JPMorgan Chase Q2 Earnings Call Transcript

123jump.com Staff
18 Jul, 2009
New York City

The financial services provider quarterly revenue soared 39% to $25.6 billion. Net quarterly income rose 36% to $2.7 billion helped by strong investment banking business. Earnings per share fell to 28 cents from 53 cents a year-ago quarter. The company repaid in full the $25 billion TARP capital.

JPMorgan Chase & Co. ((JPM))
Q2 2009 Earnings Call Transcript
July 16, 2009 8:00 a.m. ET

Executives

Julia Bates – Director, Investor Relations
James Dimon – Chairman of the Board, President & Chief Executive Officer
Michael J. Cavanagh – Chief Financial Officer

Analysts

Glenn Schorr – UBS
John McDonald - Sanford C. Bernstein & Co.
Guy Moszkowski - Banc of America Securities/Merrill Lynch
Betsy Graseck - Morgan Stanley
Michael Mayo – CLSA
Meredith Whitney - Meredith Whitney Advisors
Matthew Burnell – Wells Fargo Securities
Moshe Orenbuch - Credit Suisse
Jeffery Harte - Sandler O''Neill & Partners
Chris Kotowski – Oppenheimer & Co.
Jason Goldberg - Barclays Capital
David Trone - Fox-Pitt Kelton
Nancy Bush – NAB Research, LLC
Edward Najarian - ISI Group
Ron Mandel – GIC
Richard Staite - Atlantic Equities

Presentation

Julia Bates

Hello, this is Julia Bates, Director of Investor Relations at JPMorgan Chase. Thank you for joining us this morning. Before we get started I would like to let you know that today’s presentation may contain forward-looking statements and references to non-GAAP financial information measures.

Forward-looking statements are based on management’s current expectations and are subject to significant risks and uncertainties. Actual results may differ. For further information on these matters, please refer to the firm’s filings with the SEC and to the notes at the end of the slide presentation.

Now I would like to turn the call over to JPMorgan Chase’s Chairman and Chief Executive Officer, Jamie Dimon, and Chief Financial Officer, Mike Cavanagh.

Michael J. Cavanagh

Good morning, everybody. It’s Mike, so we’ll get started now and just if you could all refer to the presentation that’s on our website, the slides, we’ll go through. So starting with a quick recap, I won’t be redundant here with what I’ll say later but a quick recap of some of the big points in the quarter on slide one.

So as you know we had net income of $2.7 billion in the quarter, that’s earnings per share of $0.28. The EPS number is after the $1.1 billion or $0.27 TARP preferred repayment as well as the FDIC special assessment which was $0.10. That piece being booked in our corporate segment.

Normal and higher FDIC operating expenses you’ll see referred to throughout the businesses but that’s the regular cost, this $0.10 item is the second quarter special assessment. Again, booked in corporate.

So behind the results were record revenues, $28 billion for the quarter. That was a record for the quarter and also amounted to a record for the first half of the year. As well, pre-tax, pre-provision profits, $14.4 billion for the quarter and were a record for the quarter and a record for the year.

So that’s on the back obviously of some very strong results in our investment bank which we’ll cover in a few minutes but also just broadly strong results in many of our businesses, obviously with others, consumer lending in particular faced with some challenges but I’ll skip over that until we get to the business slides.

But commenting for a second on capital, obviously the very strong capital ratios, much better than what we talked about, when we’re giving you sort of a no worse than numbers earlier in the quarter when we finished the stress test.

But ended the quarter with $122 billion of Tier 1 capital and that’s 9.7% Tier 1 ratio and a 7.7% Tier 1 common ratio. Also, in terms of balance sheet strength we now have $30 billion worth of loan loss reserves, that’s a coverage ratio of loans of about 5%.

We’ll obviously talk a lot about credit on the call later on but we feel very good about the overall reserving level. We’ve brought these levels up a lot in anticipation of deterioration and well aware of some of the trends you see in non-performers and so forth but all fully contemplated in the way we think about that $30 billion reserve number for what we have ahead of us.

Also obviously repaid $25 billion in TARP capital in the quarter. And lastly before we get into the businesses it’s just important also to point out that we’re doing everything that we think we should be doing to help the country get back on the road to recovery here so have done a lot in the trial modification space and foreclosure moratorium space, both helping advise on what the best practices are there and getting underway with it in a big way ourselves.

So we’ve got 138,000 trial modifications approved in the second quarter representing about $3.5 billion worth of mortgages and we’ll see how those perform over time. That brings a total of foreclosures avoided to about $600,000. And obviously subject to safety and soundness we continue be an active lender on the back of the very strong capital we have and so that’s $150 billion of new credit extended in the quarter across the board - consumers, corporations, non-profits, municipalities, and small businesses.

So now, if we just skip past slide two which just gives you the numbers that I just referred to, let’s go straight to the investment bank on slide three. So you see the investment bank had profits of $1.5 billion on revenues of $7.3 billion. I’ll just pause here for a minute and just point out the first point here, investment banking fee revenue $2.2 billion.

That’s a record for us in a quarter and a record for anybody at any firm in any quarter in terms of investment banking fee levels. So very proud of those results. It’s inclusive of very strong and record equity underwriting volumes and fees of $1.1 billion. And I’ll just ask you to flick through it now, but the next slide just shows you the number one year-to-date rankings in essentially all the major underwriting categories on a year-to-date basis globally.

So that continues to be the case and very proud of it and obviously the number one rank year to date on fees and a number three ranking in global announced M&A on the year-to-date basis. So very, very proud of the client franchise in the corporate finance business in the investment bank.

When you move then to the markets businesses, I’ll just make a general statement that across the board we saw the benefit of strong levels of client activity and continued wider spreads as a general matter. You did also see in the equity markets and fixed income markets businesses the negative impact of our spread tightening on the valuation of some structured notes in each of those businesses.

But now just looking at each business separately, fixed income markets up $4.9 billion and that is strength across the board - rates, FX, commodities, emerging markets, so forth, all performing well. And then I’m going to show you a slide that gives you the remaining positions in leverage loans and risky mortgage assets that we’ve been talking about for many, many quarters now but the net effect on those were modestly positive P&L marks on those positions in the quarter. So going to comment on that in another second.

