Merrill Bringing Down Lewis Gives Bank 30% Profits as 'a Steal'
Oct. 5 (Bloomberg) -- Merrill Lynch & Co., which helpedbring down Kenneth D. Lewis, may end up saving his bank.
The decision by the 62-year-old Bank of America Corp. chiefexecutive officer to purchase Merrill in January for $29 billionalready is generating more than 25 percent of the bank’s profits-- along with charges by government officials that he misledinvestors about the extent of losses and bonuses.
When he announced last week that he would step down by theend of the year, Lewis could take some comfort from making theCharlotte, North Carolina-based bank, the largest in the U.S. byassets, less reliant on consumer spending, poised to benefitfrom overseas growth and better able to compete with rivalJPMorgan Chase & Co., according to David Stowell, a professor offinance at Northwestern University in Evanston, Illinois, and aformer managing director at JPMorgan.
“While the purchase brought massive mortgage-relatedlosses, it also bought 15,000 stockbrokers who link up nicelywith the bank’s deposit base,” Stowell said. “It’s hard to seehow they could keep up with JPMorgan without a big, significantacquisition like Merrill.”
Merrill’s businesses contributed $1.8 billion to Bank ofAmerica’s first-half net profit of $7.5 billion, or 28 percent,even after the bank posted $27 billion in loan charge-offs andhigher loan-loss reserves, according to company filings. Thosebusinesses are likely to account for 25 percent to 30 percent ofthe bank’s profits over the next three years, said JohnMcDonald, an analyst at Sanford C. Bernstein & Co. in New York.
Market Share
The share of the bank’s revenue that came from investmentbanking and wealth management rose to 47 percent in the firsthalf, after the Merrill acquisition, from 29 percent last year,according to the bank.
While more than three dozen senior traders and bankers haveleft since the merger, Bank of America Merrill Lynch, theinvestment banking unit, captured “some very real market-sharegains from fallen competitors that should likely provesustainable going forward,” McDonald wrote in an Oct. 1 report.
The bank this year has won 6.4 percent of advisory roles inglobal mergers and acquisitions by dollar value, compared with a7.8 percent share for the two firms in 2008 and 7.2 percent in2007, according to Bloomberg data. It ranks fifth behind MorganStanley, Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan,Bloomberg data show. By reported advisory fees, it’s in fourthplace, behind Goldman Sachs, Morgan Stanley and JPMorgan.
In global equity and equity-linked transactions, Bank ofAmerica Merrill Lynch ranks fourth, the same position Merrillheld in 2008. In U.S. bond issuance, the bank ranks third,compared with Bank of America’s fourth-place position last year.
‘A Steal’
“They have lost some people on the one hand, but on theother hand Merrill did have some really good franchise players,and at least part of that franchise is still intact,” saidMichael F. Holland, chairman of Holland & Co. in New York, whichoversees more than $4 billion including JPMorgan shares.
Bank of America’s challenge is to avoid stifling Merrill’sculture, said Charles Geisst, a finance professor at ManhattanCollege in Riverdale, New York. “Merrill Lynch has always beenone of the top three investment banks, and that will continue.”
Shares of Bank of America have risen 16 percent this year,compared with those of Citigroup, which have fallen 33 percent.The KBW Bank Index, which measures the performance of 24 largeU.S. banks, is up 1.1 percent in the same period.
“This merger made sense from just about every angle onecould look at,” Richard Bove, an analyst at Rochdale SecuritiesInc. in Lutz, Florida, wrote in a Sept. 21 report. “Inhindsight this deal was a steal because it now appears that thebank can pay for Merrill’s price with one year’s worth ofMerrill revenues.”
Real Estate Loans
The bank, which received $45 billion under the government’srescue plan, needs brokerage and investment banking fees toovercome higher losses in its credit-card and home-loanbusinesses, which make up 36 percent of revenue. Charge-offs forcredit-card loans deemed uncollectible climbed to 14.5 percentin August at the bank, the highest rate among the largest U.S.lenders. The unemployment rate rose to 9.8 percent last month,the highest level since 1983, signaling a recovery in consumer-related businesses will be slow to develop.
With real estate values down by 20 percent from their 2006peak, Bank of America also faces higher losses from its $401billion in residential loans and $75 billion in commercial-property loans, said Allen Greer, a Los Angeles real estateconsultant who left the bank in January after a 17-year career.
“The outlook for the bank has gotten uglier,” Greer said.
‘Returning Value’
Lewis, who said in his Sept. 30 resignation announcementthat the Merrill deal “is returning value already,” has warnedthat second-half results will be marred by higher losses fromconsumer and commercial real estate loans. Global card serviceslost $3.5 billion in the first half, and home lending andinsurance had a $1.2 billion deficit.
Third-quarter earnings are scheduled to be reported on Oct.16. A loss of 9 cents per share is expected, the average of 24analysts surveyed by Bloomberg.
Merrill’s prospects remain clouded by about $32 billion ofassets listed as Level 3 as of June 30, an accounting term forsecurities and loans whose value is unclear, said Mike Williams,research director at Gradient Analytics Inc. in Scottsdale,Arizona. The bank reported $122 billion in total Level 3 assets,a 4 percent decline from March 31.
“I can’t get a grasp on how many bad assets Bank ofAmerica has inherited and what kind of losses are going to flowthrough,” Williams said. “If the market for these assets doesrecover, it will prove to be the right move for the bank.”
