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JP Morgan Chase & Co. (NYSE:JPM)

Q3 2007 Earnings Call

October 17, 20079:00 am ET

Executives

James Dimon - Chairman of the Board, President, ChiefExecutive Officer

Michael Cavanagh - Chief Financial Officer

Analysts

John McDonald - Banc of AmericaSecurities

Michael Mayo - Deutsche Bank

David Hilder - Bear Stearns

Glenn Schorr – UBS

Guy Moszkowski - Merrill Lynch

Ron Mandel - GIC

Nancy Bush - NAB Research

Jeff Hart - Sandler O’Neill

Operator

Good morning, ladies and gentlemen and welcome to the JP Morgan Chase third quarter2007 earnings call. This call is beingrecorded.

Today’s presentation may contain forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of1995. These statements are subject tosignificant risks and uncertainties. Please refer to JP Morgan Chase’s filings with the Securities andExchange Commission for a description of the factors that could cause thefirm’s results to differ materially from those described in the forward-lookingstatements.

(Operator Instructions) At this time I would like to turn the call over to JP Morgan Chase’sChairman and Chief Executive Officer Jamie Dimon; and Chief Financial OfficerMichael Cavanagh. Mr. Cavanagh, please go ahead, sir.

Michael Cavanagh

Thank you very much. Good morning, everybody. Thank you for joining the call. I’m going to run through the presentationthat you should have and then hand it over to Jamie at the end for some summarycomments; then and as usual, we’ll do Q& A. Hopefully you all have the presentation in front of you.

Let’s go to the first page, third quarter 2007 highlightsand I’ll take you through at a high level what’s going on in the numbers forthe quarter. In total, earnings of $3.4 billion on $17 billion of managedrevenue. EPS of $0.97 for the quarter, that’sup 5% from a year ago. Just stop there and comment for a minute. Just to make the point that for a thirdquarter we had record revenue earnings and EPS. And then for the nine months year-to-date, the same; revenues earningsand EPS are also records. So despite achallenging environment, we feel quite good about the performance in thequarter, when it stacks up against prior periods.

Return on capital was 19% for the quarter, and 32% on ayear-to-date basis, and again, total firm, 20% for the quarter and 25% on ayear-to-date basis.

I am not going to go through business by business here inthe highlights, but the firm-wide results did benefit, of course, from thediversified mix of businesses that we had. Obviously challenging conditions brought profits down in the investmentbank, in addition to reserves which I’ll talk about. Retail profits down yearover year, despite strength in revenues.

But our four other businesses all had profit growth up atleast double-digits. In the case of twoof the businesses, record earnings levels for a quarter, as well as some strongresults in private equity.

Where that’s really coming from is just the broad themelooking back over the past several years; really, the improvement in theoperating performance across all of the businesses. It’s everything that we’ve been focused on interms of getting our operating margins business by business improved. Also while at the same time making sure we’reinvesting in what will drive the growth across all the businesses, helpingdrive the top line growth, which was nice across the businesses as well.

Last point that I would say we’re quite proud of is thestrength of capital reserves and liquidity in place. So tier one capital ratio, 8.4%, flat to lastquarter. Total capital ratio of 12.5%actually up 50 basis points from last quarter. I’m going to go into that in alittle more detail but obviously a key point to make for the quarter.

Now if we just move on, I’m not going to spend time, I’vealready given you all the numbers on slide 2. So if we move right to slide 3, the investment bank. So here you see that we had profits of netincome of $296 million in the quarter on revenues of $2.9 billion. If we just walk down the P&L on the left,you see that investment banking fee revenue line, $1.3 billion, down year overyear 6% on a lower debt underwriting side, offset by record advisory fees of $595million in the quarter.

Moving on to really the area that I’ll give focus here andI’ll go through more detail on some of these items in the next two slides thatfollow, but if you just start with fixed income markets revenues of $687million in the quarter down 72% year over year. Three pieces to just flagthere.

One, we had markdowns of $1.3 billion net of fees onleverage lending funded and unfunded commitments. We also had markdowns of $339million net of hedges on our CDO structured credit warehouse positions and someunsold syndicate positions there. Offsetting that in part was a gain of $304million related to fixed income products that were linked to the structurednotes that benefited from the widening of JP Morgan’s credit spread in thequarter.

When you adjust for those items, you have a quarter forfixed income markets that’s about $2 billion worth of revenue. Obviously those are real results, just makingthe point that net of all that we had some ups and some downs. So weaker performanceyear-over-year in credit trading and commodities but just remember, a year agoquarter was quite strong given the results embedded in the year-ago quarter, tothe positive then. Partially offset by record performance in our rates andcurrencies businesses. So a mixed bag,obviously, some ups and some downs away from the banner items I’ll drill intoin another page.

Moving on to equity markets, revenues of $537 million down18% year over year. Similarly, weakertrading results given some challenging conditions, and that was offset in partby strong client-related revenues in those results. $150 million, again,related to widening of JP Morgan credit spread benefit to our structured notesin that business.

Moving on to credit costs. After revenues here, credit costs in total were $227 million, charge-offs of $67 million. The remainder was additions to our loan lossallowance of about $160 million resulting in strengthening of allowance forloan loss reserves, coverage ratio there you see at the bottom 180 basis pointsup from the prior year in the prior quarter so strengthening the reserves inthe quarter. Expenses down, primarily related to lower compensation related toperformance. So that brings you to the $296million of profits for 6% ROE in a challenging quarter for the investment bank.

