JP Morgan Chase 2008 Annual Report Download - page 46

Management’s discussion and analysis
44 JPMorgan Chase & Co./ 2008 Annual Report
further than management’s current expectations. The wholesale provi-
sion for credit losses and nonperforming assets are likely to increase
over time as a result of the deterioration in underlying credit condi-
tions. Wholesale net charge-offs in 2008 increased from historic lows
in 2007 and are likely to increase materially in 2009 as a result of
increasing weakness in the credit environment.
The Investment Bank continues to be negatively affected by the dis-
ruption in the credit and mortgage markets, as well as by overall
lower levels of liquidity. The continuation of these factors could
potentially lead to reduced levels of client activity, lower investment
banking fees and lower trading revenue. In addition, if the Firm’s
own credit spreads tighten, as they did in the fourth quarter of 2008,
the change in the fair value of certain trading liabilities would also
negatively affect trading results. The Firm held $12.6 billion (gross
notional) of legacy leveraged loans and unfunded commitments as
held-for-sale as of December 31, 2008. Markdowns averaging 45%
of the gross notional value have been taken on these legacy posi-
tions as of December 31, 2008, resulting in a net carrying value of
$6.9 billion. Leveraged loans and unfunded commitments are difficult
to hedge effectively, and if market conditions further deteriorate,
additional markdowns may be necessary on this asset class. The
Investment Bank also held, at December 31, 2008, an aggregate $6.1
billion of prime and Alt-A mortgage exposure, which is also difficult to
hedge effectively, and $875 million of subprime mortgage exposure.
In addition, the Investment Bank had $7.7 billion of commercial mort-
gage exposure. In spite of active hedging, mortgage exposures could
be adversely affected by worsening market conditions and further
deterioration in the housing market. The combination of credit costs
and additional markdowns on the various exposures noted above
could reach or exceed $2.0 billion for the first quarter of 2009.
Earnings in Commercial Banking and Treasury & Securities Services
could decline due to the impact of tighter spreads in the low interest
rate environment or a decline in the level of liability balances. Earnings
in Treasury & Securities Services and Asset Management will likely
deteriorate if market levels continue to decline, due to reduced levels
of assets under management, supervision and custody. Earnings in the
Corporate/Private Equity segment could be more volatile due to
increases in the size of the Firm’s investment portfolio, which is largely
comprised of investment-grade securities. Private Equity results are
dependent upon the capital markets and at current market levels, man-
agement believes additional write-downs of $400 million or more are
likely in the first quarter of 2009.
Assuming economic conditions do not worsen beyond management’s
current expectations, management continues to believe that the net
income impact of the acquisition of Washington Mutual’s banking
operations could be approximately $0.50 per share in 2009; the Bear
Stearns merger could contribute $1 billion (after-tax) annualized after
2009; and merger-related items, which include both the Washington
Mutual transaction and the Bear Stearns merger, could be approxi-
mately $600 million (after-tax) in 2009.
Recent developments
On February 23, 2009, the Board of Directors reduced the Firm's quar-
terly common stock dividend from $0.38 to $0.05 per share, effective
for the dividend payable April 30, 2009, to shareholders of record on
April 6, 2009. The action taken will enable the Firm to retain an addi-
tional $5.0 billion in common equity per year. The Firm expects to
maintain the dividend at this level for the time being. The action was
taken in order to help ensure that the Firm’s balance sheet retained
the capital strength necessary to weather a further decline in economic
conditions. The Firm intends to return to a more normalized dividend
payout ratio as soon as feasible after the environment has stabilized.