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JPMorgan Chase & Co. (NYSE:JPM)

Q3 2008 Earnings Call

October 15, 2008 9:00 am ET

Executives

Michael Cavanagh – CFO

James Dimon – President & CEO

Analysts

John McDonald - Sanford C. Bernstein

Guy Moszkowski - Merrill Lynch

Mike Mayo - Deutsche Bank

Betsy Graseck - Morgan Stanley

Jeff Harte - Sandler O’Neill

Meredith Whitney - Oppenheimer

William Tanona - Goldman Sachs

Jim Mitchell - Buckingham Research

Glenn Schorr - UBS

Ron Mandel – GIC

Nancy Bush – NAB Research

Operator

Good morning ladies and gentlemen. Welcome to the JPMorgan Chase third quarter 2008 earnings call.

Today's presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based on the current beliefs and expectations of JPMorgan Chase’s management and are subject to significant risk and uncertainties.

Actual results may differ from those set forth in the forward-looking statements. Factors that could cause JPMorgan Chase’s actual results to differ materially from those described in the forward-looking statements can be found in JPMorgan Chase’s current report on Form 8-K dated September 26, 2008, its Quarterly Reports on Form-Q for the quarters ended June 30, 2008 and March 31, 2008 and its Annual Report on Form-K for the year ended December 31, 2007 each of which has been filed with the Securities and Exchange Commission and is available on JPMorgan Chase’s website, www.jpmchase.com and on the Securities and Exchange Commission website.

JPMorgan Chase does not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements. Today’s presentation may also reference non-GAAP financial measures, and you should refer to the information contained in the written slides accompanying this presentation for information about their calculation. The slides are available at JPMorgan Chase’s website.

(Operator Instructions) At this time I'd like to turn the call over to JPMorgan Chase's Chairman and Chief Executive Officer, James Dimon, and Chief Financial Officer, Michael Cavanagh; Mr. Cavanagh please go ahead sir.

Michael Cavanagh

Good morning everybody thanks for joining James and I. So we’re going to go through as usual a slide presentation that is available on our website. If you have that in front of you I hope, let me first like I did last quarter with Bear Stearns just describe upfront the impact in the quarter of the Washington Mutual transaction that closed during the quarter to clear that up before we start talking about what went on in the JPMorgan businesses for the full quarter.

The first point I’d make here is the italicized comment up top that the numbers, its only been less then three weeks since we announced and closed the Washington Mutual transaction so take the numbers that I’ll talk about here on this page related to Washington Mutual as our best estimates at this stage and do expect us to be working on future refinements if and as needed.

But with that if you go into the table you see that we reported firm-wide net income including Washington Mutual impact of $527 million or $0.11 per share. Then you see the WaMu related merger items which you’re going to see in our corporate segment for the quarter. A conforming loan loss reserve adjustment of $1.221 billion; a little higher then what we said on the WaMu call a couple of weeks back and then an extraordinary gain of $581 million which is actually zero at the time of the call.

Those two together are about $0.18 negative so bring you down to results before WaMu of $1.167 or about $0.28 per share.

Moving down to some of the bullets at the bottom, just to give you a sense for what’s coming in the future, merger-related items ongoing from this point forward, so in the fourth quarter and beyond, will again be booked in corporate the same way you’re going to see what happened with the non-operating results of Bear Stearns. That’s going to include whatever merger costs there are that flow in the future.

We’re giving you an estimate that that could be after-tax about $100 million plus or minus in the fourth quarter and cumulatively as much as $500 million plus or minus over the next several years. In addition the refinements that I talked about to the purchase accounting to the extent that they occur are going to run through P&L and that’s related to the fact that there’s a negative goodwill situation and to the accounting [inaudible] you can follow-up after the call on what all that means.

But any refinements will run through P&L but we will count them in this merger-related items line that we’ll show you and talk about in the corporate segment.

Lastly beginning next quarter we’ll obviously show the ongoing operating results as appropriate in our relevant business segments, retail, card services and commercial banking and we’ll be spending time to improve and refine the reporting methodology we have to capture all the details we want to give you.

Just a high level comment, on the earnings impact we still feel comfortable that about a $0.50 incremental EPS for 2009 is a reasonable expectation and as far as the fourth quarter goes you can pretty much expect our best guess would be pro rata portion of that $0.10, $0.12 of EPS in the fourth quarter related to WaMu.

Moving along to slide two, I won’t comment on the first several items on the page here because we’re going to hit them in the businesses but just some firm-wide items, down toward the middle of the page, you see the results include overall results include, now this is JPMorgan Chase away from Washington Mutual after-tax items that include the slightly larger benefit from reduction of deferred tax liabilities and what I talked about on the WaMu call a couple of weeks ago its $927 million after-tax.

Its spread across our business units, the bulk of it in the investment bank and then the next two items auction rate and Fannie Mae and Freddie Mac write-downs you’re going to see in our corporate segment.

On credit reserves firm-wide we increased credit reserves through the P&L by $1.3 billion in the quarter bringing the total to $15.3 billion of loan loss allowance and that’s strong coverage ratios that you’ll see here I’ll show you a final slide that gives you that across the full firm and that’s before Washington Mutual again.

As you know in addition we brought over and then added to the reserves Washington Mutual had for its non-market portfolios to the tune of $4.5 billion added to the $15.3 billion that we had. And lastly we maintained very strong Tier 1 capital, $112 billion or 8.9% Tier 1 ratio on the back of the successful capital raise of $11.5 billion of common equity that we did a couple of weeks ago.

I’m going to skip now slide three and go right to getting into the results for the investment bank on slide four. So here you see the investment bank had $882 million of net income on pre-tax income of $16 million so that’s really the flow-through of the deferred tax liability benefit that I talked about on the prior page largely going to the investment bank.

If you now work down the P&L for the business, $4 billion of overall revenues, piece of that included $1.6 billion of investment banking fee revenues, up 20% year-over-year and you’ll see on the next slide that we continue to be leading market share across the league tables as well as the top, this $1.6 billion for the year-to-date equivalent is actually the top fee earner on the street. So I feel very good about the investment banking fee franchise.

