<PAGE>   1
                                                                     EXHIBIT 13



                                                  1998 ANNUAL REPORT
                                                  J.P. MORGAN & CO. INCORPORATED


                       [PHOTO OF ANA CAPELLA GOMEZ-ACEBO]


                                                  FOCUSED
<PAGE>   2
FINANCIAL HIGHLIGHTS

J.P. Morgan & Co. Incorporated


<TABLE>
<CAPTION>
In millions, except share data - includes special items                  1998         1997
<S>                                                                   <C>          <C>
FOR THE YEAR
Revenues, net of interest expense and provision for credit losses ..  $   6 955    $   7 220
Pretax income ......................................................      1 417        2 154
Net income .........................................................        963        1 465
Dividends declared on common stock .................................        677          642

EARNINGS PER SHARE
Basic ..............................................................  $    5.08    $    7.71
Diluted ............................................................       4.71         7.17

PER COMMON SHARE
Dividends declared .................................................  $    3.84    $    3.59
Book value .........................................................      55.01        55.99

AT YEAR-END
Total stockholders' equity .........................................  $  11 261    $  11 404
Total assets .......................................................    261 067      262 159

SELECTED RATIOS
Return on average common stockholders' equity ......................        8.6%        13.4%
Common stockholders' equity as % of year-end assets ................        4.0          4.1
Total stockholders' equity as % of year-end assets .................        4.3          4.4
Tier 1 risk-based capital ratio ....................................        8.0          8.0
Total risk-based capital ratio .....................................       11.7         11.9
</TABLE>

Certain forward-looking statements contained in this Annual report are subject
to risks and uncertainties. Refer to page 47 for more information.

Refer to page 59, Glossary, for a definition of certain terms used throughout
this report. In accordance with Securities and Exchange Commission initiatives
to simplify the presentation of complex financial information, we have prepared
this report using "plain English" guidelines.


TABLE OF CONTENTS


1      Letter to shareholders

17     Overview

19     Results by business

31     Results of operations

36     Balance sheet review

49     Risk management

60     Detailed table of contents

63     Consolidated financial statements and related notes

128    Additional selected data and other information

137    Form 10-K cross-reference index

145    Corporate information

146    Key topic index


Cover: Ana Capella Gomez-Acebo is an investment banker who advises financial
institution clients in Latin America. The people of J.P. Morgan - more than
15,000 skilled professionals based in 34 countries around the world - are
focused on delivering superior performance for clients and shareholders.
<PAGE>   3
DEAR FELLOW SHAREHOLDERS


J.P. Morgan earned net income of $963 million in 1998, 34 percent less than in
1997. Operating earnings were $1.065 billion, down 27 percent, and operating
return on equity was 9.5 percent - far below the 15 to 20 percent target we have
set for ourselves and less than our cost of equity. We are dissatisfied with
these results - the more so because they do not reflect the significant earnings
power of the distinctive business franchise we have built over the past several
years. What happened?

The short answer is that we failed to fully anticipate the default of Russia in
August and underestimated the severity of the global market crisis it triggered.
This had three direct effects on our earnings. Credit market and proprietary
profits were hurt in the second half of the year as global debt markets faced a
severe liquidity squeeze. Revenues from emerging markets were depressed, in part
by losses related to Russian securities. And the cost of reducing the risk in
our credit portfolio - a key element of our credit strategy - increased as a
result of the market dislocations. Not counting missed growth opportunities,
these three factors alone cost us approximately $600 million in revenues in
1998.

For our core activities, the crisis was one of the most stringent market tests
ever. We learned many tactical lessons, but fundamentally our risk management
processes and operational support areas performed well. During the severe
volatility from August to October we relied heavily on the judgment


                                                           


                        [PHOTO OF DOUGLAS A. WARNER III]
<PAGE>   4
and experience of our senior management team. We scaled back credit exposures to
emerging Asia and Latin America by 50 percent and 40 percent, respectively, from
their year-end 1997 levels - not as a retrenchment from those areas but in
recognition of the greater risk inherent in them.

Yet even while our energies were devoted to managing through this crisis, we
moved forward decisively on our key business initiatives:

-   We saw uninterrupted market share and revenue momentum in investment banking
    and equities.

-   We continued to strengthen our leadership in asset management.

-   We significantly reduced the risk in and capital committed to our credit
    portfolio.

-   We demonstrated expense discipline and laid the groundwork for continuous
    productivity improvement.

-   We emerged from the crisis in a position of relative strength in our market
    activities.

In sum: we made tangible progress on our strategy in a very tough environment.
It is this progress, and its promise of future financial performance, that the
Board of Directors recognized in December when it authorized an increase in the
quarterly dividend on common stock from $0.95 to $0.99 per share.

A brief word on strategy. At its essence, strategy is the creation of a relevant
and distinctive value proposition for clients that yields a sustainable
competitive advantage and attractive shareholder returns. There is no question
that demand for our brand of sophisticated financial services among
corporations, institutions, and wealthy individuals is growing rapidly. Capital
markets continue to expand globally. Private wealth creation is accelerating.
Clients' challenges are becoming more complex, not less so. And the number of
firms able to address these needs in an integrated way is shrinking.

Does J.P. Morgan have a distinct competitive position? I believe we do. We are
the only wholesale financial firm that combines investment banking, commercial
banking, and asset management capabilities globally on a meaningful scale. We
integrate these capabilities to solve clients' problems in ways others cannot,
while abiding by the principles and standards that are this firm's hallmark.

We are convinced that this value proposition is as compelling to shareholders as
it is to clients. Having built the capabilities, our challenge is to generate
financial performance commensurate with that promise. In last year's annual
report I outlined five key initiatives to accomplish this. Our progress on each
one during 1998 - while overshadowed in aggregate by the financial impact of the
crisis - reaffirmed that we are on the right track.

MARKETS

Our market making activities in the fixed income, currency, and derivative
markets represent the most integrated and balanced global franchise of its kind.
Even with the significant revenue declines in the second half and our emphasis
on managing positions to address increases in market risk, pre-tax earnings for
these activities - encompassing our Interest Rate Markets, Credit Markets, and
Foreign Exchange groups - grew 15 percent in 1998, with strong contributions
from the Americas, Europe, and Asia.

The opportunities to further capitalize on our leadership in these markets are
enormous. For a globally committed firm, the expansion of capital markets,
ranging from Japan to the unified European market to the recovery of individual
emerging markets, continues to represent significant potential. Client demand is
growing in these activities - over the past four years investor client revenues
have grown at more than 15 percent annually.


2
<PAGE>   5
Moreover, multi-year technology investments have already reduced our cost per
trade in some areas by as much as 50 percent, and further efficiencies are close
to being realized.

Our leadership in derivatives is another significant source of growth. The core
growth trend of derivatives revenues in these markets over the past four years
has been approximately 30 percent a year. To expand on this platform we plan to
further increase transaction flows on our fixed cost base, capture the potential
of fast-growing segments such as credit derivatives, and expand client use of
our leading derivative technology platform.

INVESTMENT BANKING AND EQUITIES

Our goal for investment banking and equities remains unchanged: to gain share
and develop a leadership position with our clients. Our progress in 1998 was
excellent. Clients' confidence in our abilities helped increase revenues for
investment banking and equities 30 and 50 percent, respectively - these
activities now account for a quarter of our total revenues. Our market share in
completed mergers and acquisitions rose more than two points to 13 percent while
the market nearly doubled in size. In U.S. equity underwriting we almost doubled
our share of lead-managed transactions to nearly 6 percent, setting new
standards for execution and service in the process. Equities revenues were well
diversified across underwriting, brokerage, and derivatives.

[SIDEBAR -- WE ARE THE ONLY WHOLESALE FINANCIAL SERVICES FIRM THAT COMBINES
INVESTMENT BANKING, COMMERCIAL BANKING, AND ASSET MANAGEMENT CAPABILITIES
GLOBALLY ON A MEANINGFUL SCALE.]

We will build on this momentum by adding resources in key industry sectors and
aggressively expanding our client base in profitable segments to which our
integrated business approach is particularly relevant: telecommunications and
technology companies, high-growth companies with complex needs, and financial
sponsor firms.

ASSET MANAGEMENT

Asset management is a key growth and investment area for the firm and one whose
relative contribution we intend to expand over time. Clients' assets under
management grew 23 percent last year, and investment management fees on all
managed assets increased 16 percent, a solid posting in a challenging year for
global asset managers. Revenues from our unique private client franchise for the
third year in a row posted double-digit growth, increasing by 10 percent to $670
million.

The potential is even greater. Our high net worth and defined benefit activities
continue to grow rapidly. The defined contribution joint venture with American
Century is winning in competition with established competitors, having captured
more than 40 plans reaching over 400,000 participants in its first year. And we
continue to expand our channels for gathering assets in target markets globally;
during 1998 we entered into an asset management agreement in France with Banques
Populaires and an exclusive joint venture with Dai-Ichi Kangyo Bank in Japan to
provide investment trusts (mutual funds) to Japanese investors.


                                                                               3
<PAGE>   6
CREDIT


Earlier I highlighted the decision to push ahead on our credit strategy as one
of the factors contributing to lower revenues in 1998. We chose to move
aggressively because the market imbalances that underlie our strategy have
intensified: pricing in the global loan markets, particularly for
investment-grade borrowers, remains at levels that do not provide adequate
returns on capital to banks. As a result, capacity continues to decline as the
industry consolidates and traditional bank lenders withdraw from the market.
Borrowers will need to access new investors and use new forms of financing. Our
goal is to help clients develop these new sources both in the traditional loan
market and in the broader capital markets. As the third-ranked global arranger
of syndicated loans and with our leadership in fixed income markets worldwide,
we are extremely well positioned to facilitate this transition.

Given the low returns of retaining credit risk, we are significantly reducing
the capital committed to this activity and preserving our capacity for clients'
strategic financing needs. In 1998 we reduced the economic capital requirement
of our credit portfolio by 17 percent through asset sales, hedges, and roll-off
of existing exposures. Going forward, we will continue to put our capital to use
where it adds the most value to clients and shareholders.

PRODUCTIVITY

Our aim going into 1998 was to sharpen our focus on productivity of people and
capital. We demonstrated good expense discipline - operating expenses rose only
2 percent - without sacrificing necessary reinvestment. Through a detailed,
continuous productivity program, we are on track to reduce our operating
expenses before incentive compensation by $400 million in 1999. Efficient use of
capital will also remain a key priority, both as part of our credit strategy and
in our market making and proprietary risk-taking activities.

More important for the longer term, last year we began to see a new performance
mindset take hold throughout the firm as our priority shifted from transforming
our business model to extracting its performance potential.

I encourage you to devote a few minutes to the following pages, in which the
senior managers who are leading the charge on key elements of our strategy share
views on 1998 and their plans for the future. Resonating throughout is the
importance of maintaining focus. Staying focused helped us emerge from last
year's market turmoil with our risk profile improved and our risk management
processes strengthened. It enabled us to deliver efficient transaction execution
even in the worst of the market turmoil - and win market share in the process.
It allowed us to maintain a clear perspective on the forces driving
consolidation in our industry. And staying focused on rigorous execution of our
game plan will deliver the results that you and I, as shareholders, demand.


/s/ Douglas A. Warner III

Douglas A. Warner III
Chairman of the Board
and Chief Executive Officer

March 2, 1999


4
<PAGE>   7
[SIDEBAR -- AT THE CORE OF THE FIRM AND AROUND THE GLOBE, J.P. MORGAN IS
FOCUSED ON DELIVERING OUTSTANDING RESULTS IN A PRINCIPLED WAY FOR CLIENTS AND
SHAREHOLDERS.

OUR LEADERS SET THE PACE.

HERE'S HOW SOME OF THEM TACKLE KEY INITIATIVES, COMPETITIVE DIFFERENTIATION, AND
PERFORMANCE.]
<PAGE>   8
[SIDEBAR -- EXECUTING TO MEET CLIENT NEEDS - THAT'S WHERE THE BATTLE WILL BE
WON OR LOST.
            

RAMON DE OLIVEIRA]


                          [PHOTO OF RAMON DE OLIVEIRA]

<PAGE>   9
                                ASSET MANAGEMENT


"I see 1998 as a year when we did important work to increase J.P. Morgan's
competitiveness in a swiftly evolving marketplace. Our leadership in the defined
benefit and high-net-worth arenas is a springboard to capitalize on the
international boom in wealth creation and the broadening of retirement-plan
options to include individual investment choice. We're systematically tackling
those opportunities. And we remain absolutely dedicated to perfecting investment
disciplines, asking always whether our processes, products, and performance are
the best we can deliver to our clients. This is our fiduciary responsibility.

"Tough decisions were made last year. We reduced our presence in some markets so
that we could reinvest elsewhere for higher growth. We simplified some
operations with a tight focus on what works for our clients. And we struck out
in new directions. To expand our reach in personal financial services, we
created alliances with institutions in France, Germany, and Japan. These
alliances work. In our first year of partnership with American Century, we won
42 mandates to provide defined-contribution investment programs - and we'll soon
expand that partnership's reach to a broader range of individual investors.

"I tell everyone that now, for J.P. Morgan, the issue is execution. The strategy
for this firm is in place. Executing to meet client needs - that's where the
battle will be won or lost. Last year was hard - like contact sport for the
first time - and this year is critical. Asset management has a big part to play.
The goal is to double or triple our earnings as a proportion of the firm's
total."


                                                                               7
<PAGE>   10
                                    EQUITIES


"Last year was a watershed in our drive toward leadership, with defining
achievements despite the troubled financial environment. Determined execution of
our strategy across every part of Equities is paying off.

"We won mandates from very demanding clients - some long-standing, many new to
the firm. We were bookrunner for Swisscom, the largest European IPO of the year,
establishing us as a top equities player in Europe. We completed the largest
spot secondary ever - selling 10 million Gillette shares for Kohlberg Kravis
Roberts. And we were the sole bookrunner for CIT's secondary offering - the
largest U.S. secondary of the year.

"The platform for further market share gains and greater profitability is built.
We bring together top-notch fundamental research, trading skills, and a deep
knowledge of the global marketplace. We find new ways to link investors with
issuers, balancing their needs and goals. We offer derivative clients a unique
combination of global perspective, transparency, and analytic firepower.

"Success depends on differentiating ourselves - and we do. We make it our
business to execute better in day-to-day dealings with clients, the day-to-day
management of risk, the day-to-day solving of client problems, the day-to-day
marketing of a deal. We take no shortcuts. When EarthWeb tapped us for its IPO,
which reignited the technology sector in October, it was on the strength of a
meticulously planned launch strategy and thorough reading of investor demand.

"This is how we win. Strategy is important, but leadership grows from superior
performance each day in every nook and cranny of the business to best serve our
clients."


8
<PAGE>   11
                            [PHOTO OF CLAYTON ROSE]


[SIDEBAR -- WE DIFFERENTIATE OURSELVES BY SUPERIOR PERFORMANCE EACH DAY IN
EVERY NOOK AND CRANNY OF THE BUSINESS.


CLAYTON ROSE]
<PAGE>   12
[SIDEBAR -- OUR DIVERSIFIED GLOBAL FRANCHISE ALLOWED US TO STAND BY OUR CLIENTS
IN THE CRISIS AND MANAGE OUR OWN POSITIONS.

PILAR CONDE]

                             [PHOTO OF PILAR CONDE]


MARKETS


"Markets were still uneasy about emerging Asia in the first half of 1998, but
after August they deteriorated faster than we had ever seen. Liquidity
disappeared, volatility jumped - everywhere. We felt the effects of that, but
our markets franchise is diversified and global. We called on our experience and
we used our judgment. On the market-making side, we stood by our clients through
the crisis. And we managed our own positions within stress-test limits.

"In proprietary investing we made the decision to realize losses on previously
marked down Asian securities as part of our corporate strategy to cut credit
exposures. Apart from that, our many proprietary strategies and broad portfolio
allowed us to weather the storm.

"Proprietary trading remains an important complement to our client-focused
activities: a fast, high-margin business with excellent long-term returns, a
source of credibility when our own capital is at work alongside clients', a way
to gain and use market insights, and a discipline that attracts and breeds top
trading talent."

Pilar Conde


"Across credit-sensitive markets, the crisis had a profound impact but left us
well positioned - with strengthened client relationships and risk management.

"Staying committed to emerging markets has stood us in good stead on several
fronts. First, market share. We've learned from previous crises that standing by
our clients translates into lasting increases in our share of their business.
Second, our expanded global footprint - with new offices in South Africa, Korea,
and India-positions us to target local market opportunities in a cost-effective
manner. And demand for capital market and structured solutions continues to
grow. That plays to our strengths.


10
<PAGE>   13
                            [PHOTO OF NICK ROHATYN]


"In the broader credit markets, combining bond and loan origination,
distribution, and research is proving a winning formula - major transactions for
Tyco International and Lyondell, among others, demonstrate this. And our
leadership in credit derivatives and securitization is a strong advantage. For
instance, we used the BISTRO structure developed as part of our credit strategy
to help other banks in the U.S., Asia, and Europe manage risk and capital,
securitizing and selling over $40 billion of credit exposure to the capital
markets in 1998."

Nick Rohatyn


                            [PHOTO OF BILL WINTERS]


"The work we do in interest rate markets stands out because of our ability to
solve clients' problems in their entirety. In every activity-government bond
dealing, swaps and other derivatives, futures and options - we've spent years
developing technology and solutions that competitors can only approximate.
Flexibility, capital commitment, and transaction flow underlie our leading role
in these markets globally - the position that reaps the greatest rewards. Profit
growth in 1998, propelled by client demand and productivity gains, confirmed
that.

"To stay on top we've anticipated change. Take foreign exchange, where with the
introduction of the euro there seemed more potential for downside than upside.
By focusing on efficiency, on where markets and client needs were headed, we
logged a record year. We push constantly to develop innovative, customized,
productive ways to help both issuers and investors manage risk.

"That's how our competitive edge in the markets will keep advancing: by
combining a sophisticated focus on efficiency with our core client and
technology strength."

Bill Winters


                                                                              11
<PAGE>   14
INVESTMENT BANKING


"Nineteen ninety-eight saw a giant step-up in investment banking volume and the
sheer scope of transactions. At the same time, the market became more discerning
of value. Morgan was in the thick of it. We are serving as advisor to Exxon on
its $86 billion merger with Mobil, the largest merger bid ever. We advised BP on
its $55 billion merger with Amoco, AT&T on its $5 billion joint venture with
British Telecom, and Thyssen on its $5 billion merger with Krupp. We led many of
the year's most visible equity offerings.


"That success didn't just happen. Take BP, Fortis, Lyondell, or Ford: When we
advised them on defining transactions last year, they got the best strategic
advice and the most insightful ideas, shaped by a deep understanding of global
industry dynamics and access to boardrooms. They saw our genuine passion to
excel - to execute transactions which succeed for the client. And we delivered
the full range of relevant investment banking services: advice, financing, and
risk management, working as one firm, tightly integrated, rather than a
federation of product lines.

"The turbulent conditions of 1998 were a crucial test. Morgan reopened critical
markets after Russia defaulted: the high-tech IPO market with EarthWeb; the
emerging markets with an innovative $1 billion bond with warrants for Argentina;
and the high-yield market with financing for Bain Capital's purchase of Domino's
Pizza. Our trademark blend of integrity and meticulous execution - plus the
willingness and ability to be bold - made these deals succeed for our clients.
That is how we've built our leadership credentials - block by block-across
industry sectors, in cross-border work, and in defending against hostile bids.
And that is how we'll continue to win the confidence and the business of a
bigger universe of clients."


12
<PAGE>   15
[SIDEBAR -- OUR BRAND OF BOLDNESS, INTEGRITY, AND METICULOUS EXECUTION IS
CREATING A BIGGER UNIVERSE OF CLIENTS FOR US.

WALTER GUBERT]


                            [PHOTO OF WALTER GUBERT]
<PAGE>   16
[SIDEBAR -- WE SEE OUR DRIVE FOR INCREASED QUALITY AS A COMPETITIVE WEAPON.

TOM KETCHUM]



                             [PHOTO OF TOM KETCHUM]
<PAGE>   17
PRODUCTIVITY AND QUALITY


"We invested heavily to build the global capabilities of today's J.P. Morgan.
Going into 1998, a prime goal was to shift from the work of transformation to a
full-throttle drive to realize the firm's performance potential. Productivity
became a top priority. First, we focused on cutting expenses and using capital
more economically. The latter effort centers on the new strategy for our credit
business - freeing up underemployed capital and taking the lead to help clients
obtain credit on advantageous terms in the broader markets. Last year the
economic capital required to support our credit portfolio came down 17 percent.

"What have we done to make our business fundamentally more efficient?
Restructured our office network in Europe, curbed or eliminated activities in
certain locations, weeded out redundancy, centralized services, attacked both
the supply and demand sides of managing infrastructure, stream-lined scores of
processes. There are now more than 300 productivity projects being tracked for
results across the firm. Productivity measures will reduce core operating
expenses in 1999 by $400 million - while sustaining substantial investments in
business growth.

"We see a bigger payoff - beyond capital and expenses - from intensified focus
on the revenue opportunities that flow from high-quality service delivery. We
aim to improve the consistency and quality of the things that matter most to our
clients and to the firm's bottom line. To do it, we've adapted the Six Sigma
discipline used so successfully at General Electric, AlliedSignal, and other
companies to our wholesale financial services business. It provides a powerful,
fact-based approach to process redesign and quality improvements that deliver
critical value to clients.

"Stressing quality reinforces the high standards identified with J.P. Morgan
throughout its history. It will be a competitive advantage with clients and a
source of sustainable gains in productivity. This is not a project; it's a
crusade. It's not just cutting costs; it's an opportunity to distinguish our
firm in the marketplace and set a new standard of excellence in both service and
shareholder returns."


                                                                              15
<PAGE>   18
                                                                 MANAGEMENT TEAM





                         [GROUP PHOTO OF LISTED BELOW]





Douglas A. Warner III (1); Ernest Stern (2); Pilar Conde (3); Michael E.
Patterson (4); Walter A. Gubert (5); Ramon de Oliveira (6); Clayton S. Rose (7);
Roberto G. Mendoza (8); Stephen G. Thieke (9); Peter D. Hancock (10); Keith M.
Schappert (11); William T. Winters (12); John A. Mayer Jr. (13); Joseph P.
MacHale (14); Michael R. Corey (15); Nicolas S. Rohatyn (16); Thomas B. Ketchum
(17)


See page 139 for managerial responsibilities.
<PAGE>   19
[BAR GRAPHS]

TOTAL REVENUE
In millions, before special items
---------------------
1994           $5,463
1995           $5,864
1996           $6,778
1997           $7,220
1998           $6,768
---------------------
On page 17 of the annual report there is a bar chart depicting the firm's total 
revenue, before special items, for 1994 to 1998.

OPERATING EXPENSES
In millions, before special items
---------------------
1994           $3,692
1995           $3,943
1996           $4,452
1997           $5,066
1998           $5,180
---------------------
On page 17 of the annual report there is a bar chart depicting the firm's 
operating expenses, before special items, for 1994 to 1998.

OPERATING EARNINGS
In millions, before special items
---------------------
1994           $1,183
1995           $1,305
1996           $1,571
1997           $1,465
1998           $1,065
---------------------
On page 17 of the annual report there is a bar chart depicting the firm's 
operating earnings, before special items, for 1994 to 1998.

STOCKHOLDERS' EQUITY
In millions
---------------------
1994           $9,568
1995          $10,451
1996          $11,432
1997          $11,404
1998          $11,261
---------------------
On page 17 of the annual report there is a bar chart depicting the firm's 
stockholders' equity for 1994 to 1998.


On page 17 of the annual report there is a line graph depicting the firm's 
annual dividend declared for 1978 to 1998.


OVERVIEW


We faced a challenging global market environment in 1998, particularly during
the second half of the year. The crisis that began in Thailand in the summer of
1997 spread to other emerging Asian countries and developing economies
worldwide. Russia's default in August moved the crisis beyond the emerging
markets and triggered a broad-based deleveraging of all credit-sensitive
markets, with significant spillover into the equity and U.S. Treasury markets.
By year-end, while many markets had recovered at least partially, concerns
continued to focus on the emerging markets, Brazil in particular.

The three dominant characteristics of the crisis were (1) sharply wider credit
spreads on debt instruments, which led to pronounced illiquidity in many
markets, (2) extreme increases in volatility, and (3) widespread breakdowns in
historical market correlations. 

These market dislocations in the second half of 1998 affected substantially all
market participants globally and brought to the forefront the relationship
between market and credit risk management. The sharp drop in the portfolios of
many hedge funds and the widely reported recapitalization of Long-Term Capital
Management, L.P. led to increased scrutiny of the counterparty credit risk that
can result from sudden market movements.

Senior executives and business managers devoted significant efforts to managing
these interrelated risks, while continuing to push ahead on our strategic
initiatives. Our performance for the year reflects these parallel developments:
Declines in emerging markets and other credit sensitive markets, weak
proprietary results, and revenue losses related to our credit transformation
strategy more than offset strong performance in market making, investment
banking, and asset management activities, as well as the benefit of our
productivity initiatives.


1998 RESULTS
--------------------------------------------------------------------------------

J.P. Morgan's 1998 financial performance was affected by the global financial
crisis in the latter half of the year. Operating earnings for 1998 were $1,065
million before after-tax gains of $113 million on business sales and special
charges of $215 million. This compares with $1,465 million in 1997. Operating
earnings per share were $5.22, versus $7.17 in 1997. Operating return on common
equity was 9.5% in 1998, compared with 13.4% in 1997.





                                                                     Overview 17
<PAGE>   20


For 1998, revenues excluding nonrecurring gains were $6,768 million, down 6%
from $7,220 million in 1997. This was principally due to lower revenues from
activities in the credit markets, including losses on Russian securities, and
lower proprietary revenues, as well as actions taken as part of changes in our
credit strategy.

Nevertheless, several businesses posted strong revenue growth. Interest Rate
Markets revenues grew by 23%, buoyed by the flight to quality during the second
half of the year. Investment Banking revenues were up 30% for the year. Equities
revenues increased 51%. Asset Management and Servicing revenues increased 8% as
assets under management grew to $316 billion.

Operating expenses were $5,180 million for the year, excluding special charges
of $358 million, an increase of $114 million, or 2% over 1997. We increased
spending on the year 2000 initiative and European economic and monetary union
(EMU) by $109 million and continued to make necessary strategic investments.
These expenditures were offset by progress on our cost containment and
productivity initiatives and lower incentive compensation.


IMPACT OF OUR CREDIT STRATEGY

In 1998 we began to transform our credit business by helping clients access
credit efficiently in the capital markets while reducing the capital employed in
the business. As a result of this new strategy and the reduction of credit
exposures in the emerging markets, firmwide revenues in 1998 were reduced by
approximately $260 million. The total includes approximately $195 million in
losses on the sale of loans and investment securities, primarily in Asia, and
approximately $65 million in fees and hedging costs to reduce the credit risk in
our portfolio. These actions reduced our risk-adjusted assets by $7 billion and
the economic capital of the credit portfolio by 17%.

In addition, charge-offs related to emerging market loan sales during 1998 were
approximately $100 million. Emerging market exposures in Asia (excluding Japan)
and Latin America were reduced by approximately 50% and 40%, respectively, in
1998.




18 Overview
<PAGE>   21


OUR BUSINESS

J.P. Morgan is a leading global firm that meets critical financial needs for
business enterprises, governments, and individuals around the world. We advise
on corporate strategy and structure, raise capital, make markets in financial
instruments, and manage investment assets. Our expertise is based on an in-depth
knowledge of our clients' needs and the industries and environments in which
they operate. We also commit our own capital to promising enterprises and invest
and trade to capture market opportunities.

We have changed how we report our results to reflect new disclosure rules and
conform to the way we currently manage the firm. Our activities are reported in
the following segments and grouped into three sectors:


--------------------------------------
ACTIVITIES FOR CLIENTS

     GLOBAL FINANCE

     Investment Banking

     Equities

     Foreign Exchange


     Interest Rate Markets

     Credit Markets

     Credit Portfolio

     ASSET MANAGEMENT AND SERVICING
--------------------------------------

ACTIVITIES FOR OUR OWN ACCOUNT

     PROPRIETARY INVESTMENTS

     Equity Investments

     Proprietary Investing and Trading

On page 19 of the annual report there is a pie chart depicting the firm's 1998 
revenues by its three sectors.

1998 REVENUES BY SECTOR
In millions, excluding Corporate Items
--------------------------------------
Global Finance                  $4,698
Asset Management and Servicing   1,491
Proprietary Investments          1,041

On page 19 of the annual report there is a pie chart depicting the firm's 1998 
pretax income by its three sectors.

1998 PRETAX INCOME BY SECTOR
In millions, excluding Corporate Items
--------------------------------------
Global Finance                  $1,119
Asset Management and Servicing     230
Proprietary Investments            840


Reporting by sector helps simplify the presentation of complex, interrelated
activities conducted in over thirty countries by more than 15,000 people. What
the sector discussions cannot completely capture are elements of our approach
that cut across organizational boundaries and contribute powerfully to
performance. They include an enduring commitment to building relationships of
mutual trust with our clients; comprehensive management of the risk that arises
in the course of our work; the practice of combining knowledge and skills
creatively, throughout the world, to capitalize on opportunity; and the highest
standards of business conduct. We run an integrated global business infused with
these principles to build sustained competitive advantage and performance
momentum.















                                                                 Our business 19
<PAGE>   22


SUMMARY OF SECTOR RESULTS


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
                                                                                 Asset
                                                                Global      Management  Proprietary    Corporate      Consol-
In millions: years ended December 31                           Finance   and Servicing  Investments        Items       idated
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>          <C>             <C>          <C>          <C>   
1998
Total revenues .........................................        $4 698       $1 491          $1 041       $(275)       $6 955
Total expenses .........................................         3 579        1 261             201         497         5 538
                                                                                                                     
-----------------------------------------------------------------------------------------------------------------------------
Pretax income ..........................................         1 119          230             840        (772)        1 417
-----------------------------------------------------------------------------------------------------------------------------
1997                                                                                                                 
Total revenues .........................................         4 273        1 384           1 294         269         7 220
Total expenses .........................................         3 524        1 235             201         106         5 066
-----------------------------------------------------------------------------------------------------------------------------
Pretax income ..........................................           749          149           1 093         163         2 154
-----------------------------------------------------------------------------------------------------------------------------
1996                                                                                                                 
Total revenues .........................................         4 076        1 187           1 204         388         6 855
Total expenses .........................................         3 122          934             227         240         4 523
-----------------------------------------------------------------------------------------------------------------------------
Pretax income ..........................................           954          253             977         148         2 332
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>

All periods have been restated to reflect the management reporting policies that
are used internally for evaluating segment performance, in accordance with the
adoption of SFAS 131, Disclosures About Segments of an Enterprise and Related
Information. Refer to note 29, "Segments," for a discussion of our methodology.


CLIENT-FOCUSED ACTIVITIES
--------------------------------------------------------------------------------

Our business is defined by the relationships we build with our clients;
expanding the number and depth of these relationships is core to our long-term
strategy for growth. In 1998 11% of our client revenue came from new clients and
the number of clients generating revenue of $1 million or more continued to
grow, increasing 6%.


1998 CLIENT-FOCUSED REVENUES
BY INDUSTRY
Percentage
-------------------------------------------
               [PIE CHART]
-------------------------------------------
<TABLE>
<CAPTION>

<S>                              <C>
Financial institutions                 54%
Corporations                           28
Government/public finance               8
Individuals                             8
Other                                   2
</TABLE>


On page 20 of the annual report there is a pie chart depicting the firm's 1998
client-focused revenues by industry on a percentage basis.

Total revenues of $6,189 million from client-focused activities were broadly
diversified by geographic region and type of client in 1998 and grew by 9% from
1997. The increase was driven by strong growth in Investment Banking, Equities,
and Interest Rate Markets, partially offset by declines in Credit Markets and
Credit Portfolio.


1998 CLIENT-FOCUSED REVENUES
BY GEOGRAPHICAL LOCATION
Percentage
-------------------------------------------
               [PIE CHART]
-------------------------------------------
<TABLE>
<CAPTION>

<S>                              <C>
North America                          47%
Europe                                 34
Asia/Pacific                           11
Latin America                           8
</TABLE>


On page 20 of the annual report there is a pie chart depicting the firm's 1998
client-focused revenues by geographical region on a percentage basis.




20 Our business
<PAGE>   23


GLOBAL FINANCE
--------------------------------------------------------------------------------

Global Finance comprises the highly integrated advisory, capital raising, and
market making activities we undertake for clients worldwide. The sector had a
49% rise in pretax income in 1998, fueled by 10% growth in revenues and
essentially flat expenses. The results of each of the activities included in
Global Finance are discussed on the following pages.

<TABLE>
<CAPTION>
GLOBAL FINANCE REVENUES BY ACTIVITY
--------------------------------------------------------------------------------
In millions                                   1998           1997           1996
--------------------------------------------------------------------------------
<S>                                         <C>            <C>           <C>    
Investment Banking ................         $1 001         $  768        $   614
Equities ..........................            700            465            419
Foreign Exchange ..................            486            465            295
Interest Rate Markets .............          1 407          1 146          1 200
Credit Markets ....................            754            982          1 012
Credit Portfolio ..................            350            447            536
--------------------------------------------------------------------------------
Global Finance                               4 698          4 273          4 076
--------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
GLOBAL FINANCE PRETAX INCOME BY ACTIVITY
----------------------------------------------------------------
In millions                            1998      1997      1996
----------------------------------------------------------------
<S>                                  <C>       <C>       <C>    
Investment Banking ...............   $  279    $   56    $  (16)
Equities .........................      (57)     (228)     (115)
Foreign Exchange .................      196       156        (4)
Interest Rate Markets ............      560       276       322
Credit Markets ...................      (68)      165       359
Credit Portfolio .................      209       324       408

----------------------------------------------------------------
Global Finance                        1 119       749       954
----------------------------------------------------------------
</TABLE>

INVESTMENT BANKING

<TABLE>
<CAPTION>
SUMMARY OF INVESTMENT BANKING RESULTS
----------------------------------------------------------------
In millions                            1998      1997      1996
----------------------------------------------------------------
<S>                                  <C>         <C>       <C> 
Total revenues ...................   $1 001      $768      $614
Total expenses ...................      722       712       630

----------------------------------------------------------------
Pretax income                           279        56       (16)
----------------------------------------------------------------
</TABLE>


The Investment Banking segment includes corporate and institutional client
relationship management, which is conducted through our global network of client
bankers. Bankers coordinate marketing and origination activities for our full
range of products. The segment includes revenues from advisory services; in
partnership with clients, advisory professionals analyze and implement strategic
alternatives including mergers, acquisitions, privatizations, and changes in
clients' capital structure. Segment results include a portion of revenues from
debt and equity underwriting and from the origination of client derivative
transactions.

Investment Banking had a record year in 1998. Revenues rose 30% to $1,001
million, up from $768 million in 1997, reflecting market share gains and
increased global demand for mergers and acquisitions services. Total Investment
Banking expenses were $722 million in 1998, compared with $712 million the
previous year.

In 1998 Investment Banking revenues for each of our global sector teams
increased. In the coming year we aim to capitalize on this momentum by further
expanding our client franchise in key sectors. Investment Banking clients
providing revenue of more than $5 million increased by 50% in 1998, and for the
second year running, new clients constituted more than 11% of investment banking
client revenue.

We made significant strides toward our investment banking leadership objectives
in 1998, increasing market share in mergers and acquisitions and equity
underwriting while maintaining our strong positions in debt underwriting and
loan syndications. In mergers and acquisitions, we advised on 51 announced
transactions of more than $1 billion in value, up from 42 in 1997, and were
ranked sixth for worldwide announced advisory transactions by Securities Data
Co. Regionally, we ranked third in Europe and sixth in the United States in
announced transactions.





                                                                 Our business 21
<PAGE>   24



We had record revenues in Latin America, where we continue to hold an
unparalleled franchise in terms of revenues. In completed mergers and
acquisitions, we had a global market share of 12.7% in 1998, up from 10.5% in
1997. We ranked third in cross-border transactions.

J.P. MORGAN MERGERS AND ACQUISITIONS TRANSACTION VALUE
In billions
------------------------------------------------------
[BAR CHART]

On page 22 of the annual report there is a stacked bar chart depicting the total
annual value of the mergers and acquisitions transactions on which the firm
served as advisor, for 1993 to 1998. The bars show a breakdown of cross-border
volume and total volume.

Source: Securities Data Company, Inc.

We advised on many of the year's most significant transactions, across a range
of transaction types, including:

-        Intra-market: We advised Exxon on its pending $86.4 billion merger with
         Mobil, the largest transaction ever announced; Corestates on its merger
         with First Union; and Thyssen on its merger with Krupp.

-        Cross-border: We advised British Petroleum on its $55 billion merger
         with Amoco, the largest cross-border deal ever, and AT&T on the pending
         merger of its international business with British Telecom.

-        Defense: We successfully advised Computer Sciences against a hostile
         bid by Computer Associates.

-        Privatization: We advised Telecom Italia on its $2.9 billion purchase
         of three subsidiaries of Telebras, one of Latin America's largest
         privatizations.

-        Restructurings: We advised Merck on restructuring its
         multibillion-dollar U.S. pharmaceutical joint venture with Astra AB and
         divestiture of its $2.6 billion interest in its pharmaceutical joint
         venture with DuPont, and advised Ford Motor on its $26.6 billion
         spin-off of Associates First Capital.

In 1997 revenues grew 25% over the previous year, reaching $768 million on
strong advances in advisory and underwriting. Expenses in 1997 rose to $712
million from $630 million in 1996. The increase was driven by higher
compensation and benefits arising from increased staff levels and a competitive
labor market.

EQUITIES

<TABLE>
<CAPTION>
SUMMARY OF EQUITIES RESULTS
----------------------------------------------------------------
<S>                                    <C>       <C>       <C> 
In millions                            1998      1997      1996
----------------------------------------------------------------
Total revenues ...................     $700      $465      $419
Total expenses ...................      757       693       534
----------------------------------------------------------------
Pretax income                           (57)     (228)     (115)
----------------------------------------------------------------
</TABLE>


Our Equities activities comprise underwriting, market making, research, equity
derivatives, and American depository receipt (ADR) services. We help clients
execute their strategies by raising equity capital in the public and private
markets and structure derivative transactions to provide hedges or enhanced
returns. As a market maker, we act as both principal and agent to facilitate
clients' transactions in exchange-listed and over-the-counter securities. Equity
research supports both underwriting and market making.

The Equities segment had record revenues in 1998, and we moved significantly
closer to our leadership and profitability objectives. Revenues were $700
million, an increase of 51% from $465 million in 1997. This performance reflects
excellent growth in cash and derivatives market making. Brokerage commissions
rose strongly as we increased market share on leading exchanges in the United
States and Europe. Revenues from derivatives activities reflect strong client
demand and improved results from managing positions.

Our momentum in Equities continued to accelerate in 1998, with strong market
share gains and lead management positions on some of the most significant
transactions of the year. Securities Data Co. ranked us sixth in U.S. equity
lead underwriting for 1998, up from 10th in 1997, with a market share of 5.6% in
1998, up from 2.9% in 1997. We were ranked third for European equity issuance by
Bondware.

During 1998 we were lead manager of the year's second-largest initial public
offering (IPO), the $6.4 billion offering for Swisscom; lead manager for the
largest "spot secondary" offering ever completed, the $1.1 billion offering for
Gillette; lead manager for the largest U.S. secondary offering of the year, the
$1.5 billion offering for 


22 Our business
<PAGE>   25


CIT Group; and lead manager for the first IPO of a small capitalization firm
following the market turmoil of the third quarter, EarthWeb. Global equity
research continues to grow in impact and prominence, gaining rank in a variety
of independent polls.

J.P. MORGAN U.S. EQUITY OFFERINGS VOLUME
In millions
----------------------------------------
[BAR CHART]

<TABLE>
<S>           <C>
1995           $1,194
1996           $1,307
1997           $3,494
1998           $6,013
</TABLE>

On page 23 of the annual report there is a bar chart depicting the total value
of the equity offerings on which the firm served as [an] underwriter, for 1995
to 1998.

Source: Securities Data Company, Inc.

Revenues from our Equities activities were $465 million in 1997, 11% ahead of
1996. Underwriting grew strongly, and equity commissions more than doubled on
increased volume and market share. Fourth quarter 1997 losses from managing
equity derivative positions during a period of significant market volatility
partially offset these increases.

Expenses grew 9% to $757 million in 1998, up from $693 million in 1997 and $534
million in 1996. This growth, which slowed significantly in 1998 as we reached
scale, reflects investment in people and technology to build our equities
capability. We made the technology investment largely to increase processing
efficiency and reduce unit costs for our secondary and derivatives capabilities.




FOREIGN EXCHANGE

<TABLE>
<CAPTION>
SUMMARY OF FOREIGN EXCHANGE RESULTS
----------------------------------------------------------------
<S>                                    <C>       <C>       <C> 
In millions                            1998      1997      1996
----------------------------------------------------------------
Total revenues ...................     $486      $465      $295
Total expenses ...................      290       309       299
----------------------------------------------------------------
Pretax income                           196       156        (4)
----------------------------------------------------------------
</TABLE>


The Foreign Exchange segment includes foreign exchange spot, short-term interest
rate instruments, and currency derivatives sales and trading. The segment also
includes commodities sales and trading, primarily in precious metals.
These services help our clients manage their currency and commodity exposures.

Revenues from Foreign Exchange rose 5% in 1998 to $486 million, up from $465
million in 1997. These record revenues resulted from strong client demand and
related trading in G-10 and emerging markets currencies. A significant portion
of the growth was generated from providing currency-related risk management
services in conjunction with investment banking assignments, as well as
increases in transaction volume and in the number of structured products
executed for clients. While the impact of reduced activity from the anticipation
of EMU was felt in the currency markets early in the year, we had prepared for
this by developing new revenue sources through an expanded capability in
emerging markets currencies and by centralizing our infrastructure.

These revenues were achieved with a lower cost base, as we increased margins
through operational efficiencies and productivity savings. Responding to the
changing dynamics of the currency markets, we are generating more business with
clients from fewer trading and processing locations globally. Expenses declined
in 1998 to $290 million, from $309 million in 1997 and $299 million in 1996.

Revenues from Foreign Exchange rose to $465 million in 1997 from $295 million in
1996. The significant increase reflects a 30% rise in client volume
year-over-year and strong results across all products.





                                                                 Our business 23
<PAGE>   26


INTEREST RATE MARKETS

SUMMARY OF INTEREST RATE MARKETS RESULTS

<TABLE>
<CAPTION>
---------------------------------------------------------------
In millions                            1998      1997      1996
---------------------------------------------------------------
<S>                                  <C>       <C>       <C>   
Total revenues ...................   $1 407    $1 146    $1 200
Total expenses ...................      847       870       878
---------------------------------------------------------------
Pretax income                           560       276       322
---------------------------------------------------------------
</TABLE>


This segment encompasses market making and risk management activities across
interest rate markets in developed countries globally. We act as a dealer of
government securities in all the G-10 government bond markets and underwrite and
make markets in U.S. government agency and municipal bonds. We provide swaps and
other interest rate derivatives and futures and options brokerage to help our
clients manage their longer-term exposures to interest rates and currencies. Our
activities are extensively diversified across geographic regions, client sectors
and products.

Total revenues of $1,407 million rose 23% from $1,146 million in the previous
year. Global leadership as a market maker in government securities and interest
rate derivatives fueled record profitability and client volumes in Interest Rate
Markets in 1998. Strong performance was primarily driven by the increased flow
of tailored risk management transactions for clients in Europe, the United
States, and Asia. Revenue growth in government securities reflects the flight to
the highest quality securities by investors in the third quarter as well as good
management of positions in the United States and Asia. Futures and options
experienced excellent growth in all regions resulting from market share gains,
as clients used these instruments to manage risk in volatile markets.

In these activities, we combine leading positions in key cash and derivatives
markets with sophisticated risk management skills and advanced risk management
technology to serve our clients. In 1998 we were ranked first in interest rate 
derivative products overall by Institutional Investor. In futures and options
brokerage we hold leading market share positions on the world's major financial
futures exchanges. The effective integration of these capabilities to solve
clients' risk management problems creates a competitive advantage, evidenced by
our strong global position with sophisticated institutional clients.

Expenses for 1998 were $847 million, compared with $870 million in 1997 and $878
million in 1996. The margin improvement reflects the completion of several
multiyear productivity initiatives, including systems improvements to reduce
transaction costs and the restructuring of our European office network.

Revenues in 1997 for Interest Rate Markets declined from $1,200 million in 1996,
mainly reflecting lower revenues from swaps and other derivatives. Strong volume
increases were more than offset by lower positioning gains.


CREDIT MARKETS

<TABLE>
<CAPTION>
SUMMARY OF CREDIT MARKETS RESULTS
-------------------------------------------------------------------
In millions                            1998      1997      1996
-------------------------------------------------------------------
<S>                                    <C>       <C>     <C>   
Total revenues ...................     $754      $982    $1 012
Total expenses ...................      822       817       653
-------------------------------------------------------------------
Pretax income                           (68)      165       359
-------------------------------------------------------------------
</TABLE>


Credit Markets provides underwriting, market making, and research related to
investment-grade, high-yield, and emerging market debt securities. We also act
as a dealer and market maker in the derivatives, currencies, and government
securities of emerging countries in Latin America, Eastern Europe, Asia, and
Africa. In addition, this segment includes global loan syndications, structured
finance, and credit derivatives activities.

Revenues for Credit Markets fell 23% to $754 million in 1998 as a result of the
volatile and illiquid market environment. The decline was concentrated in the
second half of the year as credit spreads widened and investors withdrew from
both emerging and developed markets following Russia's default in August. As a
result of the crisis we had $130 million of losses on Russian positions as well
as lower results in emerging market external debt trading. In addition,
corporate debt inventories in both the Americas and Europe declined
significantly in value, particularly in the third quarter of the year. For the
year as a whole, these declines were only partially offset by positive loan
syndication results, increases in corporate debt underwriting, and higher
earnings from local currency securities trading in Latin America, Eastern
Europe, and emerging Asia.





24 Our business
<PAGE>   27





We were one of a small number of global firms to remain committed to the
emerging markets during 1998, supporting our clients throughout the crisis. We
were again the leading trader of emerging market debt in 1998, with a market
share of 20%, according to data from the Emerging Market Traders Association. In
the developed markets we maintained leadership positions in investment grade
debt and syndicated loans. We ranked third in the domestic agent-only syndicated
loan league table and were named Euromoney's Best International Euro Bond House
of 1998, a critical platform for expansion into more profitable, higher growth
areas.

We continued to be the dominant dealer in the small but fast-growing credit
derivatives market, with a share of approximately 37%. Our objective is to
leverage this position into a significant increase in profitability as this
market develops. We were named Credit Derivatives House of 1998 by IFR. In
addition, Investment Dealers Digest named Morgan's BISTRO series Structured
Finance: Breakthrough Deal of the Year, evidence of our strength in using
innovation to benefit clients.

A further objective for Credit Markets is to gain market share in the profitable
high-yield bond market. We led 15 high-yield offerings for almost $4 billion in
volume in 1998. Notable lead-managed transactions included a $275 million senior
subordinated note offering for Bain Capital's $1.1 billion acquisition of
Domino's Inc. and Lyondell Chemical Company's $7 billion financing of its
acquisition of ARCO Chemical.

Expenses in 1998 were $822 million, essentially flat with 1997 despite
investments in several new offices. This reflects productivity improvements over
the year as well as selective expense reductions in the fourth quarter to align
our resource commitment with market opportunities. We entered 1999 with an
expanded global presence and broader product capabilities.

Revenues of $982 million in 1997 were down slightly from $1,012 million in 1996
as revenues from structured finance activities declined from a strong 1996.
Expenses increased $164 million in 1997 as we expanded our emerging markets
presence and increased investment in structured finance and credit derivatives
activities.

CREDIT PORTFOLIO

SUMMARY OF CREDIT PORTFOLIO RESULTS

<TABLE>
<CAPTION>
---------------------------------------------------------------
In millions                            1998      1997      1996
---------------------------------------------------------------
<S>                                    <C>       <C>       <C> 
Total revenues .....................   $350      $447      $536
Total expenses .....................    141       123       128
---------------------------------------------------------------
Pretax income                           209       324       408
---------------------------------------------------------------
</TABLE>


Credit Portfolio includes results from managing the firm's principal extensions
of credit, including loans, commitments to lend, standby letters of credit and
guarantees. In addition, this segment is responsible for managing the firm's
credit risk arising from both traditional credit activities and derivatives
trading activities. As part of this responsibility, Credit Portfolio is
compensated by other business segments, and its revenues are reduced by an
estimate of our portfolio's potential credit loss and any costs associated with
hedging the firm's credit risk. In connection with our derivatives activities,
credit revenues include fluctuations in the value of derivatives positions
related to changes in the credit quality of counterparties and other market
factors.

Credit Portfolio revenues declined to $350 million in 1998 from $447 million in
1997, a drop of 22%. The decline resulted from revenue reductions associated
with transforming our credit business and reducing our emerging markets credit
exposure, as discussed on page 18 in "Impact of our credit strategy." Included
in this segment are losses of $45 million from loan sales as well as fees and
hedging costs of approximately $65 million. The decline was exacerbated by the
widening of credit spreads in the second half of the year.

In 1998 Credit Portfolio expenses were $141 million, versus $123 million in
1997.

Revenues of $447 million in 1997 were down from $536 million in 1996, primarily
reflecting fourth quarter 1997 declines in the value of our swaps portfolio
associated with a deterioration in the credit quality of Asian counterparties,
particularly in South Korea and Thailand. Expenses in 1997 declined 4% from
1996.





                                                                 Our business 25
<PAGE>   28


ASSET MANAGEMENT AND SERVICING
--------------------------------------------------------------------------------

Our asset management services provide:

-        global asset management for pension plans, governments, endowments, and
         foundations

-        integrated financial services for high-net-worth individuals

-        with American Century, fully bundled services for defined contribution
         pension plans

-        mutual fund distribution to intermediaries

This sector also operates, under contract, the Euroclear System, the world's
largest clearance and settlement system for internationally traded securities.
We provide credit and deposit services to Euroclear participants.

SUMMARY OF ASSET MANAGEMENT AND SERVICING RESULTS
<TABLE>
<CAPTION>
----------------------------------------------------------------
In millions                            1998      1997      1996
----------------------------------------------------------------
<S>                                   <C>       <C>       <C>   
Total revenues ...................    $1 491    $1 384    $1 187
Total expenses ...................     1 261     1 235       934
----------------------------------------------------------------
Pretax income                            230       149       253
----------------------------------------------------------------
</TABLE>


This segment provides portfolio management across all asset classes and markets
to institutional and individual investors in both discretionary account and
mutual fund form. Portfolio management is supported by dedicated global research
capabilities.

We also offer high-net-worth clients an advice-based, integrated array of
financial services that include tax-advantaged asset structures; a wide range of
investment options, including managed portfolios and brokerage; and credit and
liquidity services. These capabilities form the foundation for selective
expansion into the growing market for personal financial services.

In January 1998 we completed our purchase of a 45% economic interest in American
Century Companies, the fifth-largest U.S. no-load direct distribution mutual
fund company. With this investment we have gained scale and expertise in the
technology and operations for distributing and servicing mutual funds, as well
as complementary investment capabilities that broaden our product offerings
significantly. With American Century, we are jointly pursuing the growing
retirement market, distribution of mutual funds to third parties such as
financial advisors, and other opportunities in integrated personal financial
services.

Building on our leadership in pension asset management, we continue to expand
our global channels for gathering assets. In Japan we entered into a joint
venture with Dai-Ichi Kangyo Bank to offer investment trusts (mutual funds) to
Japanese clients. In France we entered into an agreement with Banques Populaires
to offer international mutual funds through its branch network. We also
broadened our product offerings with a full range of real estate investment and
private equity capabilities.





26 Our business
<PAGE>   29


Asset Management and Servicing revenues grew 8% to $1,491 million, up from
$1,384 million in 1997, driven by 11% growth in both investment management fees
and revenues from Euroclear services. Assets under management for both private
and institutional clients grew 23% to $316 billion, from $257 billion in 1997,
reflecting net new business and market appreciation. This includes assets under
management in mutual funds, which grew approximately 60% in 1998 to $36 billion.

Results for 1998 reflect strong progress toward our strategic growth objectives
for Asset Management and Servicing. Our traditional asset-gathering channels for
institutional and high-net-worth clients continued to grow, with 25% and 17%
increases, respectively, in year-end assets under management. We increased our
focus on target markets, which prompted us to sell our Australian and French
institutional investment management businesses.

In addition, through our partnership with American Century, we are competing
with market leaders and have been awarded several significant new mandates to
provide bundled defined contribution services.

Firmwide, private clients accounted for approximately $670 million of revenues,
up 10% from the previous year. This growth reflects increases in assets under
management and strong growth in full-service brokerage services. While most
private client business revenues are reported in this segment, some are recorded
in others.

Sector revenues for 1997 were $1,384 million, up 17% over 1996 on strong growth
in business with both institutional and high-net-worth clients and higher
Euroclear-related revenues.

Expenses were $1,261 million in 1998, up only 2% from $1,235 million in 1997.
Expenses that year increased 32% over 1996 as we completed our investments in
core investment capabilities and diversification of asset gathering channels.

ASSETS UNDER MANAGEMENT
[BAR CHART]

In billions
-----------------------------------------------------------------------------
<TABLE>
<CAPTION>
                             1996           1997            1998
                             ----           ----            ----
<S>                         <C>            <C>             <C>
Institutional                $159           $197            $246
Private                      $ 49           $ 60            $ 70
-----------------------------------------------------------------------------
Total                        $208           $257            $316
</TABLE>

On page 27 of the annual report there is a stacked bar chart depicting the 
total value of assets under management by the firm's Asset Management and 
Servicing sector, for 1996 to 1998. The bars show a breakdown by institutional 
and private assets under management.

GLOBAL PORTFOLIO ALLOCATION BY ASSET CLASS
[BAR CHART]

In billions: December 31
-----------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                      Non-U.S.
                                U.S. Assets            Assets       Total
                                -----------           --------      -----
<S>                               <C>                  <C>          <C>
Total                              $239                 $77           316
Money market                       $ 35                 $ 3            38
Fixed income                       $ 93                 $24           117
Equity                             $101                 $50           151
Other                              $ 10                                10
-----------------------------------------------------------------------------
</TABLE>

On page 27 of the annual report there is a stacked bar chart depicting global 
portfolio allocation by asset class for the funds under management by the 
firm's Asset Management and Servicing sector, as of December 31, 1998. The bars 
show a breakdown by U.S. and non-U.S. assets.




                                                                 Our business 27
<PAGE>   30


PROPRIETARY INVESTMENTS
--------------------------------------------------------------------------------

Proprietary Investments complements the firm's client-focused activities. It
represents a diversified set of risk-taking activities ranging from short-term
trading risk to multiyear equity investment risk.


EQUITY INVESTMENTS

<TABLE>
<CAPTION>
SUMMARY OF EQUITY INVESTMENTS RESULTS
---------------------------------------------------------------
In millions                            1998      1997      1996
---------------------------------------------------------------
<S>                                    <C>       <C>       <C> 
Total revenues ...................     $335      $399      $270
Total expenses ...................       48        47        41
---------------------------------------------------------------
Pretax income                           287       352       229
---------------------------------------------------------------
</TABLE>


Equity Investments invests the firm's capital in private equity investments
worldwide, seeking significant capital appreciation. Professionals in the group
actively leverage our global network and client relationships. This inter-
action generates unique investment opportunities. We invest in private equity
and equity-related securities in leveraged and unleveraged acquisitions,
privatizations, recapitalizations, rapidly growing companies, expansion
financings, turnaround situations, and other special equity situations. On
average, we hold investments three to five years and typically exit through a
public offering of securities or a sale of the company.

