Year-End Buyouts: Big Challenges for the Big Banks

Three major U.S. banking deals were completed last week, enabling the buyers to finalize their deals before 2008 came to a close.

The first two deals were completed Thursday, the last day of the year. Bank of America Corp. (BAC) completed its purchase of Merrill Lynch & Co. Inc. (MER), creating the largest U.S. bank - as well as the biggest challenge yet for longtime BofA Chief Executive Officer Kenneth D. Lewis. And Wells Fargo & Co. (WFC) completed its $12.7 billion purchase of Wachovia Corp. (WB) - outbidding Citigroup Inc. (C) and making a massive bet that it accurately quantified the still existing risks in Wachovia’s huge portfolio of mortgage and real estate loans.

A third major deal was finalized Wednesday. The Pittsburgh-based PNC Financial Services Group Inc. (PNC) acquired Cleveland’s National City Corp. (NCC) - yet another big lender hurt by mortgage losses - in a deal valued at roughly $3.9 billion. The deal turns PNC, which sidestepped most of the mortgage mess afflicting other lenders, into the No. 5 U.S. bank, with about $291 million in assets. National City, hampered by bad loans, was forced to seek a buyer after federal regulators told executives of the Cleveland bank that federal bailout aid wouldn’t be forthcoming, The Wall Street Journal reported.

These buyouts are the latest examples of how billions of dollars in U.S. bank rescue funds are helping fuel buyouts worldwide, and not lending at home, as a Money Morning investigative report demonstrated.

By closing its buyout of Merrill Lynch, Bank of America reaches $2.7 trillion in assets, and bypasses both JPMorgan Chase & Co. Inc. (JPM) and Citigroup in size (as measured by assets). To finance the merger, BofA had expected to issue 1.71 billion common shares, equal to $24.1 billion, plus 359,100 preferred shares. Merrill Lynch shareholders received 0.8595 of a Bank of America common share for each of their Merrill common shares.

The transaction, originally valued at $50 billion, was announced in the early morning hours of Sept. 15, about an hour before Lehman Brothers Holdings Inc (LEHMQ.PK) went bankrupt. The deal ends more than 94 years of independence for Merrill, but very likely saved the investment bank from a fate similar to Lehman in a year in which five top Wall Street banks were bought, went bankrupt, or changed their business structures.

By acquiring Merrill, BofA’s Lewis is swallowing Merrill’s so-called “thundering herd” of 17,000 brokers, which he has labeled the “crown jewel” of the buyout deal. The Charlotte, N.C.-based Bank of America will also absorb Merrill’s big investment bank, which by volume ranked fifth in debt and equity underwriting and third in merger advice in 2008, Thomson Reuters reported.

The combined company’s brokerage, credit card, investment banking, mortgage and wealth management operations, plus its deposit base, will make it the nation’s largest, or close to it.

Bank of America also takes over Merrill’s nearly 50% stake in the powerful money manager BlackRock Inc. (BLK).

“We are now uniquely positioned to win market share and expand our leadership position in markets around the world,” Lewis said in a statement on Thursday.

Big Challenges for the Big Bank

The Merrill Lynch transaction creates new challenges for Bank of America, whose shares fell 66% last year as the worsening economy led to soaring loan losses, including from Countrywide Financial Corp., which BofA bought in July. A big challenge: Lewis must find a way to stem defections of top performers and key executives even as he slashes at least 30,000 jobs in a cost-cutting initiative that should save the big bank $7 billion annually by 2012.

That won’t be enough, however. While Bank of America and Merrill together raised $25 billion of capital from the U.S. Treasury Department’s $700 billion Troubled Asset Relief Program (TARP), and BofA halved its dividend, analysts believe another dividend reduction is inevitable. And it may have to raise additional capital, too.

BofA has managed to navigate the banking mess - and has tried to capitalize on it.

Before buying Merrill, Lewis had spent close to $110 billion to buy FleetBoston Financial Corp, credit card issuer MBNA Corp., LaSalle Bank Corp., the wealth-management business of U.S. Trust, and Countrywide Financial.

Now Bank of America is generally viewed as being “too big to fail.” For his efforts, American Banker, the banking industry trade journal, last month named Lewis “Banker of the Year” for the second straight year. However, the competitive landscape Lewis faces going forward is changing radically - as is evidenced by Wells Fargo’s $12.7 billion buyout of Wachovia, a Charlotte-based rival of BofA.

John A. Thain, who became Merrill’s chief executive after losses in mortgage-related investments led to the October 2007 ouster of Stanley O’Neal, agreed to run the merged company’s global banking, securities and wealth management businesses. If he remains with the merged entity, Thain will be a prime candidate to eventually replace Lewis, who is 61 and became Bank of America’s CEO back in 2001.