Moving along to fixed income markets you see we had on the revenue side a total of $815 million of revenues. That includes $2.6 billion of write-downs related to our mortgage positions that we’ve been talking about before as well as $1 billion related to leverage lending. I’ll show you a slide on each of those so we won’t go into that in more detail right now.

And then underlying that in fixed income it was a very strong results in a bunch of other areas, record results in rates and currencies, credit trading very strong emerging markets and commodities. On the equity market side, you see $1.650 billion of revenues, up strongly year-over-year and that’s on strong client revenue and on the trading side. And then lastly you see credit portfolio down a lot from a year ago but that’s really related to derivative receivables, the widening of our counter party credit spreads obviously driving the values lower there and the negative revenues which in large part offset the benefit that you see in the bullets in fixed income markets and equity markets related to the benefit we get on our own credit spread widening.

On the credit cost line you see $234 million of credit costs, actually the preponderance of that is additions to loan loss allowance, only $13 million of actual charge-offs in the quarter that brings the allowance for loan losses in the investment bank to $2.7 billion for the 3.85% reserves to loans ratio.

And then the last point I’ll make here is you see at the bottom the end of period equity, $33 billion. I’ll comment on the back of how we arrived at that but we really spent time in the quarter looking to refine our capital allocation methodologies to our businesses and you can think of this as a common equity equivalent for the investment bank.

Moving along to slide five, I’m going to skip it, but you won’t go through it here, but you can see for yourself the strong rankings we have in the league tables on the fee side. So moving to slide six, I’ll just quickly comment on the legacy leverage lending positions. So you see we had net markdowns as I said of $1 billion for the quarter. That brings our gross markdowns to $3.8 billion on the remaining $12.9 billion of commitments that we have for a 29% markdown to a carrying value on the balance sheet of $9.1 billion.

And that is a reduction of $3.4 billion or 21% from last quarter.

Moving on to slide seven you see on the mortgage related side, same numbers we’ve been showing you in prior periods. I’ll start in the table, if you go to the left, you see the bottom line of the table $33 billion of mortgage exposure across the products shown here both residential and commercial reduced by $14.4 billion to end this past quarter at $18.6 billion for the investment bank.

If you look at the first bullet below the table, that reduction in two parts, $2.6 billion of write-downs as I talked about in the P&L, running through the P&L, as well as $11.8 billion worth of sales including $4.3 billion of which was moved over to our corporate investment portfolio which is the real buyer of these type of assets.

I’ll skip going through the details because you can read them for yourself of what comprises the different buckets that we have on the page, you see in the next couple of bullets, but obviously we feel well marked here but when you go down to the final bullet, just to explain how we think about the remaining $18.6 billion, we would think about that in two ways.

There’s a natural level of inventory that you need to support the ongoing trading and client activity in normal times. That could be anywhere from $12 billion to $15 billion and so you see $12 billion right now of that would be assets of that very nature that you expect to be business as usual and flowing in and out the door.

On top of that though we do have $6.6 billion worth of remaining positions from what we’ve been through obviously marked down and we’re just going to manage that on a mark-to-market basis in a liquidating portfolio in the investment bank under [Bill and Steve] but remain, leave our trading debt focused on facilitating client business and put that in the hands of a special team to deal with.

Moving on to retail now on slide eight you see again the main drivers as we always go through of what’s going on in the P&L so you see the growth in the branch stats, checking accounts up 10% you can read for yourself the growth in branches and ATMs, etc. Average deposits up 2% year-over-year and flattish versus last quarter but do feel good about the strength of this franchise.

Mortgages obviously originations on the mortgage loan side down some. Most of what we’re originating is conforming to government guarantee standards there and holding the market share gains that we’ve had there. Home equity originations down 77% year-over-year. When you translate that on slide nine into the P&L for the retail business, we end up with the $4.9 billion worth of revenue in the retail business overall which is up 16% year-over-year.

That drops down to $247 million of net income which is down from the year ago and prior quarter and the big reason for that is credit. So you see credit costs circled there of $1.678 billion. Obviously charge-offs are higher and you can see the charge-off rate overall down below at 244 basis points up from prior year and prior quarter but also included in that $1.7 billion of credit costs is $450 million of additions to loan loss reserves part of the firm-wide $1.3 billion increase.

In addition we added $250 million of loan loss reserves related to prime mortgages held in corporate. So I’m going to show you a couple of slides in a second on what’s going on in the major portfolios. Lastly at the bottom of the page same thing as the investment bank, you see the equity allocated to the business taking into account the WaMu acquisition increasing from $17 billion to $25 billion in the quarter.

Moving on to slide 10, I’ll talk you through the same slides we’ve seen before on our major residential mortgage portfolios. So slide 10 is home equity. I’ll just take you to the upper right box, the key stats, focus on the net charge-offs dollar line, so you see $663 million of net charge-offs, up from $511 million last quarter. I’ll just take you right down to our outlook from here on this is that we had talked about last quarter the pace of deterioration slowing off of what we had given to you earlier in the year.

It has slowed but nonetheless it continues to deteriorate so our best outlook for the near-term is that quarterly loss that $663 million could trend as high as $725 million per quarter to $800 million a quarter over the next several quarters or so.

When you move on to subprime, a little more severe degradation so you see $192 million of net charge-offs last quarter going up to $273 million and our outlook again down at the bottom bullet could be as high as $375 million to $425 million over the coming quarters by early 2009. Here was a major component of our $450 million reserve increase in the retail business was related to subprime.

On slide 12 prime mortgage, remember I said earlier that we carry some of the balances here in our retail business but many in the corporate segment and in the investment portfolio, overall the charge-offs on this portfolio of $177 million in the quarter or 1.51%, that’s going to trend as high as $300 million by early 2009 and just to remind people, we talked about this last quarter, the increase in prime.

Just to clarity a bit, this portfolio we have, mix drives a lot of what’s going on here. You see that 80% of our losses in the quarter came from California and Florida which represented 37% of the portfolio. The more important portion of why the charge-off rates are higher then you might expect is that this is not a well balanced portfolio by vintage so of the $47 billion you see in balances, about 50% are ‘06, ‘07 vintages which drive 90% plus of the losses related to this portfolio.

