Throughout countless business cycles in J.P. Morgan Chase & Co.'s history, its investors could rely on the power of the company's pedigree and its deep experience in weathering all manner of crises, elements that provided a perceptual edge no other bank could match.
The perception has clearly shifted. Amid evidence of worsening credit problems, a breakdown in its risk management models, and a downgrade in its own debt, Morgan Chase shares tumbled more than 10% Wednesday. They recovered partially, ending down 5.15%, but are now at a level that is below the company's own book value.
The decline puts Morgan Chase in a valuation class of its own this year. FleetBoston Financial Corp., hit by losses in Argentina and in corporate lending, trades at about $21.90, while its book value is $15.79, according to Thomson First Call. PNC Financial Services Group, which is under formal regulatory supervision, trades at $43.13, and its book value is $22.50.
Citigroup Inc., which shares with Morgan Chase similar issues in investment banking and the unwanted spotlight in the Enron mess, trades at $28.92, and its book value is $16.66, according to First Call. Morgan Chase trades at about $19 and its book value is $20.93.
The drop came one day after Morgan Chase warned that third-quarter earnings would be well below second-quarter results because of bad telecommunications loans and weak trading.
Now, some analysts and investors say they have begun to question whether Morgan Chase could be worth less than the sum of its parts and whether there was any value in the merger that created the firm - the two-year-old combination of Wall Street legend J.P. Morgan and corporate lending powerhouse Chase Manhattan.
Richard Bove, an analyst with Hoefer & Arnett Inc., said Morgan Chase is trading so low because investors believe that book value is overstated. "Why should anything trade below what is presumably its liquidation value?" he said
However, he said he believes the opposite - that the liquidation value is understated and that book is closer to $30 a share.
Analysts who until very recently had been supportive of Morgan Chase's efforts to maintain its dividend and work through its revenue-growth difficulties are sounding less optimistic.
"They've executed poorly in two areas where they previously had a pretty decent reputation," said Reilly Tierney, an analyst at Fox-Pitt, Kelton. Trading has been a big strength for Morgan Chase in the last two years, he said, and analysts thought the company had done "a good job" in its credit practices. "Yet now we're finding out that all these telecom loans were on nonperforming status - and there are a lot more than we thought there were," he said.
Richard Bove, an analyst with Hoefer & Arnett Inc., Mr. Bove even suggested that Morgan Chase should consider drastic changes in its attempt to get the firm back on its feet, including replacing top management. "I would think that the board of directors of this company has finally got to recognize that they need to do something about management," Mr. Bove said. "The only way they can really maximize shareholder value is to bring in someone who is going to maximize the value of the businesses that the company owns."
To be sure, William B. Harrison Jr. has been quick to communicate his disappointment with the firm's financial performance this year. On Tuesday, he said he took "full responsibility" for the results, but he continued to stress that Morgan Chase's long-term prospects were promising. "Looking ahead, I foresee no change in our fundamental strategy," Mr. Harrison said on the call.
Tanya Azarchs, a credit analyst at Standard & Poor's Corp., said Wednesday during a conference call discussing the agency's downgrade of Morgan Chase debt, "We don't think that the worst is over for the company."
One area of concern, Ms. Azarchs said, is that Morgan Chase has not yet reserved against possible losses in its litigation over $1 billion of surety bonds to Enron. Also, reserves could need boosting if nonperforming loans rise rapidly, and the investment banking environment could remain weak, she said.
But in line with the sentiments expressed late Tuesday by top Morgan Chase executives, Ms. Azarchs said: "We don't really believe that the company has major strategic issues to resolve - that is, other than how to manage their large loan exposure. We don't really expect a great deal of management turmoil or anything like that to destabilize the company."
Of course, feeble markets and a bad economy have wreaked havoc on earnings throughout the banking and brokerage industry. Morgan Chase's disproportionate exposure to the telecom sector has not helped in this challenging environment.
The debt downgrade by S&P and Fitch is not seen has having a material impact on Morgan Chase but it is one more reputational risk to fret about, analysts said. "A number clients are only going to want to do business with the highest-rated counter-party," said Brock Vandervliet, an analyst at Lehman Brothers. Moreover, in the current environment, firms given the choice of using two firms for the same trade may choose the higher rating.
"If this were three years ago, when no one was concerned about the recession, it wouldn't matter," he said. "But now, at a time when everyone is kind of looking under the rug for any sort of problem and is concerned about corporate performance, these ratings mean much more."
Other analysts said they were more concerned about the company's apparent difficulties keeping its credit portfolio and trading operations in check. Morgan Chase said credit costs will be about $1.4 billion in the third quarter, more than three times the level of the second quarter. Trading revenues of $100 million are less than 10% those of the second quarter, a period the company described as weak.
Marc J. Shapiro, the head of finance, risk management and administration at Morgan Chase, said on the conference call there was "no smoking gun" in the trading operations nor a "single point" that caused the losses. "It was everybody operating within their established risk limits not doing well, and the cumulative impact of that is a much lower quarter than we would normally have," Mr. Shapiro said.
Michael Mayo, an analyst at Prudential Securities, said Morgan Chase blamed earnings shortfalls last year on exposure in telecom-related venture capital. He questioned why it failed at that time to realize that it had too much exposure to the sector in the lending portion of its portfolio.
"They have to make sure they have adequate improvement plans in place," Mr. Mayo said. "But patience is running short."
