摩根大通 (JPM) 2002 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the JP Morgan Chase & Company Conference Call. The conference call today may contain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of JP Morgan Chase's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. Such risks and uncertainties are described in the annual report on Form 10-K for the year-ended December 31, 2001, of JP Morgan Chase & Company filed with the Securities & Exchange Commission and available at the Securities and Commissions internet site: http://www.sec.gov to which reference is hereby made. As a reminder, ladies and gentlemen, press will be on today's conference call on a listen-only mode. Again, we thank you for your patience and your JP Morgan Chase & Company Conference Call will begin momentarily. Thank you.

Welcome you to our quarterly meeting following earnings release this morning for JP Morgan Chase. We're in a slightly different room because we're working on the other room and I gather that during construction we have to temporarily relocate. So we're now on the top floor and we have a great view of the city only we can't see the view. In any event, we're going to follow the normal format for this morning. Dina Dublon is going to give you her analysis of our results for the quarter. I'm going to come back and make a few comments and then both she and I and a number of members of our senior management team are available here to take your questions both in the auditorium and on the phone. So, Dina, if you want to get it started.

Hi. Good morning to all of you on the phone, and good morning to you here in the room. The first slide is our statement regarding possible risks and uncertainties in accordance with the Private Securities Litigation Reform Act you cannot read it [ph]. At the bottom of the page, however, there is one more statement that you cannot read, but it explains that our operating numbers for 2001 throughout the presentation have been restated by adding back goodwill amortization. This is our comparison of results on the same basis as this year's first quarter which includes the adoption of SFAS 142, so again, we restated at the prior periods.

Results exceeded by a few cents the consensus estimates for the quarter. Operating earnings more than tripled in a very weak fourth quarter. The revenue environment, however, remains slow and compared to the first quarter last year, results are down. We are, therefore, focused on expense management. Credit costs declined from the unusually high fourth quarter as loan loss provisions equaled loan losses this quarter. By line of business, retail led the way with a record quarter. Investment management and private banking had a benefit of lower expenses and a very large improvement in the pre-tax margin. The investment bank delivered a return on equity of 16% in the difficult operating environment. JP Morgan Partners recorded another loss driven by the decline in the market price of Triton PCS. In this environment, we are maintaining strong liquidity and capital. There is a premium for both. Excluding JP Morgan Partners, earnings per share of $0.69 was down $0.05 from the first quarter of last year. This would have been flat if we had not restated prior periods for SFAS 142. Consolidated operating ETS after the $0.12 negative contribution of JP Morgan Partners was $0.57, again, well above the $0.17 in the fourth quarter, but $0.20 below last year. Non-operating charges were $0.09 this quarter, or about $250 million. For the full year, we have $1.2 billion in charges for the previously announced merger and relocation programs. Non-operating charges were much higher in 2001 at $2.5 billion for the year. We had this quarter, and will have in the rest of the year, additional severance costs which are included in operating expenses. I'll come back to this issue when reviewing expenses. Consolidated operating earnings for the quarter were $1.15 billion. Return on equity for the quarter was 11%, better than the prior three-quarters, but still weak. Relative to the first quarter, if you look to the right hand side, relative to the first quarter, revenues are down 8%, five percentage points of that decline is from the loss from JP Morgan Partners versus a gain in the first quarter last year. Expenses are down by 8% as well. JP Morgan Partners realized gains for the quarter were negative $13 million, including about equal amounts, $170 million each, in cash realized gains and in write offs from direct investments. At $170 million per quarter, write offs are higher than what we consider normal, but we do not see the systematic concentration issues that drove the large loss last year. Most of the write offs continue to be in the T&T [ph] sector. Realized cash gains at $170 million were just enough to offset write offs.

We are seeing modest activity in public and private markets, generally in non-T&T [ph] industries. Recent gains include TCA, Fisher Scientific, Peoples First, and North [ph] in results this quarter the Jet Glue [ph] IPO last week. The M&A market will bounce back. It has not yet. We also had market to market losses of $270 million, about [inaudible] $240 million, about $200 million of which were driven by one stock Triton PCS. We had [inaudible] gains, but generally have not found an effective way to hedge the single security idiosyncratic risk in the fourth quarter. The investment pace is slow, just over $100 million this quarter with good build [ph] flow in life sciences, slow in industrials and in T&T [ph]. T&T [ph] is down to 24% of the total portfolio by the end of the quarter. Now excluding JP Morgan Partners, for the rest of the company, earnings of $1.4 billion compared to last year's $1.5 billion. Return on equity for the rest of the company was 16% despite the fate of the capital market and where we are in the credit cycle. You can see here in a more pronounced way positive operating leverage relative to the first quarter revenues were down 3% and expenses were down 8%. Looking at the expense trend, and first, you know, if you look fourth quarter to fourth quarter, so by the fourth quarter last year expenses at $4.8 billion were almost $800 million lower, or $800 million lower than when we announced the merger. There was $3 billion lower annual spending rate. First quarter of operating expenses are at and include $100 million in non-merger related severance costs, the charge for Sumitomo and the addition of Providian for a total of $230 million. The increase over the fourth quarter also reflects higher incentive compensation in line with stronger revenues and income compared to the fourth quarter.

Given softness in revenues, we are looking to reduce capacity. Costs of such actions will continue to flow through operating expenses this year. Each business is managing to a targeted overhead ratio inclusive of costs to execute their programs. In all, all businesses are managing to improve the ratio from last year.