Equity markets, $700 million of revenues and again strong client results especially in prime services but weaker on the trading side, the positioning side in the business. Moving then down to, I’ll go right to credit costs. So credit costs - we had $871 million of credit costs, that’s charge-offs of $433 million, 2.55% charge-off rate in the quarter, up a bit from last quarter.

And then the allowance, we added $438 million bringing the total allowance to almost 8%, 7.91% to loans in the investment bank. Obviously, we did have the negative trends in charge-off rate but we reserve as we downgrade things so we think that 8% level of reserves is totally appropriate despite the movement higher in some of the non-performers there.

And so with that let me move on from the P&L for the investment bank to past the league tables which we talked about to slide five, which is the key risk exposures in the investment bank. So here we’ve collapsed onto one page the details around what we’ve talked about for many, many quarters now of what we called our key risk exposures in these two spaces.

I’m just going to recap where we are now since in the future we’ll probably stop talking about this as a generic matter and only bring it up when there’s something relevant to, or noteworthy to bring to your attention.

First on leverage lending, if you recall we started with $43 billion on a pro forma basis with Bear Stearns back in September 2007 and that’s on a notional basis. Now, we carry a remaining amount of market value of $3.3 billion and that’s carried at roughly $0.42 on the dollar so those are marked down values for what remains.

Obviously exposure came down nicely in the quarter and the P&L as I said earlier was modestly positive net of hedges on this remaining amount so obviously much smaller exposure and unlikely to be noteworthy topic of conversation in the future but before closing that out, I wanted to point out where we stood.

Next mortgage related, this, going back to its peak was $48 billion in December 2007; here we have about $12.6 billion remaining, flattish quarter over quarter. In this quarter we are modestly positive again across the board here and so what I would say about this is about half of it, a little less than half relates to normal ongoing client business inventory levels and the other half is legacy positions that we like where all of this stuff is marked, and we’ll just take the stuff that is legacy and slowly liquidate it out over time.

So again, we’ll talk about it in the future where it creates relevant P&L conversation but at the level of marks we have now in a quarter where it’s been very quiet for us, that’s where we stand on those two areas of exposure, dramatically down from where we started and so moving forward into business as usual there.

Moving on to slide six, retail financial services, I’ll just quickly hit some of the drivers of the results in this business, remember we talked about this in two buckets; the retail banking or branch side and the consumer lending which includes all the mortgage lending activity and servicing activity and mortgage portfolio we hold - auto, student loans and so forth.

So on the top, retail banking; feel very good about the underlying growth dynamics again in our business. We’ve got deposits of $348 billion, up a bit quarter over quarter. That’s despite us not chasing rates so we are priced appropriately we think in our deposits and I just will make one point here that we do expect to see some declines in the second half of the year in these levels as we deliberately reprice downwards very high priced Washington Mutual CDs that were put on the books for 12 months in the fall of last year.

So that will be a dynamic that we’ll see a little bit of downward pressure on that number in the second half of the year, but otherwise feel very good about the underlying growth stats in retail banking and you’ll see the P&L in a second.

And then on consumer lending at the bottom, I’ll just point out, you can read the numbers for yourself, but of the total $150 billion of lending we did in the quarter about just shy of $50 billion of it came through these consumer categories that you see here that I just referred to.

But remember I think the noteworthy piece is that our mortgage volumes of $41 billion or so is definitely affected by our decision to steer clear of broker originated volumes. So that’s certainly a difference from where we had been a year ago and in prior periods but for several quarters now since we made that final decision to move out of that. It’s been a differentiator. We’re picking up less volume and you’ll see that on the next page when we talk about consumer lending.

So now moving on to page seven, total P&L for the retail business, $15 million profit, if you look at the circled number on the left and then walking down the retail banking piece of that, made just shy of a billion dollars, $970 million. Obviously the substantial increase year over year, $296 million in profits largely driven by the WaMu acquisition so clear evidence there that you see WaMu delivering the profitability that we expected and I talked about.

And, as well some profit lift on a sequential quarter basis as well. Do have a little bit of higher credit costs there related to the business banking business and then moving down to consumer lending, obviously a disappointing loss of nearly a billion dollars offsetting the profitability of the retail banking side.

So there in terms of what’s going on versus last quarter, this quarter we had very modest positive gains in our MSR risk management results versus making about a billion dollars in each of the prior quarters. So this quarter more in line with usual expectations and kind of what we talked about there. And then credit costs, the big driver, $3.5 billion which includes $1.1 billion of addition to loan loss allowance. So I’m in a second going to go through those portfolio by portfolio.

So now if we just move on to slide eight, let me just, I wanted to just take -- there’s a lot of talk about the impact of foreclosure moratoriums and modifications and what it means to some of the credit stats you all look at.

So as I said at the beginning we’re active and going to continue to be in modifying mortgages. I think it’s the right thing. We do it where it makes sense to us and it makes sense to our clients and for good economic reasons here, but a little bit of misunderstanding maybe about some of the ways that this impacts.

So I’ll let you read most of this but just make a few points, on the left we definitely saw as all did a build up in loans that were delinquent in all the delinquency statistics given that we suspended foreclosures during the moratoriums in the fall and spring of this year which are described on that side of the page.

What I would say is that those will sit there longer in the delinquency bucket so, in prime and subprime you see elevated delinquency stats. But we don’t expect it to have meaningful accounting or income statement impacts. As we came out of those moratoriums we’d originally written down those loans and then made adjustments to the write-downs to take account of the longer timelines to move them through into real estate loans and foreclosure if appropriate or modify them.

So then on modifications, again I said at the beginning we’ve approved 138,000 modifications for the second quarter here but those don’t have any meaningful impact on our second quarter stats and that’s because we have to see three monthly payments under the terms of the new modification before we’ll re-underwrite that loan and it comes out of delinquency and in the meantime and there’s an example here, it just continues to roll through delinquency buckets as it otherwise would have per the contract of the term.

When we do see, if we do see, and we hope to see good success with these modifications perhaps next quarter and in future quarters we’ll talk about just the success rate but given that these are largely speaking payment reduction modifications that are done re-underwritten with real income stats and so forth we are hopeful that we see some good rates of success in the trial period.

But when we do modify you just see the description at the bottom of how we take into account when we adjust our reserves at the time we modify the expected remaining losses including an assumption for recidivism or re-default. So that’s the way it really works and we can spend more time offline if folks want to spend other time, but it’s not a material impact to any of the stats in the quarter was the point for today.