So moving on now to two slides that will just give you alittle bit more detail on some of the banner items that I’ve already talkedabout the numbers related to them. So next slide, leveraged lending. Again, $1.3 billion of mark downs in thefixed income markets line, net of fees, on a gross of fee basis it’s $1.9billion. Translates into roughly 4.9%markdown on the related loans. Thoseloans were $16 billion worth of loans that closed during the quarter. $14.7 billion funded and on the balance sheetas of the end of the third quarter. As we sit here today, or close of quarterlast quarter, $23.8 billion of future pipeline of deals expected to closewhenever that is, all the way out into ‘08. So it’s really all future dealsthat we expect to close. So your grand total of those items is $40.6 billion ofleveraged loans funded and unfunded commitments that are classified as held forsale.

Just for completeness of information in the normal course,when we’re syndicating loans, we hold a piece in our books on a held tomaturity basis, and that amounts to $2.8 billion on the same deals that got usto the $40.6 billion. Took an associated increase in loan loss allowance of$144 million which was a 5.2% translation. So there was no real different impact on the P&L related to theclassification of held for sale versus held for maturity and nothing out of theordinary about the way we approached that, that’s normal course for us.

Future expected pipeline does exclude a handful of dealswhich we do not believe will close. Werethey to close, we would not expect any material writedown in the future on thecircumstances we would expect that to transpire on.

So, again, at the top, while I say it’s a 4.9% markdown onaverage, that is very much an on-average type of number. Just know we do the marks deal by deal,tranche by tranche, with a wide range of actual markdown amounts. So the number that you average out to isnothing more than an average.

Moving on to the next slide, other investment banking risktopics. Because there’s been a lot ofdisclosure on this topic in the industry, I just want to drill into CDO and subprime trading activities. So really on the structuring and distribution side ofthe business here, of course you build up assets in your warehouses intendingto accumulate and package and sell them, and then of course sell off the piecesthat result from restructuring, leaves you when the markets dislocate withamounts that are sitting in your warehouses that need to be marked which, we domark-to-market on as a normal course, as well as whatever your unsold positionsare.

It’s related to that for CDOs. Warehouse positions and the unsold CDOpositions where we took a markdown net of hedges of $339 million. That relates to a total warehouse size plusunsold positions of about $6.8 billion; let’s call it 6.5 billion of warehousepositions and a few hundred million of unsold positions. The underlying in the warehouses is mostlyloans, stuff that is quite normal course for us to mark that.

So in sub-prime, the same type of disclosure there. We have warehouse positions of $2.6billion. Again, sub-prime whole loans,mostly Chase originated are what’s in those warehouses and then residualpositions of just shy of $500 million. The net P&L impact against that sideof the structuring and distribution business in sub-prime is slightly positivefor the quarter. Just full disclosurethere.

So away from all that we do, of course, in the normalcourse, trade in these asset classes and positions long and short and changeday to day. Trading in these assetclasses actually was a nice positive in the quarter on the P&L side. Justto give some sense of size, we run today long positions on the CDO books ofabout $1.5 billion and sub-prime positions of about $2 billion. So just to give a sense for the manageabilityof the numbers in our minds. Obviously therisk positions and the next point just says that we actively manage and hedgeany such positions and hold all of it at fair value.

So getting to that fair value point, just to close, a lot ofconversation about fair value accounting. I’ll just make the point that we talk a lot about and will spend somemore time later on talking about the strength of our balance sheet. An important part of that is making sure wefeel very good about the valuation that we have on every asset that sits on thebalance sheet. I will make the statement that that’s how wefeel about the balance sheet as we sit here and all the valuations in all ofthese categories.

But just to answer the question that we’re likely to getabout level 3. The amount of level 3assets,those dependent upon some unobservable parameter in the evaluation that we do,the amount on a percentage basis last quarter was 3% of our assets in level 3. This will move slightly to an estimate of 4%on a firm-wide basis. Primary driversjust being growth in some of the assets that were always in the level 3 category,predominantly the increase in leveraged loans we talked about already. And then,a relatively modest amount of some other asset classes shown in the finalbullet on the page due to lower liquidity and price transparency like sub-primeloans, moved into level 3 inthe quarter. But all in all 3% to 4% iswhat we expect of our balance sheet to be in level three when we disclose inour Q in a couple of weeks.

So that’s it for the investment bank. Moving on to retail financial services, thenext slide, the drivers of the P&L. Tostart with the regional banking side of things, you see $205 billion worth ofaverage deposits up 10% from a year ago. Continued just strong performance in the productivity of our branches soyou know we’ve been spending a lot to investment in them, salespeople, morebranches, more ATMs and so forth to get more productivity out of the system. Yousee it here, I won’t read all the numbers, but strong growth in checkingaccounts, credit card sales, mortgage originations and investment sales out ofthe branches; exactly what we want to see. It’s part of building a great business and part of what drives the 18%top line growth in the business.

