摩根大通 (JPM) 2002 Q2 法說會逐字稿

Presentation portion was missed.

Something that we can experiment with and use it on a broader basis outside this campus.

We have a proliferation of investor meetings going on, I guess, and I think increasingly as we have more more and more people attending my call, we'll probably vary some of these where we just simply do them by call.

But in any event, we do want to proceed in our normal pattern today.

Dina Dublon, who is our chief financial officer, will give a review of her comments on the quarter.

I'll give a few of my own comments, and then I will be joined by some of my other colleagues on the senior management team in responding to questions, both here and on the phone.

Dina?

Thank you.

Welcome to those of you here in the room and welcome to those of you on the phone.

Our first slide is our statement regarding risks and uncertainties in accordance with the Private Securities Litigation Reform Act.

Earnings this quarter were comparable to the first quarter, but below analysts consensus estimate.

We tail led the way again with another record quarter.

We gained market share in investment bank in a market that continues to shrink.

Weak trading more than offset the gains and drove results lower.

J. P. Morgan Partners loss was much smaller but still a loss.

Tech and telecom continues to drive the write-downs.

Operating earnings per share was 58 cents a share, up a penny from last quarter and up over 50% from last year, because of the very large write-downs in J. P. Morgan Partners last year.

Excluding partners, EPS is slightly down, 3 to 4%, from both last year and the first quarter of this year.

Reported EPS net of the previously announced merger and relocation charges was 50 cents.

These charges were 230 million pretax and for the second half of the year, non-operating merger charges were estimated at about 700 million.

Revenues were up 9% from the second quarter last year.

The increase is all due to the much smaller loss in J. P. Morgan and partners.

Excluding partners, revenues were flat but with a significant change in mix.

Over 700 million increase in revenues from retail offset the 600 million revenue decline in investment bank.

Total revenues were flat to the first quarter with a very similar change in mix.

Lower trading revenues and higher retail revenues.

We continue to manage to positive operating leverage by reducing expenses.

Credit costs are up significantly from last year.

Relative to the first quarter, credit costs are up due to the addition of the provision of the - of the Providian portfolio for the fourth quarter.

Operating earnings for the quarter were 1.2 billion.

Return on equity was 11% for the quarter as well as the first half.

Expenses are down 3% from the first quarter and 5% from the second quarter last year.

Operating expenses include 160 million in non-merger, severance, and related costs, up from about a hundred million last quarter.

As we have said, these costs will continue to flow through the operating line.

We will have more of these charges in the second half, although not as high as we had in the first half of the year.

We are managing expenses to be lower than 2001, including the cost of severance.

Credit costs are high, but stable.

Commercial charge-offs were 290 million or almost 1.2% of commercial loans.

Middle market credits are holding up.

It is the larger names, primarily in telecom and media, where we continue to see problems.

We have had no improvement but also no significant deterioration in the commercial portfolio.

Managed credit card charge-offs are higher, as expected Providian charge-offs on our books are up from last quarter.

Total provision equal charge-off this quarter as well as the last quarter, in the first quarter of this year.

We hold reserves against retained consumer loans.

Providian and other card security [inaudible] and lower loss rate in auto finance contributed to 130 million relief in consumer reserves.

For cards, we show improvement in all, whether it's 30, 60 or 90-day bucket for delinquency ratios.

Commercial reserves stayed about even.

The computation of reserves for the consumer and the commercial segment is more formula-driven, based on ratings and loss rate.

We increased the unallocated portion of the total reserve by 120 million, to allow for greater uncertainty in default probabilities and rating migrations in the current environment.

Unallocated reserves are now over $800 million, 16% of total reserves versus 14% in the first quarter, and 11% in the second quarter of last year.

Our policy is to stay between 10 and 20%.

Non-performing assets - and I'm on slide 8 for those of you on the phone.

Non-performing assets are up slightly to 4.4 billion from addition primarily in the telecom sector.

Non-performing assets may rise, though not dramatically.

Argentine credit exposure, net of reserves, is about 200 million.

We recognized most of our loss last year, and had no net credit costs related to Argentine in the second quarter.

While we remain active in Brazil, we have managed our Brazilian exposure down to 2.1 billion as of the end of this quarter, from 3.3 billion at the end of the year.

Reserves are 5 billion and are unchanged from the last quarter and up 1.3 billion from last year.

Loans are down and leading to an increase in the reserve to loan ratio of about 70 basis points.

We don't expect to see a material change in credit in the second half of the year.

The commercial portfolio remains under pressure, led by telecom and cable.

Consumer losses should remain close to the second-quarter levels.

Continued rollover of the Providian portfolio into securitization trust and improving delinquency trends should allow for lower consumer reserves in the second half of the year.

We expect total reserves to stay at about the same level.

Slide 9, retail and middle market posted record earnings of 686 million, up 29% from last quarter and 60% from last year.

Return on equity was 26% for the first half, 24%.

Retail was almost 60% of this quarter's consolidated earnings.

Revenues of 3-and-a-half billion was driven by this consumer lending businesses, compared to last year.

Providian adds 10% to revenue growth and 5% to expense growth.

The overhead ratio declined to 48%.

