1,027 Trading account assets 970 1,127 2,763 3,437 Securities purchased under agreements to resell and federal funds sold 407 533 1,188 1,493 Securities borrowed 456 568 1,374 1,578 Loans 415 528 1,249 1,618 Other sources 72 65 192 228 - ------------------------------------------------------------------------------------ Total interest revenue 2,783 3,249 8,253 9,617 - ------------------------------------------------------------------------------------ INTEREST EXPENSE Deposits 548 645 1,723 2,138 Trading account liabilities 298 386 866 1,218 Securities sold under agreements to repurchase and federal funds purchased 792 1,054 2,260 2,923 Other borrowed money 376 432 1,070 1,235 Long-term debt 380 400 1,131 1,145 - ------------------------------------------------------------------------------------ Total interest expense 2,394 2,917 7,050 8,659 - ------------------------------------------------------------------------------------ Net interest revenue 389 332 1,203 958 - ------------------------------------------------------------------------------------
(a) Interest revenue from debt investment securities included taxable revenue of $378 million and $1,187 million and revenue exempt from U.S. income taxes of $24 million and $79 million for the three and nine months ended September 30, 1999, respectively. Interest revenue from debt investment securities included taxable revenue of $291 million and $941 million and revenue exempt from U.S. income taxes of $30 million and $86 million for the three and nine months ended September 30, 1998, respectively. 12 13 Net interest (expense)/revenue associated with derivatives used for purposes other-than-trading was approximately ($11) million and $16 million for the three and nine months ended September 30, 1999, respectively, compared with approximately $41 million and $112 million for the three and nine months ended September 30, 1998, respectively. At September 30, 1999, approximately $40 million of net deferred gains on closed derivative contracts used for purposes other-than-trading were recorded on the "Consolidated balance sheet." These amounts are primarily net deferred gains on closed hedge contracts, which are included in the amortized cost of the debt investment portfolio as of September 30, 1999. The amount of net deferred gains or losses on closed derivative contracts changes from period to period, primarily due to the amortization of such amounts to Net interest revenue. These changes are also influenced by the execution of our investing strategies, which may result in the sale of the underlying hedged instruments and/or termination of hedge contracts. Net deferred gains (losses) on closed derivative contracts as of September 30, 1999 of $40 million, are expected to amortize into Net interest revenue as follows: $(2) million - remainder of 1999; $(7) million in 2000; ($9) million in 2001; ($6) million in 2002; ($6) million in 2003; ($3) million in 2004; and approximately ($73) million thereafter. 6. TRADING REVENUE Trading revenue is predominantly generated by our market making activities included in our Global Finance sector as well as activities in our Proprietary Investments sector. The following table presents trading revenue by principal product grouping for the three and nine months ended September 30, 1999 and 1998. Prior period amounts have been restated to reflect the product groupings as described below.
Third quarter Nine months ------------------ ---------------------- In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------ Fixed income $194 ($123) $1,224 $1,120 Equities 177 2 661 211 Foreign exchange 53 190 476 511 - ------------------------------------------------------------------------------------------------ Total trading revenue 424 69 2,361 1,842 Trading-related net interest revenue 171 78 564 231 - ------------------------------------------------------------------------------------------------ Combined total 595 147 2,925 2,073 - ------------------------------------------------------------------------------------------------
Fixed income trading revenue includes the results of making markets in both developed and emerging countries in government securities, U.S. government agency securities, corporate debt securities, money market instruments, interest rate and currency swaps, and options and other derivatives. Equities trading revenue includes the results of making markets in global equity securities, equity derivatives such as swaps, options, futures, and forward contracts, and convertible debt securities. Foreign exchange trading revenue includes the results of making markets in spot, options, and short-term interest rate products in order to help clients manage their foreign currency exposure. Foreign exchange also includes the results from commodity transactions in spot, forwards, options, and swaps. 7. INVESTMENT SECURITIES DEBT INVESTMENT SECURITIES Our debt investment securities portfolio is classified as available-for-sale. Available-for-sale securities are measured at fair value and unrealized gains or losses are reported as a net amount within the stockholders' equity account, Net unrealized gains on investment securities, net of taxes. The following table presents the gross unrealized gains and losses and a comparison of the cost, along with the fair and carrying value of our available-for-sale debt investment securities at September 30, 1999. The net unrealized depreciation on debt investment securities was $274 million at September 30, 1999, compared with a net unrealized depreciation of $169 million at June 30, 1999 and a net unrealized appreciation of $125 million at December 31, 1998. The decline from the prior periods primarily related to decreases in the value of U.S. government and agency securities. The gross unrealized gains or losses on each debt investment security include the effects of any related hedge. See note 10, "Derivatives," for additional detail of gross unrealized gains and losses associated with open derivative contracts used to hedge debt investment securities. 13 14
Gross Gross Fair and unrealized unrealized carrying In millions: September 30, 1999 Cost gains losses value - ----------------------------------------------------------------------------------------------------------- U.S. Treasury $ 1,950 $ 40 $ 1 $ 1,989 U.S. government agency, principally mortgage-backed 19,774 24 369 19,429 U.S. state and political subdivision 1,269 150 97 1,322 U.S. corporate and bank debt 84 -- -- 84 Foreign government (a) 857 -- 4 853 Foreign corporate and bank debt 348 3 20 331 Other 107 -- -- 107 - ----------------------------------------------------------------------------------------------------------- Total debt investment securities 24,389 217 491 24,115 - -----------------------------------------------------------------------------------------------------------
(a) Primarily includes debt of countries that are members of the Organization for Economic Cooperation and Development. The table below presents net debt investment securities losses during the three and nine months ended September 30, 1999 and 1998. These amounts are recorded in Investment securities revenue.
Third quarter Nine months --------------------------------------------- In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------ Gross realized gains from sales of securities $ 55 $ 4 $ 162 $ 62 Gross realized losses from sales of securities (106) (27) (281) (111) Write-downs for other-than-temporary impairments in value -- -- -- (2) Net gains on maturities, calls, and mandatory redemptions -- 2 1 2 - ------------------------------------------------------------------------------------------------------------ Net debt investment securities losses (51) (21) (118) (49) - ------------------------------------------------------------------------------------------------------------
EQUITY INVESTMENT SECURITIES Marketable available-for-sale equity investment securities Marketable equity investment securities, which are classified as available-for-sale, are recorded at fair value. Unrealized gains and losses are reported as a net amount within the stockholders' equity account, Net unrealized gains on investment securities, net of taxes. Gross unrealized gains and losses, as well as a comparison of the cost, and fair and carrying value of marketable available-for-sale equity investment securities as of September 30, 1999 are shown in the following table.
In millions: September 30, 1999 - ----------------------------------------------------------------- Cost $ 387 - ----------------------------------------------------------------- Gross unrealized gains 94 Gross unrealized losses (18) - ----------------------------------------------------------------- Net unrealized gains(a) 76 - ----------------------------------------------------------------- Fair and carrying value 463 - -----------------------------------------------------------------
(a) Primarily relates to investments in the financial services industries. Nonmarketable and other equity securities Nonmarketable equity investment securities are carried at cost on the balance sheet. The following table presents the carrying and fair value, as well as the net unrealized gains, on these securities.
In millions: September 30, 1999 - --------------------------------------------------------------------- Carrying value $ 550 Net unrealized gains on nonmarketable securities(a) 50 - --------------------------------------------------------------------- Fair value 600 - ---------------------------------------------------------------------
(a) Primarily relates to investments in the financial services industries. Also included in our equity investments are securities held in subsidiaries registered as Small Business Investment Companies (SBICs). SBICs are carried at fair value on the balance sheet, with changes in fair value recorded currently in Investment Securities Revenue. Investments in these securities were approximately $515 million at September 30, 1999, and primarily relate to investments in the financial services industries. 14 15 Gains and write-downs The following table presents gross realized gains and write-downs for other-than-temporary impairments in value related to our equity investments portfolio, excluding securities in SBICs, for the three and nine months ended September 30, 1999 and 1998. These amounts are recorded in Investment securities revenue.
Third quarter Nine months -------------------- ------------------- In millions 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------------------- Gross realized gains from marketable available-for-sale securities $ -- $ 192 $ -- $ 334 Gross realized gains from nonmarketable and other equity securities 141 5 150 16 Write-downs for other-than-temporary impairments in value (112) (48) (150) (82) - -------------------------------------------------------------------------------------------------------------------------- Net equity investment securities realized gains 29 149 -- 268 - --------------------------------------------------------------------------------------------------------------------------
Gains related to the appreciation of investments in SBICs recorded in Investment securities revenue were approximately $255 million for the three and nine months ended September 30, 1999. 8. INVESTMENT IN AMERICAN CENTURY COMPANIES, INC. In January 1998, we completed the purchase of a 45% economic interest in American Century Companies, Inc. (American Century) for $965 million. American Century is a no-load U.S. mutual fund company selling directly to individuals. The investment is accounted for under the equity method of accounting and recorded in Other assets. The excess of our investment over our share of equity (i.e., goodwill) in American Century was approximately $795 million at the time of purchase. This amount is being amortized on a straight-line basis over a period of 25 years. At September 30, 1999 and 1998, goodwill totaled $735 million and $768 million, respectively. For the three and nine months ended September 30, 1999 and 1998, amortization of goodwill was approximately $8 million and $24 million in each period, respectively. Our share of equity income in American Century and the amortization of goodwill related to this investment is recorded in Other revenue. The results of this investment are included in the Asset Management Services segment. 9. TRADING ACCOUNT ASSETS AND LIABILITIES Trading account assets and liabilities, including derivative instruments used for trading purposes, are carried at fair value. The following table presents the fair and carrying value of trading account assets and trading account liabilities at September 30, 1999. It also includes the average balances for the three and nine months ended September 30, 1999.
Carrying Average value Balance ------------ ------------------------------- September 30, Third quarter Nine months In millions: 1999 1999 1999 - ----------------------------------------------------------------------------------------- TRADING ACCOUNT ASSETS U.S. Treasury $ 7,908 $ 9,212 $ 9,871 U.S. government agency 12,780 15,525 13,676 Foreign government 17,304 16,603 19,011 Corporate debt and equity 18,479 18,453 19,239 Other securities 7,029 5,764 6,414 Interest rate and currency swaps 16,335 15,696 16,675 Credit derivatives 51 294 1,230 Foreign exchange contracts 1,945 2,568 3,110 Interest rate futures and forwards 74 36 53 Commodity and equity contracts 7,264 5,913 4,312 Purchased option contracts 17,341 19,018 19,809 - ----------------------------------------------------------------------------------------- Total trading account assets 106,510 109,082 113,400 - ----------------------------------------------------------------------------------------- TRADING ACCOUNT LIABILITIES U.S. Treasury 8,125 5,054 5,908 Foreign government 11,327 13,654 12,557 Corporate debt and equity 9,104 8,496 9,110 Other securities 4,132 1,322 2,602 Interest rate and currency swaps 12,975 12,092 13,649 Credit derivatives 514 154 1,027 Foreign exchange contracts 1,963 2,503 3,611 Interest rate futures and forwards 94 703 923 Commodity and equity contracts 5,690 4,458 3,303 Written option contracts 18,119 20,988 19,697 - ----------------------------------------------------------------------------------------- Total trading account liabilities 72,043 69,424 72,387 - -----------------------------------------------------------------------------------------
15 16 At September 30, 1999, trading account assets include the fair value of certain disputed swap contracts with South Korean counterparties. The gross derivative receivables related to these contracts, before fair value adjustments made by management, were $534 million. In October 1999, J.P. Morgan settled approximately $344 million of the gross derivative receivables under dispute. J.P. Morgan received a consideration primarily consisting of cash and, to a lesser extent, an equity interest in a South Korean financial services company. The fair value of the consideration approximated the recorded fair value of the receivables included in the settlement. Trade date receivables/payables Amounts receivable and payable for securities that have not reached their contractual settlement dates are recorded net in the "Consolidated balance sheet." Amounts receivable for securities sold of $36.0 billion were netted against amounts payable for securities purchased of $35.2 billion. This produced a net trade date receivable of $0.8 billion, recorded in Accrued interest and accounts receivable, at September 30, 1999. 10. DERIVATIVES In general, derivatives are contracts or agreements whose values are derived from changes in interest rates, foreign exchange rates, prices of securities, or financial or commodity indices. The timing of cash receipts and payments for derivatives is generally determined by contractual agreement. Derivatives are either standardized contracts executed on an exchange or negotiated over-the-counter contracts. Futures and options contracts are examples of standard exchange-traded derivatives. Forwards, swaps, and option contracts are examples of over-the-counter derivatives. Over-the-counter derivatives are generally not traded like securities. In the normal course of business, however, they may be terminated or assigned to another counterparty if the original holder agrees. Derivatives may be used for trading or other-than-trading purposes. Other-than-trading purposes are primarily related to our investing activities. Derivatives used for trading purposes include: - - interest rate and currency swap contracts - - credit derivatives - - interest rate futures, forward rate agreements, and interest rate option contracts - - foreign exchange spot, forward, futures, and option contracts - - equity swap, futures and option contracts - - commodity swap, forward and option contracts In our investing activities we use derivative instruments including: - - interest rate and currency swap contracts - - credit derivatives - - foreign exchange forward contracts - - interest rate futures and debt securities forward contracts - - interest rate and equity option contracts Interest rate swaps are contractual agreements to exchange periodic interest payments at specified intervals. The notional amounts of interest rate swaps are not exchanged; they are used solely to calculate the periodic interest payments. Currency swaps generally involve exchanging principal (the notional amount) and periodic interest payments in one currency for principal and periodic interest payments in another currency. Credit derivatives include credit default swaps and related swap and option contracts. Credit default swaps are contractual agreements that provide insurance against a credit event of one or more referenced credits. The nature of the credit event is established by the protection buyer and seller at the inception of the transaction, and includes events such as bankruptcy, insolvency, and failure to meet payment obligations when due. The protection buyer pays a periodic fee in return for a contingent payment by the protection seller following a credit event. The contingent payment is typically the loss- the difference between the notional and the recovery amount - incurred by the creditor of the reference credit as a result of the event. Foreign exchange contracts involve an agreement to exchange one country's currency for another at an agreed upon price and settlement date. The contracts reported in the following table primarily include forward contracts. 16 17 Interest rate futures are standardized exchange-traded agreements to receive or deliver a specific financial instrument at a specific future date and price. Forward rate agreements provide for the payment or receipt of the difference between a specified interest rate and a reference rate at a future settlement date. Debt security forwards include to-be-announced and when-issued securities contracts. Commodity and equity contracts include swaps and futures in the commodity and equity markets and commodity forward agreements. Equity swaps are contractual agreements to receive the appreciation or depreciation in value based on a specific strike price on an equity instrument in return for paying another rate, which is usually based on equity index movements or interest rates. Commodity swaps are contractual commitments to exchange the fixed price of a commodity for a floating price. Equity and commodity futures are exchange-traded agreements to receive or deliver a financial instrument or commodity at a specific future date and price. Equity and commodity forwards are over-the-counter agreements to purchase or sell a specific amount of a financial instrument or commodity at an agreed-upon price and settlement date. An option provides the option purchaser, for a fee, the right - but not the obligation - to buy or sell a security at a fixed price on or before a specified date. The option writer is obligated to buy or sell the security if the purchaser chooses to exercise the option. These options include contracts in the interest rate, foreign exchange, equity, and commodity markets. Interest rate options include caps and floors. The following table presents notional amounts for trading and other-than-trading derivatives, based on management's intent and ongoing usage. A summary of the on-balance-sheet credit exposure, which is represented by the net positive fair value associated with trading derivatives and recorded in Trading account assets, is also included in the following table. Our on-balance-sheet credit exposure takes into consideration $84.6 billion of master netting agreements in effect at September 30, 1999.
