How profitable was JPMorgan Chase in 2006 and what drove the increase?

Net income reached a record $14.4 billion, up from $8.5 billion in 2005. Revenue growth of 14% to $61.4 billion was the main driver, with strong trading (Principal transactions up 35% to $10.3 billion), record asset management fees, and record investment banking fees. A lower provision for credit losses and the absence of 2005's large litigation charges also boosted results, though 2006 included a $622 million after-tax gain from the sale of the corporate trust business, which is reported in discontinued operations.

Are credit costs likely to rise in 2007?

Yes, according to management's 2007 outlook. The provision for credit losses is expected to be higher than in 2006, reflecting a return toward more normal provisioning in both the wholesale and consumer businesses. Consumer net charge-offs are expected to increase as bankruptcy filings rise from the unusually low levels following the October 2005 bankruptcy law change. Wholesale credit quality was described as stable at year-end 2006.

How is JPMorgan Chase returning capital to shareholders?

The Firm paid a quarterly dividend of $0.34 per share ($1.36 annually) and repurchased 91 million shares for $3.9 billion in 2006 at an average price of $43.41. The Board's March 2006 authorization of up to $8 billion of repurchases had $5.2 billion remaining at year-end. The common dividend payout ratio fell to 34% in 2006 from 57% in 2005, and management targets a 30% to 40% payout ratio over time.

What are the most significant legal risks disclosed?

The most prominent matters include Enron-related litigation, including the $2.2 billion pretax Newby class action settlement, which is on appeal; IPO allocation securities and antitrust suits, where the Second Circuit vacated a class certification ruling in December 2006 and the proposed $425 million MOU became unenforceable; National Century Financial Enterprises noteholder litigation, with settlements totaling roughly $440 million and continuing SEC and DOJ inquiries; and credit card interchange and American Express antitrust suits. Management believes outcomes should not materially affect consolidated financial condition, but acknowledges results could exceed current reserves.

Is the balance sheet and capital position sound?

Yes. At December 31, 2006, the Firm reported a Tier 1 capital ratio of 8.7%, a total capital ratio of 12.3%, and a Tier 1 leverage ratio of 6.2%, all well above well-capitalized thresholds. Total assets were $1.35 trillion, up 13%, funded largely by $639 billion of deposits. Long-term debt rose to $133 billion after $56.7 billion of new issuance. Subsequent to year-end, S&P and Fitch raised the Firm's senior long-term ratings to AA- and the operating bank ratings to AA, supporting its funding costs.

JPM 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

JPMorgan Chase closed 2006 with record net income of $14.4 billion^a, or $4.04 per diluted share, up 70% from $8.5 billion in 2005, and a return on common equity of 13% versus 8% a year earlier.

Income from continuing operations was a record $13.6 billion^b ($3.82 per diluted share). Total net revenue rose 14% to $61.4 billion, driven by record investment banking fees, record trading and asset management revenue, and higher net interest income, while noninterest expense was roughly flat at $38.3 billion. The efficiency gains came from Bank One merger savings (about $2.5 billion cumulative realized in 2006, with a run-rate of approximately $2.8 billion entering 2007) and lower litigation charges versus 2005.

Credit costs fell sharply as the provision for credit losses dropped to $3.3 billion^c from $3.5 billion, reflecting lower bankruptcy-related losses in Card Services after the October 2005 bankruptcy reform. Management guided that the 2007 provision will rise toward a more normal level, with consumer net charge-offs increasing as bankruptcy filings normalize. Capital remained strong, with a Tier 1 capital ratio of 8.7% and $5.2 billion of remaining buyback authority under an $8 billion program; the firm repurchased $3.9 billion of stock in 2006 and paid a $0.34 quarterly dividend.

Investors should weigh the strong earnings momentum and capital return against several overhangs disclosed in the filing: continued net interest spread compression in Retail Financial Services, a rising 2007 credit cost outlook, and a long list of material legal matters, including the $2.2 billion^d Enron Newby settlement (on appeal), IPO allocation litigation, National Century Financial Enterprises claims, and interchange and American Express antitrust suits. Management nonetheless believes these matters should not materially affect consolidated financial condition beyond existing reserves.

