JPMorgan Chase & Co.
J P MORGAN CHASE & CO (Form: 10-K/A, Received: 08/03/2006 16:24:22)
 

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 2
Annual report pursuant to section 13 or 15(d) of
The Securities Exchange Act of 1934
     
For the fiscal year ended
December 31, 2005
  Commission file
number 1-5805
JPMorgan Chase & Co.
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
270 Park Avenue, New York, NY
(Address of principal executive offices)
  13-2624428
(I.R.S. employer
identification no.)
10017
(Zip code)
Registrant’s telephone number, including area code: (212) 270-6000
Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 
Common stock
Depositary shares representing a one-tenth interest in
6
5 / 8 % cumulative preferred stock (stated value—$500)
6 1 / 8 % subordinated notes due 2008
6.75% subordinated notes due 2008
6.50% subordinated notes due 2009
Guarantee of 7.50% Capital Securities, Series I, of J.P. Morgan Chase Capital IX
Guarantee of 7.00% Capital Securities, Series J, of J.P. Morgan Chase Capital X
Guarantee of 5 7 / 8 % Capital Securities, Series K, of J.P. Morgan Chase Capital XI
Guarantee of 6.25% Capital Securities, Series L, of J.P. Morgan Chase Capital XII
Guarantee of 6.20% Capital Securities, Series N, of JPMorgan Chase Capital XIV
Guarantee of 6.35% Capital Securities, Series P, JPMorgan Chase Capital XVI
Guarantee of 7.20% Preferred Securities of BANK ONE Capital VI
 
Indexed Linked Notes on the S&P 500 ® Index due November 26, 2007
JPMorgan Market Participation Notes on the S&P 500 ® Index due March 12, 2008
Capped Quarterly Observation Notes Linked to S&P 500 ® Index due September 22, 2008
Capped Quarterly Observation Notes Linked to S&P 500 ® Index due October 30, 2008
Capped Quarterly Observation Notes Linked to S&P 500 ® Index due January 21, 2009
JPMorgan Market Participation Notes on the S&P 500 ® Index due March 31, 2009
Capped Quarterly Observation Notes Linked to S&P 500 ® Index due July 7, 2009
Capped Quarterly Observation Notes Linked to S&P 500 ® Index due September 21, 2009
Consumer Price Indexed Securities due January 15, 2010
Principal Protected Notes Linked to S&P 500 ® Index due September 30, 2010


The Indexed Linked Notes, JPMorgan Market Participation Notes, Capped Quarterly Observation Notes, Consumer Price
Indexed Securities and Principal Protected Notes are listed on the American Stock Exchange;
all other securities named above are listed on the New York Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act: none
      Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. þ Yes o No
      Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K . þ
      Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
                þ Large accelerated filer   o Accelerated filer   o Non-accelerated filer                
      Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No
      The aggregate market value of JPMorgan Chase & Co. common stock held by non-affiliates of JPMorgan Chase & Co. on June 30, 2005 was approximately $123,459,434,538.
Number of shares of common stock outstanding on January 31, 2006: 3,485,553,836
Documents Incorporated by Reference: Portions of the Registrant’s proxy statement for the annual meeting of stockholders to be held on May 16, 2006, are incorporated by reference in this Form 10-K in response to Items 10, 11, 12, 13 and 14 of Part III.
 
 

 


 

Form 10-K/A Index
         
        Page
Explanatory note
      i
 
       
Part II
       
Item 8
  Financial statements and supplementary data   11
Item 9A
  Controls and procedures   12
 
       
Part IV
       
Item 15
  Exhibits, financial statement schedules   12
EXPLANATORY NOTE
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”) is filing this Amendment No. 2 to its Annual Report on Form 10-K for the year ended December 31, 2005, to reflect the restatement of the Firm’s Consolidated statements of cash flows, as discussed in Note 1 of the Notes to the Consolidated financial statements contained in Part II, Item 8: Financial statements and supplementary data. Except for Items 8 and 9A of Part II, no other information in the Form 10-K is being amended by this Amendment. This Amendment continues to speak as of the date of the original filing of the Form 10-K and the Firm has not updated the disclosure in this Amendment to speak as of any later date.

i


 

PAGES 1-10 NOT USED


 

Part II
Item 8: Financial statements and supplementary data
The Consolidated financial statements, together with the Notes thereto and the report of PricewaterhouseCoopers LLP dated February 24, 2006 and August 3, 2006 thereon, appear on pages 86 through 132.
Supplementary financial data for each full quarter within the two years ended December 31, 2005, are included on page 133 in the table entitled “Supplementary information – selected quarterly financial data (unaudited).” Also included is a “Glossary of terms’’ on page 134.


11


 

Parts II & IV
Item 9A: Controls and procedures
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Firm’s management, including its Chairman, Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chairman, Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective. See Exhibits 31.1, 31.2 and 31.3 for the Certification statements issued by the Chairman, Chief Executive Officer and Chief Financial Officer. In light of the misclassification in the Firm’s Consolidated statements of cash flows discussed below, the above-mentioned officers reevaluated the Firm’s disclosure controls and procedures and determined that their earlier conclusion regarding such controls and procedures remains valid.
The Firm is committed to maintaining high standards of internal control over financial reporting. Nevertheless, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, in a firm as large and complex as JPMorgan Chase, lapses or defi -ciencies in internal controls are likely to occur from time to time, and there can be no assurance that any such deficiencies will not result in significant deficiencies – or even material weaknesses – in internal controls in the future. See page 85 for Management’s report on internal control over financial reporting, and page 86 for the Report of independent registered public accounting firm with respect to management’s assessment of internal control.
As reported in a Current Report on Form 8-K filed by the Firm on August 3, 2006, the Firm is filing this amended Form 10-K for the year ended December 31, 2005 to restate the Consolidated statements of cash flows for the annual periods of 2005, 2004 and 2003 and is filing an amended Form 10-Q for the quarter ended March 31, 2006 to restate the Consolidated statements of cash flows for each of the quarterly periods of 2005 and the first quarter of 2006. The restatements will not affect the Firm’s Consolidated statements of income, Consolidated balance sheets or Consolidated statements of changes in stockholders’ equity for any of the affected periods. Accordingly, the Firm’s historical revenues, net income, earnings per share, total assets and regulatory capital remain unchanged.
The restatements result solely from the misclassification of cash flows related to certain residential mortgages and other loans that had been originated or purchased with the intent to sell. The cash flows from these loans had been classified as investing activities. However, in accordance with Statement of Financial Accounting Standards No. 102, “Statement of Cash Flows — Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale,” cash flows from these loans should have been, and in the future will be, classified as operating activities, rather than investing activities. Accordingly, the restatements will solely affect the classification of these activities and the subtotals of cash flows from operating and investing activities presented in the affected Consolidated statements of cash flows, but they will have no impact on the net increase (decrease) in total Cash and due from banks set forth in the Consolidated statements of cash flows for any of the previously reported periods.
There was no change in the Firm’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fourth quarter of 2005 that has materially affected, or is reasonably likely to materially affect, the Firm’s internal control over financial reporting.
Part IV
Item 15: Exhibits, financial statement schedules
            Exhibits, financial statement schedules
1.   Financial statements
 
    The Consolidated financial statements, the Notes thereto and the report thereon listed in Item 8 are set forth commencing on page 87.
 
2.   Financial statement schedules
 
    Financial statement schedules are omitted since the required information is either not applicable, not deemed material, or is shown in the respective Consolidated financial statements or in the Notes thereto.


12


 

Part IV

     
 
3.   Exhibits
 
3.1   Restated Certificate of Incorporation of JPMorgan Chase & Co. (incorporated by reference to Exhibit 3.1 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
3.2   By-laws of JPMorgan Chase & Co., effective December 31, 2005.
 
4.1   Deposit Agreement, dated as of February 8, 1996, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Morgan Guaranty Trust Company of New York (succeeded through merger by JPMorgan Chase Bank), as Depository (incorporated by reference to Exhibit 4.7 to the Registration Statement on Form 8A (File No. 1-5805) of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) filed December 20, 2000).
 
4.2
  Indenture, dated as of December 1, 1989, between Chemical Banking Corporation (now known as JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association) (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.3(a)
  Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992, between Chemical Banking Corporation (now known as JPMorgan Chase & Co.) and Morgan Guaranty Trust Company of New York (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.3(b)
  Second Supplemental Indenture, dated as of October 8, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992.
 
   
4.3(c)
  Third Supplemental Indenture, dated as of December 29, 2000, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992.
 
   
4.4(a)
  Amended and Restated Indenture, dated as of September 1, 1993, between The Chase Manhattan Corporation (succeeded through merger by JPMorgan Chase & Co.) and Chemical Bank (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.4(b)
  First Supplemental Indenture, dated as of March 29, 1996, among Chemical Banking Corporation (now known as JPMorgan Chase & Co.), The Chase Manhattan Corporation, (succeeded through merger by JPMorgan Chase & Co.), Chemical Bank, as Resigning Trustee, and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Successor Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
4.4(c)
  Second Supplemental Indenture, dated as of October 8, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
4.4(d)
  Third Supplemental Indenture, dated as of December 29, 2000, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Amended and Restated Indenture, dated as of September 1, 1993.
 
   
     
4.5(a)
  Indenture, dated as of August 15, 1982, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Manufacturers Hanover Trust Company (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.5(b)
  First Supplemental Indenture, dated as of May 5, 1986, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Manufacturers Hanover Trust Company (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(c)
  Second Supplemental Indenture, dated as of February 27, 1996, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(d)
  Third Supplemental Indenture, dated as of January 30, 1997, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and First Trust of New York, National Association (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.5(e)
  Fourth Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of August 15, 1982.
 
   
4.6(a)
  Indenture, dated as of March 1, 1993, between J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.) and Citibank, N.A. (succeeded by U.S. Bank Trust National Association), as Trustee.
 
   
4.6(b)
  First Supplemental Indenture, dated as of December 29, 2000, among J.P. Morgan & Co. Incorporated (succeeded through merger by JPMorgan Chase & Co.), The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as Trustee, to the Indenture, dated as of March 1, 1993.
 
   
4.7
  Indenture, dated as of May 25, 2001, between J.P. Morgan Chase & Co. and Bankers Trust Company (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4(a)(1) to the amended Registration Statement on Form S-3 (File No. 333-52826) of J.P. Morgan Chase & Co. filed June 13, 2001).
 
   
4.8(a)
  Junior Subordinated Indenture, dated as of December 1, 1996, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.8(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.8(b)
  Guarantee Agreement, dated as of January 24, 1997, between The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.8(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.8(c)
  Amended and Restated Trust Agreement, dated as of January 24, 1997, among The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.), The Bank of New York, as Property Trustee, The Bank of New York (Delaware), as Delaware Trustee, and the Administrative Trustees named therein (incorporated by reference to Exhibit 4.8(c) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).


13

 


 

Part IV
     
4.9(a)
  Indenture, dated as of March 3, 1997, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference to Exhibit 4.9(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.9(b)
  First Supplemental Indenture, dated as of October 2, 1998, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by Deutsche Bank Trust Company Americas), as Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.9(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.9(c)
  Form of Second Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and Deutsche Bank Trust Company Americas, as Successor Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.22 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
4.10(a)
  Indenture, dated as of March 3, 1997, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank Trust National Association), as Trustee (incorporated by reference to Exhibit 4.10(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.10(b)
  First Supplemental Indenture, dated as of October 2, 1998, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (succeeded by U.S. Bank Trust National Association), as Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.10(b) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.10(c)
  Second Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and U.S. Bank Trust National Association, as Successor Trustee, to the Indenture, dated as of March 3, 1997 (incorporated by reference to Exhibit 4.25 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
4.11(a)
  Form of Indenture, dated as of July 1, 1995, between Banc One Corporation (succeeded through merger by JPMorgan Chase & Co.) and Citibank N.A, as Trustee (incorporated by reference to Exhibit 4.11(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.11(b)
  Form of Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.) and Citibank N.A., as Trustee, to the Indenture, dated as of July 1, 1995 (incorporated by reference to Exhibit 4.31 to the amended Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed July 1, 2004).
 
   
     
4.12(a)
  Form of Indenture, dated as of December 1, 1995, between First Chicago NBC Corporation (succeeded through merger by JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association) (succeeded by U.S. Bank Trust National Association), as Trustee (incorporated by reference to Exhibit 4.12(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
4.12(b)
  Form of Supplemental Indenture, dated as of July 1, 2004, among J.P. Morgan Chase & Co., Bank One Corporation (succeeded through merger by JPMorgan Chase & Co.), JPMorgan Chase Bank, as Resigning Trustee, and U.S. Bank Trust National Association, as Successor Trustee, to the Indenture, dated as of December 1, 1995 (incorporated by reference to Exhibit 4.29 to the Registration Statement on Form S-3 (File No. 333-116822) of JPMorgan Chase & Co. filed June 24, 2004).
 
   
10.1
  Deferred Compensation Plan for Non-Employee Directors of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.) and The Chase Manhattan Bank (now known as JPMorgan Chase Bank, N.A.), as amended and restated effective December, 1996 (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.2
  Post-Retirement Compensation Plan for Non-Employee Directors of The Chase Manhattan Corporation (now known as JPMorgan Chase & Co.), as amended and restated effective May 21, 1996 (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.3
  Deferred Compensation Program of JPMorgan Chase & Co. and Participating Companies, effective as of January 1, 1996 (incorporated by reference to Exhibit 10.3 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.4
  2005 Deferred Compensation Program of JPMorgan Chase & Co., effective December 31, 2005.
 
   
10.5
  JPMorgan Chase & Co. 2005 Long-Term Incentive Plan (incorporated by reference to Appendix C of Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805) filed April 4, 2005).
 
   
10.6
  The Chase Manhattan Corporation 1996 Long-Term Incentive Plan.
 
   
10.7
  Key Executive Performance Plan of JPMorgan Chase & Co., as restated as of January 1, 2005.
 
   
10.8
  Excess Retirement Plan of The Chase Manhattan Bank and Participating Companies, restated effective January 1, 2005.
 
   
10.9
  1984 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.11 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.10
  1992 J.P. Morgan & Co. Incorporated and Affiliated Companies Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.10 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.11
  1995 J.P. Morgan & Co. Incorporated Stock Incentive Plan, as amended (incorporated by reference to Exhibit 10.12 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).


14

 


 

 
     
10.12
  1998 J.P. Morgan & Co. Incorporated and Affiliated Companies Performance Plan (incorporated by reference to Exhibit 10.13 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.13
  Executive Retirement Plan of The Chase Manhattan Corporation and Certain Subsidiaries.
 
   
10.14
  Benefit Equalization Plan of The Chase Manhattan Corporation and Certain Subsidiaries.
 
   
10.15
  Summary of Terms of JPMorgan Chase & Co. Severance Policy.
 
   
10.16
  Employment Agreement between J. P. Morgan Chase & Co. and James Dimon dated January 14, 2004 (incorporated by reference to Exhibit 10.1 of the Registration Statement on Form S-4 of J.P. Morgan Chase & Co. (File No. 333-112967) filed February 20, 2004).
 
   
10.17
  Summary of Terms of Pension of William B. Harrison, Jr. (incorporated by reference to Form 8-K Item 1.01 of JPMorgan Chase & Co. filed February 28, 2005 (File No. 1-5805)).
 
   
10.18
  Bank One Corporation Director Stock Plan, as amended (incorporated by reference to Exhibit 10(B) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.19
  Summary of Bank One Corporation Director Deferred Compensation Plan.
 
   
10.20
  Bank One Corporation Stock Performance Plan (incorporated by reference to Exhibit 10(A) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2002).
 
   
10.21
  Bank One Corporation Deferred Compensation Plan.
 
   
10.22
  Bank One Corporation Supplemental Savings and Investment Plan, as amended (incorporated by reference to Exhibit 10(E) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.23
  Bank One Corporation Supplemental Personal Pension Account Plan, as amended (incorporated by reference to Exhibit 10(F) to the Form 10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.24
  Bank One Corporation Key Executive Change of Control Plan, as amended (incorporated by reference to Exhibit 10(G) to the Form
10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.25
  Bank One Corporation Planning Group Annual Incentive Plan, as amended (incorporated by reference to Exhibit 10(H) to the Form
10-K of Bank One Corporation (File No. 1-15323) for the year ended December 31, 2003).
 
   
10.26
  Bank One Corporation Investment Option Plan.
 
   
10.27
  First Chicago Corporation Stock Incentive Plan (incorporated by reference to Exhibit 10.28 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.28
  NBD Bancorp, Inc. Performance Incentive Plan, as amended (incorporated by reference to Exhibit 10.29 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
     
10.29
  Bank One Corporation Revised and Restated 1989 Stock Incentive Plan (incorporated by reference to Exhibit 10.30 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.30
  Bank One Corporation Revised and Restated 1995 Stock Incentive Plan (incorporated by reference to Exhibit 10.31 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2004).
 
   
10.31
  Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 2005 stock appreciation rights.
 
   
10.32
  JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 2005 restricted stock units (incorporated by reference to Exhibit 10.1 to Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed April 11, 2005).
 
   
10.33
  Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of October 2005 stock appreciation rights.
 
   
10.34
  Amendment and Restatement of Letter Agreement between JPMorgan Chase & Co. and Charles W. Scharf, dated December 29, 2005.
 
   
12.1
  Computation of ratio of earnings to fixed charges.
 
   
12.2
  Computation of ratio of earnings to fixed charges and preferred stock dividend requirements.
 
   
21.1
  List of Subsidiaries of JPMorgan Chase & Co.
 
   
22.1
  Annual Report on Form 11-K of The JPMorgan Chase 401(k) Savings Plan for the fiscal year ended December 31, 2005.
 
   
23.1
  Consent of independent registered public accounting firm.*
 
   
24.1
  Powers of Attorney.*
 
   
31.1
  Certification.*
 
   
31.2
  Certification.*
 
   
31.3
  Certification.*
 
   
32
  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 
   
*
  Filed herewith
JPMorgan Chase hereby agrees to furnish to the Securities and Exchange Commission, upon request, copies of instruments defining the rights of holders for the outstanding nonregistered long-term debt of JPMorgan Chase and its subsidiaries and certain other long-term debt issued by predecessor institutions of JPMorgan Chase and assumed by virtue of the mergers with those respective institutions. These instruments have not been filed as exhibits hereto by reason that the total amount of each issue of such securities does not exceed 10% of the total assets of JPMorgan Chase and its subsidiaries on a consolidated basis. In addition, JPMorgan Chase hereby agrees to file with the Securities and Exchange Commission, upon request, the Junior Subordinated Indentures, the Guarantees and the Amended and Restated Trust Agreements for each Delaware business trust subsidiary that has issued Capital Securities, the guarantees for which have been assumed by JPMorgan Chase & Co. by virtue of the mergers of the respective predecessor institutions that originally issued such securities. The provisions of such agreements differ from the documents constituting Exhibits 4.8(a), (b) and (c) to this report only with respect to the pricing terms of each series of capital securities; these pricing terms are disclosed in Note 17 on page 117.


15


 

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Table of contents
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
     
Audited financial statements:
85
  Management’s report on internal control over financial reporting
86
  Report of independent registered public accounting firm
87
  Consolidated financial statements
91
  Notes to consolidated financial statements
 
   
Supplementary information:
133
  Selected quarterly financial data
134
  Glossary of terms
135
  Forward-looking statements
     
JPMorgan Chase & Co./ 2005 Annual Report
  21

 


 

PAGES 22-84 NOT USED

 


 

Management’s report on internal control over financial reporting
JPMorgan Chase & Co.

Management of JPMorgan Chase & Co. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Firm’s principal executive, principal operating and principal financial officers, or persons performing similar functions, and effected by JPMorgan Chase’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
JPMorgan Chase’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records, that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Firm’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Firm are being made only in accordance with authorizations of JPMorgan Chase’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Firm’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management has completed an assessment of the effectiveness of the Firm’s internal control over financial reporting as of December 31, 2005. In making the assessment, management used the framework in “Internal Control –Integrated Framework” promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the “COSO” criteria.
Based upon the assessment performed, management concluded that as of December 31, 2005, JPMorgan Chase’s internal control over financial reporting was effective based upon the COSO criteria. Additionally, based upon management’s assessment, the Firm determined that there were no material weaknesses in its internal control over financial reporting as of December 31, 2005.
Management’s assessment of the effectiveness of the Firm’s internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, JPMorgan Chase’s independent registered public accounting firm, who also audited the Firm’s financial statements as of and for the year ended December 31, 2005, as stated in their report which is included herein.
(WILLIAM B. HARRISON)
William B. Harrison, Jr.
Chairman of the Board
(JAMES DIMON)
James Dimon
President and Chief Executive Officer
(MICHAEL J. CAVANAGH)
Michael J. Cavanagh
Executive Vice President and Chief Financial Officer
 
 
February 24, 2006


     
JPMorgan Chase & Co. / 2005 Annual Report   85

 


 

Report of independent registered public accounting firm
JPMorgan Chase & Co.
(PRICEWATERHOUSECOOPERS LOGO)
PRICEWATERHOUSE COOPERS LLP 300 MADISON AVENUE NEW YORK, NY 10017
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of JPMorgan Chase & Co.:

We have completed integrated audits of JPMorgan Chase & Co.’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions on JPMorgan Chase & Co.’s 2005, 2004, and 2003 consolidated financial statements and on its internal control over financial reporting as of December 31, 2005, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of the JPMorgan Chase & Co. and its subsidiaries (the “Company”) at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in the section entitled “Restatement of the consolidated statements of cash flows” included in Note 1 to the consolidated financial statements, the Company restated its 2005, 2004 and 2003 consolidated financial statements.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in the accompanying Management’s report on internal control over financial reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control –Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
(PRICEWATERHOUSECOOPERS)
 
February 24, 2006, except with respect to our opinion on the consolidated financial statements insofar as it relates to the section entitled “Restatement of the consolidated statements of cash flows” included in Note 1, as to which the date is August 3, 2006


     
86   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Consolidated statements of income
JPMorgan Chase & Co.
                         
Year ended December 31, (in millions, except per share data) (a)   2005     2004     2003  
 
Revenue
                       
Investment banking fees
  $ 4,088     $ 3,537     $ 2,890  
Trading revenue
    5,860       3,612       4,427  
Lending & deposit related fees
    3,389       2,672       1,727  
Asset management, administration and commissions
    10,390       8,165       6,039  
Securities/private equity gains
    473       1,874       1,479  
Mortgage fees and related income
    1,054       806       790  
Credit card income
    6,754       4,840       2,466  
Other income
    2,694       830       601  
 
Noninterest revenue
    34,702       26,336       20,419  
 
Interest income
    45,200       30,595       24,044  
Interest expense
    25,369       13,834       11,079  
 
Net interest income
    19,831       16,761       12,965  
 
Total net revenue
    54,533       43,097       33,384  
 
                       
Provision for credit losses
    3,483       2,544       1,540  
 
                       
Noninterest expense
                       
Compensation expense
    18,255       14,506       11,387  
Occupancy expense
    2,299       2,084       1,912  
Technology and communications expense
    3,624       3,702       2,844  
Professional & outside services
    4,224       3,862       2,875  
Marketing
    1,917       1,335       710  
Other expense
    3,705       2,859       1,694  
Amortization of intangibles
    1,525       946       294  
Merger costs
    722       1,365        
Litigation reserve charge
    2,564       3,700       100  
 
Total noninterest expense
    38,835       34,359       21,816  
 
Income before income tax expense
    12,215       6,194       10,028  
Income tax expense
    3,732       1,728       3,309  
 
Net income
  $ 8,483     $ 4,466     $ 6,719  
 
Net income applicable to common stock
  $ 8,470     $ 4,414     $ 6,668  
 
Net income per common share
                       
Basic earnings per share
  $ 2.43     $ 1.59     $ 3.32  
Diluted earnings per share
    2.38       1.55       3.24  
 
                       
Average basic shares
    3,492       2,780       2,009  
Average diluted shares
    3,557       2,851       2,055  
 
                       
Cash dividends per common share
  $ 1.36     $ 1.36     $ 1.36  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The Notes to consolidated financial statements are an integral part of these statements.
     
JPMorgan Chase & Co. / 2005 Annual Report   87

 


 

Consolidated balance sheets
JPMorgan Chase & Co.
                 