We continue to show organic growth in cards for the seventh consecutive quarter, adding 900,000 in new accounts.

Deposits are up 12% from last year.

Home finance income almost doubled from last quarter.

All components of the business, whether origination, servicing, or loan portfolio, all of them benefitted from low rates, the steep yield curve and widening of more [inaudible] spread.

We had high mortgage applications, lower funding costs, and higher servicing balances.

In addition to the ideal operating environment, we had net hedging gains of 160 million.

Gains exceeded the write-downs in the value of mortgage servicing rights.

For operating purposes, we do not count on - we don't forecast - net hedging gains for servicing rights.

Given the very strong results in home finance, even if the environment continues to be very positive as we expect it, revenues and earnings for retail may be lower for the rest of the year.

Slide 10, treasury and security services also had a record quarter, with earnings up 22% from last quarter and 16% from a year ago.

Return on equity rebounded to 23%.

Revenues at 985 million are up 2% from last year, much slower than what the business is capable of in more normal market conditions.

It is, however, up 5% from the first quarter.

Investor services are - revenues are up 9% from a pickup in custody fees, foreign exchange revenues, as well as securities lending fees.

Institutional revenues are up 9%.

Treasury services revenues are down modestly compared to both the first-quarter and the year-ago quarter.

Both are down 1% because of low rates.

Deposit levels and fees are up in the business.

Expenses are under control.

The overratio dropped to 72%.

The group works towards a long-term overhead ratio of 68%.

Earnings in the investment bank, slide 11, are low at 485 million, down 35% and 38% from prior periods on very weak revenue and high credit costs.

We have not seen a turnaround yet.

Expenses are down, though not in line with revenues.

We put in place this quarter a new client coverage model and included in operating expenses severance related charges of 120 million, up from 50 million in the first quarter.

We are pleased that we did not lose market share while implementing this new model.

The overhead ratio for the quarter was 65%.

For the year-to-date, it's 62% excluding the searches related cost, the ratio is 61 for the quarter and 59% year-to-date.

The revenue and credit environment continues to be difficult.

In managing expenses, we are cautious about sacrificing long-term growth.

The crisis of confidence among investors suggests no meaningful pickup in market activity in the second half of the year.

With additional severance charges and caution on further cuts, we must see a recovery in revenue for the overhead ratio to decline to our targeted level for the year.

This does not seem likely.

Return on equity for the quarter was 10%.

Year-to-date, it is 13%.

Looking in more detail at revenues - I'm on slide 12 - first, trading and brokerage commissions combined at 1.4 billion are down over 20% from last year and last quarter.

Weak trading, particularly in June, drove the decline.

Fixed income is down 11% from last year because of declines in emerging markets trading.

Relative to the first quarter, the decline is due in equal parts to lower emerging markets trading and lower positioning gains in rates.

Equities are down 45% from the second quarter last year, primarily equity derivatives.

The decline from the first quarter is primarily from cash business.

Relative to our competitors and compared to the first quarter, investment banking results are favorable.

Particularly in equities.

Though absolute levels are still low.

Our pipeline is slightly below where it was at the end of March, and substantially below last June.

Equities was the bright spot, though in recent weeks we have seen deals get postponed or cancelled.

Due to the very important market conditions.

Trading, as I said, was unusually weak in June and may rebound.

The outlook for the second half, however, remains very uncertain.

This slide highlights - slide 13 highlights market share progress in a few key products.

This table shows the first half 2001 versus first half '02 and the second quarter results.

In all cases, we maintained or increased rank or market share relative to last year.

Note that in each case, market share in the second quarter was higher than in the first half of the year, highlighting the momentum in the second quarter.

Market gain shares really validate the value to clients of our broad investment banking model.

We are seeing the benefits from our investment in equities.

We are outpacing, as I said before, in a shrinking market.

Year-to-date global disclosed fees for the market are down about 15% versus the same period last year.

We are up 30%.

In fact, we were the only ones - the only top five book runners to increase fees.

Equities markets activity is running at '98 levels.

M and A is running at '95 levels.

Syndicated loan volumes increased very modestly from last quarter, but are down compared to last year.

Moving to investment management and private banking, slide 14, earnings are about the same as a year ago, as expense reductions more than offset lower revenues and higher credit costs.

Earnings are down 6% from last quarter.

Return on equity was 8%.

Tangible return on equity is over - is in excess of 20%.

The pretax margin was 21%, up from the second quarter last year but down from the 22% we had in the first quarter.

Private bank revenues, about half of the total revenues of the group declined 9% from the first quarter on lower client activity.

Loans, deposits, and brokerage fees were down.

Investment management revenues were flat with the first quarter.

Assets under management fell 40 billion from the end of March to 540 billion.

Declining equity market values and money market outflows each contributed equally to the decline.

The retail fund business continued to have positive flows.

Retail assets under management are up 11% from last year, and flat with March, despite market depreciation.

These carry higher fees and margins.

Merger integration in investment management and private banking business is always a challenge.

We have most of it behind us.

Margins have significantly improved in investment management.

In the private bank, we have the capacity to gain market share at better margins and are taking measures to deliver on this potential.