Moving along to home equity originations down 16% from ayear ago. On the mortgage loan sideactually originations of $39 billion, up 35% from a year ago. This just getsback to the point I made earlier about the strength of our balance sheet. It really allows us to grow and take marketshare in this business. We did add tothe balance sheet about $4 billion of prime loans and about $3 billion worth ofsub-prime loans, originated at very strong yields. We’re happy to have it on the balance sheetand we’re happy to use the strength of our balance sheet to take market shareand build the business. Third-party mortgage loans serviced up 17% from a yearago as well.

Moving on to the P&L next slide for retail financialservices, you see bottom line profits of $639 million, down 14% from a yearago. But working our way up to the topof the P&L you see the circled number for revenue of $4.2 billion, again up18% from a year ago.

Driven in two buckets, top line there, net interest incomeof $2.7 billion, up 9% or $224 million from a year ago. So that’s higher deposit and loan balance inthe business.

Moving into non-interest revenue, which is up $422 millionin total from a year ago, you see lending and deposit-related fees of $492million, up 21% from the year-ago period, really teeing off the growth in thebranch productivity stats I showed you on the prior page, particularly thegrowth in checking accounts which were up 14%.

Moving down to the mortgage fee and related income line,$229 million of revenues. Just to make anote that that does include $186 million markdown on the mortgage we held inthe warehouse in the course of the third quarter. The same effects on themarkets that affected our investment banking results had an effect of a writedownin the mortgage warehouse and then offset in part by the absence of a writedownof the MSR of $235 million in the year-ago period.

So moving on to credit costs. I’ll just point out the number $680 millionup substantially from a year ago. Thatincludes $306 million of addition to the loan loss allowance related to homeequity on top of the $329 million we added in the prior quarter there. Expense growth of 15% on the investment inthe branch system that I talked about earlier as well. So that again gets youdown to $639 million of profits in the business.

If we move on and just drill into home equity, the homeequity book on the next slide, you see on the upper left, the trend in 30-daydelinquencies ticking higher, translates over on the upper right to the P&Ldynamics. So you see the increase in netcharge-off dollars up to $150 million in the quarter, from $98 million lastquarter and $29 million a year ago. A chargeoff rate of 65 basis points on the $93 billion portfolio that we hold on thebalance sheet.

The real drivers of that kind of increase from last quarter,where we did add reserves and as I said, we contemplated quarterly lossesincreasing in the future to 150 to 160 in the quarter, we now see in the worsening trends anddelinquency loss that transpired in the third quarter that our quarterly losseslooking forward could go as high as $250 million to $270 million, or a charge-offrate of 105 to 110. We’ve taken ourreserves higher by the $306 million contemplating that level of higher chargeoffs in the future.

Really driven by what I think you’ve been hearing so far,which is particularly in regions of the country where home price appreciationis under the most pressure and particularly in loans that are highest loan tovalue, that is where we’re seeing the increase in severity of loss.

Of course, we’ve taken actions; again, I think it’s thesixth time in the course of the recent quarters of tightening up ofunderwriting standards across the consumer lending books and so you see somedescription of that here. Of course,taking pricing actions, with so many players exiting the markets to make surethat we get a good return on new originations that you saw on the prior coupleof pages; and at the same time, increasing our resources in our collection sideof the shop.

Moving on to sub-prime on the next slide. Really the story isn’t very different fromwhen we talked about this in the first quarter of the year. The delinquency trend trends higher, but notreally much out of the expectations that we had earlier set. Charge-off dollars on a higher portfolio of$40 million for a charge-off rate of 162. No changes in reserves here other than what relates to the highervolumes we had. I’ve already commentedon us taking about $3 billion worth of sub-prime production and adding it tothe balance sheet in the quarter, given the attractive yield in pricing. Afterhaving taken a severe cut to our underwriting interest, we’ve dropped about,with the underwriting tightening, about 40% of the volume that we’ve previouslyhad originated is knocked out. Despitethat, we are still having about stable sub-prime originations in dollar terms.

So moving on to credit card on the next slide, you seeprofits of $786 million, up 11% from a year ago, ROE of 22%. Just working through what’s going on here, wehad average outstandings of $149 billion, up 5% from a year ago. Decent growth there, but really focused nowon the next number circled which is the 89.8 of charge volume. While that’s up 3% year over year in total,within that is a 10% growth in sales volume, actual spend on our cards for gas,meals what not separate and apart from sales volume or charge volume that’srelated to balance transfer activities.

Because as we talked about last quarter, we tightened up ourmarketing to eliminate gamers and surfers and that had an effect on the overallgrowth rate and also had an effect on the year-over-year basis, had we not madethose adjustments our average outstanding growth would have been more like an8% growth rate.

Moving on then to what that translates into for revenue, itis a $221 million increase or 6%year-over-year again driven off the growth in outstandings, interchange onhigher spends and some fees. Butremember, we also talked about last quarter the changes in some of our billingpractices, which actually gave up nearly $100 million worth of what otherwisewould have been revenue growth versus the prior period.

One factor that we’ve been focused on is the managed margin,the net interest spread. You see the 829number widened out from 804 last quarter and 807 a year ago, really driven by a reduction in the mix of theoverall portfolio, lower amount in the intro and promo balances that are at alower spread.

Credit costs, $93 million, driven by a continued strongcharge-off rate of 364 and 30-day delinquency while up a little bit at 325;still both of those running at levels lower than the pre bankruptcy law changesback in late 2005. Expenses up a little bit on continued investment inmarketing in the business.

