FORM 10-Q
Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

     
For the Quarter Ended September 30, 2003   Commission file number 1-5805
     
     
J.P. MORGAN CHASE & CO.
(Exact name of registrant as specified in its charter)
     
     
Delaware   13-2624428
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)
     
270 Park Avenue, New York, New York   10017
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (212) 270-6000

     
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
  Yes [X] No [   ]
 
   
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
  Yes [X] No [   ]

 

Number of shares outstanding of each of the issuer’s classes of common stock on October 31, 2003.

     
   Common Stock, $1 Par Value   2,040,270,920

 

 


TABLE OF CONTENTS

Part I FINANCIAL INFORMATION
Item 1 CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
CONSOLIDATED BALANCE SHEETS (Unaudited)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Item 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GLOSSARY OF TERMS
IMPORTANT FACTORS THAT MAY AFFECT FUTURE RESULTS
Item 3 Quantitative and Qualitative Disclosures about Market Risk
Item 4 Controls and Procedures
Part II — OTHER INFORMATION
Item 1 Legal Proceedings
Item 2 Changes in Securities and Use of Proceeds
Item 6 Exhibits and Reports on Form 8-K
SIGNATURE
INDEX TO EXHIBITS
CERTIFICATION
CERTIFICATION
906 CERTIFICATION


Table of Contents

FORM 10-Q

TABLE OF CONTENTS

             
        Page  
Part I – Financial Information        
             
Item 1  
Consolidated Financial Statements – J.P. Morgan Chase & Co.:
       
             
   
Consolidated statements of income (unaudited) for the three and nine months ended September 30, 2003 and September 30, 2002
    3  
             
   
Consolidated balance sheets (unaudited) at September 30, 2003 and December 31, 2002
    4  
             
   
Consolidated statements of changes in stockholders’ equity (unaudited) for the nine months ended September 30, 2003 and September 30, 2002
    5  
             
   
Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2003 and September 30, 2002
    6  
             
   
Notes to consolidated financial statements (unaudited)
    7-23  
             
Item 2  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    24-66  
             
   
Glossary of Terms
    67-68  
             
   
Important Factors That May Affect Future Results
    69  
             
Item 3  
Quantitative and Qualitative Disclosures about Market Risk
    69  
             
Item 4  
Controls and Procedures
    69  
             
Part II – Other Information        
             
Item 1  
Legal Proceedings
    69-72  
             
Item 2  
Changes in Securities and Use of Proceeds
    72  
             
Item 6  
Exhibits and Reports on Form 8-K
    72  

 

The Management’s Discussion and Analysis included in this Form 10-Q contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of J.P. Morgan Chase & Co.’s management and are subject to significant risks and uncertainties. These risks and uncertainties could cause J.P. Morgan Chase & Co.’s results to differ materially from those set forth in such forward-looking statements. Such risks and uncertainties are described herein and in J.P. Morgan Chase & Co.’s Quarterly Report on Form 10-Q for the quarters ended June 30, 2003, and March 31, 2003, and the Annual Report on Form 10-K for the year ended December 31, 2002, each filed with the Securities and Exchange Commission and available at the Securities and Exchange Commission’s internet site (www.sec.gov), to which reference is hereby made.

2


Table of Contents

Part I
Item 1

J.P. MORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(in millions, except per share data)

                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2003     2002     2003     2002  
 
Noninterest revenue
                               
Investment banking fees
  $ 649     $ 545     $ 2,044     $ 2,085  
Trading revenue
    829       26       3,673       2,089  
Fees and commissions
    2,742       2,665       7,781       7,792  
Private equity gains (losses)
    120       (315 )     (130 )     (678 )
Securities gains
    164       578       1,417       816  
Mortgage fees and related income
    (17 )     512       692       1,080  
Other revenue
    213       200       385       390  
 
Total noninterest revenue
    4,700       4,211       15,862       13,574  
 
Interest income
    5,696       6,316       17,830       19,100  
Interest expense
    2,648       3,580       8,504       10,555  
 
Net interest income
    3,048       2,736       9,326       8,545  
 
Revenue before provision for credit losses
    7,748       6,947       25,188       22,119  
Provision for credit losses
    223       1,836       1,401       3,410  
 
Total net revenue
    7,525       5,111       23,787       18,709  
 
Noninterest expense
                               
Compensation expense
    2,713       2,367       9,118       7,951  
Occupancy expense
    391       478       1,430       1,181  
Technology and communications expense
    719       625       2,088       1,919  
Other expense
    1,272       1,248       3,732       3,735  
Surety settlement and litigation reserve
                100        
Merger and restructuring costs
          333             817  
 
Total noninterest expense
    5,095       5,051       16,468       15,603  
 
Income before income tax expense
    2,430       60       7,319       3,106  
Income tax expense
    802       20       2,464       1,056  
 
Net income
  $ 1,628     $ 40     $ 4,855     $ 2,050  
 
Net income applicable to common stock
  $ 1,615     $ 27     $ 4,817     $ 2,011  
 
Average common shares outstanding
                               
Basic
    2,012       1,986       2,006       1,982  
Diluted
    2,068       2,006       2,047       2,009  
Net income per common share
                               
Basic
  $ 0.80     $ 0.01     $ 2.40     $ 1.01  
Diluted
    0.78       0.01       2.35       1.00  
Cash dividends per common share
    0.34       0.34       1.02       1.02  
 

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

3


Table of Contents

Part I
Item 1 (continued)

J.P. MORGAN CHASE & CO.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(in millions, except share data)

                 
    September 30,     December 31,  
    2003     2002  
 
Assets
               
Cash and due from banks
  $ 18,585     $ 19,218  
Deposits with banks
    10,601       8,942  
Federal funds sold and securities purchased under resale agreements
    88,752       65,809  
Securities borrowed
    37,096       34,143  
Trading assets (including assets pledged of $67,717 at September 30, 2003, and $88,900 at December 31, 2002)
    230,518       248,301  
Securities:
               
Available-for-sale (including assets pledged of $36,192 at September 30, 2003, and $50,468 at December 31, 2002)
    64,941       84,032  
Held-to-maturity (fair value: $224 at September 30, 2003, and $455 at December 31, 2002)
    211       431  
Loans (net of allowance for loan losses of $4,753 at September 30, 2003, and $5,350 at December 31, 2002)
    231,448       211,014  
Private equity investments
    7,797       8,228  
Accrued interest and accounts receivable
    13,995       14,137  
Premises and equipment
    6,558       6,829  
Goodwill
    8,134       8,096  
Other intangible assets
    5,396       4,806  
Other assets
    68,668       44,814  
 
Total assets
  $ 792,700     $ 758,800  
 
Liabilities
               
Deposits:
               
U.S.:
               
Noninterest-bearing
  $ 75,463     $ 74,664  
Interest-bearing
    120,236       109,743  
Non-U.S.:
               
Noninterest-bearing
    6,402       7,365  
Interest-bearing
    111,525       112,981  
 
           
Total deposits
    313,626       304,753  
Federal funds purchased and securities sold under repurchase agreements
    131,959       169,483  
Commercial paper
    14,790       16,591  
Other borrowed funds
    8,174       8,946  
Trading liabilities
    155,801       133,091  
Accounts payable, accrued expenses and other liabilities (including the allowance for lending-related commitments of $329 at September 30, 2003, and $363 at December 31, 2002)
    54,333       38,440  
Beneficial interests of consolidated variable interest entities
    18,399        
Long-term debt
    43,945       39,751  
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
    6,716        
Guaranteed preferred beneficial interests in capital debt securities issued by consolidated trusts
          5,439  
 
Total liabilities
    747,743       716,494  
 
Commitments and contingencies (see Note 18 of this Form 10-Q)
               
Stockholders’ equity
               
Preferred stock
    1,009       1,009  
Common stock (authorized 4,500,000,000 shares, issued 2,040,863,007 shares at September 30, 2003, and 2,023,566,387 shares at December 31, 2002)
    2,041       2,024  
Capital surplus
    13,238       13,222  
Retained earnings
    28,540       25,851  
Accumulated other comprehensive income
    187       1,227  
Treasury stock, at cost (1,693,145 shares at September 30, 2003, and 24,859,844 shares at December 31, 2002)
    (58 )     (1,027 )
 
Total stockholders’ equity
    44,957       42,306  
 
Total liabilities and stockholders’ equity
  $ 792,700     $ 758,800  
 

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

4


Table of Contents

Part I
Item 1 (continued)

J.P. MORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
(in millions, except per share data)

                 
    Nine Months Ended September 30,  
    2003     2002  
 
Preferred stock
               
Balance at beginning of year and end of period
  $ 1,009     $ 1,009  
 
Common stock
               
Balance at beginning of year
    2,024       1,997  
Issuance of common stock
    17       26  
 
Balance at end of period
    2,041       2,023  
 
Capital surplus
               
Balance at beginning of year
    13,222       12,495  
Shares issued and commitments to issue common stock for employee stock-based awards and related tax effects
    16       618  
 
Balance at end of period
    13,238       13,113  
 
Retained earnings
               
Balance at beginning of year
    25,851       26,993  
Net income
    4,855       2,050  
Cash dividends declared:
               
Preferred stock
    (38 )     (39 )
Common stock ($1.02 per share each period)
    (2,128 )     (2,064 )
 
Balance at end of period
    28,540       26,940  
 
Accumulated comprehensive income (loss)
               
Balance at beginning of year
    1,227       (442 )
Other comprehensive income (loss)
    (1,040 )     1,907  
 
Balance at end of period
    187       1,465  
 
Treasury stock, at cost
               
Balance at beginning of year
    (1,027 )     (953 )
Reissuances from treasury stock
    1,082        
Forfeitures to treasury stock
    (113 )     (160 )
 
Balance at end of period
    (58 )     (1,113 )
 
Total stockholders’ equity
  $ 44,957     $ 43,437  
 
Comprehensive income
               
Net income
  $ 4,855     $ 2,050  
Other comprehensive income (loss)
    (1,040 )     1,907  
 
Total comprehensive income
  $ 3,815     $ 3,957  
 

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

5


Table of Contents

Part I
Item 1 (continued)

J.P. MORGAN CHASE & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in millions)

                 
    Nine Months Ended September 30,  
    2003     2002  
 
Operating activities
               
Net income
  $ 4,855     $ 2,050  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Provision for credit losses
    1,401       3,410  
Surety settlement and litigation reserve
    100        
Depreciation and amortization
    2,340       1,988  
Private equity unrealized losses and write-offs
    88       618  
Net change in:
               
Trading assets
    19,519       (49,026 )
Securities borrowed
    (2,953 )     1,297  
Accrued interest and accounts receivable
    150       264  
Other assets
    (25,019 )     7,997  
Trading liabilities
    22,450       34,346  
Accounts payable, accrued expenses and other liabilities
    16,283       (10,954 )
Other, net
    (1,032 )     (250 )
 
Net cash provided by (used in) operating activities
    38,182       (8,260 )
 
Investing activities
               
Net change in:
               
Deposits with banks
    (1,659 )     (704 )
Federal funds sold and securities purchased under resale agreements
    (22,943 )     (21 )
Loans due to sales and securitizations
    124,665       62,342  
Other loans, net
    (136,464 )     (57,410 )
Other, net
    1,904       (2,369 )
                     
Held-to-maturity securities:
  Proceeds     186       71  
 
  Purchases           (39 )
Available-for-sale securities:
  Proceeds from maturities     8,370       3,154  
 
  Proceeds from sales     270,332       154,534  
 
  Purchases     (259,199 )     (173,513 )
                 
Cash used in acquisitions
    (23 )     (72 )
Proceeds from divestitures of nonstrategic businesses and assets
    49       102  
 
Net cash used in investing activities
    (14,782 )     (13,925 )
 
Financing activities
               
Net change in:
               
U.S. deposits
    11,292       6,478  
Non-U.S. deposits
    (2,307 )     (7,957 )
Federal funds purchased and securities sold under repurchase agreements
    (37,524 )     26,300  
Commercial paper and other borrowed funds
    310     (4,691 )
Other, net
    64        
Proceeds from the issuance of long-term debt and capital securities
    11,042       10,558  
Repayments of long-term debt
    (6,042 )     (11,150 )
Net issuance of stock and stock-based awards
    1,002       484  
Redemption of preferred stock of subsidiary
          (550 )
Cash dividends paid
    (2,136 )     (2,086 )
 
Net cash (used in) provided by financing activities
    (24,299 )     17,386  
 
Effect of exchange rate changes on cash and due from banks
    266       358  
Net decrease in cash and due from banks
    (633 )     (4,441 )
Cash and due from banks at December 31, 2002 and 2001
    19,218       22,600  
 
Cash and due from banks at September 30, 2003 and 2002
  $ 18,585     $ 18,159  
Cash interest paid
  $ 8,523     $ 10,301  
Taxes paid
  $ 983     $ 1,025  
 

The Notes to consolidated financial statements (unaudited) are an integral part of these statements.

6


Table of Contents

Part I
Item 1 (continued)

See Glossary of Terms on pages 6768 of this Form 10-Q for definition of terms used throughout the Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accounting and financial reporting policies of J.P. Morgan Chase & Co. (“JPMorgan Chase” or the “Firm”) and its subsidiaries conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and prevailing industry practices for interim reporting. Additionally, where applicable, the policies conform to the accounting and reporting guidelines prescribed by bank regulatory authorities. The unaudited consolidated financial statements prepared in conformity with U.S. GAAP require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expense and disclosure of contingent assets and liabilities. Actual results could be different from these estimates. In addition, certain amounts have been reclassified to conform to the current presentation. In the opinion of management, all normal recurring adjustments have been included for a fair statement of this interim financial information. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in JPMorgan Chase’s Annual Report on Form 10-K for the year ended December 31, 2002 (“2002 Annual Report”).
 

NOTE 2 – TRADING ASSETS AND LIABILITIES

For a discussion of the accounting policies relating to trading assets and liabilities, see Note 3 on pages 76–77 of JPMorgan Chase’s 2002 Annual Report. The following table presents Trading assets and Trading liabilities for the dates indicated:
 
                 
    September 30,     December 31,  
(in millions)   2003     2002  
Trading assets
               
Debt and equity instruments(a):
               
U.S. government, federal agencies and municipal securities
  $ 46,610     $ 68,906  
Certificates of deposit, bankers’ acceptances and commercial paper
    5,331       4,545  
Debt securities issued by non-U.S. governments
    28,027       29,709  
Corporate securities and other
    66,763       62,039  
 
           
Total debt and equity instruments
    146,731       165,199  
 
           
Derivative receivables:
               
Interest rate
    62,033       55,260  
Foreign exchange
    8,087       7,487  
Credit derivatives
    2,644       5,511  
Equity
    9,420       12,846  
Commodity
    1,603       1,998  
 
           
Total derivative receivables
    83,787       83,102  
 
           
Total trading assets
  $ 230,518     $ 248,301  
 
           
Trading liabilities
               
Debt and equity instruments(b)
  $ 87,516     $ 66,864  
 
           
Derivative payables:
               
Interest rate
    47,326       43,584  
Foreign exchange
    8,818       8,036  
Credit derivatives
    2,902       3,055  
Equity
    8,423       10,644  
Commodity
    816       908  
 
           
Total derivative payables
    68,285       66,227  
 
           
Total trading liabilities
  $ 155,801     $ 133,091  
 
           
 
(a)   Includes assets pledged of $67.7 billion at September 30, 2003, and $88.9 billion at December 31, 2002.
(b)   Primarily represents securities sold, not yet purchased.
 

7


Table of Contents

Part I
Item 1 (continued)

NOTE 3 – MORTGAGE FEES AND RELATED INCOME

The following table presents details of Mortgage fees and related income:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Mortgage servicing fees, net of amortization, write-downs and derivatives hedging(a)
  $ 209     $ 323     $ 205     $ 628  
Residential mortgage origination/sales activities(b)
    (86 )     213       731       459  
Other derivative and economic hedges(c)
    (161 )     (47 )     (296 )     (80 )
Other mortgage banking revenue(d)
    21       23       52       73  
 
                       
Total
  $ (17 )   $ 512     $ 692     $ 1,080  
 
                       
 
(a)   Previously recorded in Fees and commissions.
(b)   Previously recorded in Other revenue.
(c)   Includes mortgage servicing rights economic hedges and the mortgage pipeline, net of economic hedges, previously recorded in Trading revenue.
(d)   Previously recorded in Fees and commissions and Other revenue.
 

NOTE 4 – INTEREST INCOME AND INTEREST EXPENSE

The following table details the components of Interest income and Interest expense:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Interest income
                               
Loans
  $ 2,885     $ 2,960     $ 8,521     $ 9,240  
Securities
    880       894       2,826       2,487  
Trading assets
    1,491       1,665       4,935       5,027  
Federal funds sold and securities purchased under resale agreements
    344       530       1,171       1,556  
Securities borrowed
    72       180       248       536  
Deposits with banks
    24       87       129       254  
 
                       
Total interest income
    5,696       6,316       17,830       19,100  
 
                       
Interest expense
                               
Deposits
    789       1,422       2,807       4,077  
Short-term and other liabilities
    1,444       1,789       4,530       5,425  
Long-term debt
    369       369       1,121       1,053  
Beneficial interests of consolidated variable interest entities
    46             46        
 
                       
Total interest expense
    2,648       3,580       8,504       10,555  
 
                       
Net interest income
    3,048       2,736       9,326       8,545  
Provision for credit losses
    223       1,836       1,401       3,410  
 
                       
Net interest income after provision for credit losses
  $ 2,825     $ 900     $ 7,925     $ 5,135  
 
                       
 

NOTE 5 – EMPLOYEE STOCK-BASED INCENTIVES

For a discussion of the accounting policies relating to employee stock-based compensation, see Note 24 on pages 96–99 of JPMorgan Chase’s 2002 Annual Report.

Effective January 1, 2003, JPMorgan Chase adopted SFAS 123 using the prospective transition method. SFAS 123 requires all stock-based compensation awards, including stock options, to be accounted for at fair value. Under the prospective transition method, all new awards granted to employees on or after January 1, 2003, are accounted for at fair value, and awards that were outstanding as of December 31, 2002, if not subsequently modified, continue to be accounted for under APB 25. Fair value is based on a Black-Scholes valuation model, with compensation expense recognized in earnings over the required service period.

Pre-tax employee stock-based compensation expense recognized in reported earnings totaled $222 million and $700 million for the three and nine months ended September 30, 2003, respectively, and $101 million and $422 million for the three and nine months ended September 30, 2002, respectively. Compensation expense for the three and nine months ended September 30, 2003, reflected $65 million and $194 million, respectively, related to the adoption of SFAS 123 and reduced costs resulting from the vesting of prior-year awards and forfeitures. Also included in Compensation expense for the three and nine months ended September 30, 2002, were the reversals of previously accrued expenses of $67 million and $120 million, respectively, related to certain forfeitable key employee stock awards granted in prior years that were deemed unlikely to vest within the timeframes specified under the terms of the awards.

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Part I
Item 1 (continued)

The following table presents net income and basic and diluted earnings per share as reported, and as if all outstanding awards were accounted for at fair value in each period, for the three and nine months ended September 30, 2003 and 2002. The lower expense from applying SFAS 123 in the three and nine months ended September 30, 2003, compared with the three and nine months ended September 30, 2002, resulted from a decrease in 2003 in the number of outstanding stock-based compensation awards, a lower common stock price, lower Black-Scholes option fair values and longer service-period requirements.

 
                                     
        Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions, except per share data)   2003     2002     2003     2002  
Net income as reported   $ 1,628     $ 40     $ 4,855     $ 2,050  
Add:
  Employee stock-based compensation expense                                
 
  included in reported net income,                                
 
  net of related tax effects     133       60       420       253  
Deduct:
  Employee stock-based compensation expense                                
 
  determined under the fair value method for                                
 
  all awards, net of related tax effects     (217 )     (289 )     (704 )     (947 )
 
                           
Pro forma net income   $ 1,544     $ (189 )   $ 4,571     $ 1,356  
 
                           
Earnings per share:                                
Basic
  As reported   $ 0.80     $ 0.01     $ 2.40     $ 1.01  
 
  Pro forma     0.76       (0.10 )     2.26       0.66  
Diluted
  As reported     0.78       0.01       2.35       1.00  
 
  Pro forma     0.74       (0.10 )     2.21       0.66  
 

NOTE 6 – SECURITIES

For a discussion of the accounting policies relating to Securities, see Note 7 on pages 79–80 of JPMorgan Chase’s 2002 Annual Report. The following table presents realized gains and losses from available-for-sale (“AFS”) securities:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Realized gains
  $ 576     $ 660     $ 2,000     $ 986  
Realized losses
    (412 )     (82 )     (583 )     (170 )
 
                       
Net realized gains
  $ 164     $ 578     $ 1,417     $ 816  
 
                       
 

The amortized cost and estimated fair value of securities were as follows for the dates indicated:

 
                                 
(in millions)            
             
    September 30, 2003     December 31, 2002  
Available-for-sale securities(a)   Amortized     Fair     Amortized     Fair  
    Cost     Value     Cost     Value  
U.S. Government and federal agencies/corporations obligations:
                               
Mortgage-backed securities
  $ 37,826     $ 37,509     $ 40,148     $ 40,456  
Collateralized mortgage obligations
    916       908       3,271       3,313  
U.S. treasuries
    12,464       12,522       22,870       23,377  
Obligations of state and political subdivisions
    3,316       3,384       1,744       1,875  
Debt securities issued by non-U.S. governments
    6,269       6,287       11,873       11,912  
Corporate debt securities
    849       861       870       882  
Equity securities
    1,345       1,363       1,198       1,196  
Other, primarily asset-backed securities(b)
    2,157       2,107       978       1,021  
 
                       
Total available-for-sale securities(c)
  $ 65,142     $ 64,941     $ 82,952     $ 84,032  
 
                       
Held-to-maturity securities(d)
  $ 211     $ 224     $ 431     $ 455  
 
                       
 
(a)   Includes assets pledged of $36.2 billion at September 30, 2003, and $50.5 billion at December 31, 2002.
(b)   Includes collateralized mortgage obligations of private issuers, which generally have underlying collateral consisting of obligations of U.S. government and federal agencies and corporations.
(c)   At September 30, 2003, includes $3.6 billion of investment securities related to variable interest entities consolidated in accordance with FIN 46.
(d)   Consists primarily of mortgage-backed securities.
 

