Bank of America chief executive Ken Lewis on Monday said his $50 billion purchase of brokerage Merrill Lynch was a “deal of a lifetime” that creates a financial services giant better equipped to weather the nation's banking crisis by serving more retail and corporate customers.
But on a rocky day for financial markets, investors sent his stock down more than 20 percent, as analysts questioned whether Lewis paid too much for an institution seen as the next likely victim in the credit crunch. Bank of America also faces a tricky integration, even as it grapples with its purchase of mortgage lender Countrywide Financial. And critics of the bank's ever-growing girth wondered how big is too big.
The takeover forms a global powerhouse and the country's biggest bank by assets, at more than $2.5 trillion. But the move comes amid tumultuous times for the financial services industry, and Lewis painted a gloomy portrait of the coming months. While he expects the economy to pick up some in late 2009, he doesn't see mounting loan losses subsiding until 2010. Lewis acknowledged the purchase means more job cuts and integration challenges, but he's betting on long-term success.
“The combined company is a much stronger entity and will survive most anything,” Lewis said at a nationally televised news conference held at the bank's new Manhattan office tower.
The transaction marries Bank of America's massive consumer bank – tops in deposits, mortgages and credit cards – with the largest force of stock brokers, a top-flight global investment bank and a stake in respected money manager BlackRock. Lewis, a Mississippi native who has spent his whole career at the bank, said the move validated his long held belief that standalone investment banks need to pair with more stable commercial banks.
As for Charlotte, the city snares another out-of-town institution and plays a role in rescuing Wall Street. Lewis confirmed the headquarters will stay here, but he noted the company already has a sprawling array of businesses, based in cities from New York to Boston to Delaware to California.
For employees, the deal means another round of job cuts, even as the company slashes 7,500 positions in its Countrywide purchase. Lewis said it would be several months before the bank knows precise layoff numbers. It expects to cut $7 billion in annual costs, or 10 percent of the combined company's cost base, by eliminating back-office jobs, reducing vendor costs and consolidating office space. Bank of America has about 206,000 employees, while Merrill Lynch has about 60,000.
Match was struck swiftly
The takeover was a surprising twist that emerged from a dramatic weekend in New York, where Wall Street executives and U.S. officials raced to find a buyer for battered investment bank Lehman Brothers but ultimately failed.
The deal began with a Saturday morning call from Merrill Lynch CEO John Thain to Lewis. While hashing out Lehman's fate at the New York Federal Reserve Bank, Thain said he decided to explore opportunities for his own firm. Investment banks are under pressure because they depend on short-term financing to fund operations, and that has become more precarious in the credit crunch. Commercial banks can count on a more reliable deposit base.
Lewis, who has long eyed Merrill, said the two executives saw the potential for a match in about “two seconds” and agreed to meet face-to-face. “It was very intense,” Lewis said. “We saw a lot of each other.”
Teams from both firms analyzed each other's books. Bank of America was familiar with Merrill as a competitor and had explored merger opportunities in the past, Bank of America chief financial officer Joe Price said. The bank also relied on assistance from investment firm J.C. Flowers, which had recently examined Merrill.
A deal was struck Sunday night and officially announced early Monday.
Thain said he did not talk to any other possible buyers. Bank of America had been in the running for Lehman, but backed off because it couldn't get any government aid. Lewis said he faced no pressure from regulators in the deal.
Whether Thain, 53, will have a role in the combined company is unclear. Some Bank of America insiders wondered whether he could be a candidate to someday succeed Lewis if he stayed on. Lewis, 61, faces mandatory retirement at age 65. Thain would receive an exit package of about $9.7 million if the deal is completed, a pay consultant told the Wall Street Journal.
Under the purchase, which is expected to be completed in the first quarter, the company's combined 20,000 stock brokers will keep the Merrill Lynch name and organization, Lewis said. The bank didn't detail other management posts.