At December 31, (in millions, except share data)   2005     2004  
 
Assets
               
Cash and due from banks
  $ 36,670     $ 35,168  
Deposits with banks
    21,661       21,680  
Federal funds sold and securities purchased under resale agreements
    133,981       101,354  
Securities borrowed
    74,604       47,428  
Trading assets (including assets pledged of $79,657 at December 31, 2005, and $77,266 at December 31, 2004)
    298,377       288,814  
Securities:
               
Available-for-sale (including assets pledged of $17,614 at December 31, 2005, and $26,881 at December 31, 2004)
    47,523       94,402  
Held-to-maturity (fair value: $80 at December 31, 2005, and $117 at December 31, 2004)
    77       110  
Interests in purchased receivables
    29,740       31,722  
 
               
Loans
    419,148       402,114  
Allowance for loan losses
    (7,090 )     (7,320 )
 
Loans, net of Allowance for loan losses
    412,058       394,794  
 
               
Private equity investments
    6,374       7,735  
Accrued interest and accounts receivable
    22,421       21,409  
Premises and equipment
    9,081       9,145  
Goodwill
    43,621       43,203  
Other intangible assets:
               
Mortgage servicing rights
    6,452       5,080  
Purchased credit card relationships
    3,275       3,878  
All other intangibles
    4,832       5,726  
Other assets
    48,195       45,600  
 
Total assets
  $ 1,198,942     $ 1,157,248  
 
Liabilities
               
Deposits:
               
U.S. offices:
               
Noninterest-bearing
  $ 135,599     $ 129,257  
Interest-bearing
    287,774       261,673  
Non-U.S. offices:
               
Noninterest-bearing
    7,476       6,931  
Interest-bearing
    124,142       123,595  
 
Total deposits
    554,991       521,456  
Federal funds purchased and securities sold under repurchase agreements
    125,925       127,787  
Commercial paper
    13,863       12,605  
Other borrowed funds
    10,479       9,039  
Trading liabilities
    145,930       151,207  
Accounts payable, accrued expenses and other liabilities (including the Allowance for lending-related commitments of $400 at December 31, 2005, and $492 at December 31, 2004)
    78,460       75,722  
Beneficial interests issued by consolidated VIEs
    42,197       48,061  
Long-term debt
    108,357       95,422  
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
    11,529       10,296  
 
Total liabilities
    1,091,731       1,051,595  
 
Commitments and contingencies (see Note 25 of this Annual Report)
               
 
               
Stockholders’ equity
               
Preferred stock
    139       339  
Common stock (authorized 9,000,000,000 shares at December 31, 2005 and 2004; issued 3,618,189,597 shares and 3,584,747,502 shares at December 31, 2005 and 2004, respectively)
    3,618       3,585  
Capital surplus
    74,994       72,801  
Retained earnings
    33,848       30,209  
Accumulated other comprehensive income (loss)
    (626 )     (208 )
Treasury stock, at cost (131,500,350 shares at December 31, 2005, and 28,556,534 shares at December 31, 2004)
    (4,762 )     (1,073 )
 
Total stockholders’ equity
    107,211       105,653  
 
Total liabilities and stockholders’ equity
  $ 1,198,942     $ 1,157,248  
 
The Notes to consolidated financial statements are an integral part of these statements.
     
88   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Consolidated statements of changes in stockholders’ equity
JPMorgan Chase & Co.
                         
Year ended December 31, (in millions, except per share data) (a)   2005     2004     2003  
 
Preferred stock
                       
Balance at beginning of year
  $ 339     $ 1,009     $ 1,009  
Redemption of preferred stock
    (200 )     (670 )      
 
Balance at end of year
    139       339       1,009  
 
 
                       
Common stock
                       
Balance at beginning of year
    3,585       2,044       2,024  
Issuance of common stock
    33       72       20  
Issuance of common stock for purchase accounting acquisitions
          1,469        
 
Balance at end of year
    3,618       3,585       2,044  
 
 
                       
Capital surplus
                       
Balance at beginning of year
    72,801       13,512       13,222  
Issuance of common stock and options for purchase accounting acquisitions
          55,867        
Shares issued and commitments to issue common stock for employee stock-based
awards and related tax effects
    2,193       3,422       290  
 
Balance at end of year
    74,994       72,801       13,512  
 
 
                       
Retained earnings
                       
Balance at beginning of year
    30,209       29,681       25,851  
Net income
    8,483       4,466       6,719  
Cash dividends declared:
                       
Preferred stock
    (13 )     (52 )     (51 )
Common stock ($1.36 per share each year)
    (4,831 )     (3,886 )     (2,838 )
 
Balance at end of year
    33,848       30,209       29,681  
 
 
                       
Accumulated other comprehensive income (loss)
                       
Balance at beginning of year
    (208 )     (30 )     1,227  
Other comprehensive income (loss)
    (418 )     (178 )     (1,257 )
 
Balance at end of year
    (626 )     (208 )     (30 )
 
 
                       
Treasury stock, at cost
                       
Balance at beginning of year
    (1,073 )     (62 )     (1,027 )
Purchase of treasury stock
    (3,412 )     (738 )      
Reissuance from treasury stock
                1,082  
Share repurchases related to employee stock-based awards
    (277 )     (273 )     (117 )
 
Balance at end of year
    (4,762 )     (1,073 )     (62 )
 
Total stockholders’ equity
  $ 107,211     $ 105,653     $ 46,154  
 
 
                       
Comprehensive income
                       
Net income
  $ 8,483     $ 4,466     $ 6,719  
Other comprehensive income (loss)
    (418 )     (178 )     (1,257 )
 
Comprehensive income
  $ 8,065     $ 4,288     $ 5,462  
 
(a) 2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The Notes to consolidated financial statements are an integral part of these statements.
     
JPMorgan Chase & Co. / 2005 Annual Report   89

 


 

Consolidated statements of cash flows
JPMorgan Chase & Co.
                         
    2005   2004   2003
Year ended December 31, (in millions) (a)   (Restated)   (Restated)   (Restated)
 
Operating activities
                       
Net income
  $ 8,483     $ 4,466     $ 6,719  
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
                       
Provision for credit losses
    3,483       2,544       1,540  
Depreciation and amortization
    4,318       3,835       3,101  
Deferred tax (benefit) provision
    (1,791 )     (827 )     1,428  
Investment securities (gains) losses
    1,336       (338 )     (1,446 )
Private equity unrealized (gains) losses
    55       (766 )     (77 )
Gain on dispositions of businesses
    (1,254 )     (17 )     (68 )
Originations and purchases of loans held-for-sale
    (108,611 )     (89,315 )     (163,025 )
Proceeds from sales and securitizations of loans held-for-sale
    102,602       95,973       162,699  
Net change in:
                       
Trading assets
    (3,845 )     (48,703 )     (2,671 )
Securities borrowed
    (27,290 )     (4,816 )     (7,691 )
Accrued interest and accounts receivable
    (1,934 )     (2,391 )     1,809  
Other assets
    (9 )     (17,588 )     (9,848 )
Trading liabilities
    (12,578 )     29,764       15,769  
Accounts payable, accrued expenses and other liabilities
    5,532       13,277       5,973  
Other operating adjustments
    1,267       (245 )     63  
 
Net cash (used in) provided by operating activities
    (30,236 )     (15,147 )     14,275  
 
                       
Investing activities
                       
Net change in:
                       
Deposits with banks
    104       (4,196 )     (1,233 )
Federal funds sold and securities purchased under resale agreements
    (32,469 )     (13,101 )     (11,059 )
Held-to-maturity securities:
                       
Proceeds
    33       66       221  
Available-for-sale securities:
                       
Proceeds from maturities
    31,053       45,197       10,548  
Proceeds from sales
    82,902       134,534       315,738  
Purchases
    (81,749 )     (173,745 )     (301,854 )
Proceeds from sales and securitizations of loans held-for-investment
    23,861       12,854       8,716  
Originations and other changes in loans, net
    (40,436 )     (47,726 )     (9,299 )
Net cash (used) received in business acquisitions or dispositions
    (1,039 )     13,864       (575 )
All other investing activities, net
    4,796       2,519       1,541  
 
Net cash (used in) provided by investing activities
    (12,944 )     (29,734 )     12,744  
 
                       
Financing activities
                       
Net change in:
                       
Deposits
    31,415       52,082       21,851  
Federal funds purchased and securities sold under repurchase agreements
    (1,862 )     7,065       (56,017 )
Commercial paper and other borrowed funds
    2,618       (4,343 )     555  
Proceeds from the issuance of long-term debt and capital debt securities
    43,721       25,344       17,195  
Repayments of long-term debt and capital debt securities
    (26,883 )     (16,039 )     (8,316 )
Proceeds from the issuance of stock and stock-related awards
    682       848       1,213  
Redemption of preferred stock
    (200 )     (670 )      
Treasury stock purchased
    (3,412 )     (738 )      
Cash dividends paid
    (4,878 )     (3,927 )     (2,865 )
All other financing activities, net
    3,868       (26 )     133  
 
Net cash provided by (used in) financing activities
    45,069       59,596       (26,251 )
 
Effect of exchange rate changes on cash and due from banks
    (387 )     185       282  
Net increase (decrease) in cash and due from banks
    1,502       14,900       1,050  
Cash and due from banks at the beginning of the year
    35,168       20,268       19,218  
 
Cash and due from banks at the end of the year
  $ 36,670     $ 35,168     $ 20,268  
 
Cash interest paid
  $ 24,583     $ 13,384     $ 10,976  
Cash income taxes paid
  $ 4,758     $ 1,477     $ 1,337  
 
Note:   In 2004, the fair values of noncash assets acquired and liabilities assumed in the Merger with Bank One were $320.9 billion and $277.0 billion, respectively, and approximately 1,469 million shares of common stock, valued at approximately $57.3 billion, were issued in connection with the merger with Bank One.
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The Notes to consolidated financial statements are an integral part of these statements.
     
90   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
Note 1 – Basis of presentation

JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a financial holding company incorporated under Delaware law in 1968, is a leading global financial services firm and one of the largest banking institutions in the United States, with operations worldwide. The Firm is a leader in investment banking, financial services for consumers and businesses, financial transaction processing, investment management, private banking and private equity. For a discussion of the Firm’s business segment information, see Note 31 on pages 130–131 of this Annual Report.
The accounting and financial reporting policies of JPMorgan Chase and its subsidiaries conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and prevailing industry practices. Additionally, where applicable, the policies conform to the accounting and reporting guidelines prescribed by bank regulatory authorities.
Certain amounts in the prior periods have been reclassified to conform to the current presentation.
Consolidation
The consolidated financial statements include accounts of JPMorgan Chase and other entities in which the Firm has a controlling financial interest. All material intercompany balances and transactions have been eliminated.
The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as special purpose entities (“SPEs”), through arrangements that do not involve controlling voting interests.
SPEs are an important part of the financial markets, providing market liquidity by facilitating investors’ access to specific portfolios of assets and risks. They are, for example, critical to the functioning of the mortgage- and asset-backed securities and commercial paper markets. SPEs may be organized as trusts, partnerships or corporations and are typically set up for a single, discrete purpose. SPEs are not typically operating entities and usually have a limited life and no employees. The basic SPE structure involves a company selling assets to the SPE. The SPE funds the purchase of those assets by issuing securities to investors. The legal documents that govern the transaction describe how the cash earned on the assets must be allocated to the SPE’s investors and other parties that have rights to those cash flows. SPEs can be structured to be bankruptcy-remote, thereby insulating investors from the impact of the creditors of other entities, including the seller of the assets.
There are two different accounting frameworks applicable to SPEs: the qualifying SPE (“QSPE”) framework under SFAS 140; and the variable interest entity (“VIE”) framework under FIN 46R. The applicable framework depends on the nature of the entity and the Firm’s relation to that entity. The QSPE framework is applicable when an entity transfers (sells) financial assets to an SPE meeting certain criteria defined in SFAS 140. These criteria are designed to ensure that the activities of the entity are essentially predetermined at the inception of the vehicle and that the transferor of the financial assets cannot exercise control over the entity and the assets therein. Entities meeting these criteria are not consolidated by the transferor or other counterparties, as long as they do not have the unilateral ability to liquidate or to cause the entity to no longer meet the QSPE criteria. The Firm primarily follows the QSPE model for securitizations of its residential and commercial mortgages, credit card loans and automobile loans. For further details, see Note 13 on pages 108–111 of this Annual Report.
When the SPE does not meet the QSPE criteria, consolidation is assessed pursuant to FIN 46R. Under FIN 46R, a VIE is defined as an entity that: (1) lacks enough equity investment at risk to permit the entity to finance its activities
without additional subordinated financial support from other parties; (2) has equity owners that lack the right to make significant decisions affecting the entity’s operations; and/or (3) has equity owners that do not have an obligation to absorb or the right to receive the entity’s losses or returns.
FIN 46R requires a variable interest holder (i.e., a counterparty to a VIE) to consolidate the VIE if that party will absorb a majority of the expected losses of the VIE, receive the majority of the expected residual returns of the VIE, or both. This party is considered the primary beneficiary. In making this determination, the Firm thoroughly evaluates the VIE’s design, capital structure and relationships among variable interest holders. When the primary beneficiary cannot be identified through a qualitative analysis, the Firm performs a quantitative analysis, which computes and allocates expected losses or residual returns to variable interest holders. The allocation of expected cash flows in this analysis is based upon the relative contractual rights and preferences of each interest holder in the VIE’s capital structure. For further details, see Note 14 on pages 111–113 of this Annual Report.
All retained interests and significant transactions between the Firm, QSPEs and nonconsolidated VIEs are reflected on JPMorgan Chase’s Consolidated balance sheets or in the Notes to consolidated financial statements.
Investments in companies that are considered to be voting-interest entities under FIN 46R in which the Firm has significant influence over operating and financing decisions are accounted for in accordance with the equity method of accounting. These investments are generally included in Other assets, and the Firm’s share of income or loss is included in Other income. For a discussion of private equity investments, see Note 9 on pages 103–105 of this Annual Report.
Assets held for clients in an agency or fiduciary capacity by the Firm are not assets of JPMorgan Chase and are not included in the Consolidated balance sheets.
Use of estimates in the preparation of consolidated financial statements
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and disclosures of contingent assets and liabilities. Actual results could be different from these estimates.


     
JPMorgan Chase & Co./ 2005 Annual Report   91

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

Foreign currency translation
JPMorgan Chase revalues assets, liabilities, revenues and expenses denominated in foreign currencies into U.S. dollars using applicable exchange rates.
Gains and losses relating to translating functional currency financial statements for U.S. reporting are included in Other comprehensive income (loss) within Stockholders’ equity. Gains and losses relating to nonfunctional currency transactions, including non-U.S. operations where the functional currency is the U.S. dollar and operations in highly inflationary environments, are reported in the Consolidated statements of income.
Statements of cash flows
For JPMorgan Chase’s Consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in Cash and due from banks.
Significant accounting policies
The following table identifies JPMorgan Chase’s significant accounting policies and the Note and page where a detailed description of each policy can be found:
                                 
Trading activities
  Note     3     Page     94  
Other noninterest revenue
  Note     4     Page     95  
Pension and other postretirement employee benefit plans
  Note     6     Page     96  
Employee stock-based incentives
  Note     7     Page     100  
Securities and private equity investments
  Note     9     Page     103  
Securities financing activities
  Note     10     Page     105  
Loans
  Note     11     Page     106  
Allowance for credit losses
  Note     12     Page     107  
Loan securitizations
  Note     13     Page     108  
Variable interest entities
  Note     14     Page     111  
Goodwill and other intangible assets
  Note     15     Page     114  
Premises and equipment
  Note     16     Page     116  
Income taxes
  Note     22     Page     120  
Accounting for derivative instruments and hedging activities
  Note     26     Page     123  
Off–balance sheet lending-related financial instruments and guarantees
  Note     27     Page     124  
Fair value of financial instruments
  Note     29     Page     126  
Restatement of the Consolidated Statements of Cash Flows
As reported in a Current Report on Form 8-K filed by the Firm on August 3, 2006, the Firm is filing an amended Form 10-K for the year ended December 31, 2005 to restate the Consolidated statements of cash flows for the annual periods of 2005, 2004 and 2003 and is filing an amended Form 10-Q for the quarter ended March 31, 2006 to restate the Consolidated statements of cash flows for each of the quarterly periods of 2005 and the first quarter of 2006. The restatements will not affect the Firm’s Consolidated statements of income, Consolidated balance sheets or Consolidated statements of changes in stockholders’ equity for any of the affected periods. Accordingly, the Firm’s historical revenues, net income, earnings per share, total assets and regulatory capital remain unchanged.
The restatements result solely from the misclassification of cash flows related to certain residential mortgages and other loans that had been originated or purchased with the intent to sell. The cash flows from these loans had been classified as investing activities. However, in accordance with Statement of Financial Accounting Standards No. 102, “Statement of Cash Flows—Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale,” cash flows from these loans should have been, and in the future will be, classified as operating activities, rather than investing activities. Accordingly, the restatements will solely affect the classification of these activities and the subtotals of cash flows from operating and investing activities presented in the affected Consolidated statements of cash flows, but they will have no impact on the net increase (decrease) in total Cash and due from banks set forth in the Consolidated statements of cash flows for any of the previously reported periods.
The Consolidated statements of cash flows for the years ended December 31, 2005, 2004, and 2003, as previously reported and as restated, are reflected on the following page.


     
91A   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Consolidated statements of cash flows
JPMorgan Chase & Co.
                                                 
    2005   2004   2003
    As previously           As previously           As previously    
Year ended December 31, (in millions) (a)   reported   Restated   reported   Restated   reported   Restated
 
Operating activities
                                               
Net income
  $ 8,483     $ 8,483     $ 4,466     $ 4,466     $ 6,719     $ 6,719  
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
                                               
Provision for credit losses
    3,483       3,483       2,544       2,544       1,540       1,540  
Depreciation and amortization
    4,318       4,318       3,835       3,835       3,101       3,101  
Deferred tax (benefit) provision
    (1,791 )     (1,791 )     (827 )     (827 )     1,428       1,428  
Investment securities (gains) losses
    1,336       1,336       (338 )     (338 )     (1,446 )     (1,446 )
Private equity unrealized (gains) losses
    55       55       (766 )     (766 )     (77 )     (77 )
Gain on dispositions of businesses
    (1,254 )     (1,254 )     (17 )     (17 )     (68 )     (68 )
Originations and purchases of loans held-for-sale
          (108,611 )           (89,315 )           (163,025 )
Proceeds from sales and securitizations of loans held-for-sale
          102,602             95,973             162,699  
Net change in:
                                               
Trading assets
    (3,845 )     (3,845 )     (48,703 )     (48,703 )     (2,671 )     (2,671 )
Securities borrowed
    (27,290 )     (27,290 )     (4,816 )     (4,816 )     (7,691 )     (7,691 )
Accrued interest and accounts receivable
    (1,934 )     (1,934 )     (2,391 )     (2,391 )     1,809       1,809  
Other assets
    (9 )     (9 )     (17,588 )     (17,588 )     (9,848 )     (9,848 )
Trading liabilities
    (12,578 )     (12,578 )     29,764       29,764       15,769       15,769  
Accounts payable, accrued expenses and other liabilities
    5,532       5,532       13,277       13,277       5,973       5,973  
Other operating adjustments
    1,267       1,267       (245 )     (245 )     63       63  
 
Net cash (used in) provided by operating activities
    (24,227 )     (30,236 )     (21,805 )     (15,147 )     14,601       14,275  
Investing activities
                                               
Net change in:
                                               
Deposits with banks
    104       104       (4,196 )     (4,196 )     (1,233 )     (1,233 )
Federal funds sold and securities purchased under resale agreements
    (32,469 )     (32,469 )     (13,101 )     (13,101 )     (11,059 )     (11,059 )
Held-to-maturity securities:
                                               
Proceeds
    33       33       66       66       221       221  
Available-for-sale securities:
                                               
Proceeds from maturities
    31,053       31,053       45,197       45,197       10,548       10,548  
Proceeds from sales
    82,902       82,902       134,534       134,534       315,738       315,738  
Purchases
    (81,749 )     (81,749 )     (173,745 )     (173,745 )     (301,854 )     (301,854 )
Proceeds from sales and securitizations of loans held-for-investment
    126,310       23,861       108,637       12,854       170,870       8,716  
Originations and other changes in loans, net
    (148,894 )     (40,436 )     (136,851 )     (47,726 )     (171,779 )     (9,299 )
Net cash (used) received in business acquisitions or dispositions
    (1,039 )     (1,039 )     13,864       13,864       (575 )     (575 )
All other investing activities, net
    4,796       4,796       2,519       2,519       1,541       1,541  
 
Net cash (used in) provided by investing activities
    (18,953 )     (12,944 )     (23,076 )     (29,734 )     12,418       12,744  
Financing activities
                                               
Net change in:
                                               
Deposits
    31,415       31,415       52,082       52,082       21,851       21,851  
Federal funds purchased and securities sold under repurchase agreements
    (1,862 )     (1,862 )     7,065       7,065       (56,017 )     (56,017 )
Commercial paper and other borrowed funds
    2,618       2,618       (4,343 )     (4,343 )     555       555  
Proceeds from the issuance of long-term debt and capital debt securities
    43,721       43,721       25,344       25,344       17,195       17,195  
Repayments of long-term debt and capital debt securities
    (26,883 )     (26,883 )     (16,039 )     (16,039 )     (8,316 )     (8,316 )
Proceeds from the issuance of stock and stock-related awards
    682       682       848       848       1,213       1,213  
Redemption of preferred stock
    (200 )     (200 )     (670 )     (670 )            
Treasury stock purchased
    (3,412 )     (3,412 )     (738 )     (738 )            
Cash dividends paid
    (4,878 )     (4,878 )     (3,927 )     (3,927 )     (2,865 )     (2,865 )
All other financing activities, net
    3,868       3,868       (26 )     (26 )     133       133  
 
Net cash provided by (used in) financing activities
    45,069       45,069       59,596       59,596       (26,251 )     (26,251 )
 
Effect of exchange rate changes on cash and due from banks
    (387 )     (387 )     185       185       282       282  
Net increase (decrease) in cash and due from banks
    1,502       1,502       14,900       14,900       1,050       1,050  
Cash and due from banks at the beginning of the year
    35,168       35,168       20,268       20,268       19,218       19,218  
 
Cash and due from banks at the end of the year
  $ 36,670     $ 36,670     $ 35,168     $ 35,168     $ 20,268     $ 20,268  
 
Cash interest paid
  $ 24,583     $ 24,583     $ 13,384     $ 13,384     $ 10,976     $ 10,976  
Cash income taxes paid
  $ 4,758     $ 4,758     $ 1,477     $ 1,477     $ 1,337     $ 1,337  
 
Note:   In 2004, the fair values of noncash assets acquired and liabilities assumed in the Merger with Bank One were $320.9 billion and $277.0 billion, respectively, and approximately 1,469 million shares of common stock, valued at approximately $57.3 billion, were issued in connection with the merger with Bank One.
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The Notes to consolidated financial statements are an integral part of these statements.
     
JPMorgan Chase & Co./ 2005 Annual Report
  91B

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

Note 2 – Business changes and developments
Merger with Bank One Corporation
Bank One Corporation merged with and into JPMorgan Chase (the “Merger”) on July 1, 2004. As a result of the Merger, each outstanding share of common stock of Bank One was converted in a stock-for-stock exchange into 1.32 shares of common stock of JPMorgan Chase. JPMorgan Chase stockholders kept their shares, which remained outstanding and unchanged as shares of JPMorgan Chase following the Merger. Key objectives of the Merger were to provide the Firm with a more balanced business mix and greater geographic diversification. The Merger was accounted for using the purchase method of accounting, which requires that the assets and liabilities of Bank One be fair valued as of July 1, 2004. The purchase price to complete the Merger was $58.5 billion.
As part of the Merger, certain accounting policies and practices were conformed, which resulted in $976 million of charges in 2004. The significant components of the conformity charges comprised a $1.4 billion charge related to the decertification of the seller’s interest in credit card securitizations, and the benefit of a $584 million reduction in the allowance for credit losses as a result of conforming the wholesale and consumer credit provision methodologies.
The final purchase price of the Merger has been allocated to the assets acquired and liabilities assumed using their fair values as of the merger date. The computation of the purchase price and the allocation of the purchase price to the net assets of Bank One – based on their respective fair values as of July 1, 2004 – and the resulting goodwill are presented on right.


