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JP Morgan Chase (NYSE:JPM)

Bear Stearns Acquisition Call

March 16, 2008 8:00 pm ET

Executives

Michael Cavanagh - CFO

Bill Winters – Co-Head, Investment Bank

Steve Black - Co-Head, Investment Bank

Analysts

Anthony Sung – Point Marketing

Mitch Northern – Q Investments

Peter Hammock – Lehman Brothers

Guy Moszkowski – Merill Lynch

Brandon Seed – R2

Brian Fires – Individual Investor

Kevin Ing

Susan Katzke – Credit Suisse

Operator

Good evening ladies and gentlemen. Welcome to the JP Morgan Chase investment call. This call is being recorded. We ask that you refer to pages 7 and 8 of the investor presentation that is available on JP Morgan Chase’s website for forward-looking statements and additional information. (Operator Instructions) At this time, I would like to turn the call over to JP Morgan Chase’s Chief Financial Officer, Mike Cavanagh. Mr. Cavanagh please begin.

Michael Cavanagh

Thank you everybody for joining us late on a Sunday evening. We appreciate you taking the time. It has been a long weekend. We’re just going to run through a few quick slides and give you a quick update and spend more time over coming days.

Let me start with a little presentation that we put out. The first page, just to run through a little bit of the rationale behind the transaction and then the page after that will run you through the key details. Obviously the banner headline is that JP Morgan Chase is buying Bear Stearns.

Just to make some points here, for all those who follow us and ask us often about our logic for doing transactions, I want to hit right off the bat this is a good economic transaction for JP Morgan Chase shareholders. Obviously the price that is being paid here, and I’ll get to it here in a minute, gives us flexibility and margin for error that was appropriate given the speed at which the transaction came together.

In the end it will be a transaction that adds $1 billion or so, plus or minus a little bit, of ongoing earnings to the company. I’ll get to that a little bit later on. Strategically you get to really some nice add on’s to the JP Morgan Chase, particularly the Investment Banking franchise.

I apologize; I am joined here by the Co-Head’s of our Investment Bank, Bill Winters and Steve Black. The three of us will take a few questions at the end.

Speaking about the Investment Bank, we pick up a strong prime brokerage and global clearing business where Bear Stearns is a leader and we look forward to bringing that capability into JP Morgan Chase. Of course a strong equities platform there also enhances our businesses here. An extension of our energy business and then across the other areas of fixed income and investment banking we get to obviously add the strength of Bear Stearns to JP Morgan Chase.

We will go through and spend some more time on this but banner level of course the significant liquidity position that JP Morgan Chase has always had will be maintained and we will be maintaining our target capital ratios with the deal as well.

So last point, we talk about the way we think about transactions is execution and we clearly have the people and stability of our business and leadership that makes us very comfortable with the ability to execute on the transaction.

If you’ll flip to the next slide I’ll just take you through some of the key details of the transaction. It is 100% acquisition of Bear Stearns. It is a stock deal. All common stock. 0.5473 fixed exchange ratio or $2.00 per share of Bear Stearns stock.

We expect as quick close as we can execute…we estimate 90 days plus or minus a little bit. Approvals – we have been working closely with various regulatory authorities so we will be getting help to move the approval process along.

Beginning immediately, obviously, we will have the Investment Banking management team led by Bill and Steve involved with the Bear Stearns leadership team in overseeing the business.

On the credit rating side we are already in discussions with the ratings agencies and we will be hearing from them shortly.

Lastly, the transaction terms. The last point is really that there is no max laws in this MAC clause in this for JP Morgan Chase. This is a deal we all want to see close and will close and we have the customary protections as the buyer against any other interested parties coming in and you’ll see why we’ve put that in as a very, very low probability.

Moving on to the next key set of points is really just going to the issues of capital and liquidity. Just to be clear, in addition to the transaction itself and the way it is structured and the certainty it should provide to everybody that the deal will close in short order. We are also effective immediately providing a JP Morgan guarantee to all of the trading obligations of Bear Stearns so all counter-parties facing off against Bear Stearns should understand they are dealing with JP Morgan Chase on that basis.