On-balance-sheet In billions: September 30, 1999 Notional amounts credit exposure - ------------------------------------------------------------------------------------------------------- Interest rate and currency swaps Trading $4,239.2 Other-than-trading(a)(b) 65.0 - ------------------------------------------------------------------------------------------------- Total interest rate and currency swaps 4,304.2 ( $16.3) - ------------------------------------------------------------------------------------------------- Credit derivatives Trading 114.4 Other-than-trading (a) 19.0 - ------------------------------------------------------------------------------------------------- Total credit derivatives 133.4 0.1 - ------------------------------------------------------------------------------------------------- Foreign exchange spot, forward, and futures contracts Trading 497.7 Other-than-trading(a)(b) 20.7 - ------------------------------------------------------------------------------------------------- Total foreign exchange spot, forward, and futures contracts 518.4 2.0 - ------------------------------------------------------------------------------------------------- Interest rate futures, forward rate agreements, and debt securities forwards Trading 1,140.7 Other-than-trading (a) 38.4 - ------------------------------------------------------------------------------------------------- Total interest rate futures, forward rate agreements, and debt securities forwards 1,179.1 -- - ------------------------------------------------------------------------------------------------- Commodity and equity swaps, forward, and futures contracts, 89.6 7.3 all trading - ------------------------------------------------------------------------------------------------- Purchased options(c) Trading 1,297.2 Other-than-trading(a) 11.8 - ------------------------------------------------------------------------------------------------- Total purchased options 1,309.0 17.3 - ------------------------------------------------------------------------------------------------- Written options, all trading(d) 1,538.2 - ------------------------------------------------------------------------------------------------- Total on-balance-sheet credit exposure 43.0 - -------------------------------------------------------------------------------------------------
(a) Derivatives used as hedges of other-than-trading positions may be transacted with third parties through independently managed J.P. Morgan derivative dealers that function as intermediaries for credit and administrative purposes. In such cases, the terms of the third-party transaction - notional, duration, currency, etc. - are matched with the terms of the internal trade to ensure the hedged risk has been offset with a third party. If such terms are not matched or a third-party trade is not transacted, the intercompany trade is eliminated in consolidation. (b) The notional amounts of derivative contracts used for purposes other-than-trading, conducted in the foreign exchange markets, primarily forward contracts, amounted to $26.4 billion at September 30, 1999, and were primarily denominated in the following currencies: Euro $6.2 billion, Japanese yen $5.7 billion, British pound $2.6 billion, Canadian dollar $2.5 billion and Swiss franc $2.4 billion. (c) At September 30, 1999, purchased options used for trading purposes included $946.8 billion of interest rate options, $198.6 billion of foreign exchange options, and $151.8 billion of commodity and equity options. Options used for purposes other-than-trading are primarily interest rate options. Purchased options executed on an exchange amounted to $228.1 billion and those negotiated over-the-counter amounted to $1,080.9 billion at September 30,1999. 17 18 (d) At September 30, 1999, written options included $1,177.1 billion of interest rate options, $211.6 billion of foreign exchange options, and $149.5 billion of commodity and equity options. Written option contracts executed on an exchange amounted to $217.1 billion and those negotiated over-the-counter amounted to $1,321.1 billion at September 30, 1999. As part of our other-than-trading activities, we use derivatives to hedge our exposure to interest rate and currency fluctuations, primarily on or related to debt investment securities. We also use them to modify the characteristics of interest rate-related balance sheet instruments such as loans, short-term borrowings, and long-term debt. Net unrealized losses associated with open derivative contracts used to hedge or modify the interest rate characteristics of related balance sheet instruments amounted to $110 million at September 30, 1999. Gross unrealized gains and gross unrealized losses associated with open derivative contracts at September 30, 1999, are as follows:
Gross Gross Net unrealized unrealized unrealized In millions: September 30, 1999 gains (losses) gains (losses) - ------------------------------------------------------------------------------------- Long-term debt $412 ($580) ($168) Debt investment securities 31 (3) 28 Deposits 137 (36) 101 Other financial instruments 107 (178) (71) - ------------------------------------------------------------------------------------- Total 687 (797) (110) - -------------------------------------------------------------------------------------
11. LOANS Included in Loans are loans held for sale of approximately $1.3 billion at September 30, 1999. These loans are recorded on the balance sheet at lower of cost or fair value and are primarily to borrowers in the U.S. in various industries. 12. OTHER CREDIT-RELATED PRODUCTS Lending commitments include commitments to extend credit, standby letters of credit, guarantees, and indemnifications related to securities lending activities. The contractual amounts of these instruments represent the amount at risk should the contract be fully drawn upon, the client default, and the value of the collateral become worthless. The following table summarizes the contractual amount of lending commitments.
In billions: September 30, 1999 - --------------------------------------------------------- Commitments to extend credit $64.7 Standby letters of credit and guarantees 14.5 Securities lending indemnifications (a) 7.2 - ---------------------------------------------------------
(a) At September 30, 1999, J.P. Morgan held cash and other collateral in full support of securities lending indemnifications. Included in Fees and Commissions are credit-related fees of $47 million and $45 million for the three months ended September 30, 1999 and 1998, respectively. Credit-related fees were $125 million and $132 million for the nine months ended September 30, 1999 and 1998, respectively. They are primarily earned from commitments to extend credit, standby letters of credit and guarantees, and securities lending indemnifications. Also included in Fees and Commissions are amounts paid to credit derivative providers of $12 million and $33 million for the three months ended September 30, 1999 and 1998, respectively. Amounts paid to credit derivative providers were $35 million and $48 million for the nine months ended September 30, 1999 and 1998, respectively. 18 19 13. IMPAIRED LOANS Total impaired loans, organized by the location of the counterparty - net of charge-offs - at September 30, 1999 and 1998 are presented in the following table.
In millions: September 30 1999 1998 (a) - --------------------------------------------------------------- COUNTERPARTIES IN THE U.S. Commercial and industrial $ 19 $ 23 Other 25 18 - ----------------------------------------------------------- 44 41 - ----------------------------------------------------------- COUNTERPARTIES OUTSIDE THE U.S. Commercial and industrial 112 5 Other, primarily individuals 13 14 - ----------------------------------------------------------- 125 19 - ----------------------------------------------------------- TOTAL IMPAIRED LOANS 169 60 - ----------------------------------------------------------- Allowance for impaired loans 32 14 - -----------------------------------------------------------
(a) Certain reclassifications were made to conform with the categorization used in Bank regulatory filings. Impaired loans for which no SFAS No. 114 reserve was deemed necessary were $37 million and $20 million as of September 30, 1999 and 1998, respectively. The following table presents an analysis of the changes in impaired loans.
Third Third Nine Nine quarter quarter months months In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------ IMPAIRED LOANS, BEGINNING PERIOD $ 67 $ 55 $ 122 $ 113 - ----------------------------------------------------------------------------------------------------------- Additions to impaired loans 109(b) 36 139 162 Less: Repayments of principal, net of additional advances (1) (11) (43) (36) Impaired loans returning to accrual status -- -- (2) (39) Charge-offs (a): Commercial and industrial (6) (6) (16) (40) Banks -- (5) (1) (66) Other, primarily other financial institutions -- (6) (25) (24) Interest and other credits -- (3) (5) (10) - ----------------------------------------------------------------------------------------------------------- IMPAIRED LOANS, SEPTEMBER 30 169 60 169 60 - -----------------------------------------------------------------------------------------------------------
(a) Charge-offs include losses on loan sales of $3 million and $11 million for the three months ended September 30, 1999 and 1998, respectively. Charge-offs include losses on loan sales, primarily banks and other financial institutions of $33 million and $89 million for the nine months ended September 30, 1999 and 1998, respectively. (b) Primarily relates to loans to the Latin American steel industry. For the three months ended September 30, 1999 and 1998, the average recorded investments in impaired loans was $109 million and $53 million, respectively. For the nine months ended September 30, 1999 and 1998, the average recorded investments in impaired loans was $102 million and $78 million, respectively. An analysis of the effect of impaired loans - net of charge-offs - on interest revenue for the three and nine months ended September 30, 1999 and 1998 is presented in the following table.
Third Third Nine Nine quarter quarter months months In millions 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------- Interest revenue that would have been recorded if accruing $4 $- $8 $4 Net interest revenue recorded related to the current period - - - 4 - -------------------------------------------------------------------------------------------------------------- Negative impact of impaired loans on interest revenue 4 - 8 - - --------------------------------------------------------------------------------------------------------------
19 20 14. ALLOWANCES FOR CREDIT LOSSES The following table summarizes the activity of our allowance for loan losses.
Third Third Nine Nine quarter quarter months months In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------------- BEGINNING BALANCE $ 335 $ 392 $ 470 $ 546 - ------------------------------------------------------------------------------------------------------------------------- (Reversal of provision)/provision for loan losses in the U.S. 19 (14) (46) 14 (Reversal of provision)/provision for loan losses outside the U.S. (64) (11) (104) 11 - ------------------------------------------------------------------------------------------------------------------------- (45) 25 (150) 25 - ------------------------------------------------------------------------------------------------------------------------- Reclassifications in the U.S. -- -- -- 6 Reclassifications outside the U.S. -- -- -- (56) - ------------------------------------------------------------------------------------------------------------------------- -- -- -- (50)(a) - ------------------------------------------------------------------------------------------------------------------------- Recoveries: Counterparties in the U.S. 2 4 3 8 Counterparties outside the U.S. 15 -- 20 5 - ------------------------------------------------------------------------------------------------------------------------- 17 4 23 13 - ------------------------------------------------------------------------------------------------------------------------- Charge-offs: Counterparties in the U.S., primarily other financial institutions in 1999 (3) (2) (38) (4) Counterparties outside the U.S.: Commercial and industrial (3) (6) (3) (38) Banks -- (5) (1) (66) Other -- (4) -- (22) - ------------------------------------------------------------------------------------------------------------------------- Net recoveries/(charge-offs) 11 (13) (19) (117) - ------------------------------------------------------------------------------------------------------------------------- ENDING BALANCE, SEPTEMBER 30 301 404 301 404 - -------------------------------------------------------------------------------------------------------------------------
(a) Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across balance sheet reserve or allowance captions - which included an adjustment for trading derivatives needed to determine fair value, an allowance for loan losses, and an allowance for credit losses on lending commitments which include commitments to extend credit, standby letters of credit, and guarantees - were shown as reclassifications. Reclassifications had no impact on net income and, accordingly, were not shown on the income statement. Subsequent to July 1, 1998, reclassifications across balance sheet captions for allowances are reflected as provisions and reversals of provisions in the "Consolidated statement of income." If reclassifications prior to July 1, 1998 were included in the "Consolidated statement of income," the captions on the income statement for the nine months ended September 30, 1999 would change with no impact on net income as follows: Provision for loan losses would be a negative (income) $50 million and Trading revenue would decrease by $50 million. The following table displays our allowance for loan losses by component as of September 30.
In millions: September 30 1999 1998 - ----------------------------------------------------------------------------- Specific counterparty components in the U.S. $ 9 $ 36 Specific counterparty components outside the U.S. 23 5 - ----------------------------------------------------------------------------- Total specific counterparty 32 41 - ----------------------------------------------------------------------------- Specific country 24 77 Expected loss (b) 245 286 - ----------------------------------------------------------------------------- Total 301 404 - -----------------------------------------------------------------------------
The following table summarizes the activity of our allowance for credit losses on lending commitments.
Third Third Nine Nine quarter quarter months months In millions 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------------------- BEGINNING BALANCE $ 160 $ 185 $ 125 $ 185 - ------------------------------------------------------------------------------------------------------------------------- (Reversal of provision)/provision for credit losses in the U.S. (2) -- 49 -- (Reversal of provision)/provision for credit losses outside the U.S. (13) -- (29) -- - ------------------------------------------------------------------------------------------------------------------------- (15) -- 20 -- - ------------------------------------------------------------------------------------------------------------------------- ENDING BALANCE, SEPTEMBER 30 145 185 145 185 - -------------------------------------------------------------------------------------------------------------------------
20 21 The following table displays our allowance for credit losses on lending commitments by component as of September 30.
In millions: September 30 1999 1998 - ------------------------------------------------------------------------- Specific counterparty components in the U.S. $ 20 $ 1 Specific counterparty components outside the U.S. 3 2 - ------------------------------------------------------------------------- Total specific counterparty 23 3 - ------------------------------------------------------------------------- Specific country 1 7 Expected loss (b) 121 175 - ------------------------------------------------------------------------- Total 145 185 - -------------------------------------------------------------------------
(b) The general component of our allowances for credit losses is used to estimate the impact of separately identified limitations in our expected loss model. Beginning in the second quarter of 1999, the general component is included as part of the expected loss component for disclosure purposes since all factors used to derive the general component relate to the expected loss component. Prior period amounts have been reclassified. 15. INVESTMENT BANKING REVENUE
Third quarter Nine months ----------------------- ---------------------- In millions 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------- Advisory and syndication fees $ 258 $ 229 $ 737 $ 618 Underwriting revenue 140 83 508 402 - --------------------------------------------------------------------------------------------- Total 398 312 1,245 1,020 - ---------------------------------------------------------------------------------------------
Advisory and syndication fees include revenues earned from; advising clients on corporate strategy including mergers, acquisitions, privatizations, and changes in capital structures and; fees earned from the arrangement and syndication of credit facilities. Underwriting revenue includes both fees from debt and equity underwriting. 16. OTHER REVENUE AND OTHER EXPENSES Other revenue For the three months ended September 30, 1999, Other revenue of negative (loss) $18 million includes $45 million of losses on hedges of the firm's anticipated foreign currency revenues and expenses. These losses were partially offset by the impact of exchange rate movements on reported revenues and expenses in the respective period. Other revenue also includes a $15 million reversal of provision for credit losses (income) related to the allowance for credit losses on lending commitments. For the nine months ended September 30, 1999, Other revenue of $120 million includes $85 million of gains on hedges of the firm's anticipated foreign currency revenues and expenses and a $20 million net provision for credit losses related to the allowance for credit losses on lending commitments. In the 1998 third quarter, Other revenue of $71 million included the $56 million net gain on the sale of the firm's investment management business in Australia. It also included losses of approximately $22 million on hedges of the firm's anticipated foreign currency revenues and expenses. In addition to the 1998 third quarter gain, Other revenue for the first nine months of 1998, included the second quarter $131 million net gain on the sale of our global trust and agency services business and approximately $38 million of losses on hedges of the firm's anticipated foreign currency revenues and expenses. See Note 4, Business Changes and Developments, for additional information. Other expenses The following table presents the major components of Other expenses.
