Case Analysis: Bank of America’s Acquisition of Merrill Lynch
Case Analysis: Bank of Americas Acquisition of Merrill Lynch
Read the case, Bank of Americas Acquisition of Merrill Lynch on page 702-718. Use the case analysis format provided below to address to identify the problems and provide several suggested solutions that the Bank of America executive team can review for possible implementation.
Be sure to identify “identify 2 to 3 problems” and “develop 2 to 3 possible solutions to the problems identified”, and use this as the focus for making your case in the case format. Note: The case questions provided at the end of each case can be used as an insight to what the problems might be; so be sure to investigate the case carefully.
*** Required reading attached (Bank of Americas Acquisition of Merrill Lynch)
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Case 23Bank of America’s Acquisition of Merrill Lynch
December 2008
On the afternoon of Monday, December 22, 2008, Ken Lewis, chairman and CEO of Bank of America Corporation, was preparing for a special meeting of Bank of America’s board of directors, which would be held by telephone at 4 p.m.
The meeting was critical to the future of Bank of America and to the future careers of Lewis and his top management team. The meeting offered the board its final opportunity to pull the plug on its acquisition of Merrill Lynch & Company, which was to be consummated in ten days’ time (January 1, 2009).
The acquisition, announced on September 15, 2008 (see Exhibit 1 for the press release), would create America’s biggest financial services company in terms of total assets. It was the culmination of a succession of acquisitions that had transformed North Carolina National Bank first into NationsBank, then, after its 1998 acquisition of San Franciscobased BankAmerica, into Bank of America Corporation.Table 1shows Bank of America’s principal acquisitions.
TABLE 1Bank of America’s growth by acquisition
Year
Company acquired
Notes
1960
Security National Bank of Greensboro merges with American Commercial Bank of Charlotte
Merged bank named North Caroline National Bank (NCNB)
1982
First National Bank of Lake City (Florida)
First outofstate acquisition by NCNB
1991
C&S/Sovren of Atlanta
NCNB changes its name to NationsBank
1993
MNC Financial of Maryland
1998
BankAmerica Corporation of San Francisco
NationsBank renamed Bank of America
2004
Fleet Boston Financial Corporation
Expands into Northeast
2006
MBNA
Bank of America becomes largest US creditcard issuer
2007
US Trust
Bank of America becomes leading US private bank for wealthy individuals
2007
ABN AMRO North America
Major subsidiary: La Salle Bank Corp.
2008
Countrywide Financial
Bank of America becomes US’s largest mortgage lender
2008
Merrill Lynch & Company, Inc.
September 15 bid to take effect January 1, 2009
Source
:http://about.bankofamerica.com/enus/ourstory/ourhistoryandheritage.html
EXHIBIT 1
The Merger Announcement: Extracts from the Press Release
CHARLOTTE (September 15, 2008)Bank of America Corporation today announced it has agreed to acquire Merrill Lynch & Co., Inc. in a $50 billion allstock transaction that creates a company unrivalled in its breadth of financial services and global reach. Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders, Bank of America Chairman and Chief Executive Officer Ken Lewis said. Together, our companies are more valuable because of the synergies in our businesses. Merrill Lynch is a great global franchise and I look forward to working with Ken Lewis and our senior management teams to create what will be the leading financial institution in the world with the combination of these two firms, said John Thain, chairman and CEO of Merrill Lynch.
Bank of America expects to achieve $7 billion in pretax expense savings, fully realized by 2012. The acquisition is expected to be accretive to earnings by 2010.
The combined company would have leadership positions in retail brokerage and wealth management. By adding Merrill Lynch’s more than 16,000 financial advisers, Bank of America would have the largest brokerage in the world with more than 20,000 advisers and $2.5 trillion in client assets.
The combination brings global scale in investment management, including an approximately 50% ownership in BlackRock, which has $1.4 trillion in assets under management. Bank of America has $589 billion in assets under management. Adding Merrill Lynch both enhances current strengths at Bank of America and creates new ones, particularly outside of the United States. Merrill Lynch adds strengths in global debt underwriting, global equities and global merger and acquisition advice. After the acquisition, Bank of America would be the number one underwriter of global high yield debt, the third largest underwriter of global equity and the ninth largest adviser on global mergers and acquisitions based on pro forma first half of 2008 results.
