, hungrily acquiring capital-markets operations as well as deepening its exposure to the New Economy, wants to morph into the financial institution of the future.
But the bank's new, multifaceted structure makes it more likely to break one of the oldest rules in banking, according to two analysts who follow the institution closely: Never throw good money after bad.
The danger is that Chase will be tempted to use its expanding web of businesses to keep afloat troubled companies that it has lent to or has taken equity stakes in, say Charles Peabody, of New York-based
, and David Tice, of Dallas-based
David Tice & Associates
"We think there is a dramatic potential for conflicts of interest and abuse," says Tice, who is advising his clients to sell Chase shares. (His firm doesn't do underwriting; Tice's
Prudent Bear fund was short Chase at the end of March, according to
In recent years, Chase has devoted huge resources of capital and personnel to provide funds to up-and-coming firms in a range of sectors. Some of these nascent companies are facing financing difficulties as the mania for New Economy stocks wanes.
As a result, the two analysts wonder whether Chase would make ill-advised attempts to shore them up. The bank could pump in funds raised through a number of channels, including its lending operation, its bond and equity businesses, its venture capital arm,
Chase Capital Partners
, or its asset management division. "I have no doubt that these conflicts of interest will become very visible," says Peabody, who rates Chase a sell. (Mitchell hasn't done underwriting for the bank.)
Chase dismisses the accusation that it would provide easy money to companies with which it has deep links. "We wouldn't be in business and have people trust us if we had conflicts like this," says Jeffrey Walker, the head of Chase Capital. (Chase Capital is an investor in the
, the publisher of this Web site.)
Still, the value of Chase Capital's stakes in its 60 listed U.S. companies has plunged. At the end of March, these holdings were worth $4.14 billion, according to Chase Capital. They now have an estimated value of $2.69 billion, representing a 35% drop-off. In addition, five of the seven IPOs done by Chase Capital companies this year are now below their offer prices, suggesting that future financing won't be easy for them. And already two Chase Capital companies that went public last year --
-- have less than a year's worth of cash left, according to New York-based
Pegasus Research International
, which analyzes Internet companies' cash-consumption rates.
In fact, Chase's large exposure to Nasdaq-listed companies has helped to drive the stock down 26.2% from its late March high, a decline that roughly tracks that of the tech-clustered index. Chase stock was trading at 74 5/16, up 13/16, or 1.1%, around noon Wednesday.
Chase is certainly not averse to extending credit to companies in which Chase Capital has equity stakes. For example, Chase was book manager on a September 1999 $600 million syndicated loan to
and a $550 million credit in December to
. And the bank has also recently participated in loans to
. Bar Entercom, all these companies are turning big losses.
Chase's Walker responds that the bank keeps on its books only a very small part of the loans or bond deals it manages: "The bank doesn't retain much exposure. It may only keep $10 million from a $600 million deal."
Perhaps indicating in-house bias, analysts at Chase's equity division, Chase H&Q, are often more optimistic than their peers about companies in which Chase Capital has stakes. This rosier stance could help the companies to raise more cash. Chase H&Q analysts cover six companies that have gotten funds from Chase Capital, and for five of them --
, Triton PCS,
and TheStreet.com -- the analysts have earnings estimates that exceed the
First Call/Thomson Financial
averages (see table, above). None of the analysts responded to a request for comment. But Walker remarks: "These research analysts know they have to be independent or people won't listen to them."
One problem for investors is that the relationships a firm may have with different parts of Chase can be hard to track. Chase Capital certainly provides extensive disclosure of its holdings compared with other banks with big private-equity arms, like
. But, as with any bank, it's hard to track who it's lending to. Says Tice: "We can't get inside their loan portfolio to see what's really going on." And Peabody wonders whether Chase's
, a debt fund that is also available to institutional investors, is being used to buy up loans and bonds that face low demand in the market.
Many Chase watchers think it highly unlikely that the bank's management will abuse its growing franchise. "I've spent a fair amount of time going over these issues with Chase," says Larry Cohn, banks analyst at
, which rates Chase a hold and hasn't done any underwriting for the bank. "I'm confident that a pretty good wall" keeps the equity and debt areas separate.
Moreover, any losses Chase might suffer at Chase Capital could be offset by gains at this consistently profitable unit, which has made an average 42% annual return on liquidated investments since it was formed in 1984. And Walker argues that the Nasdaq tumble could boost returns for Chase Capital over the long term, since investments in cash-hungry nonpublic companies are now more attractively priced.
Even so, Chase has made a colossal bet on the New Economy and on gaining a predominant position across the capital markets. It acquired tech-focused investment bank
Hambrecht & Quist
last year, the U.K.'s
in April and the
May. Chase, or rather its predecessor institutions
, got seriously burnt in the 1980s Latin debt crisis, after fully embracing the speculative mania for Third World loans. And the old Chase Manhattan saw a large real estate investment trust go bust in the late '70s. Analysts at the time said conflicts of interest at Chase were to blame; the bank set up, lent to and advised the trust.
Glass Steagall Act
, the 1933 law that kept banks from diversifying into equities, has, thankfully, been killed off. But as banks like Chase grow and change, investors may periodically want to remind themselves why it was there in the first place -- especially if the Nasdaq rout resumes.