J.P. Morgan Chase & Co. reported 2002 third quarter earnings per share, inclusive of all restructuring charges and special items, of $0.01, compared with $0.50 in the second quarter of 2002 and $0.22 in the third quarter of 2001. Net income was $40 million in the third quarter compared to $1,028 million in the second quarter and $449 million one year ago. Operating earnings per share, which exclude previously announced merger and restructuring charges and special items, were $0.16 compared with $0.58 in the second quarter of 2002 and $0.55 in the third quarter of 2001.
Operating earnings were $325 million in the third quarter compared to $1,179 million in the second quarter and $1,133 million one year ago. For a reconciliation between operating earnings and net income see the “Reconciliation of Reported to Operating Results.”
As previously announced, earnings performance this quarter was affected by higher credit costs and lower trading results.
“While the strength reflected in our Retail and Operating Services businesses is a major positive, our performance in the aggregate is very disappointing,” said William B. Harrison, Jr., Chairman and Chief Executive Officer. “In the Investment Bank, we will work through these difficult market conditions by balancing competitive advantages and actions with near-term tactical initiatives,” Mr. Harrison said. “As a management team and as shareholders, we are committed to this firm realizing its earnings potential over the longer term.”
The Investment Bank has completed a review of all major businesses. Our conclusions underscore the value of the firm’s integrated business model, the breadth of our product offering and the strength of our client franchise. To improve financial performance under current market conditions, the Investment Bank is undertaking a series of initiatives to improve efficiency as well as enable selective strategic investments. These initiatives, which will begin in the fourth quarter, are expected to generate approximately $700 million of savings and result in a reduction in staffing levels of over 2,000 as well as a reduction in consultants employed by the firm. Severance and other restructuring costs related to these initiatives are estimated to be approximately $450 million with approximately $300 million to be incurred in the fourth quarter of 2002 and the remainder in 2003. Below is a brief description of the major initiatives:
— Align the cost of our equities business with the near-term revenue outlook.
— Improve the productivity of our client coverage teams and origination functions.
— Scale our businesses in Asia and Latin America in line with market opportunities.
— Continue to improve the efficiency and effectiveness of our infrastructure support groups.
Business segment results
Retail & Middle Market Financial Services had a third consecutive quarter of record revenues and operating earnings. Operating earnings of $807 million were up 16% from the second quarter and up 92% from the third quarter of 2001. Operating ROE for the third quarter was 30% compared to 27% last quarter and 18% for the third quarter of 2001.
Operating revenues of $3.73 billion were up 8% from the second quarter and 31% from the third quarter of 2001 driven by continued high production volumes across all consumer credit businesses and low interest rates. Home Finance revenues were up 108% over the prior year and were driven by strong mortgage originations and gains realized on hedging mortgage-servicing rights. In Cardmember Services, managed credit card outstandings increased 31% from September 30, 2001 to $51.1 billion due to the Providian acquisition in the first quarter of 2002 and organic growth. There were close to 900,000 new accounts originated during the quarter, the eighth consecutive quarter of additions at this level. Total average deposits grew 14% from the third quarter of 2001.
Operating expenses of $1.65 billion increased by 2% from the second quarter and by 14% from the third quarter of 2001. The increases reflected the impact of higher business volumes. Savings generated by Six Sigma productivity programs continued to partially offset the growth in expenses. Managed (retained and securitized) credit costs of $823 million were 12% higher than the second quarter and were 14% higher than the third quarter of 2001. The year-on-year increase reflects a 15% increase in managed consumer loans and, within the managed credit card portfolio, increased charge-offs related primarily to the impact of the Providian credit card portfolio. During the quarter Cardmember Services complied with new FFIEC draft guidelines resulting in $189 million in reserves allocated against interest and fee receivables for managed delinquent accounts.
The Investment Bank had an operating loss of $256 million in the third quarter, compared to operating earnings of $486 million in the second quarter and $702 million in the third quarter of 2001. The operating loss for the quarter was driven by significantly higher credit costs and lower revenues compared to prior quarters.
Operating revenues of $2.43 billion were 21% lower than last quarter and down 31% from the third quarter of 2001.