Countrywide Deal
Bank of America also acquired Countrywide Financial Corp.in July 2008 for $2.5 billion. The deal, concluded in the midstof the worst housing slump since the 1930s, made the bank thesecond-largest U.S. home lender with a 21 percent share of homeloans in the second quarter of 2009, according to NationalMortgage News. The U.S. economy shrank for four quarters afterthe acquisition, including a 6.4 percent contraction of grossdomestic product in the first three months of this year.
While low interest rates spurred home lending during thefirst half, with revenue up 275 percent from the same period ayear earlier without Countrywide, more borrowers defaulted.
“In the long run they’ll get the bad assets fromCountrywide off their books, but they would have been better offwithout them for the next few years,” said Gradient’s Williams.
Buying Countrywide will look wise as U.S. housing pricesstabilize, said William Isaac, former chairman of the FederalDeposit Insurance Corp. The S&P/Case-Shiller home-price indexrose 1.2 percent in July from the prior month, the biggest gainsince October 2005. The index was down 13.3 percent from a yearearlier, the smallest decrease in 17 months.
Under Scrutiny
The Merrill transaction is being scrutinized by attorneysgeneral in New York, North Carolina and Ohio. Richard Cordray,attorney general of Ohio, is leading a class-action suit onbehalf of investors seeking billions of dollars from Bank ofAmerica over the Merrill transaction, and New York AttorneyGeneral Andrew Cuomo is weighing whether to bring chargesagainst executives for misleading investors. At least threeshareholder lawsuits have been filed to protest the acquisition.
Lewis’s attempt to cancel the transaction last December asfourth-quarter losses at the brokerage spiraled past $15 billiontriggered a clash with regulators, including then-TreasurySecretary Hank Paulson, who told Lewis management might beousted if the deal wasn’t concluded, according to Paulson’scongressional testimony. It also led to probes by Congress andthe Securities and Exchange Commission tied to $3.6 billion inbonuses Merrill awarded before the purchase was completed.
Settlement Rejected
U.S. District Judge Jed Rakoff in September rejected a $33million settlement between the bank and the SEC, asking whetherthe bank had lied to shareholders.
The bank “can likely digest the most probable financialpenalties,” McDonald said in his report.
Analysts project the company will bounce back with a profitof $12.6 billion next year and $23 billion in 2011, toppingJPMorgan’s expected net income of $13.1 billion and $20.7billion, according to estimates compiled by Bloomberg. Citigroupis likely to earn $2.8 billion in 2010 and $8.5 billion in 2011,the average of 12 analysts compiled by Bloomberg.
To absorb more writedowns, Bank of America has $95 billionmore in Tier 1 capital than the minimum required to maintain its“well-capitalized” status. The bank had a cash balance of $140billion as of June 30, giving it the ability to meet repaymentdemands for 33 months without issuing new debt, Chief FinancialOfficer Joe Price said on Sept. 15.
Asia Expansion
The investment bank has hired more than 200 people in Asiasince March, joining about 15,000 Merrill employees who workedoutside the U.S. before the merger. Additions include Bing Wang,who left Bank of America in 2008 and rejoined in July as head ofcorporate finance for China.
Revenue from non-North American business increased 160percent to $7.2 billion in the first half of this year comparedwith the same period in 2008, spurred by an almost threefoldincrease in Asia. The figure excludes a $7.3 billion gain fromthe sale of China Construction Bank Corp. shares. The combinedcompanies reported revenue of $4.3 billion in Europe, the MiddleEast and Africa and $2.2 billion in Asia.
Bank of America advised Suntory Holdings Ltd. on itsproposed takeover of Orangina Schweppes and Noble Group Ltd. onits sale of a 15 percent stake to China Investment Corp.,marking the biggest investment to date in the agriculturalsector by China’s sovereign wealth fund. The bank is a jointmanager of the pending initial public offerings of Wynn Macau,the Asian assets of U.S. casino operator Wynn Resorts Ltd., andKorea’s Posco Engineering & Construction.
‘Crown Jewel’
Merrill’s 15,000 brokers, termed the firm’s “crown jewel”by Lewis at the merger, “is the competitor that really no onecan match,” wealth-management head Sallie Krawcheck said in anAugust video message to employees. Global wealth and investmentmanagement reported a 15 percent gain in first-half profit to$951 million, as revenue more than doubled to $8.6 billion.
Krawcheck, 44, a former chairman of Citigroup’s globalwealth management unit, was hired by Bank of America in August.Executives at the firm say she is among at least five insidecandidates in line to succeed Lewis.
Hiring Krawcheck “was a fantastic move that shows they arebuilding a great leadership team,” said Mark Yusko, presidentof Morgan Creek Capital Inc., a $9 billion hedge fund in ChapelHill, North Carolina, that has invested in ventures withMerrill.
“Bank of America still has the capacity, once it works itsway through the present TARP crisis and loan losses, to be thenational financial Walmart,” said David Kotok, chairman ofVineland, New Jersey-based Cumberland Advisors, which oversees$1.2 billion and didn’t own any Bank of America shares as ofJune 30. “If you want to credit Lewis with something, credithim with this vision.”
To contact the reporter on this story:David Mildenberg in Charlotte at dmildenberg@bloomberg.net
Last Updated: October 4, 2009 20:00 EDTSource: Bloomberg
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