Wachovia Closes Deal, Too

The Wells Fargo/Wachovia merger closed Thursday and more than doubles Wells Fargo’s size, making it the No. 4 U.S. bank as measured by assets. Wells Fargo now also has the nation’s largest retail brokerage operations, as well as its largest branch network, with more than 6,600 offices in 39 states and Washington, D.C.

The San Francisco-based Wells Fargo agreed on Oct. 3 to buy Wachovia, beating out a smaller bid by Citigroup, which was planning to only buy a portion of Wachovia. Citigroup’s bid included government backing, while Wells Fargo’s did not. Wells Fargo said Wachovia branches will keep their brand name - or they will at least for the “near future,” Reuters reported.

Regulators pushed Wachovia to find a buyer after it was pushed to near ruin by zooming losses from “option” adjustable-rate mortgages (ARMs) that it took on back in 2006 when it bought California lender Golden West Financial Corp.

In November, Wells Fargo announced that it expected it would have to write down $71.4 billion of Wachovia’s $482.4 billion loan portfolio, including $36 billion of option ARMs and $9.6 billion of commercial real estate.

According to Reuters, analysts have said Wells Fargo was cautious in its assessment of the risks in Wachovia’s mortgage portfolio, but the U.S. economy and housing market have continued to deteriorate so quickly that those estimates might now be out of date.

“We’re not at the end” of the housing slump, Wells Fargo CEO John G. Stumpf said on Dec. 10 at a conference. “But we’re starting to see some early signs that maybe we’ve reached the bottom in housing or close to it.”

Wells Fargo is the nation’s No. 2 mortgage lender. It remained profitable by avoiding many of the risky loans that plagued Wachovia, caused the failures of Washington Mutual Inc. and IndyMac Bancorp Inc. and drove Countrywide Financial into the hands of BofA.

Wachovia shareholders received 0.1991 of a Wells Fargo share for each of their shares, valuing the bank at $5.87 per share. That’s down from $59.39 when the Golden West merger was announced in May 2006, a level never again reached. Wachovia shares closed Wednesday at $5.54, down 85.4% in 2008.
Shares of Wells Fargo closed Wednesday at $29.48, down just 2.4% for the year. The KBW Bank Index, which includes Wells Fargo, fell 50% last year, Reuters said.

Wells Fargo expects the merger to result in at least $5 billion of annual cost savings, and to boost earnings per share by 20% or more in 2011 and higher amounts thereafter.

Including Wachovia, Wells Fargo has about $1.4 trillion of assets.

Original post

Comments

[1worldcurrency:]

Too big to fail, but not too big to be nationalized, when the taxpayer gets sick of paying fat dividends and bonuses to banks that lose money.
A TARP can smother, also.

Jan 04 05:34 AM

[CautiousInv...:]

The Merrill Lynch transaction creates new challenges for Bank of America, whose shares fell 66% last year as the worsening economy led to soaring loan losses, including from Countrywide Financial Corp., which BofA bought in July. A big challenge: Lewis must find a way to stem defections of top performers and key executives even as he slashes at least 30,000 jobs in a cost-cutting initiative that should save the big bank $7 billion annually by 2012.


I find that remark about defections rather specious as employment in the entire financial landscape is shrinking. That argument is usually invoked by instituions, which just issued a bunch of preferred shares to the treasury, want to pay bonuses.

Jan 04 07:08 AM

[jrs87sch:]

Both of these companies are going to have a very rough next few years. Keeping an over-sized merger together, not to mention profitable, in these harsh economic times is going to be a struggle.

I really don't picture Thain becoming CEO of the new B of A. He needs to either retire or go to a different financial company to find an executive position because people think of him and Merrill falling as synonymous. It would not bode well for Bank of America.

Jan 04 09:21 AM

[sheople:]

There is way too much imbreeding between the "banks to big to fail" and the feds and treasury. It's hard to keep track of who is sleeping with who. It is easy to figure out who is getting screwed, though.

Jan 04 09:45 AM

[M-P:]

It's interesting how Lewis has often blamed his failings on anything but himself and his actions, which I've written about in previous posts. I'd like to see a more "mature" management style and personal ownership. I'm still amazed at how many emails and letters I get from BAC that demonstrate how siloed their customer database is and how fractured their marketing efforts are. I'll be very interested to see if Lewis can exploit his assets and up-sell and cross-sell the BAC customer base, which has grown significantly. We all own BAC at this point and I would like to see them be successful, but I don't want to see the taxpayer throw good money after bad. The too big to fail model is a little scary and puts all of us at some risk.