J. P. Morgan Partners had a private equity loss that narrowed to 125 million.

Write-downs and write-offs remain at high levels. 70% of which came from tech and telecom.

Realized gains of 110 million partially offset the write-downs and write-offs.

Exit opportunities continue to be limited.

The mark-to-market on the public portfolio had less of an impact this quarter.

Losses were partially offset by hedge gains and a gain on the jet blue IPO.

The public portfolio is now on our books at about $700 million.

As I have stressed throughout this discussion, we have not seen a turnaround yet.

The IPO market is slow, at best.

The high-yield market is on and off.

And M and A activity is very sluggish.

We have a few transactions in the pipeline expected to close in the third quarter, including the publicly-announced Barry plastics deal.

Seagate technologies has filed for an IPO which is scheduled for the second half of the year.

To break even in the second half of the year, we need an increase in realized gain to offset the current level of write-downs.

Moving to balance sheet and capital, slide 16, maintaining financial flexibility is important.

Our tier 1 capital ratio remains high at 8.7%, up from 8.3% at year end.

We are not yet re-purchasing stock.

In fact, we have been net issuers for employee benefit plans.

We will wait for acceleration of earnings before we resume repurchases.

Assets are up 4% from last quarter due to increasing trading assets.

Total loans are down.

Commercial loans are down 70 - 7% from last year.

They're slightly up this quarter.

The risk-weighted assets are down from the first quarter as well as from year end.

In summary, diversification has helped maintain operating results.

Our earnings from the investment bank are down 300 million from last year, a 38% decline.

The increase in retail and services is over 280 million, making up for most of the decline.

We continue to strengthen the franchise, whether retail or investment banking, yet capital market businesses continue to suffer from slow corporate activity and reduced market values, with no clear turning point yet.

Short-term, we see no improvement with potentially some pressure in revenues and credit.

Therefore, expense discipline and balance sheet strength remain top priorities.

We recognize that reputation is one of our most valuable assets.

We expect and hold ourselves to the highest standards of integrity.

We can't assure you that no issues will ever be raised.

It is difficult for all of us, for you and for us, to operate in an environment of mistrust where essentially rumors are picked up by the media and gain credibility before we have an opportunity to react.

We will eventually - eventually, we'll get to the other side of this tunnel as well.

Thank you.

Mark Marc?

Now we're going to summarize this quarter in terms of pluses and minuses.

I would say the three pluses are that we had a great performance in the retail side, with record revenues and record earnings, and all of our businesses in that sector performing very well.

The second very positive thing was that investment banking market share picked up across the board, across all products, and is the clear indicator that the strategy we have is a long-term successful strategy.

And the third positive would be that credit costs are stable in a difficult environment.

If I were to look at three negatives, I'd say number one, credit costs are still high relative to historical standards.

Second, investment banking revenues, particularly trading revenues, are weak relative to historical standards and the potential of the company.

And the third element is that private equity continues to show losses and not much opportunity for realized gain.

Now, the good news about all three of those things is that I think that they are somewhat cyclical.

In fact, I know they're cyclical.

What I don't know is the length of the cycle.

But we do know there will be a time when investment banking revenues pick up, when credit costs will return to a more normal period, and when private equity exit opportunities will regain their prior place in life.

And our goal is simply to continue with the strategy we have and to continue to execute on that strategy until we get to that time when the bottom-line results can show the benefit of that.

I continue to believe this is a company with tremendous operating leverage in our results, as we continue to ratchet down expense base, that operating leverage becomes even stronger and that, of course, is what we are waiting for.

At this time, I'd be happy to respond to questions, and as I indicated, I'm joined by many of my associates right here.

Thank you.

My question on the dividend.

Uh-huh.

You indicated that [inaudible] dividend rate to be about 30% and at a little more than $1.30, that indicates that your EPS would have to be $4.50 a share, give or take.

Right.

Given that the run rate for the EPS for the last two years has been around $2 and that even at the NASDAQ peak in 1999, you never got to that level, at what point is it appropriate to address the current dividend level and consider cutting it until some of these cyclical problems resolve?

That's a good question, and I think our outlook on that would be is there visibility for getting to the four, four-and-a-half dollars that would be comfortable with our policy.

It takes three things to get there.

It takes a more normal private equity revenue rate.

It takes a more normal trading and investment banking environment.

And it takes credit costs at normal levels.

If those three things happen, then we would be at a that earnings level.

Now, the question is how long can you wait, and the answer is, as long as we're comfortably covering the dividend, as long as we are increasing our capital ratios, then I would say we feel very comfortable waiting.

And as long as we have the belief - which we do - that we will get to those levels.

If those conditions change, then I think we will reassess that, but at the present time, that continues to be how we feel about it.

Ron?

Yeah.

I'm glad I'm wearing black.

In regard to the - and Dina is wearing white, so . . .

Dina, I guess what I took away from what you were saying is that the earnings in the retail business were boosted by the hedge gains, so retail earnings will probably be down in the second half, and you don't see anything turning around in investment banking in the second half, so, you know, it's hard to see earnings improving in the second half from what they were in the first half and possibly could be weaker, and then a more specific question.