Moving on to card, slide 13, here you see we had profits of $292 million in the quarter down substantially from a year ago. Main driver again credit costs, $2.2 billion up substantially from the prior year, charge-off rate of 5%, pretty much on what we previously expected up from 4.98% last quarter but essentially flat.

In addition on top of charge-offs we added $250 million to the allowance for loan loss reserves in the quarter. On the revenue side we had outstandings grow by 6% from a year ago to about $158 billion and charge volume growth of 5% when you translate that into, its modest revenue growth basically flat to a year ago.

And lastly same points at the bottom, $15 billion of capital and I’ll just tell you that’s with the view to where the business is going to go once card securitizations come on balance sheet and more under Basel II, so a good number for capital allocation to the card business.

Moving onto commercial bank on slide 14, here we had profits of $312 million, up 21% from a year ago and that’s on record revenue so the $1.125 billion is up 11% from the prior year. That’s on the back of loan growth of 18% from a year ago and deposit or liability balances up 13% from a year ago and that revenue growth is really coming across all products in the business.

Here credit costs of $126 million actually again, very modest charge-offs. You see the 22 basis point net charge-off rate in the quarter so all in all, below normalized levels for credit costs and as we’ll comment later expect this to worsen. It will worsen from these levels given the economy but so far so good for this business.

On slide 15, treasury and security services, you see profits of $406 million up from the year ago. Again liability balance up 10% helping translate to revenues up 12% from a year ago including two segments here, treasury services, the cash management businesses and security services, the custody business. On the treasury services side the $897 million of revenues were a record quarterly revenue level. WSS benefited from the market we’re in but obviously faces challenges as the market has come off in what we’ve seen in this month so far.

Overall liability balances you see of $260 billion. Moving on to asset management, $351 million worth of net income, down from a year ago and down from last quarter. Story here again as I mentioned with treasury and security services is market levels impact this so our assets under management are down by $133 billion solely due to market declines.

On the other side of that over the past 12 months we’ve continued to have inflows, $123 billion for the past year and $46 billion in for the quarter helping offset some of that. Nonetheless it translates into revenues down 11% given lower market level effect as well as performance fees.

Finally moving on the P&L to corporate, slide 17, I’ll just walk through the pieces here, private equity we have been talking about weaker conditions for liquidations and valuations on private equity so we got it this quarter. Negative revenues on unrealized losses of $206 million translates into after-tax losses of $164 million. Moving down a row you see corporate, $1.64 billion negative so this is where you see in the bullets to the bottom right, inside that number some of the big numbers are the write-down of the Fannie and Freddie preferred securities that we owned $642 million after-tax.

Also the $400 million pre-tax estimated charge related to auction rate security settlement, $248 million after-tax and lastly I commented earlier the prime loans that we hold in corporate, both the $250 million increase in loan loss allowance as well as actually charge-offs in the quarter translate into $234 million of after-tax costs in all running through that $1.64 billion negative for corporate.

Outlook for there continues to be $50 million to $100 million negative in a quarter but you’re going to have volatility around the investment portfolio as well as the credit costs related to that prime portfolio and then the last piece is the $735 million after-tax of merger-related items. This as I said earlier is where we’re going to continue to show you the impact in future quarters of Washington Mutual and Bear Stearns related items.

So here for the quarter you see the $1.2 billion conforming loan loss reserve for WaMu as well as the $600 million extraordinary gain as well as about $95 million after-tax of Bear Stearns merger-related costs, kind of in line with what we had expected.

Moving on to capital, so slide 18, you see the firm-wide view of capital, obviously came in a bit better then what we talked about a couple of weeks ago on the Washington Mutual call so you see about five rows down, Tier 1 capital ratio is a Basel I basis, 8.9% for the quarter, again that includes taking on the Washington Mutual balance sheet and the $11.5 billion of common equity we raised in closing the quarter.

And again that’s on a Basel I basis, on a Basel II basis our best estimate is that there’s substantial, maybe 100 basis points spread between the two to the positive going to Basel II. And then just the points down at the bottom, the capital allocation and funding costs, so capital allocation we spent a lot of time in this environment and thinking about what’s going on in our industry, making sure we have capital allocated properly in the businesses so we have people making good decisions as our industry obviously faces a lot of different challenges.

And what we did in trying to arrive at that is take a couple of things into mind, two of those are that Basel II will be in effect for us January of 2010 or thereabouts, as well as the off-balance sheet accounting rules that bring on in particular the credit card off-balance sheet securitization. So we tried to take a forward view of where we’re going as we thought about allocating capital to the businesses.

And then the final point is that obviously with credit spreads where they are, the cost of money, the cost of goods sold in our company period is obviously much higher and we’ve been regularly passing through higher cost of money to our businesses so they can again make good economic decisions for the shareholders on a day to day basis.

Moving on to slide 19 now I’ll just recap the numbers or let you read them yourselves, these are just refreshes of the pages we showed you the night of the Washington Mutual announcement. The top table on page 19 just shows you the $31 billion of tangible assets acquired from WaMu as booked on their books net of our write-downs and purchase accounting and the consideration we paid gets you to the estimated after-tax gain of $581 million for the quarter as well as the conforming loan loss reserve adjustments you see at the bottom.

I’ll make the same caveat on this page that these are our best estimates as we sit here now and to expect some future refinements to these numbers if necessary.

One last slide on WaMu is page 20, think of this as a preamble to the disclosure we’re going to be giving you in future quarters which really goes to the loan balances and the reserves associated with those since obviously we took a lot of loans and marked them down. I just want you to understand how it’s going to flow through our numbers, so over to the left you see the first three columns is just JPMorgan standalone before WaMu.

You see our loan balances in the first blue row if you follow your eye across there the next column is our loan loss allowance, $14.5 billion related to loan coverage and that’s 2.72% loan loss reserve coverage. When you move to the middle you see WaMu but first I’ll point you over to the side, remember that we took $108 billion worth of WaMu loans that are credit impaired the bad stuff. We wrote that down by the $30 billion to get to the $78 billion carrying value on our books now related to these loans for a markdown of just around 28%.