Third quarter Nine months ------------------- -------------------- In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------ Professional services $ 32 $ 28 $ 83 $ 87 Marketing and business development 51 42 136 131 Other 58 85 200 297 - ------------------------------------------------------------------------------------------ Total other expenses 141 155 419 515 - ------------------------------------------------------------------------------------------
21 22 17. INCOME TAXES The effective tax rate for the three months ended September 30, 1999 and 1998 was 31% and 23%, respectively. The increase in the effective tax rate reflects higher pretax income over the prior year quarter. For the nine months ended September 30, 1999 and 1998, the effective tax rate was 34% and 33%, respectively. The income tax benefit related to net realized losses and write-downs for other-than-temporary impairments in value on debt and equity investment securities, excluding securities in SBICs, was approximately $9 million and $48 million for the three and nine months ended September 30, 1999, compared to an income tax expense related to net realized gains of $47 million and $78 million for the three and nine months ended September 30, 1998. The applicable tax rate used to compute the income tax benefit related to net losses on debt and equity investment securities for the three and nine months ended September 30, 1999 was approximately 41%. For the three and nine months ended September 30, 1998, the applicable tax rate used to compute the income tax expense related to net gains on debt and equity investment securities was approximately 36%. 18. CAPITAL REQUIREMENTS J.P. Morgan, our subsidiaries, and certain foreign branches of our bank subsidiary, Morgan Guaranty Trust Company of New York (Morgan Guaranty), are subject to regulatory capital requirements of U.S. and foreign regulators. Our primary federal banking regulator, the Board of Governors of the Federal Reserve System (Federal Reserve Board), establishes minimum capital requirements for J.P. Morgan, the consolidated bank holding company, and some of our subsidiaries, including Morgan Guaranty. These requirements ensure banks and bank holding companies meet specific guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting principles. Failure to meet these requirements can result in actions by regulators that could have a direct material impact on our financial statements. The capital of J.P. Morgan and our principal subsidiaries, Morgan Guaranty and J.P. Morgan Securities Inc. (JPMSI), exceeded the minimum requirements set by each regulator at September 30, 1999. Capital ratios and amounts The following table indicates the risk-based capital and leverage ratios and amounts as of September 30, 1999 for J.P. Morgan and Morgan Guaranty under the Federal Reserve Board's market risk capital guidelines. These guidelines incorporate a measure of market risk for trading positions. Under the market risk capital guidelines, the published capital ratios of J.P. Morgan are calculated including the equity, assets, and off-balance-sheet exposures of JPMSI. In accordance with Federal Reserve Board guidelines, the risk-based capital and leverage amounts and ratios exclude the effect of SFAS No. 115. Dollars in millions Amounts Ratios(b) - ------------------------------------------------------------------- Tier 1 capital(a) J.P. Morgan $12,243 9.1% Morgan Guaranty $10,807 9.1% - ------------------------------------------------------------------- Total risk-based capital(a) J.P. Morgan $17,825 13.2% Morgan Guaranty $14,281 12.1% - ------------------------------------------------------------------- Leverage J.P. Morgan 4.8% Morgan Guaranty 6.6% - ------------------------------------------------------------------- (a) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum tier 1 capital of $5.4 billion and $4.7 billion, respectively. For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required minimum total risk-based capital of $10.8 billion and $9.5 billion, respectively. (b) Pursuant to Federal Reserve Board guidelines, the minimum tier 1 capital, total risk-based capital, and leverage ratios are 4%, 8%, and 3%, respectively, for bank holding companies and banks. Capital categories Bank regulators use five capital category definitions for regulatory supervision purposes. The categories range from well capitalized to critically undercapitalized. A bank is considered well capitalized if it has minimum tier 1 capital, total capital, and leverage ratios of 6%, 10%, and 5%, respectively, under standards provided by the regulatory framework for prompt corrective action and the Federal Reserve Board. Bank holding companies also have guidelines which determine the capital levels at which they shall be considered well capitalized. Pursuant to these guidelines, the Federal Reserve Board considers a bank holding company who has adopted the market risk rules to be well capitalized if it has minimum tier 1 capital, total capital, and leverage ratios of 6%, 10%, and 3%, respectively. 22 23 At September 30, 1999, the ratios of J.P. Morgan and Morgan Guaranty exceeded the minimum standards required for a well capitalized bank holding company and bank, respectively. Management is aware of no conditions or events that have occurred since September 30, 1999, that would change J.P. Morgan's and Morgan Guaranty's well capitalized status. 19. STOCK OPTIONS AND OTHER AWARD PLANS J.P. Morgan's stock option and stock award plans provide for the grant of stock-related awards to key employees. To satisfy awards granted under stock option and stock award plans, we may make common stock available from authorized but unissued shares. We also may purchase shares in the open market at various times during the year. Shares available for future grants under stock incentive plans totaled 9,493,000 as of July 31, 1999. A portion of these shares may be made available from treasury shares. Shares authorized for future grants under the Stock Bonus Plan are 6.5% of outstanding shares. All shares authorized under the Stock Bonus Plan are required to be settled in treasury shares. In July 1999 we granted stock option awards totaling 6,088,000 with an average exercise price of $135.72. 20. EARNINGS PER SHARE Basic EPS is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding, which includes contingently issuable shares where all necessary conditions for issuance have been satisfied. Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to dilutive potential common shares that were outstanding during the period. The computation of basic and diluted EPS for the three and nine months ended September 30, 1999 and 1998 is presented in the following table.
Third quarter Nine months --------------------------------- ---------------------------------- Dollars in millions, except share data 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------- Net income $ 442 $ 156 $ 1,546 $ 874 Preferred stock dividends and other (9) (9) (27) (27) - ------------------------------------------------------------------------------------------------------------------------------ Numerator for basic and diluted earnings per share - income available to common stockholders $ 433 $ 147 $ 1,519 $ 847 - ------------------------------------------------------------------------------------------------------------------------------ Denominator for basic earnings per share- weighted-average shares 181,511,850 181,663,864 182,405,166 182,309,867 Effect of dilutive securities: Options (a) 5,191,290(b) 5,387,808(b) 5,207,112(b) 6,445,438(b) Other stock awards (c) 7,968,493 9,275,066 8,252,293 9,391,115 4.75% convertible debentures -- 68,747 -- 69,964 - ------------------------------------------------------------------------------------------------------------------------------ 13,159,783 14,731,621 13,459,405 15,906,517 - ------------------------------------------------------------------------------------------------------------------------------ Denominator for diluted earnings per share- weighted-average number of common shares and dilutive potential common shares 194,671,633 196,395,485 195,864,571 198,216,384 - ------------------------------------------------------------------------------------------------------------------------------ Basic earnings per share $ 2.39 $ 0.81 $ 8.33 $ 4.65 Diluted earnings per share 2.22 0.75 7.76 4.28 - ------------------------------------------------------------------------------------------------------------------------------
Earnings per share amounts are based on actual numbers before rounding. (a) The dilutive effect of stock options was computed using the treasury stock method. This method computes the number of incremental shares by assuming the issuance of outstanding stock options, reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price of our common stock for the period. The related tax benefits are also considered. (b) The following options to purchase shares of our common stock were outstanding at September 30, 1999, but were not included in the computation of diluted EPS: For the three months ended September 30, 1999: 4,830,000 shares at $130.94 per share expiring July 15, 2008 and 6,074,000 shares at $135.72 per share expiring July 15, 2009. For the nine months ended September 30, 1999: 6,074,000 shares at $135.72 per share expiring July 15, 2009. For the three and nine months ended September 30, 1998: 5,129,000 shares at $130.94 per share expiring July 15, 2008. The inclusion of such options using the treasury stock method would have an antidilutive effect on the diluted EPS calculation because the options' exercise price was greater than the average market price of our common shares for the respective period. (c) Weighted-average incremental shares for other stock awards include restricted stock and stock bonus awards. The related tax benefits are also considered. 23 24 21. COMMITMENTS AND CONTINGENT LIABILITIES Excluding mortgaged properties, assets on our "Consolidated balance sheet" of approximately $115.2 billion at September 30, 1999, were pledged as collateral for borrowings, to qualify for fiduciary powers, to secure public monies as required by law, and for other purposes. At September 30, 1999 we had commitments to enter into future resale and repurchase agreements totaling $5.4 billion and $4.2 billion, respectively. 22. FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with SFAS No. 107, Disclosures about Fair Value of Financial Instruments, we estimate the fair value of all on- and off-balance-sheet financial instruments. At September 30, 1999, the SFAS No. 107 aggregate net fair value for all financial instruments approximated the net carrying values on our "Consolidated balance sheet". At June 30, 1999, the aggregate net fair value for all financial instruments exceeded the associated net carrying values on our "Consolidated balance sheet" by $0.5 billion. The decrease from June 30, 1999 primarily related to long-term debt and our traditional credit products. The SFAS No. 107 fair value of a financial instrument is the current amount that would be exchanged between willing parties (other than in a forced sale or liquidation), and is best evidenced by a quoted market price, if one exists. Where quoted market prices are not available for financial instruments, fair values are estimated using internal valuation techniques including pricing models and discounted cash flows that may not be indicative of net realizable value. Beginning June 30, 1999, we refined the valuation technique used to estimate the fair value of our traditional credit products, which includes loans, commitments to extend credit, standby letters of credit, and guarantees, to better reflect how we currently manage these exposures. The revised technique utilizes a discounted cash flows approach which uses rates based on credit spreads in various markets including credit derivatives, asset swaps and bonds. Previously, we estimated the fair value of these products based on secondary loan spreads. 23. SEGMENTS We present our results based on the segments or activities as reviewed separately by the chief operating decision maker, our Chairman and Chief Executive Officer, as well as other members of senior management. Each segment is organized based on similar products and services we provide globally to our clients or activities we undertake solely for our own account. J.P. Morgan's segments or activities are: Investment Banking, Equities, Interest Rate and Foreign Exchange Markets, Credit Markets, Credit Portfolio, Asset Management Services, Equity Investments, and Proprietary Investing and Trading. In addition to the activities of our proprietary positioning group, the Proprietary Investing and Trading segment is comprised of a separately managed credit investment securities portfolio and our investment in Long-Term Capital Management, L.P. For purposes of presentation, we have grouped these segments into the sectors Global Finance, Asset Management Services, and Proprietary Investments. In connection with the signed letter of intent between J.P. Morgan and the Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe Cooperative, Morgan will end its role as operator and banker for the Euroclear system upon the formation of a successor bank to be owned by Euroclear (See note 4, "Business changes and developments"). Accordingly, segment results have been restated to reflect Euroclear-related revenues and expenses in Corporate Items. Previously, results related to our Asset Management and Euroclear activities were included in the sector titled Asset Management and Servicing. In addition, Credit Portfolio's results were restated in the second quarter of 1999 to reflect the segment's responsibility for managing the firm's allowances for credit losses as follows: provisions for credit losses, previously included in Corporate Items, are included in the segment, and the intercompany credit loss charge previously paid to Corporate Items in lieu of recording provisions, has been eliminated. All amounts in the following tables below have been restated to reflect our current reporting structure and policies. The assessment of segment performance by senior management includes a review of pretax income for each of the segments. Our management reporting system and policies were used to determine revenues and expenses attributable to each segment. Earnings on stockholders' equity were allocated based on management's estimate of the economic capital of each segment; economic capital levels are derived principally from an estimate of risk inherent in each segment. Overhead was applied based on management's estimate of overhead usage by each segment. Transactions between 24 25 segments are recorded within segment results as if conducted with a third party and eliminated in consolidation. The accounting policies of our segments are, in all material respects, consistent with those described in note 1, "Summary of Significant Accounting Policies," of our 1998 Annual report except for management reporting policies related to the tax-equivalent adjustment. The following table presents segment pretax income for the three months ended September 30, 1999, September 30, 1998 and June 30, 1999; and the nine months ended September 30, 1999 and 1998.