Now I’m going to be very quick going through the next three slides so I’m just going to make some common points, so the first point is that obviously when you look at home equity prime and subprime, you’re going to see the charge-offs continue to trend higher versus prior periods and in a couple of cases prime and subprime we up our future guidance but the second point is that across each of these portfolios, so I just want to say it once, they flow into the early delinquency buckets and the dollar value of loans that are sitting in the early delinquency buckets has started to stabilize.

Looking back over the last 60, 90 days across the board and so that’s a new trend versus what we’d seen previously and obviously that would, we don’t know if it’s going to sustain itself but obviously if it did that would have good implications for future loss trends and could mean that we could be getting near to the end of needing to add to reserves in these portfolios. Just something to watch and point out we don’t know what the future holds obviously but an observation of what’s going on in the early delinquency buckets across the board.

So on slide nine, I’ll just quickly hit numbers here, so you see in the upper right, charge-offs of $1.265 billion in home equity in the quarter, up a bit from last quarter but the pace of growth slowing down a little bit and we continue to have our forward guidance of quarterly losses trending to, down at the bottom last bullet, trending to about $1.4 billion a quarter over the next several quarters.

Doing the same thing on slide 10 for prime, upper right box, you see $481 million in net charge-offs, up more substantially from last quarter in percentage terms but similar dollar terms and quarterly losses upping the guidance here to something maybe $100 million higher to the range of $600 million or so over the next several quarters whereas last time it was $500 million.

And then finally on subprime on slide 11, $410 million of losses in net charge-offs in the upper right in the quarter and quarterly guidance trending to about $500 million or so, that used to be $375 million to $475 million for people keeping track at home.

And so, one last point before I move off retail onto card, I just wanted to make a comment on the WaMu credit impaired portfolio that we acquired from WaMu, marked down at the time we did the deal in the fourth quarter, just make the point we have no slides in here and no news is good news on that front.

What we’re experiencing is losses that are coming in consistent with our original assumptions so seeing nothing to suggest that we have any need for further impairments based on what we see right now. So I just wanted to make that point and obviously we’ll bring that to your attention in the future if ever we do start to see trends that are worrisome.

In card, let me just move now to slide 12, obviously a disappointing loss of $672 million in the quarter. Credit costs the big story, $4.6 billion of credit costs. Most of that is charge-offs, we did add $250 million to loan loss reserves there. Now for Chase, the Chase portfolio versus the run off subprime WaMu portfolio, the Chase portfolio was a charge-off rate of 8.97%, up about 200 basis points as we said last earnings call in this quarter versus the first quarter. And obviously very high but coming in as expected and looking ahead to next quarter think of that number being in the 10% range and really beyond that it’s going to be a function of where the economy and unemployment goes. And the WaMu side behaving consistent with the trend forward that we’ll talk about on the outlook slide of trending towards the 18% to 24% range of losses that we talked about for that run off portfolio.

Next point on card is just charge volumes, so you see charge and sales volumes, sales being just the spend piece on cards, declined 7% year over year, that number is starting to stabilize. We look at it weekly but 7% down year over year together with us being less active in promoting balance transfers equates to downward pressure on our outstanding, so you see a $148 billion end of period outstandings on the Chase side versus $150 billion last quarter contributing to some revenue pressure in the business overall.

I will just say here it relates to revenues but one comment to make that in the quarter we did on the card securitization side take actions to support the securitization trust that caused the regulatory assets, the risk weighted assets in those for cards to come on balance sheet for regulatory capital purposes. I’ll show you more about that later when we do capital and that also did negatively impact revenues a bit in the quarter and so revenues in card would otherwise have been essentially flat quarter over quarter.

Moving on to the commercial bank on slide13, we had net income of $368 million, up a bit year over year. WaMu making a bit of a contribution here and up $30 million quarter over quarter. I will point out circled number is $106 billion of ending loan balances so we do see reduced client demand on the lending side in commercial bank, they’re to do, extend credit but demand is definitely coming down and we’re seeing that effect on the balance sheet footings.

Revenues in the business, $1.5 billion, up substantially year over year, again, part WaMu and also driven by record noninterest revenues, up inclusive of record investment banking revenues in the commercial bank in the quarter. Credit, similar trends to what we’ve seen before, 67 basis points of charge-off rates and some additions to loan loss allowance bringing that to just shy of 3%.

So again, we see the trends as we expected of normalizing credit, late cycle, things moving into non-performer status and credit costs charge-offs trending higher but reserves positioned well in anticipation of all that.

Next is treasury and security services on slide 14, here I’d just say it’s steady-consistent results here in the business, $379 billion of profits, up from last quarter, some seasonal strength there. Liability balances, $234 billion, down a bit quarter over quarter and year over year, seeing some normalization in liquidity flows, liability balance flows on the client side and assets under custody down a bit year over year and up a bit quarter over quarter.

That drives the revenue side here, $1.9 billion in total, flattish on the cash management side and a little down in security services side given the lower levels of assets under custody given markets and lower activity in the securities lending side.

Last business on slide 15, asset management, net income here similar story to TSS, steady results here, $352 million of profits, up a good amount quarter over quarter and down only slightly versus the prior year so recovering as market values on the assets under management recover. So $1.2 trillion in assets under management, down just 1% on a year-over-year basis and up $50 billion quarter over quarter.

Slow down in assets under management flows still $125 billion for the last year and $3 billion for the last quarter and then I guess the big point is that investment performance is what drives results in this business over time, so you can see in our supplement and see on this slide towards the bottom that we have continued good investment performance, mutual funds 80% ranked in first or second quartiles over five years and so on for the past three and past one year when you read through that.

Corporate on slide 16, so take it piece by piece, obviously a lesser level of write-downs on our private equity position so we have $6.6 billion of carrying value in private equity written down a touch for net losses of $27 million in the quarter. Outlook continues to be for challenging valuation levels in that piece of things but an improvement from where we were over the last several quarters.

Then the corporate segment you see about a billion dollars of after-tax profit here, here I’ll just simply say that we had a couple of items, trading gains in our investment portfolio, $820 million. That’s separate and above the net interest margin we get from running a higher investment portfolio. That net interest margin was high and will continue to be high so long as we sit where we are which we currently expect to.

