BUSINESSWEEK ONLINE : SEPTEMBER 18, 2000 ISSUE
SPECIAL REPORT "We're Not Transforming Anymore--We've Transformed" Morgan CEO Sandy Warner talks about taking the commercial-banking giant into big-league investment services When Douglas A. "Sandy" Warner III became the chairman and CEO of J.P. Morgan in 1995, he inherited the ambitious task of transforming a commercial bank that had been synonymous with American capitalism into an investment bank. Having finished building profitable equities and investment-banking businesses, he now wants J.P. Morgan to extend its reach from industrial giants and the very rich to newly minted millionaires, midsize companies, and high-tech startups. Though Warner wants to the bank to remain independent, it's the subject of frequent takeover speculation on Wall Street. Warner recenltly outlined his plans in an interview with Investment Banking Editor Emily Thornton. Edited excerpts follow: Q: What do you consider victory for J.P. Morgan, and what do you see as the road to getting there? A: If you had been sitting here in 1997 or 1998, you might have heard a scenario that said we wanted to be fully competitive in equities, in the top five in mergers and acquisitions, a leader in derivatives, as well as a growing asset-management business with expenses under control. And we wanted to make a 20% return on our equity, grow the top line at 15% a year, and, round numbers, make a couple of billion dollars. That's victory. That's what we just did. We're not transforming anymore -- we've transformed. Now, we need to perform. Now, the imperative is to grow. More clients and more problems solved per client. That's what this is about now. The keys for us are that the building is behind us. We have threshold scale and world-class competence. We've reduced risk in the process. We've changed our growth profile. And we have embraced the opportunity that technology represents to change fundamentally the client-acquisition equation as well as the speed of innovation in products. Q: You have said that you want to shift J.P. Morgan's dependence on proprietary trading to investment banking. Yet some analysts have pointed out that proprietary trading accounted for most of your earnings in the second quarter. How do you view those results? A: Not that way. [He smiles.] It's true. Take it away, and the quarter would not have been as good. But [analysts] should also adjust for the fact that we had an uncharacteristically weak quarter in our high-end fixed-income business, which is normally a very high contributor. If someone had told you a couple of years ago that J.P. Morgan would have a weak quarter in its interest-rate and credit-markets businesses and still have a 20% return on equity, you would have said that's not possible. Asset management is now 10% of our pretax income. That's a very different profile than what it used to be. The equities business, which contributed negatively a few years ago, contributed significantly. Diversification works in our favor. We had very strong proprietary trading, a good equities business, excellent asset-management services, and weakish investment banking. That produced a quarter with 20% return on equity and 13% top-line growth. Those are good numbers. And the trends are right. Q: At one time, I understand that J.P. Morgan wanted to be one of the "bulge bracket," top five, investment banks. I also understand the goal posts have been moved back recently. Is that true? A: We have never in our history aspired to be the biggest at anything. Never.... What we do want to be, and I believe we are today...is the first call. We don't want to be at any disadvantage for our chosen clients to any other firm on earth when they wish to solve a problem in our sphere of influence. That doesn't say for every company. That doesn't say for every problem. But when you don't have an equities capability that on any given day can beat anybody in the world in any dimension of the equities business, you're at a disadvantage. That's debilitating. That was critical to do. Once you get to a threshold of competence and capability and size, then on any given day we can solve any problem for any company on earth. That's a very important milestone for us. I'm not aware that we have ever had to disqualify ourselves from solving a client's problem because we weren't big enough. Not once. That to me is the most important measure of scale. Our object is not to be the biggest gorilla in town. We're where we want to be on scale. We're close to where we want to be on scope. And we need to work on speed. Q: Do you believe you can keep up with your competitors' growth? A: Absolutely. We'll shoot for the sky. Our top line is going to grow about 15%. Last year, it grew 31%. This year, it has grown 15%. Both are respectable numbers. I think it will continue to grow somewhere in between. A lot of growth that you're now seeing is from investments made half a dozen years ago in equities and mergers and acquisition businesses. We can't do much about the fact that we were not in the equities business prior to 1991. It was illegal. The best we could do was grow it. And the best we could do was to grow it to this confidence and competitive threshold. That's the ingredient that allows us to qualify for our clients to solve any problem. And without it, you're at a hopeless place. Q: Why not make an acquisition to double the size of your equities business? A: If there were an opportunity, we'd do it. We're not looking at the world as though ours are the only good ideas, or as if there is no combination that would help us. But you have to look beyond the headlines to see whether they make sense. Then you have to ask yourself whether the premiums you pay and the execution risk you incur is better than what you can deliver to your shareholders. Doubling up on acquisition costs is potentially value destructive. As a public company, I work for the owners. When I think something is available by way of a bid or a purchase that is more promising than delivering on our game plan, I would recommend it without reservation. But I can tell you, the threshold for us is very high. First of all, we believe in the opportunity we create for ourselves. We think we can deliver growth and shareholder value executing our plans. That is the No. 1 point. Now, here's the No. 2 point. Having built it, having made it profitable, we've taken the ball down 95 yards on this field. To deliver on the opportunity to an extent that is really exciting, we've got five yards to go to the goal line. You don't hand off the ball at the five yard line. You don't give it to somebody and say, "Help us punch it in." We need to recalibrate now. And that's what we're doing. If you're the client and we're competition with Morgan Stanley Dean Witter for your business, I want to be considered as on equal footing with Morgan Stanley. Not some concept of a new person on the block, inferior in one way or another. Facts are facts. They've been in the business longer. They do more business. They have a better resume. But I want a value proposition that screams at the client that this is a compelling alternative. And we've done