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JPMorgan Chase & Co. (NYSE:JPM)

Q2 2009 Earnings Call

July 16, 2009 8:00 am ET

Executives

Julia Bates – IR

James Dimon – CEO

Michael Cavanagh - CFO

Analysts

Glen Shore – UBS

John McDonald - Sanford C. Bernstein & Co.

Guy Moszkowski - Banc of America

Betsy Graseck - Morgan Stanley

Mike Mayo - Calyon Securities (NYSE:USA), Inc.

Meredith Whitney - Meredith Whitney Advisors

Matthew Burnell – Wells Fargo

Moshe Orenbuch - Credit Suisse

Jeff Harte - Sandler O'Neill

Chris Kotowski – Oppenheimer

Jason Goldberg - Barclays Capital

David Trone - Fox-Pitt Kelton

Nancy Bush – NAB Research

Edward Najarian - ISI Group

Ron Mandel – GIC

Richard Staite - Atlantic Equities

Operator

Good morning ladies and gentlemen and welcome to the JPMorgan second quarter 2009 earnings conference call. I would now like to turn the call over to Julia Bates; please go ahead.

Julia Bates

Hello, this is Julia Bates, Director of Investor Relations at JPMorgan Chase. Thank you for joining us this morning. Before we get started I would like to let you know that today’s presentation may contain forward-looking statements and references to non-GAAP financial information measures.

Forward-looking statements are based on management’s current expectations and are subject to significant risks and uncertainties. Actual results may differ. For further information on these matters, please refer to the firm’s filings with the SEC and to the notes at the end of the slide presentation.

Now I would like to turn the call over to JPMorgan Chase’s Chairman and Chief Executive Officer, James Dimon, and Chief Financial Officer, Michael Cavanagh.

Michael Cavanagh

Good morning everybody, so we’ll get started now and just if you could all refer to the presentation that’s on our website, the slides we’ll go through. So starting with a quick recap, I won’t be redundant here with what I’ll say later but a quick recap of some of the big points in the quarter on slide one.

So as you know we had net income of $2.7 billion in the quarter, that’s earnings per share of $0.28. The EPS number is after the $1.1 billion or $0.27 TARP preferred repayment as well as the FDIC special assessment which was $0.10. That piece being booked in our corporate segment.

Normal and higher FDIC operating expenses you’ll see referred to throughout the businesses but that’s the regular cost, this $0.10 item is the second quarter special assessment. Again, booked in corporate.

So behind the results were record revenues, $28 billion for the quarter. That was a record for the quarter and also amounted to a record for the first half of the year. As well, pre-tax, pre-provision profits, $14.4 billion for the quarter and were a record for the quarter and a record for the year.

So that’s on the back obviously of some very strong results in our investment bank which we’ll cover in a few minutes but also just broadly strong results in many of our businesses obviously with others consumer lending in particular faced with some challenges but I’ll skip over that until we get to the business slides.

But commenting for a second on capital, obviously the very strong capital ratios, much better than what we talked about, when we’re giving you sort of a no worse then numbers in the earlier in the quarter when we finished the stress test.

But ended the quarter with $122 billion of Tier 1 capital and that’s 9.7% Tier 1 ratio and a 7.7% Tier 1 common ratio. Also in terms of balance sheet strength we now have $30 billion worth of loan loss reserves, that’s a coverage ratio of loans of about 5%.

We’ll obviously talk a lot about credit on the call later on but we feel very good about the overall reserving level. We’ve brought these levels up a lot in anticipation of deterioration and well aware of some of the trends you see in non-performers and so forth but all fully contemplated in the way we think about that $30 billion reserve number for what we have ahead of us.

Also obviously repaid $25 billion in TARP capital in the quarter. And lastly before we get into the businesses its just important also to point out that we’re doing everything that we think we should be doing to help the country get back on the road to recovery here so have done a lot in the trial modification space and foreclosure moratorium space both helping advise on what the best practices are there and getting underway with it in a big way ourselves.

So we’ve got [$]138,000 in trial modifications approved in the second quarter representing about $3.5 billion worth of mortgages and we’ll see how those perform over time. That brings a total of foreclosures avoided to about $600,000. And obviously subject to safety and soundness we continue be an active lender on the back of the very strong capital we have and so that’s $150 billion of new credit extended in the quarter across the board; consumers, corporations, non-profits, municipalities, and small businesses.

So now if we just skip past slide two which just gives you the numbers that I just referred to, let’s go straight to the investment bank on slide three. So you see the investment bank had profits of $1.5 billion on revenues of $7.3 billion. I’ll just pause here for a minute and just point out the first points here, investment banking fee revenue $2.2 billion.

That’s a record for us in a quarter and a record for anybody at any firm in any quarter in terms of investment banking fee levels. So very proud of those results. Its inclusive of very strong and record equity underwriting volumes and fees of $1.1 billion. And I’ll just ask you to flick to it now, but the next slide just shows you the number one year to date rankings in essentially all the major underwriting categories on a year to date basis globally.

So that continues to be the case and very proud of it and obviously the number one rank year to date on fees and a number three ranking in global announced M&A on the year to date basis. So very, very proud of the client franchise in the corporate finance business in the investment bank.

When you move then to the markets businesses, I’ll just make a general statement that across the board we saw the benefit of strong levels of client activity and continued wider spreads as a general matter. You did also see in the equity markets and fixed income markets businesses the negative impact of our spread tightening on the valuation of some structured notes in each of those businesses.

But now just looking at each business separately, fixed income markets up $4.9 billion and that is strength across the board; rates, FX, commodities, emerging markets, so forth, all performing well. And then I’m going to show you a slide that gives you the remaining positions in leverage loans and risky mortgage assets that we’ve been talking about for many, many quarters now but the net effect on those were modestly positive P&L marks on those positions in the quarter. So going to comment on that in another second.

Equity markets, $700 million of revenues and again strong client results especially in prime services but weaker on the trading side, the positioning side in the business. Moving then down to, I’ll go right to credit costs. We had credit costs of $871 million, that’s charge-offs of $433 million, 2.55% charge-off rate in the quarter, up a bit from last quarter.

And then the allowance, we added $438 million bringing the total allowance to almost 8%, 7.91% to loans in the investment bank. Obviously we did have the negative trends in charge-off rate but we reserve as we downgrade things so we think that 8% level of reserves is totally appropriate despite the movement higher in some of the non-performers there.

And so with that let me move on from the P&L for the investment bank to past the [league] tables which we talked about to slide five, which is the key risk exposures in the investment bank. So here we’ve collapsed onto one page the details around what we’ve talked about for many, many quarters now of what we called our key risk exposures in these two spaces.

I’m just going to recap where we are now since in the future we’ll probably stop talking about this as a generic matter and only bring it up when there’s something relevant to, or noteworthy to bring to your attention.

First on leverage lending if you recall we started with $43 billion on a pro forma basis with Bear Stearns back in September, 2007 and that’s on a notional basis. Now we carry a remaining amount of market value of $3.3 billion and that’s carried at roughly $0.42 on the dollar so those are marked down values for what remains.

Obviously exposure came down nicely in the quarter and the P&L as I said earlier was modestly positive net of hedges on this remaining amount so obviously much smaller exposure and unlikely to be noteworthy topic of conversation in the future but before closing that out, I wanted to point out where we stood.

Next mortgage related this, going back to its peak was $48 billion in December 2007, here we have about $12.6 billion remaining, flattish quarter over quarter. In this quarter we are modestly positive again across the board here and so what I would say about this is about half of it, a little less than half relates to normal ongoing client business inventory levels and the other half is legacy positions that we like where all of this stuff is marked, and we’ll just take the stuff that is legacy and slowly liquidate it out over time.