We stated in January that with modest improvement in revenues, we were targeting flat expenses. Since then, we have closed on the acquisition of Providian, which adds over $260 in expenses. Yes, with softer revenues we will manage expenses to be down from last year.

Expenses and revenues have been restated to reflect recent accounting guidance requiring companies to record reimbursable costs paid on behalf of customers. This policy, which is effective January, [inaudible] revenues and expenses by an average $75 million per quarter, or $300 million for the year. Primarily, the change [inaudible] revenues and expenses is in treasury and security services in items like sub-custodian fees, which we now [inaudible] in revenue and expenses. But it does not impact income in the restatement.

A few point that I want to make on credit costs. Commercial charge offs are still at the very high level, 127 basic points of loans. It is driven by pressure on the telecom sector in aerial [ph] focus for the last year. The credit card charge off ratio is higher as expected. Losses on the Providian portfolio were included for two months and were only 6.3% since we did not acquire impaired accounts. We had discussed with you that our assumption at the acquisition time was for losses here to exceed 9%. Providian will, therefore, contribute to a higher charge off ratio on the combined portfolio. In total, the provisions for loan losses equals charge offs. In the fourth quarter last year, loan loss provision exceeded charge offs by $650 million as ratings in the commercial portfolio had deteriorated and losses on retained consumer loans had risen.

Loan loss reserves are at $480 million from December, primarily because of the initial reserves set up for the Providian portfolio. Reserves are up by $1.3 billion from the first quarter of last year. We have been quick in recognizing commercial losses and we feel comfortable with the total loan loss reserves. We haven't seen a turn yet and we may have some more pressure to increase commercial reserves.

On the consumer side, we should see lower reserve requirements as the Providian portfolio revolves into securitized trust and retained loans decline. In total, we don't see the need to increase reserves in '02. The commercial reserves to commercial loans ratio is up to 1.8% from 1.4 in the first quarter last year. The ratio total reserves to loan is up 2.3% from 1.7% in the first quarter last year. Non-performing assets are up almost $400 million, primarily from one commercial loan in Europe. We may see inching up [ph] but do not expect significant worsening from where we are. Argentina was not an issue for us this quarter. We recognized losses in the fourth quarter. Net of allocated reserves exposure is down to $360 million with net loans and commitments representing a little over $100 million. Commercial loans are down 10% from last year and you can see still down from December despite well-publicized drawdowns of commitments. Turning to the lines of business, retail and leader markets led the way this quarter with record earnings of $526 million, and return on equity of 22%. The Providian acquisition closed in early February adding $150 million to revenues. This, coupled with the continuation of strong business volumes, led to revenue growth of 18% over the year ago quarter. Card added new accounts of over 900,000, the sixth consecutive quarter of such increases. Mortgage had strong results driven by continued low interest rates and the strong housing market. Auto origination set a new record and deposit volumes were up almost 14%. The business experienced positive operating leverage from Six Sigma productivity initiatives. The focus on end to end processing, doing it right the first time and explicit consideration of the voice of the client is adding momentum to the retail business.

Credit costs increased from first quarter due to higher outstanding and higher loss ratios. In total, provisions for credit losses was $60 million lower than consumer charge offs this quarter, compared to $250 million higher than charge offs in the fourth quarter last year. While 90 day delinquency volumes increased from fourth quarter, 30 and 60-day trends are more favorable, an early indication that credit may be improving.

Retail provides the diversification benefit to the corporation as wholesale businesses suffer from the weak after market environment. There is a good pipeline of business here with revenue growth and the cumulative impact of productivity driving bottom line growth for the rest of the year. Investment management and private banking earnings are up 30% from the fourth quarter and 19% from a year ago. Return on equity was 8%. Tangible return on equity which eliminates the goodwill is higher, it is at 27%. Revenue levels are down from last year but increased modestly from the fourth quarter. Lower expenses drove the earnings growth and increase in pre-tax margins to 22% despite higher credit costs in the last six months.

The retail funds business showed better fund performance and inflows from year-end with particular strengths on the international side where inflows were at a five-quarter high. Momentum here is expected to continue based on recent recognition from Standards & Poor, as well as Liefer [ph] for European and Asian equity fund performance. Institutional flows out of lower margin money market funds more than offset the modest inflows into equity products resulting in a 4% reduction in assets under management to $538 billion from year end. We had good momentum in the business and are managing to a long-term target, a long-term pre-tax margin of 30%. Investment bank earnings at $755 million are down 27% from the first quarter, and more than doubled the low fourth quarter level. Return on equity was 16%. Relative to the first quarter of last year, the impact of large revenue decline and large expense reduction is offset by higher credit cards. Compared to the fourth quarter, revenue growth and lower credit costs drive the doubling of income. Expenses are up from the fourth quarter in part because incentives are linked to higher revenue and income. Low market activity and high credit costs have continued to put pressure on expense management. Operating expenses in the quarter include the incremental costs of settlement with Sumitomo, which belonged to this line of business, as well as severance costs beyond the previously planned merger and restructuring costs. These initiatives are part of an ongoing effort to improve productivity in order to create a capacity to make strategic investments. In a drive to efficiency, we have been centralizing certain technology functions and allocating these costs out of the business as an indirect expense. This makes the reported compensation to revenue ratio less meaningful in comparison to peers. We are, therefore, focused on the total overhead ratio. Despite the expense pressure created by the severance by legal settlement, the investment bank managed with very strong financial discipline to an overhead ratio of 58%. This is lower than the prior target of 60% and is aimed to partially offset the effect of higher credit costs on the bottom line. Trading revenues are down 19% versus the very strong first quarter last year, the second best ever, I guess, and are up 66% from a very low fourth quarter, which included the impact of Enron and Argentina. Equities trading was down from the first quarter. inaudible] declined, I guess, than it appears. It is up from a very weak fourth quarter. Fixed income trading revenues of $1.5 billion was down 7% from last year. Bond trading was great, but our business mix is weighted toward foreign exchange and derivatives which benefited last year from declining rates. Investment banking fees of $740 million represent the lowest quarterly total in the last three years. Declines in advisory are in line with our peers. We lost share in the very tight market. We maintain leadership positions in long syndication and investment grade bond. The market volume in long syndication were over 20% lower.