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Item 1 (continued)

NOTE 7 – SECURITIES FINANCING ACTIVITIES

For a discussion of the accounting policies relating to securities financing activities, see Note 8 on page 80 of JPMorgan Chase’s 2002 Annual Report. The following table details the components of securities financing activities at each of the dates indicated:
 
                 
    September 30,     December 31,  
(in millions)   2003     2002  
Securities purchased under resale agreements
  $ 85,262     $ 57,645  
Securities borrowed
    37,096       34,143  
 
Securities sold under repurchase agreements
  $ 121,246     $ 161,394  
Securities loaned
    2,162       1,661  
 

Transactions that do not meet the SFAS 140 definition of a repurchase agreement are accounted for as “buys” and “sells” rather than financing transactions. Notional amounts of transactions accounted for as purchases under SFAS 140 were $11 billion and $8 billion at September 30, 2003, and December 31, 2002, respectively. Notional amounts of transactions accounted for as sales under SFAS 140 were $5 billion and $13 billion at September 30, 2003, and December 31, 2002, respectively.

Securities borrowed and securities lent are recorded at the amount of cash collateral advanced or received. Securities borrowed consist primarily of government and equity securities. JPMorgan Chase monitors the market value of the securities borrowed and lent on a daily basis and calls for additional collateral when appropriate. Fees received or paid are recorded in Interest income or Interest expense.

JPMorgan Chase pledges certain financial instruments it owns to collateralize repurchase agreements and other securities financings. Pledged securities that can be sold or repledged by the secured party are identified as financial instruments owned (pledged to various parties) on the Consolidated balance sheets. At September 30, 2003, the Firm had received securities as collateral that can be repledged, delivered or otherwise used with a fair value of approximately $257 billion. This collateral was generally obtained under reverse repurchase or securities borrowing agreements. Of these securities, $245 billion were repledged, delivered or otherwise used, primarily as collateral, under repurchase agreements, securities lending agreements or to cover short sales.

NOTE 8 – LOANS

For a discussion of the accounting policies relating to Loans, see Note 9 on pages 80–81 of JPMorgan Chase’s 2002 Annual Report. For a discussion of the Allowance for credit losses, see the Credit Risk Management section on pages 57–58 of this Form 10-Q.

The composition of the loan portfolio at each of the dates indicated was as follows:

 
                                 
                             
(in millions)   September 30, 2003           December 31, 2002        
Commercial loans:
                               
Commercial and industrial
  $ 74,399 (e)           $ 80,651          
Commercial real estate:
                               
Commercial mortgage
    2,345               3,178          
Construction
    616               895          
Financial institutions
    10,390               6,208          
Non-U.S. governments
    658               616          
 
                           
Total commercial loans
    88,408               91,548          
Consumer loans:
                               
1–4 family residential mortgages:
                               
First liens
    68,873               49,357          
Home equity loans
    16,981               14,643          
Credit card(a)
    16,015               19,677          
Automobile financings
    38,867               33,615          
Other consumer(b)
    7,057               7,524          
 
                           
Total consumer loans
    147,793               124,816          
 
                           
Total loans(c)(d)
  $ 236,201             $ 216,364          
 
                           
 
(a)  
At September 30, 2003, excludes $1.1 billion of accrued interest and fees on securitized credit card loans that were classified in Other assets, consistent with the FASB Staff Position, Accounting for Accrued Interest Receivable Related to Securitized and Sold Receivables under SFAS 140. Prior to March 31, 2003, these receivables were classified in Loans.
(b)  
Consists of manufactured housing loans, installment loans (direct and indirect types of consumer finance), student loans, unsecured revolving lines of credit and non-U.S. consumer loans.
(c)  
Loans are presented net of unearned income of $1.4 billion and $1.9 billion at September 30, 2003, and December 31, 2002, respectively.

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Item 1 (continued)

 
(d)  
Includes loans held for sale (principally mortgage-related loans) of $36.2 billion at September 30, 2003, and $25.0 billion at December 31, 2002. The results of operations for the three months ended September 30, 2003 and 2002, included $638 million and $268 million, respectively, and for the nine months ended September 30, 2003 and 2002, included $1.4 billion and $516 million, respectively, in net gains on the sales of loans held for sale. The results of operations for the three months ended September 30, 2003 and 2002, included $36 million and $(5) million, respectively, and for the nine months ended September 30, 2003 and 2002, included $22 million and $(12) million, respectively, in adjustments to record loans held for sale at the lower of cost or market.
(e)  
Includes $10.9 billion of exposure related to variable interest entities consolidated in accordance with FIN 46, of which $10.4 billion is associated with multi-seller asset-backed commercial paper conduits.
 

NOTE 9 – SECURITIZATION AND VARIABLE INTEREST ENTITIES

Refer to Note 11 on pages 83-87 of JPMorgan Chase’s 2002 Annual Report for a further description of special-purpose entities (“SPEs”) and the Firm’s policy on consolidation relating to these entities. In January 2003, the FASB issued FIN 46, which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. The effects of FIN 46 are further discussed at the end of this note.

JPMorgan Chase is involved with SPEs, or variable interest entities (“VIEs”), in three broad categories of transactions: loan securitizations, multi-seller conduits and client intermediation. Assets held by loan securitization-related SPEs at September 30, 2003 and December 31, 2002, were approximately $96.1 billion and $90.6 billion, respectively. During the three and nine months ended September 30, 2003, the Firm securitized $8.3 billion and $22.1 billion of loans, respectively, compared with $4.8 billion and $19.5 billion, respectively, for the same periods in 2002. Assets held by multi-seller conduits for which the Firm acts as administrator at September 30, 2003 and December 31, 2002, were approximately $11.9 billion and $17.5 billion, respectively. Assets held by certain client intermediation-related SPEs at September 30, 2003 and December 31, 2002, were approximately $27.6 billion and $24.9 billion, respectively.

Loan Securitizations

JPMorgan Chase securitizes, sells and services residential mortgage, credit card, automobile and commercial loans. Assets sold to SPEs as part of the securitization process are not reflected in JPMorgan Chase’s Consolidated balance sheets (except for retained interests as described below) but are included on the balance sheet of the SPE purchasing the assets. Assets held by securitization-related SPEs as of September 30, 2003 and December 31, 2002, were as follows:
 
                 
(in billions)   September 30, 2003     December 31, 2002  
Credit card receivables
  $ 40.9     $ 40.2  
Residential mortgage receivables
    19.6       20.6  
Commercial loans
    29.4       25.2  
Automobile loans
    6.1       4.5  
Other receivables
    0.1       0.1  
 
Total
  $ 96.1     $ 90.6  
 

The table below summarizes new securitized loan transactions and the resulting pre-tax gains arising from such securitizations during the three and nine months ended September 30, 2003 and 2002.

 
                                 
Three Months Ended   September 30, 2003     September 30, 2002  
    Securitizations     Pre-Tax Gains     Securitizations     Pre-Tax Gains  
Loans   (in billions)     (in millions)     (in billions)     (in millions)  
Residential mortgage
  $ 3.3     $ 102.2     $ 1.8     $ 116.9  
Credit card
    1.7       9.3       2.1       13.0  
Automobile
    1.5       9.8              
Commercial
    1.8       49.4       0.9       16.0  
 
Total
  $ 8.3     $ 170.7     $ 4.8     $ 145.9  
 
                                 
Nine Months Ended   September 30, 2003     September 30, 2002  
    Securitizations     Pre-Tax Gains     Securitizations     Pre-Tax Gains  
Loans   (in billions)     (in millions)     (in billions)     (in millions)  
Residential mortgage
  $ 8.8     $ 245.6     $ 6.4     $ 175.6  
Credit card
    6.0       31.2       7.5       37.7  
Automobile
    3.5       12.7       3.4       5.5  
Commercial
    3.8       86.1       2.2       26.0  
 
Total
  $ 22.1     $ 375.6     $ 19.5     $ 244.8  
 

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Item 1 (continued)

In addition to the amounts set forth in the tables above, JPMorgan Chase sold residential mortgage loans totaling $35.6 billion and $13.6 billion during the third quarters of 2003 and 2002, respectively, primarily as GNMA, FNMA and Freddie Mac mortgage-backed securities, which resulted in pre-tax gains of $374 million and $89 million, respectively. During the first nine months of 2003 and 2002, JPMorgan Chase sold residential mortgage loans totaling $89.7 billion and $42.6 billion, respectively. These sales resulted in gains of $833 million and $222 million, respectively. Amounts recognized in earnings for residential mortgage securitizations activities were partially offset by unrealized losses related to loans in the pipeline (loans not yet closed) as well as not yet sold.

At September 30, 2003 and December 31, 2002, JPMorgan Chase had, with respect to its credit card master trusts, $5.9 billion and $7.3 billion, respectively, related to its undivided interest, and $1.1 billion and $978 million, respectively, related to its subordinated interest in accrued interest and fees on the securitized receivables.

The Firm maintains retained interests in its securitized and sold loans, generally in the form of senior, subordinated interest-only strips, subordinated tranches, escrow accounts and servicing rights. The Firm maintains escrow accounts, up to predetermined limits for credit card and automobile securitizations, to help protect investors in the unlikely event of deficiencies in cash flows owed to them. The amounts available in such escrow accounts are recorded in Other assets and, as of September 30, 2003, totaled $502 million and $120 million for credit card and automobile securitizations, respectively. As of December 31, 2002, these amounts were $510 million and $94 million, respectively.

The table below summarizes other retained securitization interests, primarily subordinated or residual interests, which are carried at fair value on the Firm’s Consolidated balance sheets.

 
                 
(in millions)   September 30, 2003     December 31, 2002  
Loans
               
Residential mortgage
  $ 666 (a)(b)   $ 684  
Credit card
    131 (b)     92  
Automobile
    161 (b)     151  
Commercial
    79       94  
 
Total
  $ 1,037     $ 1,021  
 
(a)  
Includes approximately $264 million of retained interests resulting from the acquisition of Advanta’s mortgage operations.
(b)  
Unrealized gains (losses) (pre-tax) recorded in Stockholders’ equity that relate to retained securitization interests totaled $177 million, $5 million and $4 million for residential mortgage, credit card and automobile, respectively.
 

The table below outlines the key economic assumptions and the sensitivity of the fair values noted above at September 30, 2003, of the remaining retained interests to immediate 10% and 20% adverse changes in those assumptions:

 
                                 
($ in millions)   Mortgage     Credit Card     Automobile     Commercial  
Weighted-average life   1.4–2.4 years   6–14 months   1.5 years   0.7–5.4 years
 
Prepayment rate   28.9–36.9 % CPR     15.2–16.4 %   1.45% WAC/WAM   NA (a)
Impact of 10% adverse change
  $ (22 )   $ (5 )   $ (9 )      
Impact of 20% adverse change
    (40 )     (9 )     (19 )      
 
Loss assumption     0–3.6 %(b)     5.4–5.5 %     0.6 %   NA (c)
Impact of 10% adverse change
  $ (29 )   $ (12 )   $ (5 )      
Impact of 20% adverse change
    (59 )     (23 )     (11 )      
Discount rate
    13–30 %(d)     5.5–12.0 %     4.2 %     3.5–17.4 %
Impact of 10% adverse change
  $ (16 )   $ (1 )   $ (1 )   $ (2 )
Impact of 20% adverse change
    (32 )     (2 )     (2 )     (3 )
 
(a)  
Not applicable, since predominantly all of these retained interests are not subject to prepayment risk.
(b)  
Expected credit losses for prime mortgage securitizations are minimal and are incorporated into other assumptions.
(c)  
Not applicable, as modeling assumptions for predominantly all of the commercial retained interests consider overcollateralization coverage and cash collateralized credit default swaps.
(d)  
During the first nine months of 2003, the Firm sold residual interests of approximately $261 million relating to sub-prime mortgage securitizations via Net Interest Margin (“NIM”) securitizations. The Firm has retained residual interests in these and prior NIM securitizations of approximately $146 million, which are valued using a 30% discount rate.
CPR – Constant prepayment rate
WAC / WAM – Weighted-average coupon/weighted-average maturity
 

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Part I
Item 1 (continued)

The sensitivity analysis in the preceding table is hypothetical. Changes in fair value based on 10% and 20% variations in assumptions generally cannot be extrapolated easily, because the relationship between the change in the assumptions and the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on fair value is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another assumption, which might counteract or magnify the sensitivities.

The table below presents information about delinquencies, net credit losses and components of reported and securitized financial assets:

 
                                                 
                    Loans 90 days or        
Type of Loan   Total loans     more past due     Net loan charge-offs  
    Sept. 30,     Dec. 31,     Sept. 30,     Dec. 31,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002     2003     2002  
Mortgage(a)
  $ 101,613     $ 81,570     $ 927     $ 956     $ 166     $ 215  
Credit card
    50,330       50,399       1,056       1,096       2,214       2,112  
Automobile
    44,876       37,980       126       130       146       128  
Other(b)
    7,057       7,524       91       98       133       135  
 
                                   
Consumer loans
    203,876       177,473       2,200       2,280       2,659       2,590  
Commercial loans
    91,043       92,866       2,644       3,749       808       1,447  
 
                                   
Total loans reported and securitized(c)
    294,919       270,339       4,844       6,029       3,467       4,037  
Less: Loans securitized(a)(d)
    (58,718 )     (53,975 )     (1,446 )     (1,306 )     (1,569 )     (1,197 )
 
                                   
Reported
  $ 236,201     $ 216,364     $ 3,398     $ 4,723     $ 1,898     $ 2,840  
 
                                   
 
(a)  
Includes $13.5 billion of outstanding principal balances on securitized subprime 1–4 family residential mortgage loans as of September 30, 2003, of which $2.5 billion relates to Advanta’s mortgage operations acquired in 2001.
(b)   Includes non-U.S. consumer loans.
(c)  
Represents both loans on the Consolidated balance sheets and loans that have been securitized but excludes loans for which the Firm’s only continuing involvement is servicing of the assets.
(d)  
Total assets held in securitization-related SPEs, as of September 30, 2003, were $96.1 billion. The $58.7 billion of loans securitized at September 30, 2003, excludes: $30.4 billion of securitized loans in which the Firm’s only continuing involvement is the servicing of the assets; $5.9 billion of seller’s interests in credit card master trusts; and $1.1 billion of escrow accounts and other assets.
 

Multi-seller Conduits

JPMorgan Chase serves as the administrator and provides contingent liquidity support and limited credit enhancement for several commercial paper conduits. JPMorgan Chase Bank had commitments to provide liquidity on an asset-specific basis to these vehicles in an amount up to $18.7 billion at September 30, 2003, and $23.5 billion at December 31, 2002. Asset-specific liquidity is the primary source of liquidity support for the conduits. In addition, program-wide liquidity is provided by JPMorgan Chase Bank to these vehicles in the event of short-term disruptions in the commercial paper market; these commitments totaled $2.3 billion and $2.5 billion at September 30, 2003 and December 31, 2002, respectively. For certain multi-seller conduits, JPMorgan Chase also provides limited credit enhancement, primarily through the issuance of letters of credit. Commitments under these letters of credit totaled $3.4 billion at September 30, 2003, and December 31, 2002. Commercial paper issued by multi-seller conduits for which the Firm acts as administrator aggregated $11.9 billion at September 30, 2003, and $17.5 billion at December 31, 2002. The Firm’s maximum credit exposure to these vehicles at September 30, 2003 is $18.7 billion as the Firm cannot be obligated to fund the entire notional amounts of asset-specific liquidity, program-wide liquidity and credit enhancement facilities at the same time. As discussed below, the Firm consolidated the asset-backed commercial paper conduits at July 1, 2003, in accordance with FIN 46 and recorded the assets held by the conduits on its Consolidated balance sheet; $10.4 billion was recorded in Loans and $1.5 billion in Available-for-sale securities at September 30, 2003.

Client Intermediation

Assets held by certain client intermediation-related SPEs at September 30, 2003 and December 31, 2002, were as follows:
 
                 
(in billions)   September 30, 2003     December 31, 2002  
Structured commercial loan vehicles(a)
  $ 6.4     $ 7.2  
Credit-linked note vehicles(b)
    12.6       7.9  
Other client intermediation vehicles(c)
    5.7       7.4  
Collateralized debt obligations (CDOs) and similar vehicles(d)
    2.9       2.4  
 

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Item 1 (continued)

 
(a)  
These are structured commercial loan vehicles managed by third parties and funded by commercial paper. JPMorgan Chase Bank had a commitment to provide liquidity to these vehicles in an amount up to $9.3 billion at September 30, 2003 and $12.0 billion at December 31, 2002. For purposes of FIN 46, the Firm’s maximum exposure to loss to the structured commercial loan vehicles is defined as the aggregate notional amounts of the liquidity facilities.
(b)  
The fair value of the Firm’s derivative contracts with credit-linked note vehicles was not material at September 30, 2003.
(c)  
These are structured vehicles in which the Firm transfers the risks and returns of the assets held by the SPE, typically debt and equity instruments, to clients through derivative contracts. The Firm’s net exposure arising from these transactions was not significant and was reflected in its Consolidated financial statements as the fair value of derivative contracts.
(d)  
The Firm or its affiliates act as assets manager for these vehicles. In addition, the Firm may warehouse assets or act as a derivative counterparty, trustee or placement agent for these vehicles, receiving market-based fees for services rendered. The Firm has invested approximately $141 million in these vehicles, which represents the Firm’s maximum exposure to loss at September 30, 2003, and records these investments at fair value through earnings.
 

Finally, the Firm may enter into transactions with SPEs structured by other parties. These transactions can include, for example, acting as a derivative counterparty, liquidity provider, investor, underwriter, trustee or custodian. These transactions are conducted at arm’s length, and individual credit decisions are based upon the analysis of the specific SPE, taking into consideration the quality of the underlying assets. JPMorgan Chase records and reports these positions similarly to any other third-party transaction.

FIN 46 Transition

Entities that are assessed for consolidation under FIN 46 are typically SPEs, although non-SPE-type entities may also be subject to the guidance. FIN 46 requires a VIE to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities (“QSPEs”), which represent a majority of the Firm’s loan securitization transactions, and certain other interests in a QSPE are not subject to the requirements of FIN 46. Effective February 1, 2003, the Firm implemented FIN 46 for VIEs created or modified after January 31, 2003, in which the Firm has an interest. Effective October 10, 2003, the FASB deferred the effective date of FIN 46 from July 1, 2003, to the first interim period ending after December 15, 2003, for all VIEs originated prior to February 1, 2003.

The Firm elected to adopt the provisions of FIN 46 as of July 1, 2003, for all VIEs originated prior to February 1, 2003, excluding certain investments made by its private equity business, as discussed below. The effect of adoption was an incremental increase in the Firm’s assets and liabilities of approximately $15 billion at September 30, 2003. The increase primarily related to Firm-sponsored multi-seller asset-backed commercial paper conduits and other entities in which the Firm’s trading and investment functions have interests that absorb a majority of the expected residual loss in the structures. As a result of its adoption of FIN 46, the Firm deconsolidated certain vehicles, primarily the wholly-owned Delaware statutory business trusts further discussed in Note 13 of this Form 10-Q and Note 16 on pages 90–91 of JPMorgan Chase’s 2002 Annual Report. Finally, certain VIEs, primarily related to certain municipal bond securitizations and structured note vehicles, with assets of approximately $3 billion, that had been consolidated under prior accounting literature continue to be consolidated in accordance with FIN 46. There was no incremental impact to the Firm’s Consolidated financial statements in the current quarter related to the continued consolidation of these VIEs.

The Firm’s private equity business could be involved with entities that may be deemed VIEs. Effective October 10, 2003, the FASB permitted nonregistered investment companies to defer consolidation of VIEs with which they are involved until the proposed Statement of Position (“SOP”) on the clarification of the scope of the Investment Company Audit Guide (“Audit Guide”) is finalized, which is expected to occur in mid-2004. Following issuance of the SOP, the FASB will consider further modification to FIN 46 to provide an exception for companies that qualify to apply the revised Audit Guide. The Firm deferred consolidation of $2.5 billion of assets related to JPMP as of July 1, 2003. Following issuance of the revised Audit Guide and further modification, if any, to FIN 46, the Firm will assess the effect of such guidance on its private equity business.

Upon adoption of FIN 46, the assets, liabilities and noncontrolling interests of VIEs were generally measured at the amounts at which such interests would have been carried had FIN 46 been effective when the Firm first met the condition to be considered the primary beneficiary. For certain VIEs, the initial carrying amount of the assets and liabilities (approximately $1.7 billion) was based on fair value at July 1, 2003, due to limited historical information. The difference between the net amount added to the balance sheet and the amount of any previously recognized interest in the newly consolidated entity was recognized as a cumulative effect of an accounting change at July 1, 2003, which resulted in a $2 million (after-tax) reduction to the Firm’s consolidated earnings. The Firm also recorded a $34 million (after-tax) reduction in other comprehensive income related to Available-for-sale securities and derivative cash flow hedges related to entities measured at the amount at which such interests would have been carried had FIN 46 been effective when the Firm first met the condition of being the primary beneficiary.

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The following table summarizes the Firm’s total consolidated VIE assets by classification on the Consolidated balance sheet as of September 30, 2003. Of the total consolidated VIE assets at September 30, 2003, $15.5 billion related to VIEs that were consolidated during the third quarter of 2003 in accordance with FIN 46; the balance related to VIEs that were consolidated prior to the third quarter of 2003 and that remain consolidated in accordance with FIN 46.

 
         
(in billions)   September 30, 2003  
Consolidated VIE assets(a)
       
Loans(b)
  $ 10.9  
Investment securities
    3.6  
Trading assets(c)
    3.2  
Other assets
    1.1  
 
     
Total consolidated assets
  $ 18.8  
 
     
 
(a)  
The Firm also holds $3.4 billion of assets primarily as a seller’s interest in certain consumer securitizations in a segregated entity as part of a two-step securitization transaction. This interest is included in the securitization activities disclosed in this footnote and is not included herein.
(b)  
Primarily relates to the consolidated multi-seller asset-backed commercial paper conduits.
(c)   Includes securities and derivatives.
 

