Competitive Test

By Kenneth Cline

Bank One CEO Jamie Dimon has sparked an impressive turnaround. Now the quest turns to top performance.

How do you wring top performance from a merger-scarred franchise in the face of stiff competition and a tight economy? The question is not unique to James "Jamie" Dimon. His challenges at Bank One Corp. mirror those of several CEOs whose newly created mega-institutions emerged from the '90s with credit and integration problems.

Across the country, these executives have rolled up their sleeves and dug down deeply into the basics, cleaning up portfolios, rebuilding management teams, knitting together systems and revitalizing business units. In Dimon's case, the achievements include reducing annual operating expenses by about 15%; lowering the company's risk profile; reinvesting in the retail franchise; and building up enough capital for a war chest, should acquisition opportunities present themselves. Not bad for a company that lost half a billion dollars in 2000.

But such improvements go only so far. The brutal truth is that companies lose time in the market while they are fixing things behind their own walls, and when they emerge from those walls they encounter rivals who have moved that much farther ahead. "We still have a ways to go to be really good," says Dimon, who took the helm in March 2000. "We still have slightly sub-optimal returns relative to the best of our competitors."

The challenge facing Dimon and all CEOs at recovering franchises is to demonstrate consistent core revenue growth — performance that is only possible by winning with the institution's major customer segments. Operational excellence is but a starting point in this competitive test. "The questions are," says Lehman Brothers analyst Brock Vandervliet, "where does the growth come from in the future and, can they outgrow some of their peers?"

For Dimon, the answers to these questions begin with nuts-and-bolts execution. Not given to making grand vision statements, the former Citigroup Inc. executive says he wants "all of our businesses to grow again" through improved marketing and sales, better service and product innovation. "Businesses have different natural growth curves, but there's not one of them that shouldn't be doing better."

The direction of the banking industry hinges on the success of such turnaround campaigns, in that failure to achieve core revenue growth will place institutions under renewed pressure to resort to defensive mergers. Dimon himself says that mergers "shouldn't be an excuse for the lack of your own performance," but he also says that acquisitions can be useful under the right circumstances.

The deciding votes will be cast by customers and investors. If Bank One's performance improves in forthcoming quarters, the stock valuation is likely to follow, increasing the range of strategic options available to the 47-year-old Dimon. "There's no reason to think Bank One can't achieve some growth without acquisitions," says Bear Stearns analyst David B. Hilder. "That just hasn't happened yet."

The Revenue Question

With Dimon clearly past what he terms the "fix-it" stage, the focus turns to improving each major line of business, and second-quarter 2003 results highlight both strengths and weaknesses.

Bank One's retail unit, though posting a hearty 31% annualized return on common equity, grew net income by only 1% from the prior-year period on revenue growth of 3%. Card services posted an 18% return, much improved from recent years but still lagging major competitors, and net income fell 9% on rising credit costs and flat revenues.

The commercial banking line of business saw revenues decline by 10%, but improved its profitability (13% ROE) on the strength of better credit quality — not a sustainable trend. Finally, the investment management unit reported a strong 34% ROE but a 17% decline in net income on a 4% revenue decline.

Putting all this together, the outlook for revenues is somewhat sluggish, with analysts predicting that the company will actually lose ground this year. Revenue growth is expected to bounce back in 2004, but will probably lag peers. Some analysts have retreated from the stock, expressing doubt that the next level can be reached. "The bloom has come off the rose in the last several quarters because people are tired of waiting for performance," says Vandervliet of Lehman Brothers, who downgraded the stock to "underweight" at the end of June.

For Dimon, job number one is beefing up retail banking, the anchor of revenues and profits (more than one-third of the total) for Bank One. Operating in 14 states, the 1,800-branch unit fell into disrepair in the wake of the 1998 merger with First Chicago NBD Corp., which distracted the prior management team. Compounding the challenge, savvy competitors have been poaching customers in key markets throughout the retail franchise.

With the all-important deposit systems finally integrated, Dimon is now pushing hard on customer-facing activities. From an infrastructure perspective, that means spending $50 million over two years to spruce up branches. Going beyond mere maintenance, the program includes some redesign work aimed at making interiors more inviting. Bank One is also spending more than $100 million over three years to update its fleet of 4,000 automated teller machines, many of which are more than five years old.

Customer Outreach

The larger priority is improving the performance of employees who deal with customers. Executive vice president and retail head Charles W. Scharf says he is working to change the culture in the branches, primarily by linking bonuses more closely with branch profitability and sales productivity.

Representatives who "come in, stare at the wall, smile and make a few phone calls won't get paid," Scharf says. As part of this effort, more authority was delegated to the branch level, where managers now oversee their own profit-and-loss statements and are responsible for the results.

Scharf is also promoting more cross-selling, which is a controversial topic within the banking industry. Some institutions, such as Wells Fargo & Co., enshrine it as a central goal; others, like U.S. Bancorp, believe the emphasis should be on customer service. Scharf says he leans more to the Wells Fargo model in that he believes good service includes needs-based cross-selling. "You are not going to grow your business over time by saying 'thank you' to people. You're going to grow your business over time by doing the right things for customers, which means making their lives better with your products and services."

