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JPMorgan and Wells face merger risk as economy sags

JPMorgan Chase & Co and Wells Fargo & Co may emerge as long-term winners in the quake that has shaken up US banks. Their staying power will be tested by their ability to complete their high-risk mergers.

JPMorgan's $1.9 billion purchase of Washington Mutual Inc's banking units and Wells Fargo's planned purchase of Wachovia Corp, originally valued at $15.1 billion, add large, powerful retail branch networks to what were already two of the biggest banks in the United States.

Both purchase prices are only a small fraction of what the targets were once worth and reflected evaporating investor confidence that Wachovia and Washington Mutual would have the time and capital to combat soaring mortgage losses.

While JPMorgan and Wells Fargo quarterly results topped forecasts on Wednesday, their continued prosperity may be at risk as the economy slides into what some expect will be a deep recession.

“Trying to integrate companies in the midst of a difficult operating environment is challenging, to say the least,” said Chris Hagedorn, who helps invest $21.4 billion at Fifth Third Asset Management in Cincinnati. “These companies have done big integrations in the past and I would give them the benefit of the doubt.”

JPMorgan has had three large mergers in recent years: Chase Manhattan Corp's 2000 purchase of JP Morgan & Co, the 2004 purchase of Bank One Corp and May's rescue of Bear Stearns Cos. Wells Fargo has not had one since 1998, when Norwest Corp bought the old Wells Fargo and took its name.

Analysts said the success of the Washington Mutual and Wachovia takeovers depends on their acquirers' abilities to live up to their past records at merger integration and a presumption they properly assessed credit risks. JPMorgan is writing down $31 billion for Washington Mutual loans, while Wells Fargo expects to write off $74 billion from Wachovia.

But economic conditions are not good.

“We necessarily need to be prepared for a bad environment,” JPMorgan Chief Executive Jamie Dimon said on a conference call. He later added: “If you are not fearful, you're crazy.”

Meanwhile, Wells Fargo Chief Financial Officer Howard Atkins said it is a “good working assumption” that the economy is in recession.

“The steps taken by the government will help over time and we'll see what happens,” he added.

Richard Moroney, chief investment officer of Horizon Investment Services LLC in Hammond, Indiana, said JPMorgan and Wells Fargo are “taking on huge risks, but getting huge opportunities. It depends on how bad mortgages, car loans and credit cards are going to get. There are also integration issues: getting computers to work, getting people to work together. We've seen those things go awry at other banks.”

Indeed, Wachovia itself has seen both sides of the coin.

Before buying the former Wachovia in 2001 and taking its name, First Union Corp lost thousands of customers when it botched the takeover of Philadelphia's CoreStates Financial. It also lost $2 billion when it shut down Money Store, a lender to people with poor credit histories.

Ken Thompson, the former chief executive of First Union and later Wachovia, at first shed that bank's reputation for poor integrations, smoothly absorbing the old Wachovia, as well as Alabama's SouthTrust Corp, a 2004 purchase.

But he shattered that progress with a $24.2 billion purchase of California mortgage lender Golden West Financial Corp in October 2006, just as the housing market was about to crash. Many analysts at first thought Wachovia overpaid, although even they did not see the scope of the eventual deterioration at Golden West, once regarded as a conservative lender.

Washington Mutual, meanwhile, last month became the largest US bank ever to fail, following rapid expansion into subprime mortgages, home equity loans and option adjustable-rate mortgages, the latter also a Golden West specialty.

JPMorgan Chief Financial Officer Michael Cavanagh told analysts the integration of Washington Mutual, acquired three weeks ago, is “progressing well.” He also said Washington Mutual - now backed by JPMorgan - has staunched the deposit outflows that prompted regulators to seize it.

Meanwhile, Atkins said a key feature of the Wachovia takeover “is to combine our sales and cross-sell culture with Wachovia's service culture.” Wells Fargo emphasizes selling several products to each customer, while Wachovia usually ranks near the top of independent customer satisfaction surveys.

“Wells Fargo is a company known for going slow in integrating deals and, if it is smart, will move quickly to identify and retain much of Wachovia's key talent,” wrote Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners LP. (Reuters)