So again we’ll talk about it in the future where it creates relevant P&L conversation but at the level of marks we have now in a quarter where its been very quiet for us, that’s where we stand on those two areas of exposure, dramatically down from where we started and so moving forward into business as usual there.

Moving on to slide six, retail financial services, I’ll just quickly hit some of the drivers of the results in this business, remember we talked about this in two buckets; the retail banking or branch side and the consumer lending which includes all the mortgage lending activity and servicing activity and mortgage portfolio we hold, auto, student loans and so forth.

So on the top, retail banking, feel very good about the underlying growth dynamics again in our business. We’ve got deposits of $348 billion up a bit quarter over quarter. That’s despite us not chasing rates so we are prices appropriately we think in our deposits and I just will make one point here that we do expect to see some declines in the second half of the year in these levels as we deliberately reprice downwards very high priced [inaudible] mutual CDs that were put on the books for 12 months in the fall of last year.

So that will be a dynamic that we’ll see a little bit of downward pressure on that number in the second half of the year, but otherwise feel very good about the underlying growth stats in retail banking and you’ll see the P&L in a second.

And then on consumer lending at the bottom, I’ll just point out, you can read the numbers for yourself, but of the total $150 billion of lending we did in the quarter about just shy of $50 billion of it came through these consumer categories that you see here that I just referred to.

But remember I think the noteworthy piece is that our mortgage volumes of $41 billion or so is definitely affected by our decision to steer clear of broker originated volumes. So that’s certainly a difference from where we had been a year ago and in prior periods but for several quarters now since we made that final decision to move out of that. It’s been a differentiator. We’re picking up less volume and you’ll see that on the next page when we talk about consumer lending.

So now moving on to page seven, total P&L for the retail business $15 million profit, if you look at the circled number on the left and then walking down the retail banking piece of that, made just shy of a billion dollars, $970 million. Obviously the substantial increase year over year, $296 million in profits largely driven by the WaMu acquisition so clear evidence there that you see WaMu delivering the profitability that we expected and I talked about.

And as well some profit lift on a sequential quarter basis as well. Do have a little bit of higher credit costs there related to the business banking business and then moving down to consumer lending, obviously a disappointing loss of nearly a billion dollars offsetting the profitability of the retail banking side.

So there in terms of what’s going on versus last quarter, this quarter we had very modest position gains in our MSR risk management results versus making about a billion dollars in each of the prior quarters. So this quarter more in line with usual expectations and kind of what we talked about there. And then credit costs, the big driver, $3.5 billion which includes $1.1 billion of addition to loan loss allowance.

So I’m in a second going to go through those portfolio by portfolio. So now if we just move on to slide eight, let me just, I wanted to take, there’s a lot of talk about the impact of foreclosure moratoriums and modifications and what it means to some of the credit stats you all look at.

So as I said at the beginning we’re active and going to continue to be in modifying mortgages. I think it’s the right thing. We do it where it makes sense to us and it makes sense to our clients and for good economic reasons here, but a little bit of misunderstanding maybe about some of the ways that this impacts.

So I’ll let you read most of this but just make a few points, on the left we definitely saw as all did a build up in loans that were delinquent in all the delinquency statistics given that we suspended foreclosures during the moratoriums in the fall and spring of this year which are described on that side of the page.

What I would say is that those will sit there longer in the delinquency bucket so, in prime and sub prime you see elevated delinquency stats. But we don’t expect it to have meaningful accounting our income statement impacts as we came out of those moratoriums we’d originally written down those loans and then made adjustments to the write-downs to take account of the longer time lines to move them through into real estate loans and foreclosure if appropriate or modify them.

So then on modifications, again I said at the beginning we’ve approved [$]138,000 modifications for the second quarter here but those don’t have any meaningful impact on our second quarter stats and that’s because we have to see three monthly payments under the terms of the new modification before we’ll re-underwrite that loan and it comes out of delinquency and in the meantime and there’s an example here, it just continues to roll through delinquency buckets as it otherwise would have for the contract of the term.

When we do see, if we do see, and we hope to see good success with these modifications perhaps next quarter and in future quarters we’ll talk about just the success rate but given that these are largely speaking payment reduction modifications that are down re-underwritten with real income stats and so forth we are hopeful that we see some good rates of success in the trial period.

But when we do modify you just see the description at the bottom of how we take into account when we adjust our reserves at the time we modify the expected remaining losses including an assumption for recidivism or re-default. So that’s the way it really works and we can spend more time offline if folks want to spend other time, but its not a material impact to any of the stats in the quarter was the point for today.

Now I’m going to be very quick going through the next three slides so I’m just going to make some common points, so the first point is that obviously when you look at home equity prime and sub prime, you’re going to see the charge-offs continue to trend higher versus prior periods and in a couple of cases prime and sub prime we up our future guidance but the second point is that across each of these portfolios, so I just want to say it once, they flow into the early delinquency buckets and the dollar value of loans that are sitting in the early delinquency buckets has started to stabilize.

Looking back over the last 60, 90 days across the board and so that’s a new trend versus what we’d seen previously and obviously that would, we don’t know if its going to sustain itself but obviously if it did that would have good implications for future loss trends and could mean that we could be getting near to the end of needing to add to reserves in these portfolios. Just something to watch and point out we don’t know what the future holds obviously but an observation of what’s going on in the early delinquency buckets across the board.

So on slide nine, I’ll just quickly hit numbers here, so you see in the upper right, charge-offs of $1.265 billion in home equity in the quarter, up a bit from last quarter but the pace of growth slowing down a little bit and we continue to have our forward guidance of quarterly losses trending to, down at the bottom last bullet, trending to about $1.4 billion a quarter over the next several quarters.

Doing the same think on slide 10 for prime, upper right box, you see $481 million in net charge-offs, up more substantially from last quarter in percentage terms but similar dollar terms and quarterly losses upping the guidance here to something maybe $100 million higher to the range of $600 million or so over the next several quarters whereas last time it was $500 million.

And then finally on sub prime on slide 11, $410 million of losses in net charge-offs in the upper right in the quarter and quarterly guidance trending to about $500 million or so, that used to be $375 million to $475 million for people keeping track at home.

And so one last point before I move off retail onto card, I just wanted to make a comment on the WaMu credit impaired portfolio that we acquired from WaMu, marked down at the time we did the deal in the fourth quarter, just make the point we have no slides in here and no news is good news on that front.

What we’re experiencing is losses that are coming in consistent with our original assumptions so seeing nothing to suggest that we have any need for further impairments based on what we see right now. So I just wanted to make that point and obviously we’ll bring that to your attention in the future if ever we do start to see trends that are worrisome.

In card, let me just move now to slide 12, obviously a disappointing loss of $672 million in the quarter. Credit costs the big story, $4.6 billion of credit costs. Most of that is charge-offs, we did add $250 million to loan loss reserves there. Now for Chase, the Chase portfolio versus the run off sub prime WaMu portfolio, the Chase portfolio was a charge-off rate of 8.97%, up about 200 basis points as we said last earnings in this quarter versus the first quarter.

And obviously very high but coming in as expected and looking ahead to next quarter think of that number being in the 10% range and really beyond that its going to be a function of where the economy and unemployment goes. And the WaMu side behaving consistent with the trend forward that we’ll talk about on the outlook slide of trending towards the 18% to 24% range of losses that we talked about for that run off portfolio.

