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JP Morgan Chase & Co. (JPM)

Q3 2007 Earnings Call

October 17, 2007 9:00 am ET

Executives

James Dimon - Chairman of the Board, President, Chief Executive Officer

Michael Cavanagh - Chief Financial Officer

Analysts

John McDonald - Banc of America Securities

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 quarter 2007 earnings call. This call is being recorded.

Today’s presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to significant risks and uncertainties. Please refer to JP Morgan Chase’s filings with the Securities and Exchange Commission for a description of the factors that could cause the firm’s results to differ materially from those described in the forward-looking statements.

(Operator Instructions) At this time I would like to turn the call over to JP Morgan Chase’s Chairman and Chief Executive Officer Jamie Dimon; and Chief Financial Officer Michael 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 presentation that you should have and then hand it over to Jamie at the end for some summary comments; 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 highlights and I’ll take you through at a high level what’s going on in the numbers for the quarter. In total, earnings of $3.4 billion on $17 billion of managed revenue. EPS of $0.97 for the quarter, that’s up 5% from a year ago. Just stop there and comment for a minute. Just to make the point that for a third quarter we had record revenue earnings and EPS. And then for the nine months year-to-date, the same; revenues earnings and EPS are also records. So despite a challenging environment, we feel quite good about the performance in the quarter, when it stacks up against prior periods.

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

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

But our four other businesses all had profit growth up at least double-digits. In the case of two of the businesses, record earnings levels for a quarter, as well as some strong results in private equity.

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

Last point that I would say we’re quite proud of is the strength of capital reserves and liquidity in place. So tier one capital ratio, 8.4%, flat to last quarter. Total capital ratio of 12.5% actually up 50 basis points from last quarter. I’m going to go into that in a little 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’ve already 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 net income 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 over year 6% on a lower debt underwriting side, offset by record advisory fees of $595 million in the quarter.

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

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

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

Moving on to equity markets, revenues of $537 million down 18% year over year. Similarly, weaker trading results given some challenging conditions, and that was offset in part by strong client-related revenues in those results. $150 million, again, related to widening of JP Morgan credit spread benefit to our structured notes in 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 loss allowance of about $160 million resulting in strengthening of allowance for loan loss reserves, coverage ratio there you see at the bottom 180 basis points up from the prior year in the prior quarter so strengthening the reserves in the quarter. Expenses down, primarily related to lower compensation related to performance. So that brings you to the $296 million 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 a little bit more detail on some of the banner items that I’ve already talked about the numbers related to them. So next slide, leveraged lending. Again, $1.3 billion of mark downs in the fixed income markets line, net of fees, on a gross of fee basis it’s $1.9 billion. Translates into roughly 4.9% markdown on the related loans. Those loans were $16 billion worth of loans that closed during the quarter. $14.7 billion funded and on the balance sheet as of the end of the third quarter. As we sit here today, or close of quarter last quarter, $23.8 billion of future pipeline of deals expected to close whenever that is, all the way out into ‘08. So it’s really all future deals that we expect to close. So your grand total of those items is $40.6 billion of leveraged loans funded and unfunded commitments that are classified as held for sale.

Just for completeness of information in the normal course, when we’re syndicating loans, we hold a piece in our books on a held to maturity basis, and that amounts to $2.8 billion on the same deals that got us to 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 the classification of held for sale versus held for maturity and nothing out of the ordinary about the way we approached that, that’s normal course for us.

Future expected pipeline does exclude a handful of deals which we do not believe will close. Were they to close, we would not expect any material writedown in the future on the circumstances we would expect that to transpire on.

So, again, at the top, while I say it’s a 4.9% markdown on average, 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 is nothing more than an average.

Moving on to the next slide, other investment banking risk topics. Because there’s been a lot of disclosure on this topic in the industry, I just want to drill into CDO and sub prime trading activities. So really on the structuring and distribution side of the business here, of course you build up assets in your warehouses intending to accumulate and package and sell them, and then of course sell off the pieces that result from restructuring, leaves you when the markets dislocate with amounts that are sitting in your warehouses that need to be marked which, we do mark-to-market on as a normal course, as well as whatever your unsold positions are.