You know, trading results were weak as you pointed out and they seemed to be weaker than some of your peers who were on the same calendar quarter.

I was wondering if you could elaborate on that a little bit.

Well, we got our new head of investment banking, who will be happy to respond to that.

David?

I'll start it off, Ron, and we'll see whether it works for you.

And we also have Steve Black and Bill Winters here, if you want to talk about either the equity or the credit rates business.

Our results on a quarter - on a prior-year quarter, on a quarterly basis, do look weak, but I think you do have to keep in mind that we had a very strong quarter a year ago.

It was about a billion six in revenues.

We had a very strong quarter in the first quarter of this year.

It was about a billion seven.

This quarter came in at a billion one. $200 million of that difference was emerging markets, largely Brazil, where you heard Dina describe our exposures there as we've - as we've taken them down and we took our hits in Brazil and I think we've moved on from there.

About another third of it related to the rates business and weakness in the rates business vis-a-vis prior periods.

And then the final part was the equities derivatives business.

So the equity derivatives was strong in the second quarter of last year.

And that's largely related, from our perspective largely related to deal flow, lack of - lack of deal activity in that market, and that's where we've seen the weaknesses.

But keep in mind we're coming - we're looking at these from a reasonably strong level vis-a-vis our peers.

[inaudible]

Yeah, but that's my point.

We were at a billion seven in the first quarter of last year.

Ron's follow-on question to those on the phone relates to first-quarter of this year versus second quarter.

We were at a billion seven.

As I said, a billion one was a low quarter for us overall, but if you - if you take 200 of that related to our emerging markets in Brazil, I think - I think it's - it's the ups and downs of the trading business.

But I think we came from a very high first quarter.

And then if Dina has any comment about - more comment about the outlook for the second half of the year.

Dina?

I don't know that I have much to add on what I said before.

I think, you know, we can all look at the numbers.

There isn't much visibility on the investment banking side.

What we have is somewhat [inaudible] trading results was June was particularly weak.

Yes, we could.

On the other hand, we had some unusual items in [inaudible] as well.

So we had this quarter unusually low trading and we had somewhat unusual market sensitive items on the mortgage banking side and, you know, for the remainder of the year, it's more of the same [inaudible] as being management.

All right.

Given the revenue weakness, where do you stand on expense initiatives?

How much expense savings do you have?

What's left, number one.

Number two, venture capital, how scrubbed is the private portion of the portfolio and what kind of losses are you looking at?

And third, if you could just comment on some of the regulatory investigations.

Okay.

With regard to expense initiatives, I think we continue to be very focused on expenses.

We have continued to reduce people, especially in those areas where we have revenue declines, which are primarily in investment management and treasury securities services and in investment banking.

In the consumer business, where we have strong volume growth, we are adding people to deal with the volume growth and our expense growth will is lower than our revenue growth, even when you make all the various adjustments.

So I think it is something that we are clearly cognizant of, the need to keep the pressure on expenses, and we continue to do so.

Because we push all of the costs of doing that into our operating expenses, it doesn't show up quite as immediately as it did if you were pushing it for a non-operating cost, but I think it is clear that we're going to continue to focus on those initiatives. [inaudible] has been a very important part of what we were doing.

It was utilized first in the retail bank because they weren't going through a merger and I think they have several hundred million dollars of payback from it.

We're applying it more broadly across the country now as we've gotten through with the merger and I think we will see additional fruits from that.

Now, the second - I'm sorry.

The second question you asked, Mike?

Venture capital.

How comfortable do we feel with our evaluations.

We feel comfortable with our evaluations.

We have a very intents I have process that we go through of looking at each company that is subject to both people in the company and people outside of the private equities side taking an independent look at it.

The market, especially in telecommunications, has continued to decline, and I think that with that has been some write-downs in our portfolio.

I can't predict whether that market is going to continue to decline.

At some point, I know it won't.

But as long as it is, there probably will be some continued write-downs.

We are not able to just say we'll write the whole thing off and when it comes back, you know, then it will be there.

That's not the right way to account for it either.

I feel very comfortable that we're on top of it, as it is moving.

There's some signs that it may be getting close to a bottom, but we'll have to see whether that works out or not.

The third, with regard to investigations, you know, I think everybody and his dog is investigating everything that is associated with some of the highly visible transactions.

We are comfortable that what we did was the right thing, and therefore, we understand why all these people want to investigate.

We think that that's their role in life and we're certainly cooperative with them, but-[lost audio]

[call operator is being contacted]

For two months.

It is not that we are disappointed in the results.

That's what we expected to happen.

We're actually making more money on a bottom-line basis than we expected to make in the first six months of the acquisition.

We think over time it will turn out to be a terrific money-making proposition, though it even is today, which we didn't expect for the first six or nine months.

So it simply means that our ratio is higher than it it's would have been, but we're not disappointed in it.

At this time, I think we'll take a question on the phone.

Thank you, ladies and gentlemen.

For questions or comments, we ask you to please press the numbers 1 followed by 4 on your touch-tone telephone at this time.

We do ask all parties to please pick up their handsets while posing their question, and if you would like to remove yourself from the queue, you may do so by pressing the pound key.

Please hold while we poll for our first audio question.