Next point on card is just charge volumes, so you see charge and sales volumes, sales being just the spend piece on cards declined 7% year over year, that number is starting to stabilize. We look at it weekly but 7% down year over year together with us being less active in promoting balance transfers equates to downturn pressure on our outstanding, so you see a $148 billion end of period outstanding on the Chase side versus $150 last quarter contributing to some revenue pressure in the business overall.

I will just say here it relates to revenues but one comment to make that in the quarter we did on the card securitization side take actions to support the securitization trust that caused the regulatory assets, the risk weighted assets in those for cards to come on balance sheet for regulatory capital purposes. I’ll show you more about that later when we do capital and that also negatively impact revenues a bit in the quarter and so revenues in card would otherwise have been essentially flat quarter over quarter.

Moving on to the commercial bank on slide13 we had net income of $368 million, up a bit year over year. WaMu making a bit of a contribution here and up $30 million quarter over quarter. I will point out circled number is $106 billion of ending loan balances so we do see reduced client demand on the lending side in commercial bank, they’re to do, extend credit but demand is definitely coming down and we’re seeing that effect on the balance sheet footings.

Revenues in the business $1.5 billion, up substantially year over year again part WaMu and also driven by record non interest revenues up inclusive of record investment banking revenues in the commercial bank in the quarter. Credit, similar trends to what we’ve seen before, 67 basis points of charge-off rates and some additions to loan loss allowance bringing that to just shy of 3%.

So again we see the trends as we expected of normalizing credit, late cycle, things moving into non performer status and credit costs charge-offs trending higher but reserves positioned well in anticipation of all that.

Next is treasury and security services on slide 14, here I’d just say its steady consistent results here in the business, $379 billion of profits, up from last quarter, some seasonal strength there. Liability balances $234 billion, down a bit quarter over quarter and year over year, seeing some normalization in liquidity flows, liability balance flows on the client side and assets under custody down a bit year over year and up a bit quarter over quarter.

That drives the revenue side here $1.9 billion in total, flattish on the cash management side and a little down in security services side given the lower levels of assets under custody given markets and lower activity in the securities lending side.

Last business on slide 15, asset management, net income here similar story to TSS, steady results here, $352 million of profits, up a good amount quarter over quarter and down only slightly versus the prior year so recovering as market values on the assets under management recover. So $1.2 trillion in assets under management, down just 1% on a year over year basis and up $50 billion quarter over quarter.

Slow down in assets under management flows still $125 billion for the last year and $3 billion for the last quarter and then I guess the big point is that investment performance is what drives results in this business over time, so you can see in our supplement and see on this slide towards the bottom that we have continued good investment performance, mutual funds 80% ranked in first or second quarter, quartiles over five years and so on for the past three and past one year when you read through that.

Corporate on slide 16, so take it piece by piece, obviously a lesser level of write-downs on our private equity position so we have $6.6 billion of carrying value in private equity written down a touch for net losses of $27 million in the quarter. Outlook continues to be for challenging valuation levels in that piece of things but an improvement from where we were over the last several quarters.

Then the corporate segment you see about a billion dollars of after-tax profit here, here I’ll just simply say that we had a couple of items, trading gains in our investment portfolio $820 million. That’s separate and above the net interest margin we get from running a higher investment portfolio. That net interest margin was high and will continue to be high so long as we are, sit where we are which we currently expect to.

But the trading gains certainly they’re volatile, this is an abnormally high level. I’ll point that out at $820 after tax. We did sell some MasterCard shares, 150 million to the positive and this is also where we booked the FDIC special assessment $419 million after tax. You take those yourself to normalize what that corporate line would be but its nearly $0.50 billion of profits and again that would be driven by the positive spread on the investment portfolio.

Page 17 is capital management, so here very proud of these numbers. Tier 1 capital $122 billion, Tier 1 common capital of $97 billion. Again Tier 1 capital ratio a very strong at 9.7% and Tier 1 common at 7.7%. As I said on the card page, this includes the consolidation of $40 billion of risk weighted assets in the quarter related to the card business. So you can see in the bullet that just projecting forward to the impact of the consolidation of off balance sheet vehicles pursuant to the FAS B changes that are coming January 1 of next year, our rough estimate is that the remaining impact could be about 40 basis points when you look at the other off balance sheet items and other accounting that would go along with that.

But ultimately obviously there’s ongoing interpretation around those rules so things could change between here and there. Page 18, just shows you the loan loss reserve piece. This is loan loss reserves of $29 billion, there’s another billion related to lending related commitments and the $30 billion I talked about earlier and you just see the expected trend of loan loss to total loans trending higher earlier and as non performing loans come up as the downgrades that are anticipated along the way evolve, you see the ratio of reserves to non performing loans come down.

But still we show those ratios for consumer wholesale and firm wide at the bottom and very comfortable with where we sit there but obviously future economic conditions are going to dictate whether we are in fact near the end or not but we believe we could be getting close.

On the outlook slide page 19, you got the investment bank again we don’t know what the future holds, uncertain environment obviously continues. There’s still risks out there and trading can be volatile so no real guidance for you there, make your own assumptions.

Retail, I just recapped what the loss projections that we talked about in each of the main portfolios. We do expect continued underlying growth there. On the card services side you see the 10% loss rate for next quarter that we plus or minus that I talked about for the Chase portfolio and 18% to 24% is where WaMu is going to go.

But we do expect continued pressure on revenues given lower consumer spend levels having an effect on outstanding. Commercial bank the underlying growth is good. We like being in the market share there. We do have strong reserves but credit trends will continue to normalize. Treasury and security services and asset management, nothing really to point out, you can read for yourself and private and equity and corporate I just hit the key points there.

So with that, I’d like to just throw it open to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Glen Shore – UBS

Glen Shore – UBS

So maybe just on NIM first, you had some NIM compression, you obviously have a really low interest rate environment but also you’re running off obviously all the old Heloc sub prime and other high interest rate loans so just thoughts on the go forward there.

Michael Cavanagh

You hit on it, with the run off in some of the portfolios compression in some of the investment portfolio and investment bank trading type of assets, that’s the real change quarter over quarter from first to second and net interest margin a little decline in dollars overall. I’d expect it to be flattish as best I can tell looking ahead from here to the third quarter.

Glen Shore – UBS

The consumer financial protection agency, its kind of being formed but we’ve seen the directionality if you will of where they’d go related to changes made in the card business, I know these are moving parts but is there a way to paint a more rosy or less ugly picture in terms of profitability and revenues and available credit and things like that from on the go forward for the [CSCA] could take things.

James Dimon

That agency is just being discussed and there are some very important points. We are big supporters of proper consumer protection and in particular we probably were some of the first to point out that the mortgage business is kind of half regulated and half unregulated and that’s where a lot of the problems turned out.

So we do think that a lot of work needs to be done there. The credit card, we think there should be less regulatory agencies not more just for ongoing ease, control, and things like that so we’re worried that the more agencies, the more politics and bureaucracy around it and the credit card bill itself, that kind of was, we think of the things they did we thought some were completely appropriate.

We already had the best practices in most of those areas but we think it went a little bit too far so we’ll entail credit card companies in general we believe cutting back on credit they give both the lower end of the curve and the way they do credit. You’ll no longer be able to do fixed cards. You’ll no longer be able to do a bunch of things so it will reduce credit and it will at least reduce profitability we believe in the short run meaning the rest of this year and mostly next year.

Glen Shore – UBS

Just a numbers thing, could you just give us where the [inaudible] credit portfolio stands, I think it was $32-ish billion at the end of first quarter.

