JP Morgan Chase 2005 Annual Report Download - page 28

Management’s discussion and analysis
JPMorgan Chase & Co.
26 JPMorgan Chase & Co. /2005 Annual Report
Provision for credit losses in 2005 was a benefit to earnings, mainly due to
continued improvement in the credit quality of the loan portfolio. The increase
in expense was primarily the result of higher performance-based incentive
compensation due to increased revenues.
Retail Financial Services operating earnings benefited from the overall strength
of the U.S. economy, which led to increased deposit, home equity and mortgage
balances. In addition to the benefit from higher balances, revenues increased
due to improved mortgage servicing rights (“MSRs”) risk management
results. Expenses declined, reflecting ongoing efficiency improvements across
all businesses even as investments continued in retail banking distribution
and sales, with the net addition during the year of 133 branch offices, 662
ATMs and over 1,300 personal bankers. These benefits were offset partially
by narrower spreads on loans due to the interest rate environment and net
losses associated with loan portfolio sale activity. The provision for credit losses
benefited from improved credit trends in most consumer lending portfolios and
from loan portfolio sales, but was affected negatively by a special provision
related to Hurricane Katrina.
Card Services operating earnings benefited from lower expenses driven by
merger savings and greater efficiencies from the operating platform conversion,
which resulted in lower processing and compensation costs. Revenue benefited
from higher loan balances and customer charge volume resulting from marketing
initiatives and increased consumer spending. Partially offsetting this growth
were narrower spreads on loan balances due to an increase in accounts in
their introductory rate period and higher interest rates.The managed provision
for credit losses increased due to record levels of bankruptcy-related charge-offs
related to the new bankruptcy legislation that became effective in October
2005 and a special provision related to Hurricane Katrina. Despite these events,
underlying credit quality remained strong, with a managed net charge-off ratio of
5.21%, down from 5.27% in 2004.
Commercial Banking operating earnings benefited from wider spreads and higher
volumes related to liability balances and increased loan balances. Partially offset-
ting these benefits were narrower loan spreads related to competitive pressures
in some markets and lower deposit-related fees due to higher interest rates.
The provision for credit losses increased due to a special provision related to
Hurricane Katrina, increased loan balances and refinements in the data used to
estimate the allowance for credit losses. However, the underlying credit quality
in the portfolio was strong throughout the year, as evidenced by lower net
charge-offs and nonperforming loans compared with 2004.
Treasury & Securities Services operating earnings grew significantly in 2005.
Revenue growth resulted from business growth and widening spreads on,
and growth in, liability balances, all of which benefited from global economic
strength and capital market activity. Partially offsetting this growth were
lower deposit-related fees due to higher interest rates. Expenses decreased
due to lower software impairment charges, partially offset by higher compen-
sation expense resulting from new business growth, the Vastera acquisition
completed in April, and by charges taken in the second quarter to terminate a
client contract.
Asset & Wealth Management operating earnings benefited from net asset
inflows and asset appreciation, both the result of favorable capital markets
and improved investment performance, which resulted in an increased level of
Assets under management. Results also benefited from the acquisition of a
majority interest in Highbridge Capital Management in the fourth quarter of
2004 and growth in deposit and loan balances. Expenses increased due pri-
marily to the acquisition of Highbridge and higher performance-based incentive
compensation related to increased revenue.
Corporate segment operating earnings were affected negatively by repositioning
of the Treasury Investment portfolio. This decline was offset partially by the
gain on the sale of BrownCo of $1.3 billion (pre-tax) and improved Private
Equity results.
The Firm had, at year-end, total stockholders’ equity of $107 billion, and a Tier 1
capital ratio of 8.5%.The Firm purchased $3.4 billion, or 93.5 million shares of
common stock during the year.
2006 Business outlook
The following forward-looking statements are based upon the current beliefs
and expectations of JPMorgan Chase’s management and are subject to
significant risks and uncertainties. These risks and uncertainties could cause
JPMorgan Chase’s results to differ materially from those set forth in such
forward-looking statements.
JPMorgan Chase’s outlook for 2006 should be viewed against the backdrop
of the global economy, financial markets and the geopolitical environment, all
of which are integrally linked. While the Firm considers outcomes for, and has
contingency plans to respond to, stress environments, the basic outlook for
2006 is predicated on the interest rate movements implied in the forward rate
curve for U.S. treasuries, the continuation of favorable U.S. and international
equity markets and continued expansion of the global economy.
The performance of the Firm’s capital markets and wholesale businesses are
affected by overall global economic growth and by financial market movements
and activity levels. The Investment Bank enters 2006 with a strong investment
banking fee pipeline and continues to focus on new product expansion initiatives,
such as commodities and securitized products, which are intended to benefit
growth and reduce volatility in trading results over time. Compared with 2005,
the Investment Bank anticipates lower credit portfolio revenues due to
reduced gains from loan workouts. Asset & Wealth Management anticipates
continued growth driven by continued net inflows to Assets under supervision.
Treasury & Securities Services and Commercial Banking expect growth due to
increased business activity and product sales.
Retail Financial Services anticipates benefiting from the expanded branch
network and salesforce, and improved sales productivity and cross-selling in
the branches, partially offset by pressure on loan and deposit spreads due to
the higher interest rate environment. The acquisition of Collegiate Funding
Services is expected to contribute modestly to earnings in 2006.
Card Services anticipates that managed receivables will grow in line with
the overall credit card industry, benefiting from marketing initiatives, new
partnerships and the acquisition of the Sears Canada credit card business.
Revenues and expenses also will reflect the full-year impact of the Paymentech
deconsolidation and the acquisition of the Sears Canada credit card business.
The Corporate segment includes Private Equity, Treasury and other corporate
support units. The revenue outlook for the Private Equity business is directly
related to the strength of the equity markets and the performance of the under-
lying portfolio investments. If current market conditions persist, the Firm antici-
pates continued realization of private equity gains in 2006, but results can be
volatile from quarter to quarter. It is anticipated that Treasury net interest