                 
(in millions, except per share amounts)   July 1, 2004  
 
Purchase price
               
Bank One common stock exchanged
    1,113          
Exchange ratio
    1.32          
 
             
JPMorgan Chase common stock issued
    1,469          
Average purchase price per JPMorgan Chase common
share (a)
  $ 39.02          
 
             
 
          $ 57,336  
Fair value of employee stock awards and direct acquisition costs
            1,210  
 
             
Total purchase price
          $ 58,546  
 
Net assets acquired:
               
Bank One stockholders’ equity
  $ 24,156          
Bank One goodwill and other intangible assets
    (2,754 )        
 
             
Subtotal
    21,402          
 
Adjustments to reflect assets acquired at fair value:
               
Loans and leases
    (2,261 )        
Private equity investments
    (72 )        
Identified intangibles
    8,665          
Pension plan assets
    (778 )        
Premises and equipment
    (417 )        
Other assets
    (267 )        
 
Amounts to reflect liabilities assumed at fair value:
               
Deposits
    (373 )        
Deferred income taxes
    932          
Other postretirement benefit plan liabilities
    (49 )        
Other liabilities
    (1,162 )        
Long-term debt
    (1,234 )        
 
             
 
            24,386  
 
             
Goodwill resulting from Merger (b)
          $ 34,160  
 
(a)   The value of the Firm’s common stock exchanged with Bank One shareholders was based on the average closing prices of the Firm’s common stock for the two days prior to, and the two days following, the announcement of the Merger on January 14, 2004.
 
(b)   Goodwill resulting from the Merger reflects adjustments of the allocation of the purchase price to the net assets acquired through June 30, 2005. Minor adjustments subsequent to June 30, 2005, are reflected in the December 31, 2005 Goodwill balance in Note 15 on page 114 of this Annual Report.


     
92
  JPMorgan Chase & Co./ 2005 Annual Report


 

Condensed statement of net assets acquired
The following condensed statement of net assets acquired reflects the fair value of Bank One net assets as of July 1, 2004.
         
(in millions)   July 1, 2004  
 
Assets
       
Cash and cash equivalents
  $ 14,669  
Securities
    70,512  
Interests in purchased receivables
    30,184  
Loans, net of allowance for loan losses
    129,650  
Goodwill and other intangible assets
    42,825  
All other assets
    47,739  
 
Total assets
  $ 335,579  
 
Liabilities
       
Deposits
  $ 164,848  
Short-term borrowings
    9,811  
All other liabilities
    61,494  
Long-term debt
    40,880  
 
Total liabilities
    277,033  
 
Net assets acquired
  $ 58,546  
 
Acquired, identifiable intangible assets
Components of the fair value of acquired, identifiable intangible assets as of July 1, 2004, were as follows:
                         
    Fair value     Weighted average     Useful life  
    (in millions)     life (in years)     (in years)  
 
Core deposit intangibles
  $ 3,650       5.1     Up to 10
Purchased credit card relationships
    3,340       4.6     Up to 10
Other credit card-related intangibles
    295       4.6     Up to 10
Other customer relationship intangibles
    870       4.6–10.5     Up to 20
 
Subtotal
    8,155       5.1     Up to 20
Indefinite-lived asset management intangibles
    510       NA   NA
 
Total
  $ 8,665                  
 
Unaudited pro forma condensed combined financial information
The following unaudited pro forma condensed combined financial information presents the results of operations of the Firm had the Merger taken place at January 1, 2003.
                 
Year ended December 31, (in millions, except per share)   2004     2003  
 
Noninterest revenue
  $ 31,175     $ 28,966  
Net interest income
    21,366       21,715  
 
Total net revenue
    52,541       50,681  
Provision for credit losses
    2,727       3,570  
Noninterest expense
    40,504       33,136  
 
Income before income tax expense
    9,310       13,975  
Net income
  $ 6,544     $ 9,330  
 
               
Net income per common share:
               
Basic
  $ 1.85     $ 2.66  
Diluted
    1.81       2.61  
 
               
Average common shares outstanding:
               
Basic
    3,510       3,495  
Diluted
    3,593       3,553  
 
Other business events
Collegiate Funding Services
On March 1, 2006, JPMorgan Chase acquired, for approximately $663 million, Collegiate Funding Services, a leader in student loan servicing and consolidation. This acquisition will enable the Firm to create a comprehensive education finance business.
BrownCo
On November 30, 2005, JPMorgan Chase sold BrownCo, an on-line deep-discount brokerage business, to E*TRADE Financial for a cash purchase price of $1.6 billion. JPMorgan Chase recognized an after-tax gain of $752 million. BrownCo’s results of operations are reported in the Asset & Wealth Management business segment; however, the gain on the sale, which is recorded in Other income in the Consolidated statements of income, is reported in the Corporate business segment.
Sears Canada credit card business
On November 15, 2005, JPMorgan Chase purchased Sears Canada Inc.’s credit card operation, including both the private-label card accounts and the co-branded Sears MasterCard ® accounts. The credit card operation includes approximately 10 million accounts with $2.2 billion (CAD$2.5 billion) in managed loans. Sears Canada and JPMorgan Chase entered into an ongoing arrangement under which JPMorgan Chase will offer private-label and co-branded credit cards to both new and existing customers of Sears Canada.
Chase Merchant Services, Paymentech integration
On October 5, 2005, JPMorgan Chase and First Data Corp. completed the integration of the companies’ jointly owned Chase Merchant Services and Paymentech merchant businesses, to be operated under the name of Chase Paymentech Solutions, LLC. The joint venture is the largest financial transaction processor in the U.S. for businesses accepting credit card payments via traditional point of sale, Internet, catalog and recurring billing. As a result of the integration into a joint venture, Paymentech has been deconsolidated and JPMorgan Chase’s ownership interest in this joint venture is accounted for in accordance with the equity method of accounting.
Neovest Holdings, Inc.
On September 1, 2005, JPMorgan Chase completed its acquisition of Neovest Holdings, Inc., a provider of high-performance trading technology and direct market access. This transaction will enable the Investment Bank to offer a leading, broker-neutral trading platform across asset classes to institutional investors, asset managers and hedge funds.
Vastera
On April 1, 2005, JPMorgan Chase acquired Vastera, a provider of global trade management solutions, for approximately $129 million. Vastera’s business was combined with the Logistics and Trade Services businesses of TSS’ Treasury Services unit. Vastera automates trade management processes associated with the physical movement of goods internationally; the acquisition enables TS to offer management of information and processes in support of physical goods movement, together with financial settlement.


     
JPMorgan Chase & Co. / 2005 Annual Report   93

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

JPMorgan Partners
On March 1, 2005, the Firm announced that the management team of JPMorgan Partners, LLC, a private equity unit of the Firm, will become independent when it completes the investment of the current $6.5 billion Global Fund, which it advises. The buyout and growth equity professionals of JPMorgan Partners will form a new independent firm, CCMP Capital, LLC, and the venture professionals will separately form a new independent firm, Panorama Capital, LLC. JPMorgan Chase has committed to invest the lesser of $875 million or 24.9% of the limited partnership interests in the fund to be raised by CCMP Capital, and has committed to invest the lesser of $50 million or 24.9% of the limited partnership interests in the fund to be raised by Panorama Capital. The investment professionals of CCMP and Panorama will continue to manage the JPMP investments pursuant to a management agreement with the Firm.
Cazenove
On February 28, 2005, JPMorgan Chase and Cazenove Group plc (“Cazenove”) formed a business partnership which combined Cazenove’s investment banking business and JPMorgan Chase’s U.K.-based investment banking business in order to provide investment banking services in the United Kingdom and Ireland. The new company is called JPMorgan Cazenove Holdings.
Other acquisitions
During 2004, JPMorgan Chase purchased the Electronic Financial Services (“EFS”) business from Citigroup and acquired a majority interest in hedge fund manager Highbridge Capital Management (“Highbridge”).
Note 3 – Trading activities
Trading assets include debt and equity securities held for trading purposes that JPMorgan Chase owns (“long” positions). Trading liabilities include debt and equity securities that the Firm has sold to other parties but does not own (“short” positions). The Firm is obligated to purchase securities at a future date to cover the short positions. Included in Trading assets and Trading liabilities are the reported receivables (unrealized gains) and payables (unrealized losses) related to derivatives. These amounts include the derivative assets and liabilities net of cash received and paid, respectively, under legally enforceable master netting agreements. At December 31, 2005, the amount of cash received and paid was approximately $26.7 billion and $18.9 billion, respectively. At December 31, 2004, the amount of cash received and paid was approximately $32.2 billion and $22.0 billion, respectively. Trading positions are carried at fair value on the Consolidated balance sheets.
Trading revenue
                         
Year ended December 31, (a) (in millions)   2005     2004     2003  
 
Fixed income and other (b)
  $ 4,554     $ 2,976     $ 4,046  
Equities (c)
    1,271       797       764  
Credit portfolio (d)
    35       (161 )     (383 )
 
Total
  $ 5,860     $ 3,612     $ 4,427  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Includes bonds and commercial paper and various types of interest rate derivatives as well as foreign exchange and commodities.
 
(c)   Includes equity securities and equity derivatives.
 
(d)   Includes credit derivatives.
Trading assets and liabilities
The following table presents the fair value of Trading assets and Trading liabilities for the dates indicated:
                 
December 31, (in millions)   2005     2004  
 
Trading assets
               
Debt and equity instruments:
               
U.S. government and federal agency obligations
  $ 16,283     $ 16,867  
U.S. government-sponsored enterprise obligations
    24,172       23,513  
Obligations of state and political subdivisions
    9,887       3,486  
Certificates of deposit, bankers’ acceptances and commercial paper
    5,652       7,341  
Debt securities issued by non-U.S. governments
    48,671       50,699  
Corporate securities and other
    143,925       120,926  
 
Total debt and equity instruments
    248,590       222,832  
Derivative receivables:
               
Interest rate
    30,416       45,892  
Foreign exchange
    2,855       7,939  
Equity
    5,575       6,120  
Credit derivatives
    3,464       2,945  
Commodity
    7,477       3,086  
 
Total derivative receivables
    49,787       65,982  
 
Total trading assets
  $ 298,377     $ 288,814  
 
Trading liabilities
               
Debt and equity instruments (a)
  $ 94,157     $ 87,942  
 
Derivative payables:
               
Interest rate
    28,488       41,075  
Foreign exchange
    3,453       8,969  
Equity
    11,539       9,096  
Credit derivatives
    2,445       2,499  
Commodity
    5,848       1,626  
 
Total derivative payables
    51,773       63,265  
 
Total trading liabilities
  $ 145,930     $ 151,207  
 
(a)   Primarily represents securities sold, not yet purchased.
Average Trading assets and liabilities were as follows for the periods indicated:
                         
Year ended December 31, (a) (in millions)   2005     2004     2003  
 
Trading assets – debt and equity instruments
  $ 237,370     $ 200,467     $ 154,597  
Trading assets – derivative receivables
    57,365       59,521       85,628  
                 
Trading liabilities – debt and equity instruments (b)
  $ 93,102     $ 82,204     $ 72,877  
Trading liabilities – derivative payables
    55,723       52,761       67,783  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Primarily represents securities sold, not yet purchased.


     
94   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Note 4 – Other noninterest revenue
Investment banking fees
This revenue category includes advisory and equity and debt underwriting fees. Advisory fees are recognized as revenue when related services are performed. Underwriting fees are recognized as revenue when the Firm has rendered all services to the issuer and is entitled to collect the fee from the issuer, as long as there are no other contingencies associated with the fee (e.g., the fee is not contingent upon the customer obtaining financing). Underwriting fees are net of syndicate expenses. In addition, the Firm recognizes credit arrangement and syndication fees as revenue after satisfying certain retention, timing and yield criteria.
The following table presents the components of Investment banking fees:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Underwriting:
                       
Equity
  $ 864     $ 780     $ 699  
Debt
    1,969       1,859       1,549  
 
Total Underwriting
    2,833       2,639       2,248  
Advisory
    1,255       898       642  
 
Total
  $ 4,088     $ 3,537     $ 2,890  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
Lending & deposit related fees
This revenue category includes fees from loan commitments, standby letters of credit, financial guarantees, deposit-related fees in lieu of compensating balances, cash management-related activities or transactions, deposit accounts, and other loan servicing activities. These fees are recognized over the period in which the related service is provided.
Asset management, administration and commissions
This revenue category includes fees from investment management and related services, custody and institutional trust services, brokerage services, insurance premiums and commissions and other products. These fees are recognized over the period in which the related service is provided.
Mortgage fees and related income
This revenue category includes fees and income derived from mortgage origination, sales and servicing, and includes the effect of risk management activities associated with the mortgage pipeline, warehouse and the mortgage servicing rights (“MSRs”) asset (excluding gains and losses on the sale of Available-for-sale (“AFS”) securities). Origination fees and gains or losses on loan sales are recognized in income upon sale. Mortgage servicing fees are recognized over the period the related service is provided, net of amortization. Valuation changes in the mortgage pipeline, warehouse, MSR asset and corresponding risk management instruments are generally adjusted through earnings as these changes occur. Net interest income and securities gains and losses on AFS securities used in mortgage-related risk management activities are not included in Mortgage fees and related income. For a further discussion of MSRs, see Note 15 on pages 114–116 of this Annual Report.
Credit card income
This revenue category includes interchange income from credit and debit cards, annual fees, and servicing fees earned in connection with securitization activities. Volume-related payments to partners and expenses for rewards programs are also recorded within Credit card income. Fee revenues are recognized as earned, except for annual fees, which are recognized over a 12-month period. Expenses related to rewards programs are recorded when earned by the customer.
Credit card revenue sharing agreements
The Firm has contractual agreements with numerous affinity organizations and co-brand partners, which grant to the Firm exclusive rights to market to their members or customers. These organizations and partners provide to the Firm their endorsement of the credit card programs, mailing lists, and may also conduct marketing activities and provide awards under the various credit card programs. The terms of these agreements generally range from 3 to 10 years. The economic incentives the Firm pays to the endorsing organizations and partners typically include payments based upon new accounts, activation, charge volumes, and the cost of their marketing activities and awards.
The Firm recognizes the portion of payments based upon new accounts to the affinity organizations and co-brand partners, as deferred loan origination costs. The Firm defers these costs and amortizes them over 12 months. Payments based upon charge volumes and considered by the Firm as revenue sharing with the affinity organizations and co-brand partners are deducted from Credit card income as the related revenue is earned. The Firm expenses payments based upon marketing efforts performed by the endorsing organization or partner to activate a new account as incurred. These costs are recorded within Noninterest expense.
Note 5 – Interest income and interest expense
Details of Interest income and Interest expense were as follows:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Interest income
                       
Loans
  $ 26,062     $ 16,771     $ 11,812  
Securities
    3,129       3,377       3,542  
Trading assets
    9,117       7,527       6,592  
Federal funds sold and securities purchased under resale agreements
    4,125       1,627       1,497  
Securities borrowed
    1,154       463       323  
Deposits with banks
    680       539       214  
Interests in purchased receivables
    933       291       64  
 
Total interest income
    45,200       30,595       24,044  
 
                       
Interest expense
                       
Interest-bearing deposits
    10,295       4,630       3,604  
Short-term and other liabilities
    9,542       6,260       5,871  
Long-term debt
    4,160       2,466       1,498  
Beneficial interests issued by consolidated VIEs
    1,372       478       106  
 
Total interest expense
    25,369       13,834       11,079  
 
Net interest income
    19,831       16,761       12,965  
Provision for credit losses
    3,483       2,544       1,540  
 
Net interest income after provision for credit losses
  $ 16,348     $ 14,217     $ 11,425  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.


     
JPMorgan Chase & Co. / 2005 Annual Report   95

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

Note 6 – Pension and other postretirement employee benefit plans
New U.S.-based postretirement plans were introduced in 2005 after the Bank One plans were merged into the heritage JPMorgan Chase plans as of December 31, 2004.
The Firm’s defined benefit pension plans are accounted for in accordance with SFAS 87 and SFAS 88. The postretirement medical and life insurance plans are accounted for in accordance with SFAS 106.
The Firm uses a measurement date of December 31 for pension and other postretirement employee benefit plans. In addition, as of August 1, 2005, the U.S. postretirement medical and life insurance plan was remeasured to reflect a mid-year plan amendment and the final Medicare Part D regulations that were issued on January 21, 2005. For the Firm’s defined benefit pension plan assets, fair value is used to determine the expected return on pension plan assets. For the Firm’s other postretirement employee benefit plan assets, a calculated value that recognizes changes in fair value over a five-year period is used to determine the expected return on other postretirement employee benefit plan assets. Unrecognized net actuarial gains and losses and prior service costs associated with the U.S. defined benefit pension plan are amortized over the average future service period of plan participants, which is currently 10 years. For other postretirement employee benefit plans, unrecognized gains and losses are also amortized over the average future service period, which is currently 8 years. However, prior service costs associated with other postretirement employee benefit plans are recognized over the average years of service remaining to full eligibility age, which is currently 6 years.
Defined Benefit Pension Plans
The Firm has a qualified noncontributory U.S. defined benefit pension plan that provides benefits to substantially all U.S. employees. The U.S. plan employs a cash balance formula, in the form of salary and interest credits, to determine the benefits to be provided at retirement, based upon eligible compensation and years of service. Employees begin to accrue plan benefits after completing one year of service, and benefits generally vest after five years of service. The Firm also offers benefits through defined benefit pension plans to qualifying employees in certain non-U.S. locations based upon eligible compensation and years of service.
It is the Firm’s policy to fund the pension plans in amounts sufficient to meet the requirements under applicable employee benefit and local tax laws. The Firm did not make any U.S. pension plan contributions in 2005 and based upon the current funded status of this plan, the Firm does not expect to make significant contributions in 2006. In 2004, the Firm made a cash contribution to its U.S. defined benefit pension plan of $1.1 billion, funding the plan to the maximum allowable amount under applicable tax law. Additionally, the Firm made cash contributions totaling $78 million and $40 million to fully fund the accumulated benefit obligations of certain non-U.S. defined benefit pension plans as of December 31, 2005 and 2004, respectively.
Postretirement medical and life insurance
JPMorgan Chase offers postretirement medical and life insurance benefits to certain retirees and qualifying U.S. employees. These benefits vary with length of service and date of hire and provide for limits on the Firm’s share of covered medical benefits. The medical benefits are contributory, while the life insurance benefits are noncontributory. As of August 1, 2005, the eligibility requirements for U.S. employees to qualify for subsidized retiree medical coverage were revised and life insurance coverage was eliminated for active employees retiring after 2005. Postretirement medical benefits also are offered to qualifying U.K. employees.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted. The Act established a prescription drug benefit under Medicare (“Medicare Part D”) and a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Firm has determined that benefits provided to certain participants are at least actuarially equivalent to Medicare Part D and has reflected the effects of the subsidy in the financial statements and disclosures retroactive to the beginning of 2004 (July 1, 2004 for Bank One plans) in accordance with FSP SFAS 106-2.
JPMorgan Chase’s U.S. postretirement benefit obligation is partially funded with corporate-owned life insurance (“COLI”) purchased on the lives of eligible employees and retirees. While the Firm owns the COLI policies, COLI proceeds (death benefits, withdrawals and other distributions) may be used only to reimburse the Firm for net postretirement benefit claim payments and related administrative expenses. The U.K. postretirement benefit plan is unfunded.
The following tables present the funded status and amounts reported on the Consolidated balance sheets, the accumulated benefit obligation and the components of net periodic benefit costs reported in the Consolidated statements of income for the Firm’s U.S. and non-U.S. defined benefit pension and postretirement benefit plans:


     
96   JPMorgan Chase & Co. / 2005 Annual Report

 


 

                                                 
    Defined benefit pension plans        
    U.S.     Non-U.S.     Other postretirement benefit plans (c)(d)  
December 31, (in millions)   2005     2004 (b)   2005     2004 (b)   2005     2004 (b)
 
Change in benefit obligation
                                               
Benefit obligation at beginning of year
  $ (7,594 )   $ (4,633 )   $ (1,969 )   $ (1,659 )   $ (1,577 )   $ (1,252 )
Merger with Bank One
          (2,497 )           (25 )           (216 )
Cazenove business partnership
                (291 )                  
Benefits earned during the year
    (280 )     (251 )     (25 )     (17 )     (13 )     (15 )
Interest cost on benefit obligations
    (431 )     (348 )     (104 )     (87 )     (81 )     (81 )
Plan amendments
          70                   117       32  
Employee contributions
                            (44 )     (36 )
Actuarial gain (loss)
    (122 )     (511 )     (310 )     (99 )     21       (163 )
Benefits paid
    723       555       66       64       187       167  
Curtailments
    28       21                   (9 )     (8 )
Special termination benefits
                      (12 )     (1 )     (2 )
Foreign exchange impact and other
                255       (134 )     5       (3 )
 
Benefit obligation at end of year
  $ (7,676 )   $ (7,594 )   $ (2,378 )   $ (1,969 )   $ (1,395 )   $ (1,577 )
 
Change in plan assets
                                               
Fair value of plan assets at beginning of year
  $ 9,637     $ 4,866     $ 1,889     $ 1,603     $ 1,302     $ 1,149  
Merger with Bank One
          3,280             20             98  
Cazenove business partnership
                252                    
Actual return on plan assets
    703       946       308       164       43       84  
Firm contributions
          1,100       78       40       3       2  
Benefits paid
    (723 )     (555 )     (66 )     (64 )     (19 )     (31 )
Foreign exchange impact and other
                (238 )     126              
 
Fair value of plan assets at end of year
  $ 9,617 (e)   $ 9,637 (e)   $ 2,223     $ 1,889     $ 1,329     $ 1,302  
 
Reconciliation of funded status
                                               
Funded status
  $ 1,941     $ 2,043     $ (155 )   $ (80 )   $ (66 )   $ (275 )
Unrecognized amounts: (a)
                                               
Net transition asset
                      (1 )            
Prior service cost
    40       47       3       4       (105 )     (23 )
Net actuarial loss
    1,078       997       599       590       335       321  
 
Prepaid benefit cost reported in Other assets
  $ 3,059     $ 3,087     $ 447 (f)   $ 513 (f)   $ 164     $ 23  
 
Accumulated benefit obligation
  $ (7,274 )   $ (7,167 )   $ (2,303 )   $ (1,931 )   NA   NA
 
(a)   For pension benefit plans, the unrecognized net loss is primarily the result of declines in interest rates in recent years, as offset by recent asset gains and amounts recognized through amortization in expense. Other factors that contribute to this unrecognized amount include demographic experience, which differs from expected, and changes in other actuarial assumptions. For other postretirement benefit plans, the primary drivers of the cumulative unrecognized loss was the decline in the discount rate in recent years and the medical trend, which was higher than expected. These losses have been offset somewhat by the recognition of future savings attributable to Medicare Part D subsidy payments.
 
(b)   Effective July 1, 2004, the Firm assumed the obligations of heritage Bank One’s pension and postretirement plans. These plans were similar to those of JPMorgan Chase and were merged into the Firm’s plans effective December 31, 2004.
 
(c)   The Medicare Prescription Drug, Improvement and Modernization Act of 2003 resulted in a $35 million reduction in the Accumulated other postretirement benefit obligation as of January 1, 2004. During 2005, an additional $116 million reduction was reflected for recognition of the final Medicare Part D regulations issued on January 21, 2005.
 
(d)   Includes postretirement benefit obligation of $44 million and $43 million and postretirement benefit liability (included in Accrued expenses) of $50 million and $57 million at December 31, 2005 and 2004, respectively, for the U.K. plan, which is unfunded.
 
(e)   At December 31, 2005 and 2004, approximately $405 million and $358 million, respectively, of U.S. plan assets relate to surplus assets of group annuity contracts.
 