Michael Cavanagh

Non performers I think on that last slide is about 14 and criticized overall is in the credit stats in the supplement. I don’t have it handy.

Operator

Your next question comes from the line of John McDonald - Sanford C. Bernstein & Co.

John McDonald - Sanford C. Bernstein & Co.

In card, any theories on why the delinquencies are improving, is it concentrated in the 30 day delinquency bucket less so then in the 60 and 90 day in credit card.

Michael Cavanagh

I would say its in those early buckets. We’re starting to just see the same as, similar commentary to the home equity and mortgage space. But again its early to draw big conclusions from that but early bucket is starting to look more stable. As is consumer spend, spend in card what we see is declines at 7% year over year that you see in our charge volume kind of indicative of where spend is overall and you’re to see it stabilize at that kind of level. So weaker then what it was versus a year ago but better than the worst point and trending a little bit more stable but again, we don’t know how long that holds on.

John McDonald - Sanford C. Bernstein & Co.

So with the delinquencies improving but the outlook for charge-offs to be up another 100 basis points next quarter it seems that bankruptcy is becoming a bigger percentage of the charge-offs.

James Dimon

The real reason is that the balances are going to be going down a little bit. The [inaudible] of charge-offs will be about the same, balance will be going down a little bit. And as for the front end is obviously notoriously fickle, but part of that at least in my opinion relates to the fact its kind of the rate of change of unemployment, new unemployment claims. So I think once unemployment levels off, you may see that number actually start to come down a little bit.

We don’t know that but there are good reasons to believe that.

John McDonald - Sanford C. Bernstein & Co.

On the reserve build you made the comments that the degree of reserve build is declining with a 5% ratio, what metrics are you looking at to stop building reserves and see the end of reserve building.

Michael Cavanagh

Its going to be, its your notion of what you’re expected imbedded losses are so its going to really be dictated for me here on things like as James just said, does the unemployment rate stabilize or does it keep changing and same with broader economic trends as it relates to the corporate side as well. You need that stuff to stabilize a bit before you get to a place where if you think your losses are peaking out there looking out a year and beyond, you get to the point where you can consider that to be the, given how strongly reserved we feel we are, that would be the indicator that we’re at the end.

John McDonald - Sanford C. Bernstein & Co.

So its really when your forward 12 month forecast stops changing.

Michael Cavanagh

Generally speaking, yes.

John McDonald - Sanford C. Bernstein & Co.

And one quick question on the credit portfolio revenues, investment bank, that’s a tough line for us to forecast, it moves around a lot and [inaudible] in that line and whether those could be reoccurring or—

Michael Cavanagh

Well you know CVA, DVA, very complicated obviously so in credit portfolio we managed the change in value of derivative assets and liabilities, counter parties in our own credit spread, that collective CVA, DVA impact was a couple hundred million positive in the quarter but in any given quarter sometimes they neutralize, sometimes they don’t but there was a modest positive in there in what was managed in credit portfolio but the preponderance of the negative was the accounting asymmetry where we hedged some of our traditional accrual book loans, the $70 billion of retained loans in the investment bank, excess held positions and so forth, we have hedges that are mark-to-market instruments and with tightening credit spreads in the quarter those dropped in value with no offset because of the accrual loans don’t get marked.

And so that negative was partially offset by CVA DVA. It’s a function of spreads, its very hard to predict that line. All I can do is explain it to you one quarter to the next, so you can look at a long-term trend and put a placeholder in there and we’ll explain it quarter by quarter.

John McDonald - Sanford C. Bernstein & Co.

And you have reserves in addition to those hedges, are those loans that also have reserves against them.

Michael Cavanagh

Yes.

Operator

Your next question comes from the line of Guy Moszkowski - Banc of America

Guy Moszkowski - Banc of America

This question is about the sub prime and prime buckets and the expected loss rate guidance being ticked upward a bit and the disconnect between that and what I’m hearing about what you’re seeing in the early delinquency buckets, maybe you can just help us reconcile why you still feel you need to raise the out quarters loss guidance if you think the delinquencies are stabilizing here.

Michael Cavanagh

Think about the, there’s the roll rates in the later buckets effect ultimate losses as well as severity of loss so its forming better views about what’s already in the pipeline and how it will behave—

James Dimon

And we expect unemployment to get worse so we kind of built that in a little bit.

Guy Moszkowski - Banc of America

So it’s a little bit like the answer on the card.

James Dimon

Yes, so in cards we have a lot of visibility into next quarter as opposed to this, this is more erratic.

Guy Moszkowski - Banc of America

And just to go back to the investment bank credit portfolio hit because of the hedges, so really the way to look at that is that you had hedging effectiveness which was compounded in terms of the bottom line for the unit by the fact that you had a pretty large increase in loan losses in the hedged portfolio, is that right.

James Dimon

That’s correct.

Michael Cavanagh

Well on the one line, its revenues only but for the total economics, exactly right.

Guy Moszkowski - Banc of America

Right because we saw that loan loss rate move up quite a bit to about 2.5%, did you have some large specific losses there.

James Dimon

There is one, but [that’s going to] be idiosyncratic and the fact is the reserves are very high. Its hard to imagine you’re going to really need more reserves but the actual losses, MPAs will go up and the actual losses will bounce all around the place.

Guy Moszkowski - Banc of America

On the credit enhancement that you talked about for the card securitizations, can you give us an idea of the order of magnitude in terms of the increase of your funding costs that you’re seeing there because of the need to credit enhance more.

Michael Cavanagh

Its not that so much, we put new receivables in and issue notes that are zero discount and depresses revenue so its just increasing credit enhancement in those trusts from about 11% to about 14%, creates a revenue—

James Dimon

--underline interest costs at all, those are all existing deals and the new deals we’ve done, obviously some were done at LIBOR plus 300, 200 or 100 or something like that, just the accounting for it.

Guy Moszkowski - Banc of America

But the economics are ultimately different in terms of your willing to accept more credit loss on those securitizations, is that correct.

James Dimon

No you’re confusing apples and oranges, the securitizations are purely an accounting thing where it costs us a couple of million dollars this quarter because we did the enhancement. Whether we finance the balance sheet or not is purely what’s the cheapest way to finance the balance sheet. Its unlikely in 01/01/10 going forward we’d be doing credit card securitizations at all. It’s a timing issue and that’s all it is. It doesn’t change that we actually underwrite credit cards.

Guy Moszkowski - Banc of America

The implication wasn’t that but I understand what you’re saying.

Operator

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

Betsy Graseck - Morgan Stanley

Just three things, one on the card, are you obviously in 01/01/10 going to be bringing over onto GAAP assets, its already in [wrap] but the GAAP assets of the card securitizations, is your comment suggesting that you’re going to be funding it with deposits, you’re not going to be doing incrementally more securitizations going forward and can you give us some color on whether or not you’re going to bring it over at fair value or at face value plus reserve.

James Dimon

First of all we just fund the balance, not that you fund with deposits, we simply make a decision how to fund it and its more likely then not the firm will just fund it because it will be cheaper then doing securitizations and as you know we have a lot of liquidity and funding capability and I think the requirement is it comes over at fair value but basically there’ll be an addition to reserves below the line, [inaudible] capital which is why when it goes on the balance sheet it doesn’t change risk weighted assets but it reduces your tangible common equity.

Michael Cavanagh

That’s all factored into the 40 basis point expected January 1 impact on the Chase related assets, there’ll be a gap of leverage ratio impact but not a ratio we worry about.

Betsy Graseck - Morgan Stanley

You talked about the mod programs and the moratoriums not having an impact on the results in the quarter does, is that just on the P&L or would MPAs have looked different without the mod program, the moratoriums.