that.... Q: Over the summer, Swiss bank UBS purchased Paine Webber and Bear Stearns CEO James Cayne suggested an asking price. Why shouldn't we think that J.P. Morgan will be next? A: What's at work here is something different than what we're talking about. It's an essential building block of the global stage. If you don't have it, you've got to buy it. No matter what it costs. From an architecture point of view, we're complete. There's nothing around that we have to have that we don't have. We couldn't have said that five years ago. That's why equities are so important to us. We just had to keep our heads down and get it done no matter what. This whole scale argument ignores, by and large, the impact of new competitors who are faster and very focused. What people are missing at the moment is that, in fact, the pressures are more disaggregation pressures. The potential for ideas to combine quickly and easily with technology, to combine quickly and easily with capital. Three years from now, the conversation we'll be having is about how well we have executed what will be seen as a disaggregation strategy, not a consolidation strategy. It's simply not going to be desirable from a shareholders' point of view to aggregate, consolidate, all of the pieces that one would like to have, in a perfect world, to deliver on these enormous opportunities.... This is a big marketplace. Can it sustain 10 players? Can it sustain three? If you listen to some of our competitors, they would have you believe that...the pecking order is defined by the initial public offering league tables or the merger and acquisition league tables. There's a whole lot more going on in institutional and wholesale finance that offers growth, profitability, excitement for people, and rewards for shareholders. That's not going to change. Q: Some analysts believe that the only way that J.P. Morgan can defend its independence is if it achieves returns on equity on a par with superstar investment banks. Will that happen? A: Two things: All returns on equity are not equal. The reason for that is it ignores risk. In any given period, you can make 20%, 30%, 40% return on equity. But you don't know just looking at that how much risk has been taken or is in the business mix. A very risky firm may produce a very high ROE, which would be valued the same or less than a firm that produced a lower ROE with much less risk. It's only a part of the equation. Point No. 2: In 1997, the combination of equities, investment banking, and asset management, which are all very high ROE businesses, produced zero return [for J.P. Morgan]. We made some money in asset management. We lost money in investment banking because we were building it. We lost money in equities because we were building it. In the first half of this year, the combination of asset management, equities, and investment banking accounted for 39% of our pretax income. We had a 22% return on equity. We had a very good first half compared to what we've been doing. But what we've been doing was unacceptable. Could it have been three points better? Easy. The model works. But are we yet with the share that we will have with this trajectory? No. Will we get there? Yes. If the environment doesn't change, will we produce those kinds of returns projecting this model forward? No question about it. It's the same confidence I had when we were doing 14% returns and told the world we would be doing 15% to 20% ROE in two years. Q: What are the opportunities for growth that you are excited about? A: I think the asset-management business extended globally is a spectacular opportunity. It seems to me that everywhere you look, savings systems, public-finance systems, welfare systems, the redistribution of wealth argues that people who are trusted to deliver first-class advice and service in this area will have a home run. In J.P. Morgan, you have a firm that has a leading capability in fixed-income derivatives, foreign-exchange derivatives, credit derivatives, and equity derivatives. You can count on one hand the number of firms that have those credentials. Mixing and matching those capabilities and selling solutions to people who want to shed or rearrange risk is a spectacular opportunity, and it's getting bigger. What's truly transformational about what's going on now is technology. There's a ton of opportunity at the next level. It's mind-boggling. Q: There's a perception that it will be more difficult for J.P. Morgan to reach the league of bulge-bracket investment banks, the higher it goes. Would you agree? A: The popular myth is that the share we have acquired has been against the second tier, and that now, the challenge is much greater because we're going head to head with bigger, more entrenched players. That's simply inaccurate. The fact of the matter is that every single merger and acquisition or equity deal we do, [bulge bracket investment banks] compete with us. We go head-to-head with Goldman Sachs. Q: It seems you had an advantage in Europe, even though you do not seem to be at the top of the league tables there. A: We weren't in the equities business. If you weren't a dominant player in the largest equity market in the world, the U.S., your credentials for going to Europe -- with it being illegal in the largest market, where everyone gets their credibility...where margins for growth are created -- it's a no starter. It wasn't illegal in Europe. It was simply impractical. Q: Why did you join J.P. Morgan? A: I was a pre-med at Yale University. I had been pretty focused on medical school and becoming a doctor, even to the point of spending vacations working in hospitals. I was very focused. I liked it, and I think I could have been pretty good at it. My father said he would support and encourage a medical-school education quite happily. But he would be much more comfortable about it if I took a summer off, if not a year off, and did something completely different. In the summer of 1967, I did that and went to J.P. Morgan. I thoroughly enjoyed the experience. One of my business colleagues said, "If you're interested, when you graduate from Yale, we hope you'll come back." My father kept saying, "Why don't you take a year off?" And I felt I had the flexibility to do that, because I had, and still have, asthma. So I was not eligible to do what most of my friends were doing, which was going to Vietnam. I felt like I was given a year when I had flexibility, for better or worse. So I called the head of personnel of J.P. Morgan, and I said, "I accept your offer." Q: What keeps you at J.P. Morgan? A: Every year I have been at J.P. Morgan has been better than the last one. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS J.P. Morgan: Dressed for a Deal? TABLE: CEO Warner Wants to Stay Independent... TABLE: ...But J.P. Morgan's Strengths Could Make It a Target... TABLE: ...Though at a Steep Price TABLE: The Bank Is Chasing Growth and Improving Returns CHART: Percent Return of Average Common Equity Building the Anti-J.P. Morgan ONLINE ORIGINAL: "We're Not Transforming Anymore -- We've Transformed" INTERACT E-Mail to Business Week Online

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