What remains then is in the middle of the page under the green column for Washington Mutual loan balances, the remainder, the good stuff, that wasn’t marked down is $131 billion that needs normal loan loss reserves against it. So including the additional conforming loan accounting entry we booked we have $4.5 billion of loan loss reserve related to the Washington Mutual loans that have reserves and then those two columns, two sets of columns add over to JPMorgan consolidated.

So again there are things moving through these numbers that we’re going to be very clear when we get to our fourth quarter results on how it flows through the numbers.

Washington Mutual integration on page 21 will just say that it’s progressing well. Important point is that the deposit base is really stabilizing and growing since September 30 with positive net inflows on seven out of the past nine days. And then finally our outlook, I think I’ve hit all the comments here.

I’ll just say one or two things in addition that in really across retail, really across all the businesses you see our comment that you can generally be expecting higher credit costs and the worse economic conditions get, the more likely it is, or it is likely if economic conditions worsen that we’ll continue adding to our loan loss reserves in coming quarters.

But in card in particular if you see down there on the left side of the page, you can expect losses of the 5% or so range in the fourth quarter which is in line with what we previously said, but given what we’re seeing in the economy its reasonable at this stage to up the expectations for losses in card for 2009. So we say here that you can expect something more to the tune of 6% loan losses at the beginning of the year growing to something more like 7% at the end of the year, but again highly dependent upon the economy.

In asset management, TSS, subject to market conditions, corporate the $50 million to $100 million I already described, and Washington Mutual the $0.50 of EPS incremental next year with a pro rata piece of that coming in the fourth quarter as I said earlier.

So with all that one other item is paymentech gains from the dissolution of our merchant services business with First Data, that will be about an after-tax gain assuming it goes through in early November on schedule of $800 million, so after-tax but obviously given expectations for loan loss reserving, we’ll see what, don’t expect that to be dropping to the bottom line is what I’d say.

So with that, let me wrap that up and James and I can take some questions.

James Dimon

Let me just give a couple of overall comments before we take some questions, obviously we necessarily need to be prepared for a bad environment. We don’t know what the environment is going to be and Michael took you through all the credit numbers. If you look at them, other then home lending which we think is far worse then we would have expected, we’re actually not that bad, non-performers, delinquencies, in card etc. but when you see this kind of unemployment, this kind of uncertainty, the reduced consumer spend, we are getting braced for increasing loan loss reserves going forward.

So its reasonable as a shareholder for you to expect that trading results can be very tough going forward, that charge-offs are going to be going up, the loan loss reserve will be added at least the next couple of quarters but we’re going into the environment with extremely strong balance sheet; 8.9% Tier 1 before the government’s addition to that, very strong loan loss reserve, we think among the strongest in the industry which probably be strengthening going forward.

And I think of note when you go through this press release there is real growth. In some areas it’s in market share like investment banking and mortgages even though it’s a tough business, in other areas its really raw growth. In deposits and loans and you see that in TSS, private bank, commercial, and so we feel pretty good about it. Even in the card business where we have low expectations for spend, our spend is up 5% and from what we know VISA numbers are more like zero so we seem to be gaining a little bit of share there too.

I also want to point out that in the investment bank, on of the things, if you back out those losses which we don’t think you always should do, but the trading results were pretty good but another way to view that is that based on what we just went through in September and obviously for the whole quarter but September in particular, you have to feel pretty good with the violent swings in volatility that we’re able to manage through that process across all of our products globally and not be highly surprised.

That goes from the Lehman bankruptcy to the AIG issues to swings in certain securities of 25% in a day and you could imagine what its like to manage through that process and I think for our people here, I think its very important to note it was an unbelievable thing to watch the people accomplish the WaMu acquisition, managing the portfolios, a lot of people were dealing with clients and mortgages and issues trying to do the right thing for the clients everyday so it makes you really proud to watch what the people here are able to accomplish and I think it also portends very well what could be accomplished in the future.

I’ll also mention on the treasury package because I know it’s in the back of your minds, we were presented with a package from the government and the way, this is the way that JPMorgan saw it. The United States government is trying to do some very powerful things to fix the situation and a lot of people can cover the whole bunch of different programs but they had one and I think what they’re doing in this package plus all the prior things that have been done is very powerful and you will start to see some effect.

So we really saw this as doing something which is very good for the system. It is equally true if you said, well they’re asymmetric benefits for, it could be a negative for JPMorgan versus competition. That may very well be true but we did not think that JPMorgan should be selfish or parochial and try to stop what’s good for the system because it might be mildly bad for us relative to some of our competitors. So we hope it will work. There’s $25 billion of capital if it comes in the door. We hope to be able to find ways to use it, to benefit our shareholders and continue to be there for our clients.

I do want to point out that we are there for our clients, commercial loans are up 18%, the investment banking loans were way up, and a lot of the things we do every day we’re trying to do the best we can to be in business for our clients even in some categories where if you asked the question, if you borrowed at today’s marginal costs, and lent out at today’s yields in home equity, auto, you’re probably losing money.

But we still try to stay in business in the right way for people who walk into our branches or deal with our bankers so we will stop there and open the floor to any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John McDonald - Sanford C. Bernstein

John McDonald - Sanford C. Bernstein

In the equity trading could you comment on share gains in prime brokerage and also the contribution of the Bear Stearns business this quarter versus last quarter?

James Dimon

We’ve had some gain in prime broker and I’m going to say if you look at total downs there able to go something like 25% over the quarter so Bear is performing kind of the way we expect but I don’t remember the specific numbers of what it did, the equity--

Michael Cavanagh

It’s definitely an improvement in P&L over the last quarter but not yet and I would still say we’re tracking towards the incremental profits we expected to get by the 2009, health in the business but not a dramatic change in P&L just yet.

John McDonald - Sanford C. Bernstein

So it’s not yet a net positive but it should be still towards the $250 million per quarter by the end of next year?

James Dimon

It’s a small net positive but not a good net positive.

John McDonald - Sanford C. Bernstein

In the credit card business the margin was up quarter to quarter was wondering if the prime LIBOR spread was something that started to hurt towards the end of the quarter and do you expect that to impact you more going forward?