Jan 04 10:29 AM

[tylakewalker:]

Besides being "Too big to fail" Bank of America has proven "Too big to offer anything resembling good customer service"
Furthermore, these large banks are stealing from taxpayers. Boycott them, close your accounts with the large banks and open accounts with small banks and credit unions.

Jan 04 11:12 AM

[Moon Kil Woong:]

My biggest bone of contention is that are banks buying other banks because it makes any business strategic sense vs. attempts to get the givaway Paulson cash and the Fed's bond buys or backing deals. If it is the latter then it just highlights that the US will now be a programmed manipulated economy driven by political forces and Fed manipulations which, although independent from the government acts like a government agency without any oversight whatsoever.

The Fed was never created or designed to run industrial policy, manage portfolios, determine fair value of corporate and mortgage bonds and broker stock deals to support the stock market. The Fed is out of their leauge and off their legal leash. Just because politicians don't want to take the responsibility to determine fiscal policy, budgeting, and monetary authority, does that mean we should dump it on unelected bureaucrats who may or may not have ulterior motives.

In the end of the day Paulson probably cares a heck of a lot more about Goldman Sacs and his bankers friends than he will ever care about America or the average citizen. So can you blame him for his lopsided decisions. They were certainly predictable.

As the author points out, banks decisions on this matter are attempts to become essentially government backed bureaucracies free from the economic forces they were suppose to be beholden to, capitalism. If there is no risk of bankrupcy you start getting very wacky results.

Why don't they close 50% of their branches to save money and act like the DMV. I would not be surprised.


I also mentioned before, banks are trying to get to your CD and other money that requires no Federal reserve deposits so they can use those funds to pay their hidden losses. So in the end, you are feeding them even more free givaways besides government givaways. You won't see them until they run out of those and start eating themselves. That's when the real cost comes to light. And by then it will be too late.

I hope this will never happen but if the downturn lingers... it is a possibility. I think the government is trying to avoid reform by limiting pain. If you have a broken leg, shooting yourself up with morphine to walk an extra mile will only make your dilemma worse.

Jan 04 11:31 AM

[Moon Kil Woong:]

Sorry I mean money market accounts, not CDs. Banks are trying to get their hands on as much of this free, non-fed reserve deposit requirement cash it can get to help their cash flow. That's why they are always trying to get you to switch your $ from CDs to them.

Jan 04 11:37 AM

[1977°C:]

The big banks that had to fail already did so, year 2009 will be part II of year 2008 only with one major difference, the banks that remained will start to gain market share from the ones that left.This is natural process and it takes time it doesn't mean that bank stocks will rise at all, it only means that there is place to fill the demand gap as demand for banking didn't disappear with the banks that went bust.
This demand for banking overall will make rising revenues ( I had 4 bank accounts last year, now only 1 as I was not sure if other 3 banks will remain so this 1 bank gets 2-3 times more money from me for the services I used before with 4 banks) and even rising profits.
I would not invest now in most banks but one I think will be taken over soon Fifth Third Bancorp (NasdaqGS: FITB) and I am watching carefully.

Jan 04 12:03 PM

[ebworthen:]

I'm closing my accounts at WaMu (whatever they decide to call it) and refinancing my mortgage with a small bank.

Theft and indentured servitutde is what the average person has experienced with financial institutions and the government.

Rome wasn't destroyed in a day, it was dismantled from within by greed and the betrayal of the average ciitzen.

Jan 04 02:09 PM

[Kevin Walmsley:]

Too big to fail probably means they're also too big to succeed. Now that the taxpayer is on the hook for future losses, why should the banks lend? Would you?
Suppose you were a banking executive at the new, federally funded Bank of America, and have before you a loan application from a large retailer. Or a big commercial developer. Or an aircraft leasing company. Or a heavy equipment manufacturer. And you know that in the event of default, not only might you lose your job, but you might have to testify before Barney Frank's goons on the House Financial Services Committee, followed by the possibility of incarceration. Would such a prospect make you more inclined to lend? Or less so?
As soon as the United States Congress became part of their board of directors, Wall Street became Amtrak. Too big to fail, yes. Too politically connected to officially go bankrupt, yes.

But no sane person would invest money in it.

Jan 04 11:31 PM

[1worldcurrency:]

And why should you invest in companies that have lost money? These are not companies that burn cash in an attempt to come up with a cancer cure or solar-electric car. Their only business is to make money, which they stink at. The only reason they can pay dividends is they get hundreds of billions in TARP and Fed money.

Jan 05 06:29 AM