Bottom Line Backs Value for B of A of Merrill Deal

First in a series

A year later, there are signs Bank of America Corp. may be turning the corner with its much-maligned acquisition of Merrill Lynch & Co., leading some of the deal's original critics to believe it is paying off strategically.

Hurriedly arranged during the market's near-meltdown last September, the purchase has extracted its pound of flesh from the principal participants. Not all observers are ready to forgive chief executive Kenneth D. Lewis for the high price B of A paid in terms of finances and reputation. And certainly, from a legal perspective, Merrill is the nightmare that never seems to end for either the banking company or Lewis; high-profile departures and lingering issues over Merrill bonuses and disclosures to shareholders have become the norm.

Still, beyond that, on an operational basis, some people — not all — are warming up to the deal's fundamentals.

Gary Townsend, the CEO of Hill-Townsend Capital LLC, said, "Perspective has been dreadfully lacking" in the past year as people assessed the deal. "The timing of it was poor, and the amount they paid was too much," he said. "But at the end of the day, Merrill may provide over time a significant boost to Bank of America."

"Merrill Lynch is making a hell of a lot of money for the company," said D. Anthony Plath, a finance professor at the University of North Carolina at Charlotte. "From a strategic perspective, it makes perfect sense for them to have a killer investment bank. The only question is, how to do it in a way that benefits the shareholders?"

Jessica Oppenheim, a spokeswoman for the $2.3 trillion-asset Charlotte company, said Tom Montag and Sallie Krawcheck, who were tapped last month to oversee the businesses most closely linked to Merrill, were unavailable to comment. But Oppenheim did say the Merrill purchase presented "a huge opportunity to deliver one of the deepest and most sophisticated portfolios of financial solutions in the industry."

Merrill contributed to investment banking revenue that rose 60% in the second quarter, from a quarter earlier, to $1.6 billion. The rebranded Bank of America Merrill Lynch topped the first-half league tables for high-yield debt, leveraged loans and mortgage-backed securities, according to Dealogic.

Richard Bove, an analyst at Rochdale Securities, estimated in a note to clients last week that business lines with ties to Merrill had given B of A's profit a net lift of $5.6 billion in the first half of 2009, compared to a year earlier. This was true for trading, investment banking and wealth management, he said.

Observers said that such results are encouraging against the backdrop of an improving operating environment.

Marshall Front, the chairman of Front Barnett Associates Inc., a Chicago investment firm, said he has yet "to make a final judgment" on the deal's success but is "aggressively" buying B of A stock. "The financial markets have begun to recover, and people will view this deal in a different light in a year or two," he said.

Bove wrote in his note that he fears B of A may be forced to sell Merrill to defuse the company's mounting legal problems. "This would be a blow to the company and its shareholders," he wrote.

Plath, the finance professor, said B of A's biggest blunder was miscalculating "the arena" around the deal. "They have been totally blown away by the animosity and heavy-handedness that occurred," he said. Though Lewis was justified in firing former Merrill CEO John Thain after the bonus issue blew up, he said, the decision hurt a seamless integration. "That's when the wheels really came off," he said.

B of A lost several high-profile Merrill executives after Thain's mid-January ouster, though the company has touted the retention and promotions of both Montag and Andrea Orcel, a top investment banker in London who last week was named executive chairman of global banking and markets.

The company has said that broker attrition stabilized in March and that it had about 15,000 at June 30; hiring in the investment bank is offsetting defections, it added. "We continue to hire advisers and have added hundreds since January," Oppenheim said. "The advisers we are gaining are, on average, twice as productive as those we are losing."

Townsend said defections should be expected with B of A. "They are doing the best they can with what was a difficult marriage," he said. "To make it work, Bank of America had to cut significant costs. Compensation will never be the same. It's what they do with every merger." The legal issues "will end," he said, adding, "They only seem endless because currently we are going through it."

Just because some observers are warming up to the deal does not mean they are ready to let Lewis off the hook for making it a year ago, however. The underlying angst that played heavily into Lewis' losing his chairman title during April's shareholder meeting persists. And some said Lewis' position remains tenuous as B of A is hit by waves of embarrassing legal battles over the lack of disclosure last winter on bonuses and the mounting fourth-quarter losses at Merrill.

"The fact that the bonuses and losses were not disclosed is troubling" and overshadows positive momentum, said Timothy Yeager, a professor at the University of Arkansas and former economist at the St. Louis Fed. "What we don't observe are the benefits of the deal going forward."

Front agreed. "There are still a lot of people who hate Ken Lewis and are betting this deal is going to fail, but every week I see a small subset relent to take a less pessimistic outlook of the company." The key, he said, will be third-quarter results, which would show whether Bank of America has sustainable momentum.

Plath said that, for him, the real determinant of success would involve seeing the merged companies' main business lines — investment banking and mortgage and retail banking — working together. Such integration has always proven challenging for big banks. "They are running their individual businesses wonderfully, but they haven't gotten them working together," he said.

B of A has acted to connect various businesses. It moved 750 bank specialists to work with Merrill financial advisers, and they are pitching products such as mortgages and home equity lines to brokerage clients. Similar moves are under way to connect brokerage with commercial banking.

"That is the next step of creating value," Plath said. "Let's wait for the world to improve … , and they will be a huge force to be reckoned with in finance."