Candor must be contagious at JPMorgan Chase & Co.
Michael J. Cavanagh, the chief financial officer, sounded a lot like his blunt-talking boss, chief executive James Dimon, when he discussed the future of the nation's third-largest banking company.
"We've got work to do to get to even 'average' financial performance, and that's the gap that we really need to be focused on," Mr. Cavanagh said in an interview last month. But, he added, "there's nothing about the collective sets of businesses, franchises, and position of this place that says … you can't go from here to being the best."
Perhaps surprisingly he traced some of JPM's current problems to the mediocre performance of Bank One Corp. at the time the two companies merged in July 2004. (It's surprising because Mr. Cavanagh was the chief administrative officer of Bank One's commercial bank while Mr. Dimon was the holding company's CEO.)
"There's a little bit of mysticism in some quarters about the turnaround of Bank One," Mr. Cavanagh said. "It took a lot of work to simply get to 'OK.' "
The Chicago company was "strategically impaired" - facing aggressive competitors and limited growth opportunities, Mr. Cavanagh said. There was only so much management could do before a major strategic decision became imperative, he said.
That's when Bank One found JPMorgan Chase.
But now, 18 months after the deal was unveiled, JPMorgan Chase has to prove to its investors and perhaps to itself that the pieces of the $1.2 trillion-asset company work together.
Mr. Dimon told investors during a conference last month sponsored by Citigroup Inc., "I just think if we're going to stand in front of you and talk about [how] we have a good company, we should earn 20%" return on equity. That's "what we want to strive for as a company."
Last year the company returned 8%.
Mr. Dimon has given investors little hope that it will achieve the 20% goal this year. But he has made clear internally that he expects improvement.
"Jamie has said he wants to see us really performing at a solid financial level, business by business" this year, Mr. Cavanagh said.
JPMorgan Chase does not compare itself to two other members of the trillionaires club: Citigroup Inc., which returned 22.3% last year, and Bank of America Corp., with an ROE of 17%. Instead it wants to match up against the best in each business line. For instance, be as good in retail banking as Wells Fargo & Co. or as MBNA Corp. was in credit cards or as Goldman Sachs Group Inc. is in investment banking.
JPM has structured its six business lines in a way that makes the comparisons easy. And the three largest - retail banking, credit cards, and investment banking - all need to be improved to measure up.
A quarter of JPMorgan Chase's earnings come from abroad, but most observers agree it is missing a key business: international retail.
Mr. Cavanagh concedes this weakness. "I would not sit here and tell you that it's not on our minds for the long term."
In September the company hired Robert I. Lipp, the former chairman of St. Paul Travelers Cos. Inc. and longtime Citi executive, to advise its board on developing an international strategy.
Its private banking operations could also be larger overseas, given its cachet, executives have said.
The November 2004 joint venture with Cazenove Group PLC expanded JPMorgan Chase's investment banking business in the United Kingdom and Europe. (Also in late 2004, it bought Highbridge Capital Management, a hedge fund.)
To the surprise of many, JPMorgan Chase has planted no stake in China, as Citi, Bank of America, Royal Bank of Scotland, and HSBC Holdings have done. But Mr. Cavanagh defended the decision.
"We agree that China could be, obviously, a huge opportunity," he said. "And it's just at the stage where, looking at what others are doing, it's unclear that anyone's got the silver bullet, but it's certainly an area that warrants us being focused."
Whether JPMorgan Chase will ever add a retail brokerage to its lines of business also remains unclear. Mr. Dimon has remained vague on the issue, and Mr. Cavanagh said retail brokerage is a "maybe" at best.
He was adamant JPMorgan Chase would not follow Citi's lead and drop its asset management business.
The strategy to focus on fund management but not on its own distribution system is a major difference between JPMorgan Chase and Citi, which last year swapped its asset management business with Legg Mason Inc.'s brokerage and capital markets businesses.
RAMPING UP RETAIL
Retail banking took up the bulk of the Bank One integration work, and its returns have been rocky. The goal is an ROE of 28% to 30% in retail. The business hit that return in the first and second quarters of 2005, but fell back to 19% in the third and 23% in the fourth.
Besides Bank One, JPM did a host of other bank acquisitions that were never really integrated.
"A decade of prior mergers … really kept the focus on near-term [goals] as opposed to fundamental integration," Mr. Cavanagh said. In 2000, Chase Manhattan Corp., itself the result of several large bank mergers, bought J.P. Morgan Chase & Co.
