Monday, September 15, 2008

Merrill Lynch Is No More

In a rushed bid to ride out the storm sweeping American finance, 94-year-old Merrill Lynch & Co. agreed late Sunday to sell itself to Bank of America Corp. for $50 billion.

The deal, worked out in 48 hours of frenetic negotiating, could instantly reshape the U.S. banking landscape, making the nation's prime behemoth even bigger. Late Sunday night, the companies' boards had approved the deal, but lawyers were negotiating over last-minute details.

Driven by Chief Executive Kenneth Lewis, Bank of America has already made dozens of acquisitions large and small, including the purchase of ailing mortgage lender Countrywide Financial Corp. earlier this year. In adding Merrill Lynch, it would control the nation's largest force of stock brokers as well as a well-regarded investment bank.

The combination, if approved by shareholders, would create a bank of vast reach, involved in nearly every nook and cranny of the financial system, from credit cards and auto loans to bond and stock underwriting, merger advice and wealth management.

Through the weekend, federal officials, including Federal Reserve Bank of New York head Timothy Geithner, made it clear that they strongly encouraged a deal to sell Merrill. They worried the firm could be the next to approach the brink of failure after Lehman Brothers Holdings Inc., said people familiar with the matter.

The all-stock deal came together quickly. With Merrill stock dropping sharply last week, Merrill President Gregory Fleming, a former financial-institutions adviser, urged Merrill Chief Executive John Thain to contact Mr. Lewis to see if he would be interested in a sale. The two banks had had preliminary discussions in the past, so the interest was there, according to a person familiar with the matter.

The Better Deal

On Saturday afternoon, Mr. Thain called Mr. Lewis, who responded favorably. Bank of America, which by then had been considering a bid for Lehman as well, decided that Merrill was the better deal and felt more comfortable with Merrill since the two had engaged in prior discussions. Mr. Thain then went to the Federal Reserve Bank of New York. He quickly saw that a deal for Lehman was unlikely, according to a person close to him, which strengthened his resolve to pursue a deal with Bank of America.

With a deal looming, Mr. Thain canceled a previously planned trip to Asia. The two camps began a marathon series of meetings at Wachtell, Lipton, Rosen & Katz, the law firm which has long represented Bank of America in its deals.

Word began to leak out on Sunday at the New York Fed, where top Wall Street executives had been huddled to discuss the fate of Lehman.

Executives were relieved that Merrill had found a buyer. "Who was the magician who pulled this rabbit out of a hat?" exclaimed a top executive of one bank.

The deal shows how the credit crisis has created opportunities for financially sound buyers. At $50 billion, Merrill is being sold at about two-thirds of its value of one year ago and half its all-time peak value of early 2007.

The deal values Merrill at $29 a share. Merrill's shares changed hands at $17.05 each on Friday, after falling sharply in the wake of Lehman's looming demise.

"Why would Bank of America do this?" said analyst Nancy Bush at NAB Research LLC in Annandale, N.J. "Ken Lewis always likes to buy the biggest thing he can. So why not this? You are master of the universe, basically."

Merrill could give Bank of America strength around the world, including emerging markets such as India. And Merrill is also strong in underwriting, an area Bank of America identified last week at an investors' conference where it would like to be more aggressive.

Bank of America and Merrill Lynch wouldn't comment on any discussions.

The deal is all the more dramatic because Merrill, upon the arrival of Mr. Thain, did more than many U.S. financial giants to insulate itself from the financial crisis that began last year. It raised large amounts of capital, purged itself of toxic assets and sold big equity stakes, such as its holding in financial-information giant Bloomberg LP. That Merrill has opted to sell itself thus underscores the severity of the crisis.

The integration of Merrill, known for its proud and sometimes testy brokerage force, could turn out to be the biggest test of Mr. Lewis's career. Typically, the bank has made one big deal and then taken time to carefully merge the two institutions. But in recent years, acquisitions have come at a furious pace. In 2004, the bank bought FleetBoston Financial Corp. A year later, the bank agreed to buy MBNA Corp., the credit-card firm. In 2007, Bank of America bought Chicago's LaSalle Bank as part of the breakup of Dutch bank ABN-Amro Holding NV. Then came this year's purchase of Countrywide.

'The Ultimate Realist'

Absorbing Merrill comes with huge risks. Merrill had the highest ratio of "problem assets" subject to write-downs to capital of the top three independent securities firms, according to Fox-Pitt, Kelton. Analysts were already betting it would have to write down another $3 billion or more in the third quarter beyond what it had announced in July.

"I think John Thain at Merrill is the ultimate realist," said Ms. Bush, the NAB Research analyst, who expected federal regulators to bless the deal.

"He knows if Lehman goes under he is not far behind. He wants to cut the best deal he can."

In the past 15 months, Merrill and Lehman have both had tens of billions of dollars worth of risky, hard-to-sell assets carried on balance sheets that were piled high with debt. When the credit crunch hit in mid-2007, the assets kept deteriorating in value and couldn't easily be sold, eating into both firms' capital cushions. Recently, Lehman's balance sheet topped $600 billion and Merrill's $900 billion.

Merrill's previous chief, Stan O'Neal, was ousted in October 2007. His successor, Mr. Thain, tried to repair the firm's balance sheet by arranging an infusion of more than $6 billion in capital starting last December, tapping investors led by Temasek Holdings, a Singapore government investment fund.

But the losses kept coming this year. Mr. Thain was forced in July to sell a huge slug of more than $30 billion in collateralized debt obligations, or securities backed by pools of mortgages or other assets, at a price of just 22 cents on the dollar. That step required the firm to raise still more capital, under painful terms that re-priced some of the December stock sales at about half the original price.

During the flurry of historic deal making this weekend, Merrill also put out feelers to Morgan Stanley about a possible deal, which would have united two of Wall Street's oldest brands, according to a person familiar with the talks. But the talks didn't go anywhere because there wasn't enough time for Morgan Stanley to review the idea and Merrill wanted to do a deal quickly, this person said. Merrill was also stepping up talks with commercial banks both in Europe and the U.S.

Mr. Thain would collect an exit package worth about $9.7 million if Bank of America completes its takeover, according to David M. Schmidt, a pay consultant for James F. Reda and Associates LLC in New York.

That figure represents accelerated vesting of restricted stock units that Mr. Thain got when he took command last December. Only two thirds of those 500,000 units would become shares that he could sell.

One top Merrill executive lamented the sale of the venerable company, saying, "It's sad but inevitable." This executive said that he was pleased it was Merrill, rather than rival broker Morgan Stanley, that was hatching a deal with Bank of America.

Front and Center

The futures of both Morgan Stanley and Goldman Sachs will be front and center Monday morning, as Wall Street wakes up to a world where the independent broker-dealers are increasingly few in number. They would be the last of the big five independent firms, with Merrill and Bear Stearns Cos. having been sold and Lehman likely to close down.

This tumultuous year has made it clear that investment banks like Lehman and Bear Stearns face vulnerabilities that commercial banks such as J.P. Morgan and Bank of America are less prone to. The investment banks must constantly depend on short- and medium-term money markets to fund their operations. Commercial banks, meanwhile, can count on more stable consumer deposit bases.

Winthrop H. Smith Jr., a former Merrill executive whose father helped build the firm, said the acquisition would represent "a very sad moment for myself and my family and the thousands of families who worked for Merrill Lynch over our 94-year history, sad to see a firm that always prided itself on its independence absorbed" into another.

Source - Wall Street Journal


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