Thank you.

Our first question is coming from Henry McVeigh of Morgan Stanley.

Please state your question.

Good morning.

Can you hear me?

Yes.

Okay.

A couple questions for Dina.

One, Dina, it seems like on the private equity, that you were saying the issue is really not on the write-downs but more on the realized gain side and I just want to make sure that's what you were inferring.

I [inaudible] that write-downs - that we are not expecting any large write-downs on Jaap morgue partners.

We don't have the same concentration issue that we had a year ago, and yes [inaudible] in order for us to see a positive bottom line, we need to see [inaudible].

That's not to say we won't have write-downs.

Right.

But no -

I think, Henry, if you look at historical levels of write-down -

Uh-huh.

- they would have run for some long period of time in the range of a hundred and - hundred to hundred and fifty million dollars a quarter, would not be unusual, even $200 million a quarter would not be unusual.

Right.

So it is not so unusual to have $200 million in write-downs.

What's unusual is that we don't have the realized gains to offset that.

Right.

As you would expect in a portfolio of our size to be in the neighborhood of $500 million a quarter.

Right.

Just wanted to make sure.

And then on - the second thing I wanted to follow up on was - and I apologize if you answered this because I had to jump from one other call - the home finance went from 132 to 268 and auto finance went from 33 to 82.

I heard you mention that there was a - that there was a gain on a hedge.

Was there anything else that really bolstered those numbers?

Yes.

In auto finance, we had a reduction in the credit loss allowance, in the provision, because as we - our methodology is predicated on delinquencies, current losses, retained loans, and expectations of future losses.

And when you run that - and also average holding period, average period that the loan is on our books, since our reserve is for the life of the loan.

Uh-huh.

So when you ran the calculations through this quarter, for a variety of reasons, including the good credit performance, the reserve in that business was higher than it needed to be.

That was the primary reason.

In addition to the fact that it had very good volume growth and very much wider spreads in that business, as people have gotten out of that business and as there's less competition in that business.

Then we have seen - and as we're in a favorable interest rate environment, we have seen spreads widen in that business.

Okay.

With regard to the mortgage business, it was partially helped by hedge gains, but also it would be true to say that origination gains, the warehouse effect, spreads on warehouse loans, and the positive continued increase in servicing also contributed to the improved earnings.

Okay.

Just one follow-up, last question.

Just Dina had said in her commentary that she expected continued revenue pressure and continued high credit costs, and then if you infer that you're saying that the consumer bucket is getting - you know, is getting better - that's what Don said - so most of the issues that we should be looking for on the credit side are related to the corporate?

Is that -

I think I would say consistent with what we said in the first quarter, which is that consumer costs are getting better.

Consumer credit is getting better.

We're still seeing continued positive delinquency trends, and that will probably mean, given the way we reserve based on expected future losses that provisions in the consumer area will probably continue to be somewhat less than actual charge-offs.

Okay.

On the commercial side, it's possibly the reverse, although we are seeing a leveling out of problems, and although there's a lot of stuff in the news, it is not necessarily new news to us and -

Right.

Our evaluation of the loans.

We are charging off a significant amount of loans, as we try to stay ahead of this game, and in other words for the provision to have to go up, your loans have to deteriorate by more than what you charge off, and it is - at some point, which is probably not too far away, we're going to get to the point where that is not continuing to happen.

Okay.

Great.

That's very helpful.

Okay.

Next question on the phone?

Thank you.

Our next question is coming from Jude da contra-shear an of Merrill Lynch.

Please state your question.

Hi, Mark.

How are you.

Hi, Judith.

A couple questions.

Or this one may be for Dina but Dina mentioned an unallocated reserve policy of 10 to 20% and now you're kind of moving up on unallocated reserves to 16% this quarter.

The question is as follows: My recollection is, other banks commonly have unallocated reserve levels considerably higher, and it seems a little bit odd that, you know, you're this far into a credit cycle and you're only now going into the upper half of that policy range.

How do you sort of square up both those issues?

Well, first of all, our reading of the SEC policy is that you should not have an unallocated reserve that's significantly higher than that.

Secondly, with regard to where we are in the credit cycle, we don't really look at it as where we are in the credit cycle.

Our normal policy, if you will, is that provision equals charge-off.

We also run through this specific allocation methodology, and if that policy leads us to one where we have too high an unallocated, then we would bring provision down below charge-off.

If the reverse happened, if it was too low on unallocated as was in danger of happening last year, then we would raise the provision to offset it.

So I think our policy is very consistent.

I think it is absolutely in accordance with what the SEC wants, and it is - it is a methodology that we've followed for the past several years fairly religiously.

It does sound, though, that if the consumer continues to improve, you're going to have more releases of consumer reserves, and to keep provision equal to charge-offs, I haven't done the math but it would seem like you could get fairly quickly to a case where you'd go above 20%.

Would you let that happen?

Would you change the unallocated policy.

No, we would not let that happen.

Okay.

The other two questions I just had quickly.

That investment management fees as apart from transactional fees in the investment management business were flat this quarter.

Can you reconcile that with a drop in managed assets?

And the other question is, in the investment bank, the core overhead ratio, apart from severance, went from 57 to 61%.

