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NewsOctober 21 2009

Merrill Lynch - can Bank of America make it work?

Bank of America Merrill Lynch has had a rough year.Its CEO is being forced to retire, it is under intense regulatory scrutiny and senior investment bankers have left in droves. Yet it is holding up well in the league tables, and deal flow is looking pretty strong. Is Bank of America beating the odds and making a success of the acquisition?Geraldine Lambe reports
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The news on October 15th at Bank of America (BofA) CEO Ken Lewis had been pressured into forfeiting his 2009 salary by the US Treasury's ‘special master' for compensation horrified Wall Street and crowned a turbulent 10 months for the bank. Since completing its rescue acquisition of Merrill Lynch, taking $45bn from the government to shore up its own capital base and to help absorb Merrill's 2008 losses, Bank of America has experienced unprecedented government intervention, and aggressive state and Federal regulatory scrutiny. Mr Lewis has felt the full brunt of the media and regulatory spotlight. Early in the year he was forced to step down as chairman after he and the board of directors were accused of misleading investors about Merrill's mounting losses and the agreement to pay bonuses to Merrill executives. In early September, Federal district judge Jed Rakoff took the unusual step of rejecting a $33m settlement levied by the Securities and Exchanges Commission (SEC), saying that BofA should face a full investigation, not get a "slap on the wrist".On September 30, in what many assume to be an attempt to take the heat off the bank, Mr Lewis surprised the markets - and the bank - by announcing his early retirement by the end of the year. New York attorney general Andrew Cuomo immediately quashed any notion that he would back down, saying Mr Lewis's retirement would have "no impact" on his investigation.If the Merrill acquisition has brought Mr Lewis's tenure at BofA to an untimely end, the unwelcome glare of the media and regulators has also exacerbated tensions within the new organisation. The bank has had a rough year, losing a lot of key bankers and fighting fires as much as managing the business. Yet league and revenue tables show that the investment bank has held up surprisingly well, and the combined platform is getting business that BofA alone could only have dreamed of. Much remains to be done and as a whole, the franchise remains heavily exposed to the nervous US consumer, but is Bank of America Merrill Lynch over the worst?

Difficult DaysIn the dark days of Q1 this year, legacy Merrill Lynch experienced dizzying changes of leadership and lost bankers left, right and centre. First, Greg Fleming, newly  appointed as Bank of America Merrill Lynch's(BofA-ML) head of investment banking, left in the first week of January. Many insiders saw this as a potentially fatal blow to the investment bank; he was one of the Merrill leaders seen as critical in holding the investment bank steady during what was expected to be a tricky integration. Moreover, Mr Fleming had built Merrill's world class  financial institutions business and helped to create the  European platform as a force within Merrill. In the same week, Bob McCann, previously head of the retail brokerage unit, resigned, followed in short order by Brent Clapacs, co-head of European markets. Then John Thain, who along with Mr Fleming had orchestrated the sale of Merrill to BofA, left the bank less than a month after the deal was completed.

Taking the fall: Under-fire Bank of America CEO Ken Lewis is retiring by the end of a turbulent year

Bank of America's general counsel, Brian Moynihan, was put in charge of the investment bank. He had a wealth of integration experience, but all he could do was watch a procession of more than 20 managing directors leave the bank in three months. Competitors scented weakness and within two months of Mr Fleming's departure, Deutsche Bank hired a dozen of Merrill's financial institutions group (FIG) team, including the three Heaton brothers - Eric, David and Seth - who had worked at Merrill their whole career.The growing focus on compensation - which led to seven of Merrill's most senior bankers being subpoenaed by Mr Cuomo touched a raw nerve. Merrill investment bankers, who already felt as if they had paid a heavy price for the actions of the few who took the bank into subprime and built-up a massive exposure to collateralised debt obligations (CDOs), began to feel increasingly uncomfortable in a commercial bank that was under a punishing microscope."It is not my business that led to Merrill's losses or the subprimecrisis,"saysoneseniormergersandacquisitions (M&A) banker. "We do a deal, and we get paid for it; if we don't do the deal, we don't get paid for it. At the most, even in an underwriting deal, investment bankers put risk on the books for one, two or three weeks."