Revenues for Equity Investments for 1998 were $335 million, down from $399
million in 1997. This included gains net of write-downs of $316 million on
investments that included Mid-Ocean Limited, Travelers Property Casualty Corp.,
and the U.K. company Virgin Rail. Write-downs of $100 million related mostly to
emerging markets portfolio companies.

We continued to strengthen our position as a leading global private equity
investor in 1998. We committed over $460 million to 36 companies, reflecting
strong deal flow generated largely through the J.P. Morgan network. We committed
funds primarily to companies in the telecommunications, retail, consumer
products, health care, and financial services industries. Over half of our
investments were made outside the United States, where we continue to see more
attractive investment opportunities.


Notable 1998 investments included:

-        $47.5 million investment for a 17.9% interest in both Corfuerte, S.A.
         de C.V., and Authentic Acquisition Corporation, the Mexican and U.S.
         branded food products subsidiaries of DESC, S.A. de C.V.

-        $26.5 million investment for a 7.4% interest in Domino's Pizza, the
         second-largest, privately held restaurant chain in the world

-        $20.9 million investment for a 6.4% interest in AEA International, a
         leading provider of specialized international health care services to
         multinational corporations

At year-end, our $1.1 billion portfolio, at cost, comprised 100 investments
diversified by industry and geographic region.

Revenues in 1997 were $399 million and consisted primarily of sales of
investments in the insurance and telecommunications industries, up from $270
million in 1996.

EQUITY INVESTMENTS GEOGRAPHIC BREAKDOWN - [BAR CHART]
<TABLE>
<CAPTION>
                         
In millions, cost basis    Investments made prior to 1998    Investments in 1998        Total
---------------------------------------------------------------------------------------------
<S>                      <C>                              <C>                       <C>
Asia                                $ 31                            $ 48                $ 79
---------------------------------------------------------------------------------------------
North America                       $503                            $168                $671
---------------------------------------------------------------------------------------------
Europe                               $57                             $80                $137
---------------------------------------------------------------------------------------------
Latin America                       $121                            $ 83                $204
---------------------------------------------------------------------------------------------
</TABLE>

On page 28 of the annual report there is a stacked bar chart depicting
J.P. Morgan's Equity investments, on a cost basis, by geographical region.

EQUITY INVESTMENTS PORTFOLIO AT YEAR-END - [BAR CHART]
<TABLE>
<CAPTION>
                                                               Investment made
In millions, cost basis    Investments made for the year        in prior years        Total
---------------------------------------------------------------------------------------------
<S>                      <C>                              <C>                     <C>
1996...................             $356                            $486              $  842
---------------------------------------------------------------------------------------------
1997...................             $278                            $509              $  787
---------------------------------------------------------------------------------------------
1998...................             $379                            $712              $1 091
---------------------------------------------------------------------------------------------
</TABLE>

On page 28 of the annual report there is a stacked bar chart depicting
J.P. Morgan's Equity investments, on a cost basis, at 1996, 1997 and 1998.



                









28 Our business
<PAGE>   31
PROPRIETARY INVESTING AND TRADING

<TABLE>
<CAPTION>
SUMMARY OF PROPRIETARY INVESTING & TRADING RESULTS
---------------------------------------------------------------
In millions                            1998      1997      1996
---------------------------------------------------------------
<S>                                    <C>       <C>       <C> 
Total revenues .....................   $706      $895      $934
Total expenses .....................    153       154       186
---------------------------------------------------------------
Pretax income                           553       741       748
---------------------------------------------------------------
Total return revenues                   467       657       624
---------------------------------------------------------------
</TABLE>


The Proprietary Investing and Trading segment takes market and credit risk
positions for our own account. In addition to the activities of our dedicated
proprietary positioning group, this segment also includes the following
separately managed investments: a proprietary emerging markets portfolio, a
credit investment securities portfolio, and our investment in Long-Term Capital
Management, L.P. Experienced market professionals across several segments manage
these investments, employing many currencies and types of instruments, including
fixed income securities, foreign exchange, equity securities, commodity
products, and related derivatives.

Positions may be held for various lengths of time, depending on the strategy and
actual market performance. Longer-term investments are made in government,
mortgage-backed, and corporate debt securities.

This segment also manages the firm's liquidity and capital profile to ensure
that we have access to funding at a reasonable cost, under all market
conditions, to support all the firm's business activities.

Reported revenues from Proprietary Investing and Trading were $706 million in
1998, a decline of 21% from $895 million the previous year. Revenues from our
credit investment securities portfolio were a loss of $129 million in 1998,
compared to a gain of $45 million in 1997. Results were driven by $150 million
of losses from sales and impairment write-downs of investment securities, in
connection with the reductions in our portfolio of emerging Asia investments
(see "Impact of our credit strategy" in "Overview," page 18). Revenue from our
proprietary emerging market portfolio amounted to a loss of $80 million in 1998,
compared with a gain of $22 million in 1997, reflecting losses on illiquid
positions. Offsetting these losses were gains in our proprietary positioning
group.

Total return revenues, which combine reported revenues and the change in net
unrealized appreciation is the more meaningful measure of performance for this
segment. Total return revenues were $467 million in 1998, compared with $657
million in 1997. This decline reflects decreases in the value of U.S. government
agency securities.

Reported revenues were $895 million in 1997, down from $934 million in 1996
mainly due to lower net interest revenues from risk-adjusting swaps. Total
return revenues for 1997 were $657 million, compared with $624 million in 1996,
as gains in the proprietary positioning group were offset by declines in our
credit investment securities portfolio, primarily in Asia.





                                                                 Our business 29
<PAGE>   32


CORPORATE ITEMS
--------------------------------------------------------------------------------


<TABLE>
<CAPTION>
SUMMARY OF CORPORATE ITEMS RESULTS
--------------------------------------------------------------------------------
In millions                             1998              1997             1996
--------------------------------------------------------------------------------
<S>                                     <C>               <C>              <C>  
Total revenues .............            $(275)            $ 269            $ 388
Total expenses .............              497               106              240
--------------------------------------------------------------------------------
Pretax income                            (772)              163              148
--------------------------------------------------------------------------------
</TABLE>


Corporate Items revenues of negative $275 million declined $544 million from
1997. We classify Corporate Items revenue into three broad categories:

-        Recurring items not allocated to the segments include such items as:
         provisions for credit losses, unallocated net interest revenue, results
         of hedging anticipated net foreign currency revenues and expenses
         across all business segments, corporate-owned life insurance, and
         certain equity earnings of affiliates. These revenues declined $432
         million in 1998, primarily due to a $176 million decline in hedging
         results and $100 million related to provisions for credit losses and
         other valuation adjustments.

-        Nonrecurring items not allocated to the segments include gains on sales
         of businesses, revenues associated with businesses that have been sold
         or discontinued, and other one time corporate revenue items. These
         revenues increased $124 million over last year, largely because of 1998
         gains on the sales of our global trust and agency services and our
         Australian institutional asset management businesses, totaling $187
         million.

-        Consolidation and management reporting offsets comprise offsets to
         certain revenues recorded in the business segments, including the
         allocation of earnings on equity out of corporate items and into
         business segments, adjustments to bring business segments to a
         tax-equivalent basis, and a number of eliminations and other management
         accounting adjustments. These revenues decreased $236 million in 1998
         from 1997. The primary driver was a decline of $175 million in earnings
         on equity retained in Corporate Items. More of the firm's capital was
         allocated to the business segments in 1998 than in the previous year as
         a result of increased market volatility and risk levels, particularly
         in the second half of 1998.

Corporate Items expenses increased $391 million in 1998 over 1997. Expenses grew
in 1998 because of the special charges taken in the first and fourth quarters in
connection with expense reduction initiatives, which totaled $358 million across
all segments.

Corporate Items revenues in 1997 were $269 million, down from $388 million in
1996. This decline was primarily due to a decrease in revenues related to
custody and cash processing activities that were sold or discontinued in 1996
and a one time gain of $77 million in 1996 related to the partial sale of a
minority investment.

Expenses of $106 million in 1997 declined from $240 million in 1996, mainly
reflecting lower expenses from sold or discontinued businesses.


30 Our business
<PAGE>   33



RESULTS OF OPERATIONS

COMPONENTS OF REVENUE
--------------------------------------------------------------------------------

This section describes changes in the revenue components that appear in the
"Consolidated statement of income." Each component of revenue is generated in
one or more business activities and is therefore influenced by the market
factors relating to those activities.


NET INTEREST REVENUE

Net interest revenue is the difference between interest revenue and interest
expense generated across our business activities. It is affected by changes in
interest rates, funding strategies, and the relative proportion and composition
of our interest-bearing and noninterest-bearing assets, liabilities, capital,
and off-balance-sheet instruments. Provisions for loan losses are included in
this caption.

Net interest revenue of $1,171 million in 1998 included a $110 million provision
for loan losses. The provision was deemed necessary to maintain the appropriate
allowance level for probable losses existing in our loan portfolio in light of
charge-offs on emerging Asia exposures. Excluding the provision, net interest
revenue decreased 32% to $1,281 million from 1997, primarily reflecting lower
net interest revenue from our interest rate markets and proprietary investing
activities. The decrease was partially offset by increases related to our
equities securities borrowing activities, local market positions in Eastern
Europe, and higher Euroclear-related deposits.

In 1997 net interest revenue increased 10% to $1,872 million from 1996. The
increase was due to our market making activities, particularly from local market
positions in Eastern Europe and Asia. Also contributing were higher
Euroclear-related deposits. These increases were partially offset by declines
related to proprietary investing positions.

TRADING REVENUE

Trading revenue represents the daily change in the fair value of our
trading-related assets and liabilities. We generate trading revenue
predominantly from market making activities included in the Global Finance
sector as well as activities in the Proprietary Investments sector.

Trading revenue captures only a portion of the total revenues generated by our
activities and excludes other important related sources of revenue, including
net interest revenue and fees and commissions. As a result, it does not reflect
the integrated nature of our activities.

Total trading revenue was $2,362 million in 1998, an increase of 11% from $2,137
in 1997. Sharp increases in trading revenue from swaps and government and agency
securities drove the rise. Also contributing to the increase were higher foreign
exchange trading revenues, which saw strong client demand in emerging market and
G-7 currencies, stronger results in equity derivatives, and strong results in
proprietary trading, particularly activities in Europe and Asia. Offsetting the
increases were losses in emerging markets, largely related to Russian trading
account positions, losses in corporate debt securities, and lower results in
precious metals.

In 1997 trading revenue fell by 14% from $2,477 million in 1996. Strong
increases in foreign exchange revenue, reflecting higher client demand across
products, were offset by declines in most other market making activities. In
particular, equities trading revenue declined significantly, mainly due to
losses from managing equity derivative positions during the fourth quarter of
1997. Sharp decreases in trading revenues from local market activities and
external debt trading in emerging markets also contributed to the decline.





                                                        Results of operations 31
<PAGE>   34


INVESTMENT BANKING REVENUE

We earn investment banking revenue by providing clients with financial advice
and execution, and by raising capital through equity and debt underwritings and
loan syndications. Investment banking revenue is reported in many of our
segments, most significantly Investment Banking, Equities, and Credit Markets.

Investment banking revenue grew 25% in 1998 to a record $1,401 million as we
continued to capture market share globally in mergers and acquisitions and
benefited from increased global investment banking activity. Advisory and
syndication fees rose 30% to $830 million, reflecting the robust demand for
investment banking services, particularly in the Americas and Europe, and a
broadening client base. Underwriting revenue increased 17% to $571 million as we
continued to raise more debt and equity for a broad range of clients.

In 1997 investment banking revenue increased 22% to $1,123 million, driven by
market share gains and strong global investment banking activity. Advisory and
syndication fees rose 12% to $637 million, buoyed by higher merger and
acquisition activity. Underwriting revenue increased 38% to $486 million on
market share gains in robust markets for debt and equity.


INVESTMENT MANAGEMENT REVENUE

We earn investment management revenue by providing investment services to
institutional and private clients. This revenue includes fees from administering
trusts and estates. Most investment management revenue is reported in the Asset
Management and Servicing sector. In 1998 investment management revenue rose 11%
to $881 million, driven by a 23% growth in assets under management to $316
billion. The increase in assets under management reflected net new business and
market appreciation. The 1998 result excludes investment management revenue from
defined contribution activities, which were transferred to a new joint venture
with American Century. Our share of the net results of this venture (revenues
less expenses) is reported in Other revenue. Including fees earned on defined
contribution assets, investment management revenue would have increased 16% in
1998, to $915 million.

In 1997 investment management revenue rose 17% to $792 million. This increase
reflects growth in assets under management, due to new business from
institutional and private clients as well as market appreciation. Assets under
management increased 24% to $257 billion.

FEES AND COMMISSIONS

We earn fees and commissions by providing operational and credit-related
services to clients. Operational services include brokerage for futures and
options and equity securities, securities custody and clearing, and cash
management services. These services are included in the Interest Rate Markets
and Equities segments as well as in our Asset Management and Servicing sector.
Credit-related services include commitments to extend credit, standby letters of
credit and guarantees, which are included in the Credit Portfolio segment, and
securities lending indemnifications, which are primarily included in the Asset
Management and Servicing sector.

Fees and commissions were $748 million, $647 million, and $582 million in 1998,
1997, and 1996, respectively. Included in 1996 was $45 million related to sold
or discontinued custody and cash processing businesses.

Fees and commissions increased 16% in 1998, primarily owing to higher equities
brokerage commissions - reflecting increased market share and volumes on U.S.
and European exchanges - and strong futures and options brokerage results. These
increases were partially offset by $65 million in credit derivative fees paid as
part of our credit strategy and exposure reduction initiatives.

Excluding the revenue from exited custody and cash processing businesses, fees
and commissions increased 20% in 1997. The increase was driven mostly by growth
in commissions in equity brokerage, reflecting higher market share and volume
gains on U.S. and European stock exchanges.





32 Results of operations
<PAGE>   35


INVESTMENT SECURITIES REVENUE

Investment securities revenue includes gains and losses on debt and equity
investment securities, other-than-temporary impairments in value, and related
dividend income. The majority of investment securities revenue is recorded in
the Proprietary Investments sector.

Investment securities revenue was $205 million in 1998 and largely reflected net
gains of $316 million from the sale of equity investments (including securities
of Small Business Investment Companies). These equity-related gains came
primarily from sales of certain equity investments in the insurance industry,
and were partially offset by impairment write-downs of $100 million, mostly
related to emerging markets portfolio companies. We also realized net losses of
$140 million on debt investment securities, primarily related to emerging Asia.

Investment securities revenue of $409 million in 1997 included equity gains of
$366 million, primarily from sales of insurance and telecommunications industry
investments.

In 1996 net gains on equity investments of $269 million, mostly related to a
health care industry investment, contributed to investment securities revenue of
$303 million.

OTHER REVENUE

This category includes gains and losses on hedges of anticipated foreign
currency revenues and expenses. These gains and losses are partially offset by
the impact of exchange rate movements on reported revenues and expenses over the
year. This category also includes our share of income or loss on investments
carried under the equity method of accounting, including our investments in
American Century Companies and Long-Term Capital Management, L.P.; the
amortization of goodwill related to our equity method investments; provisions
related to the allowance for credit losses on off-balance-sheet instruments;
gains or losses on loan sales; and other miscellaneous transactions.

Other revenue of $187 million in 1998 includes a negative provision (income) of
$60 million related to a decrease in our allowance for credit losses on
off-balance-sheet instruments; net pretax gains of $131 million and $56 million
on the sales of our global trust and agency services business and Australian
investment management business, respectively; earnings from equity in affiliates
(excluding American Century) of $44 million; and losses of $56 million on hedges
of anticipated foreign currency revenues and expenses. The impact of our
investment in American Century, including related goodwill amortization, was not
significant.

In 1997 Other revenue of $240 million included approximately $120 million of
gains on hedges of anticipated foreign currency revenues and expenses. It also
included $40 million of earnings from equity in affiliates.

For 1996 Other revenue was $195 million and included a gain of $77 million from
the partial sale of a minority investment, $52 million of gains on hedges of
anticipated foreign currency revenues and expenses, and $25 million of earnings
from equity in affiliates.





                                                        Results of operations 33
<PAGE>   36
OPERATING EXPENSES

---------------------------------------------------------------
In millions(a)
---------------------------------------------------------------
[BAR CHART]
<TABLE>
<CAPTION>
                         1996           1997           1998
                         ----           ----           ----
<S>                      <C>            <C>            <C>
Employee compensation
 and benefits            $2 884         $3 027         $2 992
Noncompensation costs    $1 568         $2 039         $2 188
---------------------------------------------------------------
Total                     4 452          5 006          5 180
</TABLE>


On page 34 there is a stacked bar chart depicting the firm's operating expenses
for 1996 to 1998. The bars show a breakdown by employee compensation and
benefits and noncompensation costs before special charges.

(a) Excluding special charges of $71 million and $358 million for the years
ended December 31, 1996 and 1998, respectively.



Our principal recurring operating expense components are employee compensation
and benefits, technology and communications, occupancy, and other expenses.
Compensation expense, which includes salaries and benefits, is closely related
to staffing levels and the mix of our employee population. It also includes
incentive compensation, which varies significantly with operating earnings.

Before special charges of $358 million, operating expenses for 1998 were
$5,180 million, up 2% over 1997. The increase was due primarily to costs for
preparing our systems for the year 2000 and economic and monetary union in
Europe (EMU), which totalled $205 million in 1998, up from $96 million in 1997.
The increase also reflected continued spending on client-focused activities,
principally in Equities, which was partially offset by lower incentive
compensation in line with lower earnings.

The total cost of year 2000 compliance is estimated at $300 million. This covers
internal systems renovation and testing, testing equipment, contingency
planning, and internal and external project staffing. We expect to incur most of
the remaining $75 million of year 2000 costs in 1999. EMU preparation was
substantially completed in the fourth quarter of 1998. For further information
on the year 2000 initiative, see the section "Operating risk" in "Risk
management."

We incurred special charges of $215 million and $143 million in the first and
fourth quarters of 1998, respectively, related to the restructuring of business
activities and other productivity initiatives. These charges included
$241 million in severance costs in connection with staff reductions of
approximately 1,700, $112 million in real estate costs primarily related to
consolidating several European locations, and $5 million in equipment
write-downs. They related to cost reduction programs that are expected to
generate annualized savings of $410 million, approximately $175 million of which
were achieved in 1998. Refer to note 3 of our consolidated financial statements,
"Restructuring of business activities," for more information.

We continue to maintain a sharp focus and discipline in our spending. Our target
is to reduce total expenses before incentive compensation by $400 million in
1999 compared with 1998. In addition to actions we took in 1998, more than 300
projects to improve productivity are under way throughout the firm. They include
the creation of a shared service center for the execution of financial and
operational functions supporting the markets activities, the reengineering of
various processes and service support models in each business area with the goal
of streamlining the way we deliver services to our clients, as well as a
reduction in the number of technology products we support. The $400 million
target does not reflect the adoption of new accounting guidance, which will
require capitalization of certain software costs (estimated at $130 million in
1999, net of expected amortization) that were previously expensed as incurred in
Technology and communications expenses. Refer to note 2, "Accounting changes and
developments," as well as page 47, "Forward-looking statements," regarding
information contained in this paragraph.

In 1997 total operating expenses grew 14% to $5,066 million, up from $4,452
million before a special charge in 1996, primarily reflecting targeted spending
to expand our asset management and investment banking capabilities, as well as
to capitalize on our leadership position in markets activities.

Our total number of employees was 15,674, 16,943, and 15,527 as of December 31,
1998, 1997, and 1996, respectively. The decrease in staff in 1998 reflects the
productivity efforts discussed previously, and was partially offset by
additions, particularly in the Asset Management and Servicing sector.



34 Results of operations
<PAGE>   37


EMPLOYEE COMPENSATION AND BENEFITS

Employee compensation and benefits is our largest cost of doing business;
recruiting and retaining a highly skilled, diverse workforce is critical for us
to compete successfully. We compensate employees based on both their performance
and the firm's performance. A large component of total pay is in the form of
incentive compensation, which increases as a proportion of total pay for our
most highly compensated individuals. In addition, for highly compensated
employees, a significant proportion of incentive compensation is in the form of
stock bonus or restricted stock, aligning their compensation with longer-term
shareholder returns.

In 1998 employee compensation and benefits totaled $2,992 million before
severance costs of $241 million. This decline of 1% from 1997 reflects lower
incentive compensation accruals partially offset by higher salaries.

Employee compensation and benefits expense increased 5% in 1997 to 
$3,027 million, from $2,884 million in 1996, driven by increased salaries 
related to higher staff levels in our client-focused business, more competitive 
market conditions, and staffing for various technology initiatives, including 
year 2000 compliance.


TECHNOLOGY AND COMMUNICATIONS EXPENSES

Technology and communications expenses are our second-largest cost of doing
business. A strong and efficient technology infrastructure is key to maintaining
our competitive advantage in the global financial markets. In addition to
equipment and software costs, these expenses include fees paid to the Pinnacle
Alliance (the "Alliance"), which was formed in July 1996 to manage parts of our
technology infrastructure, and other consulting and outsourcing arrangements.

Technology and communications expenses before special charges of $5 million rose
16% to $1,187 million in 1998, up from $1,025 million in 1997. This increase is
due to costs associated with our preparation for year 2000 and EMU, along with
higher spending on key technology initiatives, as described next in "Total
information technology spending." The 1997 figure was up from $785 million in
1996; the 1996 figure included a $71 million special charge related to the
formation of the Alliance. The increase was due to key initiatives, higher
levels of business activity, and a full year of payments to the Alliance.

TOTAL INFORMATION TECHNOLOGY SPENDING

Total information technology (IT) spending includes technology and
communications expense and other technology-related costs, mainly employee
compensation and benefits. Total IT spending was $1,610 million in 1998, up 18%
from $1,370 in 1997 and $1,045 million in 1996, excluding the special charge.
The increase in total IT spending in 1998 was driven largely by the following
key initiatives:

-        meeting technology demands for the year 2000 compliance and EMU

-        enhancing our risk management capabilities

-        increasing efficiency through system upgrades and infrastructure
         standardization across our activities

This higher spending reflects the momentum of our initiatives as projects
progress through the development cycle.


NET OCCUPANCY

Net occupancy expenses include rent, real estate taxes, utilities, depreciation,
insurance, and other costs related to properties we own and lease worldwide.

Net occupancy expenses before special charges were $325 million in 1998,
compared with $333 million in 1997. Higher net rental expense and depreciation
in the current year was more than offset by a $28 million charge incurred in
1997 in connection with the renovation of New York office space. Special charges
were $112 million in 1998. In 1997 net occupancy expenses increased 13% over
1996 to $333 million, largely because of the $28 million renovation charge.


OTHER EXPENSES

Other expenses include travel, professional fees, outside services, certain
brokerage fees, taxes (other than income taxes), and training fees.

In 1998 other expenses were essentially unchanged at $676 million, compared with
$681 million in 1997. Other expenses increased 22% in 1997 over 1996, reflecting
higher travel-related expenses resulting from greater levels of client-focused
activity, higher professional fees, and higher outside service fees.


INCOME TAXES

Income taxes were $454 million in 1998, $689 million in 1997, and $758 million
in 1996. The decreases were due primarily to lower pretax income. The effective
tax rate was 32.0% in 1998, 32.0% in 1997, and 32.5% in 1996.




                                                        Results of operations 35
<PAGE>   38


BALANCE SHEET REVIEW



<TABLE>
<CAPTION>
TRADING-RELATED ASSETS AND LIABILITIES
--------------------------------------------------------------------------------
In billions: average balances          1998      1997      1996
--------------------------------------------------------------------------------
TRADING-RELATED ASSETS:
<S>                                    <C>       <C>       <C>   
Trading account assets ............    $125.1    $106.4    $ 77.9
Securities purchased under
 agreements to resell and
 federal funds sold ...............      38.9      40.4      43.1
Securities borrowed ...............      40.7      36.3      25.3
--------------------------------------------------------------------------------
Total .............................     204.7     183.1     146.3
PERCENTAGE OF TOTAL
  AVERAGE ASSETS ..................        72%       72%       68%
--------------------------------------------------------------------------------
TRADING-RELATED LIABILITIES:
Trading account liabilities .......      77.4      65.7      49.1
Securities sold under
  agreements to repurchase
  and federal funds purchased .....      70.5      67.1      63.4
--------------------------------------------------------------------------------
TOTAL .............................     147.9     132.8     112.5
PERCENTAGE OF TOTAL
  AVERAGE LIABILITIES .............        54%       55%       55%
--------------------------------------------------------------------------------
</TABLE>


Trading-related assets and liabilities, which represent the majority of our
balance sheet, have increased over the last three years, reflecting growth in
our client-focused market making activities. The amount of these assets and
liabilities held fluctuates daily according to client needs and market
movements.


TRADING ACCOUNT ASSETS AND LIABILITIES

Trading account assets and liabilities consist predominantly of cash securities
and derivative receivables and payables (unrealized gains or losses).

Cash securities include U.S. Treasury, U.S. government agency, foreign
government securities, and corporate debt and equity securities. Our cash
securities inventories have increased over the past three years, primarily
reflecting growth in our market making activities.

Derivatives, in general, are contracts or agreements whose values are derived
from changes in interest rates, foreign exchange rates, prices of securities, or
financial or commodity indices. We carry derivatives used in our trading
activities at fair value and record the unrealized gain or loss (the positive or
negative fair value) in trading account assets or liabilities on the balance
sheet; any changes in the value of our trading derivatives are recorded in
Trading revenue on our "Consolidated statement of income." Derivatives are often
referred to as off-balance-sheet financial instruments because the notional
amounts of their contracts are not recorded on the balance sheet; however, the
unrealized gains or losses on trading derivatives are recorded on the balance
sheet.

We are a global leader in structuring and trading a broad range of
derivatives transactions for our clients as part of their risk management,
capital raising, and investment activities. Our competitive advantages in
derivatives are our strong client relationships, backed by global structuring
and distribution capabilities; sophisticated research and technological support;
our strong capital base; and our integrated approach to these activities. In our
trading activities, we act as a dealer in derivative instruments to help clients
manage exposure to interest rates, foreign exchange rates, prices of securities,
and financial or commodity indices. We also assume trading positions based on
our market expectations and to benefit from price differentials between
instruments and markets. In addition, we use derivatives to manage risks
associated with our credit, investing, and funding strategies, as discussed in
the following sections. Refer to note 11, "Derivatives," for more information on
our use of derivatives.

Like cash instruments, derivatives are subject to market and credit risk. We
evaluate derivative risk in much the same way as risks associated with cash
instruments. Refer to "Risk management" for more information on how we manage
these risks. Unlike cash instruments, however, where credit exposure is
generally represented by the notional or principal value, the credit exposure
associated with derivatives is generally a fraction of the notional value of the
instrument and is represented by the derivative instrument's unrealized gain
reported on the balance sheet at a point in time. The on-balance-sheet credit
exposure of derivatives will therefore fluctuate with market movements,
sometimes significantly, depending on the nature of the exposure.

The following table provides the aggregate notional amounts and on-balance-sheet
credit exposure for each derivative instrument category in our trading
activities. The on-balance-sheet credit exposure amounts take into consideration
the benefit of master netting agreements.


36 Balance sheet review
<PAGE>   39
Overall, the increase in on-balance-sheet exposure and notionals since 1996
reflects growth in our client-focused market making activities. The growth of
on-balance-sheet exposure has been reduced by the greater use of master netting
agreements in recent years. The benefit of master netting agreements was $107.6
billion, $63.1 billion, and $36.5 billion at December 31, 1998, 1997, and 1996,
respectively.


TRADING DERIVATIVES: NOTIONAL AND CREDIT EXPOSURE

<TABLE>
<CAPTION>
                                                              1998                          1997                           1996
                                        ---------------------------------------------------------------------------------------
                                                  On-balance-sheet              On-balance-sheet               On-balance-sheet
                                                            credit                        credit                         credit
In billions: December 31                Notional          exposure    Notional          exposure    Notional           exposure
-------------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>       <C>                 <C>       <C>                 <C>           <C>
Interest rate, currency,                                                                                                       
 credit default and related swaps ...   $3 796.2          $   19.5    $2 479.4          $   19.7    $1 858.0               $11.3
 Foreign exchange spot,                                                                                                          
 forward, and futures contracts ......     565.4               4.1       670.6               5.7       583.3                 2.5
 Interest rate futures,
 forward rate agreements, and                                                                                                   
 debt securities forwards ............   1 458.3               0.3       869.4               0.3       524.8                 0.4
Commodity and equity swaps,
 forward, and futures                                                                                                           
   contracts .........................      86.0               3.3        92.4               2.9        77.2                 2.8
Purchased option contracts ...........   1 291.5              20.9       768.9              12.4       614.8                 8.5
Written option contracts .............   1 544.0                --     1 005.9                --       713.0                  --
--------------------------------------------------------------------------------------------------------------------------------
Total                                    8 741.4              48.1     5 886.6              41.0     4 371.1                25.5
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Amounts in the above table do not reflect the benefit of collateral. We actively
use collateral to reduce credit exposure in our derivative activities. Of the
$48.1 billion of on-balance-sheet credit exposure (net derivative receivables)
at December 31, 1998, approximately $9 billion was collateralized by highly
rated liquid securities (U.S. government securities) and cash. Approximately 80%
of all net derivative receivables to non-investment-grade counterparties was
secured.

The following table shows the estimated percentages of the on-balance-sheet
credit exposure of our derivatives after master netting agreements by
counterparty credit rating, based on our internal credit ratings. The
percentages do not take into consideration collateral. Our ratings of AAA, AA,
A, and BBB represent investment-grade ratings. Ratings of BB and below represent
non-investment-grade ratings. These ratings are analogous to those of public
rating agencies in the United States.

DERIVATIVE COUNTERPARTY CREDIT RATINGS

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
Percentage at December 31                                                   1998
--------------------------------------------------------------------------------
<S>                                                                         <C>
AAA, AA ..................................................................   52%
A ........................................................................   32
BBB ......................................................................   11
BB and below .............................................................    5
--------------------------------------------------------------------------------
Total                                                                       100
--------------------------------------------------------------------------------
</TABLE>

OTHER TRADING-RELATED ASSETS AND LIABILITIES

We use securities purchased under agreements to resell (resale agreements) and
securities borrowed as short-term financing tools to provide liquidity for
trading clients and to facilitate deliveries to customers. We use securities
sold under agreements to repurchase (repurchase agreements) as short-term
financing for trading-related positions and as one source of financing for our
debt investment securities portfolio.


DEBT INVESTMENT SECURITIES


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions: December 31                           1998        1997        1996
--------------------------------------------------------------------------------
<S>                                              <C>         <C>         <C>   
Fair and carrying value .......................  $36 232     $22 768     $24 865
--------------------------------------------------------------------------------
</TABLE>

We hold debt investment securities to maximize total return. Our debt investment
securities portfolio includes U.S. Treasury and other U.S. government agency
securities, U.S. state and political subdivision securities, non-U.S. government
securities, and U.S. and non-U.S. corporate and bank debt securities. This
portfolio is classified as available-for-sale, with securities carried at fair
value on the balance sheet and unrealized gains and losses reported as a net
amount within the stockholders' equity account, Net unrealized gains on
investment securities, net of taxes. We use derivatives to hedge exposure to
interest rate and currency fluctuations in managing this portfolio. Refer to
note 9, "Investment securities," and note 11, "Derivatives," for more
information.

The increase in debt investment securities in 1998 reflects higher positions in
U.S. government agency securities; these securities accounted for approximately
90% of the portfolio. Amounts issued by non-U.S. governments and corporations
were approximately 2% at year-end 1998, down from 11% at December 31, 1997, and
16% at December 31, 1996.


                                                       Balance sheet review   37
<PAGE>   40
CREDIT-RELATED PRODUCTS

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                           Commit-       Standby     Securities
                                          ments to    letters of        lending
                                            extend    credit and     indemnifi-
In billions: December 31         Loans      credit    guarantees     cations(a)
--------------------------------------------------------------------------------
<S>                              <C>      <C>         <C>            <C> 
Within one year ..............   $ 9.9       $32.4         $ 7.7           $4.1
After one year                                                          
   but within five ...........    12.5        44.0           7.5             --
More than five years .........     3.1         7.1           0.7             --
--------------------------------------------------------------------------------
Total 1998 ...................    25.5        83.5          15.9            4.1
Total 1997 ...................    31.6        80.4          15.8            5.3
Total 1996 ...................    28.1        64.7          13.9            5.5
--------------------------------------------------------------------------------
</TABLE>
                                                                
(a) At December 31, 1998, 1997, and 1996, we held cash and other collateral in
full support of securities lending indemnifications.


Loans

We diversify our loan portfolio by borrower, industry, and geographic area. For
the past three years, our loan portfolio consisted mainly of shorter-term loans.
At December 31, 1998, nearly 40% of loans were set to mature within one year and
88% within five years. More than 80% of our loans are based on a floating
interest rate.


Commitments to extend credit

Commitments to extend credit are off-balance-sheet conditional contracts to lend
money to a client in the future under specific terms. The increase in our
commitments during the past three years was primarily a result of our continued
support of clients' commercial paper programs as well as growth in syndicated
lending. Nearly 40% of all commitments mature within one year and 91% within
five years.


Standby letters of credit and guarantees

Standby letters of credit and guarantees are off-balance-sheet unconditional
contracts issued to support clients' obligations to third parties, who are the
beneficiaries. We pay the beneficiary on demand if a client does not meet a
contractual obligation. The client is required to reimburse us for any payments
we make in connection with the standbys or guarantees. Nearly 50% of all standby
letters of credit and guarantees mature within one year and 95% mature within
five years.


Securities lending indemnifications

Securities lending indemnifications are off-balance-sheet contracts in which we
guarantee that a third-party lender of securities will be protected if the
borrower defaults or refuses to meet its obligation. We act as the lender's
agent and receive collateral from the borrower - in the form of cash,
securities, or letters of credit - equal to the market value of the securities
borrowed plus a margin. Securities borrowers are mainly nonbank financial
institutions. On average, securities are lent for less than 30 days. We provide
securities lending indemnifications primarily as part of our role in Euroclear.

The maximum credit risk for the above credit-related products is measured by
their contractual amounts. For example, the risk of a loan is the amount of
money lent to the client. For off-balance-sheet credit-related instruments, the
risk is the amount that would be owed should the contract be drawn upon, the
client default, and the collateral become worthless. A significant number of
off-balance-sheet commitments expire, however, without being drawn upon.
Moreover, commitments usually include financial covenants and/or material
adverse change clauses that, if triggered, enable us to withdraw from the
obligation to lend. Refer to "Risk management" for more information on how we
manage credit risk.

In addition to maintaining a portfolio consisting mainly of highly rated
counterparties, we use credit derivatives to manage the risks associated with
our credit extensions. The use of credit derivatives for our own account is an
important part of our credit transformation strategy, as it allows us to reduce
risk and capital employed by credit activities. Since December 1997 we
significantly reduced credit risk on approximately $20 billion of traditional
credit product exposures through the use of securitizations and name-specific
credit default swaps.

The following table presents the percentage of our total credit-related product
exposure by counterparty credit rating, based on our internal credit ratings,
and after the impact of purchased credit protection. At December 31, 1998, 1997,
and 1996, 83% or more of our potential credit exposure was with counterparties
of investment-grade quality (internal rating of BBB or higher).

TOTAL CREDIT-RELATED INSTRUMENTS BY COUNTERPARTY CREDIT RATING

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
Percentage at December 31                          1998        1997        1996
--------------------------------------------------------------------------------
<S>                                                <C>         <C>         <C>
AAA, AA ........................................    32%         24%         24%
A ..............................................    35          40          41
BBB ............................................    16          23          22
BB and below ...................................    17          13          13
--------------------------------------------------------------------------------
Total                                              100         100         100
--------------------------------------------------------------------------------
</TABLE>
                                                                      
                                                                      
38   Balance sheet review
<PAGE>   41
                                                                      
IMPAIRED LOANS
--------------------------------------------------------------------------------
The following table presents impaired loans, net of charge-offs, at December 31
for the past three years. Refer to note 1, "Summary of significant accounting
policies," for a description of how we identify impaired loans.

IMPAIRED LOANS

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions: December 31                          1998         1997         1996
--------------------------------------------------------------------------------
<S>                                               <C>          <C>          <C> 
Commercial and industrial ......................  $ 12         $ 55         $ 89
Banks and other financial
   institutions ................................     2           30           --
Other ..........................................   108           28           31
--------------------------------------------------------------------------------
Total impaired loans                               122          113          120
--------------------------------------------------------------------------------
</TABLE>

Impaired loans were $122 million at December 31, 1998, versus $113 million at
December 31, 1997. The decrease in impaired commercial and industrial loans was
primarily due to foreign counterparty-related charge-offs and repayments during
the year. The decrease in banks and other financial institutions relates to
certain counterparties that returned to performing status, as well as
charge-offs during the year. Offsetting these decreases was an increase in other
impaired loans related primarily to one counterparty in the United States.

Impaired loans were $113 million at December 31, 1997, compared with $120
million at the end of 1996. The decrease in commercial and industrial loans was
offset by newly classified impaired loans to banks and other financial
institutions, related to emerging Asian counterparties.


ALLOWANCES FOR CREDIT LOSSES
--------------------------------------------------------------------------------
We maintain allowances for credit losses to absorb losses inherent in our
traditional extensions of credit that we believe are probable and that can be
reasonably estimated. These allowances include an allowance for loans and an
allowance for off-balance-sheet financial instruments such as commitments,
standby letters of credit, and guarantees.

The firm relies on its Asset Quality Review process to assist management in
determining the appropriate actions to be taken with regard to exposures
experiencing credit concerns. These actions include establishing or maintaining
appropriate levels of allowances or reserves. The process is based on a
bottom-up evaluation of probable losses by counterparty, industry, and country;
a statistical model estimate for probable losses on our remaining performing
portfolio; and a general component for probable losses that is necessary to
reflect the imprecise, subjective, and judgmental elements inherent in
evaluating credit risk. For additional detail on the Asset Quality Review
process and the determination of allowances, see "Credit risk" in the section
"Risk management," as well as note 1, "Summary of significant accounting
policies," and note 15, "Allowances for credit losses."

In determining the appropriate size of our allowances, we make use of our
historical experience over the course of past credit cycles. Credit cycles are
closely linked to economic cycles in terms of timing and depth. They are
difficult to define with precision, and in management's judgment should be
viewed in their entirety - from peak to trough. Using an estimate of a full
cycle compensates for the fact that the distribution of credit losses is not
even over time, that is, when losses occur they are often large and correlated
among counterparties. Our estimate of the full credit cycle is generally
longer-term in nature (i.e., four to seven years), which reflects our historical
experience of the length of past credit cycles, and appropriately matches the
risks in our existing portfolio, which consists of diverse exposures with
short-, medium-, and long-term maturities.

We believe our use of past credit cycle experience is appropriate because our
current portfolio is similar to those of the past: institutionally based, with
significant emerging market exposures. Our experience has shown that credit
losses, when they occur, are significant and highly correlated, particularly
across emerging markets. At times our loss experience has been much better than
expected, either because economic conditions improved or because we successfully
managed our credit exposures, resulting in lower net charge-offs than expected.


Allowance for loan losses

The following table summarizes the activity of the allowance for loan losses for
the years ended December 31, 1998, 1997, and 1996.

ALLOWANCE FOR LOAN LOSSES - ACTIVITY

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions                                    1998         1997         1996
--------------------------------------------------------------------------------
<S>                                           <C>          <C>       <C>  
BALANCE, JANUARY 1                            $ 546        $ 566     (b)$1 130
--------------------------------------------------------------------------------
Provision for loan losses                       110           --           --
--------------------------------------------------------------------------------
Recoveries ..............................        19           40           25
Charge-offs:
   Commercial and industrial ............       (46)         (21)         (30)
   Banks and other financial
      institutions ......................       (83)         (17)          --
   Other ................................       (26)          (2)          (9)
--------------------------------------------------------------------------------
Net charge-offs                                (136)          --          (14)
--------------------------------------------------------------------------------
Reclassifications(a)                            (50)         (20)     (b)(550)
--------------------------------------------------------------------------------
BALANCE, DECEMBER 31                            470          546          566
--------------------------------------------------------------------------------
</TABLE>

See notes (a) and (b) on the following page.


                                                       Balance sheet review   39
<PAGE>   42
(a) Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across
balance sheet reserve or allowance captions - which included an adjustment for
derivatives in our trading account (See note 10, "Trading account assets and
liabilities," to our consolidated financial statements), an allowance for loans
and an allowance for off-balance-sheet financial instruments such as commitments
and standby letters of credit and guarantees - were shown as reclassifications.
Reclassifications had no impact on net income, and accordingly, were not shown
on the "Consolidated statement of income." Subsequent to July 1, 1998,
reclassifications across balance sheet captions for allowances are reflected as
provisions or reversals of provisions in the relevant components of the
"Consolidated statement of income."

(b) Prior to December 31, 1996, our reserves and allowances for credit losses
were displayed in the aggregate as a reduction of loans in our "Consolidated
balance sheet." Beginning December 31, 1996, in accordance with the AICPA Banks
and Savings Institutions Audit Guide, the aggregate allowance was apportioned
and displayed as a reduction to loans, a reduction of trading assets related to
determining the fair value of our derivatives portfolio (See note 10, "Trading
account assets and liabilities," to our consolidated financial statements), and
as Other liabilities related to off-balance-sheet credit instruments. Amounts
were allocated based on assigning specific counterparty, industry, and country
amounts based on the nature of the underlying counterparty exposure; amounts
related to the general component were proportionally allocated to balance sheet
captions based on an assessment of the level of risk of the underlying
exposures.


The following table displays our allowance for loan losses by component at
December 31, 1998, 1997, and 1996.

ALLOWANCE FOR LOAN LOSSES BY COMPONENT

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions: December 31                        1998          1997          1996
--------------------------------------------------------------------------------
<S>                                             <C>           <C>           <C> 
Specific counterparty ........................  $ 34          $106          $114
Specific country .............................    93           198           273
Specific industry ............................    --            --            15
Expected loss ................................   228           171           102
General ......................................   115            71            62
--------------------------------------------------------------------------------
Total allowance                                  470           546           566
--------------------------------------------------------------------------------
</TABLE>

DECEMBER 31, 1998, VERSUS DECEMBER 31, 1997

The allowance for loan losses decreased to $470 million at December 31, 1998,
from $546 million at the previous year-end. The decrease was due primarily to
net charge-offs of $136 million in 1998 and a reclassification to our trading
portfolio in the first quarter related to impaired derivative receivables, which
was partially offset by a provision for loan losses of $110 million. Most
charge-offs resulted from losses on loan sales to counterparties in emerging
Asia, which were incurred as part of the firm's exposure reduction initiatives.
The provision for loan losses was required to maintain an appropriate allowance
for probable losses. Charge-offs in 1997 were $40 million, which were completely
offset by recoveries.

The specific counterparty component, which represents the SFAS No. 114
impairment reserve, decreased to $34 million, reflecting declines in
counterparty allocations across regions, primarily because of the return of
certain counterparties to performing status during the year and lower loss
estimates related to emerging Asian counterparties. Although specific
counterparty allocations declined, the level of impaired loans did not change
significantly, primarily reflecting the addition of one counterparty in 1998
which more than offset loans returning to performing status.

The specific country component - which focuses on countries experiencing
financial stress - decreased 53% to $93 million as of December 31, 1998,
reflecting lower exposures to countries in emerging Asia. Total exposure to
emerging Asia was down more than 50% - see page 42. The decrease was partially
offset by the addition of a specific country loss estimate for Brazilian credit
exposures, reflecting volatile economic conditions stemming from uncertainties
about fiscal reforms. Countries included in the specific country component at
year-end 1998 were South Korea, Indonesia, Malaysia, Thailand, and Brazil. These
countries were all subject to International Monetary Fund (IMF) support
programs. The loss estimates for each country were determined by management by
applying a percentage loss estimate on a "tiering of risk" basis (e.g.,
sovereigns have a lower percentage of coverage than corporates). We used
historical loss experience and judgment, considering secondary market data where
applicable to determine these estimates.

During the course of 1998 we incurred losses, primarily through loan sales, to
counterparties in emerging Asia. We believe that while financial conditions in
the region improved during the year, losses in our remaining emerging Asian
exposures were probable and that, in light of recent experience, our loss
estimates were reasonable. With regard to Brazil, there was a significant
deterioration in the credit situation demonstrated by the need for an IMF
program in the fourth quarter of 1998. As a result, we determined that it was
necessary to have a specific country allocation for Brazil. We have not yet
observed actual losses to confirm our estimated probable losses but believe that
the estimates are reasonable given recent events in Brazil.

The expected loss component increased 33% to $228 million at December 31, 1998.
The increase reflected our assessment that estimated probable losses for Latin
American credits - excluding Brazil, which was covered by the country component
- were higher than at the end of 1997 due to recent events. We believe that the
increase was appropriate to reflect our recent loss experiences in emerging
markets, including the fact that there is a high correlation among emerging
markets when losses occur. To determine the loss estimates, we used bond spreads
in the region as an indicator of credit quality, since the situation was judged
too volatile for us to rely on published credit ratings typically used in our
expected loss models.


40   Balance sheet review
<PAGE>   43
The general component was $115 million at December 31, 1998, compared with $71
million at December 31, 1997. The increase reflected management's assessment of
amounts needed to cover risks not adequately addressed by the other components.
In particular, volatile conditions in emerging markets increased the level of
uncertainty surrounding the appropriateness of the country and expected loss
components; this coupled with management's assessment of coverage needed for
imperfections in models led to the increase in the general component to an
amount deemed appropriate.

DECEMBER 31, 1997 VERSUS DECEMBER 31, 1996 

The allowance for loan losses was $546 million as of December 31, 1997, compared
with $566 million as of December 31, 1996. Charge-offs in 1997 of $40 million
were related primarily to counterparties in emerging Asia. In 1996 charge-offs
of a similar amount related to a small number of borrowers in the United States.

The specific counterparty component was $106 million at December 31, 1997, and
consisted primarily of counterparties in North America and, to a lesser extent,
emerging Asia. This compared with a counterparty component of $114 million at
December 31, 1996, which included exposures across all regions.

The specific country component decreased 27% to $198 million at December 31,
1997 from $273 million at December 31, 1996. The focus of this component shifted
from Latin America in 1996 to emerging Asia in 1997. Specific Latin American
country allocations were removed, reflecting the region's stronger credit
performance and improved macroeconomic conditions following the aftermath of the
1994 Mexican peso devaluation. It also reflected management's judgment that
exposures to Latin America should be considered in determining the expected loss
component of the allowance for performing credits.

During 1997 conditions in emerging Asia, which were marked by an abrupt
disappearance of liquidity and a currency collapse throughout the region
following the July Thai baht devaluation, raised serious credit concerns. At
December 31, 1997, loss estimates in the country component comprised allocations
for Indonesia, South Korea, and Thailand - countries subject to IMF support
programs. This reflected the refinement of our methodology for the country
component to include countries experiencing financial stress, as demonstrated by
such factors as the existence of IMF programs, and to include "nonstressed"
countries in the expected loss calculation. We determined the country loss
estimates for each country based on a "tiering of risk" basis, as discussed
previously.

The specific industry component, which included loss estimates for exposures to
counterparties in the U.S. tobacco and nonfood retail industries, was deemed no
longer necessary, reflecting reduced tobacco-related positions and progress on
the settlement of litigation, and improvements in the retail industry.

The expected loss component increased to $171 million at December 31, 1997 from
$102 million at December 31, 1996, primarily reflecting the inclusion of Latin
American exposures as previously discussed, and to a lesser extent, higher loss
estimates to certain "nonstressed" Asian and Eastern European countries.

The general component was $71 million at December 31, 1997, compared with $62
million at December 31, 1996, and reflected our estimate of probable losses due
to other risk factors inherent in evaluating credit risk, including model
imperfections.


Allowance for off-balance-sheet credit instruments

The following table summarizes the activity of the allowance for credit losses
for off-balance-sheet credit instruments for the years ended December 31, 1998,
1997, and 1996.

Allowance for off-balance-sheet credit instruments - activity

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions                                         1998      1997      1996
--------------------------------------------------------------------------------
<S>                                                <C>       <C>       <C>      
BALANCE, JANUARY 1                                 $ 185     $ 200     $  -- (b)
--------------------------------------------------------------------------------
Negative provision for credit losses                 (60)       --        --
--------------------------------------------------------------------------------
Reclassifications(a)                                  --       (15)      200(b)
--------------------------------------------------------------------------------
BALANCE, DECEMBER 31                                 125       185       200
--------------------------------------------------------------------------------
</TABLE>

(a) See note (a) to table on page 40.

(b) See note (b) to table on page 40.

The following table displays our allowance for credit losses on
off-balance-sheet instruments by component at December 31, 1998, 1997, and 1996.

ALLOWANCE FOR OFF-BALANCE-SHEET CREDIT INSTRUMENTS BY COMPONENT

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions: December 31                              1998      1997      1996
--------------------------------------------------------------------------------
<S>                                                  <C>       <C>        <C>  
Specific counterparty ............................   $    3    $    2     $  62
Specific country .................................       30        58        -
Specific industry ................................       -         -         38
Expected loss ....................................       66        53        41
General ..........................................       26        72        59
--------------------------------------------------------------------------------
Total allowance                                         125       185       200
--------------------------------------------------------------------------------
</TABLE>

DECEMBER 31, 1998 VERSUS DECEMBER 31, 1997

The allowance for credit losses for off-balance-sheet credit instruments
decreased to $125 million at December 31, 1998, resulting in a negative
provision of $60 million, recorded in Other revenue, which was needed to reflect
the allowance at an appropriate level.


                                                       Balance sheet review   41
<PAGE>   44
The specific counterparty component was $3 million at December 31, 1998,
compared with $2 million the previous year. The specific country component
decreased 48% to $30 million at December 31, 1998, from $58 million, reflecting
lower exposures to countries in emerging Asia. The decrease was partially offset
by the addition of a loss estimate for Brazil. The expected loss component
increased 25% to $66 million as of December 31, 1998, reflecting the higher
estimated losses for Latin American credits, as previously discussed. The
general component was $26 million at December 31, 1998, compared with $72
million at December 31, 1997. The decrease reflected management's decision to
reduce loss estimates based on their judgment and experience with
off-balance-sheet credit instruments, which become loans when they are drawn, as
well as to be in line with desired coverage ratios to compensate for modeling
imperfections and other risk factors.

DECEMBER 31, 1997 VERSUS DECEMBER 31, 1996

The allowance for credit losses on off-balance-sheet instruments decreased to
$185 million at December 31, 1997, from $200 million at December 31, 1996,
reflecting reduced risk related to the purchase of credit protection on
approximately $8 billion of commitment exposures.

The specific counterparty component decreased to $2 million at December 31, 1997
from $62 million at December 31, 1996; year-end 1996 consisted of large amounts
to a small number of counterparties. The specific country component increased to
$58 million at December 31, 1997, reflecting allocations to emerging Asia. The
expected loss component increased to $53 million at December 31, 1997, from $41
million as of December 31, 1996, primarily reflecting the inclusion of Latin
American exposures as previously discussed. The specific industry component for
U. S. tobacco and nonfood retail industries was deemed no longer necessary at
December 31, 1997, reflecting reduced tobacco-related positions and progress on
the settlement of litigation and improvements in the retail industry. The
general component was $72 million at December 31, 1997, versus $59 million at
December 31, 1996 and reflected our estimate of probable losses due to other
risk factors inherent in evaluating credit risk, including model imperfections.


INTERNATIONAL ALLOWANCES FOR CREDIT LOSSES

The international portion of our allowances for loans and off-balance-sheet
instruments was $341 million, $486 million and $478 million at December 31,
1998, 1997, and 1996, respectively. It represented approximately 57%, 66%, and
62% of our total credit-related product allowances in each of the respective
years. The decrease in 1998 reflects lower exposures to emerging markets and the
impact of charge-offs, largely through loan sales in Asia. Refer to note 15,
"Allowances for credit losses," for more information.

CREDIT RESERVE FOR IMPAIRED DERIVATIVES

Trading assets include a credit adjustment for impaired derivatives, as
determined based on management's judgment. This adjustment is needed to
appropriately reflect these exposures at fair value and was categorized as the
trading allowance in previous financial statements. Refer to note 10, "Trading
account assets and liabilities."


EXPOSURES TO EMERGING COUNTRIES

In 1998 we proactively decreased our exposures to certain emerging markets to
reflect the increased risk associated with these assets as well as our
longer-term credit transformation strategy. As a result, emerging market
exposures in Asia (excluding Japan) and Latin America were reduced by
approximately 50% and 40%, respectively, in 1998. Consistent with our credit
strategy and market opportunities, we will continue to actively manage exposures
as judged appropriate.

The following tables present exposures to certain emerging markets based on
management's view of total exposure. The management view takes into account the
following cross-border and local exposures: the notional or contract value of
loans, commitments to extend credit, securities purchased under agreements to
resell, interest- earning deposits with banks; the fair values of trading
account assets (cash securities and derivatives, excluding any collateral we may
hold to offset these exposures) and investment securities; and other monetary
assets. It also considers the impact of credit derivatives, at their notional or
contract value, when we have bought or sold credit protection outside of the
respective country. Trading assets reflect the net of long and short positions
of the same issuer.


42   Balance sheet review
<PAGE>   45
EXPOSURES TO EMERGING COUNTRIES, BY TYPE OF FINANCIAL INSTRUMENT

EMERGING ASIA
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                                   Credit    
In billions:                                                Deriva-   Other out-   deriva-   Commit-     Local      Total
December 31, 1998                                  Loans      tives   standings     tives     ments   exposure   exposure
-------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>      <C>       <C>          <C>       <C>      <C>        <C>  
China ..........................................   $  --      $ 0.1       $  --     $  --     $  --      $  --      $ 0.1
Hong Kong ......................................     0.5        0.1         0.2      (0.1)      0.1        0.8        1.6
Indonesia ......................................     0.1        0.1          --        --        --         --        0.2
Malaysia .......................................      --         --         0.1      (0.1)       --         --         --
Philippines ....................................      --        0.1         0.1        --        --         --        0.2
Singapore ......................................      --         --         0.2      (0.1)       --        0.1        0.2
South Korea ....................................     0.4        1.1         0.5      (0.3)       --         --        1.7
Taiwan .........................................      --         --          --        --       0.1         --        0.1
Thailand .......................................      --        0.1         0.1        --        --         --        0.2
Other ..........................................     0.2        0.1          --        --        --         --        0.3
-------------------------------------------------------------------------------------------------------------------------
Total Asia, excluding Japan(a)                       1.2        1.7         1.2      (0.6)      0.2        0.9        4.6
-------------------------------------------------------------------------------------------------------------------------
<CAPTION>
December 31, 1997                                                                                     
-------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>      <C>       <C>          <C>       <C>      <C>        <C>  
China ..........................................     0.1        0.2         0.1        --        --         --        0.4
Hong Kong ......................................     1.1        0.7         0.6       0.1       0.4         --        2.9
Indonesia ......................................     0.1        0.4         0.2        --       0.1         --        0.8
Malaysia .......................................     0.1        0.1         0.2        --        --         --        0.4
Philippines ....................................     0.1         --         0.2        --        --         --        0.3
Singapore ......................................      --        0.6          --        --        --         --        0.6
South Korea ....................................     1.2        1.4         0.5        --       0.3         --        3.4
Taiwan .........................................      --         --          --        --        --         --         --
Thailand .......................................     0.1        0.8         0.3        --        --         --        1.2
Other ..........................................     0.1        0.2         0.1        --        --         --        0.4
-------------------------------------------------------------------------------------------------------------------------
Total Asia, excluding Japan(a)                       2.9        4.4         2.2       0.1       0.8         --       10.4
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

LATIN AMERICA
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                                   Credit             
In billions:                                                 Deriva-  Other out-   deriva-   Commit-     Local      Total
December 31, 1998                                  Loans      tives   standings     tives     ments   exposure   exposure
-------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>       <C>      <C>          <C>       <C>      <C>        <C>
Argentina ......................................   $ 0.1      $ 0.3       $ 0.7     $(0.4)    $  --      $ 0.6      $ 1.3
Brazil .........................................     0.5         --         0.7      (0.2)       --        0.9        1.9
Chile ..........................................     0.4         --         0.1      (0.1)       --         --        0.4
Colombia .......................................     0.2         --         0.4        --        --         --        0.6
Mexico .........................................     0.6        0.2         0.3      (0.3)       --        0.4        1.2
Other ..........................................     0.5        0.4         0.2      (0.1)      0.1         --        1.1
-------------------------------------------------------------------------------------------------------------------------
Total Latin America, excluding the Caribbean         2.3        0.9         2.4      (1.1)      0.1        1.9        6.5
-------------------------------------------------------------------------------------------------------------------------
<CAPTION>                                                                                                      
December 31, 1997                                                                                     
-------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>      <C>       <C>          <C>       <C>      <C>        <C>  
Argentina ......................................     0.7        0.4        1.3       (0.2)       --        0.1        2.3
Brazil .........................................     0.9        0.2        1.3       (0.2)       --        1.4        3.6
Chile ..........................................     0.8         --        0.2         --        --         --        1.0
Colombia .......................................     0.5         --        0.2         --       0.1         --        0.8
Mexico .........................................     0.7        0.4        0.7       (0.1)      0.2         --        1.9
Other ..........................................     0.8         --        0.7         --        --         --        1.5
-------------------------------------------------------------------------------------------------------------------------
Total Latin America, excluding the Caribbean         4.4        1.0        4.4       (0.5)      0.3        1.5       11.1
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Total exposures to Japan, based on management's view, were $6.9 billion and
$12.9 billion at December 31, 1998 and 1997, respectively.