Michael Cavanagh

No, on mods, on moratoriums the point is that loans that would otherwise have gone to foreclosure left delinquencies and been in REO have been sort of stuck in the delinquency bucket so delinquency stats, levels later buckets like 90 day plus are just going to be elevated for a period of time until those suspended foreclosures get worked through.

So that’s just a timing issue. You got a little bit of a double up inside the later buckets there. But no economic impact because we write assets down in those later buckets to what we think we’ll realize when we sell them. So that’s been, stayed true throughout. And then—

James Dimon

You will see foreclosures go up when this is over. The P&L has already reflected it.

Michael Cavanagh

And then on the modification side, its no impact on anything yet because when, if you’re 60 days delinquent and then you start a modification, a modified loan and make your first payment, if its less than your contractual payment you will still roll to the 90 day bucket in the delinquency stats. So there is no, and that’s what that example on that page is intended to display. If you successfully complete three payments under your new modification your loan would then be successful as a trial mod and then become an official re-written loan and then it would come out of delinquencies.

Betsy Graseck - Morgan Stanley

So you’re saying MPs really wouldn’t have changed that much relative to—

James Dimon

As I said it didn’t affect P&L, MPAs are higher. In the future it will bring down MPAs and we’ll disclose that to you at the time.

Betsy Graseck - Morgan Stanley

And on home equity, I get this question all the time about how you’re assessing and not just you but everybody who has home equity, how you’re assessing reserves against that if the first lien is getting modified. If you’ve got customers where the first lien is getting modified and you’ve got a second on that first lien, does it impact your analysis on how much you have to reserve for your second lien.

James Dimon

Yes, and its all given the [loss in default] but some of them are 100% losses and we recognize as charge-offs and some we have a valid second lien which we expect to be paid so its really different in different circumstances.

Betsy Graseck - Morgan Stanley

The borrower has to be delinquent though before you do any kind of reserving against the second.

James Dimon

Yes, except remember the reserving, we’re looking forward in forecasting.

Betsy Graseck - Morgan Stanley

And then just on capital your comment, your Tier 1 ratio 7.7 I know you said in the last call that you had that targeting somewhere around 7, I realize that we’re not out of the woods, I realize that regulators haven’t had official comments on whether or not they’re going to change capital requirements but can you just give us a sense as to how you’re thinking about the capital, where you’re letting it, where you’d be willing to let it drift to, what is going to influence your thinking on dividends.

James Dimon

Yes, so the 7, I wouldn’t call it a target, I think what we’re really saying is that we expect it to be around there. I think after that to get out of TARP and stuff we were asked to raise another $5 million of common equity and this shows you why we didn’t really think we needed to. So we’re growing what I would call excess capital and we don’t really think that there’s a reason to have much more than 7% or something like that.

But we’re going to wait and see what the rules are because obviously those are going to change. Before we do anything with the dividend we’d really like to see the change in delinquencies, charge-offs, and the economy so we have a little more certainty going forward about the environment.

We still have a huge stock purchase program and we’re going to be optimistic and we think we can buy a lot of stock back and we have the wherewithal to do a good job for shareholders and still maintain a [inaudible] balance sheet we’ll consider that at any point in time.

Betsy Graseck - Morgan Stanley

Are you saying you would be willing to do stock buyback ahead of dividend increase.

James Dimon

I would, yes.

Betsy Graseck - Morgan Stanley

Why.

James Dimon

To make more money for shareholders.

Betsy Graseck - Morgan Stanley

Could it impact your EPS outlook.

James Dimon

No, depends what the stock price is, so when our preferreds were down at $0.50 to the dollar wanted to buy those back too but because of TARP we weren’t able to do it. So I’m not going to tell you what price we’re going to do it, I’m just simply saying that a rational person would say at one point you might actually do something like that depending where the stock goes and what your options are.

Betsy Graseck - Morgan Stanley

Sure and the dividend is more reflective of stability in the model.

[inaudible]

Operator

Your next question comes from the line of Mike Mayo - Calyon Securities (USA), Inc.

Mike Mayo - Calyon Securities (USA), Inc.

I guess I have a question, I’ll call it the three C’s, and that would be your exposure to the corporate space, if I’m reading this right MPA and wholesale loans jumped $2 billion in the last three months, then your exposure to CIT and your exposure to California, so just generally credit quality on the wholesale side.

James Dimon

CIT it will be basically immaterial, corporate MPAs are going to go up. Remember you reserve for those as the credits get downgraded so its really reflected in the 8% loan loss reserves in large corporate and California, are you talking about corporate or consumer.

Mike Mayo - Calyon Securities (USA), Inc.

Just general, I mean how do you think about California, your exposure there, whether you would be more exposed or less exposed. I guess the IOUs weren’t that much for you but to the extent that California gets much weaker than expected how do you think about that in terms of your outlook with regard to your consumer loans in the state and any other exposure you might have.

James Dimon

We are in business in California forever. So we’re not going to be guessing about the next six months so we’re building branches, we’re still underwriting mortgages, and small business loans, and all the things that we need to do. Our standards, like loan to value in certain markets a little bit lower than 80% just to protect ourselves from numbers going down.

California has always been very resilient, in fact we see little signs, a lot of the MSAs mark us there. They actually have upped prices and home price in the last couple of months. That’s a positive. They’ve been going down for the better part of two or three years. So you could argue that California is starting to see a little bit of a return but in terms of building the business we’re going to build the business and not guess and pull in and out because we think it may get worse or better in the short run.

Mike Mayo - Calyon Securities (USA), Inc.

And then with regard to, I’m repeating a question from before, but if delinquencies might be stabilizing but your losses go higher so you’re saying the severity of losses getting greater.

Michael Cavanagh

In part, yes.

Mike Mayo - Calyon Securities (USA), Inc.

And just generally speaking I can’t tell if you’re guiding for much less reserve building or not from your comments so far, in other words if you see 12 months from now things should be getting better then you’ll bring it down, are you there yet.

James Dimon

I think the second you see things really stabilize we won’t need any additional reserves. That could be as early as next quarter, that could be some time next year.

Michael Cavanagh

We just don’t know.

James Dimon

But I think its reasonable to assume that there’ll be some additional reserve builds the next two quarters but its possible that we actually start to see an improvement that that will be wrong, $30 billion is a lot of reserves, we’re 8% investment banking, we’re almost 3% in commercial banking and we’re huge numbers across everything else.

The second you see things start getting better those will be excess reserves.

Operator

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

Meredith Whitney - Meredith Whitney Advisors

Most of my questions relate to mortgage, with respect to comments you’ve made on the different origination channels, it looks like you’re correspondent channel actually picked up and I’m wondering if this is just repackaging Jennie Mae loans, or what the duration of the strength in that channel is going to be and then I’ve got other questions with respect to either, there’s a lot of discussion in terms of I know its early stage, but how successful, how difficult it is to modify loans. There’s an article obviously in the paper today about Saxon, you’ve modified more than you competition, can you give early color on terms of the difficulty and the early experience with that. And then I have another question on hedging strategy and commercial after that.

James Dimon

CNT, went down to the extent we got rid of broker related CNT, but it went to the extent that the traditional correspondents, banks and stuff like that picked up share. We don’t have any other details to show you now but we could probably get that.

Michael Cavanagh

That’s the correspondent line.

James Dimon

And modifications are hard to do. We’ve hired hundreds of thousands of people. We’ve opened up a lot of offices. We’ve written new systems. It’s a complex process. Unfortunately we have a backlog. We’re trying to whittle that down. And think of when you look at mods, separate mods before which were more traditional, people deferring payments, putting them in the back end from the new mods where you actually have reduction in payments or reduction in principal.