Thain said he had heard almost all positive feedback from his firm's “thundering herd” of financial advisers. Once the deal is complete, Lewis said they should expect a flurry of client referrals from his coast-to-coast branch network as Bank of America looks to tap affluent customers.
Under the deal, which needs shareholder and regulatory approval, the bank would pay 0.8595 of a Bank of America share for each Merrill share. That's a 70 percent premium over Friday's closing price of $17.05 and a 29 percent premium over the average of the last five trading days. With the plunge in Bank of America's stock price Monday, though, the deal is now worth less.
The bank will take $2 billion in restructuring charges. It estimates the deal will reduce earnings by 3 percent in 2009 and be break-even in 2010.
Bank of America shares fell more than 21 percent to $26.55. Merrill shares jumped early in the day but ended almost flat at $17.06.
Asked if he paid too much, Lewis said he probably could have spent less but didn't want to risk Merrill surviving on its own or linking up with another rival. “I don't know anybody who's perfect at picking the absolute bottom,” he said.
Deal changes bank
The Merrill takeover dramatically alters a company that had relied heavily on its consumer bank for income.
Bank of America made 70 percent of its revenue from consumer banking in the first half of this year. With Merrill, it would have made about 48 percent of its revenue from consumer banking, with investment banking accounting for 32 percent and wealth management producing 20 percent.
Lewis has long expressed misgivings about buying an investment bank because of the risk and the potential for culture clashes. He admitted that the bank's progress in investment banking has been “frustrating” over the years, but noted Merrill Lynch gives the bank immediate size and scale, along with bringing its expertise in wealth management.
“I like it again,” he said of investment banking.
Bank of America's bid for Merrill Lynch could be a home run in the long term, analysts said, but they were hesitant to declare any short-term victory, given Merrill's continued exposure to subprime mortgages and the fact Bank of America might have to pay big bonuses to keep Merrill's top brokers from jumping ship.
The bank is also still digesting a recent acquisition spree.
It bought former subprime lender Countrywide on July 1 and is still converting systems from its purchase of LaSalle Bank in 2007. Lewis said the LaSalle and Countrywide transitions will be complete by the time his team turns to Merrill systems early in 2010. “I don't want to underestimate the size and the degree of difficulty,” he said. But the deal, he added, “will be done.”
Though Merrill CEO Thain has moved quickly to slash his firm's troubled assets, his firm remains exposed to problematic subprime mortgages and commercial real estate loans, said Jaime Peters, an analyst at Morningstar.
The deal will slightly lower Bank of America's capital holdings – a cushion to protect against losses – but it will remain well above the regulatory minimum, the bank said. It will look to rebuild capital over time and will consider “all options,” including lowering the dividend or selling some of its stake in China Construction Bank, executives said.
Getting bigger isn't always best for banks. It can be difficult to get businesses to work together, manage risk and serve customers effectively.
“Previous attempts at creating a true financial supermarket have not been particularly successful,” said Bill Cline, managing partner of The Cline Group, a capital markets consulting firm in South Carolina. He noted how Citigroup has shed some of the businesses it acquired under former chief executive Sandy Weill.
As the bank expanded under Lewis, it has faced criticism for eclipsing a 10 percent cap on total U.S. deposits, raising fees and cutting jobs. Merrill brings Bank of America $100 billion more in deposits, but executives said these wouldn't count against the cap.
The Service Employees Union International, one of the bank's most vocal critics, said consolidation is creating banks that are “too big to fail.” That means the government will feel obligated to bail them out, said SEIU spokeswoman Lynda Tran. “We're getting bigger banks, but not the stronger rules,” she said.
Asked whether his bank plans to do any more big deals, Lewis said the company will focus on serving customers and successfully carrying out the Merrill transition. He noted the deal has been long talked about, coming up in his first interview as CEO seven years earlier.
“I don't know if I'll ever get to do another acquisition during my career,” he said. “This is too important not to get right.”