Digesting Merrill A Challenge for BofA’s Lewis

December 13, 2008 Updated: December 14, 2008

NEW YORK—On a conference call to discuss Bank of America Corp.’s surprising takeover of venerable brokerage house Merrill Lynch on Sep. 15, Bank of America (BofA) CEO Kenneth Lewis said the merger “brings together two story brands and creates a company unrivaled in this breadth of financial services and global reach.”

Lewis is no stranger to wheeling and dealing, completing more than $100 billion worth of acquisitions since his appointment as the firm’s chief executive. But last year’s $4 billion purchase of subprime mortgage lender Countrywide Financial proved disastrous, as the company faced dozens of lawsuits and substantial mortgage asset devaluation as the mortgage market worsened in 2008.

In October BofA settled with 15 state attorneys general to modify subprime mortgages inherited from Countrywide for $8.4 billion.

While Merrill has a slew of bad mortgage assets, Lewis was obviously more attracted to Merrill’s army of 16,000-strong financial advisors and its solid wealth management group. The deal may turn out to be a winner, but the biggest question facing BofA today is how well the company can integrate Merrill into its business and what kind of savings, if any, will result.

‘Panicked’ Sale

BofA scooped up Merrill on Sunday, Sep. 14, during the same weekend of a Federal Reserve-brokered meeting to rescue Lehman Brothers Holdings Inc. Both BofA and British bank Barclays Plc were potential buyers of Lehman’s assets.

But in the waning hours of that fateful Sunday, both Lehman suitors balked at purchasing Lehman without a similar guarantee from the Fed that assisted the Bear Stearns sale five months earlier. In a shocking turn of events, Merrill sold itself to BofA, and a deal was announced the following Monday.

A report by New York Magazine last week alleged that Merrill CEO John Thain, who was at the negotiations table for the Lehman rescue, “panicked” and sold his company hastily to BofA. Thain had previously denied that his company needed additional capital.

On the conference call Lewis lauded potential benefits of the deal.

“Merrill Lynch brokerage provides us with an immediate platform with expertise, strength and delivery capabilities,” he said. “We have retail banking distribution; they have financial advisors giving us the capability to provide client solutions across the full-range of both banking and investment products.”

Some analysts are very skeptical of Merrill’s financial wellbeing, and feel that like its Countrywide deal, BofA may find a few nasty surprises ahead.

“There are some hand grenades on the balance sheet that are going to blow up on Bank of America,” James Ellman, a former Merrill Lynch money manager told Bloomberg News. “The cost savings are going to be nowhere near what they’ve already promised.”

Responding to a question on BofA’s due diligence on Merrill’s financial assets, Joe Price, BofA CFO, said that the company “had well over 45 people from our team on site as well as others off site, outside counsel” scrutinizing Merrill’s books.

Uncertain Future

The U.S. economic condition has deteriorated since BofA and Merrill’s merger announcement. During the past two months Congress passed the $700 billion troubled asset relief program, job losses reached their highest levels since 1974, and last week lawmakers announced that the United States is officially in a recession.

Thain will assume the position as global head of investment banking and wealth management post merger, and is a possible successor to Lewis’s position as CEO.

Even Lewis, BofA’s ever-optimistic CEO, conceded that his company may be facing tougher times in the future. “Given reported earnings for the third quarter and an economic outlook that shows a weaker economy going in to 2009, we view paying a lower dividend as prudent capital management,” Lewis announced on a call with analysts for third-quarter earnings.

Integrating Merrill’s 60,000 employees into BofA’s workforce of 247,000 people may be a difficult task, some analysts believe. Merrill’s presence will balloon Bank of America to become the largest brokerage firm in the world, in addition to being the largest bank by assets and the largest loan servicing company in the United States.

Lewis will undoubtedly retain most of Merrill’s marquee financial advisors and salespeople, together nicknamed “The Thundering Herd,” a reference to Merrill’s corporate logo the bull. BofA’s CEO admitted last month that post-merger job cuts may number in the thousands, a figure some analysts believe to be too low.

Also, some current BofA bankers and traders may feel uneasy regarding their job security, as Merrill’s incoming investment banking and trading operations are more established and more heralded.

BofA may ultimately reap the rewards of its Merrill acquisition, but if its past mergers are any indication (think FleetBoston and MBNA), the present is mired with risks and missteps that could derail Lewis’s promise.