In the third quarter of 2003, the Firm classified the interest-bearing beneficial interest liabilities of the consolidated VIEs in a new line item titled “Beneficial interests of consolidated variable interest entities.” The holders of these beneficial interests do not have recourse to the general credit of JPMorgan Chase. See page 47 of this Form 10-Q for the maturity profile of the FIN 46 long-term beneficial interests.

FIN 46 is a complex accounting standard. The FASB is currently in the process of amending FIN 46 for various technical modifications and is developing implementation guidance on FIN 46 through various FASB Staff Positions (“FSPs”). The Firm will assess the impact of the amendment to FIN 46, any new implementation guidance issued by the FASB, as well as the evolving interpretations of FIN 46 among accounting professionals; additional guidance and interpretations may affect the Firm’s application of FIN 46 to the Firm’s activities in future periods.

 

NOTE 10 – GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets consist of the following:
 
                 
(in millions)   September 30, 2003     December 31, 2002  
Goodwill
  $ 8,134     $ 8,096  
 
           
Other intangible assets:
               
Mortgage servicing rights
  $ 4,007     $ 3,230  
Purchased credit card relationships
    1,078       1,269  
All other intangibles
    311       307  
 
           
Total other intangible assets
  $ 5,396     $ 4,806  
 
           
 

Goodwill

For the nine months ended September 30, 2003, goodwill increased $38 million, principally in connection with purchase accounting adjustments and acquisitions of institutional trust services businesses in the first nine months of 2003. Goodwill was not impaired at September 30, 2003, or December 31, 2002, nor was any goodwill written off during the nine months ended September 30, 2003 or 2002.

Goodwill by business segment is as follows:

 
                 
(in millions)   September 30, 2003     December 31, 2002  
Investment Bank
  $ 2,058     $ 2,051  
Treasury & Securities Services
    1,013       996  
Investment Management & Private Banking
    4,179       4,165  
JPMorgan Partners
    377       377  
Chase Financial Services
    507       507  
 
           
Total goodwill
  $ 8,134     $ 8,096  
 
           
 

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Item 1 (continued)

Mortgage servicing rights

For a further description of mortgage servicing rights (“MSRs”) and interest rate risk management of MSRs, see Note 12 on pages 87–88 of JPMorgan Chase’s 2002 Annual Report. The following table summarizes the changes in residential MSRs during the first nine months of 2003 and 2002:
 
                 
    Nine Months Ended September 30,  
(in millions)   2003     2002  
Balance at January 1
  $ 4,864     $ 7,749  
Additions
    2,411       1,505  
Sales
           
Other-than-temporary impairment
    (274 )      
Amortization
    (1,078 )     (1,024 )
SFAS 133 hedge valuation adjustments
    (502 )     (3,592 )
 
           
Balance at September 30
    5,421       4,638  
Less: valuation allowance
    1,414       1,032  
 
           
Balance at September 30, after valuation allowance
  $ 4,007     $ 3,606  
 
           
Estimated fair value at September 30
  $ 4,007     $ 3,606  
 
           
Weighted-average prepayment speed assumption   21.2 %CPR   26.7 %CPR
Weighted-average discount rate
    7.64 %     8.30 %

CPR – Constant Prepayment Rate

The valuation allowance represents the extent to which the carrying value of MSRs exceeds its estimated fair value. Changes in the valuation allowance are the result of the recognition of impairment or the recovery of previously recognized impairment charges due to changes in market conditions during the period. The changes in the valuation allowance for MSRs were as follows:

 
                 
    Nine Months Ended September 30,  
(in millions)   2003     2002  
Balance at January 1
  $ 1,634     $ 1,170  
Other-than-temporary impairment
    (274 )      
Impairment adjustment
    54       (138 )
 
           
Balance at September 30
  $ 1,414     $ 1,032  
 
           
 

During the second quarter of 2003, the Firm recorded an other-than-temporary impairment of its MSRs of $274 million, which permanently reduced the gross carrying value of the MSRs and the related valuation allowance. The permanent reduction precludes subsequent reversals. This write-down had no impact on the results of operations or financial condition of the Firm.

The Firm evaluates other-than-temporary impairment by reviewing changes in mortgage and other market interest rates over historical periods and then determines an interest rate scenario to estimate the amounts of the MSRs’ gross carrying value and the related valuation allowance that could be expected to be recovered in the foreseeable future. Any gross carrying value and related valuation allowance amount that are not expected to be recovered in the foreseeable future, based upon the interest rate scenario, are considered to be other-than-temporary.

Purchase credit card relationships and other intangible assets

There were no purchased credit card relationship intangibles added during the nine months ended September 30, 2003. For the nine months ended September 30, 2003, other intangibles increased by $40 million, principally in connection with purchase accounting adjustments and acquisitions of institutional trust services businesses, servicing assets on securitized automobile loans and an acquisition of a retirement plan services business. All of the Firm’s acquired intangible assets are subject to amortization.

The components of other intangible assets were as follows:

 
                                                         
                            Three Months Ended     Nine Months Ended  
(in millions)   September 30, 2003   September 30,     September 30,  
    Gross     Accumulated     Net Carrying     2003     2002     2003     2002  
    Amount     Amortization     Value     Amortization Expense     Amortization Expense  
Purchased credit card relationships
  $ 1,885     $ 807     $ 1,078     $ 64     $ 71     $ 192     $ 208  
All other intangibles
    709       398 (a)     311       9       9       28       33  
 
                                               
Total amortization expense
                          $ 73     $ 80     $ 220     $ 241  
 
                                               
 
(a)   Includes $8 million of amortization expense related to servicing assets on securitized automobile loans, which is recorded in Fees and commissions, for the nine months ended September 30, 2003.
 

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Item 1 (continued)

Future amortization expense

The following table presents estimated amortization expense related to purchased credit card relationships and all other intangible assets at September 30, 2003:
 
                 
(in millions)   Purchased credit     All other  
Year ended December 31,   card relationships     intangible assets  
2003(a)
  $ 62     $ 13  
2004
    243       46  
2005
    235       40  
2006
    222       35  
2007
    187       29  
2008
    117       27  
 
(a)   Excludes $192 million and $28 million recorded in Purchased credit card relationships and All other intangible assets, respectively, during the first nine months of 2003.
 

NOTE 11 – PRIVATE EQUITY INVESTMENTS

For a further description of private equity investments, see Note 13 on page 88 of JPMorgan Chase’s 2002 Annual Report. The following table presents the carrying value and cost of the private equity investment portfolio for the dates indicated:
 
                                 
(in millions)            
    September 30, 2003     December 31, 2002  
    Carrying             Carrying        
    value     Cost     value     Cost  
Total investment portfolio
  $ 7,797     $ 9,768     $ 8,228     $ 10,312  
 

The following table presents private equity gains (losses) for the periods indicated, primarily related to JPMorgan Partners:

 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Direct investments:
                               
Realized cash gains (net)
  $ 134     $ 92     $ 346     $ 312  
Write-ups / (write-downs / write-offs)
          (225 )     (365 )     (601 )
Mark-to-market gains (losses)(a)
    27       (122 )     169       (319 )
 
                       
Total direct investments
    161       (255 )     150       (608 )
Private third-party fund investments (net)
    (41 )     (60 )     (280 )     (70 )
 
                       
Total private equity gains (losses)
  $ 120     $ (315 )   $ (130 )   $ (678 )
 
                       
 
(a)   Includes mark-to-market gains (losses) and reversals of mark-to-market gains (losses) due to sales of publicly-traded securities.
 

NOTE 12 – RESTRUCTURING COSTS

All merger and restructuring costs associated with various programs announced prior to January 1, 2002, were reflected in the merger and restructuring costs caption of the Consolidated statement of income and had been incurred as of December 31, 2002. For a discussion of such costs incurred by the Firm in the three and nine months ended September 30, 2002, see Note 5 on page 11 of the Firm’s Form 10-Q for the quarter ended September 30, 2002. Additionally, as indicated in Note 6 on page 78 of JPMorgan Chase’s 2002 Annual Report, all previously recorded liabilities for merger charges of $1.25 billion and right-sizing charges of $300 million had been fully utilized as of December 31, 2002.

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Restructuring costs associated with programs announced after January 1, 2002, are reflected in the related expense category of the Consolidated statement of income. A summary of such costs, by expense category and segment, are shown in the following table for the three and nine months ended September 30, 2003 and 2002.

 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Expense category
                               
Compensation
  $ 64     $ 108     $ 192     $ 333  
Occupancy
    (7 )     100       199       112  
Technology and communications
    8       4       36       30  
Other
    1       8       20       13  
 
                       
Total
  $ 66     $ 220     $ 447     $ 488  
 
                       
 
                                 
(in millions)   Three Months Ended September 30,     Nine Months Ended September 30,  
Segment   2003     2002     2003     2002  
Investment Bank
  $ 26     $ 79     $ 280     $ 250  
Treasury & Securities Services
    10       4       38       12  
Investment Management & Private Banking
    11       14       18       22  
JPMorgan Partners
                2        
Chase Financial Services
    26       15       42       74  
Support Units and Corporate
    (7 )     108       67       130  
 
                       
Total
  $ 66     $ 220     $ 447     $ 488  
 
                       
 

NOTE 13 – JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES HELD BY TRUSTS THAT ISSUED GUARANTEED CAPITAL DEBT SECURITIES and GUARANTEED PREFERRED BENEFICIAL INTERESTS IN CAPITAL DEBT SECURITIES ISSUED BY CONSOLIDATED TRUSTS

At September 30, 2003, the Firm had established 13 wholly-owned Delaware statutory business trusts (issuer trusts) that issued guaranteed preferred beneficial interests in the Firm’s junior subordinated deferrable interest debentures. Prior to FIN 46, 12 of these issuer trusts were considered consolidated subsidiaries of JPMorgan Chase; the $5.4 billion of preferred securities as of June 30, 2003, were included in JPMorgan Chase’s Consolidated balance sheet in the Liabilities section, under the caption “Guaranteed preferred beneficial interests in capital debt securities issued by consolidated trusts,” and the retained common capital securities of the issuer trusts were eliminated against the Firm’s investment in the issuer trusts. Distributions on the preferred securities were recorded as Interest expense on the Consolidated statement of income. For a further description of these preferred securities, see Note 16 on pages 90–91 of JPMorgan Chase’s 2002 Annual Report.

As a result of the adoption of FIN 46, JPMorgan Chase deconsolidated all 13 issuer trusts. As a result, the junior subordinated deferrable interest debentures issued by JPMorgan Chase to the issuer trusts, totaling $6.7 billion, are reflected in the Firm’s consolidated balance sheet in the Liabilities section at September 30, 2003, under the caption “Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities.” JPMorgan Chase will record interest expense on the corresponding junior subordinated debentures in its Consolidated statements of income. The Firm also recorded in Other assets in its Consolidated balance sheet at September 30, 2003 the common capital securities issued by the issuer trusts.

The debentures issued by the 13 issuer trusts to JPMorgan Chase, less the capital securities of the business trusts, continue to qualify as Tier 1 capital under interim guidance issued by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).

NOTE 14 – PREFERRED STOCK OF SUBSIDIARY

On February 28, 2002, Chase Preferred Capital Corporation redeemed all 22 million outstanding shares of its 8.10% Cumulative Preferred Stock, Series A, at a redemption price per share of $25 plus accrued and unpaid dividends.

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NOTE 15 – EARNINGS PER SHARE

For a discussion of the computation of basic and diluted earnings per share (“EPS”), see Note 20 on page 92 of JPMorgan Chase’s 2002 Annual Report. The following table presents the calculation of basic and diluted EPS for the three and nine months ended September 30, 2003 and 2002:
 
                                 
    Three Months Ended     Nine Months Ended  
(in millions, except per share amounts)   Sept. 30, 2003     Sept. 30, 2002     Sept. 30, 2003     Sept. 30, 2002  
Basic earnings per share
                               
Net income
  $ 1,628     $ 40     $ 4,855     $ 2,050  
Less: Preferred stock dividends
    13       13       38       39  
 
                       
Net income applicable to common stock
  $ 1,615     $ 27     $ 4,817     $ 2,011  
 
                       
Weighted-average basic shares outstanding
    2,012.2       1,986.0       2,006.0       1,982.3  
Net income per share
  $ 0.80     $ 0.01     $ 2.40     $ 1.01  
 
                       
Diluted earnings per share
                               
Net income applicable to common stock
  $ 1,615     $ 27     $ 4,817     $ 2,011  
 
                       
Weighted-average basic shares outstanding
    2,012.2       1,986.0       2,006.0       1,982.3  
Additional shares issuable upon exercise of stock options for dilutive effect
    56.0       19.8       41.0       27.0  
 
                       
Weighted-average diluted shares outstanding
    2,068.2       2,005.8       2,047.0       2,009.3  
Net income per share(a)
  $ 0.78     $ 0.01     $ 2.35     $ 1.00  
 
                       
 
(a)  
Options issued under employee benefit plans to purchase 320 million and 375 million shares of common stock were outstanding for the three months ended September 30, 2003 and 2002, respectively, but were not included in the computation of diluted EPS because the result would have been anti-dilutive. For the nine months ended September 30, 2003 and 2002, options issued under employee benefit plans to purchase common stock excluded from the computation were 349 million and 358 million, respectively.
 

NOTE 16 – COMPREHENSIVE INCOME

Comprehensive income is composed of Net income and other comprehensive income (“OCI”), which includes the after-tax change in unrealized gains and losses on AFS securities, cash flow hedging activities and foreign currency translation adjustments (including the impact of related derivatives).
 
                                 
    Unrealized             Cash     Accumulated other  
(in millions)   gains (losses)     Translation     flow     comprehensive  
Nine Months Ended September 30, 2003   on AFS securities(a)     adjustments     hedges     income (loss)  
Beginning balance
  $ 731     $ (6)     $ 502     $ 1,227  
Net change during period
    (678) (b)     (c)     (362) (e)     (1,040 )
 
                       
Ending balance
  $ 53     $ (6) (d)   $ 140     $ 187  
 
                       
Nine Months Ended September 30, 2002
                               
Beginning balance
  $ (135 )   $ (2)     $ (305 )   $ (442 )
Net change during period
    1,282 (b)     (4) (c)     629 (e)     1,907  
 
                       
Ending balance
  $ 1,147     $ (6) (d)   $ 324     $ 1,465  
 
                       
 
(a)  
Primarily represents the after-tax difference between the fair value and amortized cost of the AFS securities portfolio.
(b)  
The net change during the nine months ended September 30, 2003 was primarily driven by increasing rates and the recognition of gains on sales of AFS securities. The net change during the nine months ended September 30, 2002 was primarily driven by decreasing rates, partially offset by the recognition of gains on sales of AFS securities.
(c)  
At September 30, 2003, included $303 million of after-tax gains on foreign currency translation from operations for which the functional currency is other than the U.S. dollar, which were offset by $303 million of after-tax losses on hedges. At September 30, 2002, included $52 million of after-tax net gains on foreign currency translation from operations for which the functional currency is other than the U.S. dollar, which were offset by $56 million of after-tax net losses on hedges.
(d)  
Included after-tax gains and losses on foreign currency translation, including related hedge results from operations for which the functional currency is other than the U.S. dollar.
(e)  
The net change for the nine months ended September 30, 2003, included $479 million of after-tax gains recognized in income and $117 million of after-tax gains, representing the net change in derivative fair values that were recorded in comprehensive income. The net change for the nine months ended September 30, 2002, included $119 million of after-tax losses recognized in income and $510 million of after-tax gains, representing the net change in derivative fair values that were reported in comprehensive income.
 

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Item 1 (continued)

NOTE 17 – CAPITAL

For a discussion of the calculation of risk-based capital ratios, see Note 26 on pages 99–100 of JPMorgan Chase’s 2002 Annual Report. The Firm changed its calculation of risk-weighted assets during the third quarter of 2003; capital ratios for periods prior to June 30, 2003, have not been recalculated.

The following table presents the risk-based capital ratios for JPMorgan Chase and its significant banking subsidiaries. At September 30, 2003, the Firm and each of its depository institutions, including those listed in the table below, were “well-capitalized” as defined by banking regulators.

 
                         
            Significant banking subsidiaries  
September 30, 2003 (in millions, except ratios)   JPMorgan Chase(a)     JPMorgan Chase Bank(a)     Chase USA(a)  
Tier 1 capital
  $ 42,533     $ 34,575     $ 4,863  
Total capital
    59,455       45,317       6,816  
Risk-weighted assets(b)
    490,590       422,565       44,603  
Adjusted average assets
    770,707       639,963       33,619  
 
Tier 1 capital ratio
    8.7 %     8.2 %     10.9 %
Total capital ratio
    12.1       10.7       15.3  
Tier 1 leverage ratio
    5.5       5.4       14.5  
 
(a)  
Assets and capital amounts for JPMorgan Chase’s banking subsidiaries reflect intercompany transactions, whereas the respective amounts for JPMorgan Chase reflect the elimination of intercompany transactions.
(b)  
Risk-weighted assets of JPMorgan Chase, JPMorgan Chase Bank and Chase USA included off–balance sheet risk-weighted assets in the amounts of $167.4 billion, $146.7 billion and $12.4 billion, respectively, at September 30, 2003.
 

The following table shows the components of the Firm’s Tier 1 and total capital:

                                 
    September 30,             December 31,          
(in millions)   2003           2002          
 
Tier 1 capital
                               
Common stockholders’ equity
  $ 43,755             $ 40,065          
Nonredeemable preferred stock
    1,009               1,009          
Minority interest (a)
    6,866               5,520          
Less:Goodwill and investments in certain subsidiaries
    8,160               8,122          
         Nonqualifying intangible assets and other
    937               902          
 
Tier 1 capital
  $ 42,533             $ 37,570          
 
Tier 2 capital
                               
Long-term debt and other instruments qualifying as Tier 2
  $ 12,286             $ 11,801          
Qualifying allowance for credit losses
    5,013               5,458          
Less: Investment in certain subsidiaries
    377               334          
 
Tier 2 capital
  $ 16,922             $ 16,925          
 
Total qualifying capital
  $ 59,455             $ 54,495          
 
(a)   Minority interest primarily includes trust preferred stocks of certain business trusts.
 

NOTE 18 – COMMITMENTS AND CONTINGENCIES

For a discussion of legal proceedings, see Part II, Item 1 of this Form 10-Q.

NOTE 19 – ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The majority of JPMorgan Chase’s derivatives are entered into for trading purposes. The Firm also uses derivatives as an end-user to hedge market exposures, modify the interest rate characteristics of related balance sheet instruments or meet longer-term investment objectives. Both trading and end-user derivatives are recorded in Trading assets and liabilities. For a further discussion of the Firm’s use of derivative instruments, see pages 50–53 and Note 28 on pages 101–102 of JPMorgan Chase’s 2002 Annual Report.

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Item 1(continued)

The following table presents derivative instrument hedging-related activities for the three and nine months ended September 30, 2003 and 2002:

 
                                 
    Three Months Ended     Nine Months Ended  
  September 30,     September 30,  
(in millions)   2003     2002     2003     2002  
Fair value hedge ineffective net gains/(losses)(a)
  $ (277 )   $ 6     $ 243     $ 247  
Cash flow hedge ineffective net gains/(losses)(a)
    (2 )           (2 )     (1 )
Cash flow hedging gains on forecasted transactions that failed to occur
                       
 
(a)   Includes ineffectiveness and the components of hedging instruments that have been excluded from the assessment of hedge effectiveness.
 
Over the next 12 months, it is expected that $143 million (after-tax) of net gains recorded in other comprehensive income at September 30, 2003 will be recognized in earnings. The maximum length of time over which forecasted transactions are hedged is 10 years, related to core lending and borrowing activities.

NOTE 20 — OFF-BALANCE SHEET LENDING-RELATED FINANCIAL INSTRUMENTS AND GUARANTEES

For a discussion of off-balance sheet lending-related financial instruments and guarantees and the Firm’s related accounting policies, see Note 29 on pages 102-103 of JPMorgan Chase’s 2002 Annual Report.

To provide for the risk of loss inherent in commercial-related contracts, an allowance for credit losses on lending-related commitments is maintained. See pages 57-58 of this Form 10-Q for a further discussion on the allowance for credit losses on lending-related commitments.

The following table summarizes the contractual amounts relating to off-balance sheet lending-related financial instruments and guarantees and the related allowance for credit losses on lending-related commitments at September 30, 2003, and December 31, 2002:

 

Off-balance sheet lending-related financial instruments

                                 
                    Allowance for  
    Contractual amount     lending-related commitments  
    September 30,     December 31,     September 30,     December 31,  
(in millions)   2003     2002     2003     2002  
Consumer-related   $ 176,677     $ 151,138     NA     NA  
Commercial-related:
                               
Other unfunded commitments to extend credit(a)(b)(c)
  $ 171,561     $ 196,654     $ 180     $ 213  
Standby letters of credit and guarantees(a)(d)
    35,064       38,848       147       147  
Other letters of credit(a)
    2,417       2,618       2       3  
 
                       
Total commercial-related
  $ 209,042     $ 238,120     $ 329     $ 363  
Customers’ securities lent(e)   $ 136,927     $ 101,503     NA     NA  
 
(a)  
Net of risk participations totaling $16 billion at September 30, 2003 and December 31, 2002.
(b)  
Includes unused advised lines of credit totaling $20 billion at September 30, 2003, and $22 billion at December 31, 2002. In regulatory filings with the Federal Reserve Board, unused advised lines are not reportable.
(c)  
Includes certain asset purchase agreements of $19 billion at September 30, 2003, and $36 billion at December 31, 2002; excludes $12 billion of asset purchase agreements to multi-seller asset-backed commercial paper conduits consolidated in accordance with FIN 46 at September 30, 2003. The allowance for credit losses on lending-related commitments related to these agreements was insignificant at September 30, 2003, and December 31, 2002.
(d)  
Collateral held by the Firm in support of these agreements was $8 billion at September 30, 2003 and December 31, 2002.
(e)  
Collateral held by the Firm in support of these agreements was $141 billion at September 30, 2003, and $110 billion at December 31, 2002.
 

