Over the weekend, I had some time to reflect on the financial services events of the past nine months. From conversations with a couple of industry veterans, my business partner, and two economics students, and various Wall Street Journal articles in the past week, I realized that there are two cross-currents in the industry which have accidentally led to the current, possibly temporary, resurgence of the most mediocre of all of the original US money center banks, Chase.
One current has been Chase's historic and continuing role as a large, mediocre money center bank which has usually been far less risk-taking and aggressive than other US large commercial banks.
The other is the recent credit crisis which has, ironically, left the staid and usually lagging Chase as the commercial bank of last resort for the Fed's rescue of Bear Stearns.
Even in the latter case, Chase hardly excites.
For instance, this morning's news featured Chase's increased bid for the wreck of Bear Stearns. Now, the plodding commercial bank is willing to pay $10/share, quintuple what CEO Jamie Dimon swore was his highest offer only last week.
In the Journal's Marketing section, Carol Hymowitz extolled Jamie Dimon & Co.'s prompt action to buy Bear Stearns two weekends ago. Unfortunately, Ms. Hymowitz neglected to ask whether this is really a smart, long term move for Chase shareholders.
My guess is that it is not.
This morning I had a long conversation with my old friend, sometime mentor and business partner, B. We agreed that Chase's purchase of Bear Stearns is probably an expensive luxury.
There are many reasons for this, some of which will be the subject for another post. As I have written elsewhere in the past few months on this blog, I believe that margins and growth in underwriting and M&A business confirm that these investment banking businesses suffer from excess capacity and have become commoditized.
Trading, another classic core investment banking business, does not have a shortage of capacity, either. However, profit in this business comes from advantaged traders, risk management, and superior strategies. In this regard, few commercial or investment banks have recently demonstrated any of these. Goldman Sachs would be the one exception.
That said, what, specifically, is Chase buying, besides a new building, for its $10/share offer? As a commercial bank in the wake of the end of Glass Steagall, Chase can do any business Bear could do. And Bear engaged in poor risk management, which makes me wonder just how valuable its book of business would be.
The one business that Chase has singled out as desirable, prime brokerage, could, as always, have been less expensively obtained by hiring the ex-Bear staff of this business, not buying the entire firm.
In fact, B and I laughed over how Dimon had probably been lamenting how late Chase was to the original mortgage banking and securitization party.
But what would you expect from a large money center bank which is the result of cobbling together seven large predecessor banks.
Many years ago, my mentor, Chase Manhattan Bank SVP of Corporate Planning, Gerry Weiss, opined, when asked about eventually merging Chemical, Manufacturers Hanover, and Chase,
'Why would you want to do that? All you'd have from merging three mediocre money center banks is one great big mediocre money center bank?'
Just so. The modern Chase is the result of two bloodlines. From New York, just what my old boss feared came to pass. Chemical took over Manufacturers Hanover when neither was dominant, but Chemical was doing better than the latter. Then Chemical took Chase and its name when mutual fund manager Michael Price drove the ailing, slow-moving latter bank to seek a buyer before Price forced its CEO, Tom Labrecque, to break up Chase Manhattan.
Later on, JP Morgan, long having run out of steam from its days in the mid-80s as a dynamic, nimble money center along with Bankers Trust, fell into Chase's lap.
Meanwhile, in the Midwest, BancOne's acquisition model had stalled and the bank had fallen on hard times. In 1998, the product of a merger between Detroit's NBD and First Chicago took over BancOne, but kept the latter's name. This merged Illinois-based bank was what Jamie Dimon went west to manage before selling the mess to Chase a few years ago.
Thus, ironically, Chase is now the product of seven (or more, if you begin to count Manufacturers Bank, as distinct from its old merger partner, the Hanover Trust Company, and Chase as distinct from the now-merged Manhattan Company) mediocre, large US commercial banks. Not one of the predecessors banks was ever seen in the same aggressive light as BofA or Citigroup, not to mention the acquiring regional powerhouses, the old National Bank of North Carolina, now known as BofA, or First Union, now Wachovia.
The banking history is in order, I believe, to help us understand how Chase has become the staid, large, mediocre bank of today. Not having shot itself in the foot with SIVs like Citigroup, or over-expansive mortgage and investment banking, like BofA, Chase got the chance to receive a $30B guarantee gift from the Fed earlier this month, in exchange for taking over the remnants of Bear Stearns.
If you look at the nearby, Yahoo-sourced price chart of Chase and the S&P500 Index for the past two years, you see that the former has now outperformed the latter. But only within the last several months.The two have closely tracked over the period, with Chase outperforming modestly for a slightly longer time. The sharp rise in Chase's price so recently as to approximate a vertical line suggests this is unsustainable. As recently as late last month, the S&P was ahead.
My guess is that, over the next six months to a year, Chase's margin of outperformance will shrink and, quite likely, disappear.
As the remaining stable money center bank, Chase may be destined to outperform its commercial bank peers, but probably not the S&P.
You can dress it up anyway you like, but Chase's core culture(s) is one of mediocrity, lack of innovation, and risk aversion.
That should allow it to survive, but hardly become a preferred holding to the index over time.
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