James Dimon

That number alone if it stayed where it is today could cost us $100 million a month in that business. We don’t expect it to stay there and obviously there are actions we can take to reduce it over time.

James Dimon

And you’re right it wasn’t a significant factor in the third quarter.

John McDonald - Sanford C. Bernstein

On the card, any changes toward the end of the quarter in payment rates and behavior as the market fell apart in terms of just revolve and payment rates?

James Dimon

Yes, so spend numbers dropped from a year ago and they’re now running on the consumer side plus 3%, 4%, 5% a week. I think the industry is closer, at least we know the VISA numbers are around zero. Payment rates came down a little bit which you expect to see in an environment like this and obviously the losses are kind of trending upward in a nice steady fashion like we told you to expect.

John McDonald - Sanford C. Bernstein

On the government’s plan with the preferred, do you expect them to be restrictive on how banks deploy the capital or pretty much free reign for the banks to use their discretion subject to--?

James Dimon

It’s a non-voting preferred so we don’t expect the government to get involved in our business. But it’s clear that the government would like us to use the capital to facilitate clients, to make loans and stuff like that and we want to do that too so I think we have a common interest in this.

Operator

Your next question comes from the line of Guy Moszkowski - Merrill Lynch

Guy Moszkowski - Merrill Lynch

I just wanted to follow-up on the use of the government capital, would you think its reasonably leveragable especially given the availability of the debt guarantee or is the government actually do you think expecting you to maintain Tier 1 close to 12%?

James Dimon

I don’t think the government is telling us what to do with the capital, and when you say leveragable I think you can use it. We fully expect to use some of it to do a good job for our shareholders and the government guarantee on the debt side just makes it easier for banks to rollover their liabilities and some banks are having trouble doing that; JPMorgan was not.

Guy Moszkowski - Merrill Lynch

But presumably given that you’ll be receiving an injection of $25 billion of Tier 1 capital if you leveraged it even a few times over an used the fact that you can borrow at basically treasuries plus 75, given the 75 basis point cost of the guarantee, it would seem like it could actually be an interesting opportunity or am I looking at it wrong?

James Dimon

No, I think if you are a bank that’s [filling a hole], obviously you can’t do that. If you were a bank that’s not [filling a hole] obviously you can do some of that. But we just got it so we haven’t, we haven’t even got it yet so we’re just sitting here making sure we do it right and obviously it will relate to the environment you see going ahead. It’s very important for us just I think it’s very important for the government that all these institutions be able to weather whatever happens coming forward.

Guy Moszkowski - Merrill Lynch

And do you plan to use the TARP asset sale facility to reduce some of those mortgage exposures that you talked about?

James Dimon

Look I don’t think it’s highly relevant to us honestly and we’re down to smaller numbers now and so the answer is probably not but we’ll see how the details come out and we’ll figure it out then. I think the TARP facility when it comes out may very well help the markets and that will help anyone who wants to trade in those markets because you have real prices and real discovery and real ability to how you manage your own assets and capital.

Guy Moszkowski - Merrill Lynch

On Bear Stearns, given what you paid for the company versus the book value that they stated at the time of the merger, and the fact that you didn’t record an extraordinary gain there you would essentially be carrying maybe $10 billion of reserves and you talked about a variety of the things that those were set up for, but largely it would be for securities valuation and I was wondering have you burned through all those reserves at this point and would some of the securities losses that you showed this quarter have been from the Bear Stearns portfolio or do you still have some of those valuation reserves available?

James Dimon

I think we’ve been clear right from the beginning there are no valuation reserves ever in the Bear Stearns deal. All those assets came over and were marked at fair value. There were reserves for litigation, severance, a whole bunch of stuff like that, but they were our best estimate. There is nothing left over from Bear Stearns. If you said what would your losses have been in mortgages this quarter had you not done the Bear Stearns deal, my guess is about 40% of that came from Bear Stearns.

Operator

Your next question comes from the line of Mike Mayo - Deutsche Bank

Mike Mayo - Deutsche Bank

So when do you get the $25 billion in preferred?

James Dimon

I don’t know. I think the paperwork is not finished on that and obviously we’re going to read that very carefully.

Mike Mayo - Deutsche Bank

Would you be willing to use that $25 billion for new acquisitions?

James Dimon

I would be willing to use it for anything that made sense for JPMorgan shareholders.

Mike Mayo - Deutsche Bank

And Bear Stearns, how much of the Fed’s backup has been eaten into?

James Dimon

There’s no Fed backup. The Fed is financing $30 billion of assets and we’re taking the first $1.1 billion or whatever the number is of loss there and again we’ve been very consistent. We think the Fed is going to get all their money back and we expect to get a little bit of our first loss note back too. But I don’t know. They’re managing that. It’s up to them and it depends how they manage it over time. They make their own reports by the way what they think the market value of that is and the last report I saw said it’s about what it started at and obviously its bounced all over the place in the last month.

Mike Mayo - Deutsche Bank

Have you made any changes to mark-to-market accounting? I guess there’s been a lot of noise in the SEC and there’s and IASB proposal for European banks that would allow them to move assets from fair value accounting to more loan type accounting, any views on all of this, any changes ahead or any changes already made?

James Dimon

We have made no changes to our accounting. I think with the SEC guidelines set out is that in markets where there’s kind of no trading you’ve got to use your judgment and models and stuff like that. We’ve made no change in ours. I think the European banks, we are already allowed if we want to move from a trading account to a held to maturity account and we took you all through that last time, we did do that with a little bit of stuff and put up a lot more reserves, not less when we did that because, the matter of fact we wanted more reserves.

They said the banks can do that themselves in Europe now.

Mike Mayo - Deutsche Bank

As far as your outlook you mentioned the Lehman bankruptcy risk remain, and I guess that relates to CDS, but can you elaborate and how important are these risks?

James Dimon

We think we’re going to be fine on those risks but we just want it pointed out, it’s really two things to simplify it a little bit, one is trading. And honestly all of us thought that if you ever saw a mutual called the major dealer exit that it would be very tough on trading, it was. But I think it was, I think the street, it was able to get through that rather quickly and easily but there’s still some open issues relating to that, but not big.

