How the Government Forced BofA to Marry Merrill Lynch

Bank of America (BAC) chief executive Ken Lewis had coveted Merrill Lynch for quite some time. So when Merrill CEO John Thain contacted Lewis to ask if his bank was interested in buying Merrill, Lewis jumped at the chance.

John Thain sensed that Lehman Brothers (LEHMQ.PK) was about to fall, and if he didn’t act quickly, Merrill would be next. On September 15, 2008, Lehman filed for bankruptcy and Bank of America announced it was acquiring Merrill Lynch. Despite the financial tsunami that immediately ensued worldwide, Lewis proudly announced Bank of America would acquire Merrill in an all stock deal valued at $50 billion, or $29 a share.

Indeed, during the conference call to announce the deal, Lewis bragged that no government assistance was required to consummate the marriage.

We now know that Lewis spoke too soon. It seems Lewis was so besotted with his corporate fiancé that he was willing to overlook not only how rapidly the financial system had deteriorated, but also the manure piling up from the “thundering herd” in losses emanating from commercial real estate bonds and asset-backed securities.

On December 5, one day after American Banker named Lewis “Banker of the Year,” Bank of America and Merrill Lynch shareholders approved the marriage now valued at $16.5 billion. Three days later John Thain was preparing to ask Merrill’s Board to give him a $10 million wedding bonus that was said to have infuriated Ken Lewis.

By mid-December Ken Lewis was ready to call off the wedding, telephoning Fed Chairman Bernanke of his intention. At 6:00 PM on December 17, Lewis met with Bernanke and Treasury Secretary Paulson who told him Bank of America had to consummate the marriage. Lewis told them he would invoke a “material adverse change” clause in the contract to cancel the deal based on his newfound financial knowledge. Bernanke and Paulson responded that doing so would reflect not only the bank’s lack of due diligence in acquiring Merrill, but Bank of America’s inability to meet its commitment. They said that Bank of America’s failure to consummate the deal would cause further systemic risk to an already fragile financial system. Bernanke and Paulson assured Lewis that if Merrill’s fourth quarter numbers were as bad as Lewis believed, the Treasury would provide a rescue package similar to what Citigroup (C) got in November.

Ken Lewis and John Thain kept quiet, and on January 1, 2009, Bank of America married Merrill Lynch. As word leaked out that Bank of America had gotten a second helping of TARP from the government, Bank of America hastily rescheduled its fourth quarter 2008 earnings call to 7:00 AM January 16. The Treasury with the approval of the Obama administration injected an additional $20 billion into Bank of America in exchange for preferred shares paying an 8% dividend. The Treasury, the Federal Reserve, and the FDIC agreed to backstop up to $118 billion in “selected capital markets exposure” (75% of which is Merrill’s) for an additional $4 billion preferred stock plus warrants. And in a new twist coming from the playbook of Obama National Economic Council Director-Designate Larry Summers, Bank of America was forced to shave its 32 cents per quarter common dividend down to a penny. Bank of America had a fourth quarter loss of $1.79 billion. (For FY08, Bank of America had a $4.01 billion profit.) Merrill’s fourth quarter loss was $15.31 billion.

No doubt the next phase of the saga will be shareholder lawsuits as lawyers try to determine what did Ken Lewis know about Merrill and when did he know it? And it’s not just the shareholders who are angry that the value of their investment has been severely diluted. Just last week Bank of America employees received shares worth $14.33 apiece as compensation; yesterday the stock closed at $7.18.

Ken Lewis will be 62 on April 9, raising the possibility that Bank of America’s Board of Directors might allow him to announce his retirement rather than be fired. Regardless of whether Ken Lewis and John Thain remain at Bank of America, questions should be raised concerning the government’s insistence that the deal be consummated under its original terms. The opaque transformation from insisting that Bear Stearns common shareholders be punished to salvaging Merrill Lynch’s common shareholders to outright giving away the store to the private equity holders of Chrysler Financial is astonishing. There is still no consistency as to who lives and who dies, who is merely tortured and who is rewarded with mercy. Bank of America won’t be a “bank of opportunity” for shareholders until they buy their way out. But just like the Mafia and the roach motel, once you get in it’s nearly impossible to get out. Uncle Sam still needs Bank of America to carry out its social policies.

No disclosures.