Total exposures to South Africa, based on management's view, were $1.1 billion
and $2.1 billion at December 31, 1998 and 1997, respectively.


                                                       Balance sheet review   43
<PAGE>   46
EXPOSURES TO EMERGING COUNTRIES,
BY TYPE OF COUNTERPARTY

EMERGING ASIA
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In billions:                                        Govern-                Total
December 31, 1998                         Banks      ments      Other   exposure
--------------------------------------------------------------------------------
<S>                                       <C>       <C>         <C>     <C>  
China ...............                     $  --      $  --      $ 0.1      $ 0.1
Hong Kong ...........                        --        0.7        0.9        1.6
Indonesia ...........                        --         --        0.2        0.2
Malaysia ............                        --         --         --         --
Philippines .........                        --         --        0.2        0.2
Singapore ...........                       0.1         --        0.1        0.2
South Korea .........                       0.8        0.6        0.3        1.7
Taiwan ..............                       0.1         --         --        0.1
Thailand ............                       0.2         --         --        0.2
Other ...............                       0.3         --         --        0.3
--------------------------------------------------------------------------------
Total Asia, excluding                    
   Japan                                    1.5        1.3        1.8        4.6
--------------------------------------------------------------------------------
<CAPTION>
December 31, 1997                        
--------------------------------------------------------------------------------
<S>                                       <C>       <C>         <C>     <C>  
China ...............                       0.1        0.2        0.1        0.4
Hong Kong ...........                       1.0        0.1        1.8        2.9
Indonesia ...........                       0.5         --        0.3        0.8
Malaysia ............                       0.2         --        0.2        0.4
Philippines .........                       0.1        0.1        0.1        0.3
Singapore ...........                        --        0.4        0.2        0.6
South Korea .........                       2.2        0.2        1.0        3.4
Taiwan ..............                        --         --         --         --
Thailand ............                       0.6        0.5        0.1        1.2
Other ...............                       0.3         --        0.1        0.4
--------------------------------------------------------------------------------
Total Asia, excluding                    
   Japan                                    5.0        1.5        3.9       10.4
--------------------------------------------------------------------------------
</TABLE>

LATIN AMERICA
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In billions:                                        Govern-                Total
December 31, 1998                         Banks      ments      Other   exposure
--------------------------------------------------------------------------------
<S>                                       <C>       <C>         <C>     <C>  
Argentina ...........                     $  --      $ 0.6      $ 0.7      $ 1.3
Brazil ..............                       0.2        0.6        1.1        1.9
Chile ...............                        --         --        0.4        0.4
Colombia ............                        --        0.1        0.5        0.6
Mexico ..............                       0.1        0.1        1.0        1.2
Other ...............                       0.5         --        0.6        1.1
--------------------------------------------------------------------------------
Total Latin America,                     
   excluding the                         
   Caribbean                                0.8        1.4        4.3        6.5
--------------------------------------------------------------------------------
<CAPTION>
December 31, 1997                        
--------------------------------------------------------------------------------
<S>                                       <C>       <C>         <C>     <C>  
Argentina ...........                       0.1        1.2        1.0        2.3
Brazil ..............                       0.3        1.1        2.2        3.6
Chile ...............                       0.1         --        0.9        1.0
Colombia ............                       0.1        0.1        0.6        0.8
Mexico ..............                       0.2        0.5        1.2        1.9
Other ...............                       0.1        0.3        1.1        1.5
--------------------------------------------------------------------------------
Total Latin America,                     
   excluding the                         
   Caribbean                                0.9        3.2        7.0       11.1
--------------------------------------------------------------------------------
</TABLE>


Exposures to hedge funds

Volatile market conditions in the third quarter of 1998 created significant
losses and severe liquidity concerns for many hedge funds.

As a result of these concerns, we reassessed our policies and exposures related
to hedge funds and made a number of improvements. They included:

-   updating due diligence on our hedge fund client base and screening out the
    least creditworthy counterparties 

-   strengthening margin agreements to include up-front margin requirements 
    that take into account liquidation considerations

-   reviewing all documentation

-   increasing information monitoring requirements

-   reviewing daily exposure changes and their correlation with market
    parameters

The net amount J.P. Morgan was owed by hedge funds under derivative and foreign
exchange contracts on a mark-to-market basis was approximately $1.3 billion at
December 31, 1998. Substantially all of this amount was secured by cash and U.S.
Treasury and agency securities under daily mark-to-market collateral agreements.
We also finance trading positions for hedge funds through reverse repurchase
agreements. The net amount of collateral owed the firm under derivative and
foreign exchange contracts and short-term financing agreements was approximately
$90 million. In addition, we have approximately $6 million of unsecured loans
and commitments.

J.P. Morgan made a $300 million equity investment in Long-Term Capital
Management, L.P., in September 1998 as part of a consortium of firms that
recapitalized the hedge fund.


FINANCIAL POSITION
--------------------------------------------------------------------------------

Sources of funds

We have developed access to a diverse funding base around the world. This
enhances funding flexibility, limits dependence on any one source of funds, and
generally lowers the cost of funds. In making funding decisions, management
considers market conditions, prevailing interest rates, liquidity needs, and the
desired maturity profile. We also use derivatives to modify the characteristics
of interest rate-related instruments such as short-term borrowings and long-term
debt. Refer to note 11, "Derivatives."

Our sources of funds include interest-bearing and non-interest-bearing deposits,
commercial paper, bank notes, trading account liabilities, repurchase
agreements, federal funds, and long-term debt and capital securities.


44   Balance sheet review
<PAGE>   47
Repurchase agreements represent secured sources of funding using our inventory
of government and agency, money market, and corporate securities as collateral.
Maturities range from overnight to as far out as a year, with close to 80%
maturing in less than three months.

Short-term borrowings

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In billions: Average balances                  1998          1997          1996
--------------------------------------------------------------------------------
<S>                                          <C>           <C>           <C>    
Interest-bearing deposits ................   $  56.7       $  55.9       $  49.1
Noninterest-bearing deposits .............       1.7           1.5           3.0
Commercial paper .........................       9.7           4.9           4.1
Other liabilities for borrowed
   money .................................      14.3          18.2          16.4
Securities sold under
   agreements to repurchase
   and federal funds purchased ...........      70.5          67.1          63.4
--------------------------------------------------------------------------------
</TABLE>


The above table presents the average balances of our short-term borrowings.
Interest-bearing deposits include time deposits and certificates of deposit and
generally have maturities of less than one year. Noninterest-bearing deposits
include items in the process of collection and compensating balances from
clients. Other liabilities for borrowed money include bank notes with an
original maturity of less than one year, term federal funds purchased, and other
short-term borrowings.

Long-term debt
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In billions: December 31                                1998      1997      1996
--------------------------------------------------------------------------------
<S>                                                    <C>       <C>       <C>
Long-term debt qualifying as
   risk-based capital ..............................   $ 4.6     $ 4.7     $ 3.7
Long-term debt not qualifying as                      
   risk-based capital ..............................    23.0      18.2       9.4
--------------------------------------------------------------------------------
Total long-term debt                                    27.6      22.9      13.1
--------------------------------------------------------------------------------
</TABLE>

In 1998 we continued to take advantage of market opportunities to extend the
maturity of our liabilities and pursue non-U.S.-dollar funding opportunities in
Europe and Japan. During the year we issued $12.4 billion in long-term debt
(debt with an original maturity greater than one year), of which approximately
$0.1 billion qualifies as risk-based capital. Approximately $7.7 billion of
maturities and $580 million of early redemptions offset the additions to
long-term debt.

In 1997 we issued $12.3 billion in long-term debt, of which approximately
$1.4 billion qualifies as risk-based capital. Offsetting these issuances were
approximately $1.6 billion of maturities and $458 million of early redemptions.


CAPITAL SECURITIES

In January 1997 JPM Capital Trust II, a wholly owned subsidiary of J.P. Morgan,
issued $400 million of 7.95% trust preferred securities. This qualified as tier
1 risk-based capital under the Board of Governors of the Federal Reserve System
guidelines.


STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions: December 31                              1998      1997      1996
--------------------------------------------------------------------------------
<S>                                                 <C>       <C>       <C>   
Common stockholders' equity .....................   $10 567   $10 710   $10 738
Total stockholders' equity ......................    11 261    11 404    11 432
--------------------------------------------------------------------------------
Total stockholders' equity to                     
   year-end assets                                      4.3%      4.4%      5.2%
--------------------------------------------------------------------------------
</TABLE>
                                   

At December 31, 1998, common and total stockholders' equity had declined from
the previous year. This was due to stock repurchases and a decrease in
unrealized appreciation on debt and marketable equity securities. These
decreases more than offset earnings in excess of common and preferred dividends
and increases related to shares under employee benefit plans. Common and total
stockholders' equities were essentially unchanged in 1997 from the previous
year. Earnings in excess of common and preferred dividends and increases related
to shares under employee benefit plans were offset by higher common stock
repurchases.

The ratio of total stockholders' equity to year-end assets was essentially
unchanged in 1998. The 1997 ratio decreased primarily as a result of the growth
of $40 billion in year-end assets.

In 1998 we purchased approximately 6.6 million common shares worth $755 million
to lessen the dilutive impact on earnings per share of our employee benefit
plans. During 1997 we purchased 14 million common shares: approximately 7
million shares to lessen the dilutive impact on earnings per share of our
employee benefit plans and approximately 7 million shares pursuant to our Board
of Directors' December 1996 authorization to buy up to $750 million of common
stock, financed principally with the proceeds of a November 1996 issue of trust
preferred securities.

In December 1998 our Board of Directors increased the regular quarterly dividend
on the company's common stock to $0.99 per share from $0.95 per share for the
quarter ending December 31, 1998. Our Board also approved the purchases of up to
$750 million of J.P. Morgan common stock, subject to market conditions and other
factors. These purchases may be made periodically in 1999 or beyond in the open
market or through privately negotiated transactions.


                                                       Balance sheet review   45
<PAGE>   48
CAPITAL STRENGTH
--------------------------------------------------------------------------------
J.P. Morgan, our subsidiaries, and certain foreign branches of our bank
subsidiary, Morgan Guaranty Trust Company of New York (Morgan Guaranty), are
required to meet the capital adequacy rules of several U.S. and non-U.S.
regulators. Our primary federal banking regulator, the Federal Reserve Board,
establishes minimum capital requirements for J.P. Morgan, the consolidated bank
holding company, and for some of our subsidiaries, including Morgan Guaranty.
The Federal Reserve Board has risk-based capital guidelines for evaluating the
capital adequacy of bank holding companies and banks. In addition, guidelines
for a leverage ratio designed to complement the risk-based capital ratios have
been established. A bank holding company and bank are considered well
capitalized if certain risk-based capital and leverage ratios are maintained.
J.P. Morgan and its principal subsidiaries exceeded the minimum standards set by
each regulator at December 31, 1998. J.P. Morgan and Morgan Guaranty also
exceeded the minimum standards for a well capitalized bank holding company and
bank, respectively, at December 31, 1998, and are aware of no conditions or
events since year-end that would change our well capitalized status.

Refer to note 22, "Capital requirements," for more information.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                            J.P. Morgan                     Well
                                         --------------   Required   capitalized
December 31                              1998      1997    minimum       minimum
--------------------------------------------------------------------------------
<S>                                      <C>       <C>    <C>        <C> 
Tier 1 capital ......................     8.0%      8.0%      4.0%          6.0%
Total risk-based capital ............    11.7      11.9       8.0          10.0
Leverage ............................     3.9       4.4       3.0           3.0
--------------------------------------------------------------------------------

<CAPTION>
                                         Morgan Guaranty                    Well
                                         ---------------  Required   capitalized
December 31                              1998      1997    minimum       minimum
--------------------------------------------------------------------------------
<S>                                      <C>       <C>    <C>        <C>
Tier 1 capital ......................     8.7%      7.8%      4.0%          6.0%
Total risk-based capital ............    12.0      10.8       8.0          10.0
Leverage ............................     5.3       5.2       3.0           5.0
--------------------------------------------------------------------------------
</TABLE>

Risk-adjusted assets represent the total of all on- and off-balance-sheet
assets adjusted for risk-based factors as prescribed by the Federal Reserve
Board. J.P. Morgan's risk-adjusted assets at December 31, 1998 and 1997, were
$140.2 billion and $148.5 billion, respectively. The decrease in risk-adjusted
assets was due primarily to a combination of a reduction in the capital employed
as part of our credit transformation strategy, our reduced credit exposures in
emerging markets, and net roll-offs of credit extensions.


ACCOUNTING CHANGES AND DEVELOPMENTS
--------------------------------------------------------------------------------
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted starting
with our financial statements for the quarter ended March 31, 2000. The standard
will require us to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through earnings.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of the derivative will either be offset against the change in
fair value of the hedged asset, liability, or firm commitment through earnings,
or be recognized in other comprehensive income until the hedged item is
recognized in earnings. If the change in fair value of a derivative designated
as a hedge is not effectively offset, as defined, by the change in value of the
item it is hedging, this difference will be immediately recognized in earnings.

While we have not determined the specific impact of SFAS No. 133 on our earnings
and financial position, we have identified, based on current hedging strategies,
our activities that would be most affected by the new standard. Specifically,
the Proprietary Investing and Trading segment uses derivatives to hedge its
investment portfolio, deposits, and issuance of debt - primarily hedges of
interest rate risk. Our credit activities use credit derivatives to hedge credit
risk, and to a lesser extent, use other derivatives to hedge interest rate risk.
Management is currently evaluating the impact of SFAS No. 133 on our hedging
strategies. The actual assessment of the impact on the firm's earnings and
financial position of adopting SFAS No. 133 will be made based on our January 1,
2000 positions in accordance with the standard.


46   Balance sheet review
<PAGE>   49
ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL
USE

In March 1998 the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement requires that we
capitalize certain costs associated with the acquisition or development of
internal use software. Effective January 1, 1999, we adopted SOP 98-1;
restatement of financial statements of previous years is not allowed. We expect
its adoption to result in the capitalization of approximately $130 million of
software costs during 1999, net of expected 1999 amortization. Previously, these
costs would have been expensed as incurred. Once the software is ready for its
intended use, we will begin amortizing capitalized costs on a straight-line
basis over its expected useful life. This period generally will not exceed three
years.

REPORTING ON THE COSTS OF START-UP ACTIVITIES

In April 1998 the AICPA issued SOP 98-5, Reporting on the Costs of Start Up
Activities. This statement requires that we expense certain costs related to new
operations that were previously eligible for capitalization. Effective January
1, 1999, we adopted SOP 98-5; restatement of the financial statements of prior
years is not allowed. The adoption of SOP 98-5 did not have a material impact on
our earnings or financial position.


BUSINESS ENVIRONMENT AND OTHER INFORMATION
--------------------------------------------------------------------------------

Our business environment

We conduct business in an unpredictable global environment. Many variables may
have an impact on the firm's results or operations, including:

-   economic and market conditions (including the liquidity of secondary
    markets)

-   volatility of market prices, rates, and indices

-   timing and volume of market activity

-   availability of capital 

-   inflation

-   political events (including legislative, regulatory, and other developments,
    such as the economic and monetary union in Europe)

-   competitive forces (including the ability to attract and retain highly
    skilled individuals)

-   the ability to develop and support technology and information systems

-   investor sentiment

As a result of these variables, revenues and net income in any particular
period may:

-   not be indicative of full-year results

-   vary from year to year

-   impact the firm's ability to achieve its strategic objectives


Forward-looking statements

Certain sections of our Annual report contain forward-looking statements. We use
words such as expect, believe, anticipate, and estimate to identify these
statements. In particular, disclosures made in the "Letter to shareholders" and
"Results of operations" sections related to performance targets and savings as
well as disclosures on the year 2000 initiative contain forward-looking
statements. Such statements are based on our current expectations and are
subject to various risks and uncertainties, as discussed above in "Our business
environment" and the section "Risk management". These risks and uncertainties
could cause actual results to differ materially from those currently
anticipated. J.P. Morgan claims the protection afforded by the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.


                                                       Balance sheet review   47
<PAGE>   50
Our competition

In all areas of business, J.P. Morgan and its subsidiaries operate in an
intensely competitive environment, especially regarding services and pricing. In
the U.S., we face competition from investment banks, money center bank holding
companies, many regional and foreign banks, and a wide range of nonbank
financial institutions. Internationally, our competitors are investment banks,
commercial banks, and universal banks in the money centers of Europe, Asia, and
Latin America.


Regulations

J.P. Morgan is subject to regulation under the Bank Holding Company Act of 1956
(the Act). Under the Act, we are required to file reports with the Board of
Governors of the Federal Reserve System (the Board). We are also subject to
examination by the Board. The Act prevents J.P. Morgan and its subsidiaries from
engaging in activities not related to banking and limits the amount of
securities we may acquire of a company engaging in nonbanking activities.
Federal law and Board interpretations limit the extent to which we can engage in
certain aspects of the securities business. The Glass-Steagall Act prohibits
affiliates of banks that are members of the Federal Reserve System - including
J.P. Morgan Securities Inc. (JPMSI), a section 20 subsidiary - from being
engaged principally in bank-ineligible underwriting and dealing activities
(mainly corporate debt and equity securities). This prohibition restricts
JPMSI's gross revenues from these activities to a maximum of 25% of total gross
revenues.

Our largest subsidiary, Morgan Guaranty Trust Company of New York (Morgan
Guaranty), is a member of the Federal Reserve System and the Federal Deposit
Insurance Corporation (FDIC). Its business is subject to both U.S. federal and
state law. It is examined and regulated by U.S. federal and state banking
authorities. J.P. Morgan and its nonbank subsidiaries are affiliates of Morgan
Guaranty within the meaning of the applicable federal statutes. Morgan Guaranty
is subject to restrictions on loans and extensions of credit to J.P. Morgan and
certain other affiliates. It is also restricted on some other types of
transactions with J.P. Morgan or involving our securities. Among other wholly
owned subsidiaries:

-   JPMSI is a broker-dealer registered with and subject to regulation by the
    Securities and Exchange Commission (SEC) and is a member of the National
    Association of Securities Dealers, the New York Stock Exchange, and other
    exchanges.

-   J.P. Morgan Futures Inc. is subject to regulation by the Commodity Futures
    Trading Commission, the National Futures Association, and the commodity
    exchanges and clearing houses of which it is a member.

-   J.P. Morgan Investment Management Inc. is registered with the SEC as an
    investment advisor under the Investment Advisers Act of 1940, as amended.

J.P. Morgan subsidiaries that conduct business in other countries are also
subject to regulations and restrictions imposed by those jurisdictions,
including capital requirements.


Properties

J.P. Morgan owns and occupies buildings in locations around the world, which
include: New York (60 Wall Street - headquarters, 23 Wall Street, 15 Broad
Street and 522 Fifth Avenue), Delaware, London, and Paris. We also lease office
space in locations around the world including New York, Delaware, Brussels,
Paris, and London.

J.P. Morgan's financing arrangement for an office building complex in London
involved the sale to the lender of a 52.5% interest in the building complex.
This arrangement excluded the interior office finishing, furniture, and
technology. This transaction is described in note 18, "Long-term debt." The
building at 60 Wall Street is subject to a $405 million mortgage as of December
31, 1998.

On December 23, 1998, the City and State of New York and the New York Stock
Exchange announced an agreement to build a new Exchange on land currently
occupied by J.P. Morgan facilities at 15 Broad Street, 23 Wall Street, and 37
Wall Street in New York City. We do not anticipate any disruption to our
operations, or any material impact on our financial statements, as a result of
this transaction.


48   Balance sheet review
<PAGE>   51
RISK MANAGEMENT

OVERVIEW

Risk is inherent in our business, and sound risk management is key to our
success. We have developed and implemented comprehensive policies and procedures
to identify, mitigate, and monitor risk across the firm. These practices rely on
constant communication, judgment, and knowledge of products and markets by the
people closest to them, combined with regular oversight by a central risk
management group and senior management.

The major types of risk to which we are exposed are:

-        Market risk: the possibility of loss due to changes in market prices
         and rates, the correlations among them, and their levels of volatility

-        Credit risk: the possibility of loss due to changes in the quality of
         counterparties, the correlations among them, and the market prices for
         credit risk assets. We are subject to credit risk in our lending
         activities, sales and trading activities, and derivative activities and
         when we act as an intermediary on behalf of clients and other third
         parties.

-        Liquidity risk: the risk of being unable to fund our portfolio of
         assets at reasonable rates and to appropriate maturities

-        Operating risk: the potential for loss arising from breakdowns in
         policies and controls for ensuring the proper functioning of people,
         contracts, systems, and facilities

Our risk management processes are built on a foundation of early identification
and measurement. They are regularly reviewed and modified as our business
changes in response to market, credit, product, and other developments. We
constantly seek to strengthen our risk management process. Further, we mitigate
our exposure to losses from unexpected events by diversifying our activities
across instruments, markets, clients, and geographic regions.

HOW WE ARE ORGANIZED TO MANAGE RISK

We have established control mechanisms at various levels within the firm to
ensure high standards of risk management. Business managers have the primary
responsibility for managing risk. Located in markets around the world, they have
firsthand knowledge of market, industry, credit, economic, and political
conditions in their host countries. They are therefore best equipped to use
their experience and insight, along with risk management tools, to adjust their
risk strategies in a timely manner. They continually review new activities and
material changes to our existing activities to ensure that significant risks are
identified and that appropriate control procedures are in place.

The primary oversight unit is the Corporate Risk Management group (CRMG), which
develops, communicates, and oversees our view and process for managing risk
across activities. The CRMG also helps identify and implement ways to optimize
risk-based return on capital. The CRMG is independent of the business groups and
is managed by the head of the Risk Management Committee and Capital Committee.
The group reports directly to the chairman and chief executive officer. To
accomplish its objectives, this group:

-        sets risk management policies for the firm

-        establishes and controls market risk limits and concentration limits
         for credit risk for products, countries, industries, and geographic
         regions

-        performs independent reviews of significant risk concentrations and has
         the authority to challenge any risk position

-        oversees allocation of balance sheet capacity and adherence to capital
         targets

In addition to the CRMG, various senior management committees provide forums for
senior management oversight of our risk profile:
                                                              Risk management 49
<PAGE>   52
-        The Risk Management Committee oversees management of all market and
         credit-related risks. This committee comprises the firm's most senior
         professionals and is chaired by the head of the CRMG. The committee
         adds to the transparency of principal risks through regular attendance
         from senior business managers to discuss, among other matters,
         significant market and credit exposures, concentrations of positions,
         risk strategies, financial strength, asset quality, significant
         position and risk limit changes, and special agenda items such as
         potential new products.

-        The Capital Committee manages the firm's overall capital structure,
         with the goal of maximizing shareholder value within a strong capital
         position relative to risk.

-        The Operating Risk Committee sets the firm's overall strategic
         operating risk agenda, monitors issues related to the firm's control
         framework, and is responsible for operating strategy and organizational
         model; operating risk and control environment; productivity and quality
         programs; and infrastructure leadership development.

-        The Asset Quality Review Committee reviews counterparty, country,
         industry, and product exposures requiring special monitoring due to
         credit concerns and recommends actions to be taken.

-        The Liquidity Risk Committee reviews trends in the firm's overall
         liquidity risk profile and communicates any significant changes to the
         Risk Management Committee.

-        The Investment Committee oversees proprietary equity investment
         activities, advises on portfolio strategy, approves all investments
         made over defined limits, and monitors portfolio risk.

Several groups that are independent of the business units - Audit, Legal, and
Financial - track risk from a variety of perspectives and make sure that the
businesses operate within established corporate policies and limits. In
addition, the Board of Directors periodically reviews changes in our risk
profiles and policies.

MARKET RISK

Market risk arises from trading and investing in both our client-focused and
proprietary activities. Exposure to this risk stems from diverse factors that
affect changes in interest and foreign exchange rates, equity and commodity
prices, and the correlations among them and their levels of volatility. The
portfolio effect of holding diverse instruments across a variety of business
activities and geographic areas helps reduce the potential impact on earnings
from market risk.

Market risk management

Our ability to estimate potential losses that could arise from adverse changes
in market conditions is a key element of managing market risk. While
quantitative measures are integral to our process, judgment and experience are
crucial in assessing whether our level of market risk is acceptable. In
particular, when markets experience extreme conditions, as in the third and
fourth quarters of 1998, we continue to use our tools to quantify our risks but
rely on management's judgment to interpret and gauge the impact that extreme
changes in volatility and market correlations can have on positions that, in
normal markets, are estimated to be low-risk.

DAILY EARNINGS AT RISK

Our primary tool for the systematic measuring and monitoring of market risk is
the Daily Earnings at Risk (DEaR) calculation. DEaR is a statistical measure
used to estimate the firm's exposure to market risk within a given level of
confidence over a defined time period. DEaR takes into consideration almost all
financial instruments that expose the firm to market risk. Instruments that have
market risk but are not included in our DEaR calculation primarily comprise
investments held in our equity investments activities as well as investments
held as part of our credit investment securities portfolio. These investments
are included in our Proprietary Investments sector. The Investment Committee
monitors our equity investments; the Risk Management Committee monitors our
credit investment securities portfolio.

DEaR is an estimate, at a 95% confidence level, of the worst expected loss in
the value of our portfolios over a one-day time horizon. DEaR allows for a
consistent and uniform measure of market risk across all applicable products and
activities. It also facilitates regular comparison of risk estimates with daily
trading results, providing an indication of the quality of these estimates as
well as opportunities to enhance our risk measurement processes.

The DEaR measure makes assumptions about market behavior and takes into account
numerous variables that may cause a change in the value of our portfolios,
including interest rates, foreign exchange rates, equity and commodity prices
and their volatilities, and correlations among these variables. Our standard
forecast assumes that daily changes in market risk factors are normally
distributed and an adverse market movement of 1.65 standard deviations. Our
Financial group regularly calculates, reviews, and updates the empirical market
information that serves as the basis for the DEaR calculation.

50 Risk management
<PAGE>   53
During the fourth quarter of 1998, the underlying statistical methodology for
our firmwide DEaR calculation was changed from a variance/covariance model to a
model that uses historical simulations; the change was made in order to better
estimate nonlinear risks associated with certain positions (e.g., options). The
overall impact on our DEaR estimates was not significant.

Based on this statistical foundation, DEaR provides a summary measure of market
risk. For instance, on December 31, 1998, DEaR for our trading activities was
$35 million at the 95% confidence level. In other words, 95% of the time, under
normal market conditions, a loss of no more than $35 million would be expected
to occur over the course of one day as a result of our trading positions on
December 31, 1998.

In addition to calculating DEaR, we also use DEaR limits to define the maximum
DEaR a given portfolio should have at any one point in time. Limits are an
important tool for managing our trading and investing activities' market risk
and are intended as a mechanism to ensure adequate discussion of changes in risk
appetite. The CRMG sets DEaR limits for:

-        each global trading business

-        firmwide trading activities combined

-        firmwide trading and investing activities combined (aggregate DEaR)

Within these overall limits, business managers set regional, local, product, and
trader limits or guidelines. The level of risk to be assumed is based on our
overall objectives, business manager experience, client and regulatory
requirements, market liquidity, and volatility.

We estimate DEaR each day for each global trading business, as well as for
firmwide trading and aggregate market risk. Management reviews daily reports of
profit and loss, aggregate positions, and the firm's market risk profile. These
reports compare DEaR by individual activity and risk type with relevant DEaR
limits and include a description of significant positions and a discussion of
market conditions. Risk managers meet daily to discuss the firm's global market
risk profile and trading and investing strategies.

STRESS TESTING

We regularly supplement our DEaR calculations with stress testing at both the
firmwide and business-specific levels. Stress testing measures the impact of
abnormal movements in market risk factors on the firm's portfolios. This
provides senior management with an analysis of the potential impact on the
firm's revenue. In selective cases, we supplement DEaR limits with
stress-test-based limits - limits for the risk of loss beyond the expected
confidence level - for those portfolios that are particularly susceptible to
extreme market-related valuation losses.

BUSINESS RISK REVIEWS

The CRMG periodically performs special reviews of our risk-taking activities.
These reviews include, but are not limited to, detailed risk analyses of
selected portfolios, including reviews of the liquidity and turnover of trading
asset inventories, as well as reviews of issues related to new products and the
models and controls used to calculate and monitor market and credit risk.

MARKET RISK PROFILES

Overall, the markets in 1998 were significantly more volatile than in the past
several years. Extreme conditions from August to October - sharp increases in
volatilities, illiquidity, and breakdowns in historical correlations - caused
actual results to exceed DEaR estimates predicted by our models by more than the
expected frequency. Those results were, however, generally within the estimates
of our stress testing, which confirmed the reasonableness of our stress testing
assumptions. Overall, our risk management efforts served us well during a
difficult period. We attribute this to our comprehensive risk management
process, which recognizes the limitations of models and integrates their use, as
tools, with our management experience, market leadership, and strong emphasis on
risk transparency and discipline.

Following are the market risk profiles for the firm at and for the years ended
December 31, 1998 and 1997. The level of market risk, which includes the effect
of diversification, varies with market factors, level of client activity, and
market movements.

                                                              Risk management 51
<PAGE>   54
DEaR FOR TRADING ACTIVITIES

Average DEaR for trading activities increased 65% over the previous year to $38
million, reflecting growth in our market making activities as well as extreme
increases in volatility from August through October. Since we use DEaR primarily
as a measure of expected volatility of short-term trading positions, our model
weights recent patterns of market volatility and correlations most heavily. As a
result, our DEaR estimates changed rapidly in the August to October period of
market turmoil.

During 1998, the actual volatility of daily revenue increased by more than 100%
over the previous year, which was significantly more than the increase in our
DEaR estimates of risk. These conditions caused actual daily revenue to
exceed estimates predicted by our DEaR models by more than the expected
frequency. In 1998 daily revenue fell short of the downside DEaR band (average
daily revenue less the DEaR estimate) on 20 days, or more than 5% of the time.
Nine of these 20 occurrences fell within the August to October period.
Approximately half of the 20 occurrences exceeded our estimates by only a small
margin. Results for 1997 were consistent with statistical expectations.

The market risk profiles for our trading activities for each business day in
1998 and 1997 as measured by DEaR, are presented in the graph below.

DEaR FOR TRADING ACTIVITIES

                                    [GRAPH]

Depicted on page 52 of the annual report is a timeline of Daily Earnings at Risk
for our trading activities for each business day in 1998 and 1997, as well as
the average quarterly DEaR, in millions of dollars, for each quarter of 1998 and
1997. For 1998, in millions of dollars, the high was $55, the low was $27, and
the average was $38. For 1997, in millions of dollars, the high was $35, the low
was $15, and the average was $23.

PRIMARY RISK EXPOSURES IN OUR TRADING ACTIVITIES

The average and period-end DEaR for 1998 and 1997, segregated by type of primary
market risk exposure associated with our trading activities, is presented in the
table below.

<TABLE>
<CAPTION>
===========================================================================================
                                                                   December 31  December 31
In millions                             1998 average   1997 average       1998         1997
-------------------------------------------------------------------------------------------
<S>                                     <C>            <C>         <C>          <C>
Interest rate risk ................              $30          $20          $31          $26
Foreign exchange rate risk ........               18            7           11           12
Equity price risk .................               12            8           12           13
Commodity price risk ..............                3            3            3            4
Diversification effects ...........              (25)         (15)         (22)         (27)
-------------------------------------------------------------------------------------------
Total                                             38           23           35           28
-------------------------------------------------------------------------------------------
</TABLE>

52 Risk management
<PAGE>   55
Interest rate risk is the possibility that changes in interest rates will affect
the value of financial instruments. Our primary risk exposures to interest rates
from trading activities are in sovereign and corporate bond markets across North
America, Europe, Asia, and Latin America; mortgage-backed securities markets in
the U.S.; and interest rate derivatives. They also include spread, volatility,
and basis risk. We use instruments such as interest rate swaps, options, U.S.
government securities, futures and forward contracts to manage our exposure to
interest rate risk.

Foreign exchange rate risk represents the possibility that fluctuations in
foreign exchange rates will impact the value of our financial instruments. Our
primary risk exposures to foreign exchange rates arise from transactions in all
major countries and most minor countries throughout Europe, Latin America, and
Asia. We manage the risk arising from foreign currency transactions primarily
through currency swaps; options; and spot, futures, and forward contracts.

Equity price risk is the possibility that equity security prices will fluctuate,
affecting the value of equity securities and other instruments that derive their
value from a particular stock, a defined basket of stocks, or a stock index. Our
primary risk exposure to equity price risk arises from our activities in our
equity derivatives portfolio. We manage the risk of loss primarily through the
use of equity cash, future, swap, and option instruments.

Given the nature of our business, we expect frequent changes to our primary risk
exposures over the course of a year. Our integrated approach to managing market
risk considers this expectation and facilitates a dynamic and proactive
adjustment of the risk profile across all our trading activities as needed.

Histogram of daily 1998 revenues

The histogram below shows the distribution of 1998 daily revenue from our
trading activities, which includes trading revenue, trading-related net interest
revenue, commissions, and other sources of revenue. It is used to compare the
reasonableness of our DEaR prediction to what occurred during the year.

DAILY TRADING REVENUE

                                    [GRAPH]

Depicted on page 53 of the annual report is a histogram showing the frequency
distribution of 1998 daily revenue from our trading activities, which includes
trading revenue, trading-related net interest revenue, commissions, and other
sources of revenue in millions of dollars. It also shows the upside and downside
confidence bands around which our daily revenue was distributed.

As shown in the above histogram, trading-related revenue was substantially more
volatile than expected under DEaR estimates. At a 95% confidence interval, the
distribution of 1998 revenues would imply an average DEaR of $51 million. This
compares with our actual average 1998 DEaR estimate of $38 million. The
difference reflects the extreme volatile conditions experienced during the year.

DEaR FOR PROPRIETARY INVESTING ACTIVITIES

Average DEaR for our proprietary investing activities was $33 million in 1998
and ranged from $8 million to $109 million. This compares with average DEaR of
$16 million in 1997 and a range of $10 million to $25 million. DEaR for our
proprietary investing activities was $72 million and $15 million, respectively,
at December 31, 1998 and December 31, 1997.

                                                              Risk management 53
<PAGE>   56
In estimating risk for our investing activities, we have measured the risk in
this portfolio using the same one-day horizon and 95% confidence interval used
for trading, in order to facilitate aggregation with our trading risk
activities. This approach to risk estimation does not, however, fit well with
the longer horizon or with other risk features of these nontrading activities.
For this reason, we also track risk in our investing portfolio using a one-week
value-at-risk measure. As discussed earlier, our DEaR estimate is extremely
sensitive to recent patterns of volatility and correlations and, as a result,
the August to October turmoil had a significant impact on our estimates. When
applied to our investing portfolio, which included increased holdings of U.S.
government agency mortgage-backed securities over the previous year, these
conditions produced the significant increases noted in our risk estimates -
estimates that were well above what management believed would be the inherent
level of risk in our investment portfolio, once markets normalized.

The primary sources of market risk associated with our proprietary investing
activities are spread risk in our mortgage-backed securities portfolio and
interest rate risk associated with fixed income securities.

As discussed above, due to the longer-term nature of our investing activities,
we use a weekly time horizon to evaluate our risk estimates relative to total
return. For the year ended December 31, 1998, on four occurrences out of 52,
weekly total return fell short of expected weekly results by amounts greater
than related weekly risk estimates. Three of the four occurrences fell within
the August to October crisis period. Results for 1997 were consistent with
statistical expectations.

As noted earlier, the credit investment securities portfolio, which is included
in Proprietary Investments, is not included in DEaR for our proprietary
investing activities. The risks associated with this portfolio are managed
consistent with, and as part of, our approach to managing other forms of credit
risk. If the credit investment portfolio had been included in proprietary
investing DEaR, the impact would have not been significant on December 31, 1998;
and it would have been $2 million on December 31, 1997.

AGGREGATE DEaR

Average aggregate DEaR was $55 million in 1998, up from $29 million in 1997. The
increase reflects the growth in our markets businesses, and larger positions in
our proprietary activities, as well as extraordinarily high volatilities,
particularly from August through October. Aggregate DEaR ranged from $33 million
to $120 million in 1998, compared with $22 million to $37 million in 1997. At
December 31, 1998 and 1997, aggregate DEaR was $83 million and $31 million,
respectively.

CREDIT RISK

Credit risk arises in many of our business activities. In lending activities, it
occurs primarily through loans, conditional contracts to lend money to a client
in the future under specific terms (commitments), and unconditional contracts to
support clients' obligations to third parties (standby letters of credit and
guarantees).

In sales and trading activities, credit risk arises because of the possibility
that our counterparty will not be able or willing to fulfill its obligation on a
transaction on or before settlement date.

In derivative activities, credit risk arises when counterparties to derivative
contracts, such as interest rate swaps, are obligated to pay us the positive
fair value or receivable resulting from the execution of contract terms.

We are subject to credit risk when we act as an intermediary on behalf of
clients and other third parties - for example, when we indemnify third-party
lenders on the performance of their borrowers on stock loan transactions or
advance payments to third parties on behalf of securities clearance and
settlement activities.

Credit risk also arises from issuers of government and corporate bonds and
selected equity securities that are utilized in our market making and
proprietary investing activities. This form of credit risk is measured and
managed as part of our market risk management process.

Exposure to credit risk is measured in terms of both current and potential
exposure. Current credit exposure is generally represented by the notional or
principal value of on-balance-sheet financial instruments and off-balance-sheet
direct credit substitutes, such as commitments and standby letters of credit and
guarantees. Current credit exposure includes the positive fair value of
derivative instruments. Because many of our exposures vary with changes in
market prices and the borrowing needs of our clients, we also estimate the
potential credit exposure over the remaining term of transactions through
statistical analyses of market prices and borrowing patterns. In determining our
exposure, we consider collateral and master netting agreements, which we use to
reduce individual counterparty risk, primarily in connection with derivative
products.

CREDIT RISK MANAGEMENT

We continuously manage the credit risk of individual transactions,
counterparties, countries, and other portfolio levels through (1) the request
and approval process, (2) on-going credit monitoring, including regular large
risk reviews and monthly business risk reviews, (3) proactive exposure
management, (4) our Asset Quality Review (AQR) process, and (5) the use of
economic capital-at-risk and other tools.

54 Risk management
<PAGE>   57
Request and approval

The initial decision of whether to extend credit is done on a name-by-name
basis. Credit approvals are made by experienced credit officers, based on an
evaluation of the counterparty's creditworthiness and the type of credit
arrangement, for a given transaction or in total for that counterparty. The
officers consider the counterparty's current and projected financial condition
as well as the covenants, collateral, and protection available in the event of
credit quality deterioration. Credit officers are granted authority to extend
credit at different levels, with the largest or riskiest credit extension
decisions requiring the approval of senior credit managers. In addition, the
CRMG sets concentration limits for various industries, countries, geographic
regions and products.

Ongoing credit monitoring

After credit has been extended, credit officers and industry analysts, in
collaboration with business managers, continue to monitor the counterparty's
credit quality. Collateral is often used as an important element in this
process. Senior credit officers regularly review current and potential exposure
and adherence to limits on both individual counterparties and portfolios. Credit
risk is also monitored by the senior members of the Risk Management Committee
and senior credit officers, who review each counterparty to whom we have
significant exposure. The Risk Management Committee regularly reviews our
overall credit risk profile in light of current market conditions.

We use collateral as a means of mitigating credit exposure from over-the-counter
derivative contracts. Credit officers are also involved in the decision to
collateralize (structure collateral terms) and in the ongoing monitoring of
collateralized exposures. The firm currently has more than 900 collateralized
relationships with all types of counterparties - including hedge funds, banks
and broker-dealers, and corporate clients - across the credit rating spectrum.
Collateral generally consists of highly-rated liquid securities and cash. At
least once each day, we compute the value of our credit exposure and the value
of collateral currently held against it for all counterparties with which we
have a collateral agreement. Each day, or as often as we consider necessary, we
call for additional collateral from our counterparties.

Proactive exposure management

Proactive portfolio management involves making interim credit decisions and
changing risk concentrations in response to market events or changes in the
firm's credit strategy. Tools for active management include sales of loans and
investment securities, unwinding of derivative contracts, credit derivative
transactions and other hedges, and capital market transactions such as
securitizations.

Asset Quality Review

Our credit review procedures are designed to promote early identification of
counterparty, country, industry, and product exposures that require special
monitoring. These procedures are based on the Asset Quality Review process, a
systematic bottom-up review of exposures that is used by management to estimate
probable credit losses and determine the appropriateness of our related
allowances. This process relies extensively on management's experience and
judgment. It is dynamic and ongoing throughout the year, with major reviews at
the end of every quarter. Key participants include senior members of the Risk
Management Committee, the Senior Credit Officer, the Controller, and
representatives of our external and internal auditors and legal counsel.

Every quarter, credit officers identify risks for review by the senior
management team. The starting point is the Special Review List, a list of
counterparties that require special periodic review until the Senior Credit
Officer determines that there is no further need to do so. The items reviewed
represent the credit concerns of our credit officers worldwide on specific
counterparties, industries, and countries that merit analysis and discussion.

The relevant credit risk officer analyzes and prepares a write-up on the risk,
which includes the history of our relationship with the counterparty, current
exposure and cause for concern with current exposure, business financials,
market performance, an impairment analysis, and management's business and
financial strategy. The write-up concludes with a recommendation to the AQR
Committee. Such a recommendation could be placement on impaired status, specific
allocation, charge-off, or continued review. Similar write-ups are prepared on
industries or countries as appropriate.

Each credit risk issue is presented to the AQR Committee by the assigned credit
risk officer at the Committee's quarterly meetings. Based on this discussion,
the AQR Committee, using its judgment and experience, determines the appropriate
actions (placement on impaired status, specific allocation, or charge-off) that
should be taken with regard to specific individual counterparties, industries,
and countries.

The AQR Committee then considers appropriate actions to be taken in addition to
the specific risk decisions reached at the AQR Committee meeting. This typically
includes a review of expected loss calculations for the existing performing
portfolio; business and economic conditions; regulatory requirements; our
historical experience; concentrations of risk by country, industry, product, and
client; the relative size of many of our credit exposures, given our wholesale
orientation; the level and history of impaired assets and charge-offs; and the
estimated sale prices of certain exposures.

                                                              Risk management 55
<PAGE>   58
The outcome of the review results in a quarterly determination of the
appropriateness of the level of the allowances for credit losses and the
necessity for provisions or reversals of provisions. This review is performed
separately for each allowance classification - loans and commitments to extend
credit - and on a component-by-component basis within each allowance.

A review is also performed by the AQR Committee on any other significant
exposures with credit concerns to determine appropriate actions. This includes a
review of derivative receivables with credit risk issues to determine the
appropriate credit adjustment needed to determine the fair value of the
portfolio.

Our approach to determining the appropriate allowances uses a bottom-up
evaluation of probable losses by counterparty, industry, or country component; a
statistical model estimate for probable losses on our performing portfolio; and
a general component for probable losses that is necessary to reflect the
imprecise, subjective, and judgmental elements inherent in evaluating credit
risk. Refer to note 1, "Summary of significant accounting policies," for more
information on the components of our allowances. The results of the AQR process
are documented and reviewed by the chief financial officer and the chairman. The
Board of Directors is updated each quarter on credit events affecting the firm
and our assessment of the appropriateness of our allowances.

ECONOMIC CAPITAL-AT-RISK AND OTHER TOOLS

In any given year, credit losses may exceed expected losses. As discussed
earlier, expected losses under applicable accounting literature are
appropriately reserved for in allowances for credit losses. We utilize a
simulation model to estimate potential unexpected losses, referred to as
economic capital-at-risk, due to both counterparty defaults and rating
downgrades. The model incorporates exposures from traditional credit products
and derivatives and uses the credit quality and maturity profile of exposures as
well as correlations between counterparties as key inputs. Together, our
allowances and economic capital-at-risk estimate give us an estimate of a
potential aggregate credit risk-related loss we could incur at specific levels
of confidence.

No single measure can capture all dimensions of credit risk. We supplement the
measures described above with additional credit risk information and tools,
including stress tests, to fortify our understanding of the potential range of
adverse outcomes from the firm's credit risk. These sensitivity analyses,
together with management's judgment, provide an estimate of the potential
exposure and losses resulting from changes to our credit risk model's
parameters.

LIQUIDITY RISK

The objective of our liquidity policy is to maintain sufficient capital, plus
long-term debt and capital securities, to ensure the capacity to fund the
institution on a fully collateralized basis if necessary. The strategy ensures
that, even under adverse conditions, we have access to funds necessary to meet
client needs, maturing liabilities, and the capital requirements of our
subsidiaries. Further, on a weekly basis, we perform stress tests on our
liquidity profile to evaluate the reasonableness of our projections and our
ability to raise funds, even under adverse circumstances. Since liquidity risk
is closely linked to both credit and market risk, many of the previously
discussed processes and mechanisms also apply to the monitoring and management
of liquidity risk.

The Global Liquidity Management group is responsible for identifying, measuring,
and monitoring our liquidity profile and for ensuring that current and future
funding requirements are met. We raise funds globally through a variety of
instruments, including deposits, commercial paper, bank notes, repurchase
agreements, federal funds, long-term debt, and capital securities.

OPERATING RISK

Operating risk includes:

-        Execution risk: the risk that the execution of a transaction will be
         inconsistent with management's intentions and expectations. Key aspects
         of execution risk include failure to detect and manage unauthorized
         transactions, improper capture, and faulty processing and recording of
         transaction details, as well as inadequate safeguarding of assets.

-        Information risk: the risk that information created, received,
         processed, stored, or transmitted within or outside the firm will be
         unavailable, of poor quality, improperly utilized, or inappropriately
         accessed. Information risk includes the risks arising from the
         processes and technology used to manage information.

-        Relationship risk: the risk to the firm of damaging client
         relationships as a result of inappropriate or unsatisfactory delivery
         of products or services. It also includes the risk of entering into
         relationships with clients and counterparties whose character or
         business practices do not meet our standards.

-        Legal/regulatory risk: the risk of changes to, or noncompliance with,
         federal, state, or local laws and regulations or lack of conformity
         with relevant standards (e.g., accounting standards). It is also the
         risk that a transaction is not legally enforceable or will become
         unenforceable over its life or that contractual obligations will not be
         fulfilled.

56 Risk management
<PAGE>   59
-        People risk: the potential for a lack of appropriate skills and
         resources and related supervision to meet business requirements, for
         the misuse of these resources, and for inappropriate judgment or
         improper behavior of staff.

Operating risk management

Primary responsibility for managing operating risk rests with business managers.
These individuals, with the support of their staff, are responsible for
establishing and maintaining internal control procedures that are appropriate
for their operating environments. To this end, the objectives of each business
activity are identified and the risks associated with those objectives assessed.
The business managers institute a series of policies, standards, and procedures
to manage these risks, considering their nature and magnitude. Periodic
self-assessment and monitoring mechanisms help ensure that established internal
controls are effective and operating in accordance with established standards.

The Operating Risk Committee is responsible for setting the firm's overall
strategic operating risk agenda and monitoring its progress. The Committee meets
regularly to discuss the most significant operating risks facing the firm, to
monitor the health of the control environment, and to initiate actions as
necessary to offset those risks.

Our Internal Audit department objectively reviews our business activities to
assess the quality of the control environment and recommend actions to address
any issues. It supports the Audit and Examining Committee, a key independent
oversight body composed of members of the Board of Directors who are independent
of management. This committee is kept abreast of the overall and business level
control environment, as well as the status of important control initiatives.

Our control environment is built on the integrity, competence, and supervision
of our professionals, as well as management's control philosophy and operating
style. This comprehensive system of internal controls is designed to ensure
compliance with the policies and procedures of the firm and the appropriate
management of operating risks, all of which support the firm's objectives.

Two unique examples of potential operating risk are preparation for the year
2000 and the economic and monetary union in Europe (EMU). We successfully
handled the introduction of the euro - the single currency of the European
Community - on January 4, 1999. Year 2000 preparation remains on schedule and is
discussed in the following section.

The year 2000 initiative

With the new millennium approaching, organizations are examining their computer
systems to ensure that they are year 2000 compliant. The issue, in simple terms,
is that many existing computer systems fail to properly identify dates after
December 31, 1999. Systems that calculate, compare, or sort using the incorrect
date will cause erroneous results, ranging from system malfunctions to incorrect
or incomplete transaction processing. If systems are not updated, potential
risks include business interruption or shutdown, financial loss, reputation
loss, regulatory actions, and/or legal liability. J.P. Morgan uses computers in
all aspects of its business including processing of transactions from inception
through to settlement.

We have undertaken a firmwide initiative to address the year 2000 issue and
developed a comprehensive plan to mitigate the internal and external risks. The
internal components of the initiative address software applications, technology
products and facilities; the external components address credit and operating
risk and fiduciary responsibilities. Each business line is responsible for
remediating within its operating area, addressing all interdependencies within
the firm, and identifying and managing risk posed by external entities,
including clients, counterparties, vendors, exchanges, depositories, utilities,
suppliers, agents, and regulatory agencies. A multidisciplinary team of internal
and external experts supports the business teams by providing direction and
firmwide coordination.

We divided our remediation plan into five phases:

-        Awareness: To begin, we launched a firmwide awareness campaign,
         developed and implemented an organizational model, set up a management
         oversight committee, and established a risk model. Status: complete.

-        Inventory/assessment: We conducted a firmwide inventory of information
         technology (IT) and non-IT (e.g., telecommunications, power, facilities
         applications, and products), documented business processes, and
         identified external interfaces and dependencies. In this phase we
         assessed the potential impact on these inventories, prioritized
         renovation activities, developed renovation plans, and determined the
         compliance status of third-party products and services. Status:
         complete.

-        Renovation/replacement: We set about to identify "replace vs. renovate"
         opportunities, renovate applications and products, and document code
         and system changes. Status: 90% complete for critical applications.

-        Testing: We established a consistent testing methodology, conducted
         unit and system tests, and received certification sign-off from senior
         business managers. Status: 89% complete for critical applications.

-        Implementation: This final phase entails implementing critical updated
         applications and products and conducting final compliance
         certification. Status: 72% complete for critical applications.

                                                              Risk management 57
<PAGE>   60
The awareness and inventory/assessment phases were completed in 1997. The
renovation/replacement and testing phases were substantially completed by
December 31, 1998; over 90% of internal critical applications achieved
certification, based on the firm's certification process, which meets Federal
Financial Institutions Examination Council (FFIEC) guidelines for year 2000
compliance. In the implementation phase, over two-thirds of critical, certified
applications have been implemented globally. The remaining critical applications
are scheduled to be tested and substantially implemented by June 30, 1999. Among
building systems, over 90% of those in firm-owned premises and 75% of those in
rented premises have been tested. We have also successfully participated in
several industry tests, including the Securities Industry Association-sponsored
Equities Beta Test and Futures Industry Association-sponsored Futures and
Options Beta Test. The main risk to completing the remaining technology schedule
is the performance of vendor-supplied software and service providers.

Based on currently available information, management does not believe that the
year 2000 issue as it relates to our internal systems will have a material
adverse impact on the firm's financial condition or overall trends in results of
operations. There can be no assurance, however, that the failure to ensure year
2000 capability by a third party would not have a material adverse effect on the
firm. To date, we have not received sufficient information from certain parties
and international markets to complete our external assessment. The failure of
external parties to resolve their own year 2000 issues could expose J.P. Morgan
to potential losses, impairment of business processes and activities, and
financial markets disruption. We are working with key external parties to stem
the potential risks the year 2000 problem poses to us and the global financial
community.

As such, the focus of the program has turned toward the assessment and
mitigation of external risks. The overall goal of our Risk Mitigation Delivery
Model is to identify year 2000 risks and institute plans to mitigate these
risks. The following steps have been, or are being, taken:

-        Identify and address the year 2000 program risks which would prevent
         the completion of work to achieve year 2000 compliance for all high
         critical/ high risk functions - Status: complete;

-        Deploy mitigation strategies prior to the millennium event in order to
         reduce the probability of business disruption at the millennium change
         - Status: ongoing;

-        Develop business recovery plans for high likelihood and impact risk
         areas in the event of post-millennium failure - Status: due June;

-        Develop an overall command center (crisis management) framework for
         successfully responding to potential business disruptions as they
         occur, caused either by internal or external failures - Status: due
         April;

-        Establish risk committees within each line of business to monitor risk
         sources and oversee the implementation of the above mitigation -
         Status: complete.

To date, we have completed an initial assessment of readiness of the key clients
who, in aggregate, represent the majority of our credit exposure. A process is
in place to monitor readiness on an ongoing basis and take credit action where
appropriate. For other external parties, we have developed scenario and
contingency plans that identify and track the impact and likelihood of key
events that could impact our ability to conduct business as usual. These plans
identify trigger points to actions that will mitigate risk on a timely basis,
prior to the millennium. During the first half of 1999, business recovery plans
will be developed to manage both internal and external failures that may take
place over and after the millennium changeover, including February 29, 2000.

The cost to prepare the firm for the year 2000 is estimated at $300 million,
including $225 million incurred through December 1998 ($130 million in 1998 and
$95 million in 1997). Costs incurred relating to this project are funded through
operating cash flow and expensed during the period in which they are incurred.
The firm's expectations about future costs associated with the year 2000 are
subject to uncertainties that could cause actual spending to differ materially
from that anticipated.

The above section on the year 2000 initiative contains forward-looking
statements including, without limitation, statements relating to the firm's
plans, expectations, intentions, and adequate resources that are made pursuant
to the "safe harbor" provisions of the Private Securities Litigation Reform Act
of 1995. Estimates are based on assumptions of future events, including the
availability of resources, third-party renovation plans, and other factors.
There can be no guarantee, however, that our estimates will be achieved or that
there will not be a delay in achieving our plans. Specific factors that could
cause actual results to differ materially from our estimates include, but are
not limited to, the availability and cost of resources, the ability to locate
and correct all relevant noncompliant systems, and timely responses to and
renovations by third parties and similar uncertainties. Refer to page 47 for
more information on forward-looking statements.

