Despite the intense coverage that J.P. Morgan Chase & Co.'s (JPM) Jan. 14 acquisition of Bank One Corp. received, one crucial aspect eluded many commentators: Unlike most financial-services industry deals, the aim wasn't simply to create a behemoth. "The focus is not only on size but on improving income streams," says Hamilton E. James, vice-chairman of private investment firm The Blackstone Group.
These days, just being big doesn't cut it -- balance is what's beautiful. Consider: At a stroke, J.P. Morgan reduced its reliance on uneven investment-banking and trading earnings by receiving a big slug of far more stable commercial bank revenues. Bank One got growth -- and economies of scale -- for its credit-card and retail-banking businesses.
Watch for a rash of similar mergers in which financial institutions with volatile earnings scramble to find stabilizers, and those struggling to maintain record profits hunt for scale and growth. It's a trend that's likely to moderate big earnings swings in very much the same way that Citigroup has done.
The main impetus comes from commercial and retail banks. Many risk losing their momentum because the motors driving their recent fat profits are starting to sputter. The Mortgage Bankers Assn. expects home lending to drop 53%, to $1.6 trillion, this year; corporate lending is sluggish; and consumers are staggering under a huge debt load. Bankers say Washington Mutual Inc. (WAMU), whose earnings stalled after a heady period of growth, could be forced into a shotgun marriage. "Why would anyone want to own the stock of a company that is reducing earnings estimates when they could own the stock of one that isn't?" asks Reilly Tierney, financial services analyst at investment bank Fox-Pitt, Kelton. WaMu declined to comment.
Investment banks that thrived by issuing and trading record amounts of bonds as interest rates fell are looking for acquisitions to steady their earnings. One reason Lehman Brothers Inc. (LEH) ponied up $2.6 billion for asset manager Neuberger Berman in July was to get the latter's regular fee income. Bankers say Bear, Stearns Cos. (BSC) and others could follow suit as the market zeroes in on earnings quality. On Jan. 21, Merrill Lynch & Co. (MER) said it was interested in making "bolt-on" acquisitions that can be easily integrated into its growth strategy. "We're raising the bar for institutions in terms of the size of their capital and the diversity of their earnings," says Gary Parr, deputy chairman of Lazard, adviser to Bank One.
Will the new strategies work? It'll be hard to tell until the fog of special charges that mergers produce lifts. But they have a better rationale than past financial deals that self-destructed. By Emily Thornton