Its very early to tell. We’re hopeful it will be good but its very early to tell.

Meredith Whitney - Meredith Whitney Advisors

With respect to your hedging strategy on your MSR, you’re outlook in terms, is that more rates influenced for this quarter or duration. I want to separate the two because if you’re modification efforts are successful the duration might expand and separate from just a rates hedge. Does your hedging strategy stay constant or are you more reflective of the hedging strategy.

James Dimon

Use as a baseline okay, the MSR is short duration. Its short volatility and its short to mortgage basis. We’re constantly adjusting future assumptions but we think about the whole portfolio. By product, 5’s, 55’s, 6’s, Fannie Mae’s, FHA’s, mods, etc., we’re always doing that. And the baseline is to be hedged there but obviously make decisions about when to unhedge some of those exposures.

And I mentioned the three major ones. And yes, things like mods obviously will change duration. We try to incorporate that in what we do. We’re not taking big, we’re not punting on the MSR and taking big bets on it.

Meredith Whitney - Meredith Whitney Advisors

I’m not suggesting you are but anecdotally what I’m hearing is the mods could have a tremendous impact on the valuation of the MSR and was trying to get your feel for that.

James Dimon

And believe me we will adjust for that and so I think even if you—

Michael Cavanagh

Our forward assumptions do the best they can in terms of how the asset is going to behave to predict that so that we can hedge it the best we can.

James Dimon

Even if you hedged 100% of those things you’re still going to have a swing in, by hundreds of millions of dollars every quarter because obviously what actually happens and what your model predicts will always be different.

Meredith Whitney - Meredith Whitney Advisors

On the commercial side, how much loan modification is going in that channel because your assets are going down, your revenues are going up, what type of modifications are going in that channel, what type of market share are you gaining in that channel and then what’s the cross current in terms of the fee share with the investment bank as well.

James Dimon

All the fees in the corporate mods, its really in the investment bank you’re referring about modifications where you have changes in terms and conditions and fees and extensions and its negotiated one by one. It’s a good thing, we get paid to do it. All the fees in the investment bank but it also helps the companies, you get paid more in the short run and you have to do it deal by deal. And that includes stuff that’s nonperforming, includes stuff which is in default, includes stuff which is not even near default.

And very often the credit gets better because they do things to make the credit better so that they, you get the lenders to modify the loan.

Meredith Whitney - Meredith Whitney Advisors

I also did mean in the commercial bank.

Michael Cavanagh

And then in the commercial bank there’s higher levels, particularly in the mid corporate space of activity tapping into capital markets so the commercial banks piece I think of investment banking fees or fees they were associated with were $300 million or so running north of the billion dollar run rate we talked about when we did the JPMorgan Bank one deal for the year to date. That’s not modification. That’s just sort of share of debt and syndicated loan underwriting fees largely speaking.

Meredith Whitney - Meredith Whitney Advisors

On the basic main street level, how much of modifications are impacting commercial lending.

James Dimon

Very little.

Operator

Your next question comes from the line of Matthew Burnell – Wells Fargo

Matthew Burnell – Wells Fargo

Just a couple of follow-up questions on questions that have already been asked, but in terms of your comments relative to exposure to CIT were your comments reflective of your exposure to small business in the retail sector and if not, what would be the impact on your reserving and credit—

James Dimon

We have exposure to CIT secured unsecured but I’m telling you the initial, the primary and direct effect on the P&L would be not material to us. You’re talking about the secondary effect, like do those companies that they deal with have some issues, I’m sure there would be something there but I wouldn’t think that would be a major thing and remember even companies in bankruptcy continue to service accounts and things like that.

Obviously if we have clients who are involved in that or participate, when we’ve looked at that we think we’re fine but we’ll be engaged trying to minimize the impact of that. Net, net it wouldn’t be material.

Matthew Burnell – Wells Fargo

And let me follow-up on Mike’s question in terms of corporate credit quality, the charge-offs in that portfolio were up fairly materially this quarter versus the prior quarter, can you give us a little more color as to where those charge-offs are coming, is that commercial real estate, are there other [industries] in that portfolio.

Michael Cavanagh

Industry, media and one in particular, a little telecom so its not commercial real estate.

James Dimon

Its going to always be idiosyncratic where you have some big company goes bankrupt and you have $200 million charge-off. You may have already reserved for it some of it by the way. So that’s why we say its always going to be idiosyncratic, the reserves are high, nonperforming is going to go up, charge-offs is going to be very lumpy.

Operator

Your next question comes from the line of Moshe Orenbuch - Credit Suisse

Moshe Orenbuch - Credit Suisse

I was wondering if you could talk a little bit about the revenue outlook in the credit card, you talked about obviously having pressure from lower sales volumes on outstandings, what about the pricing side of things. You’re not alone in this but the loss right now exceeds at least your net interest margin. How should we think about your ability to regain some in pricing particularly given what might be coming down the pike in 2010 from the legislation.

Michael Cavanagh

As we’ve said before in the near-term meaning this year and next, its going to be hard to see how we turn a profit in the card business and for the very dynamics you just said. We’ll do the best we can but its beyond that in anticipating how to reshape the business as we deal with the credit environment we’re currently in and then deal with the legislative changes and business practice changes.

We will get to a business that over the horizon, that I was just referring to, earns a good return and it will be whatever size business on the lending side can generate a good return on capital.

James Dimon

But it won’t be next year. The way to look at it is a big part of that business is fine. It earns a decent return. We don’t have to make a lot of changes and then there’s a chunk of it, 30 or 40% we’re going to have to make some real changes. So a reasonable expectation is that revenues are stressed a little bit next year, charge-offs are high, and the business looses money.

And the legislation itself all things being equal, its very hard with all things being equal because part of it is how all the competitors respond to it and will put, its already in my number about loosing money but that will cost $500, $600, $700 million next year.

Moshe Orenbuch - Credit Suisse

Just a follow-up on a different topic, you talked a little bit about the MSR valuation and hedging, as you kind of look at the rate environment as we enter the third quarter is there anything about it that would cause the kind of swing you had in the valuation adjustment. I guess its hard for us to know from the outside how to think about that.

James Dimon

I’ll be really clear, if you hedge 100% of your models and you do your models well, you’re going to have a swing of a couple hundred million dollars a quarter no matter what but it will net out over time.

Michael Cavanagh

And we call that the MSR risk management revenue. You can see that in our press release.

James Dimon

Its just how actual pay downs and products act versus what your model said.

Michael Cavanagh

It was $81 million positive this quarter but as James said, if you look back over time on average that’s in the range of plus or minus several hundred million dollars.

James Dimon

And in addition we sometimes make decisions that make that number bigger or smaller. There are times we are not going to hedge [inaudible] or volatility. We could be right or wrong. There may even be times we don’t hedge all the duration as a business matter. So assume if you’re 100% hedged you have a couple million dollar swing and it could be a lot more than that depending if we change how we position it.

Michael Cavanagh

And we talk about it when we do. So that’s what happened in the last two quarters where we had a billion dollar positive numbers, it was on the back of deliberate decisions. That worked out.

Operator

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

Jeff Harte - Sandler O'Neill

Within the investment bank, I guess I’m specifically wondering about prime brokerage. In the industry we’ve seen assets contract and there’s been a lot of disruptions but it seems like things might be getting a little better, can you talk a bit about whether competition is increasing at all there or whether you’re seeing a stabilization in redemptions and kind of your outlook there.