58 Risk management
<PAGE>   61
GLOSSARY

Assets under management: assets we hold in an agency or fiduciary capacity for
clients. These assets are not assets of J.P. Morgan, and therefore, are not
included on our balance sheet.

Charge-off: a receivable, loan or other open account balance that has proven
uncollectible and is written off.

Collateral: assets pledged by a party to secure credit exposure arising from a
loan or derivative contract. In the event of counterparty default, the secured
party may liquidate the assets and use the proceeds to offset the loss on a
derivative contract or repay the balance of a loan.

Credit default swap: an agreement between two parties whereby one party pays the
other a fixed periodic coupon for the specified life of the agreement. The other
party makes no payments unless a specified credit event (such as a default)
occurs. If such a credit event occurs, the party makes a payment to the first
party and the swap then terminates.

Currency swaps: an agreement that generally involves exchanging principal at
inception and maturity - the notional amount - and periodic interest payments in
one currency for principal and periodic interest payments in another currency.

Derivative: a contract or agreement whose value is derived from changes in
interest rates, foreign exchange rates, prices of securities, or financial or
commodity indices.

EMU: the economic and monetary union taking place in Europe, which has resulted
in the introduction of a shared currency called the euro.

Foreign exchange contracts: derivative contracts that involve an agreement to
exchange one country's currency for another at an agreed-upon price and
settlement date.

Future: a standardized exchange-traded derivative contract to buy or sell a
specific financial instrument, commodity, or index at a specific future date and
price.

G-7 (Group of Seven): seven major industrialized countries that try to
coordinate monetary and fiscal policies with the goal of creating a more stable
world economic system. They are the United Kingdom, Canada, France, Germany,
Italy, Japan, and the United States.

G-10 (Group of 10): includes countries of the G-7 plus Belgium, the Netherlands
and Sweden.

Hedge fund: generally, a private partnership of accredited investors that buys
and sells stocks, bonds, and commodities, often using derivatives and leverage,
based on sophisticated strategies.

Hedging: the financial technique in which transactions or contractual agreements
are undertaken to reduce the risk of loss from one or more types of business
risk including unfavorable movements in interest rates, foreign exchange rates,
or equity or commodity prices.

International Monetary Fund (IMF): an international lending organization that
focuses on lowering trade barriers and stabilizing currencies. It helps
developing nations pay their debts and usually imposes tough guidelines aimed at
lowering inflation, cutting imports, and raising exports.

Initial public offering (IPO): a corporation's first offering of stock to the
public.

Interest rate swaps: a derivative contract involving the exchange of periodic
interest payments for a specified time. The notional amounts of interest rate
swaps are not exchanged; they are used solely to calculate the periodic interest
payments.

Mark to market: adjustment of the valuation of a security or portfolio to
reflect current fair values.

Master netting agreements: agreements under which gains and losses associated
with qualifying transactions with the same counterparty are offset so that
credit exposure is reduced.

Option: an agreement that provides the purchaser the right, but not the
obligation, to buy (call) or sell (put) a security at a fixed price (exercise or
strike price) on or before a specified date. The buyer pays a nonrefundable fee
(the premium) to the seller (the writer).

Risk-based capital: a measure of a bank's financial strength developed by
banking regulators, taking into account the risks inherent in the bank's assets
as well as its off-balance-sheet exposures.

Securities purchased under agreements to resell (resale or reverse repo
agreements): an agreement between a seller and a buyer, usually of U.S.
Government or agency securities, whereby the dealer agrees to buy securities and
the investor agrees to repurchase them, at an agreed-upon price and usually at a
stated time.

Securities sold under agreements to repurchase (repurchase agreements): an
agreement between a seller and a buyer, usually of U.S. Government or agency
securities, whereby the seller agrees to repurchase the securities at an
agreed-upon price and usually at a stated time.

Spread risk: the possibility that changes in credit spreads will affect the
value of financial instruments.

Stress test: a single-scenario risk assessment used for analyzing the market
risk of a portfolio. The methodology consists of simulating the performance of a
portfolio under one or a handful of user-defined adverse market scenarios.

Write-down: a downward adjustment of the value of an asset.

Yankee bond: a dollar-denominated bond issued in the U.S. by non-U.S.
corporations.

Year 2000 initiative: the endeavor to fix the year 2000 problem, which is the
inability of computer systems to properly recognize dates beyond December 31,
1999.

                                                                     Glossary 59
<PAGE>   62
Table of contents

61   Responsibility for financial reporting

62   Report of independent accountants

63   Consolidated statement of income -
     J.P. Morgan & Co. Incorporated

64   Consolidated balance sheet -
     J.P. Morgan & Co. Incorporated

65   Consolidated statement of changes in
     stockholders' equity

67   Consolidated statement of cash flows -
     J.P. Morgan & Co. Incorporated

68   Consolidated statement of condition -
     Morgan Guaranty Trust Company of New York

69   Notes to consolidated financial statements

128  Additional selected data

130  Selected consolidated quarterly financial data

131  Consolidated average balances and
     taxable-equivalent net interest earnings

134  Cross-border and local outstandings

136  Form 10-K annual report

137  Form 10-K cross-reference index

138  Signatures

139  Management

140  J.P. Morgan directory

142  Board of Directors

143  International Council

144  Directors Advisory Council

145  Corporate information

146  Index



60 Table of contents
<PAGE>   63
RESPONSIBILITY FOR FINANCIAL REPORTING

The consolidated financial statements in this Annual report were prepared by the
management of J.P. Morgan. In doing so, management applied generally accepted
accounting principles and also exercised its judgment and made estimates
wherever they were deemed appropriate. Other financial information that is
included in this Annual report is consistent with that of the consolidated
financial statements.

In discharging its responsibility for both the integrity and fairness of these
statements and information, and for the examination of the accounting systems
from which they are derived, management maintains a system of internal control
designed to provide reasonable assurance, weighing the costs with the benefits
sought, that transactions are executed in accordance with its authorization and
in compliance with laws and regulations, assets are safeguarded, and proper
records are maintained. An important element in management's effort to establish
a reliable control environment is the careful selection, training, and
development of professional personnel. Management believes that the system of
internal control, which is subject to close scrutiny by management itself and by
internal auditors and is revised as considered necessary, supports the integrity
and reliability of the consolidated financial statements.

Further, independent accountants perform a study and evaluation of the system of
internal accounting control for the purpose of expressing an opinion on the
consolidated financial statements of J.P. Morgan.

The Board of Directors of J.P. Morgan appoints an Audit and Examining Committee
responsible for monitoring the accounting practices and internal controls of the
firm. The committee, whose membership consists of directors who are not officers
or employees of J.P. Morgan, meets periodically with members of the internal
auditing staff to discuss the nature and scope of their work and to review such
reports and other matters as the committee deems necessary. The committee also
recommends to the Board of Directors the engagement of an independent accounting
firm and meets with representatives of that firm to discuss the examination of
the consolidated financial statements as well as other auditing and financial
reporting matters. Both the internal auditors and the independent accountants
are given access to the Audit and Examining Committee at any time to discuss
privately matters they believe may be of significance.

In addition, J.P. Morgan is examined periodically by examiners from the Federal
Reserve System, the State of New York Banking Department, the New York Stock
Exchange, and other regulatory agencies. The Board of Directors and management
consider reports that arise from such examinations.

Douglas A. Warner III
Chairman of the Board

John A. Mayer Jr.
Chief Financial Officer

                                       Responsibility for financial reporting 61
<PAGE>   64
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
of J.P. Morgan & Co. Incorporated

We have audited the accompanying consolidated balance sheet of J.P. Morgan & Co.
Incorporated ("J.P. Morgan") and its subsidiaries as of December 31, 1998 and
1997, the related consolidated statements of income, of changes in stockholders'
equity, and of cash flows for each of the three years in the period ended
December 31, 1998, and the consolidated statement of condition of Morgan
Guaranty Trust Company of New York and its subsidiaries as of December 31, 1998
and 1997. These financial statements are the responsibility of J.P. Morgan's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements audited by us present
fairly, in all material respects, the financial position of J.P. Morgan and its
subsidiaries at December 31, 1998 and 1997, the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1998, and the financial position of Morgan Guaranty Trust Company of New York
and its subsidiaries at December 31, 1998 and 1997, in conformity with generally
accepted accounting principles.

PricewaterhouseCoopers LLP
New York, New York
January 13, 1999

62 Report of independent accountants
<PAGE>   65
CONSOLIDATED STATEMENT OF INCOME
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
====================================================================================================================================
In millions, except share data                                                              1998              1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                      <C>               <C>               <C>
NET INTEREST REVENUE
Interest revenue .............................................................           $12 641           $12 353           $10 713
Interest expense .............................................................            11 360            10 481             9 011
------------------------------------------------------------------------------------------------------------------------------------
Net interest revenue .........................................................             1 281             1 872             1 702
Provision for loan losses (notes 1, 15) ......................................               110                --                --
------------------------------------------------------------------------------------------------------------------------------------
Net interest revenue after provisions for loan losses ........................             1 171             1 872             1 702

NONINTEREST REVENUES

Trading revenue ..............................................................             2 362             2 137             2 477
Investment banking revenue ...................................................             1 401             1 123               921
Investment management revenue ................................................               881               792               675
Fees and commissions .........................................................               748               647               582
Investment securities revenue ................................................               205               409               303
Other revenue (notes 1, 4, 15) ...............................................               187               240               195
------------------------------------------------------------------------------------------------------------------------------------
Total noninterest revenues ...................................................             5 784             5 348             5 153

TOTAL REVENUES, NET OF INTEREST EXPENSE AND PROVISIONS FOR CREDIT LOSSES .....             6 955             7 220             6 855

OPERATING EXPENSES (note 3)

Employee compensation and benefits ...........................................             3 233             3 027             2 884
Net occupancy ................................................................               437               333               296
Technology and communications ................................................             1 192             1 025               785
Other expenses ...............................................................               676               681               558
------------------------------------------------------------------------------------------------------------------------------------
Total operating expenses .....................................................             5 538             5 066             4 523

Income before income taxes ...................................................             1 417             2 154             2 332
Income taxes .................................................................               454               689               758
------------------------------------------------------------------------------------------------------------------------------------
Net income ...................................................................               963             1 465             1 574

PER COMMON SHARE
Net income
  Basic ......................................................................           $  5.08           $  7.71           $  8.11
  Diluted ....................................................................              4.71              7.17              7.63
Dividends declared ...........................................................              3.84              3.59              3.31
------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>

                                             Consolidated statement of income 63
<PAGE>   66
CONSOLIDATED BALANCE SHEET
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
==================================================================================================================================
                                                                                                                       December 31
In millions, except share data                                                                                      1998      1997
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                                               <C>       <C>
ASSETS
Cash and due from banks ......................................................................................    $1 203    $1 758
Interest-earning deposits with banks .........................................................................     2 371     2 132
Debt investment securities available-for-sale carried at fair value
  (cost: $36 107 at 1998 and $22 507 at 1997) ................................................................    36 232    22 768
Equity investment securities .................................................................................     1 169     1 085
Trading account assets .......................................................................................   113 896   111 854
Securities purchased under agreements to resell
  ($31 056 at 1998 and $39 002 at 1997) and federal funds sold ...............................................    31 731    39 002
Securities borrowed ..........................................................................................    30 790    38 375
Loans, net of allowance for loan losses of $470 at 1998 and $546 at 1997 .....................................    25 025    31 032
Accrued interest and accounts receivable .....................................................................     7 689     4 962
Premises and equipment, net ..................................................................................     1 881     1 838
Other assets .................................................................................................     9 080     7 353
----------------------------------------------------------------------------------------------------------------------------------
Total assets                                                                                                     261 067   262 159
----------------------------------------------------------------------------------------------------------------------------------

LIABILITIES
Noninterest-bearing deposits:
  In offices in the U.S. .....................................................................................     1 242     1 482
  In offices outside the U.S. ................................................................................       563       744
Interest-bearing deposits:
  In offices in the U.S. .....................................................................................     7 724     9 232
  In offices outside the U.S. ................................................................................    45 499    47 421
----------------------------------------------------------------------------------------------------------------------------------
Total deposits ...............................................................................................    55 028    58 879
Trading account liabilities ..................................................................................    70 643    71 141
Securities sold under agreements to repurchase
  ($62 784 at 1998 and $53 202 at 1997) and federal funds purchased ..........................................    63 368    57 804
Commercial paper .............................................................................................     6 637     6 622
Other liabilities for borrowed money .........................................................................    12 515    17 176
Accounts payable and accrued expenses ........................................................................     9 859    10 865
Long-term debt not qualifying as risk-based capital ..........................................................    23 037    18 246
Other liabilities, including allowance for credit losses of $125 at 1998
  and $185 at 1997 ...........................................................................................     2 999     4 129
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                 244 086   244 862

Liabilities qualifying as risk-based capital:
Long-term debt ...............................................................................................     4 570     4 743
Company-obligated mandatorily redeemable preferred securities of subsidiaries ................................     1 150     1 150
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities ............................................................................................   249 806   250 755
Commitments and contingencies (notes 13, 23, 24, and 26)

STOCKHOLDERS' EQUITY
Preferred stock (authorized shares: 10 000 000)
  Adjustable-rate cumulative preferred stock, $100 par value (issued and outstanding: 2 444 300) .............       244       244
  Variable cumulative preferred stock, $1 000 par value (issued and outstanding: 250 000) ....................       250       250
  Fixed cumulative preferred stock, $500 par value (issued and outstanding: 400 000) .........................       200       200
Common stock, $2.50 par value (authorized shares: 500 000 000;
  issued: 200 873 067 at 1998 and 200 692 673 at 1997) .......................................................       502       502
Capital surplus ..............................................................................................     1 252     1 360
Common stock issuable under stock award plans ................................................................     1 460     1 185
Retained earnings ............................................................................................     9 614     9 398
Accumulated other comprehensive income:
  Net unrealized gains on investment securities, net of taxes ................................................       147       432
  Foreign currency translation, net of taxes .................................................................       (46)      (22)
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                  13 623    13 549
Less: treasury stock (25 866 786 shares at 1998 and 24 374 944 shares at 1997) at cost .......................     2 362     2 145
----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity                                                                                        11 261    11 404
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity                                                                       261 067   262 159
----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>

64 Consolidated balance sheet
<PAGE>   67
Consolidated statement of changes in stockholders' equity
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
==================================================================================================================================
                                                                  1998                          1997                          1996
                                          ----------------------------  ----------------------------  ----------------------------
                                          Stockholders'  Comprehensive  Stockholders'  Comprehensive  Stockholders'  Comprehensive
In millions:                                     equity         income         equity         income         equity         income
----------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>            <C>            <C>            <C>            <C>            <C>
PREFERRED STOCK
Adjustable-rate cumulative 
  preferred stock balance,
    January 1 and December 31 ............        $ 244                         $ 244                         $ 244
Variable cumulative preferred 
  stock balance,
    January 1 and December 31 ............          250                           250                           250
Fixed cumulative preferred 
  stock:
Balance, January 1 .......................          200                           200                            --
Shares issued.............................           --                            --                           200
----------------------------------------------------------------------------------------------------------------------------------
Total preferred stock, December 31 .......          694                           694                           694
----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
Balance, January 1 and December 31 .......          502                           502                           502
----------------------------------------------------------------------------------------------------------------------------------
CAPITAL SURPLUS
Balance, January 1 .......................        1 360                         1 446                         1 430
Shares issued or distributed under 
  dividend reinvestment plan, various 
  employee benefit plans, and conversion 
  of debentures and income tax benefits 
  associated with stock options ..........         (108)                          (86)                           16
----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31 .....................        1 252                         1 360                         1 446
----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ISSUABLE UNDER STOCK 
  AWARD PLANS
Balance, January 1 .......................        1 185                           838                           556
Deferred stock awards, net ...............          275                           347                           282
----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31 .....................        1 460                         1 185                           838
----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance, January 1 .......................        9 398                         8 635                         7 731
Net income ...............................          963           $963          1 465         $1 465          1 574         $1 574
Dividends declared on preferred stock ....          (37)                          (35)                          (33)
Dividends declared on common stock .......         (677)                         (642)                         (617)
Dividend equivalents on common 
  stock issuable .........................          (33)                          (25)                          (20)
----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31 .....................        9 614                         9 398                         8 635
----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income, subtotal ...........                         963                         1 465                         1 574
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                    Consolidated statement of changes in stockholders' equity 65
<PAGE>   68
<TABLE>
<CAPTION>
=================================================================================================================================
                                                                1998                          1997                           1996
                                        ----------------------------  ----------------------------   ----------------------------
                                        Stockholders'  Comprehensive  Stockholders'  Comprehensive   Stockholders'  Comprehensive
In millions:                                   equity         income         equity         income          equity         income
---------------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>            <C>            <C>            <C>             <C>            <C>
Comprehensive income, subtotal from 
  previous page .....................                            963                         1 465                          1 574
---------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME 
Net unrealized gains on investment 
  securities:
Balance, net of taxes, January 1 ....            432                          464                            566
---------------------------------------------------------------------------------------------------------------------------------
Net unrealized holding gains/(losses) 
  arising during the period, before 
  taxes (($169) in 1998, $137 in 
  1997, and $50 in 1996, net of 
  taxes) ............................           (285)                         217                             66
Reclassification adjustment for net 
  gains included in net income, 
  before taxes ($112 in 1998, $164 
  in 1997, and $162 in 1996, net 
  of taxes) .........................           (169)                        (261)                          (258)
---------------------------------------------------------------------------------------------------------------------------------
Change in net unrealized gains on 
  investment securities, before 
  taxes .............................           (454)                         (44)                          (192)
Income tax benefit/(expense) ........            169                           12                             90
---------------------------------------------------------------------------------------------------------------------------------
Change in net unrealized gains on 
  investment securities, net of 
  taxes .............................           (285)           (285)         (32)             (32)         (102)            (102)
Balance, net of taxes, December 31 ..            147                          432                            464
---------------------------------------------------------------------------------------------------------------------------------
Foreign currency translation:
Balance, net of taxes, January 1 ....            (22)                         (12)                            (4)
---------------------------------------------------------------------------------------------------------------------------------
Translation adjustment arising 
  during the period, before taxes ...            (38)                         (14)                           (14)
Income tax benefit ..................             14                            4                              6
---------------------------------------------------------------------------------------------------------------------------------
Translation adjustment arising 
  during the period, net of taxes ...            (24)            (24)         (10)             (10)           (8)              (8)
---------------------------------------------------------------------------------------------------------------------------------
Balance, net of taxes, December 31 ..            (46)                         (22)                           (12)
---------------------------------------------------------------------------------------------------------------------------------
Total accumulated other comprehensive 
  income, net of taxes, 
  December 31 .......................            101                          410                            452
---------------------------------------------------------------------------------------------------------------------------------

LESS: TREASURY STOCK
Balance, January 1 ..................           2 145                       1 135                            824
Purchases ...........................             755                       1 500                            604
Shares issued/distributed, primarily 
  related to various employee 
  benefit plans .....................            (538)                       (490)                          (293)
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31 ................           2 362                       2 145                          1 135
---------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity ..........          11 261                      11 404                         11 432
---------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income ..........                            654                         1 423                          1 464
---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>

66 Consolidated statement of changes in stockholders' equity
<PAGE>   69
CONSOLIDATED STATEMENT OF CASH FLOWS
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
==================================================================================================================================
In millions                                                                                    1998            1997           1996
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>              <C>            <C>
NET INCOME .........................................................................        $   963          $1 465        $1 574
Adjustments to reconcile to cash provided by (used in) operating activities:
  Net provision for credit losses ..................................................             50              --            --
  Gain on sale of businesses .......................................................           (113)             --            --
  Noncash items: depreciation, amortization, deferred income taxes,
    stock award plans, and write-downs on investment securities ....................            864             544           695
  Net (increase) decrease in assets:
   Trading account assets ..........................................................         (1 868)        (20 993)      (21 919)
   Securities purchased under agreements to resell .................................          7 981          (6 564)         (297)
   Securities borrowed .............................................................          7 585         (10 444)       (8 101)
   Loans held for sale .............................................................         (2 645)            144          (214)
   Accrued interest and accounts receivable ........................................         (2 724)          1 804        (3 227)
  Net increase (decrease) in liabilities:
   Trading account liabilities .....................................................           (318)         20 149         5 632
   Securities sold under agreements to repurchase ..................................          9 608          (2 929)       15 314
   Accounts payable and accrued expenses ...........................................           (489)          5 205        (3 699)
Other changes in operating assets and liabilities, net .............................         (2 035)          1 202         2 412
Net investment securities gains included in cash flows
  from investing activities ........................................................           (290)           (437)         (294)
---------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                              16 569         (10 854)      (12 124)
---------------------------------------------------------------------------------------------------------------------------------
Net (increase) decrease in interest-earning deposits with banks ....................           (234)           (225)           78
Debt investment securities:
  Proceeds from sales ..............................................................         13 874          22 655        29 754
  Proceeds from maturities, calls, and mandatory redemptions .......................          9 247           4 093         6 831
  Purchases ........................................................................        (37 341)        (25 007)      (36 923)
Net (increase) decrease in federal funds sold ......................................           (675)             50           (50)
Net decrease (increase) in loans ...................................................          8 563          (3 670)       (4 452)
Investment in American Century Companies, Inc. .....................................           (965)             --            --
Investment in Long-Term Capital Management, L.P. ...................................           (300)             --            --
Payments for premises and equipment ................................................           (247)           (138)         (183)
Other changes, net .................................................................           (741)           (627)          180
---------------------------------------------------------------------------------------------------------------------------------
CASH (USED IN) INVESTING ACTIVITIES                                                          (8 819)         (2 869)       (4 765)
---------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in noninterest-bearing deposits ............................           (419)             16        (1 822)
Net (decrease) increase in interest-bearing deposits ...............................         (3 295)          6 106         8 109
Net (decrease) increase in federal funds purchased .................................         (4 018)           (710)        1 016
Net increase in commercial paper ...................................................             16           2 490         1 331
Other liabilities for borrowed money proceeds ......................................         21 977          22 773        27 736
Other liabilities for borrowed money payments ......................................        (24 394)        (25 797)      (26 222)
Long-term debt proceeds ............................................................         12 906          12 315         5 288
Long-term debt payments ............................................................         (8 594)         (2 075)       (1 426)
Proceeds from issuance of company-obligated mandatorily redeemable
  preferred securities of subsidiaries .............................................             --             400           750
Capital stock issued or distributed ................................................            179             245           424
Capital stock purchased ............................................................           (755)         (1 500)         (604)
Dividends paid .....................................................................           (707)           (673)         (643)
Other changes, net .................................................................         (1 258)          1 036         2 319
---------------------------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES                                              (8 362)         14 626        16 256
---------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and due from banks .........................             57             (51)            4

(DECREASE) INCREASE IN CASH AND DUE FROM BANKS .....................................           (555)            852          (629)
Cash and due from banks, beginning of year .........................................          1 758             906         1 535
---------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks, end of year                                                          1 203           1 758           906
---------------------------------------------------------------------------------------------------------------------------------
Cash disbursements made for:
  Interest .........................................................................        $11 455         $10 030        $8 898
  Income taxes .....................................................................            800           1 254           748
---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>

                                         Consolidated statement of cash flows 67
<PAGE>   70
CONSOLIDATED STATEMENT OF CONDITION
Morgan Guaranty Trust Company of New York

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                                                                                                 December 31
In millions, except share data                                                                     1998                 1997
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                                            <C>                  <C>
ASSETS
Cash and due from banks .....................................................................  $  1 147             $  1 663
Interest-earning deposits with banks ........................................................     2 372                2 195
Debt investment securities available-for-sale carried at fair value (note 9) ................     3 634               20 539
Trading account assets ......................................................................    90 770               88 995
Securities purchased under agreements to resell .............................................    33 316               28 045
Securities borrowed .........................................................................     8 193               13 831
Loans, net of allowance for loan losses of $470 at 1998 and $545 at 1997 ....................    24 876               30 851
Accrued interest and accounts receivable ....................................................     3 898                4 534
Premises and equipment, net of accumulated depreciation of $1 160 at 1998                                         
  and $1 208 at 1997 ........................................................................     1 703                1 669
Other assets ................................................................................     5 337                4 096
----------------------------------------------------------------------------------------------------------------------------
Total assets                                                                                    175 246              196 418
----------------------------------------------------------------------------------------------------------------------------

LIABILITIES                                                                                                       
Noninterest-bearing deposits:                                                                                     
         In offices in the U.S. .............................................................     1 232                1 492
         In offices outside the U.S. ........................................................       572                  752
Interest-bearing deposits:                                                                                        
         In offices in the U.S. .............................................................     7 749               10 156
         In offices outside the U.S. ........................................................    46 668               48 343
----------------------------------------------------------------------------------------------------------------------------
Total deposits ..............................................................................    56 221               60 743
Trading account liabilities .................................................................    64 776               61 562
Securities sold under agreements to repurchase and federal funds purchased ..................    14 916               26 017
Other liabilities for borrowed money ........................................................     8 646               10 433
Accounts payable and accrued expenses .......................................................     6 123                7 160
Long-term debt not qualifying as risk-based capital (including $736 at 1998 and
  $1 267 at 1997 of notes payable to J.P. Morgan) ...........................................    10 358               14 320
Other liabilities, including allowance for credit losses of $125 at 1998 and                 
  $185 at 1997 ..............................................................................       542                2 713
----------------------------------------------------------------------------------------------------------------------------
                                                                                                161 582              182 948
                                                                                                                  
Long-term debt qualifying as risk-based capital (including $3 053 at 1998 and
  $2 878 at 1997 of notes payable to J.P. Morgan) ...........................................     3 186                3 037
----------------------------------------------------------------------------------------------------------------------------
Total liabilities ...........................................................................   164 768              185 985
Commitments and contingencies                                                                                     
                                                                                                                  
STOCKHOLDER'S EQUITY                                                                                              
Preferred stock, $100 par value (authorized shares: 2 500 000) ..............................         -                    -
Common stock, $25 par value (authorized shares: 11 000 000; issued and                                            
  outstanding: 10 599 027) ..................................................................       265                  265
Surplus .....................................................................................     3 305                3 155
Undivided profits ...........................................................................     6 836                6 927
Accumulated other comprehensive income:                                                                           
  Net unrealized gains on investment securities, net of taxes ...............................       118                  108
  Foreign currency translation, net of taxes ................................................       (46)                 (22)
----------------------------------------------------------------------------------------------------------------------------
Total stockholder's equity                                                                       10 478               10 433
----------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity                                                      175 246              196 418
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

The accompanying notes are an integral part of this consolidated financial
statement.


Member of the Federal Reserve System and Federal Deposit Insurance Corporation.



68 Consolidated statement of condition - Morgan Guaranty Trust Company of New
   York
<PAGE>   71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

J.P. Morgan & Co. Incorporated (J.P. Morgan), a global financial services firm,
is the holding company for a group of subsidiaries that provide a range of
financial services, including:

-        advisory
-        underwriting
-        financing
-        market making
-        asset management
-        brokerage

We serve a broad client base that includes corporations, governments,
institutions, and individuals. We also use our expertise and resources to enter
into transactions for our own account.

J.P. Morgan and our subsidiaries, including Morgan Guaranty Trust Company of New
York (Morgan Guaranty), use accounting and reporting policies and practices that
conform with U.S. generally accepted accounting principles.

BASIS OF PRESENTATION

CONSOLIDATION

Financial information included in the accounts of J.P. Morgan, and the
subsidiaries for which our ownership is more than 50% of the company, is
contained in the consolidated financial statements. All material intercompany
accounts and transactions are eliminated during consolidation.

For companies in which our voting or economic interest is 20% to 50%, we use the
equity method of accounting to determine our investments' carrying value. These
investments are included in Other assets and our share of income or loss is
included in Other revenue. The excess of our investment over our share of equity
(i.e., goodwill) is included in Other assets and is amortized on a straight-line
basis over the estimated period of benefit and is recorded in Other revenue.

Assets that we hold in an agency or fiduciary capacity are not assets of J.P.
Morgan. Therefore, they are not included in our "Consolidated balance sheet."

USE OF ESTIMATES IN THE PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS

To conform with generally accepted accounting principles, we are required to
prepare our consolidated financial statements using estimates and assumptions.
These estimates and assumptions affect our reported assets and liabilities and
our disclosure of contingent assets and liabilities at the date of the
consolidated financial statements. Our revenues and expenses reported during the
period are also affected. Actual results could be different from these
estimates.

FOREIGN CURRENCY TRANSLATION

Assets and liabilities denominated in foreign currencies are translated into
U.S. dollars using end-of-the-period exchange rates. We translate revenues and
expenses using weighted-average exchange rates.

The impact of translating the financial statements of a foreign operation where
the functional currency is other than the U.S. dollar is recorded in
Stockholders' equity, including the related hedge and tax effects.

The impact of translating the financial statements of a foreign operation where
the functional currency is the U.S. dollar, including an operation in a highly
inflationary environment, is reported in the "Consolidated statement of income."

                                   Notes to consolidated financial statements 69
<PAGE>   72
FAIR VALUE

For financial instruments carried at fair value, J.P. Morgan bases fair value on
listed market prices or broker or dealer price quotations. If listed market
prices or quotations are not available - as is the case for many
over-the-counter derivatives - we base fair value on management's estimates
using internal valuation techniques. With respect to the pricing of derivatives,
we consider fair value to consist of three elements:

-   position valuation that uses quoted values or related input factors (e.g.,
    volatility) which assume all counterparties have the same credit rating and
    that does not consider other factors, such as liquidity 

-   an adjustment of the resulting portfolio value for estimated credit spreads
    to reflect the credit quality (rating) of each specific counterparty and
    other pricing adjustments 

-   an adjustment of the portfolio of traded derivatives for inherent credit
    risk not appropriately reflected in credit spreads (counterparty ratings),
    including situations in which a counterparty's default or unwillingness to
    pay is probable and estimable

RECLASSIFICATIONS

We have reclassified certain amounts from previous years to conform with our
1998 presentation.

DEBT INVESTMENT SECURITIES

We hold debt investment securities to maximize total return. Our debt investment
securities portfolio includes:

-        U.S. Treasury and other U.S. government agency securities
-        U.S. state and political subdivision securities
-        Foreign government securities
-        U.S. and foreign corporate and bank debt securities

Debt investment securities are classified as available-for-sale and are carried
at fair value on our "Consolidated balance sheet." Available-for-sale securities
may be sold in response to or in anticipation of changes in interest rates and
prepayment risk, liquidity considerations, and other factors. Any unrealized
gains and losses, including the effect of hedges, are reported net within the
separate stockholders' equity account, Net unrealized gains on investment
securities, net of taxes, until realized.

Realized gains and losses are included in Investment securities revenue in the
"Consolidated statement of income." We generally use the specific identification
method to determine our gain or loss when a security is sold. We record debt
investment securities transactions on their respective trade dates. We reduce
the carrying values of individual debt investment securities through write-downs
to reflect any impairments in value that are other-than-temporary. Such
write-downs are included in Investment securities revenue.

EQUITY INVESTMENT SECURITIES

We hold equity investment securities of companies for long-term appreciation.
Equity investment securities consist of both marketable and nonmarketable
securities. They are recorded on a trade date basis.

We carry marketable equity investment securities at fair value. Unrealized gains
and losses, including the effect of hedges, are reported as a net amount within
the stockholders' equity account, Net unrealized gains on investment securities,
net of taxes, until realized. Nonmarketable equity investment securities are
carried at cost. Carrying values of individual equity investment securities are
reduced through write-downs to reflect other-than-temporary impairments in
value.

Securities held in subsidiaries registered as Small Business Investment
Companies (SBICs) are carried at fair value with changes in value recognized
currently in earnings.

Realized gains and losses on equity investment securities, generally computed by
the average cost method, changes in the fair value of securities held in SBICs,
other-than-temporary impairments in value, and related dividend income are
included in Investment securities revenue.

70 Notes to consolidated financial statements
<PAGE>   73
TRADING ACCOUNT ASSETS AND LIABILITIES

We use trading account assets and liabilities to facilitate client transactions
and to take advantage of market opportunities. Trading account assets and
liabilities include cash instruments, such as government and corporate debt and
equity securities, and the unrealized gains and losses on trading related
derivatives.

Trading account assets include securities purchased that we own ("long"
positions). Trading account liabilities include securities that we have sold to
other parties but do not own ourselves. These securities are "short" positions,
and we are obligated to purchase them at a future date.

Trading account assets and Trading account liabilities are carried at fair value
and recorded on a trade date basis. We recognize gains and losses on trading
positions as Trading revenue.

DERIVATIVES USED FOR TRADING PURPOSES

Derivative instruments used for trading purposes or used to manage risk in our
trading portfolios include swaps, futures, forwards, and options contracts in
the interest rate, foreign exchange, equity, credit, and commodity markets.

We carry derivatives used for trading purposes at fair value. We recognize gains
and losses from these derivatives in Trading revenue. We recognize, over the
life of the agreement, the portion of a performing derivative's fair value that
reflects credit considerations adjusted for changes in counterparty ratings,
ongoing servicing, and transaction hedging costs in Trading revenue.

We report unrealized gains and losses in Trading account assets or Trading
account liabilities after taking into consideration the offsetting permitted
under Financial Accounting Standards Board (FASB) Interpretation No. 39,
Offsetting of Amounts Related to Certain Contracts. This offsetting is achieved
through the use of master netting agreements.

We record the fair values of purchased options on a gross basis in Trading
account assets. The fair values of written options are recorded on a gross basis
in Trading account liabilities.

DERIVATIVES USED FOR PURPOSES OTHER-THAN-TRADING 
We use derivatives for purposes other-than-trading to:

-  hedge exposures
-  modify the interest rate characteristics of related balance sheet instruments
-  meet longer-term investment objectives, including maximizing net interest 
   revenue

We describe the specific criteria required for derivatives used for such
purposes below. Derivatives that do not meet these criteria are carried at fair
value with changes in their value included in the "Consolidated statement of
income."

Derivatives used as hedges must be effective at reducing the risk associated
with the exposure being hedged. They must be designated as a hedge at the
beginning of the derivative contract. Changes in the derivative's fair value
must be highly correlated with changes in the fair value of the underlying
hedged item for the entire life of the contract. Derivatives used for hedging
purposes include swaps, forwards, futures, and purchased options in interest
rate, foreign exchange, and credit markets.

Interest rate swaps are also used to modify the interest rate characteristics of
related balance sheet instruments. Swaps used to modify the interest rate
characteristics of nontrading-related balance sheet instruments must be linked
to the related asset or liability, whereby the terms of the swap generally equal
the terms of the related asset or liability, at the beginning and over the
entire life of the derivative contract. We generally defer unrealized gains and
losses on all of these derivative contracts.

                                   Notes to consolidated financial statements 71
<PAGE>   74
Derivatives that are either used to hedge or modify the interest rate
characteristics of debt investment securities are carried at fair value.
Unrealized gains and losses on these derivatives are included in Net unrealized
gains on investment securities, net of taxes, a separate component of
stockholders' equity. Cash margin requirements associated with futures contracts
and option premiums for contracts used as hedges are recorded in Other assets or
Other liabilities. The interest component associated with derivatives used as
hedges or to modify the interest rate characteristics of assets and liabilities
is recognized over the contract's life in Net interest revenue. When a contract
is settled or terminated, the cumulative change in the fair value is recorded as
an adjustment to the carrying value of the underlying asset or liability and
recognized in Net interest revenue over the asset or liability's expected
remaining life. If the underlying instrument is sold, we immediately recognize
the cumulative change in the derivative's value in the component of earnings
relating to the underlying instrument.

Prior to January 1, 1998, we used risk-adjusting swaps in a manner similar to
debt investment securities to achieve a desired overall interest rate profile by
increasing or decreasing our overall exposure to interest rate risk.
Risk-adjusting swaps included only interest rate swaps that replicated the cash
flows of nonamortizing cash instruments. They did not contain leverage or
embedded option features. Interest revenue and expense associated with these
swaps were accrued over the life of the swap agreement in Net interest revenue.
We carried risk-adjusting swaps at whichever amount was lower: the aggregate
cost or fair value. Aggregate unrealized net valuation adjustments, if any, were
recorded in Other revenue. Refer to note 11, "Derivatives."

SECURITIES FINANCING ARRANGEMENTS

Securities purchased under agreements to resell (resale agreements) and
Securities sold under agreements to repurchase (repurchase agreements) are
generally treated as collateralized lending and borrowing transactions. They are
carried at the amounts for which the securities will subsequently be resold or
reacquired, including accrued interest. Resale and repurchase agreements
conducted with the same counterparty are reported net provided they meet the
requirements of FASB Interpretation No. 41, Offsetting of Amounts Related to
Certain Repurchase and Reverse Repurchase Agreements. We take possession of
securities purchased under resale agreements. We also monitor the fair value of
the underlying securities, most of which are U.S. government and agency
securities. We compare this with the related receivable plus accrued interest.
If necessary, we request additional collateral.

Securities borrowed for cash collateral are included on the "Consolidated
balance sheet" at the amount of cash advanced in connection with the transaction
and consist primarily of government and equity securities to cover short
positions. Interest income and Interest expense are accrued ratably over the
life of the agreement.

PREMIUMS AND DISCOUNTS

We generally recognize amortization of premiums and accretion of discounts as
Interest expense or Interest revenue over the life of the instrument.

LOANS

Loans are generally reported at the principal amount outstanding. Purchased
loans are reported at the remaining unpaid principal net of any unamortized
discount or premium. We report loans held-for-sale at either cost or fair value,
whichever is lower. Loans held for trading purposes are carried at fair value
with gains and losses included in the "Consolidated statement of income." Loan
origination fees are deferred and recognized as an adjustment to yield over the
life of the loan. Interest income is accrued on the unpaid principal balance and
is included in Interest revenue.

IMPAIRED LOANS

Loans are identified as impaired when:

-  A default occurs or is expected to occur,

-  The payment of principal and/or interest or other cash flows is greater than
   90 days past due, depending the terms of the contract, or

72 Notes to consolidated financial statements
<PAGE>   75
-  Management has serious doubts as to the collectibility of future cash flows,
   even if the loan is currently performing.

Once a loan is identified as impaired, management regularly assesses impairment
in accordance with Statement of Financial Accounting Standards (SFAS) No. 114,
Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures (collectively with SFAS 114, SFAS No. 114). Management's assessment
of loan impairment is based on the present value of expected future cash flows,
observable market value, or the fair value of the collateral, as required under
SFAS No. 114. If the value of the asset is deemed impaired, an allowance is
established or appropriated for the amount deemed uncollectible; if the
impairment is deemed permanent or highly probable, the exposure is charged off
against the appropriate allowance.

When a loan is recognized as impaired, the accrual of interest is discontinued
and any previously accrued but unpaid interest on the loan is reversed against
the current period's interest revenue. Interest received on impaired loans is
applied in the following order:

1.  against the recorded impaired loan until paid in full
2.  as a recovery up to any amounts charged off related to the impaired loan
3.  as revenue

Impaired loans may be restored to performing status when all payments of
principal and/or interest or other cash flows are current or if management's
formal assessment of the counterparty's business and economic condition
indicates a revised classification. In the case of loans whose interest was
interrupted for a substantial period, a regular payment performance must be
established before the loan is restored to performing status.

ALLOWANCES FOR CREDIT LOSSES

We maintain allowances for credit losses to absorb losses inherent in our
traditional extensions of credit that we believe are probable of occurring and
that can be reasonably estimated. These allowances include an allowance for
loans and an allowance for off-balance-sheet credit financial instruments such
as commitments, and standby letters of credit and guarantees.

Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across
balance sheet reserve or allowance captions - which included a reserve for
trading derivatives needed to determine fair value, an allowance for loans, and
an allowance for off-balance-sheet financial instruments such as commitments and
standby letters of credit and guarantees - were shown as reclassifications.
Reclassifications had no impact on net income and, accordingly, were not shown
on the "Consolidated statement of income." Subsequent to July 1, 1998,
reclassifications across balance sheet captions for allowances are reflected as
provisions or reversals of provisions in the "Consolidated statement of income."

Our credit review procedures are designed to promote early identification of
counterparty, country, industry, and product exposures that require special
monitoring. These procedures are based on the firm's Asset Quality Review (AQR)
process, a systematic bottom-up review of exposures that is used by management
to estimate probable credit losses and determine the appropriateness of our
related allowances. This process relies extensively on management's experience
and judgment.

The AQR process determines the appropriate allowances based on an estimate of
probable losses by counterparty, industry, or country component; a statistical
model estimate for expected losses on our remaining performing portfolio; and a
general component for probable losses that is necessary to reflect the
imprecise, subjective, and judgmental elements inherent in evaluating credit
risk. Management believes this approach is appropriate given our institutional
client orientation and emerging markets portfolio. Accordingly, in determining
the appropriate level of our allowances, we focus on the following components at
each reporting period, if applicable, for each allowance:

-  Specific counterparty: an estimate of probable losses related to specific
   counterparties experiencing particular credit issues determined in accordance
   with SFAS No. 114 for loans and in accordance with SFAS No. 5, Accounting for
   Contingencies, for off-balance-sheet credit financial instruments.

                                   Notes to consolidated financial statements 73
<PAGE>   76
-  Specific industry: an estimate of probable losses related to exposures to
   counterparties in industries undergoing financial and structural distress.
   Industry allocations exclude exposures addressed in specific counterparty
   allocations. 

-  Specific country: an estimate of probable losses resulting from exposures to
   counterparties in countries experiencing political and transfer risk,
   countrywide economic distress, or problems regarding the legal enforceability
   of contracts. This component amount is determined by applying a percentage
   loss estimate on a "tiering of risk" basis (e.g., sovereigns have a lower
   percentage of coverage than corporates) as determined by management using
   historical loss experience and judgment, which considers secondary market
   data, where applicable. Included in this allocation are reserve requirements,
   if any, that are mandated by the Federal Reserve Board. Specific country
   allocations exclude exposures addressed in specific counterparty and industry
   allocations. 

-  Expected loss: an estimate based on statistical modeling of the probable loss
   inherent in our existing performing portfolio of traditional credit products,
   net of recoveries. Key drivers of the model include: the amount and duration
   of exposures, counterparty ratings, historical default information, and
   recovery rates. The expected loss allocation excludes exposures covered by
   the specific allocations discussed above and is intended to recognize
   probable losses on a portfolio basis that have not yet been specifically
   identified. 

-  General: a judgmental assessment of probable losses not adequately captured
   by the specific or expected loss components with regard to our existing
   portfolio of credit extensions. It is needed to reflect the imprecise,
   subjective, and judgmental elements in evaluating credit risk. In determining
   the general component, management considers both its absolute size to cover
   various risk factors as well as its percentage coverage for modeling risk. In
   their determination, management considers the following risk factors:
   business and economic conditions; regulatory requirements; historical
   experience; concentrations of risk; the relative size of our credit exposures
   given our wholesale orientation; the level of counterparties on the special
   review list; and the level and history of charge-offs and impaired assets.
   With regard to our use of expected loss models, this component attempts to
   compensate, using an analysis based on coverage ratios, for inherent
   imperfections in our modeling, including the fact that default and recovery
   statistics are primarily based on U.S. corporate experience that does not
   completely match our global book of risk, our view of current economic trends
   versus the historical determination of the models, and the impact of using
   averages versus actual occurrences. In determining the appropriate level of
   this component, we generally maintain a coverage ratio for traditional credit
   products so that the combination of the expected loss and general components
   would be at least 150% of the expected loss component.

The AQR Committee determines, using its judgment and experience, the appropriate
actions (placement on impaired status, specific allocation, or charge-off) that
should be taken with regard to specific counterparties, industries, and
countries. The senior members of the AQR Committee then consider appropriate
actions to be taken in addition to the specific risk decisions, including a
review of the expected loss calculations of the existing performing portfolio
and other risk factors as discussed above in the general component. The outcome
of the AQR Committee's review results in a quarterly determination of the
appropriateness of the level of our allowances for credit losses and of whether
or not provisions are necessary. This review is performed separately for each
allowance classification - loans and commitments to extend credit - and on a
component-by-component basis within each allowance.

A review is also performed by the AQR Committee on any other significant
exposures with credit concerns to determine the appropriate actions. This
includes a review of our derivative receivables when there are credit risk
issues to determine the appropriate credit adjustment needed to determine the
fair value of the portfolio. Provisions related to loans and off-balance-sheet
financial instruments are reflected in Net interest revenue and Other revenue,
respectively.

PREMISES AND EQUIPMENT

Premises and equipment, including leasehold improvements, are stated at cost
after subtracting accumulated depreciation and amortization. We generally
compute depreciation using the straight-line method over the estimated useful
life of an asset. For leasehold improvements, we use the straight-line method
over the lesser of the lease term or the estimated economic useful life of the
improvement.

74 Notes to consolidated financial statements
<PAGE>   77
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARIES

Company-obligated mandatorily redeemable preferred securities of subsidiaries
(trust preferred securities) are accounted for as a liability on our
"Consolidated balance sheet." Dividends (or distributions) on trust preferred
securities are treated as interest and expensed on an accrual basis. Interest
related to the trust preferred securities is included in the interest expense
caption in our "Consolidated statement of income."

FEE REVENUE

Investment banking revenue includes underwriting revenues as well as merger and
acquisition, private placement, advisory, and loan syndication fees.
Underwriting revenues are reflected net of syndicate expenses and arise from
securities offerings in which the firm acts as an underwriter. Underwriting
revenues are recorded on a trade date basis. All other fees are recognized as
revenue when the related services are performed. In addition, we recognize
credit arrangement and syndication fees as revenue after certain retention,
timing, and yield criteria are satisfied.

Investment management revenue and revenue from Fees and commissions are
recognized when the related service is performed. We recognize commitment fees
as revenue in the period when the unused commitment is available.

STOCK OPTIONS AND STOCK AWARDS

We account for our stock-based compensation plans in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.

In accordance with APB No. 25, we do not record compensation cost in conjunction
with stock options granted under stock-based compensation plans. This is because
on the day of the grant, the options exercise price is not less than the market
price of the underlying stock. We record compensation expenses for the following
stock awards:

-  restricted stock awards
-  stock bonus awards
-  stock unit awards
-  deferred stock payable in stock

The compensation expense is recorded over the period in which the recipients
perform services at J.P. Morgan.

Effective January 1, 1996, J.P. Morgan adopted SFAS No. 123, Accounting for
Stock-Based Compensation, which permits either:

-  recognizing compensation cost for the estimated fair value of employee
   stock-based compensation arrangements on the grant date, or 

-  disclosing in the notes to the consolidated financial statements the pro
   forma effects of stock-based compensation on net income and earnings per
   share, as if the fair value-based method of valuing options and awards had
   been used to record compensation cost.

We adopted the disclosure option and continue to apply APB Opinion No. 25 in
accounting for our stock-based compensation plans.

INCOME TAXES

J.P. Morgan and its eligible subsidiaries file a consolidated U.S. federal
income tax return. We use the asset and liability method required by SFAS No.
109, Accounting for Income Taxes, to provide income taxes on all transactions
recorded in the consolidated financial statements. The asset and liability
method requires that income taxes reflect the expected future tax consequences
of temporary differences between the carrying amounts of assets or liabilities
for book purposes versus tax purposes. Accordingly, a deferred tax liability or
asset is determined for each temporary difference based on the enacted tax rates
that are expected to be in effect when the underlying items of income and
expense are expected to be realized. Our expense for Income taxes includes the
current and deferred portions of our expense. We establish a valuation allowance
to reduce deferred tax assets to the amount we expect to be realized.

                                   Notes to consolidated financial statements 75
<PAGE>   78
STATEMENT OF CASH FLOWS

For J.P. Morgan's "Consolidated statement of cash flows," we define our cash and
cash equivalents as those amounts included in Cash and due from banks. We
classify cash flows from investment securities, including securities
available-for-sale, as investing activities. Cash flows from sales of investment
securities with remaining lives of more than one year when purchased and less
than 90 days when sold, mandatory redemptions, and calls are classified as
proceeds from maturities. We classify cash flows from derivative transactions
used as hedges in the same manner as the items being hedged.

2. ACCOUNTING CHANGES AND DEVELOPMENTS

ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS
OF LIABILITIES

In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which provides
new accounting and reporting standards for sales, securitizations, and servicing
of receivables and other financial assets and for extinguishments of
liabilities. In December 1996, the FASB issued SFAS No. 127, Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125. This statement
deferred the provisions of SFAS No. 125 for transfers involving repurchase
agreements, securities borrowing/lending transactions, and financial assets
provided as collateral until January 1, 1998. Effective January 1, 1998, we
adopted the provisions of SFAS No. 127. The adoption of this standard did not
have a material impact on our consolidated financial statements.

REPORTING COMPREHENSIVE INCOME

Effective January 1, 1998, we adopted SFAS No. 130, Reporting Comprehensive
Income, which establishes the concept of comprehensive income and provides
standards for reporting it. Comprehensive income is defined as the change in
equity of an entity excluding such transactions with stockholders as the
issuance of common or preferred stock, payment of dividends, and purchase of
treasury shares. Comprehensive income has two major components: net income, as
reported in the "Consolidated statement of income," and other comprehensive
income. Other comprehensive income includes such items as unrealized gains and
losses on available-for-sale securities and foreign currency translation. This
standard is limited to issues of reporting and presentation and does not address
recognition or measurement. Its adoption therefore did not affect our earnings,
liquidity, or capital resources. All periods presented have been restated to
conform to the new requirements.

DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION

Effective with the filing of this Annual report, we adopted SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. This
standard establishes the criteria for determining an operating segment and the
required financial information to be disclosed. SFAS No. 131 also establishes
standards for disclosing related information regarding products and services,
geographic areas, and major customers. This standard supersedes SFAS No. 14,
Financial Reporting for Segments of a Business Enterprise. This standard is
limited to issues of reporting and presentation and does not address recognition
or measurement. Its adoption therefore did not affect our earnings, liquidity,
or capital resources. All periods presented have been restated to conform to the
new requirements.

76 Notes to consolidated financial statements
<PAGE>   79
EMPLOYER'S DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Effective December 31, 1998, we adopted SFAS No. 132, Employer's Disclosures
about Pensions and Other Postretirement Benefits, which revises an employer's
disclosures about pensions and other postretirement benefits. This standard
supersedes the disclosure requirements for pension and other benefits of SFAS
No. 87, Employer's Accounting for Pensions; SFAS No. 88, Employer's Accounting
for Settlements and Curtailments of Defined Benefit Plans and for Termination
Benefits; and SFAS No. 106, Employer's Accounting for Postretirement Benefits
Other than Pensions. The standard requires additional information on the changes
in the benefit obligations and plan assets and eliminates certain disclosures to
facilitate the financial analysis of these plans. This standard is limited to
issues of reporting and presentation and does not address recognition or
measurement. Therefore, its adoption did not affect our earnings, liquidity, or
capital resources. All periods presented have been restated to conform to the
new requirements.

ACCOUNTING FOR DERIVATIVE AND HEDGING ACTIVITIES

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is required to be adopted starting
with our financial statements for the quarter ended March 31, 2000. The standard
will require us to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through earnings.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of the derivative will either be offset against the change in
fair value of the hedged asset, liability, or firm commitment through earnings
or be recognized in other comprehensive income until the hedged item is
recognized in earnings. If the change in fair value of a derivative designated
as a hedge is not effectively offset, as defined, by the change in value of the
item it is hedging, this difference will be immediately recognized in earnings.
While we have not determined the specific impact of SFAS No. 133 on our earnings
and financial position, we have identified, based on current hedging strategies,
our activities that would be most affected by the new standard. Specifically,
the Proprietary Investing and Trading segment uses derivatives to hedge its
investment portfolio, deposits, and issuance of debt - primarily hedges of
interest rate risk. Our credit activities use credit derivatives to hedge credit
risk, and to a lesser extent, use other derivatives to hedge interest rate risk.
Management is currently evaluating the impact of SFAS No. 133 on our hedging
strategies. The actual assessment of the impact on the firm's earnings and
financial position of adopting SFAS No. 133 will be made based on our January 1,
2000 positions in accordance with the standard.

ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL
USE

In March 1998, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This statement requires that we
capitalize certain costs associated with the acquisition or development of
internal use software. Effective January 1, 1999, we adopted SOP 98-1;
restatement of financial statements of previous years is not allowed. We expect
its adoption to result in the capitalization of approximately $130 million in
software costs during 1999, net of expected 1999 amortization. Previously, these
costs would have been expensed as incurred. Once the software is ready for its
intended use, we will begin amortizing capitalized costs on a straight-line
basis over its expected useful life. This period will generally not exceed three
years.

REPORTING ON THE COSTS OF START-UP ACTIVITIES

In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of Start-Up
Activities. This statement requires that we expense certain costs related to new
operations that previously were eligible for capitalization. Effective January
1, 1999, we adopted SOP 98-5; restatement of the financial statements of
previous years is not allowed. The adoption of SOP 98-5 did not have a material
impact on our earnings or financial position.

                                   Notes to consolidated financial statements 77
<PAGE>   80
3. RESTRUCTURING OF BUSINESS ACTIVITIES

The 12 months ended December 31, 1998 include pretax charges totaling $358
million ($215 million after tax); this reflects a first quarter 1998 pretax
charge of $215 million ($129 million after tax) and a fourth quarter 1998 pretax
charge of $143 million ($86 million after tax).

During the first quarter 1998, the firm announced a plan to restructure certain
sales and trading functions in Europe, refocus our investment banking and
equities businesses in Asia, and rationalize resources throughout the firm. As a
result of this decision, the first quarter 1998 charge reflected
severance-related costs of $140 million recorded in Employee compensation and
benefits associated with staff reductions of approximately 900; $70 million in
Net occupancy, primarily related to lease termination fees, estimated losses on
sublease agreements, and the write-off of various leasehold improvements and
equipment, primarily in Europe; and $5 million in Technology and communications,
related to equipment write-offs. During the fourth quarter 1998, we revised our
estimates of remaining costs under the plan and reduced the liability by $7
million; this adjustment was recorded in Net occupancy. Excluding certain
long-term commitments, the reserve related to this charge was substantially
utilized as of December 31, 1998.

During the fourth quarter 1998, the firm incurred an additional charge related
to cost reduction programs that are part of its productivity initiatives. The
charge reflected severance-related costs of $101 million recorded in Employee
compensation and benefits associated with staff reductions of approximately 800.
It also reflected $42 million (net of the $7 million adjustment discussed above)
in Net occupancy primarily related to estimated losses on sublease agreements
and the write-off of various leasehold improvements and furniture and fixtures
in several European locations. As of December 31, 1998, approximately $113
million of the fourth-quarter charge was accrued in Other liabilities of which
$91 million related to severance and the remainder related to real estate. We
expect to use the majority of this remaining reserve by the end of 1999,
excluding certain long-term commitments.

While predominantly impacting the European and North American regions, the
special charges primarily affected all client-focused activities as defined by
our reported segments in note 29, "Segments."

Additional costs associated with these initiatives did not meet the requirement
for inclusion in the first- or fourth-quarter charge. These items will be
expensed as incurred but are not expected to have a material impact on the firm.
The remaining reserve relates to future cash outflows associated with severance
payments, lease termination benefits, and other exit costs. We do not anticipate
that the payment of these items will have a material impact on the financial
position or liquidity of the firm.

4. BUSINESS CHANGES AND DEVELOPMENTS

OCCUPANCY

On December 23, 1998, the City and State of New York and the New York Stock
Exchange announced an agreement to build a new Exchange on land currently
occupied by J.P. Morgan facilities at 15 Broad Street, 23 Wall Street, and 37
Wall Street in New York City. We do not anticipate any disruption to our
operations, or any material impact to the firm's financial statements, as a
result of this transaction.

INVESTMENT IN LONG-TERM CAPITAL MANAGEMENT, L.P.

In September 1998, we made a $300 million equity investment in Long-Term Capital
Management, L.P. as part of a consortium of firms that recapitalized the hedge
fund. The investment is being accounted for under the equity method of
accounting. This investment is included in the Proprietary Investing and
Trading segment.