But the trading gains, certainly they’re volatile; this is an abnormally high level. I’ll point that out at $820 million after tax. We did sell some MasterCard shares, $150 million to the positive and this is also where we booked the FDIC special assessment $419 million after tax. You take those yourself to normalize what that corporate line would be but it’s nearly $0.5 billion of profits and again that would be driven by the positive spread on the investment portfolio.

Page 17 is capital management, so here very proud of these numbers. Tier 1 capital, $122 billion, Tier 1 common capital of $97 billion. Again Tier 1 capital ratio a very strong at 9.7% and Tier 1 common at 7.7%. As I said on the card page, this includes the consolidation of $40 billion of risk weighted assets in the quarter related to the card business. So you can see in the bullet that just projecting forward to the impact of the consolidation of off balance sheet vehicles pursuant to the FASB changes that are coming January 1 of next year, our rough estimate is that the remaining impact could be about 40 basis points when you look at the other off balance sheet items and other accounting that would go along with that. But ultimately obviously there’s ongoing interpretation around those rules so things could change between here and there.

Page 18, just shows you the loan loss reserve piece. This is loan loss reserves of $29 billion, there’s another billion related to lending-related commitments and the $30 billion I talked about earlier and you just see the expected trend of loan loss to total loans trending higher earlier and as nonperforming loans come up as the downgrades that are anticipated along the way evolve, you see the ratio of reserves to nonperforming loans come down.

But still we show those ratios for consumer wholesale and firm wide at the bottom and very comfortable with where we sit there but obviously future economic conditions are going to dictate whether we are in fact near the end or not but we believe we could be getting close.

On the outlook slide, page 19, you got the investment bank again, we don’t know what the future holds, uncertain environment obviously continues. There’s still risks out there and trading can be volatile so no real guidance for you there, make your own assumptions.

Retail, I just recapped what the loss projections that we talked about in each of the main portfolios. We do expect continued underlying growth there. On the card services side you see the 10% loss rate for next quarter that we plus or minus that I talked about for the Chase portfolio and 18% to 24% is where WaMu is going to go.

But we do expect continued pressure on revenues given lower consumer spend levels having an effect on outstandings. Commercial bank, the underlying growth is good. We like being in the market share there. We do have strong reserves but credit trends will continue to normalize. Treasury and security services and asset management, nothing really to point out, you can read for yourself and private equity and corporate, I just hit the key points there.

So with that, operator, I’d like to just throw it open to questions.

Question-and-Answer Session

Operator

At this time, if you would like to participate in the Q&A session, please press star followed by the number one on your telephone keypad. We’ll pause for just a moment and compile the Q&A roster. And your first question comes from the line of Glenn Schorr.

Glenn Schorr – UBS

Good morning. So maybe just quickly on NIM first, you had some NIM compression, you obviously have a really low interest rate environment but also you’re running off obviously all the old HELOC subprime and other high interest rate loans so just thoughts on the go forward there.

Michael J. Cavanagh

Marginally stabilizing. You hit on it, with the run off in some of the portfolios compression in some of the investment portfolio and investment bank trading type of assets, that’s the real change quarter over quarter from first to second and net interest margin a little decline in dollars overall. I’d expect it to be flattish as best I can tell looking ahead from here to the third quarter.

Glenn Schorr – UBS

Okay. The Consumer Financial Protection Agency, it’s kind of being formed but we’ve seen the directionality if you will of where they’d go related to changes made in the card business. I know these are moving parts but is there a way to paint a more rosy or less ugly picture in terms of profitability and revenues and available credit and things like that from on the go forward for the CFPA could take things.

James Dimon

Well, Glenn, this is Jamie. That agency is just being discussed and there are some very important points. We are big supporters of proper consumer protection and in particular we probably were some of the first to point out that the mortgage business is kind of half regulated and half unregulated and that’s where a lot of the problems turned out.

So, we do think that a lot of work needs to be done there. The credit card, we think there should be less regulatory agencies not more just for ongoing ease, control, and things like that so we’re worried that the more agencies, the more politics and bureaucracy around it and the credit card bill itself, that kind of was, we think of all the things they did, we thought some were completely appropriate.

We already had the best practices in most of those areas but we think it went a little bit too far so we’ll entail credit card companies in general, we believe cutting back on credit they give both the lower end of the curve and the way they do credit. You’ll no longer be able to do fixed cards. You’ll no longer be able to do a bunch of things so it will reduce credit and it will at least reduce profitability we believe in the short run meaning the rest of this year and mostly next year.

Glenn Schorr – UBS

That would be great. Last one, just a numbers thing, could you just give us where the credit portfolio stands, I think it was $32-ish billion at the end of first quarter.

Michael J. Cavanagh

Nonperformers I think on that last slide is about 14 and criticized overall is in the credit stats in the supplement, Glenn. I don’t have it handy.

Glenn Schorr – UBS

Don’t worry. That’s fine. Thank you both.

Operator

And there is a question from the line of John McDonald.

John McDonald - Sanford C. Bernstein & Co.

Mike, in card, any theories on why the delinquencies are improving, is it concentrated in the 30 day delinquency bucket less so than in the 60 and 90 day in credit card.

Michael J. Cavanagh

I would say it’s in those early buckets. We’re starting to just see the same as, similar commentary to the home equity and mortgage space. But again, it’s early, John, to draw big conclusions from that but early bucket is starting to look more stable. As is consumer spend, spend in card what we see is declines at 7% year over year that you see in our charge volume kind of indicative of where spend is overall and you’re starting to see it stabilize at that kind of level. So weaker than what it was versus a year ago but better than the worst point and trending a little bit more stable but again, we don’t know how long that holds on.

John McDonald - Sanford C. Bernstein & Co.

So with the delinquencies improving but the outlook for charge-offs to be up another 100 basis points next quarter it seems that bankruptcy is becoming a bigger percentage of the charge-offs.

James Dimon

The real reason is that the balances are going to be going down a little bit. All of charge-offs will be about the same, balance will be going down a little bit. And the front end is obviously notoriously fickle, but part of that at least in my opinion relates to the fact it’s kind of the rate of change of unemployment, new unemployment claims. So I think once unemployment levels off, you may see that number actually start to come down a little bit.

We don’t know that but there are good reasons to believe that.

John McDonald - Sanford C. Bernstein & Co.

