Merrill Lynch takeover is a match for Bank of America's ambitions

Merrill Lynch takeover is a match for Bank of America's ambitions

The groundwork was laid in 1998, when Hugh McColl's NationsBank swallowed up BofA to create the country's largest bank. Whether the marriage will succeed, however, is a big question.

By Michael A. Hiltzik and E. Scott Reckard, Los Angeles Times Staff Writers

September 16, 2008

A.P. Giannini is remembered as the revered founder of Bank of America, but the institution that snagged Merrill Lynch & Co. in a pressure-filled takeover last weekend is very much Hugh McColl's Bank of America.

McColl was the boss of Charlotte, N.C.-based NationsBank Corp. in 1998 when it swallowed up Bank of America, then based in San Francisco. The hard-charging former Marine deftly outflanked BofA's more worldly management team to ensure that the bank would be based in Charlotte, that his directors would control the board and that his successor would be a NationsBank man.

That successor, Kenneth D. Lewis, has gone beyond fulfilling McColl's dream of running the biggest bank in the country by creating what may become a global powerhouse of retail banking, brokerage and money management. Now the question is: Can he make this deal work?

That's far from a sure thing. There are vast differences between the two corporate cultures, and the deal was thrown together so quickly that potential land mines may have been overlooked, said Rob Hegarty, a financial services industry analyst.

"It's far too early to call this a success," said Hegarty, managing director at Tower Group. "I'm calling it 'Heartland Meets Big City' -- and we know how most of those marriages end up."

New York-based Merrill Lynch has been a troubled company, hobbled by holdings of hard-to-value mortgage securities that have been written down by billions of dollars this year already.

Lewis and John Thain, Merrill's chief executive, said Monday that the write-down process had nearly run its course, but widespread suspicion exists on Wall Street that the investment firm's portfolio still harbors lots of overvalued and illiquid securities -- one reason that its very survival had begun to come into doubt.

Merrill Lynch is also known for its insular, paternalistic culture, resistant to dramatic change -- a factor in the ouster of Thain's predecessor, E. Stanley O'Neal, last fall. O'Neal, who instituted draconian staff cuts, was considered aloof and insensitive to the traditions of what many of the firm's old-timers called "Mother Merrill."

Bank of America Corp., meanwhile, has its own challenges. Since taking over from McColl in 2000, Lewis has been following his mentor's path of building BofA by acquisitions, mostly of banks with strong retail franchises in geographic regions where BofA had scant foothold, such as New England and the Midwest.

But the acquisition of Merrill Lynch, which will require shareholder and regulatory approval, caps an extraordinary yearlong surge of deal-making for Lewis, coming after the $21-billion purchase of Chicago-based LaSalle Bank from Netherlands-based ABN Amro and its $4-billion takeover of Countrywide Financial Corp., the hobbled mortgage lender.

Taken together, the three deals represent "the biggest integration challenge we've ever seen in the American banking industry," said D. Anthony Plath, an associate professor of finance at the University of North Carolina and a longtime observer of Bank of America.

But he adds that the task matches the role Lewis played under McColl. "McColl was the strategist," he said. "Lewis was the integrator."

Yet Lewis' latest acquisitions, particularly the Countrywide and Merrill Lynch deals, come with powerful strategic rationales too. Both are based on the calculation that the financial markets are undervaluing strong franchises and overreacting to short- or medium-term conditions.

Many analysts questioned the bank's fire-sale purchase of Calabasas-based Countrywide, which had been driven close to bankruptcy by losses in its portfolio of high-risk residential home loans. But at an investment conference in San Francisco on Monday, Barbara J. DeSoer, president of BofA's mortgage, home equity and insurance unit, said the wisdom of the deal would become clear when the housing market turns around.

"We saw the opportunity," DeSoer said. "Homeownership remains a fundamental goal of most Americans, and we believe the U.S. housing sector will be strong again."

Lewis made a similar point in explaining the price BofA will pay, in its shares, for Merrill Lynch -- 34% over the brokerage giant's closing price Friday, based on BofA's closing price Monday.

"We could have rolled the dice and got it at a lower price," perhaps by waiting a day or two, Lewis told securities analysts in a conference call. Merrill Lynch was vulnerable to the same crisis of confidence among trading partners and stock investors that had brought low the investment banks Bear Stearns and Lehman Bros., lending urgency to a possible rescue deal.

Lewis acknowledged that the acquisition might not add to BofA's bottom line until 2010. "But the long-term benefits are so overwhelming, it's such a strategic opportunity, that we elected not to roll the dice," he said. "I don't know anyone who's perfect at picking the absolute bottom" of an investment downturn.

Stock market investors may not have found that argument persuasive. BofA shares fell more than 21% on Monday, closing at $26.55. That reduced the value of the deal to about $40 billion, from $50 billion at Friday's closing price.

Standard & Poor's Ratings Services lowered its long-term credit rating on Bank of America a notch, saying the purchase of Merrill would "place further pressure" on the bank's capital, which was already strained by the Countrywide acquisition.

The Merrill deal may rank as a climactic chapter in the long history of Bank of America, which Giannini founded as Bank of Italy in 1904 and quickly expanded beyond its initial clientele of Italian shopkeepers and merchants in San Francisco's North Beach neighborhood.

Not long after his death in 1949, his offspring had become the largest and most profitable bank in the world, its growth fueled by postwar boom times in California and its backing of West Coast industries including farming and moviemaking.

In the 1980s and 1990s, however, the bank was stumbling. It was forced to take large write-downs of loans to Brazil in 1987. That decade also ushered in a wrenching era of deregulation and consolidation, as banking executives who had lived their entire careers in patrician, noncompetitive bliss were forced to compete in a new world of roughhousing competitiveness.

That world was tailor-made for Hugh McColl, who began building his Charlotte bank by acquiring regional banks, primarily in the Southeast.

By 1998 McColl had concluded that such a piecemeal approach would never give his institution the national footprint he craved. Acquiring bank after bank with $40 billion to $80 billion in assets "just wouldn't get us there," he told the Wall Street Journal.

The $60-billion takeover of Bank of America, which was itself looking for a way to leap beyond its core market in the West, created a behemoth with $570 billion in assets. (The bank had assets of $1.7 trillion at the end of last year.)

McColl also maneuvered to keep the combined institution firmly under NationsBank control. The acquisition agreement stated that "it is the present intention" for then-BankAmerica Corp. Chief Executive David Coulter to succeed McColl as chief executive of the new Bank of America upon McColl's retirement in 2000 -- a far cry from the ironclad arrangement Coulter favored.

Just over a year later, McColl fired Coulter, blaming him for a $372-million loss on an ill-advised BofA loan to investment firm D.E. Shaw. Lewis took Coulter's place as heir apparent.

Under Lewis' leadership, BofA has managed to avoid some of the deeper trading potholes that have tripped up its banking competitors, such as Citigroup Inc.

"They've taken their share of hits," said Joe Morford, banking analyst at RBC Capital Markets. "But generally speaking, they have emerged with a far better capital position" than rivals. That has positioned Lewis well to time his "longtime interests in expanding in key product areas and capabilities -- specifically mortgages and retail brokerages," Morford said.

That's not to say that BofA's record has been entirely clean. Last fall, Lewis announced that the bank had suffered a $1.5-billion trading loss, contributing to a 32% drop in earnings for the third quarter ended Sept. 30 compared with a year earlier.

The results seemed to have chastened Lewis in his quest for investment banking prominence. "I've had all the fun I can stand in investment banking at the moment," he told securities analysts at the time. "Getting bigger in it is not something I want to do."

michael.hiltzik@latimes.com

scott.reckard@latimes.com