In November 2002, the FASB issued FIN 45, which requires a guarantor to recognize, at the inception of a guarantee, a liability in an amount equal to the fair value of the obligation undertaken in issuing the guarantee. As of January 1, 2003, newly issued or modified guarantees that are not derivative contracts have been recorded on the Firm’s Consolidated balance sheet at their fair value at inception. The Firm considers the following off-balance sheet lending arrangements to be guarantees under FIN 45: certain asset purchase agreements, standby letters of credit and financial guarantees, and securities lending indemnifications. See Note 29 on pages 102-103 of JPMorgan Chase’s 2002 Annual Report for further information regarding these guarantees and for a description of the Firm’s obligations under indemnification agreements.

The amount of the liability related to guarantees recorded at September 30, 2003, excluding the allowance for credit losses on lending-related commitments and derivative contracts discussed below, was approximately $53 million. In addition to the contracts noted above, there are certain derivative contracts to which the Firm is a counterparty that meet the characteristics of a guarantee under FIN 45. For a description of the derivatives the Firm considers to be guarantees, see Note 29 on pages 102-103 of JPMorgan Chase’s

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Part I
Item 1(continued)

2002 Annual Report. These derivatives are recorded on the Consolidated balance sheets at fair value. The total notional values of the derivatives that the Firm deems to be guarantees were $51 billion and $47 billion at September 30, 2003, and December 31, 2002, respectively. The fair values related to these contracts were a derivative receivable of $146 million and a derivative payable of $479 million at September 30, 2003. The fair values of these contracts were a derivative receivable of $141 million and a derivative payable of $814 million at December 31, 2002.

NOTE 21 — FAIR VALUE OF FINANCIAL INSTRUMENTS

Refer to Note 31 on pages 104-106 of JPMorgan Chase’s 2002 Annual Report for a full description of fair value methodologies by product. For those financial instruments that are not recorded on the Consolidated balance sheet at fair value, fair value is based on quoted market prices, where available. If listed prices or quotes are not available, fair value is based on internally developed models that primarily use market-based or independent information as inputs. Primary market prices are used to determine the fair value of certain of the Firm’s financial instruments, such as loans and lending-related commitments, as they provide an estimate of prices at which such financial instruments could currently be originated.

These methods may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, the use of different methodologies or secondary market prices to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date; for example, using the cost of credit derivatives to estimate the fair value of commercial loans and lending-related commitments may produce a different fair value than that obtained by discounting the loan or the commitment using primary market rates. If the cost of credit derivatives were used, the fair value of the Firm’s commercial loans would be approximately $1.0 billion and $0.1 billion greater than the carrying value (i.e., commercial loans net of the allowance for loan losses) at September 30, 2003, and December 31, 2002, respectively. Following the same approach, the maximum incremental depreciation in fair value of the Firm’s lending-related commitments would be approximately 10 basis points and 40 basis points of the total notional value of these commitments at September 30, 2003, and December 31, 2002, respectively.

The following table presents the financial assets and liabilities valued under SFAS 107:

 
                                                 
    September 30, 2003     December 31, 2002  
  Carrying     Estimated     Appreciation/     Carrying     Estimated     Appreciation/  
(in billions)   value     fair value     (depreciation)     value     fair value     (depreciation)  
 
                                   
Total financial assets
  $ 773.3     $ 775.8     $ 2.5     $ 739.2     $ 742.4     $ 3.2  
 
                                       
Total financial liabilities(a)
  $ 746.6     $ 749.1       (2.5 )   $ 715.6     $ 716.3       (0.7 )
 
                                   
Estimated fair value in excess of carrying value
                  $                     $ 2.5  
 
                                           
 
(a)  
Includes the allowance for lending-related commitments of $329 million at September 30, 2003, and $363 million at December 31, 2002. The fair value of the Firm’s lending-related commitments, using primary market rates, approximates these balances.
 

NOTE 22 — SEGMENT INFORMATION

JPMorgan Chase is organized into five major businesses: Investment Bank, Treasury & Securities Services, Investment Management & Private Banking, JPMorgan Partners and Chase Financial Services. These businesses are segmented based on the products and services provided or the type of customer serviced, and they reflect the manner in which financial information is currently evaluated by the Firm’s management. Results of these lines of business are presented on an “operating” basis. For a definition of “operating” basis, see the Glossary of Terms on page 67 of this Form 10-Q.

During the second quarter of 2003, JPMorgan Chase implemented new capital measurement methodologies for commercial credit risk, operating risk and private equity risk, resulting in the reallocation of capital among certain business segments. The Firm also revised its internal management reporting policies to: (1) allocate certain revenues, expenses and tax-related items that had been recorded within the Corporate segment to the other business segments, and (2) assign to Treasury & Securities Services a corporate credit allocation associated with certain credit exposures managed within the Investment Bank’s credit portfolio related to certain shared clients. The line-of-business operating results for the three and nine months ended September 30, 2003 and 2002, in the following table reflect the revised internal management reporting policies, which were previously disclosed in the Firm’s Form 8-K dated July 11, 2003. Restatements of segment results may occur in the future. For a further discussion concerning JPMorgan Chase’s business segments, see Segment Results on pages 30-44 of this Form 10-Q.

JPMorgan Chase uses shareholder value added (“SVA”) and earnings, on an operating basis, as its principal measures of franchise profitability. A 12% (after-tax) cost of capital is used for all businesses except JPMorgan Partners, which has a 15% (after-tax) cost of capital. See Segment Results on pages 24-25 and Note 33 on pages 108-109 of JPMorgan Chase’s 2002 Annual Report for a further discussion of performance measurements and policies for cost of capital allocation. The table below provides a summary of the Firm’s segment results for the three and nine months ended September 30, 2003 and 2002:

22


Table of Contents

Part I
Item 1(continued)

                                                         
                    Investment                            
(in millions, except ratios)           Treasury &     Management             Chase     Corporate/        
  Investment     Securities     & Private     JPMorgan     Financial     Reconciling        
Three Months Ended   Bank     Services     Banking     Partners     Services     Items(a)     Total  
September 30, 2003
                                                       
Operating revenue(b)
  $ 3,203     $ 1,013     $ 737     $ 78     $ 3,350     $ (162 )   $ 8,219  
Intersegment revenue(b)
    (55 )     52       18       1       (21 )     5        
Operating earnings (loss)
    922       157       85       10       460       (6 )     1,628  
Average allocated capital
    18,910       2,604       5,490       5,721       8,991       1,415       43,131 (e)
Average managed assets(c)
    512,127       18,351       33,199       8,649       223,373       19,224       814,923  
Shareholder value added
    344       78       (82 )     (207 )     185       (7 )     311  
Return on allocated capital(d)     19 %     24 %     6 %   NM       20 %   NM       15 %(e)
 
September 30, 2002
                                                       
Operating revenue(b)
  $ 2,481     $ 1,029     $ 695     $ (359 )   $ 3,667     $ (212 )   $ 7,301  
Intersegment revenue(b)
    (34 )     41       19       (8 )     6       (24 )      
Operating earnings (loss)
    (255 )     201       68       (278 )     761       (172 )     325  
Average allocated capital
    19,448       2,601       5,607       6,183       8,634       (305 )     42,168 (e)
Average managed assets(c)
    494,705       15,943       34,968       9,404       178,817       18,877       752,714  
Shareholder value added
    (849 )     122       (104 )     (514 )     498       (117 )     (964 )
Return on allocated capital(d)   NM       31 %     5 %   NM       35 %   NM       3 %(e)
 
                                                         
                    Investment                            
            Treasury &     Management             Chase     Corporate/        
(in millions, except ratios)   Investment     Securities     & Private     JPMorgan     Financial     Reconciling        
Nine Months Ended   Bank     Services     Banking     Partners     Services     Items(a)     Total  
September 30, 2003
                                                       
Operating revenue(b)
  $ 11,518     $ 2,934     $ 2,058     $ (270 )   $ 11,021     $ (665 )   $ 26,596  
Intersegment revenue(b)
    (132 )     132       81       1       (37 )     (45 )      
Operating earnings (loss)
    2,950       414       187       (298 )     2,015       (413 )     4,855  
Average allocated capital
    19,911       2,708       5,470       5,873       8,705       (80 )     42,587 (e)
Average managed assets(c)
    510,915       18,434       33,569       9,025       214,404       20,776       807,123  
Shareholder value added
    1,147       170       (309 )     (962 )     1,226       (277 )     995  
Return on allocated capital(d)     20 %     20 %     4 %   NM       31 %   NM       15 %(e)
 
September 30, 2002
                                                       
Operating revenue(b)
  $ 9,291     $ 2,961     $ 2,189     $ (860 )   $ 10,121     $ (574 )   $ 23,128  
Intersegment revenue(b)
    (134 )     130       79       (6 )     (5 )     (64 )      
Operating earnings (loss)
    1,024       503       250       (692 )     1,899       (330 )     2,654  
Average allocated capital
    19,779       2,678       5,678       6,358       8,650       (1,979 )     41,164 (e)
Average managed assets(c)
    488,657       17,276       36,473       9,694       176,661       22,404       751,165  
Shareholder value added
    (768 )     261       (265 )     (1,411 )     1,115       (12 )     (1,080 )
Return on allocated capital(d)     7 %     25 %     6 %   NM       29 %   NM       8 %(e)
 
(a)   Corporate/Reconciling Items includes Support Units, Corporate and the net effect of management accounting policies.
(b)  
Operating Revenue includes Intersegment Revenue, which includes intercompany revenue and revenue-sharing agreements, net of intersegment expenses. Transactions between business segments are primarily conducted at fair value.
(c)   Includes credit card receivables that have been securitized.
(d)   Based on annualized amounts.
(e)   Based on the Firm’s average common stockholders’ equity.
 
The table below presents a reconciliation of the combined segment information to the Firm’s reported net income, as included in the Consolidated statement of income, for the three and nine months ended September 30, 2003 and 2002.
 
                                 
(in millions)   Three Months Ended September 30,     Nine Months Ended September 30,  
    2003     2002     2003     2002  
Consolidated operating earnings
  $ 1,628     $ 325     $ 4,855     $ 2,654  
Special items and merger and restructuring costs
          (285 )           (604 )
 
                       
Consolidated net income
  $ 1,628     $ 40     $ 4,855     $ 2,050  
 
                       
 
                       
 

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Table of Contents

Part I
Item 2

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

 
                                                                 
Financial Performance                                    
                                     
                                   
(in millions, except per                           Third Quarter Change     Nine Months Ended Sept. 30,  
share and ratio data)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Revenue
  $ 7,748     $ 9,034     $ 6,947       (14 )%     12 %   $ 25,188     $ 22,119       14 %
Noninterest expense
    5,095       5,832       5,051       (13 )     1       16,468       15,603       6  
Provision for credit losses
    223       435       1,836       (49 )     (88 )     1,401       3,410       (59 )
Net income     1,628       1,827       40       (11 )   NM       4,855       2,050       137  
Net income per share — diluted     0.78       0.89       0.01       (12 )   NM       2.35       1.00       135  
Return on average common equity (“ROCE”)     15 %     17 %     %   (200 )bp   1,500 bp     15 %     7 %   800 bp
 
Tier 1 capital ratio     8.7 %     8.4 %     8.7 %   30 bp   bp                        
Total capital ratio
    12.1       12.0       12.4       10       (30 )                        
Tier 1 leverage ratio
    5.5       5.5       5.4             10                          
 

Financial Highlights — Reported Basis: Reported net income for J.P. Morgan Chase & Co. (“JPMorgan Chase” or the “Firm”) in the third quarter of 2003 was $1.6 billion, or $0.78 per share, compared with net income of $40 million, or $0.01 per share, in the third quarter of 2002, and net income of $1.8 billion, or $0.89 per share, in the second quarter of 2003. For the first nine months of 2003, reported net income was $4.9 billion, or $2.35 per share, compared with $2.1 billion, or $1.00 per share, in the same period last year.

Total revenues were $7.7 billion, up 12% from the third quarter of 2002 and down 14% from the second quarter of 2003. The year-over-year increase was led by the Investment Bank (“IB”), which had higher fixed income revenues and investment banking fees. However, these revenues and fees were lower than in the second quarter of 2003; the decline from that quarter was also attributable to lower home finance revenues at Chase Financial Services (“CFS”). For the first nine months of 2003, total revenue was $25.2 billion, up 14% from the same period last year, led by stronger performance in both IB and CFS.

Total noninterest expense was $5.1 billion, up 1% from the third quarter of 2002 and down 13% from the second quarter of 2003. The increase over the year-ago quarter was driven by Compensation expense, up 15%, due to higher performance-related incentives as a result of the improvement in revenues. The decline from the second quarter of 2003 reflected lower incentives expense associated with the decline in revenues and a reduction in Occupancy expense, which included real estate charges for unoccupied space in the second quarter. For the first nine months of 2003, total noninterest expense was $16.5 billion, up 6% from the same period last year, primarily driven by higher performance-related incentives expense and a higher level of charges for unoccupied excess real estate.

The provision for credit losses for the 2003 third quarter of $223 million was down 88% compared with the 2002 third quarter and down 49% compared with the 2003 second quarter. The provision this quarter was lower than total net charge-offs of $614 million, reflecting continued improvement in the quality of the commercial loan portfolio. Commercial nonperforming assets and criticized exposure levels declined 27% and 32%, respectively, from December 31, 2002, as a result of restructurings, reduced exposures and charge-offs during 2003. Consumer credit quality remained stable.

JPMorgan Chase’s Tier 1 Capital ratio was 8.7% at September 30, 2003. The Firm changed its calculation for risk-weighted assets during the third quarter of 2003; if the June 30, 2003, Tier 1 capital ratio had been calculated on the same basis as it was for September 30, 2003, the Tier 1 ratio would have been 8.4%, rather than the 8.7% previously reported. Tier 1 capital ratios for periods prior to June 30, 2003, have not been recalculated.

Summary of Segment Results: IB posted earnings of $922 million and $3.0 billion, and returns on allocated capital of 19% and 20% for the third quarter and nine months ended September 30, 2003, respectively, driven by stronger performance in investment banking and capital markets and lending; earnings declined from the second quarter of 2003 as unfavorable market conditions contributed to lower investment banking and portfolio management results. CFS’s 2003 third quarter earnings of $460 million and return on allocated capital of 20% declined from the same period last year due to a volatile interest rate environment in the 2003 third quarter; year-to-date earnings of $2.0 billion and a return on allocated capital of 31% reflected high production volumes across all consumer credit businesses. Treasury & Securities Services (“T&SS”) and Investment Management & Private Banking (“IMPB”) posted higher revenues, earnings and returns on allocated capital, compared with the second quarter of 2003, and JPMorgan Partners (“JPMP”) had private equity gains of $120 million in the third quarter of 2003. For a discussion of the Firm’s segment results, see pages 30-44 of this Form 10-Q.

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Table of Contents

Part I
Item 2 (continued)

 

RESULTS OF OPERATIONS

 

The following section provides a discussion of JPMorgan Chase’s results of operations on a reported basis.

 
                                                                 
Revenues                                    
                                     
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Investment banking fees
  $ 649     $ 779     $ 545       (17 )%     19 %   $ 2,044     $ 2,085       (2 )%
Trading revenue
    829       1,546       26       (46 )   NM       3,673       2,089       76  
Fees and commissions
    2,742       2,551       2,665       7       3       7,781       7,792        
Private equity gains (losses)
    120       (29 )     (315 )   NM     NM       (130 )     (678 )     81  
Securities gains
    164       768       578       (79 )     (72 )     1,417       816       74  
Mortgage fees and related income
    (17 )     292       512     NM     NM       692       1,080       (36 )
Other revenue
    213       64       200       233       7       385       390       (1 )
Net interest income
    3,048       3,063       2,736             11       9,326       8,545       9  
 
                                                     
Total revenue
  $ 7,748     $ 9,034     $ 6,947       (14 )     12     $ 25,188     $ 22,119       14  
 
                                               
 

Investment banking fees

For a discussion of Investment banking fees, which are primarily recorded in IB, see IB segment results on pages 32-34 of this Form 10-Q.

Trading revenue

The table below provides the components of Trading revenue:
 
                                                                 
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Equities   $ 130     $ 218     $ (161 )     (40 )%   NM     $ 587     $ 314       87 %
Fixed income and other
    699       1,328       187       (47 )     274 %     3,086       1,775       74  
 
                                                     
Total   $ 829     $ 1,546     $ 26       (46 )   NM     $ 3,673     $ 2,089       76  
 
                                               
 

Trading revenue in the quarter of $829 million improved significantly from last year’s third quarter revenue of $26 million and was down 46% from the second quarter of 2003. For the nine months ended September 30, 2003, Trading revenue of $3.7 billion was up 76% from the same period last year. The growth from both periods last year reflected stronger client and portfolio management revenues, related to market-making and proprietary risk-taking activities. Trading revenue was down from the second quarter of 2003 due to lower portfolio management results. Trading revenue, on a reported basis, excludes the impact of Net interest income (“NII”) related to IB’s trading activities, which is reported in NII. However, the Firm includes NII in Trading revenue for segment reporting purposes to better assess the profitability of IB’s trading business. For additional information on Trading revenue, see IB segment discussion on pages 32-34 of this Form 10-Q.

Fees and commissions

Fees and commissions of $2.7 billion for the quarter increased 3% and 7% compared with the third quarter of 2002 and the second quarter of 2003, respectively. For the first nine months of 2003, Fees and commissions were flat versus the comparable period in 2002. The table below provides the significant components of Fees and commissions:
 
                                                                 
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Investment management, custody and processing services
  $ 944     $ 891     $ 923       6 %     2 %   $ 2,720     $ 2,896       (6 )%
Credit card revenue
    756       698       806       8       (6 )     2,146       2,062       4  
Brokerage and investment services
    343       321       321       7       7       941       958       (2 )
Other lending-related service fees
    157       127       128       24       23       408       386       6  
Deposit service fees
    298       284       288       5       3       867       851       2  
Other fees
    244       230       199       6       23       699       639       9  
 
                                                     
Total
  $ 2,742     $ 2,551     $ 2,665       7       3     $ 7,781     $ 7,792        
 
                                               
 

Compared with the third quarter of 2002 and the second quarter of 2003, Investment management, custody and processing services fees increased 2% and 6%, respectively, primarily due to the increasing equity valuations of assets under management and non-U.S. securities under custody. Credit card revenue was 6% lower than in the third quarter of 2002 but 8% higher than in the immediately preceding quarter. Brokerage and investment services fees increased 7% from both the 2002 third quarter and the 2003 second

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Part I
Item 2 (continued)

quarter, stemming from a higher volume of brokerage transactions associated with more active global equities markets. The other factors contributing to the increases were the impact of growth in business volume, new business and recent acquisitions, including JPMorgan Retirement Planning Services (“RPS”) in June 2003.

For the first nine months of 2003, Investment management, custody and processing services fees were 6% lower than in the same period last year, principally driven by the lower year-over-year values of assets under management and institutional outflows. This decrease was offset by higher Credit card revenue of 4% and the impact of growth in business volume, new business and recent acquisitions.

For additional information on Fees and commissions, see the segment discussions of T&SS for custody and securities processing fees, IMPB for investment management fees, and CFS for consumer-related fees on pages 34-35, 36-37 and 39-44, respectively, of this Form 10-Q.

Private equity gains (losses)

Private equity gains were $120 million, compared with losses of $315 million in the third quarter of 2002 and $29 million in the second quarter of 2003. For the first nine months of the year, Private equity losses were $130 million, versus losses of $678 million for the same period a year ago. For a discussion of Private equity gains (losses), which are primarily recorded in JPMP, see JPMP segment results on pages 37-39 of this Form 10-Q.

Securities gains

Securities gains of $164 million declined 72% and 79% from the third quarter of 2002 and the second quarter of 2003, respectively. On a year-to-date basis, Securities gains of $1.4 billion were up 74% from the same period last year. The declines from the prior quarters were driven by lower gains realized from sales of mortgage-backed securities in IB and Chase Home Finance (“CHF”), due to the impact of higher interest rates. The increase from the first nine months of 2002 was attributable to the substantial gains realized in the first half of 2003, when rates were at their lowest level in several years. IB uses securities to manage, in part, asset/liability exposures of the Firm; CHF uses these instruments to economically hedge the value of mortgage servicing rights (“MSRs”).

Mortgage fees and related income

Mortgage fees and related income declined to negative $17 million in the third quarter of 2003 from $512 million in the same quarter of last year and $292 million in the immediately preceding quarter. On a year-to-date basis, income of $692 million declined 36% from the same period in 2002. For a further disclosure of Mortgage fees and related income, see Note 3 on page 8 of this Form 10-Q.

Other revenue

Other revenue of $213 million rose by 7% from the 2002 third quarter and 233% from the 2003 second quarter. Revenue in the 2003 third quarter reflected several gains, including $61 million from loan restructurings; $51 million from sales of securities acquired in loan satisfactions; and $50 million of gains from a higher volume of commercial real estate loan securitizations. These were partly offset by lower net results of corporate and bank-owned life insurance policies. The third quarter of 2002 included a $50 million gain on the sale of the Firm’s interest in a non-U.S. securities clearing firm, and $20 million related to the cancellation of the proposed purchase by New York City of 15 Broad/23 Wall Street. In the first nine months of 2003, Other revenue was slightly lower compared with the same period a year ago.

Net interest income

NII of $3.0 billion was $312 million higher than in the third quarter of 2002 and relatively flat compared with the second quarter of 2003. The increase from last year was primarily driven by the declining interest rate environment, resulting in record originations in, and wider spreads on, mortgage loans. However, in the 2003 third quarter, deposit spreads declined. For the nine months ended September 30, 2003, NII of $9.3 billion increased 9% compared with the same period last year, due to lower overall funding costs and volume growth in mortgages and automobile loans. Trading-related net interest income of $449 million was up $63 million from the 2002 third quarter and down $30 million from the 2003 second quarter.