78 Notes to consolidated financial statements
<PAGE>   81
SALE OF INVESTMENT MANAGEMENT BUSINESS IN AUSTRALIA

In July 1998, we completed the sale of our investment management business in
Australia to Salomon Smith Barney Asset Management (a subsidiary of Citigroup),
resulting in a net gain of $56 million ($34 million after tax) recorded in Other
revenue. The sale will not have a material effect on our ongoing earnings.

SALE OF GLOBAL TRUST AND AGENCY BUSINESS

In June 1998 we completed the sale of our global trust and agency services
business to Citibank (a wholly owned subsidiary of Citigroup), resulting in a
net gain of $131 million ($79 million after tax) recorded in Other revenue. The
sale will not have a material effect on our ongoing earnings.

INVESTMENT IN AMERICAN CENTURY

In January 1998 we completed the purchase of a 45% economic interest in American
Century Companies, Inc. (American Century) for $965 million. American Century is
a no-load U.S. mutual fund company selling directly to individuals. The
investment is accounted for under the equity method of accounting and recorded
in Other assets. The excess of our investment over our share of equity (i.e.,
goodwill) in American Century was approximately $795 million at the time of
purchase. This amount is being amortized on a straight-line basis over a period
of 25 years and at December 31, 1998, totaled $759 million. Our share of equity
income or loss in American Century and the amortization of goodwill related to
this investment are recorded in Other revenue. Our investment in American
Century is included in our Asset Management and Servicing sector.

5. INTEREST REVENUE AND EXPENSE

The table below presents an analysis of interest revenue and expense obtained
from on- and off-balance-sheet financial instruments. Interest revenue and
expense associated with derivative financial instruments are included with
related balance sheet instruments. These derivative financial instruments are
used as hedges or to modify the interest rate characteristics of assets and
liabilities and include swaps, forwards, futures, options, and debt securities
forwards.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
In millions                                                                      1998         1997         1996
---------------------------------------------------------------------------------------------------------------
<S>                                                                           <C>          <C>          <C>
INTEREST REVENUE
Deposits with banks ......................................................... $   294      $   199      $   110
Debt investment securities(a) ...............................................   1 456        1 557        1 601
Trading account assets ......................................................   4 344        4 275        3 275
Securities purchased under agreements to resell and federal funds sold ......   2 031        2 059        2 254
Securities borrowed .........................................................   2 088        1 784        1 284
Loans .......................................................................   2 109        2 029        1 776
Other sources(b) ............................................................     319          450          413
---------------------------------------------------------------------------------------------------------------
Total interest revenue                                                         12 641       12 353       10 713
---------------------------------------------------------------------------------------------------------------

INTEREST EXPENSE
Deposits ....................................................................   2 823        2 753        2 541
Trading account liabilities .................................................   1 541        1 652        1 302
Securities sold under agreements to repurchase and federal funds
   purchased ................................................................   3 846        3 532        3 295
Other borrowed money ........................................................   1 613        1 447        1 248
Long-term debt ..............................................................   1 537        1 097          625
---------------------------------------------------------------------------------------------------------------
Total interest expense                                                         11 360       10 481        9 011
---------------------------------------------------------------------------------------------------------------
Net interest revenue                                                            1 281        1 872        1 702
---------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Interest revenue from debt investment securities included taxable revenue of
$1,335 million, $1,462 million, and $1,484 million and revenue exempt from U.S.
income taxes of $121 million, $95 million, and $117 million in 1998, 1997, and
1996, respectively.

(b) Primarily risk-adjusting swaps for the years ended December 31, 1997 and
1996. Refer to note 11, "Derivatives."

                                   Notes to consolidated financial statements 79
<PAGE>   82
Net interest revenue associated with derivatives used for purposes
other-than-trading was approximately $159 million in 1998, $177 million in 1997,
$125 million in 1996. At December 31, 1998 and 1997, approximately $249 million
and $298 million, respectively, of net deferred losses on closed derivative
contracts used for purposes other-than-trading were recorded on the
"Consolidated balance sheet." These amounts are primarily net deferred losses on
closed hedge contracts, which are included in the amortized cost of the debt
investment portfolio at December 31, 1998 and 1997. The amount of net deferred
gains or losses on closed derivative contracts changes from period to period,
primarily due to the amortization of such amounts to Net interest revenue. These
changes are also influenced by the execution of our investing strategies, which
may result in the sale of the underlying hedged instruments and/or termination
of hedge contracts. Net deferred losses (gains) on closed derivative contracts
as of December 31, 1998, are expected to amortize into Net interest revenue as
follows: $86 million in 1999; $78 million in 2000; $72 million in 2001; $17
million in 2002; ($2) million in 2003; and approximately ($2) million
thereafter.

6. TRADING REVENUE

Trading revenue is predominantly generated by our market making activities
included in our Global Finance sector as well as activities in our Proprietary
Investments sector.

The following table presents trading revenue by principal product grouping for
1998, 1997, and 1996.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
In millions                                             1998         1997         1996
--------------------------------------------------------------------------------------
<S>                                                   <C>          <C>          <C>
Fixed income........................................  $1 424       $1 629       $1 754
Equities............................................     241          225          332
Foreign exchange....................................     697          283          391
--------------------------------------------------------------------------------------
Total trading revenue                                  2 362        2 137        2 477
--------------------------------------------------------------------------------------
</TABLE>

Fixed income trading revenue includes the results of making markets in both
developed and emerging countries in government securities, U.S. government
agency securities, corporate debt securities, money market instruments, interest
rate and currency swaps, and options and other derivatives. Equities trading
revenue includes the results of making markets in global equity securities and
equity derivatives such as swaps, options, futures, and forward contracts.
Foreign exchange trading revenue includes the results of making markets in spot,
options, and short-term interest rate products in order to help clients manage
their foreign currency exposure. Foreign exchange also includes the results from
commodity transactions in spot, forwards, options, and swaps.

80 Notes to consolidated financial statements
<PAGE>   83
7. OTHER REVENUE AND OTHER EXPENSES

OTHER REVENUE

In 1998 Other revenue of $187 million includes a negative provision (income) of
$60 million related to a decrease in our allowance for credit losses for
off-balance-sheet instruments; a $56 million net gain on the sale of the firm's
investment management business in Australia and a $131 million net gain on the
sale of the firm's global trust and agency service businesses (see note 4,
"Business changes and developments"); and losses of approximately $56 million on
hedges of the firm's anticipated foreign currency revenues and expenses. It also
includes earnings from equity in affiliates (excluding American Century) of $44
million, the majority of which relates to our Proprietary Investing and Trading
segment. The impact of our investment in American Century, including related
amortization, was not significant and is included in the Asset Management and
Servicing sector.

In 1997 Other revenue of $240 million included approximately $120 million of
gains on hedges of anticipated foreign currency revenue and expenses and $40
million of earnings from equity in affiliates.

In 1996 Other revenue of $195 million included a gain of $77 million from the
partial sale of a minority investment, $52 million of gains on hedges of
anticipated foreign currency revenue and expenses and $25 million of earnings
from equity in affiliates.

OTHER EXPENSES

The following table presents the major components of Other expenses.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------
In millions                                               1998         1997         1996
----------------------------------------------------------------------------------------
<S>                                                       <C>          <C>          <C>
Professional services..................................   $123         $135         $113
Marketing and business development.....................    169          200          165
Other..................................................    384          346          280
----------------------------------------------------------------------------------------
Total other expenses                                       676          681          558
----------------------------------------------------------------------------------------
</TABLE>


8. CASH AND DUE FROM BANKS

J.P. Morgan is required to maintain noninterest-earning reserve balances with
U.S. Federal Reserve banks and various foreign central banks. Such balances,
which are based principally on deposits outstanding, are included in Cash and
due from banks. At December 31, 1998 and 1997, required reserves were $260
million and $267 million, respectively, compared with average required reserves
during the year of $293 million in 1998 and $196 million in 1997.

                                   Notes to consolidated financial statements 81
<PAGE>   84
   9. INVESTMENT SECURITIES

   Debt investment securities
   Our debt investment securities portfolio is classified as available-for-sale.
   Available-for-sale securities are measured at fair value, and unrealized
   gains or losses are reported as a net amount within the stockholders' equity
   account, Net unrealized gains on investment securities, net of taxes.

   The following table presents the gross unrealized gains and losses and a
   comparison of the cost, along with the fair and carrying value of our
   available-for-sale debt investment securities at December 31, 1998, 1997, and
   1996. The gross unrealized gains or losses on each debt investment security
   include the effects of any related hedge. See note 27, "Estimating the fair
   value of financial instruments," for additional detail of gross unrealized
   gains and losses associated with open derivative contracts used to hedge debt
   investment securities.


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
                                                                       Gross       Gross       Fair and
                                                                     unrealized   unrealized   carrying
In millions: December 31                                   Cost        gains       losses        value
-------------------------------------------------------------------------------------------------------
1998
<S>                                                      <C>          <C>          <C>          <C>    
U.S. Treasury ......................................     $   620      $   130      $     1      $   749
U.S. government agency, principally mortgage-backed       32 458           34          117       32 375
U.S. state and political subdivision ...............       1 800          174           31        1 943
U.S. corporate and bank debt .......................         200            2            5          197
Foreign government(a) ..............................         376            -            9          367
Foreign corporate and bank debt ....................         536            2           55          483
Other ..............................................         117            1            -          118
-------------------------------------------------------------------------------------------------------
Total debt investment securities                          36 107          343          218       36,232
-------------------------------------------------------------------------------------------------------
</TABLE>



<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
                                                                    Gross        Gross      Fair and
                                                                  unrealized   unrealized    carrying
In millions: December 31                                 Cost        gains       losses       value
-----------------------------------------------------------------------------------------------------
1997
<S>                                                      <C>      <C>          <C>         <C> 
U.S. Treasury .......................................    $1 035       $142      $  1       $  1 176
U.S. government agency, principally mortgage-backed .    16 779        126        75         16 830
U.S. state and political subdivision ................     1 440        184        10          1 614
U.S. corporate and bank debt ........................       428          1         2            427
Foreign government(a) ...............................       784          5        14            775
Foreign corporate and bank debt .....................     1 929          2        99          1 832
Other ...............................................       112          2         -            114
-----------------------------------------------------------------------------------------------------
Total debt investment securities                         22 507        462       201         22 768
-----------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
                                                                             Gross        Gross       Fair and
                                                                          unrealized    unrealized     carrying
In millions: December 31                                          Cost        gains       losses        value
---------------------------------------------------------------------------------------------------------------
1996
<S>                                                             <C>         <C>          <C>           <C>  
U.S.Treasury .............................................      $  1 773    $  80        $  13         $  1 840
U.S. government agency, principally mortgage-backed ......        16 848      109          114           16 843
U.S. state and political subdivision .....................         1 575      164           15            1 724
U.S. corporate and bank debt .............................           304        1            -              305
Foreign government(a) ....................................         1 501       39            6            1 534
Foreign corporate and bank debt ..........................         2 499       11            2            2 508
Other ....................................................           110        1            -              111
---------------------------------------------------------------------------------------------------------------
Total debt investment securities                                  24 610      405          150           24 865
---------------------------------------------------------------------------------------------------------------
</TABLE>

   (a) Primarily includes debt of countries that are members of the Organization
   for Economic Cooperation and Development.




82   Notes to consolidated financial statements

    
<PAGE>   85
   At December 31, 1998, there were no securities of a single issuer, excluding
   the U.S. Treasury and U.S. government agencies, whose fair value exceeded 10%
   of stockholders' equity.

   The table below presents net debt investment securities gains/(losses) during
   1998, 1997, and 1996. These amounts are recorded in Investment securities
   revenue.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions                                                                  1998         1997         1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                         <C>          <C>          <C>  
Gross realized gains from sales of securities .......................       $ 105        $ 128        $ 231
Gross realized losses from sales of securities ......................        (225)        (102)        (214)
Net gains on maturities, calls, and mandatory redemptions ...........           8            5            -
Write-downs for other-than-temporary impairments in value ...........         (28)         (29)           -
-----------------------------------------------------------------------------------------------------------
Net debt investment securities (losses)/gains(a)                             (140)           2           17
-----------------------------------------------------------------------------------------------------------
</TABLE>

   (a) Primarily related to emerging Asia exposures.

   The following table displays the maturities and related weighted-average
   rates of available-for-sale debt investment securities as of December 31,
   1998. Mortgage-backed securities are included based on their weighted-average
   lives, which reflects anticipated future prepayments based on a consensus of
   dealers in the market.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                            After one year   After five years
                                                 Within         but within         but within      After 10
In millions: December 31                       one year         five years           10 years        years          Total
---------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>              <C>                   <C>              <C>  
U.S. Treasury ...........................        $  64            $  88            $ 180             $ 288            $ 620
U.S. government agency, principally                                                                               
   mortgage-backed ......................          174           21 619           10 560               105           32 458
U.S. state and political subdivision ....           59              409              245             1 087            1 800
U.S. corporate and bank debt ............          115               35               46                 4              200
Foreign government ......................          296                9               45                26              376
Foreign corporate and bank debt .........           38              216              254                28              536
Other ...................................            -                -                -               117              117
---------------------------------------------------------------------------------------------------------------------------
Total debt investment securities, at cost          746           22 376           11 330             1 655           36 107
Fair value ..............................          764           22 408           11 282             1 778           36 232
---------------------------------------------------------------------------------------------------------------------------
Net unrealized gains/(losses)                       18               32              (48)              123              125
---------------------------------------------------------------------------------------------------------------------------
Average rate on debt investment                                                                                   
   securities, at cost(a)                         4.54%            8.01%            7.28%             8.42%            7.73%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


   (a) Average rates represent the weighted average at December 31, 1998, and
   include the effects of various hedging transactions. Average rates do not
   give effect to unrealized gains and losses that are reflected as a component
   of stockholders' equity. U.S. state and political subdivision securities have
   been adjusted to a taxable-equivalent basis.


   In the Morgan Guaranty "Consolidated statement of condition" on page 68, the
   balance for Debt investment securities available-for-sale carried at fair
   value decreased from $20.5 billion at December 31, 1997, to $3.6 billion at
   December 31, 1998, reflecting Morgan Guaranty's sale of approximately $18
   billion of debt investment securities to an affiliated J.P. Morgan entity
   during 1998.

   EQUITY INVESTMENT SECURITIES

   Equity investment securities include both marketable and nonmarketable
   securities and are generally owned by J.P. Morgan Capital Corporation, a
   wholly owned nonbank subsidiary of J.P. Morgan. Quoted or estimated values of
   equity investment securities do not necessarily represent the net realizable
   amounts. This is because such factors as the timing, size of the position, or
   the market's liquidity may not support realization of these values.
   Management determines the fair values for equity investment securities, using
   financial and other available information, when the publicly quoted market
   prices do not accurately represent the gain or loss that would be realized
   from a sale or if there are no publicly quoted market prices. Most of our
   equity investment securities are subject to legal, regulatory, and
   contractual restrictions that limit our ability to dispose of them freely.


                                  Notes to consolidated financial statements  83
<PAGE>   86
   MARKETABLE AVAILABLE-FOR-SALE EQUITY INVESTMENT SECURITIES

   Marketable equity investment securities, which are classified as
   available-for-sale, are recorded at fair value. Unrealized gains and losses
   are reported as a net amount within the stockholders' equity account, Net
   unrealized gains on investment securities, net of taxes. Gross unrealized
   gains and losses, as well as a comparison of the cost, and fair and carrying
   value of marketable available-for-sale equity investment securities at
   December 31, 1998, 1997, and 1996 are shown in the following table.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions: December 31                                                     1998         1997         1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                          <C>          <C>          <C> 
Cost                                                                         $446         $207         $365
-----------------------------------------------------------------------------------------------------------
Gross unrealized gains ...............................................        143          436          479
Gross unrealized losses ..............................................        (34)          (9)          (2)
-----------------------------------------------------------------------------------------------------------
Net unrealized gains                                                          109(a)       427(b)       477(b)
-----------------------------------------------------------------------------------------------------------
Fair and carrying value                                                       555          634          842
-----------------------------------------------------------------------------------------------------------
</TABLE>

   (a) Primarily relates to investments in the telecommunications and financial
       services industries.

   (b) Primarily relates to investments in the insurance industry.


   NONMARKETABLE AND OTHER EQUITY SECURITIES

   Nonmarketable equity investment securities are carried at cost on the balance
   sheet. Securities held in subsidiaries registered as Small Business
   Investment Companies (SBICs) are carried at fair value on the balance sheet,
   with changes in fair value recorded currently in Investment securities
   revenue. The following table presents the carrying and fair value, as well as
   the net unrealized gains, on nonmarketable and other equity securities.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions: December 31                                                     1998         1997         1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                          <C>          <C>          <C> 
Carrying value .......................................................       $614         $451         $448
Net unrealized gains on nonmarketable securities .....................        104(a)       136(a)       115(b)
-----------------------------------------------------------------------------------------------------------
Fair value                                                                    718          587          563
-----------------------------------------------------------------------------------------------------------
</TABLE>

(a) Primarily relates to investments in the telecommunications and financial
    services industries. 

(b) Primarily relates to investments in the telecommunications and insurance
    industries.


   REALIZED GAINS AND WRITE-DOWNS

   The following table presents gross realized gains and write-downs for
   other-than-temporary impairments in value related to our equity investments
   portfolio, excluding securities in SBICs, for the years ending December 31,
   1998, 1997, and 1996. These amounts are recorded in Investment securities
   revenue.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions                                                                  1998         1997         1996
-----------------------------------------------------------------------------------------------------------
<S>                                                                          <C>          <C>          <C> 
Gross realized gains from marketable available-for-sale securities ....      $334         $262         $245
Gross realized gains from nonmarketable and other equity securities ...        68          144           32
Write-downs for other-than-temporary impairments in value .............       (89)         (37)         (30)
-----------------------------------------------------------------------------------------------------------
Net equity investment securities realized gains                               313          369          247
-----------------------------------------------------------------------------------------------------------
</TABLE>


84  Notes to consolidated financial statements

<PAGE>   87
   10. TRADING ACCOUNT ASSETS AND LIABILITIES

   Trading account assets and liabilities, including derivative instruments used
   for trading purposes, are carried at fair value. The following table presents
   the fair and carrying value of trading account assets and trading account
   liabilities at December 31, 1998 and 1997. It also includes the average
   balance for the years then ended.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
                                                                             1998                       1997
---------------------------------------------------------------------------------------------------------------
                                                               Carrying      Average     Carrying      Average
In millions: December 31                                         value       balance       value       balance
---------------------------------------------------------------------------------------------------------------
<S>                                                            <C>          <C>          <C>          <C>  
TRADING ACCOUNT ASSETS(a)
U.S. Treasury ................................................ $  18 262    $  11 758    $  10 840    $  14 783
U.S. government agency .......................................     6 040       10 194        9 923        7 662
Foreign government ...........................................    20 163       28 858       24 755       26 263
Corporate debt and equity ....................................    16 862       20 908       18 972       19 233
Other securities .............................................     4 445        8 771        6 439        7 125
Interest rate, currency, credit default and related swaps ....    19 530       23 013       19 672       16 126
Foreign exchange contracts ...................................     4 132        4 849        5 710        4 874
Interest rate futures and forwards ...........................       259          202          308          359
Commodity and equity contracts ...............................     3 310        2 911        2 859        1 908
Purchased option contracts ...................................    20 893       13 668       12 376        8 074
---------------------------------------------------------------------------------------------------------------
                                                                 113 896      125 132      111 854      106 407
---------------------------------------------------------------------------------------------------------------
TRADING ACCOUNT LIABILITIES
U.S. Treasury ................................................     5 786        8 934       10 955       10 971
Foreign government ...........................................    10 213       14 291       11 119       12 045
Corporate debt and equity ....................................     7 752        9 365        7 662        7 821
Other securities .............................................     2 209        2 546        2 048        2 345
Interest rate, currency, credit default and related swaps ....    17 603       19 891       15 072       13 467
Foreign exchange contracts ...................................     4 396        4 870        6 852        6 374
Interest rate futures and forwards ...........................     1 323          979        1 061          849
Commodity and equity contracts ...............................     2 951        2 681        3 211        2 636
Written option contracts .....................................    18 410       13 889       13 161        9 169
---------------------------------------------------------------------------------------------------------------
                                                                  70 643       77 446       71 141       65 677
---------------------------------------------------------------------------------------------------------------
</TABLE>

   (a) Includes the credit adjustment for impaired derivatives of $321 million
   ($346 million average balance) at December 31, 1998, and $350 million ($350
   million average balance) at December 31, 1997. This adjustment was
   categorized as the trading account allowance in previous financial
   statements.


   Included in trading account assets are gross derivative receivables of $535
   million and $546 million at December 31, 1998 and 1997, respectively, that
   relate to disputed swap contracts with South Korean counterparties. A portion
   of the credit adjustment for impaired derivatives relates to these contracts
   and is necessary to record these exposures at fair value.

   TRADE DATE RECEIVABLES/PAYABLES

   Amounts receivable and payable for securities that have not reached their
   contractual settlement dates are recorded net in the "Consolidated balance
   sheet." Amounts receivable for securities sold of $9.8 billion were netted
   against amounts payable for securities purchased of $9.0 billion. This
   produced a net trade date receivable of $0.8 billion, recorded in Accrued
   interest and accounts receivable at December 31, 1998. In 1997 amounts
   payable for securities purchased of $18.7 billion were netted against amounts
   receivable for securities sold of $15.3 billion. This produced a net trade
   date payable of $3.4 billion, recorded in Accounts payable and accrued
   expenses, at December 31, 1997.


                            Notes to consolidated financial statements       85
<PAGE>   88
   11. DERIVATIVES

   In general, derivatives are contracts or agreements whose values are derived
   from changes in interest rates, foreign exchange rates, prices of securities,
   or financial or commodity indices. The timing of cash receipts and payments
   for derivatives is generally determined by contractual agreement. Derivatives
   are either standardized contracts executed on an exchange or negotiated
   over-the-counter contracts. Futures and options contracts are examples of
   standard exchange-traded derivatives. Forwards, swaps, and option contracts
   are examples of over-the-counter derivatives. Over-the-counter derivatives
   are generally not traded like securities. In the normal course of business,
   however, they may be terminated or assigned to another counterparty if the
   original holder agrees.

   Derivatives may be used for trading or other-than-trading purposes.
   Other-than-trading purposes are primarily related to our investing
   activities.

   Derivatives used for trading purposes include:

   -  interest rate and currency swap contracts

   -  credit default swaps and related contracts

   -  interest rate futures, forward rate agreements, and interest rate option
      contracts

   -  foreign exchange spot, forward, futures, and option contracts

   -  equity swap, futures, and option contracts

   -  commodity swap, forward, and option contracts

   In our investing activities we use derivative instruments including:

   -  interest rate and currency swap contracts 

   -  credit default swaps and related contracts

   -  foreign exchange forward contracts
   
   -  interest rate futures and debt securities forward contracts

   -  interest rate and equity option contracts

   Interest rate swaps are contractual agreements to exchange periodic interest
   payments at specified intervals. The notional amounts of interest rate swaps
   are not exchanged; they are used solely to calculate the periodic interest
   payments. Currency swaps generally involve exchanging principal (the notional
   amount) and periodic interest payments in one currency for principal and
   periodic interest payments in another currency.

   Credit default swaps are contractual agreements that provide insurance
   against a credit default of one or more referenced credits. The protection
   buyer pays a periodic fee in return for a contingent payment by the
   protection seller in case of default. The contingent payment is typically the
   loss incurred by the creditor of the reference credit in the event of default
   - that is, the difference between the notional and the recovery rate.

   Foreign exchange contracts involve an agreement to exchange one country's
   currency for another at an agreed upon price and settlement date. The
   contracts reported in the following table primarily include forward
   contracts.

   Interest rate futures are standardized exchange-traded agreements to receive
   or deliver a specific financial instrument at a specific future date and
   price. Forward rate agreements provide for the payment or receipt of the
   difference between a specified interest rate and a reference rate at a future
   settlement date. Debt security forwards include to-be-announced and
   when-issued securities contracts.

   Commodity and equity contracts include swaps and futures in the commodity and
   equity markets and commodity forward agreements. Equity swaps are contractual
   agreements to receive the appreciation or depreciation in value based on a
   specific strike price on an equity instrument in return for paying another
   rate, which is usually based on equity index movements or interest rates.
   Commodity swaps are contractual commitments to exchange the fixed price of a
   commodity for a floating price. Equity and commodity futures are
   exchange-traded agreements to receive or deliver a financial instrument or
   commodity at a specific future date and price. Equity and commodity forwards
   are over-the-counter agreements to purchase or sell a specific amount of a
   financial instrument or commodity at an agreed-upon price and settlement
   date.


86              Notes to consolidated financial statements
<PAGE>   89
   An option provides the option purchaser, for a fee, the right - but not the
   obligation - to buy or sell a security at a fixed price on or before a
   specified date. The option writer is obligated to buy or sell the security if
   the purchaser chooses to exercise the option. These options include contracts
   in the interest rate, foreign exchange, equity, and commodity markets.
   Interest rate options include caps and floors.

   The following table presents notional amounts for trading and
   other-than-trading derivatives, based on management's intent and ongoing
   usage. A summary of the on-balance-sheet credit exposure, which is
   represented by the net positive fair value associated with trading
   derivatives and recorded in Trading account assets, is also included in the
   following table. Our on-balance-sheet credit exposure takes into
   consideration $107.6 billion and $63.1 billion of master netting agreements
   in effect as of December 31, 1998 and 1997, respectively.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                               On-balance-sheet
                                                                    Notional amounts            credit exposure
---------------------------------------------------------------------------------------------------------------------------
In billions: December 31                                            1998         1997           1998         1997
---------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>          <C>              <C>         <C> 
Interest rate, currency, credit default and related swaps
  Trading ....................................................     $3 796.2     $2 479.4
  Other-than-trading(a)(b)(c) ................................         69.5        225.7
---------------------------------------------------------------------------------------------------------------------------
  Total interest rate, currency, credit
  default and related swaps                                         3 865.7      2 705.1         $19.5        $19.7
---------------------------------------------------------------------------------------------------------------------------
Foreign exchange spot, forward, and futures contracts
  Trading ......................................................      565.4        670.6
  Other-than-trading(a)(b) .....................................       37.6         49.6
---------------------------------------------------------------------------------------------------------------------------
  Total foreign exchange spot, forward, and futures
  contracts                                                           603.0        720.2           4.1          5.7
---------------------------------------------------------------------------------------------------------------------------
Interest rate futures, forward rate agreements,
  and debt securities forwards
  Trading ....................................................      1 458.3        869.4
  Other-than-trading .........................................          8.7         18.1
---------------------------------------------------------------------------------------------------------------------------
  Total interest rate futures, forward rate agreements,
  and debt securities forwards                                      1 467.0        887.5           0.3          0.3
---------------------------------------------------------------------------------------------------------------------------
Commodity and equity swaps, forward,
  and futures contracts, all trading .........................         86.0         92.4           3.3          2.9
---------------------------------------------------------------------------------------------------------------------------
Purchased options(d)
  Trading ....................................................      1 291.5        768.9
  Other-than-trading(a) ......................................          0.5          1.5
---------------------------------------------------------------------------------------------------------------------------
  Total purchased options                                           1 292.0        770.4          20.9         12.4
---------------------------------------------------------------------------------------------------------------------------
Written options, all trading(e)(f) ...........................      1 544.0      1 005.9            -            -
---------------------------------------------------------------------------------------------------------------------------
Total on-balance-sheet credit exposure                                                            48.1         41.0
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


   (a) Derivatives used as hedges of other-than-trading positions may be
   transacted with third parties through independently managed J.P. Morgan
   derivative dealers that function as intermediaries for credit and
   administrative purposes. In such cases, the terms of the third-party
   transaction - notional, duration, currency, etc. - are matched with the terms
   of the internal trade to ensure the hedged risk has been offset with a third
   party. If such terms are not matched or a third-party trade is not
   transacted, the intercompany trade is eliminated in consolidation.

   (b) At December 31, 1998 and 1997, the notional amounts of derivative
   contracts used for purposes other-than-trading conducted in the foreign
   exchange markets, primarily forward contracts, amounted to $42.7 billion and
   $54.0 billion, respectively. At December 31, 1998, these contracts were
   primarily denominated in the following currencies: German deutsche mark $5.6
   billion, French franc $5.4 billion, Japanese yen $4.6 billion, British pound
   $3.6 billion, European currency unit $3.2 billion, Swiss franc $3.1 billion,
   and Italian lira $2.7 billion. At December 31, 1997, these contracts were
   primarily denominated in the following currencies: German deutsche mark $10.7
   billion, Japanese yen $9.2 billion, Italian lira $6.9 billion, French franc
   $6.3 billion, Swiss franc $3.8 billion, and European currency unit $2.7
   billion.

   (c) Effective January 1, 1998, all swaps previously classified as
   risk-adjusting were marked to market, resulting in an immaterial impact to
   the "Consolidated statement of income." These swaps were then either linked
   to a related nontrading asset or liability (to modify the interest rate
   characteristics of a particular nontrading instrument), reclassified as
   trading (as part of our proprietary trading portfolio), or terminated. This
   resulted from the reduced usage of these swaps to meet longer-term investment
   objectives. The notional amount of risk-adjusting swaps at December 31, 1997,
   was $162.2 billion.



                            Notes to consolidated financial statements       87
<PAGE>   90
   (d) At December 31, 1998 and 1997, purchased options used for trading
   purposes included $987.1 billion and $523.0 billion, respectively, of
   interest rate options; $200.9 billion and $193.9 billion, respectively, of
   foreign exchange options; and $103.5 billion and $52.0 billion, respectively,
   of commodity and equity options. Only interest rate options are used for
   purposes other-than-trading. Purchased options executed on an exchange
   amounted to $269.5 billion and $149.0 billion and those negotiated
   over-the-counter amounted to $1,022.5 billion and $621.4 billion at December
   31, 1998 and 1997, respectively.

   (e) At December 31, 1998 and 1997, written options included $1,239.4 billion
   and $729.1 billion, respectively, of interest rate options; $196.7 billion
   and $217.0 billion, respectively, of foreign exchange options; and $107.9
   billion and $59.8 billion, respectively, of commodity and equity options.
   Written options executed on an exchange amounted to $395.9 billion and $92.8
   billion and those negotiated over-the-counter amounted to $1,148.1 billion
   and $913.1 billion at December 31, 1998 and 1997, respectively.

   (f) The total notional amount of written put options includes $20.8 billion
   and $13.9 billion of written put option contracts on debt securities at
   December 31, 1998 and 1997, respectively.


   The following table presents notional and on-balance-sheet credit exposure by
maturity.

   NOTIONAL AMOUNT (TRADING AND OTHER-THAN-TRADING)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                                                After one year  After five years
                                                    Within        but within      but within      After 10
In billions: December 31                            one year       five years      10 years         years        Total 1998
----------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>         <C>             <C>               <C>            <C>  
Interest rate, currency, credit default and
 related swaps ...................................   $1 101.5       $1 684.6       $890.4          $189.2           $3 865.7
Foreign exchange spot, forward, and                                                                          
 futures contracts ...............................      593.5            9.3          0.2               -              603.0
Interest rate futures, forward rate                                                                          
 agreements, and debt securities                                                             
 forwards .......................................     1 180.8          284.9          1.2             0.1            1 467.0
Commodity and equity swaps, forward,                                                             
 and futures contracts ..........................        67.1           16.6          2.3               -               86.0
Purchased option contracts ......................       539.8          649.5         89.0            13.7            1 292.0
Written option contracts ........................       427.7        1 020.0         89.0             7.3            1 544.0
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

   ON-BALANCE-SHEET CREDIT EXPOSURE (TRADING)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
                                                                After one year  After five years
                                                      Within       but within     but within       After 10
In billions: December 31                             one year      five years       10 years        years       Total 1998
--------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>        <C>             <C>                <C>          <C> 
Interest rate, currency, credit default and
 related swaps ..................................        $1.5           $8.4           $8.0           $1.6          $19.5
Foreign exchange spot, forward, and                                                                              
 futures contracts ..............................         4.1            -              -              -              4.1
Interest rate futures, forward rate                                                                              
 agreements, and debt securities                                                                                  
 forwards .......................................         0.2            0.1            -              -              0.3
Commodity and equity swaps, forward,                                                                             
 and futures contracts ..........................         3.3            -              -              -              3.3
Purchased option contracts ......................         8.4            7.8            2.6            2.1           20.9
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

   The following table presents on-balance-sheet credit exposure associated with
   trading derivatives by the type of counterparty.


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
                                               Nonbank finan-    Govern-
In billions: December 31                      cial institutions   ments       Banks      All other      Total
-------------------------------------------------------------------------------------------------------------
<S>                                           <C>                <C>          <C>        <C>            <C> 
1998
On-balance-sheet credit exposure ........            $6.7         $6.7        $28.9         $5.8        $48.1
-------------------------------------------------------------------------------------------------------------
1997
On-balance-sheet credit exposure ........             9.5          5.0         22.1          4.4         41.0
-------------------------------------------------------------------------------------------------------------
</TABLE>



88  Notes to consolidated financial statements
<PAGE>   91
   12. LOANS

   INDUSTRY OR TYPE OF BORROWER

   The table below provides loan detail by industry of borrower and location of
   booking office - not taking into consideration the allowance for loan losses
   - at December 31.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
   In millions: December 31                          1998          1997         1996         1995         1994
---------------------------------------------------------------------------------------------------------------
LOANS IN OFFICES IN THE U.S.
<S>                                                <C>          <C>          <C>          <C>          <C>
Commercial and industrial .....................    $  1 014     $  1 326     $  1 878     $  1 990     $  3 047
Financial institution:
  Banks .......................................         746          232          641          729          458
  Other financial institutions ................       1 111          939          902          527          738
Collateralized by real estate .................         728        1 330          324          365          365
Other, primarily individuals and including
 U.S. state and political subdivisions ........       1 398        1 509        1 488        1 666        1 483
---------------------------------------------------------------------------------------------------------------
                                                      4 997        5 336        5 233        5 277        6 091
---------------------------------------------------------------------------------------------------------------
LOANS IN OFFICES OUTSIDE THE U.S.
Commercial and industrial .....................      11 141       12 576       12 026       10 045        8 451
Financial institution:
     Banks ....................................       1 540        3 419        2 853        1 447        1 940
     Other financial institutions .............       3 364        4 805        4 522        3 013        2 460
Collateralized by real estate .................       1 071        1 153          364          281          329
Foreign governments and official
 institutions .................................         798          693          811        1 042          846
Other, primarily individuals and including
 U.S. state and political subdivisions ........       2 584        3 596        2 311        2 348        1 963
---------------------------------------------------------------------------------------------------------------
                                                     20 498       26 242       22 887       18 176       15 989
---------------------------------------------------------------------------------------------------------------
Total loans                                          25 495       31 578       28 120       23 453       22 080
---------------------------------------------------------------------------------------------------------------
</TABLE>

   LOCATION OF BORROWER

   The following table presents the distribution of total loans - not taking
   into consideration the allowance for loan losses - at December 31, on the
   basis of the location of the borrower.


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
   In millions: December 31                                                      1998         1997
----------------------------------------------------------------------------------------------------
<S>                                                                            <C>          <C> 
LOANS TO BORROWERS IN THE U.S.
In offices in the U.S. .................................................       $  3 941     $  4 366
In offices outside the U.S. ............................................          8 559        9 036
----------------------------------------------------------------------------------------------------
                                                                                 12 500       13 402
----------------------------------------------------------------------------------------------------
LOANS TO BORROWERS OUTSIDE THE U.S.
In offices in the U.S. .................................................          1 056          970
In offices outside the U.S. ............................................         11 939       17 206
----------------------------------------------------------------------------------------------------
                                                                                 12 995       18 176
----------------------------------------------------------------------------------------------------
Total loans                                                                      25 495       31 578
----------------------------------------------------------------------------------------------------
</TABLE>


                                  Notes to consolidated financial statements  89
<PAGE>   92
   MATURITY PROFILE OF LOAN PORTFOLIO

   The following table shows our loan portfolio - not taking into consideration
   the allowance for loan losses - by maturity, industry of borrower, and
   location of booking office at December 31, 1998.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                Maturing
---------------------------------------------------------------------------------------------------------------------------
                                                               After one       After five
                                                   Within       year but        years but        After
In millions: December 31                          one year     within five      within 10        10 years             Total
                                                 --------------------------------------------------------------------------
<S>                                              <C>           <C>             <C>               <C>               <C> 
LOANS IN OFFICES IN THE U.S. ...............
Commercial and industrial ..................     $   68         $   841          $  103           $   2            $  1 014
Financial institution:                                                                     
   Banks ...................................        546             200               -               -                 746
   Other financial institutions ............        816             245              45               5               1 111
Collateralized by real estate ..............        200             240             156             132                 728
Other, primarily individuals and including .                                                                    
   U.S. state and political subdivisions ...        967             244              93              94               1 398
---------------------------------------------------------------------------------------------------------------------------
                                                  2 597           1 770             397             233               4 997
---------------------------------------------------------------------------------------------------------------------------
LOANS IN OFFICES OUTSIDE THE U.S.                                                                            
Commercial and industrial ..................      2 783           7 222           1 094              42              11 141
Financial institution: .....................                                                                    
  Banks ....................................      1 266             244              30               -               1 540
  Other financial institutions .............      1 117           1 337             570             340               3 364
Collateralized by real estate ..............        239             583             152              97               1 071
Foreign governments and official                                                                      
  institutions .............................        317             347              96              38                 798
Other, primarily individuals and including                                                                     
  U.S. state and political subdivisions ....      1 555             976              52               1               2 584
-------------------------------------------------------------------------------------------------------------------------------
                                                  7 277          10 709           1 994             518              20 498
-------------------------------------------------------------------------------------------------------------------------------
Total loans                                       9 874          12 479           2 391             751              25 495
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>

   INTEREST RATE STRUCTURE OF LOAN PORTFOLIO

   The table below shows our loan portfolio based on interest rate structure and
   location of booking office at December 31, 1998.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                           Maturing
-----------------------------------------------------------------------------------------------------------------
                                                                After one     After five
                                                    Within       year but      years but       After
   In millions: December 31                        one year    within five     within 10      10 years      Total
-----------------------------------------------------------------------------------------------------------------
<S>                                                <C>         <C>           <C>            <C>          <C> 
LOANS AT FIXED RATES OF INTEREST
Offices in the U.S..........................        $   892      $    892      $   193         $196      $  2 173
Offices outside the U.S. ...................          1 601           566           29          243         2 439
-----------------------------------------------------------------------------------------------------------------
                                                      2 493         1 458          222          439         4 612
-----------------------------------------------------------------------------------------------------------------
LOANS AT FLOATING RATES OF INTEREST
Offices in the U.S. ........................          1 705           878          204           37         2 824
Offices outside the U.S. ...................          5 676        10 143        1 965          275        18 059

-----------------------------------------------------------------------------------------------------------------
                                                      7 381        11 021        2 169          312        20 883

-----------------------------------------------------------------------------------------------------------------
Total loans                                           9 874        12 479        2 391          751        25 495
-----------------------------------------------------------------------------------------------------------------
</TABLE>


90  Notes to consolidated financial statements
<PAGE>   93
   LOAN CONCENTRATIONS

   We diversify our portfolio of loans by borrower, industry, and geographic
   area. At year-end 1998 and 1997, 56% and 47%, respectively, of loans were in
   the United States. This proportion is based on the location of the borrower
   or, in the case of guaranteed loans, the location of the guarantor. With the
   exception of the United States, no more than 8% of our loans were in any
   single country at the end of 1998 and 1997, respectively.

   At December 31, 1998 and 1997, 16% and 17%, respectively, of our loans were
   backed by marketable securities or cash collateral. After the exclusion of
   these collateralized amounts, the only individual industry that exceeded 10%
   of total loans was banks, which accounted for 12% and 14% of total loans at
   December 31, 1998 and 1997, respectively.

   LOANS HELD FOR SALE
   Included in Loans are loans held for sale of approximately $2.8 billion as of
   December 31, 1998, compared with $105 million at December 31, 1997. These
   loans are recorded on the balance sheet at lower of cost or fair value and
   are primarily to borrowers in the U.S. in various industries.



   13. OTHER CREDIT-RELATED PRODUCTS

   Credit-related financial instruments include commitments to extend credit,
   standby letters of credit and guarantees, and indemnifications related to
   securities lending activities. The contractual amounts of these instruments
   represent the amount at risk should the contract be fully drawn upon, the
   client default, and the value of the collateral become worthless.

   The total contractual amount of credit-related financial instruments does not
   represent the future liquidity requirements since we expect a significant
   amount of commitments to expire or mature without being drawn. The credit
   risk associated with these instruments varies depending on the client's
   creditworthiness and the value of any collateral held. Commitments to extend
   credit generally require clients to meet certain credit-related terms and
   conditions before drawdown. We require collateral in connection with
   securities lending indemnifications. Market risk for commitments to extend
   credit and standby letters of credit and guarantees, while not significant,
   may exist as availability of and access to credit markets changes.

   The following table summarizes the contractual amount of credit-related
   instruments at December 31.


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
In billions: December 31                                           1998         1997
-------------------------------------------------------------------------------------
<S>                                                                <C>          <C>  
Commitments to extend credit ...................................   $83.5        $80.4
Standby letters of credit and guarantees .......................    15.9         15.8
Securities lending indemnifications(a) .........................     4.1          5.3
-------------------------------------------------------------------------------------
</TABLE>

   (a) At December 31, 1998 and 1997, J.P. Morgan held cash and other collateral
   in full support of securities lending indemnifications.

   The following table presents the contractual amount of our commitments to
   extend credit and standby letters of credit and guarantees, separated by type
   of counterparty.


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
                                                 Nonbank
                                                financial       Govern-
In billions: December 31                       institutions      ments        Banks       All other      Total
--------------------------------------------------------------------------------------------------------------
<S>                                            <C>              <C>           <C>         <C>           <C> 
1998
Commitments to extend credit ...............        $13.4         $5.5         $6.6        $58.0(a)     $83.5
Standby letters of credit and guarantees ...          4.0          2.0          3.7          6.2(b)      15.9
-------------------------------------------------------------------------------------------------------------
1997
Commitments to extend credit ...............         16.4          5.3          4.6         54.1(a)      80.4
Standby letters of credit and guarantees ...          3.8          2.5          2.1          7.4(b)      15.8
-------------------------------------------------------------------------------------------------------------
</TABLE>


   (a) At December 31, 1998, the automobile and utilities industries exceeded
   10% of this amount. At December 31, 1997, the utilities industry exceeded 10%
   of this amount.

   (b) The utilities, petroleum, and health care industries at December 31, 1998
   and 1997, each exceeded 10% of this amount.



                                Notes to consolidated financial statements   91
<PAGE>   94
   Included in Fees and commissions are credit-related fees of $180 million,
   $165 million, and $156 million for the years ended December 31, 1998, 1997,
   and 1996, respectively. They are primarily earned from commitments to extend
   credit, standby letters of credit and guarantees, and securities lending
   indemnifications. Also included in Fees and Commissions are amounts paid to
   credit derivative providers of $65 million in 1998.

   PURCHASE OF CREDIT PROTECTION

   Since December 1997 the firm significantly reduced credit risk on
   approximately $20 billion of traditional credit product exposures (loans,
   commitments to extend credit, standby letters of credit and guarantees)
   through the use of securitizations and name-specific credit default swaps.

   14. IMPAIRED LOANS

   Total impaired loans - net of charge-offs - at December 31 are presented in
   the following table.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------
In millions: December 31                        1998         1997         1996
<S>                                            <C>          <C>          <C>  
------------------------------------------------------------------------------
Commercial and industrial .................    $  12        $  55        $  89
Banks and other financial institutions ....        2           30            -
Other .....................................      108           28           31
------------------------------------------------------------------------------
Total impaired loans                             122          113          120
------------------------------------------------------------------------------
Allowance for impaired loans                      34           50           56
------------------------------------------------------------------------------
</TABLE>


   Impaired loans for which no SFAS No. 114 reserve was deemed necessary were
   $15 million, $9 million, and $5 million as of December 31, 1998, 1997, and
   1996, respectively. The amount of the allowance against impaired loans was
   determined after measuring impairment based on the present value of expected
   future cash flows discounted at the loan's effective rate, an observable
   market price, or the fair value of the collateral.

   An analysis of the effect of impaired loans - net of charge-offs - on
   interest revenue for 1998, 1997, and 1996 is presented in the following
   table.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
In millions                                                                  1998         1997         1996
------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>          <C>          <C>
Interest revenue that would have been recorded if accruing ........            $6          $ 9          $14
Net interest revenue recorded:
  Related to the current period ...................................             5            3            3
  Related to prior periods ........................................             -            2            1

------------------------------------------------------------------------------------------------------------
Positive (negative) impact of impaired loans on interest revenue               (1)          (4)         (10)
------------------------------------------------------------------------------------------------------------
</TABLE>


   Interest that would have been recorded if accruing, represents $3 million, $4
   million, and $12 million from borrowers in the U.S. and $3 million, $5
   million, and $2 million from borrowers outside the U.S. in 1998, 1997, and
   1996, respectively.

   Interest revenue recorded represents $3 million, $6 million, and $3 million
   from borrowers in the U.S. and $2 million, ($1) million, and $1 million from
   borrowers outside the U.S. in 1998, 1997, and 1996, respectively.

   For the 12 months ended December 31, 1998, 1997, and 1996, the average
   recorded investments in impaired loans were $78 million, $99 million, and
   $141 million, respectively.


92   Notes to consolidated financial statements

<PAGE>   95
   The following table presents impaired loans - net of charge-offs - organized
by the location of the counterparty.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions: December 31                           1998         1997         1996         1995         1994
-----------------------------------------------------------------------------------------------------------
<S>                                              <C>           <C>          <C>          <C>           <C> 
COUNTERPARTIES IN THE U.S.
Commercial and industrial ...................    $    6        $  12        $  83        $  59         $106
Other .......................................        96           16           17           31           60
-----------------------------------------------------------------------------------------------------------
                                                    102           28          100           90          166
-----------------------------------------------------------------------------------------------------------
COUNTERPARTIES OUTSIDE THE U.S.
Commercial and industrial ...................         6           43            6            8           30
Banks and other financial institutions ......         2           30            -            -            -
Other .......................................        12           12           14           19           23
-----------------------------------------------------------------------------------------------------------
                                                     20           85           20           27           53
-----------------------------------------------------------------------------------------------------------
Total impaired loans                                122          113          120          117          219
-----------------------------------------------------------------------------------------------------------
</TABLE>

   The following table presents an analysis of the changes in impaired loans.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions                                        1998         1997         1996         1995         1994
-----------------------------------------------------------------------------------------------------------
<S>                                                <C>          <C>          <C>          <C>          <C> 
IMPAIRED LOANS, JANUARY 1                          $113         $120         $117         $219         $282
-----------------------------------------------------------------------------------------------------------
Additions to impaired loans .................       252          123          123          124          152
Less:
  Repayments of principal, net of
    additional advances .....................       (40)         (21)         (57)        (113)         (55)
  Impaired loans returning to
    accrual status ..........................       (39)         (48)           -            -          (53)
  Charge-offs:(a)  
    Commercial and industrial ...............       (46)         (21)         (30)         (39)         (53)
    Banks and other financial institutions ..       (83)         (17)           -            -            -
    Other ...................................       (26)          (2)          (9)         (16)         (19)
  Interest and other credits ................        (9)          (7)         (11)         (12)         (11)
  Sales and swaps of loans ..................         -          (14)         (13)         (46)         (24)
-----------------------------------------------------------------------------------------------------------
IMPAIRED LOANS, DECEMBER 31                         122          113          120          117          219
-----------------------------------------------------------------------------------------------------------
</TABLE>
   (a) Charge-offs include losses on loan sales of $105 million for 1998 with a
   carrying value of $1.1 billion. The carrying value of loans sold is not
   included in the above table.



   15. ALLOWANCES FOR CREDIT LOSSES

   We maintain allowances for credit losses to absorb losses inherent in our
   traditional extensions of credit that we believe are probable of occurring
   and that can be reasonably estimated. These allowances include an allowance
   for loans and an allowance for off-balance-sheet financial instruments such
   as commitments and standby letters of credit and guarantees.

   Prior to December 31, 1996, our reserves and allowances for credit losses
   were displayed in the aggregate as a reduction of loans in our "Consolidated
   balance sheet." Beginning December 31, 1996, in accordance with the AICPA
   Banks and Savings Institutions Audit Guide, the aggregate allowance was
   apportioned and displayed as a reduction to loans, as a reduction of trading
   assets related to determining the fair value of our derivatives portfolio
   (see note 10, "Trading account assets and liabilities"), and as other
   liabilities related to off-balance-sheet credit instruments. Amounts were
   allocated based on assigning specific counterparty, industry, and country
   allocations based on product or balance sheet caption of the underlying
   counterparty exposure; amounts related to the general component were
   proportionally allocated to balance sheet captions based on an assessment of
   the level of risk of the underlying exposures.

   Prior to July 1, 1998, changes, excluding charge-offs and recoveries, across
   balance sheet reserve or allowance captions - which included an adjustment
   for trading derivatives needed to determine fair value, an allowance for
   loans, and an allowance for off-balance-sheet financial instruments such as
   commitments, and standby letters of credit and guarantees - were shown as
   reclassifications.



                                Notes to consolidated financial statements   93
<PAGE>   96
   Reclassifications had no impact on net income and, accordingly, were not
   shown on the "Consolidated statement of income." Subsequent to July 1, 1998,
   reclassifications across balance sheet captions for allowances are reflected
   as provisions or reversals of provisions in the "Consolidated statement of
   income." If reclassifications prior to July 1, 1998 were included in the
   "Consolidated statement of income," these captions would change as follows,
   with no impact on net income: In 1998, Provision for loan losses and Trading
   revenue would both decrease by $50 million; in 1997, Provision for loan
   losses would decrease by $20 million, Trading revenue would decrease by $35
   million, and Other revenue would increase by $15 million; in 1996, Provision
   for loan losses would decrease by $307 million, Trading revenue would
   decrease by $196 million, and Other revenue would decrease by $111 million.

   The following table summarizes the activity of the allowance for loan losses
   during the last three years.


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
   In millions                                                               1998         1997         1996
---------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>           <C>         <C>      
BEGINNING BALANCE, JANUARY 1                                                $ 546         $566        $1 130(d)
---------------------------------------------------------------------------------------------------------------
Provision for loan losses in the U.S. ...............................          60            -            -
Provision for loan losses outside the U.S. ..........................          50            -            -
---------------------------------------------------------------------------------------------------------------
                                                                              110            -            -
---------------------------------------------------------------------------------------------------------------
Reclassifications in the U.S. .......................................           6            5         (198)
Reclassifications outside the U.S. ..................................         (56)         (25)        (352)
---------------------------------------------------------------------------------------------------------------
                                                                              (50)         (20)        (550)(d)
---------------------------------------------------------------------------------------------------------------
Recoveries:
 Counterparties in the U.S. .........................................          13           20           20
 Counterparties outside the U.S. ....................................           6           20            5
---------------------------------------------------------------------------------------------------------------
                                                                               19           40           25
---------------------------------------------------------------------------------------------------------------
Charge-offs:(a)
 Counterparties in the U.S. .........................................          (5)          (3)         (36)
 Counterparties outside the U.S.
         Commercial and industrial .................................          (44)         (20)          (1)
         Banks and other financial institutions .....................         (83)         (17)           -
         Other ......................................................         (23)           -           (2)
---------------------------------------------------------------------------------------------------------------
                                                                             (155)         (40)         (39)
---------------------------------------------------------------------------------------------------------------
Net charge-offs(b)                                                           (136)           -          (14)
---------------------------------------------------------------------------------------------------------------
ENDING BALANCE, DECEMBER 31                                                   470          546          566
---------------------------------------------------------------------------------------------------------------
International portion of the allowance, December 31(c)                        272          379          389
---------------------------------------------------------------------------------------------------------------
</TABLE>


   (a) Charge-offs include losses on loan sales, primarily banks and other
   financial institutions, of $105 million during 1998.

   (b) Net charge-offs as a percentage of average loans were 0.44%, 0.00%, and
   0.05% for 1998, 1997, and 1996, respectively.

   (c) Not reflected in the above table are transfers to the international
   portion of the allowance from the domestic portion of $43 million, $32
   million, and $23 million in 1998, 1997, and 1996, respectively.

   (d) Balance at January 1, 1996 represents the aggregate allowance.
   Reclassifications represent the estimated apportionment of the aggregate
   allowance at December 31, 1995 as well as changes across balance sheet
   captions for allowances during 1996.


   The following table displays our allowance for loan losses by component as of
December 31.


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
   In millions: December 31                                                  1998         1997         1996
------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>          <C>          <C>  
Specific counterparty components in the U.S. .................              $  29        $  55        $  86
Specific counterparty components outside the U.S. ............                  5           51           28
------------------------------------------------------------------------------------------------------------
Total specific counterparty                                                    34          106          114
------------------------------------------------------------------------------------------------------------
Specific country .............................................                 93          198          273
Specific industry ............................................                  -            -           15
Expected loss ................................................                228          171          102
General ......................................................                115           71           62
------------------------------------------------------------------------------------------------------------
Total                                                                         470          546          566
------------------------------------------------------------------------------------------------------------
</TABLE>


94 Notes to consolidated financial statements
<PAGE>   97
   The following table summarizes the activity of the allowance for credit
   losses on off-balance-sheet financial instruments during the last three
   years.


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
   In millions                                                               1998         1997         1996
------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>          <C>         <C>  
BEGINNING BALANCE, JANUARY 1                                                 $185         $200        $   -
------------------------------------------------------------------------------------------------------------
Negative provision for credit losses ($49 in the U.S.)                        (60)           -            -
------------------------------------------------------------------------------------------------------------
Reclassifications in the U.S. .....................................             -            -          111
Reclassifications outside the U.S. ................................             -          (15)          89
------------------------------------------------------------------------------------------------------------
                                                                                -          (15)         200(b)
------------------------------------------------------------------------------------------------------------
ENDING BALANCE, DECEMBER 31                                                   125          185          200
------------------------------------------------------------------------------------------------------------
International portion of the allowance, December 31(a)                         69          107           89
------------------------------------------------------------------------------------------------------------
</TABLE>

   (a) Not reflected in the above table are transfers to/(from) the
   international portion of the allowance to the domestic portion of ($27)
   million, $33 million, and $89 million in 1998, 1997, and 1996, respectively.

   (b) See note (d) on previous page.


   The following table displays our allowance for credit losses on
   off-balance-sheet instruments by component as of December 31.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
   In millions: December 31                                                  1998         1997         1996
------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>         <C>            <C>
Specific counterparty components in the U.S. ............................    $  1        $   -          $31
Specific counterparty components outside the U.S. .......................       2            2           31
------------------------------------------------------------------------------------------------------------
Total specific counterparty .............................................       3            2           62
------------------------------------------------------------------------------------------------------------
Specific country ........................................................      30           58            -
Specific industry .......................................................       -            -           38
Expected loss ...........................................................      66           53           41
General .................................................................      26           72           59
------------------------------------------------------------------------------------------------------------
Total ...................................................................     125          185          200
------------------------------------------------------------------------------------------------------------
</TABLE>

   The following table summarizes the activity of the aggregate allowance for
   credit losses that was shown as a reduction of loans in 1995 and 1994.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
   In millions                                                          1995             1994
-------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>               <C>   
BEGINNING BALANCE, JANUARY 1 ..............................           $1 131            $1 157
-------------------------------------------------------------------------------------------------------------
Recoveries: ...............................................                           
 Counterparties in the U.S. ...............................               37                14
 Counterparties outside the U.S. ..........................               17                31
-------------------------------------------------------------------------------------------------------------
                                                                          54                45
-------------------------------------------------------------------------------------------------------------
Charge-offs: ..............................................                           
 Counterparties in the U.S. ...............................              (45)              (51)
 Counterparties outside the U.S. ..........................                         
   Commercial and industrial ..............................               (6)               (2)
   Banks and other financial institutions .................                -                 -
   Other ..................................................               (4)              (19)
-------------------------------------------------------------------------------------------------------------
                                                                         (55)              (72)
-------------------------------------------------------------------------------------------------------------
Net charge-offs(a) ........................................               (1)              (27)
Translation adjustment ....................................                -                 1
-------------------------------------------------------------------------------------------------------------
ENDING BALANCE, DECEMBER 31 ...............................            1 130             1 131
-------------------------------------------------------------------------------------------------------------
International portion of the allowance, December 31 .......              716               647
-------------------------------------------------------------------------------------------------------------
</TABLE>


(a) Net charge-offs as a percentage of average loans were 0.01% and 0.11% for
1995 and 1994, respectively.



