Merrill Bringing Down Lewis Gives Bank 30% Profits

Oct. 5 (Bloomberg) -- Merrill Lynch & Co., which helped bring down Kenneth D. Lewis, may end up saving his bank.

The decision by the 62-year-old Bank of America Corp. chief executive officer to purchase Merrill in January for $29 billion already is generating more than 25 percent of the bank’s profits -- along with charges by government officials that he misled investors about the extent of losses and bonuses.

When he announced last week that he would step down by the end of the year, Lewis could take some comfort from making the Charlotte, North Carolina-based bank, the largest in the U.S. by assets, less reliant on consumer spending, poised to benefit from overseas growth and better able to compete with rival JPMorgan Chase & Co., according to David Stowell, a professor of finance at Northwestern University in Evanston, Illinois, and a former managing director at JPMorgan.

“While the purchase brought massive mortgage-related losses, it also bought 15,000 stockbrokers who link up nicely with the bank’s deposit base,” Stowell said. “It’s hard to see how they could keep up with JPMorgan without a big, significant acquisition like Merrill.”

Merrill’s businesses contributed $1.8 billion to Bank of America’s first-half net profit of $7.5 billion, or 28 percent, even after the bank posted $27 billion in loan charge-offs and higher loan-loss reserves, according to company filings. Those businesses are likely to account for 25 percent to 30 percent of the bank’s profits over the next three years, said John McDonald, an analyst at Sanford C. Bernstein & Co. in New York.

Market Share
The share of the bank’s revenue that came from investment banking and wealth management rose to 47 percent in the first half, after the Merrill acquisition, from 29 percent last year, according to the bank.

While more than three dozen senior traders and bankers have left since the merger, Bank of America Merrill Lynch, the investment-banking unit, captured “some very real market-share gains from fallen competitors that should likely prove sustainable going forward,” McDonald wrote in an Oct. 1 report.

The bank this year has won 6.4 percent of advisory roles in global mergers and acquisitions by dollar value, compared with a 7.8 percent share for the two firms in 2008 and 7.2 percent in 2007, according to Bloomberg data. It ranks fifth behind Morgan Stanley, Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan, Bloomberg data show. By reported advisory fees, it’s in fourth place, behind Goldman Sachs, Morgan Stanley and JPMorgan.

In global equity and equity-linked transactions, Bank of America Merrill Lynch ranks fourth, the same position Merrill held 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 the other hand Merrill did have some really good franchise players, and at least part of that franchise is still intact,” said Michael F. Holland, chairman of Holland & Co. in New York, which oversees more than $4 billion including JPMorgan shares.

Bank of America’s challenge is to avoid stifling Merrill’s culture, said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York. “Merrill Lynch has always been one of the top three investment banks, and that will continue.”

Shares of Bank of America have risen 19 percent this year, compared with Citigroup, which have fallen 31 percent. The KBW Bank Index, which measures the performance of 24 large U.S. banks, is up 3.1 percent in the same period.

Goldman Recommendation
Bank of America gained 52 cents, or 3.2 percent, to $16.86 in composite trading on the New York Stock Exchange at 2:07 p.m. Goldman Sachs raised its view on Bank of America and the nation’s biggest banks to “attractive” from “neutral,” saying their share prices don’t reflect prospects for earnings growth.

“This merger made sense from just about every angle one could look at,” Richard Bove, an analyst at Rochdale Securities Inc. in Lutz, Florida, wrote in a Sept. 21 report. “In hindsight this deal was a steal because it now appears that the bank can pay for Merrill’s price with one year’s worth of Merrill revenues.”

The bank, which received $45 billion under the government’s rescue plan, needs brokerage and investment-banking fees to overcome higher losses in its credit-card and home-loan businesses, which make up 36 percent of revenue. Charge-offs for credit-card loans deemed uncollectible climbed to 14.5 percent in 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.

Real Estate
With real-estate values down by 20 percent from their 2006 peak, Bank of America also faces higher losses from its $401 billion in residential loans and $75 billion in commercial- property loans, said Allen Greer, a Los Angeles real estate consultant who left the bank in January after a 17-year career.

“The outlook for the bank has gotten uglier,” Greer said.

The bank plans to make a decision on the appointment of an “emergency” chief executive officer this week should Lewis step down before the end of the year, the Wall Street Journal said today, citing unidentified people familiar with the situation.

Lewis, who said in his Sept. 30 resignation announcement that the Merrill deal “is returning value already,” has warned that second-half results will be marred by higher losses from consumer and commercial real-estate loans. Global card services lost $3.5 billion in the first half, and home lending and insurance had a $1.2 billion deficit.

Earnings Schedule
Third-quarter earnings are scheduled to be reported on Oct. 16. A loss of 9 cents per share is expected, the average of 24 analysts surveyed by Bloomberg.

Merrill’s prospects remain clouded by about $32 billion of assets listed as Level 3 as of June 30, an accounting term for securities 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 of America has inherited and what kind of losses are going to flow through,” Williams said. “If the market for these assets does recover, it will prove to be the right move for the bank.”

Bank of America also acquired Countrywide Financial Corp. in July 2008 for $2.5 billion. The deal, concluded in the midst of the worst housing slump since the 1930s, made the bank the second-largest U.S. home lender with a 21 percent share of home loans in the second quarter of 2009, according to National Mortgage News. The U.S. economy shrank for four quarters after the acquisition, including a 6.4 percent contraction of gross domestic product in the first three months of this year.

Home Loans
While low interest rates spurred home lending during the first half, with revenue up 275 percent from the same period a year earlier without Countrywide, more borrowers defaulted.

“In the long run they’ll get the bad assets from Countrywide off their books, but they would have been better off without them for the next few years,” said Gradient’s Williams.

Buying Countrywide will look wise as U.S. housing prices stabilize, said William Isaac, former chairman of the Federal Deposit Insurance Corp. The S&P/Case-Shiller home-price index rose 1.2 percent in July from the prior month, the biggest gain since October 2005. The index was down 13.3 percent from a year earlier, the smallest decrease in 17 months.

Attorney General
The Merrill transaction is being scrutinized by attorneys general in New York, North Carolina and Ohio. Richard Cordray, attorney general of Ohio, is leading a class-action suit on behalf of investors seeking billions of dollars from Bank of America over the Merrill transaction, and New York Attorney General Andrew Cuomo is weighing whether to bring charges against executives for misleading investors. At least three shareholder lawsuits have been filed to protest the acquisition.

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