On an aggregate basis, the Firm’s total average interest-earning assets were $591 billion, compared with $549 billion in the third quarter of 2002 and $571 billion in the second quarter of 2003. The net interest yield on these assets, on a fully taxable-equivalent basis, was 2.05%, up six basis points from the prior-year quarter and down 11 basis points from the 2003 second quarter.

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Item 2 (continued)

NONINTEREST EXPENSE

Noninterest expense of $5.1 billion was relatively flat compared with the third quarter of 2002, but was down 13% from the second quarter of 2003. For the nine months ended September 30, 2003, Noninterest expense of $16.5 billion was up 6% from the same period last year. The following table presents the components of Noninterest expense:
 
                                                                 
Noninterest expense                                    
                                     
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Compensation expense
  $ 2,713     $ 3,231     $ 2,367       (16 )%     15 %   $ 9,118     $ 7,951       15 %
Occupancy expense
    391       543       478       (28 )     (18 )     1,430       1,181       21  
Technology and communications expense
    719       732       625       (2 )     15       2,088       1,919       9  
Other expense
    1,272       1,226       1,248       4       2       3,732       3,735        
Surety settlement and litigation reserve
          100           NM     NM       100           NM  
Merger and restructuring costs
                333     NM     NM             817     NM  
 
                                                     
Total noninterest expense
  $ 5,095     $ 5,832     $ 5,051       (13 )     1     $ 16,468     $ 15,603       6  
 
                                                     
 

Compensation expense

For the third quarter and first nine months of 2003, Compensation expense rose 15% over both comparable prior-year periods, to $2.7 billion and $9.1 billion, respectively. The increase was attributable to higher performance-related incentive accruals and higher pension and other postretirement benefit costs, primarily due to changes in actuarial assumptions. The increase related to incentive accruals includes the impact of adopting SFAS 123 effective January 1, 2003, and the reversal in 2002 of previously accrued expenses for certain forfeitable key employee stock awards. The increases were partially offset by reduced costs related to the vesting of prior-year stock awards, forfeitures of stock awards, lower severance-related costs, and the transfer beginning April 1, 2003, of 2,800 employees to IBM in connection with a technology infrastructure outsourcing agreement. The 16% decrease from the immediately preceding quarter was primarily due to lower performance-related cash incentive accruals of $570 million.

Occupancy expense

Occupancy expense of $391 million decreased 18% from the third quarter of 2002 and 28% from the second quarter of 2003 but, on a year-to-date basis, was 21% above the same period of 2002. The Firm recorded a $7 million credit partly as a result of the sale of 15 Broad/23 Wall Street in the third quarter of 2003 and recorded charges for unoccupied excess real estate of $128 million, $78 million and $98 million in the second and first quarters of this year and in the third quarter of 2002, respectively. The increase in Occupancy expense for the nine months ended September 30, 2003, was primarily the result of additional leased space in midtown Manhattan, higher real estate taxes in New York and the cost of enhanced safety measures. JPMorgan Chase continues to evaluate its current and projected space requirements. There is no assurance that the Firm will be able to dispose of its excess premises, or that it will not incur additional charges in connection with such dispositions.

Technology and communications expense

In the third quarter of 2003, Technology and communications expense was $719 million, up 15% from the third quarter of 2002, but down slightly from the second quarter of 2003. For the nine months ended September 30, 2003, Technology and communications expense was $2.1 billion, up 9% versus the same period last year. These increases were primarily due to the shift in expenses from Compensation expense and Other expense into Technology and communications expense as a result of the aforementioned IBM outsourcing agreement. The impact on total expenses as a result of this agreement is expected to be small in 2003.

Other expense

Other expense increased only slightly from both the third quarter of 2002 and the second quarter of 2003 and was flat for the comparable year-to-date period. The following table presents the components of Other expense:

 
                                                                 
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Professional services
  $ 325     $ 324     $ 307       %     6 %   $ 974     $ 925       5 %
Outside services
    294       310       256       (5 )     15       876       745       18  
Marketing
    179       167       179       7             510       469       9  
Travel and entertainment
    103       102       102       1       1       294       315       (7 )
Amortization of intangibles
    73       73       80             (9 )     220       241       (9 )
All other
    298       250       324       19       (8 )     858       1,040       (18 )
 
                                                     
Total other expense
  $ 1,272     $ 1,226     $ 1,248       4       2     $ 3,732     $ 3,735        
 
                                               
 

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Item 2 (continued)

Professional services and Outside services increased from last year’s quarter and year-to-date period to support the volume growth in the national consumer credit and securities processing businesses. These were partly offset by expense management initiatives, including a shift in Professional services expense to Technology and communications expense, the result of approximately 1,000 system consultants moving to IBM in connection with the outsourcing agreement. The 4% increase in Other expense from the 2003 second quarter reflected higher credit card marketing expense and additional accruals related to pending legal matters unrelated to Enron.

Surety settlement and litigation reserve

The second quarter of 2003 included a $100 million addition to the Enron-related litigation reserve.

Merger and restructuring costs

All costs related to business restructurings announced after January 1, 2002, were recorded in their related expense categories. By contrast, merger and restructuring costs of $333 million in the 2002 third quarter and $817 million for the 2002 year-to-date period for programs announced prior to January 1, 2002, were viewed by management as nonoperating expenses or “special items.” Refer to Note 12 on pages 17-18 of this Form 10-Q for a summary of costs incurred in 2003 and 2002, and to page 21 and Note 6 on page 78 of JPMorgan Chase’s 2002 Annual Report.

Management currently anticipates that Noninterest expense for full-year 2003 will be higher than for full-year 2002, excluding the impact of Enron-related litigation and merger charges, driven primarily by increased incentives from improved business performance.

Provision for credit losses

The 2003 third quarter Provision for credit losses of $223 million was $1.6 billion lower than in the comparable 2002 quarter and $212 million lower than in the 2003 second quarter. The provision for credit losses of $1.4 billion for the nine months ended September 30, 2003, was $2.0 billion lower than for the same period last year. The declines from the prior periods primarily reflected continued improvement in the quality of the commercial loan portfolio. For a discussion of charge-offs associated with the commercial and consumer loan portfolios and the Allowance for credit losses, see pages 47-58 and 57-58, respectively, of this Form 10-Q.

Income tax expense

Income tax expense was $802 million, compared with $20 million in the third quarter of 2002 and $940 million in the second quarter of 2003. For the first nine months of 2003, Income tax expense was $2.5 billion, compared with $1.1 billion for the first nine months of 2002. The effective tax rate was 33% in the third quarter of 2003, compared with 34% for all other periods. The decline was principally attributable to a change in the proportion of income subject to state and local taxes.

 

RECONCILIATION FROM REPORTED RESULTS TO OPERATING BASIS

 

The Firm prepares its Consolidated financial statements using U.S. GAAP. The Consolidated financial statements prepared in accordance with U.S. GAAP appear on pages 3-6 of this Form 10-Q. That presentation, which is referred to as “reported basis,” provides the reader with an understanding of the Firm’s results that can be consistently tracked from year to year and enables a comparison of the Firm’s performance with other companies’ U.S. GAAP financial statements.

In addition to analyzing the Firm’s results on a reported basis, management uses the non-GAAP financial measure “operating basis” to assess each of its lines of business and to measure overall Firm results against targeted goals. Operating basis starts with reported U.S. GAAP results and then excludes the impact of credit card securitizations. JPMorgan Chase periodically securitizes a portion of its credit card portfolio by selling a pool of credit card receivables to a trust, which issues securities to investors. When credit card receivables are securitized, the Firm ceases to accrue the related interest and credit costs; instead, the Firm receives fee revenue for continuing to service those receivables and additional revenue from any interest and fees on the receivables in excess of the interest paid to investors, net of credit losses and servicing fees. As a result, securitization does not change JPMorgan Chase’s reported or operating net income; however, it does affect the classification of items in the Consolidated statements of income.

The Firm also reports credit costs on a “managed” or “operating” basis. Credit costs on an operating basis are composed of the Provision for credit losses in the Consolidated statements of income (which includes a provision for credit card receivables on the Consolidated balance sheets) as well as credit costs associated with securitized credit card loans. As a holder of residual interests in securitization trusts, the Firm bears its share of the credit costs for securitized loans. In the Firm’s U.S. GAAP Consolidated financial statements, credit costs associated with securitized credit card loans reduce the noninterest income remitted to the Firm from the trusts. This income is reported in credit card revenue in Fees and commissions over the life of the securitization.

Prior to 2003, the Firm also excluded from its operating results the impact of merger and restructuring costs and special items, as these transactions were viewed by management as not part of the Firm’s normal daily business operations or unusual in nature and, therefore, not indicative of trends. (To be considered a special item, the nonrecurring gain or loss had to be at least $75 million or more during 2002.) Commencing in 2003, management has determined that many of the costs previously considered nonoperating will be deemed operating costs; therefore, all such costs will be included in the Firm’s reported results. However, it is possible that in the future, management may designate certain material gains or losses incurred by the Firm to be “special items.”

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Item 2 (continued)

The following summary tables provide a reconciliation between the Firm’s reported and operating results for the periods indicated:

 
                                                                                 
    Three Months Ended September 30, 2003   Three Months Ended September 30, 2002
(in millions, except per   Reported     Credit     Special             Operating     Reported     Credit     Special             Operating  
share data)   results(a)     card(b)     items(c)     Reclasses(d)     basis     results(a)     card(b)     items(c)     Reclasses(d)     basis  
 
Consolidated income statement
                                                                               
Revenue:
                                                                               
Investment banking fees
  $ 649     $     $     $     $ 649     $ 545     $     $     $     $ 545  
Trading revenue
    829                   449       1,278       26                   386       412  
Fees and commissions
    2,742       (173 )                 2,569       2,665       (237 )                 2,428  
Private equity gains (losses)
    120                         120       (315 )                       (315 )
Securities gains
    164                         164       578                         578  
Mortgage fees and related income
    (17 )                       (17 )     512                         512  
Other revenue
    213       (14 )                 199       200       (10 )                 190  
Net interest income
    3,048       658             (449 )     3,257       2,736       601             (386 )     2,951  
 
Total revenue
    7,748       471                   8,219       6,947       354                   7,301  
 
Noninterest expense:
                                                                               
Compensation expense (e)
    2,713                         2,713       2,367                         2,367  
Noncompensation expense(e)(f)
    2,382                         2,382       2,351             (98 )           2,253  
Merger and restructuring costs
                                  333             (333 )            
 
Total noninterest expense
    5,095                         5,095       5,051             (431 )           4,620  
Operating margin
    2,653       471                   3,124       1,896       354       431             2,681  
Credit costs
    223       471                   694       1,836       354                   2,190  
 
Income before income tax expense
    2,430                         2,430       60             431             491  
Income tax expense
    802                         802       20             146             166  
 
Net income
  $ 1,628     $     $     $     $ 1,628     $ 40     $     $ 285     $     $ 325  
 
Earning per share — diluted
  $ 0.78     $     $     $     $ 0.78     $ 0.01     $     $ 0.15     $       0.16  
 
                                                                                 
    Nine Months Ended September 30, 2003   Nine Months Ended September 30, 2002
(in millions, except per   Reported     Credit     Special             Operating     Reported     Credit     Special             Operating  
share data)   results (a)     card(b)     items(c)     Reclasses(d)     basis     results(a)     card(b)     items(c)     Reclasses(d)     basis  
 
Consolidated income statement
                                                                               
Revenue:
                                                                               
Investment banking fees
  $ 2,044     $     $     $     $ 2,044     $ 2,085     $     $     $     $ 2,085  
Trading revenue
    3,673                   1,611       5,284       2,089                   1,212       3,301  
Fees and commissions
    7,781       (464 )                 7,317       7,792       (468 )                 7,324  
Private equity gains (losses)
    (130 )                       (130 )     (678 )                       (678 )
Securities gains
    1,417                         1,417       816                         816  
Mortgage fees and related income
    692                         692       1,080                         1,080  
Other revenue
    385       (42 )                 343       390       (49 )                 341  
Net interest income
    9,326       1,914             (1,611 )     9,629       8,545       1,526             (1,212 )     8,859  
 
Total revenue
    25,188       1,408                   26,596       22,119       1,009                   23,128  
 
Noninterest expense:
                                                                               
Compensation expense (e)
    9,118                         9,118       7,951                         7,951  
Noncompensation expense(e)(f)
    7,350                         7,350       6,835             (98 )           6,737  
Merger and restructuring costs
                                  817             (817 )            
 
Total noninterest expense
    16,468                         16,468       15,603             (915 )           14,688  
Operating margin
    8,720       1,408                   10,128       6,516       1,009       915             8,440  
Credit costs
    1,401       1,408                   2,809       3,410       1,009                   4,419  
 
Income before income tax expense
    7,319                         7,319       3,106             915             4,021  
Income tax expense
    2,464                         2,464       1,056             311             1,367  
 
Net income
  $ 4,855     $     $     $     $ 4,855       $2,050     $     $ 604     $     $ 2,654  
 
Earning per share — diluted
  $ 2.35     $     $     $     $ 2.35     $ 1.00     $     $ 0.30     $     $ 1.30  
 

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Item 2 (continued)

 
(a)   Represents condensed results as reported in JPMorgan Chase’s Consolidated financial statements.
(b)   Represents the impact of credit card securitizations. For securitized receivables, amounts that normally would be reported as NII and as Provision for credit losses are reported as noninterest revenue.
(c)   For 2002, includes merger and restructuring costs and other special items. For a description of special items, see Glossary of terms on page 68 of this Form 10-Q.
(d)   On an operating basis, JPMorgan Chase reclassifies trading-related net interest income from NII to Trading revenue.
(e)   Includes severance and other related costs associated with expense containment programs implemented in 2002.
(f)   Includes Occupancy expense, Technology and communications expense, Other expense and Surety settlement and litigation reserve.
 

Other Non-GAAP Financial Measures Used By the Firm in Evaluating Its Lines of Business

The Firm uses the shareholder value added (“SVA”) framework to measure performance of its business segments. To derive SVA, a non-GAAP financial measure, the Firm applies a cost of capital to each business segment. The capital elements and resultant capital charges provide the businesses with the financial framework to evaluate the trade-off between the use of capital by each business unit versus its return to shareholders. See segment results on page 24-25 of JPMorgan Chase’s 2002 Annual Report for a further discussion of SVA. The following table provides a reconciliation of the Firm’s SVA to operating earnings on a consolidated basis:
 
                                 
  Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Operating earnings
  $ 1,628     $ 325     $ 4,855     $ 2,654  
Less: preferred dividends   13       13       38       39  
 
                       
Adjusted operating earnings   1,615       312       4,817       2,615  
Less: cost of capital
    1,304       1,276       3,822       3,695  
 
                       
SVA
  $ 311     $ (964 )   $ 995     $ (1,080 )
 
                       
         
 

The following table provides a reconciliation of the Firm’s average assets to average managed assets, a non-GAAP financial measure:

 
                                 
  Three Months Ended September 30,     Nine Months Ended September 30,  
(in millions)   2003     2002     2003     2002  
Average assets
  $ 782,426     $ 724,366     $ 775,122     $ 726,007  
Average credit card securitizations
    32,497       28,348       32,001       25,158  
 
                       
Average managed assets
  $ 814,923     $ 752,714     $ 807,123     $ 751,165  
 
                       
 

SEGMENT RESULTS

 

JPMorgan Chase’s segment results reflect the manner in which financial information is currently evaluated by the Firm’s management and is presented on an “operating” basis. Prior-period segment results have been adjusted to reflect alignment of management accounting policies or changes in organizational structure among businesses. Line-of-business operating results reflect the revised internal management reporting policies previously disclosed in the Firm’s Form 8-K dated July 11, 2003. For a further discussion of these management accounting policies changes, see Note 22 on page 22 of this Form 10-Q.

Restatements of segment results may occur in the future as a result of the continued allocation of revenue and expense items from the Corporate segment to the other business segments. See Support Units and Corporate on page 44 of this Form 10-Q for a further discussion. For a discussion of the Firm’s methodologies of allocating capital to its business units, see Capital Management on pages 45-46 of this Form 10-Q, and Segment Results on pages 24-25 of JPMorgan Chase’s 2002 Annual Report.

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Part I
Item 2 (continued)

The table below provides summary financial information on an operating basis for the five major business segments and the Corporate segment. It also reconciles operating revenue to reported revenue and operating earnings to net income.

 

Summary of segment results

                                                                 
Operating revenue                                    
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Investment Bank
  $ 3,203     $ 4,254     $ 2,481       (25 )%     29 %   $ 11,518     $ 9,291       24 %
Treasury & Securities Services
    1,013       985       1,029       3       (2 )     2,934       2,961       (1 )
Investment Management & Private Banking
    737       679       695       9       6       2,058       2,189       (6 )
JPMorgan Partners     78       (70 )     (359 )   NM     NM       (270 )     (860 )     69  
Chase Financial Services
    3,350       3,976       3,667       (16 )     (9 )     11,021       10,121       9  
Support Units and Corporate
    (162 )     (310 )     (212 )     48       24       (665 )     (574 )     (16 )
 
Total operating revenue
    8,219       9,514       7,301       (14 )     13       26,596       23,128       15  
 
Less: Impact of credit card securitizations
    471       480       354       (2 )     33       1,408       1,009       40  
 
Total reported revenue
  $ 7,748     $ 9,034     $ 6,947       (14 )     12     $ 25,188     $ 22,119       14  
 
                                                                 
Operating earnings                                    
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Investment Bank   $ 922     $ 1,086     $ (255 )     (15 )%   NM     $ 2,950     $ 1,024       188 %
Treasury & Securities Services
    157       126       201       25       (22 )%     414       503       (18 )
Investment Management & Private Banking
    85       67       68       27       25       187       250       (25 )
JPMorgan Partners     10       (91 )     (278 )   NM     NM       (298 )     (692 )     57  
Chase Financial Services
    460       881       761       (48 )     (40 )     2,015       1,899       6  
Support Units and Corporate
    (6 )     (242 )     (172 )     98       97       (413 )     (330 )     (25 )
 
Total operating earnings
    1,628       1,827       325       (11 )     401       4,855       2,654       83  
 
Less: Impact of special items (a)
                285     NM     NM             604     NM  
 
Net income   $ 1,628     $ 1,827     $ 40       (11 )   NM     $ 4,855     $ 2,050       137  
 
(a)   Includes merger and restructuring costs and other special items in 2002.

 

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Part I
Item 2 (continued)

INVESTMENT BANK

For a discussion of the business profile of the Investment Bank, see pages 26-28 of JPMorgan Chase’s 2002 Annual Report. The following table sets forth selected IB financial data:
                                                                 
                                   
(in millions, except ratios and                           Third Quarter Change     Nine Months Ended September 30,  
employees)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue
  $ 3,203     $ 4,254     $ 2,481       (25 )%     29 %   $ 11,518     $ 9,291       24 %
Operating expense:
                                                               
Compensation expense
    977       1,392       722       (30 )     35       3,690       2,910       27  
Noncompensation expense
    823       913       846       (10 )     (3 )     2,571       2,569        
Severance and related costs
    26       150       79       (83 )     (67 )     280       250       12  
 
                                                     
Total operating expense
    1,826       2,455       1,647       (26 )     11       6,541       5,729       14  
Operating margin
    1,377       1,799       834       (23 )     65       4,977       3,562       40  
Credit costs     (181 )     (4 )     1,316     NM     NM       60       1,904       (97 )
Corporate credit allocation
    (11 )     (11 )     (25 )           56       (36 )     (68 )     47  
Operating earnings   $ 922     $ 1,086     $ (255 )     (15 )   NM     $ 2,950     $ 1,024       188  
 
                                               
 
Average allocated capital
  $ 18,910     $ 20,061     $ 19,448       (6 )%     (3 )%   $ 19,911     $ 19,779       1 %
Average assets
    512,127       495,114       494,705       3       4       510,915       488,657       5  
Shareholder value added     344       481       (849 )     (28 )   NM       1,147       (768 )   NM  
Return on allocated capital     19 %     22 %   NM     (300 )bp   NM       20 %     7 %   1,300 bp
Overhead ratio     57       58       66 %     (100 )   (900 )bp     57       62       (500 )
Overhead ratio (excluding severance and related costs)
    56       54       63       200       (700 )     54       59       (500 )
Compensation as % of revenue (excl. severance and related costs)
    31       33       29       (200 )     200       32       31       100  
Full-time equivalent employees
    14,491       14,464       16,370       %     (11 )%                        
Shareholder value added:
                                                               
Operating earnings   $ 922     $ 1,086     $ (255 )     (15 )   NM     $ 2,950     $ 1,024       188 %
Less: preferred dividends
    5       5       5                   16       16        
 
                                                     
Adjusted operating earnings     917       1,081       (260 )     (15 )   NM       2,934       1,008       191  
Less: cost of capital
    573       600       589       (5 )     (3 )     1,787       1,776       1  
 
                                                     
Total shareholder value added   $ 344     $ 481     $ (849 )     (28 )   NM     $ 1,147     $ (768 )   NM  
 
                                               
 
                                                                 
OPERATING REVENUE:                                    
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Investment banking fees
                                                               
Advisory
  $ 161     $ 162     $ 139       (1 )%     16 %   $ 482     $ 527       (9 )%
Equity underwriting
    173       163       56       6       209       444       382       16  
Debt underwriting
    302       440       334       (31 )     (10 )     1,094       1,137       (4 )
 
                                                     
Total
    636       765       529       (17 )     20       2,020       2,046       (1 )
 
                                                     
Capital markets & lending
                                                               
Fixed income
    1,449       2,175       908       (33 )     60       5,616       3,962       42  
Global treasury
    371       626       607       (41 )     (39 )     1,602       1,260       27  
Credit portfolio
    406       298       441       36       (8 )     1,116       1,213       (8 )
Equities
    341       390       (4 )     (13 )   NM       1,164       810       44  
 
                                                     
Total
    2,567       3,489       1,952       (26 )     32       9,498       7,245       31  
 
                                                     
Total
  $ 3,203     $ 4,254     $ 2,481       (25 )     29     $ 11,518     $ 9,291       24  
 
                                               
 
TOTAL-RETURN REVENUE:
                                                               
(in millions)
                                                               
Capital markets & lending total-return revenue (a)
                           
Fixed income
  $ 1,525     $ 2,111     $ 942       (28 )%     62 %   $ 5,588     $ 4,024       39 %
Global treasury
    492       437       363       13       36       1,465       1,047       40  
Credit portfolio
    406       298       441       36       (8 )     1,116       1,213       (8 )
Equities
    341       390       (4 )     (13 )   NM       1,164       810       44  
 
                                                     
Total
  $ 2,764     $ 3,236     $ 1,742       (15 )     59     $ 9,333     $ 7,094       32  
 
                                               
 
(a)   Total-return revenue represents operating revenue plus the change in unrealized gains or losses on investment securities and hedges (included in comprehensive income) and internally transfer-priced assets and liabilities.
 