Sources:

• New York Times: “For Bank of America, the Pressure Mounts Over Merrill Deal”
• Wall Street Journal: “BoA’s Latest Hit”, “Bank of America Goes On Offense”, “Mugging Bank of America”

Comments

[Ishortyou:]

Well things are not going to get better untill the oversupply in housing inventories go down. So far we have 18 months supply in housing inventories, about 600,000 new house starts and building permits, rising foreclosures, etc. all these factors creat a glut in the housing market that needs to be corrected. A Federal bann in new housing starts is a must, with it the equilibrium will be faster to be reached as well a better economy stand.

Jan 18 12:43 PM

[GregT:]

As a CEO, your first obligation is to do what is right for your shareholders. I realize that we are in a financial crisis, but CEO's should not abandon common sense - or their shareholders. BAC shareholders were screwed... By both the government and their own CEO. Owners of a healthy bank should not be forced to pay the price to save a failing one. The owners of BAC were deceived by both Lewis and MER. Furthermore, our government officials forced a private company to single handedly take on the burden of rescuing a failing institution. In the process the owners of the healthy private bank were screwed out of their equity and dividends.

Jan 18 12:59 PM

[tk77mann:]

No need for a federal ban on housing starts. The economy has done that already. What is needed is stability in the housing market. Lower interest rates, fewer job losses (and therefore more housing demand), and banks able to loan money will together start the process of absorbing the oversupply of housing.

Jan 18 01:01 PM

[Charlotte:]

Temple Sloan needs to step up to his responsibility as lead Director and fire Lewis quickly. The speed at which BAC is deteriorating suggests that he may have a week or two at most.

Jim Hance could quickly step in as CEO for a 2 year transition period or Al DeMolina could step in as permanent CEO (as bad as BAC is it's Shangrila compared to what was required to save GMAC).

Others that need to go include Joe Price (who led due diligence on LaSalle, Countrywide and Merrill and himself to be far beyond his capability), Amy Brinkley (who is among the worst CRO's of all time), Liam McGee who insisted ion the massive expansion of BACs mortgage and Home Equity businesses even as the market was exploding and Steel Alphin (the HR puppet who has been Lewis chief enabler in purging the company of any and all succession candidates). Nothing would improve morale at BAC more than to see Lewis and Alphin escorted from the building.

Everyone knows that Temple Sloan defines the term gentleman, but now everyone wants to know if he also has the courage and backbone to do the right thing.

Jan 18 01:12 PM

[eliazar:]

One thing is clear, nobody is able to pay the average house price at this time. So houses should work just as oil does, lower the price and sell. Once the cost of housing drops down, the economy will be back on track.
The average home price is 180k, or so right now, but people can not pay that much. If houses drop to 120k, then, and until that happens the market will be back on it's feet. The further we wait to lower the price, the worse it will get.
Come on!!! I want to pay 1000 a month for a decent house here in Seattle, but the average paimente is 2200!!! Get real, I didn't want to pay $4 a gallon for gas, so they lowered the gas price by half. But I'm not driving that much untill I get $1 a gallon.

Jan 18 10:54 PM

[rmenton:]

It now looks like BAC significantly overpaid, which would have been a direct result of inadequate due diligence. Thain said the positions which led to the deterioration in earnings were legacy. Therefore they should have been examined at the time of due diligence. I don't know about invoking a "material change" clause. As for the shareholders, let's hope the new administration is willing to inherit the mistakes of Paulson/Bernanke/Lewis in respect of more losses. Clearly lawsuits will start springing up, and heads will roll. Will the shareholder get an escape route, is the question.

Jan 18 11:27 PM

[Stoex:]

No doubt material information regarding the MER purchase and ensuing deterioraton was voluntarily kept from shareholders. Not that is was a decision, it was a choice by the leader. What else has the leader been up to when it comes to decision making and personal wealth?
Shareholders and regulators should demand an inquiry to any hedging of personal shares (as compensation) that Lewis and his managers may have participated in over the last 2 - 3 years. Why? These cronies have been awarded hundreds of thousands of dollars as bonus money in the form of shares. No doubt they had a vesting or holding period, but can you imagine Lewis being awarded a bonus of say $1 million dollars with a holding period of three years and be held to market price flucuations that could result in him actually receiving less? That would be like saying, "Here Ken is your $1 million dollar bonus but we have no idea what its actually worth upon cashing out."
So did Lewis and any of his managers put on an over the counter collar on any awarded shares and when did they do this and more importantly did they do it at a time of being in possession of material information or when they where making decisions impacting shareholders. Such collars are not uncommon among the "rich". They will give up some upside (selling a call) and be protected from some downside (buying a put). As an otc trade, it doesn't hit the tape so nobody notices and the holder of the collar has protected his/her wealth.