It’s related to that for CDOs. Warehouse positions and the unsold CDO positions where we took a markdown net of hedges of $339 million. That relates to a total warehouse size plus unsold positions of about $6.8 billion; let’s call it 6.5 billion of warehouse positions and a few hundred million of unsold positions. The underlying in the warehouses is mostly loans, 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 $2.6 billion. Again, sub-prime whole loans, mostly Chase originated are what’s in those warehouses and then residual positions of just shy of $500 million. The net P&L impact against that side of the structuring and distribution business in sub-prime is slightly positive for the quarter. Just full disclosure there.

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

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

But just to answer the question that we’re likely to get about 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 drivers just 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 final bullet on the page due to lower liquidity and price transparency like sub-prime loans, moved into level 3 in the quarter. But all in all 3% to 4% is what we expect of our balance sheet to be in level three when we disclose in our Q in a couple of weeks.

So that’s it for the investment bank. Moving on to retail financial services, the next slide, the drivers of the P&L. To start with the regional banking side of things, you see $205 billion worth of average deposits up 10% from a year ago. Continued just strong performance in the productivity of our branches so you know we’ve been spending a lot to investment in them, salespeople, more branches, more ATMs and so forth to get more productivity out of the system. You see it here, I won’t read all the numbers, but strong growth in checking accounts, credit card sales, mortgage originations and investment sales out of the 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 a year ago. On the mortgage loan side actually originations of $39 billion, up 35% from a year ago. This just gets back to the point I made earlier about the strength of our balance sheet. It really allows us to grow and take market share in this business. We did add to the balance sheet about $4 billion of prime loans and about $3 billion worth of sub-prime loans, originated at very strong yields. We’re happy to have it on the balance sheet and we’re happy to use the strength of our balance sheet to take market share and build the business. Third-party mortgage loans serviced up 17% from a year ago as well.

Moving on to the P&L next slide for retail financial services, you see bottom line profits of $639 million, down 14% from a year ago. But working our way up to the top of the P&L you see the circled number for revenue of $4.2 billion, again up 18% from a year ago.

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

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

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

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

If we move on and just drill into home equity, the home equity book on the next slide, you see on the upper left, the trend in 30-day delinquencies ticking higher, translates over on the upper right to the P&L dynamics. So you see the increase in net charge-off dollars up to $150 million in the quarter, from $98 million last quarter and $29 million a year ago. A charge off rate of 65 basis points on the $93 billion portfolio that we hold on the balance sheet.

The real drivers of that kind of increase from last quarter, where we did add reserves and as I said, we contemplated quarterly losses increasing in the future to 150 to 160 in the quarter, we now see in the worsening trends and delinquency loss that transpired in the third quarter that our quarterly losses looking forward could go as high as $250 million to $270 million, or a charge-off rate of 105 to 110. We’ve taken our reserves higher by the $306 million contemplating that level of higher charge offs 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 appreciation is under the most pressure and particularly in loans that are highest loan to value, that is where we’re seeing the increase in severity of loss.

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

Moving on to sub-prime on the next slide. Really the story isn’t very different from when we talked about this in the first quarter of the year. The delinquency trend trends higher, but not really 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 higher volumes we had. I’ve already commented on us taking about $3 billion worth of sub-prime production and adding it to the balance sheet in the quarter, given the attractive yield in pricing. After having taken a severe cut to our underwriting interest, we’ve dropped about, with the underwriting tightening, about 40% of the volume that we’ve previously had originated is knocked out. Despite that, we are still having about stable sub-prime originations in dollar terms.

So moving on to credit card on the next slide, you see profits of $786 million, up 11% from a year ago, ROE of 22%. Just working through what’s going on here, we had average outstandings of $149 billion, up 5% from a year ago. Decent growth there, but really focused now on 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’s related to balance transfer activities.

Because as we talked about last quarter, we tightened up our marketing to eliminate gamers and surfers and that had an effect on the overall growth rate and also had an effect on the year-over-year basis, had we not made those adjustments our average outstanding growth would have been more like an 8% growth rate.

Moving on then to what that translates into for revenue, it is a $221 million increase or 6% year-over-year again driven off the growth in outstandings, interchange on higher spends and some fees. But remember, we also talked about last quarter the changes in some of our billing practices, which actually gave up nearly $100 million worth of what otherwise would 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 829 number widened out from 804 last quarter and 807 a year ago, really driven by a reduction in the mix of the overall portfolio, lower amount in the intro and promo balances that are at a lower spread.

