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Commentary: J.P. Morgan Should Cut the Merger Talk


By Emily Thornton

It's one of Wall Street's oldest tricks: If something's broke, don't fix it -- just go out and buy something else. Or at least start talking about doing so, as J.P. Morgan Chase (JPM) Co. Chairman and CEO William B. Harrison did on May 13.

He told investors at a financial-services conference in New York that he's considering buying a regional retail bank once the firm's stock price improves further and he can afford an acquisition. "The tougher question is, would you do another big merger...to get more size," he said. "We'll look at that."

It's understandable that Harrison is feeling his oats. Morgan's earnings soared 43%, to $1.4 billion, in the first quarter this year from a year ago, thanks to strong mortgage business and bond trading. Its stock is up 27% since the start of the year, trading at $30.50 on May 14. That's nearly triple the 10% or so rise in the shares of rivals such as Citigroup (C) and Goldman, Sachs & Co.

Still, it's way too early to start talking about dealmaking again. Despite the scintillating runup in Morgan stock this year, it is still trading at 38.5% below what it was when it merged with Chase Manhattan on Dec. 31, 2000. Over that time span, it has lagged the Standard & Poor's 500 Financials Index by 19 percentage points. Besides, there's a risk of a correction in the stock price: Analysts tracked by Thomson Financial/First Call now expect Morgan's second-quarter earnings to be down 7% vs. a year ago if its mortgage and bond businesses slow.

A far deeper worry is the question of timing. Harrison, then the boss of Chase, bought the venerable J.P. Morgan near the top of the market. Subsequently, the investment banking business crumbled, and the firm became mired in Wall Street scandals ranging from allegedly helping Enron (ENRNQ) Corp. hide the debt on its balance sheet to doling out shares in hot initial public offerings, allegedly in return for higher fees.

Now, the risk is that Harrison might dive deeper into retail banking at the wrong moment. Already, net interest margins -- the difference between the interest rates that retail banks charge their customers and what they themselves pay to borrow money -- are contracting. Also, if interest rates head up, the boom in mortgage refinancing and other consumer lending could end. Both trends have been major drivers of rising retail bank profits for months.

Buying more branches may not comfort investors. Many remain leery of Morgan and of Harrison himself, because of ongoing headaches in the merger, which resulted in a mass exodus of execs. "Given their lack of skill at integration, it's unimaginable that anyone would want to sell to them," says Burnham Financial Services Fund (BURKX) Manager Anton V. Schutz. He dumped his Morgan holdings in January.

Because Morgan's retail branch network is basically limited to the New York area and Texas, it would be easy to find a good fit without any geographic overlap. But the obvious candidates, such as FleetBoston Financial Corp. and Pittsburgh-based PNC Financial Services Group Inc., are beset with problems themselves. A bigger deal involving national franchises could be tricky: Outfits such as KeyCorp (KEY) or U.S. Bancorp would be difficult to swallow.

In addition, Harrison could find himself in the nightmare position of becoming the prey, not the predator. For instance, there have been market rumors from time to time that Bank One (ONE) Corp. might be interested in buying Morgan. Bank One has refused comment, and the rumors have died down since Morgan's stock price started rising.

Still, Harrison should remember that the market is rewarding the bank for putting the house of Morgan Chase in better repair. "The last thing people want is for Morgan to add risk," says E. Reilly Tierney, financial-services analyst at Fox (FOX) Kelton who owns Morgan shares and has a "neutral" on the stock. In short, shareholders want to enjoy the full benefits of the 2000 merger, not leap into another adventure. Thornton covers investment banking.


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