Loss of key BankersOne by one, BofA-ML lost its most senior managers in healthcare, oil and gas and industrials. Most importantly, these were some of the handful of sectors where there was any activity. Many feared that Andrea Orcel, with whom Mr Fleming had a close relationship, might follow him out of the door.This would have been a disaster, as he had become  the lynchpin of Merrill's FIG offering and one of the European platform's most influential investment bankers. It began to look as if the investment bank was spinning out of control. One ex-Merrill banker says he left because the Merrill culture, as well as its bankers, was  disappearing. "There seemed to be a complete lack of ambition for the investment bank. Mr Moynihan told us that the plan was for the investment bankers to add some value to corporate banking relationships. This seemed to be symptomatic of BofA's culture. Any sense of partnership had gone."Just as damaging, he says that the credit application process was slow, bureaucratic and unresponsive. Decision-making was centralised to the US, with credit decisions made in Charlotte, North Carolina, and loans decided in New York."You just sent in your request and eventually a decision would come back from the US," says the banker. "There was no discussion; no comeback. As a result, the bank made some very questionable decisions around business for some long-standing and profitable clients.  That was damaging to my business. It didn't feel I was being encouraged to stay. Nor did I feel anyone would care if I left."Steadying The Investment BankIn August, Tom Montag, a Goldman banker for 22 years who joined Merrill under Mr Thain as head of sales and trading six weeks before the BofA acquisition, was named as head of the investment bank, with combined responsibility for the corporate and investment bank as well as global markets. Mr Moynihan was put in charge of BofA's giant consumer bank.Bankers welcomed the news, seeing in Mr Montag's Goldman heritage someone who understood the partnership culture that had been so important at Merrill.If anyone doubted that Mr Montag, whose career has been spent in sales and trading, had the right background  to rebuild the confidence of the firm's investment bankers, he showed a touch of genius in appointing Mr Orcel as executive chairman, global banking and markets. Mr Orcel is extremely well liked, and his decision to stay at the firm is seen as both a stabilising influence and a strong signal that the old Merrill has not been destroyed. According to people inside the bank, Mr Montag proposed a Goldman-style partnership that pairs opposites:an investment banker with someone in sales and trading; a client man who spends his time on the road with someone internal who makes things work. And in trying to create Goldmanesque management committees, where partners debate everything but the final decisions are taken by a handful of people at the very top, he may be able to create an organisational structure which suits BofA's desire to have processes and committees, but keeps Merrill's senior managers involved and informed. Everyone heaved a sigh of relief when Mr Orcel accepted.

Mr Montag says Mr Orcel will help him to strategically map out the growth of global banking and markets worldwide. He is also keen to develop Mr Orcel's extraordinary laundry list of relationships. "Andrea is central to our plans for the investment bank," says Mr Montag. "We have a great working relationship. He is a consummate relationship banker and we need to leverage that."

Investment Bankers NeededA key priority must be to restock the depleted ranks of investment bankers. In June, the bank secured Steven

"The first difficult months created a great deal of resolve among those that stayed. ironically, it has brought the team together - Tom Montag"

Niemczyk as global head of asset management investment banking from UBS, where he had the same role. But he is the only hire announced so far for Merrill's crucial FIG platform.In August, the bank brought in a 10-man real estate team in Australia, also from UBS, quickly followed with the hire of Craig Drummond, formerly co-head of Goldman Sachs JB Were, to lead BofA-ML's Australian business. This brings recent hires in the country to 35.Another key hire is Alan Murray, formerly global head of energy M&A at Citigroup, who joined as a managing director in energy investment banking in late September.On the markets side - Mr Montag's home turf - there has been a predictable influx of Goldman people. Sanaz Zaimi, previously a partner and co-head of structuring sales for Europe at Goldman, will have a dual responsibility as head of sales for fixed income, currencies and commodities (FICC), and debt and equity structured products for EMEA. Other Goldman poaches include Christopher Bae, now co-head of global foreign exchange options and head of EMEA FX trading, Marco Piccioni, head of southern Europe sales and marketing, and Christoph Gugelman, head of the FICC solutions group. Other key hires include AJ Murphy as head of Americas leveraged loans capital markets from JPMorgan and David Ross, who joined from Deutsche Bank in September as head of European leveraged finance capital markets. Filling the holes - particularly in the bank's FIG team – will be crucial if BofA-ML is to maintain any kind of momentum. Mr Montag says there are more hires to come. “There are people who haven’t been announced yet. We feel incredibly good about the calibre of people that we are attracting,” he says, but notes that the “war for talent is as robust as it has ever been”.