SUMMARY OF SEGMENT RESULTS - ------------------------------------------------------------------------------------------------------------------ Asset Interest Manage- Investment Rate and Credit Credit Global ment Equity In millions Banking Equities FX Markets Markets Portfolio Finance Services Investments - ------------------------------------------------------------------------------------------------------------------ THIRD QUARTER 1999 Total Revenues $310 $289 $331 $186(a) $269(b)(f) $1,385 $353 $341 Total Expenses 209 214 288 156 34 901 296 53 - ----------------------------------------------------------------------------------------------------------------- Pretax Income 101 75 43 30 235 484 57 288 - ----------------------------------------------------------------------------------------------------------------- THIRD QUARTER 1998 Total Revenues 238 141 348 (140)(a) 50(b)(g) 637 300 160 Total Expenses 166 162 280 77 42 727 272 15 - ----------------------------------------------------------------------------------------------------------------- Pretax Income 72 (21) 68 (217) 8 (90) 28 145 - ----------------------------------------------------------------------------------------------------------------- SECOND QUARTER 1999 Total Revenues 320 427 555 361(a) 152(b)(f) 1,815 343 13 Total Expenses 228 236 321 210 41 1,036 276 13 - ----------------------------------------------------------------------------------------------------------------- Pretax Income 92 191 234 151 111 779 67 - - ----------------------------------------------------------------------------------------------------------------- NINE MONTHS 1999 Total Revenues 888 1,004 1,548 1,243(a) 575(b)(h) 5,258 1,005 332 Total Expenses 647 680 968 625 120 3,040 836 80 - ----------------------------------------------------------------------------------------------------------------- Pretax Income 241 324 580 618 455 2,218 169 252 - ----------------------------------------------------------------------------------------------------------------- NINE MONTHS 1998 Total Revenues 736 520 1,583 462(a) 339(b)(g) 3,640 901 288 Total Expenses 526 578 971 537 109 2,721 833 39 - ----------------------------------------------------------------------------------------------------------------- Pretax Income 210 (58) 612 (75) 230 919 68 249 - -----------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------- Proprietary Investing Proprietary Corporate Consol- In millions Trading Investments Items(e) idated - ---------------------------------------------------------------------- THIRD QUARTER 1999 Total Revenues ($14)(c)(d) $327 ($80) $1,985 Total Expenses 37 90 54 1,341 - ---------------------------------------------------------------------- Pretax Income (51) 237 (134) 644 - ---------------------------------------------------------------------- THIRD QUARTER 1998 Total Revenues 147(c)(d) 307 57 1,301 Total Expenses 35 50 50 1,099 - ---------------------------------------------------------------------- Pretax Income 112 257 7 202 - ---------------------------------------------------------------------- SECOND QUARTER 1999 Total Revenues 44(c)(d) 57 (24) 2,191 Total Expenses 42 55 50 1,417 - ---------------------------------------------------------------------- Pretax Income 2 2 (74) 774 - ---------------------------------------------------------------------- NINE MONTHS 1999 Total Revenues 149(c)(d) 481 (77) 6,667 Total Expenses 112 192 257 4,325 - ---------------------------------------------------------------------- Pretax Income 37 289 (334) 2,342 - ---------------------------------------------------------------------- NINE MONTHS 1998 Total Revenues 514(c)(d) 802 108 5,451 Total Expenses 114 153 440 4,147 - ---------------------------------------------------------------------- Pretax Income 400 649 (332) 1,304 - ----------------------------------------------------------------------
(a) Revenues related to the structuring of tax-advantaged loans and structured credit products for Credit Portfolio were $5 million and $11 million for the three months ended September 30, 1999 and 1998, respectively, and $22 million for the three months ended June 30, 1999. For the nine months ended September 30, 1999 and 1998 these revenues were $45 million and $19 million, respectively. These amounts are eliminated in consolidation. (b) The adjustment to gross-up Credit Portfolio's revenue to a taxable basis was $7 million and $6 million for the three months ended September 30, 1999 and 1998, respectively, and $7 million for the three months ended June 30, 1999. These revenues were $20 million for each of the nine months ended September 30, 1999 and 1998, respectively. These amounts are eliminated in consolidation. (c) The adjustment to gross up the Proprietary Investing and Trading segment tax-exempt revenues to a taxable basis was $37 million and $33 million for the three months ended September 30, 1999 and 1998, respectively, and $30 million for the three months ended June 30, 1999. For the nine months ended September 30, 1999 and 1998 the adjustment was $105 million and $85 million, respectively. These amounts are eliminated in consolidation. (d) Total return revenues, which combine reported revenues and the change in net unrealized appreciation/depreciation, were ($110) million and $167 million for the three months ended September 30, 1999 and 1998, respectively, and $26 million for the three months ended June 30, 1999. Total return for the nine months ended September 30, 1999 and 1998 was ($1) million and $455 million, respectively. (e) We classify the revenues and expenses of Corporate Items into three broad categories: Recurring items not allocated to the segments - including recurring corporate items, unallocated net interest revenue, results of hedging anticipated net foreign currency revenues and expenses across all segments, corporate-owned life insurance, and equity earnings of certain affiliates. Recurring items included in revenues were ($97) million and ($18) million for the three months ended September 30, 1999 and 1998, respectively, ($30) million for the three months ended June 30, 1999, and ($86) million and ($190) million for the nine months ended September 30, 1999 and 1998, respectively. Nonrecurring items not allocated to the segments - includes gains on sales of businesses, revenues and expenses associated with businesses that have been sold or discontinued including revenues and expenses related to Euroclear activities, special charges, and other one-time corporate items. Nonrecurring revenues were $64 million and $130 million for the three months ended September 30, 1999 and 1998, respectively and $79 million for the three months ended June 30, 1999. Nonrecurring revenues were $199 million and $443 million for the nine months ended September 30, 1999 and 1998, respectively. Significant nonrecurring revenue items include the following: third quarter of 1998 pretax gain of $56 million related to the sale of the firm's investment management business in Australia; second quarter of 1998 pretax gain of $131 million related to the sale of the firm's global trust and agency services business. Nonrecurring expenses in the first quarter of 1998 include a charge of $215 million in connection with restructuring initiatives. Corporate items includes in revenues and expenses related to Euroclear activities as follows:
Third quarter Second quarter Nine months 1999 1998 1999 1999 1998 --------------------------------------------------- Total revenues $58 $83 $67 $187 $237 Total expenses 8 12 3 19 41 --------------------------------------------------- Pretax income 50 71 64 168 196
25 26 Consolidation and management reporting offsets - comprises offsets to certain amounts recorded in the segments, including the allocation of earnings on equity out of corporate items and into the segments, adjustments to bring segments to a tax-equivalent basis, and other management accounting adjustments. Consolidation and management reporting offset revenues were ($47) million and ($55) million for the three months ended September 30, 1999 and 1998, respectively, ($73) million for the three months ended June 30, 1999, and ($190) million and ($145) million for the nine months ended September 30, 1999 and 1998, respectively. (f) Includes a third quarter 1999 reversal of provision for credit losses of ($60) million. (g) Includes a third quarter 1998 provision for credit losses of $75 million. (h) Includes a third quarter 1999 reversal of provision for credit losses of ($60) million, and a second quarter 1999 net reversal of provision for credit losses of ($70) million. The following table presents segment assets at period end, as well as average period assets, for the nine months ended September 30, 1999, for the six months ended June 30, 1999, and for the year ended December 31, 1998.
Assets (a) - ------------------------------------------------------------------------------------------------ Asset Interest Manage- Rate and Credit Credit Global Ment Equity In billions Equities FX Markets Markets Portfolio Finance Services Investments - ------------------------------------------------------------------------------------------------ 1999 At September 30 $31 $122 $22 $15 $190 $9 $2 Average 35 123 26 16 200 10 1 1999 At June 30 34 126 26 16 202 10 1 Average 35 123 28 17 203 9 1 1998 At December 31 28 123 22 17 190 7 1 Average 31 137 31 21 220 7 1 - ------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------- Propriet- Propriet- ary- ary Investing Invest- Corporate In billions and Trading ments Items Total - ----------------------------------------------------------------------- 1999 At September 30 $41 $43 $13 $255 Average 46 47 7 264 1999 At June 30 47 48 9 269 Average 47 48 8 268 1998 At December 31 57 58 6 261 Average 51 52 4 283 - -----------------------------------------------------------------------
(a) The unrealized gains and losses related to derivatives contracts are reflected in the total assets of each respective business; however, the credit risks related to these exposures are primarily managed centrally by Credit Portfolio. 24. INTERNATIONAL OPERATIONS For financial reporting purposes, our operations are divided into domestic and international components. We believe that the method we have chosen to allocate our results among domestic and international sources, while inexact, is appropriate. Because our operations are highly integrated, we need to make estimates and assumptions to identify revenues and expenses by geographic region. The following is a summary of these assumptions: - - Client-focused revenues are assigned to the region managing the client relationship for a particular product. For investment banking activities, this is the client's head office; for most other products, it is the location where the activity is transacted. - - Market making revenues that cannot be specifically attributed to individual clients (for examples, gains or losses from positions taken to facilitate client transactions) are generally allocated based on the proportion of regional revenues. - - Revenues from proprietary investing and trading activities are based on the location of the risk-taker. - - Expenses are allocated based on the estimated cost associated with servicing the regions' client base. - - Earnings on stockholders' equity are mainly allocated based on each region's proportion of regional revenue, and adjustments are made for differences between domestic and international tax rates. 26 27 The results for the three and nine months ended September 30, 1999 and 1998 were distributed among domestic and international operations, as presented in the following table.
Income Pretax tax Net Total Total income/ expense/ income/ In millions revenues(a,j) expenses (loss) (benefit) (loss) - ------------------------------------------------------------------------------------------------------------------------ THIRD QUARTER 1999 Europe(b) $ 595(h) $ 437 $ 158 $ 63 $ 95 Asia Pacific 85(h) 145 (60) (24) (36) Latin America(c) 102(h) 35 67 27 40 - ----------------------------------------------------------------------------------------------------------------------- Total international operations 782 617 165 66 99 Domestic operations(d) 1,203(h) 724 479 136 343 - ----------------------------------------------------------------------------------------------------------------------- Total 1,985 1,341 644 202 442 - ----------------------------------------------------------------------------------------------------------------------- THIRD QUARTER 1998 Europe(b) 211 354 (143) (57) (86) Asia Pacific 138(e) 106 32 13 19 Latin America(c) 90 42 48 19 29 - ----------------------------------------------------------------------------------------------------------------------- Total international operations 439 502 (63) (25) (38) Domestic operations(d) 862 597 265 71 194 - ----------------------------------------------------------------------------------------------------------------------- Total 1,301 1,099 202 46 156 - ----------------------------------------------------------------------------------------------------------------------- NINE MONTHS 1999 Europe(b) 2,110(i) 1,317 793 318 475 Asia Pacific 408(i) 427 (19) (7) (12) Latin America(c) 751(i) 152 599 239 360 - ----------------------------------------------------------------------------------------------------------------------- Total international operations 3,269 1,896 1,373 550 823 Domestic operations(d) 3,398(i) 2,429 969 246 723 - ----------------------------------------------------------------------------------------------------------------------- Total 6,667 4,325 2,342 796 1,546 - ----------------------------------------------------------------------------------------------------------------------- NINE MONTHS 1998 Europe(b) 1,602(f) 1,371(g) 231 92 139 Asia Pacific 507(e) 396(g) 111 45 66 Latin America(c) 389 184 205 82 123 - ----------------------------------------------------------------------------------------------------------------------- Total international operations 2,498 1,951 547 219 328 Domestic operations(d) 2,953 2,196(g) 757 211 546 - ----------------------------------------------------------------------------------------------------------------------- Total 5,451 4,147 1,304 430 874 - -----------------------------------------------------------------------------------------------------------------------
(a) Includes net interest revenue and noninterest revenues. (b) Includes the Middle East and Africa. (c) Includes Mexico, Central America, and South America. (d) Includes the United States, Canada, and the Caribbean. Results relate substantially to United States operations for both years. (e) Includes 1998 third quarter net pretax gain of $56 million related to the sale of our investment management business in Australia. (f) Includes 1998 second quarter net pretax gain of $131 million related to the sale of our global trust and agency services business. (g) Total expenses include a 1998 first quarter $215 million pretax charge related to the restructuring of business activities which was recorded as follows: $116 million in Europe, $15 million in Asia Pacific, and $84 million in Domestic operations. (h) Includes 1999 third quarter reversal of provision for credit losses of ($60) million, which was recorded as follows: ($32) million in Europe, ($33) million in Asia Pacific, ($12) million in Latin America, and $17 million in Domestic operations. (i) Includes 1999 net reversal of provision for credit losses of ($130) million, which was recorded as follows: $(21) million in Europe, ($71) million in Asia Pacific, ($41) million in Latin America, and $3 million in Domestic operations. (j) Includes 1998 provisions for credit losses of $75 million, which was recorded as follows: $27 million in Europe, $6 million in Asia Pacific, $6 million in Latin America, and $36 million in Domestic operations. 27 28 PART I ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL HIGHLIGHTS J.P. Morgan today reported third quarter net income of $442 million, or $2.22 per share, up from $156 million, or $0.75 per share, in the third quarter of 1998. Return on equity was 15.6% in the quarter. Net income for the first nine months was $1.546 billion compared with $874 million in the first nine months of 1998. Earnings per share were $7.76 versus $4.28 a year ago. Year-to-date return on equity was 18.6%. The Board of Directors of J.P. Morgan also approved the purchase of up to $3 billion of J.P. Morgan common stock and announced its intention to increase the quarterly common stock dividend to $1.00 from $0.99 per share when it meets again in December. These actions reflect J.P. Morgan's strong business momentum and a significant improvement in capital productivity. Over the past seven quarters we have reduced by 50% the risk and capital needs of our credit portfolio, improved risk-taking efficiency in our markets activities, and implemented a wide-ranging productivity initiative. At the same time, our investment banking and equities activities have turned solidly profitable and the contribution of our asset management services business continues to grow. We remain committed to J.P. Morgan's strong capitalization and retain ample capital to pursue the numerous growth opportunities in our target markets. OTHER HIGHLIGHTS FOR THE THIRD QUARTER: - - Operating revenues of $1.985 billion were 59% ahead of last year - - Global Finance revenues of $1.385 billion reflect growth in advisory services and strong results in equities, while fixed income trading results were weaker - - Proprietary Investments revenues of $327 million were driven by results in Equity Investments - - Assets under management increased 18% from a year ago, to $323 billion - - Core expenses before bonuses for the nine months of 1999 were down by more than $330 million THIRD QUARTER RESULTS AT A GLANCE
Third quarter Second quarter - ---------------------------------------------------------------------------------------------------- In millions of dollars, except per share data 1999 1998 1999 - ---------------------------------------------------------------------------------------------------- Revenues $ 1,985 $ 1,301(a) $ 2,191 Operating expenses (1,341) (1,099) (1,417) Income taxes (202) (46) (270) - ---------------------------------------------------------------------------------------------------- Net income 442 156 504 Net income per share $ 2.22 $ 0.75 $ 2.52 Dividends declared per share $ 0.99 $ 0.95 $ 0.99 - ----------------------------------------------------------------------------------------------------
(a) Includes a gain of $56 million related to the sale of the firm's investment management business in Australia. OTHER DEVELOPMENTS Euroclear On September 1, 1999 J.P. Morgan and the Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe Cooperative announced the signing of a letter of intent to create a new, market-owned European bank to operate all aspects of the Euroclear System, the leading clearance and settlement system for internationally traded securities. Subject to a definitive agreement being reached, J.P. Morgan will remain operator of Euroclear until the successor bank is established, which is expected to take up to 18 months. After that, Morgan will remain an important participant and shareholder of Euroclear and retain a seat on its Board. The management and staff of Euroclear, numbering approximately 1,200 Morgan employees, will transfer to the new entity. Under the agreement in principle Morgan will continue to receive pretax banking income from Euroclear for three years following the signing of a definitive agreement. This income is subject to a minimum of $195 million and maximum of $295 million per year, whether it is earned by Morgan prior to the formation of the new bank or afterward by the new bank. After the new bank is formed, it will also pay Morgan for certain transition costs and for assets and know-how that are transferred to it. 28 29 SEGMENT ANALYSIS For the purposes of reporting our results, we divide our business segments or activities into three sectors: Global Finance, Asset Management Services, and Proprietary Investments. Reporting by sector helps simplify the presentation of complex, interrelated activities conducted in over thirty countries by over 15,000 people. The first two sectors - Global Finance and Asset Management Services - comprise the services we provide to clients. Proprietary Investments represent the activities we undertake exclusively for our own account. For a description of our business sectors and activities within each sector, refer to the J.P. Morgan & Co. Incorporated 1998 Annual report. Certain information and amounts have been restated to reflect management's current reporting structure - refer to note 23, "Segments," for more details. Presented below are the summary results for each sector for the three and nine months ended September 30, 1999 and 1998, and the three months ended June 30, 1999. SUMMARY OF SECTOR RESULTS
Interest Investment Rate and Credit Credit GLOBAL In millions Banking Equities FX Markets Markets Portfolio FINANCE - -------------------------------------------------------------------------------------------------------------- THIRD QUARTER 1999 Total Revenues $ 310 $ 289 $ 331 $ 186 $269 (a) $ 1,385 Total Expenses 209 214 288 156 34 901 - -------------------------------------------------------------------------------------------------------------- Pretax Income 101 75 43 30 235 484 - -------------------------------------------------------------------------------------------------------------- THIRD QUARTER 1998 Total Revenues 238 141 348 (140) 50 (b) 637 Total Expenses 166 162 280 77 42 727 - -------------------------------------------------------------------------------------------------------------- Pretax Income 72 (21) 68 (217) 8 (90) - --------------------------------------------------------------------------------------------------------------
