JP Morgan Chase 2003 Annual Report Download - page 26

M anagement’s discussion and analysis
J.P. M organ Chase & Co.
24 J.P. Morgan Chase & Co. / 2003 Annual Report
upgrade, and S&P affirmed all of the Firm’s ratings. See Business
events below.
Risk management
The Firm made substantial progress in low ering its risk profile in
2003.
To tal commercial credit exposure, w hich includes loans, deriva-
tive receivables, lending-related commitments and other assets,
declined by $30.2 billion, or 7% , from December 31, 2002.
Increased financings in the public markets, reduced loan
demand and loan sales drove the decline. In 2003, the Firm
implemented a more stringent exposure-review process and
low er absolute exposure limits for industry and single-name con-
centrations, including investment-grade obligors. The Firm w as
also more active in managing commercial credit by selling higher-
risk loans and commitments and entering into single-name
credit default sw ap hedges.
Total consumer loans on a managed basis, which includes both
reported and securitized loans, increased by $15.7 billion, or 10% ,
from December 31, 2002. The consumer portfolio is predominantly
U.S.-based. The largest component, 1–4 family residential mort-
gage loans, which are primarily secured by first mortgages, com-
prised 43% of the total consumer portfolio at December 31, 2003.
JPM P’s private equity portfolio declined by 12% to $7.3 billion at
December 31, 2003, from $8.2 billion at December 31, 2002.
At year-end 2003, the portfolio w as diversified across industry sec-
tors and geographies – w ith a higher percentage invested in more
mature leveraged buyouts and a low er percentage in venture invest-
ments than at year-end 2002. The carrying value of JPM P’s portfolio
has decreased year-over-year, consistent w ith management’s goal to
reduce, over time, the capital committed to private equity.
The Firm uses several tools, both statistical and nonstatistical, to
measure market risk, including Value-at-Risk (“ VAR” ), Risk identi-
fication for large exposures (“ RIFLE” ), economic value stress tests
and net interest income stress tests. The Firm calculates VAR daily
on its trading and nontrading activities. Average trading VAR
decreased for full-year 2003. The year-end trading VAR increased
compared w ith year-end 2002 due to higher VAR for equity
activities. In 2003, trading losses exceeded VAR on only one day,
a result that is consistent w ith the 99% confidence level.
Average, maximum, and December 31 nontrading VAR increased
in 2003, primarily due to the increase in market volatility during
the 2003 third quarter and to the rise in interest rates in the sec-
ond half of 2003. There w as an additional day in 2003 in w hich
losses exceeded VAR; this w as attributable to certain positions in
the mortgage banking business.
The Firm is also committed to maintaining business practices of
the highest quality. The Fiduciary Risk Committee is responsible
for overseeing that businesses providing investment or risk man-
agement products and services perform at the appropriate stan-
dard in their relationships w ith clients. In addition, the Policy
Review Office oversees the review of transactions w ith clients in
terms of appropriateness, ethical issues and reputation risk, with
the goal that these transactions are not used to mislead
investors or others.
During the year, the Firm revised its capital allocation method-
ologies for credit, operational, business and private equity risk.
This resulted in the reallocation of capital among the risk cate-
gories and the business segments; the reallocation did not result
in a significant change in the amount of total capital allocated
to the business segments as a w hole.
For a further discussion of Risk management and the capital allo-
cation methodology, see pages 45–74 of this Annual Report.
Business outlook
Global economic conditions and financial markets activity are
expected to continue to improve in 2004. While rising interest
rates may negatively affect the mortgage and Global Treasury busi-
nesses; on the positive side, gains in market share, rising equity val-
ues and increased market activity may benefit many of the Firm’s
other businesses.
The Firm expects to see a different mix of earnings in 2004. IB is tar-
geting higher issuer and investor client revenue, but securities gains
and net interest income may be lower. M ortgage earnings are likely
to decline from the record set in 2003, and grow th in other retail
businesses may not be sufficient to offset the decline in mortgage
revenue. Improved equity markets and increased M &A activity may
provide increased exit opportunities in private equity and could
result in higher fees in IM PB and in the custody business of TSS.
Commercial net charge-off ratios may be low er, but credit costs
may rise as the reduction in the Allowance for credit losses slow s.
The Firm expects stable consumer net charge-off ratios in 2004.
Business events
Agreement to merge with Bank One Corporation
On January 14, 2004, JPM organ Chase and Bank One Corporation
(“ Bank One” ) announced an agreement to merge. The merger
agreement, w hich has been approved by the boards of directors of
both companies, provides for a stock-for-stock merger in w hich
1.32 shares of JPM organ Chase common stock w ill be exchanged,
on a tax-free basis, for each share of Bank One common stock.
The merged company, headquartered in New York, w ill be
know n as J.P. M organ Chase & Co. and w ill have combined
assets of $1.1 trillion, a strong capital base, 2,300 branches in
17 states and top-tier positions in retail banking and lending,
credit cards, investment banking, asset management, private
banking, treasury and securities services, middle markets and pri-
vate equity. It is expected that cost savings of $2.2 billion (pre-
tax) w ill be achieved over a three-year period. M erger-related
costs are expected to be $3 billion (pre-tax).
The merger is subject to approval by the shareholders of both
institutions as w ell as U.S. federal and state and non-U.S. regula-
tory authorities. It is expected to be completed in mid-2004.
For further information concerning the merger, see Note 2 on
page 87 of this Annual Report.