Over the weekend, Bank of New York Company Inc. and J.P. Morgan Chase & Co. announced a planned asset swap.

BNY said it intends to enter into a transaction involving the sale of its retail and regional middle market businesses to JPMorgan for US$3.1 billion with a premium of US$2.3 billion. Simultaneously, JPMorgan will sell its corporate trust business to Bank of New York for US$2.8 billion with a premium of US$2.15 billion.

The difference in premiums will result in a net cash payment of US$150 million to Bank of New York.
BNY is also subject to a contingent payment of up to US$50 million from JPMorgan, tied to customer retention.

The proposed transaction is subject to various regulatory approvals and is expected to close by the end of the third quarter in 2006.

In response to the deal, Dominion Bond Rating Service confirmed the ratings of both firms. DBRS said it believes that the transaction will result in better strategic allocation of BNY’s capital and resources, lower its risk profile, and improve its future earnings prospects. However, given Bank of New York’s already high ratings, DBRS does not consider the potential benefits of the transaction to warrant positive rating consideration at this time.

It notes that Bank of New York is selling a retail franchise that has traditionally produced stable earnings and a large low-cost core deposit base. “At the same time the company is strengthening its already powerful global securities business through the acquisition. The approximately US$15 billion each in loans and deposits to be sold to J.P. Morgan will be replaced by comparable amounts of corporate trust assets and equally stable deposits arising from the trust business,” DBRS observes. “Importantly, the company can forego the expenses it would have to incur to upgrade its low growth retail franchise to match those of its prime competitors, while boosting its market position and gaining further geographic diversification in its core corporate trust business.”

DBRS says that Bank of New York’s earnings will likely decline in the short to intermediate term to reflect the costs associated with the sale of the retail assets and the integration of the acquired trust business. In addition, the company’s tangible common equity ratios will suffer because of the goodwill related to the purchase. However, DBRS expects earnings to increase following the integration process, and tangible common equity ratios to be restored from earnings retention within a reasonable period.

As for J.P. Morgan Chase, DBRS says, “The ratings confirmation reflects J.P. Morgan’s strengthening of its New York metro area franchise by acquiring the retail and middle market business from The Bank of New York. Although the sale of J.P. Morgan’s corporate trust business to Bank of New York will reduce its income from its fee-based businesses, this modest reduction is likely to be offset by the added earnings in the acquired businesses.”

DBRS notes that the ratings reflect the powerful franchise being created by the merger of J.P. Morgan and Bank One Corporation. DBRS also notes the company’s below-peer financial performance – a result, in part, of the costs and challenges associated with the integration of two large bank holding companies.

Although small relative to J.P. Morgan’s overall scale, DRBS expects that JPMorgan will benefit modestly from the swap by strengthening the company’s deposit and branch franchise.

J.P. Morgan will face additional costs associated with the refurbishment, re-branding, and systems conversion of Bank of New York’s branches, it cautions. In addition, the company may face some customer attrition during the conversion process.

“While the swap provides an opportunity to bolster J.P. Morgan’s position in this market, it adds to the company’s stress; it is already engaged in extensive merger integration and upgrade efforts across its franchise while facing challenges from diverse competitors,” it says.