For the first time, we were the number three underwriter of stocks and bond globally. The pipeline has leveled off in the past few months, though still at the low level compared to the beginning of last year. M&A is down while debt and equity underwritings are up from year end.

Treasury and security services income is down about 15% from both the fourth quarter and the first quarter of last year. Return on equity was down to 19% to a very good number, but down to 19%. Revenue decline was led by investor services. The business here is strong in cross border custody with lower activity and with diversion making equity market investor services had lower foreign exchange revenues, lower asset base fees and lower deposit balances. Institutional trust revenues were up from both the fourth quarter and the first quarter. Treasury services revenues were up from the first quarter last year driven by higher deposit volumes despite lower spreads and more funds under management from cross sales offset with investment bank and investment management. Expenses were up 3% year on year and 4% from the fourth quarter. Investor services in particular is working to determine the right level of staffing and infrastructure given each revenue decline with the number of Six Sigma projects underway. The accounting change I spoke of earlier grosses up [ph] revenues and expenses impact this group the most. It impacted this quarter [inaudible] by about $50 million, and for the year by about $220 million. The increase in the overhead this restatement of revenue grossing up [ph] of revenue and expenses causes the overhead ratio to appear higher by one and a half to two percentage points. It will lead to some adjustment to our targeted case of improving this ratio. We had stated to you that our target ratio here before was 65%. In this environment there is a premium for maintaining strong liquidity and capital. We raised $8 billion in additional liquidity this quarter and extended the average maturity of our commercial paper and our long-term debt. Given the current revenue environment and the non-operating charges I discussed, we do want to retain financial flexibility. We are managing to a Tier 1 ratio that is higher than our target. This quarter we closed on the acquisition of the Providian portfolio, we ended the quarter with a Tier 1 ratio of 8.5%. We are not repurchasing stock. As the market improves and we generate free cash flow, we will review our buyback program.

Recognizing that the environment is not ideal, the results this quarter do show progress. Expense discipline continues to be a priority for the firm will manage to targeted overhead ratios in each of the businesses reacting to any softness in revenues, yet ensuring that we can selectively [inaudible]. With solid contribution for some of the businesses improving operating leverage in the whole company and eventually lower credit costs, we have loss of upside potential when capital markets recover. One firm, one team is our new call to arms in the firm. Looking to deliver to the client, the whole range of services we excel at and increasing our commitment and accountability for delivering results.

Before I turn the podium back to Mark, I want to mention that on April 26th we have a scheduled investor meeting. We will be sending out the notice later today. A few members of our senior management will be addressing some hot topics – commercial paper backup facilities, special purpose entities and derivatives. The meeting will be held here in this room beginning at 9:00 a.m. Friday, April 26th. There will be also a call in number and a webcast if you cannot attend in person. As usual, all materials will be posted on our website on the day of the meeting. Mark.

Thank you, Dina. Just to put in perspective a little bit this quarter's results in terms of perspective of longer-term trend, it seems to me that we are a company that has made great progress over the course of the past year, especially since the merger. But that progress has been obscured by four things. The first of them has been decline in the credit and the credit cycle becoming a much more negative effect on earnings causing us the need to build reserves. The second of those has been a reversal of the private equity valuations which has caused considerable reduction in what was previously earnings and the need to write down some investments. The third has been weakness in all capital markets activities, which we have not been immune from in terms of declines in the M&A marketplace and the [inaudible] impact of that in terms of financing. And the fourth thing has been the publicity associated with Enron, which was true initially and continues to be true.

Now the good news that I see is that the first three of those things are cyclical and the last, hopefully, is a one-time event, even though it may have a long tail in terms of publicity. The first three are cyclical. We know that. What we don't know is how long the cycle is. It does appear to be that there are signs that with regard to credit and private equity valuations, we are nearing the end of the cycle. And, therefore, the need to add to reserves is less, the need to take write downs will be less over time, and the opportunities for exit and better valuations in private equity will be better over time. We are certainly not ready to declare victory yet, but the heavy drag that those things have been on earnings appears to be lessening.