Sources:
http://newsroom.bankofamerica.com/pressrelease/corporateandfinancialnews/bankamericabuysmerrilllynchcreatinguniquefinancial, accessed October 1, 2012. Reproduced with permission.
Despite its size, little planning preceded the merger announcement. It came the same day that Lehman Brothers filed for Chapter 11 bankruptcy protection amidst growing fears that the global financial system was going into meltdown. Anticipating that Merrill Lynch might be the next major financial institution to fail, the acquisition was hastily brokered by the chairman of the Federal Reserve Board, Ben Bernanke, and the US Treasury Secretary, Hank Paulson. Announcing the merger, Bank of America’s chairman and CEO, Ken Lewis, stated: The fact that we could put this transaction together in less than 48 hours is a great statement on the strength of both our teams, but also on the great strategic fit which, from the instant that we talked about it, became clear that this transaction would make a lot of sense.
Others were less convinced that the transaction made sense. The biggest concern was that Bank of America was overpaying. TheFinancial Times’Lex column commented:
Even if Merrill is being taken out at a third of its 52week high, it is, in the circumstances, hardly a steal at 1.8 times tangible book value and 12 times 2009 earnings. Mr.Thain’s willingness to accept market realities has enabled Merrill shareholders to escape a total wipeout. As Jamie Dimon noted after acquiring Bear Stearns, there is a difference between buying a house and buying a house that’s on fire. While flames are licking at Merrill’s outhouses, Mr. Thain has persuaded BofA’s Ken Lewis there is still plenty of time to douse them. But until Mr. Lewis can prove that Merrill has suffered only cosmetic damage, he will struggle to get investors excited about promised savings worth $7bn or 10% of the cost base. BofA’s shares fell 15%, destroying $23bn of value.
If the deal proceeds to plan, BofA would secure the Merrill brand and the largest retail broker network in the US, with a 17,000strong herd of financial advisers as well as a leading investment bank and wealth management franchise. There are, though, two big dangers. First, much of the risk Merrill has offloaded in its vendorfinanced sale of toxic securities could come back to haunt its new owner. Second, a culture war between two workforces remunerated according to different pay systems seems unavoidable.1
During the final quarter of 2008, pessimism about the merger continued to grow. Bank of America’s share price declined from $29.55 on September 16, 2008 to $13.53 on December 22. The main concern was Merrill’s balance sheet. On October 16, Merrill reported a thirdquarter loss of $5.1 billion resulting mostly from a writedown in the value of its CDOs (collateralized debt obligations) and other realestate related assets.
By midDecember it was becoming clear that Merrill’s fourthquarter results would be even worse. Bank of America’s chief financial officer, Joe Price, estimated that Merrill Lynch’s fourthquarter losses had risen from $9 billion to $12 billion.
These revelations about the full horrors of Merrill’s financial position removed any lingering doubts over whether Bank of America had overpaid for Merrill: current losses and future writedowns probably meant that Merrill Lynch was worth absolutely nothing. The issue for Lewis and the board was whether to invoke the MAC clause in the merger agreement, which allowed the merger to be called off in the event of a materially adverse event occurring.
There followed a flurry of communications between Lewis, Bernanke, Paulson, and officials at the US Treasury. After informing them of Bank of America’s desire to exit the merger, Lewis became a target of sustained pressure from the Department of the Treasury in particular.