James Dimon

We’ve seen a small increase in prime broker in the last quarter or so. But our ongoing assumption is that you’re going to have a lot of competition and investment banking is a very competitive business and there’s no reason to think that we’re going to be a beneficiary from people having problems in the future.

So all the big competitors are still there and they’re still very good.

Jeff Harte - Sandler O'Neill

And this is a tough question to answer I know, but along these lines seeing the level of equity origination revenues in the quarter and kind of looking forward, we’ve have a lot of [FIG] refi’s. From an investment banking capital raising standpoint what can realistically be done as an encore. Is there enough demand on the investor side and supply from the corporate side to keep supporting investment banking levels near-term.

James Dimon

If you’re talking about next quarter its awful hard to answer that question. But I think if you look and obviously we’re still in a pretty big recession but the quarter before there was huge fixed income, this quarter’s equity, I think there will be a lot of people who are raising debt and equity or preferred to recapitalize and refinance the balance sheets. And obviously it will be lumpy and whether the market is willing to accommodate big supplies of those things.

And its also been a global phenomenon. So when you look at it globally, its possible you’ll continue to have pretty active investment banking fee markets as people try to change and fix their balance sheets and get ready for new environments. But your guess is as good as ours.

Jeff Harte - Sandler O'Neill

And in the corporate segment the, let’s call it trading gains on the portfolio, is there any way we should think of that going forward or is that just going to be a wildcard like fixed income trading revenues tend to be in the investment bank.

Michael Cavanagh

Think of that as pretty much excess revenues generally positive over time, a little bit volatility but at this level it was much higher than normal.

James Dimon

Most of that portfolio is held for [A of S], so it doesn’t have a trading gain or loss. And obviously because of the markets we took advantage of buying certain things in there that we obviously were right to buy but they had to by their nature be put in a trading portfolio. So it will be a little volatile but don’t expect big gains that like, put it that way.

And you saw last year when Fannie Mae went bankrupt and we had to write-down the preferred, that was a loss. So this is the flip side. We did the bank preferreds and stuff like that that had to go in trading portfolios, so this is just the flip side.

Jeff Harte - Sandler O'Neill

And I know this isn’t necessarily as big an issue for you specifically relative to the industry but everyone is still concerned about commercial real estate and how its performing, you haven’t really mentioned it as being a problem in the quarter or the quarter highlighted it, can you give any color as to how you’re seeing general trends in the commercial real estate market.

James Dimon

I will give you a general comment, commercial real estate in the United States of America is going to get worse consistently over the next several quarters. That should not be a surprise to anybody. Of course real estate is idiosyncratic because did you have good developers, did you have good [underlines], did you have good down payments, did you have good equity, did you build a good building, are you in a good place.

All those various things. We’ve got two major real estate exposures. We have what we call CTL which is multi families, smaller loans, its performing fine and we actually—

Michael Cavanagh

That we got from WaMu, the $30-ish billion portfolio from WaMu.

James Dimon

It will get worse but we don’t expect it to be significant, materially significant to our numbers and we also have a more traditional real estate portfolio but I would say both the bank one, JPMorgan and Chase we’ve been so conservative of the last eight or nine years that its been doing nothing but in general shrinking other than the acquisition of WaMu and yes, $12 billion and losses are, charge-offs were—

Julia Bates

For the real estate banking, [construction] of 186 basis points.

James Dimon

And the commercial term lending was 36 and both will get worse but they’re not that big a number for us that’s its going to be completely significant. It is a big deal for regional banks.

Operator

Your next question comes from the line of Chris Kotowski – Oppenheimer

Chris Kotowski – Oppenheimer

Two credit card related questions, one is you’ve addressed to some extent in terms of saying you expect pressure on the margins, but I guess I’m wondering if you look out two or three years in the credit card business, how seismic a shift in the business model are we looking at in cards going from a borrowing vehicle to a payments and transaction vehicle and is it your expectation that two or three years from now the pre-provision profits will be more or less similar as a percent of outstandings to what they are now or are we looking at something really different.

James Dimon

Half the business won’t change at all. And I think it’s a mistake to look at it as spend or borrow because a lot of people do a little bit of both. So certain, so airline cards and stuff like that, I don’t think they’re going to change that much. Its more spend, it’s a little borrow, and there are parts of the business which will change forever.

You’re not going to have fixed rate cards, you’re going to have much lower people offering to do balance transfers. You can’t offer low rates to certain customers because you can’t, they’re almost be sitting out there forever under the new laws. So my guess is the end of the day the business will be smaller, I don’t know 10 or 15% but it will return to normal profitability because otherwise you wouldn’t be in the business at all.

And obviously some of the borrow business would be gone forever. I think people would be required to do less sub prime which we don’t do, but I think in the business there’ll be less of that. But I think it may take a couple of years to get back to that place but it will be a decent business again. And we have particularly competitive advantage because we think there’s an enormous advantage to having branches, customers cross selling, we know the credit acts better, credit card credit acts better when you have a deposit account.

So hopefully you’ll see us come out with some great new products and—

Michael Cavanagh

--and partners, business and rewards associated with it will be a big deal as well and we like our position there.

Chris Kotowski – Oppenheimer

And then if you look through your database, you must track it by county and all that and if you look at some of the markets where you’ve had chronically high unemployment, distressed regions in the Midwest or what have you, and where you’ve had say double-digit unemployment for a year or two years, three years, does at some point do the losses start coming down just because you’re not extending credit to those areas.

James Dimon

We’ve disclosed this before that credit card losses have a direct and highly correlated to both unemployment and to home prices and obviously home prices and unemployment have a pretty direct correlation too. So where you’ve had chronically high unemployment you’ve also had chronically high losses, I do believe that one point when unemployment stabilizes losses stabilize and even start to trend down.

Michael Cavanagh

We don’t have enough places where we see that stabilization to give the read but we believe that to be true.

James Dimon

And with more careful underwriting you’ll see the benefit of that. You already see for example in auto loans which have a much shorter duration so you can actually more quickly adjust underwriting, that there has been an improvement in credit all things being equal.

Operator

Your next question comes from the line of Jason Goldberg - Barclays Capital

Jason Goldberg - Barclays Capital

With respect to equity trading I guess your results relative to I guess the one reported to date, a bit softer, you brought VaR down they brought VaR up, can you just give some more color around that.

James Dimon

The first thing I’ll tell you is I don’t really pay much attention to VaR because it think its an artificial, it’s a good single point measure but that doesn’t tell you the risk you took all quarter of things you did.

Yes we had good cash, good derivatives, good primary issuance, great primary issuance, and hedging and stuff like that, we’re [in the wrong side] of the market.

Jason Goldberg - Barclays Capital

And with respect to we saw private equity write-downs versus write-ups, and some others given the strength of the market, any more color there.

Michael Cavanagh

No, just do it, its all idiosyncratic so its position by position valuations. Hard to make a general comment compared to anybody else on that score.

Jason Goldberg - Barclays Capital

My concerns of home equity delinquency stabilizing, you’re very hesitant to give an outlook there. I guess as you look at kind of other metrics beyond just 30 day delinquencies any way you’re leaning in terms of is this seasonal or is this actually real improvement, are you seeing any kind of different trends by geography.

Michael Cavanagh

No, like we said only hesitant in that I don’t have the ability to see into the future. So we are seeing and its been pretty steady now for several months the early bucket delinquency rates stabilizing. So and you see we didn’t up our near-term loss guidance in that portfolio so for what that’s worth, recent trends have been decent in home equity.