02—Key points

Key Highlights

Record 2006 net income of $14.4 billion ($4.04 diluted EPS), up 70% year over year; return on common equity of 13% versus 8% in 2005.
Total net revenue rose 14% to $61.4 billion, led by record investment banking fees ($5.5 billion, up 35%) and record trading and asset management revenue; Investment Bank revenue hit $18.3 billion.
Noninterest expense was essentially flat at $38.3 billion, with a 2006 efficiency ratio (overhead ratio) improving to 62% from 71%, aided by about $2.5 billion of cumulative Bank One merger savings.
Provision for credit losses declined to $3.3 billion from $3.5 billion, but management expects 2007 provisions to be higher as bankruptcy-driven benefits normalize.
Balance sheet grew to $1.35 trillion in assets and $115.8 billion in stockholders' equity; Tier 1 capital ratio was 8.7% and the Firm repurchased $3.9 billion of common stock in 2006.
Acquisitions and portfolio actions during 2006 included The Bank of New York's consumer and middle-market banking businesses (339 branches), Collegiate Funding Services, Kohl's and other private-label card portfolios, and the sale of the insurance underwriting business.
Significant litigation remains outstanding, including Enron-related actions, IPO allocation suits, National Century Financial Enterprises claims, and interchange and American Express antitrust cases, which management says should not materially affect consolidated financial condition beyond reserves.

03—Questions

Frequently Asked Questions

How profitable was JPMorgan Chase in 2006 and what drove the increase?
Net income reached a record $14.4 billion, up from $8.5 billion in 2005. Revenue growth of 14% to $61.4 billion was the main driver, with strong trading (Principal transactions up 35% to $10.3 billion), record asset management fees, and record investment banking fees. A lower provision for credit losses and the absence of 2005's large litigation charges also boosted results, though 2006 included a $622 million after-tax gain from the sale of the corporate trust business, which is reported in discontinued operations.
Are credit costs likely to rise in 2007?
Yes, according to management's 2007 outlook. The provision for credit losses is expected to be higher than in 2006, reflecting a return toward more normal provisioning in both the wholesale and consumer businesses. Consumer net charge-offs are expected to increase as bankruptcy filings rise from the unusually low levels following the October 2005 bankruptcy law change. Wholesale credit quality was described as stable at year-end 2006.
How is JPMorgan Chase returning capital to shareholders?
The Firm paid a quarterly dividend of $0.34 per share ($1.36 annually) and repurchased 91 million shares for $3.9 billion in 2006 at an average price of $43.41. The Board's March 2006 authorization of up to $8 billion of repurchases had $5.2 billion remaining at year-end. The common dividend payout ratio fell to 34% in 2006 from 57% in 2005, and management targets a 30% to 40% payout ratio over time.
What are the most significant legal risks disclosed?
The most prominent matters include Enron-related litigation, including the $2.2 billion pretax Newby class action settlement, which is on appeal; IPO allocation securities and antitrust suits, where the Second Circuit vacated a class certification ruling in December 2006 and the proposed $425 million MOU became unenforceable; National Century Financial Enterprises noteholder litigation, with settlements totaling roughly $440 million and continuing SEC and DOJ inquiries; and credit card interchange and American Express antitrust suits. Management believes outcomes should not materially affect consolidated financial condition, but acknowledges results could exceed current reserves.
Is the balance sheet and capital position sound?
Yes. At December 31, 2006, the Firm reported a Tier 1 capital ratio of 8.7%, a total capital ratio of 12.3%, and a Tier 1 leverage ratio of 6.2%, all well above well-capitalized thresholds. Total assets were $1.35 trillion, up 13%, funded largely by $639 billion of deposits. Long-term debt rose to $133 billion after $56.7 billion of new issuance. Subsequent to year-end, S&P and Fitch raised the Firm's senior long-term ratings to AA- and the operating bank ratings to AA, supporting its funding costs.

04—Continue

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