JP Morgan Chase 2005 Annual Report Download - page 60

Management’s discussion and analysis
JPMorgan Chase & Co.
58 JPMorgan Chase & Co. /2005 Annual Report
accord (“Basel I”), in effect since 1988. The goal of the Basel II Framework is
to improve the consistency of capital requirements internationally, make
regulatory capital more risk-sensitive, and promote enhanced risk management
practices among large, internationally active banking organizations. JPMorgan
Chase supports the overall objectives of the Basel II Framework.
U.S. banking regulators are in the process of incorporating the Basel II
Framework into the existing risk-based capital requirements. JPMorgan Chase
will be required to implement advanced measurement techniques in the U.S.
by employing internal estimates of certain key risk drivers to derive capital
requirements. Prior to implementation of the new Basel II Framework, JPMorgan
Chase will be required to demonstrate to its U.S. bank supervisors that its internal
criteria meet the relevant supervisory standards. JPMorgan Chase expects to be
in compliance within the established timelines with all relevant Basel II rules.
Dividends
The Firm’s common stock dividend policy reflects JPMorgan Chase’s earnings
outlook, desired payout ratios, need to maintain an adequate capital level and
alternative investment opportunities. In 2005, JPMorgan Chase declared a quar-
terly cash dividend on its common stock of $0.34 per share. The Firm continues
to target a dividend payout ratio of 30-40% of operating earnings over time.
Stock repurchases
On July 20, 2004, the Board of Directors approved an initial stock repurchase
program in the aggregate amount of $6.0 billion. This amount includes shares
to be repurchased to offset issuances under the Firm’s employee stock-based
plans. The actual amount of shares repurchased is subject to various factors,
including market conditions; legal considerations affecting the amount and
timing of repurchase activity; the Firm’s capital position (taking into account
goodwill and intangibles); internal capital generation; and alternative potential
investment opportunities. Under the stock repurchase program, during 2005,
the Firm repurchased 93.5 million shares for $3.4 billion at an average price
per share of $36.46. During 2004, the Firm repurchased 19.3 million shares
for $738 million at an average price per share of $38.27. As of December 31,
2005, $1.9 billion of authorized repurchase capacity remained.
The Firm has determined that it may, from time to time, enter into written trading
plans under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate
the repurchase of common stock in accordance with the repurchase program.
A Rule 10b5-1 repurchase plan would allow the Firm to repurchase shares
during periods when it would not otherwise be repurchasing common stock –
for example, during internal trading “black-out periods.” All purchases under a
Rule 10b5-1 plan must be made according to a predefined plan that is estab-
lished when the Firm is not aware of material nonpublic information.
For additional information regarding repurchases of the Firm’s equity securi-
ties, see Part II, Item 5, Market for registrant’s common equity, related stock-
holder matters and issuer purchases of equity securities, on page 11 of
JPMorgan Chase’s 2005 Form 10–K.
Off–balance sheet arrangements and contractual cash obligations
Special-purpose entities
JPMorgan Chase is involved with several types of off-balance sheet arrange-
ments, including special purpose entities (“SPEs”), lines of credit and loan
commitments. The principal uses of SPEs are to obtain sources of liquidity for
JPMorgan Chase and its clients by securitizing financial assets, and to create
other investment products for clients. These arrangements are an important
part of the financial markets, providing market liquidity by facilitating
investors’ access to specific portfolios of assets and risks. For example, SPEs
are integral to the markets for mortgage-backed securities, commercial paper,
and other asset-backed securities.
The basic SPE structure involves a company selling assets to the SPE. The SPE
funds the purchase of those assets by issuing securities to investors. To insulate
investors from creditors of other entities, including the seller of assets, SPEs
can be structured to be bankruptcy-remote.
JPMorgan Chase is involved with SPEs in three broad categories: loan securitiza-
tions, multi-seller conduits and client intermediation. Capital is held, as deemed
appropriate, against all SPE-related transactions and related exposures, such as
derivative transactions and lending-related commitments. For a further discussion
of SPEs and the Firm’s accounting for them, see Note 1 on page 91, Note 13
on pages 108–111 and Note 14 on pages 111–113 of this Annual Report.
The Firm has no commitments to issue its own stock to support any SPE
transaction, and its policies require that transactions with SPEs be conducted
at arm’s length and reflect market pricing. Consistent with this policy, no
JPMorgan Chase employee is permitted to invest in SPEs with which the Firm
is involved where such investment would violate the Firm’s Code of Conduct.
These rules prohibit employees from self-dealing and prohibit employees from
acting on behalf of the Firm in transactions with which they or their family
have any significant financial interest.
For certain liquidity commitments to SPEs, the Firm could be required to provide
funding if the credit rating of JPMorgan Chase Bank were downgraded below
specific levels, primarily P-1,A-1 and F1 for Moody’s, Standard & Poor’s and
Fitch, respectively. The amount of these liquidity commitments was $71.3
billion and $79.4 billion at December 31, 2005 and 2004, respectively.
Alternatively, if JPMorgan Chase Bank were downgraded, the Firm could be
replaced by another liquidity provider in lieu of providing funding under the
liquidity commitment, or, in certain circumstances, could facilitate the sale or
refinancing of the assets in the SPE in order to provide liquidity.
Of its $71.3 billion in liquidity commitments to SPEs at December 31, 2005,
$38.9 billion was included in the Firm’s other unfunded commitments to
extend credit and asset purchase agreements, included in the following table.
Of the $79.4 billion of liquidity commitments to SPEs at December 31, 2004,
$47.7 billion was included in the Firm’s other unfunded commitments to
extend credit and asset purchase agreements. As a result of the Firm’s consol-
idation of multi-seller conduits in accordance with FIN 46R, $32.4 billion of
these commitments, compared with $31.7 billion at December 31, 2004, are
excluded from the following table, as the underlying assets of the SPEs have
been included on the Firm’s Consolidated balance sheets.
The Firm also has exposure to certain SPEs arising from derivative transactions;
these transactions are recorded at fair value on the Firm’s Consolidated balance
sheets with changes in fair value (i.e., MTM gains and losses) recorded in
Trading revenue. Such MTM gains and losses are not included in the revenue
amounts reported in the table below.
The following table summarizes certain revenue information related to
variable interest entities (“VIEs”) with which the Firm has significant
involvement, and qualifying SPEs (“QSPEs”). The revenue reported in the
table below primarily represents servicing and custodial fee income. For a
further discussion of VIEs and QSPEs, see Note 1, Note 13 and Note 14,
on pages 91, 108–111 and 111–113, respectively, of this Annual Report.