                   Notes to consolidated financial statements       95
<PAGE>   98
   The following table displays our aggregate allowance for credit losses by
component as of December 31.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
   In millions: December 31                                                               1995         1994
------------------------------------------------------------------------------------------------------------
<S>                                                                                    <C>          <C>    
Specific counterparty components in the U.S. ..................................        $   142      $   116
Specific counterparty components outside the U.S. .............................             59           70
------------------------------------------------------------------------------------------------------------
Total specific counterparty ...................................................            201          186
------------------------------------------------------------------------------------------------------------
Specific country ..............................................................            610          464
Specific industry .............................................................             82            -
Expected loss .................................................................            112          194
General .......................................................................            125          287
------------------------------------------------------------------------------------------------------------
Total allowance                                                                          1 130        1 131
------------------------------------------------------------------------------------------------------------
</TABLE>


   16. PREMISES AND EQUIPMENT

   The components of premises and equipment at December 31 are presented in the
following table.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
In millions: December 31                                                                  1998         1997
-----------------------------------------------------------------------------------------------------------
<S>                                                                                    <C>          <C>    
Land ..............................................................                    $   112      $   112
Buildings .........................................................                      1 130        1 080
Equipment and furniture ...........................................                      1 064        1 170
Leasehold improvements ............................................                        420          342
Property under financing obligation: land and building                                     488          486
Construction-in-progress ..........................................                         17           27
-----------------------------------------------------------------------------------------------------------
                                                                                         3 231        3 217
Less: accumulated depreciation ....................................                      1 350        1 379
-----------------------------------------------------------------------------------------------------------
                                                                                         1 881        1 838
-----------------------------------------------------------------------------------------------------------
</TABLE>


   Depreciation expense was $208 million in 1998, $185 million in 1997, and $212
   million in 1996. No interest was capitalized in connection with various
   construction projects in 1998 or 1997. Refer to note 2, "Accounting changes
   and developments," and note 4, "Business changes and developments."


   17. DEPOSITS AND OTHER BORROWINGS

   DEPOSITS

   Except for time deposits in 1997, no average balance in offices in the U.S.
   for any individual deposit category exceeded 10% of the average total
   deposits in 1998, 1997, and 1996. In 1997 the average balance and rate paid
   for time deposits in offices in the U.S. were $7,350 million and 5.75%,
   respectively.

   Average deposits in offices outside the U.S. are presented in the following 
   table.

<TABLE>
<CAPTION>
                                                               1998                       1997                      1996
                                                     ------------------------   -----------------------    -----------------------
                                                      Average       Average      Average      Average       Average       Average
In millions                                            balance     rate paid     balance     rate paid      balance      rate paid
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>          <C>           <C>         <C>            <C>          <C>
INTEREST-BEARING DEPOSITS
From banks in foreign countries ................       $13 908        4.86%       $14 777        4.55%      $13 753        4.96%
From foreign governments and official institutions      12 787        5.04         13 656        5.15        11 020        4.97
Other time .....................................        19 992        4.96         15 461        5.02        16 830        5.96
On demand ......................................         2 357        4.74          2 360        2.69         3 545        2.96
----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits in                                                                                      
 offices outside the U.S. ......................        49 044        4.95         46 254        4.79        45 148        5.18
----------------------------------------------------------------------------------------------------------------------------------
NONINTEREST-BEARING DEPOSITS                                                                                            
From banks in foreign countries ................           222                        121                        29     
From foreign governments and official institutions           -                          2                         5     
Other demand ...................................           562                        329                       703     
----------------------------------------------------------------------------------------------------------------------------------
Total noninterest-bearing deposits in                                                                                   
 offices outside the U.S.                                  784                        452                       737     
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


96        Notes to consolidated financial statements
<PAGE>   99
   Foreign country-related deposits in offices in the U.S. totaled approximately
   $0.8 billion at December 31, 1998; $0.6 billion at December 31, 1997; and
   $0.8 billion at December 31, 1996.

   A profile of the maturities of time certificates of deposit and other time
   deposits in denominations of $100,000 or more as of December 31, 1998, is
   presented in the following table.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
                                                                           After six
                                                     Within  After three  months but        After
                                                      three   months but      within          one
In millions: December 31, 1998                       months   within six    one year         year        Total
---------------------------------------------------------------------------------------------------------------
<S>                                                 <C>       <C>         <C>            <C>          <C>  
OFFICES IN THE U.S.                      
Time certificates of deposit ............           $ 4 355       $1 102      $  181      $     3      $ 5 641
Other time deposits .....................                95            -           -          346          441
---------------------------------------------------------------------------------------------------------------
                                                      4 450        1 102         181          349        6 082
---------------------------------------------------------------------------------------------------------------
OFFICES OUTSIDE THE U.S.
Time certificates of deposit ............             5 369        1 391         581          100        7 441
Other time deposits .....................            21 720        1 794       1 373        2 096       26 983
---------------------------------------------------------------------------------------------------------------
                                                     27 089        3 185       1 954        2 196       34 424
---------------------------------------------------------------------------------------------------------------
</TABLE>

   PURCHASED FUNDS AND OTHER BORROWINGS

   Purchased funds and other borrowings are detailed in the following table.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
In millions                                   1998             1997           1996
------------------------------------------------------------------------------------
<S>                                          <C>             <C>             <C> 
SECURITIES SOLD UNDER AGREEMENTS 
TO REPURCHASE
Balance at year-end ................         $62 784         $53 202         $56 117
Average balance ....................          68 534          63 163          59 812
Maximum month-end balance ..........          82 740          73 447          69 548
Average interest rate:
  During year ......................            5.45%           5.24%           5.19%
  At year-end ......................            4.76            5.99            5.98
------------------------------------------------------------------------------------
FEDERAL FUNDS PURCHASED (DAY-TO-DAY)
Balance at year-end ................         $   584         $ 4 602         $ 5 312
Average balance ....................           2 003           3 958           3 612
Maximum month-end balance ..........           7 770           6 186           5 312
Average interest rate:
  During year ......................            5.63%           5.56%           5.30%
  At year-end ......................            5.24            6.43            6.19
------------------------------------------------------------------------------------
COMMERCIAL PAPER
Balance at year-end ................         $ 6 637         $ 6 622        $  4 132
Average balance ....................           9 682           4 858           4 133
Maximum month-end balance ..........          12 738           6 622           5 102
Average interest rate:
  During year ......................            5.57%           5.39%           5.44%
  At year-end ......................            5.19            5.78            5.50
------------------------------------------------------------------------------------
OTHER LIABILITIES FOR BORROWED MONEY
Federal funds purchased (term):
  Balance at year-end ..............          $  460          $1 465        $    386
  Average balance ..................             689             435             554
  Maximum month-end balance ........           1 495           1 465             800
  Average interest rate:
   During year .....................            5.66%           5.71%           5.57%
   At year-end .....................            5.29            5.79            5.51
Other:
  Balance at year-end ..............         $12 055         $15 711        $ 19 562
  Average balance ..................          13 620          17 813          15 810
  Maximum month-end balance ........          16 407          20 107          20 142
  Average interest rate:
   During year .....................            6.90%           6.02%           6.20%
   At year-end .....................            6.39            4.78            5.63
------------------------------------------------------------------------------------
</TABLE>

                                Notes to consolidated financial statements    97
<PAGE>   100
   Average interest rates during each year were computed by dividing total
   interest expense by the average amount borrowed. Average interest rates at
   year-end are average rates for a single day and, as such, may reflect one-day
   market distortions that may not be indicative of generally prevailing rates.
   Original maturities of securities sold under agreements to repurchase
   generally are not more than six months. Original maturities of commercial
   paper are generally not more than nine months. Other liabilities for borrowed
   money generally have original maturities of one year or less.



   18. LONG-TERM DEBT

   The net proceeds from the issuance of J.P. Morgan's long-term debt may be
   used for general corporate purposes. This includes investing in equity and
   debt securities and advancing funds to our subsidiaries. We have the option
   to redeem certain debt before it matures at specified prices.

   LONG-TERM DEBT QUALIFYING AS RISK-BASED CAPITAL

   Long-term debt that qualifies as risk-based capital generally must be
   unsecured and subordinated with an original weighted-average maturity of at
   least five years. Subordinated debt would be junior in right of payment to
   all other indebtedness in the event of our liquidation. The following table
   presents long-term debt that qualifies as risk-based capital. It represents
   all our subordinated issues at December 31.

<TABLE>
<CAPTION>
                                                   
                                                   --------------------------------------------------------------
                                                   J.P. Morgan (parent)   Morgan Guaranty              Total debt
                                                   ---------------------------------------            outstanding
                                                    Fixed  Floating      Fixed   Floating       -----------------
In millions                                          rate    rate         rate     rate         1998         1997
-----------------------------------------------------------------------------------------------------------------
Contractual maturity date
<S>                                             <C>          <C>         <C>           <C>    <C>         <C>          
1998.........................................   $      -     $    -      $    -        $ -    $      -    $   643(a)(b)
2000.........................................          -        200           -          -         200        200
2002.........................................        200        446         213          -         859        846
2003.........................................        228          -           -          -         228        223
2004 - 2008..................................      1 902        294           -          -       2 196      2 241
Thereafter...................................      1 576(c)      55           -          -       1 631      1 522
-----------------------------------------------------------------------------------------------------------------
                                                                                                 5 114      5 675
Less: amortization for risk-based capital
purposes(d)                                                                                       (544)      (932)
-----------------------------------------------------------------------------------------------------------------
Total long-term debt qualifying as risk-based 
capital                                                                                          4 570      4 743
-----------------------------------------------------------------------------------------------------------------
</TABLE>
   (a) Amounts include $1 million of outstanding convertible debentures at
   December 31, 1997. At December 31, 1997, these debentures were convertible
   into 72,100 shares of J.P. Morgan common stock at $20 per share.

   (b) Amounts include $392 million of outstanding zero-coupon notes at December
   31, 1997. The principal amount of these notes is $400 million. The yield to
   maturity on the notes, which do not bear interest, is 8.66%. The carrying
   value increases as the discount on the notes is accreted to interest expense.

   (c) Amounts include $299 million of outstanding zero-coupon notes at December
   31, 1998. The principal amount of these notes is $2,396 million, of which $10
   million matures in 2017, $2,250 million matures in 2027, $100 million matures
   in 2028, and $36 million matures in 2038. The weighted average yield to
   maturity on the notes, which do not bear interest, is 5.21%. The carrying
   value increases as the discount on the notes is accreted to interest expense.

   (d) The balance of debt qualifying as risk-based capital is reduced 20% per
   year during each of the last five years prior to maturity.


98    Notes to consolidated financial statements
<PAGE>   101
LONG-TERM DEBT NOT QUALIFYING AS RISK-BASED CAPITAL

The following table presents long-term debt that does not qualify as risk-based
capital. Most of the debt in this table is senior debt at December 31. Senior
debt has a higher claim on our assets than junior or subordinated debt.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                             J.P. Morgan (parent)       Morgan Guaranty                     Total debt
                                           -----------------------   --------------------                  outstanding
                                            Fixed          Floating   Fixed        Floating         ------------------
In millions                                  rate            rate      rate          rate           1998          1997
-------------------------------------------------------------------------------------------------------------------------
CONTRACTUAL MATURITY DATE
<S>                                        <C>                <C>        <C>         <C>         <C>         <C>  
1998...................................    $    -             $    -     $    -      $    -      $     -     $6 988
1999...................................     1 806              2 650      1 638       4 220       10 314      3 254
2000...................................     1 301(a)           3 248        264          35        4 848        963(a)
2001...................................       917(b)             400        950         333        2 600      1 769
2002...................................        88                  5        498           -          591        687
2003...................................       570                  _        332           -          902        711
2004 - 2008............................       740(c)             506        331         135        1 712      1 473(c)
Thereafter.............................       608(c)(d)          114        306(e)      225        1 253      1 182(c)(d)(e)
British pound financing obligation(f)..                                                              273        287
-------------------------------------------------------------------------------------------------------------------------
                                                                                                  22 493     17 314
Add: amortization for risk-based capital
  purposes(g)..........................                                                              544        932
-------------------------------------------------------------------------------------------------------------------------
Total long-term debt not qualifying as
  risk-based capital                                                                              23 037     18 246
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Amounts include 2.5% cumulative Series A Commodity-Indexed Preferred
Securities (ComPS) with a face value of $50 million, a carrying value of $50
million at December 31, 1998 and 1997, and a maturity date, which may change as
defined, of October 16, 2000. J.P. Morgan Index Funding Company I (JPMIFC),a
wholly owned subsidiary of J.P. Morgan, is the issuer of the ComPS. The ComPS
redemption price is indexed to the JPMCI Crude Oil Total Return Index, and may
be more or less than the face amount of the ComPS. The proceeds of the sale of
ComPS and JPMIFC's common stock were used by JPMIFC to purchase $50 million,
2.5% Series A Intercompany Notes (Intercompany Notes) of Morgan Guaranty. The
Intercompany Notes are the sole assets of JPMIFC and have the same terms as the
ComPS. The obligations of J.P. Morgan under agreements with JPMIFC, as defined,
constitute a full and unconditional guarantee, on a subordinated basis, of
payments due on the ComPS.

(b) Amounts include $9 million of outstanding zero-coupon notes at December 31,
1998. The principal amount of these notes is $10 million. The weighted-average
yield to maturity on the notes, which do not bear interest, is 5.21%. The
carrying value increases as the discount on the notes is accreted to interest
expense.

(c) Includes notes maturing in 2008 - 2009 for which the interest rates were
reset during 1998 for the following 10-year term at a rate based on the interest
rate for 10-year U.S. Treasury securities at that time. The carrying amount of
these notes was $425 million at December 31, 1998 and 1997.

(d) Amounts include a convertible mortgage loan with a carrying value of $405
million at December 31, 1998 and 1997. The interest rate on the loan increases
1/2% every four years from 7%, as set in 1988, to 9% in 2004. After 2008 the
rate will be fixed based on the interest rate for 10-year U.S. Treasury
securities at that time. Beginning in 2008 the loan may be converted, at the
option of the lender, into a 49% interest in the J.P. Morgan building at 60 Wall
Street. If the loan is converted, J.P. Morgan will have the option to lease the
property for seven 10-year terms. J.P. Morgan has the right to prepay the debt
if the lender does not exercise the conversion option. The loan is
collateralized by the 60 Wall Street building owned by Morgan Guaranty.

(e) Amounts represent $306 million of outstanding zero-coupon notes at December
31, 1998. The principal amount of these notes is $3,221 million. The
weighted-average yield to maturity on the notes, which do not bear interest, is
14.56%. The carrying value increases as the discount on the notes is accreted to
interest expense.

(f) Represents the sale of a 52.5% interest in J.P. Morgan's office building
complex in London. The transaction is treated as a financing obligation, which
is being amortized over a 25-year period, corresponding with J.P. Morgan's
initial lease term for the entire complex. J.P. Morgan has renewal options to
lease this space for an additional 50 years. The lease contains escalation
clauses under which rental payments will be redetermined every five years,
beginning after year 15. Interest on the financing obligation is imputed
annually at an effective rate that varies depending on then-current rental rates
in the London real estate market. The aggregate amounts of minimum cash payments
(at the December 31, 1998 exchange rate) to be applied to the financing
obligation for each of the five years subsequent to December 31, 1998, and
thereafter are presented in the following table.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions
--------------------------------------------------------------------------------
<S>                                                                      <C>  
1999 ..........................................................          $  26
2000 ..........................................................             26
2001 ..........................................................             27
2002 ..........................................................             27
2003 ..........................................................             27
Thereafter ....................................................            223
--------------------------------------------------------------------------------
Total cash payments ...........................................            356
Less: interest ................................................            (83)
--------------------------------------------------------------------------------
Balance outstanding at December 31, 1998                                    273
--------------------------------------------------------------------------------
</TABLE>

(g) The balance of debt qualifying as risk-based capital is reduced 20% per year
during each of the last five years prior to maturity.


                                Notes to consolidated financial statements    99
<PAGE>   102

The long-term debt tables above include non-U.S. dollar denominated debt
totaling $4,943 million and $4,318 million at December 31, 1998 and 1997,
respectively. Of this amount, $4,189 million and $3,685 million were fixed rate
instruments and $754 million and $633 million were floating rate instruments at
December 31, 1998 and 1997, respectively.

Also included in these long-term debt tables are notes issued under J.P.
Morgan's domestic and Euro-medium term notes programs totaling $9,884 million
and $2,186 million at December 31, 1998 and 1997, respectively. Based solely on
contractual terms, the weighted-average interest rate of these issues was 5.42%
and 5.98% at December 31, 1998 and 1997, respectively. Maturities of these
issues at December 31, 1998 range from 1999 to 2038.

The ranges of interest rates associated with long-term debt at December 31 are
summarized in the following table for 1998 and 1997. They are based on the yield
to maturity for zero-coupon notes and contractual terms for all other issues.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                                       1998            1997
--------------------------------------------------------------------------------
<S>                                                <C>             <C>       
U.S. dollar fixed rate issues ..................   2.50 - 10.00%   2.50 - 10.00%
U.S. dollar floating rate issues(a) ............   4.97 -  8.00    5.00 - 10.98
Non-U.S. dollar fixed rate issues ..............   2.00 - 22.00    2.00 - 22.00
Non-U.S. dollar floating rate issues(a) ........   1.00 -  9.84    1.00 - 14.00
--------------------------------------------------------------------------------
</TABLE>

(a) Floating rates are determined by formulas and may be subject to certain
minimum or maximum rates.

The weighted-average interest rate for total long-term debt was 6.50% and 6.19%
at December 31, 1998 and 1997, respectively. In order to modify exposure to
interest rate and currency exchange rate movements, J.P. Morgan utilizes
derivative instruments, primarily interest rate and currency swaps, in
conjunction with some of its debt issues. The effect of derivative instruments
used to modify our exposure to interest rate and currency exchange rate
movements is included in the calculation of interest expense on the associated
debt. The weighted-average interest rate for total long-term debt, including the
effects of the related derivative instruments, was 5.51% and 5.88% at December
31, 1998 and 1997, respectively.

19. INCOME TAXES

J.P. Morgan and eligible subsidiaries file a consolidated U.S. federal income
tax return. The following table presents the current and deferred portions of
income tax expense included in the "Consolidated statement of income." Portions
of the current and deferred U.S. income tax expense (benefit) for 1996 and 1997
have been reclassified to reflect more closely the tax returns as filed.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
                                                     1998                             1997                            1996
                              ---------------------------      ---------------------------     ---------------------------
In millions                   Current    Deferred   Total      Current    Deferred   Total     Current    Deferred   Total
--------------------------------------------------------------------------------------------------------------------------
INCOME TAX EXPENSE (BENEFIT)
<S>                           <C>        <C>        <C>        <C>        <C>        <C>       <C>        <C>        <C>  
U.S. ....................     $  20      $(366)     $(346)     $ 221      $(151)     $  70     $ 179      $ (17)     $ 162
Foreign .................       794        (53)       741        539          7        546       586        (74)       512
State and local .........        66         (7)        59        106        (33)        73       120        (36)        84
--------------------------------------------------------------------------------------------------------------------------
                                880       (426)       454        866       (177)       689       885       (127)       758
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

The income tax expense related to net realized gains and write-downs for
other-than-temporary impairments in value on debt and equity investment
securities, excluding securities in SBICs, was $60 million in 1998, $137 million
in 1997, and $98 million in 1996.

The table below presents the components of deferred tax assets and liabilities
at December 31 for 1998, 1997, and 1996.


100    Notes to consolidated financial statements
<PAGE>   103

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
In millions: December 31                                          1998     1997      1996
-----------------------------------------------------------------------------------------
DEFERRED TAX ASSETS
<S>                                                              <C>      <C>      <C>   
Compensation and benefits ..................................     $1 173   $  971   $  835
Allowances for credit losses and other valuation adjustments        363      430      443
Foreign tax credit carry forward (expiring in 2003) ........        200        -        -
Foreign operations .........................................        105       62       65
Write-down of equity investment securities .................         31       22       44
Other ......................................................        279      244      165
-----------------------------------------------------------------------------------------
Total deferred tax assets before valuation allowance .......      2 151    1 729    1 552
Less: valuation allowance(a) ...............................        120      120      120
-----------------------------------------------------------------------------------------
Total deferred tax assets                                         2 031    1 609    1 432
-----------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
Gains on debt and equity investment securities .............        434      521      549
Lease financing transactions ...............................        130      144      142
Unremitted earnings ........................................        104       91      101
Depreciation ...............................................          -       19       58
Other ......................................................        129      146      187
-----------------------------------------------------------------------------------------
Total deferred tax liabilities                                      797      921    1 037
-----------------------------------------------------------------------------------------
</TABLE>

(a) The valuation allowance is primarily related to the ability to recognize tax
benefits associated with foreign operations.

J.P. Morgan recorded an income tax liability of $87 million, $256 million, and
$268 million at December 31, 1998, 1997, and 1996, respectively, related to the
net unrealized gains on investment securities classified as available-for-sale.

The following table displays a reconciliation of the difference between the
expected U.S. statutory income tax rate and J.P. Morgan's effective income tax
rate.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------
Percentage of pretax income                                        1998       1997       1996
----------------------------------------------------------------------------------------------
<S>                                                                <C>        <C>        <C>  
U.S. statutory tax rate ......................................     35.0%      35.0%      35.0%
Increase (decrease) due to:
     State and local taxes, net of U.S. income tax effects....      2.7        2.2        2.3
     Tax-exempt income .......................................     (7.7)      (4.9)      (2.7)
     Other ...................................................      2.0       (0.3)      (2.1)
----------------------------------------------------------------------------------------------
Effective tax rate                                                 32.0       32.0       32.5
----------------------------------------------------------------------------------------------
</TABLE>


                               Notes to consolidated financial statements    101
<PAGE>   104

20. COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARIES

In November 1996 JPM Capital Trust I (Trust I) issued $750 million of cumulative
capital securities (trust preferred securities) with a fixed rate of 7.54%. In
January 1997 JPM Capital Trust II (Trust II) issued $400 million of trust
preferred securities with a fixed rate of 7.95%. Trust I and Trust II are wholly
owned subsidiaries of J.P. Morgan.

The trust preferred securities:

-        have a stated value and liquidation preference of $1,000 per share

-        have no voting rights

-        qualify as tier 1 capital under current Federal Reserve guidelines

Trust I used the proceeds from the sale of its 7.54% trust preferred securities
and the sale of its common stock to J.P. Morgan to purchase $773.2 million of
7.54% junior subordinated debentures (intercompany debentures) of J.P. Morgan.
Trust II used the proceeds from the sale of its 7.95% trust preferred securities
and the sale of its common stock to J.P. Morgan to purchase $412.4 million of
intercompany debentures of J.P. Morgan. The intercompany debentures are
unsecured and rank subordinate and junior in right of payment to all other debt,
liabilities, and obligations of J.P. Morgan. Therefore, their claim on J.P.
Morgan's assets comes after all of J.P. Morgan's other obligations are
fulfilled. The intercompany debentures represent the sole assets of Trust I and
Trust II.

Interest on each of the trust preferred securities is cumulative, payable
semiannually, and fully and unconditionally guaranteed by J.P. Morgan - but only
if, and to the extent that, the semiannual interest payments are made on the
intercompany debentures by J.P. Morgan. Interest related to the trust preferred
securities is recorded on an accrual basis and included in the Interest expense
caption on our "Consolidated statement of income." The obligations of J.P.
Morgan under the trust agreements, as defined, constitute a full and
unconditional guarantee by J.P. Morgan of the trusts' obligations under the
trust preferred securities issued.

The $773.2 million 7.54% intercompany debentures mature on January 15, 2027.
Upon approval from the Federal Reserve, J.P. Morgan has the right to redeem the
7.54% intercompany debentures, starting on January 15, 2007. They can be
redeemed at 103.77% of the stated liquidation preference amount on or after
January 15, 2007, with this price declining 0.377% per year until January 15,
2017. After January 15, 2017, the price will equal 100% of the stated
liquidation preference amount.

The $412.4 million 7.95% intercompany debentures mature on February 1, 2027.
Upon approval from the Federal Reserve, J.P. Morgan has the right to redeem the
7.95% intercompany debentures, starting on February 1, 2007. They can be
redeemed at 103.975% of the stated liquidation preference amount on or after
February 1, 2007, with this price declining 0.398% per year until February 1,
2017. After February 1, 2017, the price will equal 100% of the stated
liquidation preference amount.

Proceeds from any redemption or maturity of the intercompany debentures held by
Trust I or Trust II would cause a mandatory redemption of the respective trust
preferred securities of Trust I or Trust II, having an aggregate liquidation
amount equal to the principal amount of respective intercompany debentures
redeemed.

In accordance with Securities and Exchange Commission Staff Accounting Bulletin
No. 53, J.P. Morgan is not required to disclose separate financial statements
for Trust I and II because Trust I and Trust II are wholly owned, have no
independent operations, and are issuing securities that contain a full and
unconditional guarantee of their parent, J.P. Morgan.

The proceeds from the issuance of the 7.54% trust preferred securities were used
in 1997 to purchase $750 million of J.P. Morgan common stock in the open market
or through privately negotiated transactions. This action was approved by the
Board of Directors in December 1996.


102      Notes to consolidated financial statements
<PAGE>   105

21. PREFERRED STOCK

Total authorized shares of preferred stock were 10,000,000 at December 31, 1998
and 1997, respectively. With the exception of fixed cumulative preferred stock,
series H shares, J.P. Morgan may redeem the outstanding preferred stock, in
whole or in part, at our option, for the stated value plus accrued and unpaid
dividends. The Series H shares may not be redeemed before March 31, 2006. All
preferred stock has a dividend preference over other stock in the paying of
dividends, a preference in the liquidation of assets, and is generally
nonvoting. This table presents preferred stock outstanding at December 31, 1998
and 1997.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                            Authorized, issued, and
                                                               outstanding shares          Dividend rate(a)
                                                           -------------------------   -------------------------
                                                              1998           1997         1998           1997
----------------------------------------------------------------------------------------------------------------
<S>                                                        <C>           <C>           <C>            <C>  
Adjustable rate cumulative preferred stock, Series A
   (stated value: $100 per share) ....................     2 444 300     2 444 300          5.00%          5.00%
Variable cumulative preferred stock, Series B, C, D, E
   and F (50 000 shares each series; stated value:
   $1 000 per share) .................................       250 000       250 000     4.23-4.38      4.23-4.38
Fixed cumulative preferred stock, Series H
   (stated value: $500 per share) ....................       400 000       400 000          6.63           6.63
----------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Series A: The quarterly dividend rate is determined by a formula based on
the interest rates of certain actively traded U.S. Treasury obligations. The
quarterly rate in no event will be less than 5.00% or greater than 11.50% per
annum. The Series A preferred stock qualifies as tier 1 capital.

Series B, C, D, E, and F: Dividend rates for each series are determined
periodically either by auction or remarketing. The dividend rates may not exceed
certain maximums that are 110% to 200% of various market interest rates,
depending on the prevailing credit rating of the instrument at the dividend
determination dates and the duration of the then-current dividend periods. The
dividend periods may vary from one day to 30 years, depending on the dividend
determination method used. During 1998 and 1997, J.P. Morgan reset the dividend
rates approximately every 49 days. The dividend rates stated above represent the
range of those in effect at year-end. These series of preferred stock qualify as
tier 2 capital.

Series H: The quarterly dividend rate is paid at the fixed rate of 6.625% per
annum. The Series H preferred stock qualifies as tier 1 capital.

22. CAPITAL REQUIREMENTS

J.P. Morgan, our subsidiaries, and certain foreign branches of our bank
subsidiary Morgan Guaranty Trust Company of New York are subject to regulatory
capital requirements of U.S. and foreign regulators. Our primary federal banking
regulator, the Board of Governors of the Federal Reserve System (Federal Reserve
Board), establishes minimum capital requirements for J.P. Morgan, the
consolidated bank holding company, and some of our subsidiaries, including
Morgan Guaranty. These requirements ensure that banks and bank holding companies
meet specific guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting principles. Failure to meet these requirements can result in actions
by regulators that could have a direct material impact on our financial
statements. The capital of J.P. Morgan and our principal subsidiaries, Morgan
Guaranty and J.P. Morgan Securities Inc. (JPMSI), exceeded the minimum
requirements set by each regulator at December 31, 1998.

At September 30, 1997, J.P. Morgan adopted the Federal Reserve Board's market
risk capital guidelines for calculation of risk-based capital ratios. This
framework incorporates a measure of market risk for trading positions and is
based on an amendment to the Basle Capital Accord that requires banking
institutions with significant trading activity to measure and hold capital in
support of their exposure to market risk. Under this standard, our risk-based
capital ratios take into account:

-        general market risk and specific issuer risk of our debt and equity
         trading portfolios

-        general market risk associated with all trading and nontrading foreign
         exchange and commodity positions

In addition, the guidelines no longer exclude the capital and assets of JPMSI,
our Section 20 subsidiary, from risk-based capital calculations for J.P. Morgan,
the bank holding company. They also reduce the minimum leverage ratio required
for a bank holding company to retain a well-capitalized status from 4% to 3%.
The guidelines continue to exclude the effect of SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Adoption of these guidelines
had a beneficial impact on the capital ratios of both J.P. Morgan and Morgan
Guaranty.


                    Notes to consolidated financial statements               103
<PAGE>   106

CAPITAL RATIOS AND AMOUNTS

The following tables indicate the risk-based capital and leverage ratios and
amounts for J.P. Morgan and Morgan Guaranty at December 31, 1998 and 1997.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
                                                         1998                    1997
                                     ------------------------ -----------------------
Dollars in millions: December 31     Amounts(a)     Ratios(b) Amounts(c)    Ratios(b)
-------------------------------------------------------------------------------------
<S>                                  <C>            <C>       <C>           <C>
Tier 1 capital
   J.P. Morgan .................     $11 213         8.0%     $11 854         8.0%
   Morgan Guaranty .............      10 337         8.7       10 305         7.8
-------------------------------------------------------------------------------------
Total risk-based capital
   J.P. Morgan .................      16 454        11.7       17 680        11.9
   Morgan Guaranty .............      14 251        12.0       14 215        10.8
-------------------------------------------------------------------------------------
Leverage
   J.P. Morgan .................                     3.9                      4.4
   Morgan Guaranty .............                     5.3                      5.2
-------------------------------------------------------------------------------------
</TABLE>

(a) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required
minimum tier 1 capital of $5.6 billion and $4.8 billion, respectively, at
December 31, 1998. The required minimum total risk-based capital for J.P. Morgan
and Morgan Guaranty was $11.2 billion and $9.5 billion, respectively, at
December 31, 1998.

(b) Pursuant to Federal Reserve Board guidelines, the minimum tier 1 capital,
total risk-based capital, and leverage ratios are 4%, 8%, and 3%, respectively,
for bank holding companies and banks.

(c) For capital adequacy purposes, J.P. Morgan and Morgan Guaranty required
minimum tier 1 capital of $5.9 billion and $5.3 billion, respectively, at
December 31, 1997. The required minimum total risk-based capital for J.P. Morgan
and Morgan Guaranty was $11.9 billion and $10.6 billion, respectively, at
December 31, 1997.

J.P. MORGAN RISK-BASED CAPITAL

The following table shows the components of J.P. Morgan's risk-based capital at
December 31, 1998 and 1997. The table includes JPMSI.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
                                                                                      December 31
                                                                                  -------------------
In millions                                                                        1998         1997
-----------------------------------------------------------------------------------------------------
<S>                                                                               <C>         <C>
Common stockholders' equity .................................................     $10 422     $10 281
Adjustable and fixed-rate cumulative preferred stock ........................         444         444
Company-obligated mandatorily redeemable preferred securities of subsidiaries       1 150       1 150
Less: investments in certain subsidiaries and goodwill(a) ...................         803          21
-----------------------------------------------------------------------------------------------------
TIER 1 CAPITAL ..............................................................      11 213      11 854
-----------------------------------------------------------------------------------------------------
Variable cumulative preferred stock .........................................         248         248
Long-term debt qualifying as risk-based capital .............................       4 570       4 743
Qualifying allowances for credit losses and other valuation adjustments .....         906       1 059
Less: investments in certain subsidiaries(a) ................................         483         224
-----------------------------------------------------------------------------------------------------
TIER 2 CAPITAL ..............................................................       5 241       5 826
TOTAL RISK-BASED CAPITAL ....................................................      16 454      17 680
-----------------------------------------------------------------------------------------------------
</TABLE>

(a) Certain portions of our investments in certain subsidiaries are deducted
from both tier 1 and tier 2 capital.

CAPITAL CATEGORIES

Bank regulators use five capital category definitions for regulatory supervision
purposes. The categories range from well capitalized to critically
undercapitalized. A bank is considered well capitalized if it has minimum tier 1
capital, total capital, and leverage ratios of 6%, 10%, and 5%, respectively,
under standards provided by the regulatory framework for prompt corrective
action and the Federal Reserve Board.

Bank holding companies also have guidelines that determine the capital levels at
which they shall be considered well capitalized. Pursuant to these guidelines,
the Federal Reserve Board considers a bank holding company to be well
capitalized if it has minimum tier 1 capital, total capital, and leverage ratios
of 6%, 10%, and 3%, respectively.


104    Notes to consolidated financial statements

<PAGE>   107

At December 31, 1998 and 1997, the ratios of J.P. Morgan and Morgan Guaranty
exceeded the minimum standards required for a well capitalized bank holding
company and bank. Management is aware of no conditions or events that have
occurred since December 31, 1998 which would change J.P. Morgan's and Morgan
Guaranty's well capitalized status.

RISK-ADJUSTED ASSETS

The following table sets forth the consolidated risk-adjusted assets of J.P.
Morgan.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
                                                                Under new market risk guidelines
                                                                                    December 31,
                                                                 1998                       1997
                                                 --------------------   ------------------------
                                                  Balance                Balance
                                                   sheet/       Risk-      sheet/          Risk-
                                                 notional    adjusted    notional       adjusted
In billions                                        amount     balance      amount        balance
------------------------------------------------------------------------------------------------
<S>                                               <C>         <C>         <C>            <C>    
ASSETS
Cash and due from banks and interest-
   earning deposits with banks ..............     $   3.6     $   0.9     $   3.9        $   1.2
Debt investment securities ..................        36.2         3.0        22.8            3.1
Equity investment securities ................         1.2         1.1         1.1            0.7
Trading account assets ......................       113.9        22.9       111.9           18.1
Resale agreements and federal funds sold ....        31.7         5.2        39.0            6.6
Securities borrowed .........................        30.8        12.7        38.4           15.0
Loans, net ..................................        25.0        19.3        31.0           25.1
Premises and equipment, net .................         1.9         1.9         1.8            1.8
Other assets ................................        16.8        11.9        12.3            9.4
------------------------------------------------------------------------------------------------
Total assets                                        261.1        78.9       262.2           81.0
------------------------------------------------------------------------------------------------
OFF-BALANCE-SHEET EXPOSURES
Commitments to extend credit ................        83.5        12.5        80.4           21.6
Standby letters of credit and guarantees ....        15.9         9.2        15.8            6.8
Securities lending indemnifications .........         4.1         0.6         5.3            1.3
Other credit facilities .....................         0.2         0.8         3.4            2.0
Foreign exchange contracts, including foreign
   exchange options .........................      1000.6         6.1      1131.1            9.6
Currency swaps ..............................       271.1         3.8       271.2            7.7
Interest rate swaps .........................      3594.6         9.7      2433.9            5.3
Interest rate and other contracts ...........      3991.4        18.6      2345.3           13.2
------------------------------------------------------------------------------------------------
Total off-balance-sheet exposures                  8961.4        61.3(a)   6286.4           67.5(a)
------------------------------------------------------------------------------------------------
Risk-adjusted assets                                            140.2                      148.5
------------------------------------------------------------------------------------------------
</TABLE>

(a) Includes $13.6 billion and $14.7 billion at December 31, 1998 and 1997,
respectively, related to potential future credit exposure as defined in the
risk-based capital framework.


                             Notes to consolidated financial statements      105
<PAGE>   108

NET CAPITAL REQUIREMENT OF JPMSI

JPMSI is subject to the Securities and Exchange Commission (SEC) Uniform Net
Capital Rule, which requires it to maintain a minimum net capital. JPMSI has
elected to compute its net capital requirement in accordance with the
Alternative Method under SEC Rule 15c3-1 (a)(ii), which requires a broker or
dealer to maintain at all times net capital, as defined, at the greater of $1
million or 2% of aggregate debit items arising from customer transactions.

At December 31, 1998, JPMSI had net capital, as defined under such rules, of
$1,023 million, and a net capital requirement and excess net capital of $76
million and $947 million, respectively. At December 31, 1997, JPMSI had net
capital, as defined under such rules, of $786 million, and a net capital
requirement and excess net capital of $110 million and $676 million,
respectively.

23. EMPLOYEE BENEFITS

DEFINED BENEFIT PLANS

We have noncontributory defined benefit pension plans covering most of our
regular employees. In addition, certain U.S. employees hired before February 1,
1989 may be eligible for postretirement health care and life insurance when they
retire, though we have no contractual obligation to provide this coverage. Our
cost to provide postretirement benefits to non-U.S. employees has not been
material.

Pension plan assets are managed by trustees and are invested primarily in fixed
income securities, listed stocks and commingled pension trust funds. Other
postretirement benefit obligations are funded with corporate-owned life
insurance (COLI) purchased on the lives of eligible employees and retirees.
Assets of the COLI policy are held in a separate account with the insurance
company. The insurance company invests the cash value of the policy in equities,
bonds and other debt securities. While we own the COLI policy, the COLI proceeds
(death benefits, withdrawals, and other distributions) may be used only to
reimburse J.P. Morgan for its net postretirement claim payments and related
administrative expenses.

Assets of our funded pension plans exceeded their accumulated benefit
obligations at September 30, 1998 and 1997 (the dates of the actuarial
valuations). Accumulated benefit obligations for unfunded pension plans were $66
million at September 30, 1998 and $90 million at September 30, 1997. The benefit
obligations projected for these unfunded pension plans were $70 million and $105
million at September 30, 1998 and 1997, respectively.

The following tables present information related to our benefit plans, including
amounts recorded on the consolidated balance sheet and the components of net
periodic benefit cost. Settlement gains were due mainly to conversion of several
pension plans from defined benefit to defined contribution. Curtailment gains
reflect reduced liabilities due to employee terminations.


106      Notes to consolidated financial statements
<PAGE>   109

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
                                                            Pension benefits  Other postretirement benefits
                                                      ----------------------  -----------------------------
In millions                                             1998            1997           1998            1997
-----------------------------------------------------------------------------------------------------------
<S>                                                   <C>             <C>             <C>             <C>  
RECONCILIATION OF BENEFIT OBLIGATION
Benefit obligation, beginning of year ......         $1 345          $1 192           $ 210           $ 192
Service cost ...............................             63              57               5               4
Interest cost ..............................             94              89              15              15
Benefits paid ..............................            (67)            (62)            (10)             (7)
Actuarial (gains)/losses ...................             84              79              15               6
Plan amendments ............................             10              --             (12)             --
Settlements ................................            (53)             --              --              --
Curtailments ...............................            (17)             --              (5)             --
Effect of foreign exchange rates ...........              9             (10)             --              --
-----------------------------------------------------------------------------------------------------------
Benefit obligation at end of year                     1 468           1 345             218             210
-----------------------------------------------------------------------------------------------------------
RECONCILIATION OF FAIR VALUE OF PLAN ASSETS
Fair value of plan assets, beginning of year          1 555           1 309             168              96
Actual return on plan assets ...............             78             294              18              35
Employer contributions .....................             84              21              40              40
Benefits paid ..............................            (64)            (57)             --              --
COLI Proceeds ..............................             --              --              (4)             (3)
Settlements ................................            (16)             --              --              --
Effect of foreign exchange rates ...........              8             (12)             --              --
-----------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year              1 645           1 555             222             168
-----------------------------------------------------------------------------------------------------------
FUNDED STATUS
Funded status at September 30 ..............            177             210               4             (42)
Unrecognized net actuarial (gains)/losses ..            (84)           (226)            (85)           (103)
Unrecognized prior service cost ............             34              30             (12)             --
Unrecognized net asset at transition .......            (14)            (19)             --              --
Fourth quarter expense .....................             (6)             (7)             --              --
Fourth quarter contributions ...............              6               7              79              40
Fourth quarter net benefit claims ..........             --              --               2               2
-----------------------------------------------------------------------------------------------------------
Net amount recognized                                   113              (5)            (12)           (103)
-----------------------------------------------------------------------------------------------------------
</TABLE>

The following table provides the amounts recognized in the "Consolidated balance
sheet" at December 31 of both years:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
                                                                     Pension benefits   Other postretirement benefits
                                                                ---------------------   -----------------------------
In millions                                                      1998            1997            1998            1997
---------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>             <C>             <C>             <C>  
Prepaid benefit cost recorded in Other assets ........          $ 213           $ 146           $  --           $  --
Accrued benefit liability recorded in Accounts payable
and accrued expenses .................................           (100)           (151)            (12)           (103)
---------------------------------------------------------------------------------------------------------------------
Net amount recognized                                             113              (5)            (12)           (103)
---------------------------------------------------------------------------------------------------------------------
</TABLE>


                            Notes to consolidated financial statements      107

<PAGE>   110

The following table provides the components of net periodic benefit cost for the
plans reflected in Employee compensation and benefits in the "Consolidated
statement of income" for fiscal years 1998, 1997, and 1996.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
                                                              Pension benefits                   Other postretirement benefits
                                         -------------------------------------           -------------------------------------
In millions                               1998            1997            1996            1998            1997            1996
------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>             <C>             <C>             <C>             <C>             <C>  
Service cost ..................          $  62           $  56           $  60           $   5           $   4           $   5
Interest cost .................             94              90              88              15              15              15
Expected return on plan assets            (119)           (112)           (109)            (15)            (11)             (7)
Amortization of:
    Net transition assets .....             (7)             (7)             (7)             --              --              --
    Prior service cost ........              2               2              --              --              --              --
    Net actuarial gains .......             (2)             (2)             --              (5)             (4)             (4)
------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost .....             30              27              32              --               4               9
Curtailment gains .............            (11)             --              --              (5)             --              --
Settlement gains ..............            (14)             --              --              --              --              --
------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost after
curtailments and settlements                 5              27              32              (5)              4               9
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The assumptions used in the measurement of the firm's benefit obligation are
shown in the following table:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                         Pension benefits             Other postretirement benefits
                                                        ---------------------------------          --------------------------------
                                                         1998          1997          1996          1998          1997          1996
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>           <C>           <C>           <C>           <C>           <C> 
Weighted-average assumptions as of September 30
   Discount rate ..............................          6.3%          7.0%          7.6%          6.5%          7.3%          7.8%
   Expected return on plan assets .............          8.7           8.7           9.3           9.0           9.0           9.0
   Rate of compensation increase ..............          3.6           4.7           4.9           3.8           4.8           4.8
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

For measurement purposes, a 10.5% annual rate of increase in the per capita cost
of covered health care benefits was assumed for 2000. The rate was assumed to
decrease gradually each year to a rate of 5.5% in 2009 and to remain at that
level thereafter.

Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A 1% change in assumed health care cost
trend rates would have the following effects:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions                                       1% increase        1% decrease
--------------------------------------------------------------------------------
<S>                                               <C>                <C>  
Effect on annual expense ..................              $  1              $ (2)
Effect on benefit obligations .............                11               (18)
--------------------------------------------------------------------------------
</TABLE>

DEFINED CONTRIBUTION PLANS

J.P. Morgan maintains several defined contribution pension plans. The most
significant is the Deferred Profit Sharing/401(k) Plan, covering substantially
all U.S. employees. We contribute to this plan based on our financial
performance, and participants may make pretax contributions to tax-deferred
investment portfolios. Non-U.S. defined contribution plans are administered in
accordance with local laws. Total expense, which represents J.P. Morgan's
contribution for these plans, was $28 million for 1998, $27 million for 1997,
and $39 million for 1996.


108  Notes to consolidated financial statements
<PAGE>   111

24. STOCK OPTIONS AND OTHER AWARD PLANS

J.P. Morgan's stock option and stock award plans provide for the grant of
stock-related awards to key employees, including:

-        stock options

-        restricted stock awards

-        stock bonus awards

-        stock unit awards

-        deferred stock payable in stock

To satisfy awards granted under stock option and stock award plans, we may make
common stock available from authorized but unissued shares. We also may purchase
shares in the open market at various times during the year. Shares available for
future grants under stock incentive plans totaled 11,021,000 at December 31,
1998. A portion of these shares may be made available from treasury shares.
Shares authorized for future grants under the Stock Bonus Plan are 2.5% of
outstanding shares. All shares authorized under the Stock Bonus Plan are
required to be settled in treasury shares. We account for our stock-based
compensation plans in accordance with APB Opinion No. 25 and related
interpretations. Compensation cost recognized for our stock award plans in the
"Consolidated statement of income" for 1998, 1997, and 1996 was $327 million,
$381 million, and $272 million, respectively.

If we had determined compensation cost for our stock-based compensation plans
based on fair value at the award grant dates consistent with the method of SFAS
No. 123, the net income and earnings per share for 1998, 1997, and 1996 would
approximate the pro forma amounts in the following table.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
In millions, except share data                      1998              1997             1996
--------------------------------------------------------------------------------------------
<S>                                             <C>               <C>               <C>   
Net income(a)              As reported .        $    963          $  1 465          $  1 574
                           Pro forma ...             913             1 418             1 522
--------------------------------------------------------------------------------------------
Basic earnings per share   As reported .        $   5.08          $   7.71          $   8.11
                           Pro forma ...            4.81              7.46              7.84
--------------------------------------------------------------------------------------------
Diluted earnings per share As reported          $   4.71          $   7.17          $   7.63
                           Pro forma .              4.45              6.94              7.37
--------------------------------------------------------------------------------------------
</TABLE>

(a) For pro forma purposes, the fair value of stock option awards is amortized
over the relative vesting periods; the fair value of other stock awards is
generally expensed entirely in the year of performance to which it relates. At
December 31, 1998, 1997, and 1996, the unamortized expense, net of taxes, of
nonvested options for pro forma purposes was $96 million, $62 million, and $28
million, respectively.

STOCK OPTIONS

Stock options under the Stock Incentive Plans are issued at exercise prices not
less than the market value of the stock on the grant date. In accordance with
APB Opinion No. 25 and related Interpretations, no compensation cost has been
recognized for fixed stock option plans. Stock options are generally exercisable
one to five years following the date of grant and in no event later than 10
years from the date of grant. Options generally vest ratably over the vesting
period.

J.P. Morgan uses a modified Black-Scholes option-pricing model to estimate the
fair value of each option grant. We use this method because employee stock
options are much different from traded options and because changes in subjective
assumptions can materially affect the fair value estimate. The modified
Black-Scholes model takes into account the estimated lives of the options and an
expected dividend yield based on historical dividend rate increases.

The following weighted-average assumptions were used as inputs to the modified
Black-Scholes model for grants in 1998, 1997, and 1996, respectively:

-        dividend yield of 2.93%, 3.26%, and 4.24%

-        five-year monthly historical volatility of 19.3%, 16.7%, and 18.5%

-        risk-free interest rate of 5.57%, 6.35%, and 5.98%

-        expected life of seven years


                               Notes to consolidated financial statements   109
<PAGE>   112

A summary of our stock option activity and related information follows.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                       1998                        1997                        1996
                                      ---------------------    ------------------------    ------------------------
                                                  Weighted-                   Weighted-                   Weighted-
                                                    average                     average                     average
                                                   exercise                    exercise                    exercise
                                           Shares     price         Shares        price        Shares         price
-------------------------------------------------------------------------------------------------------------------
<S>                                    <C>          <C>         <C>            <C>         <C>              <C>    
Outstanding at beginning
of year..........................      25 078 738   $ 74.02     25 072 115     $  64.45    24 325 921       $ 59.75
Granted..........................       5 307 392    129.98      4 687 145       107.80     5 208 808         78.44
Exercised........................      (3 283 539)    58.38     (4 554 749)       55.88    (4 189 674)        54.33
Forfeited........................        (366 455)    96.59       (125 773)       80.41      (271 958)        68.18
Expired..........................          (2 893)    31.31             --           --          (982)        41.94
-------------------------------------------------------------------------------------------------------------------
Outstanding at year-end                26 733 243     86.75     25 078 738        74.02    25 072 115         64.45
-------------------------------------------------------------------------------------------------------------------
Exercisable at year-end                15 210 649     68.11     15 669 676        61.87    15 991 664         59.13
-------------------------------------------------------------------------------------------------------------------
Weighted-average fair
value of options granted
during the year                            $29.23                   $22.60                     $13.47
-------------------------------------------------------------------------------------------------------------------
</TABLE>

The following table summarizes information about stock options outstanding and
exercisable, at December 31, 1998.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                                                 Options outstanding             Options exercisable
                                        --------------------------------------------      --------------------------
                                                               Weighted-
                                                                 average   Weighted-                       Weighted-
                                                               remaining     average                         average
                                              Number         contractual    exercise            Number      exercise
Range of exercise prices                 outstanding        life (years)       price       exercisable         price
--------------------------------------------------------------------------------------------------------------------
<S>                                      <C>                       <C>      <C>              <C>            <C>     
$31-$61.......................             6 729 680               4.51     $  56.83         6 725 515      $  56.83
$65-$85.......................             9 801 979               5.55        73.57         7 136 424         71.22
$100-$131.....................            10 201 584               9.00       119.15         1 348 710        107.94
--------------------------------------------------------------------------------------------------------------------
</TABLE>

Stock options are generally granted in the middle of the year. Before 1997,
stock options were generally granted in January.

RESTRICTED STOCK AWARDS

Restricted stock awards under the Stock Incentive and Stock Bonus Plans are
provided in the form of share credits. Each share credit is equivalent to one
share of J.P. Morgan common stock. Restricted stock awards generally become
fully vested on the fifth anniversary of the award date.

The participant may receive the award payment as soon as the award has become
vested, but it may be deferred pursuant to the participant's election or as
specified by the committee of the Board of Directors that administers the plans,
in each case subject to the discretion of such committee.

At December 31, 1998, we had 3,584,551 total share credits, representing
previously granted restricted stock awards. In 1997 we had 3,585,911 share
credits, and in 1996 we had 3,395,355 share credits. These share credits include
credits attributable to dividend equivalents. For the 1998 award year, 222,693
share credits were granted at the weighted-average fair value of $107.00 per
share. For the 1997 and 1996 award years, 422,594 and 485,507 share credits were
granted at the weighted-average fair value of $102.67 and $95.34 per share,
respectively.


110  Notes to consolidated financial statements
<PAGE>   113

STOCK BONUS AWARDS

Stock bonus awards under the Stock Incentive and Stock Bonus Plans are
substantially similar to restricted stock awards, except that stock bonus awards
(excluding those prior to 1997) generally become fully vested on the second
anniversary of the award date and are subject to an additional three-year
holding period. Stock bonus awards prior to 1997 generally become fully vested
on the third anniversary of the award date. The participant may receive the
award payment as soon as the award has become vested and the holding period, if
applicable, has been satisfied, but it may be deferred pursuant to the
participant's election or as specified by the committee of the Board of
Directors administering the plans, in each case subject to the discretion of
such committee.

At December 31, 1998, 1997, and 1996, total share credits, representing
previously granted stock bonus awards, were 8,348,763, 5,890,648, and 4,030,763
credits, respectively. These share credits include credits attributable to
dividend equivalents. For the 1998 award year, 2,484,849 share credits were
granted at the weighted-average fair value of $107.29 per share. For the 1997
and 1996 award years, 3,079,353 and 2,126,067 share credits were granted at the
weighted-average fair value of $101.47 and $103.14 per share, respectively.

STOCK UNIT AWARDS

Stock unit awards under the Stock Bonus Plans are similar to restricted stock
and stock bonus awards. However, the value of a stock unit award, not including
the value of dividend equivalents accrued on the award, will never exceed (but
may be less than) the dollar value of the original award. Stock unit awards
(excluding those prior to 1997) generally become fully vested on the second
anniversary of the award date and are subject to an additional three-year
holding period. Stock unit awards prior to 1997 generally become fully vested on
the third anniversary of the award date. The participant may receive the award
payment as soon as the award has become vested and the holding period, if
applicable, has been satisfied.

At December 31, 1998, 1997, and 1996, total share credits, representing
previously granted stock units, were 421,991, 324,382, and 176,481 credits,
respectively. These share credits include credits attributable to dividend
equivalents. For the 1998 award year, 75,741 share credits were granted at the
weighted-average fair value of $106.84 per share. For the 1997 and 1996 award
years, 172,459 and 145,594 share credits were granted at the weighted-average
fair value of $101.47 and $103.44 per share, respectively.

DEFERRED STOCK PAYABLE IN STOCK

J.P. Morgan's Incentive Compensation Plans allow eligible employees to defer all
or a portion of their current annual incentive compensation into several types
of accounts - including a J.P. Morgan common stock account. Deferral amounts are
not subject to forfeiture. The amounts that employees defer into the J.P. Morgan
common stock account are converted into share credits. They earn dividend
equivalents during the deferral period. Commencing in the year following
retirement or termination of employment, a participant's balance in the J.P.
Morgan common stock account is distributed in the form of J.P. Morgan common
stock.

At December 31, 1998 and 1997, total share credits payable in stock - including
share credits attributable to dividend equivalents - were 2,426,232 and
2,307,228 credits, respectively. For the 1998 award year, 56,646 share credits
were granted at the weighted-average fair value of $105.06 per share. For the
1997 and 1996 award years, 259,690 and 306,284 share credits were granted at the
weighted-average fair value of $112.85 and $97.63 per share, respectively.

Stock awards other than options are generally granted in January following the
award year. In January 1999, 2,668,441 share credits representing stock awards
were granted.

PERFORMANCE PLAN

In July 1998 the firm adopted the 1998 Performance Plan of J.P. Morgan & Co.
Incorporated and Affiliated Companies ("Performance Plan"). Awards granted under
the Performance Plan will be earned based on the achievement of firmwide
performance goals (including significantly improved risk-adjusted returns,
earnings growth, and expense management) during the 1998 - 2000 performance
period. Unless determined otherwise, the awards, if any, will be paid in cash in
January 2001.


                                  Notes to consolidated financial statements 111
<PAGE>   114

25. EARNINGS PER SHARE

Effective December 31, 1997, we adopted SFAS No. 128, Earnings per Share, which
establishes new standards for computing and presenting earnings per share (EPS).
1996 amounts have been restated to conform to the new requirements.

Basic EPS is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding, which includes
contingently issuable shares where all necessary conditions for issuance have
been satisfied. Diluted EPS includes the determinants of basic EPS and, in
addition, gives effect to dilutive potential common shares that were outstanding
during the period.