Okay. On the reserve build Mike made the comments that the degree of reserve build is declining with a 5% ratio, what metrics are you looking at to stop building reserves and see the end of reserve building.

Michael J. Cavanagh

It’s going to be, it’s your notion of what you’re expected embedded losses are so it’s going to really be dictated for me here on things like as Jamie just said, does the unemployment rate stabilize or does it keep changing and same with broader economic trends as it relates to the corporate side as well. You need that stuff to stabilize a bit before you get to a place where if you think your losses are peaking out there looking out a year and beyond, you get to the point where you can consider that to be the, given how strongly reserved we feel we are, that would be the indicator that we’re at the end.

John McDonald - Sanford C. Bernstein & Co.

So it’s really when your forward 12 month forecast stops changing.

Michael J. Cavanagh

Generally speaking, yes.

John McDonald - Sanford C. Bernstein & Co.

And one quick question on the credit portfolio revenues, investment bank, that’s a tough line for us to forecast, it moves around a lot and the CVA issues in that line and whether those could be reoccurring or --

Michael J. Cavanagh

Well, you know CVA, DVA, very complicated obviously so in credit portfolio we managed the change in value of derivative assets and liabilities, counterparties in our own credit spread, that collective CVA, DVA impact was a couple hundred million positive in the quarter but in any given quarter sometimes they neutralize, sometimes they don’t but there was a modest positive in there in what was managed in credit portfolio but the preponderance of the negative was the accounting asymmetry where we hedged some of our traditional accrual book loans, the $70 billion of retained loans in the investment bank, excess held positions and so forth, we have hedges that are mark-to-market instruments and with tightening credit spreads in the quarter those dropped in value with no offset because the accrual loans don’t get marked.

And so that negative was partially offset by CVA, DVA. It’s a function of spreads; it’s very hard to predict that line. All I can do is explain it to you one quarter to the next, so you can look at a long-term trend and put a placeholder in there and we’ll explain it quarter by quarter.

John McDonald - Sanford C. Bernstein & Co.

And you have reserves in addition to those hedges, are those loans that also have reserves against them.

Michael J. Cavanagh

Yes.

John McDonald - Sanford C. Bernstein & Co.

Okay. Thanks.

Operator

And your next question comes from the line of Guy Moszkowski with Banc of America.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

Good morning. This question is about the subprime and prime buckets and the expected loss rate guidance being ticked upward a bit and the disconnect between that and what I’m hearing about what you’re seeing in the early delinquency buckets, maybe you can just help us reconcile why you still feel that you need to raise the out quarters loss guidance if you think the delinquencies are stabilizing here.

Michael J. Cavanagh

Think about the, there’s the roll rates in the later buckets affect ultimate losses as well as severity of loss so it’s forming better views about what’s already in the pipeline and how it will behave.

James Dimon

And we expect unemployment to get worse so we kind of built that in a little bit.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

Okay, fair enough. So it’s a little bit like the answer on the card.

James Dimon

Yes, so in cards we have a lot of visibility into next quarter as opposed to this, this is more erratic.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

And just to go back to the investment bank credit portfolio hit because of the hedges, so really the way to look at that is that you had hedging effectiveness which was compounded in terms of the bottom line for the unit by the fact that you had a pretty large increase in loan losses in the hedged portfolio, is that right.

James Dimon

That’s correct.

Michael J. Cavanagh

Well on the one line, it’s revenues only but for the total economics, exactly right.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

Right because we saw that loan loss rate move up quite a bit to about 2.5%, did you have some large specific losses there?

James Dimon

There is one, but that’s going to be idiosyncratic and the fact is the reserves are very high. It’s hard to imagine you’re going to really need more reserves but the actual losses, NPAs will go up and the actual losses will bounce all around the place.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

Okay and then the final question I have is on the credit enhancement that you talked about for the card securitizations, can you give us an idea of the order of magnitude in terms of the increase of your funding costs that you’re seeing there because of the need to credit enhance more.

Michael J. Cavanagh

It’s not that so much, we put new receivables in and issue notes that are zero discount depresses revenue so it’s just increasing credit enhancement in those trusts from about 11% to about 14%, creates a revenue --

James Dimon

That doesn’t change the underlying interest costs at all, those are all existing deals and the new deals we’ve done, obviously some were done at LIBOR plus 300, 200 or 100 or something like that, just the accounting for it.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

But the economics are ultimately different in terms of your willing to accept more credit loss on those securitizations, is that correct.

James Dimon

No, you’re confusing apples and oranges, the securitizations are purely an accounting thing where it cost us a couple of million dollars this quarter because we did the enhancement. Whether we finance the balance sheet or not is purely what’s the cheapest way to finance the balance sheet. It’s unlikely in 01/01/10 going forward we’d be doing credit card securitizations at all. It’s a timing issue and that’s all it is. It doesn’t change that we actually underwrite credit cards.

Guy Moszkowski - Banc of America Securities/Merrill Lynch

The implication wasn’t that but I understand what you’re saying. Thank you.

Operator

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

Good morning. Just three things, one on the card, are you obviously in 01/01/10 going to be bringing over onto GAAP assets, it’s already in wrap, right, but the GAAP assets of the card securitizations, is your comment suggesting that you’re going to be funding it with deposits, you’re not going to be doing incrementally more securitizations going forward and can you give us some color on whether or not you’re going to bring it over at fair value or at face value plus reserve.

James Dimon

First of all we just fund the balance, not that you fund with deposits, we simply make a decision how to fund it and it’s more likely than not the firm will just fund it because it will be cheaper than doing securitizations and as you know we have a lot of liquidity and funding capability and I think the requirement is it comes over at fair value but basically there’ll be an addition to reserves below the line to reduce capital which is why when it goes on the balance sheet it doesn’t change risk weighted assets but it reduces your tangible common equity.

Michael J. Cavanagh

That’s all factored into the 40 basis point expected January 1 impact on the Chase related assets, there’ll be a gap of leverage ratio impact but not a ratio we worry about.

Betsy Graseck - Morgan Stanley

You talked about the mod programs and the moratoriums not having an impact on the results in the quarter, is that just on the P&L or would NPAs have looked different without the mod program, the moratoriums.