Now shouldn't this be a disclosure requirement in all financial statements? Its not. We do get their share holdings but not on their personal hedging, if any, against those shares. Where is the SEC on all this? Why are shareholders demanding more? Why is there no confidence in the management of BAC? Seems like we all know why, just nobody doing anything about it.

Jan 19 09:20 AM

[mrbill:]

B o A CEO lackey calls Merill CEO lackey right before merger...

BAC: Hey, I hear your numbers are bad.

MER: Huh? There good.

BAC: No there not.

MER: Are too.

BAC: Stop it! I say they're bad, if you disagree, well, the deal's off.

MER: WTF???

BAC: Listen dope. If they're not bad, then the deal can't go through and you won't get your bonus. Got it?

MER: ??? Okay, okay, I get it. The numbers are bad then, and we'll prove it.

BAC: Fantastic!

Next week, B o A lackey gets semi-official numbers, then calls Bernanke & Paulson....

BAC: Look dudes, this sh$$t ain't gonna happen.

B/P: What do you mean?

BAC: The numbers are bad and there's a clause!!! We are out of this. Sorry.

B/P: You know your reputation is on the line.

BAC: So what! I'm a banker LOL!

B/P: Haha! You're a CEO of a major bank, actually. But that's close enough. Fine, how much do you need?

BAC: (big grin) a Twenty ?

B/P: Hmm... well okay, $20 billion it is. We'll just grab it from the TARP funds.

BAC: Hey Thanks!

B/P: Don't thank us, thank the U.S. Tax payers.

BAC: ROFL!

B/P: LOL!!!!

Jan 19 03:03 PM

[AssetReset:]

you should be doing earnings call recaps

You think BofA and Merrill colluded to understate Merrill's worth and get TARP funds?
Are you high?
Did you SEE what happen to B of A's stock price? It halved.
Its Corporate suicide to understate assets (or overstate estimated losses), especially in this hair-trigger market


On Jan 19 03:03 PM mrgeneric wrote:

> B o A CEO lackey calls Merill CEO lackey right before merger...<br/>
>
> BAC: Hey, I hear your numbers are bad.
>
> MER: Huh? There good.
>
> BAC: No there not.
>
> MER: Are too.
>
> BAC: Stop it! I say they're bad, if you disagree, well, the deal's
> off.
>
> MER: WTF???
>
> BAC: Listen dope. If they're not bad, then the deal can't go through
> and you won't get your bonus. Got it?
>
> MER: ??? Okay, okay, I get it. The numbers are bad then, and we'll
> prove it.
>
> BAC: Fantastic!
>
> Next week, B o A lackey gets semi-official numbers, then calls Bernanke
> &amp; Paulson....
>
> BAC: Look dudes, this sh$$t ain't gonna happen.
>
> B/P: What do you mean?
>
> BAC: The numbers are bad and there's a clause!!! We are out of this.
> Sorry.
>
> B/P: You know your reputation is on the line.
>
> BAC: So what! I'm a banker LOL!
>
> B/P: Haha! You're a CEO of a major bank, actually. But that's close
> enough. Fine, how much do you need?
>
> BAC: (big grin) a Twenty ?
>
> B/P: Hmm... well okay, $20 billion it is. We'll just grab it from
> the TARP funds.
>
> BAC: Hey Thanks!
>
> B/P: Don't thank us, thank the U.S. Tax payers.
>
> BAC: ROFL!
>
> B/P: LOL!!!!

Jan 19 04:29 PM

[diana Listmann:]

IT COULD BE THAT NOT ONLY WILL BANK OF AMERICA END UP
WITH ONE OF THE BIGGEST BAILOUTS BEFORE THIS ALL ENDS
BUT, HOPEFULLY THEY WILL END UP WITH ONE OF THE LARGEST
CLASS ACTION LAWSUITS FROM ITS STOCK HOLDERS!

I PLAN TO BE ONE OF THEM.

Jan 19 04:48 PM

[ozcutty2:]

I actually like what BAC have done, it was an all stock deal and included a chunk of BLK which is valuable.
The problem is everyone is so short term, in a couple of years Ken Lewis's aquisitions may look amazing value, but the public and the government want to interfere and ruin any long term thinking for short term political gain.

Same situation in UK, lets punish the banks, sure we will give them money, but we will make them pay 8-12% interest (which they can't afford) and wipe out shareholders. After all shareholders and rich greedy people who deserve to be punished.

Jan 19 06:58 PM