(f)   At December 31, 2005 and 2004, Accrued expenses related to non-U.S. defined benefit pension plans that JPMorgan Chase elected not to prefund fully totaled $164 million and $124 million, respectively.
                                                                         
    Defined benefit pension plans        
    U.S.     Non-U.S.     Other postretirement benefit plans  
For the year ended December 31, (in millions)   2005     2004 (a)   2003 (b)   2005     2004 (a)   2003 (b)   2005 (c)   2004 (a) (c)   2003 (b)
 
Components of net periodic benefit cost
                                                                       
Benefits earned during the period
  $ 280     $ 251     $ 180     $ 25     $ 17     $ 16     $ 13     $ 15     $ 15  
Interest cost on benefit obligations
    431       348       262       104       87       74       81       81       73  
Expected return on plan assets
    (694 )     (556 )     (322 )     (109 )     (90 )     (83 )     (90 )     (86 )     (92 )
Amortization of unrecognized amounts:
                                                                       
Prior service cost
    5       13       6       1       1             (10 )           1  
Net actuarial loss
    4       23       62       38       44       35       12              
Curtailment (gain) loss
    2       7       2                   8       (17 )     8       2  
Settlement (gain) loss
                            (1 )                        
Special termination benefits
                            11             1       2        
 
Reported net periodic benefit costs
  $ 28     $ 86     $ 190     $ 59     $ 69     $ 50     $ (10 )   $ 20     $ (1 )
 
(a)   Effective July 1, 2004, the Firm assumed the obligations of heritage Bank One’s pension and postretirement plans. These plans were similar to those of JPMorgan Chase and were merged into the Firm’s plans effective December 31, 2004.
 
(b)   Heritage JPMorgan Chase results only for 2003.
 
(c)   The Medicare Prescription Drug, Improvement and Modernization Act of 2003 resulted in a $15 million and $5 million reduction in 2005 and 2004, respectively, in net periodic benefit cost. The impact on 2005 cost was higher as a result of the final Medicare Part D regulations issued on January 21, 2005.
     
JPMorgan Chase & Co. / 2005 Annual Report   97

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

JPMorgan Chase has a number of other defined benefit pension plans (i.e., U.S. plans not subject to Title IV of the Employee Retirement Income Security Act). The most significant of these plans is the Excess Retirement Plan, pursuant to which certain employees earn service credits on compensation amounts above the maximum stipulated by law. This plan is a nonqualified, noncontributory U.S. pension plan with an unfunded liability at December 31, 2005 and 2004, in the amount of $273 million and $292 million, respectively. Compensation expense related to this pension plan totaled $21 million in 2005, $28 million in 2004 and $19 million in 2003.
Plan assumptions
JPMorgan Chase’s expected long-term rate of return for U.S. pension and other postretirement employee benefit plan assets is a blended average of the investment advisor’s projected long-term (10 years or more) returns for the various asset classes, weighted by the portfolio allocation. Asset-class returns are developed using a forward-looking building-block approach and are not based strictly upon historical returns. Equity returns are generally developed as the sum of inflation, expected real earnings growth and expected long-term dividend yield. Bond returns are generally developed as the sum of inflation, real bond yield and risk spread (as appropriate), adjusted for the expected effect on returns from changing yields. Other asset-class returns are derived from their relationship to the equity and bond markets.
In the U.K., which represents the most significant of the non-U.S. pension plans, procedures similar to those in the U.S. are used to develop the expected long-term rate of return on pension plan assets, taking into consideration local market conditions and the specific allocation of plan assets. The expected
long-term rate of return on U.K. plan assets is an average of projected long-term returns for each asset class, selected by reference to the yield on long-term U.K. government bonds and AA-rated long-term corporate bonds, plus an equity risk premium above the risk-free rate.
In 2005, the discount rate used in determining the benefit obligation under the U.S. pension and other postretirement employee benefit plans was selected by reference to the yield on a portfolio of bonds whose redemptions and coupons closely match each of the plan’s projected cash flows; such portfolio is derived from a broad-based universe of high quality corporate bonds as of the measurement date. In years in which this hypothetical bond portfolio generates excess cash, such excess is assumed to be reinvested at the one-year forward rates implied by the Citigroup Pension Discount Curve published as of the measurement date. Prior to 2005, discount rates were selected by reference to the year-end Moody’s corporate AA rate, as well as other high-quality indices with a duration that was similar to that of the respective plan’s benefit obligations. The discount rate for the U.K. pension and other postretirement employee benefit plans was determined by matching the duration of the Firm’s obligations with the corresponding duration from the yield curve of the year-end iBoxx £ corporate AA 15-year-plus bond index.
The following tables present the weighted-average annualized actuarial assumptions for the projected and accumulated benefit obligations, and the components of net periodic benefit costs for the Firm’s U.S. and non-U.S. defined benefit pension and postretirement benefit plans, as of year-end.


                                 
    U.S.     Non-U.S.  
For the year ended December 31,   2005     2004     2005     2004  
 
Weighted-average assumptions used to determine benefit obligations
                               
Discount rate:
                               
Pension
    5.70 %     5.75 %     2.00-4.70 %     2.00-5.30 %
Postretirement benefit
    5.65       5.75       4.7       5.3  
Rate of compensation increase
    4.00       4.50       3.00-3.75       1.75-3.75  
 
                                                 
    U.S.     Non-U.S.  
For the year ended December 31,   2005     2004     2003 (b)   2005     2004     2003 (b)
 
Weighted-average assumptions used to determine net periodic benefit costs
                                               
Discount rate
    5.75% (a)     6.00 %     6.50 %     2.00-5.30 %     2.00-5.75 %     1.50-5.60 %
Expected long-term rate of return on plan assets:
                                               
Pension
    7.50       7.50-7.75       8.00       3.25-5.75       3.00-6.50       2.70-6.50  
Postretirement benefit
    4.75-7.00       4.75-7.00       8.00     NA     NA     NA  
Rate of compensation increase
    4.00       4.25-4.50       4.50       1.75-3.75       1.75-3.75       1.25-3.00  
 
(a)   The postretirement plan was remeasured as of August 1, 2005, and a rate of 5.25% was used from the period of August 1, 2005, through December 31, 2005.
 
(b)   Heritage JPMorgan Chase results only for 2003.
     
98   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The following tables present JPMorgan Chase’s assumed weighted-average medical benefits cost trend rate, which is used to measure the expected cost of benefits at year-end, and the effect of a one-percentage-point change in the assumed medical benefits cost trend rate.
                         
December 31,   2005     2004 (a)   2003 (b)
 
Health care cost trend rate assumed
                       
for next year
    10 %     10 %     10 %
Rate to which cost trend rate is assumed to decline (ultimate trend rate)
    5       5       5  
Year that rate reaches ultimate trend rate
    2012       2011       2010  
 
                 
(in millions)   1-Percentage-   1-Percentage-
For the year ended December 31,2005   point increase   point decrease
 
Effect on total service and interest costs
  $ 4     $ (3 )
Effect on postretirement benefit obligation
    64       (55 )
 
(a)   Effective July 1, 2004, the Firm assumed the obligations of heritage Bank One’s pension and postretirement plans. These plans were similar to those of JPMorgan Chase and were merged into the Firm’s plans effective December 31, 2004.
 
(b)   2003 reflects the results of heritage JPMorgan Chase only.
At December 31, 2005, the Firm reduced the discount rate used to determine its U.S. benefit obligations to 5.70% for the pension plan and to 5.65% for the postretirement benefits plans from the prior year rate of 5.75% for both plans. The Firm also changed the health care benefit obligation trend assumption to 10% for 2006, grading down to an ultimate rate of 5% in 2013. The 2006 expected long-term rate of return on its U.S. pension plan assets remained at 7.50%. The 2006 expected long-term rate of return on the Firm’s COLI post-retirement plan assets remained at 7.00%; however, with the merger of Bank One’s other postretirement plan assets, the Firm’s overall expected long-term rate of return on U.S. postretirement employee benefit plan assets decreased to 6.84% and 6.80% in 2005 and 2004, respectively, to reflect a weighted average expected rate of return for the merged plan. The interest crediting rate assumption used to determine pension benefits changed to 5.00% from 4.75% in 2005, primarily due to changes in market interest rates which will result in additional expense of $18 million. The changes as of December 31, 2005, to the discount rates are expected to increase 2006 U.S. pension and other postretirement benefit expenses by approximately $5 million and to the non-U.S. pension and other postretirement benefit expenses by $23 million. The rate of compensation increase assumption of 4.00% at December 31, 2005, reflects the consolidation of the prior JPMorgan Chase and Bank One age-weighted increase assumptions; the impact to expense is not expected to be material.
JPMorgan Chase’s U.S. pension and other postretirement benefit expenses are most sensitive to the expected long-term rate of return on plan assets. With all other assumptions held constant, a 25-basis point decline in the expected long-term rate of return on U.S. plan assets would result in an increase of approximately $26 million in 2006 U.S. pension and other postretirement benefit expenses. A 25-basis point decline in the discount rate for the U.S. plans would result in an increase in 2006 U.S. pension and other postretirement benefit expenses of approximately $20 million and an increase in the related projected benefit obligations of approximately $233 million. A 25-basis point decline in the discount rates for the non-U.S. plans would result in an increase in the 2006 non-U.S. pension and other postretirement benefit expenses of $12 million. A 25-basis point increase in the interest crediting rate would result in an increase in 2006 U.S. pension expense of approximately $18 million.
Investment strategy and asset allocation
The investment policy for the Firm’s postretirement employee benefit plan assets is to optimize the risk-return relationship as appropriate to the respective plan’s needs and goals, using a global portfolio of various asset classes diversified by market segment, economic sector, and issuer. Specifically, the goal is to optimize the asset mix for future benefit obligations, while managing various risk factors and each plan’s investment return objectives. For example, long-duration fixed income securities are included in the U.S. qualified pension plan’s asset allocation, in recognition of its long-duration obligations. Plan assets are managed by a combination of internal and external investment managers and, on a quarterly basis, are rebalanced to target, to the extent economically practical.
The Firm’s U.S. pension plan assets are held in various trusts and are invested in well-diversified portfolios of equities (including U.S. large and small capitalization and international equities), fixed income (including corporate and government bonds), Treasury inflation-indexed and high-yield securities, cash equivalents, and other securities. Non-U.S. pension plan assets are held in various trusts and are similarly invested in well-diversified portfolios of equity, fixed income and other securities. Assets of the Firm’s COLI policies, which are used to fund partially the U.S. postretirement benefit plan, are held in separate accounts with an insurance company and are invested in equity and fixed income index funds. In addition, tax-exempt municipal debt securities, held in a trust, are used to fund the U.S. postretirement benefit plan. As of December 31, 2005, the assets used to fund the Firm’s U.S. and non-U.S. defined benefit pension and postretirement benefit plans do not include JPMorgan Chase common stock, except in connection with investments in third-party stock-index funds.


The following table presents the weighted-average asset allocation at December 31 for the years indicated, and the respective target allocation by asset category, for the Firm’s U.S. and non-U.S. defined benefit pension and postretirement benefit plans.
                                                                         
    Defined benefit pension plans        
    U.S.     Non-U.S. (a)     Postretirement benefit plans (b)
    Target   % of plan assets     Target   % of plan assets     Target   % of plan assets
December 31,   Allocation   2005     2004     Allocation   2005     2004     Allocation     2005     2004  
 
Asset category
                                                                       
Debt securities
    30 %     33 %     38 %     74 %     75 %     76 %     50 %     54 %     54 %
Equity securities
    55       57       53       25       24       24       50       46       46  
Real estate
    5       6       5       1       1                          
Other
    10       4       4                                      
 
Total
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %
 
(a)   Represents the U.K. defined benefit pension plan only, as plans outside the U.K. are not significant.
 
(b)   Represents the U.S. postretirement benefit plan only, as the U.K. plan is unfunded.
     
JPMorgan Chase & Co. / 2005 Annual Report   99

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
Estimated future benefit payments
The following table presents benefit payments expected to be paid, which include the effect of expected future service, for the years indicated. The postretirement medical and life insurance payments are net of expected retiree contributions.
                                 
            Non-     Other postretirement        
Year ended December 31,   U.S. pension     U.S. pension     benefits before        
(in millions)   benefits     benefits     Medicare Part D subsidy     Medicare Part D subsidy  
 
2006
  $ 558     $ 67     $ 124     $ 14  
2007
    550       70       127       15  
2008
    565       74       127       16  
2009
    584       77       128       17  
2010
    600       81       129       19  
Years 2011–2015
    3,266       396       633       111  
 

Defined contribution plans
JPMorgan Chase offers several defined contribution plans in the U.S. and certain non-U.S. locations. The most significant of these plans is the 401(k) Savings Plan, which covers substantially all U.S. employees. The 401(k) Savings Plan allows employees to make pre-tax contributions to tax-deferred investment portfolios. The JPMorgan Chase Common Stock Fund within the 401(k) Savings Plan is a nonleveraged employee stock ownership plan. The Firm matches eligible employee contributions up to a certain percentage of benefits-eligible compensation per pay period, subject to plan and legal limits. Employees begin to receive matching contributions after completing a specified service requirement and are immediately vested in such company contributions. The Firm’s defined contribution plans are administered in accordance with applicable local laws and regulations. Compensation expense related to these plans totaled $392 million in 2005, $317 million in 2004 and $240 million in 2003.
Note 7 – Employee stock-based incentives
Effective January 1, 2003, JPMorgan Chase adopted SFAS 123 using the prospective transition method. SFAS 123 requires all stock-based compensation awards, including stock options and stock-settled stock appreciation rights (“SARs”), to be accounted for at fair value. The Firm currently uses the Black-Scholes valuation model to estimate the fair value of stock options and SARs. Stock options that were outstanding as of December 31, 2002, continue to be accounted for under APB 25 using the intrinsic value method. Under this method, no expense is recognized for stock options or SARs granted at the stock price on grant date, since such options have no intrinsic value. Compensation expense for restricted stock and restricted stock units (“RSUs”) is measured based upon the number of shares granted and the stock price at the grant date. Compensation expense is recognized in earnings over the required service period.
In connection with the Merger in 2004, JPMorgan Chase converted all outstanding Bank One employee stock-based awards at the merger date, and those awards became exercisable for or based upon JPMorgan Chase common stock. The number of awards converted, and the exercise prices of those awards, was adjusted to take into account the Merger exchange ratio of 1.32.
On December 16, 2004, the FASB issued SFAS 123R, which revises SFAS 123 and supersedes APB 25. In March 2005, the SEC issued SAB 107, which provides interpretive guidance on SFAS 123R. Accounting and reporting under SFAS 123R is generally similar to the SFAS 123 approach. However, SFAS 123R
requires all share-based payments to employees, including grants of employee stock options and SARs, to be recognized in the income statement based upon their fair values. Pro forma disclosure is no longer an alternative. SFAS 123R permits adoption using one of two methods – modified prospective or modified retrospective. In April 2005, the U.S. Securities and Exchange Commission approved a new rule that, for public companies, delayed the effective date of SFAS 123R to no later than January 1, 2006. The Firm adopted SFAS 123R on January 1, 2006, under the modified prospective method.
Key employee stock-based awards
In 2005, JPMorgan Chase granted long-term stock-based awards under the 1996 Long-Term Incentive Plan as amended (“the 1996 Plan”) until May 2005 and under the 2005 Long-Term Incentive Plan (“the 2005 Plan”) thereafter to certain key employees. These two plans, plus prior Firm plans and plans assumed as the result of acquisitions, constitute the Firm’s plans (“LTI Plans”). The 2005 Plan was adopted by the Board of Directors on March 15, 2005, and became effective on May 17, 2005, after approval by shareholders at the annual meeting. The 2005 Plan replaces three existing stock compensation plans – the 1996 Plan and two non-shareholder approved plans – all of which expired in May 2005. Under the terms of the 2005 Plan, 275 million shares of common stock are available for issuance during its five-year term. The 2005 Plan is the only active plan under which the Firm is currently granting stock-based incentive awards.
In 2005, 15.5 million SARs settled only in shares and 1.7 million nonqualified stock options were granted. Under the LTI Plans, stock options and SARs are granted with an exercise price equal to JPMorgan Chase’s common stock price on the grant date. Generally, options and SARs cannot be exercised until at least one year after the grant date and become exercisable over various periods as determined at the time of the grant. These awards generally expire 10 years after the grant date.
In December 2005, the Firm accelerated the vesting of approximately 41 million unvested, out-of-the-money employee stock options granted in 2001 under the Growth and Performance Incentive Program (“GPIP”), which were scheduled to vest in January 2007. These options were not modified other than to accelerate vesting. The related expense was approximately $145 million, and was recognized as compensation expense in the fourth quarter of 2005. The Firm believes that at the time the options were accelerated they had limited economic value since the exercise price of the accelerated options was $51.22 and the closing price of the Firm’s common stock on the effective date of the acceleration was $39.69.


     
100   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The following table presents a summary of JPMorgan Chase’s option and SAR activity under the LTI Plans during the last three years:
                                                 
    2005     2004     2003  
Year ended December 31, (a)   Number of     Weighted-average     Number of     Weighted-average     Number of     Weighted-average  
(Options/SARs in thousands)   options/SARs     exercise price     options/SARs     exercise price     options     exercise price  
 
Outstanding, January 1
    376,330     $ 37.59       294,026     $ 39.88       298,731     $ 40.84  
Granted
    17,248       35.55       16,667       39.79       26,751       22.15  
Bank One Conversion, July 1
  NA     NA       111,287       29.63     NA     NA  
Exercised
    (26,731 )     24.28       (27,763 )     25.33       (14,574 )     17.47  
Canceled
    (28,272 )     44.77       (17,887 )     46.68       (16,882 )     47.57  
 
Outstanding, December 31
    338,575     $ 37.93       376,330     $ 37.59       294,026     $ 39.88  
Exercisable, December 31
    286,017     $ 38.89       246,945     $ 36.82       176,163     $ 37.88  
 
(a)   2004 includes six months of awards for the combined Firm and six months of awards for heritage JPMorgan Chase. 2003 reflects the awards for heritage JPMorgan Chase only.
The following table details the distribution of options and SARs outstanding under the LTI Plans at December 31, 2005:
                                         
    Options/SARs outstanding     Options/SARs exercisable  
(Options/SARs in thousands)           Weighted-average     Weighted-average remaining             Weighted-average  
Range of exercise prices   Outstanding     exercise price     contractual life (in years)     Exercisable     exercise price  
 
$7.27–$20.00
    2,504     $ 19.12     0.8       2,503     $ 19.12  
$20.01–$35.00
    125,422       28.02     5.8       88,418       27.22  
$35.01–$50.00
    135,263       40.04     4.9       119,710       40.13  
$50.01–$63.48
    75,386       51.27     4.8       75,386       51.27  
 
Total
    338,575     $ 37.93     5.2       286,017     $ 38.89  
 

The following table presents a summary of JPMorgan Chase’s restricted stock and RSU activity under the LTI Plans during the last three years:
                         
(in thousands)   Number of restricted stock/RSUs  
Year ended December 31, (a)   2005     2004     2003  
 
Outstanding, January 1
    85,099       85,527       55,886  
Granted
    38,115       32,514       44,552  
Bank One conversion
  NA       15,116     NA
Lapsed (b)
    (30,413 )     (43,349 )     (12,545 )
Forfeited
    (8,197 )     (4,709 )     (2,366 )
 
Outstanding, December 31
    84,604       85,099       85,527  
 
(a)   2004 includes six months of awards for the combined Firm and six months of awards for heritage JPMorgan Chase. 2003 reflects the awards for heritage JPMorgan Chase only.
 
(b)   Lapsed awards represent both restricted stock for which restrictions have lapsed and RSUs that have been converted into common stock.
Restricted stock and RSUs are granted by JPMorgan Chase at no cost to the recipient. These awards are subject to forfeiture until certain restrictions have lapsed, including continued employment for a specified period. The recipient of a share of restricted stock is entitled to voting rights and dividends on the common stock. An RSU entitles the recipient to receive a share of common stock after the applicable restrictions lapse; the recipient is entitled to receive cash payments equivalent to any dividends paid on the underlying common stock during the period the RSU is outstanding. Effective January 2005, the equity portion of the Firm’s annual incentive awards were granted primarily in the form of RSUs.
The vesting of certain awards issued prior to 2002 is conditioned upon certain service requirements being met and JPMorgan Chase’s common stock reaching and sustaining target prices within a five-year performance period. During 2002, it was determined that it was no longer probable that the target stock prices related to forfeitable awards granted in 1999, 2000, and 2001 would be achieved within their respective performance periods, and accordingly, previously accrued expenses were reversed. The target stock prices for these awards range from $73.33 to $85.00. These awards were forfeited as follows: 1.2 million shares granted in 1999 were forfeited in January 2004; and 1.2 million shares granted in 2000 were forfeited in January 2005. Additionally, 1.2 million shares granted in 2001 were forfeited in January 2006.
Broad-based employee stock options
No broad-based employee stock option grants were made in 2005. Prior awards were granted by JPMorgan Chase under the Value Sharing Plan, a non-shareholder-approved plan. The exercise price is equal to JPMorgan Chase’s common stock price on the grant date. The options become exercisable over various periods and generally expire 10 years after the grant date.


     
JPMorgan Chase & Co. / 2005 Annual Report   101

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents a summary of JPMorgan Chase’s broad-based employee stock option plans and SAR activity during the past three years:
                                                 
Year ended December 31,   2005     2004     2003  
    Number of     Weighted-average     Number of     Weighted-average     Number of     Weighted-average  
(Options/SARs in thousands)   options/SARs     exercise price     options/SARs     exercise price     options     exercise price  
 
Outstanding, January 1
    112,184     $ 40.42       117,822     $ 39.11       113,155     $ 40.62  
Granted
                6,321       39.96       12,846       21.87  
Exercised
    (2,000 )     24.10       (5,960 )     15.26       (2,007 )     13.67  
Canceled
    (4,602 )     39.27       (5,999 )     39.18       (6,172 )     37.80  
 
Outstanding, December 31
    105,582     $ 40.78       112,184     $ 40.42       117,822     $ 39.11  
Exercisable, December 31
    52,592     $ 40.29       30,082     $ 36.33       36,396     $ 32.88  
 
The following table details the distribution of broad-based employee stock options and SARs outstanding at December 31, 2005:
                                         
    Options/SARs outstanding   Options/SARs exercisable  
(Options/SARs in thousands)           Weighted-average     Weighted-average remaining           Weighted-average  
Range of exercise prices   Outstanding     exercise price     contractual life (in years)   Exercisable     exercise price  
 
$20.01–$35.00
    15,200     $ 25.01       4.3       10,490     $ 26.42  
$35.01–$50.00
    70,088       41.18       4.5       41,990       43.72  
$50.01–$51.22
    20,294       51.22       5.1       112       51.22  
 
Total
    105,582     $ 40.78       4.6       52,592     $ 40.29  
 

Comparison of the fair and intrinsic value measurement methods
Pre-tax employee stock-based compensation expense related to the LTI plans totaled $1.6 billion in 2005, $1.3 billion in 2004 and $919 million in 2003.
The following table presents net income (after-tax) and basic and diluted earnings per share as reported, and as if all outstanding awards were accounted for at fair value:
                                 
Year ended December 31, (a)                    
(in millions, except per share data)     2005     2004     2003  
 
Net income as reported   $ 8,483     $ 4,466     $ 6,719  
Add:
  Employee stock-based compensation expense originally included in reported net income     938       778       551  
Deduct:
  Employee stock-based compensation expense determined under the fair value method for all awards     (1,015 )     (960 )     (863 )
 
Pro forma net income   $ 8,406     $ 4,284     $ 6,407  
 
Earnings per share:                        
Basic:
  As reported   $ 2.43     $ 1.59     $ 3.32  
 
  Pro forma     2.40       1.52       3.16  
Diluted:
  As reported   $ 2.38     $ 1.55     $ 3.24  
 
  Pro forma     2.36       1.48       3.09  
 
(a)   2004 results include six months of awards for the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The following table presents JPMorgan Chase’s weighted-average, grant-date fair values for the employee stock-based compensation awards granted, and the assumptions used to value stock options and SARs under the Black-Scholes valuation model:
                         
Year ended December 31, (a)   2005     2004     2003  
 
Weighted-average grant-date fair value
                       
Stock options:
                       
Key employee
  $ 10.44     $ 13.04     $ 5.60  
Broad-based employee
  NA       10.71       4.98  
Converted Bank One options
  NA       14.05     NA  
Restricted stock and RSUs (all payable solely in stock)
    37.35       39.58       22.03  
Weighted-average annualized stock option valuation assumptions
                       
Risk-free interest rate
    4.25 %     3.44 %     3.19 %
Expected dividend yield (b)
    3.79       3.59       5.99  
Expected common stock price volatility
    37       41       44  
Assumed weighted-average expected life of stock options (in years)
                       
Key employee
    6.8       6.8       6.8  
Broad-based employee
  NA       3.8       3.8  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Based primarily upon historical data at the grant dates.