At today's Bank One, this process begins at account opening. A customer who comes into a branch to open an account is steered to a banker, not a teller. This officer then gathers as much information as possible using a brief financial profile and may suggest other products that might be helpful. "The moment the customer is sitting there in the chair is the best time to cross-sell," Scharf says. "We think it's really those first six months that are going to make or break the relationship" (Click here for related story).

To keep up with competitors, Scharf has also introduced new products (free checking, free check imaging and a reward-based debit card) and extended branch hours across the franchise by about 20%.

Bank One's retail makeover is still ongoing. Scharf is currently in the process of consolidating multiple teller systems and integrating customer information files across all product categories. Improving branch performance through training and incentives will require a particularly long and arduous effort. "Getting all our middle managers, bankers and tellers on the same page is not complicated, but it is hard work," Scharf says.

Card Challenge

While the retail business line is primarily a story of building on strengths, Bank One's volatile credit card unit remains much more problematical. The unit has recently won some important new alliances, including Amazon.com and Walt Disney Co. But analysts question whether growth will ever return to the levels that were considered normal in the '90s. "Credit card loan growth is at the lowest level seen in 20 years, so there is intense competition across that industry," says Bear Stearns' Hilder. One reason: home equity rates are so low that card borrowing makes less sense for consumers.

Dimon is more optimistic, pointing out that Bank One enjoys vast economies of scale in the card business, being the industry's third-largest player. The parent company can also supply the card unit with low-cost capital and leverage its branch system for distribution. The challenge lies in marketing, he says, where Bank One lags some competitors in terms of expense per customer acquired. "We have good reason to think we can win in that business."

From a balance sheet perspective, Bank One's corporate bank is mainly a story of declining credit problems and rising loss reserve coverage, but questions about growth remain. Nationally, the large corporate market has struggled in recent years because of the economy, and the outlook remains uncertain. Having cleaned up the loan portfolio, tightened underwriting and reorganized the bank around the best customers, Dimon seems content to ride out the wait for the next economic upswing.

Middle market lending is one business line where Dimon's fix-it routine hasn't quite worked out as planned. While tightening underwriting standards and clamping down controls on relationship managers may have made sense from a credit perspective, some customers were alienated and the bank itself lost talented employees.

To re-start the engine, Bank One has sorted through the middle-market customer base to identify those clients whose patronage and cross-sell potential warrant priority treatment. And Dimon is now in the process of restoring some authority to front-line lenders. "We did more damage than was necessary," he says.

Battle for Chicago

Although Dimon has brought the company a long way, the performance statistics aren't yet telling the desired story. Among the top 50 banks, for example, Bank One ranked 47th in year-to-year operating revenue growth in the second quarter, 30th in earnings-per-share growth before extraordinary items and 36th in annualized return on average assets, according to SNL Financial LC, Charlottesville, Va.

One interpretation is that while Dimon has made a lot of progress in fixing inherited problems, competitors who were less burdened have continued moving ahead. And many of these competitors are now attacking Bank One in its core markets, including Chicago. Major players such as Bank of America Corp. and Washington Mutual Inc. are entering this market through de novo branches, while established competitors, such as Fifth Third Bancorp, are also on the move. The net result will likely be hundreds of new branches in the Windy City within a few years.

Bank One intends to defend its home turf vigorously. "It's going to be very tough to compete with us," Dimon declares, noting Bank One's unrivalled network of branches (208) and ATMs (1,000) in metro Chicago, which the company plans to supplement with an additional 30 branches and 70 cash machines. The new branches, combined with refurbishment of the older ones, amounts to a $95 million program over two years.

And competitors may be somewhat late to the game. "The right time to have attacked Bank One was 1998 through 2000," says Bear Stearns' Hilder. "Although the new entrants will gain some market share, largely in the suburbs, Bank One is vastly better prepared to meet the competition today."

That said, questions remain as to whether Bank One can hold its own in competition with the very best retail players, some of whom have been honing their game for decades. And this is not just a Chicago issue — it resonates across Bank One's 14-state footprint. Beyond operational excellence and product excellence is the goal of relationship excellence, and this the area where Bank One needs a breakthrough. And that will take time.

Will Bank One shareholders — and Dimon himself — remain patient, or will the pressure to do a "transforming" acquisition win out in the end? Dimon himself has publicly stated his desire for Bank One to be a "national player" in financial services and says a potential deal "will generally be driven by the retail side of the bank." And he's already shown a willingness to pull the trigger on deals, albeit relatively small ones.

This puts Dimon squarely in the dilemma shared by his CEO peers at various major institutions across the country, which is that internal growth takes a long time while deals can be done quickly. Especially given that Dimon earned a reputation at Citigroup as an effective dealmaker, "there are expectations that he will make accretive acquisitions," Hilder says. "If he's not able to do that, there might be cause for disappointment."

In any case, Dimon has clearly moved from the fix-it stage to the grow-it stage at Bank One.

Mr. Cline is senior editor with Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

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