Moving on to capital, I will show you some detailed numbers in a second when we talk through financial impact but we do again expect our target capital ratio by the time we close the deal to be right around our target level of 8% to tier one and other ratios will be in line with that. So continued strength of capital netted the deal.

Again, strength of liquidity is unimpaired by the transaction. One point to mention really is we have put in place with the Federal Reserve a special lending facility that is a non-recourse facility of JP Morgan Chase for up to $30 billion or so of illiquid assets largely mortgage related. So that is in doing our due diligence an area that we needed to get comfort upon. Some of the more illiquid assets on the balance sheets so obviously it couldn’t be in stronger hands than could be a range for financing through the Federal Reserve and again with no recourse to JP Morgan Chase.

Moving on to slide four, again when you look at 12-18 months once we get through our work of combining the businesses that you’ve seen us do before, we do believe that again 12-18 months out the earnings power…the incremental earnings power that will come from the businesses coming together is roughly $1 billion after taxes plus or minus a little bit. Again, the leading contributor to that is going to be the prime brokerage and clearing business which is fully additive to what we do here at JP Morgan Chase along with the additive nature of some of the other activities, equities, commodities and so forth that I mentioned earlier.

We will be working over the coming months to sharpen our pencils around transaction-related costs but we are working within our minds something in the $5-$6 billion pre-tax range that will come with the deal. So you see a menu here of things that will come along with that. Obviously we will be looking at various reserves for the combined company at the time of the deal. That includes litigation reserves. We will be looking to de-leverage the balance sheet so expect that we have provided for that in the $5-$6 billion number, and then conforming accounting, consolidation related expenses of facilities, severance and what not are catched all in that number.

So when you think about that on an after-tax basis against the existing book capital of Bear Stearns it gets you to the additive capital nature to JP Morgan Chase of the transaction against what we expect will be a de-levered balance sheet.

I’m just going to move on and make a comment. We obviously spend a lot of time in due diligence thinking through the risk positions of the firm and how they related to those that we had. I just flagged on page five that obviously the big area of focus was the mortgage positions at Bear where they were leaders in that business. Here you can see we flagged rough estimates of some of the exposures we are taking on, gross exposures, and some of these categories that we have flagged for you before on the JP Morgan Chase side. You’ll see it totals up to about $33 billion worth of exposure in those buckets and roughly $20 of the $30 billion non-recourse facility with the FED will be related to these assets bringing the net which will help again de-lever the balance sheet and bring down our risk related asset exposures before the time of the close or immediately. Then that is for a net of about $13. Then we do take on a little bit more of leveraged lending exposures that you see noted at the bottom just shy of $9 billion or so.

Lastly, you can see on the last page here just some points around the strategic fit of the various businesses and you can see for yourself but really it is across all the areas. There is strengths that we are going to look to capitalize on in the Bear Stearns franchise beyond the obvious ones I talked about and you can see some of those advantages here.

With that I think I will wrap up the opening remarks and just take a few minutes worth of questions here.

So the net of it…before operator we go to things…I’ll just go back to the front and taking off of the way we think about deals. We are highly confident in our ability to execute here to fit together with the businesses we have in particular related to the Investment Banking opportunities and makes a lot of strategic sense. Of course the financial logic is compelling. So feel good about the transaction. With that let me just hand it to Steve to make a remark or two.

Steve Black

Good evening. I just want to add one comment. When you look at the slide on strategic fit and go across on the capital markets/investment banking pieces. For those of you who were on our investor day presentation and go back and look at that and the things that we outlined as potential growth areas and things that we still wanted to invest in and add, whether it was to continue and grow our scale in the equity business, the strong desire to find some way to get a prime brokerage ability, continue to build out in our secured product and mortgage business, continue to add in our commodity space particularly around energy, the fact we had been doing a prime brokerage fixed income business but wanted to continue to build out in that scope, and that we still though in spite of having a leading investment banking franchise around our MNA equity capital and debt capital market share we still thought there was great opportunity to expand the wallet with the number of clients that we don’t happen to do business with and I think the combination of the Bear Stearns platform across every one of those areas fits exactly the bill that we outlined on investor day of things we thought and wanted to continue to build on. So it is a terrific bid from a very well established franchise that a lot of which can take leading positions that we have and take them to a whole different level. So I’m very pleased to have an opportunity to do it.