Michael J. Cavanagh

No, on mods -- on moratoriums the point is that loans that would otherwise have gone to foreclosure left delinquencies and been in REO have been sort of stuck in the delinquency bucket so delinquency stats, delinquency levels later buckets like 90-day plus are just going to be elevated for a period of time until those suspended foreclosures get worked through.

So that’s just a timing issue. You got a little bit of a double up inside the later buckets there. But no economic impact because we write assets down in those later buckets to what we think we’ll realize when we sell them. So that’s been, stayed true throughout. And then --

James Dimon

You will see foreclosures go up when this is over. The P&L has already reflected it.

Michael J. Cavanagh

And then on the modification side, it’s no impact on anything yet because when, if you’re 60 days delinquent and then you start a modification, a modified loan and make your first payment, if it’s less than your contractual payment you will still roll to the 90 day bucket in the delinquency stats. So there is no, and that’s what that example on that page is intended to display. If you successfully complete three payments under your new modification your loan would then be successful as a trial mod and then become an official re-written loan and then it would come out of delinquencies.

Betsy Graseck - Morgan Stanley

So you’re saying NPAs really wouldn’t have changed that much relative to --

James Dimon

As I said it didn’t affect P&L, NPAs are higher. In the future it will bring down NPAs and we’ll disclose that to you at the time.

Betsy Graseck - Morgan Stanley

And on home equity, I get this question all the time about how you’re assessing and not just you but everybody who has home equity, how you’re assessing reserves against that if the first lien is getting modified. If you’ve got customers where the first lien is getting modified and you’ve got a second on that first lien, does it impact your analysis on how much you have to reserve for your second lien.

James Dimon

Yes, and it’s all given, the loss given default but some of them are 100% losses and we recognize as charge-offs and some we have a valid second lien which we expect to be paid off so it’s really different in different circumstances.

Betsy Graseck - Morgan Stanley

The borrower has to be delinquent though before you do any kind of reserving against the second.

James Dimon

Yes, except remember the reserving, we’re looking forward in forecasting.

Betsy Graseck - Morgan Stanley

And then just lastly on capital, your common Tier 1 ratio 7.7, I know you said in the last call that you had that targeting somewhere around 7, I realize that we’re not out of the woods, I realize that regulators haven’t had official comments on whether or not they’re going to change capital requirements but can you just give us a sense as to how you’re thinking about the capital, where you’re letting it, where you’d be willing to let it drift to, what is going to influence your thinking on dividends.

James Dimon

Yes, so the 7, I wouldn’t call it a target, I think what we’re really saying is that we expect it to be around there. I think after that to get out of TARP and stuff we were asked to raise another $5 million of common equity and this shows you why we didn’t really think we needed to. So we’re growing what I would call excess capital and we don’t really think that there’s a reason to have much more than 7% or something like that.

But we’re going to wait and see what the rules are because obviously those are going to change. But dividend - before we do anything with the dividend we’d really like to see the change in delinquencies, charge-offs, and the economy so we have a little more certainty going forward about the environment.

We still have a huge stock purchase program and we’re going to be optimistic and we think we can buy a lot of stock back and we have the wherewithal to do a good job for shareholders and still maintain a (inaudible) balance sheet we’ll consider that at any point in time.

Betsy Graseck - Morgan Stanley

Are you saying you would be willing to do stock buyback ahead of dividend increase?

James Dimon

I would, yes.

Betsy Graseck - Morgan Stanley

Why?

James Dimon

To make more money for shareholders.

Betsy Graseck - Morgan Stanley

Could it impact your EPS outlook?

James Dimon

No, depends what the stock price is, so when our preferreds were down at $0.50 to the dollar wanted to buy those back too but because of TARP we weren’t able to do it. So I’m not going to tell you what price we’re going to do it, I’m just simply saying that a rational person would say at one point you might actually do something like that depending where the stock goes and what your options are.

Betsy Graseck - Morgan Stanley

Sure and the dividend is more reflective of stability in the model.

James Dimon

Normalized earnings there.

Betsy Graseck - Morgan Stanley

Okay, thanks.

Operator

And your next question comes from the line of Mike Mayo with CLSA.

Michael Mayo – CLSA

Good morning. I guess I have a question, I’ll call it the three Cs, and that would be your exposure to the corporate space, if I’m reading this right NPAs and wholesale loans jumped $2 billion in the last three months, then your exposure to CIT and your exposure to California, so just generally credit quality on the wholesale side.

James Dimon

CIT, it will be basically immaterial, corporate NPAs are going to go up. Remember you reserve for those as the credits get downgraded so it’s really reflected in the 8% loan loss reserves in large corporate and California, are you talking about corporate or consumer.

Michael Mayo – CLSA

Just general, I mean how do you think about California, your exposure there, whether you would be more exposed or less exposed. I guess the IOUs weren’t that much for you but to the extent that California gets much weaker than expected, how do you think about that in terms of your outlook with regard to your consumer loans in the state and any other exposure you might have.

James Dimon

We are in business in California forever. So we’re not going to be guessing about the next six months so we’re building branches, we’re still underwriting mortgages, and small business loans, and all the things that we need to do. Our standards, like loan to value in certain markets a little bit lower than 80% just to protect ourselves from numbers going down.

California has always been very resilient, in fact we see little signs, a lot of the MSAs mark us there. They actually have upped prices and home price in the last couple of months. That’s a positive. They’ve been going down for the better part of two or three years. So you could argue that California is starting to see a little bit of a return but in terms of building the business we’re going to build the business and not guess and pull in and out because we think it may get worse or better in the short run.

Michael Mayo – CLSA

And then with regard to, I’m repeating a question from before, but if delinquencies might be stabilizing but your losses go higher so you’re saying the severity of losses getting greater.

Michael J. Cavanagh

In part, yes.

Michael Mayo – CLSA

And just generally speaking I can’t tell if you’re guiding for much less reserve building or not from your comments so far, in other words if you see 12 months from now things should be getting better then you’ll bring it down, are you there yet.

James Dimon

I think the second you see things really stabilize we won’t need any additional reserves. That could be as early as next quarter, that could be some time next year.

Michael J. Cavanagh

We just don’t know.

James Dimon

But I think it’s reasonable to assume that there’ll be some additional reserve builds the next two quarters but it’s possible that we actually start to see an improvement that that will be wrong, $30 billion is a lot of reserves, we’re 8% investment banking, we’re almost 3% in commercial banking and we’re huge numbers across everything else.