Investment Banking fees of $533 million decreased 32% from the second quarter and were down 34% from the third quarter of 2001. The decrease reflects industry-wide weakness in both M&A activity and underwriting volumes in the equity and debt markets. Advisory revenues were down 28% and 58% from the second quarter of 2002 and the third quarter of 2001, respectively. For the first nine months of 2002, the Investment Bank improved its ranking to #4 in global announced M&A with a market share of 16%, including a #1 ranking in European announced M&A.(1)
Underwriting revenues and other fees were down 34% from the second quarter and down 18% from the third quarter of 2001, driven by weakness in equity underwriting activity. The firm maintained its #2 ranking in underwriting U.S. investment grade bonds.(1)
Trading revenues (including related net interest income) of $370 million declined from $1.12 billion in the second quarter of 2002 and from $1.50 billion in the third quarter of 2001. Fixed income results decreased 39% from the second quarter and 51% from the third quarter of 2001 due to weakness in interest rate trading and seasonally lower client flow compared to the second quarter. The decline in equities was due to lower portfolio management results in equity derivatives, convertibles and cash securities. Partially offsetting the decline in trading revenues were investment securities gains of $465 million. These gains resulted from the strong performance of global treasury, which manages the firm’s interest rate exposures and investment securities activities. Global treasury’s activities complement and offer a strategic balance and diversification benefit to the firm’s trading activities. Global treasury manages interest rate risk of the firm on a “total return” basis, which measures both realized income (securities gains or losses and net interest income) and unrealized gains or losses on assets and liabilities of the firm. The total return from these activities was $363 million in the third quarter, up 70% from the second quarter.
Credit costs were $1.32 billion for the quarter, up from $306 million in the second quarter and $268 million in the third quarter of 2001. The increase includes significantly higher charge-offs, primarily in the telecommunication and cable sectors, and a provision in excess of charge-offs for loans and off-balance sheet commitments.
Operating expenses for the third quarter of $1.65 billion decreased by 19% from the second quarter and by 23% from the third quarter of 2001. The decline reflects lower incentive compensation expense as a result of the weak operating performance. Operating expenses in the third quarter included severance and related costs of $79 million compared to $123 million in the second quarter and none in the third quarter of last year. Including these severance and related costs, the overhead ratio for the third quarter was 68% compared to 65% in the second quarter and 61% in the third quarter of 2001. Excluding these costs the overhead ratio for the quarter was 64% compared to 61% in both the second quarter of 2002 and the third quarter of 2001.
Treasury & Securities Services, our wholesale operating services business, had record operating earnings of $212 million, an increase of 22% from the second quarter and 23% from the third quarter of 2001. Operating ROE for the quarter was 28% compared to 23% in the second quarter of 2002 and the third quarter of 2001.
Operating revenues were $1.02 billion in the third quarter of 2002, up 4% from the second quarter and up 5% from the third quarter of 2001, substantially due to a $50 million gain on the sale of an investment in an overseas securities clearing firm. Institutional Trust revenues were marginally below the second quarter of 2002 and 16% higher than the third quarter of 2001. The increase from the prior year reflected the impact of acquisitions and new business wins partially offset by the effect of slower fixed income activity. Investor Services revenues were down 8% from the second quarter of 2002 due to seasonal dividend activity in global markets in the earlier period. Revenues were down 9% from the third quarter of 2001 primarily due to the surge in deposit balances in 2001 following September 11 events. Also contributing to the decline were lower spreads on foreign exchange and securities lending resulting from the weak market environment. Revenues in Treasury Services were up 8% from the second quarter and 3% from the third quarter of last year despite considerably lower revenues on free balances in today’s low interest rate environment.
Operating expenses decreased 3% from the second quarter of 2002 and 1% from the third quarter of 2001. The overhead ratio for the third quarter was 68% compared to 73% in the second quarter of 2002 and the third quarter of 2001. Investment Management & Private Banking had operating earnings of $98 million, down 12% from the second quarter and 21% from the third quarter of 2001. Pre-tax margin in the third quarter was 17%, compared with 19% last quarter and 22% in the third quarter of 2001.
Operating revenues of $691 million in the third quarter were 5% below the second quarter and 9% lower than the third quarter of 2001. Declines in global equity valuations and lower investor activity levels accounted for most of the decreases. Additionally, reductions in the Private Bank’s credit portfolio reduced net interest earnings from the year ago quarter. During the third quarter, Brown & Co., the specialty online brokerage unit of JPMorgan Chase that was previously part of the firm’s retail business, was transferred to this unit as part of a strategy to grow the retail asset management business. Operating expenses of $551 million for the quarter were 3% below the second quarter and down 7% from the third quarter of 2001. Total assets under management at quarter-end of $492 billion were 9% lower than the second quarter and down 15% from the third quarter of 2001. Market depreciation and institutional outflows accounted for the year-on-year decline. These effects outweighed the positive flows and increased assets under management for retail mutual funds. Including the 45% interest in American Century, assets under management were $524 billion at quarter-end, $577 billion as of the second quarter 2002 and $619 billion as of the third quarter 2001.