But Charles W. Scharf, the head of retail banking, said JPM is now concentrating on creating a retail strategy that in some ways bucks the trend that has defined consumer banking for years.
For instance, don't look for new JPMorgan Chase branches only at busy intersections - it won't rent the most expensive corner retail office. Its new branches are often in the middle of the block.
It is also increasing the number of outlets rather than total square footage, and it has no intention of making its branches resemble anything but a bank.
The new branches and the refurbished ones are brighter and "a little more informal," Mr. Scharf said. "You will not see lots and lots of marble, but it's not going to look like a coffee shop, either."
People mingle in coffee shops; bank branches, he said, should be designed for quick transactions. But "that doesn't mean that we don't always think about who we can partner with, and test out different co-location strategies," he added.
Last year JPMorgan Chase struck a deal with Duane Reade to put automated teller machines in the chain's 270 drugstores. That accentuated the philosophy of the more locations, the better, even if it is just an ATM.
"Duane Reade is a wonderful partner, because it generates a lot of foot traffic," Mr. Scharf said. "Every store has a real Chase sign in the window, and they allowed us to put the ATMs in the front and not hide them in the back."
More, and different types, of partnerships with other retailers could well follow, he said.
JPM opened 140 branches last year, including 70 in the New York market. A third of the 150 branches it plans to open this year are to be in New York: 25 in Manhattan and another 25 in the rest of the metropolitan area. In all it has 2,641 branches right now.
According to the latest data available, JPMorgan Chase had a 23.8% deposit market share in the metropolitan New York market at June 30, 2005, up from 19.9% four years ago. Without the massive inflow of deposits following the stock market slump in 2000, it would have lost share, Mr. Scharf said.
"I am not sure we could have maintained our market share without changing," he said.
Mr. Scharf also overhauled JPMorgan Chase's compensation structure, introducing profit-and-loss analysis for each branch. Employees are paid on individual rather than team performance under a formula that measures, among other things, customer retention and the number of paid products a branch employee sells and cross-sells.
JPM's deposits rose 6% over all last year, to $555 billion. In the fourth quarter retail and small-business deposits were up 3% on average from a year earlier, to $177.4 billion. The number of checking accounts rose 8%, to 8.8 million.
Mr. Scharf would not specify JPMorgan Chase's deposit growth and market share goals for New York or elsewhere. He said he expects it to build share in all markets, including Manhattan, but many analysts and bankers said its leading 38.6% share could make growth in Manhattan difficult.
Mr. Scharf countered that the large market share in the borough "should make it easy for us to grow," because JPMorgan Chase can take full advantage of its marketing and its array of products, namely credit cards. Late last year it plastered New York with billboards for the rollout of its Blink contactless credit and debit cards.
"This place has woken up," Mr. Scharf said of the New York market. But if JPMorgan has convinced itself that its capacity to grow is not tapped out in New York, it has yet to convince at least some of its competitors.
Asked about the renewed vigor of JPMorgan Chase in New York, North Fork Bancorp Inc. chairman John A. Kanas said: "They are the largest donor of new business. They are spending their time to protect the market share that they own. They are not out there to expand market share, even though they talk about it. And that's not a great position to be in."
But Mr. Scharf said: "A lot of the small banks have just lived for years off of just doing a better job on a local basis than the big banks. Over the last couple of years many of the big banks have gotten their acts together - they have gotten a lot smarter about how to get the right mix of the benefit of the large organization with wanting to be local.
"And if the big banks that have all these products and services actually execute day in and day out, it will be a tough environment for the smaller and the mid-tier banks out there. Because I don't understand, if we do our job well, why anyone wouldn't bank with us."
The company took the JPMorgan Chase name but adopted Bank One's technology.
Mr. Cavanagh said getting the two companies' credit card businesses on one system is what "you worry about the most."
"I think the pieces were bigger than anything the industry had ever seen before," he said. "But certainly, in aggregate, it was the biggest move of a card business - and you didn't hear anything about problems with that execution, which was great."
CARDS
The cards business is not performing up to par, though. It generated $1.9 billion of operating earnings in 2005, 18% of JPMorgan Chase's overall earnings. Its ROE was 16%, pumped up by falling loan-loss reserves. The goal is to reach 20%, maybe not every quarter, but on average, the company said.
The combined outfit split card operations into a separate line of business, as Bank One had done. (JPMorgan tucked cards into retail banking.)
Richard J. Srednicki, JPMorgan Chase's chief executive for card services, said at a Credit Suisse conference this month that a lack of near-prime and subprime lending hurt the unit's performance, as did its limited exposure to international markets.
