JP Morgan Chase 2006 Annual Report Download - page 32

MANAGEMENT’S DISCUSSION AND ANALYSIS
JPMorgan Chase & Co.
30 JPMorgan Chase & Co. / 2006 Annual Report
and 2005, respectively, pertaining to certain material litigation matters. For a fur-
ther discussion of litigation, refer to Note 27 on pages 130–131 of this Annual
Report. Also contributing to the decline from the prior year were charges of $93
million in connection with the termination of a client contract in TSS in 2005;
and in RFS, the sale of the insurance business in the third quarter of 2006. These
items were offset partially by higher charges related to other litigation, and the
impact of growth in business volume, acquisitions and investments in the busi-
nesses.
For discussion of Amortization of intangibles and Merger costs, refer to Note 16
and Note 9 on pages 121–123 and 108, respectively, of this Annual Report.
2005 compared with 2004
Noninterest expense for 2005 was $38.4 billion, up 13% from 2004, primarily
due to the full-year impact of the Merger. Excluding Litigation reserve charges
and Merger costs, Noninterest expense would have been $35.1 billion, up 22%.
In addition to the Merger, expenses increased as a result of higher performance-
based incentives, continued investment spending in the Firm’s businesses and
incremental marketing expenses related to launching the new Chase brand, par-
tially offset by merger-related savings and operating efficiencies throughout the
Firm. Each category of Noninterest expense was affected by the Merger. The dis-
cussions that follow highlight factors other than the Merger that affected the
2005 versus 2004 comparison.
Compensation expense rose as a result of higher performance-based incentives;
additional headcount due to the insourcing of the Firm’s global technology
infrastructure (effective December 31, 2004, when JPMorgan Chase terminated
the Firm’s outsourcing agreement with IBM); the impact of several investments,
including Cazenove, Highbridge and Vastera; the accelerated vesting of certain
employee stock options; and business growth. The effect of the termination
of the IBM outsourcing agreement was to shift expenses from Technology
and communications expense to Compensation expense. The increase in
Compensation expense was offset partially by merger-related savings through-
out the Firm. For a detailed discussion of employee stock-based incentives, see
Note 8 on pages 105–107 of this Annual Report.
The increase in Occupancy expense was due primarily to the Merger, partially
offset by lower charges for excess real estate and a net release of excess
property tax accruals, as compared with $103 million of charges for excess
real estate in 2004.
Technology and communications expense was down slightly. This reduction
reflects the offset of six months of the combined Firm’s results for 2004
against the full-year 2005 impact from termination of the JPMorgan Chase
outsourcing agreement with IBM. The reduction in Technology and communi-
cations expense due to the outsourcing agreement termination is offset most-
ly by increases in Compensation expense related to additional headcount and
investments in the Firm’s hardware and software infrastructure.
Professional and outside services were higher compared with the prior year as
a result of the insourcing of the Firm’s global technology infrastructure,
upgrades to the Firm’s systems and technology, and business growth. These
expenses were offset partially by operating efficiencies.
Marketing expense was higher compared with the prior year, primarily as a
result of the Merger and the cost of advertising campaigns to launch the new
Chase brand.
Noninterest expense
Year ended December 31,
(in millions) 2006 2005 2004(a)
Compensation expense $ 21,191 $ 18,065 $ 14,291
Occupancy expense 2,335 2,269 2,058
Technology, communications and
equipment expense 3,653 3,602 3,687
Professional & outside services 3,888 4,162 3,788
Marketing 2,209 1,917 1,335
Other expense 3,272 6,199 6,537
Amortization of intangibles 1,428 1,490 911
Merger costs 305 722 1,365
Total noninterest expense $ 38,281 $ 38,426 $ 33,972
(a) 2004 results include six months of the combined Firm’s results and six months of heritage
JPMorgan Chase results.
2006 compared with 2005
Total noninterest expense for 2006 was $38.3 billion, down slightly from the prior
year. The decrease was due to material litigation-related insurance recoveries of
$512 million in 2006 compared with a net charge of $2.6 billion (includes $208
million material litigation-related insurance recoveries) in 2005, primarily associat-
ed with the settlement of the Enron and WorldCom class action litigations and for
certain other material legal proceedings. Also contributing to the decrease were
lower Merger costs, the deconsolidation of Paymentech, the sale of the insurance
business, and merger-related savings and operating efficiencies. These items were
offset mostly by higher performance-based compensation and incremental
expense of $712 million related to SFAS 123R, the impact of acquisitions and
investments in businesses, as well as higher Marketing expenditures.
The increase in Compensation expense from 2005 was primarily a result of
higher performance-based incentives, incremental expense related to SFAS
123R of $712 million for 2006, and additional headcount in connection with
growth in business volume, acquisitions, and investments in the businesses.
These increases were offset partially by merger-related savings and other
expense efficiencies throughout the Firm. For a detailed discussion of the adop-
tion of SFAS 123R and employee stock-based incentives see Note 8 on pages
105 – 107 of this Annual Report.
The increase in Occupancy expense from 2005 was due to ongoing investments
in the retail distribution network, which included the incremental expense from
The Bank of New York branches, partially offset by merger-related savings and
other operating efficiencies.
The slight increase in Technology, communications and equipment expense for
2006 was due primarily to higher depreciation expense on owned automobiles
subject to operating leases and higher technology investments to support busi-
ness growth, partially offset by merger-related savings and operating efficiencies.
Professional & outside services decreased from 2005 due to merger-related
savings and operating efficiencies, lower legal fees associated with several
legal matters settled in 2005 and the Paymentech deconsolidation. The
decrease was offset partly by acquisitions and business growth.
Marketing expense was higher compared with 2005, reflecting the costs of
campaigns for credit cards.
Other expense was lower due to significant litigation-related charges of $2.8 bil-
lion in 2005, associated with the settlement of the Enron and WorldCom class
action litigations and certain other material legal proceedings. In addition, the
Firm recognized insurance recoveries of $512 million and $208 million, in 2006