Moving on to the commercial bank profits here, again pleasedwith the results. $258 million worth of net income in the commercial bank, anotherbusiness that had double-digit growth in profits, up 12% from a year ago. Driven by growth in the balance sheet, soaverage loans up 15%. Liability balancesup 22% from a year ago, both to record levels.

Revenue translates into 8% year over year growth of $1 billionreally spread across client divisions as well as products, treasury servicesbeing the lead along with lending and investment banking revenues. Credit costs here continue to run at strong levels. You see the net charge-off rate in thebusiness of 13 basis points versus 16 ayear ago. So credit still performing well, though with the growth we had in thebalance sheet we’ve added reserves in the business to the tune of about $90million here. You see the very strongallowance to loans, a coverage ratio of 267 basis points at the bottom of thepage, and good expense discipline here to finish out the commercial bank withthe overhead ratio of 47% improved from 54% a year ago. It translates to the 15% ROE we had in thebusiness for the quarter.

Treasury and security services, really business recordsacross the board in the business for the quarter, profits of $360 million, a record,up 41% from a year ago. Liability balances and assets under custody growing 23%and 21% respectively, again to record levels. Record revenue of $1.7 billion, up 17% from a year ago. Expense control,again good pre-tax margin widened out to 33% from a year ago to get to the 360of profits in the business. So verypleased with the results there.

Moving on to the last of the businesses, asset management onthe next slide, you see record net income again in this business of $521million, up 51% from a year ago, really driven by the circled number towardsthe bottom, assets under management of $1.2 trillion, up 24% from a yearago. Of course, driven by continuedstrong investment performance, allowing for continued strength and positiveflows. Flows in asset under management, positive inflows of 1$12 million overthe past year, $33 billion in the past quarter which drives the $2.2 billion ofrevenue up 35% from a year ago.

Again, coming across the board, very strong growth inprivate bank revenues and complemented by, actually we don’t talk about it alot, the strong deposit and loan growth coming out of private clients andprivate banks. Pre-tax margin of 38%improved as well year over year for the $521 million of profits on the bottomline.

Next slide, just quickly on corporate. Profits in private equity after tax of $409million. Actually down from last quarterand up from the prior year. Privateequity gains pre-tax of $766 million, so another strong quarter there. Then inthe treasury and other corporate, the remainder of corporate, we had positive$142 million. Both these numbers we saidare going to be lumpy and this one we usually expect a loss in the range of $50million to $100 million.

Here this quarter we’ve benefited from a couple ofitems. One was gain on sale of some ofour MasterCard shares, which amounted to $71 million after tax and then also wehad trading gains in our top of the house investment portfolio activities,really mostly related to expression of concern around the credit marketconditions. We were short some hedges andthat generated some positive results on credit hedging in corporate thatrepresented $194 million of profits in corporate.

Moving on to capital management balance sheet, I flaggedsome of these numbers up front for you so you can read them yourselves in termsof strong trends we have. Capital ratioseither stable or improving, tier 1 at 8.4 and total capital at 12.5. We did repurchaseabout $2 billion of stock in the quarter.

Aside from capital, I feel great about the liquidity andfunding position of the company. We’ve prefundedmuch of the 2007 need in the first half of the year and so really looking aheadfrom here with some activity that we had during the third quarter, we’ve reallymet the bulk of our funding needs for the next three to six months as we sithere today.

It puts us in a great position between capital and liquidityto meet our clients’ needs and also to build our businesses. So we have the example in the mortgagebusiness of having the wherewithal to be strategic about where we can use ourcapital strength to build businesses and be opportunistic.

The last point, I touched on as we went our way through this,the reserve coverage ratios really remains strong across the businesses. You see top to bottom strength in reservecoverage ratios loan loss reserves to loans in each of our businesses andoverall 162 on the wholesale side and 184 on the consumer side, both up from ayear ago. Total reserves actually up $1.4 billion from a year ago, so while wewere having strong earnings results over the year-to-date and keeping a strongbalance sheet, it did not come at the expense of weakening our credit reserveposition.

So with that, I will just hand it over to Jamie for awrap-up and a little bit on outlook

James Dimon

I’ll just make a few comments and we’ll open it up to allyour questions. One, we feel pretty goodabout the performance of the company in spite of the environment. One of the things that’s notable is theimprovement of margins over time. Mikementioned the balance sheet. We’vealways believed in a [inaudible] balance sheet but it also includes liquidity,prefunding issues, maintain strong reserves. We also completed, by the way, allthe last major part of our merger consolidations, including probably thelargest deposit consolidation of all time and the largest credit cardconsolidation of all time. We’re now forthe first time since I’ve been involved with Bank One or JP Morgan Chase, we’repretty much on one platform, which feels great. We still have a lot of work to do, but one platform for deposits andcash management and both the loan systems.

Investment bank, I think we feel in a challengingenvironment we could have done a little bit better. We look at the bank, we want to earn 21% onaverage to the cycle. To us, that means30% in good times hopefully; in not a great year, 10%, and hopefully in aterrible quarter, zero. We wouldn’t putthis quarter as one of the worst of all times, et cetera, so we thought wecould have done a little bit better than 6%.

Mike mentioned, but we did avoid some of the potholes ofsub-prime and for the most part, CDO. Obviously the leveraged loans hit us like everybody else. We’ve made some adjustments to hopefullyprotect us from that going forward.