ASSET MANAGE- Proprietary MENT Equity Investing PROPRIETARY CORPORATE CONSOL- In millions SERVICES Investments and Trading INVESTMENTS ITEMS (h) IDATED - --------------------------------------------------------------------------------------------------------- THIRD QUARTER 1999 Total Revenues $ 353 $ 341 ($ 14) $ 327 ($ 80) $ 1,985 Total Expenses 296 53 37 90 54 1,341 - --------------------------------------------------------------------------------------------------------- Pretax Income 57 288 (51) 237 (134) 644 - --------------------------------------------------------------------------------------------------------- THIRD QUARTER 1998 Total Revenues 300 160 147 307 57 (c) 1,301 Total Expenses 272 15 35 50 50 1,099 - --------------------------------------------------------------------------------------------------------- Pretax Income 28 145 112 257 7 202 - ---------------------------------------------------------------------------------------------------------
INCREASE / (DECREASE), THIRD QUARTER 1999 VS THIRD QUARTER 1998 Total Revenues 72 148 (17) 326 219 748 Total Expenses 43 52 8 79 (8) 174 - --------------------------------------------------------------------------------------------------------------- Pretax Income 29 96 (25) 247 227 574 - --------------------------------------------------------------------------------------------------------------- SECOND QUARTER 1999 Total Revenues 320 427 555 361 152 (d) 1,815 Total Expenses 228 236 321 210 41 1,036 - --------------------------------------------------------------------------------------------------------------- Pretax Income 92 191 234 151 111 779 - ---------------------------------------------------------------------------------------------------------------
Total Revenues 53 181 (161) 20 (137) 684 Total Expenses 24 38 2 40 4 242 - --------------------------------------------------------------------------------------------------------- Pretax Income 29 143 (163) (20) (141) 442 - --------------------------------------------------------------------------------------------------------- SECOND QUARTER 1999 Total Revenues 343 13 44 57 (24) 2,191 Total Expenses 276 13 42 55 50 1,417 - --------------------------------------------------------------------------------------------------------- Pretax Income 67 -- 2 2 (74) 774 - ---------------------------------------------------------------------------------------------------------
INCREASE / (DECREASE), THIRD QUARTER 1999 VS SECOND QUARTER 1999 Total Revenues (10) (138) (224) (175) 117 (430) Total Expenses (19) (22) (33) (54) (7) (135) - --------------------------------------------------------------------------------------------------------------- Pretax Income 9 (116) (191) (121) 124 (295) - --------------------------------------------------------------------------------------------------------------- NINE MONTHS 1999 Total Revenues 888 1,004 1,548 1,243 575 (e) 5,258 Total Expenses 647 680 968 625 120 3,040 - --------------------------------------------------------------------------------------------------------------- Pretax Income 241 324 580 618 455 2,218 - --------------------------------------------------------------------------------------------------------------- NINE MONTHS 1998 Total Revenues 736 520 1,583 462 339 (b) 3,640 Total Expenses 526 578 971 537 109 2,721 - --------------------------------------------------------------------------------------------------------------- Pretax Income 210 (58) 612 (75) 230 919 - ---------------------------------------------------------------------------------------------------------------
Total Revenues 10 328 (58) 270 (56) (206) Total Expenses 20 40 (5) 35 4 (76) - ---------------------------------------------------------------------------------------------------------- Pretax Income (10) 288 (53) 235 (60) (130) - ---------------------------------------------------------------------------------------------------------- NINE MONTHS 1999 Total Revenues 1,005 332 149 481 (77) 6,667 Total Expenses 836 80 112 192 257 4,325 - ---------------------------------------------------------------------------------------------------------- Pretax Income 169 252 37 289 (334) 2,342 - ---------------------------------------------------------------------------------------------------------- NINE MONTHS 1998 Total Revenues 901 288 514 802 108 (f) 5,451 Total Expenses 833 39 114 153 440 (g) 4,147 - ---------------------------------------------------------------------------------------------------------- Pretax Income 68 249 400 649 (332) 1,304 - ----------------------------------------------------------------------------------------------------------
INCREASE / (DECREASE), NINE MONTHS 1999 VS NINE MONTHS 1998 Total Revenues 152 484 (35) 781 236 1,618 Total Expenses 121 102 (3) 88 11 319 - ------------------------------------------------------------------------------------------------------------- Pretax Income 31 382 (32) 693 225 1,299 - -------------------------------------------------------------------------------------------------------------
Total Revenues 104 44 (365) (321) (185) 1,216 Total Expenses 3 41 (2) 39 (183) 178 - ------------------------------------------------------------------------------------------------------- Pretax Income 101 3 (363) (360) (2) 1,038 - -------------------------------------------------------------------------------------------------------
29 30 (a) Includes a third quarter 1999 reversal of provision for credit losses of ($60) million. (b) Includes a third quarter 1998 provision for credit losses of $75 million. (c) Includes a third quarter 1998 pretax gain of $56 million related to the sale of the firm's investment management business in Australia. (d) Includes a second quarter 1999 net reversal of provision for credit losses of ($70) million. (e) Includes a third quarter 1999 reversal of provision for credit losses of ($60) million, and a second quarter 1999 net reversal of provision for credit losses of ($70) million. (f) Includes a third quarter 1998 pretax gain of $56 million related to the sale of the firm's investment management business in Australia, and a second quarter 1998 pretax gain of $131 million related to the sale of the firm's global trust and agency services business. (g) Includes a first quarter 1998 pretax charge of $215 million related to restructuring of business activities. (h) Corporate Items includes revenues and expenses related to Euroclear activities, as follows:
Third Qtr. Third Qtr. Second Qtr. Nine Months Nine Months 1999 1998 1999 1999 1998 - ------------------------------------------------------------------------------------------ Total revenues $ 58 $ 83 $ 67 $187 $237 Total expenses 8 12 3 19 41 - ------------------------------------------------------------------------------------ Pretax income 50 71 64 168 196 - ------------------------------------------------------------------------------------
SECTOR RESULTS Revenues were $1.985 billion in the third quarter of 1999, up 59% from the 1998 period, excluding last year's $56 million gain on the sale of our Australian investment management business. Revenues from client-focused activities, reported in the Global Finance and Asset Management Services sectors, increased 85% to $1.738 billion. Revenues from Proprietary Investments were $327 million versus $307 million a year ago. GLOBAL FINANCE revenues of $1.385 billion more than doubled over the third quarter of 1998, which was affected by extreme market dislocations. - - Investment Banking revenues of $310 million were up 30% from last year's quarter. Advisory services, equity capital markets services, and derivative origination activities continued to expand with clients across a diverse range of industries. Advisory revenues surpassed both last year's quarter and the second quarter of 1999. For the first nine months of 1999, Thomson Financial Securities Data Corporation ranked J.P. Morgan 6th in completed mergers and acquisitions volume worldwide with a 13.1% market share. - - Equities revenues of $289 million increased $148 million from last year. Both cash and equity derivative results increased. Equity underwriting revenues increased as we continued to grow market share - J.P. Morgan ranked 6th in U.S. equity lead underwriting with a 5.5% market share for 1999 and commission revenues were more than 20% above last year on higher market share. Equity derivative revenues more than doubled from a year ago when results were affected by sharp increases in volatility and illiquid markets, but were down from the second quarter. - - Interest Rate and Foreign Exchange Markets revenues of $331 million reflect very strong derivative client activity across all regions, combined with weaker trading results. Interest Rate Markets revenues rose over last year as we continued to expand our derivative client franchise, but declined from the second quarter 1999 due to weaker trading results primarily associated with illiquid European markets early in the quarter. Foreign Exchange revenues, while stable through 1999, were down from a very strong third quarter a year ago. - - Credit Markets revenues of $186 million were achieved in a difficult environment that reflected concerns over interest rate increases and widening spreads, especially for lower-rated securities. Lower issuer and investor demand for most instruments reduced overall volumes meaningfully in the quarter, which led to a 48% decline in revenues versus the second quarter. In last year's quarter, severe market dislocations resulted in losses of $140 million. - - Credit Portfolio had revenues of $269 million compared to $152 million in the previous quarter and $50 million in the same quarter a year ago. Improving credit default swap spreads on higher-rated counterparties and continuing refinements in measuring and managing credit risk associated with derivative exposures contributed to revenues during the quarter. Ongoing improvement in credit markets and the lowering of certain emerging markets exposures in our traditional credit portfolio resulted in a $60 million reduction (i.e., income) in the allowances for credit losses after charge-offs and recoveries. The economic capital requirement of our credit portfolio has declined by 50% from December 31, 1997, in line with our previously announced target. 30 31 ASSET MANAGEMENT SERVICES revenues increased 18% to $353 million versus last year, reflecting asset growth, a shift towards higher-fee alternative investment disciplines, and performance fees. Assets under management rose 18% to $323 billion, driven by market appreciation and new business from defined benefit plans and private clients. Assets under management from private clients increased 16% to $72 billion. PROPRIETARY INVESTMENTS revenues were $327 million, up 7%. - - Equity Investments, which represents equity portfolio management for Morgan's own account, reported revenues of $341 million in the third quarter, compared with $160 million a year ago. The increase was mostly attributable to investments in the cable television and telecommunications industries, partially offset by write-downs that primarily related to an investment in the insurance industry. - - Proprietary Investing and Trading reported a loss of $14 million compared to a gain of $147 million last year. Total return - reported revenues and the change in net unrealized value - was a loss of $110 million compared with a gain of $167 million. The lower results were driven primarily by our U.S. government agency investment portfolio and our positioning activities in Asia. CORPORATE ITEMS had negative revenues of $80 million, including $58 million of positive revenues from activities related to Euroclear. Revenues are $56 million lower than the second quarter and $137 million lower than last year, mainly due to the change in the value of hedges of the firm's anticipated net foreign currency revenues and expenses. These hedging results are partially offset by the impact of exchange rate movements on revenues and expenses reported in the business segments. Additionally, in the third quarter of 1998, we recognized a $56 million gain on the sale of our investment management business in Australia. FINANCIAL REVIEW REVENUES Revenues were $1.985 billion in the third quarter of 1999, up 59% from the 1998 period, excluding last year's $56 million gain on the sale of our Australian investment management business. Revenues were down 10% or $206 million from the second quarter of 1999. Excluding gains on business sales (See note 4, Business changes and developments), revenues for the first nine months of 1999 were $6.667 billion up 27% over the same period a year ago. Net interest revenue represents the aggregate of interest revenue and expense generated from the firm's client-focused and proprietary activities using a variety of asset, liability, and off-balance-sheet instruments. Excluding loan loss provisions/reversals, third quarter 1999 net interest revenue was $389 million compared to $332 million in the year ago quarter. This increase resulted primarily from higher net interest revenue from activities in our Interest Rate and Foreign Exchange Markets, Credit Markets and Credit Portfolio segments. Third quarter 1999 included a $45 million negative provision to reduce the allowance for loan losses reflecting ongoing improvements in credit markets and the lowering of certain emerging markets exposures in our traditional credit portfolio. This compares to a $25 million provision to increase the allowance in the prior year quarter. Excluding loan loss provisions/reversals, net interest revenue for the first nine months of 1999 was $1.203 billion, compared with $958 million for the first nine months of 1998. Year to date September 30, 1999 included negative provisions to reduce the allowance for loan losses of $150 million, versus a provision for loan losses of $25 million in the same period a year ago. Total trading revenue was $424 million in the third quarter of 1999 versus only $69 million in the third quarter of 1998, which was impacted by severe market dislocations. The increase was driven by higher trading revenues in our Global Finance sector primarily in our Equities, Credit Markets and Credit Portfolio segments. These results were partially offset by lower revenue in our Proprietary Investments sector. Compared to the second quarter of 1999, total trading revenue declined 47% or $379 million on lower results, primarily in our Interest Rate and Foreign Exchange Markets, Credit Markets and Equities segments. Year-to-date trading revenues increased to $2.361 billion from $1.842 billion for the first nine months of 1999. 31 32 Investment banking revenue grew 28% to $398 million in the third quarter of 1999 from $312 million in the third quarter of 1998, reflecting growth with clients across a diverse range of industries. Underwriting revenue grew 69% to $140 million, and advisory and syndication fees rose 13% to $258 million. For the first nine months of 1999, Thomson Financial Securities Data Company Inc. ranked J.P. Morgan sixth in completed merger and acquisitions worldwide, with a market share of 13.1%. Investment banking revenue for the first nine months of 1999 increased 22% to $1.245 billion, over the same 1998 period. Investment management revenue increased 21% to $270 million in the 1999 third quarter from a year ago. Assets under management were $323 billion at September 30, 1999, compared with $274 billion a year ago; the increase reflected net new business and market appreciation. For the first nine months of 1999, investment management revenue was $776 million, an increase of 17% over the prior year period. Fees and commissions were $206 million, up 13% from $182 million in the year-ago quarter, driven by lower fees paid to credit derivative providers and to a lesser extent higher equity commissions. For the year to date, fees and commissions were $611 million compared to $569 million in the same 1998 period. Investment securities revenue was $271 million in the third quarter of 1999, compared to $136 million in the third quarter of 1998 and a loss of $29 million in the second quarter of 1999. This increase reflects gains from investments in the cable television and telecommunications industries, partially offset by write-downs that primarily related to an investment in the insurance industry. For the current nine-month period, investment securities revenue was $201 million versus $247 million for the first nine months of 1998. Other revenue was negative (loss) $18 million in the third quarter of 1999, compared with revenue of $71 million a year earlier. For the third quarter of 1999, other revenue includes $45 million of losses on hedges of anticipated foreign currency revenues. These losses were partially offset by the impact of exchange rate movements on reported revenues and expenses in the respective period. Other revenue also included a $15 million negative provision to reduce the allowance for credit losses on lending commitments. For the three months ended September 30, 1998, other revenue includes a $56 million net gain on the sale of the firm's investment management business in Australia. Other revenue for the first nine months of 1999 was $120 million, compared with $179 million for the first nine months of 1998. OPERATING EXPENSES Operating expenses were $1.341 billion, an increase of 22% from the same period a year ago. Non-compensation operating expenses were 15% lower this quarter as we continued our focus on productivity. Compensation expenses rose as a result of increased bonus accruals. The firm's efficiency ratio was 68% in the third quarter. Costs associated with preparation for the Year 2000 were $9 million for the third quarter, down from $45 million last year, which also included preparation for European Economic and Monetary Union. For the first nine months of 1999, costs of preparation for the Year 2000 and European Economic and Monetary Union were $47 million, down from $155 million a year ago. Third quarter 1999 software costs of $37 million were capitalized rather than recorded as expenses because of a change in accounting rules and are not included in the 1999 expenses. For the nine months ended September 30, 1999, $103 million of software costs were capitalized. Operating expenses for the first nine months of 1999 were $4.325 billion. Before bonus accruals and excluding the effect of software capitalization, this represents a reduction of more than $330 million compared with the first nine months of last year. At September 30, 1999, staff totaled 15,287 employees, compared with 14,902 at June 30, 1999, 15,674 at December 31, 1998 and 16,155 employees at September 30, 1998. Income-tax expense in the third quarter totaled $202 million, based on an effective tax rate of 31%, compared with $46 million in the year-earlier quarter. The increase in expense reflects higher pretax income. ASSETS Total assets were $255 billion at September 30, 1999, compared with $269 billion at June 30, 1999 and $261 billion at December 31, 1998. 32 33 ASSET QUALITY IMPAIRED LOANS
September 30, June 30, December 31, In millions: 1999 1999 1998 (a) - ----------------------------------------------------------------------------------------- Commercial and industrial $ 131 $ 38 $ 25 Other 38 29 97 - ------------------------------------------------------------------------------------ Total impaired loans 169 67 122 - ------------------------------------------------------------------------------------
(a) Certain reclassifications were made to conform with the categorization used in Bank regulatory filings. Impaired loans were $169 million at September 30, 1999 versus $67 million at June 30, 1999. The increase in "Commercial and industrial" impaired loans during the third quarter of 1999 primarily relates to newly classified loans in the Latin American steel industry. ALLOWANCES FOR CREDIT LOSSES We maintain allowances for credit losses to absorb losses inherent in our traditional extensions of credit that we believe are probable and that can be reasonably estimated. These allowances include an allowance for loan losses and an allowance for credit losses on lending commitments, which include commitments to extend credit, standby letters of credit, and guarantees. In determining the appropriate size of our allowances, we make use of our historical experience over the course of past credit cycles. We believe our use of past credit cycle experience is appropriate because our current portfolio is similar to that of the past: institutionally based, with significant emerging market exposures. Our experience has shown that credit losses, when they occur, are significant and highly correlated, particularly across emerging markets. The actual amount of credit losses realized may vary from estimated losses at each period end, due to improved economic conditions or successful management of our credit exposures, resulting in lower net charge-offs than expected. Our process includes procedures to limit differences between estimated and actual credit losses, which include detailed quarterly assessments by senior management and model adjustments to reflect current market indicators of credit quality. In March 1999, a Joint Working Group, comprised of banking and securities regulators, was formed to provide clarification to the banking industry regarding the appropriate accounting, disclosure, and documentation requirements for allowances for credit losses. We are in the process of reviewing our model for estimating credit losses and determining the appropriate level of our allowances, with the goal of refining it based on our review, which will incorporate any guidance issued by the Joint Working Group. The following table summarizes the activity of our allowances for credit losses for the three and nine months ended September 30, 1999 and 1998.
