How the Government Forced BofA to Marry Merrill Lynch

Jan.18.09 | About: Bank of (BAC)

Bank of America (NYSE: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 (OTC:LEHMQ) 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 (NYSE: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.

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