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Bullish On Merrill Lynch

July 21st, 2011 |

After former Bank of America Corp. Chief Executive Officer Ken Lewis scooped up a dying Merrill Lynch & Co. in September 2008, the deal looked amazingly bad.

Merrill lost more than $27 billion that year and the federal government had to give Bank of America $20 billion in capital to assist the acquisition. Then, Merrill turned around and paid top executives $3.6 billion in bonuses shortly after the deal closed. Even worse, Bank of America was forced to pay $150 million to the Securities and Exchange Commission to settle charges that the escalating losses at Merrill were disguised from shareholders while the deal was pending. Lewis later said Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Hank Paulson threatened to fire him if he backed out of the acquisition.

The Wall Street Journal called it the “deal from hell” and listed it under a compilation of some of the worst deals ever. But was it?

The Merrill deal might always have a mixed legacy. Some analysts—not to mention investor extraordinaire Warren Buffett—have argued that Lewis grossly overpaid for Merrill. The deal was valued at $50 billion when it was first announced and seemed a high price to pay for a company about to go belly up. Buffett said that if Bank of America had just waited a day, it could have paid nothing. Merrill was going the way of Lehman Brothers—which filed for bankruptcy on the same day the Merrill acquisition was announced. Still, the deal has shaped up rosy in comparison to the bank’s January 2008 purchase of mortgage lender Countrywide Financial Corp., with its portfolio of risky mortgages still racking up billions of dollars in losses and hobbling the bank years later.

In contrast, the legacy Merrill Lynch businesses are about the only thing making the bank any money today. Granted, the stock market rebound is a big part of that, as traders have racked up fees with the run up in stock prices and investment bankers have gotten more deals done, but the contrast is striking. The capital markets and wealth management operations, the bulk of which came from Merrill Lynch, have made the bank $22 billion in profits since the acquisition. Considering the final purchase price in January 2009 was $29 billion, Bank of America almost broke even. The nearly 100-year-old brand that is Merrill Lynch also is poised to take charge of the retirement assets of a coming wave of Baby Boomers, many of them Bank of America customers who could be won over to the investing side.

Bank of America’s investment bank is now a global enterprise during a time of increased deal-making, thanks to the Merrill acquisition. Bank of America Merrill Lynch is now the number two global investment bank in terms of revenue, behind JPMorgan Chase & Co., and has increased its global revenue market share from 6.8 percent in 2009 to 7.9 percent in the first quarter of 2011, according to research firm Dealogic.

“Merrill is clearly the tail wagging the dog right now at Bank of America,’’ says Nancy Bush, SNL Financial contributing editor, who follows Bank of America.

Richard Bove, an analyst with Stamford, Connecticut-based brokerage firm Rochdale Securities, thinks the merger is providing an opportunity for the bank to grow into international markets at a time when its domestic growth opportunities are limited.  Bank of America is hamstrung by a federal law capping the amount of domestic deposits any one bank can hold to 10 percent.

That means growth must come from either a struggling U.S. economy or international markets.

“The growth of wealth around the world dwarfs the growth of wealth in the United States,’’ Bove says. “I think this merger is pretty close to being the best that Bank of America or (its predecessor) NationsBank ever did,’’ he says. “This one was a blockbuster and it was extraordinarily successful for them.”

Even the cultural clashes predicted between conservative Southern bankers and aggressive Wall Street types from Merrill Lynch were overblown, Bove says.

Bank of America’s new CEO, Brian Moynihan, who had previously run the investment banking business for Bank of America, has allowed Merrill Lynch to maintain a separate identity. Unlike certain other institutions acquired by Bank of America or its predecessor, NationsBank, Merrill Lynch got to keep its name, its culture and its famous bull logo.

 “They stepped back and said there was value in the name and decided to let Merrill Lynch be more of its own deal,’’ says Bush. “It clearly was a good decision to recognize that brand and the equity it had.”

The fear that Bank of America would push brokers to sell mortgages or other products their customers might not want hasn’t come to fruition, brokers say, even though the company continues to talk about the cross-selling opportunities between the two.

One Merrill Lynch broker, who didn’t want to be identified because he was speaking to a reporter in violation of the firm’s strict media policy, says he hasn’t gotten a lot of referrals from the Bank of America side, but he has a whole new slate of loan offerings to pitch to his clients, including small business loans or even money to buy a jet. Before, Merrill Lynch could offer very little credit, especially to small business owners, except for a line of credit against the client’s investment assets.

He also says Bank of America is much more actively involved in local charities than Merrill Lynch was, and promotes volunteerism among employees every week.

Kent Rains, a former Merrill Lynch broker in Overland Park, Kansas, who left in May of last year, says he loved his former manager, Steve Pryor, but joining the independent broker-dealer Multi-Financial Securities Corp. meant more money and just as much access to financial products for his customers. He keeps 91 percent of his management fees now, using that to pay office expenses and his secretary’s salary, up from a 40 percent payout at Merrill Lynch.

“I loved working for Merrill. I thought I would retire at Merrill,’’ he says.

Rains says he lost some clients amid all the bad publicity about the $3.6 billion bonuses after the Bank of America acquisition, and a reported $1.2 million then-Merrill Lynch CEO John Thain spent to rehab his office.

“You’d spend 15 minutes of a client review just having to explain it,’’ he says. Clients would say, “We’re not leaving you, we’re leaving the company.”

Bank of America representatives did not respond to messages for comment on this story.

However much a disaster the Merrill acquisition might have looked in the beginning, it’s certainly paying off now.

Wealth management’s total client assets in the first quarter remained roughly the same as last year, at $2.2 trillion, despite the sale of Columbia Management in May 2010, which took $98 billion in assets off the books.

The average financial advisor made $931,000 in annualized revenue for Merrill Lynch in the first quarter, the highest among big brokerage firms.