     
102   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Note 8 – Noninterest expense
Merger costs
Costs associated with the Merger were reflected in the Merger costs caption of the Consolidated statements of income. A summary of such costs, by expense category, is shown in the following table for 2005 and 2004. There were no such costs in 2003.
                 
Year ended December 31, (in millions)   2005     2004 (a)
 
Expense category
               
Compensation
  $ 238     $ 467  
Occupancy
    (77 )     448  
Technology and communications and other
    561       450  
 
Total (b)
  $ 722     $ 1,365  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   With the exception of occupancy-related write-offs, all of the costs in the table require the expenditure of cash.
The table below shows the change in the liability balance related to the costs associated with the Merger.
                 
Year ended December 31, (in millions)   2005     2004 (a)
 
Liability balance, beginning of period
  $ 952     $  
Recorded as merger costs
    722       1,365  
Recorded as goodwill
    26       1,028  
Liability utilized
    (903 )     (1,441 )
 
Total
  $ 797     $ 952  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
Note 9 – Securities and
private equity investments
Securities are classified as AFS, Held-to-maturity (“HTM”) or Trading. Trading securities are discussed in Note 3 on page 94 of this Annual Report. Securities are classified as AFS when, in management’s judgment, they may be sold in response to or in anticipation of changes in market conditions, or as part of the Firm’s management of its structural interest rate risk. AFS securities are carried at fair value on the Consolidated balance sheets. Unrealized gains and losses after SFAS 133 valuation adjustments are reported as net increases or decreases to Accumulated other comprehensive income (loss). The specific identification method is used to determine realized gains and losses on AFS securities, which are included in Securities /private equity gains on the Consolidated statements of income. Securities that the Firm has the positive intent and ability to hold to maturity are classified as HTM and are carried at amortized cost on the Consolidated balance sheets.
The following table presents realized gains and losses from AFS securities and private equity gains (losses):
                         
Year ended December 31, (a)                  
(in millions)   2005     2004     2003  
 
Realized gains
  $ 302     $ 576     $ 2,123  
Realized losses
    (1,638 )     (238 )     (677 )
 
Net realized securities gains (losses)
    (1,336 )     338       1,446  
Private equity gains
    1,809       1,536       33  
 
Total Securities/private equity gains
  $ 473     $ 1,874     $ 1,479  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.


The amortized cost and estimated fair value of AFS and held-to-maturity securities were as follows for the dates indicated:
                                                                 
    2005   2004
            Gross   Gross                   Gross   Gross    
    Amortized   unrealized   unrealized   Fair   Amortized   unrealized   unrealized   Fair
December 31, (in millions)   cost   gains   losses   value   cost   gains   losses   value
 
Available-for-sale securities
                                                               
U.S. government and federal agency obligations:
                                                               
U.S. treasuries
  $ 4,245     $ 24     $ 2     $ 4,267     $ 13,621     $ 7     $ 222     $ 13,406  
Mortgage-backed securities
    80       3             83       2,405       41       17       2,429  
Agency obligations
    165       16             181       12                   12  
Collateralized mortgage obligations
    4                   4       71       4       4       71  
U.S. government-sponsored enterprise obligations
    22,604       9       596       22,017       46,143       142       593       45,692  
Obligations of state and political subdivisions
    712       21       7       726       2,748       126       8       2,866  
Debt securities issued by non-U.S. governments
    5,512       12       18       5,506       7,901       59       38       7,922  
Corporate debt securities
    5,754       39       74       5,719       7,007       127       18       7,116  
Equity securities
    3,179       110       7       3,282       5,810       39       14       5,835  
Other, primarily asset-backed securities (a)
    5,738       23       23       5,738       9,103       25       75       9,053  
 
Total available-for-sale securities
  $   47,993     $ 257     $ 727     $   47,523     $  94,821     $ 570     $ 989     $  94,402  
 
Held-to-maturity securities (b)
                                                               
Total held-to-maturity securities
  $ 77     $ 3     $     $ 80     $ 110     $ 7     $     $ 117  
 
(a)   Includes collateralized mortgage obligations of private issuers, which generally have underlying collateral consisting of obligations of the U.S. government and federal agencies and corporations.
 
(b)   Consists primarily of mortgage-backed securities.
     
JPMorgan Chase & Co. / 2005 Annual Report   103

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents the fair value and unrealized losses for AFS securities by aging category at December 31:
                                                 
    Securities with unrealized losses  
    Less than 12 months     12 months or more             Total  
            Gross             Gross     Total     Gross  
    Fair     unrealized     Fair     unrealized     Fair     unrealized  
2005 (in millions)   value     losses     value     losses     value     losses  
 
Available-for-sale securities
                                               
U.S. government and federal agency obligations:
                                               
U.S. treasuries
  $ 3,789     $ 1     $ 85     $ 1     $ 3,874     $ 2  
Mortgage-backed securities
                47             47        
Agency obligations
    7             13             20        
Collateralized mortgage obligations
    15             30             45        
U.S. government-sponsored enterprise obligations
    10,607       242       11,007       354       21,614       596  
Obligations of state and political subdivisions
    237       3       107       4       344       7  
Debt securities issued by non-U.S. governments
    2,380       17       71       1       2,451       18  
Corporate debt securities
    3,076       52       678       22       3,754       74  
Equity securities
    1,838       7       2             1,840       7  
Other, primarily asset-backed securities
    778       14       370       9       1,148       23  
 
Total securities with unrealized losses
  $ 22,727     $ 336     $ 12,410     $ 391     $ 35,137     $ 727  
 
                                                 
    Securities with unrealized losses  
    Less than 12 months     12 months or more             Total  
            Gross             Gross     Total     Gross  
    Fair     unrealized     Fair     unrealized     Fair     unrealized  
2004 (in millions)   value     losses     value     losses     value     losses  
 
Available-for-sale securities
                                               
U.S. government and federal agency obligations:
                                               
U.S. treasuries
  $ 10,186     $ 154     $ 940     $ 68     $ 11,126     $ 222  
Mortgage-backed securities
    344       1       1,359       16       1,703       17  
Agency obligations
    5             3             8        
Collateralized mortgage obligations
    278       4       2             280       4  
U.S. government-sponsored enterprise obligations
    34,760       282       10,525       311       45,285       593  
Obligations of state and political subdivisions
    678       6       96       2       774       8  
Debt securities issued by non-U.S. governments
    3,395       17       624       21       4,019       38  
Corporate debt securities
    1,103       13       125       5       1,228       18  
Equity securities
    1,804       14       23             1,827       14  
Other, primarily asset-backed securities
    1,896       41       321       34       2,217       75  
 
Total securities with unrealized losses
  $ 54,449     $ 532     $ 14,018     $ 457     $ 68,467     $ 989  
 

Impairment is evaluated considering numerous factors, and their relative significance varies case to case. Factors considered include the length of time and extent to which the market value has been less than cost; the financial condition and near-term prospects of the issuer of the securities; and the Firm’s intent and ability to retain the security in order to allow for an anticipated recovery in market value. If, based upon the analysis, it is determined that the impairment is other-than-temporary, the security is written down to fair value, and a loss is recognized through earnings.
Included in the $727 million of gross unrealized losses on AFS securities at December 31, 2005, was $391 million of unrealized losses that have existed for a period greater than 12 months. These securities are predominately rated AAA and the unrealized losses are due to overall increases in market interest rates and not due to underlying credit concerns of the issuers. Substantially all of the securities with unrealized losses aged greater than 12 months have a market value at December 31, 2005, that is within 4% of their amortized cost basis.
In calculating the effective yield for mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMO”), JPMorgan Chase includes the effect of principal prepayments. Management regularly performs simulation testing to determine the impact that market conditions would have on its MBS and CMO portfolios. MBSs and CMOs that management believes have prepayment risk are included in the AFS portfolio and are reported at fair value.


     
104   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The following table presents the amortized cost, estimated fair value and average yield at December 31, 2005, of JPMorgan Chase’s AFS and HTM securities by contractual maturity:
                                                 
    Available-for-sale securities     Held-to-maturity securities  
Maturity schedule of securities   Amortized     Fair     Average     Amortized     Fair     Average  
December 31, 2005 (in millions)   cost     value     yield (a)   cost     value     yield (a)
 
Due in one year or less
  $ 6,723     $ 6,426       2.77 %   $     $       %
Due after one year through five years
    7,740       8,009       3.72                    
Due after five years through 10 years
    5,346       5,366       4.70       30       31       6.96  
Due after 10 years (b)
    28,184       27,722       4.69       47       49       6.73  
 
Total securities
  $ 47,993     $ 47,523       4.27 %   $ 77     $ 80       6.82 %
 
(a)   The average yield is based upon amortized cost balances at year-end. Yields are derived by dividing interest income by total amortized cost. Taxable-equivalent yields are used where applicable.
 
(b)   Includes securities with no stated maturity. Substantially all of JPMorgan Chase’s MBSs and CMOs are due in 10 years or more based upon contractual maturity. The estimated duration, which reflects anticipated future prepayments based upon a consensus of dealers in the market, is approximately four years for MBSs and CMOs.

Private equity investments are primarily held by the Private Equity business within Corporate (which includes JPMorgan Partners and ONE Equity Partners businesses). The Private Equity business invests in buyouts, growth equity and venture opportunities in the normal course of business. These investments are accounted for under investment company guidelines. Accordingly, these investments, irrespective of the percentage of equity ownership interest held by Private Equity, are carried on the Consolidated balance sheets at fair value. Realized and unrealized gains and losses arising from changes in value are reported in Securities/private equity gains in the Consolidated statements of income in the period that the gains or losses occur.
Privately-held investments are initially valued based upon cost. The carrying values of privately-held investments are adjusted from cost to reflect both positive and negative changes evidenced by financing events with third-party capital providers. In addition, these investments are subject to ongoing impairment reviews by Private Equity’s senior investment professionals. A variety of factors are reviewed and monitored to assess impairment including, but not limited to, operating performance and future expectations of the particular portfolio investment, industry valuations of comparable public companies, changes in market outlook and the third-party financing environment
 
 
Note 10 – Securities financing activities
JPMorgan Chase enters into resale agreements, repurchase agreements, securities borrowed transactions and securities loaned transactions primarily to finance the Firm’s inventory positions, acquire securities to cover short positions and settle other securities obligations. The Firm also enters into these transactions to accommodate customers’ needs.
Securities purchased under resale agreements (“resale agreements”) and securities sold under repurchase agreements (“repurchase agreements”) are generally treated as collateralized financing transactions and are carried on the Consolidated balance sheets at the amounts the securities will be subsequently sold or repurchased, plus accrued interest. Where appropriate, resale and repurchase agreements with the same counterparty are reported on a net basis in accordance with FIN 41. JPMorgan Chase takes possession of securities purchased under resale agreements. On a daily basis, JPMorgan Chase monitors the market value of the underlying collateral received from its counterparties, consisting primarily of U.S. and non-U.S. government and agency securities, and requests additional collateral from its counterparties when necessary.
over time. The Valuation Control Group within the Finance area is responsible for reviewing the accuracy of the carrying values of private investments held by Private Equity.
Private Equity also holds publicly-held equity investments, generally obtained through the initial public offering of privately-held equity investments. Publicly-held investments are marked to market at the quoted public value. To determine the carrying values of these investments, Private Equity incorporates the use of discounts to take into account the fact that it cannot immediately realize or risk-manage the quoted public values as a result of regulatory and/or contractual sales restrictions imposed on these holdings.
The following table presents the carrying value and cost of the Private Equity investment portfolio for the dates indicated:
                                 
    2005     2004  
    Carrying             Carrying        
December 31, (in millions)   value     Cost     value     Cost  
 
Total private
equity investments
  $ 6,374     $ 8,036     $ 7,735     $ 9,103  
 
 
 
Transactions similar to financing activities that do not meet the SFAS 140 definition of a repurchase agreement are accounted for as “buys” and “sells” rather than financing transactions. These transactions are accounted for as a purchase (sale) of the underlying securities with a forward obligation to sell (purchase) the securities. The forward purchase (sale) obligation, a derivative, is recorded on the Consolidated balance sheets at its fair value, with changes in fair value recorded in Trading revenue.
Securities borrowed and securities lent are recorded at the amount of cash collateral advanced or received. Securities borrowed consist primarily of government and equity securities. JPMorgan Chase monitors the market value of the securities borrowed and lent on a daily basis and calls for additional collateral when appropriate. Fees received or paid are recorded in Interest income or Interest expense.


     
JPMorgan Chase & Co. / 2005 Annual Report   105

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

                 
December 31, (in millions)   2005     2004  
 
Securities purchased under resale agreements
  $ 129,570     $ 94,076  
Securities borrowed
    74,604       47,428  
 
Securities sold under repurchase agreements
  $ 103,052     $ 105,912  
Securities loaned
    14,072       6,435  
 
JPMorgan Chase pledges certain financial instruments the Firm owns to collateralize repurchase agreements and other securities financings. Pledged securities that can be sold or repledged by the secured party are identified as financial instruments owned (pledged to various parties) on the Consolidated balance sheets.
At December 31, 2005, the Firm had received securities as collateral that can be repledged, delivered or otherwise used with a fair value of approximately $331 billion. This collateral was generally obtained under resale or securities borrowing agreements. Of these securities, approximately $320 billion were repledged, delivered or otherwise used, generally as collateral under repurchase agreements, securities lending agreements or to cover short sales.
Note 11 – Loans
Loans are reported at the principal amount outstanding, net of the Allowance for loan losses, unearned income and any net deferred loan fees. Loans held for sale are carried at the lower of cost or fair value, with valuation changes recorded in noninterest revenue. Loans are classified as “trading” where positions are bought and sold to make profits from short-term movements in price. Loans held for trading purposes are included in Trading assets and are carried at fair value, with gains and losses included in Trading revenue. Interest income is recognized using the interest method, or on a basis approximating a level rate of return over the term of the loan.
Nonaccrual loans are those on which the accrual of interest is discontinued. Loans (other than certain consumer loans discussed below) are placed on nonaccrual status immediately if, in the opinion of management, full payment of principal or interest is in doubt, or when principal or interest is 90 days or more past due and collateral, if any, is insufficient to cover principal and interest. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against Interest income. In addition, the amortization of net deferred loan fees is suspended. Interest income on nonaccrual loans is recognized only to the extent it is received in cash. However, where there is doubt regarding the ultimate collectibility of loan principal, all cash thereafter received is applied to reduce the carrying value of such loans. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured.
Consumer loans are generally charged to the Allowance for loan losses upon reaching specified stages of delinquency, in accordance with the Federal Financial Institutions Examination Council (“FFIEC”) policy. For example, credit card loans are charged off by the end of the month in which the account becomes 180 days past due or within 60 days from receiving notification of the filing of bankruptcy, whichever is earlier. Residential mortgage products are generally charged off to net realizable value at 180 days past due. Other consumer products are generally charged off (to net realizable value if collateralized) at 120 days past due. Accrued interest on residential mortgage products, and automobile and education financings and certain other consumer loans are accounted for in accordance with the nonaccrual loan policy discussed
in the preceding paragraph. Interest and fees related to credit card loans continue to accrue until the loan is charged off or paid. Accrued interest on all other consumer loans is generally reversed against interest income when the loan is charged off. A collateralized loan is considered an in-substance foreclosure and is reclassified to assets acquired in loan satisfactions, within Other assets, only when JPMorgan Chase has taken physical possession of the collateral, but regardless of whether formal foreclosure proceedings have taken place.
The composition of the loan portfolio at each of the dates indicated was as follows:
                 
December 31, (in millions)   2005     2004  
 
U.S. wholesale loans:
               
Commercial and industrial
  $ 70,233     $ 61,033  
Real estate
    13,612       13,038  
Financial institutions
    11,100       14,195  
Lease financing receivables
    2,621       3,098  
Other
    14,499       8,504  
 
Total U.S. wholesale loans
    112,065       99,868  
 
 
               
Non-U.S. wholesale loans:
               
Commercial and industrial
    27,452       25,120  
Real estate
    1,475       1,747  
Financial institutions
    7,975       7,280  
Lease financing receivables
    1,144       1,052  
 
Total non-U.S. wholesale loans
    38,046       35,199  
 
 
               
Total wholesale loans: (a)
               
Commercial and industrial
    97,685       86,153  
Real estate (b)
    15,087       14,785  
Financial institutions
    19,075       21,475  
Lease financing receivables
    3,765       4,150  
Other
    14,499       8,504  
 
Total wholesale loans
    150,111       135,067  
 
 
               
Total consumer loans: (c)
               
Consumer real estate
               
Home finance – home equity & other
    76,727       67,837  
Home finance – mortgage
    56,726       56,816  
 
Total Home finance
    133,453       124,653  
Auto & education finance
    49,047       62,712  
Consumer & small business and other
    14,799       15,107  
Credit card receivables (d)
    71,738       64,575  
 
Total consumer loans
    269,037       267,047  
 
Total loans (e)(f)(g)
  $ 419,148     $ 402,114  
 
(a)   Includes Investment Bank, Commercial Banking, Treasury & Securities Services and Asset & Wealth Management.
 
(b)   Represents credits extended for real estate–related purposes to borrowers who are primarily in the real estate development or investment businesses and for which the primary repayment is from the sale, lease, management, operations or refinancing of the property.
 
(c)   Includes Retail Financial Services and Card Services.
 
(d)   Includes billed finance charges and fees net of an allowance for uncollectible amounts.
 
(e)   Loans are presented net of unearned income of $3.0 billion and $4.1 billion at December 31, 2005 and 2004, respectively.
 
(f)   Includes loans held for sale (primarily related to securitization and syndication activities) of $34.2 billion and $24.5 billion at December 31, 2005 and 2004, respectively.
 
(g)   Amounts are presented gross of the Allowance for loan losses.


     
106   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The following table reflects information about the Firm’s loans held for sale, principally mortgage-related:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Net gains on sales of loans held for sale
  $ 596     $ 368     $ 933  
Lower of cost or fair value adjustments
    (332 )     39       26  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
Impaired loans
JPMorgan Chase accounts for and discloses nonaccrual loans as impaired loans and recognizes their interest income as discussed previously for nonaccrual loans. The Firm excludes from impaired loans its small-balance, homogeneous consumer loans; loans carried at fair value or the lower of cost or fair value; debt securities; and leases.
The table below sets forth information about JPMorgan Chase’s impaired loans. The Firm primarily uses the discounted cash flow method for valuing impaired loans:
                 
December 31, (in millions) (a)   2005     2004  
 
Impaired loans with an allowance
  $ 1,095     $ 1,496  
Impaired loans without an allowance (b)
    80       284  
 
Total impaired loans
  $ 1,175     $ 1,780  
 
Allowance for impaired loans under SFAS 114 (c)
  $ 257     $ 521  
Average balance of impaired loans during the year
    1,478       1,883  
Interest income recognized on impaired loans during the year
    5       8  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   When the discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, then the loan does not require an allowance under SFAS 114.
 
(c)   The allowance for impaired loans under SFAS 114 is included in JPMorgan Chase’s Allowance for loan losses.
Note 12 – Allowance for credit losses
JPMorgan Chase’s Allowance for loan losses covers the wholesale (risk-rated) and consumer (scored) loan portfolios and represents management’s estimate of probable credit losses inherent in the Firm’s loan portfolio. Management also computes an Allowance for wholesale lending-related commitments using a methodology similar to that used for the wholesale loans.
The Allowance for loan losses includes an asset-specific component and a formula-based component. Within the formula-based component is a statistical calculation and an adjustment to the statistical calculation.
The asset-specific component relates to provisions for losses on loans considered impaired and measured pursuant to SFAS 114. An allowance is established when the discounted cash flows (or collateral value or observable market price) of the loan is lower than the carrying value of that loan. To compute the asset-specific component of the allowance, larger impaired loans are evaluated individually, and smaller impaired loans are evaluated as a pool using historical loss experience for the respective class of assets.
The formula-based component covers performing wholesale and consumer loans and is the product of a statistical calculation, as well as adjustments to such calculation. These adjustments take into consideration model imprecision, external factors and economic events that have occurred but are not yet reflected in the factors used to derive the statistical calculation.
The statistical calculation is the product of probability of default and loss given default. For risk-rated loans (generally loans originated by the wholesale lines of business), these factors are differentiated by risk rating and maturity. For scored loans (generally loans originated by the consumer lines of business), loss is primarily determined by applying statistical loss factors and other risk indicators to pools of loans by asset type. Adjustments to the statistical calculation for the risk-rated portfolios are determined by creating estimated ranges using historical experience of both loss given default and probability of default. Factors related to concentrated and deteriorating industries are also incorporated into the calculation where relevant. Adjustments to the statistical calculation for the scored loan portfolios are accomplished in part by analyzing the historical loss experience for each major product segment. The estimated ranges and the determination of the appropriate point within the range are based upon management’s view of uncertainties that relate to current macroeconomic and political conditions, quality of underwriting standards, and other relevant internal and external factors affecting the credit quality of the portfolio.
The Allowance for lending-related commitments represents management’s estimate of probable credit losses inherent in the Firm’s process of extending credit. Management establishes an asset-specific allowance for lending-related commitments that are considered impaired and computes a formula-based allowance for performing wholesale lending-related commitments. These are computed using a methodology similar to that used for the wholesale loan portfolio, modified for expected maturities and probabilities of drawdown.
The allowance for credit losses is reviewed at least quarterly by the Chief Risk Officer of the Firm, the Risk Policy Committee, a risk subgroup of the Operating Committee, and the Audit Committee of the Board of Directors of the Firm relative to the risk profile of the Firm’s credit portfolio and current economic conditions. As of December 31, 2005, JPMorgan Chase deemed the allowance for credit losses to be appropriate (i.e., sufficient to absorb losses that are inherent in the portfolio, including those not yet identifiable).
As a result of the Merger, management modified its methodology for determining the Provision for credit losses for the combined Firm. The effect of conforming methodologies in 2004 was a decrease in the consumer allowance of $254 million and a decrease in the wholesale allowance (including both funded loans and lending-related commitments) of $330 million. In addition, the Bank One seller’s interest in credit card securitizations was decertificated; this resulted in an increase to the provision for loan losses of approximately $1.4 billion (pre-tax) in 2004.


     
JPMorgan Chase & Co. / 2005 Annual Report   107

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

JPMorgan Chase maintains an allowance for credit losses as follows:
                 
    Reported in:
Allowance for            
credit losses on:   Balance sheet   Income statement
 
Loans
  Allowance for loan losses   Provision for credit losses
Lending-related commitments
  Other liabilities   Provision for credit losses
 
The table below summarizes the changes in the Allowance for loan losses:
                 
December 31, (in millions)   2005     2004 (c)
 
Allowance for loan losses at January 1
  $ 7,320     $ 4,523  
Addition resulting from the Merger, July 1, 2004
          3,123  
Gross charge-offs
    (4,869 )     (3,805 ) (d)
Gross recoveries
    1,050       706  
 
Net charge-offs
    (3,819 )     (3,099 )
Provision for loan losses:
               
Provision excluding accounting policy conformity
    3,575       1,798  
Accounting policy conformity (a)
          1,085  
 
Total Provision for loan losses
    3,575       2,883  
 
               
Other
    14       (110 ) (e)
 
Allowance for loan losses at December 31
  $ 7,090 (b)   $ 7,320 (f)
 
(a)   Represents an increase of approximately $1.4 billion as a result of the decertification of heritage Bank One seller’s interest in credit card securitizations, partially offset by a reduction of $357 million to conform provision methodologies.
 
(b)   2005 includes $203 million of asset-specific and $6.9 billion of formula-based allowance. Included within the formula-based allowance was $5.1 billion related to a statistical calculation (including $400 million related to Hurricane Katrina), and an adjustment to the statistical calculation of $1.8 billion.
 
(c)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(d)   Includes $406 million related to the Manufactured Home Loan portfolio in the fourth quarter of 2004.
 
(e)   Primarily represents the transfer of the allowance for accrued interest and fees on reported and securitized credit card loans.
 