Operator

Your next question comes from the line of David Trone - Fox-Pitt Kelton

David Trone - Fox-Pitt Kelton

I wanted to go back to Jeff Harte’s question on the underwriting outlook, could you just tell us what the pipeline looks like in investment banking.

James Dimon

Its okay but pipelines, we don’t usually refer to pipelines because they are fickle too. You could have a huge pipeline in equity but there’s nothing you can do about it and it disappears if the markets aren’t there for it. But its okay.

David Trone - Fox-Pitt Kelton

So about flattish then.

James Dimon

Yes, but if you asked the same question before last quarter I would have said okay and we had a great underwriting quarter.

Michael Cavanagh

You don’t necessarily see all the activity sitting in the pipeline at the get go.

David Trone - Fox-Pitt Kelton

The secondary offers come within the quarter. On the fixed income trading side, I just wanted to get something clear. You mentioned in the slides strong performance across all products. Could you just look sequentially from the first quarter, was there anything particularly strong or particularly weak.

Michael Cavanagh

No, I mean, strength generally is what we mean. A little bit of differentiation but nothing to really draw attention to.

David Trone - Fox-Pitt Kelton

And thoughts on the shared national credit exam.

Michael Cavanagh

I think you’ve got what we see as the results of that reflected in our numbers this quarter.

Operator

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

Nancy Bush – NAB Research

Couple of questions here on sort of core deposit pricing, have you hit the floor in consumer deposit pricing and do you expect any material impacts to NIM one way or the other to come from core deposit pricing over the next couple of quarters.

Michael Cavanagh

The only thing I’d mention, no generally but the only thing I mentioned is that looking at the Washington Mutual deposits, there’s some very high rate time deposit money that will likely roll off where its not related to an existing retail branch customer. We’re not going to be chasing, holding on to those kind of hot money deposits and paying a price to do it so that will obviously effect the levels of NIM in the retail business.

Nancy Bush – NAB Research

Has the WaMu run off been sort of generally where you expected it to be.

Michael Cavanagh

I think it was pretty good as we talked about going back to the deal closed late September right so when we talked about it during our October earnings call it was the early read that we had immediately stabilized the behavior there and then with the stuff that’s gone on in that business so for the core activity real retail clients, its behaving nicely.

As I said, there is a chunk of the deposit base there that is sort of non-affiliated, non-client, just attracted by the rates so that’s going to behave a little differently but we’re fine with that.

Nancy Bush – NAB Research

We’ve had a couple of news stories in the past couple of days about the continued difficulty in getting jumbo mortgage money and how that’s impacting some of the high cost real estate markets, can you just speak to sort of your jumbo origination trends and how you’re underwriting at this point.

James Dimon

I think that’s a very good question and there are some people out there with lower jumbo rates then we have and we are doing them. We’ve been very conservative. We’ll probably be a little more aggressive going forward.

Michael Cavanagh

And we focused on our own clients to begin with.

James Dimon

But jumbo spreads to conformity have come in. For awhile they were very high and I’m going to say they’re 75 to 125 basis points today.

Nancy Bush – NAB Research

And we had repurchase of warrants yesterday, not particularly cheap, any thoughts about when that issue will get resolved.

James Dimon

Did we do the analysis.

Michael Cavanagh

We’re working on it. I dealt with that one, we basically are just following the government’s process so we made an offer. Government didn’t take us up on that offer so in the natural process we’ve allowed them rather than go through a negotiated or rather a pretty convoluted appraisal process, have allowed them just to take it to a public auction given what their announced intentions are.

So we don’t know anything yet on the timing for that or how exactly they’ll carry that forward. But we’re totally fine. Understand their approach and what they’re trying to get done.

Operator

Your next question comes from the line of Edward Najarian - ISI Group

Edward Najarian - ISI Group

One thing quick, I know you’re very reluctant to comment on an outlook for trading revenue but can you just give us a sense on two things, on customer trading especially on the fixed income side are spreads still in the month of July remaining abnormally wide from a customer trading standpoint and do you get the sense that you’re picking up, broad based, that you’re picking up market share in your various fixed income trading businesses.

James Dimon

I would answer the second question first which is yes, I think we’ve picked up share over time. Its actually been reflected in some analysis we do when we look at client share and fixed income because throughout this whole crisis we’ve been open. We’ve been making markets, we’ve been trading and obviously some people weren’t and spreads have been coming down.

Obviously they were very high, ridiculously high, no one had the right to expect to stay that high and our ongoing assumption would be that there should probably be decent client volume but spreads are going to come down. And we’ve seen it happening in various products already.

Edward Najarian - ISI Group

Spreads are going to come down in the third quarter, or reasonably quickly.

Michael Cavanagh

I think they came down over the course of the second quarter and its best we would assume competition comes back and knocks them a little bit tighter.

Operator

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

Ron Mandel – GIC

I was wondering if you all could comment on compensation expense on a linked quarter basis as revenue one quarter was up and comp was down about 10% and if you could include the comp trends in the investment bank where the ratio was also down, how you’re thinking about that now.

James Dimon

We do it fairly consistently to how I’ve always done it. And it’s a risk adjusted measure so that number can bounce around any particular quarter depending how the revenue is earned and where they were earned and things like that. So we’re like anybody else, we’re going to be competitive in investment banking comp.

We have a very good business. We’re very proud of the results there and that number will jump around. We do it every quarter. Its not like we do a high number three quarters and do a low number the fourth quarter. So its probably more level then other people might actually do it.

Michael Cavanagh

We don’t know the second half of the year obviously and that’s when we really figure it out for good.

Ron Mandel – GIC

What was different in the mix of revenues this quarter that would have led to lower comp on the same overall corporate revenue.

Michael Cavanagh

A lot of ins and outs, I would just say its when we look at it on a six month, year to date basis, we’re comfortable with where we sit.

Ron Mandel – GIC

So are you suggesting that we should really look at the six month—

Michael Cavanagh

Yes I think six months level, as James said, underlying approach is very much risk based so comp to revenue is not a great proxy, but it’s the best you all can do so I’d take the first six months as a way to approach it for second half.

Ron Mandel – GIC

And in non-comp were there any particular things we should think about there, any particular cost cutting measures that might effect the second half or expense trends that might increase—

Michael Cavanagh

Are we talking about the firm or the investment bank.

Ron Mandel – GIC

The firm.

Michael Cavanagh

Just the things we pointed out, FDIC expense and so forth.

Operator

Your next question comes from the line of Richard Staite - Atlantic Equities

Richard Staite - Atlantic Equities

I just wanted to ask about overall revenues and strategy, obviously hit revenue record this quarter but clearly you’re working as a background where although your customers corporate then individuals now deleveraging and loans are shrinking so really what are the opportunities for growth over the next couple of years. Will total revenues potentially fall over this period and are there any businesses in particular that you’d like to see your market share improve.

James Dimon

We want our market share to improve in every business. I don’t think it’s a bad thing that corporate loans are going down because a lot of those loans are going down because people are accessing capital markets and that’s a good thing and we do business with that too.

In terms of building the business we don’t, just as a business matter and a more philosophical statement, we’re going to have great bankers calling on great clients, doing real business the best way we can do it. We open branches, we do our marketing and the revenues are going to bounce around.

You could forecast GEP and unemployment and global, just like we can so that’s your job to do that. We’re going to build the business relentlessly day in and day out with great products and great services and great people and profits and revenues will be what they are.

Michael Cavanagh

Thank you everybody and we look forward to talking to you next quarter.

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Source: JPMorgan Chase & Co. Q2 2009 (Qtr End 06/30/09) Earnings Call Transcript
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