Michael Cavanagh

With that operator we will take a few questions.

Question-and-Answer Session

Operator

Thank you, Mr. Cavanagh. (Operator Instructions) We’ll take our first question. Caller, your line is open.

Anthony Sung – Point Marketing

Hi guys. This is Anthony [Sung] from [Point Marketing.] Quick question. Will Bear still be in business, going through with existing deals? For instance, I ask this because my existing firm was thinking to purchase maybe $1-$2 billion worth of prime and alt-A products and I was just wondering with the transition will Bear still be able to go ahead and execute?

Bill Winters

Bear Stearns is absolutely open for business. That is the purpose of the guarantee that we’ve put in place that should give ever body in the market complete comfort that when dealing with Bear Stearns you are backed by the full facing credit of JP Morgan. So Bear is open for business today with all the credit backing that we can provide and intends to remain completely in the market up to and through the day when we complete the acquisition and obviously then afterwards as a part of JP Morgan.

Anthony Sung – Point Marketing

Okay. And…

Michael Cavanagh

Can we limit it to one question at a shot please?

Anthony Sung – Point Marketing

Sure. Thanks guys.

Operator

Next caller your line is open.

Mitch [Northern – Q Investments]

Just wanted to confirm. It said that JP Morgan is immediately guaranteeing trading obligations. If the shareholders do not approve the transaction what happens to that guarantee? Also the slide had mentioned costs of de-leveraging. If you can expand on what that means?

Michael Cavanagh

The cost of de-leveraging is as I said we intend to reduce the balance sheet as time goes by between now and the closing and then beyond the closing. So obviously we have provided for in the $5-$6 billion estimate for a variety of things which includes the impact of some of the reductions in size of the balance sheet.

Steve Black

Let me be clear on this. Part of the reason we structured the transaction the way we did with the $30 billion in non-recourse financing from the FED was to avoid the need for any kind of a fire sale of assets. JP Morgan is perfectly comfortable with the assets we are acquiring effectively via the guarantee, but Mike has pointed out that over time in a very orderly way we will look to rebalance our balance sheet as we were doing in any case inside JP Morgan and as Bear was doing in any case. But with the benefit of the combination and the liquidity and the financing support from the FED that can be a very orderly process that we don’t expect to have any material impact on the market.

Mitch [Northern – Q Investments]

With regard to the guarantee of trading, if the merger is not completed what happens to the full facing credit of JP Morgan? Is that still behind Bear Stearns?

Steve Black

First of all the guarantee applies to all transactions on the books today and any transactions that are entered into while that guarantee is in place. We have every expectation that Bear Stearns shareholders will approve this deal. I think we are offering the best alternative that they got at this point and I would be surprised if a better alternative came along. If in the future the shareholders do fail to approve the transaction, then our guarantee would no longer apply prospectively. Of course everything that was on the books up to and to that point would be covered by the guarantee.

Bill Winters

That shareholder vote is an ongoing process that takes place. If it does fail over the course of the continuing vote brought back again throughout the period of twelve months.

Next question operator?

Operator

Caller, your line is open.

Peter Hammock – Lehman Brothers

Could you clarify on the guarantee whether senior unsecured shareholders will also receive the guarantee of JP Morgan? Bond holders, I’m sorry.

Steve Black

Holding company? Bond holders of the holding company will not benefit between the time of the announcement now and the time of the close of the transaction but upon the close of the transaction JP Morgan Chase assume the capital structure of Bear Stearns. So that is the way to think about it. We are interested in guaranteeing the business activities of Bear Stearns between now and close as those are activities conducted by JP Morgan Chase.

Peter Hammock – Lehman Brothers

But it is solely the operating activities as opposed to the debt?

Steve Black

That’s correct.

Peter Hammock – Lehman Brothers

Thank you.

Operator

Next caller, your line is open.

Guy Moszkowski – Merill Lynch

I’ve a couple of questions for you. First, is there some reconciliation that you could give us in broad terms from the book value per share, which is of course a reported number around $80 at last reporting, and the $2 other than the transactional costs of $6 billion?

