White-Shoe Shuffle

At a time when banking megamergers have become de rigueur – last week’s proposed $34 billion union of Wells Fargo and Norwest is just the latest such deal – J.P. Morgan & Co. stands out because of its quaintly old-school commitment to its own independence. At a time when the idea of “universal banking” is all the rage, Morgan stands out as a pioneer in that field, having over the past decade transformed itself from a commercial bank (which did mainly loans and trusts) into a high-powered investment bank that can offer its corporate clients everything but a shoe shine. And at a time when many large banks are raking in unprecedented profits, Morgan stands out all the more – but in this case because its earnings have hardly budged since 1993. Morgan investors are now wondering when re-invention will translate into results.

Morgan’s basic problem is simple enough: It’s spent too much money re-inventing itself, so that in three of the past four years its expenses have actually grown faster than its revenues. For a while, Morgan was able to argue plausibly that it had to spend in order to gain a foothold in markets where it had never been before. But after ten years, that argument is wearing a bit thin. Its profits have been stagnant, its return on equity is actually below what it was before the move into investment banking, and it recently announced it was cutting 5 percent of its 16,534-person workforce. The company has been especially hard-hit by the crisis in Asia, which put a severe dent in the revenue Morgan gets from trading securities. But the company has greater long-term concerns than whether the baht is about to rebound, as the business press has been more than happy to point out over the last few months.

While Morgan’s problems are real, though, there is something unsatisfying about all of the heat the bank has been taking. The criticism leveled against Morgan has been so wide-ranging – everyone thinks Morgan’s doing something wrong, though they disagree about what, exactly – that at times the bank itself seems to be nothing more than a handy screen upon which anxieties and concerns about the turmoil in the banking industry as a whole can be projected. This is a world in which, as former Morgan CEO Dennis Weatherstone has said, “there is no banking industry. Today the label means nothing.” It’s not too surprising that everyone is still groping for answers.

Morgan has thus simultaneously been criticized for being too exclusive, for being too wrapped up in the mystique that’s still attached to its name, and for being too big and growing too fast. Some on the Street see it as too white-glove and not aggressive enough, but Morgan has been more than willing to get its hands dirty by underbidding its competitors. And while the company has gotten little of the lucrative business that comes from working with highly leveraged companies that can raise money only by issuing high-yield securities, CEO Sandy Warner earlier this year described Morgan’s strategy as having been “Chase anything that moves.” (Of course, he then went on to declare that the company needed to be more selective about where it was directing its resources.)

At the same time, the fact that Morgan continues to treasure its independence at a time when merging is the hip thing to do has made it an easy target. The constant swirl of merger rumors that surrounds it – in the past year alone, Deutsche Bank, Chase, and Travelers all reportedly came a-courting – ends up making a merger seem like not just something Morgan may do but something it should do. Like kids at a keg party, everyone would be happier if the holdout started drinking.

The virtues of bigness – or rather of monumentalness – remain unproven, though, and in the case of Morgan, which is already the nation’s fourth-largest bank, with $272 billion in assets, it’s not exactly clear what a merger would add. Retail banking, which is the one thing Morgan has never engaged in and which a merger with a bank like Chase would enable it to do, is becoming less important to the industry as a whole, and Morgan has a significant foothold in almost every other part of the business. More important, mergers are always in some sense about the union (or collision) of corporate cultures, and here Morgan’s vaunted sense of its individuality would probably make any marriage a stormy one at best. Even if Morgan’s decision to buck the conventional wisdom is the right one, of course, that doesn’t mean that staying its current course will be enough to succeed, which is why over the past year the bank has done a much better job of reaching out both to potential clients (who are looking for signs that Morgan has moved beyond its white-shoe roots) and to its shareholders.

In some important sense, Morgan is still very much a product of its past. In the almost 60 years since its debut as a stand-alone commercial bank, Morgan has done business mainly with high-end corporate and government clients. (Even in the past, paradoxes abounded: Morgan actually became a public corporation in 1942, and it was ahead of the times in the aggressiveness of its trading operations.) The core of Morgan’s business – and its identity – was its relationship with America’s most important corporations. In the sixties, for instance, 97 of the country’s 100 largest corporations had accounts with Morgan, and it was by an overwhelming margin the largest corporate lender in the country. Today, even after its reinvention, the blue chips are still at the heart of Morgan’s business. As analyst Marni Pont O’Doherty of Keefe, Bruyette & Woods puts it, “For the blue-chip companies, Morgan’s trying to be the one-stop shop. They want to be the first place these companies call whenever they have any kind of business to do.”

The problem is that General Electric or Ford can call pretty much anywhere and have the person at the other end of the line snap to attention. And while Morgan’s name is good, it’s not any better than, say, that of Morgan Stanley. That means, in turn, that blue-chip companies are able to – and, in fact, do – play banks off against one another. As with everything, competition drives prices down, so that even if you get GE’s business, it’s probably going to be less profitable than a smaller company’s junk bonds would have been.

There’s something painfully ironic about all this. For most of this century, Morgan constructed an entire business around the assumption that you worked with the biggest companies because they were the most reliable, the most loyal, and, to be sure, the most profitable. And as long as Morgan was the dominant player, and as long as big corporations thought they needed banks like Morgan to fund their operations, that assumption was true enough.

But Morgan isn’t the dominant player in investment or commercial banking, and blue-chip companies don’t need banks – of any stripe – that much anymore. In the first place, their revenues are now so vast that they’re able to fund almost all their investment needs from the money they make. (If you’re General Motors and you have $15 billion in cash, what, exactly, can a bank really offer you?) In the second place, blue chips that do want to raise money can, if they want, go straight to the markets. Using an investment bank often seems to be more a courtesy than anything else. And what all this has meant is that the biggest companies turn out not to be particularly loyal and not particularly reliable.

Morgan recognizes this, on some level at least, which is why it’s begun reaching out to clients it previously wouldn’t have gone near, including growth companies like computer Zip-disk-drive maker Iomega. Smaller companies, after all, have fewer places to go and are generally more grateful. The same is true of companies in emerging markets, where Morgan has established a huge presence from which it should reap real rewards once Asia and Latin America rebound. Unfortunately, smaller companies are more likely to end up embarrassing you, as happened when Morgan served as banker for Bre-X Minerals, a Canadian mining company that concocted one of the great hoaxes of the century around an imaginary Indonesian gold strike.

The truth is that if you look hard enough at Morgan, which quite capably transformed itself into a competitive investment bank, and you look at its struggle to convert its strategic success into bottom-line profits, you start to wonder how profitable the future of investment banking itself will be.

To be sure, that may seem like a ludicrous concern at a time when the merger-and-acquisition market is booming, when investment banks are raking in hundreds of millions in underwriting fees, and when the average return on equity of investment banks is sky-high. But investment banking is at heart a business of middlemen, people who buy things – stocks and bonds – from a company in order to sell them to customers. And we do seem to be living in an economy in which the middleman is gradually being pushed aside. Morgan may have done an excellent job of re-inventing itself for a world that has already raced beyond it.

White-Shoe Shuffle