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Part I
Item 2 (continued)

IB reported operating earnings of $922 million in the quarter, compared with an operating loss of $255 million in the third quarter of 2002 and operating earnings of $1.1 billion in the second quarter of 2003. For the first nine months of 2003, operating earnings of $3.0 billion were 188% higher than in the same period last year. For the third quarter of 2003, return on allocated capital was 19%, compared with 22% in the previous quarter. Return on allocated capital for the first nine months of 2003 was 20%, compared with 7% in the first nine months of 2002. Operating revenue of $3.2 billion in the third quarter of 2003 was 29% higher than in the third quarter of 2002 and down 25% from the second quarter of 2003. For the first nine months of 2003, operating revenue of $11.5 billion increased 24% over the same period last year.

Investment banking fees of $636 million increased 20% from the third quarter of 2002 and were down 17% from the second quarter of 2003. Advisory revenues were up 16% from the third quarter of 2002 and down 1% from the second quarter of 2003, reflecting continued market weakness in merger and acquisition (“M&A”) activity. Equity underwriting fees were up 209% from the third quarter of 2002, reflecting increases in market share and equity volumes. Compared with the second quarter of 2003, equity underwriting fees were up 6%. Debt underwriting revenue was down versus both periods; the decline from the second quarter of 2003 reflected lower loan syndication fees, as demand for new corporate loans decreased, and lower bond underwriting fees, as market volumes declined. For the nine months ended September 30, 2003, Investment banking fees decreased 1% compared with the prior-year period, driven by declines in M&A activity and offset by growth in equity underwriting. For the first nine months of the year, the Firm improved its rankings in Global announced M&A to #3 and Global equity & equity related to #4, and it maintained its #1 ranking in Global syndicated loans and its #2 ranking in U.S. investment-grade bonds.

IB’s capital markets and lending activities include Fixed income and Equities market-making and proprietary risk-taking; Global treasury, which manages the Firm’s overall interest rate exposure and investment securities activities; and Credit portfolio, which includes corporate lending and credit risk management activities. Capital markets and lending operating revenue includes both client revenue and portfolio management revenue; the latter reflects net gains or losses, exclusive of client revenue, generated from managing residual risks in the portfolios. In addition, portfolio management revenue includes gains or losses related to proprietary risk-taking activities to capture market opportunities. IB evaluates its capital markets activities by considering all revenue related to these activities, including Trading revenue, Fees and commissions, Securities gains and related Net interest income and Other revenue. These activities are managed on a total-return revenue basis, including operating revenue plus the change in unrealized gains or losses on investment securities and hedges (included in comprehensive income) and internally transfer-priced assets and liabilities.

Capital markets and lending operating revenue for the quarter was $2.6 billion, up 32% from the third quarter of 2002 and down 26% when compared with the second quarter of 2003. For the first nine months of 2003, Capital markets and lending operating revenue was $9.5 billion, up 31% from last year.

Capital markets and lending total-return revenue of $2.8 billion was up 59% from the third quarter of 2002 on stronger client and portfolio management revenue, related to both market-making activities and proprietary risk-taking activities. Compared with the second quarter of 2003, capital markets and lending total return revenue was down 15%, as lower portfolio management results more than offset increased client revenue. Capital markets client revenue was at the highest quarterly level since the merger. Fixed income revenue of $1.5 billion increased 62% from the third quarter of 2002 and decreased 28% from the second quarter of 2003. The decline from the second quarter was primarily driven by lower portfolio management results in the global rates businesses, which were not positioned to take advantage of the increase in interest rates in the middle of the quarter. Global treasury had revenue of $492 million, up 36% from the third quarter of 2002 and up 13% from the second quarter of 2003. The increase was driven by gains from portfolio positioning, as interest rates increased and mortgage-backed securities spreads tightened. Global treasury’s activities complement, and offer a strategic balance and diversification benefit to, the Firm’s trading and fee-based activities. Credit portfolio revenue of $406 million was down 8% from the third quarter of 2002, driven primarily by lower mark-to-market (“MTM”) revenue related to credit derivatives used to economically hedge IB’s credit exposure. The decrease in MTM revenue was generally driven by overall widening of credit spreads in the third quarter of 2002 as compared with the overall global tightening of credit spreads in the third quarter of 2003. Compared with the second quarter of 2003, Credit portfolio revenue was up 36% due to higher MTM revenue, driven primarily by less severe credit spread tightening in the third quarter of 2003. For additional information, see the Credit Risk Management discussion on credit derivatives on pages 53-55 of this Form 10-Q. Equity capital markets revenue of $341 million was up substantially compared with results in the third quarter of 2002, which included weak portfolio management results in equity derivatives. Compared with the second quarter of 2003, equity capital markets revenue declined 13%, as higher client revenue in the cash business was more than offset by lower portfolio management results in equity derivatives.

For the first nine months of 2003, Capital markets and lending total-return revenue was $9.3 billion, up 32% from last year. Fixed income revenue was up 39% due to higher portfolio management revenue in the first half of 2003, driven by favorable positioning in interest rate, credit and foreign exchange markets. Global treasury revenue was up 40% from last year due to risk positioning to benefit from interest rate movements. Credit portfolio revenue of $1.1 billion was down 8% from last year, due to lower MTM revenue resulting from credit spread tightening in the second quarter of 2003, as well as lower net interest income, reflecting lower levels of commercial loan outstandings. Equities revenue of $1.2 billion was up 44% due to higher client and portfolio management results in derivatives and convertibles.

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Part I
Item 2 (continued)

Operating expense of $1.8 billion increased 11% from the third quarter of 2002 and decreased 26% from the second quarter of 2003. The increase from last year was driven by higher incentives resulting from improved financial performance, partially offset by lower noncompensation expenses and lower severance and related costs. Noncompensation expense decreased 3% from the third quarter of 2002 and 10% from the second quarter of 2003, primarily due to lower litigation costs. Severance and related costs decreased 67% from the third quarter of 2002, primarily related to severance, and decreased 83% from the second quarter of 2003, primarily driven by lower real estate charges.

For the first nine months of 2003, operating expense was $6.5 billion, up 14% compared with the same period last year, mainly due to higher incentives from improved financial performance. Noncompensation expense of $2.6 billion was flat compared with the first nine months of 2002. Severance and related costs of $280 million were up 12% from the same period last year reflecting the impact of losses on subletting unoccupied real estate, partially offset by lower severance costs.

Credit costs, reflecting a reduction in the allowance for credit losses, were negative $181 million for the quarter, compared with $1.3 billion for the third quarter of 2002 and negative $4 million in the second quarter of 2003. The lower provision resulted from the restructuring of several nonperforming commercial loans and improvement in the overall credit quality of the portfolio. For the first nine months of 2003, credit costs were $60 million, or 97% lower than in the same period last year. For additional information, see Credit Risk Management on pages 47-59 of this Form 10-Q.

The outlook for IB remains cautiously optimistic, based upon the gradual improvement of the overall economic environment. Continued economic improvement should support growth in client-related activities within capital markets, allow for a more favorable investment banking market and improve credit portfolio quality.

                                                                 
 
Market Share/Rankings:(a)   Third Quarter   Nine Months Ended September 30,
    2003   2002   2003   2002
Global syndicated loans
    15 %     #  1       21 %     #  1       18 %     #  1       24 %     #  1  
U.S. investment-grade bonds
    15       #  2       15       #  2       15       #  2       17       #  2  
Euro-denominated corporate international bonds
    7       #  2       5       #  9       5       #  6       6       #  4  
Global equity and equity-related
    9       #  4       2       #15       10       #  4       5       #  8  
U.S. equity and equity-related
    7       #  6       3       #  8       11       #  4       6       #  6  
Global announced M&A
    14       #  6       12       #  7       16       #  3       14       #  7  
 
(a)  
Derived from Thomson Financial Securities data, which reflects subsequent updates to prior-period information. Global announced M&A is based on rank value; all other rankings are based on proceeds, with full credit to each book manager/equal if joint.
 
 
TREASURY & SECURITIES SERVICES
For a discussion of the profiles for each business within T&SS, see pages 29-30 of JPMorgan Chase’s 2002 Annual Report. The following table sets forth selected financial data of T&SS:
                                                                 
 
(in millions, except ratios and                           Third Quarter Change     Nine Months Ended September 30,  
employees)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue
  $ 1,013     $ 985     $ 1,029       3 %     (2 )%   $ 2,934     $ 2,961       (1 )%
Operating expense:
                                                               
Compensation expense
    312       312       286             9       939       884       6  
Noncompensation expense
    456       465       450       (2 )     1       1,348       1,343        
Severance and related costs
    10       24       4       (58 )     150       38       12       217  
 
                                                     
Total operating expense
    778       801       740       (3 )     5       2,325       2,239       4  
Operating margin
    235       184       289       28       (19 )     609       722       (16 )
Credit costs     (1 )     1       (1 )   NM             1       (1 )   NM  
Corporate credit allocation
    11       11       25             (56 )     36       68       (47 )
Operating earnings
  $ 157     $ 126     $ 201       25       (22 )   $ 414     $ 503       (18 )
 
                                                     
 
Average allocated capital
  $ 2,604     $ 2,765     $ 2,601       (6 )%     %   $ 2,708     $ 2,678       1 %
Average assets
    18,351       19,381       15,943       (5 )     15       18,434       17,276       7  
Shareholder value added
    78       43       122       81       (36 )     170       261       (35 )
Return on allocated capital     24 %     18 %     31 %   600 bp   (700 )bp     20 %     25 %   (500 )bp
Overhead ratio
    77       81       72       (400 )     500       79       76       300  
Assets under custody (in billions)
  $ 6,926     $ 6,777     $ 6,251       2 %     11 %                        
Full-time equivalent employees
    14,294       14,393       14,739       (1 )     (3 )                        

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Part I
Item 2 (continued)

                                                                 
                            Third Quarter Change     Nine Months Ended September 30,  
    3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Shareholder value added:
                                                               
Operating earnings
  $ 157     $ 126     $ 201       25 %     (22 )%   $ 414     $ 503       (18 )%
Less: preferred dividends     1             1       NM             2       2        
 
                                                   
Adjusted operating earnings
    156       126       200       24       (22 )     412       501       (18 )
Less: cost of capital
    78       83       78       (6 )           242       240       1  
 
                                                     
Total shareholder value added
  $ 78     $ 43     $ 122       81       (36 )   $ 170     $ 261       (35 )
 
                                               

 
                                                                 
                            Third Quarter Change     Nine Months Ended September 30,  
    3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue by business:
                                                               
Treasury Services
  $ 501     $ 472     $ 467       6 %     7 %   $ 1,451     $ 1,354       7 %
Investor Services
    371       360       384       3       (3 )     1,071       1,181       (9 )
Institutional Trust Services
    237       240       220       (1 )     8       682       644       6  
Other(a)
    (96 )     (87 )     (42 )     (10 )     (129 )     (270 )     (218 )     (24 )
 
                                                     
Total
  $ 1,013     $ 985     $ 1,029       3       (2 )   $ 2,934     $ 2,961       (1 )
 
                                                     
 
(a)   Includes the elimination of revenues related to the shared activities with Chase Middle Market, and a $50 million gain on the sale of CEDEL in the third quarter of 2002.
 

T&SS reported operating earnings of $157 million in the third quarter of 2003, a decrease of 22% from the third quarter of 2002 and an increase of 25% from the second quarter of 2003. Return on allocated capital for the quarter was 24%, compared with 31% for the third quarter of 2002 and 18% for the second quarter of 2003. For the first nine months of 2003, operating earnings of $414 million were 18% lower compared with the same period last year. Return on allocated capital for the first nine months of 2003 was 20%, compared with 25% for the same period last year.

Operating revenue was $1.0 billion, a decrease of 2% from the third quarter of 2002 and an increase of 3% from the second quarter of 2003. T&SS results for the third quarter of 2002 included a pre-tax gain of $50 million on the sale of the Firm’s interest in Centrale de Livraison de Valeurs Mobilieres (“CEDEL”), a non-U.S. securities clearing firm. Adjusting for this gain, revenue would have risen 3% versus the previous year. Treasury Services revenue increased by 7% from the third quarter of 2002 and by 6% from the second quarter of 2003, due to higher trade and commercial card revenue, and increased balance-related earnings, including higher balance deficiency fees resulting from the lower interest rate environment. Investor Services revenue decreased 3% from the third quarter of 2002, the result of lower NII, due to the lower interest rate environment, partially offset by higher demand deposit accounts and other noninterest-bearing deposits. The decrease was also the result of lower foreign exchange revenue resulting from a higher volume of lower-margin transactions. Revenue increased 3% from the second quarter of 2003 due to higher custody fees, driven by market appreciation of customers’ securities and new business. Institutional Trust Services revenue was up 8% from the third quarter of 2002 due to growth in certain debt product lines, increased volume in the asset servicing business and the impact of acquisitions; revenue declined a modest 1% from the second quarter of 2003.

Total T&SS revenue for the first nine months of $2.9 billion was 1% lower compared with the same period last year. Investor Services revenue of $1.1 billion decreased by 9%, reflecting continued weakness in global equity markets, which were substantially offset by a 7% increase in revenue at Treasury Services and a 6% increase at Institutional Trust Services. The increase of Treasury Services revenue to $1.5 billion was fueled by higher balance-related earnings. Institutional Trust Services revenue was up due to growth in certain debt product lines, increased volume in the asset servicing business and the impact of acquisitions. The decrease in the Other business line for the quarter and nine-month period is primarily attributable to the $50 million pre-tax gain in the third quarter of 2002 upon the sale of CEDEL.

Operating expense increased 5% from the third quarter of 2002, attributable to higher expenses at Treasury Services and Institutional Trust Services in support of increased revenues, as well as higher severance, the impact of acquisitions, the cost associated with expensing of options and increased pension costs. Operating expense decreased 3% from the second quarter of 2003, which included charges to provide for losses on subletting unoccupied excess real estate. The overhead ratio of 77% for the third quarter of 2003 increased from 72% in the third quarter of 2002 and decreased from 81% in the second quarter of 2003. For the first nine months of 2003, operating expense was $2.3 billion, up 4% from the same period last year. The overhead ratio for the nine months was 79%, compared with 76% for the same period last year. The overhead ratio in the prior-year periods benefited from the gain upon the sale of CEDEL.

 

League Table #1 Rankings

U.S. dollar clearing and commercial payments (FImetrix, 2003)
Issuing and paying agent for U.S. commercial paper (DTC, September 30, 2003)
American depositary receipt bank in terms of reported ADR market cap under management (SEC 13-F filings, June 2003)
Automated Clearing House transactions originated (NACHA, 2003)
Trustee for U.S. debt, including MBS and ABS based on number of issues, first nine months of 2003 (Thomson Financial, 2003)
 

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Item 2 (continued)

INVESTMENT MANAGEMENT & PRIVATE BANKING

For a discussion of the business profile of IMPB, see pages 31-32 of JPMorgan Chase’s 2002 Annual Report. The following table reflects selected financial data of IMPB:
 
                                                                 
(in millions, except ratios and                           Third Quarter Change     Nine Months Ended September 30,  
employees)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue
  $ 737     $ 679     $ 695       9 %     6 %   $ 2,058     $ 2,189       (6 )%
Operating expense
    613       576       563       6       9       1,763       1,721       2  
Credit costs     (7 )           26     NM     NM       (1 )     71     NM  
 
                                                     
Pre-tax margin
    131       103       106       27       24       296       397       (25 )
Operating earnings
  $ 85     $ 67     $ 68       27       25     $ 187     $ 250       (25 )
 
                                                     
 
 
Average allocated capital
  $ 5,490     $ 5,481     $ 5,607       %     (2 )%   $ 5,470     $ 5,678       (4 )%
Average goodwill capital
    4,097       4,096       4,117                   4,098       4,116        
Average assets
    33,199       33,929       34,968       (2 )     (5 )     33,569       36,473       (8 )
Shareholder value added
    (82 )     (99 )     (104 )     17       21       (309 )     (265 )     (17 )
Tangible shareholder value added
    47       28       26       68       81       72       122       (41 )
Return on allocated capital     6 %     5 %     5 %   100 bp   100 bp     4 %     6 %   (200) bp
Return on tangible allocated capital
    25       20       19       500       600       19       23       (400 )
Overhead ratio
    83       85       81       (200 )     200       86       79       700  
Pre-tax margin ratio
    18       15       15       300       300       14       18       (400 )
Full-time equivalent employees
    7,716       7,884       8,080       (2 )%     (5 )%                        
Shareholder value added:
                                                               
Operating earnings
  $ 85     $ 67     $ 68       27       25     $ 187     $ 250       (25 )%
Less: preferred dividends
    2       1       2       100             5       5        
 
                                                   
Adjusted operating earnings
    83       66       66       26       26       182       245       (26 )
Less: cost of capital
    165       165       170             (3 )     491       510       (4 )
 
                                                     
Total shareholder value added
    (82 )     (99 )     (104 )     17       21       (309 )     (265 )     (17 )
Add: goodwill exclusion impact
    129       127       130       2       (1 )     381       387       (2 )
 
                                                     
Tangible SVA(a)
  $ 47     $ 28     $ 26       68       81     $ 72     $ 122       (41 )
 
                                                     
 
(a)   In addition to shareholder value added (“SVA”), the Firm uses tangible SVA, a non-GAAP financial measure, as an additional measure of the economics of the IMPB business segment. To derive tangible SVA, the impact of goodwill is excluded.
 

IMPB reported operating earnings of $85 million in the third quarter of 2003, an increase of 25% from the third quarter of 2002 and 27% from the second quarter of 2003. Pre-tax margin was 18%, compared with 15% in both the third quarter of 2002 and the second quarter of 2003. For the first nine months of 2003, operating earnings of $187 million were 25% lower compared with the same period last year. Return on allocated capital for the third quarter of 2003 was 6%, compared with 5% in both the third quarter of 2002 and the second quarter of 2003. Return on tangible allocated capital was 25%, compared with 19% in the third quarter of 2002 and 20% in the second quarter of 2003.

Operating revenue was $737 million, 6% higher than in the third quarter of 2002 and 9% higher than in the second quarter of 2003. For the first nine months of 2003, revenue of $2.1 billion was 6% lower compared with the same period last year. The increase from the prior-year quarter primarily reflected increasing global equity valuations, the acquisition of RPS and stronger brokerage activity. The RPS acquisition and increased equity valuations also contributed to the growth in revenue versus the second quarter of 2003, as did net inflows of assets under supervision and stronger brokerage activity. Net outflows of assets under supervision, lower average equity valuations and lower brokerage activity, partially offset by the acquisition of RPS, accounted for the year-to-date operating revenue decrease.

Operating expense of $613 million was 9% higher compared with the third quarter of 2002 and 6% higher than in the second quarter of 2003. For the first nine months of 2003, operating expense of $1.8 billion was 2% higher compared with the same period last year. The increases from both periods in 2002 reflected higher compensation expense and additional expenses arising from the acquisition of RPS, partially offset by the impact of merger and other expense savings initiatives implemented during 2002 and 2003. The increase from the second quarter of 2003 was driven by the acquisition of RPS. Credit costs were negative $7 million for the third quarter of 2003, down from $26 million in the third quarter of 2002. For the first nine months of 2003, credit costs were negative $1 million, down from $71 million for the same period last year. The decline in credit costs reflects recoveries and improvements in the quality of the credit portfolio.

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Item 2 (continued)

The table below reflects the assets under supervision in IMPB:

 
                                         
                            September 30, 2003  
                            Change  
(in billions)   Sept. 30,     June 30,     Sept. 30,     June 30,     Sept. 30,  
    2003     2003     2002     2003     2002  
Assets under supervision
                                       
Client segment:
                                       
Retail
  $ 88     $ 84     $ 77       5 %     14 %
Private banking
    132       130       126       2       5  
Institutional
    307       298       298       3       3  
 
                                 
Assets under management(a)
    527       512       501       3       5  
Custody/brokerage/administration/deposits
    193       182       131       6       47  
 
                                 
Assets under supervision(b)
  $ 720     $ 694     $ 632       4       14  
 
                                 
Product class:
                                       
Liquidity
  $ 149     $ 140     $ 130       6       15  
Fixed income
    146       150       150       (3 )     (3 )
Equities and other
    232       222       221       5       5  
 
                                 
Assets under management
    527       512       501       3       5  
Custody/brokerage/administration/deposits
    193       182       131       6       47  
 
                                 
Assets under supervision
  $ 720     $ 694     $ 632       4       14  
 
                                 
 
(a)   Assets under management represent assets actively managed by IMPB on behalf of institutional, retail and private banking clients.
(b)   Assets under supervision represent assets under management as well as custody, brokerage, administration and deposit accounts.
 

Total assets under supervision (“AUS”) at September 30, 2003, of $720 billion were 14% higher than at September 30, 2002, and 4% higher than at June 30, 2003. Equity market appreciation and the acquisition of RPS, which added $41 billion in administration assets, drove the year-over-year increase. In addition, equity market appreciation and net inflows of assets under supervision drove the increase from the prior quarter. Not reflected in AUS is the Firm’s 44% interest in American Century Companies, Inc., whose assets under management were $80 billion as of September 30, 2003, $78 billion as of June 30, 2003, and $70 billion as of September 30, 2002.