And the second is we were a huge financing tri party agent and we have collateral against that and some of that collateral we have to liquidate and some of that collateral belongs to some other people. We think that all will sort out.

Operator

Your next question comes from the line of Betsy Graseck - Morgan Stanley

Betsy Graseck - Morgan Stanley

Could you talk a little bit about the card business? We realize that the House had passed some legislation that potentially will make its way to the Senate in the beginning of the year and you’ve got the Fed regulators looking at a proposal [inaudible], what are you doing in the card business to prepare yourself for the potential that these legislation changes?

James Dimon

First of all keep in mind that we already had eliminated double cycle billing and we had already eliminated [off us] pricing. This is where we changed your pricing because of FICO score change or something like that. So two of the biggest things that people complain about we already don’t do. So put them to the side and that cost us money. It was like $300 or $400 million--

Michael Cavanagh

It was [$700] million, it was going back about a year, [three quarters of a year].

James Dimon

So the other stuff and there’s a whole bunch of stuff out there, I would put in the category it could be significant so any one change on its own could be hundreds of millions of dollars or something like that. In total they could be well over a billion but there are actions that would take place that would change a lot of that. So for example if you can’t re-price your loans, you’re not going to make certain types of loans. If you have to have people pay off teaser rate loans last on a series of loans, we’re not going to make teaser rate loans. So a lot of that stuff I think competitively will cause changes in profits in the short-run but not in the long-run.

It will change your pricing, if you cannot price for risk, you’re going to charge everybody else more, that’s what’s going to happen.

Betsy Graseck - Morgan Stanley

I know in your comments to the Fed you indicated that the industry or your portfolio in particular would be smaller, can you give us any sense of the degree to which you think you might need to pull back on your outstandings?

James Dimon

Yes, we already have but honestly like some of the teaser outstandings that we pulled back on worked out profitable anyway. We’re going to run the business for profit. If outstandings go down $10 million so be it.

Betsy Graseck - Morgan Stanley

When you did the WaMu announcement you indicated a slide where you had your home lending loss severity expectations based on current estimates, deeper recessions, severe recession, based on what you were saying earlier it seems like you might be triangulating more towards a deeper recession in your outlook, is that fair to say or not?

James Dimon

Our outlook is kind of what we see with a little twist that we expect it to get worse. And so we don’t really know but I think you know what, we have to be prepared that it gets a lot worse. And we are.

Operator

Your next question comes from the line of Jeff Harte - Sandler O’Neill

Jeff Harte - Sandler O’Neill

In the mortgage related exposures and the investment bank you showed the decline and I think you said $4.3 billion of it went into corporate, of the total decline going back beyond just the third quarter how much has gone into corporate do you know?

James Dimon

Just that piece. So corporate has $100 billion portfolio and that portfolio is for interest rate exposures, for collateral reasons, to manage the balance sheet of the company, we are moving some of that portfolio slowly and carefully into higher yielding assets. Because remember we’re here for shareholders and some of these assets we think are going to give great returns to shareholders over time. So it’s not in a great rush but those assets will include a little bit of AAA CLO, a little bit of bank preferred, a little bit of Alt-A, a little bit of CMBS, and we’re not going to do it ad hoc, we’re just going to do it over time. So those assets that they move were the same type of assets they were buying. And they were moved at fair value so there was no benefit to anyone in it.

Jeff Harte - Sandler O’Neill

Are they mark-to-market?

James Dimon

Yes, most of those will continue to be mark-to-market in the treasury portfolio. So you will see a little more volatility in corporate because more of the assets there are being held in a trading portfolio because they have to be, but again we’re here for shareholder results and if we have to take a little bit more risk to do a good thing for shareholders we’re willing to take a little more volatility.

Jeff Harte - Sandler O’Neill

I know there’s no way to normalize trading revenues but if we back out the big marked downs of $3.6 billion in the quarter trading revenues looked really, really good.

James Dimon

They were really, really good.

Jeff Harte - Sandler O’Neill

Is that kind of wow that was fantastic, we’ll never see that again or, I’m just surprised given how much volatility there was in the quarter?

James Dimon

Honestly it was an exceptional performance. Some areas I think the rising tide lifted all boats so I think you’ll see a lot of trading desk in certain currencies and certain rates and other areas, and other areas our people just did an exceptional job. Emerging markets, we were hedged for a downturn on the equity side, we were prepared and positioned for markets going down so we benefited from that and it, we’re not taking big bets on it but it was pretty good performance.

We don’t expect that to repeat though.

Jeff Harte - Sandler O’Neill

From a deposit standpoint almost $970 billion on the balance sheet is more then I was expecting combining you with Washington Mutual, can you talk at all about, are you gaining more market share there is there any pricing pressure changes on the deposit side?

James Dimon

We think in the market share side and the wholesale side, yes. And you see that in TSS. And we think in private bank the answer would be yes. Retail the answer is no and part of the reason we weren’t competing aggressively for funds nor are we in areas we had this big flight to quality. So I think if you were in California or Florida and you were strong, you had a big inflow. We weren’t in California and Florida so we weren’t the beneficiary of flight to quality but we think we’re probably gaining a little bit of share and I think the deposits in the last month were up $100 billion in total.

Operator

Your next question comes from the line of Meredith Whitney - Oppenheimer

Meredith Whitney – Oppenheimer

You didn’t quantify how many of your businesses are impacted by the prime LIBOR inversion and I want to be clear in terms of the decline in originations on your mortgage portfolio, was that more credit based or in terms of tightening underwriting standards or prime LIBOR--?

James Dimon

Prime LIBOR has a huge negative effect on card; it has a modest beneficial effect across some other businesses. So that’s not a big deal and it doesn’t affect, directly effect the origination business. The origination business and I think this is true for a lot of people in the industry, people have gone back to old fashioned 80% LTV, real verified income, more disciplined appraisals, and in some areas they won’t even go to 85% LTV because of expected home decreases. So we are not at 80% in California, Nevada, or Florida, we’re at 65%.

That’s why its down and I think that’s true for us and everybody else, almost everything being originated is eligible for Fannie Mae, Freddie Mac, or FHA and so therefore you have this great reduction for us and for other people in origination. Obviously the quality of that stuff is going to be much higher.