Credit costs, $93 million, driven by a continued strong charge-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 changes back in late 2005. Expenses up a little bit on continued investment in marketing in the business.

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

Revenue translates into 8% year over year growth of $1 billion really spread across client divisions as well as products, treasury services being 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 the business of 13 basis points versus 16 a year ago. So credit still performing well, though with the growth we had in the balance sheet we’ve added reserves in the business to the tune of about $90 million here. You see the very strong allowance to loans, a coverage ratio of 267 basis points at the bottom of the page, and good expense discipline here to finish out the commercial bank with the overhead ratio of 47% improved from 54% a year ago. It translates to the 15% ROE we had in the business for the quarter.

Treasury and security services, really business records across 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 360 of profits in the business. So very pleased with the results there.

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

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

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

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

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

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

It puts us in a great position between capital and liquidity to meet our clients’ needs and also to build our businesses. So we have the example in the mortgage business of having the wherewithal to be strategic about where we can use our capital 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 reserve coverage ratios loan loss reserves to loans in each of our businesses and overall 162 on the wholesale side and 184 on the consumer side, both up from a year ago. Total reserves actually up $1.4 billion from a year ago, so while we were having strong earnings results over the year-to-date and keeping a strong balance sheet, it did not come at the expense of weakening our credit reserve position.

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

James Dimon

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

Investment bank, I think we feel in a challenging environment we could have done a little bit better. We look at the bank, we want to earn 21% on average to the cycle. To us, that means 30% in good times hopefully; in not a great year, 10%, and hopefully in a terrible quarter, zero. We wouldn’t put this quarter as one of the worst of all times, et cetera, so we thought we could have done a little bit better than 6%.

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

I hope you all know our determination to build the best investment bank in the world, and we’re going to continue to build in emerging markets, in Asia, global securitized properties, and obviously there’s a lot of focus. You see these stories come across about trimming here and trimming there, but that to me is business as usual. There are certain areas where you’re just not going to see the volumes going forward and it is prudent to kind of cut back in those areas going over time.

We’re cautious of the next quarter or two. We’re not predicting what’s going to happen because we don’t know. Trading in the last two weeks has been okay. But clearly there are still a lot of issues out there that may take a little bit of time to resolve. There’s still a lot of risk on the balance sheet. You see a lot of these leveraged loans being sold. But between leveraged loans and sub-prime and hedges, et cetera, obviously there’s some substantial market risk out there.

RFS, great revenue growth, a lot of good underlying growth. I hope you see it in sales and mortgages, 23%, cars 59%. Checking accounts 15%. Obviously we had to add to reserves in home equity. Mike mentioned that what we can see clear to is that losses in the next quarter will go to about $250 million a quarter. That does not mean they can’t go a little higher after that.

We’re cautious on the housing outlook, we consistently thought it was probably worse than most other people, but we are taking this time to build our mortgage business. One of the slides showed, and I think Mike mentioned, that our mortgage share in both home equity and prime mortgage and sub prime is going to go up pretty substantially. We love the business. We think it’s a critical product. We’ve been adding where we can certain salespeople; more of it is going to be retail, less of it will be broker. But maybe that won’t have a dramatic influence in the next quarter or two, but we would like to really grow in that business. We think now is the time to do it.

Treasury security services, the commercial bank card and private equity all did rather well. Again, I’d like you to look at the underlying numbers of sales and units. 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 about 15%. Card spend up 10%, and private equity, just thrilled with the results. We don’t count on them quarter by quarter. But they’ve just done one outstanding job. We hope our shareholders feel that they’re earning a lot of value, because we certainly do.

I also want to point out that credit card losses, this is more for your models going forward, we do expect them to increase to a much more 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 economy that number could get worst and if there’s real strength that number could get a little bit better.

So we are pretty happy with our results. We don’t know what the future portends but we think 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 of America Securities.

