Competitive Intelligence

Merger of JP Morgan Chase & Bank One Puts New Pressure on Competitors Large & Small

The wave of consolidation in the U.S. financial services industry has given birth to another mega-bank - and the new team of J.P. Morgan Chase & Co. and Bank One Corp. already is talking about getting bigger.

The nation's third- and sixth-largest banks announced plans for a merger after markets closed Wednesday, a deal that leapfrogs last fall's Bank of America-FleetBoston hook-up to become number two behind Citigroup, assuming both transactions are approved.

For $58 billion, J.P. Morgan Chase acquires Bank One's Midwest banking strength, $290 billion in assets and 1,800 branches in 14 states while keeping its name and New York headquarters status intact. It also gets a successor to 60-year-old chief executive William B. Harrison Jr., who agreed to give up that post in 2006 to Jamie Dimon, a Wall Street darling since before his four-year stint as Bank One's CEO, Dimon kept his Manhattan apartment before taking to the CEO’s office in Chicago. Dimon will be president and chief operating officer in the interim.

The banking acquisitions may not stop there, as Harrison and Dimon acknowledged they will have an eye on possible future deals once this one is completed, which they expect by mid-2004. "We're well-positioned if the right opportunity is there," Harrison said in a Wednesday evening conference call with reporters. "If the right situation comes along, we'll look at it."

This merger would create a company with assets of $1.1 trillion — a powerhouse in corporate and retail banking with 2,300 branches that trails only Citigroup's $1.19 trillion. It's the third largest U.S. banking deal ever, with the two bigger combinations the Travelers Group-Citicorp merger in 1998 that created Citigroup and the NationsBank-BankAmerica combo the same year that created the Bank of America.

In a Thursday morning meeting with Wall Street analysts, Harrison emphasized that integration of Bank One's retail operations with J.P. Morgan's commercial and investment banking prowess would create "a balanced model" that should lead to less-volatile earnings and a higher market valuation. Harrison also disclosed that he and Dimon "had talked over the years about strategic options" but that negotiations toward a merger became serious last November. The New York bank at that point had completed the integration of the J.P. Morgan investment house and Chase Manhattan bank that had begun in 2000. "And then the financials began to come around," Harrison said, referring to writedowns of troubled commercial loans and settlements on Enron regulatory issues.

Dimon called the J.P. Morgan-Bank One combination "the perfect fit" and added: "The reason to do this is because it's great for shareholders ... and right for the company."

J.P. Morgan gets diversification out of capital markets into retail banking, and Dimon gets to run the combined company with the brokerage capability he was coveting. But, the deal will come at a steep price for the as many as 10,000 employees who will lose their jobs when the companies' operations are integrated. Harrison, who will retain the chairman's title after he gives way to Dimon, said the companies were still identifying overlapping jobs to be cut. That number of job cuts would amount to 7 percent of the combined work force of 145,000, but the agreement was unanimously approved by the boards of directors of both companies.

"This landmark transaction will create one of the world's great financial services companies - a powerful enterprise well-positioned to generate significant value for our shareholders, customers and communities," Harrison said.

Dimon said the merger "makes tremendous sense strategically, operationally and financially." Asked about the possibility of future retail bank acquisitions, Harrison said they would be considered but, as a strong force in wholesale and retail banking, "we don't have to do another merger to be successful.

Bank One shareholders would receive 1.32 J.P. Morgan shares for each share they own. Based on J.P. Morgan's closing price of $39.22 on Wednesday, the transaction would have a value of about $51.77 for each of the 1.12 billion outstanding shares of Bank One stock - a total of $58 billion - and create an enterprise with a combined market capitalization of about $130 billion. The premium paid for Bank One amounts to about 14 percent based on closing market prices.

The retail financial services business will be based in Chicago, as will its middle market business, which includes the consumer banking, small business banking and consumer lending activities except for the credit-card business.

Losing a Fortune 100 company to New York is a blow to Chicago, which has lost the top billing for numbers of large corporations through mergers or closure in recent years, although it did add Boeing in 2001. It also takes away the company that was its sole candidate to be a national bank. Bank One had been based in Columbus, Ohio, before moving its headquarters to Chicago in 1998. Dimon said the merged bank is making a "major commitment" to Chicago by keeping much of its business there. He also said that contrary to widespread industry talk, he hadn't been "dying to get back to New York" and may even commute from his Chicago home if his family wants to stay here.

Analyst Reilly Tierney praised the deal for not being overly expensive and because "it gives Jamie Dimon a platform to build a serious global investment bank" and also answers the succession issues at J.P. Morgan. He said the combination will be especially potent in auto finance and credit cards. "They're going to be as big as Citi in the United States," he said.