(f)   2004 includes $469 million of asset-specific loss and $6.8 billion of formula-based loss. Included within the formula-based loss is $4.8 billion related to statistical calculation and an adjustment to the statistical calculation of $2.0 billion.
The table below summarizes the changes in the Allowance for lending-related commitments:
                 
December 31, (in millions)   2005     2004 (c)
 
Allowance for lending-related commitments at January 1
  $ 492     $ 324  
Addition resulting from the Merger, July 1, 2004
          508  
 
               
Provision for lending-related commitments:
               
Provision excluding accounting policy conformity
    (92 )     (112 )
Accounting policy conformity (a)
          (227 )
 
Total Provision for lending-related commitments
    (92 )     (339 )
 
               
Other
          (1 )
 
Allowance for lending-related commitments at December 31 (b)
  $ 400     $ 492  
 
(a)   Represents a reduction of $227 million to conform provision methodologies in the wholesale portfolio.
 
(b)   2005 includes $60 million of asset-specific and $340 million of formula-based allowance. 2004 includes $130 million of asset-specific and $362 million of formula-based allowance. The formula-based allowance for lending-related commitments is based upon a statistical calculation. There is no adjustment to the statistical calculation for lending-related commitments.
 
(c)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
Note 13 – Loan securitizations
JPMorgan Chase securitizes, sells and services various consumer loans, such as consumer real estate, credit card and automobile loans, as well as certain wholesale loans (primarily real estate) originated by the Investment Bank. In addition, the Investment Bank purchases, packages and securitizes commercial and consumer loans. All IB activity is collectively referred to below as Wholesale activities. Interests in the sold and securitized loans may be retained.
The Firm records a loan securitization as a sale when the transferred loans are legally isolated from the Firm’s creditors and the accounting criteria for a sale are met. Those criteria are (1) the assets are legally isolated from the Firm’s creditors; (2) the entity can pledge or exchange the financial assets or, if the entity is a QSPE, its investors can pledge or exchange their interests; and (3) the Firm does not maintain effective control via an agreement to repurchase the assets before their maturity or have the ability to unilaterally cause the holder to return the assets.
Gains or losses recorded on loan securitizations depend, in part, on the carrying amount of the loans sold and are allocated between the loans sold and the retained interests, based upon their relative fair values at the date of sale. Gains on securitizations are reported in noninterest revenue. Since quoted market prices are generally not available, the Firm usually estimates the fair value of these retained interests by determining the present value of future expected cash flows using modeling techniques. Such models incorporate management’s best estimates of key variables, such as expected credit losses, prepayment speeds and the discount rates appropriate for the risks involved.
Retained interests that are subject to prepayment risk, such that JPMorgan Chase may not recover substantially all of its investment, are recorded at fair value; subsequent adjustments are reflected in Other comprehensive income or in earnings, if the fair value of the retained interest has declined below its carrying amount and such decline has been determined to be other-than-temporary.
Interests in the securitized loans are generally retained by the Firm in the form of senior or subordinated interest-only strips, subordinated tranches, escrow accounts and servicing rights, and they are generally recorded in Other assets. In addition, credit card securitization trusts require the Firm to maintain a minimum undivided interest in the trusts, representing the Firm’s interests in the receivables transferred to the trust that have not been securitized. These interests are not represented by security certificates. The Firm’s undivided interests are carried at historical cost and are classified in Loans. Retained interests from wholesale activities are reflected as trading assets.
JPMorgan Chase retains servicing responsibilities for all residential mortgage, credit card and automobile loan securitizations and for certain wholesale activity securitizations it sponsors, and receives servicing fees based on the securitized loan balance plus certain ancillary fees. The Firm also retains the right to service the residential mortgage loans it sells in connection with mortgage-backed securities transactions with the Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”). For a discussion of mortgage servicing rights, see Note 15 on pages 114–116 of this Annual report.
JPMorgan Chase-sponsored securitizations utilize SPEs as part of the securitization process. These SPEs are structured to meet the definition of a QSPE (as discussed in Note 1 on page 91 of this Annual Report); accordingly, the assets and liabilities of securitization-related QSPEs are not reflected in the Firm’s Consolidated balance sheets (except for retained interests, as described below) but are included on the balance sheet of the QSPE purchasing the


     
108   JPMorgan Chase & Co. / 2005 Annual Report

 


 

assets. Assets held by securitization-related SPEs as of December 31, 2005 and 2004, were as follows:
                 
December 31, (in billions)   2005     2004  
 
Credit card receivables
  $ 96.0     $ 106.3  
Residential mortgage receivables
    29.8       19.1  
Wholesale activities (a)
    72.9       44.8  
Automobile loans
    5.5       4.9  
 
Total
  $ 204.2     $ 175.1  
 
(a)   Co-sponsored securitizations include non-JPMorgan Chase originated assets.
The following table summarizes new securitization transactions that were completed during 2005 and 2004, the resulting gains arising from such securitizations, certain cash flows received from such securitizations, and the key economic assumptions used in measuring the retained interests, as of the dates of such sales:


                                                                 
Year ended December 31,   2005     2004 (a)  
    Residential                     Wholesale     Residential                     Wholesale  
(in millions)   mortgage     Credit card     Automobile     activities (e)   mortgage     Credit card     Automobile     activities (e)
 
Principal securitized
  $ 18,125     $ 15,145     $ 3,762     $ 22,691     $ 6,529     $ 8,850     $ 1,600     $ 8,756  
Pre-tax gains (losses)
    21       101       9 (c)     131       47       52       (3 )     135  
Cash flow information:
                                                               
Proceeds from securitizations
  $ 18,093     $ 14,844     $ 2,622     $ 22,892     $ 6,608     $ 8,850     $ 1,597     $ 8,430  
Servicing fees collected
    17       94       4             12       69       1       3  
Other cash flows received
          298             3       25       225             16  
Proceeds from collections reinvested in revolving securitizations
          129,696                         110,697              
 
Key assumptions (rates per annum):
                                                               
Prepayment rate (b)
    9.1–12.1 %     16.7–20.0 %     1.5 %     0–50 %     23.8–37.6 %     15.5–16.7 %     1.5 %     17.0–50.0 %
 
  CPR     PPR     ABS             CPR     PPR     ABS          
 
Weighted-average life (in years)
    5.6–6.7       0.4–0.5       1.4–1.5       1.0–4.4       1.9–3.0       0.5–0.6       1.8       2.0–4.0  
Expected credit losses
    (d)     4.7–5.7 %     0.6–0.7 %     0–2.0 % (d)     1.0–2.3 %     5.5–5.8 %     0.6 %     0.0–3.0 % (d)
Discount rate
    13.0–13.3 %     12.0 %     6.3–7.3 %     0.6–18.5 %     15.0–30.0 %     12.0 %     4.1 %     0.6–5.0 %
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   CPR: constant prepayment rate; ABS: absolute prepayment speed; PPR: principal payment rate.
 
(c)   The auto securitization gain of $9 million does not include the write-down of loans transferred to held-for-sale in 2005 and risk management activities intended to protect the economic value of the loans while held-for-sale.
 
(d)   Expected credit losses for prime residential mortgage and certain wholesale securitizations are minimal and are incorporated into other assumptions.
 
(e)   Wholesale activities consist of wholesale loans (primarily commercial real estate) originated by the Investment Bank as well as $11.4 billion and $1.8 billion of consumer loans purchased from the market in 2005 and 2004, respectively, and then packaged and securitized by the Investment Bank.

In addition to securitization transactions, the Firm sold residential mortgage loans totaling $52.5 billion, $65.7 billion and $123.2 billion during 2005, 2004 and 2003, respectively, primarily as GNMA, FNMA and Freddie Mac mortgage-backed securities; these sales resulted in pre-tax gains of $293 million, $58.1 million and $564.3 million, respectively.
At both December 31, 2005 and 2004, the Firm had, with respect to its credit card master trusts, $24.8 billion and $35.2 billion, respectively, related to undivided interests, and $2.2 billion and $2.1 billion, respectively, related to subordinated interests in accrued interest and fees on the securitized receivables, net of an allowance for uncollectible amounts. Credit card securitization trusts require the Firm to maintain a minimum undivided interest of 4% to 12% of the principal receivables in the trusts. The Firm maintained an average undivided interest in principal receivables in the trusts of approximately 23% for both 2005 and 2004, respectively.
The Firm also maintains escrow accounts up to predetermined limits for some credit card and automobile securitizations, in the unlikely event of deficiencies in cash flows owed to investors. The amounts available in such escrow accounts are recorded in Other assets and, as of December 31, 2005, amounted to
$754 million and $76 million for credit card and automobile securitizations, respectively; as of December 31, 2004, these amounts were $395 million and $132 million for credit card and automobile securitizations, respectively.
The table below summarizes other retained securitization interests, which are primarily subordinated or residual interests and are carried at fair value on the Firm’s Consolidated balance sheets:
                 
December 31, (in millions)   2005     2004  
 
Residential mortgage (a)
  $ 182     $ 433  
Credit card (a)
    808       494  
Automobile (a)(b)
    150       85  
Wholesale activities (c)
    265       23  
 
Total
  $ 1,405     $ 1,035  
 
(a)   Pre-tax unrealized gains (losses) recorded in Stockholders’ equity that relate to retained securitization interests totaled $60 million and $118 million for Residential mortgage; $6 million and $(3) million for Credit card; and $5 million and $11 million for Automobile at December 31, 2005 and 2004, respectively.
 
(b)   In addition to the automobile retained interest amounts noted above, the Firm also retained senior securities totaling $490 million at December 31, 2005, from 2005 auto securitizations that are classified as AFS securities. These securities are valued using quoted market prices and are therefore not included in the key economic assumption and sensitivities table that follows.
 
(c)   In addition to the wholesale retained interest amounts noted above, the Firm also retained subordinated securities totaling $51 million at December 31, 2005, from re-securitization activities. These securities are valued using quoted market prices and are therefore not included in the key assumptions and sensitivities table that follows.


     
JPMorgan Chase & Co. / 2005 Annual Report   109

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
The table below outlines the key economic assumptions used to determine the fair value of the other retained interests at December 31, 2005 and 2004, respectively; and it outlines the sensitivities of those fair values to immediate 10% and 20% adverse changes in those assumptions:
                                 
December 31, 2005 (in millions)   Residential mortgage   Credit card   Automobile   Wholesale activities
 
Weighted-average life (in years)
    0.5–3.5       0.4–0.7       1.2       0.2–4.1  
 
Prepayment rate
  20.1–43.7 % CPR   11.9–20.8 % PPR   1.5 % ABS     0.0–50.0 % (a)
Impact of 10% adverse change
  $ (3 )   $ (44 )   $     $ (5 )
Impact of 20% adverse change
    (5 )     (88 )     (2 )     (6 )
 
Loss assumption
    0.0–5.2 % (b)     3.2–8.1 %     0.7 %     0.0–2.0 % (b)
Impact of 10% adverse change
  $ (10 )   $ (77 )   $ (4 )   $ (6 )
Impact of 20% adverse change
    (19 )     (153 )     (9 )     (11 )
Discount rate
    12.7–30.0 % (c)     6.9–12.0 %     7.2 %     0.2–18.5 %
Impact of 10% adverse change
  $ (4 )   $ (2 )   $ (1 )   $ (6 )
Impact of 20% adverse change
    (8 )     (4 )     (3 )     (12 )
 
                                 
December 31, 2004 (in millions)   Residential mortgage   Credit card   Automobile   Wholesale activities
 
Weighted-average life (in years)
    0.8–3.4       0.5–1.0       1.3       0.2–4.0  
 
Prepayment rate
  15.1–37.1 % CPR   8.3–16.7 % PPR   1.4 % ABS     0.0–50.0 % (a)
Impact of 10% adverse change
  $ (5 )   $ (34 )   $ (6 )   $ (1 )
Impact of 20% adverse change
    (8 )     (69 )     (13 )     (1 )
 
Loss assumption
    0.0–5.0 % (b)     5.7–8.4 %     0.7 %     0.0–3.0 % (b)
Impact of 10% adverse change
  $ (17 )   $ (144 )   $ (4 )   $  
Impact of 20% adverse change
    (34 )     (280 )     (8 )      
Discount rate
    13.0–30.0 % (c)     4.9–12.0 %     5.5 %     1.0–22.9 %
Impact of 10% adverse change
  $ (9 )   $ (2 )   $ (1 )   $  
Impact of 20% adverse change
    (18 )     (4 )     (2 )      
 
(a)   Prepayment risk on certain wholesale retained interests are minimal and are incorporated into other assumptions.
 
(b)   Expected credit losses for prime residential mortgage and certain wholesale securitizations are minimal and are incorporated into other assumptions.
 
(c)   The Firm sold certain residual interests from sub-prime mortgage securitizations via Net Interest Margin (“NIM”) securitizations and retains residual interests in these NIM transactions, which are valued using a 30% discount rate.

The sensitivity analysis in the preceding table is hypothetical. Changes in fair value based upon a 10% or 20% variation in assumptions generally cannot be extrapolated easily, because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. In reality, changes in one
factor may result in changes in another assumption, which might counteract or magnify the sensitivities.
Expected static-pool net credit losses include actual incurred losses plus projected net credit losses, divided by the original balance of the outstandings comprising the securitization pool.


The table below displays the expected static-pool net credit losses for 2005, 2004 and 2003, based upon securitizations occurring in that year:
                                                 
    Loans securitized in: (a)
    2005   2004 (b)   2003 (b)
    Residential mortgage (c)   Automobile   Residential mortgage   Automobile   Residential mortgage   Automobile
 
December 31, 2005
    0.0 %     0.9 %     0.0–2.4 %     0.8 %     0.0–2.0 %     0.5 %
December 31, 2004
  NA     NA       0.0–3.3       1.1       0.0–2.1       0.9  
December 31, 2003
  NA     NA     NA     NA       0.0–3.6       0.9  
 
(a)   Static-pool losses are not applicable to credit card securitizations due to their revolving structure.
 
(b)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(c)   2005 securitizations consist of prime-mortgage securitizations only. Expected losses are minimal and incorporated in other assumptions.
     
110   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The table below presents information about delinquencies, net credit losses and components of reported and securitized financial assets at December 31, 2005 and 2004:
                                                 
                    Nonaccrual and 90 days or     Net loan charge-offs (a)  
    Total Loans     more past due     Year ended  
December 31, (in millions)   2005     2004     2005     2004     2005     2004  
 
Home finance
  $ 133,453     $ 124,653     $ 863     $ 673     $ 154     $ 573  
Auto & education finance
    49,047       62,712       195       193       277       263  
Consumer & small business and other
    14,799       15,107       280       295       141       154  
Credit card receivables
    71,738       64,575       1,091       1,006       3,324       1,923  
 
Total consumer loans
    269,037       267,047       2,429       2,167       3,896       2,913  
Total wholesale loans
    150,111       135,067       1,042       1,582       (77 )     186  
 
Total loans reported
    419,148       402,114       3,471       3,749       3,819       3,099  
 
                                               
Securitized loans:
                                               
Residential mortgage (b)
    8,061       11,533       370       460       105       150  
Automobile
    5,439       4,763       11       12       15       24  
Credit card
    70,527       70,795       730       1,337       3,776       2,898  
 
Total consumer loans securitized
    84,027       87,091       1,111       1,809       3,896       3,072  
Securitized wholesale activities
    9,049       1,401       4                    
 
Total loans securitized (c)
    93,076       88,492       1,115       1,809       3,896       3,072  
 
Total loans reported and securitized (d)
  $ 512,224     $ 490,606     $ 4,586     $ 5,558     $ 7,715     $ 6,171  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results.
 
(b)   Includes $5.9 billion and $10.3 billion of outstanding principal balances on securitized sub-prime 1–4 family residential mortgage loans as of December 31, 2005 and 2004, respectively.
 
(c)   Total assets held in securitization-related SPEs were $204.2 billion and $175.1 billion at December 31, 2005 and 2004, respectively. The $93.1 billion and $88.5 billion of loans securitized at December 31, 2005 and 2004, respectively, excludes: $85.6 billion and $50.8 billion of securitized loans, in which the Firm’s only continuing involvement is the servicing of the assets; $24.8 billion and $35.2 billion of seller’s interests in credit card master trusts; and $0.7 billion and $0.6 billion of escrow accounts and other assets, respectively.
 
(d)   Represents both loans on the Consolidated balance sheets and loans that have been securitized, but excludes loans for which the Firm’s only continuing involvement is servicing of the assets.

Note 14 – Variable interest entities
Refer to Note 1 on page 91 of this Annual Report for a further description of JPMorgan Chase’s policies regarding consolidation of variable interest entities.
JPMorgan Chase’s principal involvement with VIEs occurs in the following business segments:
  Investment Bank: Utilizes VIEs to assist clients in accessing the financial markets in a cost-efficient manner by providing the structural flexibility to meet their needs pertaining to price, yield and desired risk. There are two broad categories of transactions involving VIEs in the IB: (1) multi-seller conduits and (2) client intermediation; both are discussed below. The IB also securitizes loans through QSPEs which are not considered VIEs, to create asset-backed securities, as further discussed in Note 13 on pages 108–111 of this Annual Report.
 
  Asset & Wealth Management: Provides investment management services to a limited number of the Firm’s mutual funds deemed VIEs. AWM earns a fixed fee based upon assets managed; the fee varies with each fund’s investment objective and is competitively priced. For the limited number of funds that qualify as VIEs, AWM’s relationships with such funds are not considered significant interests under FIN 46R.
 
  Treasury & Securities Services: Provides trustee and custodial services to a number of VIEs. These services are similar to those provided to non-VIEs. TSS earns market-based fees for services provided. Such relationships are not considered significant interests under FIN 46R.
 
  Commercial Banking: Utilizes VIEs to assist clients in accessing the financial markets in a cost-efficient manner. This is often accomplished through the use of products similar to those offered in the Investment Bank.
    Commercial Banking may assist in the structuring and/or on-going administration of these VIEs and may provide liquidity, letters of credit and/or derivative instruments in support of the VIE.
  The Firm’s Private Equity business, included in Corporate, is involved with entities that may be deemed VIEs. Private equity activities are accounted for in accordance with the Investment Company Audit Guide (“Audit Guide”). The FASB deferred adoption of FIN 46R for non-registered investment companies that apply the Audit Guide until the proposed Statement of Position on the clarification of the scope of the Audit Guide is finalized. The Firm continues to apply this deferral provision; had FIN 46R been applied to VIEs subject to this deferral, the impact would have had an insignificant impact on the Firm’s Consolidated financial statements as of December 31, 2005.
As noted above, there are two broad categories of transactions involving VIEs with which the IB is involved: multi-seller conduits and client intermediation. These categories are discussed more fully below.
Multi-seller conduits
The Firm is an active participant in the asset-backed securities business, helping meet customers’ financing needs by providing access to the commercial paper markets through VIEs known as multi-seller conduits. These entities are separate bankruptcy-remote corporations in the business of purchasing interests in, and making loans secured by, receivable pools and other financial assets pursuant to agreements with customers. The entities fund their purchases and loans through the issuance of highly-rated commercial paper. The primary source of repayment of the commercial paper is the cash flow from the pools of assets.


     
JPMorgan Chase & Co. / 2005 Annual Report   111

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

JPMorgan Chase serves as the administrator and provides contingent liquidity support and limited credit enhancement for several multi-seller conduits. The commercial paper issued by the conduits is backed by collateral, credit enhancements and commitments to provide liquidity sufficient to support receiving at least a liquidity rating of A-1, P-1 and, in certain cases, F1.
As a means of ensuring timely repayment of the commercial paper, each asset pool financed by the conduits has a minimum 100% deal-specific liquidity facility associated with it. In the unlikely event an asset pool is removed from the conduit, the administrator can draw on the liquidity facility to repay the maturing commercial paper. The liquidity facilities are typically in the form of asset purchase agreements and are generally structured such that the bank liquidity is provided by purchasing, or lending against, a pool of non-defaulted, performing assets. Deal-specific liquidity is the primary source of liquidity support for the conduits.
Program-wide liquidity in the form of revolving and short-term lending commitments also is provided by the Firm to these vehicles in the event of short-term disruptions in the commercial paper market.
Deal-specific credit enhancement that supports the commercial paper issued by the conduits is generally structured to cover a multiple of historical losses expected on the pool of assets and is provided primarily by customers (i.e., sellers) or other third parties. The deal-specific credit enhancement is typically in the form of over-collateralization provided by the seller but also may include any combination of the following: recourse to the seller or originator, cash collateral accounts, letters of credit, excess spread, retention of subordinated interests or third-party guarantees. In certain instances, the Firm provides limited credit enhancement in the form of standby letters of credit.


The following table summarizes the Firm’s involvement with Firm-administered multi-seller conduits:
                                                 
    Consolidated     Nonconsolidated     Total  
December 31, (in billions)   2005     2004     2005     2004 (b)   2005     2004 (b)
 
Total commercial paper issued by conduits
  $ 35.2     $ 35.8     $ 8.9     $ 9.3     $ 44.1     $ 45.1  
Commitments
                                               
Asset-purchase agreements
  $ 47.9     $ 47.2     $ 14.3     $ 16.3     $ 62.2     $ 63.5  
Program-wide liquidity commitments
    5.0       4.0       1.0       2.0       6.0       6.0  
Program-wide limited credit enhancements
    1.3       1.4       1.0       1.2       2.3       2.6  
 
                                               
Maximum exposure to loss (a)
    48.4       48.2       14.8       16.9       63.2       65.1  
 
(a)   The Firm’s maximum exposure to loss is limited to the amount of drawn commitments (i.e., sellers’ assets held by the multi-seller conduits for which the Firm provides liquidity support) of $41.6 billion and $42.2 billion at December 31, 2005 and 2004, respectively, plus contractual but undrawn commitments of $21.6 billion and $22.9 billion at December 31, 2005 and 2004, respectively. Since the Firm provides credit enhancement and liquidity to these multi-seller conduits, the maximum exposure is not adjusted to exclude exposure absorbed by third-party liquidity providers.
 
(b)   In December 2003 and February 2004, two multi-seller conduits were restructured, with each conduit issuing preferred securities acquired by an independent third-party investor; the investor absorbs the majority of the expected losses of the conduit. In determining the primary beneficiary of the restructured conduits, the Firm leveraged an existing rating agency model – an independent market standard – to estimate the size of the expected losses, and the Firm considered the relative rights and obligations of each of the variable interest holders.

The Firm views its credit exposure to multi-seller conduit transactions as limited. This is because, for the most part, the Firm is not required to fund under the liquidity facilities if the assets in the VIE are in default. Additionally, the Firm’s obligations under the letters of credit are secondary to the risk of first loss provided by the customer or other third parties – for example, by the overcollateralization of the VIE with the assets sold to it or notes subordinated to the Firm’s liquidity facilities.
Client intermediation
As a financial intermediary, the Firm is involved in structuring VIE transactions to meet investor and client needs. The Firm intermediates various types of risks (including fixed income, equity and credit), typically using derivative instruments as further discussed below. In certain circumstances, the Firm also provides liquidity and other support to the VIEs to facilitate the transaction. The Firm’s current exposure to nonconsolidated VIEs is reflected in its Consolidated balance sheets or in the Notes to consolidated financial statements. The risks inherent in derivative instruments or liquidity commitments are managed similarly to other credit, market and liquidity risks to which the Firm is exposed. The Firm intermediates principally with the following types of VIEs: credit-linked note vehicles and municipal bond vehicles.


     
112   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The Firm structures credit-linked notes in which the VIE purchases highly-rated assets (such as asset-backed securities) and enters into a credit derivative contract with the Firm to obtain exposure to a referenced credit not held by the VIE. Credit-linked notes are issued by the VIE to transfer the risk of the referenced credit to the investors in the VIE. Clients and investors often prefer a VIE structure, since the credit-linked notes generally carry a higher credit rating than they would if issued directly by JPMorgan Chase.
The Firm is involved with municipal bond vehicles for the purpose of creating a series of secondary market trusts that allow tax-exempt investors to finance their investments at short-term tax-exempt rates. The VIE purchases fixed-rate, longer-term highly-rated municipal bonds by issuing puttable floating-rate certificates and inverse floating-rate certificates; the investors in the inverse floating-rate certificates are exposed to the residual losses of the VIE (the “residual interests”). For vehicles in which the Firm owns the residual interests, the Firm consolidates the VIE. In vehicles where third-party investors own the residual interests, the Firm’s exposure is limited because of the high credit quality of the underlying municipal bonds, the unwind triggers based upon the market value of the underlying collateral and the residual interests held by third parties. The Firm often serves as remarketing agent for the VIE and provides liquidity to support the remarketing.
Assets held by credit-linked and municipal bond vehicles at December 31, 2005 and 2004, were as follows:
                 
December 31, (in billions)   2005     2004  
 
Credit-linked note vehicles (a)
  $   13.5     $   17.8  
Municipal bond vehicles (b)
      13.7         7.5  
 
(a)   Assets of $1.8 billion and $2.3 billion reported in the table above were recorded on the Firm’s Consolidated balance sheets at December 31, 2005 and 2004, respectively, due to contractual relationships held by the Firm that relate to collateral held by the VIE.
 