Steve Black

Guy, all I can tell you is we did extensive work over a short period of time to get comfortable with putting together a transaction that makes sense all around but obviously looking as our duties to JP Morgan shareholders and the deal that we laid out didn’t result in the ability to pay more than the modest amount that was paid over to the Bear Stearns shareholders.

Guy Moszkowski – Merill Lynch

And is the most significant element of the difference between book value and what you are paying other than the litigation and the cost of de-leveraging just essentially marks on mortgage assets?

Bill Winters

It is all the items that Mike laid out in the slides. It is also understand a cushion to protect JP Morgan shareholders during particular turbulent times in the market.

Steve Black

The short due diligence period and actually getting the deal executed. It takes some work to do and that is the return to us in exchange for the risk taken.

Guy Moszkowski – Merill Lynch

Fair enough. I’m just thinking about your anticipating putting significant marks on mortgage assets in closing the transaction. How does that read across your own holdings of mortgage assets?

Michael Cavanagh

Guy we are very comfortable with the level at which Bear Stearns has marketed their positions. Broadly consistent with JP Morgan. Obviously during volatile markets there are differences asset to asset. We are comfortable with the marks. We are comfortable with the risk exposure that JP Morgan is left with. We think that it will be known that any merger is fundamentally distracting and the time that we all spend both at JP Morgan and Bear Stearns focusing on merger integration is time that we’re not spending on other things during a time when we want to be very focused. So for all those reasons we are very comfortable both with what we’ve found and what we’ve acquired but we needed a pretty substantial cushion both for the direct transaction related expenses including retention for key people at Bear Stearns that we want to make sure continue to work for us and to compensate us for both the risk and the opportunity cost in this market.

Guy Moszkowski – Merill Lynch

That’s fair enough thank you. Let me just follow up with one last question. On the mortgage businesses as you sort of compare what you already had in place in terms of the capital market side of your mortgage business and what you find at Bear how much overlap is there? How complementary are their platforms with your own?

Steve Black

Guy, we’ve actually had a chance to be in there for exactly a day and a half. So I’d say it is probably too early to tell but clearly they’ve had an outstanding platform for an extended period of time. We have been growing and building ours. We’ll go in and do what we always do and figure out where it is complementary. Where there might be some overlap. What we think the normalized business looks like over the next 12, 18 to 24 months and then make the appropriate alternations that need to be made at that time. But it is way too early for us to tell at this stage.

Needless to say, a very, very good strong business and one that in the long run will be very additive and as you know from the conversations we had at investor day it is a business we are looking to pick up market share in and it is a great environment to be able to do that.

Michael Cavanagh

Guy as you can see on page five to the first part of your question, the commercial mortgage backed security, prime and sub prime disclosures are not dissimilar in size to JP Morgan’s. The hedging approach at Bear Stearns was not dissimilar to JP Morgan. As we stated on investor day we felt that we had not as much of that exposure as we really wanted to carry and hence the decent chunk of the mortgage related risk positions at Bear Stearns are being financed with the FED on non-recourse facility.

Guy Moszkowski – Merill Lynch

Just to cap it off, it certainly doesn’t sound as if when you went in there you found a massive problem with respect to risk management or hedging. It sounds like, given what you are saying it is very similar to your own, it sounds like you’ve found something you are fundamentally comfortable with. Is that fair?

Michael Cavanagh

That’s correct. To say that it was a very well run, tight operation with good risk controls and a risk discipline that was very similar to our own.

Guy Moszkowski – Merill Lynch

Thanks very much. I appreciate it.

Operator

We move on to our next question. Caller, your line is open. Hearing no response we move on to the next caller. Please go ahead caller. Your line is open.

[Brandon Seed – R2]

I just had one question. You talked about the guarantee. Regarding clearance, your prime brokerage business, how long is that guarantee good for if shareholders do fail to approve this transaction?

Steve Black

The guarantee is good for the period of time that the shareholders have to approve the transaction for everything that is on the books now or will be on the books for that timeframe. If the shareholders choose not to approve the transaction, they have to continuously take it back to a vote over the course of a 12-month period.