I think your goal was 60%, I think you said.

Can we see any improvement in the second half of the year back to - to, you know - you know, from these levels if markets don't really recover or, you know, are we just going to hang above the goal indefinitely here?

Well, to answer the second question, of course it gets easier as revenue increases.

If revenue continues to fall or be short of that, then I think it gets more difficult and we'll have to decide where we wind up in terms of primarily compensation as it relates to that level.

We are looking at it carefully, both trying to balance long-term and short-term interest, but I think we've had a good record of managing expenses down to the significant revenue shortfall we have had so far, and it's something that we'll continue to try to manage to those levels.

The ability to do it will be somewhat dependent on where the revenue levels fall out.

With regard to investment management, Jess Daley is here, and he'll respond to that question.

Yes, Julius.

I'd make two clarifying comments then.

One is there is the A-1 numbers that Dina talked about were quarter end to quarter end, and most of the market reduction occurred in June, and there is somewhat of a lag between revenues associated with investment management and the actual investment management number.

That being said, I think the biggest issue is of the 40 billion, 21 billion is representative of money market assets which are generally lower yielding, and of that 21 billion, 14-and-a-half billion came from specifically one government client where the yield on those assets was less than 4 basis points.

So very low revenue impact.

And I think - I guess one third thing I would add is as Dina mentioned, we are seeing net growth in our retail assets, which are tending to be higher-yield.

So we would expect some impact from the market reduction to flow through our revenue number the next quarter, although partially offset by, I think, the improvement in the mix of our assets from institution to retail, which as you know is something that we have been working on for a while.

Okay, okay.

Thank you.

Next question on the phone?

Thank you.

Our next question is coming from Robert Albertson of Sandler O'Neal.

Please state your question.

Hi.

Two, really.

One to David.

History seems to teach us that when there's a poor quarter in trading, it usually snaps back fairly quickly, usually in the second - the very following quarter.

And I'm wondering if you feel that this is a different situation or not.

And then to Marc, this is a little philosophical, I apologize, but on August 14th, I gather you sign your name again.

What are your thoughts and actions?

How are you thinking differently or not about that, and what are you hearing from some of your peers?

David?

I'll take the first one, Robert.

I think - I don't - I don't have a great Crystal ball on what the third quarter is going to look like here.

But the point I would - I should have responded - I'm going to respond to the question you asked and the question Ron asked earlier.

We did have a weak quarter in terms of trading, but if you look at the - I was making an argument that the first quarter was particularly strong.

If you look at our first half vis-a-vis the other players, I would argue we're right in line.

At least some of the data I have shows us down about 20% first half of '02 over the first half of '01 and that's just about where everybody was on the trading side.

I think, Robert, the difficulty with predicting a quick snapback is two fold.

One is just these markets, in and of themselves as we've been observing them for the last few weeks, and then the summer, which there's definitely a seasonal pattern to some of these things.

So that's the difficulty with making a prediction here.

But is volatility lacking sufficiently that that's the biggest bug a boo, or is it just across the board.

Well, volatility is certainly back, but is there some trend around it I think is the problem.

I think with regard to the philosophical question, I would view that we sign our names to any financial statements that we've ever put out, and actually signing one more document probably doesn't make a whole lot of difference.

But I mean I guess what I'm getting at is do you think there are going to be changes in general because of this?

I'm not really thinking so much of J. P. Morgan Chase as what you're hearing.

I think that if you look - if you'd look at the broader issue of corporate America, I think the closer scrutiny that people pay to all the practices that have grown up over the last several years, it seems likely to me that there will be some additional changes in those practices.

Just given the fact that we have - what is it - something like 6,000 public corporations tells me that there's likely to be some number of them that will make changes as they apply more scrutiny to a process and as practices which maybe have been lax in the past get changed.

I don't think that that implies a fundamental overhaul in the - for the vast majority of very large companies in America who I think have been playing by the rules and playing accurately by the rules.

We'll have to see how it comes out, but certainly that has been the result so far.

Thank you both.

Next question?

Thank you.

Our next question is coming from chip Dickson of Lehman Brothers.

Please state your question.

Thanks.

Morning, Mark.

Good morning, Dina.

A couple questions.

One, could you tell us how the shared national credit exam went for J. P. Morgan Chase?

Update us on your telecom exposure.

And I may have missed it.

Why did the commercial loan book and credit-related exposures grow this quarter, because most companies that have reported have had flat to down - a flat to down experience.

Suzanne Hammett is here, who is head of credit policy.

I'll let her comment on those questions.

Hi, chip.

Three questions.

The first question, on the commercial exposure numbers, our actual commercial loans were up slightly due to, in large part, a couple of large over quarter-end client transactions which actually now in the third quarter are no longer among us.

We did see a rather dramatic upswing in our mark to to market arena due to the movement in the dollar against other currencies.

Okay?

As a general matter.

Stepping down to - or into our telecom exposure, we reported to you all a year ago, and have subsequently published our credit-related assets as it relates to our telecom portfolio.

We are down 15% in total credit-related assets on telecom since a year ago, basically pretty flat to the first quarter of this year, and we're - we're continuing to manage that number as tightly as you would expect we would be.