The upturn in capital market activity will probably be longer incoming. Again, we don't know when that will be. It will follow the uptick in the economy and we know that M&A generally has a fairly long lead time between announced transactions and seeing them come through our bottom line, both with respective [inaudible] and with respect to the financing and hedging activities that also drive a lot of our revenues. Because it may be an extended period of time, we are focusing significantly on expenses, particularly in the investment bank where we're trying to resize the expense face to projective revenues. We've made a great deal of progress, we are continuing to work on things that will engender more progress, even though there may be some short term costs in terms of severance and dealing with the cost of change.

The Enron situation appears to be with us for a while. We know that it's an event that caused great publicity even though there have been lots of other – people have lost a lot more money in other activities than Enron. We know that what we did was appropriate and proper and that over time we'll have the opportunity to [inaudible] case clearly. There's nothing we've done that shouldn't be public or couldn't be public. We're certainly cooperating with everybody that has a strong interest in it.

In the meantime, as these things recede, the strength of our franchise, I think, is showing through. We've had great progress in consumer banking, very strong top line growth and bottom line growth in consumer banking that, I think, has an opportunity to continue for quite some time. Trends are very positive here. We're certainly seeing improvement in margins and investment management and private banking, and think we are setting the table for the resumption of strong revenue growth. We are improving margins in investment banking in spite of declining revenues. Though the fundamentals are in place, these things that have retarded bringing those to the bottom line have certainly been in place, but, I think, see some easing of those pressures and hopefully, we can begin to see more of the progress that we feel in this company flow to bottom line and flow to shareholders.

With those comments, I'll be happy to respond to your questions and as I indicated earlier, I'm joined in the room by several of my colleagues who will take the more difficult questions. Ron.

Thanks. I was just wondering if you, Mark, or maybe Suzanne, could elaborate on what you're seeing as the leading indicators of credit that give you some comfort at not building reserves and then the other question was if you could give more quantification of your outlook for expenses this year because you mentioned some things that would be added, like Providian and the gross up [ph], so are you actually looking for a dollar decline? If you could elaborate on that.

Sure. Suzanne, do you want to lead off? Do we have a microphone?

Ron, Dina indicated, though it gave a sense of a couple of the indicators only in a little more detail. On the consumer front where it is easier to have a vision, if you will, as to credit quality, we are seeing an improvement in the delinquency rates, particularly, at this point, in the earlier maturities. And this has been a witness, if you will, in evidence through the first quarter of this year.

Ed, let me also point out that Dave Coulter is joining us on the phone today and I don't know whether Dave, if you can respond to that or Ed Murphy's in the room here to respond to that.

I'll give a little response, but am I coming through loud and clear?

Yeah, you are.

Okay, I believe that was Ron Mandell that asked the question. Ron, when we look across the board at the portfolio overall, just give you a couple of stats and I want to really stress that we're not drawing a straight line through these stats and saying this is what the year is going to be, but if we look at auto finance, for instance, 90-day delinquencies, we're 21 basis points in the fourth quarter and there's 16 in the first quarter. If we look at the early delinquencies of card, as I'm sure you are aware, you flow through various card buckets and the charge offs we're seeing today sort of entered the buckets six months ago. 30-day delinquencies and card have fallen, once again, certainly not a trend, but from 4.77 to 4.57, or 20 basis points.

In home finance, we had across the board, although I don't have the stats at my fingertips here, we have across the board reduction in delinquencies even in the manufactured housing business, which has tended to be a pretty coincident indicator with the economy and we are seeing increased charge offs in manufactured housing that sort of reflects the inventory glut of things in the charge off category. But as we look across the board at those early stage delinquency stats, there's some hopeful news.

Suzanne, you want to comment on the commercial side?

Okay. On the commercial side, we have seen now for – during the first quarter, as compared to the fourth quarter, a stabilization, if you will, of the risks deterioration in the commercial portfolio. And then we have, you know, the watch list or those names that are at the bottom of our portfolio in terms of risks profile. That volume has not materially increased quarter over quarter. Again, a quarter – I'd like to see a couple of more quarters to give me the comfort. It's a little bit more difficult, as you know, to have the clarity of visibility on the commercial front, but that is a sign that which gives us hope and helps us in terms of feeling that we are approaching the peak.

Let me just add to that. I think my instinct is on the commercial side our charge offs will continue to be higher than what we consider to be normal, but I think we anticipated that and that's why we added the reserves last year. And so, I think the need to further add to the reserves, while there may be some need on the commercial side, my guess it's more than offset by the easing of pressure on the consumer side and that's why we think it is unlikely, at this time, that we would need to charge earnings beyond the current charge offs in this year.

On the expenses, I think really Dina commented on the issues that are there. We do have businesses that are growing as in the consumer business. We have had a positive spread between revenue and expense growth, but, for example, compared to the first quarter of a year ago, you have 18% top line revenue growth and 13% expense growth, which we think is a good spread, both somewhat influenced by the acquisition of the Providian credit card acquisition. But, the point is there's going to be some growth there. There's going to be shrinkage in the areas where we do not have revenue growth. If you net all that together, what we're saying can you consider the cost of severance, which before we've treated below the line. What we're saying is we still think expenses will be somewhat lower in this year than they were last year. Yeah, Robert.

Dina mentioned that the Six Sigma showing up [inaudible] retail and I realize that it's hard to quantify it, but over the month I'm sure you're getting a better feel for what it might do. Can you update us as to any new quantification of its potential, and secondly, could you give us an update of any changes with the state of play of the rating agencies?