John McDonald - Banc of America Securities

Hi, two quick questions on credit. In the home equity book, the losses that you’re seeing there, is it confined to certain higher risk pieces of the home equity portfolio? You mentioned high LPV. Is it a broad based deterioration in your home equity portfolio? Could you comment on 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 are going down. So obviously, it’s in some other areas too, but that is the bulk of the losses

John McDonald - Banc of America Securities

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

James Dimon

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

John McDonald - Banc of America Securities

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

Michael Cavanagh

I think it’s pretty consistent with what we said before, so the timeframe is in ‘08. We’re saying a more normalized level would be somewhere around that level and it will get there 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 a little bit more color on where you were hit in the equity results? Were you hit in some way by what happened in quantitative and stat ARB type operations in the quarter? Because generally we saw that equity results tended 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 dramatically in 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. How is your thinking about capital now? Are you thinking about buying back more stocks, now that the stock price has gone down? Are you thinking about using up some of that excess capital for acquisitions? You already mentioned expanding market share?

Michael Cavanagh

Forget the acquisition thing because it’s a whole different issue. But I think the issue, obviously we’re a bank and we have to be prepared to finance clients. We do have the $40 billion of unfunded partially 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 more aggressively. So we’ll use it to grow our 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 it is 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 it that will take precedence. But that does not 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 in auto or credit card. One of the insights -- that’s not a great insight, but -- retail sales which you are seeing credit cards up 10%. So we don’t see a tremendously weak consumer. But if you look at credit card delinquencies or spend in troubled areas like Florida and parts of California, Michigan, et cetera. It is clearly affecting those delinquencies and spend a little bit. So we just don’t know what it’s going to portend for the whole economy.

Operator

Your next question comes from David Hilder - Bear Stearns.

David Hilder - Bear Stearns

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

Michael Cavanagh

It’s the LTVs which are over 90 with a stated income in any place we see home prices going down. A lot of it, like I said, the lion’s share is also broker business. So as you go down to 85% or 80% LTV the problems 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 and uncomfortable at the same time. I just want to check the accounting on all the mortgage-related positions. You had a positive P&L impact in the sub-prime warehouse and residual positions, and I would call your CDO mark reasonably good, all things considered and everything that’s happened.

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

Michael Cavanagh

All of those securities are held for sale and mark-to-market at fair value so nothing is held to maturity. In the CDO warehouse, for example, we mark the underlying loans to market. 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 into it. We were fairly hedged. So we’re pretty conservative accountants. Our concerns are the same as your concerns. We want to make sure the books are as clean as they possibly can be.

James Dimon

There’s no point in talking about the strength of your balance 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 you mention 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-prime residuals, for example, we thought -- I don’t have these exact numbers in front of me -- but the lifetime losses would be something like 3% in the Chase residuals. Well, we now think those losses will be two to 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 or better 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, just because I noticed that the OCI line even improved this quarter, so I’m just thinking 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 basically corporate securities. A lot of them are Fannie Mae, 5.5% and 6% and some treasuries and some munis and yes, some mortgages are held there. Some of the mortgages 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 - Merrill Lynch.

Guy Moszkowski - Merrill Lynch

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

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

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

Guy Moszkowski - Merrill Lynch

That $20 billion number that you had identified earlier in the year, how has that evolved? Where are 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 $12 billion worth of sub-prime loans owned in the retail business at the end of the quarter. Zero in held for sale there. To Jamie’s point, the $3.2 billion that we had in held for sale in the quarter some of that was sold and some of that was brought back into the owned portfolio at a marked level and new production in the quarter, which is running at a couple billion dollars in the quarter went straight into portfolio.

James Dimon

I think there was an old slide that we used to use that showed you sub prime across multiple portfolios, and we’d be happy to share that with you. But if it was in credit card it’s still there. We don’t originate a lot of sub-prime. If it’s in auto we have a sub-prime business which is doing fine. And even home equity has some sub-prime, but that’s in the home equity numbers we just gave you. So I think we just took a different slice at how we 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 like that. Sounds like overall that’s pretty static.

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 you refresh all the FICO scores, et cetera.

Guy Moszkowski - Merrill Lynch

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

Michael Cavanagh

It is clear that there may be asymmetric benefits to different parties in this super SIV idea. But it’s also clear that it may ameliorate some of the pressure on some of the markets taking place today. Assuming it gets successful conclusion and there’s a $100 billion super SIV JP Morgan will be completely protected. In fact we’ll be paid to do this, but it could help ameliorate some of the market. So if the system is helped we think it’s good for people. It’s perfectly 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 the super SIV buys good assets from the SIVs having trouble rolling over their commercial paper, then the SIVs out there now have lower quality assets. So I’m not clear how they will be able to finance themselves with lower asset quality.