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON LOAN LOSSES LENDING COMMITMENTS - -------------------------------------------------------------------------------------------------------------- Third Third Third Third quarter quarter quarter quarter In millions 1999 1998 1999 1998 - ---------------------------------------------------------------------------------------------------------- BEGINNING BALANCE, JULY 1 $ 335 $ 392 $ 160 $ 185 - ------------------------------------------------------------------------------------------------------- Provision for credit losses -- 25 -- -- Reversal of provision for credit losses (45) -- (15) -- - ------------------------------------------------------------------------------------------------------- Recoveries: 17 4 -- -- Charge-offs: Commercial and industrial (6) (6) -- -- Banks -- (5) -- -- Other -- (6) -- -- - ------------------------------------------------------------------------------------------------------- Net recoveries/(charge-offs) 11 (13) -- -- - ------------------------------------------------------------------------------------------------------- ENDING BALANCE, SEPTEMBER 30 301 404 145 185 - -------------------------------------------------------------------------------------------------------
33 34
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON LOAN LOSSES LENDING COMMITMENTS - ------------------------------------------------------------------------------------------------------------------ Nine months Nine months Nine months Nine months In millions 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------ BEGINNING BALANCE, JANUARY 1 $ 470 $ 546 $ 125 $ 185 - ------------------------------------------------------------------------------------------------------------ Provision for credit losses -- 25 35 -- Reversal of provision for credit losses (150) -- (15) -- - ------------------------------------------------------------------------------------------------------------ Reclassifications (a) -- (50) -- -- - ------------------------------------------------------------------------------------------------------------ Recoveries: 23 13 -- -- Charge-offs: Commercial and industrial (16) (40) -- -- Banks (1) (66) -- -- Other, primarily financial institutions in 1999 (25) (24) -- -- - ------------------------------------------------------------------------------------------------------------ Net charge-offs (19) (117) -- -- - ------------------------------------------------------------------------------------------------------------ ENDING BALANCE, SEPTEMBER 30 301 404 145 185 - ------------------------------------------------------------------------------------------------------------
(a) Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across balance sheet reserve or allowance captions - which included an adjustment for trading derivatives needed to determine fair value, an allowance for loan losses, and an allowance for credit losses which include commitments to extend credit, standby letters of credit, and guarantees - were shown as reclassifications. Reclassifications had no impact on net income and, accordingly, were not shown on the income statement. Subsequent to July 1, 1998, reclassifications across balance sheet captions for allowances are reflected as provisions and reversals of provisions in the "Consolidated statement of income." The following table displays our allowances for credit losses by component at September 30, 1999, June 30, 1999, and December 31, 1998.
ALLOWANCE FOR ALLOWANCE FOR CREDIT LOSSES ON LENDING LOAN LOSSES COMMITMENTS - ------------------------------------------------------------------------------------------------------------------- September 30, June 30, December 31, September 30, June 30, December 31, In millions: 1999 1999 1998 1999 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Specific counterparty $ 32 $ 14 $ 34 $ 23 $ 20 $ 3 Specific country 24 32 93 1 3 30 Expected loss (b) 245 289 343 121 137 92 - --------------------------------------------------------------------------------------------------------------- Total 301 335 470 145 160 125 - ---------------------------------------------------------------------------------------------------------------
(b) The general component of our allowances for credit losses is used to estimate the impact of separately identified limitations in our expected loss model. Beginning in the second quarter of 1999, the general component is included as part of the expected loss component for disclosure purposes since all factors used to derive the general component relate to the expected loss component. Prior period amounts have been reclassified. Ongoing improvements in credit markets and the lowering of certain emerging markets exposures in our traditional credit portfolio resulted in a $60 million reduction in the allowances for credit losses, before net recoveries of $11 million during the third quarter of 1999. The negative provision (revenue) of $60 million included negative provisions of $45 million for loan losses and $15 million for credit losses on lending commitments. The allowance for loan losses was $301 million at September 30, 1999, compared with $335 million at June 30, 1999. The allowance for credit losses on lending commitments was $145 million at September 30, 1999, compared to $160 million at June 30, 1999, respectively. The specific counterparty component of the allowance for loan losses, which represents the SFAS No. 114 impairment reserve, was $32 million and $14 million at September 30, 1999 and June 30, 1999, respectively. The increase in the specific counterparty component from the prior quarter primarily reflects the addition of counterparty allocations in the Latin American steel industry. The specific counterparty component of the allowance for credit losses on lending commitments was $23 million at September 30, 1999, compared with $20 million at June 30, 1999. The specific country component focuses on countries experiencing financial stress. The loss estimates for each country were determined by management by applying a percentage loss estimate on a "tiering of risk basis" (e.g. different loss estimates based on whether exposures are sovereigns versus corporates or cross-border versus local). To determine these estimates, management utilized historical loss experience and secondary market data, where applicable. The specific country component of the allowance for loan losses decreased to $24 million at September 30, 1999 from $32 million at 34 35 June 30, 1999. Countries included in the specific country component of the allowance for loan losses at September 30, 1999 were Brazil and Indonesia - consistent with June 30, 1999. The decrease in the specific country component of the allowance for loan losses reflects continued improvement in Brazil's credit market conditions, as well as a reduction in loan exposures. The specific country allocation of the allowance for credit losses on lending commitments represents an allocation for Indonesia at both September 30, 1999 and June 30, 1999. The expected loss component, which includes the general component, is an estimate, based on statistical modeling, of the probable loss inherent in our existing performing portfolio of traditional credit products, net of recoveries. The general component of our allowances for credit losses is used to estimate the impact of separately identified limitations in our expected loss model. Beginning in the second quarter of 1999, the general component is included as part of the expected loss component for disclosure purposes since all factors used to derive the general component relate to the expected loss component. Prior period amounts have been reclassified to conform with this presentation. In determining the appropriate level of the general component, loss estimates related to our emerging market exposures, excluding Brazil and Indonesia which are covered by the specific country component, were adjusted to reflect the credit pricing inherent in bond spreads in emerging markets, as well as regional estimates of recovery. This adjustment was made to compensate for the fact that our expected loss model utilizes default and recovery statistics that are based on U.S. corporate experience, which do not match the risks associated with exposures in emerging markets. In addition, the general component is needed to adjust the results produced by our expected loss model to reflect facility draw-down percentages upon default that we believe are more reflective of historical and industry experience. The expected loss component of the allowance for loan losses decreased to $245 million at September 30, 1999 from $289 million at June 30, 1999. The expected loss component of the allowance for credit losses on lending commitments was $121 million at September 30, 1999, compared with $137 million at June 30, 1999. The decrease in the expected loss component in the allowances primarily reflects improved credit conditions during the year in emerging markets as indicated by an overall improvement in bond spreads in these regions. 35 36 EXPOSURES TO EMERGING COUNTRIES The following tables present exposures to certain emerging markets based on management's view of total exposure as of September 30, 1999. The management view takes into account the following cross-border and local exposures: the notional or contract value of loans, commitments to extend credit, securities purchased under agreements to resell, interest-earning deposits with banks; the fair values of trading account assets (cash securities and derivatives, excluding any collateral we hold to offset these exposures) and investment securities; and other monetary assets. It also considers the impact of credit derivatives, at their notional or contract value, where we have bought or sold credit protection outside of the respective country. Trading assets reflect the net of long and short positions of the same issuer. Management's view differs from bank regulatory rules, which are established by the Federal Financial Institutions Examination Council (FFIEC), because of its treatment of credit derivatives, trading account short positions, and the use of fair values versus cost of investment securities. In addition, management does not net local funding or liabilities against local exposures as allowed by the FFIEC. By type of financial instrument
Credit Total In billions Deriva- Other out- deriva- Commit- cross- Local Total September 30, 1999 Loans tives standings tives ments border exposure exposure - ----------------------------------------------------------------------------------------------------------------------------------- China $ -- $0.1 $ -- ($0.1) $ -- $ -- $ -- $ -- Hong Kong 0.2 0.5 0.4 ( 0.2) 0.2 1.1 0.3 1.4 Indonesia 0.1 -- -- -- 0.1 0.2 -- 0.2 Malaysia -- -- -- 0.1 -- 0.1 -- 0.1 Philippines -- -- 0.1 -- -- 0.1 -- 0.1 Singapore -- 0.4 0.1 (0.1) -- 0.4 0.1 0.5 South Korea 0.2 0.8 0.4 (0.3) -- 1.1 0.5 1.6 Taiwan -- -- -- -- -- -- -- -- Thailand -- 0.1 0.1 0.1 -- 0.3 -- 0.3 Other -- -- -- -- -- -- 0.2 0.2 - --------------------------------------------------------------------------------------------------------------------------------- Total Asia, excluding Japan(a) 0.5 1.9 1.1 (0.5) 0.3 3.3 1.1 4.4 - --------------------------------------------------------------------------------------------------------------------------------- Argentina 0.1 0.1 0.8 (0.5) -- 0.5 0.4 0.9 Brazil 0.2 -- 0.3 -- -- 0.5 1.1 1.6 Chile 0.4 -- -- -- -- 0.4 -- 0.4 Colombia 0.2 -- 0.1 -- -- 0.3 -- 0.3 Mexico 0.4 0.4 0.4 (0.3) -- 0.9 0.3 1.2 Other 0.2 -- 0.3 -- 0.1 0.6 -- 0.6 - --------------------------------------------------------------------------------------------------------------------------------- Total Latin America, 1.5 0.5 1.9 (0.8) 0.1 3.2 1.8 5.0 excluding the Caribbean - ---------------------------------------------------------------------------------------------------------------------------------
By type of counterparty
In billions Govern- September 30, 1999 Banks ments Other Total - ----------------------------------------------------------------------------------------- China $ -- $ -- $ -- $ -- Hong Kong 0.6 0.2 0.6 1.4 Indonesia -- -- 0.2 0.2 Malaysia 0.1 -- -- 0.1 Philippines -- -- 0.1 0.1 Singapore 0.4 -- 0.1 0.5 South Korea 0.4 0.9 0.3 1.6 Taiwan -- -- -- -- Thailand 0.2 -- 0.1 0.3 Other -- 0.2 -- 0.2 - ----------------------------------------------------------------------------------------- Total Asia, excluding Japan(a) 1.7 1.3 1.4 4.4 - ----------------------------------------------------------------------------------------- Argentina -- 0.4 0.5 0.9 Brazil 0.4 0.9 0.3 1.6 Chile -- -- 0.4 0.4 Colombia -- 0.1 0.2 0.3 Mexico -- 0.4 0.8 1.2 Other -- 0.2 0.4 0.6 - ----------------------------------------------------------------------------------------- Total Latin America, excluding the 0.4 2.0 2.6 5.0 Caribbean - -----------------------------------------------------------------------------------------
(a) Total exposures to Japan, based upon management's view, were $3.8 billion at September 30, 1999. Total exposures to South Africa, based upon management's view, were $1.9 billion at September 30, 1999. 36 37 CAPITAL STOCKHOLDERS' EQUITY Total stockholders' equity was approximately $12.0 billion at September 30, 1999. Stockholders' equity included approximately $108 million of net unrealized depreciation on debt investment securities and marketable equity investment securities, net the related deferred tax benefit of $89 million. This compares with $52 million of net unrealized depreciation at June 30, 1999, net of the related tax benefit of $49 million. The net unrealized depreciation on debt investment securities was $274 million at September 30, 1999, compared with a net unrealized depreciation of $169 million at June 30, 1999. The decline in debt investment securities primarily related to decreases in the value of U.S. government and agency securities reflecting the negative effect of a rise in Treasury yields. The net unrealized appreciation on marketable equity investment securities was $76 million at September 30, 1999, and $68 million at June 30, 1999. Included in the table below are selected ratios based upon stockholders' equity.