I'll respond to the first and let Dina respond to the second. With regard to Six Sigma, we have projects underway – or recently finished or underway – where we think the opportunity for expense savings is on the magnitude of a half a million dollars. We're also starting new projects as we go through the year. We've clearly seen the impact of most in the consumer side. We made a decision last year that that was where we were going to adopt it first because other parts of the bank were in the middle of a merger and it was more difficult to adopt those techniques while you're focused on merger and integration. So, consumers are ahead of the game there. I think they would say that they can already seen several hundred million dollars that benefits us more in the pipeline. So I think the numbers can be quite large and we're optimistic about it. Dina, you want to comment on the rating agency?

We really don't have anything new since about mid-February which is when [inaudible] confirmed the ratings in the firm. The outlook is stable. We've had increased dialogue as you would expect with the rating agencies these past six months versus what we used to have a year and a half ago. But there is nothing to report on beyond that.

Danny.

Yeah, I was wondering if you could be a little bit more specific on the severance charges you expect to flow through operating expenses – that's number one. And number two, if [basbies] ph proposed changes on STE [ph] and commercial paper go through, how will that impact your targeted Tier 1 capital ratio?

To try to be more specific, the fact is that anything that is that is new beyond what we've said what we estimated, would be a big would be a billion two relating to the merger and relocation initiatives that had already begun prior to last year. That will be charged to non-operating. Anything else that is new, will be charge to operating expenses. inaudible] I can't tell you. I think our feeling is that that net of all those actions will be a slight reduction of expense. But it may be that they'll be higher in the second quarter and you'll get the benefits in the third and fourth quarters. But I'd be reluctant to forecast the exact magnitude of it. with respect to the impact of the changes in the rules regarding STE's [ph], the rules – the perspective changes in the rules are so widely varying from day to day that it's a little bit harder to track exactly what the impact will be. We think we've been conservative in applying the rules thus far. The rules may change and require some consolidation and our view is it will not have a material impact on our ratios. We will probably adjust target ratios because we think we've already captured economic risks of those activities in our internal capital evaluation. And, therefore, if we need to adjust external ratios for some changes in the ground rules, we would consider doing that. But, I'd be hesitant to give an exact impact because the ground rules keep changing so significantly. Mike.

Within investment banking fixed income is doing well. Can you give some of the more detailed reasons that the subsegments that are performing [inaudible] whether or not that momentum is continuing in the second quarter?

In terms of within fixed income?

Fixed income.

Don Layton, do you want to respond to that question?

Yeah. Fixed income has, basically, the mix that the businesses that we tend to call credit products, the bond business largely, is doing well. There's continuing large corporate issuance in this country and abroad, and as you recall [inaudible], we have the – for investment grade bonds, we're number two globally. And that is considering on the trading side up quarter over quarter on the bond side about flat for underwriting. The business that is more tended upon just derivative interest rate flows and treasuries, is doing worse than last year by about a 20%. You recall last year's first quarter was highlighted by Al Greenspan cutting rates dramatically, so it was a rather unusual target they hit, as Dina mentioned, in aggregate the [inaudible] did quite well. In terms of this quarter, bond issuance continues to do well. The theme is not Alan Greenspan cutting rates, but it is a general theme that corporations are shoring up their balance sheets by extending maturities, reducing commercial paper, other short-term borrowings as a general trend so that business, which we had originally thought would go a bit softer from last year's record, because it wouldn't have the rate cuts, is in fact doing quite decently. You have pipeline itself in fixed income.

Jim.

To follow up on that, could you comment on the derivative activity contribution to trading and investment banking. And also, what happened in the custody business this quarter that cross-referenced in slowdown?

I'm going to let Don talk about the custody business, but with regard to derivatives, I think I prefer to defer that until next Friday, a week from Friday when we'll have a very long presentation on derivatives activities and earnings from those activities and risk control in those activities. Don, with regard to custody?

The investor services business as we call it, revenue declined first quarter over first quarter by 10%. It is very heavily tied to the equities business globally. You will – if you look generally at the equities business, whether it's trading or underwriting revenue, you'll find the average industry is down about 40-50%. So it's got a partial market sensitivity with that. Among the custody competitors, our business model is more market sensitive than most because our special fortes have been cross border custody (i.e., peatwed [ph] investors in the US invest outside or vice versa), and that is the most market sensitive part of the business. It also has generally been depressed a bit by interest rate levels because it does earn that interest [inaudible] on the cash that passes through it. But that's not the dominant part. Volumes have been lower in the equities business. Some of our revenues are tied to transaction volumes and such. Yeah, and I should mention, along with Suzanne's comment about credit quality flattening, the revenues are down 10% first quarter first quarter, but are flat in the fourth quarter so we're getting the question of possibly bottoming out here in general.

Okay, I'm going to start with some questions on the phone and then I'll come back in the room. We'll take the first question from the phone. Are there any questions on the phone?

Hi, everybody. Two questions, Mark. First, I'm just wondering if you'd talk a little bit broadly about the decision – what was the thought process, a little bit more in terms of the decision to flatten out the reserve building so abruptly. I mean, you had a couple of quarters where it was rising so noticeably and I understand your point that, you know, you're seeing some stabilization and credit ratings and maybe some improvement in the consumer, but given all the intensity of issues surrounding credit, why did you – why are you electing to sort of flatten that out so quickly. And I'm committing [ph] this specific question behind this, I'm curious in the Providian acquisition the reserves that you established there, it sounds like you feel like you have a lot of flexibility on consumer reserving, possibly excess reserves. Did that acquisition actually give you, you know, particular flexibility to draw down, you know, to over provide?