In terms of the effects on competitors, Wachovia said the merger wouldn’t force their hand, but looking at the relative scale of competitors in this market following the consolidation in these past few years – the top three are all within about 20 percent of one another’s size, but number four is less than half the size of number three – we can expect to see even fewer banks out there than we have today.

There was a nice competitive and market effects overview at The Deal that puts it all in perspective:

It's the second 11-figure bank deal in the U.S. in three months. And whereas Bank of America Corp.'s $47 billion purchase of FleetBoston Financial Corp. in October precipitated a wave of small bank deals (and may have helped push the J.P. Morgan deal), the acquisition of Bank One is seen as heralding a wave of big deals — really big deals.

Statistics from SNL Financial show that once the J.P. Morgan, Bank One and BofA-Fleet deals close, there will be three massive American banks: New York-based Citigroup Inc., with $1.2 trillion in assets; J.P. Morgan, with $1.08 trillion; and Charlotte, N.C.-based Bank of America with $933 billion.

But the No. 4 bank, Wells Fargo & Co. of San Francisco, is less than half the size of Bank of America with $394 billion in assets. Analysts and bankers believe that 2004 will be highlighted by the race to make up ground between the big three and the rest of the pack.

The banks analysts say are now in the spotlight are: Wells Fargo; No. 5 Wachovia Corp. of Charlotte; No. 6 U.S. Bancorp of Minneapolis; No. 8 Sun Trust Banks Inc. of Atlanta; and No. 20 Comerica Inc. of Detroit.

"We believe the end game is now being played, and that the pressure for banks to pick their partners will only intensify as the number of both large potential suitors and truly difference-making targets shrinks," said Michael A. Plodwick and Richard Erin Caddell of Blaylock & Partners in a note to clients on Thursday, which predicted consolidation among the top 10 banks. "Also, that BAC [BofA] has recovered nearly all of the value it lost following the Fleet announcement should provide further incentive for potential buyers and sellers."

One banker said Wachovia in particular is worth watching because chairman and chief executive Ken Thompson will feel pressure in his core East Coast retail network now that the three mega-banks are concentrated in this market.

Overlapping the basic need to bulk up will be the need to find partners that are complementary to each bank's existing business. A West Coast bank like Wells Fargo will probably want an eastern partner like Bank of New York or Wachovia. A corporate bank like U.S. Bancorp will probably want to increase its retail business, so a partner like Winston-Salem, N.C.-based BB&T Corp. may be suitable.

Meanwhile, the middle market will feel the effects of the J.P. Morgan-Bank One deal, especially in the Midwest. After BofA announced the FleetBoston deal, banks in the Northeast scrambled to merge so they would have a larger network with which to poach disgruntled customers of the enlarged bank. And bankers foresee a similar pattern occurring now in the Midwest.

"The movement at the top of the industry only encourages that hope among the smaller players," said Ted Peters, president and chief executive of Bryn Mawr Trust Co. of Philadelphia. "We're sure to see more action among the local banks in 2004."

SNL said there were 68 U.S. bank deals in the fourth quarter with a total value of $57.3 billion. That means that excluding the Bank of America deal, the average value of the other 67 deals was a mere $163 million, showing the prevalence of small deals in the quarter.

Three foreign banks may also be drawn into the consolidation if it rapidly gains pace. ABN Amro Holdings NV of the Netherlands has the seventh-largest banking presence in the U.S. and could expand its Chicago-based network further. London-based HSBC Holdings plc has a New York franchise and is still integrating its Household International acquisition of last year, but certainly has the capital to expand further. And Royal Bank of Scotland plc has built its Citizens Financial unit into the 17th-largest U.S. bank mainly through small purchases, and may now be ready for a bigger acquisition, possibly Sovereign Bancorp. Inc. of Pennsylvania.

Yet the recent spate of mergers has also driven up the cost of U.S. banks, and another banker said that could prove a barrier to foreign banks that have been talking about entering the U.S. market, such as Barclays plc and Lloyds TSB Group plc of Britain.

Indeed, this puts new pressure on Citibank to expand its domestic retail footprint, and they have another capital markets competitor with an even larger low-cost deposit base to leverage. The chess board has shifted and banks with strong, but not dominant, deposit franchises will be rethinking their strategy.

But, I don't think consolidation will necessarily be a bad thing for consumers.

Now that U.S. banks are feeling a bit more confident about their borrower's health and some optimism has been reflected in equity markets, M&A activity will heat up after a couple of years' off and this should strengthen the U.S. banking market globally, which has historically been a fragmented one compared to other markets around the world. It's unusual that we don't have a bank that has more then 10 percent of market share of deposits in the U.S. Thanks to consolidation we're finally beginning to get banks with a nationwide franchise, so common elsewhere in the world.

- Arik

Posted by Arik Johnson at January 16, 2004 12:52 PM | TrackBack