JPMorgan Chase uses teaser rates and marketing to lure customers away from competitors, though the card unit's CFO, Ray Fischer, denied during the Credit Suisse conference that his company is "a price leader," or even aggressive in pricing credit card loans.
But Mr. Srednicki said JPMorgan Chase' focus on prime and superprime, where returns are squeezed by heavy competition, has turned into a disadvantage. "We are doing an expansion into some parts of the credit spectrum," he told analysts and investors.
Mr. Srednicki added that the company is focusing on near-prime, not subprime, customers. "We expect to make progress this year" to improve returns, but the unit is still likely to fall short of its targets, he said.
Changes in minimum payment regulations are "a big swing factor this year," Mr. Srednicki said. "If it results in less losses than we thought, maybe we will get there a little earlier."
Mr. Fischer added, "Our goal is to continually drive earnings at least 10% on a year-in, year-out basis."
INVESTMENT BANKING
The investment bank continues to be JPMorgan Chase's Achilles' heel. The division had operating earnings of $3.7 billion last year, or 35.2% of the company's overall earnings.
The business returned 18%, thanks to two extraordinarily strong trading quarters, though earnings remained flat. During the weak second and third quarters, the ROE was 12% and 13%, respectively, and Mr. Dimon reiterated that the goal was 20% a year. Brad Hintz, an analyst with Alliance Capital Management LP's Sanford C. Bernstein & Co., wrote in a Feb. 1 note that reducing its trading operation by 20% would have lifted JPMorgan Chase' overall return on equity to 10.7% last year.
But Mr. Dimon said this year will be better, because his company has diversified its trading business, and it won't repeat the trading mistakes that occurred in the first and second quarters of 2005. "We've built out a little bit more energy, mortgages, asset-backeds, corporate, some of the sales forces," he said during the Citigroup conference. "We're going to build the training areas."
Analysts on conference calls repeatedly pressed Mr. Dimon to be more specific about the mistakes and about why trading remained such a volatile force in earnings. Some were particularly puzzled that it was commodity trading that hurt fourth-quarter results, the very area Mr. Dimon built up to smooth earnings out.
The CEO, however, insisted that JPMorgan Chase had skilled employees but will hire more, and that trading losses are part of the business. "We are not going to overreact to a bad trading quarter," he said.
MORE, AND THE FUTURE
After merging with Bank One, JPMorgan Chase created a separate unit for commercial banking instead of folding it into the investment bank, as Citigroup and Bank of America have done and as JPMorgan was previously set up.
Commercial banking earned $1 billion, or 9.5% of total net income. The unit's ROE was 30%.
From the JPMorgan Chase structure, a separate trust and securities services unit survived. It generated the same amount and share of earnings as the commercial bank but was the company's fastest-growing segment. Its results more than doubled, to $1 billion.
Both companies had an asset management line of business, which for the combined JPMorgan Chase makes up 11.4% of earnings, generating $1.2 billion in income.
Acquisitions may be an option in several lines of business, particularly in cards and retail banking, but executives are tight-lipped about any buyout targets and generally downplay the company's dealmaking ambitions.
The lack of appetite to buy was one reason Michael L. Mayo of Prudential Equity Group upgraded JPMorgan Chase's stock to "outperform" from "neutral weight" on Jan. 31. In his research note he mentioned the company's commitment to improving efficiency and disciplined use of capital, and wrote, "We sense management frustration with the stock price, which, to us, means less acquisitions and more [stock] buybacks."
Meanwhile, the company sold its online brokerage business, BrownCo, to E-Trade Financial Corp. for $1.6 billion, and announced this month that it would sell its insurance underwriting unit to Protective Life Corp. for $1.2 billion.
Nearly two years of integrating, building, selling, and buying by JPMorgan Chase has left some observers wondering what it wants to achieve.
"This company seems to lack a mission statement beyond simply being a large financial conglomerate that will be everything to everyone and cut costs," Richard X. Bove of Punk, Ziegel & Co. wrote in a research report issued in mid-January. Why, he asked, should its business units not be separated? "A corporation needs to be more than the sum of its parts if it intends to capture investors' imaginations," Mr. Bove added.
In his presentation at the Citi conference, Mr. Dimon's response was, "We are toying with one day showing you all why we think the combination of this company is a powerful franchise."
JPMorgan Chase executives will have another chance Tuesdaywhen they host an all-day meeting with investors and analysts.