Yeah, those are good questions. Our reserving policy is a fairly quantitative exercise. We go through on commercial loans and evaluate the specific risk of loss on problem credit and general risk of loss on the rest of our portfolio based on historical loss rates for certain buckets. We do the same thing on the consumer side based on the average length of life of each type of credit and the expected loss rates for those credits, both a little historical, but mostly expected loss rates over the next year or so for those credits. When that has the impact, as I think I pointed out last time, when things are deteriorating, it causes you to front end the impact of those charges. Front end them in terms of the fact that you're reserving in anticipation of future losses, that, combined with our policy, which is to take losses aggressively. So, I think it is noteworthy, for example, that in Argentina we did absorb all of those losses in the fourth quarter of last year and reserves. Part of the building of reserves last quarter was specifically for Argentina, or in Enron that we charged it down last quarter down to less than 20% of the face value of the notes. I think the reserving policy, combined with an aggressive recognition of loss policy is what makes it more painful as you go through the early part, of the difficult part of the credit cycle, but it gets you to the peak faster and then there will be a downside where actually reserves will come down. We're not at that point, for sure, but I think what has changed for us is the lessening of likelihood that consumer losses are going to continue to build throughout the year.

I would say in the fourth quarter of last year, we might have guessed that that would, with a more negative outlook for the economy and looking at delinquencies, that that might continue to build throughout the year. Now our view would be that we're probably getting closer to a peak in consumer loss ratios. And therefore, the need to add to reserves, or maybe even the expectation that we had last year when we established reserves, that the now expected loss rate may be a little bit lower than what those expectations were. So I think what's changed is the real economy has changed. Our outlook and our experience has changed, and therefore, it causes the more abrupt change in our provisioning. And that is a product of the new world that we live in which causes us to want to up front these problems.

As to the second issue that you raised with regard to Providian, when we acquired the Providian assets, even though they are in a securitized trust, the rules are – the accounting rules are – that it all has to be consolidated on the balance sheet until such time as those credit cards revolve over. And then they're deemed to be securitized receivables. So at that time they tend to flow out and that'll take about 18 months, I guess. So that portfolio will run down on our books and, therefore, the reserves for them will run down on our books. Now, from an accounting standpoint, that is offset by the fact that the goodwill that was created with the reserve is amortized over five years or seven years, I guess –

[cross-talk]

but they're amortized over seven or eight – but that's front loaded, front loaded to the first year. So, in effect, we've got some accounting charges that relate to the accounting, and we do have some relief from the fact that the provision generally will be lower than charge offs related to that specific part of the portfolio.

inaudible] on the reserve that you have of Providian, if you look at the reserve relative to expected loss today for that portfolio versus the rest of the card portfolio, how does that relationship compare?

It would be higher because we would expect to have higher losses.

But the ratio itself, the ratio itself would be higher?

The ratio itself would be higher. Okay, next question on the phone.

Good morning. This is a question for Dina. Dina, when you indicated, I think last quarter you said expenses were going to be flat, now you're pointing that they'll be down and that includes, I just want to make sure I understand this, that includes $150 million association of expenses with Providian as well as the severance? And can you give us any update on how we should think about the severance going forward versus this quarter?

Yeah, we are looking at expenses to be lower, including the costs of Providian which are not $150 million for the year, they're higher than that, they were $48 million or $46 million for the first two months and they will, as Mark indicated, have a higher lever of intangible amortization as we go forward, but I don't think I indicated the level of expenses for Providian for the year. So, yes, it includes Providian and includes severance costs. We’re looking at – it's tied to a revenue outlook so the revenue outlook today is more cautious than the revenue outlook we had in January on the capital market side, on the investment bank side. So that's the context in which we are looking to have expenses being lower than last year.

No, I can't give you a magnitude. It all depends on the revenue environment. And, you know, I think it's really an indication for you that we are responding to revenue pressures by managing expenses. And focus on the operating ratio on the overhead ratio of the company that is what we are managing too in investment bank, very much so.

And really in any specific business that we operate.

Right. And then, just – you indicated, one thing you kind of mentioned briefly in passing about share buybacks, can you just walk investors through your mindset of one? What would be the kind of the data points that you would need to go back into repurchase mode?

I think we feel right now that it's a time to be building capital ratios. We worry about – we don't know fully what the impact of the consolidation will be. That will have some impact on capital ratios. And we're not quite at the end of this credit cycle. So, we feel it's prudent to have strong capital ratios. The data points that it would take to resume share buybacks, I think, would be stronger generation of internal earnings, in other words, stronger earnings than what we have right now. Would be higher capital ratios than we have right now, and third, and a clearer signal that we were toward the end of the credit cycle.

Now I think all three of those things are going to happen and, you know, I don't know whether it would be the end of this year or sometime next year, but I think they're clearly going to happen, and I think there will be a point at which we have significant generation of free capital. We've been retarded this past year by these heavy non-operating charges which are going down from last year's $2.5 billion pre-tax to this year $1.2 pre-tax. And we've been retarded by very low earnings, which we think has the potential to be higher. But we have had good control of the balance sheet. Loans are down; commercial loans are down 10% from a year ago. They're down 3% from year-end in spite of all the pressures that were in the commercial paper market. So, I think we have had very tight control of the balance sheet and that is – that will continue and that will give us, as these other factors come into play, significant free generation of capital and will enable significant buybacks at some point in time or else the redeployment of that capital into profitable growth.