Richard Lipstein, a managing director and partner at headhunter Boyden Global Executive Search in New York, says brokers who stayed with Merrill got the security of Bank of America’s balance sheet and more financial products to sell.

“My sense is, (the merger) has gone fairly well,” he says.

Lipstein adds that while Sallie Krawcheck, Bank of America’s president of Global Wealth & Investment Management, has a good reputation in the industry, brokers also can be difficult to please.

“There’s a lot at stake,’’ he says. “You have to keep the brokers happy or they can walk out the door with your [customers’] assets.”

Bank of America says it has 15,600 financial advisors, down from about 20,000 when the deal was announced.

After the acquisition, the bank nudged out some of the lower-producing advisors by shifting their pay downward, says Scott Smith, associate director of Cerulli Associates in Boston, which tracks data on brokerage firms.

The firm’s independent analysis estimates Merrill Lynch lost a net 3,488 brokers in 2009, the latest year available, but Smith says some of that was competition from independent firms and regional banks, which have been nabbing brokers from all the wirehouses, as the big national brokerages are called. Independent brokerage firms offer more leeway for the entrepreneurial broker, and the possibility of more pay, if the broker doesn’t lose too many clients in the switch.

In Registered Rep magazine’s Broker Report Card survey, collected in October of 2010 from more than 800 brokers, Merrill received the third highest marks from advisors rating their firms, behind Raymond James & Associates and Edward Jones. Seventy-one percent of Merrill Lynch advisors rated their firm the best to work for, down from 78 percent the year before. The ratings were based on qualities such as work environment, freedom from pressure to sell certain products, compliance support and management.

Smith thinks Merrill Lynch is in a great position to take advantage of the retirement needs of Baby Boomers, many of whom do business at Bank of America, but might not have investments with Merrill Lynch.

“They can train tellers [to cross-sell],’’ he says. “It’s a natural referral opportunity.”

Cross-selling activity has given the wealth management division $4.5 billion in new assets, said President of Global Banking and Markets Tom Montag, at an analyst day in March.

At the same event, Krawcheck estimated that Merrill Lynch clients have $300 billion in loans and $600 billion in deposits with bank competitors, an obvious selling opportunity.

The retail banking side also offers opportunities for the brokerage business. Hoping to tap into the next generation of wealth, Bank of America launched Merrill Edge in January 2011, an online brokerage where people with less than $250,000 to invest can handle their own account online or talk to a call center.

It’s an important market for Bank of America, which has estimated that 22 percent of its retail banking clients are “mass affluent,” meaning they have from $50,000 to $250,000 of investable assets.

The call center and online brokerage is not a change in strategy from legacy Merrill Lynch. The company, which was founded in 1914, catered to everyday Americans in its early decades with its branch network of financial advisors. But in the last few decades, like other brokerages, it has focused the attention of its “thundering herd” of brokers on higher-net worth clients, pushing those with less to invest into an online brokerage account.

For the financial advisors who deal directly with clients, “They have very sticky, very profitable relationships,’’ says Jaime Peters, an analyst at Chicago-based Morningstar, who covers Bank of America. When their investments lose value, “people tend to blame the stock market or mutual funds, not their broker.”

Peters is less enthusiastic about the capital markets end of the business, which she considers difficult to differentiate from competitors.

But it’s not nearly as difficult as the mortgage banking and credit card business has been for Bank of America.

“I don’t think anyone would dispute that Countrywide was a crappy acquisition,’’ says Peters, who added that the Countrywide and credit card company MBNA acquisitions have been far worse for Bank of America than Merrill Lynch. Bank of America’s home loans and card businesses have lost a combined $27 billion between 2008 and 2010 in the midst of the housing meltdown and recession. Plus, the bank still is grappling with problems in mortgages from its Countrywide acquisition. Bank of America said in late June it would take a more than $20 billion hit to earnings related to an $8.5 billion settlement with investors who bought mortgage-backed securities tied to Countrywide loans, as well as set-asides for future mortgage-related claims and goodwill write-downs.  Earlier this year, Bank of America was alone among its large bank peers in saying it couldn’t raise dividends to shareholders following stress tests mandated by the government. It appears, the mortgage hangover has lingered. 

In contrast, Merrill Lynch dumped most of its bad assets in the fourth quarter of 2008 before the sale, which engendered a lot of bad publicity back then, but diminished the bad assets on Bank of America’s books.

Of course, if interest rates rise, loan portfolios continue to improve, and the stock market comes off its highs, then the retail banking side of the business will look better and the halo glow around Merrill won’t be so bright, SNL's Bush says.

For now, the bank is finishing the final touches of the integration of Merrill, so it can turn its attention next year to extracting efficiencies at the bank, including consolidating four different deposit systems into one.

The Merrill Lynch deal has shaped up to be a success story, according to Jefferson Harralson, a stock analyst in Atlanta who covers Bank of America for investment bank Keefe, Bruyette & Woods.

“It was a big step in the direction of where Bank of America wanted to be,’’ he says. “They wanted to be bigger. Strategically, it fit.”

 And it needs to be a good strategic fit because it’s hard to argue that Bank of America didn’t overpay for a company that might well have ended up failing, handing former CEO Ken Lewis the opportunity to acquire Merrill at a fire sale price. “Clearly, Lewis was trying to do the right thing,’’ Bush says. “He didn’t want Merrill to come into the bank as a devalued franchise. He wanted to welcome them in at a fair price. His instinct was probably correct, but it wasn’t good for his shareholders.”   |BD|

nsnyder

Naomi Snyder is the managing editor for Bank Director, an information resource for directors and officers of financial companies. You can follow her on Twitter at twitter.com/naomisnyder or get connected on LinkedIn.