Paulson reminded Lewis of the risks to the entire US financial system that would result from Bank of America’s rescinding of the merger agreement, risks that would inevitably have a major impact upon Bank of America itself. Paulson also indicated that, should Bank of America invoke the MAC clause, the US government would seek the removal of Bank of America’s board and top management team. However, if Bank of Americawent ahead with the merger, the Treasury and Federal Reserve System would provide whatever assistance was needed by Bank of America to restore its capital and to protect it against the adverse impact of toxic Merrill Lynch assets.2
As Lewis got ready to speak to his fellow board members, he realized that he was faced with the most difficult decision of his entire career. If Bank of America went ahead with the merger, Merrill’s appalling financial situation would be a major drag on Bank of America’s performance, would depress its share price, and would undoubtedly anger shareholders. However, beyond the short term, probably the next two to three years, he believed that shareholders would reap considerable benefit from the strategic advantages from creating one of the world’s biggest universal banks. Rescinding the merger and leaving Merrill Lynch to its fate might also be the trigger for the financial calamity that President Bush had forewarned in his recognition that: This sucker might go down!3
The potential conflict between Lewis’s moral obligations to his shareholders and to his country was further complicated by his legal duties. As chairman and CEO, Lewis was required to inform shareholders of company matters relevant to their interests. Although shareholders had on December 5 approved the acquisition of Merrill Lynch, this was without the new projections of Merrill’s fourthquarter losses. When Lewis had raised issues of disclosure with Bernanke and Paulson, he had been informed that such disclosure would not be conducive to the stability of the US financial system.4
The Strategic Issues Arising from the Merger
The strategic arguments in favor of the merger were outlined in a joint press conference by the two CEOs (Ken Lewis and John Thain) made on September 15, 2008. Lewis saw Merrill Lynch as adding critical strengths to Bank of America in relation to both individual financial services and corporate financial services.Figure 1shows two slides from their presentation.
FIGURE 1Extract from merger presentation by Ken Lewis and John Thain
In terms of individual financial services, Merrill Lynch’s USwide network of local offices and its army of financial advisers would represent a massive extension of Bank of America’s existing brokerage and wealthmanagement services. In addition, Bank of America anticipated that the combination of the largest US wealthmanagement organization with one of America’s biggest retail banks with presence in 31 states would offer considerable opportunity for offering a wider range of financial services to the clients of each.
Merrill Lynch’s much bigger presence outside of the US would also offer Bank of America the opportunity to build a truly international wealthmanagement business.
In terms of Bank of America’s corporate and investment banking, the merger would transform Bank of America from a provider of corporate banking services with comparatively smallscale investment banking activities into one of the world’s leading investment banks. Not only was Merrill strongly positioned in all the world’s major financial centers; it had also established a strong position in the emerging markets of Asia, Eastern Europe, Latin America, Africa, and the Middle East, most notably in the BRIC countries. Appendices 1 and 2 provide information on the businesses and performance of the two companies.
The Costs and Benefits of Universal Banking
With the addition of Merrill Lynch, Bank of America would become one of the world’s leading universal banks along with Citigroup and JPMorgan Chasebanks that had taken advantage of the repeal of the GlassStegall Act to combine commercialand investment banking. This socalled universal banking model was common in Europe, where UBS, Deutsche Bank, Credit Suisse, BNP Paribas, Barclays, Royal Bank of Scotland, and UniCredit had long combined conventional banking services with capital market activities, corporate advisory services, market making, and proprietary trading.
The relative merits of diversification and specialization within banking services were a topic of debate and disagreement.
The case for universal banking was based upon the benefits, first, of risk spreading and, second, of synergies among different banking services:
The riskspreading benefits of universal banking became apparent during the financial crisis, when most US investment banks either failed or converted into bank holding companies. The stability of the universal banks was their ability to finance themselves through bank deposits rather than relying on wholesale money markets. Within retail banking, the casualties were among specialists such as Washington Mutual, Halifax Bank of Scotland, and Northern Rock. However, apart from 20082009, the stability benefits of diversification are less evident. Like other diversified companies, universal banks appear to suffer a conglomerate discount. Nor are their credit ratings superior to those of specialist banks.
Synergies within universal banks related to economies of spreading the costs of IT and corporate services over multiple businesses and the benefits of crossselling services to customers. At the retail level these included selling both banking services and wealth management products and services to the same consumers. For corporate clients it involved providing a wide range of banking, advisory, and corporate finance services. There were also believed to be vertical integration benefits from combining investment banking servicesespecially underwriting and securitization with a retail distribution network of banks and wealth management advisors.
However, as with risk spreading, the synergy benefits of investment banks tended to exist more in theory than in practice. Crossselling had long been an elusive goal for financial service companies. It had inspired mergers between banks and insurance firms to create bancassurance companies. Yet, there were few companies that could point to major revenue gains from crossselling financial services.
