JP Morgan Chase 2003 Annual Report Download - page 48

M anagement’s discussion and analysis
J.P. M organ Chase & Co.
46 J.P. Morgan Chase & Co. / 2003 Annual Report
Capital also is assessed against business units for certain nonrisk
factors. Businesses are assessed capital equal to 100% of any
goodw ill and 50% for certain other intangibles generated through
acquisitions. Additionally, JPM organ Chase assesses an “ asset
capital tax” against managed assets and some off–balance sheet
instruments. These assessments recognize that certain minimum
regulatory capital ratios must be maintained by the Firm.
JPM organ Chase also estimates the portfolio effect on required
economic capital based on correlations of risk across risk cate-
gories. This estimated diversification benefit leads to a reduction
in required economic capital for the Firm.
The total required economic capital for JPM organ Chase as deter-
mined by its models and after considering the Firm’s estimated
diversification benefits is then compared w ith available common
stockholders’ equity to evaluate overall capital utilization. The
Firm’s policy is to maintain an appropriate level of excess capital to
provide for grow th and additional protection against losses.
The Firm’s capital in excess of that w hich is internally required as of
December 31, 2003, increased by $2.7 billion over December 31,
2002. The change was primarily due to an increase in average
common stockholders’ equity of $1.6 billion and to a $1.3 bil-
lion reduction in average capital allocated to business activities,
principally in relation to credit risk and private equity risk. Credit
risk capital decreased by $0.9 billion from the prior year, primarily
due to a reduction in commercial exposures, improvement in
the credit quality of the commercial portfolio and an increase
in hedging of commercial exposures using single-name credit
derivatives. Private equity risk decreased primarily as a result of
the reduction in JPM P’s private equity portfolio.
Regulatory capital: JPM organ Chase’s primary federal banking
regulator, the Federal Reserve Board, establishes capital require-
ments, including w ell-capitalized standards and leverage ratios,
for the consolidated financial holding company and its state-
chartered banks, including JPM organ Chase Bank. The Office of
the Comptroller of the Currency establishes similar capital
requirements and standards for the Firm’s national bank sub-
sidiaries, including Chase M anhattan Bank USA, N.A. As of
December 31, 2003, the financial holding company and its
banking subsidiaries maintained capital levels w ell in excess of
the minimum capital requirements.
At December 31, 2003, the Tier 1 and Total capital ratios w ere
8.5% and 11.8% , respectively, and the Tier 1 leverage ratio w as
5.6% . The Capital Committee reviews the Firm’s capital levels
and policies regularly in light of changing economic conditions
and business needs. At December 31, 2003, Total capital of
JPM organ Chase (the sum of Tier 1 and Tier 2 capital) w as
$59.8 billion, an increase of $5.3 billion from December 31,
2002. This increase reflected a $5.6 billion increase in Tier 1
capital, primarily driven by a $3.8 billion increase in retained
earnings (net income less common and preferred dividends)
generated during the period, $1.1 billion in Tier 1 trust preferred
net issuance and $1.3 billion in net stock issuances related to
employee stock-based benefit plans. This increase w as partially
offset by a higher deduction for goodw ill and nonqualifying
Capital and Liquidity management
Capital management
JPM organ Chase’s capital management framew ork helps to
optimize the use of capital by:
• Determining the amount of capital commensurate w ith:
- internal assessments of risk as estimated by the Firm’s
economic capital allocation model
- the Firm’s goal to limit losses, even under stress conditions
- targeted regulatory ratios and credit ratings
- the Firm’s liquidity management strategy.
• Directing capital investment to activities w ith the most
favorable risk-adjusted returns.
Economic risk capital: JPM organ Chase assesses capital ade-
quacy utilizing internal risk assessment methodologies. The Firm
assigns economic capital based primarily on five risk factors:
credit risk, market risk, operational risk and business risk for
each business, and private equity risk, principally for JPM P. The
methodologies quantify these risks and assign capital accordingly.
These methodologies are discussed in the risk management
sections of this Annual Report.
A review of the Firm’s risk and capital measurement methodolo-
gies w as completed in 2003, resulting in the reallocation of
capital among the risk categories and certain business segments.
The new capital measurement methodologies did not result in a
significant change in the total capital allocated to the business
segments as a w hole. Prior periods have been adjusted to reflect
the revised capital measurement methodologies. For a further
discussion of these new methodologies, see Capital allocation for
credit risk, operational risk and business risk, and private equity
risk on pages 52, 73 and 74, respectively, of this Annual Report.
Internal capital allocation methodologies may change in the
future to reflect refinements of economic capital methodologies.
Available versus required capital
Yearly Averages
(in billions) 2003 2002
Common stockholders’ equit y $ 43.0 $41.4
Economic risk capital:
Credit risk 13.1 14.0
Market risk 4.5 4.7
Operational risk 3.5 3.5
Business risk 1.7 1.8
Private equity risk 5.4 5.8
Economic risk capital 28.2 29.8
Goodwill / Intangibles 8.9 8.8
Asset capital tax 4.1 3.9
Capital against nonrisk factors 13.0 12.7
Total capital allocated to business activities 41.2 42.5
Diversification effect (5.1) (5.3)
Tot al required int ernal capit al 36.1 37.2
Firm capit al in excess of required capital $ 6.9 $4.2