I hope you all know our determination to build the best investmentbank in the world, and we’re going to continue to build in emerging markets, inAsia, global securitized properties, and obviously there’s a lot of focus. You see these stories come across abouttrimming here and trimming there, but that to me is business as usual. There are certain areas where you’re just notgoing to see the volumes going forward and it is prudent to kind of cut back inthose areas going over time.

We’re cautious of the next quarter or two. We’re not predicting what’s going to happenbecause we don’t know. Trading in thelast two weeks has been okay. Butclearly there are still a lot of issues out there that may take a little bit oftime to resolve. There’s still a lot ofrisk on the balance sheet. You see a lotof these leveraged loans being sold. Butbetween leveraged loans and sub-prime and hedges, et cetera, obviously there’ssome substantial market risk out there.

RFS, great revenue growth, a lot of good underlyinggrowth. I hope you see it in sales andmortgages, 23%, cars 59%. Checkingaccounts 15%. Obviously we had to add toreserves in home equity. Mike mentionedthat what we can see clear to is that losses in the next quarter will go toabout $250 million a quarter. That doesnot mean they can’t go a little higher after that.

We’re cautious on the housing outlook, we consistentlythought it was probably worse than most other people, but we are taking thistime to build our mortgage business. Oneof the slides showed, and I think Mike mentioned, that our mortgage share inboth home equity and prime mortgage and sub prime is going to go up prettysubstantially. We love thebusiness. We think it’s a criticalproduct. We’ve been adding where we cancertain salespeople; more of it is going to be retail, less of it will bebroker. But maybe that won’t have adramatic influence in the next quarter or two, but we would like to really growin that business. We think now is thetime to do it.

Treasury security services, the commercial bank card andprivate equity all did rather well. Again, I’d like you to look at the underlying numbers of sales andunits. In treasury, security services,loans up 23%, custody 21%. Asset management,up 24%, loans I think it was 10%, deposits almost 20%. In the commercial bank, liabilities,deposits, which are a critical product, up 22%. Investment banking sales, i.e., ECM, DCM derivatives et cetera up about15%. Card spend up 10%, and privateequity, just thrilled with the results. We don’t count on them quarter by quarter. But they’ve just done one outstanding job. Wehope our shareholders feel that they’re earning a lot of value, because wecertainly do.

I also want to point out that credit card losses, this ismore for your models going forward, we do expect them to increase to a muchmore normalized level between 4% and 4.5% next year. That is not a forecast of the future. That’s just a normalization of all the trends,bankruptcy laws that have taken place in the past. Obviously if there’s real weakness in the economythat number could get worst and if there’s real strength that number could geta little bit better.

So we are pretty happy with our results. We don’t know what the future portends but wethink we’re in pretty good shape to deal with it.

So I’ll stop there and we’ll open the floor to questions.

Question-and-Answer Session

Operator

Your first question comes from John McDonald - Banc ofAmerica Securities.

John McDonald - Bancof America Securities

Hi, two quick questions on credit. In the home equity book, the losses thatyou’re seeing there, is it confined to certain higher risk pieces of the homeequity portfolio? You mentioned high LPV. Is it a broad based deterioration in yourhome equity portfolio? Could you commenton that?

James Dimon

No, it is largely due to the same risk factors sub prime,higher LTV, stated income and broker business in markets where home prices aregoing down. So obviously, it’s in someother areas too, but that is the bulk of the losses

John McDonald - Bancof America Securities

What percent of your portfolio has that combination ofcharacteristics, particularly the underwriting criteria, not the homemortgages. The high LTV stated income?

James Dimon

John, I don’t know that number off the top of my head but wecan get that for you if you call back later.

John McDonald - Bancof America Securities

Second follow-up is just what drove you to put a timeframeon the normalization of card losses? Is that unemployment based? Previously yousaid over time. Why did you put sometimeframe on it now?

Michael Cavanagh

I think it’s pretty consistent with what we said before, sothe timeframe is in ‘08. We’re saying amore normalized level would be somewhere around that level and it will getthere sometime in ‘08.

Operator

We’ll go next to Guy Moszkowski - Merrill Lynch.

Guy Moszkowski -Merrill Lynch

I was wondering if first of all you could just give us alittle bit more color on where you were hit in the equity results? Were you hit in some way by what happened inquantitative and stat ARB type operations in the quarter? Because generally we saw that equity resultstended to improve over the course of the quarter.

Michael Cavanagh

You know, I don’t think it was any particular place. The volumes were up but it wasn’t dramaticallyin any kind of quantity or anything like that. We feel pretty good with our equity results this quarter.

Operator

We’ll go next to Michael Mayo - Deutsche Bank.

Michael Mayo -Deutsche Bank

Mike, you’ve talked about having a fortress balance sheet,having above-average capital levels. Howis your thinking about capital now? Areyou thinking about buying back more stocks, now that the stock price has gonedown? Are you thinking about using upsome of that excess capital for acquisitions? You already mentioned expanding market share?