JPMORGAN PARTNERS

For a discussion of the business profile of JPMP, see pages 33-34 of JPMorgan Chase’s 2002 Annual Report. The following table sets forth selected financial data of JPMP:
 
                                                                 
                            Third Quarter Change     Nine Months Ended September 30,  
(in millions, except employees)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue   $ 78     $ (70 )   $ (359 )   NM     NM     $ (270 )   $ (860 )     69 %
Operating expense
    64       74       79       (14 )%     (19 )%     201       230       (13 )
 
                                                     
Operating margin     14       (144 )     (438 )   NM     NM       (471 )     (1,090 )     57  
Operating earnings (loss)   $ 10     $ (91 )   $ (278 )   NM     NM     $ (298 )   $ (692 )     57  
 
                                               
 
 
Average allocated capital
  $ 5,721     $ 5,916     $ 6,183       (3 )%     (7 )%   $ 5,873     $ 6,358       (8 )%
Average assets
    8,649       9,008       9,404       (4 )     (8 )     9,025       9,694       (7 )
Shareholder value added
    (207 )     (314 )     (514 )     34       60       (962 )     (1,411 )     32  
Full-time equivalent employees
    325       329       364       (1 )     (11 )                        
Shareholder value added:
                                                               
Operating earnings   $ 10     $ (91 )   $ (278 )   NM     NM     $ (298 )   $ (692 )     57  
Less: preferred dividends
    2       1       2       100             5       6       (17 )
 
                                                     
Adjusted operating earnings     8       (92 )     (280 )   NM     NM       (303 )     (698 )     57  
Less: cost of capital
    215       222       234       (3 )     (8 )     659       713       (8 )
 
                                                     
Total shareholder value added
  $ (207 )   $ (314 )   $ (514 )     34       60     $ (962 )   $ (1,411 )     32  
 
                                               
 

JPMP had net operating earnings of $10 million for the 2003 third quarter, compared with a net operating loss of $278 million in the third quarter of 2002 and a net operating loss of $91 million in the second quarter of 2003. For the first nine months of 2003, JPMP had operating losses of $298 million, compared with operating losses of $692 million for the same period last year.

Total net private equity gains were $120 million, compared with net losses of $299 million in the third quarter of 2002 and net losses of $22 million in the second quarter of 2003. In the current quarter, JPMP’s direct private equity investments recorded net

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Item 2 (continued)

gains of $161 million, compared with net losses of $239 million in the third quarter of 2002 and net gains of $123 million in the second quarter of 2003. JPMP’s direct private equity results in the current quarter included $134 million in net realized cash gains, $26 million in MTM gains on public securities, and $1 million in positive net valuation changes on private investments. The net valuation changes reflected write-downs of $65 million, which were entirely offset by $66 million of write-ups. In private third-party funds, JPMP recorded a $41 million net loss on its limited partner interests, compared with net losses of $60 million and $145 million in the third quarter of 2002 and the second quarter of 2003, respectively. The third quarter 2003 results included losses on the disposition of funded interests in private third-party funds under contract to be sold in the fourth quarter.

Although the current quarter’s operating results reflect improvement over the 2002 third quarter and 2003 second quarter, JPMP will not realize consistently positive results until market conditions improve and exit opportunities increase.

 
                                                                 
                          Third Quarter Change     Nine Months Ended September 30,  
(in millions)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Direct investments:
                                                               
Realized cash gains (net)
  $ 134     $ 153     $ 91       (12 )%     47 %   $ 333     $ 308       8 %
Write-ups / (write-downs / write-offs)
    1       (177 )     (210 )   NM     NM       (352 )     (600 )     41  
MTM gains (losses)(a)
    26       147       (120 )     (82 )   NM       167       (318 )   NM  
 
                                                     
Total direct investments
  161       123       (239 )     31     NM       148       (610 )   NM  
Private third-party fund investments (net)
    (41 )     (145 )     (60 )     72       32       (280 )     (70 )     (300 )
 
                                                     
Total private equity gains (losses)
  $ 120     $ (22 )   $ (299 )   NM     NM     $ (132 )   $ (680 )     81  
 
                                               
 
 
(a)   Includes MTM gains (losses) and reversals of MTM gains (losses) due to public securities sales.
 

JPMorgan Partners Investment Portfolio

The following table presents the carrying value and cost of the JPMP investment portfolio for the dates indicated:
                                                 
    September 30, 2003     December 31, 2002     September 30, 2002  
  Carrying             Carrying             Carrying        
(in millions)   value     Cost     value     Cost     value     Cost  
Public securities (66 companies)(a)(b)
  $ 705     $ 560     $ 520     $ 663     $ 488     $ 764  
Private direct securities (861 companies)(b)
    5,686       7,188       5,865       7,316       5,694       7,186  
Private third-party fund investments (288 funds)(b)(c)
    1,406       2,020       1,843       2,333       1,831       2,216  
 
                                   
Total investment portfolio
  $ 7,797     $ 9,768     $ 8,228     $ 10,312     $ 8,013     $ 10,166  
 
                                   
% of portfolio to the Firm’s common equity(d)
    17 %             20 %             19 %        
 
                                         
 
(a)   The quoted public value was $1.1 billion at September 30, 2003, $761 million at December 31, 2002, and $720 million at September 30, 2002.
(b)   Represents the number of companies and funds at September 30, 2003.
(c)   Unfunded commitments to private third-party equity funds were $1.7 billion at September 30, 2003, $2.0 billion at December 31, 2002, and $2.3 billion at September 30, 2002.
(d)   For purposes of calculating this ratio, the JPMP carrying value excludes the post-December 31, 2002, impact of public MTM valuation adjustments, and the Firm’s common equity excludes SFAS 115 equity balances.
 

The carrying value of the JPMP private equity portfolio at September 30, 2003, was $7.8 billion, a 3% reduction from the September 30, 2002, carrying value of $8.0 billion. The reduction was primarily the result of a $400 million decrease in the carrying value of private third-party fund investments, driven by sales and write-downs as JPMP looks to dispose opportunistically of noncore assets.

The carrying value of industrial investments increased to 28% of the total portfolio at September 30, 2003, compared with 25% at September 30, 2002, reflecting JPMP’s increased investment in industrial buyout activity during the period. JPMP made direct investments of $137 million for the Firm’s account during the third quarter of 2003, primarily in the Consumer and Life Sciences/Healthcare Infrastructure sectors.

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Item 2 (continued)

The industry group percentages in the accompanying table are based on the carrying values of JPMP’s private equity portfolio as of September 30, 2003, December 31, 2002, and September 30, 2002. In terms of dollar amounts, some industry sectors have the same, or lower, carrying values at September 30, 2003, as compared with December 31, 2002, and September 30, 2002, but these sectors may comprise the same or a higher percentage of the total carrying value of the September 30, 2003, portfolio than they did at December 31, 2002, and September 30, 2002. This is the result of the lower total carrying value of the JPMP portfolio as of September 30, 2003.

(JPMP's PRIVATE EQUITY PORTFOLIO BY INDUSTRY GROUP)

CHASE FINANCIAL SERVICES

For a description of CFS and a discussion of the profiles for each business, see pages 35-38 of JPMorgan Chase’s 2002 Annual Report. The following table reflects selected financial data of CFS:
 
                                                                 
(in millions, except ratios and                                    
employees)                           Third Quarter Change     Nine Months Ended September 30,  
  3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Operating revenue
  $ 3,350     $ 3,976     $ 3,667       (16 )%     (9 )%   $ 11,021     $ 10,121       9 %
Operating expense:
                                                               
Compensation expense
    692       757       662       (9 )     5       2,170       1,927       13  
Noncompensation expense
    1,023       1,008       978       1       5       3,054       2,819       8  
Severance and related costs
    26       2       15     NM       73       42       74       (43 )
 
                                                     
Total operating expense
    1,741       1,767       1,655       (1 )     5       5,266       4,820       9  
Operating margin
    1,609       2,209       2,012       (27 )     (20 )     5,755       5,301       9  
Credit costs
    883       817       823       8       7       2,577       2,285       13  
Operating earnings
  $ 460     $ 881     $ 761       (48 )     (40 )   $ 2,015     $ 1,899       6  
 
                                                     
 
 
Average allocated capital
  $ 8,991     $ 8,650     $ 8,634       4 %     4 %   $ 8,705     $ 8,650       1 %
Average managed assets (a)
    223,373       217,278       178,817       3       25       214,404       176,661       21  
Shareholder value added
    185       620       498       (70 )     (63 )     1,226       1,115       10  
Return on allocated capital     20 %     41 %     35 %   (2,100 )bp   (1,500 )bp     31 %     29 %   200 bp
Overhead ratio
    52       44       45       800       700       48       48        
Full-time equivalent employees
    46,231       45,268       42,839       2 %     8 %                        
Shareholder value added:
                                                               
Operating earnings
  $ 460     $ 881     $ 761       (48 )     (40 )   $ 2,015     $ 1,899       6 %
Less: preferred dividends
    3       2       3       50             8       8        
 
                                                     
Adjusted operating earnings
    457       879       758       (48 )     (40 )     2,007       1,891       6  
Less: cost of capital
    272       259       260       5       5       781       776       1  
 
                                                     
Total shareholder value added
  $ 185     $ 620     $ 498       (70 )     (63 )   $ 1,226     $ 1,115       10  
 
                                                     
 
(a)   Includes credit card receivables that have been securitized.
 

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Item 2(continued)

CFS reported operating earnings of $460 million in the third quarter of 2003, a decrease of 40% from the third quarter of 2002 and 48% from the second quarter of 2003. For the first nine months of 2003, operating earnings of $2.0 billion were 6% higher compared with the same period last year. Return on allocated capital was 20%, compared with 35% for the third quarter of 2002 and 41% for the previous quarter. For the first nine months of 2003, return on allocated capital was 31%, compared with 29% for the same period last year.

Operating revenue was $3.4 billion, a decrease of 9% from the third quarter of 2002 and 16% from the second quarter of 2003. For the nine months ended September 30, 2003, operating revenue was $11.0 billion, or 9% higher than in the same period last year. The decrease in revenue from the third quarter of 2002 and the second quarter of 2003 primarily reflected a volatile interest rate environment, which negatively impacted Chase Home Finance’s operating (excluding MSR hedging revenue) and MSR hedging revenue. On a year-to-date basis, the increased revenue was driven by high production volumes across all consumer credit businesses, partially offset by the negative impact of low interest rates on deposits. The national consumer credit businesses (Chase Home Finance, Chase Cardmember Services and Chase Auto Finance) contributed 73% of CFS’s third quarter 2003 operating revenue.

Operating expense of $1.7 billion for the quarter was 5% higher compared with the third quarter of 2002 and 1% lower than in the second quarter of 2003. For the first nine months of 2003, operating expense was up 9% compared with the same period last year. The increases, compared with last year’s three months and nine months ended September 30, 2002, reflected higher business volumes, salaries and benefits and, for the nine-month period, higher performance-related incentive accruals, including an accrual for option expense. CFS’s overhead ratio was 52%, compared with 45% for the third quarter of 2002 and 44% for the second quarter of 2003. The higher overhead ratio reflects the decline in revenue. For the first nine months of 2003, the overhead ratio remained flat at 48%. Savings generated by Six Sigma and other productivity programs continued to partially offset the growth in expenses.

Credit costs on a managed basis (including securitized credit cards) of $883 million increased 7% compared with the third quarter of 2002, reflecting a 24% increase in average managed loans outstanding and 6% higher charge-offs, primarily due to higher bankruptcies. Credit costs increased 8% compared with the second quarter of 2003, primarily as a result of a 5% increase in average managed loans outstanding. Charge-offs were flat compared with the previous quarter. The increases in average managed loans compared with the third quarter of 2002 and second quarter of 2003 were primarily due to higher levels of mortgage and auto originations. Credit costs for the first nine months of 2003 increased 13% to $2.6 billion, primarily due to a higher level of charge-offs in 2002 in excess of the provision for credit losses; also contributing to the cost increase was a 20% rise in average managed loans, reflecting higher mortgage and auto originations and higher credit card outstandings from increased customer purchase volume.

 
     
Leadership positions
   
Chase Home Finance
  # 4 in originations (Inside Mortgage Finance, third quarter of 2003)
 
  # 4 in servicing (Inside Mortgage Finance, August 2003)
Chase Cardmember Services
  # 4 credit card issuer in the U.S. (Bankcard Barometer, August 2003)
Chase Auto Finance
  # 3 auto finance lender (R.L. Polk & Co., August 2003)
 

The following table sets forth certain key financial performance measures of the businesses within CFS.

 
                                                                 
                                   
(in millions)                           Third Quarter Change     Nine Months Ended September 30,  
Operating revenue   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Home Finance
                                                               
Operating revenue (excluding MSR hedging revenue)
  $ 668     $ 1,086     $ 708       (38 )%     (6 )%   $ 2,805     $ 2,007       40 %
MSR hedging revenue
    (6 )     233       263       NM       NM       313       261       20  
 
                                                     
Total(a)
    662       1,319       971       (50 )     (32 )     3,118       2,268       37  
Cardmember Services
    1,578       1,520       1,556       4       1       4,566       4,395       4  
Auto Finance
    218       222       165       (2 )     32       639       501       28  
Regional Banking
    637       658       699       (3 )     (9 )     1,927       2,140       (10 )
Middle Market
    367       356       376       3       (2 )     1,087       1,107       (2 )
Other consumer services(b)
    (112 )     (99 )     (100 )     (13 )     (12 )     (316 )     (290 )     (9 )
 
                                                     
Total
  $ 3,350     $ 3,976     $ 3,667       (16 )     (9 )   $ 11,021     $ 10,121       9  
 
                                               

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Part I
Item 2 (continued)

                                                                 
(in millions)                                    
                            Third Quarter Change     Nine Months Ended September 30,
    3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change
Operating expense
                                                               
Home Finance
  $ 416     $ 377     $ 311       10 %     34 %   $ 1,156     $ 919       26 %
Cardmember Services
    552       539       546       2       1       1,625       1,548       5  
Auto Finance
    72       72       61             18       211       183       15  
Regional Banking
    569       573       550       (1 )     3       1,708       1,660       3  
Middle Market
    225       219       200       3       13       655       616       6  
Other consumer services(b)
    (93 )     (13 )     (13 )     NM       NM       (89 )     (106 )     16  
 
                                                     
Total
  $ 1,741     $ 1,767     $ 1,655       (1 )     5     $ 5,266     $ 4,820       9  
 
                                                     
Operating earnings
                                                               
Home Finance
  $ 124     $ 567     $ 385       (78 )%     (68 )%   $ 1,120     $ 774       45 %
Cardmember Services
    206       173       232       19       (11 )     533       538       (1 )
Auto Finance
    50       68       24       (26 )     108       157       134       17  
Regional Banking
    18       42       76       (57 )     (76 )     95       281       (66 )
Middle Market
    70       82       94       (15 )     (26 )     243       267       (9 )
Other consumer services(b)
    (8 )     (51 )     (50 )     84       84       (133 )     (95 )     (40 )
 
                                                     
Total
  $ 460     $ 881     $ 761       (48 )     (40 )   $ 2,015     $ 1,899       6  
 
                                                     
 
(a)   Includes Mortgage fees and related income, Net interest income and Securities gains.
(b)   Includes the elimination of revenues and expenses related to the shared activities with Treasury Services, discontinued operations and support services.
 

Chase Home Finance

In the third quarter of 2003, CHF reported operating earnings of $124 million, a decrease of 68% compared with the third quarter of 2002 and 78% compared with the second quarter of 2003. CHF’s third quarter 2003 total operating revenue of $662 million, comprised of operating revenue (which excludes MSR hedging revenue) and MSR hedging revenue, decreased 32% and 50% from the third quarter of 2002 and the second quarter of 2003, respectively. While markets were extremely volatile during the third quarter of 2003, the hedging of MSRs generated a small net loss of $6 million, compared with hedging gains of $263 million in the third quarter of 2002 and $233 million last quarter. Operating revenue (which excludes MSR hedging revenue) of $668 million declined $40 million and $418 million compared with the third quarter of 2002 and second quarter of 2003. The principal reasons for the declines were losses from the hedging of pipeline and warehouse loans, as compared with gains in the third quarter of 2002 and second quarter of 2003, and lower revenue resulting from customer rate-lock extensions to accommodate record volumes.

For the first nine months of 2003, CHF had record earnings of $1.1 billion, 45% higher than in the same period last year, due to the strong refinancing market and higher revenue from hedging MSRs. Total operating revenue for the first nine months of 2003 was $3.1 billion, 37% higher than in the same period last year. The strong results for the first nine months of 2003 were due to CHF’s record level of residential first-mortgage loan originations and continued expansion into strategic business sectors, such as home equity, where origination volumes increased 74% compared with the same period last year.

Total origination volume in the 2003 third quarter was at an all-time high of $93 billion, an increase of 158% and 19% from the third quarter of 2002 and the second quarter of 2003, respectively.

 
                                                                 
(in billions)                                    
Origination Volume                           Third Quarter Change     Nine Months Ended September 30,  
    3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
Retail, wholesale, and correspondent
  $ 68     $ 55     $ 29       24 %     134 %   $ 164     $ 73       125 %
Correspondent negotiated transactions
    25       23       7       9       257       69       22       214  
 
                                                     
Total
  $ 93     $ 78     $ 36       19       158     $ 233     $ 95       145  
 
                                                     
 

CHF uses a combination of derivatives and AFS securities to hedge the value of its MSRs. As disclosed below, during the third quarter of 2003, positive valuation adjustments of $258 million were offset by $264 million of aggregate derivative losses, realized losses on sales of AFS securities, and net interest earned on AFS securities.

 
                                                                 
                                   
(in millions)                           Third Quarter Change     Nine Months Ended September 30,  
MSR Hedging Revenue   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change  
MSR valuation adjustments   $ 258     $ (799 )   $ (2,251 )   NM   NM   $ (1,015 )   $ (3,773 )     73 %
Hedging gains (losses)     (264 )     1,032       2,514     NM   NM     1,328       4,034       (67 )
 
                                                     
Net revenue   $ (6 )   $ 233     $ 263     NM   NM   $ 313     $ 261       20  
 
                                                     
 

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Item 2 (continued)

Operating expense of $416 million in the third quarter of 2003 was up 34% and 10% compared with the third quarter of 2002 and the second quarter of 2003, respectively. For the first nine months of 2003, operating expense of $1.2 billion was 26% higher compared with the same period last year. The increase in operating expense was a result of growth in origination volume and in the home equity business, as well as a higher level of mortgage servicing activity.

Credit costs of $61 million for the third quarter of 2003 declined from $62 million in the third quarter of 2002 and increased from $58 million in the second quarter of 2003. The net charge-off rate for the third quarter of 2003 was 0.15%, down from 0.21% in the third quarter of 2002 and 0.18% in the second quarter of 2003, primarily the result of a higher proportion of loans that were originated for sale. The 30+ delinquency rate on loans held for investment was 2.1% for the third quarter of 2003, down from 2.8% and 2.2% from the third quarter of 2002 and second quarter of 2003, respectively. For the first nine months of 2003, credit costs were $227 million, up 47% from the same period last year. The increase was due to a higher provision for credit losses, primarily the result of higher loan balances. The net charge-off rate for the nine-month period was 0.18%, down from 0.24% for the same period a year ago.

Chase Cardmember Services

Operating earnings at Chase Cardmember Services (“CCS”) were $206 million, a decrease of 11% from the third quarter of 2002 and an increase of 19% from the second quarter of 2003. The decrease in earnings from the same period last year reflects an increase in credit costs due primarily to a relatively high level of bankruptcies; credit costs were $705 million, compared with $648 million in the third quarter of 2002. The earnings decrease was also attributable to higher payment rates and a slowdown in the rate of receivable growth, reflective of industry trends. The increase in earnings from the second quarter of 2003 reflected higher net interest and fee-related revenue. During the first nine months of 2003, operating earnings decreased 1% compared with the same period last year, due to higher expenses related to increased new-product and customer-acquisition marketing, as well as higher rebate costs associated with the marketing of rewards-based products. Higher credit costs reflecting an increase in average loans outstanding also contributed to the decline in earnings.

Operating revenue increased 1% from the third quarter of 2002 and 4% from the second quarter of 2003. The increase in operating revenue from the third quarter of 2002 reflected higher fee-related revenue and lower funding costs. The increase from the previous quarter reflected balance growth in higher-yielding segments and growth in fee-related revenue. Total volume (purchases, balance transfers and cash advances) was essentially unchanged from the third quarter of 2002, as higher purchase volume was offset by lower cash advances and balance transfers. Total volume increased 3% from the second quarter of 2003, driven by higher purchase volume that partly reflected the movement towards rewards-based products. Average managed loans were $50.9 billion at the end of the third quarter of 2003, up 1% from the third quarter of 2002 and essentially unchanged from the second quarter of 2003. For the first nine months of 2003, operating revenue increased 4% compared with the same period last year, reflecting higher average loans outstanding, lower funding costs and an increase in fee-related revenue. For the nine-month period, total volume increased 5% compared with the same period last year.

Total operating expense increased 1% from the third quarter of 2002 and 2% from the second quarter of 2003. The increase from the second quarter of 2003 was due primarily to greater marketing investment to stimulate existing account usage and acquire new customers. In the third quarter, CCS added more than one million new accounts and launched a new co-branded reward card with Marathon Ashland Petroleum LLC. For the first nine months of 2003, operating expense was up 5% compared with the same period last year, reflecting higher marketing and volume-related expenses, partly offset by productivity initiatives. These initiatives have enabled CCS to fund the marketing of new and existing value-added rewards-based products to capture wallet share and more effectively position CCS for the future.

The managed net charge-off rate for the third quarter was 5.83%, up 29 basis points from the third quarter of 2002 and down 19 basis points from the second quarter of 2003. The increase from the third quarter of 2002 was primarily attributable to higher bankruptcies, partly offset by higher recoveries. The decline in the net charge-off rate from the second quarter of 2003 reflects ongoing improvement efforts related to risk management and collection practices. The managed net charge-off rate for the nine-month period was 5.93%, compared with 5.95% for the same period of 2002. The 30+ delinquency rate was 4.62% in the third quarter of 2003, up 15 basis points from the third quarter of 2002 and 22 basis points from the second quarter of 2003. The increase in the delinquency rate from the year-ago quarter primarily reflected slower receivable growth. The increase in the delinquency rate from the second quarter of this year primarily reflects seasonality.