And as part of our overall mix, it continues, as Dina mentioned, to be in the area that is giving us - and is giving the industry - the most [inaudible].

And what was the third question

The shared national credit exam, how did it go for you?

We do not have our final numbers yet, but the preliminary indications are that actually we came out quite well, and we are particularly pleased with that preliminary performance against how we felt we did last year, which wasn't poor but we could improve upon that performance.

So we feel pretty good about our - the out - what the outcome will be of shared national credit, which should be basically an August event for us.

Okay.

Thanks a lot.

Next question?

Thank you.

Our next question is coming from Andy Collins of U.S. Bankcorp.

Please state your question.

Yeah.

Good morning Mark and Dina.

I was just following up on Ron's question, Ron Mandell, about the outlook for the second half.

I mean I guess so far, you guys have posted about a buck fifteen and to hit consensus, you'd have to hit a buck fifty six in the second half, so I'm just wondering if you could kind of - do you think that that's reasonable, given where consensus is today?

As you know, we don't comment on specific bottom-line earnings per share numbers, and we allow you to do your own work.

Okay.

And just following up on the - a couple of other questions.

Trading was kind of weak in June.

I was wondering how - so far, how it's going in July?

And then also, if you could touch on hedging gains, you know, given the steepness in the yield curve, didn't you see a lot of mortgage servicing losses that might not be there going forward if the hedging gains go away?

Well, with regard to the former, we don't comment on it between quarters, in terms of what the outcome is because it changes so much from day to day.

With regard to the latter, it of course is possible that if interest rates or mortgage rates don't change, that we will not see the servicing write-downs that we saw in the first quarter.

I mean in the second quarter.

What happened in the second quarter was we had significant servicing write-downs, but the assets that we had that hedged those write-downs actually more than offset that.

So what would happen in the third quarter is anybody's guess.

I think we have, you know, very good systems for managing that risk.

I think managing mortgage servicing risk is one of the most complex things that any company can do, and it is something that we spend a great deal of time on, and because it has importance to our business.

But I think it would be one of those areas where it would be very difficult to predict what the outcome would be from month to month.

Okay.

So - and the trading issue, you won't say one way or another about the Brazilian situation?

Well, I'll say that we've reduced our exposure, and I'll say that, you know, we continue to mark things to market.

We're not necessarily always long in our trading exposures, so it's a question of getting it right and we'll just see - have to see how it turns out.

Okay.

Great.

Thank you.

Next question?

Thank you.

And as a reminder, ladies and gentlemen, for any further questions or comments, we ask you to please press 1 followed by 4 on your touch-tone telephone at this time.

Our next question is coming from Richard [inaudible] of Hoffer internet.

Please state your question.

Good morning.

I'm trying to figure out the relationship between the bank's capital and its trading activities.

In other words, I make the assumption that the risk in the derivatives portfolio is roughly equal to the company's common equity at the present time, and I then make the further assumption that there is a constraint on your ability to expand your trading activities if you're in that situation.

Could you clarify whether that has any relevance or not?

No, I don't think that's the way we would look at it.

We would look at - we've got two risks.

One is our credit risk.

Our credit risk in that - in the derivative portfolio is a receivable of about $70 billion.

When you net cash collateral against that, it's between 45 and $50 billion.

We look at that just like loan exposures, commercial loan exposures, a hundred billion dollars, consumer loan exposure is 200 billion - another $125 billion.

We would look at the grade, the rating of the counter-party and we would assign capital based on that rating.

So - and actually, in our derivatives portfolio, 85% of the counter-parties are investment grade.

So - and then the second risk we've got is market risk, which generally, even in the derivatives book, is smaller than the credit risk.

So I would say, no, that's only one component of what we hold capital for, and on balance, I would say that if you look at derivative activities in general, or trading activities in general, it's certainly not the largest component for which we hold capital.

But isn't there -

I don't feel constrained with regard to the expansion of that activity.

Our capital ratios are very strong.

So in other words, at the moment, you don't feel that there's any link between the amount of capital in the institution and the amount of trading activity.

Well, there's no question there's a link, but what you said was that all our capital was devoted to it or we were constrained by it, and I don't feel that way.

I see.

Okay.

Thank you.

We'll take the next question in the room.

Right here.

Thank you.

The question regards slide 8, just on credit, going back to a couple of the credit questions.

I was interested in your comments on the Enron surety bond.

It just seems to me from what I've done, in terms of research, in general surety bonds either get paid right away or they never get paid, and in fact, if they don't get paid, even [inaudible] lawsuit, how does that affect your reserves as a percent of loan, how does that affect your capital [inaudible]?

The way we're accounting for the surety bonds is that they're held in other assets.

FAS 5 is very specific on this situation.

If you have a loss contingency or a contingent event that might cause you to have a loss, if it's more probable than not that it will happen, then you have to record the loss.

If it is not more probable than not, then you don't record the loss.

In our case, our opinion is that it is not probable that we will have a loss.

We believe that we will win the lawsuit and that the counter-parties are creditworthy and will pay when they're ordered to do so by the court.

If we don't win, then we would have to write it down to the value of an unsecured claim against Enron.