(b)   Total amounts consolidated due to the Firm owning residual interests were $4.9 billion and $2.6 billion at December 31, 2005 and 2004, respectively, and are reported in the table. Total liquidity commitments were $5.8 billion and $3.1 billion at December 31, 2005 and 2004, respectively. The Firm’s maximum credit exposure to all municipal bond vehicles was $10.7 billion and $5.7 billion at December 31, 2005 and 2004, respectively.
Finally, the Firm may enter into transactions with VIEs structured by other parties. These transactions can include, for example, acting as a derivative counterparty, liquidity provider, investor, underwriter, placement agent, trustee or custodian. These transactions are conducted at arm’s length, and individual credit decisions are based upon the analysis of the specific VIE, taking into consideration the quality of the underlying assets. JPMorgan Chase records and reports these positions similarly to any other third-party transaction. These activities do not cause JPMorgan Chase to absorb a majority of the expected losses of the VIEs or to receive a majority of the residual returns of the VIE, and they are not considered significant for disclosure purposes.
Consolidated VIE assets
The following table summarizes the Firm’s total consolidated VIE assets, by classification on the Consolidated balance sheets, as of December 31, 2005 and 2004:
                 
December 31, (in billions)   2005     2004  
 
Consolidated VIE assets (a)
               
Investment securities (b)
  $   1.9     $   10.6  
Trading assets (c)
    9.3       4.7  
Loans
    8.1       3.4  
Interests in purchased receivables
    29.6       31.6  
Other assets
    3.0       0.4  
 
Total consolidated assets
  $   51.9     $   50.7  
 
(a)   The Firm also holds $3.9 billion and $3.4 billion of assets, at December 31, 2005 and December 31, 2004, respectively, primarily as a seller’s interest, in certain consumer securi-tizations in a segregated entity, as part of a two-step securitization transaction. This interest is included in the securitization activities disclosed in Note 13 on pages 108–111 of this Annual Report.
 
(b)   The decline in balance is primarily attributable to the sale of the Firm’s interest in a structured investment vehicle’s capital notes and resulting deconsolidation of this vehicle in 2005.
 
(c)   Includes the fair value of securities and derivatives.
Interests in purchased receivables include interests in receivables purchased by Firm-administered conduits, which have been consolidated in accordance with FIN 46R. Interests in purchased receivables are carried at cost and are reviewed to determine whether an other-than-temporary impairment exists. Based upon the current level of credit protection specified in each transaction, primarily through overcollateralization, the Firm determined that no other-than-temporary impairment existed at December 31, 2005.
The interest-bearing beneficial interest liabilities issued by consolidated VIEs are classified in the line item titled, “Beneficial interests issued by consolidated variable interest entities” on the Consolidated balance sheets. The holders of these beneficial interests do not have recourse to the general credit of JPMorgan Chase. See Note 17 on page 117 of this Annual Report for the maturity profile of FIN 46 long-term beneficial interests.
FIN 46R transition
In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”) to address various technical corrections and implementation issues that had arisen since the issuance of FIN 46. Effective March 31, 2004, JPMorgan Chase implemented FIN 46R for all VIEs, excluding certain investments made by its private equity business, as previously discussed. Implementation of FIN 46R did not have a significant effect on the Firm’s Consolidated financial statements.


     
JPMorgan Chase & Co. / 2005 Annual Report   113

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

Note 15 – Goodwill and other intangible assets
Goodwill is not amortized but instead tested for impairment in accordance with SFAS 142 at the reporting-unit segment, which is generally one level below the six major reportable business segments (as described in Note 31 on pages 130–131 of this Annual Report); plus Private Equity (which is included in Corporate). Goodwill is tested annually (during the fourth quarter) or more often if events or circumstances, such as adverse changes in the business climate, indicate there may be impairment. Intangible assets determined to have indefinite lives are not amortized but instead are tested for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the fair value of the indefinite-lived intangible asset to its carrying amount. Other acquired intangible assets determined to have finite lives, such as core deposits and credit card relationships, are amortized over their estimated useful lives in a manner that best reflects the economic benefits of the intangible asset. In addition, impairment testing is performed periodically on these amortizing intangible assets.
Goodwill and other intangible assets consist of the following:
                 
December 31, (in millions)   2005     2004  
 
Goodwill
  $ 43,621     $ 43,203  
Mortgage servicing rights
    6,452       5,080  
Purchased credit card relationships
    3,275       3,878  
 
                 
December 31, (in millions)   2005     2004  
 
All other intangibles:
               
Other credit card-related intangibles
  $ 124     $ 272  
Core deposit intangibles
    2,705       3,328  
All other intangibles
    2,003       2,126  
 
Total All other intangible assets
  $    4,832     $   5,726  
 
Goodwill
As of December 31, 2005, goodwill increased by $418 million compared with December 31, 2004, principally in connection with the establishment of the business partnership with Cazenove, as well as the acquisitions of Vastera, Neovest and the Sears Canada credit card business. These increases to Goodwill were partially offset by the deconsolidation of Paymentech. Goodwill was not impaired at December 31, 2005 or 2004, nor was any goodwill written off due to impairment during the years ended December 31, 2005, 2004 or 2003.
Goodwill attributed to the business segments was as follows:
                         
    Dec. 31,     Dec. 31,     Goodwill resulting  
(in millions)   2005     2004     from the Merger  
 
Investment Bank
  $ 3,531     $ 3,309     $ 1,179  
Retail Financial Services
    14,991       15,022       14,576  
Card Services
    12,984       12,781       12,802  
Commercial Banking
    2,651       2,650       2,599  
Treasury & Securities Services
    2,062       2,044       465  
Asset & Wealth Management
    7,025       7,020       2,539  
Corporate (Private Equity)
    377       377        
 
Total goodwill
  $ 43,621     $ 43,203     $ 34,160  
 
Mortgage servicing rights
JPMorgan Chase recognizes as intangible assets mortgage servicing rights, which represent the right to perform specified residential mortgage servicing activities for others. MSRs are either purchased from third parties or retained upon sale or securitization of mortgage loans. Servicing activities include collecting principal, interest, and escrow payments from borrowers; making tax and insurance payments on behalf of the borrowers; monitoring delinquencies and executing foreclosure proceedings; and accounting for and remitting principal and interest payments to the investors of the mortgage-backed securities.
The amount capitalized as MSRs represents the amount paid to third parties to acquire MSRs or is based on fair value, if retained upon the sale or securitization of mortgage loans. The Firm estimates the fair value of MSRs using a discounted future cash flow model. The model considers portfolio characteristics, contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenues and costs to service, as well as other economic factors.
During the fourth quarter of 2005, the Firm enhanced its valuation of MSRs by utilizing an option-adjusted spread (“OAS”) valuation approach. An OAS approach projects MSR cash flows over multiple interest rate scenarios in conjunction with the Firm’s proprietary prepayment model, and then discounts these cash flows at risk-adjusted rates. Prior to the fourth quarter of 2005, MSRs were valued using cash flows and discount rates determined by a “static” or single interest rate path valuation model. The initial valuation of MSRs under OAS did not have a material impact on the Firm’s financial statements.
The Firm compares fair value estimates and assumptions to observable market data where available and to recent market activity and actual portfolio experience. Management believes that the assumptions used to estimate fair values are supportable and reasonable.
The Firm accounts for its MSRs at the lower of cost or fair value, in accordance with SFAS 140. MSRs are amortized as a reduction of the actual servicing income received in proportion to, and over the period of, the estimated future net servicing income stream of the underlying mortgage loans. For purposes of evaluating and measuring impairment of MSRs, the Firm stratifies the portfolio on the basis of the predominant risk characteristics, which are loan type and interest rate. Any indicated impairment is recognized as a reduction in revenue through a valuation allowance, which represents the extent that the carrying value of an individual stratum exceeds its estimated fair value.


     
114   JPMorgan Chase & Co. / 2005 Annual Report

 


 

The Firm evaluates other-than-temporary impairment by reviewing changes in mortgage and other market interest rates over historical periods and then determines an interest rate scenario to estimate the amounts of the MSRs’ gross carrying value and the related valuation allowance that could be expected to be recovered in the foreseeable future. Any gross carrying value and related valuation allowance amounts that are not expected to be recovered in the foreseeable future, based upon the interest rate scenario, are considered to be other-than-temporary.
The carrying value of MSRs is sensitive to changes in interest rates, including their effect on prepayment speeds. JPMorgan Chase uses a combination of derivatives, AFS securities and trading instruments to manage changes in the fair value of MSRs. The intent is to offset any changes in the fair value of MSRs with changes in the fair value of the related risk management instrument. MSRs decrease in value when interest rates decline. Conversely, securities (such as mortgage-backed securities), principal-only certificates and derivatives (when the Firm receives fixed-rate interest payments) decrease in value when interest rates increase. The Firm offsets the interest rate risk of its MSRs by designating certain derivatives (e.g., a combination of swaps, swaptions and floors that produces an interest rate profile opposite to the designated risk of the hedged MSRs) as fair value hedges of specified MSRs under SFAS 133. SFAS 133 hedge accounting allows the carrying value of the hedged MSRs to be adjusted through earnings in the same period that the change in value of the hedging derivatives is recognized through earnings. Both of these valuation adjustments are recorded in Mortgage fees and related income.
When applying SFAS 133, the loans underlying the MSRs being hedged are stratified into specific SFAS 133 asset groupings that possess similar interest rate and prepayment risk exposures. The documented hedge period for the Firm is daily. Daily adjustments are performed to incorporate new or terminated derivative contracts and to modify the amount of the corresponding similar asset grouping that is being hedged. The Firm has designated changes in the benchmark interest rate (LIBOR) as the hedged risk. In designating the benchmark interest rate, the Firm considers the impact that the change in the benchmark rate has on the prepayment speed estimates in determining the fair value of the MSRs. The Firm performs both prospective and retrospective hedge-effectiveness evaluations, using a regression analysis, to determine whether the hedge relationship is expected to be highly effective. Hedge effectiveness is assessed by comparing the change in value of the MSRs as a result of changes in benchmark interest rates to the change in the value of the designated derivatives. For a further discussion on derivative instruments and hedging activities, see Note 26 on page 123 of this Annual Report.
Securities (both AFS and Trading) also are used to manage the risk exposure of MSRs. Because these securities do not qualify as hedges under SFAS 133, they are accounted for under SFAS 115. Realized and unrealized gains and losses on trading securities are recognized in earnings in Mortgage fees and related income; interest income on the AFS securities is recognized in earnings in Net interest income; and unrealized gains and losses on AFS securities are reported in Other comprehensive income. Finally, certain nonhedge derivatives, which have not been designated by management in SFAS 133 hedge relationships, are used to manage the economic risk exposure of MSRs and are recorded in Mortgage fees and related income.
Certain AFS securities purchased by the Firm to manage structural interest rate risk were designated in 2005 as risk management instruments of MSRs. At December 31, 2005 and 2004, the unrealized loss on AFS securities used to manage the risk exposure of MSRs was $174 million and $3 million, respectively.
The following table summarizes MSR activity and related amortization for the dates indicated. It also includes the key assumptions and the sensitivity of the fair value of MSRs at December 31, 2005, to immediate 10% and 20% adverse changes in each of those assumptions.
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Balance at January 1
  $ 6,111     $ 6,159     $ 4,864  
Additions
    1,897       1,757       3,201  
Bank One merger
  NA       90     NA  
Sales
          (3 )      
Other-than-temporary impairment
    (1 )     (149 )     (283 )
Amortization
    (1,295 )     (1,297 )     (1,397 )
SFAS 133 hedge valuation adjustments
    90       (446 )     (226 )
 
Balance at December 31
    6,802       6,111       6,159  
Less: valuation allowance
    350       1,031       1,378  
 
Balance at December 31, after valuation allowance
  $ 6,452     $ 5,080     $ 4,781  
 
                       
Estimated fair value at December 31
  $ 6,668     $ 5,124     $ 4,781  
Weighted-average prepayment speed assumption (CPR)
    17.56 %     17.29 %     17.67 %
Weighted-average discount rate
    9.68 %     7.93 %     7.31 %
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
CPR: Constant prepayment rate
         
    2005  
 
Weighted-average prepayment speed assumption (CPR)
    17.56 %
Impact on fair value with 10% adverse change
  $ (340 )
Impact on fair value with 20% adverse change
    (654 )
 
Weighted-average discount rate
    9.68 %
Impact on fair value with 10% adverse change
  $ (231 )
Impact on fair value with 20% adverse change
    (446 )
 
CPR: Constant prepayment rate.
The sensitivity analysis in the preceding table is hypothetical and should be used with caution. As the figures indicate, changes in fair value based upon a 10% and 20% variation in assumptions generally cannot be easily extrapolated because the relationship of the change in the assumptions to the change in fair value may not be linear. Also, in this table, the effect that a change in a particular assumption may have on the fair value is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.
The valuation allowance represents the extent to which the carrying value of MSRs exceeds its estimated fair value for its applicable SFAS 140 strata. Changes in the valuation allowance are the result of the recognition of impairment or the recovery of previously recognized impairment charges due to changes in market conditions during the period. The changes in the valuation allowance for MSRs were as follows:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Balance at January 1
  $ 1,031     $ 1,378     $ 1,634  
Other-than-temporary impairment
    (1 )     (149 )     (283 )
SFAS 140 impairment (recovery) adjustment
    (680 )     (198 )     27  
 
Balance at December 31
  $ 350     $ 1,031     $ 1,378  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results, while 2003 results include heritage JPMorgan Chase only.


     
JPMorgan Chase & Co. / 2005 Annual Report   115

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

The Firm recorded an other-than-temporary impairment of its MSRs of $1 million, $149 million and $283 million, in 2005, 2004 and 2003, respectively, which permanently reduced the gross carrying value of the MSRs and the related valuation allowance. The permanent reduction precludes subsequent reversals. This write-down had no impact on the results of operations or financial condition of the Firm.
Purchased credit card relationships and All other intangible assets
During 2005, purchased credit card relationship intangibles decreased by $603 million as a result of $703 million in amortization expense, partially offset by the purchase of the Sears Canada credit card business. All other intangible assets decreased by $894 million in 2005 primarily as a result of $836 million in amortization expense and the impact of the deconsolidation of Paymentech. Except for $513 million of indefinite-lived intangibles related to asset management advisory contracts which are not amortized but instead are tested for impairment at least annually, the remainder of the Firm’s other acquired intangible assets are subject to amortization.


The components of credit card relationships, core deposits and other intangible assets were as follows:
                                                 
    2005   2004
                    Net                   Net
    Gross   Accumulated   carrying   Gross   Accumulated   carrying
December 31, (in millions)   amount   amortization   value   amount   amortization   value
 
Purchased credit card relationships
  $  5,325     $  2,050     $  3,275     $  5,225     $  1,347     $  3,878  
All other intangibles:
                                               
Other credit card–related intangibles
    183       59       124       295       23       272  
Core deposit intangibles
    3,797       1,092       2,705       3,797       469       3,328  
Other intangibles
    2,582       579 (a)     2,003       2,528       402 (a)     2,126  
                         
Amortization expense (in millions) (b)   2005     2004     2003  
 
Purchased credit card relationships
  $  703     $  476     $  256  
Other credit card–related intangibles
    36       23        
Core deposit intangibles
    623       330       6  
All other intangibles
    163       117       32  
 
Total amortization expense
  $  1,525     $  946     $  294  
 
(a)   Includes $14 million and $16 million for 2005 and 2004, respectively, of amortization expense related to servicing assets on securitized automobile loans, which is recorded in Asset management, administration and commissions.
 
(b)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
Future amortization expense
The following table presents estimated amortization expenses related to credit card relationships, core deposits and All other intangible assets at December 31, 2005:
                                         
            Other credit            
(in millions)   Purchased credit   card-related   Core deposit   All other    
Year ended December 31,   card relationships   intangibles   intangibles   intangible assets   Total
 
2006
  $  688     $  16     $  547     $  163     $  1,414  
2007
    620       15       469       145       1,249  
2008
    515       15       402       132       1,064  
2009
    372       15       329       123       839  
2010
    312       13       276       110       711  
 

Note 16 – Premises and equipment
Premises and equipment, including leasehold improvements, are carried at cost less accumulated depreciation and amortization. JPMorgan Chase computes depreciation using the straight-line method over the estimated useful life of an asset. For leasehold improvements, the Firm uses the straight-line method computed over the lesser of the remaining term of the leased facility or 10 years. JPMorgan Chase has recorded immaterial asset retirement obligations
related to asbestos remediation under SFAS 143 and FIN 47 in those cases where it has sufficient information to estimate the obligations’ fair value.
JPMorgan Chase capitalizes certain costs associated with the acquisition or development of internal-use software under SOP 98-1. Once the software is ready for its intended use, these costs are amortized on a straight-line basis over the software’s expected useful life, and reviewed for impairment on an ongoing basis.


     
116   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Note 17 – Long-term debt
JPMorgan Chase issues long-term debt denominated in various currencies, although predominantly U.S. dollars, with both fixed and variable interest rates. The following table is a summary of long-term debt (including unamortized original issue debt discount and SFAS 133 valuation adjustments):
                                                 
By remaining contractual maturity at December 31, 2005     Under             After     2005     2004  
(in millions)           1 year     1–5 years     5 years     total     total  
 
Parent company                                        
Senior debt: (a)
  Fixed rate   $ 5,991     $ 14,705     $ 4,224     $ 24,920     $ 25,563  
 
  Variable rate     3,574       11,049       2,291       16,914       15,128  
 
  Interest rates (b)     2.80–6.88 %     0.22–6.63 %     1.12–8.85 %     0.22–8.85 %     0.20–7.63 %
                                         
Subordinated debt:
  Fixed rate   $ 758     $ 8,241     $ 15,818     $ 24,817     $ 22,055  
 
  Variable rate           26       1,797       1,823       2,686  
 
  Interest rates (b)     6.13–7.88 %     4.80–10.00 %     1.92–9.88 %     1.92–10.00 %     1.92–10.00 %
 
 
  Subtotal   $ 10,323     $ 34,021     $ 24,130     $ 68,474     $ 65,432  
 
Subsidiaries                                        
Senior debt: (a)
  Fixed rate   $ 636     $ 3,746     $ 2,362     $ 6,744     $ 6,249  
 
  Variable rate     5,364       21,632       5,013       32,009       22,097  
 
  Interest rates (b)     3.00–10.95 %     1.71–17.00 %     1.76–13.00 %     1.71–17.00 %     1.71–13.00 %
                                         
Subordinated debt:
  Fixed rate   $     $ 845     $ 285     $ 1,130     $ 1,644  
 
  Variable rate                              
 
  Interest rates (b)           6.13–6.70 %     8.25 %     6.13–8.25 %     6.00–8.25 %
 
 
  Subtotal   $ 6,000     $ 26,223     $ 7,660     $ 39,883     $ 29,990  
 
Total long-term debt   $ 16,323     $ 60,244     $ 31,790     $ 108,357 (d)(e)(f)   $ 95,422  
 
FIN 46R long-term beneficial interests: (c)                                        
 
  Fixed rate   $ 80     $ 9     $ 376     $ 465     $ 775  
 
  Variable rate     26       95       1,768       1,889       5,618  
 
  Interest rates (b)     3.39–7.35 %     0.51–7.00 %     2.42–12.79 %     0.51–12.79 %     0.54–12.79 %
 
Total FIN 46R long-term beneficial interests   $ 106     $ 104     $ 2,144     $ 2,354     $ 6,393  
 
(a)   Included are various equity-linked or other indexed instruments. Embedded derivatives separated from hybrid securities in accordance with SFAS 133 are reported at fair value and shown net with the host contract on the balance sheet. Changes in fair value of separated derivatives are recorded in Trading revenue.
 
(b)   The interest rates shown are the range of contractual rates in effect at year-end, including non-U.S. dollar fixed and variable-rate issuances, which excludes the effects of related derivative instruments. The use of these derivative instruments modifies the Firm’s exposure to the contractual interest rates disclosed in the table above. Including the effects of derivatives, the range of modified rates in effect at December 31, 2005, for total long-term debt was 0.49% to 17.00%, versus the contractual range of 0.22% to 17.00% presented in the table above.
 
(c)   Included on the Consolidated balance sheets in Beneficial interests issued by consolidated variable interest entities.
 
(d)   At December 31, 2005, long-term debt aggregating $27.7 billion was redeemable at the option of JPMorgan Chase, in whole or in part, prior to maturity, based upon the terms specified in the respective notes.
 
(e)   The aggregate principal amount of debt that matures in each of the five years subsequent to 2005 is $16.3 billion in 2006, $17.8 billion in 2007, $23.4 billion in 2008, $11.1 billion in 2009, and $8.0 billion in 2010.
 
(f)   Includes $2.3 billion of outstanding zero-coupon notes at December 31, 2005. The aggregate principal amount of these notes at their respective maturities is $5.9 billion.

The weighted-average contractual interest rate for total long-term debt was 4.62% and 4.50% as of December 31, 2005 and 2004, respectively. In order to modify exposure to interest rate and currency exchange rate movements, JPMorgan Chase utilizes derivative instruments, primarily interest rate and cross-currency interest rate swaps, in conjunction with some of its debt issues. The use of these instruments modifies the Firm’s interest expense on the associated debt. The modified weighted-average interest rate for total long-term debt, including the effects of related derivative instruments, was 4.65% and 3.97% as of December 31, 2005 and 2004, respectively.
JPMorgan Chase & Co. (Parent Company) has guaranteed certain debt of its subsidiaries, including both long-term debt and structured notes sold as part of the Firm’s trading activities. These guarantees rank on a parity with all of the Firm’s other unsecured and unsubordinated indebtedness. Guaranteed liabilities totaled $170 million and $320 million at December 31, 2005 and 2004, respectively.
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
At December 31, 2005, the Firm had 22 wholly-owned Delaware statutory business trusts (“issuer trusts”) that issued guaranteed preferred beneficial interests in the Firm’s junior subordinated deferrable interest debentures.
The junior subordinated deferrable interest debentures issued by the Firm to the issuer trusts, totaling $11.5 billion and $10.3 billion at December 31, 2005 and 2004, respectively, were reflected in the Firm’s Consolidated balance sheets in the Liabilities section under the caption “Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities.” The Firm also records the common capital securities issued by the issuer trusts in Other assets in its Consolidated balance sheets at December 31, 2005 and 2004.


