JP Morgan Chase 2003 Annual Report Download - page 42

loan originations and applications. CHF’s production market
share grew from 5.8% in 2002 to 7.6% in 2003, primarily
due to successful expansion in first mortgage and home equity
lending through grow th in strategic, higher-margin distribution
channels such as retail, w holesale, telephone-based and e-com-
merce. Origination volume totaled a record $284 billion, an
increase of 82% from 2002. Home Equity volume, a strategic
grow th area, increased by 71% from the prior year. In addition,
despite record levels of loan prepayments in 2003, loans serv-
iced increased by 10% from year-end 2002 to $470 billion at
December 31, 2003.
CHF manages and measures its results from two key perspec-
tives: its operating businesses (Production /Servicing and Portfolio
Lending) and revenue generated through managing the interest
rate risk associated with M SRs. The table below reconciles man-
agement’s perspective on CHF’s business results to the reported
GAAP line items show n on the Consolidated statement of
income and in the related Notes to consolidated financial state-
ments. While the operating and hedging activities are interrelated,
the M SR hedging function is a risk management activity subject
to significant volatility as market interest rates and yield curves
fluctuate. As a result, operating business results are reported
separately from hedging results to gain a better perspective on
each activity.
Operat ing basis revenue
Operating MSR hedging Reported
Year ended December 31,
(in millions) 2003 2002 2003 2002 2003 2002
Net interest income $2,204 $1,208 $575 $234 $2,779 $1,442
Securities gains ——359 498 359 498
Mortgage fees and
related income 1,596 1,543 (704) (555) 892 988
Total $3,800 $2,751 $230 $177 $4,030 $2,928
gains/(losses) on AFS Securities w ere $(144) million at December 31,
2003, and $377 million at December 31, 2002. For a further dis-
cussion of M SRs, see Critical Accounting Estimates on page 77
and Note 16 on pages 107–109 of this Annual Report.
Operating expense of $1.7 billion increased by 28% from 2002
as a result of growth in origination volume as w ell as a higher
level of mortgage servicing. Substantial portions of CHF’s
expenses are variable in nature and, accordingly, fluctuate w ith
the overall level of origination and servicing activity. In addition
to increases brought on by higher business volumes, expenses
increased due to higher performance-related incentives, as w ell
as strategic investments made to further expand into higher-
margin business sectors, along w ith production-related restruc-
turing efforts initiated in the fourth quarter of 2003. These
increases w ere partially offset by continued gains in productivity
and benefits realized from Six Sigma initiatives during 2003.
Credit costs of $240 million for 2003 increased by 26% from
2002 due to a higher provision for credit losses, primarily the
result of higher loan balances. Credit quality continued to be
strong relative to 2002, as evidenced by a low er net charge-off
ratio and 30+ day delinquency rate.
Business-related metrics
As of or for the year ended December 31,
(in billions, except ratios) 2003 2002 Change
Origination volume by channel
Retail, wholesale, and correspondent $201 $113 78%
Correspondent negotiated transactions 83 43 93
Total $284 $156 82%
Origination volume by product
First mortgage $260 $142 83%
Home equity 24 14 71
Total $284 $156 82%
Loans serviced $470 $426 10%
End-of-period outstandings 73.7 63.6 16
Total average loans owned 74.1 56.2 32
MSR carrying value 4.8 3.2 50
Number of customers (in millions) 4.1 4.0 2
30+ day delinquency rate 1.81% 3.07% (126)bp
Net charge-off ratio 0.18 0.25 (7)
Overhead ratio 42 46 (400)
CHF achieved record financial performance in 2003, as total
revenue of $4.0 billion increased by 38% from 2002. Record
operating earnings of $1.3 billion increased by 48% from 2002.
CHF’s operating revenue (excluding M SR hedging revenue) of
$3.8 billion increased by 38% over 2002. The strong perform-
ance was due to record production revenue resulting from
market-share grow th, record margins and higher home equity
revenue. M anagement expects a decrease in revenue in 2004,
as production margins are expected to decline due to low er
origination volumes and increased price competition.
In its hedging activities, CHF uses a combination of derivatives
and AFS securities to manage changes in the market value of
M SRs. The intent is to offset any changes in the market value
of M SRs w ith changes in the market value of the related risk
management instrument. During 2003, negative M SR valuation
adjustments of $785 million w ere more than offset by $1.0 bil-
lion of aggregate derivative gains, realized gains on sales of AFS
securities and net interest earned on AFS securities. Unrealized
M anagement’s discussion and analysis
J.P. M organ Chase & Co.
40 J.P. Morgan Chase & Co. / 2003 Annual Report