The second you see things start getting better those will be excess reserves.

Michael Mayo – CLSA

All right. Thank you.

Operator

And your next question comes from the line of Meredith Whitney with Meredith Whitney Advisors.

Meredith Whitney - Meredith Whitney Advisors

Good morning. Most of my questions relate to mortgage, with respect to comments you’ve made on the different origination channels, it looks like you’re correspondent channel actually picked up and I’m wondering if this is just repackaging Ginnie Mae loans, or what the duration of the strength in that channel is going to be and then I’ve got other questions with respect to either, there’s a lot of discussion in terms of, I know it’ s early stage, but how successful, how difficult it is to modify loans. There’s an article obviously in the paper today about Saxon, you’ve modified more than your competition, can you give early color on terms of the difficulty and the early experience with that. And then I have another question on hedging strategy and commercial after that.

James Dimon

CNT, went down to the extent we got rid of broker-related CNT, but it went to the extent that the traditional correspondents, banks and stuff like that picked up share. We don’t have any other details to show you now but we could probably get that.

Michael J. Cavanagh

That’s the correspondent line.

James Dimon

And modifications are hard to do. We’ve hired hundreds of thousands of people. We’ve opened up a lot of offices. We’ve written new systems. It’s a complex process. Unfortunately we have a backlog. We’re trying to whittle that down. And think of when you look at mods, separate mods before which were more traditional, people deferring payments, putting them in the back end from the new mods where you actually have reduction in payments or reduction in principal.

It’s very early to tell. We’re hopeful it will be good but it’s very early to tell.

Meredith Whitney - Meredith Whitney Advisors

With respect to your hedging strategy on your MSR, your outlook in terms, is that more rates influenced for this quarter or duration. I want to separate the two because if you’re modification efforts are successful the duration might expand and separate from just a rates hedge. Does your hedging strategy stay constant or are you more reflective of the hedging strategy?

James Dimon

Use as a baseline okay, the MSR is short duration, it’s short volatility and it’s short to mortgage basis. We’re constantly adjusting future assumptions but we think about the whole portfolio. By product, 5’s, 55’s, 6’s, Fannie Mae’s, FHA’s, mods, etc., we’re always doing that. And the baseline is to be hedged there but obviously make decisions about when to unhedge some of those exposures and I mentioned the three major ones. And yes, things like mods obviously will change duration. We try to incorporate that in what we do. We’re not taking big -- we’re not punting on the MSR and taking big bets on it.

Meredith Whitney - Meredith Whitney Advisors

I’m not suggesting you are but anecdotally what I’m hearing is the mods could have a tremendous impact on the valuation of the MSR and was trying to get your feel for that.

James Dimon

And believe me we will adjust for that and so I think even if you --

Michael J. Cavanagh

Our forward assumptions do the best they can in terms of how the asset is going to behave to predict that so that we can hedge it the best we can.

James Dimon

Even if you hedged 100% of those things you’re still going to have a swing in, by hundreds of millions of dollars every quarter because obviously what actually happens and what your model predicts will always be different.

Meredith Whitney - Meredith Whitney Advisors

On the commercial side, how much loan modification is going in that channel because your assets are going down, your revenues are going up, what type of modifications are going in that channel, what type of market share are you gaining in that channel and then what’s the cross current in terms of the fee share with the investment bank as well. And I have another question. Thanks.

James Dimon

All the fees in the corporate mods, it’s really in the investment bank you’re referring about modifications where you have changes in terms and conditions and fees and extensions and it’s negotiated one by one. It’s a good thing, we get paid to do it. All the fees in the investment bank but it also helps the companies, you get paid more in the short run and you have to do it deal by deal. And that includes stuff that’s nonperforming, includes stuff which is in default, it includes stuff which is not even near default.

And very often the credit gets better because they do things to make the credit better so that they -- you get the lenders to modify the loan.

Meredith Whitney - Meredith Whitney Advisors

I also did mean in the commercial bank.

Michael J. Cavanagh

And then in the commercial bank there’s higher levels, particularly in the mid-corporate space of activity tapping into capital markets so the commercial bank’s piece I think of investment banking fees or fees they were associated with were $300 million or so running north of the billion dollar run rate we talked about when we did the JPMorgan Bank one deal for the year to date. That’s not modification. That’s just sort of share of debt and syndicated loan underwriting fees largely speaking.

Meredith Whitney - Meredith Whitney Advisors

On the basic main street level, how much of modifications are impacting commercial lending.

James Dimon

Very little.

Meredith Whitney - Meredith Whitney Advisors

Okay. Thank you.

Operator

And your next question comes from the line of Matt Burnell with Wells Fargo Securities.

Matthew Burnell – Wells Fargo Securities

Good morning. Thanks for taking my call. Just a couple of follow-up questions on questions that have already been asked, but in terms of your comments relative to exposure to CIT, were your comments reflective of your exposure to small business in the retail sector and if not, what would be the impact on your reserving and credit --

James Dimon

We have exposure to CIT secured and unsecured but I’m telling you the initial, the primary and direct effect on the P&L would be not material to us. You’re talking about the secondary effect, like do those companies that they deal with have some issues, I’m sure there would be something there but I wouldn’t think that would be a major thing and remember even companies in bankruptcy continue to service accounts and things like that.

Obviously, if we have clients who are involved in that or participate, when we’ve looked at that we think we’re fine but we’ll be engaged trying to minimize the impact of that. Net, net it wouldn’t be material.

Matthew Burnell – Wells Fargo Securities

And let me follow-up on Mike’s question in terms of corporate credit quality, the charge-offs in that portfolio were up fairly materially this quarter versus the prior quarter, can you give us a little more color as to where those charge-offs are coming, is that commercial real estate, are there other industries in that portfolio.

Michael J. Cavanagh

Industry, media and one in particular, a little telecom so it’s not commercial real estate.

James Dimon

It’s going to always be idiosyncratic where you have some big company goes bankrupt and you have $200 million charge-off. You may have already reserved for it, some of it by the way. So that’s why we say it’s always going to be idiosyncratic, the reserves are high, nonperforming is going to go up, charge-offs is going to be very lumpy.

Matthew Burnell – Wells Fargo Securities

Great. Thank you.