Chase Auto Finance

Results at Chase Auto Finance (“CAF”) consist of the Auto Finance and Education Finance businesses. CAF’s operating earnings of $50 million increased 108% from the third quarter of 2002 and decreased 26% from the second quarter of 2003. The increase in earnings from the third quarter of last year was driven by continued revenue growth, improved operating efficiency and lower credit costs. The decrease from the second quarter of 2003 was driven primarily by higher credit costs, reflecting continued portfolio growth and an increase in expected lease charge-off rates, partially offset by an improvement in expected loan charge-off rates. For the first nine months of 2003, operating earnings were $157 million, 17% higher compared with the same period last year. The increase was driven by an increase in average loans outstanding, partly offset by higher volume-related operating expenses and higher credit costs.

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Item 2 (continued)

CAF reported revenue of $218 million for the third quarter of 2003, up 32% from the third quarter of 2002 and down 2% from the second quarter of 2003. The increase in revenue from last year was driven by strong operating performance, due to higher average loans outstanding, reflecting continued strong origination volume and lower funding costs. The decrease in revenue from the second quarter of 2003 was driven by lower origination volumes and lower spreads. CAF had loan and lease origination volume of $7.0 billion in the third quarter of 2003, an 8% and 11% decrease from the third quarter of 2002 and second quarter of 2003, respectively. For the first nine months of 2003, operating revenue of $639 million was up 28% compared with the same period last year, and origination volume of $22.3 billion was at a record level, up 21% from the prior period.

Operating expense of $72 million was up 18% from the third quarter of 2002 and flat compared with the second quarter of 2003. For the first nine months of 2003, operating expense of $211 million was 15% higher compared with the same period last year. The increase in expenses from the prior-year quarter was driven by higher average loans outstanding and, for the nine-month period, higher origination volumes and higher average loans outstanding.

Credit costs of $61 million decreased 24% compared with the third quarter of 2002 due to slightly lower charge-offs and a reduction in required reserve additions. Compared with the second quarter of 2003, credit costs increased 72%, due to slightly higher charge-offs and charge-offs in excess of the provision last quarter. Credit costs increased 48% during the first nine months of 2003 compared with the same period last year, due to higher volumes of loans outstanding and charge-offs in excess of the provision for credit losses last year. Credit quality continues to be strong relative to last year. The net charge-off rate decreased to 0.41% in the third quarter of 2003, from 0.59% in the third quarter of 2002, and the 30+ delinquency rate decreased to 1.16% in the third quarter of 2003, from 1.43% in the third quarter of 2002. The charge-off rate increased from 0.37% in the second quarter of 2003, and the 30+ delinquency rate increased slightly from 1.14% in the second quarter of 2003. These increases were primarily due to seasonality.

Chase Regional Banking

Operating earnings at Chase Regional Banking (“CRB”) of $18 million decreased 76% compared with the third quarter of 2002 and 57% compared with the second quarter of 2003. The decrease from the third quarter of 2002 primarily resulted from declining spreads on deposits, partially offset by growth in average deposits. The decrease from the second quarter of 2003 was primarily due to the recognition in the second quarter of a further gain on the sale of CRB’s Eastern Caribbean operations and an increase in credit costs. For the first nine months of 2003, operating earnings of $95 million declined 66% compared with the same period last year, driven by lower deposit spreads and increased credit costs.

Operating revenue of $637 million decreased 9% from the third quarter of 2002 and 3% from the second quarter of 2003. The decline in revenue from the third quarter of 2002 was predominantly attributable to the lower interest rate environment, which resulted in lower net interest earned on deposit balances. Growth in average deposits of 8% from the third quarter of 2002 partially offset the decline in net interest. The decline in revenue from the second quarter of 2003 was due to the above-mentioned gain, partly offset by a 2% increase in average deposits. For the first nine months of 2003, operating revenue declined 10% compared with the same period last year, due to the lower interest rate environment.

Operating expense was up 3% from the comparable 2002 period and down 1% from the second quarter of 2003. For the first nine months of 2003, operating expense of $1.7 billion was 3% higher compared with the same period last year. The increases were due primarily to higher compensation expenses related to increased staff levels.

Credit costs of $36 million were up $18 million from the third quarter of 2002 and $22 million from the second quarter of 2003. The increase was the result of a $17 million rise in the allowance for credit losses and the impact of increased loan volume. For the first nine months of 2003, credit costs were $58 million, compared with negative $5 million for the same period last year. The increase is related to the aforementioned items as well charge-offs in excess of the provision for credit losses that occurred in 2002.

As of September 30, 2003, CRB’s deposit mix was 18% demand, 14% interest checking, 47% savings, 10% money market and 11% time (CDs). At September 30, 2002, the deposit mix was 18% demand, 13% interest checking, 46% savings, 8% money market and 15% time (CDs). As of September 30, 2003, core deposits (total deposits less time deposits) grew 11% from December 31, 2002, and 13% from September 30, 2002.

Chase Middle Market

Chase Middle Market (“CMM”) operating earnings of $70 million were down 26% from the third quarter of 2002 and down 15% from the second quarter of 2003. For the nine months ended September 30, 2003, operating earnings of $243 million declined 9% compared with the same period a year ago. The decreases from the third quarter of 2002 and from the nine months ended September 30, 2002, were primarily attributable to lower deposit spreads, as a result of the lower interest rate environment, and higher severance expenses. The decline from the second quarter of 2003 was due to higher severance in the third quarter.

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Item 2 (continued)

Operating revenue of $367 million in the third quarter of 2003 decreased 2% from the third quarter of 2002 and increased 3% from the second quarter of 2003. The decrease from the same quarter last year was the result of the lower interest rate environment, partially offset by higher deposit levels and capital markets fees. The increase from the second quarter of this year was due to higher deposit service fees. For the nine months ended September 30, 2003, revenue of $1.1 billion was down 2% from the same period last year. Deposits were up 19% and loans increased 5% when compared with the first nine months of 2002; however, net interest income was down 4% due to the lower-rate environment. The revenue decline from the third quarter and first nine months of 2002 was partly offset by higher deposit service fees, as the lower interest rate environment resulted in reduced values of customers’ compensating balances; consequently, customers paid incremental fees for deposit services.

Operating expense was $225 million, an increase of 13% compared with the third quarter of 2002 and 3% compared with the second quarter of 2003. For the first nine months of 2003, operating expense of $655 million was 6% higher than in the same period last year. The increase in expenses from all comparative periods was primarily due to higher severance costs and higher performance-based incentives. Credit costs of $21 million were up $7 million compared with the third quarter of 2002, and up from negative $3 million in the second quarter of 2003 due to higher charge-offs and charge-offs in excess of the provision for last quarter. Credit costs for the first nine months of 2003 were $16 million, down 53% from the same period last year due to lower required reserves.

SUPPORT UNITS AND CORPORATE

JPMorgan Chase’s Support Units and Corporate segment includes Corporate technology, legal, audit, corporate finance, human resources, risk management and corporate marketing. For a further discussion of the business profiles of these Support Units as well as a description of Corporate, see page 39 of JPMorgan Chase’s 2002 Annual Report.
                                                                 
 
                            Third Quarter Change     Nine Months Ended September 30,
(in millions, except employees)   3Q 2003     2Q 2003     3Q 2002     2Q 2003     3Q 2002     2003     2002     Change
Operating revenue
  $ (162 )   $ (310 )   $ (212 )     48 %     24 %   $ (665 )   $ (574 )     (16 )%
Operating expense     73       159       (64 )     (54 )     NM       372       (51 )     NM  
Credit costs           101       26       NM       NM       172       160       8  
 
                                                     
Pre-tax loss
    (235 )     (570 )     (174 )     59       (35 )     (1,209 )     (683 )     (77 )
Income tax benefit     (229 )     (328 )     (2 )     30       NM       (796 )     (353 )     (125 )
 
                                                     
Operating earnings (loss)
  $ (6 )   $ (242 )   $ (172 )     98       97     $ (413 )   $ (330 )     (25 )
 
                                                     
 
 
 
Average allocated capital   $ 1,415     $ (114 )   $ (305 )     NM       NM     $ (80 )   $ (1,979 )     96 %
Average assets
    19,224       21,610       18,877       (11 )%     2 %     20,776       22,404       (7 )
Shareholder value added     (7 )     (195 )     (117 )     96       94       (277 )     (12 )     NM  
Full-time equivalent employees
    9,883       9,918       13,245             (25 )                        
 
 

Corporate reflects the residual accounting effect after the application of management accounting policies, which include allocating technology, operational and staff support costs to the respective revenue-generating businesses. This allows management to evaluate business performance on an allocated basis.

The Corporate segment historically reports a net loss, primarily driven by negative revenue. This occurs from overallocating revenues as a result of funds transfer-pricing and other management accounting policies. Expense items in the Corporate segment result from timing differences in allocations to business segments, residuals from interoffice allocations among the business segments and other items considered appropriate to retain in this segment. Although the Corporate segment generally has no credit exposures, it maintains the residual component of the Allowance for credit losses, which is not allocated to any business segment. For the nine months ended September 30, 2003, credit costs increased by $12 million. For a further discussion of the residual component, see pages 57–58 of this Form 10-Q.

The decline in the net loss from the second quarter of 2003 is attributable to the Firm not requiring a provision for the residual component of the Allowance for credit losses in the third quarter of 2003. Also contributing to the decline were timing differences related to the allocation from the Corporate sector of technology and other corporate expenses to the various businesses. The year-to-date increase in expense was due to higher incentives, including the impact in 2002 of reversing previously accrued expenses related to forfeitable stock awards, and higher technology-related costs.

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Part I
Item 2 (continued)

 
 
RISK AND CAPITAL MANAGEMENT
 

JPMorgan Chase is in the business of managing risk to create shareholder value. The major risks to which the Firm is exposed are credit, market, operational, business, liquidity and private equity risk. For a discussion of these risks and definitions of terms associated with managing these risks, see pages 40–65 and the Glossary of Terms in JPMorgan Chase’s 2002 Annual Report.

 
 
CAPITAL AND LIQUIDITY MANAGEMENT
 
CAPITAL MANAGEMENT
 

Economic capital

JPMorgan Chase assesses capital adequacy utilizing internal risk assessment methodologies. The Firm assigns economic risk 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 JPMP). The methodologies quantify these risks and assign capital accordingly. Additionally, the Firm assesses capital against certain nonrisk factors.

A review of the Firm’s risk and capital measurement methodologies was completed in the second quarter of 2003, resulting in the reallocation of capital among the risk categories and certain business segments. New capital measurement methodologies were implemented but did not result in a significant change in the total capital allocated to the business segments as a whole. Prior periods were restated to reflect the revised capital measurement methodologies. For a further discussion of these new methodologies, see Capital Allocation for Credit Risk, Operational and Business Risk Management and Private Equity Risk Management on pages 59, 61 and 62, respectively, of this Form 10-Q. Also see JPMorgan Chase’s Form 10-Q for the quarter ended June 30, 2003, and Form 8-K dated July 11, 2003, for more details. Internal capital allocation methodologies may change in the future to reflect refinements of economic capital methodologies.

The Firm’s capital in excess of internally required capital at September 30, 2003, increased by $1.8 billion over September 30, 2002, primarily due to an increase in average common stockholders’ equity of $0.9 billion and a reduction in average capital allocated to business activities, principally for credit risk. Credit risk capital decreased $0.8 billion over the period, primarily due to a reduction in commercial exposures, improvement in the credit quality of the commercial portfolio and an increase in single-name credit derivative hedge activity.

The following discussion of JPMorgan Chase’s capital management focuses primarily on developments since December 31, 2002, and should be read in conjunction with page 41 and Note 26 of JPMorgan Chase’s 2002 Annual Report.

 
                 
Available Versus Required Capital   Quarterly Averages  
(in billions)   3Q 2003     3Q 2002  
Common stockholders’ equity
  $ 43.1     $ 42.2  
 
           
Economic risk capital
               
Credit risk
    12.7       13.5  
Market risk
    5.0       4.8  
Operational risk
    3.4       3.5  
Business risk
    1.7       1.8  
Private equity risk
    5.4       5.7  
 
           
Economic risk capital
    28.2       29.3  
 
           
 
Goodwill / Intangibles
    8.8       8.9  
Asset capital tax
    4.1       3.8  
 
           
Capital against nonrisk factors
    12.9       12.7  
 
           
Total capital allocated to business activities
    41.1       42.0  
 
Diversification effect
    (5.3 )     (5.3 )
 
           
Total required internal capital
  $ 35.8     $ 36.7  
 
           
Firm capital in excess of required capital
  $ 7.3     $ 5.5  
 
           
 

Regulatory Capital

JPMorgan Chase’s risk-based capital ratios at September 30, 2003, were well in excess of minimum regulatory guidelines. At September 30, 2003, Tier 1 and Total Capital ratios were 8.7% and 12.1%, respectively, and the Tier 1 leverage ratio was 5.5%. At September 30, 2003, total capital of JPMorgan Chase (the sum of Tier 1 and Tier 2 Capital) was $59.5 billion, an increase of $5.0 billion from December 31, 2002. This increase reflected a $5.0 billion increase in Tier 1 Capital, primarily driven by $2.7 billion in retained earnings (net income less common and preferred dividends) generated during the period, $1.1 billion in Tier 1 trust preferred

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issuance and $1.0 billion in net stock issuances related to employee benefit plans. There was minimal impact to the Firm’s Tier 1 and Total Capital ratios due to the adoption of FIN 46, as the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) provided interim regulatory capital relief related to asset-backed commercial paper conduits and trust preferred vehicles. The effects of FIN 46 on the Firm’s leverage ratio at September 30, 2003, was a reduction of approximately 12 basis points as no regulatory capital relief was provided for leverage calculations. The Firm did not repurchase shares of its common stock during the first nine months of 2003. The Firm changed its calculation of risk-weighted assets during the third quarter of 2003; capital ratios for periods ended prior to June 30, 2003, have not been recalculated.

Dividends

In the third quarter of 2003, JPMorgan Chase declared a quarterly cash dividend on its common stock of $0.34 per share, payable October 31, 2003, to stockholders of record at the close of business on October 6, 2003.
 
 
LIQUIDITY MANAGEMENT
 

The following discussion of JPMorgan Chase’s liquidity management focuses primarily on developments since December 31, 2002, and should be read in conjunction with pages 42–43 of JPMorgan Chase’s 2002 Annual Report.

In managing liquidity, the Firm considers a variety of liquidity risk measures as well as market conditions, prevailing interest rates, liquidity needs and the desired maturity profile of its liabilities.

JPMorgan Chase’s liquidity management framework utilizes liquidity monitoring tools and a contingency funding plan to maintain appropriate levels of liquidity through normal and stress periods. The parent company’s liquidity policy is to maintain sufficient liquidity to meet funding requirements for normal operating activities and to repay all obligations with a maturity of one year and under. In addition, JPMorgan Chase maintains appropriate liquidity to manage through normal and stress periods, taking into account historical data on funding of loan commitments (i.e., commercial paper backup facilities), liquidity commitments to conduits and collateral-posting requirements. Sources of funds include the capital markets, the operations of the Firm’s subsidiaries (including the ability of JPMorgan Chase Bank to raise funds through deposits) and securitization programs.

Consistent with its liquidity management policy, the Firm will continue to raise funds at the holding company sufficient to cover estimated obligations that will mature over the next 12 months.

Credit Ratings

JPMorgan Chase’s parent holding company and JPMorgan Chase Bank’s credit ratings as of October 31, 2003, were as follows:

 
                 
    JPMorgan Chase   JPMorgan Chase Bank
    Short-term debt   Senior long-term debt   Short-term debt   Senior long-term debt
Moody’s
  P-1   A1   P-1   Aa3
S&P   A-1   A+   A-1+   AA-
Fitch   F1   A+   F1   A+
 

As of October 31, 2003, the ratings outlook for the parent holding company by Moody’s Investor Services (“Moody’s”), Standard & Poor’s (“S&P”) and Fitch, Inc. (“Fitch”) was stable.

Balance sheet

The Firm’s total assets increased $34 billion, to $793 billion at September 30, 2003, from $759 billion at December 31, 2002. The September 30, 2003, balance sheet includes the effect of adopting FIN 46, which added $15 billion to total assets, including $11 billion in commercial loans primarily associated with multi-seller asset-backed commercial paper conduits. Commercial loans declined, despite the $11 billion impact of adopting FIN 46, as a result of weaker loan demand, as well as the Firm’s ongoing efforts to reduce commercial exposure. Mortgage loans were up significantly, reflecting record origination and refinancing activity brought about by lower interest rates during 2003. Additionally, there was a continued, unusually high level of U.S. Treasury securities settlement failures (especially 10-year U.S. Treasury Notes) by major market participants; the effect of these failures was to increase Other assets and Accounts payable, accrued expenses and other liabilities by approximately $14 billion. Other than the balance sheet impact, the settlement failures had essentially no impact on the Firm’s results for the nine months ended September 30, 2003. In addition, Trading assets and Securities both declined consistent with the outlook for interest rates. The decline in commercial loans and the ongoing growth in deposits contributed to the decline in Federal funds purchased and securities sold under repurchase agreements.

Issuances

During the nine months ended September 30, 2003, JPMorgan Chase issued approximately $11.0 billion of long-term debt; during the same period, $6.0 billion of long-term debt matured or was redeemed. In addition, the Firm securitized approximately $8.8 billion of residential mortgage loans, $6.0 billion of credit card loans and $3.5 billion of automobile loans, resulting in pre-tax gains on securitizations of $245.6 million, $31.2 million and $12.7 million, respectively. For a further discussion of loan securitizations, see Note 9 of this Form 10-Q and Note 11 on pages 83–87 of JPMorgan Chase’s 2002 Annual Report.

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Off-balance sheet arrangements

Special-purpose entities (“SPEs”) or special-purpose vehicles (“SPVs”) are an important part of the financial markets, providing market liquidity by facilitating investors’ access to specific portfolios of assets and risks. JPMorgan Chase is involved with SPEs in three broad categories of transactions: loan securitizations, multi-seller conduits and client intermediation. Capital is held, as appropriate, against all SPE-related transactions and exposures such as derivative transactions and lending commitments. The Firm has no commitments to issue its own stock to support an SPE transaction, and its policies require that transactions with SPEs be conducted at arm’s length and reflect market pricing. For a further discussion of SPEs and the Firm’s accounting for SPEs, see Note 9 of this Form 10-Q.

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 $36 billion at September 30, 2003. If JPMorgan Chase Bank were required to provide funding under these commitments, the Firm could be replaced as liquidity provider. Additionally, with respect to the multi-seller conduits and structured commercial loan vehicles for which JPMorgan Chase Bank has extended liquidity commitments, the Bank could facilitate the sale or refinancing of the SPE assets in order to provide liquidity. All of the Firm’s liquidity commitments to SPEs, after taking into account the consolidation of multi-seller conduits in accordance with FIN 46, are included in the Firm’s total $172 billion in other unfunded commitments to extend credit included in the table below, which is described in more detail in Note 20 of this Form 10-Q. The adoption of FIN 46 did not affect the Firm’s liquidity commitments to SPEs.

The following table summarizes JPMorgan Chase’s off-balance sheet lending-related financial instruments at September 30, 2003:

 
                                         
(in millions)   Under 1 year     1–3 years     4–5 years     After 5 years     Total  
Contractual cash obligations
                                       
Long-term debt
  $ 7,916     $ 12,459     $ 10,824     $ 12,746     $ 43,945  
FIN 46 long-term beneficial interests(a)
    17       952       140       1,985       3,094  
 
                             
Total contractual cash obligations
  $ 7,933     $ 13,411     $ 10,964     $ 14,731     $ 47,039  
 
                             
Off-balance sheet lending-related commitments
                                       
Consumer-related
  $ 151,352     $ 486     $ 150     $ 24,689     $ 176,677  
Commercial-related:
                                       
Other unfunded commitments to extend credit(b)(c)
    96,158       49,289       22,918       3,196       171,561  
Standby letters of credit and guarantees(b)
    18,054       10,666       4,707       1,637       35,064  
Other letters of credit(b)
    1,848       413       110       46       2,417  
 
                             
Total commercial-related
    116,060       60,368       27,735       4,879       209,042  
 
                             
Total lending-related commitments
  $ 267,412     $ 60,854     $ 27,885     $ 29,568     $ 385,719  
 
                             
 
(a)   Included on the consolidated balance sheet in Beneficial interests of consolidated variable interest entities.
(b)   Net of risk participations totaling $16 billion at September 30, 2003 and December 31, 2002.
(c)   Includes unused advised lines of credit totaling $20 billion at September 30, 2003, and $22 billion at December 31, 2002. In regulatory filings with the Federal Reserve Board, unused advised lines are not reportable.
 

CREDIT RISK MANAGEMENT

 
The following discussion of JPMorgan Chase’s credit risk profile as of September 30, 2003, focuses primarily on developments since December 31, 2002, and should be read in conjunction with pages 45–57, pages 65–66 and Notes 9, 10, 29 and 30 of JPMorgan Chase’s 2002 Annual Report.

The Firm assesses its credit exposures on a managed basis, taking into account the impact of credit card securitizations. For a reconciliation of credit costs on a managed, or operating, basis to reported results, see page 29 of this Form 10-Q. The following table presents the Firm’s managed credit-related information for the dates indicated.

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CREDIT PORTFOLIO
 
The following table presents a summary of managed credit-related information for the dates indicated:

 
                                                 
                    Nonperforming     Past due 90 days and  
    Credit exposure     assets(l)     over and accruing  
    September 30,     December 31,     September 30,     December 31,     September 30,     December 31,  
(in millions, except ratios)   2003     2002     2003     2002     2003     2002  
 
COMMERCIAL
                                               
Loans – U.S.
  $ 58,082 (i)   $ 56,667     $ 1,360     $ 2,059     $ 35     $ 57  
Loans – Non-U.S.
    30,326       34,881       1,238       1,613       2        
 
Total commercial loans(a)
  &n