Michael Cavanagh

Forget the acquisition thing because it’s a whole differentissue. But I think the issue, obviouslywe’re a bank and we have to be prepared to finance clients. We do have the $40 billion of unfundedpartially funded or unfunded commitments. If the environment gets tough, we have to fund revolvers. We made mortgages, both prime and sub-prime of$6 billion and put them on the balance sheet. We expect to do that again next quarter if not even possibly moreaggressively. So we’ll use it to growour businesses, our primary thing is service to clients. In an environment like this, stock buy back,we’ll price it, take second place unless it goes down so far that we think itis such a fabulous purchase.

Michael Mayo -Deutsche Bank

You don’t think it’s a fabulous purchase here?

Michael Cavanagh

No, I think I just said we might have requirements for itthat will take precedence. But that doesnot mean that we’re not going to do any.

Michael Mayo -Deutsche Bank

The state of the U.S.consumer, we know mortgage has been a little weak. You mentioned home equity. Is that leaking into other areas?

Michael Cavanagh

Surprisingly little; we don’t really see a weak consumer inauto or credit card. One of the insights-- that’s not a great insight, but -- retail sales which you are seeing creditcards up 10%. So we don’t see atremendously weak consumer. But if youlook at credit card delinquencies or spend in troubled areas like Floridaand parts of California, Michigan,et cetera. It is clearly affecting those delinquencies and spend a littlebit. So we just don’t know what it’sgoing to portend for the whole economy.

Operator

Your next question comes from David Hilder - Bear Stearns.

David Hilder - BearStearns

Just a follow-up on your reference to high LTV, home equity,where are the problems? Is it atoriginal LTVs of 90% or some other number?

Michael Cavanagh

It’s the LTVs which are over 90 with a stated income in anyplace we see home prices going down. Alot of it, like I said, the lion’s share is also broker business. So as you go down to 85% or 80% LTV theproblems rapidly diminish or when you go to stated income to qualified income.

Operator

Your next question comes from Glenn Schorr - UBS.

Glenn Schorr - UBS

Mind you this is a good thing, but it’s a good thing anduncomfortable at the same time. I just want to check the accounting on all themortgage-related positions. You had apositive P&L impact in the sub-prime warehouse and residual positions, andI would call your CDO mark reasonably good, all things considered andeverything that’s happened.

So the question is, are all these assets marked to fairvalue? Are any of them held tomaturity? Was this just great risk managementin preparing for a rainy day because you’ve been selling off securities in thatsecurities portfolio over the last two years?

Michael Cavanagh

All of those securities are held for sale and mark-to-marketat fair value so nothing is held to maturity. In the CDO warehouse, for example, we mark the underlying loans tomarket. So we’re not marking baskets,we’re actually going loan by loan and marking to market. In the sub prime, I think we were ahead of the game, some insights intoit. We were fairly hedged. So we’re pretty conservativeaccountants. Our concerns are the sameas your concerns. We want to make surethe books are as clean as they possibly can be.

James Dimon

There’s no point in talking about the strength of yourbalance sheet unless you feel very good about your accounting.

Glenn Schorr - UBS

I hear you, and I think the results are great.

Michael Cavanagh

You have the issues that some shareholders have is that youmention the sub-prime residual is 474. Well, that clearly is a mark to model. But the way that’s mark to model is when we originally did those sub-primeresiduals, for example, we thought -- I don’t have these exact numbers in frontof me -- but the lifetime losses would be something like 3% in the Chase residuals. Well, we now think those losses will be twoto three times worse and using all the new assumptions, running it through,discounting it at a very high discount rate, that’s the number.

If it deteriorates, sure, it could be $100 million worse orbetter but we think at those values they’re probably pretty good value. The discount rates are not 8%. They’re more like 15% or 20%.

Glenn Schorr - UBS

I think that record’s great. Does this include all the securities in the trading account assets, justbecause I noticed that the OCI line even improved this quarter, so I’m justthinking you own a ton of mortgages that’s just great hedging as well?

Michael Cavanagh

The OCI line, none of that is in the investment bank. That is all securities held at basicallycorporate securities. A lot of them areFannie Mae, 5.5% and 6% and some treasuries and some munis and yes, somemortgages are held there. Some of themortgages are held as loans and therefore not marked in OCI. But we’re very cognizant of those mortgages,they’re all high quality mortgages.

Operator

Your next question comes from Guy Moszkowski - MerrillLynch.

Guy Moszkowski -Merrill Lynch

On the $20 billion or so in sub-prime and the riskier higherLTV assets that you identified at a point earlier in the year, and you hadtalked about I think roughly $4 billion or $5 billion of that being held forsale in your release. I think in your prepared remarks, you talked aboutdecisions to retain some of those type of assets rather than keeping them inheld for sale. Can you just help us reconcile the numbers from before versuswhat you’re talking about now and why you made those decisions?

They are all marked. Some were sold. And then wedecided to keep some after the mark. Sothey’re put back in the portfolio but at a reduced value, because we thinkthey’re much better value to hold at this price.

Like we said, we are originating sub-prime mortgagesnow. We think they’re very clean andwe’re putting them on balance sheet. Sothere will be no warehouse for now.

Guy Moszkowski -Merrill Lynch

That $20 billion number that you had identified earlier inthe year, how has that evolved? Whereare we with that now at this point then?