James Dimon

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

Michael Cavanagh

SIVs it’s by their choice if they avail themselves of this or 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 lower quality assets and they can’t finance themselves then they have to sell the lower quality assets. So I don’t know, maybe the point is just to establish a market in the lower quality assets but it seems like if they come to market sooner rather than later and everyone sooner rather than later has to mark down their analogous holdings and lower quality 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 and that’s life in the fast lanes. But there may be some SIVs it can help. To me it can 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 balance sheet grew in the quarter reflecting back-up commercial paper lines to SIVs and other --

Michael Cavanagh

I think it peaked out at like $10 billion and today it’s $5 billion 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 the price and which is normal needs The sum of it is just regular usage of client usage of their revolving facilities and some CP back-up facilities.

Michael Cavanagh

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

Ron Mandel - GIC

Right. But as I said I 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 months ago?

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 - NAB Research

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

Michael Cavanagh

Charlie is not in the room but you can feel free to call him after this. I think the core deposit trends are -- I think it was ex-Bank of New York it was 4%. We don’t disclose it. We’re starting to see some life in the Bank of New York branches themselves. Remember we just put all the new technology in and all the new tools and all the new training, but we’re comfortable you’ll start to see those branches grow the way you start to see one branch grow and as Chase 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 - NAB Research

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

James Dimon

Yes. And those we’re starting 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 a bit higher than some of your peers. I estimated 2% to 4% or so, and also higher than the long-term loss rate of about 1%. How do you think about the level of the 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 go tranche by tranche and credit by credit and you look at the bid side of the market. We try to be as conservative as possible. There are some pieces in there, $0.88 on the dollar some pieces $0.99 on the dollar. We don’t obviously know what everybody else did. We think what we did is completely appropriate and proper. Remember those are September 30th marks. I think your other comment about the 1%, looking like lifetime losses -- if you held them for 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 I guess some of that was due to the credit cards, but per your Q, I thought you get hurt a little bit from lower interest rates. Could you give us some color on your balance sheet management?

James Dimon

One quick thing. One of the big ones which you really look at is retail has been basically flat and consistent over a long period of time. Obviously card went up.

Michael Cavanagh

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

James Dimon

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

Michael Cavanagh

Those are parallel shocks.

James Dimon

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

Michael Cavanagh

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

Operator

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

Jeff Hart - Sandler O’Neill

A couple of questions. I guess I’m thinking in the investment bank, more so, what kind of underlying 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 of underwriting and are you seeing decent trading volumes in some of the fixed income markets accelerating as we’ve move from September to October as we then move 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 markets has come back. Credit areas actually opening 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 conversations taking all over the place. We’re still in business. We’re open for business. We’ve done some leveraged loans. Bausch & Lomb got priced yesterday. The markets that were closed down, that got kind of closed down or frozen, they’ve been slowly getting better consistently over the last eight weeks or so.

Jeff Hart - Sandler O’Neill

On the investment banking side, is it reasonable to assume that if strategic activity levels really pick up, it could be significant enough to offset a slowdown in the private equity and sponsored business? I’m trying to get a feel for the relative contribution 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 for some of it, but we don’t really know.

Jeff Hart - Sandler O’Neill

Finally in mortgage banking, I’m just kind of looking at some of the MSR valuation adjustments. It looks like there’s a pretty big negative valuation mark coming from changes to inputs into the model. I know you 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 spreads moved around. It has a negative impact on the MSR and a positive impact on the hedges we have on the MSR, which is like two lines below. So the net of those 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’s fine. There was something like 39 inputs into it. Every now and then there are model input changes which were unhedged and you’ll have a swing item. That could easily be zero to $100 million a quarter. That we just have to learn to live with because there’s almost nothing you can do about it. The likely outcome, by the way, is prepayments have been going down across all mortgage products. Whole prices going down would be a plus to the MSR over time.

Operator

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

James Dimon

Folks, thank you very much.

Michael Cavanagh

Thank you. See you next quarter.

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