On the Wave of Crisis, Bank of America Emerges as a Financial Giant

After acquiring Merrill Lynch for $50 billion, Bank of America has created a group nearly as strong as Citigroup and has jumped into the top tier in the field of debt and equity trading worldwide.

Prepared by: Vanja Figenwald
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Once it gets dark for one, it dawns for another; this is true in life as well as in the financial world. More specifically, while the top five banks struggled for survival, some others, previously of secondary importance, have surfaced and welcomed their five minutes of fame. One of the names most frequently mentioned in this context was that of Bank of America, which saved Merrill Lynch for $50 billion. The new star has become Ken Lewis, the head of Bank of America, who, with this acquisition, created a group nearly as strong as Citigroup, the strongest American bank by assets. However, it remains unclear whether this strengthened Bank of America, as its friends affectionately call it, will benefit its shareholders or how it will navigate the currently turbulent seas of the financial world. It is certain that Lewis understands the epic proportions of the opportunity presented to him.

– I approached Stan O’Neal (then head of Merrill) a few years ago, but he showed no interest – Lewis recalls his initial attempts towards his rival. However, thanks to a stroke of luck, he found himself in a position to complete his grand strategic vision. The acquisition of Merrill by Bank of America will create exactly the kind of player that the head envisioned, a dominant factor in almost all financial services. By capturing Merrill’s herd of 16,700 financial advisors, it became the largest brokerage institution in the world with $2.5 billion in client assets. If both companies maintain their current market shares, Bank of America will leap from a second-tier player to the top tier in the field of debt and equity trading worldwide. After years of acquisitions that created the first true national banking brand, this bank already occupies the top position in credit card business, retail banking (with over six thousand branches), and mortgages, thanks to the recent acquisition of Countrywide. Bank of America is now a true financial supermarket, a business model that thrives at rivals JP Morgan Chase under their head Jamie Dimon, but struggles at Citigroup.

Competitive Tension is Decreasing

Lewis, who is 61 years old, does not hide that he believes he has an advantage over the aforementioned duo because he is larger – in more businesses and in more places. He describes the future of finance in a way that might best be described as cautiously optimistic. He predicts the end of extravagant salaries and an increasingly difficult market that will leave only a few giants alive and a battlefield full of casualties. However, this is not necessarily all bad, if Lewis is to be believed. After all, he hates inflated salaries on Wall Street, the crisis has brought Merrill Lynch into his lap, and every downturn in the investment banking market is water to his mill. Nevertheless, Lewis has no illusions that the next few years will be smooth sailing for him. The golden age of financial services is nearly over and will never be the same again, he believes. His biggest problem currently is the dire situation for consumers as he sees the credit pie of the average American, pressed by high fuel prices and mortgages and with a threatened job, drastically shrinking.

Citizens, in his view, are as weak as the banks, which means they will struggle to service current debts such as mortgages, credit cards, and auto loans. Therefore, Lewis sees an opportunity to expand his share by increasing credit while his rivals wither on the sidelines. The advantage of Bank of America is not only its substantial capital fund but also that remaining players, such as Morgan Stanley and Goldman Sachs, will have to significantly reduce their balances after transitioning to traditional banking. Lewis is therefore convinced that the remaining banks will be significantly easier competitors than before. Why? Well, since Goldman and Morgan must reduce their balances by cutting their load, they will not be able to offer the same financial options that their corporate clients increasingly demand, who expect banks to expand their credit lines and allow loan restructurings. And therein lies the rabbit. To satisfy and attract new corporate clients, banks must do the exact opposite, namely increase their balance sheets.

Is Merrill Overpriced?

Regardless of how all the pieces fall into place in his favor, Lewis still faces certain obstacles. One of them is the issue of Bank of America’s capital, which has significantly decreased due to the acquisitions of Merrill and Countrywide. If the bank fails to raise its capital levels, its capital-to-assets ratio will fall to 7.4 percent, which is below the targeted eight to 8.5 percent. Lewis’s possible solution is to cut the company’s $3 billion quarterly dividend, specifically $11.8 billion annually. This, in turn, will disappoint investors who rushed to its stock due to its reliability and increasing profitability. Moreover, this is also a self-inflicted wound for Lewis, who until recently assured investors that cutting the dividend was unlikely. Another major question for Bank of America is the potential overpayment for Merrill. Although Lewis considers the acquisition a ‘strategic life opportunity,’ the value paid is questionable. At one point, Lehman was also in the mix, but after closer examination, Bank of America decided that the potential gain could not be measured against a certain loss of ten billion dollars.

He demanded significant state involvement from Treasury Secretary Paulson, and when he refused, he decided to walk away from Lehman, which soon collapsed. Just a day later, he was called by John Thain, Merrill’s head, who proposed a merger, which brings us back to the question of why Lewis paid a 70 percent premium on Merrill’s stock, or $29 per share, which was the closing price that Friday, when it was clear that Merrill would find itself in a far worse position over the weekend due to Lehman’s collapse. Lewis explains this by saying that it would have been much harder for Bank of America to buy Merrill’s brokerage, which was their main interest, had it gone bankrupt. The matter would have gone to auction, and Bank of America would then have had to compete with rivals who had also been in the game from the start, such as Goldman and Morgan. Lewis does not regret the higher price because he is convinced it is worth more than $50 billion.