Views on B of A-Merrill: Good Fit, Plenty of Risk

With the deal to acquire Merrill Lynch & Co. Inc., Kenneth D. Lewis is poised take Bank of America Corp. to a size that Citigroup Inc. at its biggest couldn't match.

The questions on many minds once the deal came to light was first whether B of A, or any company, should be accepting the kind of risks an investment banking deal entails at this point in the cycle, and second, whether it made any sense at all to offer as rich a premium as B of A did.

For Mr. Lewis, a key factor that he said mitigated the risk in the deal was his judgment that Merrill could have ridden out the storm without a transaction.

Mr. Lewis, B of A's chief executive, said his company's review showed that Merrill Lynch "had the liquidity and capacity to see this through." In a call with analysts on Monday, he said the deal was much more about seizing upon "a rare opportunity" to rapidly expand his company than playing the role of a white knight preventing the failure of a major firm. Merrill has the largest retail brokerage operation on Wall Street, with 60,000 employees.

Mr. Lewis said that, because he felt Merrill Lynch could survive independently, and because of its massive network of financial advisers, he thought another buyer might move in had he held out for a lower price than the $29 a share, 70% premium agreed to by B of A.

"We thought the long-term benefits were so overwhelming … that we elected not to roll the dice" and bargain for a lower price, Mr. Lewis said on the analyst call.

Some analysts concurred with the view that Merrill probably did have the wherewithal to survive a cycle that has claimed Bear Stearns and driven Lehman Brothers into bankruptcy.

"I think Merrill could have gone on on its own, but the nerves of the market are in control," Robert Albertson, chief strategist at Sandler O'Neill & Partners LP, said in an interview Monday.

But many say that B of A will have much to prove, a characterization that echoes somewhat the sentiment after its deal to buy the mortgage lender Countrywide Financial. Indeed, B of A's shares were down more than 20% on a dismal day in the stock market.

"You've got to be worried about just how much Merrill is exposed to credit-default swaps. That's the next shoe to drop. I don't think it's big at Merrill, but there is probably risk there," Robert Ellis, senior vice president of wealth management at Marsh & McLennan Cos.' Celent, said in an interview Monday. "And there also may be more assets, tied to commercial real estate, that may need to be written down."

Offsetting that perceived risk somewhat is the fact that Merrill, under CEO John Thain, has already posted significant writedowns of troubled assets.

Merrill reported cumulative net losses of $19 billion over the past four quarters, a period in which it wrote off about $39 billion on bad investments, most of them mortgage-backed securities that sunk in worth as home-loan defaults mounted.

Christopher Whalen, the managing director of Lord, Whalen LLC's Institutional Risk Analytics in New York, said: "I am very concerned about Bank of America. … I assume Thain has done a good job writing down all this stuff, but you can't assume that they're done."

A year ago, such a deal would have been a most improbable outcome given the direction each executive was taking his company. Mr. Lewis was pulling back from investment banking, saying — in comments that he later dialed back — that he had "had all the fun" he could stand in it.

Mr. Thain, who became CEO less than a year ago, acknowledged that when he took the job, his plans did not include trying to find a seller. He said a deal rose to the surface only after market conditions deteriorated further over the past several months. "It is fair to say that this is not necessarily the outcome I expected when I took the job," Mr. Thain said during a joint press conference with Mr. Lewis on Monday in New York.

Mr. Lewis said he led a 48-hour round of talks over the weekend, trying to hammer out a deal amid mounting concern about spreading weakness in the financial system. B of A passed on a possible Lehman deal after federal authorities said they would not intervene to save the troubled brokerage house.

Mr. Lewis said Mr. Thain called him Saturday morning to jump-start deal talks. Within a couple of hours, the two met in person, and by Saturday afternoon B of A bankers were poring over Merrill Lynch's books. "It didn't take but about two seconds to see the strategic implications, the positive implications," Mr. Lewis said.

Buying Merrill Lynch, an iconic Wall Street wealth management and investment banking firm with operations in 40 countries, would turn B of A into a money management powerhouse, with 20,000 financial advisers, 16,000 of them from Merrill.

The $1.74 trillion-asset company said it has its sights set on rapid growth in money management, with India, China, Russia, Brazil, and parts of the Middle East as key target markets.

Mr. Lewis acknowledged there was heavy pressure on his company to rebuild capital levels before closing the Merrill Lynch deal. B of A's Tier 1 capital ratio was above 8% before it acquired beleaguered mortgage company Countrywide Financial Corp. in July. That deal lowered B of A's Tier 1 ratio to just above 7%. That is well above the 6% that regulators consider a well-capitalized level, but Mr. Lewis said B of A will need to further buffer its capital levels because of the inevitable hit that the Merrill deal poses.

He did not provide any specifics but said "all options" were on the table, including a possible dividend cut.

Observers said to expect cuts to rank high on Mr. Lewis' priority list. B of A, "to make this work and to achieve their financial goals, will need to take a lot of costs out," Gary Townsend, the president and CEO of Hill-Townsend Capital LLC, said in an interview Monday.

Mr. Ellis said that, despite risks with undertaking another major deal in the current credit environment, B of A has a proven track record of evaluating the merits of a deal, and he said the quick profitability of Countrywide proves this point. B of A's executives "are very sophisticated," Mr. Ellis said. "I think they took a very good look and said they can absorb whatever Merrill's problems are in exchange for acquiring a very attractive retail brokerage, one that is still the best of all the brokerages out there."

B of A said it expects to, excluding restructuring charges, break even on the Merrill Lynch deal in the second year of the combination. And, after layoffs in departments where there is overlap, it expects about $7 billion in savings for the combined firms by 2012.

Mr. Lewis said he did not yet know where and how many layoffs would occur, and he said B of A had not yet decided on a possible executive role for Mr. Thain after the two companies are combined.

"We're good at" integrations, Mr. Lewis said. "This is not our first time."

And as for investment banking, he said, "I like it again."