September 30, June 30, December 31, September 30, Dollars in billions, except share data 1999 1999 1998 1998 - --------------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity $ 12.0 $ 11.8 $ 11.3 $ 11.5 - ---------------------------------------------------------------------------------------------------------------------------- Rate of return on average common stockholders' equity (a) 18.6% 20.1% 8.6% 10.3%(b) - ---------------------------------------------------------------------------------------------------------------------------- As percent of period-end total assets: Common equity 4.4% 4.1% 4.0% 3.6% Total equity 4.7% 4.4% 4.3% 3.9% Book value per common share (c) $58.42 $57.60 $55.01 $56.22 - ----------------------------------------------------------------------------------------------------------------------------
(a) Represents the rate of return on average common stockholders' equity annualized based on the year-to-date results for the nine months ended September 30, 1999, six months ended June 30, 1999, year ended December 31, 1998, and nine months ended September 30, 1998. Excluding the impact of SFAS No. 115, the annualized rate of return on average common stockholders' equity would have been 18.6%, 20.2%, 8.8%, and 10.8% for the nine months ended September 30, 1999, six months ended June 30, 1999, twelve months ended December 31, 1998, and nine months ended September 30, 1998, respectively. (b) Excluding the 1998 second quarter after tax gain of $79 million related to the sale of the firm's global trust and agency securities business, the 1998 third quarter after tax gain of $34 million related to the sale of the firm's investment management business in Australia, and the 1998 first quarter after tax charge of $129 million related to the restructuring of business activities, the annualized rate of return on average common stockholders' equity was 10.5% (including the impact of SFAS No. 115) and 11.0% (excluding the impact of SFAS No. 115) for the nine months ended September 30, 1998. (c) Excluding the impact of SFAS No. 115, the book value per common share would have been $58.99, $57.87, $54.24, and $54.70 at September 30, 1999, June 30, 1999, December 31, 1998, and September 30, 1998, respectively. During the third quarter of 1999, the firm purchased approximately $235 million shares of its common stock or 1.9 million shares, for a total of $682 million or 5.3 million shares in the first nine months of 1999. These purchases are part of the December 1998 authorization to repurchase $750 million of common stock subject to market conditions and other factors. These purchases may be made periodically in 1999 or beyond in the open market or through privately negotiated transactions. As previously mentioned, the Board of Directors approved the purchase of up to $3 billion of J.P. Morgan common stock and announced its intention to increase the quarterly common stock dividend to $1.00 from $0.99 per share when it meets again in December. Refer to Financial Highlights for further information. REGULATORY CAPITAL REQUIREMENTS At September 30, 1999, the capital of J.P. Morgan and Morgan Guaranty Trust Company of New York (Morgan Guaranty) remained well above the minimum standards set by regulators. Further, the capital ratios of J.P. Morgan and Morgan Guaranty exceeded the minimum standards for a well capitalized bank holding company and bank, respectively, at September 30, 1999. At September 30, 1999, under the Federal Reserve Board market risk capital guidelines for calculation of risk-based capital ratios, J.P. Morgan's tier 1 and total risk-based capital ratios were 9.1% and 13.2%, respectively; the leverage ratio was 4.8%. At June 30, 1999, J.P. Morgan's tier 1 and total risk-based capital ratios were 8.4% and 12.5%, respectively, and the leverage ratio was 4.5%. At December 31, 1998, J.P. Morgan's tier 1 and total risk-based capital ratios were 8.0% and 11.7%, respectively, and the leverage ratio was 3.9%. Refer to note 18, Capital Requirements, for further information. 37 38 Risk-adjusted assets represent the total of all on- and off-balance sheet exposures adjusted for risk-based factors as prescribed by the Federal Reserve Board. J.P. Morgan's risk-adjusted assets as of September 30, 1999 were $134.9 billion, compared with $142.5 billion at June 30, 1999. At December 31, 1998, risk-adjusted assets were $140.2 billion. FORWARD-LOOKING STATEMENTS Certain sections of our Form 10-Q contain forward-looking statements. We use words such as "expects," "believe," "anticipate," and "estimate" to identify these statements. In particular, disclosures made in Financial Highlights, Financial Review and The year 2000 initiative contain forward-looking statements. Such statements are based on our current expectations and are subject to various risks and uncertainties as discussed in the Business environment and other information and Risk management sections of our 1998 Annual report. Actual results could differ materially from those currently anticipated due to a number of variables in addition to those discussed elsewhere in this document and in the firm's other public filings, press releases and discussions with management, including: - - economic and market conditions (including the liquidity of secondary markets) - - volatility of market prices, rates, and indices - - timing and volume of market activity - - availability of capital - - inflation - - political events (including legislative, regulatory, and other developments) - - competitive forces (including the ability to attract and retain highly skilled individuals) - - the ability to develop and support technology and information systems - - investor sentiment. As a result of these variables, revenues and net income in any particular period may: - - not be indicative of full-year results - - vary from year to year - - impact the firm's ability to achieve its strategic objectives J.P. Morgan claims the protection afforded by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. 38 39 RISK MANAGEMENT Risk is inherent in our business, and sound risk management is key to our success. We have developed and implemented comprehensive policies and procedures to identify, mitigate, and monitor risk across the firm. These practices rely on constant communication, judgment, and knowledge of products and markets by the professionals closest to them, combined with regular oversight by a central risk management group and senior management. The major types of risk to which we are exposed are: - - Market risk: the possibility of loss due to changes in market prices and rates, the correlations among them, and their levels of volatility - - Credit risk: the possibility of loss due to changes in the quality of counterparties, the correlations among them, and the market prices for credit risk assets. We are subject to credit risk in our lending activities, sales and trading activities, and derivative activities and when we act as an intermediary on behalf of clients and other third parties. - - Liquidity risk: the risk of being unable to fund our portfolio of assets at reasonable rates and to appropriate maturities - - Operating risk: the potential for loss arising from breakdowns in policies and controls for ensuring the proper functioning of people, contracts, systems, and facilities Our risk management processes are built on a foundation of early identification and measurement. They are regularly reviewed and modified as our business changes in response to market, credit, product, and other developments. We constantly seek to strengthen our risk management process. Further, we mitigate our exposure to losses from unexpected events by diversifying our activities across instruments, markets, clients and geographic regions. Please refer to our 1998 Annual report for a detailed discussion of how we manage risk. MARKET RISK Market risk arises from trading and investing in both our client-focused and proprietary activities. Our ability to estimate potential losses that could arise from adverse changes in market conditions is a key element of managing market risk. While quantitative measures are integral to our process, judgment and experience are crucial in assessing whether our level of market risk is acceptable. In particular when markets experience extreme conditions, we continue to use our tools to quantify our risks but rely on management's judgment to interpret and gauge the impact that extreme changes in volatility and market correlations can have on positions that, in normal markets, are estimated to be low-risk. Our primary tool for the systematic measuring and monitoring of market risk is the Daily Earnings at Risk (DEaR) calculation. DEaR is an estimate, at a 95% confidence level, of the worst expected loss in the value of our portfolios over a one-day time horizon. The DEaR measure makes assumptions about market behavior and takes into account numerous variables that may cause a change in the value of our portfolios, including interest rates, foreign exchange rates, equity and commodity prices and their volatilities, and correlations among these variables. Effective June 30, 1999, we enhanced our measurement of DEaR to incorporate credit risk related to counterparty exposure in our trading derivatives portfolio. We began to measure the credit risk embedded in derivative trading exposures based on market prices for credit risk. Previously, these exposures were measured using a combination of historical default experience derived from credit rating agencies and other fair value adjustments. We continue to refine our risk measurement and reporting methodology. Prior period amounts have not been restated due to data limitations. As a result, DEaR for the twelve months ended September 30, 1999 has been presented in accordance with our previous risk measurement methodology. The level of market risk, which is measured on a diversified basis, will vary with market factors, the level of client activity, and price and market movements. Quarterly trading and proprietary investing DEaR Firm-wide market and credit risk DEaR for our trading activities approximated $33 million at September 30, 1999 versus $45 million at June 30, 1999. This reflects, before diversification benefits, market risk DEaR of $26 million at September 30, 1999 ($27 million at June 30, 1999) and derivative credit risk DEaR of approximately $20 million at September 30, 1999 ($35 million at June 30, 1999). The decrease in credit risk DEaR reflects greater use of credit derivatives to reduce overall portfolio risk levels, as well as methodology enhancements. DEaR for our proprietary investing activities, which consists largely of U.S. government agency securities, was $24 million at September 30, 1999, versus $30 million at June 30, 1999. 39 40 Twelve-month market risk profile DEaR for trading activities Average DEaR for our trading activities, excluding credit risk related to derivative counterparty exposure as previously discussed, was $32 million and ranged from $19 million to $48 million for the twelve months ended September 30, 1999. For the twelve months ended December 31, 1998, average DEaR for trading activities was $38 million and ranged from $27 million to $55 million. We evaluate the reasonableness of DEaR for our trading activities by comparing actual daily revenue to estimates predicted by our models. During the twelve months ended September 30, 1999, daily revenue fell short of the downside DEaR band (average daily revenue less the DEaR estimate) by more than the expected frequency or greater than 5% of the time. This primarily resulted from a combination of extreme market conditions experienced in the latter half of 1998 and higher average trading revenue in 1999. Our primary market risk exposures in our trading activities: The twelve month average and period-end DEaR for September 30, 1999 and December 31, 1998, segregated by type of market risk exposure associated with our trading activities, is presented in the table below.
- ---------------------------------------------------------------------------------------------------------------------- Twelve months ended Period-end (Average) ------------------------------------ ---------------- ----------------------- September 30, December 31, September 30, December 31, In millions 1999 1998 1999 1998 - ---------------------------------------------------------------------------------------------------------------------- Interest rate risk $27 $30 $20 $31 Foreign exchange rate risk 9 18 7 11 Equity price risk 8 12 2 12 Commodity price risk 2 3 - 3 Diversification effects (14) (25) (3) (22) - ---------------------------------------------------------------------------------------------------------------------- Total 32 38 26 35 - ----------------------------------------------------------------------------------------------------------------------
Interest rate risk Interest rate risk is the possibility that changes in interest rates will affect the value of financial instruments. Our primary risk exposures to interest rates from trading activities are in sovereign and corporate bond markets across North America, Europe, Asia and Latin America; mortgage-backed security markets in the U.S.; and interest rate derivatives. They also include spread, volatility, and basis risk. We use instruments such as interest rate swaps, options, U.S. government securities, and futures and forward contracts to manage our exposure to interest rate risk. Foreign exchange rate risk Foreign exchange rate risk represents the possibility that fluctuations in foreign exchange rates will impact the value of our financial instruments. Our primary risk exposures to foreign exchange rates arise from transactions in all major countries and most minor countries throughout Europe, Latin America, and Asia. We manage the risk arising from foreign currency transactions primarily through currency swaps; options; and spot, futures and forward contracts. Equity price risk Equity price risk is the possibility that equity security prices will fluctuate, affecting the value of equity securities and other instruments that derive their value from a particular stock, a defined basket of stocks, or a stock index. Our primary risk exposure to equity price risk arises from our activities in our equity derivatives portfolio. We manage the risk of loss through the use of equity cash, future, swap, and option instruments. Given the nature of our business, we expect frequent changes to our primary risk exposures over the course of a year. Our integrated approach to managing market risk considers this expectation and facilitates a dynamic and proactive adjustment of the risk profile across all our trading activities as needed. DEaR for proprietary investing activities Average DEaR for our proprietary investing activities for the twelve months ended September 30, 1999 was $42 million, and ranged from $19 million to $109 million. This compares with average DEaR of $33 million and a range from $8 million to $109 million for the twelve months ended December 31, 1998. 40 41 The primary sources of market risk associated with our proprietary investing activities are spread risk in our mortgage-backed securities portfolio and interest rate risk associated with fixed income securities. Spread risk is the possibility that changes in credit spreads will affect the value of our financial instruments. In estimating risk for our investing activities, we have measured the risk in this portfolio using the same one-day horizon and 95% confidence interval used for trading, in order to facilitate aggregation with our trading risk activities. This approach to risk estimation does not, however, fit well with the longer horizon or with other risk features of these nontrading activities. For this reason, we also track risk in our investing portfolio using a one-week value-at-risk measure to evaluate our risk estimates relative to total return. For the twelve months ended September 30, 1999, weekly total return fell short of expected weekly results by amounts greater than related weekly risk estimates on more times than the expected frequency. This resulted primarily from the extreme market conditions experienced in the latter half of 1998. Aggregate DEaR Aggregate DEaR, excluding derivative credit risk DEaR, averaged $57 million for the twelve months ended September 30, 1999 and ranged from $26 million to $120 million. For the twelve months ended December 31, 1998, average aggregate DEaR was $55 million and ranged from $33 million to $120 million. OPERATING RISK The year 2000 initiative With the new millennium approaching, organizations are examining their computer systems to ensure that they are year 2000 compliant. The issue, in simple terms, is that many existing computer systems fail to properly identify dates after December 31, 1999. Systems that calculate, compare, or sort using the incorrect date will cause erroneous results, ranging from system malfunctions to incorrect or incomplete transaction processing. If systems are not updated, potential risks include business interruption or shutdown, financial loss, reputation loss, regulatory actions, and/or legal liability. J.P. Morgan uses computers in all aspects of its business including processing of transactions from inception through to settlement. We have undertaken a firmwide initiative to address the year 2000 issue and developed a comprehensive plan to mitigate the internal and external risks. The internal components of the initiative address software applications, technology products and facilities; the external components address credit and operating risk and fiduciary responsibilities. Each business line is responsible for remediating within its operating area, addressing all interdependencies within the firm, and identifying and managing risk posed by external entities, including clients, counterparties, vendors, exchanges, depositories, utilities, suppliers, agents, and regulatory agencies. A multidisciplinary team of internal and external experts supports the business teams by providing direction and firmwide coordination. We divided our remediation plan into five phases: - - Awareness: To begin, we launched a firmwide awareness campaign, developed and implemented an organizational model, set up a management oversight committee, and established a risk model. Status: complete. - - Inventory/assessment: We conducted a firmwide inventory of information technology (IT) and non-IT (e.g., telecommunications, power, facilities applications, and products), documented business processes, and identified external interfaces and dependencies. In this phase we assessed the potential impact on these inventories, prioritized renovation activities, developed renovation plans, and determined the compliance status of third-party products and services. Status: complete. - - Renovation/replacement: We set about to identify "replace vs. renovate" opportunities, renovate applications and products, and document code and system changes. Status: complete. - - Testing: We established a consistent testing methodology, conducted unit and system tests, and received certification sign-off from senior business managers. Status: complete. - - Implementation: This final phase entailed the implementation of critical updated applications and products and conducting final compliance certification. Status: complete. The awareness and inventory/assessment phases were completed in 1997. The renovation/replacement and testing phases are now fully complete. As of September 30th, we met all Federal Financial Institutions Examination Council (FFIEC) and Federal Reserve requirements. We have also successfully participated in several industry tests including (i) the Securities Industry Association-sponsored Equities Beta Test (July 1998), Market Data Beta Test (February 1999) and Industry-wide Street Test (March-April 1999), (ii) the Futures Industry Association-sponsored Futures and Options Beta 41 42 Test (September 1998), (iii) the New York Clearing House's Global Payments Systems Test (September 1999), (iv) various non-US industry tests in such countries as the United Kingdom, Germany, Japan, Singapore, Argentina, and (v) point to point testing with major financial clearing entities. Based on currently available information, management does not believe that the year 2000 issue as it relates to our internal systems will have a material adverse impact on the firm's financial condition. However, the failure of external parties to resolve their own year 2000 issues could expose J.P. Morgan to potential losses, impairment of business