[Brandon Seed – R2]

So the guarantee is just the 12 months because that is how long…

Steve Black

Let’s be clear. We all firmly believe the shareholders at Bear Stearns will approve the transaction so we believe it is a moot point. But if the shareholders do not approve it then the guarantee would eventually go away when that process has run its course over the course of twelve months.

[Brandon Seed – R2]

So the guarantee is the lesser of approval or twelve months.

Michael Cavanagh

Just to be clear. We have a guarantee on all trades on the books as of today. All trades that get put on the books up to any date where our deal could ever fall away, which we don’t think would happen, and only prospectively from that point forward would the JP Morgan guarantee not exist.

[Brandon Seed – R2]

But as part of the process they have to keep going back to each shareholder for approval over a 12-month period?

Steve Black

No. We would expect that shareholders would approve this transaction on the first pass, but of course that is up to the shareholders to decide.

I think we’re going to just take one or two more.

Brian [Fires – Individual Investor]

I was just wondering how this valuation helps the Bear Stearns shareholders as they go through Chapter 11 and the orderly liquidation of the assets of the company?

Michael Cavanagh

I’m afraid you’d have to ask that question to Bear Stearns.

Brian [Fires – Individual Investor]

I vote not to approve this sale.

Operator

Caller your line is open.

Kevin [Ing]

How comfortable are you given the 1-1/2 days of due diligence in your ability to assess the derivative exposure, the risk exposure and how are you comfortable that this does not stem the systemic risk that could affect the other broker dealers?

Michael Cavanagh

We’ve known Bear Stearns for a long time. Obviously due diligence was short but the way we’ve structured the transaction as we’ve just described we are very comfortable with the transaction in light of the environment we are operating in. So we feel like it is a good transaction again for JP Morgan Chase shareholders.

Steve Black

We had 200 people give or take looking at, going through and working with the folks at Bear Stearns for 3-4 days.

Kevin [Ing]

And how about the systemic risk to the environment?

Steve Black

I think the Fed made a series of announcements along with our announcement at Bear Stearns across a very large liquidity injection quite different from anything they have done before that will go a long way towards stemming some of the systemic risks by allowing primary dealers to use the window, a much broader class of assets, a much more market driven funding level. So I think this, in and of itself, the Bear Stearns transaction you could argue either may or may not have done much on that front but having taken Bear Stearns out of the problem category and at the same time the strong action by the Federal Reserve I think we would certainly anticipate that the market will behave quite differently on Monday than was on Thursday and Friday.

Kevin [Ing]

Given that you believe that Bear marked their portfolio consistent with the way you guys marked your portfolio, do you really believe the book value or do you believe the book value that they stated I guess on the Friday call of being in the mid-80’s? I’m just trying to reconcile that with the $2 per share.

Steve Black

I think that Mike took you through what the contributors were to the final price that made sense for JP Morgan shareholders. It is an art, not a science. It can’t be reconciled back penny for penny. There are a thousand moving pieces, including all the moving pieces over the weekend that are reflected in the final price that JP Morgan is prepared to pay.

One last question, operator.

Operator

Thank you. Caller your line is open.

Susan Katzke – Credit Suisse

I was hoping you could just help us out with understanding what is left in terms of the clearing and prime brokerage balances?

Michael Cavanagh

It is a little premature to really spend a lot of time drilling into the characteristics of the business at this very moment. Obviously it was a very busy, active week of counter parties at Bear Stearns. I think we’ll be able to give you a little bit better picture down the road. We certainly feel good about the ongoing franchise capability given the quality of the business, the people at Bear Stearns along with the strong balance sheet and credit rating that we bring to the business and all the other complementary aspects of our investment bank sales and trading activities. But I think we feel quite fine about despite the recent events that the health of the franchise and the prime brokerage and clearing business is in very good shape.

Susan Katzke – Credit Suisse

Just to clarify, does Bear Stearns own its building?

Steve Black

Bear Stearns does own its building.

Susan Katzke – Credit Suisse

Thank you so much.

Michael Cavanagh

So we’ll look forward to updating you very soon. Thanks for joining us late on a Sunday night and you can bring any other questions you have back to our Investment Relations team. Thanks again.

Operator

That does conclude today’s conference call. You may now disconnect.

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