In terms of other economies of scope, the risk was that any such economies were offset by the added complexity created from integrating functions and establishing coordination among different financial service businesses. Costtoincome ratios, a key measure of efficiency among financial service companies, tended to be higher in most universal banks than in more specialist institutions.
In principle, universal banks should also derive economies from their ability to use banking deposits to finance their underwriting, market making, and trading activities, thereby giving them greater independence from external capital markets. However, any such potential economies were limited by an evertightening regulatory framework that was designed to prevent cheap retail deposits being used to finance riskier investmentbanking activities.
However, the greatest disadvantages of complexity relate to the effective management of universal banks. Professor Jordi Canals of IESE argued, financial conglomerates involve additional problems related to risk management, conflicts of interest and capital allocation.5In large universal banks, effective risk management is compromised by the increasing distance of top management from operational decision making. Conflicts of interest arise between individuals engaged in different activities and for different clients. While constraints on reallocating capital often result in a tolerance for underperforming business units.
Finally, this complexity affects the design of management systemsnot least compensation systemsand the management of corporate culture. Economic commentator John Kay, observed:
Within every diversified retail bank, there is evidence of the fundamental tension between the cultures of trading and dealmaking buccaneering, entrepreneurial, graspingand the conservative bureaucratic approach appropriate for retail banking. It is a conflict in which the investment bankers and traders generally come out on top.6
Appendix 1: Bank of America Corporation: Business Activities and Performance (extracts from 10K report for 2007)
General
Bank of America Corporation (Bank of America or the Corporation) is a Delaware corporation, a bank holding company and a financial holding company under the GrammLeachBliley Act. Our principal executive offices are located in the Bank of America Corporate Center, Charlotte, North Carolina 28255.
Through our banking subsidiaries (the Banks) and various nonbanking subsidiaries throughout the US and in selected international markets, we provide a diversified range of banking and nonbanking financial services and products through three business segments: Global Consumer and Small Business Banking, Global Corporate and Investment Banking and Global Wealth and Investment Management. We currently operate in 32 states, the District of Columbia and more than 30 foreign countries. The Bank of America footprint covers more than 82% of the US population and 44% of the country’s wealthy households. In the US we serve approximately 59 million consumer and small business relationships with more than 6100 retail banking offices, more than 18,500 ATMs and approximately 24 million active online users. We have banking centers in 13 of the 15 fastest growing states and hold the top market share in six of those states
As of December 31, 2007, there were approximately 210,000 fulltime equivalent employees within Bank of America and our subsidiaries. Of these employees, 116,000 were employed within Global Consumer and Small Business Banking, 21,000 were employed within Global Corporate and Investment Banking and 14,000 were employed within Global Wealth and Investment Management
TABLE 2SelectedFive Year Summary of Financial Data
($billion, except where indicated)
2007
2006
2005
2004
2003
Income statement
Net interest income
34.4
34.6
30.7
28.0
20.5
Noninterest income
31.9
38.0
26.4
22.7
18.3
Total revenue, net of interest expense
66.3
72.6
57.2
50.7
38.8
Provision for credit losses
8.4
5.0
4.0
2.8
2.8
Noninterest expense, before merger and restructuring charges
36.6
34.8
28.3
26.4
20.2
Merger and restructuring charges
0.4
0.8
0.4
0.6
Income before income taxes