It's not exactly an all-or-nothing situation because the facts of some of the sureties are slightly different than others, and we're dealing with 11 different insurance companies.

It could be all or nothing, but it doesn't have to be that way.

In any event, when something occurs that makes it change, either we get the money or there's a different probability that we will get the money, then we would have an accounting event that would happen at that time.

There's no reserve.

It's not in loan loss reserves.

It was originally a trading sift.

We moved it to other assets.

Mike?

Yeah.

Just a quick follow-up.

How much insurance do you have for potential lawsuits or criminal fines or anything else you want to dream up?

Do you have insurance for that, and how much?

Well, we have lots of insurance, but it all - sometimes the insurance companies don't pay, so I don't know that we're - I don't know that we're necessarily relying on that insurance.

I think we believe that we don't have liability in these cases, and we'll have to see how it works out.

And separately, how much in reserves do you have for each Argentina and Brazil, and how does that compare to your cross-border exposure?

In Argentina, our net exposure is about $200 million, and I think our gross exposure would probably be around $500 million.

Now, if you - if you take effectively credit reserves that we have both in the trading book and in the loan book.

In Brazil, the reserves would be much smaller than that as a percentage.

The loan book we have are predominated, I would say, by commodity producers who get their money in dollars and who wouldn't necessarily be affected unless there was some severe currency controls.

The counter-parties that we have in the trading book are, of course, carried at their current market spreads.

So I think it's something, again, that we've been clearly ahead of in terms of evaluating them at current market.

That's not to say we don't have exposure, if there is a much more adverse situation than we presently have, but we are clearly mark-to-market with regard to both trading book and reserves that are sufficient to deal with the current outlook on the loan portfolio.

u've reduced your exposure in a 00:59:03 Brazil at a lot faster pace than some of your 00:59:06 peers.

How are you evaluating the Brazilian 00:59:09 situation? 00:59:09 00:59:09 >> MARK: We're viewing it as a risky place right 00:59:11 now and one in which we think it's appropriate to 00:59:13 reduce our exposure.

I is there another question 00:59:17 on the phone? 00:59:18 00:59:18 >> OPERATOR: Thank you.

Our next question, from 00:59:20 the phone lines, is coming from Steve [inaudible] 00:59:24 of second curve capital.

Please state your 00:59:25 question. 00:59:26 00:59:26 >> ANALYST: Thanks.

My question has already been 00:59:30 answered. 00:59:30 00:59:30 >> MARK: Okay.

And then we'll take the last 00:59:32 question here in the room. 00:59:33 00:59:33 >> ANALYST: Two questions, Mark.

One on - on 00:59:36 the investment bank and the other is sort of 00:59:38 credit related.

On the investment bank, if you 00:59:40 look at the compensation expense, the absolute 00:59:42 number, it's down substantially from earlier last 00:59:48 year, but the last three quarters, it's basically 00:59:50 been pretty flat as an absolute number, despite 00:59:52 rather volatile revenue, so the first issue is, 00:59:56 what does that - what, if anything, does that say 00:59:58 about bonus accruals during that period, and what's your policy about that?

Secondly, given that it's flat at a rather low number in the sense of, you know, mid-30s comp expense ratio, how many downside flexibility do you have in that number?

And then I'll come back to the credit thing.

Okay.

One thing that's affected it in the last couple of quarters is the inclusion of severance costs in compensation, which we didn't have in the fourth quarter of last year.

We were charging it in a different way.

We had some in the first quarter, and we had more in the second quarter.

So that has had some effect on it.

With regard to whether we can move down - or whether we're constrained because it's already at a very low level, there are some structural reasons why ours is lower than some of our peers, including the inclusion of a loan portfolio which has a lower expense to revenue ratio.

And because I think the size of our business enables us to be more efficient.

I do think, obviously, there is some point at which, as revenues decline, it gets more and more difficult to keep that ratio in line.

We are not - I don't know that we're at that point yet, but if we get to much further declines in revenue, then I think that that is - that would be something that would put pressure on that number.

And moving on to credit, as you know, the [inaudible] committee put out a press release last week with some substantial changes in their proposals, and even though they haven't publicly released the next - the guidance for the quantitative impact study yet, I gather they've been discussing it with the banks in some detail over the last few weeks.

So are you in a position at this point to talk at all about the effects of this on J. P. Morgan Chase?

It's pretty much a changing landscape.

From what we've seen, our best guess is that it would probably result in lower required capital ratios for us.

We are operating at capital ratios that are well above regulatory required capital ratios today, so it's - I don't know whether it would have a significant effect on what we carry, because what we carry is what we think is appropriate to the risk that we have today, without regard to regulatory minimums.

But I think that from what little - the work we've done in a rapidly changing landscape - and some of it is hard to do because it calls for significant technological investment to get the data that's necessary to do it - but our general supposition would be that regulatory minimums certainly are not going to go up, and may go down relative to our adoption of the [Bazel] conventions.

Thank you.

Okay.

Thank you very much.

I appreciate your coming, and we will continue to be around both here and on the phone to respond to your questions.

Thank you for your participation, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your lines at this time, and have a wonderful day.