Michael Cavanagh

I’m not sure where the $20 billion number, where you got it,but in our sub-prime mortgage portfolio, you can see it on slide 9, we got $12billion worth of sub-prime loans owned in the retail business at the end of thequarter. Zero in held for salethere. To Jamie’s point, the $3.2 billionthat we had in held for sale in the quarter some of that was sold and some ofthat was brought back into the owned portfolio at a marked level and newproduction in the quarter, which is running at a couple billion dollars in thequarter went straight into portfolio.

James Dimon

I think there was an old slide that we used to use thatshowed you sub prime across multiple portfolios, and we’d be happy to sharethat with you. But if it was in creditcard it’s still there. We don’toriginate a lot of sub-prime. If it’s inauto we have a sub-prime business which is doing fine. And even home equity has some sub-prime, butthat’s in the home equity numbers we just gave you. So I think we just took a different slice at howwe looked at it last time.

Michael Cavanagh

That’s what it was. It was little slices of the other books.

Guy Moszkowski -Merrill Lynch

I remember it was like $3 billion in card and stuff likethat. Sounds like overall that’s prettystatic.

James Dimon

Let me remind you the $3 billion card is at origination,since part of the proposal you are always migrating down. It’s a lot more effective today if yourefresh all the FICO scores, et cetera.

Guy Moszkowski -Merrill Lynch

Let me just ask a question which is not related to thequarter but something that’s been in the news a lot this week, which is the SIVrestructuring plans that the Treasury together with yourselves and two otherlarge banks have talked about. Can yougive us a little bit of your take as to why you would get involved in this, howis this a plus for JPM as well as for the broader market?

Michael Cavanagh

It is clear that there may be asymmetric benefits todifferent parties in this super SIV idea. But it’s also clear that it may ameliorate some of the pressure on someof the markets taking place today. Assuming it gets successful conclusion and there’s a $100 billion superSIV JP Morgan will be completely protected. In fact we’ll be paid to do this, but it could help ameliorate some ofthe market. So if the system is helpedwe think it’s good for people. It’sperfectly reasonable that JP Morgan take part in something like that.

Operator

Your next question comes from Ron Mandel - GIC.

Ron Mandel - GIC

I also have a question regarding super SIV. The part I’m wondering about is that if thesuper SIV buys good assets from the SIVs having trouble rolling over theircommercial paper, then the SIVs out there now have lower quality assets. So I’m not clear how they will be able tofinance themselves with lower asset quality.

James Dimon

I think the issue, all the SIVs are different so this maybenefit some and not others. But I alsothink for some of the SIVs it’s a question of short-term funding needs. They do have some longer-term capital inmedium notes et cetera if they can give themselves a little bit more time, theycan decide how they want to liquidate some of those assets, et cetera. I don’t think it’s going to help every SIVequally

Michael Cavanagh

SIVs it’s by their choice if they avail themselves of thisor the many other solutions that will be worked on bilaterally.

Ron Mandel - GIC

But it just seems to me that the SIVs that have the lowerquality assets and they can’t finance themselves then they have to sell thelower quality assets. So I don’t know,maybe the point is just to establish a market in the lower quality assets butit seems like if they come to market sooner rather than later and everyonesooner rather than later has to mark down their analogous holdings and lowerquality assets… It’s just not clear how this helps the overall.

Michael Cavanagh

There may be some SIVs that it’s not going to help andthat’s life in the fast lanes. But theremay be some SIVs it can help. To me itcan ameliorate the pressure on some of them. Nobody is doing it to bail anybody out. My presumption would be some of these people already marked some of their assets to market.

Ron Mandel - GIC

One other question in this regard. Wonder how much you added on your own balancesheet grew in the quarter reflecting back-up commercial paper lines to SIVs andother --

Michael Cavanagh

I think it peaked out at like $10 billion and today it’s $5billion or $6 billion or $7 billion.

Ron Mandel - GIC

A billion you said?

Michael Cavanagh

It peaked out at around $10 billion. Today it’s $5 billion or $6 billion.

James Dimon

We get that report every day, it is all over the place. It’s hard to tell now what is due to theprice and which is normal needs The sum of it is just regular usage of clientusage of their revolving facilities and some CP back-up facilities.

Michael Cavanagh

The other thing is this SIV is only going to buy higherquality paper. I keep reading in thenewspaper it’s going to be doing other things. It’s really only meant for higher quality paper.

Ron Mandel - GIC

Right. But as I saidI thought that was the problem for the SIVs that just had lower quality paper?

Michael Cavanagh

No one said every SIV is going to be saved.

Ron Mandel - GIC

The $5 billion now, what would that have been six monthsago?

Michael Cavanagh

I thought I said it peaked out at around $10 billion.

Ron Mandel - GIC

So $5 billion is more normal?

Michael Cavanagh

Yes.

Operator

Your next question comes from Nancy Bush - NAB Research.

Nancy Bush - NABResearch

Good morning. If Charlie is in the room, could he talk moreabout core deposit trends in the branches and particularly how trends are goingwith the Bank of New York branches?

Michael Cavanagh

Charlie is not in the room but you can feel free to call himafter this. I think the core deposittrends are -- I think it was ex-Bank of New Yorkit was 4%. We don’t disclose it. We’restarting to see some life in the Bank of New York branches themselves. Remember we just put all the new technologyin and all the new tools and all the new training, but we’re comfortable you’llstart to see those branches grow the way you start to see one branch grow and asChase branches grow, as we put systems into place.