Just one follow up and this may be for Jus Dailey [ph], but on Flemmings, and in the asset management division, did the contracts roll off at the end of last year so that will help on the comp side and did we see that? And then two is, I'm surprised that you said you had the highest international flows in five quarters. Can you just give us some color, is that retail, institutional, and what do you see driving that?

Okay, Jus, will you respond to that?

Yeah. Contracts did roll off, so you are seeing part of that on the Flemming side. In terms of the retail asset that Dina talked about, internationally that was the strongest, were essentially flat institutionally and there were mutual funds both in Europe and in Asia. So it's a high-yielding asset rolling in.

Mark, this is Dave Coulter, could I just add one comment to those just made?

Sure.

I think Dina, I don't get this opportunity often, so I definitely ought to take it. I think Dina misspoke a bit when she talked about assets under management at the end of the first quarter. She said 538. It should be 583, and that is down from a level of 605 in the fourth quarter and that is all sort of the hunter money market flows which flowed in strongly throughout last year and flowed up somewhat in the first quarter.

It's duly noted, but I think the important point is the one that Jus made and that is the mix of the assets is what's important. Our highest margin assets are European and Asian retail equity mutual funds. And that is where we're beginning to see some more positive signs. In the retail flows, first quarter over fourth quarter were up 16%. Okay, next question in the room. Yeah.

Looking at the level of interest income and interest expense and the yield on the spread, in light of the current economic environment, in terms of interest rates going forward, what are you looking forward to in terms of the rate situation and what are we looking for in terms of maybe, perhaps, that improvement on the interest margin?

Our view is if the economy is improving and will continue to improve, that rates will begin to go up sometime this summer or fall. We are not particularly exposed plus or minus to the impact of rising rates so I don't think it will have a negative affect on us. I think the affect will be more positive because of the pick up in economic activity and its impact on credit, on private equity valuation and on the M&A activity. So, my guess is the impact on that interest income per se will be fairly neutral but the impact on our business will be positive. Next question. Yeah.

Short one. First of all, from Dina's comments, I got the sense that you might not be doing the NASDAQ hedge going forward given the lack of correlation. Is that true?

We looked at different hedging techniques and we may not be using that one.

Okay. And then just a couple of brief ones. Goodwill declined $270 million or so in the quarter.

I think it was more a reclassification from goodwill to intangibles as we're looking at what needs to be amortized going forward.

Okay, and there's one last one, delinquencies, the dollar amount delinquencies did rise pretty significantly in the credit card business sequentially. Was any of that related to Providian, but I thought you took only the higher problem stuff that wasn't kind of 90-day plus with Providian.

Yeah, I think you're right, [inaudible], but we do take some with delinquencies – that are delinquent. So, with an $8 billion addition to our portfolio and the fact that it was acquired on February 1st and this data is of March 31st, there would be some significant impact from delinquencies from that portfolio. I think it was most of that portfolio went up a little bit as Suzanne pointed out – 90-day delinquencies are up slightly, 30-day and 60-day delinquencies are down. Yeah.

Perhaps everyone knows this, but in the past few years, you have spoken, I think about the retail area with revenues growing so rapidly and I've heard presentations of Pacific Northwest Mortgage thing and the auto thing and then Brown, what are the factors that are causing this rapid growth in retail?

Dave, would you say it's management or what?

I'd definitely say good management. Really, it's across the board. We are – we have very strong underlying businesses and Chase Home Finance were the number two originator, number three servicer. It generated $180 billion of mortgage product last year. That has continued – that pace activity has continued into the first quarter. We have a great mortgage company. And the card business, we talked last time about why we were interested in Providian. I think we began by saying look, we feel like the new management team there over the last two years has created a very solvent operational platform that we could build off of, and I think you're beginning to see that they've also created a marketing platform.

In this year, in '02, we plan to do what we call 35,000 marketing tests. That's all sorts of marketing variations of, you know, which products work, where, for what demographics, what terms. The standard in this business is Cap One who, I think, who would probably say well they do 60,000 marketed tests a year. That number for us, that degree of market, sort of, penetration is up from 500 market tests two years ago. So I think across the board, as you look at the products we're putting out and the branch and middle market structure we have in New York we're just seeing great flows. The share of the small business, for instance, in New York is up from about 18% to, I think, about 24% in terms of primary market share in the New York market. Next closest competitor is Six. So, we're seeing the results of, I think, in a kind of top line growth of this franchise that sort of reflects its underlying strength.

Okay, next question on the phone.

Thanks. Good morning, everybody. As the leader in mortgage syndications, or I should say loan syndications, and the introduction of market flex, could you talk a little bit about what you're seeing in terms of pricing flexibility in the face of corporate demand to term out their credit and how much room you think you might have to cut your loan portfolio even as your clients might be even more interested in taking down bank debt as opposed to more market sensitive credit.

Geoff Boisi is here. Geoff, would you like to respond to that question?

I don't have a really great answer for that to be honest with you. I mean, we're, you know, seeing an uptick in terms of the whole leverage finance area right now, but from a specific pricing standpoint, to be honest, I don't have a specific answer. I don't know. Do you?