The computation of basic and diluted EPS for the years ended December 31 are
presented in the following table.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
Dollars in millions, except share data                                            1998                  1997                1996
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                   <C>                  <C>   
Net Income .....................................................                  $963                $1 465             $1 574
Preferred stock dividends and other ............................                   (35)                  (36)                (33)
--------------------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings
  per share - income available to
  common stockholders ..........................................                   928                 1 429               1 541
--------------------------------------------------------------------------------------------------------------------------------
Denominator for basic earnings
  per share - weighted-average shares ..........................           182 437 574           185 241 295         189 888 455
Effect of dilutive securities:
  Options(a) ...................................................             5 789 576(b)          6 893 623           5 614 099(c)
  Other stock awards(d) ........................................             8 914 892             7 109 024           6 426 250
  4.75% convertible debentures .................................                59 016                74 373              81 433
--------------------------------------------------------------------------------------------------------------------------------
                                                                            14 763 484            14 077 020          12 121 782
--------------------------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings
  per share - weighted-average number
  of common shares and dilutive
  potential common shares ......................................           197 201 058           199 318 315         202 010 237
--------------------------------------------------------------------------------------------------------------------------------
Basic earnings per share .......................................                 $5.08                 $7.71               $8.11
Diluted earnings per share .....................................                  4.71                  7.17                7.63
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Earnings per share amounts are based on actual numbers before rounding.

(a) The dilutive effect of stock options was computed using the treasury stock
method. This method computes the number of incremental shares by assuming the
issuance of outstanding stock options, reduced by the number of shares assumed
to be repurchased from the issuance proceeds, using the average market price of
our common stock for the period. The related tax benefits are also considered.

(b) Options to purchase 5,110,500 shares of our common stock at $130.94 per
share were outstanding at December 31, 1998, but were not included in the
computation of diluted EPS. The inclusion of such options using the treasury
stock method would have an antidilutive effect on the diluted EPS calculation
because the options' exercise price was greater than the average market price of
our common shares for 1998. These options expire on July 15, 2008.

(c) Options to purchase 500,000 shares of our common stock at $104.92 per share
were outstanding at December 31, 1996, but were not included in the computation
of diluted EPS. The inclusion of such options using the treasury stock method
would have an antidilutive effect on the diluted EPS calculation because the
options' exercise price was greater than the average market price of our common
shares for 1996. These options expire on October 13, 2006.

(d) Weighted-average incremental shares for other stock awards include
restricted stock and stock bonus awards. See note 24, "Stock options and other
award plans," for further information.


112 Notes to consolidated financial statements
<PAGE>   115

26. COMMITMENTS AND CONTINGENT LIABILITIES

PLEDGED ASSETS

Excluding mortgaged properties, assets on the "Consolidated balance sheet" of
approximately $93.1 billion at December 31, 1998, and approximately $77.7
billion at December 31, 1997, were pledged as collateral for borrowings, to
qualify for fiduciary powers, to secure public monies as required by law, and
for other purposes.

SEGREGATED ASSETS

In compliance with rules and regulations established by domestic and foreign
regulators, cash of $1,068 million and $152 million and securities with a market
value of $3,207 million and $2,380 million were segregated in special bank
accounts for the benefit of securities and futures brokerage customers at
December 31, 1998 and 1997, respectively.

RENTAL EXPENSE AND COMMITMENTS

Operating expenses include net rentals of $143 million in 1998, $83 million in
1997, and $96 million in 1996.

Our minimum rental commitments for noncancelable leases of premises and
equipment are $1,242 million at December 31, 1998 - in the aggregate. Certain
leases contain renewal options and escalation clauses. For each of the five
years after December 31, 1998, our minimum rental commitments for noncancelable
leases of premises and equipment are:

-        $103 million in 1999

-        $107 million in 2000

-        $90 million in 2001

-        $82 million in 2002

-        $79 million in 2003

SUBSIDIARY AND AFFILIATE OBLIGATIONS

In the ordinary course of business, J.P. Morgan guarantees the performance of
certain obligations of certain subsidiaries and affiliates. We do not expect
that these agreements will have a material effect on the results of our
operations.

LEGAL ACTION

Various legal actions and proceedings are pending against or involve J.P. Morgan
and our subsidiaries. After reviewing with counsel all actions and proceedings
pending against or involving us, management considers that the outcome of such
matters will not have a material adverse effect on J.P. Morgan's financial
condition.


                                 Notes to consolidated financial statements  113
<PAGE>   116

27. ESTIMATING THE FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with generally accepted accounting principles, our financial
instruments are recorded in our "Consolidated balance sheet" using several
methods, including historical cost and fair value. The amount at which a
financial instrument is recorded in our "Consolidated balance sheet" is referred
to as the carrying value.

HISTORICAL COST METHOD

The historical carrying value generally represents the amount received when a
liability is incurred or the amount paid to purchase an asset less subsequent
amortization and allowances that management estimates as uncollectible amounts.

FAIR VALUE METHOD

The fair value of a financial instrument is the amount for which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale.

In accordance with SFAS No. 107, Disclosures about Fair Value of Financial
Instruments, we estimate and disclose the fair value of all on- and
off-balance-sheet financial instruments. The SFAS No. 107 fair value of a
financial instrument is best evidenced by a quoted market price, if one exists.
Where quoted market prices are not available for financial instruments, fair
values are estimated using internal valuation techniques including pricing
models and discounted cash flows that may not be indicative of net realizable
value. The use of other valuation techniques may produce results that are
different from those obtained under current fair value methodologies. For
example, using the cost of credit derivatives to hedge loan exposures as a
method to estimate the fair value of loans, rather than discounting loans using
current market rates, would result in fair values that are substantially lower.
A detailed discussion on how we estimate fair value follows.


114  Notes to consolidated financial statements

<PAGE>   117
OUR BALANCE SHEET: CARRYING VALUE VERSUS FAIR VALUE

The following table presents the carrying value and fair value of J.P. Morgan's
financial instruments at December 31, 1998 and 1997.


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
                                                                         1998                          1997
                                                -----------------------------  ----------------------------
                                                                       Appre-                        Appre-
                                                                     ciation/                      ciation/
                                                Carrying      Fair    (depre-  Carrying      Fair   (depre-
In billions: December 31                          value      value   ciation)     value     value  ciation)
-----------------------------------------------------------------------------------------------------------
<S>                                             <C>          <C>     <C>       <C>         <C>       <C>
FINANCIAL INSTRUMENTS USED FOR
TRADING PURPOSES

FINANCIAL ASSETS
Trading account assets(a)(b) ...............      $113.9     $113.9    $    -    $111.9    $111.9      $   -
Securities purchased under agreements to
   resell and federal funds sold(c) ........        31.7       31.7         -      39.0      39.0          -
Securities borrowed(d) .....................        30.8       30.8         -      38.4      38.4          -

FINANCIAL LIABILITIES
Trading account liabilities(a) .............        70.6       70.6         -      71.1      71.1          -
Securities sold under agreements to
   repurchase and federal funds purchased(c)        63.4       63.5      (0.1)     57.8      57.9       (0.1)

FINANCIAL INSTRUMENTS USED FOR PURPOSES
OTHER THAN TRADING

FINANCIAL ASSETS(e)
Debt investment securities .................        36.2       36.2         -      22.8      22.8          -
Equity investment securities ...............         1.2        1.3       0.1       1.1       1.2        0.1
Loans, net .................................        25.0       25.2       0.2      31.0      31.5        0.5
Other financial assets(f) ..................        18.6       18.6         -      15.8      15.8          -

FINANCIAL LIABILITIES(e)
Deposits ...................................        55.0       55.0         -      58.9      58.9          -
   Related derivatives .....................           -       (0.3)      0.3         -      (0.1)       0.1
Other liabilities for borrowed money .......        12.5       12.5         -      17.2      17.2          -
Long-term debt(h) ..........................        27.6       28.5      (0.9)     23.0      23.6       (0.6)
   Related derivatives .....................           -       (0.4)      0.4         -      (0.5)       0.5
Company-obligated mandatorily redeemable
   preferred securities of subsidiaries ....         1.2        1.3      (0.1)      1.2       1.3       (0.1)
   Related derivatives .....................           -       (0.1)      0.1         -      (0.1)       0.1
Other financial liabilities(g) .............        19.5       19.4       0.1      21.6      21.3        0.3

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
Commitments to extend credit and standby
   letters of credit and guarantees ........           -       (0.1)     (0.1)        -      (0.1)      (0.1)
------------------------------------------------------------------------------------------------------------
Excess of net fair values over net carrying
values before considering income taxes .....                                -                            0.7
------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Refer to note 10, "Trading account assets and liabilities," for detail of
financial instruments, including derivatives, used for trading purposes.

(b) Amounts restated, for all periods presented, to reflect all elements of fair
value as described under the caption "Fair value" in note 1, "Summary of
significant accounting policies." In prior years, the credit adjustment for
impaired derivatives was not included. Refer to note 11, " Derivatives."

(c) These financial instruments are generally treated as collateralized lending
and borrowing transactions and are carried at the amounts at which the
securities will subsequently be resold or re-acquired, including accrued
interest. Securities sold under agreements to repurchase are also used as one
source of financing for the debt investment securities portfolio.

(d) These financial instruments, which are collateralized by cash, are carried
at amounts equal to the cash advanced.

(e) Derivatives are used to hedge or modify the interest rate characteristics of
debt investment securities, loans, deposits, other liabilities for borrowed
money, long-term debt, and other financial assets and liabilities. Net
unrealized gains and losses associated with such derivatives contracts amounted
to $785 million and $668 million at December 31, 1998 and 1997, respectively.
Gross unrealized gains and gross unrealized losses associated with open
derivatives contracts used for these purposes at December 31, 1998 and 1997, are
presented in the following table. Such amounts primarily relate to interest rate
and currency swaps used to hedge or modify the interest rate characteristics of
long-term debt; debt investment securities, principally mortgage-backed
securities; deposits; and other financial instruments.


                                  Notes to consolidated financial statements 115
<PAGE>   118
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                         Gross          Gross               Net
                                    unrealized     unrealized        unrealized
In millions: December 31                 gains          losses    gains/(losses)
--------------------------------------------------------------------------------
<S>                                  <C>           <C>            <C>
1998
Long-term debt ................          $ 554            $133            $421
Debt investment securities ....             13              25             (12)
Deposits ......................            343              16             327
Other financial instruments ...            242             193              49
--------------------------------------------------------------------------------
Total                                    1 152             367             785
--------------------------------------------------------------------------------
1997
Long-term debt ................           $533           $  59            $474
Debt investment securities ....             36             104             (68)
Deposits ......................            109              13              96
Other financial instruments ...            265              99             166
--------------------------------------------------------------------------------
Total                                      943             275             668
--------------------------------------------------------------------------------
</TABLE>

(f) Includes cash and due from banks, interest-earning deposits with banks,
accrued interest and accounts receivable, and other financial assets.

(g) Estimating the fair value for J.P. Morgan's convertible mortgage loan and
British pound financing obligation is not practicable due to the complex terms
and conditions associated with the transactions. As a result, the fair value is
reflected at the carrying value for purposes of this disclosure only. For
additional information regarding these financing obligations, see note 18,
"Long-term debt."

(h) Includes commercial paper, accounts payable and accrued expenses, and other
financial liabilities.

HOW WE ESTIMATE FAIR VALUE

The following summary describes the valuation methods used to determine the fair
value estimates of each class of financial instruments for which it is
practicable to estimate fair value.

FINANCIAL INSTRUMENTS CARRIED AT FAIR VALUE

Debt and marketable equity investment securities and trading account assets and
liabilities, including derivatives used for trading purposes, are carried at
fair value. Fair value is based on listed market prices or broker or dealer
price quotations. If listed market prices or quotations are not available, we
base fair value on management estimates using internal valuation techniques.
Refer to the caption "Fair value" in note 1, "Summary of significant accounting
policies," for further information.

FINANCIAL INSTRUMENTS CARRIED AT COST: CARRYING VALUE APPROXIMATES FAIR VALUE
DUE TO FINANCIAL INSTRUMENTS' SHORT-TERM NATURE

For short-term balance sheet instruments that do not have publicly quoted market
prices, the carrying value approximates fair value. These balance sheet
instruments include cash and due from banks, certain securities purchased under
agreements to resell and federal funds sold, securities borrowed, certain loans,
accrued interest and accounts receivable, certain other financial assets,
certain securities sold under agreements to repurchase and federal funds
purchased, accounts payable and accrued expenses, and certain other financial
liabilities. Instruments are generally classified as short-term if they have a
maturity or repricing profile of one year or less.

FINANCIAL INSTRUMENTS CARRIED AT COST: FAIR VALUE BASED ON AVAILABLE QUOTED
MARKET PRICES

The fair values of certain loans and other financial assets and certain other
financial liabilities are determined based on quoted market prices for the
instruments or similar issues in their most active market.


116  Notes to consolidated financial statements
<PAGE>   119
FINANCIAL INSTRUMENTS CARRIED AT COST: FAIR VALUE DERIVED USING ESTIMATION
TECHNIQUES

DEPOSITS AND OTHER INTEREST-EARNING ASSETS

We use interest rates derived from prevailing market yield curves that closely
reflect our interest-earning deposit and borrowing rates. We use these interest
rates to discount interest-earning deposits, other interest-earning assets,
interest-bearing deposits, other borrowings, and long-term repurchase
agreements.

COMMERCIAL PAPER AND LONG-TERM DEBT

To estimate fair values for commercial paper, we use J.P. Morgan's current
commercial paper rates. To estimate fair values for most long-term debt, we use
J.P. Morgan's current cost of funds for debt with similar terms and remaining
maturities.

LOANS

We discount loans at current market rates that are applicable to loans of
similar type, maturity, and credit standing to estimate their fair value. The
fair value of impaired loans is calculated using discounted expected cash flows,
the fair value of any collateral or observable market values.

NONMARKETABLE EQUITY INVESTMENT SECURITIES

The fair values of equity investment securities for which there are no publicly
quoted market prices are determined by management based on financial and other
available information.

COMMITMENTS TO EXTEND CREDIT

We determine the fair value of commitments to extend credit, standby letters of
credit, and guarantees by comparing the contractual future stream of fees with
fee streams adjusted to reflect current market rates that are applicable to
instruments of similar type, maturity, and credit standing.

SECURITIES LENDING INDEMNIFICATIONS

Similar to commitments to extend credit, we determine the fair value of
securities lending indemnifications based on fee streams, which are at market
rates since most agreements mature in less than 30 days.

The following table summarizes the fair values of all on- and off-balance-sheet
financial instruments according to the valuation methods used to determine fair
value estimates.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       Off-balance-
                                                                                                                              sheet
                                                          Financial assets                 Financial liabilities        instruments
                                         ---------------------------------     ---------------------------------        -----------
In billions: December 31                 Carrying value         Fair value     Carrying value         Fair value         Fair value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>                    <C>            <C>                    <C>                <C>
1998
CARRIED AT FAIR VALUE ................           $150.9             $150.9              $70.6              $70.6            $     -
CARRIED AT COST
Carrying value approximates fair value
   due to short-term nature ..........             75.2               75.2               80.6               80.6                  -
Fair value based on available quoted
   market prices .....................              4.3                4.3                2.7                2.7                  -
Fair value derived using estimation
   techniques ........................             27.0               27.3               95.1               95.3               (0.1)
------------------------------------------------------------------------------------------------------------------------------------
                                                  257.4              257.7              249.0              249.2               (0.1)
------------------------------------------------------------------------------------------------------------------------------------
1997
CARRIED AT FAIR VALUE ................           $135.4             $135.4            $  71.1            $  71.1            $     -
CARRIED AT COST
Carrying value approximates fair value
   due to short-term nature ..........             89.0               89.0               78.3               78.3                  -
Fair value based on available quoted
   market prices .....................              4.3                4.3                4.7                4.7                  -
Fair value derived using estimation
   techniques ........................             31.3               31.9               96.0               95.8               (0.1)
------------------------------------------------------------------------------------------------------------------------------------
                                                  260.0              260.6              250.1              249.9               (0.1)
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                  Notes to consolidated financial statements 117
<PAGE>   120
28. CONCENTRATIONS OF FINANCIAL INSTRUMENTS

The counterparties to our financial instruments operate in diverse industries of
the global economy, most significantly in North America and Europe, and include
nonbank financial institutions, governments, and banks.

For financial reporting purposes only, summarized in the following table are
amounts of credit exposure associated with all on- and off-balance-sheet
financial instruments based on the location of the counterparty. It does not
reflect the location of the counterparty ultimately responsible for the
obligation because it does not take into consideration collateral or formal
guarantees that may shift the location of the credit exposure.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
                                                          Nonbank
                                                        financial         Govern-
In billions: December 31                          institutions(a)           ments           Banks       All other            Total
----------------------------------------------------------------------------------------------------------------------------------
<S>                                               <C>                     <C>              <C>          <C>                <C>
1998
ON-BALANCE-SHEET
North America(b) .............................              $32.7           $64.1           $27.2           $22.8          $146.8
Europe(c) ....................................               10.5            18.3            44.4            12.8            86.0
Asia-Pacific .................................                1.6             9.9             1.1             3.0            15.6
Latin America(d) .............................                2.9             4.3             0.8             3.6            11.6
----------------------------------------------------------------------------------------------------------------------------------
Total on-balance-sheet credit exposure                       47.7            96.6            73.5            42.2           260.0(e)
----------------------------------------------------------------------------------------------------------------------------------
OFF-BALANCE-SHEET
North America(b) .............................               14.5             7.2            11.6            53.9            87.2
Europe(c) ....................................               15.3             1.1             6.3             8.9            31.6
Asia-Pacific .................................                1.3            10.4             0.8             2.6            15.1
Latin America(d) .............................                0.1             0.1            -                0.2             0.4
----------------------------------------------------------------------------------------------------------------------------------
Total off-balance-sheet credit exposure                      31.2            18.8            18.7            65.6           134.3
----------------------------------------------------------------------------------------------------------------------------------
Total credit exposure                                        78.9           115.4            92.2           107.8(f)        394.3
----------------------------------------------------------------------------------------------------------------------------------
Cash and marketable security collateral                      46.5             2.9            41.6             7.1            98.1
----------------------------------------------------------------------------------------------------------------------------------
1997
ON-BALANCE-SHEET
North America(b) .............................              $45.6         $  45.3           $24.7         $  20.1          $135.7
Europe(c) ....................................               15.7            21.9            40.2            10.6            88.4
Asia-Pacific .................................                3.5            13.1             3.8             3.6            24.0
Latin America(d) .............................                1.0             5.7             1.3             5.1            13.1
----------------------------------------------------------------------------------------------------------------------------------
Total on-balance-sheet credit exposure                       65.8            86.0            70.0            39.4           261.2(e)
----------------------------------------------------------------------------------------------------------------------------------
OFF-BALANCE-SHEET
North America(b) .............................               19.9             6.1             9.8            49.7            85.5
Europe(c) ....................................                8.6             2.0            14.0            10.9            35.5
Asia-Pacific .................................                2.6             6.9             1.2             1.6            12.3
Latin America(d) .............................                0.2             0.1             0.1             0.4             0.8
----------------------------------------------------------------------------------------------------------------------------------
Total off-balance-sheet credit exposure                      31.3            15.1            25.1            62.6           134.1
----------------------------------------------------------------------------------------------------------------------------------
Total credit exposure ........................               97.1           101.1            95.1           102.0(f)        395.3
----------------------------------------------------------------------------------------------------------------------------------
Cash and marketable security collateral                      60.2             2.2            44.5             6.8           113.7
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(a) Nonbank financial institutions include securities firms, insurance
companies, and investment companies.

(b) Includes the United States, Canada, and the Caribbean.

(c) Includes the Middle East and Africa.

(d) Includes Mexico, Central America, and South America.

(e) On-balance-sheet assets without credit exposure totaled approximately $1.1
billion and $1.0 billion in 1998 and 1997, respectively.

(f) The utilities industry exceeded 10% of this amount at December 31, 1998 and
1997.


118 Notes to consolidated financial statements
<PAGE>   121
29. SEGMENTS

Effective with the filing of this Annual Report, we adopted SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which
establishes standards for reporting information about operating segments. Refer
to note 2, "Accounting changes and developments," for more information. All
periods shown have been presented in conformity with this new standard.

Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or decision making group, in assessing
performance. In accordance with the new standard, we have presented results
based on the segments as reviewed separately by the chief operating decision
maker, our Chairman and Chief Executive Officer, as well as other members of
senior management. Each segment is organized based on similar products and
services we provide globally to our clients or activities we undertake solely
for our own account, and is managed by individuals who report directly to the
Chairman and Chief Executive Officer.

J.P. Morgan's segments or activities are: Investment Banking, Equities, Foreign
Exchange, Interest Rate Markets, Credit Markets, Credit Portfolio, Asset
Management and Servicing, Equity Investments, and Proprietary Investing and
Trading. In addition to the activities of our proprietary positioning group, the
Proprietary Investing and Trading segment is comprised of the following
separately managed investments: a proprietary emerging markets portfolio; a
credit investment securities portfolio; and our investment in Long-Term Capital
Management, L.P. For purposes of presentation, we have grouped these segments
into the sectors Global Finance, Asset Management and Servicing, and Proprietary
Investments.

The assessment of segment performance by senior management includes a review of
pretax income for each of the segments. Our management reporting system and
policies were used to determine revenues and expenses attributable to each
segment. Earnings on stockholders' equity were allocated based on management's
estimate of the economic capital of each segment; economic capital levels are
derived principally from an estimate of risk inherent in each segment.
Consistent with our internal reporting, in 1998 and 1997, overhead was allocated
to the segments based on segment expenses; in 1996, overhead was allocated
primarily based on segment head count. Overhead represents costs associated with
various support functions that exist for the benefit of the firm as a whole.
Transactions between segments are recorded within segment results as if
conducted with a third party and eliminated in consolidation.

The accounting policies of our segments are, in all material respects,
consistent with those described in note 1, "Summary of Significant Accounting
Policies," except for management reporting policies related to managing the
firm's credit risk and the tax-equivalent adjustment. As compensation for
managing the firm's credit risk, Credit Portfolio revenues reflect fees received
from other segments and are reduced by an estimate of potential credit loss,
which is computed using statistical modeling techniques. The consolidated
results of the firm's Asset Quality Review process, which determines firmwide
provisions for credit losses and other valuation adjustments, are included in
Corporate Items. For purposes of comparability, segment results include an
adjustment to gross-up tax-exempt revenue to a taxable basis. Amounts recorded
within the segments that relate to managing the firm's credit risk and the
tax-equivalent adjustment are eliminated in consolidation.

The following table presents segment pretax income for the years ended December
31, 1998, 1997, and 1996.


                                  Notes to consolidated financial statements 119
<PAGE>   122
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                      Net interest      Noninterest          Total           Total          Pretax
In millions, 1998                                         revenues         revenues       revenues        expenses       income(10)
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>               <C>               <C>             <C>            <C>
Investment Banking .............................            $   (1)         $1 002          $1 001          $  722         $  279
Equities .......................................               107             593             700             757            (57)
Foreign Exchange ...............................                47             439             486             290            196
Interest Rate Markets ..........................              (276)          1 683           1 407             847            560
Credit Markets(1) ..............................               440             314             754             822            (68)
Credit Portfolio(2)(3) .........................               432             (82)            350             141            209
-----------------------------------------------------------------------------------------------------------------------------------
GLOBAL FINANCE .................................               749           3 949           4 698           3 579          1 119
ASSET MANAGEMENT AND SERVICING(4) ..............               395           1 096           1 491           1 261            230
Equity Investments .............................               (19)            354             335              48            287
Proprietary Investing and Trading(4)(5)(6)(7)(8)               358             348             706             153            553
-----------------------------------------------------------------------------------------------------------------------------------
PROPRIETARY INVESTMENTS ........................               339             702           1 041             201            840
Corporate Items(9) .............................              (312)             37            (275)            497           (772)
-----------------------------------------------------------------------------------------------------------------------------------
Total                                                        1 171           5 784           6 955           5 538          1 417
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                      Net interest      Noninterest          Total           Total          Pretax
In millions, 1997                                         revenues         revenues       revenues        expenses       income(10)
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>               <C>               <C>             <C>            <C>
Investment Banking ...............................          $   (1)          $  769          $  768          $  712          $   56
Equities .........................................              20              445             465             693            (228)
Foreign Exchange .................................              64              401             465             309             156
Interest Rate Markets ............................              38            1 108           1 146             870             276
Credit Markets ...................................             397              585             982             817             165
Credit Portfolio (2)(3) ..........................             403               44             447             123             324
-----------------------------------------------------------------------------------------------------------------------------------
GLOBAL FINANCE ...................................             921            3 352           4 273           3 524             749
ASSET MANAGEMENT AND SERVICING ...................             350            1 034           1 384           1 235             149
Equity Investments ...............................             (22)             421             399              47             352
Proprietary Investing and Trading(5)(7)(8) .......             518              377             895             154             741
-----------------------------------------------------------------------------------------------------------------------------------
PROPRIETARY INVESTMENTS ..........................             496              798           1 294             201           1 093
Corporate Items(9) ...............................             105              164             269             106             163
-----------------------------------------------------------------------------------------------------------------------------------
Total                                                        1 872            5 348           7 220           5 066           2 154
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                      Net interest      Noninterest          Total           Total          Pretax
In millions, 1996                                         revenues         revenues       revenues        expenses       income(10)
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>               <C>               <C>             <C>            <C>
Investment Banking ...............................          $   (3)          $  617          $  614          $  630          $  (16)
Equities .........................................             (62)             481             419             534            (115)
Foreign Exchange .................................              13              282             295             299              (4)
Interest Rate Markets ............................              94            1 106           1 200             878             322
Credit Markets ...................................             275              737           1 012             653             359
Credit Portfolio (2)(3) ..........................             368              168             536             128             408
-----------------------------------------------------------------------------------------------------------------------------------
GLOBAL FINANCE ...................................             685            3 391           4 076           3 122             954
ASSET MANAGEMENT AND SERVICING ...................             284              903           1 187             934             253
Equity Investments ...............................             (28)             298             270              41             229
Proprietary Investing and Trading(5)(7)(8) .......             651              283             934             186             748
-----------------------------------------------------------------------------------------------------------------------------------
PROPRIETARY INVESTMENTS ..........................             623              581           1 204             227             977
Corporate Items(9) ...............................             110              278             388             240             148
-----------------------------------------------------------------------------------------------------------------------------------
Total                                                        1 702            5 153           6 855           4 523           2 332
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(1) Includes $48 million of revenues related to the structuring of credit
protection products and tax-advantaged loans for Credit Portfolio. This amount
is eliminated in consolidation.

(2) The adjustment to gross-up Credit Portfolio's tax-exempt revenue to a
taxable basis was $26 million in 1998, $24 million in 1997 and $20 million in
1996. These amounts are eliminated in consolidation.

(3) The net impact to Credit Portfolio for managing the firm's credit risk,
including estimated potential losses on its own positions, was ($62) million in
1998, ($55) million in 1997, and ($41) million in 1996. These amounts are
eliminated in consolidation.

(4) Includes results from certain investments accounted for under the equity
method of accounting. See note 7, "Other revenue and other expenses," for
additional information.


120 Notes to consolidated financial statements
<PAGE>   123
(5) Revenues from our credit investment securities portfolio were ($129) million
in 1998, $45 million in 1997, and $37 million in 1996. Revenues from our
proprietary emerging markets portfolio were ($80) million in 1998 and $22
million in 1997. Expenses for these portfolios were not significant.

(6) Includes $35 million of gains related to the sale of investment securities
to Interest Rate Markets. This amount is eliminated in consolidation.

(7) The adjustment to gross-up Proprietary Investing and Trading's tax-exempt
revenues to a taxable basis was $119 million in 1998, $84 million in 1997, and
$61 million in 1996. These amounts are eliminated in consolidation.

(8) Total return revenues, which combine reported revenues and the change in net
unrealized appreciation, were $467 million in 1998, $657 million in 1997, and
$624 million in 1996.

(9) We classify the revenues and expenses of Corporate Items into three broad
categories:

   -  Recurring items not allocated to the segments - includes recurring
      Corporate Items, such as provisions for credit losses and other valuation
      adjustments, unallocated net interest revenue, results of hedging
      anticipated net foreign currency revenues and expenses across all
      segments, corporate-owned life insurance, and equity earnings of certain
      affiliates. Recurring items included in revenues were ($376) million in
      1998, $56 million in 1997, and ($67) million in 1996.

   -  Nonrecurring items not allocated to the segments - includes gains on the
      sale of businesses, revenues and expenses associated with businesses that
      have been sold or discontinued, special charges, and other one-time
      corporate items. Nonrecurring revenues were $189 million in 1998, $65
      million in 1997, and $262 million in 1996. Nonrecurring expenses in 1998
      include $358 million of special charges taken in connection with the
      restructuring of business activities and other productivity initiatives -
      See note 3, Restructuring of business activities. Nonrecurring expenses in
      1996 include a $71 million technology-related special charge.

   -  Consolidation and management reporting offsets - comprises offsets to
      certain amounts recorded in the segments, including the allocation of
      earnings on equity out of corporate items and into the segments,
      adjustments to bring segments to a tax-equivalent basis, and other
      management accounting adjustments. Consolidation and management reporting
      offset revenues were ($88) million in 1998, $148 million in 1997 and $193
      million in 1996.

(10) The table below provides an estimate of the total noncash amounts (net
provision of credit losses, depreciation, amortization, stock award plans, and
write-downs on investment securities) included in the pretax income of each
segment for the years ended December 31, 1998, 1997, and 1996.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
In millions                                     1998          1997          1996
--------------------------------------------------------------------------------
<S>                                            <C>           <C>           <C>
Investment Banking ...................         $ 121         $ 112         $ 105
Equities .............................            76            71            65
Foreign Exchange .....................            27            32            35
Interest Rate Markets ................            77            87           106
Credit Markets .......................            74            94            85
Credit Portfolio .....................             9            13            21
--------------------------------------------------------------------------------
GLOBAL FINANCE .......................           384           409           417
ASSET MANAGEMENT AND SERVICING .......           142           111            86
Equity Investments ...................            95            44            36
Proprietary Investing and Trading ....           554           225           279
--------------------------------------------------------------------------------
PROPRIETARY INVESTMENTS ..............           649           269           315
Corporate Items ......................            75            23             5
--------------------------------------------------------------------------------
Total                                          1 250           812           823
--------------------------------------------------------------------------------
</TABLE>

The following table presents segment assets at December 31, as well as the
average annual assets, for 1998 and 1997. Our management reporting system and
policies were used to determine assets attributable to each segment.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                          1998                                 1997
                                                             ---------------------------------     --------------------------------
Assets, in billions                                          at December 31            Average     at December 31           Average
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>                   <C>                <C>                   <C>
Equities ...............................................              $  28              $  31              $  27              $  26
Foreign Exchange .......................................                  7                  9                 10                 10
Interest Rate Markets ..................................                112                124                103                106
Credit Markets .........................................                 26                 35                 33                 31
Credit Portfolio .......................................                 17                 21                 21                 22
-----------------------------------------------------------------------------------------------------------------------------------
GLOBAL FINANCE .........................................                190                220                194                195
ASSET MANAGEMENT AND SERVICING(2) ......................                  8                 10                  9                 11
Equity Investments .....................................                  1                  1                  1                  1
Proprietary Investing and Trading(1)(2) ................                 57                 51                 46                 44
-----------------------------------------------------------------------------------------------------------------------------------
PROPRIETARY INVESTMENTS ................................                 58                 52                 47                 45
Corporate Items ........................................                  5                  1                 12                  2
-----------------------------------------------------------------------------------------------------------------------------------
Total                                                                   261                283                262                253
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(1) Assets relate primarily to our proprietary positioning group.

(2) Refer to note 4, "Business changes and developments."


                               Notes to consolidated financial statements    121
<PAGE>   124
The table below provides the components of revenue for each of our sectors for
the years ended December 31, 1998, 1997, and 1996.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                         Asset
                                                       Global       Management      Proprietary         Corporate
In millions, 1998                                     Finance    and Servicing      Investments             Items             Total
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>        <C>                <C>                 <C>                 <C>
Net interest revenues ....................            $   749           $  395           $  339            $ (312)           $1 171
Trading revenue ..........................              2 045               24              318               (25)            2 362
Investment banking revenue ...............              1 373               25                7                (4)            1 401
Investment management revenue ............                 --              894               --               (13)              881
Fees and commissions .....................                438              147               (1)              164               748
Investment securities revenue ............                 --               --              236               (31)              205
Other revenue ............................                 93                6              142               (54)              187
-----------------------------------------------------------------------------------------------------------------------------------
Total noninterest revenues ...............              3 949            1 096              702                37             5 784
-----------------------------------------------------------------------------------------------------------------------------------
Total revenues                                          4 698            1 491            1 041              (275)            6 955
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                         Asset
                                                       Global       Management      Proprietary         Corporate
In millions, 1997                                     Finance    and Servicing      Investments             Items             Total
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>           <C>                <C>                 <C>                 <C>
Net interest revenues ................             $   921            $  350            $  496            $  105             $ 1 872
Trading revenue ......................               1 781                38               265                53               2 137
Investment banking revenue ...........               1 111                25                10               (23)              1 123
Investment management revenue ........                  --               808                --               (16)                792
Fees and commissions .................                 333               138                 2               174                 647
Investment securities revenue ........                  --                --               438               (29)                409
Other revenue ........................                 127                25                83                 5                 240
-----------------------------------------------------------------------------------------------------------------------------------
Total noninterest revenues ...........               3 352             1 034               798               164               5 348
-----------------------------------------------------------------------------------------------------------------------------------
Total revenues                                       4 273             1 384             1 294               269               7 220
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                         Asset
                                                       Global       Management      Proprietary         Corporate
In millions, 1996                                     Finance    and Servicing      Investments             Items             Total
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>          <C>                <C>                 <C>                 <C>
Net interest revenues ..................            $  685            $  284            $  623             $  110            $1 702
Trading revenue ........................             2 096                45               241                 95             2 477
Investment banking revenue .............               903                29                 6                (17)              921
Investment management revenue ..........                --               681                --                 (6)              675
Fees and commissions ...................               247               142                (3)               196               582
Investment securities revenue ..........                --                --               302                  1               303
Other revenue ..........................               145                 6                35                  9               195
-----------------------------------------------------------------------------------------------------------------------------------
Total noninterest revenues .............             3 391               903               581                278             5 153
-----------------------------------------------------------------------------------------------------------------------------------
Total revenues                                       4 076             1 187             1 204                388             6 855
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


122    Notes to consolidated financial statements
<PAGE>   125
30. INTERNATIONAL OPERATIONS
--------------------------------------------------------------------------------

For financial reporting purposes, our operations are divided into domestic and
international components. We believe that the method we have chosen to allocate
our results among domestic and international sources, while inexact, is
appropriate.

ASSETS

In general, we distribute assets on the basis of the location of the
counterparty, with the exception of premises and equipment, which is distributed
based on the location of the office recording the asset.

REVENUES AND EXPENSES

Because our operations are highly integrated, we need to make estimates and
assumptions to identify revenues and expenses by geographic region. The
following is a summary of these assumptions:

-  Client-focused revenues are assigned to the region managing the client
   relationship for a particular product. For investment banking activities,
   this is the client's head office; for most other products, it is the location
   where the activity is transacted.

-  Market making revenues that cannot be specifically attributed to individual
   clients (for example, gains or losses from positions taken to facilitate
   client transactions) are generally allocated based on the proportion of
   regional revenues.

-  Revenues from proprietary investing and trading activities are based on the
   location of the risk taker.

-  Expenses are allocated based on the estimated cost associated with servicing
   the regions' client base.

-  Earnings on stockholders' equity are mainly allocated based on each region's
   proportion of regional revenue, and adjustments are made for differences
   between domestic and international tax rates.

Assets at December 31 and results for the years ended December 31, 1998, 1997,
and 1996 were distributed among domestic and international operations as
presented in the following table.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                             Total             Total             Total           Pretax    Income tax           Net
In millions                                 assets          revenues(a)       expenses           income       expense        income
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>                <C>              <C>                 <C>       <C>               <C>
1998
Europe(b) ......................         $  86 144            $2 295(e)         $1 865(g)        $  430        $  172        $  258
Asia-Pacific ...................            15 215               733(f)            533(g)           200            80           120
Latin America(c) ...............            11 556               500               222(g)           278           111           167
-----------------------------------------------------------------------------------------------------------------------------------
Total international operations .           112 915             3 528             2 620              908           363           545
Domestic operations(d) .........           148 152             3 427             2 918(g)           509            91           418
-----------------------------------------------------------------------------------------------------------------------------------
Total                                      261 067             6 955             5 538            1 417           454           963
-----------------------------------------------------------------------------------------------------------------------------------

1997
Europe(b) ......................         $  88 018            $2 026            $1 578           $  448        $  179        $  269
Asia-Pacific ...................            22 791               798               554              244            98           146
Latin America(c) ...............            12 885               645               262              383           153           230
-----------------------------------------------------------------------------------------------------------------------------------
Total international operations .           123 694             3 469             2 394            1 075           430           645
Domestic operations(d) .........           138 465             3 751             2 672            1 079           259           820
-----------------------------------------------------------------------------------------------------------------------------------
Total                                      262 159             7 220             5 066            2 154           689         1 465
-----------------------------------------------------------------------------------------------------------------------------------

1996
Europe(b) ......................            75 738             2 063             1 367              696           278           418
Asia-Pacific ...................            21 807               844               458              386           154           232
Latin America(c) ...............            10 037               523               227              296           118           178
-----------------------------------------------------------------------------------------------------------------------------------
Total international operations .           107 582             3 430             2 052            1 378           550           828
Domestic operations(d)(e) ......           114 444             3 425             2 471(h)           954           208           746
-----------------------------------------------------------------------------------------------------------------------------------
Total                                      222 026             6 855             4 523            2 332           758         1 574
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(a) Includes net interest revenue and noninterest revenues.

(b) Includes the Middle East and Africa.

(c) Includes Mexico, Central America, and South America.

Notes to the above table continued on the following page.


                               Notes to consolidated financial statements    123
<PAGE>   126
(d) Includes the United States, Canada, and the Caribbean. Total assets include
$137.3 billion, $123.9 billion, and $103.1 billion at December 31, 1998, 1997,
and 1996, respectively, related to United States operations. Total revenue and
expenses relate substantially to United States operations for all years.

(e) Includes 1998 second quarter net pretax gain of $131 million related to the
sale of our global trust and agency services business. Refer to note 4,
"Business changes and developments."

(f) Includes 1998 third quarter net pretax gain of $56 million related to the
sale of our investment management business in Australia. Refer to note 4,
"Business changes and developments."

(g) Total expenses include 1998 special charges of $358 million, which was
recorded as follows: $183 million in Europe, $22 million in Asia Pacific, $3
million in Latin America, and $150 million in domestic operations. Refer to note
3, "Restructuring of business activities."

(h) Expenses for domestic operations include a technology-related charge of $71
million in 1996.


The table below presents the composition of international assets at December 31.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
In millions: December 31                                                       1998                    1997                    1996
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                     <C>                     <C>
Interest-earning deposits with banks:
   At overseas branches or subsidiaries of U.S. banks .......             $       241             $        23            $       290
   Other ....................................................                   1 455                   1 832                  1 461
Loans, net ..................................................                  12 723                  17 797                 13 746
Investment securities .......................................                     642                   2 580                  3 591
Trading account assets ......................................                  74 609                  73 328                 60 629
Other assets ................................................                  23 245                  28 134                 27 865
-----------------------------------------------------------------------------------------------------------------------------------
Total international assets                                                    112 915                 123 694                107 582
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


31. CERTAIN RESTRICTIONS: SUBSIDIARIES
--------------------------------------------------------------------------------

Under the Federal Reserve Act and New York State law, there are legal
restrictions limiting the amount of dividends that Morgan Guaranty - a state
member bank - can declare. The most restrictive test requires approval of the
Federal Reserve Board if Morgan Guaranty's declared dividends exceed the net
profits for the current year combined with the preceding two years' net profits.
The calculation of the amount available for payment of dividends is based on net
profits determined in accordance with bank regulatory accounting principles,
reduced by the amount of dividends declared. At December 31, 1998, the
cumulative retained net profits for the years 1998 and 1997 available for
distribution as dividends in 1999 without approval of the Federal Reserve Board
were approximately $502 million.

The Federal Reserve Board may prohibit the payment of dividends if it determines
that circumstances relating to the financial condition of a bank are such that
the payment of dividends would be an unsafe and unsound practice.

U.S. federal law also places restrictions on certain types of transactions
engaged in by insured banks and their subsidiaries with certain affiliates,
including, in the case of Morgan Guaranty, J.P. Morgan and its nonbanking
subsidiaries. "Covered transactions" are limited to 20% of capital and surplus,
as defined, and "covered transactions" with any one such affiliate are limited
to 10% of capital and surplus. "Covered transactions" include:

-  loans and extensions of credit to such an affiliate

-  purchases of assets from such an affiliate

-  any guarantees, acceptances, and letters of credit issued on behalf of such
   an affiliate

Such loans, extensions of credit, guarantees, acceptances, and letters of credit
must be collateralized. In addition, a wide variety of transactions engaged in
by insured banks and their subsidiaries with such affiliates are required to be
made on terms and under circumstances that are at least as favorable to the bank
or subsidiary concerned as those prevailing at the time for comparable
transactions with nonaffiliated companies.

Certain other subsidiaries are subject to various restrictions, mainly
regulatory requirements, that may limit cash dividends and advances to J.P.
Morgan and that establish minimum capital requirements.


124  Notes to consolidated financial statements
<PAGE>   127
32. CONDENSED FINANCIAL STATEMENTS OF J.P. MORGAN (PARENT)

Presented below are the condensed statements of income, balance sheet, and cash
flows for J.P. Morgan & Co. Incorporated, the parent company.


J.P. MORGAN (PARENT) STATEMENT OF INCOME

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
In millions                                                                           1998                1997                1996
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                 <C>                  <C>
REVENUES
Equity in undistributed earnings of subsidiaries .......................            $   212             $   855              $1 093
Dividends from subsidiaries:
   Bank ................................................................                472                 404                 150
   Other ...............................................................                264                 201                 360
-----------------------------------------------------------------------------------------------------------------------------------
Total equity in earnings of subsidiaries ...............................                948               1 460               1 603
Interest from subsidiaries .............................................              1 298                 739                 637
Other interest revenue .................................................                 38                  53                  37
Investment banking revenue allocations from subsidiaries ...............                141                 125                 103
Service fees from subsidiaries .........................................                250                 248                 186
Investment securities revenue ..........................................                 46                  --                  (7)
Other revenue ..........................................................                  7                   3                  (9)
-----------------------------------------------------------------------------------------------------------------------------------
Total revenues                                                                        2 728               2 628               2 550
-----------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Interest (includes $94 in 1998, $101 in 1997, and $9 in 1996
   to subsidiaries) ....................................................              1 525                 891                 714
Employee compensation and benefits .....................................                248                 245                 203
Other expenses .........................................................                139                 129                 103
-----------------------------------------------------------------------------------------------------------------------------------
Total expenses                                                                        1 912               1 265               1 020
-----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes .............................................                816               1 363               1 530
Income tax benefit .....................................................               (147)               (102)                (44)
-----------------------------------------------------------------------------------------------------------------------------------
Net income                                                                              963               1 465               1 574
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                  Notes to consolidated financial statements 125
<PAGE>   128
J.P. MORGAN (PARENT) BALANCE SHEET

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       December 31
In millions                                                                                            1998                   1997
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                               <C>                    <C>
ASSETS
Interest-earning deposits with subsidiary bank ....................................               $     591              $     439
Debt investment securities available-for-sale carried at fair value ...............                     993                    941
Equity investment securities ......................................................                      10                     10
Investments in subsidiaries:
   Bank ...........................................................................                  10 478                 10 433
   U.S. broker-dealer .............................................................                     746                    595
   Other nonbanks .................................................................                   1 065                  1 073
Advances to subsidiaries:
   Bank ...........................................................................                   3 728                  4 069
   U.S. broker-dealer(a) ..........................................................                   6 690                  3 014
   Other nonbanks, primarily securities-related(b) ................................                   9 565                  7 303
Accrued interest and accounts receivable, primarily from subsidiary bank ..........                     362                    287
Other assets (includes $2 990 in 1998 and $2 158 in 1997 related to
   corporate-owned life insurance contracts; $1 095 in 1998 and $875 in 1997
   related to deferred tax assets) ................................................                   4 636                  3 197
----------------------------------------------------------------------------------------------------------------------------------
Total assets                                                                                         38 864                 31 361
----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Securities sold under agreements to repurchase (includes $349 in 1997 with
   subsidiary bank) ...............................................................                      --                    351
Commercial paper ..................................................................                   6 127                  6 090
Other liabilities for borrowed money ..............................................                     148                    498
Accounts payable and accrued expenses .............................................                   1 829                  1 628
Long-term debt not qualifying as risk-based capital ...............................                  13 365                  5 143
Other liabilities .................................................................                     511                    477
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                     21 980                 14 187
Long-term debt qualifying as risk-based capital ...................................                   4 437                  4 584
Intercompany debentures(c) ........................................................                   1 186                  1 186
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities                                                                                    27 603                 19 957
----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity                                                                           11 261                 11 404
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity                                                           38 864                 31 361
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(a) At December 31, 1998 and 1997, $5.7 billion and $2.1 billion, respectively,
of these advances was collateralized by marketable securities, primarily U.S.
government and agency securities.

(b) At December 31, 1998 and 1997, $7.6 billion and $5.7 billion, respectively,
of this balance was collateralized by marketable equity and government agency
securities.

(c) Consists solely of junior subordinated debentures issued to JPM Capital
Trust I and Trust II. Refer to note 20, "Company-obligated mandatorily
redeemable preferred securities of subsidiaries."


126  Notes to consolidated financial statements
<PAGE>   129
J.P. MORGAN (PARENT) STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
In millions                                                                              1998           1997                  1996
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                  <C>             <C>                   <C>
NET INCOME ....................................................................      $    963        $ 1 465               $ 1 574
Adjustments to reconcile to cash provided by operating activities:
  Equity in undistributed (earnings) of subsidiaries ..........................          (212)          (855)               (1 093)
  Net increase (decrease) due to changes in other balance sheet
    amounts ...................................................................           (93)           (54)                  116
  Net investment securities (gains) losses included in cash flows from
    investing activities ......................................................           (46)             -                     7
-----------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES                                                     612            556                   604
-----------------------------------------------------------------------------------------------------------------------------------
Net (increase) decrease in interest-earning deposits with subsidiary bank .....          (152)          (237)                  227
Debt investment securities:
  Proceeds from sales and maturities ..........................................         2 330          1 394                 1 173
  Purchases ...................................................................        (2 373)        (1 161)               (1 605)
Net increase in advances to subsidiaries ......................................        (5 605)        (3 461)               (1 712)
Capital to subsidiaries .......................................................          (252)           (26)                  (23)
Net payments for insurance contracts ..........................................          (703)          (453)                 (717)
Other changes, net ............................................................           (33)           (41)                   (8)
-----------------------------------------------------------------------------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES                                                      (6 788)        (3 985)               (2 665)
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in securities sold under agreements
  to repurchase ...............................................................          (351)          (154)                  403
Net increase in commercial paper ..............................................            19          2 660                   706
Net increase (decrease) in other liabilities for borrowed money ...............          (390)           515                (1 140)
Long-term debt:
  Proceeds ....................................................................         9 655          3 302                 1 792
  Payments ....................................................................        (1 848)        (1 754)                    -
Intercompany debentures:
  Proceeds ....................................................................             -            413                   773
Capital stock issued or distributed ...........................................           179            245                   424
Capital stock purchased .......................................................          (755)        (1 500)                 (604)
Dividends paid ................................................................          (707)          (673)                 (643)
Cash receipts from subsidiaries for common stock issuable .....................           338            370                   307
Other changes, net ............................................................            36              5                    41
-----------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES                                                   6 176          3 429                 2 059
-----------------------------------------------------------------------------------------------------------------------------------
DECREASE IN CASH AND DUE FROM BANKS                                                         -              -                    (2)
Cash and due from banks, beginning of year ....................................             -              -                     2
-----------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks, end of year                                                        -              -                     -
-----------------------------------------------------------------------------------------------------------------------------------
Cash disbursements for interest and taxes                                               1 267            827                   692
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                  Notes to consolidated financial statements 127
<PAGE>   130
ADDITIONAL SELECTED DATA
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
Dollars in millions, except share data                     1998              1997            1996            1995           1994
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>               <C>             <C>              <C>            <C>
SELECTED FINANCIAL DATA
Total interest revenue ...........................     $ 12 641          $ 12 353        $ 10 713         $ 9 937        $ 8 379
Total noninterest revenues .......................        5 784             5 348           5 153           3 901          3 536
----------------------------------------------------------------------------------------------------------------------------------
Total revenues ...................................       18 425            17 701          15 866          13 838         11 915
Interest expense .................................       11 360            10 481           9 011           7 934          6 398
Provision for loan losses ........................         (110)               --              --              --             --
----------------------------------------------------------------------------------------------------------------------------------
Total revenue, net of interest expense
  and provision for credit losses ................        6 955             7 220           6 855           5 904          5 517
Total operating expenses .........................        5 538 (e)         5 066           4 523           3 998          3 692
----------------------------------------------------------------------------------------------------------------------------------
Net income .......................................          963             1 465           1 574           1 296          1 215
At year-end:
  Total assets ...................................      261 067           262 159         222 026         184 879        154 917
  Long-term debt and other capital
    securities(a) ................................       28 757            24 139          13 853           9 327          6 802
  Stockholders' equity ...........................       11 261            11 404          11 432          10 451          9 568
  Common stockholders' equity ....................       10 567            10 710          10 738           9 957          9 074
  Tier 1 risk-based capital ......................       11 213            11 854             (b)             (b)            (b)
  Total risk-based capital .......................       16 454            17 680             (b)             (b)            (b)
Per common share:
  Net income:
    Basic(c) .....................................     $   5.08          $   7.71        $   8.11        $   6.70       $   6.20
    Diluted(c) ...................................         4.71              7.17            7.63            6.42           6.02
  Book value .....................................        55.01 (d)         55.99 (d)       54.43 (d)       50.71 (d)      46.73 (d)
  Dividends declared .............................         3.84              3.59            3.31            3.06           2.79

EARNINGS RATIOS
Net income as % of:
  Average total assets ...........................         0.34%(d)          0.58%(d)        0.73%(d)        0.73%(d)       0.70%(d)
  Average stockholders' equity ...................          8.4 (d)          12.9 (d)        14.3 (d)        13.2 (d)       12.5 (d)
  Average common stockholders' equity ............          8.6 (d)          13.4 (d)        14.9 (d)        13.6 (d)       12.9 (d)

DIVIDEND PAYOUT RATIO
  Dividends declared per common share as %
    of diluted net income per common share .......         81.5%             50.1%           43.4%           47.7%          46.3%

CAPITAL RATIOS
Average stockholders' equity as % of
  average total assets ...........................          4.1%(d)           4.5%(d)         5.1%(d)         5.5%(d)        5.7%(d)
Common stockholders' equity as % of:
  Average total assets ...........................          3.7 (d)           4.2 (d)         5.0 (d)         5.6 (d)        5.3 (d)
  Total year-end assets ..........................          4.0 (d)           4.1 (d)         4.8 (d)         5.4 (d)        5.9 (d)
Total stockholders' equity as % of:
  Average total assets ...........................          4.0 (d)           4.5 (d)         5.3 (d)         5.9 (d)        5.5 (d)
  Total year-end assets ..........................          4.3 (d)           4.4 (d)         5.2 (d)         5.7 (d)        6.2 (d)
Tier 1 risk-based capital ratio ..................          8.0               8.0             (b)             (b)            (b)
Total risk-based capital ratio ...................         11.7              11.9             (b)             (b)            (b)
Leverage ratio ...................................          3.9               4.4             (b)             (b)            (b)

OTHER SELECTED DATA
Registered holders of record of common
  stock at year-end ..............................       27 992            29 186          29 607          29 391         29 596
Common shares outstanding at
  year-end (in thousands) ........................      175 006           176 318         184 923         187 116        187 701
Employees at year-end:
  In the U.S. ....................................        8 402             8 994           8 579           8 855          9 607
  Outside the U.S. ...............................        7 272             7 949           6 948           6 758          7 448
----------------------------------------------------------------------------------------------------------------------------------
Total employees                                          15 674            16 943          15 527          15 613         17 055
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


128  Additional selected data
<PAGE>   131
(a) Includes $4,570 million, $4,743 million, $3,692 million, $3,590 million, and
$3,197 million of long-term debt qualifying as risk-based capital in 1998, 1997,
1996, 1995, and 1994, respectively, and $1,150 of company-obligated mandatorily
redeemable preferred securities of subsidiaries in 1998 and 1997, qualifying as
risk-based capital.

(b) The December 31, 1998 and 1997 amounts and ratios reflect the adoption of
the Federal Reserve Board's market risk capital guidelines for calculation of
risk-based capital ratios. These guidelines include incorporating a measure of
market risk for trading positions. In addition, the capital and assets of the
Section 20 subsidiary, J.P. Morgan Securities Inc., are no longer excluded from
the calculations. Prior-period amounts and ratios included in the following
table have not been restated and accordingly exclude the equity, assets, and
off-balance-sheet exposures of J.P. Morgan Securities Inc. See note 22, "Capital
requirements."

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
Dollars in millions                                                          1996                     1995                     1994
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                      <C>                      <C>
Tier 1 risk-based capital ...............................                 $10 873                  $ 9 033                  $ 8 265
Total risk-based capital ................................                  15 145                   13 398                   12 221
Tier 1 risk-based capital ratio .........................                     8.8%                     8.8%                     9.6%
Total risk-based capital ratio ..........................                    12.2                     13.0                     14.2
Leverage ratio ..........................................                     5.9                      6.1                      6.5
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(c) Effective December 31, 1997, we adopted the provisions of SFAS No. 128,
Earnings per Share. SFAS No. 128 supercedes APB No. 15 and related
interpretations and replaces the computations of primary and fully diluted
earnings per share (EPS) with basic and diluted EPS, respectively. Prior-period
amounts have been restated. See note 25, "Earnings per share."

(d) The following table presents certain ratios excluding the effect of
SFAS No. 115 for the years ended December 31, 1998, 1997, 1996, 1995, and 1994.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                               1998            1997            1996            1995            1994
<S>                                                        <C>             <C>             <C>             <C>             <C>
Book value per common share ........................       $  54.24        $  53.74        $  52.08        $  47.83        $  44.39
-----------------------------------------------------------------------------------------------------------------------------------
Net income as % of:
  Average total assets .............................           0.34%           0.58%           0.73%           0.73%           0.71%
  Average stockholders' equity .....................           8.62           13.48           14.89           13.78            13.6
  Average common stockholders' equity ..............           8.84            14.0            15.6            14.3            14.2
-----------------------------------------------------------------------------------------------------------------------------------
Average stockholders' equity as % of average
  total assets .....................................            4.0             4.3             4.9             5.3             5.2
-----------------------------------------------------------------------------------------------------------------------------------
Common stockholders' equity as % of:
  Average total assets .............................           3.69            4.08            4.79            5.29             5.0
  Total year-end assets ............................           3.99            3.93            4.64            5.11             5.6
-----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity as % of:
  Average total assets .............................           3.93            4.35            5.12            5.57             5.3
  Total year-end assets ............................           4.26            4.20            4.96            5.37             5.9
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(e) 1998 includes charges in the first and fourth quarters totaling $358 million
($215 million after tax) related to the restructuring of business activities and
other cost reduction programs. The charges were recorded as follows: $241
million in Employee compensation and benefits, related to severance; $112
million in Net occupancy, related to real estate write-offs; and $5 million in
Technology and communications, related to equipment write-offs.