20.9
32.0
24.5
20.9
15.8
Income tax expense
5.9
10.8
8.0
7.0
5.0
Net income
15.0
21.1
16.5
13.9
10.8
Performance ratios (%)
Return on average assets
0.94
1.44
1.30
1.34
1.44
Return on average common shareholders’ equity
11.08
16.27
16.51
16.47
21.50
Return on average tangible shareholders’ equity
22.25
32.80
30.19
28.93
27.84
Total ending equity to total ending assets
8.56
9.27
7.86
9.03
6.76
Total average equity to total average assets
8.53
8.90
7.86
8.12
6.69
Dividend payout
72.26
45.66
46.61
46.31
39.76
Market price per share of common stock
Closing ($)
41.26
53.39
46.15
46.99
40.22
High closing ($)
54.05
54.90
47.08
47.44
41.77
Low closing ($)
41.10
43.09
41.57
38.96
32.82
Market capitalization
183.1
238.0
184.6
190.1
115.9
Average balance sheet
Total loans and leases
776.2
652.4
537.2
472.6
356.2
Total assets
1,602.1
1,466.7
1,269.9
1,044.6
749.1
Total deposits
717.2
673.0
632.4
551.6
406.2
Longterm debt
169.9
130.1
97.7
92.3
67.1
Total shareholders’ equity
136.7
130.5
99.9
84.8
50.1
Asset quality
Allowance for credit losses
12.1
9.4
8.4
9.0
6.6
Nonperforming assets measured at historical cost
5.9
1.9
1.6
2.5
3.0
Allowance for loan and lease losses as % of total loans and leases
1.33
1.28
1.40
1.65
1.66
Net chargeoffs
6.5
4.5
4.6
3.1
3.1
Net chargeoffs as % of average loans and leases
0.84
0.70
0.85
0.66
0.87
Nonperforming loans and leases as % of total loans and leases
0.64
0.25
0.26
0.42
0.77
Nonperforming assets as % of total loans, leases and foreclosed properties
0.68
0.26
0.28
0.47
0.81
Ratio of the allowance for loan and lease losses at December 31 to net chargeoffs
1.79
1.99
1.76
2.77
1.98
Capital ratios (period end)
Riskbased capital:
Tier 1
6.87
8.64
8.25
8.20
8.02
Total
11.02
11.88
11.08
11.73
12.05
Tier 1 Leverage
5.04
6.36
5.91
5.89
5.86
TABLE 3GLOBALCONSUMER AND SMALL BUSINESS BANKING
2007 ($billion)
Total
Deposits
Card services
Consumer real estate
ALMaand other
Net interest income
28.8
9.4
16.6
2.3
0.5
Noninterest income:
Card income
10.2
2.1
8.0
0.0
Service charges
6.0
6.0
0.0
Mortgage banking income
1.3
1.3
All other income
1.3
(0.0)
0.9
0.1
0.4
Total noninterest income
18.9
8.2
9.0
1.4
0.4
Total revenue, net of interest expense
47.7
17.6
25.5
3.7
0.9
Provision for credit losses
12.9
0.3
11.3
1.0
0.3
Noninterest expense
20.1
9.1
8.3
2.0
0.6
Income (loss) before income taxes
14.7
8.2
5.9
0.6
(0.1)
Income tax expense
5.3
3.08
2.2
0.2
(0.2)
Net income
9.4
5.2
3.7
0.4
0.1
Net interest yieldb(%)
8.15
2.97
7.87
2.04
n.m.
Return on average equity
14.94
33.61
8.43
9.00
n.m.
Efficiency ratiob
42.07
51.81
32.49
55.24
n.m.
Period endtotal assets
443.0
358.6
257.0
133.3
n.m.
Note:
n.m. = not meaningful.
aAsset and liability management.
bThe efficiency ratio measures the costs expended to generate a dollar of revenue; net interest yield evaluates how many basis points we are earning over the cost of funds.
The strategy for GCSBB is to attract, retain and deepen customer relationships. We achieve this strategy through our ability to offer a wide range of products and services through a franchise that stretches coast to coast through 32 states and the District of Columbia. We also provide creditcard products to customers in Canada, Ireland, Spain and the United Kingdom. In the US we serve approximately 59 million consumer and smallbusiness relationships utilizing our network of 6149 banking centers, 18,753 domestic branded ATMs, and telephone and internet channels. Within GCSBB there are three primary businesses:
Depositsprovides a comprehensive range of products to consumers and small businesses. Our products include traditional savings accounts, money market savings accounts, CDs and IRAs, and noninterest and interestbearing checking accounts. Debit card results are also included in Deposits.
Card Servicesprovides a broad offering of products, including US Consumer and Business Card, Unsecured Lending, and International Card. We offer a variety of cobranded and affinity creditcard products and have become the leading issuer of credit cards through endorsed marketing in the US and Europe.During 2007, Merchant Services was transferred to Treasury Services within GCIB.