Meredith Whitney – Oppenheimer

Given the fact that the industry is pulling back credit across the board, are you seeing areas where you’ve pulled back credit deteriorating much further obviously the states, the sand states are experiencing the most credit deterioration but have you given a test example of pulling back credit in one area and seeing all your competitors in that being a catalyst for chronic increase in deteriorating credit?

James Dimon

No I think the answer is probably yes but we’ll never really know so if everyone pulls out of credit out of California obviously it will accelerate the depreciation in homes in California make it harder, scarier to provide credit and let me just make a general comment about a crisis like this.

One of the things that happens which I think the government is focusing on is a lot of individual actors, I’m talking about you as investors, banks as providers of credit, individuals, small businesses, large businesses, all start to take actions that are rational for them as an individual or a corporation but in total can cause exactly what you’re talking about.

And that’s one of the things that the government is trying to reverse. It’s not just the banks. It’s the individuals who invest in banks, its people who provide capital to other financial institutions or moving the money back overseas and so you do see a little bit of that and they’re trying to arrest that. That is the one thing that’s got people most scared and they’re trying to stop it and I think what the government is doing is pretty powerful medicine. I’d say the governments around the world is pretty powerful medicine and I think you will start to see some beneficial effect of that in the next couple of weeks.

Meredith Whitney – Oppenheimer

If you really believed that you’d be gunning credit card lines, right because you believe that the inversion would abate?

James Dimon

We’re not speculators. But we are buying slightly more risky assets and we’re growing our businesses everywhere so we’re not panicking. Credit cards were up, credit card receivables were up. We’re not pulling out of California. We’re still going there. We’re still marketing. Obviously we’re trying to modify what’s going on. We’re not going to say, yahoo, this is over, extend credit like we did without fear. If you’re not fearful, you’re crazy.

Operator

Your next question comes from the line of William Tanona - Goldman Sachs

William Tanona - Goldman Sachs

Some of the other investment banks provided some pretty good color in terms of where they have certain assets marked within their investment bank, just wondering if you would be willing to provide that same level of detail across prime, Alt-A, subprime, CMBS, you give the exposure reductions but we don’t really know where those things are marked.

James Dimon

So leverage loans we did and I’ll give you some numbers right now, ready? Prime loans is not really applicable, securities high 50s, Alt-A performing about mid 70s, non-performing 40s, that’s loans. Alt-A securities high 20s, subprime mid 30s, CMBS loans mid 80s, securities mid 70s, that’s all we’re going to give you because its competitive information.

William Tanona - Goldman Sachs

In terms of the retail financial services, if I look at the charge-off rates for the prime loans that are retail financial services, it looks like its about 96 basis points this quarter versus the charge-offs for corporate which are about 30, what’s the difference between those prime mortgages held in RFS versus corporate?

James Dimon

It’s mostly vintage. We may change the reporting of them; combine it so we don’t cause this confusion going forward. One of the things I should mention, when you look at the mortgage business that we kind of looked at the $12 billion ongoing is trading, its moving, that’s what we need to do to service clients, properly marked, you shouldn’t see huge, obviously there’s risk in trading, but it should be back to more normal risk and there’s $6 billion, its marked, but put it in as liquidating very hard to trade, you can’t trade it all. Its marked down to we’re going to get, I would believe, we’re going to get very substantial returns, from 10% to 20% as we liquidate it using fairly bad assumptions.

We don’t like it but it’s not that big a deal anymore.

William Tanona - Goldman Sachs

The commentary in terms of your outlook you talked about basically expecting or having lower expectations for earnings within the investment banking results, is that just relative to this quarter or is that just in general what we should be expecting?

James Dimon

I just think you should be very cautious. I’m guessing what the environment is going to be so this crisis isn’t over so we’re just guessing like you can guess on your own. We don’t know anything that you don’t know. We’re just guessing that it still could be pretty tough out there for awhile. We might have some more markdowns that, we have really healthy loan loss reserves, like $77 billion of loans, we have almost 4% up against that. That’s historically high but it’s very idiosyncratic. If one big company fails that could be a huge loss for us so we’re just prepared to be a little bit tougher in the investment bank. We hope to make some money but we’re not going to count on it for now. I [would] be shocked if we make a lot of money one of these quarters either by the way.

Operator

Your next question comes from the line of Jim Mitchell - Buckingham Research

Jim Mitchell - Buckingham Research

In the mortgage market with the TARP are you seeing any impact on stabilizing pricing there which could help reduce the risk of write-downs going forward?

James Dimon

A little bit in Alt-A and maybe a little bit in some of the CMBS stuff. Remember TARP hasn’t started yet but just the anticipation might cause some of that. Surprisingly we haven’t really seen anything in agencies, agency MBS which the spreads are still damn near the highs and we think those are probably very good buys. And I would expect one day we’re going to wake up those [inaudible] in dramatically.

Michael Cavanagh

Then the buying that was announced last weekend by the agencies monthly, $20 billion each is going to be helpful as well.

James Dimon

We were up to Fannie Mae and Freddie Mac preferreds, but whatever they are, I think we can get real value for that back one day too. I just think it could be years from now.

Jim Mitchell - Buckingham Research

Maybe that dovetails into the securities gains that you had this quarter was that realized in the available for sale portfolio or was it mark-to-market in your corporate trading book or is it hedges, where were those gains?

James Dimon

It was realized in the AFS portfolio. There was some trading losses in there that—

Michael Cavanagh

Some trading losses on some non-interest rate products and on just changing [coupon] trades in some of the mortgages on there that were realized gains.

Operator

Your next question comes from the line of Glenn Schorr - UBS

Glenn Schorr – UBS

On the [inaudible] temporary liquidity guarantee program, did you know round about how much you have coming due through June 30 and is there any reason why you wouldn’t max out on that issuance?

Michael Cavanagh

I don’t have the number handy and we haven’t really thought through it exactly.

James Dimon

Remember it includes, the way we understand it it includes CP, promissory notes, maturing debt, all unsecured, holding company and bank, so it’s a pretty big number and its 125% of that.