                                                    Additional selected data 129
<PAGE>   132
SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA
J.P. Morgan & Co. Incorporated
(Unaudited)

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
In millions, except share data                                                   1998                                          1997
                                          ------------------------------------------    -------------------------------------------
Three months ended                         Dec. 31   Sept. 30     June 30     Mar. 31    Dec. 31   Sept. 30     June 30     Mar. 31
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>       <C>        <C>         <C>          <C>       <C>          <C>         <C>
Interest revenue ......................     $3 024     $3 249      $3 106      $3 262     $3 271     $3 161      $3 029      $2 892
Interest expense ......................      2 701      2 917       2 816       2 926      2 816      2 689       2 534       2 442
Provision for loan losses .............        (85)       (25)         --          --         --         --          --          --
-----------------------------------------------------------------------------------------------------------------------------------
Net interest revenue after
  provision for loan losses ...........        238        307         290         336        455        472         495         450
Total noninterest revenues(a) .........      1 266        994       1 863       1 661      1 225      1 444       1 296       1 383
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue, net of interest
  expense and provision for loan losses      1 504      1 301       2 153       1 997      1 680      1 916       1 791       1 833
Total operating expenses(b) ...........      1 391      1 099       1 416       1 632      1 308      1 326       1 241       1 191
-----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ............        113        202         737         365        372        590         550         642
Income taxes ..........................         24         46         256         128        101        194         176         218
-----------------------------------------------------------------------------------------------------------------------------------
NET INCOME ............................         89        156         481         237        271        396         374         424
-----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE 
Net income:
  Basic ...............................     $ 0.44     $ 0.81      $ 2.57      $ 1.26     $ 1.44     $ 2.10      $ 1.98      $ 2.19
  Diluted .............................       0.42       0.75        2.36        1.15       1.33       1.96        1.85        2.04
Dividends declared ....................       0.99       0.95        0.95        0.95       0.95       0.88        0.88        0.88
-----------------------------------------------------------------------------------------------------------------------------------
Price range per common share
  on the composite tape:
  High ................................   $115 7/8  $133 9/16  $148 11/16  $138 13/16   $125 3/4  $116 13/16   $113 1/8    $109 7/8
  Low .................................     74 1/2     84 5/8   116 15/16    98 13/16    105 1/2   104 1/16      93 1/8          96
Closing price per common
  share at quarter-end ................   105 1/16     84 5/8   117 1/16    134 5/16     112 7/8    113 5/8     104 3/8      98 1/4
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The principal market on which the company's common stock is traded is the New
York Stock Exchange.

(a) Refer to note 7, "Other revenue and other expenses," to our consolidated
financial statements.

(b) Refer to note 3, "Restructuring of business activities," to our consolidated
financial statements.


The 1998 fourth-quarter results are discussed in J.P. Morgan's earnings release
dated January 19, 1999, which has been filed with the Securities and Exchange
Commission on Form 8-K.


130  Selected consolidated quarterly financial data
<PAGE>   133
CONSOLIDATED AVERAGE BALANCES AND TAXABLE-EQUIVALENT NET INTEREST EARNINGS
J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
Dollars in millions                                            1998                           1997                           1996
                                      -----------------------------    ---------------------------   ----------------------------
Interest and average rates on          Average              Average    Average             Average   Average              Average
a taxable-equivalent basis             balance   Interest      rate    balance  Interest      rate   balance   Interest      rate
---------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>        <C>         <C>      <C>       <C>      <C>      <C>       <C>         <C>
ASSETS
Interest-earning deposits
  with banks,  mainly in offices
  outside the U.S. ..............      $ 2 079    $   294     14.14%   $ 2 035   $   199      9.78%   $ 2 022   $   110      5.44%
Debt investment securities in
  offices in the U.S.:(a)
  U.S. Treasury .................          723         61      8.44      1 296        95      7.33      1 581       106      6.70
U.S. state and political
  subdivision ...................        1 535        168     10.94      1 264       148     11.71      1 591       183     11.50
  Other .........................       21 128      1 185      5.61     17 260     1 095      6.34     17 399     1 109      6.37
Debt investment securities in
  offices outside the U.S.(a) ...        1 519        109      7.18      3 733       273      7.31      4 452       271      6.09
Trading account assets:
  In offices in the U.S. ........       30 394      1 837      6.04     25 245     1 587      6.29     16 591       994      5.99
  In offices outside the U.S. ...       36 227      2 509      6.93     39 367     2 693      6.84     29 656     2 285      7.71
Securities purchased under
  agreements to resell and
  federal funds sold
  In offices in the U.S. ........       17 372        939      5.41     15 660       895      5.72     24 653     1 269      5.15
  In offices outside the U.S. ...       21 478      1 092      5.08     24 785     1 164      4.70     18 411       985      5.35
Securities borrowed, mainly in
  offices in the U.S. ...........       40 680      2 088      5.13     36 287     1 784      4.92     25 310     1 284      5.07
Loans:
  In offices in the U.S. ........        6 452        464      7.19      5 146       381      7.40      6 227       418      6.71
  In offices outside the U.S. ...       24 491      1 650      6.74     25 490     1 661      6.52     21 794     1 371      6.29
Other interest-earning assets:(b)
  In offices in the U.S. ........        2 112        122         *        774       168         *        940       139         *
  In offices outside the U.S. ...          944        199         *        707       282         *      1 027       274         *
---------------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets ...      207 134     12 717      6.14    199 049    12 425      6.24    171 654    10 798      6.29
Cash and due from banks .........        1 429                             797                            935
Other noninterest-earning assets        74 621                          53 049                         42 454
---------------------------------------------------------------------------------------------------------------------------------
Total assets                           283 184                         252 895                        215 043
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The percentage of average interest-earning assets attributable to offices
outside the U.S. was 45% in 1998, 52% in 1997, and 47% in 1996. Average balances
are derived from daily balances except in the case of some subsidiaries, which
are derived from month-end balances. Interest and average rates applying to the
following asset categories have been adjusted to a taxable-equivalent basis:
Debt investment securities in offices in the U.S., Trading account assets in
offices in the U.S., and Loans in offices in the U.S. The applicable tax rate
used to adjust tax-exempt interest to a taxable-equivalent basis was
approximately 41% in 1998, 1997, and 1996.

Impaired loans are included in the determination of average total loans.

(a) For the 12 months ended December 31, 1998, 1997, and 1996, average debt
investment securities are computed based on historical amortized cost, excluding
the effects of SFAS No. 115 adjustments.

(b) Interest revenue includes the effect of certain off-balance-sheet
transactions.

*Not meaningful.


Consolidated average balances and taxable-equivalent net interest earnings   131

<PAGE>   134
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
Dollars in millions                                                1998                          1997                          1996
                                            ---------------------------    --------------------------    --------------------------
Interest and average rates on                Average            Average    Average            Average    Average             Average
a taxable-equivalent basis                   balance  Interest     rate    balance  Interest     rate    balance  Interest      rate
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>       <C>       <C>        <C>      <C>       <C>        <C>      <C>        <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing deposits:
  In offices in the U.S. .................  $  7 674   $   397     5.17%   $ 9 676  $    538     5.56%   $ 3 962  $    204     5.15%
  In offices outside the U.S. ............    49 044     2 426     4.95     46 254     2 215     4.79     45 148     2 337     5.18
Trading account liabilities:
  In offices in the U.S. .................     9 424       665     7.06     11 390       785     6.89      8 295       522     6.29
  In offices outside the U.S. ............    15 085       876     5.81     14 291       867     6.07     11 056       780     7.05
Securities sold under agreements to
  repurchase and federal funds
  purchased, mainly in offices in
  the U.S. ...............................    70 537     3 846     5.45     67 121     3 532     5.26     63 424     3 295     5.20
Commercial paper, mainly in offices in
  the U.S. ...............................     9 682       539     5.57      4 858       262     5.39      4 133       225     5.44
Other interest-bearing liabilities:
  In offices in the U.S. .................    12 323       811     6.58     15 590       958     6.14     14 331       819     5.71
  In offices outside the U.S. ............     3 360       263     7.83      4 026       227     5.64      2 258       204     9.03
Long-term debt, mainly in offices in
  the U.S. ...............................    26 066     1 537     5.90     18 155     1 097     6.04     10 643       625     5.87
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities .......   203 195    11 360     5.59    191 361    10 481     5.48    163 250     9 011     5.52
Noninterest-bearing deposits:
  In offices in the U.S. .................       884                         1 033                         2 298
  In offices outside the U.S. ............       784                           452                           737
Other noninterest-bearing liabilities ....    66 812                        48 696                        37 767
-----------------------------------------------------------------------------------------------------------------------------------
Total liabilities ........................   271 675                       241 542                       204 052
Stockholders' equity .....................    11 509                        11 353                        10 991
-----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity   283 184                       252 895                       215 043
Net yield on interest-earning assets: ....                         0.66                          0.98                          1.04
  Attributable to offices in the U.S.(a) .                         0.01                          0.13                          0.76
  Attributable to offices outside the
    U.S.(a) ..............................                         1.44                          1.78                          1.36
Taxable-equivalent net interest earnings:                1 357                         1 944                         1 787
  Attributable to offices in the U.S.(a) .                  11                           121                           699
  Attributable to offices outside the
    U.S.(a) ..............................               1 346                         1 823                         1 088
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The percentage of average interest-bearing liabilities attributable to offices
outside the U.S. was 44% in 1998, 47% in 1997, and 47% in 1996.

(a) Funding costs are allocated based on the location of the office recording
the asset. No allocation is made for capital.


132  Consolidated average balances and taxable-equivalent net interest earnings
<PAGE>   135
ANALYSIS OF YEAR-TO-YEAR CHANGES IN TAXABLE-EQUIVALENT NET INTEREST EARNINGS

J.P. Morgan & Co. Incorporated


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                  1998/97 Increase (decrease)            1997/96 Increase (decrease)
                                                                            due to change in:                     due to change in:
                                                           ---------------------------------      ---------------------------------
                                                           Average      Average     Increase      Average      Average    Increase
In millions                                                balance         rate    (decrease)     balance         rate   (decrease)
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>          <C>         <C>           <C>          <C>       <C>
INTEREST-EARNING ASSETS
Interest-earning deposits with banks, mainly in offices
  outside the U.S. ....................................      $   4        $  91        $  95       $    1       $   88       $   89
Debt investment securities in offices in the U.S.:
  U.S. Treasury .......................................        (47)          13          (34)         (20)           9          (11)
  U.S. state and political subdivision ................         30          (10)          20          (38)           3          (35)
  Other ...............................................        226         (136)          90           (9)          (5)         (14)
Debt investment securities in offices outside the U.S.        (159)          (5)        (164)         (48)          50            2
Trading account assets:
  In offices in the U.S. ..............................        315          (65)         250          541           52          593
  In offices outside the U.S. .........................       (219)          35         (184)         687         (279)         408
Securities purchased under agreements to resell and
   federal funds sold:
     In offices in the U.S. ...........................         94          (50)          44         (503)         129         (374)
     In offices outside the U.S. ......................       (162)          90          (72)         310         (131)         179
Securities borrowed, mainly in offices in the U.S. ....        225           79          304          539          (39)         500
Loans:
  In offices in the U.S. ..............................         94          (11)          83          (78)          41          (37)
  In offices outside the U.S. .........................        (66)          55          (11)         239           51          290
Other interest-earning assets:
  In offices in the U.S. ..............................        141         (187)         (46)         (28)          57           29
  In offices outside the U.S. .........................         76         (159)         (83)        (102)         110            8
-----------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-EARNING ASSETS .........................        552         (260)         292        1 491          136        1 627
-----------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
  In offices in the U.S. ..............................       (105)         (36)        (141)         317           17          334
  In offices outside the U.S. .........................        136           75          211           55         (177)        (122)
Trading account liabilities:
  In offices in the U.S. ..............................       (139)          19         (120)         209           54          263
  In offices outside the U.S. .........................         47          (38)           9          206         (119)          87
Securities sold under agreements to repurchase and
  federal funds purchased, mainly in offices in the U.S.       184          130          314          198           39          237
Commercial paper, mainly in offices in the U.S. .......        268            9          277           39           (2)          37
Other interest-bearing liabilities:
  In offices in the U.S. ..............................       (212)          65         (147)          75           64          139
  In offices outside the U.S. .........................        (42)          78           36          119          (96)          23
Long-term debt, mainly in offices in the U.S. .........        467          (27)         440          454           18          472
-----------------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES ....................        604          275          879        1 672         (202)       1 470
-----------------------------------------------------------------------------------------------------------------------------------
CHANGE IN TAXABLE-EQUIVALENT NET INTEREST EARNINGS ....        (52)        (535)        (587)        (181)         338          157
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Changes in the average balance/rate are allocated based on the percentage
relationship of the change in average balance or average rate to the total
increase (decrease). Included in the above analysis is approximately $2 million
and $1 million of interest revenue recorded in 1997 and 1996, respectively, that
related to prior years. There was no interest revenue recorded in 1998 that
related to prior years.


TAXABLE-EQUIVALENT NET INTEREST EARNINGS AND THE CONSOLIDATED STATEMENT OF
INCOME

J.P. Morgan & Co. Incorporated

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
In millions                                                                                   1998             1997             1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                        <C>              <C>              <C>
Taxable interest revenue ........................................................          $12 511          $12 208          $10 551
Tax-exempt interest revenue, adjusted to a taxable-equivalent basis .............              206              217              247
------------------------------------------------------------------------------------------------------------------------------------
Total interest revenue, adjusted to a taxable-equivalent basis ..................           12 717           12 425           10 798
Less: interest expense ..........................................................           11 360           10 481            9 011
------------------------------------------------------------------------------------------------------------------------------------
Taxable-equivalent net interest earnings ........................................            1 357            1 944            1 787
Less: adjustment of tax-exempt interest revenue .................................               76               72               85
------------------------------------------------------------------------------------------------------------------------------------
Net interest revenue, as in the consolidated statement of income ................            1 281            1 872            1 702
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


 Consolidated average balances and taxable-equivalent net interest earnings 133
<PAGE>   136
CROSS-BORDER AND LOCAL OUTSTANDINGS


The following presents our cross-border and local outstandings under the
regulatory basis established by the Federal Financial Institutions Examination
Council (FFIEC). Bank regulatory rules differ from management's view in the
treatment of credit derivatives, trading account short positions, and the use of
fair value versus cost of investment securities. In addition, management does
not net local funding or liabilities against any local exposures as allowed by
the FFIEC. Refer to page 42 for more information on exposures based on
management's view.

In accordance with regulatory rules, cross-border outstandings include,
regardless of currency:

-  all claims of our U.S. offices against foreign residents

-  all claims of our foreign offices against residents of other foreign
   countries

Local outstandings include all claims of our foreign offices with residents of
the same foreign country, net of local funding.

All outstandings are based on the location of the ultimate counterparty; that
is, if collateral or a formal guarantee exists, the country presented is
determined by the location where the collateral is held and realizable, or the
location of the guarantor. Cross-border and local outstandings include the
following: interest-earning deposits with banks, investment securities, trading
account assets including derivatives, securities purchased under agreements to
resell, loans, accrued interest, investments in affiliates, and other monetary
assets. Commitments include all cross-border commitments to extend credit,
standby letters of credit, and guarantees, and securities lending
indemnifications.

The following tables show each country where cross-border and local outstandings
exceeded 0.75% of total assets at December 31, 1998, 1997, and 1996.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Total out-
                                                                                                                          standings
                                                                      Net local        Total         % of                       and
In millions                                   Govern-                      out-         out-        Total       Commit-     commit-
December 31, 1998                  Banks        ments     Other(a)    standings    standings       assets         ments       ments
------------------------------------------------------------------------------------------------------------------------------------
<S>                              <C>          <C>         <C>         <C>          <C>             <C>          <C>      <C>
Japan .....................      $ 1 064      $11 189       $2 327       $5 049      $19 629         7.52%       $1 204      $20 833
Germany ...................       11 983        1 533        1 578          169       15 263         5.85         1 415       16 678
Italy .....................        2 921        9 597          562           73       13 153         5.04            76       13 229
France ....................        5 604          994        2 282           --        8 880         3.40         2 318       11 198
The Netherlands ...........        6 101          878          906           --        7 885         3.02           367        8 252
United Kingdom ............        3 362          104        4 293           --        7 759         2.97         1 306        9 065
Cayman Islands ............          151           --        4 630           --        4 781         1.83           300        5 081
Spain .....................        1 854        1 216        1 376          189        4 635         1.78           512        5 147
Switzerland ...............        2 249          615        1 357           --        4 221         1.62           802        5 023
Belgium ...................        1 429        1 135        1 088           --        3 652         1.40         4 469        8 121
Canada ....................        1 776          957          758           --        3 491         1.34         1 601        5 092
South Korea ...............          891          656          736           --        2 283         0.87            54        2 337
Hong Kong .................          251           16          803        1 082        2 152         0.82           188        2 340
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Includes nonbank financial institutions and commercial and industrial
entities.


134  Cross-border and local outstandings
<PAGE>   137
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Total out-
                                                                                                                          standings
                                                                      Net local        Total         % of                       and
In millions                                   Govern-                      out-         out-        Total       Commit-     commit-
December 31, 1997                  Banks        ments     Other(a)    standings    standings       assets         ments       ments
------------------------------------------------------------------------------------------------------------------------------------
<S>                              <C>          <C>         <C>         <C>          <C>             <C>          <C>      <C>
United Kingdom ...........        $6 314      $   643       $6 181           --      $13 138         5.01%       $1 185    $14 323
Japan ....................         2 748        5 410        2 876           --       11 034         4.21         1 866     12 900
France ...................         5 614        1 025        2 072      $   744        9 455         3.61         1 889     11 344
Germany ..................         4 904        2 855        1 014           24        8 797         3.36         1 230     10 027
Cayman Islands ...........             6          473        6 368           --        6 847         2.61           160      7 007
The Netherlands ..........         2 751          999        2 082           --        5 832         2.22           704      6 536
Italy ....................         1 644        3 238          623           --        5 505         2.10             4      5 509
Belgium ..................         2 104        1 938        1 199           --        5 241         2.00         4 191      9 432
Switzerland ..............         2 742          556        1 028          477        4 803         1.83         1 319      6 122
Canada ...................         1 490        1 840          791           --        4 121         1.57         1 716      5 837
Spain ....................         1 362        1 783          545           --        3 690         1.41           170      3 860
Brazil ...................           310        1 061          826        1 393        3 590         1.37            24      3 614
South Korea ..............         1 901          190        1 089           --        3 180         1.21           282      3 462
Hong Kong ................           620           58        1 769           --        2 447         0.93           412      2 859
Argentina ................           129        1 241          903           69        2 342         0.89             5      2 347
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a) Includes nonbank financial institutions and commercial and industrial
entities.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                         Total out-
                                                                                                                          standings
                                                                      Net local        Total         % of                       and
In millions                                   Govern-                      out-         out-        Total       Commit-     commit-
December 31, 1996                  Banks        ments     Other(a)    standings    standings       assets         ments       ments
------------------------------------------------------------------------------------------------------------------------------------
<S>                              <C>          <C>         <C>         <C>          <C>             <C>          <C>      <C>

United Kingdom ............       $4 092       $  303       $3 891           --       $8 286         3.73%       $  994      $9 280
Germany ...................        3 549        3 188          491       $  585        7 813         3.52         1 189       9 002
Japan .....................        2 950        2 033        2 477           --        7 460         3.36         1 110       8 570
France ....................        3 668        1 242          602           --        5 512         2.48         1 476       6 988
The Netherlands ...........        2 678        1 480          910           --        5 068         2.28           661       5 729
Italy .....................        1 016        2 287          391           --        3 694         1.66           172       3 866
Switzerland ...............        2 108          320          589          317        3 334         1.50           894       4 228
Cayman Islands ............            8           --        2 712           --        2 720         1.23            91       2 811
Brazil ....................           81        1 273          610          681        2 645         1.19            47       2 692
Spain .....................        1 088        1 215          183           --        2 486         1.12           177       2 663
Belgium ...................          727        1 059          691           --        2 477         1.12         3 414       5 891
Canada ....................          758          916          789           --        2 463         1.11         1 150       3 613
Australia .................          437          219          282        1 299        2 237         1.01           183       2 420
Mexico ....................          399          473          928          153        1 953         0.88            78       2 031
Russia ....................           --        1 697           --           --        1 697         0.76            --       1 697
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


(a) Includes nonbank financial institutions and commercial and industrial
entities.


                                         Cross-border and local outstandings 135
<PAGE>   138
FORM 10-K ANNUAL REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


--------------------------------------------------------------------------------
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1998

J.P. MORGAN & CO. INCORPORATED
(Incorporated in the State of Delaware)
60 Wall Street, New York, NY 10260-0060
(212) 483-2323

--------------------------------------------------------------------------------

FILED WITH:
Securities and Exchange Commission, Washington, DC 20549

COMMISSION FILE NUMBER:
1-5885

I.R.S. EMPLOYER IDENTIFICATION NUMBER:
13-2625764

THE FOLLOWING SECURITIES ARE REGISTERED ON THE NEW YORK STOCK EXCHANGE PURSUANT
TO SECTION 12(b) OF THE ACT:

Common Stock, $2.50 Par Value

Adjustable Rate Cumulative Preferred Stock, Series A, No Par Value, Stated Value
$100

Depository shares representing a one-tenth interest in 6-5/8% Cumulative
Preferred Stock, Series H, No Par Value, Stated Value $500

THE FOLLOWING SECURITIES ARE REGISTERED ON THE AMERICAN STOCK EXCHANGE PURSUANT
TO SECTION 12(b) OF THE ACT:

2.5% Commodity-Indexed Preferred Securities (ComPS(SM)), Series A issued by J.P.
Morgan Index Funding Company I and guaranteed by J.P. Morgan & Co. Incorporated

Commodity-Index Preferred Securities (ComPS(SM)), Series B issued by J.P. Morgan
Index Funding Company I and guaranteed by J.P. Morgan & Co. Incorporated,
Initial Face Amount $13

NO SECURITIES ARE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT.

The aggregate market value of the voting stock held by nonaffiliates of J.P.
Morgan totaled $19,614,031,243 at February 26, 1999.

The number of shares outstanding of J.P. Morgan's Common Stock, $2.50 Par Value,
at February 26, 1999, totaled 176,009,254 shares.

J.P. Morgan (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and
(2) has been subject to such filing requirements for the past 90 days.

Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein nor in any amendment to this Form 10-K, and is not contained in
J.P. Morgan's 1999 Proxy Statement incorporated by reference in Part III of this
Form 10-K.

J.P. Morgan's definitive Proxy Statement dated March 11, 1999, is incorporated
by reference in response to Part III, Items 10, 11, 12, and 13 of Form 10-K. 


136  Form 10-K annual report
<PAGE>   139
FORM 10-K CROSS-REFERENCE INDEX
------------------------------------------------------------
    PART I

1.   BUSINESS
     Description of business, 19-30, 47-48
     Number of employees, 128
     Financial information about foreign and
     domestic operations, 42-44, 123-124,
     134-135
     Distribution of assets, liabilities, and
     stockholders' equity; interest rates and interest
     differential, 131-133
     Investment portfolio, 82-84
     Loan portfolio, 72-74, 89-92
     Summary of loan loss experience, 73-74, 92-96
     Deposits, 96-97, 131-133
     Return on equity and assets, 128-129
     Short-term borrowings, 97-98

2.   PROPERTIES, 48

3.   LEGAL PROCEEDINGS(a)

4.   SUBMISSION OF MATTERS TO A VOTE OF
     SECURITY HOLDERS(a)
------------------------------------------------------------

     PART II

5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND
     RELATED STOCKHOLDER MATTERS, 124,128-130

6.   SELECTED FINANCIAL DATA, 128-129

7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF
     FINANCIAL CONDITION AND RESULTS OF
     OPERATIONS, 1-4, 17-59

7a.  QUANTITATIVE AND QUALITATIVE DISCLOSURES
     ABOUT MARKET RISK, 49-54

8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY
     DATA
     Report of independent accountants, 62
     J.P. Morgan & Co. Incorporated
         Consolidated statement of income, 63
         Consolidated balance sheet, 64
         Consolidated statement of changes in
         stockholders' equity, 65-66
         Consolidated statement of cash flows, 67
     Morgan Guaranty Trust Company of New York -
     Consolidated statement of condition, 68
     Notes to consolidated financial statements,
     69-127
     Selected consolidated quarterly
     financial data,(b) 130

9.   CHANGES IN AND DISAGREEMENTS WITH
     ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
     DISCLOSURE(a)

---------------------------------------------

     PART III

10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE
     REGISTRANT(c)

11.  EXECUTIVE COMPENSATION(c)

12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
     OWNERS AND MANAGEMENT(c)

13.  CERTAIN RELATIONSHIPS AND RELATED
     TRANSACTIONS(c)
---------------------------------------------

     PART IV

14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
     AND REPORTS ON FORM 8-K

     1.  Financial statements have been
         included in Item 8.

     2.  Financial statement schedules
         Schedule III - Condensed financial
         information of J.P. Morgan & Co.
         Incorporated (parent), 125-127

---------------------------------------------

     EXHIBITS

3a.  Restated certificate of incorporation, as
     amended (incorporated by reference to
     Exhibit 3a to J.P. Morgan's
     post-effective amendment No. 1 to Form
     S-3, Registration No. 33-55851)

3b.  By-laws of J.P. Morgan as amended through
     April 10, 1996 (incorporated by reference
     to Exhibit 3b to J.P. Morgan's report on
     Form 8-K, dated April 11, 1996)

4.   Instruments defining the rights of
     security holders, including indentures(d)

10a. 1992 stock incentive plan, as amended
     (incorporated by reference to Exhibit 10a
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1994, File No. 1-5885)

10b. Director stock plan, as amended
     (incorporated by reference to Exhibit 10b
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1994, File No. 1-5885)

10c. Deferred compensation plan for
     directors' fees, as amended (incorporated
     by reference to Exhibit 10c to J.P.
     Morgan's annual report on Form 10-K for
     the year ended December 31, 1992, File
     No. 1-5885)

10d. 1989 stock incentive plan, as amended
     (incorporated by reference to Exhibit 10d
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1994, File No. 1-5885)

10e. 1987 stock incentive plan, as amended
     (incorporated by reference to Exhibit 10e
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1994, File No. 1-5885)

10f. Incentive compensation plan, as amended
     (incorporated by reference to Exhibit 10f
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1997, File No. 1-5885)

10g. Stock option award (incorporated by
     reference to Exhibit 10h to J.P. Morgan's
     quarterly report on Form 10-Q for the
     quarter ended March 31, 1995, File No.
     1-5885)

10h. 1995 stock incentive plan, as amended
     (incorporated by reference to Exhibit 10i
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1996, File No. 1-5885)

10i. 1995 executive officer performance plan
     (incorporated by reference to Exhibit 10j
     to J.P. Morgan's annual report on Form
     10-K for the year ended December 31,
     1995, File No. 1-5885)

10j. 1998 performance plan (incorporated by
     reference to Exhibit 10 to J.P. Morgan's
     quarterly report on Form 10-Q for the
     quarter ended September 30, 1998, File
     No. 1-5885)

12.  Statements re computation of ratios

13.  Annual report to stockholders(e)

21.  Subsidiaries of J.P. Morgan

23.  Consent of independent accountants

24.  Powers of attorney

27.  Financial data schedule
---------------------------------------------

     REPORTS ON FORM 8-K

     Report on Form 8-K dated October 19,
     1998, was filed with the Securities and
     Exchange Commission during the quarter
     ended December 31, 1998, which reported
     the issuance by J.P. Morgan of a press
     release reporting its earnings for the
     three- and nine-month periods ended
     September 30, 1998.

     In addition, Form 8-K dated December 9,
     1998, was filed announcing a dividend
     increase, lower results for the fourth
     quarter, and a stock repurchase program.

---------------------------------------------
     This report on Form 10-K has not been
     approved or disapproved by the
     Securities and Exchange Commission nor
     has the Commission passed upon the
     accuracy or adequacy of this report.
     Portions of the annual report to
     stockholders are not required for the
     Form 10-K report and are not filed as
     part of J.P. Morgan's Form 10-K.

---------------------------------------------

(a)  Nothing to report.

(b)  Fourth quarter 1998 results are
     incorporated by reference to the report
     on Form 8-K dated January 19, 1999,
     filed with the Securities and Exchange
     Commission.

(c)  Incorporated by reference to the
     definitive Proxy Statement dated March
     11, 1999.

(d)  J.P. Morgan hereby agrees to furnish to
     the Commission, upon request, a copy of
     any unfiled agreements defining the
     rights of holders of long-term debt of
     J.P. Morgan and of all subsidiaries of
     J.P. Morgan for which consolidated or
     unconsolidated financial statements are
     required to be filed.

(e)  Only those sections of the annual report
     to stockholders referenced in the
     cross-reference index above are
     incorporated in the report on Form 10-K.

---------------------------------------------

     Other schedules and exhibits are omitted
     because the required information either
     is not applicable or is shown in the
     consolidated financial statements or the
     notes thereto.


                                            Form 10-K cross-reference index 137
<PAGE>   140
SIGNATURES
--------------------------------------------------------------------------------

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on March
11, 1999, on its behalf by the undersigned, thereunto duly authorized.

J.P. MORGAN & CO. INCORPORATED
Registrant



RACHEL F. ROBBINS
-------------------------------
Rachel F. Robbins
Secretary


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on March 11, 1999, by the following persons on behalf of
the registrant in the capacities indicated.



JOHN A. MAYER JR.
-------------------------------
John A. Mayer Jr.
Chief Financial Officer
(Principal financial officer)



DAVID H. SIDWELL
-------------------------------
David H. Sidwell
Managing Director and Controller
(Principal accounting officer)




Douglas A. Warner III*
Chairman of the Board and Director
Paul A. Allaire* Director
Riley P. Bechtel* Director
Lawrence A. Bossidy* Director
Martin Feldstein* Director
Ellen V. Futter* Director
Hanna H. Gray* Director
Walter A. Gubert*
Vice Chairman of the Board and Director
James R. Houghton* Director
James L. Ketelsen* Director
John A. Krol* Director
Roberto G. Mendoza*
Vice Chairman of the Board and Director
Michael E. Patterson*
Vice Chairman of the Board and Director
Lee R. Raymond* Director
Richard D. Simmons* Director
Kurt F. Viermetz* Director
Douglas C. Yearley* Director


*  By: JAMES C. P. BERRY
-------------------------------
James C. P. Berry
Attorney-in-fact


138 Signatures
<PAGE>   141
MANAGEMENT
--------------------------------------------------------------------------------

DOUGLAS A. WARNER III
  Chairman of the Board
  Chief Executive Officer

WALTER A. GUBERT
ROBERTO G. MENDOZA
MICHAEL E. PATTERSON
  Vice Chairmen of the Board

PETER D. HANCOCK
  Chairman, Risk Management Committee
      and Capital Committee

THOMAS B. KETCHUM
  Chief Administrative Officer

JOHN A. MAYER JR.
  Chief Financial Officer

ERNEST STERN
  Managing Director

STEPHEN G. THIEKE
  Managing Director

RAMON DE OLIVEIRA
KEITH M. SCHAPPERT
  Asset Management Services

WALTER A. GUBERT
  Investment Banking

CLAYTON S. ROSE
  Equities

NICOLAS S. ROHATYN
  Credit Markets
  Credit Portfolio

WILLIAM T. WINTERS
  Interest Rate Markets
  Foreign Exchange

PILAR CONDE
MICHAEL R. COREY
  Proprietary Positioning

BART J. BROADMAN
BRUCE N. CARNEGIE-BROWN
  Asia Pacific

JOSEPH P. MACHALE
  Europe, Middle East, Africa

MIGUEL GUTIERREZ
CARLOS M. HERNANDEZ
  Latin America

LUC BOMANS
  Euroclear System

MARTHA J. GALLO
  Auditor

PETER A. MILLER
  Chief Information Officer

DAVID H. SIDWELL
  Controller

RACHEL F. ROBBINS
  General Counsel

JOHN F. BRADLEY
NANCY BAIRD HARWOOD
  Human Resources

LAURA W. DILLON
  Corporate Communication

JOHN G. DANIELLO
  Corporate Services



                                                                  Management 139

<PAGE>   142
J.P. MORGAN DIRECTORY
Offices of J.P. Morgan & Co. Incorporated and its subsidiaries and affiliates

   NORTH AMERICA
   --------------------------------------------------------------------------
   NEW YORK
   60 Wall Street
   New York, NY 10260-0060
   (1-212) 483-2323

   BOSTON
   2 International Place, 18th Floor
   Boston, MA 02110
   (1-617) 428-4777

   CHICAGO
   227 West Monroe Street, Suite 2800
   Chicago, IL 60606
   (1-312) 541-3300

   DALLAS
   300 Crescent Court, Suite 400
   Dallas, TX 75201
   (1-214) 758-2000

   HOUSTON
   1 Houston Center
   1221 McKinney Street
   Suites 3131 and 3150
   Houston, TX 77010-2009
   (1-713) 276-4600

   LOS ANGELES
   333 South Hope Street, 35th Floor
   Los Angeles, CA 90071
   (1-213) 437-9300

   MONTREAL
   1501 McGill College Avenue, Suite 510
   Montreal, Quebec H3A 3M8, Canada
   (1-514) 840-1300

   NEWARK, DELAWARE
   500 Stanton Christiana Road
   Newark, DE 19713
   (1-302) 651-2323

   PALM BEACH
   109 Royal Palm Way
   Palm Beach, FL 33480
   (1-561) 838-4600

   PHILADELPHIA
   1600 Market Street, 47th Floor
   Philadelphia, PA 19103
   (1-215) 640-3400

   SAN FRANCISCO
   101 California Street, 38th Floor
   San Francisco, CA 94111
   (1-415) 954-3200

   WASHINGTON, D.C.
   1300 I Street, NW, 10th Floor
   Washington, DC 20005
   (1-202) 962-7200

   TORONTO
   Royal Bank Plaza, South Tower, Suite 2200
   Toronto, Ontario M5J 2J2, Canada
   (1-416) 981-9200

   NASSAU
   P.O. Box N 4899, Bahamas Financial Centre
   Charlotte and Shirley Streets
   Nassau, Bahamas
   (1-242) 326-5519

   CAYMAN ISLANDS
   c/o CIBC Bank and Trust Company (Cayman) Limited
   P.O. Box 694
   George Town, Grand Cayman
   Cayman Islands
   (1-809) 949-8666

   LATIN AMERICA
   --------------------------------------------------------------------------
   BUENOS AIRES
   Avenida Corrientes 411, 2nd Floor
   1043 Buenos Aires, Argentina
   (54-1) 325-8046

   CARACAS
   Centro Profesional Eurobuilding
   Piso 8, Oficina 8-B
   Calle LaGuairita, Chuao
   Caracas 1060, Venezuela
   (58-2) 993-6944

   LIMA
   Centro Empresarial Pardo y Aliaga
   Pardo y Aliaga 699, Oficina 302
   San Isidro
   L 27 Lima, Peru
   (51-1) 440-2611

   MEXICO CITY
   Avenida de las Palmas 405
   Torre Optima Pisos 14, 15, y 16
   COLONIA LOMAS DE CHAPULTEPEC 11000 Mexico D.F.
   (52-5) 540-9333

   RIO DE JANEIRO
   Praia de Botafogo, 228 - bloco A 
   14th Floor - Room 1405 
   22250-040 Rio de Janeiro
   RJ, Brazil
   (55-21) 553-1142

   SANTIAGO
   Alcantara 200, 10th Floor
   Oficina 1001 Las Condes
   Santiago, Chile
   (56-2) 206-6474

   SAO PAULO
   Avenida Paulista, 1294
   CEP 01310-915 Sao Paulo
   SP Brazil
   (55-11) 281-3700
 
   AFRICA
   --------------------------------------------------------------------------
   JOHANNESBURG
   11th Floor, The Forum
   2 Maude Street, Sandton Square
   Sandown, 2196
   Johannesburg, South Africa
   (27-11) 302-1600


                                    For a listing of significant subsidiaries of
                                    J.P. Morgan and the state or jurisdiction of
                                    their incorporation, please refer to Exhibit
                                                                21 to Form 10-K.

140  J.P. Morgan directory
<PAGE>   143
   EUROPE
   --------------------------------------------------------------------------
   LONDON
   60 Victoria Embankment
   London EC4Y 0JP
   United Kingdom
   (44-171) 600-2300

   AMSTERDAM
   Apollolaan 171
   1077 AS Amsterdam
   The Netherlands
   (31-20) 676-7766

   BRUSSELS
   35, Avenue des Arts
   1040 Brussels, Belgium
   (32-2) 508-8211

   FRANKFURT
   Borsenstrasse 2-4
   60313 Frankfurt am Main
   Germany
   (49-69) 7124-0

   GENEVA
   8, rue de la Confederation
   1204 Geneva, Switzerland
   (41-22) 739-1111

   MADRID
   Jose Ortega y Gasset, 29
   28006 Madrid, Spain
   (34-1) 435-6041

   MILAN
   Corso Venezia, 54
   20121 Milan, Italy
   (39-2) 774-4101

   MOSCOW
   Paveletskaya Square 2, Building 1
   Moscow, 113054
   Russian Federation
   (7-095) 937-7300

   PARIS
   14, Place Vendome
   75001 Paris, France
   (33-1) 4015-4500

   PRAGUE
   Mala Stupartska 7
   110 00 Praha 1
   Czech Republic
   (42-2) 2481-3068

   ROME
   Via Po, 23
   00189 Rome, Italy
   (39-6) 8530-1236

   WARSAW
   LIM Center, 19TH Floor, Suite 1911
   A1, Jerozolimskie 65/79
   00-679 Warsaw, Poland
   (48-22) 630-6752

   ZURICH
   Dreikoenigstrasse 21
   8002 Zurich, Switzerland
   (41-1) 206-8111
   
   ASIA-PACIFIC
   --------------------------------------------------------------------------
   TOKYO
   Akasaka Park Building
   2-20 Akasaka 5-chome
   Minato-ku, Tokyo 107, Japan
   (81-3) 5573-1100

   BANGKOK
   130 Sindhorn Tower III, 27th Floor
   130 Wireless Road
   Lumpini Patumwan
   Bangkok 10330, Thailand
   (66-2) 263-3933

   BEIJING
   27th Floor, CITIC Building
   No. 19, Jianguomenwai Dajie
   Beijing 100004, China
   (86-10) 522-7488

   HONG KONG
   One, International Finance Centre
   1 Harbor View Street
   Central
   Hong Kong
   (852) 2231-1000

   JAKARTA
   World Trade Center, 14th Floor
   Jalan Jendral Sudirman Kav. 29-31
   Jakarta 12920, Indonesia
   (62-21) 522-9229

   LABUAN
   Financial Park Building
   9th Floor, Jalan Merdeka
   87000 W.P. Labuan
   Malaysia
   (02-087) 459000

   MANILA
   Tower one ayala triangle, 22nd floor
   Ayala Avenue, Corner
   Paseo de Roxas
   Makati City
   Metro Manila 1226, Philippines
   (63-2) 848-6088

   MELBOURNE
   333 Collins Street,
   GPO Box 1888R
   Melbourne, Victoria 3000
   Australia
   (61-3) 9623-8300

   MUMBAI (BOMBAY)
   Vakils House
   18, Sprott Road, Ballard Estate
   Mumbai 400 001, India
   (91-22) 270 2201/6

   SEOUL
   13th Floor, KorAm Bank Building
   39, Da-dong, Chung-ku
   Seoul 100-180, Korea
   (82-2) 3705-6699

   SHANGHAI
   Shanghai Center, East Tower, Room 667
   1376 Nan Jing Road West
   Shanghai 200040, China
   (86-21) 6279-7301

   SINGAPORE
   32-08 DBS Building, Tower 2
   6, Shenton Way
   Singapore, 068809
   (65) 220-8144

   SYDNEY
   1 O'Connell Street
   GPO Box 5248
   Sydney, NSW 2001, Australia
   (61-2) 9551-6100

   TAIPEI
   Bank Tower, 10th Floor
   205 Tun Hwa North Road
   Taipei, Taiwan
   (886-2) 712-2333

                                                       J.P. Morgan directory 141
<PAGE>   144
BOARD OF DIRECTORS
J.P. Morgan & Co. Incorporated

   --------------------------------------------------------------------------
   DOUGLAS A. WARNER III
   Chairman of the Board
   Chief Executive Officer
 
   --------------------------------------------------------------------------
   PAUL A. ALLAIRE
   Chairman of the Board and
   Chief Executive Officer
   Xerox Corporation

   RILEY P. BECHTEL
   Chairman and Chief Executive Officer
   Bechtel Group, Inc.

   LAWRENCE A. BOSSIDY
   Chairman of the Board and
   Chief Executive Officer
   AlliedSignal Inc.

   MARTIN FELDSTEIN
   President and Chief Executive Officer
   National Bureau of Economic Research, Inc.

   ELLEN V. FUTTER
   President
   American Museum of Natural History

   HANNA H. GRAY
   President Emeritus and Harry Pratt Judson
   Distinguished Service Professor of History
   The University of Chicago

   WALTER A. GUBERT
   Vice Chairman of the Board

   JAMES R. HOUGHTON
   Chairman Emeritus of the Board
   Corning Incorporated

   JAMES L. KETELSEN
   Retired Chairman of the Board and
   Chief Executive Officer
   Tenneco Inc.

   JOHN A. KROL
   Retired Chairman of the Board
   E.I. du Pont de Nemours and Company

   ROBERTO G. MENDOZA
   Vice Chairman of the Board

   MICHAEL E. PATTERSON
   Vice Chairman of the Board

   LEE R. RAYMOND
   Chairman of the Board and
   Chief Executive Officer
   Exxon Corporation

   RICHARD D. SIMMONS
   Retired President
   The Washington Post Company and
   International Herald Tribune

   KURT F. VIERMETZ
   Retired Vice Chairman of the Board

   DOUGLAS C. YEARLEY
   Chairman of the Board and
   Chief Executive Officer
   Phelps Dodge Corporation

   COMMITTEES OF THE BOARD

   --------------------------------------------------------------------------
   EXECUTIVE COMMITTEE
   J.P. MORGAN AND MORGAN GUARANTY
   Messrs. Warner (Chairman), Gubert,
   Houghton, Mendoza, Patterson

   AUDIT COMMITTEE
   J.P. MORGAN
   EXAMINING COMMITTEE
   MORGAN GUARANTY
   Messrs. Ketelsen (Chairman), Allaire,
   Feldstein, Ms. Futter, Mr. Krol

   COMMITTEE ON FIDUCIARY MATTERS
   J.P. MORGAN
   Dr. Gray (Chairman), Messrs. Allaire,
   Bechtel, Ketelsen, Simmons

   COMMITTEE ON MANAGEMENT
   DEVELOPMENT AND EXECUTIVE
   COMPENSATION
   J.P. MORGAN
   Messrs. Houghton (Chairman), Bechtel,
   Raymond, Yearley

   COMMITTEE ON DIRECTOR NOMINATIONS
   AND BOARD AFFAIRS
   J.P. MORGAN
   Mr. Raymond (Chairman), Dr. Gray,
   Messrs. Krol, Yearley

   COMMITTEE ON EMPLOYMENT POLICIES
   AND BENEFITS
   MORGAN GUARANTY
   Messrs. Simmons (Chairman), Bossidy,
   Feldstein, Ms. Futter

142 Board of Directors
<PAGE>   145
INTERNATIONAL COUNCIL
J.P. Morgan & Co. Incorporated

   Formed in 1967 and composed of business leaders and prominent individuals
   from public life, the International Council advises the senior management of
   J.P.Morgan on matters relating to its global business. It meets approximately
   every eight months to discuss relevant issues of international concern and
   interest.

   In 1998 Karen Katen and Marco Tronchetti Provera became members, and Carlo De
   Benedetti retired from the Council. At the beginning of 1999, Bill Bradley
   resigned from the Council upon announcing his candidacy for President of the
   United States. Claes Dahlback and William S. Stavropoulos joined the Council,
   and Robert Allen, Bo Berggren, and Jorge Born retired.

   HON. GEORGE P. SHULTZ
   Chairman of the Council
   Distinguished Fellow
   Hoover Institution, Stanford University
   Stanford, California

   H.E. SHEIKH MOHAMMED ABALKHAIL
   Former Minister of Finance and Economy
   Kingdom of Saudi Arabia
   Riyadh, Saudi Arabia

   JOHN T. CHAMBERS
   President and Chief Executive Officer
   Cisco Systems, Inc.
   San Jose, California

   CLAES DAHLBACK
   President and Chief Executive Officer
   Investor AB
   Stockholm, Sweden

   H. MIGUEL ETCHENIQUE
   Chairman of the Board and President
   Brasmotor S.A.
   Sao Paulo, Brazil

   CLAUDIO X. GONZALEZ
   Chairman and Chief Executive Officer
   Kimberly-Clark de Mexico, S.A. de C.V.
   Mexico City, Mexico

   SIR CHRISTOPHER HOGG
   Chairman
   Reuters Holdings PLC
   London, England

   THE RT. HON. THE LORD HOWE OF
   ABERAVON, CH, QC
   House of Lords
   London, England

   DURK I. JAGER
   President and Chief Executive Officer
   The Procter & Gamble Company
   Cincinnati, Ohio

   ALAIN A. JOLY
   Chairman and Chief Executive Officer
   L'Air Liquide S.A.
   Paris, France

   KAREN KATEN
   President, U.S. Pharmaceuticals
   Pfizer Inc.
   New York, New York

   DEREK L. KEYS
   Executive Director
   Gencor Limited
   Johannesburg, South Africa

   YOTARO KOBAYASHI
   Chairman and Chief Executive Officer
   Fuji Xerox Co., Ltd.
   Tokyo, Japan

   HON. LEE KUAN YEW
   Senior Minister
   Singapore

   KARL OTTO POHL
   Partner
   Sal. Oppenheim Jr. & Cie.
   Frankfurt, Germany

   JOHN B. PRESCOTT, A.C.
   Former Managing Director and
      Chief Executive Officer
   The Broken Hill Proprietary Company Ltd.
   Melbourne, Australia

   CONDOLEEZZA RICE
   Provost
   Stanford University
   Stanford, California

   JURGEN E. SCHREMPP
   Chairman of the Board of Management
   DaimlerChrysler A.G.
   Stuttgart, Germany

   JESS SODERBERG
   Partner and Chief Executive Officer
   A.P. Moller
   Copenhagen, Denmark

   WILLIAM S. STAVROPOULOS
   President and Chief Executive Officer
   The Dow Chemical Company
   Midland, Michigan

   MARCO TRONCHETTI PROVERA
   Chairman and Chief Executive Officer
   Pirelli S.p.A.
   Milan, Italy

   DENNIS WEATHERSTONE
   Retired Chairman
   J.P. Morgan & Co. Incorporated
   New York, New York

   L.R. WILSON, O.C.
   Chairman of the Board
   BCE Inc.
   Toronto, Canada

   FREDERICK H.S. ALLEN
   Executive Secretary of the Council
   Paris, France

                                                       International Council 143
<PAGE>   146
DIRECTORS ADVISORY COUNCIL
Morgan Guaranty Trust Company of New York

   The Directors Advisory Council of Morgan Guaranty Trust Company, whose
   members are retired directors of J.P. Morgan, provides counsel to management
   and the Board.


   ELLMORE C. PATTERSON
   Chairman
   Directors Advisory Council
   Retired Chairman of the Board
   J.P. Morgan & Co. Incorporated

   RALPH E. BAILEY
   Former Vice Chairman of the Board
   E.I. du Pont de Nemours and Company
   and Retired Chairman of the Board and
   Chief Executive Officer
   Conoco Inc.

   BORIS S. BERKOVITCH
   Retired Vice Chairman of the Board
   J.P. Morgan & Co. Incorporated

   JAMES O. BOISI
   Retired Vice Chairman of the Board
   J.P. Morgan & Co. Incorporated

   CARTER L. BURGESS

   FRANK T. CARY
   Retired Chairman of the Board
   International Business Machines Corporation

   CHARLES D. DICKEY JR.
   Retired Chairman of the Board
   Scott Paper Company

   WALTER A. FALLON
   Former Chairman of the Board
   Eastman Kodak Company

   LEWIS W. FOY
   Former Chairman of the Board
   Bethlehem Steel Corporation

   HOWARD GOLDFEDER
   Retired Chairman of the Board and
   Chief Executive Officer
   Federated Department Stores, Inc.

   JOHN J. HORAN
   Former Chairman of the Board and
   Chief Executive Officer
   Merck & Co., Inc.

   HOWARD W. JOHNSON
   President Emeritus and Former
   Chairman of the Corporation
   Massachusetts Institute of Technology

   EDWARD R. KANE
   Former President
   E.I. du Pont de Nemours and Company

   RALPH F. LEACH
   Retired Chairman of the
   Executive Committee
   J.P. Morgan & Co. Incorporated

   ROBERT V. LINDSAY
   Retired President
   J.P. Morgan & Co. Incorporated

   HOWARD J. MORGENS
   Chairman Emeritus
   The Procter & Gamble Company

   DONALD E. PROCKNOW
   Former Vice Chairman of the Board and
   Chief Operating Officer
   AT&T Technologies, Inc.

   THOMAS RODD
   Retired Vice Chairman of the Board
   J.P. Morgan & Co. Incorporated

   WARREN M. SHAPLEIGH
   Retired Vice Chairman of the Board
   Ralston Purina Company

   JOHN G. SMALE
   Chairman of the Executive
   Committee of the Board
   General Motors Corporation
   and Retired Chairman of the Board and
   Chief Executive Officer
   The Procter & Gamble Company

   OLCOTT D. SMITH
   Retired Chairman of the Board
   Aetna Life and Casualty Company

144 Directors Advisory Council
<PAGE>   147
CORPORATE INFORMATION

   CORPORATE HEADQUARTERS
   J.P. Morgan & Co. Incorporated
   60 Wall Street
   New York, NY 10260-0060
   1-212-483-2323


   ANNUAL MEETING
   The annual meeting of stockholders of J.P. Morgan will be held on Wednesday,
   April 14, 1999, at 11:00 a.m. in Morgan Hall West, 46th floor, 60 Wall
   Street, New York.


   LISTING
   The common stock of J.P. Morgan is listed on the New York, Amsterdam,
   Frankfurt, London, Paris, Swiss, and Tokyo stock exchanges. International
   Depository Receipts for the stock are listed on the Brussels and London stock
   exchanges. NYSE symbol: JPM

   The Adjustable Rate Cumulative Preferred Stock, Series A, of J.P. Morgan is
   listed on the New York Stock Exchange. NYSE symbol: JPM Pr A

   Depository shares representing a one-tenth interest in 6 5/8% Cumulative
   Preferred Stock, Series H, of J.P. Morgan are listed on the New York Stock
   Exchange. NYSE symbol: JPM Pr H

   TRANSFER AGENT AND REGISTRAR

   Common Stock, Adjustable Rate Cumulative Preferred Stock, Series A,
   Depository shares on 6 5/8% Cumulative Preferred Stock, Series H:
   First Chicago Trust Company, a division of EquiServe
   P.O. Box 2500
   Jersey City, NJ 07303-2500
   1-800-519-3111

   Variable Cumulative Preferred Stock,
   Series B through F:
   Bankers Trust Company
   4 Albany Street, 4th floor
   New York, NY 10006-1500
   1-212-250-6850


   FORM 10-K
   J.P. Morgan's annual report on Form 10-K as filed with the Securities and
   Exchange Commission is incorporated in this report.


   DIVIDEND REINVESTMENT AND STOCK
   PURCHASE PLAN
   Stockholders wishing to receive a prospectus for the dividend reinvestment
   and stock purchase plan are invited to write to or call:
   First Chicago Trust Company, a division
   of EquiServe
   J.P. Morgan Dividend Reinvestment Plan
   P.O. Box 2500
   Jersey City, NJ 07303-2500
   1-800-519-3111

   1998 REPORT ON CONTRIBUTIONS
   For a copy of J.P. Morgan's 1998 report on philanthropic activities in 1998,
   write to or call
   Corporate Communication - Publications
   J.P. Morgan & Co. Incorporated
   60 Wall Street
   New York, NY 10260-0060
   1-212-648-9607


   CONTACTS
   Investor Relations: 1-212-648-9446
   Media Relations: 1-212-648-9553

   Please visit us on the Internet:
   www.jpmorgan.com


   EQUAL OPPORTUNITY AT J.P. MORGAN
   J.P. Morgan is committed to providing equal opportunity in the workplace. The
   firm, through this commitment, benefits from the full use and development of
   its employees.

                                                       Corporate Information 145
<PAGE>   148
KEY TOPIC INDEX

<TABLE>
<CAPTION>
TOPIC                                                      NOTE              PAGE 
<S>                                                       <C>               <C>
   BUSINESS SEGMENTS                                                     
   Our business                                                                19
   Segments                                                Note 29            119
                                                                         
   CAPITAL
   Financial position                                                          44
   Long-term debt                                          Note 18             98
   Trust preferred securities                              Note 20            102
   Preferred stock                                         Note 21            103
   Capital requirements                                    Note 22            103
                                                                         
   CREDIT RISK AND EXPOSURES                                             
   Credit-related products                                                     38
   Credit risk                                                                 54
   Loans                                                                 
      Accounting policies for loans                        Note 1              72
      Loans                                                Note 12             89
   Other credit-related products                           Note 13             91
   Impaired loans                                                        
      Impaired loans - management                                        
         discussion                                                            39
      Accounting policies for                                            
         impaired loans                                    Note 1              72
      Impaired loans                                       Note 14             92
   Allowances for credit losses                                          
      Allowances for credit losses -                                     
         management discussion                                                 39
      Accounting policies for allowances                                 
         for credit losses                                 Note 1              73
      Allowances for credit losses                         Note 15             93
   Exposures to emerging countries                                             42
   Exposures to hedge funds                                                    44
   Cross-border and local outstandings                                   
      (FFIEC basis)                                                           134
                                                                         
   DERIVATIVES
   Uses and exposures -                                                  
      management discussion                                                    36
   Accounting policies for derivatives                     Note 1              71
   Impact of SFAS No. 133 -                                              
      management discussion                                                    46
   Impact of SFAS No. 133                                  Note 2              77
   Notional amounts and credit exposures                   Note 11             86
                                                                         
   EMPLOYEE BENEFITS AND COMPENSATION PLANS                              
   Employee compensation expenses                                              35
   Accounting policies for stock options                                 
      and stock awards                                     Note 1              75
   Employee benefits                                       Note 23            106
   Stock options and other award plans                     Note 24            109
                                                                         
   INTERNATIONAL DISCLOSURES
   Exposures to emerging countries                                             42
   Concentration of financial instruments                  Note 28            118
   International operations                                Note 30            123
   Cross-border and local outstandings                                   
      (FFIEC basis)                                                           134
                                                                         
   INVESTMENT SECURITIES
   Investment securities revenue                                               33
   Debt investment securities                                                  37
   Accounting policies for investment                                    
      securities                                           Note 1              70
   Investment securities                                   Note 9              82
                                                                         
   MARKET RISK                                                                 50
                                                                         
   Productivity initiatives                                              
   Operating expenses                                                          34
   Restructuring of business activities                    Note 3              78
                                                                         
   RISK MANAGEMENT                                                             49
                                                                         
   YEAR 2000
   Operating expenses                                                          34
   The year 2000 initiative                                                    57
</TABLE>


146 Key topic index                      (C) 1999 J.P. Morgan & Co. Incorporated
                                                Printed in USA on recycled paper
<PAGE>   149
J.P. Morgan is a leading global financial services firm that meets critical
financial needs for business enterprises, governments, and individuals
worldwide. We advise on corporate strategy and structure; raise capital;
develop, structure, and make markets in financial instruments; and manage
investment assets. We also commit our own capital to promising enterprises and
invest and trade to capture market opportunities for our own account.

We are committed to offering advice and execution of the highest quality,
conducting our business in a principled way, and maintaining the global market
presence that helps our clients succeed while enhancing returns for our
stockholders.
<PAGE>   150
J.P. Morgan & Co. Incorporated
60 Wall Street
New York, NY 10260-0060
(1-212) 483-2323