JPMorgan Partners had an operating loss of $284 million for the quarter compared to an operating loss of $169 million in the second quarter and an operating loss of $153 million in the third quarter of 2001. Total net private equity gains were negative $299 million, as compared to negative $125 million in the second quarter and negative $102 million in the third quarter of 2001. The third quarter 2002 results were driven by write-downs and write-offs on private holdings. Net mark-to-market losses on public securities of $120 million were partially offset by net realized gains of $111 million. Losses on the private portfolio and public portfolio were concentrated in telecommunications and technology investments. Book value, as of September 30, 2002, of the telecommunications, media and technology public and private portfolios was $1.4 billion, including $386 million in telecommunications, $257 million in media and $769 million in technology. The private equity market continues to be unsettled, with limited exit opportunities and constrained financing.
Operating expenses were $4.62 billion, a 7% decline from both the second quarter of this year and the third quarter of 2001. Third quarter operating expenses included $122 million in severance and other costs associated with current restructuring programs. This compared with $162 million of these expenses in the second quarter. The third quarter of 2002 also included a $67 million reversal of previously accrued expenses associated with restricted stock issued under employee benefit plans that contained stock price targets, which now appear unlikely to be attained. These reversals totaled $120 million year to date.
Commercial net charge-offs in the third quarter of 2002 were $834 million, compared to $293 million in the previous quarter and $189 million in the third quarter of 2001. The increase was primarily attributable to companies in the telecommunications and related sectors and, to a lesser extent, the cable sector. The charge-off ratio for commercial loans was 3.53% for the third quarter of 2002, 1.17% for the second quarter of 2002 and 0.65% for the third quarter of 2001.
Consumer net charge-offs on a managed basis were $786 million, down from $862 million in the prior quarter and an increase from $626 million in the third quarter of 2001. The year-over-year increase was due to the inclusion of the Providian portfolio acquired during the first quarter of this year. On a managed basis, the credit card net charge-off ratio was 5.51%, compared to 6.42% for the second quarter and 5.64% for the third quarter of 2001. The improvement from the second quarter reflects lower bankruptcies and higher balances. Overall, consumer delinquency statistics remain relatively stable.
Provision for Credit Losses of $1.84 billion was $570 million in excess of charge-offs. The provision includes $292 million for losses in lending-related commitments. The loan loss provision in excess of loan charge-offs was $200 million in the third quarter of 2001.
Total Nonperforming Assets were $5.54 billion at September 30, 2002, which includes $1.13 billion related to the Enron surety receivables and letter of credit. Excluding this amount, which is the subject of litigation with creditworthy entities, nonperforming assets totaled $4.41 billion. This compares to $3.25 billion last quarter and $2.65 billion as of September 30, 2001. The increase from the second quarter of 2002 relates primarily to nonperforming telecommunications-related and cable loans.
Total assets and capital
Total assets as of September 30, 2002 were $742 billion, compared with $741 billion as of June 30, 2002 and $799 billion as of September 30, 2001. Commercial loans were down 7% or $7.2 billion from the second quarter and decreased 16% or $19.1 billion from the third quarter of 2001. Managed consumer loans increased 7% from the second quarter and increased 15% from the third quarter of 2001. The Tier 1 capital ratio was 8.6% at September 30, compared to 8.8% at June 30, 2002 and 8.2% at September 30, 2001.
Other financial information
Special Items in the third quarter of 2002 included $333 million (pre-tax) in merger and restructuring costs and $98 million (pre-tax) in real estate reserves for excess capacity related to facilities, compared to $229 million (pre-tax) in merger and restructuring costs in the second quarter of 2002. Special items in the third quarter of 2001 included merger and restructuring costs (pre-tax) of $876 million. Special items through the first three quarters of 2002 were $915 million and are in line with our full year targeted non-operating expenses of $1.2 billion.
J.P. Morgan Chase & Co. is a leading global financial services firm with assets of $742 billion and operations in more than 50 countries. The firm is a leader in investment banking, asset management, private banking, private equity, custody and transaction services and retail and middle market financial services. A component of the Dow Jones Industrial Average, JPMorgan Chase is headquartered in New York and serves more than 30 million consumer customers and the world’s most prominent corporate, institutional and government clients.
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