Consumer Real Estategenerates revenue by providing an extensive line of consumer real estate products and services to customers nationwide. Consumer Real Estate products are available to our customers through a retail network of personal bankers located in 6149 banking centers, mortgage loan officers in nearly 200 locations and through a sales force offering our customers direct telephone and online access to our products. Consumer Real Estate products include fixed and adjustable rate loans for home purchase and refinancing needs, reverse mortgages, lines of credit and home equity loans. Mortgage products are either sold into the secondary mortgage market to investors while retaining the Bank of America customer relationships or are held on our balance sheet for ALM purposes The Consumer Real Estate business includes the origination, fulfillment, sale and servicing of first mortgage loan products, reverse mortgage products and home equity products.
TABLE 4Global corporate and investment banking
2007 ($billion)
Total
Business lending
Capital market and advisory
Treasury services
Net interest income
11.2
5.0
2.8
3.8
Noninterest income:
Service charges
2.8
0.5
0.1
2.1
Investment and brokerage services
0.9
0.0
0.9
0.1
Investment banking income
2.5
2.5
Trading account profits (loss)
(5.2)
(0.2)
(5.1)
0.1
All other income
1.1
0.8
(1.0)
1.1
Total noninterest income
2.2
1.2
(2.5)
3.3
Total revenue, net of interest expense
13.4
6.2
0.3
7.1
Provision for credit losses
0.7
0.6
0.0
Noninterest expense
11.9
2.2
5.6
3.9
Income (loss) before income taxes
0.8
3.4
(5.3)
3.3
Income tax expense
0.3
1.2
(2.0)
1.2
Net income (loss)
0.5
2.1
(3.4)
2.1
Net interest yield (%)
1.66
2.00
n.m.
2.79
Return on average equity (%)
1.19
13.12
(25.41)
26.31
Efficiency ratio
88.88
34.98
n.m.
54.02
Period endtotal assets
776.1
305.5
413.1
180.4
Note:
n.m. = not meaningful.
Global Corporate and Investment Banking provides a wide range of financial services both to our issuer and investor clients, who range from business banking clients to large international corporate and institutional investor clients,using a strategy to deliver valueadded financial products and advisory solutions. Global Corporate and Investment Banking’s products and services are delivered from three primary businesses: Business Lending, CMAS and Treasury Services are provided to our clients through a global team of client relationship managers and product partners. In addition, ALM/Other includes the results of ALM activities and other GCIB activities (such as commercial insurance business, which was sold in the fourth quarter of 2007). Our clients are supported through offices in 22 countries, which are divided into four distinct geographic regions: US and Canada; Asia; Europe, Middle East and Africa; and Latin America.
Business Lendingprovides a wide range of lendingrelated products and services to our clients Products include commercial and corporate bank loans and commitment facilities, which cover our business banking clients, middle market commercial clients and our large multinational corporate clients. Realestate lending products are issued primarily to public and private developers, homebuilders and commercial realestate firms. Leasing and assetbased lending products offer our clients innovative financing solutions. Products also include indirect consumer loans, which allow us to offer financing through automotive, marine, motorcycle and recreational vehicle dealerships. Business Lending also contains the results for the economic hedging of our risk to certain credit counterparties utilizing various risk mitigation tools.
Capital Markets and Advisory Servicesprovides financial products, advisory services and financing globally to our institutional investor clients in support of their investing and trading activities. We also work with our commercial and corporate issuer clients to provide debt and equity underwriting and distribution capabilities, mergerrelated advisory services and risk management solutions using interest rate, equity, credit, currency and commodity derivatives, foreign exchange, fixed income and mortgagerelated products. The business may take positions in these products and participate in marketmaking activities dealing in government securities, equity and equitylinked securities, highgrade and highyield corporate debt securities, commercial paper, mortgagebacked securities and ABS. Underwriting debt and equity, securities research and certain marketbased activities are executed through Banc of America Securities, LLC, which is a primary dealer in the US.
Treasury Servicesprovides integrated working capital management and treasury solutions to clients worldwide through our network of proprietary offices and special clearing arrangements. Our clients include multinational
