JP Morgan Chase 2006 Annual Report Download - page 28

MANAGEMENT’S DISCUSSION AND ANALYSIS
JPMorgan Chase & Co.
26 JPMorgan Chase & Co. / 2006 Annual Report
The discussion that follows highlights the performance of each business
segment compared with the prior year, and discusses results on a managed
basis unless otherwise noted. For more information about managed basis,
See Explanation and reconciliation of the Firm’s use of non-GAAP financial
measures on pages 32–33 of this Annual Report.
Investment Bank net income was flat compared with the prior year, as
record revenue was offset by higher compensation expense and a provision for
credit losses compared with a benefit in the prior year. Revenue benefited
from investments in key business initiatives, increased market share and higher
global capital markets activity. Record investment banking fees were driven by
record debt and equity underwriting fees and strong advisory fees. Fixed
income markets revenue set a new record with strength in credit markets,
emerging markets and currencies. Equity markets revenue was also at a record
level, reflecting strength in cash equities and equity derivatives. The current-
year Provision for credit losses reflects portfolio activity; credit quality
remained stable. The increase in expense was primarily the result of higher
performance-based compensation including the impact of a higher ratio of
compensation expense to revenue and the adoption of SFAS 123R.
Retail Financial Services net income was down from the prior year as
lower results in Mortgage Banking were offset partially by improved perform-
ance in Regional Banking and Auto Finance. Revenue declined due to lower
revenue in Mortgage Banking, narrower loan and deposit spreads in Regional
Banking and the sale of the insurance business on July 1, 2006. Deposit and
loan spreads reflected the current interest rate and competitive environments.
These factors were offset partially by increases in average deposit and loan
balances and higher deposit-related and branch production fees in Regional
Banking, which benefited from the continued investment in the retail banking
distribution network and the overall strength of the U.S. economy. The provi-
sion for credit losses declined from the prior year due to the absence of a spe-
cial provision related to Hurricane Katrina in 2005, partially offset by the
establishment of additional allowance for loan losses related to loans acquired
from The Bank of New York. Expense increased, reflecting the purchase of
Collegiate Funding Services in the first quarter of 2006 and ongoing invest-
ments in the retail banking distribution network, with the net addition during
the year of 438 branch offices (including 339 from The Bank of New York),
1,194 ATMs and over 500 personal bankers. Partially offsetting these increases
were the sale of the insurance business and merger-related and other operat-
ing efficiencies.
Card Services net income was a record, increasing significantly compared
with the prior year, primarily the result of a lower provision for credit losses.
Net revenue (excluding the impact of the deconsolidation of Paymentech)
declined slightly from the prior year. Net interest income was flat as the bene-
fit of an increase in average managed loan balances, partially due to portfolio
acquisitions as well as marketing initiatives, was offset by the challenging
interest rate and competitive environments. Noninterest revenue declined as
increased interchange income related to higher charge volume from increased
consumer spending was more than offset by higher volume-driven payments
to partners, including Kohl’s, and increased rewards expense. The managed
provision for credit losses benefited from significantly lower bankruptcy-related
credit losses following the new bankruptcy legislation that became effective in
October 2005. Underlying credit quality remained strong. Expense (excluding
the impact of the deconsolidation of Paymentech) increased driven by higher
marketing spending and acquisitions, partially offset by merger savings.
Commercial Banking net income was a record in 2006. Record revenue
benefited from higher liability balances, higher loan volumes and increased
investment banking revenue, all of which benefited from increased sales
efforts and U.S. economic growth. Partially offsetting these benefits were loan
spread compression and a shift to narrower-spread liability products. The pro-
vision for credit losses increased compared with the prior year reflecting port-
folio activity and the establishment of additional allowances for loan losses
related to loans acquired from The Bank of New York, partially offset by a
release of the unused portion of the special reserve established in 2005 for
Hurricane Katrina. Credit quality remained stable. Expense increased due to
higher compensation expense related to the adoption of SFAS 123R and
increased expense related to higher client usage of Treasury Services’ products.
Treasury & Securities Services net income was a record and increased
significantly over the prior year. Revenue was at a record level driven by high-
er average liability balances, business growth, increased product usage by
clients and higher assets under custody, all of which benefited from global
economic growth and capital markets activity. This growth was offset partially
by a shift to narrower-spread liability products. Expense increased due to
higher compensation related to business growth, investments in new products
and the adoption of SFAS 123R. The expense increase was offset partially by
the absence of a prior-year charge to terminate a client contract.
Asset Management net income was a record in 2006. Record revenue ben-
efited from increased assets under management driven by net asset inflows
and strength in global equity markets, and higher performance and placement
fees. The Provision for credit losses was a benefit reflecting net loan recover-
ies. Expense increased due primarily to higher performance-based compensa-
tion, incremental expense from the adoption of SFAS 123R, and increased
minority interest expense related to Highbridge Capital Management, LLC
(“Highbridge”), offset partially by the absence of BrownCo.
Corporate segment reported significantly improved results (excluding the
impact of discontinued operations, as discussed further, below) driven by
lower expense, improved revenue and the benefit of tax audit resolutions.
Revenue benefited from lower securities losses, improved net interest spread
and a higher level of available-for-sale securities partially offset by the
absence of the gain on the sale of BrownCo and lower Private Equity results.
Expense benefited from the absence of prior-year litigation reserve charges,
higher insurance recoveries relating to certain material litigation, lower merg-
er-related costs and other operating efficiencies. These benefits were offset
partially by incremental expense related to the adoption of SFAS 123R.
On October 1, 2006, the Firm completed the exchange of selected corporate
trust businesses, including trustee, paying agent, loan agency and document
management services, for the consumer, business banking and middle-market
banking businesses of The Bank of New York. The corporate trust businesses,
which were previously reported in TSS, were reported as discontinued opera-
tions. The related balance sheet and income statement activity is reflected in
the Corporate segment for all periods presented. During 2006, these busi-
nesses produced $795 million of net income compared with net income of
$229 million in the prior year. Net income from discontinued operations was
significantly higher in 2006 due to a one-time after-tax gain of $622 million
related to the sale of these businesses. A modest amount of costs associated
with the acquisition side of this transaction are included in Merger costs.