Operator

And your next question comes from the line of Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch - Credit Suisse

Great, thanks. I was wondering if you could talk a little bit about the revenue outlook in the credit card, you talked about obviously having pressure from lower sales volumes on outstandings, what about the pricing side of things. You’re not alone in this but the loss right now exceeds at least your net interest margin. How should we think about your ability to regain some in pricing particularly given what might be coming down the pike in 2010 from the legislation?

Michael J. Cavanagh

As we’ve said before in the near-term meaning this year and next, it’s going to be hard to see how we turn a profit in the card business and for the very dynamics you just said. We’ll do the best we can but it’s beyond that in anticipating how to reshape the business as we deal with the credit environment we’re currently in and then deal with the legislative changes and business practice changes.

We will get to a business that over the horizon, that I was just referring to, earns a good return and it will be whatever size business on the lending side can generate a good return on capital.

James Dimon

But it won’t be next year. The way to look at it is a big part of that business is fine. It earns a decent return. We don’t have to make a lot of changes and then there’s a chunk of it, 30% or 40% we’re going to have to make some real changes. So a reasonable expectation is that revenues are stressed a little bit next year, charge-offs are high, and the business loses money.

And the legislation itself all things being equal, it’s very hard with all things being equal because part of it is how all the competitors respond to it and will put, it’s already in my number about losing money but that will cost $500, $600, $700 million next year.

Moshe Orenbuch - Credit Suisse

Just a follow-up on a different topic, you talked a little bit about the MSR valuation and hedging, as you kind of look at the rate environment as we enter the third quarter is there anything about it that would cause the kind of swing you had in the valuation adjustment. I guess it’s hard for us to know from the outside how to think about that.

James Dimon

I’ll be really clear, if you hedge 100% of your models and you do your models well, you’re going to have a swing of a couple hundred million dollars a quarter no matter what but it will net out over time.

Michael J. Cavanagh

And we call that the MSR risk management revenue. You can see that in our press release.

James Dimon

It’s just how actual pay downs and products act versus what your model said.

Michael J. Cavanagh

It was $81 million positive this quarter but as Jamie said, if you look back over time on average that’s in the range of plus or minus several hundred million dollars.

James Dimon

And in addition we sometimes make decisions that make that number bigger or smaller. There are times when we are not going to hedge mortgage basis or volatility. We could be right or wrong. There may even be times we don’t hedge all the duration as a business matter. So assume if you’re 100% hedged you have a couple million dollar swing and it could be a lot more than that depending if we change how we position it.

Michael J. Cavanagh

And we talk about it when we do. So that’s what happened in the last two quarters where we had a billion dollar positive numbers, it was on the back of deliberate decisions. That worked out.

Moshe Orenbuch - Credit Suisse

Great. Thanks so much.

Operator

And your next question comes from the line of Jeff Harte with Sandler O''Neill & Partners.

Jeffery Harte - Sandler O''Neill & Partners

Good morning, a couple of things. Within the investment bank, I guess I’m specifically wondering about prime brokerage. In the industry we’ve seen assets contract and there’s been a lot of disruptions but it seems like things might be getting a little better, can you talk a bit about whether competition is increasing at all there or whether you’re seeing a stabilization in redemptions and kind of your outlook there.

James Dimon

We’ve seen a small increase in prime broker in the last quarter or so. But our ongoing assumption is that you’re going to have a lot of competition and investment banking is a very competitive business and there’s no reason to think that we’re going to be a beneficiary from people having problems in the future.

So all the big competitors are still there and they’re still very good.

Jeffery Harte - Sandler O''Neill & Partners

And this is a tough question to answer I know, but along these lines seeing the level of equity origination revenues in the quarter and kind of looking forward, we’ve have a lot of FICC refis. From an investment banking capital raising standpoint what can realistically be done as an encore. Is there enough demand on the investor side and supply from the corporate side to keep supporting investment banking levels near-term?

James Dimon

If you’re talking about next quarter it’s awful hard to answer that question. But I think if you look and obviously we’re still in a pretty big recession but the quarter before there was huge fixed income, this quarter’s equity, I think there will be a lot of people who are raising debt and equity or preferred to recapitalize and refinance the balance sheets. And obviously it will be lumpy and whether the market is willing to accommodate big supplies of those things.

And it’s also been a global phenomenon. So when you look at it globally, it’s possible you’ll continue to have pretty active investment banking fee markets as people try to change and fix their balance sheets and get ready for new environments. But your guess is as good as ours.

Jeffery Harte - Sandler O''Neill & Partners

And in the corporate segment the, let’s call it trading gains on the portfolio, is there any way we should think of that going forward or is that just going to be a wildcard like fixed income trading revenues tend to be in the investment bank.

Michael J. Cavanagh

Think of that as pretty much excess revenues generally positive over time, a little bit volatility but at this level it was much higher than normal.

James Dimon

Most of that portfolio is held for AFS, so it doesn’t have a trading gain or loss. And obviously because of the markets we took advantage of buying certain things in there that we obviously were right to buy but they had to by their nature be put in a trading portfolio. So it will be a little volatile but don’t expect big gains that like, put it that way.

And you saw last year when Fannie Mae went bankrupt and we had to write-down the preferred, that was a loss. So this is the flip side. We did the bank preferreds and stuff like that that had to go in trading portfolios, so this is just the flip side.

Jeffery Harte - Sandler O''Neill & Partners

And I know this isn’t necessarily as big an issue for you specifically relative to the industry but everyone is still concerned about commercial real estate and how it’s performing, you haven’t really mentioned it as being a problem in the quarter or in the quarter highlighted it, can you give any color as to how you’re seeing general trends in the commercial real estate market.

James Dimon

I will give you a general comment; commercial real estate in the United States of America is going to get worse consistently over the next several quarters. That should not be a surprise to anybody. Of course real estate is idiosyncratic, did you have good developers, did you have good underwriting, did you have good down payments, did you have good equity, did you build a good building, are you in a good place. All those various things. We’ve got two major real estate exposures. We have what we call CTL which is multi families, smaller loans, it’s performing fine and we actually --

Michael J. Cavanagh

That we got from WaMu, the $30-ish billion portfolio from WaMu.

James Dimon

It will get worse but we don’t expect it to be significant, materially significant to our numbers and we also have a more traditional real estate portfolio but I would say both the bank one, JPMorgan and Chase we’ve been so conservative of the last eight or nine years that it’s been doing nothing but in ge