Enron has been called many nasty things lately, but merger-wrecker? Yup. Enron's troubles might mean that Merrill Lynch's 14,000 brokers no longer have to wonder what it would be like to work for a big commercial bank — at least for a while.
For years, Merrill has operated amid rumors that it would be acquired by a large bank. Why? To keep its place in the sweetest, highest-margin parts of the investment banking business — including M&A advisory services and equity and debt underwriting — Merrill would need access to the balance sheet of a giant bank. Or so the argument went. The same rationale drove J.P. Morgan into the arms of Chase, and Salomon Smith Barney into what ultimately became Citigroup.
As recently as Jan. 31, Smith Barney financial services analyst Guy Moszkowski declared in a research note that “failure to achieve meaningful margin improvement without revenue impairment would probably bring MER closer to a merger, presumably with a large global bank.”
But as the Enron saga unfolds, pressure on Merrill to sell out may subside, analysts say. “After what J.P. Morgan Chase went through with Enron, the whole strategy of using your balance sheet to try to get investment banking business is under question,” says Craig Woker, financial services analyst at Morningstar.
Under that strategy, massive, diversified financial institutions provide low-margin financing — such as short-term loans and lines of credit — to corporate giants, in hopes of drumming up lucrative advisory and underwriting business for their investment banking arms. Merrill, whose balance sheet does not include billions of dollars in bank deposits, faces a competitive disadvantage if corporations start expecting huge credit lines from their investment banks.
But that may be less of an issue than it previously seemed. “Enron is making people wonder how smart it is to be so heavily exposed to one company,” Woker says. Hammered by its Enron exposure, J.P. Morgan Chase recorded a rare $332 million loss in the fourth quarter of 2001. And the trouble could continue — the bank still holds more than $2 billion worth of bad loans to the failed energy giant. Citigroup, too, is heavily exposed to Enron, and it only avoided steep losses through a controversial hedging strategy.
“I think [the Enron scandal] definitely eases pressure on Merrill, at least in the short term,” says Alyssa Rieder, lead manager of the Franklin Blue Chip fund, which invests around 19 percent of its $180 million in assets in the financial sector. “The main question becomes, how much of an isolated incident is Enron?”
She says if more corporate implosions slam the earnings statements of J.P. Morgan Chase and its ilk, the case for Merrill as an independent entity will remain strong. If Enron's failure turns out to be a unique instance of chicanery — and not a systemic crisis of fancy accounting and fake earnings — then pressure will continue on Merrill to partner with a vast commercial bank.
“Every other developed country in the world has a much less fragmented financial services sector than the U.S.,” Rieder says, adding that with the end of the Glass-Stegall Act, the sector stands to undergo increased consolidation. Merrill, she says, would make a prize catch for a foreign bank wanting exposure to U.S. capital markets, or a domestic bank wanting to cash in on the next investment banking and stock-trading bonanza.
10 Years Ago in Registered Rep
Today's brokers are older, happier and more likely to be male. Fee business is growing, cold calling is declining and many say poor products are still a problem. One key to big numbers: specializing in stocks and bonds or money manager consulting.
— RR survey.