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Morgan shift to lending?
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August 29, 2001: 9:01 a.m. ET
Investment bank subject of rumors, tries lending, will keep Discover
A weekly column by Staff Writer Luisa Beltran
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NEW YORK (CNNfn) - Morgan Stanley, the venerable Wall Street investment bank, scored big points when it combined with brokerage Dean Witter four years ago. Now the odds are good it may shoot for another deal.
But what kind? Three major alternatives are surfacing: Buying a commercial banking operation, selling its Discover card business, or selling itself to a larger financial partner. Any of these alternatives could take months, even years, to fully formulate. In the meantime, the company is dipping into the lending business as economic times tighten.
New York-based Morgan Stanley (MWD: Research, Estimates), which will report fiscal third-quarter results around Sept. 20, has been hit hard by the economic downturn. Like many of its rivals, the bank reported sharply lower profits for its second quarter, when profit dropped by more than one-third to $930 million.
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Luisa Beltran
covers mergers and IPOs for CNNfn.com | |
The third quarter now is expected to be worse, with many investment banks continuing to suffer from the decline in advisory fees for arranging mergers and a drop in underwriting business.
"The third quarter will be the bottom," said analyst Diana Yates of A.G. Edwards Inc.
New business
Morgan is one of the few independent financial institutions to lose market share this year, analysts said.
Its tenuous position has caused it to reallocate some funds and try to compete against rival commercial banks that are offering cheap credit in an attempt to win more lucrative investment banking work, analysts said.
To this end Morgan has injected an undisclosed amount into a Utah banking subsidiary in a bid to do more lending. Press reports have valued the Morgan injection at $2 billion. The switch will chip away at Morgan's profitability, since lending is a low-margin business. Morgan is expected to file with the Securities and Exchange Commission soon, where it will unveil the size and value of the injection.
This modest move into lending plus the supposed inroads commercial banks are making into investment banking are feeding speculation that Morgan will have to merge with or buy a commercial bank.
Morgan says that speculation is off and argues that the market currently favors the investment banking model rather than commercial banking.
"We believe the capital markets will continue to disintermediate the commercial banks in the credit markets, so there is no compelling strategic reason to do a transaction," Morgan Chief Financial Officer Steve Crawford told CNNfn.com.
The AmEx talk
Morgan Stanley has been rumored in merger talks several times in the past year. Before J.P. Morgan combined with Chase last year, Morgan Stanley was expected to be involved. In June, news emerged that Morgan, along with Citigroup, had been in talks with American Express Co. Morgan also was mentioned in a possible takeover bid for A.G. Edwards.
Morgan Stanley is one of the few companies that could buy American Express (AXP: Research, Estimates), boosting the merchant acceptance of both networks, analyst E. Reilley Tierney of Fox-Pitt, Kelton said. A combination would produce substantial cost savings from merging the back offices and boost the number of financial advisors to 25,000, surpassing top dog Merrill Lynch (MER: Research, Estimates) by 20 percent.
A merger would also combine AmEx's charge card business with Morgan's Discover unit.
But many continue to discount the ever popular AmEx rumors. AmEx shares, which have dropped nearly 40 percent from their 52-week high, still are too expensive for Morgan, whose own stock has dropped 50 percent. Morgan last year was trading at 6 times book value but is now at half that amount.
Morgan CFO Crawford declined comment on the potential deal.
Selling Discover?
Some believe that Morgan may be more prone to sell its Discover card operations. Discover has never really fit into Morgan's overall core business, providing little opportunity to cross-sell, and the investment bank has considered selling it.
The Discover unit will get hit in the third quarter because of a change in U.S. personal bankruptcy law that will make it harder to file for bankruptcy. Consumers will be looking to file before the switch, causing a spike in credit card losses, A.G. Edwards' Yates said.
Discover suffers because it produces a lower return on assets and generates lower risk-adjusted yield rates than other cards, analyst Mark Constant of Lehman Brothers said. Discover's brand isn't as highly recognized as Visa or MasterCard nor as widely accepted.
Despite the drawbacks, Discover still can boost revenue. "Morgan was interested in selling Discover and now they are happy they have it because of the recurring fee base," financial services analyst Harry Milling of Morningstar.com said.
Morgan likely will keep the Discover unit even though it doesn't fit with the bank's overall business model, insiders said.
Who could buy?
Beyond buying a commercial operation or selling Discover, there's the possibility that Morgan Stanley may go on the block itself. That may become a necessity in the next three years as the company faces competition from financial services behemoths like Citigroup.
But there aren't many potential partners that could buy Morgan. HSBC Holdings PLC, the U.K.'s largest bank, has the bankroll, but analysts believe it would be a better fit with an outfit like Merrill Lynch.
Deutsche Bank, Europe's biggest bank, is mentioned frequently as a would-be buyer for any firm. But the German bank's culture of domination is believed to be a main drawback.
"You don't work with Deutsche Bank, you work for them, " said Fox-Pitt's Tierney.
J.P. Morgan Chase (JPM: Research, Estimates), once it works through its own merger, could be poised to make a bid. But the bank is currently embroiled in job cuts and declining profits, which could keep it busy for a while.
One wild card is emerging in the financial services industry. Bank One, led by former Citigroup (C: Research, Estimates) president Jamie Dimon, possibly could play a part in future consolidation. Bank One (ONE: Research, Estimates), currently the No. 5 U.S. bank, is one of the largest issuers of credit cards through its First USA unit.
But Dimon must get Bank One off the ground before it can do anything. 
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Wall Street firms on decline, could be European fodder - Aug. 15, 2001
Deutsche Bank profits hit - Aug. 1, 2001
Bank One CFO resigns - Apr. 20, 2000
JP Morgan in third round cuts - Aug. 27, 2001
Bank of America, Citigroup top 2Q target - July 16, 2001
Morgan Stanley profit drops but exceeds target - June 21, 2001
Morgan pitches merger to AmEx, report says - June 11, 2001
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Morgan Stanley
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