Glenn Schorr – UBS

It seems like well worth it not that your balance sheet was in that rough of a spot, it just seems like a--

James Dimon

So you guys basically just want to stick all the money and leverage up and go for it.

Glenn Schorr – UBS

Hunker down in the bunkers sounds pretty good to me these days. On the balance sheet on slide four you saw other assets double from $90 billion to $180 billion, is that anything in particular?

Michael Cavanagh

You mean the supplement. Let me come back to you on that, it may just be all the cash that’s coming in going into, it’s got to be WaMu.

Glenn Schorr – UBS

What are the signs you do look for in terms of when the boosting of the reserves stops because you’re at obviously extremely high levels as you pointed out of the loan loss reserves, is it the pace of increase on the both delinquencies, unemployment and charge-offs?

James Dimon

I think the second you see a levelization of charge-offs, with some certainly going forward that you don’t need any additions to reserves.

Operator

Your next question comes from the line of Ron Mandel – GIC

Ron Mandel – GIC

On the treasury program if you think over the longer term there’s some incentives to buyback the preferred stock that the treasury is taking the number of warrants, the higher coupon, I’m wondering if you could maybe elaborate on how you think about, you may want to issue stock to buyback the preferred and also just maybe how many warrants you think are going to be issued under the program?

James Dimon

Once we decide to go into the program I was thinking could we have $50 billion. So think of it this way obviously by the time you get to the 9% you’ll probably want to have paid it off and the warrants are equal to the value you gain. So in our case they’re going to get warrants if the way it’s currently written, 10 year warrants on $3.75 billion of stock, those warrants are worth, you can estimate it at $1.2 billion, which is an additional cost on the $25 billion.

So it’s 5% plus the way I look at it, a year plus another 5% for the full term. You just monetize the cost of the warrants. So it’s not bad money that way. There is a way if you refinance it sooner, you’re going to refinance it with real Tier 1 capital that you can eliminate half the warrants and we’ll deal with that in due course. That to me becomes a truly financial decision. You do that or not do that, but the government made this part of it not an unattractive thing so that people can get the capital, use the capital and hopefully do some good with the capital.

Ron Mandel – GIC

How many warrants, warrants for how many shares and--?

James Dimon

It’s not the shares, its warrants for $3.75 billion worth of stock; you could do your own share calculation. The market value of those warrants would be something like $1.2 billion or $1.3 billion use your own model.

Michael Cavanagh

The strike is based on a trailing 20 day price.

James Dimon

I’m simply saying think of that, of the whole $25 billion it’s under 5%, maybe 6% so if you spread it over the first five years of the 5% of money, your money is costing you 6.5%. Its still cheaper then most companies can raise money at today. And it’s real Tier 1 so it’s very cheap Tier 1. So to that extent it’s not a bad economic transaction.

Ron Mandel – GIC

And then you could even reduce the warrants as you mentioned by--

James Dimon

There’s a way to reduce them, but you could argue that a lot of people wouldn’t want to because that’s cheaper capital then they could otherwise get.

Ron Mandel – GIC

So on your balance sheet this is additional Tier 1 capital?

James Dimon

It’s all Tier 1 capital.

Ron Mandel – GIC

Not the preferred part, the warrants part.

James Dimon

The warrants are not Tier 1 capital; they are just a dilution on the balance sheet.

Michael Cavanagh

It would be $25 billion on top of the $112 billion in Tier 1 capital we currently have.

Ron Mandel – GIC

The other part of the FDIC program besides the debt guarantee was a checking account guarantee, are you going to opt in to that and if so what will the cost be--?

James Dimon

I think what they said is 10 basis points in that and think of that as an operating account guarantee. I think the real point of that wasn’t for JPMorgan, its really for smaller community banks and stuff that do a lot of small business middle market and they don’t want those people to be afraid that they’re operating accounts are at risk.

Ron Mandel – GIC

And then the 10 basis point cost--

James Dimon

It doesn’t mean anything to us either way whether we do it or don’t.

Operator

Your final question comes from the line of Nancy Bush – NAB Research

Nancy Bush – NAB Research

This is sort of a philosophical question; this treasury program that was announced yesterday I think came as a bit of a surprise to everybody. It seems to have been done with a few days thought and mostly as a result of what happened in Europe but what is your feeling about how this has changed the dynamic for capital raising going forward? Is it going to make it more expensive for the banking industry to raise capital beyond this period of treasury investment? Can you give me your philosophical thoughts about it?

James Dimon

I don’t really think so; I think that one day everything will have normalized again. That might be three or five years out. I think what they really wanted to do; I don’t know how long they worked on this, so I wouldn’t assume it was just three days. I do think they had to do something relative to the rest of the world so if you were in their shoes you would look at it and say well the rest of the world is guaranteeing deposits, United States is not and the rest of the world, you might create other consequences so but I agree with you. Making policy on the run is a very hard thing to do and it always has these huge unintended consequences which is really hard to forecast ahead of time or have any foresight on at all.

But I think one day it will normalize and will make raising capital more expensive for banks. We’ll go back to a more normal world and people will probably spend a lot more attention on credit, which they should.

Nancy Bush – NAB Research

You have been a huge beneficiary of basically institutional failures in this environment, is it your sense that this treasury program will slow that process, is it intended to slow the process, is it intended to prop up banks that should probably fail? Is that one of the unintended consequences?

James Dimon

I think that one of the consequences is, is that this program obviously helps the weaker more then it helps the strong. And I think I mentioned that if you don’t want to be parochial or selfish, as long as it really materially helping the system, we all should be in favor of it. So you can sit around the table and argue all day long where we would have been better off and sure, but you’re not better off if the system goes down.

But I don’t think the intent on the treasury, I think they’re very conscious of, they don’t intend to hold up failing banks and you haven’t seen them do that. What you’ve seen them do is be pretty aggressive to try to get failing banks in the hands of good owners. So they’re going to have to throughout this program, the devil will be in the details how they manage it. So you will be looking at how they really manage it going forward and we’ll be second guessing them too at one point.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

James Dimon

Thank you very much and we’ll talk to you soon.

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Source: JPMorgan Chase & Co. F3Q08 (Qtr End 09/30/08) Earnings Call Transcript
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