processes and activities, and financial markets disruption. We are working with key external parties to stem the potential risks the year 2000 problem poses to us and the global financial community. As such, the focus of the program is now concentrated on the assessment and mitigation of external risks. The overall goal of our Risk Mitigation Delivery Model is to identify year 2000 risks and institute plans to mitigate these risks. The following steps have been, or are being, taken: - - Identify and address the year 2000 program risks which would prevent the completion of work to achieve year 2000 compliance for all high critical/high risk functions - Status: complete; - - Deploy mitigation strategies prior to the millennium event in order to reduce the probability of business disruption at the millennium change - Status: complete; - - Develop business recovery plans for high likelihood and impact risk areas in the event of post-millennium failure - Status: complete; - - Develop an overall command center (crisis management) framework for successfully responding to potential business disruptions as they occur, caused either by internal or external failures - Status: complete; - - Establish risk committees within each line of business to monitor risk sources and oversee the implementation of the above mitigation - Status: complete; - - Validate command center framework and perform "dress rehearsals" of business recovery plans - Status: A global, firmwide test of our command center framework was conducted in October 1999. The test included all businesses in all regions and involved all levels of staff including senior business managers and decision makers. Additional tests will be conducted in November and December. To date, we have completed readiness assessments of the key clients who, in aggregate, represent the majority of our credit exposure. A process is in place to monitor readiness on an ongoing basis and take credit action where appropriate. We have also assessed the readiness of important non-client counterparties and individual countries; in the latter case we have done so in conjunction with the Global 2000 Coordinating Group, an industry group formed to facilitate the readiness of the global financial community for the year 2000 date change. These assessments are updated on an ongoing basis, in particular with respect to counterparties and countries who fall into the "high risk, high impact" category. We have developed scenario and contingency plans that identify and track the impact and likelihood of key events that could impact our ability to conduct business as usual. These plans identify trigger points to actions that will mitigate risk on a timely basis, prior to the millennium. During the first half of 1999, business recovery plans were developed to manage both internal and external failures that may take place over and after the millennium changeover, including February 29, 2000. Validation and "dress rehearsals" of the business recovery plans have occurred and will continue throughout the year. Additionally, general uncertainty about the outcome of the millennium change may cause market participants to temporarily reduce the level of their market activities. Consequently, there may be a downturn in client and general market activity for a period of time before and after January 1, 2000. If this occurs, our net revenues may be adversely affected depending on the length of the reduction in activity and how broadly it affects the markets. Costs to prepare the firm for year 2000 are estimated at $300 million, including $265 million incurred through September 1999 ($225 million through December 31, 1998; $40 million in the nine months ended September 30, 1999). Costs incurred relating to this project are funded through operating cash flow and expensed during the period in which they are incurred. The firm's expectations about future costs associated with the year 2000 are subject to uncertainties that could cause actual spending to differ materially from that anticipated. The above section on the year 2000 initiative contains forward-looking statements including, without limitation, statements relating to the firm's plans, expectations, intentions, and adequate resources, that are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Estimates are based on assumptions of 42 43 future events, including the availability of resources, third-party renovation plans and other factors. There can be no guarantee, however, that our estimates will be achieved, or that there will not be a delay in achieving our plans. Specific factors that could cause actual results to differ materially from our estimates include, but are not limited to, the availability and cost of resources, the ability to locate and correct all relevant noncompliant systems, and timely responses to and renovations by third-parties, and similar uncertainties. Refer to page 38 for more information on forward-looking statements. 43 44 - ------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated - -------------------------------------------------------------------------------
Dollars in millions, Interest and average rates on a taxable-equivalent basis Three months ended ---------------------------------------------------------------------------- September 30, 1999 September 30, 1998 ---------------------------------------------------------------------------- Average Average Average Average balance Interest rate balance Interest rate ---------------------------------------------------------------------------- ASSETS Interest-earning deposits with banks, mainly in offices outside the U.S. $ 2,520 $ 61 9.60% $ 1,925 $ 107 22.05% Debt investment securities in offices in the U.S. (a): U.S. Treasury 455 10 8.72 673 16 9.43 U.S. state and political subdivision 1,322 40 12.00 1,695 43 10.06 Other 23,349 341 5.81 18,500 259 5.55 Debt investment securities in offices outside the U.S. (a) 2,190 27 4.89 1,357 22 6.43 Trading account assets: In offices in the U.S. 34,276 587 6.79 30,750 473 6.10 In offices outside the U.S. 23,957 383 6.34 35,056 655 7.41 Securities purchased under agreements to resell: In offices in the U.S. 22,184 290 5.19 15,372 226 5.83 In offices outside the U.S. 13,013 117 3.57 24,330 307 5.01 Securities borrowed, mainly in offices in the U.S. 37,037 456 4.88 40,796 568 5.52 Loans: In offices in the U.S. 8,062 131 6.45 6,496 124 7.57 In offices outside the U.S. 17,964 284 6.27 23,666 404 6.77 Other interest-earning assets (b): In offices in the U.S. 2,953 39 * 3,318 34 * In offices outside the U.S. 896 33 * 790 31 * - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 190,178 2,799 5.84 204,724 3,269 6.34 Cash and due from banks 1,141 1,495 Other noninterest-earning assets 64,590 78,418 - ----------------------------------------------------------------------------------------------------------------------------------- Total assets 255,909 284,637 - -----------------------------------------------------------------------------------------------------------------------------------
Interest and average rates applying to the following asset categories have been adjusted to a taxable-equivalent basis: Debt investment securities in offices in the U.S.; Trading account assets in offices in the U.S.; and Loans in offices in the U.S. The applicable tax rate used to determine these adjustments was approximately 41% for the three months ended September 30, 1999 and 1998. (a) For the three months ended September 30, 1999 and 1998, average debt investment securities are computed based on historical amortized cost, excluding the effects of SFAS No. 115 adjustments. (b) Interest revenue includes the effect of certain off-balance-sheet transactions. * Not meaningful 44 45 CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated - -------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- Dollars in millions, Interest and average rates on a taxable-equivalent basis Three months ended ---------------------------------------------------------------------------- September 30, 1999 September 30, 1998 ---------------------------------------------------------------------------- Average Average Average Average balance Interest rate balance Interest rate ---------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits: In offices in the U.S. $ 4,785 $ 68 5.64% $ 4,421 $ 67 6.01% In offices outside the U.S. 43,704 480 4.36 48,196 578 4.76 Trading account liabilities: In offices in the U.S. 7,320 123 6.67 9,204 159 6.85 In offices outside the U.S. 14,400 175 4.82 13,014 227 6.92 Securities sold under agreements to repurchase and federal funds purchased, mainly in offices in the U.S. 62,583 792 5.02 73,845 1,054 5.66 Commercial paper, mainly in offices in the U.S. 12,437 164 5.23 10,221 145 5.63 Other interest-bearing liabilities: In offices in the U.S. 7,758 156 7.98 10,976 214 7.74 In offices outside the U.S. 2,726 56 8.15 4,540 73 6.38 Long-term debt, mainly in offices in the U.S. 27,441 380 5.49 27,136 400 5.85 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 183,154 2,394 5.19 201,553 2,917 5.74 Noninterest-bearing deposits: In offices in the U.S. 899 717 In offices outside the U.S. 570 791 Other noninterest-bearing liabilities 59,518 69,780 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 244,141 272,841 Stockholders' equity 11,768 11,796 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity 255,909 284,637 Net yield on interest-earning assets 0.84 0.68 - ------------------------------------------------------------------------------------------------------------------------------------ Net interest earnings 405 352 - ------------------------------------------------------------------------------------------------------------------------------------
45 46 - ------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated
- ------------------------------------------------------------------------------- Dollars in millions, Interest and average rates on a taxable-equivalent basis Nine months ended ---------------------------------------------------------------------------- September 30, 1999 September 30, 1998 ---------------------------------------------------------------------------- Average Average Average Average balance Interest rate balance Interest rate ---------------------------------------------------------------------------- ASSETS Interest-earning deposits with banks, mainly in offices outside the U.S. $ 2,574 $ 221 11.48% $ 1,946 $ 236 16.21% Debt investment securities in offices in the U.S. (a): U.S. Treasury 555 35 8.43 743 46 8.28 U.S. state and political subdivision 1,483 130 11.72 1,407 117 11.12 Other 25,579 1,062 5.56 19,257 815 5.66 Debt investment securities in offices outside the U.S. (a) 2,579 93 4.82 1,737 95 7.31 Trading account assets: In offices in the U.S. 31,930 1,482 6.21 30,015 1,418 6.32 In offices outside the U.S. 27,055 1,282 6.34 38,286 2,021 7.06 Securities purchased under agreements to resell and federal funds sold, In offices in the U.S. 20,793 769 4.94 15,075 617 5.47 In offices outside the U.S. 13,415 419 4.18 23,495 876 4.98 Securities borrowed, mainly in offices in the U.S. 37,889 1,374 4.85 40,641 1,578 5.19 Loans: In offices in the U.S. 6,829 345 6.75 6,628 357 7.20 In offices outside the U.S. 19,529 906 6.20 25,116 1,264 6.73 Other interest-earning assets (b): In offices in the U.S. 2,061 82 * 2,269 109 * In offices outside the U.S. 946 110 * 1,001 119 * - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 193,217 8,310 5.75 207,616 9,668 6.23 Cash and due from banks 1,411 1,358 Other noninterest-earning assets 69,381 73,097 - ----------------------------------------------------------------------------------------------------------------------------------- Total assets 264,009 282,071 - -----------------------------------------------------------------------------------------------------------------------------------
Interest and average rates applying to the following asset categories have been adjusted to a taxable-equivalent basis: Debt investment securities in offices in the U.S.; Trading account assets in offices in the U.S.; and Loans in offices in the U.S. The applicable tax rate used to determine these adjustments was approximately 41% for the nine months ended September 30, 1999 and 1998. (a) For the nine months ended September 30, 1999 and 1998, average debt investment securities are computed based on historical amortized cost, excluding the effects of SFAS No. 115 adjustments. (b) Interest revenue includes the effect of certain off-balance-sheet transactions. * Not meaningful 46 47 - ------------------------------------------------------------------------------- CONSOLIDATED AVERAGE BALANCES AND NET INTEREST EARNINGS J.P. Morgan & Co. Incorporated
- ------------------------------------------------------------------------------- Dollars in millions, Interest and average rates on a taxable-equivalent basis Nine months ended ---------------------------------------------------------------------------- September 30, 1999 September 30, 1998 ---------------------------------------------------------------------------- Average Average Average Average balance Interest rate balance Interest rate ---------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits: In offices in the U.S. $ 7,137 $ 269 5.04% $ 7,318 $ 306 5.59% In offices outside the U.S. 45,695 1,454 4.25 50,053 1,832 4.89 Trading account liabilities: In offices in the U.S. 6,870 351 6.83 9,972 553 7.41 In offices outside the U.S. 13,949 515 4.94 14,527 665 6.12 Securities sold under agreements to repurchase and federal funds purchased, mainly in offices in the U.S. 62,322 2,260 4.85 70,551 2,923 5.54 Commercial paper, mainly in offices in the U.S. 10,962 418 5.10 9,363 395 5.64 Other interest-bearing liabilities: In offices in the U.S. 8,954 502 7.50 12,947 635 6.56 In offices outside the U.S. 3,595 150 5.58 3,934 205 6.97 Long-term debt, mainly in offices in the U.S. 28,038 1,131 5.39 25,748 1,145 5.95 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 187,522 7,050 5.03 204,413 8,659 5.66 Noninterest-bearing deposits: In offices in the U.S. 896 880 In offices outside the U.S. 601 858 Other noninterest-bearing liabilities 63,350 64,275 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities 252,369 270,426 Stockholders' equity 11,640 11,645 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity 264,009 282,071 Net yield on interest-earning assets 0.87 0.65 - ----------------------------------------------------------------------------------------------------------------------------------- Net interest earnings 1,260 1,009 - -----------------------------------------------------------------------------------------------------------------------------------
47 48 CROSS-BORDER AND LOCAL OUTSTANDINGS UNDER THE REGULATORY BASIS For financial reporting purposes only, the following table presents our cross-border and local outstandings under the regulatory basis established by the Federal Financial Institutions Examination Council (FFIEC). Bank regulatory rules differ from management's view in the treatment of credit derivatives, trading account short positions, and the use of fair value versus cost of investment securities. In addition, management does not net local funding or liabilities against any local exposures as allowed by the FFIEC. Refer to page 36 for more information on exposures based on the management view. In accordance with the regulatory rules, cross-border outstandings include, regardless of currency: - - all claims of our U.S. offices against foreign residents - - all claims of our foreign offices against residents of other foreign countries Local outstandings include all claims of our foreign offices with residents of the same foreign country, net of local funding. All outstandings are based on the location of the ultimate counterparty; that is, if collateral or a formal guarantee exists, the country presented is determined by the location where the collateral is held and realizable, or the location of the guarantor. Cross-border and local outstandings include the following: interest-earning deposits with banks; investment securities; trading account assets including derivatives; securities purchased under agreements to resell; loans; accrued interest; investments in affiliates; and other monetary assets. Commitments include all cross-border commitments to extend credit, standby letters of credit, and guarantees, and securities lending indemnifications. The following table shows each country where cross-border and local outstandings exceed 0.75% of total assets, as of September 30, 1999.
Total out- standings Net local Total % of and In millions Govern- out- out- Total Commit- commit- September 30, 1999 Banks ments Other(a) Standings standings assets ments ments - --------------------------------------------------------------------------------------------------------------------- Germany $11,412 $3,103 $1,513 $- $16,028 6.29% $958 $16,986 United Kingdom 6,952 718 2,484 - 10,154 3.98 1,080 11,234 Netherlands 4,989 1,218 3,680 - 9,887 3.88 552 10,439 Italy 1,848 3,931 1,287 - 7,066 2.77 41 7,107 France 2,849 1,325 2,815 - 6,989 2.74 815 7,804 Spain 2,129 1,738 1,537 - 5,404 2.12 313 5,717 Switzerland 2,046 388 1,079 - 3,513 1.38 575 4,088 Japan (b) 1,520 486 1,010 - 3,016 1.18 1,068 4,084 Luxembourg 331 19 2,440 - 2,790 1.09 40 2,830 Mexico (b) 52 1,775 729 163 2,719 1.07 9 2,728 Cayman Islands 7 - 2,474 - 2,481 0.97 1,168 3,649 Argentina (b) 154 1,799 330 - 2,283 0.90 - 2,283 Brazil (b) 55 1,366 340 295 2,056 0.81 - 2,056 - ---------------------------------------------------------------------------------------------------------------------
(a) Includes nonbank financial institutions and commercial and industrial entities. (b) See page 36 for exposures to these countries under the management view. 49 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 12. Statement re computation of ratios (incorporated by reference to exhibit 12 to J.P. Morgan's report on Form 8-K, dated October 18, 1999) 27. Financial data schedule (b) Reports on Form 8-K The following reports on Form 8-K were filed with the Securities and Exchange Commission during the quarter ended September 30, 1999: July 19, 1999 (Items 5 and 7) Reported the issuance by J.P. Morgan of a press release announcing its earnings for the three-month period ended June 30, 1999. September 1, 1999 (Items 5 and 7) Reported the issuance by J.P. Morgan of a joint press release announcing that it and the Boards of Euroclear Clearance System PLC and Euroclear Clearance System Societe Cooperative (the "Boards") have signed a letter of intent to create a new Euroclear bank that will take over J.P. Morgan's operating and banking roles to the Euroclear system once the successor bank is established. September 8, 1999 (Items 5 and 7) Reported the issuance by J.P. Morgan of two separate press releases announcing that Lloyd D. Ward, Chairman and Chief Executive Officer of Maytag Corporation, has been elected to the Board of Directors (release dated September 8, 1999), and that the firm held a planned update for the investment community covering the firm's progress on strategic initiatives (release dated September 9, 1999) 49 50 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. J.P. MORGAN & CO. INCORPORATED ----------------------------------- (Registrant) /s/ DAVID H. SIDWELL ----------------------------------- NAME: DAVID H. SIDWELL TITLE: MANAGING DIRECTOR AND CONTROLLER (PRINCIPAL ACCOUNTING OFFICER) DATE: November 15, 1999 50 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 SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND DISCLOSURES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 1,000,000 U.S. DOLLARS 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 1 1,609 2,145 36,755 106,510 0 0 0 25,415 301 254,819 48,823 81,553 87,033 25,402 0 694 502 10,812 254,819 1,249 1,266 5,738 8,253 1,723 7,050 1,203 (130) 201 4,325 2,342 2,342 0 0 1,546 8.33 7.76 0.87 169 0 0 0 595 (42) 23 446 29 26 391 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 a reversal of provision for loan losses of ($150) million, and a provision for credit losses on lending commitments of $20 million, recorded in Other revenue. 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 includes the specific country and expected loss components of our allowances for credit losses. The unallocated amounts represent our allowances to specific counterparties determined in accordance with SFAS No. 114 and SFAS No. 5, for loans and off-balance-sheet credit instruments, respectively.
-----END PRIVACY-ENHANCED MESSAGE-----