It was a long, painful process — a kind of death by a thousand leaks — but after months of disclosures and complaints about Bank of America Corp.’s acquisition of Merrill Lynch & Co. last year and BofA’s decision to pay billions in bonuses to its investment bankers, Kenneth Lewis bowed to the seemingly inevitable when he announced he was stepping down as CEO.
The bitter irony for Lewis is that just as his own position was becoming untenable, Merrill’s performance was beginning to justify the deal. The New York–based investment bank is set to generate about one quarter of the combined firm’s net income and nearly 20 percent of revenues this year, based on company filings.
“Merrill Lynch is holding up BofA earnings,” says Paul Miller, banking analyst at Arlington, Virginia–based FBR Capital Markets Corp. “Without it, the bank would be losing money in a big way.”
Lewis staunchly defended the takeover even as he was grilled by investigators, including New York State Attorney General Andrew Cuomo, and criticized by many shareholders for the deal. The strategic reasons for buying Merrill Lynch “are still in place, and they’re playing out as we speak,” Lewis told Institutional Investor in an interview several weeks before his September 30 announcement that he would retire at the end of the year. “We now are a huge investment bank and we’ve built out the equity platform in one fell swoop, and we achieved a sizable international presence at the same time. It answered all the questions about our commitment and our geographic reach.”
The recession and housing collapse have hit BofA’s big consumer banking business hard. Huge losses on credit card, home lending and insurance helped push the bank into a net loss of $1 billion in the third quarter, compared with a profit of $1.2 billion in the same period a year earlier. The bank is expected to take charge-offs of about $35 billion on troubled assets for the full year.
Merrill, however, has benefited from the revival of capital markets activity this year. The investment bank generated $1.84 billion in net income in the first six months of the year, or about 25 percent of BofA’s $7.47 billion in earnings for the period, according to company filings. The investment banking unit had revenues of $12.1 billion over the period, representing about 18 percent of the group’s overall revenues of $68.5 billion. Lewis contends that the combined BofA-Merrill should eventually be capable of producing net income of $30 billion.
“Merrill is generating some pretty good dough,” says Anthony Polini, banking analyst at Raymond James & Associates. “Skeptics have to think this deal makes sense over time.”
Those results failed to spare Lewis, who had become increasingly mired in government investigations over whether senior BofA officials misled shareholders about Merrill’s bonus payments and deteriorating financial condition late last year, just before the takeover was approved. Cuomo, whose office has reportedly subpoenaed five BofA board directors, said Lewis’s resignation would not affect his inquiry. Separately, the Securities and Exchange Commission heads to court in February to pursue civil charges related to disclosures about the Merrill bonuses after a U.S. district court judge threw out the agency’s proposed $33 million settlement with BofA.
Investors, meanwhile, have also criticized the deal’s dilutive impact on their holdings. BofA has increased the number of outstanding shares by more than 74 percent since announcing the Merrill Lynch purchase. The takeover also prompted the bank to seek an additional $20 billion in federal bailout funds, raising its total to $45 billion.
“The only thing Ken Lewis has focused on is size, footprint and market share — not risk, risk return or protecting shareholders,” notes Jonathan Finger, managing partner of Houston-based Finger Interests Number One.
Lewis, 62, also failed to pay enough attention to his own succession, shuffling staff in August but failing to leave the board with a clear heir apparent. Sources say leading candidates include chief risk officer Gregory Curl, 61, and Brian Moynihan, 49, head of consumer banking. For whoever gets the job, repayment of $45 billion in government bailout funds will be a top priority. Time may be crucial, following the decision by federal pay czar Kenneth Feinberg to cut compensation for the bank’s top executives this year. That could leave BofA open to executive departures, as competitors operating without government pay restrictions poach senior talent.