James Dimon

The growth curves are looking similar. I’m sure Charlie will show that soon.

Nancy Bush - NABResearch

When you say signs of life, you’re including branch sales ofmortgages, cards, have those started yet in the branches?

James Dimon

Yes. And those we’restarting to see slowly improve too

Operator

Your next question comes from Michael Mayo - Deutsche Bank.

Michael Mayo -Deutsche Bank

Your write down of leveraged loans was 5% and that seems abit higher than some of your peers. Iestimated 2% to 4% or so, and also higher than the long-term loss rate of about1%. How do you think about the level ofthe write down on your portfolio versus peer or historical?

James Dimon

Remember, this is just an average. So there is some pieces of paper you gotranche by tranche and credit by credit and you look at the bid side of themarket. We try to be as conservative aspossible. There are some pieces inthere, $0.88 on the dollar some pieces $0.99 on the dollar. We don’t obviously know what everybody elsedid. We think what we did is completelyappropriate and proper. Remember thoseare September 30th marks. I think yourother comment about the 1%, looking like lifetime losses -- if you held themfor loans you could have made that kind of argument. These are held for sell.

Michael Mayo -Deutsche Bank

Should we assume your loans are more risky or that you were conservative?

Michael Cavanagh

You’ve got to make that determination yourself.

Michael Mayo -Deutsche Bank

Then separately, your margin went up consolidated and Iguess some of that was due to the credit cards, but per your Q, I thought youget hurt a little bit from lower interest rates. Could you give us some color on your balancesheet management?

James Dimon

One quick thing. Oneof the big ones which you really look at is retail has been basically flat andconsistent over a long period of time. Obviouslycard went up.

Michael Cavanagh

The investment bank went up a little bit in this environmentwhen you back that out, you know, we’re up really a little bit in retail and alittle bit of pressure just due to the short-term dislocations in the marketbetween Fed funds and LIBOR, Mike, which will normalize out a little bit. A bunch of dynamics running through to up 100whereas we were close to flat at the end of last quarter will probably besomething in the negative 150 to 200, to and up from where we’ve already beenearnings to risk.

James Dimon

You should be cautioned because close to 100, I would putalmost in the de minimus category. Itdoesn’t mean if rates go up or down that you’ll see our margin change by thatamount.

Michael Cavanagh

Those are parallel shocks.

James Dimon

We won’t be changing how we invest the money or how wemanage the balance sheet that just shows you where we would be today in astatic change.

Michael Cavanagh

The far more important balance sheet decision isn’t whatyour short-term interest rate exposure is, it is where you invest your moneylong. That’s a tougher decision.

Operator

Your next question comes from Jeff Hart - Sandler O’Neill.

Jeff Hart - SandlerO’Neill

A couple of questions. I guess I’m thinking in the investment bank, more so, what kind ofunderlying client risk appetite you’re seeing? I’m thinking what’s beyond the pipeline. Are you still having a lot of conversations in M&A and kind ofunderwriting and are you seeing decent trading volumes in some of the fixedincome markets accelerating as we’ve move from September to October as we thenmove to tend of the year?

Michael Cavanagh

It’s all over the place. So it’s really hard to answer that question. Asia, very good. Equities globally very good; emerging marketshas come back. Credit areas actuallyopening up slowly but it’s less than it was before. So it’s really all over the place. In terms of strategic conversations,absolutely. There are conversationstaking all over the place. We’re stillin business. We’re open forbusiness. We’ve done some leveragedloans. Bausch & Lomb got pricedyesterday. The markets that were closeddown, that got kind of closed down or frozen, they’ve been slowly gettingbetter consistently over the last eight weeks or so.

Jeff Hart - SandlerO’Neill

On the investment banking side, is it reasonable to assumethat if strategic activity levels really pick up, it could be significantenough to offset a slowdown in the private equity and sponsored business? I’m trying to get a feel for the relativecontribution of each of those investment banking revenues.

James Dimon

That’s a really hard thing to say. That’s two ifs. If it did yes, it probably would make up forsome of it, but we don’t really know.

Jeff Hart - SandlerO’Neill

Finally in mortgage banking, I’m just kind of looking atsome of the MSR valuation adjustments. It looks like there’s a pretty big negative valuation mark coming fromchanges to inputs into the model. I knowyou have been fine tuning that in the past. Is that still an ongoing process? I was surprised to see $810 million mark due to changes in assumptions.

Michael Cavanagh

Jeff, that’s not a change in methodology or anything. It’s just the fact that the mortgage spreadsmoved around. It has a negative impacton the MSR and a positive impact on the hedges we have on the MSR, which islike two lines below. So the net ofthose two numbers is what to look at and it wasn’t a significant number.

James Dimon

The MSR actually did very well this quarter. And if you look at all net-net it’sfine. There was something like 39 inputsinto it. Every now and then there aremodel input changes which were unhedged and you’ll have a swing item. That could easily be zero to $100 million aquarter. That we just have to learn tolive with because there’s almost nothing you can do about it. The likely outcome, by the way, isprepayments have been going down across all mortgage products. Whole prices going down would be a plus tothe MSR over time.

Operator

Mr. Dimon and Mr. Cavanagh, there are no further questionsat this time.

James Dimon

Folks, thank you very much.

Michael Cavanagh

Thank you. See you next quarter.

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