I don't think pricing power is as strong as you would think it would be in this environment. So, I think we're still dealing with fairly low margins.

Do you guys see any ability to push that at the margin or willingness to, perhaps, take more credit on balance sheet temporarily with a view towards being able to term it out as the market turns around? Or I should say, as risk appetite on the part of investors increases?

Well, we haven't changed our standards about the need to syndicate 90% or more of credits. And that's essential to our philosophy in terms of diversifying credit exposure and that remains our standard.

Yeah, I think the important point here is that we continue to be very aggressive in this marketplace. We're responding on, obviously, a case by case basis. We have taken a very, very sharp look at our overall portfolio, but the marketplace, I think, is seeing from us a continued aggressive stance, both in terms of our willingness to commit capital and our aggressiveness in pricing. Having said that, we're trying to be exceedingly prudent. We see an environment out there, particularly as we see companies take strategic moves, combining those strategic moves looking at what the corporate finance activity is, we are – we have used our balance sheet quite aggressively in helping [inaudible] through that period of time, both in terms of our willingness to commit capital, but also from a pricing standpoint. In general, right now, we're seeing exceedingly competitive markets as Citi Group, in particular, has been quite aggressive and we've been responding to that. But our position as it relates to syndicated lump [ph] market, has – you know, we've maintained our leadership position and, you know, on a month to month basis, that's been improving.

I think the one thing that's clear is that having leadership across all debt products is an enormous competitive advantage and I don't think it's an accident that one and two players in loan syndication and investment rates and debt issuance are the same is an accident. Because I think, having a combined product set across the whole range of debt is an enormous capability.

And I would just add, and Don mentioned before, we see our pipeline, particularly in the fixed income area, but I'd also say in the equity area, but particularly in the fixed income area, because that's what you're questioning, has started to increase over the last couple of months.

Next question from the phone.

Yeah, can you give us a sense of how we should project the corporate line? I'm speaking about the line that had $150 million loss this quarter and a $257 million loss in the fourth quarter. How should we think about that going forward?

I think you should think of it as a small loss. There are instances – there are times when we had charges that don't get allocated, but our instinct over time is to try to make that as small as possible and to allocate everything out. So, over time, I would expect it to be something that would shrink.

So what types of things might have shown up in that line item this quarter versus the fourth quarter?

Well, I think the reason that it probably came down from the fourth quarter is that part of the unallocated provision increase in the fourth quarter went to the corporate sector.

Okay. And when you say small, you mean small as in $150 million?

Well, the problem is there's about 50 things that go into it that all net out to that, and I think, over time, what I would do is expect it to be smaller.

Okay, thanks.

Next question on the phone.

Good afternoon. Two questions here. Wheat [ph] made some comments yesterday about their exposure to the venture capital business and the fact that they wanted to limit their exposure, to lessen their exposure. I mean on a de facto basis, you've been lessening your exposure, but I haven't really heard too much philosophical discussion of that business and its claim on capital. So if you could address that. And secondly, a really big question here, excluding the four, sort of special and not controllable factors that you cited, Mark, about – that have impacted the merger, sort of looking beyond those, where do you feel that the Chase Morgan merger has worked really well and where has it worked really poorly?

Okay. With regard to private equity, I think we've been clear that our path to getting to a – well, let me back up a minute. We have a great private equity business and one that has outperformed its peers over a long period of time. On the other hand, we feel that we have had too large a concentration in that portfolio. And the best way to deal with that over time is to invest less going forward. We are doing that by getting more third party money and by lowering the pace of investments. Right now, we're around 21 or 22%, I think, of Tier 1 capital in terms of the $8.5 billion balance of that portfolio. A perspective, prior to the merger, that number was as high as 38%. I think our target over time would be to reduce it to around 15% and that will happen because of a lower investment pace over a several year period of time. We do think it's a business that integrates well with the rest of our [inaudible] that provides a lot of value to the corporate and private banking businesses and does produce above-average shareholder returns over time.

With respect to the merger, I think what has worked well is the people integration, the addition of trying to get the all star team from two large institutions has worked well, and relative to the expectations that you always set in these mergers, our retention has been good. I think what has not worked well is simply we've been in this difficult market environment and that's made it more problematic than the last two mergers where we had a lot of wind on our back. Over the long run, of course, it's not bad to go through difficult periods because it forges teamwork, it causes people to work together. It has certainly forced us to relook at the way certain expenses are set and recalibrate that in a way which I think over time will produce much more earnings. It has been a challenge, but one I think that we have dealt with successfully. Dina, would you like to make a comment?

Yeah, I would like to add that we have merged about a year, a year and a quarter ago. We, overall, have gained share in a shrinking market. But we have gained share in the first year of the merger. So, the success of the merger is not just – the final is the success with the client and the fact that we have been able despite our going through the merger to gain share is an indication of the success of the model and execution.

Okay, I think we'll take one more question on the phone and then one in the room and then we'll conclude and we'll be happy to stay here for those that have additional questions. Last question from the phone.

I'm showing no questions on the telephone.

Okay. Is there a question in the room? Okay, that's easier than I thought it would be. Thank you very much for being here and as I said, we'll be able to stay a minute or two afterwards. April 26th is the meeting on derivatives. Thanks.