     
JPMorgan Chase & Co. / 2005 Annual Report   117

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
The debentures issued to the issuer trusts by the Firm, less the capital securities of the issuer trusts, qualify as Tier 1 capital. The following is a summary of the outstanding capital securities, net of discount, issued by each trust and the junior subordinated deferrable interest debenture issued by JPMorgan Chase to each trust as of December 31, 2005:
                                                         
    Amount   Principal           Stated maturity            
    of capital   amount of           of capital            
    securities   debenture           securities   Earliest   Interest rate of   Interest
    issued   held   Issue   and   redemption   capital securities   payment/
December 31, 2005 (in millions)   by trust (a)   by trust (b)   date   debentures   date   and debentures   distribution dates
 
Bank One Capital III
  $ 474     $ 616       2000       2030     Any time     8.75 %   Semiannually
Bank One Capital V
    300       335       2001       2031       2006       8.00 %   Quarterly
Bank One Capital VI
    525       556       2001       2031       2006       7.20 %   Quarterly
Chase Capital I
    600       619       1996       2026       2006       7.67 %   Semiannually
Chase Capital II
    495       511       1997       2027       2007     LIBOR + 0.50%   Quarterly
Chase Capital III
    296       306       1997       2027       2007     LIBOR + 0.55%   Quarterly
Chase Capital VI
    249       256       1998       2028     Any time   LIBOR + 0.625%   Quarterly
First Chicago NBD Capital I
    248       256       1997       2027       2007     LIBOR + 0.55%   Quarterly
First Chicago NBD Institutional Capital A
    499       551       1996       2026       2006       7.95 %   Semiannually
First Chicago NBD Institutional Capital B
    250       273       1996       2026       2006       7.75 %   Semiannually
First USA Capital Trust I
    3       3       1996       2027       2007       9.33 %   Semiannually
JPM Capital Trust I
    750       773       1996       2027       2007       7.54 %   Semiannually
JPM Capital Trust II
    400       412       1997       2027       2007       7.95 %   Semiannually
J.P. Morgan Chase Capital IX
    500       509       2001       2031       2006       7.50 %   Quarterly
J.P. Morgan Chase Capital X
    1,000       1,022       2002       2032       2007       7.00 %   Quarterly
J.P. Morgan Chase Capital XI
    1,075       1,009       2003       2033       2008       5.88 %   Quarterly
J.P. Morgan Chase Capital XII
    400       393       2003       2033       2008       6.25 %   Quarterly
JPMorgan Chase Capital XIII
    472       487       2004       2034       2014     LIBOR + 0.95%   Quarterly
JPMorgan Chase Capital XIV
    600       593       2004       2034       2009       6.20 %   Quarterly
JPMorgan Chase Capital XV
    994       1,049       2005       2035     Any time     5.88 %   Semiannually
JPMorgan Chase Capital XVI
    500       501       2005       2035       2010       6.35 %   Quarterly
JPMorgan Chase Capital XVII
    496       499       2005       2035     Any time     5.85 %   Semiannually
 
Total
  $ 11,126     $ 11,529                                          
 
(a)   Represents the amount of capital securities issued to the public by each trust, net of unamortized discount.
 
(b)   Represents the principal amount of JPMorgan Chase debentures held as assets by each trust, net of unamortized discount amounts. The principal amount of debentures held by the trusts includes the impact of hedging and purchase accounting fair value adjustments that are recorded on the Firm’s financial statements.
Note 18 – Preferred stock

JPMorgan Chase is authorized to issue 200 million shares of preferred stock, in one or more series, with a par value of $1 per share. Outstanding preferred stock at December 31, 2005 and 2004, was 280,433 and 4.28 million shares, respectively. On May 6, 2005, JPMorgan Chase redeemed a total of 4.0 million shares of its Fixed/adjustable rate, noncumulative preferred stock.
Dividends on shares of the outstanding series of preferred stock are payable quarterly. The preferred stock outstanding takes precedence over JPMorgan Chase’s common stock for the payment of dividends and the distribution of assets in the event of a liquidation or dissolution of the Firm.


The following is a summary of JPMorgan Chase’s preferred stock outstanding as of December 31:
                                                         
    Stated value and                                           Rate in effect at  
(in millions, except   redemption   Shares     Outstanding at December 31,   Earliest   December 31,  
per share amounts and rates)   price per share (b)   2005     2004     2005     2004     redemption date   2005  
 
6.63% Series H cumulative (a)
  $  500.00       0.28       0.28     $   139     $  139       3/31/2006       6.63 %
Fixed/adjustable rate, noncumulative
    50.00             4.00             200              
 
Total preferred stock
            0.28       4.28     $   139     $  339                  
 
(a)   Represented by depositary shares.
 
(b)   Redemption price includes amount shown in the table plus any accrued but unpaid dividends.
     
118   JPMorgan Chase & Co. / 2005 Annual Report

 


 

Note 19 – Common stock
At December 31, 2005, JPMorgan Chase was authorized to issue 9.0 billion shares of common stock with a $1 par value per share. In connection with the Merger, the shareholders approved an increase in the amount of authorized shares of 4.5 billion from the 4.5 billion that had been authorized as of December 31, 2003. Common shares issued (newly issued or distributed from treasury) by JPMorgan Chase during 2005, 2004 and 2003 were as follows:
                         
December 31, (a) (in millions)   2005     2004     2003  
 
Issued – balance at January 1
    3,584.8       2,044.4       2,023.6  
Newly issued:
                       
Employee benefits and compensation plans
    34.0       69.0       20.9  
Employee stock purchase plans
    1.4       3.1       0.7  
Purchase accounting acquisitions and other
          1,469.4        
 
Total newly issued
    35.4       1,541.5       21.6  
Cancelled shares
    (2.0 )     (1.1 )     (0.8 )
 
Total issued – balance at December 31
    3,618.2       3,584.8       2,044.4  
 
 
                       
Treasury – balance at January 1
    (28.6 )     (1.8 )     (24.9 )
Purchase of treasury stock
    (93.5 )     (19.3 )      
Share repurchases related to employee stock-based awards (b)
    (9.4 )     (7.5 )     (3.0 )
Issued from treasury:
                       
Employee benefits and compensation plans
                25.8  
Employee stock purchase plans
                0.3  
 
Total issued from treasury
                26.1  
 
Total treasury – balance at December 31
    (131.5 )     (28.6 )     (1.8 )
 
Outstanding
    3,486.7       3,556.2       2,042.6  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Participants in the Firm’s stock-based incentive plans may have shares withheld to cover income taxes. The shares withheld amounted to 8.2 million, 5.7 million and 2.3 million for 2005, 2004 and 2003, respectively.
During 2005 and 2004, the Firm repurchased 93.5 million shares and 19.3 million shares, respectively, of common stock under a stock repurchase program that was approved by the Board of Directors on July 20, 2004. The Firm did not repurchase shares of its common stock during 2003 under a prior stock repurchase program.
As of December 31, 2005, approximately 507 million unissued shares of common stock were reserved for issuance under various employee or director incentive, compensation, option and stock purchase plans.
Note 20 – Earnings per share
SFAS 128 requires the presentation of basic and diluted earnings per share (“EPS”) in the income statement. Basic EPS is computed by dividing net income applicable to common stock by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed using the same method as basic EPS but, in the denominator, the number of common shares reflect, in addition to outstanding shares, the potential dilution that could occur if convertible securities or other contracts to issue common stock were converted or exercised into common stock. Net income available for common stock is the same for basic EPS and diluted EPS, as JPMorgan Chase had no convertible securities, and therefore, no adjustments to net income available for common stock were necessary. The following table presents the calculation of basic and diluted EPS for 2005, 2004 and 2003:
                         
Year ended December 31,                  
(in millions, except per share amounts) (a)   2005     2004     2003  
 
Basic earnings per share
                       
Net income
  $ 8,483     $ 4,466     $ 6,719  
Less: preferred stock dividends
    13       52       51  
 
Net income applicable to common stock
  $ 8,470     $ 4,414     $ 6,668  
 
                       
Weighted-average basic shares outstanding
    3,491.7       2,779.9       2,008.6  
 
Net income per share
  $ 2.43     $ 1.59     $ 3.32  
 
Diluted earnings per share
                       
Net income applicable to common stock
  $ 8,470     $ 4,414     $ 6,668  
 
                       
Weighted-average basic shares outstanding
    3,491.7       2,779.9       2,008.6  
Add: Broad-based options
    3.6       5.4       4.1  
Restricted stock, restricted stock units and key employee options
    62.0       65.3       42.4  
 
Weighted-average diluted shares outstanding
    3,557.3       2,850.6       2,055.1  
 
Net income per share (b)
  $ 2.38     $ 1.55     $ 3.24  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Options issued under employee benefit plans to purchase 280 million, 300 million and 335 million shares of common stock were outstanding for the years ended 2005, 2004 and 2003, respectively, but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares.
Note 21 – Accumulated other
comprehensive income (loss)
Accumulated other comprehensive income (loss) includes the after-tax change in unrealized gains and losses on AFS securities, cash flow hedging activities and foreign currency translation adjustments (including the impact of related derivatives).
                                 
                            Accumulated
Year ended   Unrealized           Cash   other
December 31, (a)   gains (losses)   Translation   flow   comprehensive
(in millions)   on AFS securities (b)   adjustments   hedges   income (loss)
 
Balance at December 31, 2002
  $ 731     $ (6 )   $ 502     $ 1,227  
Net change
    (712 )           (545 )     (1,257 )
 
Balance at December 31, 2003
    19       (6 )     (43 )     (30 )
Net change
    (80 ) (c)     (2 ) (d)     (96 )     (178 )
 
Balance at December 31, 2004
    (61 )     (8 )     (139 )     (208 )
Net change
    (163 ) (e)     (f)     (255 )     (418 )
 
Balance at December 31, 2005
  $ (224 )   $ (8 )   $ (394 )   $ (626 )
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Represents the after-tax difference between the fair value and amortized cost of the AFS securities portfolio and retained interests in securitizations recorded in Other assets.
 
(c)   The net change during 2004 was due primarily to rising interest rates and recognition of unrealized gains through securities sales.
(d)   Includes $280 million of after-tax gains (losses) on foreign currency translation from operations for which the functional currency is other than the U.S. dollar offset by $(282) million of after-tax gains (losses) on hedges.
(e)   The net change during 2005 was due primarily to higher interest rates, partially offset by the reversal of unrealized losses through securities sales.
(f)   Includes $(351) million of after-tax gains (losses) on foreign currency translation from operations for which the functional currency is other than the U.S. dollar offset by $351 million of after-tax gains (losses) on hedges.


     
JPMorgan Chase & Co. / 2005 Annual Report   119

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.

The following table presents the after-tax changes in net unrealized holdings gains (losses) and the reclassification adjustments in unrealized gains and losses on AFS securities and cash flow hedges. Reclassification adjustments include amounts recognized in net income during the current year that had been previously recorded in Other comprehensive income.
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Unrealized gains (losses) on AFS securities:
                       
Net unrealized holdings gains (losses) arising during the period, net of taxes (b)
  $ (1,058 )   $ 41     $ 149  
Reclassification adjustment for (gains) losses included in income, net of taxes (c)
    895       (121 )     (861 )
 
Net change
  $ (163 )   $ (80 )   $ (712 )
 
 
                       
Cash flow hedges:
                       
Net unrealized holdings gains (losses) arising during the period, net of taxes (d)
  $ (283 )   $ 34     $ 86  
Reclassification adjustment for (gains) losses included in income, net of taxes (e)
    28       (130 )     (631 )
 
Net change
  $ (255 )   $ (96 )   $ (545 )
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   Net of income tax expense (benefit) of $(648) million for 2005, $27 million for 2004 and $92 million for 2003.
 
(c)   Net of income tax expense (benefit) of $(548) million for 2005, $79 million for 2004 and $528 million for 2003.
 
(d)   Net of income tax expense (benefit) of $(187) million for 2005, $23 million for 2004 and $60 million for 2003.
 
(e)   Net of income tax expense (benefit) of $(18) million for 2005 and $86 million for 2004 and $438 million for 2003.
Note 22 – Income taxes
JPMorgan Chase and eligible subsidiaries file a consolidated U.S. federal income tax return. JPMorgan Chase uses the asset-and-liability method required by SFAS 109 to provide income taxes on all transactions recorded in the Consolidated financial statements. This method requires that income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets or liabilities for book and tax purposes. Accordingly, a deferred tax liability or asset for each temporary difference is determined based upon the tax rates that the Firm expects to be in effect when the underlying items of income and expense are realized. JPMorgan Chase’s expense for income taxes includes the current and deferred portions of that expense. A valuation allowance is established to reduce deferred tax assets to the amount the Firm expects to realize.
Due to the inherent complexities arising from the nature of the Firm’s businesses, and from conducting business and being taxed in a substantial number of jurisdictions, significant judgments and estimates are required to be made. Agreement of tax liabilities between JPMorgan Chase and the many tax jurisdictions in which the Firm files tax returns may not be finalized for several years. Thus, the Firm’s final tax-related assets and liabilities may ultimately be different.
Deferred income tax expense (benefit) results from differences between assets and liabilities measured for financial reporting and for income-tax return purposes. The significant components of deferred tax assets and liabilities are reflected in the following table:
                 
December 31, (in millions)   2005     2004  
 
Deferred tax assets
               
Allowance for other than loan losses
  $ 3,554     $ 3,711  
Employee benefits
    3,381       2,677  
Allowance for loan losses
    2,745       2,739  
Non-U.S. operations
    807       743  
Fair value adjustments
    531        
 
Gross deferred tax assets
  $ 11,018     $ 9,870  
 
Deferred tax liabilities
               
Depreciation and amortization
  $ 3,683     $ 3,558  
Leasing transactions
    3,158       4,266  
Fee income
    1,396       1,162  
Non-U.S. operations
    1,297       1,144  
Fair value adjustments
          186  
Other, net
    149       348  
 
Gross deferred tax liabilities
  $ 9,683     $ 10,664  
 
Valuation allowance
  $ 110     $ 150  
 
Net deferred tax asset (liability)
  $ 1,225     $ (944 )
 
A valuation allowance has been recorded in accordance with SFAS 109, primarily relating to deferred tax assets associated with certain portfolio investments.
The components of income tax expense included in the Consolidated statements of income were as follows:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
Current income tax expense
                       
U.S. federal
  $ 4,269     $ 1,695     $ 965  
Non-U.S.
    917       679       741  
U.S. state and local
    337       181       175  
 
Total current expense
    5,523       2,555       1,881  
 
Deferred income tax (benefit) expense
                       
U.S. federal
    (2,063 )     (382 )     1,341  
Non-U.S.
    316       (322 )     14  
U.S. state and local
    (44 )     (123 )     73  
 
Total deferred (benefit) expense
    (1,791 )     (827 )     1,428  
 
Total income tax expense
  $ 3,732     $ 1,728     $ 3,309  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
The preceding table does not reflect the tax effects of unrealized gains and losses on AFS securities, SFAS 133 hedge transactions and certain tax benefits associated with the Firm’s employee stock plans. The tax effect of these items is recorded directly in Stockholders’ equity. Stockholders’ equity increased by $425 million, $431 million and $898 million in 2005, 2004 and 2003, respectively, as a result of these tax effects.
U.S. federal income taxes have not been provided on the undistributed earnings of certain non-U.S. subsidiaries, to the extent that such earnings have been reinvested abroad for an indefinite period of time. For 2005, such earnings approximated $333 million on a pre-tax basis. At December 31, 2005, the cumulative amount of undistributed pre-tax earnings in these subsidiaries approximated $1.5 billion. It is not practicable at this time to determine the income tax liability that would result upon repatriation of these earnings.


     
120   JPMorgan Chase & Co. / 2005 Annual Report

 


 

On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law. The Act creates a temporary incentive for U.S. companies to repatriate accumulated foreign earnings at a substantially reduced U.S. effective tax rate by providing a dividends received deduction on the repatriation of certain foreign earnings to the U.S. taxpayer (the “repatriation provision”). The new deduction is subject to a number of limitations and requirements.
In the fourth quarter of 2005, the Firm applied the repatriation provision to $1.9 billion of cash from foreign earnings, resulting in a net tax benefit of $55 million. The $1.9 billion of cash will be used in accordance with the Firm’s domestic reinvestment plan pursuant to the guidelines set forth in the Act.
The tax expense (benefit) applicable to securities gains and losses for the years 2005, 2004 and 2003 was $(536) million, $126 million and $477 million, respectively.
A reconciliation of the applicable statutory U.S. income tax rate to the effective tax rate for the past three years is shown in the following table:
                         
Year ended December 31, (a)   2005     2004     2003  
 
Statutory U.S. federal tax rate
    35.0 %     35.0 %     35.0 %
Increase (decrease) in tax rate resulting from:
                       
U.S. state and local income taxes, net of federal income tax benefit
    1.6       0.6 (b)     2.1  
Tax-exempt income
    (3.0 )     (4.1 )     (2.4 )
Non-U.S. subsidiary earnings
    (1.4 )     (1.3 )     (0.7 )
Business tax credits
    (3.6 )     (4.1 )     (0.9 )
Other, net
    2.0       1.8       (0.1 )
 
Effective tax rate
    30.6 %     27.9 %     33.0 %
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   The lower rate in 2004 was attributable to changes in the proportion of income subject to different state and local taxes.
The following table presents the U.S. and non-U.S. components of income before income tax expense:
                         
Year ended December 31, (in millions) (a)   2005     2004     2003  
 
U.S.
  $ 8,959     $ 3,817     $ 7,333  
Non-U.S. (b)
    3,256       2,377       2,695  
 
Income before income tax expense
  $ 12,215     $ 6,194     $ 10,028  
 
(a)   2004 results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase results. 2003 reflects the results of heritage JPMorgan Chase only.
 
(b)   For purposes of this table, non-U.S. income is defined as income generated from operations located outside the United States of America.
Note 23 – Restrictions on cash and intercompany funds transfers
JPMorgan Chase Bank’s business is subject to examination and regulation by the Office of the Comptroller of the Currency (“OCC”). The Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).
The Federal Reserve Board requires depository institutions to maintain cash reserves with a Federal Reserve Bank. The average amount of reserve balances deposited by the Firm’s bank subsidiaries with various Federal Reserve Banks was approximately $2.7 billion in 2005 and $3.8 billion in 2004.
Restrictions imposed by federal law prohibit JPMorgan Chase and certain other affiliates from borrowing from banking subsidiaries unless the loans are secured in specified amounts. Such secured loans to the Firm or to other affiliates are generally limited to 10% of the banking subsidiary’s total capital, as determined by the risk-based capital guidelines; the aggregate amount of all such loans is limited to 20% of the banking subsidiary’s total capital.
The principal sources of JPMorgan Chase’s income (on a parent company-only basis) are dividends and interest from JPMorgan Chase Bank and the other banking and nonbanking subsidiaries of JPMorgan Chase. In addition to dividend restrictions set forth in statutes and regulations, the FRB, the OCC and the FDIC have authority under the Financial Institutions Supervisory Act to prohibit or to limit the payment of dividends by the banking organizations they supervise, including JPMorgan Chase and its subsidiaries that are banks or bank holding companies, if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the banking organization.
At January 1, 2006 and 2005, JPMorgan Chase’s bank subsidiaries could pay, in the aggregate, $7.4 billion and $6.2 billion, respectively, in dividends to their respective bank holding companies without prior approval of their relevant banking regulators. Dividend capacity in 2006 will be supplemented by the banks’ earnings during the year.
In compliance with rules and regulations established by U.S. and non-U.S. regulators, as of December 31, 2005 and 2004, cash in the amount of $6.4 billion and $4.3 billion, respectively, and securities with a fair value of $2.1 billion and $2.7 billion, respectively, were segregated in special bank accounts for the benefit of securities and futures brokerage customers.
Note 24 – Capital
There are two categories of risk-based capital: Tier 1 capital and Tier 2 capital. Tier 1 capital includes common stockholders’ equity, qualifying preferred stock and minority interest less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1, subordinated long-term debt and other instruments qualifying as Tier 2, and the aggregate allowance for credit losses up to a certain percentage of risk-weighted assets. Total regulatory capital is subject to deductions for investments in certain subsidiaries. Under the risk-based capital guidelines of the FRB, JPMorgan Chase is required to maintain minimum ratios of Tier 1 and Total (Tier 1 plus Tier 2) capital to risk-weighted assets, as well as minimum leverage ratios (which are defined as Tier 1 capital to average adjusted on–balance sheet assets). Failure to meet these minimum requirements could cause the FRB to take action. Bank subsidiaries also are subject to these capital requirements by their respective primary regulators. As of December 31, 2005 and 2004, JPMorgan Chase and all of its banking subsidiaries were well-capitalized and met all capital requirements to which each was subject.


     
JPMorgan Chase & Co. / 2005 Annual Report   121

 


 

Notes to consolidated financial statements
JPMorgan Chase & Co.
The following table presents the risk-based capital ratios for JPMorgan Chase and the Firm’s significant banking subsidiaries at December 31, 2005 and 2004:
                                                         
    Tier 1      Total      Risk-weighted     Adjusted     Tier 1     Total     Tier 1  
(in millions, except ratios)   capital     capital     assets (c)     average assets (d)     capital ratio     capital ratio     leverage ratio  
 
December 31, 2005
                                                       
JPMorgan Chase & Co. (a)
  $ 72,474     $ 102,437     $ 850,643     $ 1,152,546       8.5 %     12.0 %     6.3 %
JPMorgan Chase Bank, N.A.
    61,050       84,227       750,397       995,095       8.1       11.2       6.1  
Chase Bank USA, N.A.
    8,608       10,941       72,229       59,882       11.9       15.2       14.4  
                                                         
December 31, 2004
JPMorgan Chase & Co. (a)
  $ 68,621     $ 96,807     $ 791,373     $ 1,102,456       8.7 %     12.2 %     6.2 %
JPMorgan Chase Bank, N.A.
    55,489       78,478       670,295       922,877       8.3       11.7       6.0  
Chase Bank USA, N.A.
    8,726       11,186       86,955       71,797       10.0       12.9       12.2  
                                                         
Well-capitalized ratios (b)
                                    6.0 %     10.0 %     5.0 % (e)
Minimum capital ratios (b)
                                    4.0       8.0       3.0 (f)
 
(a)   Asset and capital amounts for JPMorgan Chase’s banking subsidiaries reflect intercompany transactions, whereas the respective amounts for JPMorgan Chase reflect the elimination of intercompany transactions.
(b)   As defined by the regulations issued by the FRB, FDIC and OCC.
(c)   Includes off-balance sheet risk-weighted assets in the amounts of $279.2 billion, $260.0 billion and $15.5 billion, respectively, at December 31, 2005, and $250.3 billion, $229.6 billion and $15.5 billion, respectively, at December 31, 2004.
(d)   Average adjusted assets for purposes of calculating the leverage ratio include total average assets adjusted for unrealized gains/losses on securities, less deductions for disallowed goodwill and other intangible assets, investments in subsidiaries and the total adjusted carrying value of nonfinancial equity investments that are subject to deductions from Tier 1 capital.
(e)   Represents requirements for bank subsidiaries pursuant to regulations issued under the Federal Deposit Insurance Corporation Improvement Act. There is no Tier 1 leverage component in the definition of a well-capitalized bank holding company.
(f)   The minimum Tier 1 leverage ratio for bank holding companies and banks is 3% or 4% depending on factors specified in regulations issued by the FRB and OCC.

The following table shows the components of the Firm’s Tier 1 and Total capital:
                 
December 31, (in millions)   2005     2004  
 
Tier 1 capital
               
Total stockholders’ equity
  $ 107,211     $ 105,653  
Effect of net unrealized losses on AFS securities
and cash flow hedging activities
    618       200  
 
Adjusted stockholders’ equity
    107,829       105,853  
Minority interest (a)
    12,660       11,050  
Less: Goodwill
    43,621       43,203  
Investments in certain subsidiaries
    401       370  
Nonqualifying intangible assets
    3,993       4,709  
 
Tier 1 capital
  $ 72,474     $ 68,621  
 
Tier 2 capital
               
Long-term debt and other instruments
qualifying as Tier 2
  $ 22,733     $ 20,690  
Qualifying allowance for credit losses
    7,490       7,798  
Less: Investments in certain subsidiaries
and other
    260       302  
 
Tier 2 capital
  $ 29,963     $ 28,186  
 
Total qualifying capital
  $ 102,437     $ 96,807  
 
(a)   Primarily includes trust preferred securities of certain business trusts.
Note 25 – Commitments and contingencies
At December 31, 2005, JPMorgan Chase and its subsidiaries were obligated under a number of noncancelable operating leases for premises and equipment used primarily for banking purposes. Certain leases contain renewal options or escalation clauses providing for increased rental payments based upon maintenance, utility and tax increases or require the Firm to perform restoration work on leased premises. No lease agreement imposes restrictions on the Firm’s ability to pay dividends, engage in debt or equity financing transactions, or enter into further lease agreements.
The following table shows required future minimum rental payments under operating leases with noncancelable lease terms that expire after December 31, 2005:
         
Year ended December 31, (in millions)        
 
2006
  $ 993  
2007
    948  
2008
    901  
2009
    834  
2010
    724  
After
    5,334  
 
Total minimum payments required (a)
    9,734  
Less: Sublease rentals under noncancelable subleases
    (1,323 )
 
Net minimum payment required