The Value of MerrillMany argue that the drama surrounding BofA’s acquisition of Merrill Lynch not only ignores the febrile environment in which the deal was consummated but also the long-term strategic sense of the acquisition. It immediately added two business lines in which the bank was barely present – cash equities and M&A – as well as a powerful international presence that BofA had long tried to build. Moreover, the brokerage and wealth management business had virtually no crossover with BofA’s own offering.Internationally, matching Merrill’s equity and fixedincome distribution with Bank of America’s balance sheet could be a powerful proposition. At the moment, the balance sheet is mostly deployed in the US while most of its competitors are already fully deployed outside of the US. In selectively deploying the balance sheet as it integrates Merrill’s international business, the potential upside is compelling.

The value of that diversification was demonstrated by JPMorgan’s Q3 results as much as BofA’s own. Just as JPMorgan’s performance was rescued by its investment bank – where net income of $1.9bn outweighed a net loss of $1bn in the consumer lending business and a net loss of $700m in card services – so, too, did Merrill’s contribution help to offset BofA’s downward spiralling US consumer business.

The Charlotte bank, which posted an overall loss of $1bn for the quarter, took permanent losses of $9.6bn from an array of bad debt – including mortgages, home equity loans and credit cards, as well as in commercial real estate. By contrast, its revenues in the corporate and investment bank were boosted by the addition of Merrill’s equity and investment banking businesses.

While it is difficult to say what Merrill’s precise contribution has been because its various businesses have been spread throughout BofA, Merrill significantly boosted overall trading revenue, which rose 57% over the second quarter to $3.4bn, and was largely responsible for the increase of 71% in advisory fees and equity revenues of $1.4bn.

Moreover, the bank’s increased muscle is measured clearly in data provider Dealogic’s Q3 league tables. It is no great surprise that, for the year to September 30, BofA-ML ranked number one in high-yield corporate debt, leveraged loans and mortgage-backed securities both globally and in the US – these were legacy BofA strengths – but in equity capital markets, it now ranks fifth globally, fourth in the US and seventh in EMEA; in M&A, it now ranks fifth globally and in the US, and ninth and 12th in EMEA and Asia-Pacific, respectively. These were businesses in which legacy BofA had virtually no presence. Such jumps are reflected in overall investment banking fees: it now ranks third globally and second in the US.

"Without cash equities or advisory we had to have a niche strategy Jonathan Moulds"

Internal FrustrationInside the bank, there is visible frustration that there is so little recognition of what benefits the acquisition brings to the overall platform and of how far the bank has already come with a difficult integration in the worst possible business environment. Jonathan Moulds, president of EMEA, Latin America and Canada, acknowledges that the acquisition got off to a rocky start in the dark days of Q1 and Q2 this year, but argues that the bank has come a long way fast.

Mr Moulds, who at BofA was responsible for building operations outside of the US, is in a good position to see the difference: internationally, he says, the Merrill acquisition puts paid to criticism that Bank of America was more accurately seen as Bank in America.

“BofA didn’t have anything like the scale or the product reach of some of our broader competitors,” says Mr Moulds. “Without cash equities or advisory we had to have a niche strategy, and in that sense our build-out was very successful. But the Merrill acquisition is entirely complementary and means that we now have the full breadth of products backed by significant financial strength. Now, if we miss out on a piece of business, we will have to ask ourselves why.”

Andrea Orcel [pictured]is extremely well liked, and his decision to stay at the firm is seen as a signal that the old merrill has not been destroyed

In the markets division, there is palpable excitement about where the acquisition has taken the bank. According to Bruce Thompson, global head of capital markets, BofA-ML will have a larger equity business than Goldman Sachs this year, taking it to second or third in the equity and equity-linked related fees table. That is not a place that legacy BofA could ever have dreamed of being, he says. Looking back to the first and second quarters of this year, when the platform was haemorrhaging investment bankers and the bank suffered the opening salvos of damaging regulatory scrutiny (euphemistically referred to as ‘noise around the platform’ within the bank) it is not where anyone else expected them to be, either.

Growing Momentum

Mr Thompson reels off a host of recent equity deals to demonstrate the momentum in the business. In Santander’s Brazilian equity offering in the first week of October – the largest initial public offering (IPO) of the year – BofA-ML was one of four bookrunners; for Verisk Analytics, the largest IPO in the US since Visa, it was left lead bookrunner alongside Morgan Stanley. Also in October, BofA-ML wrapped up a rights deal for Swedbank as one of two bookrunners, another for Société Générale as one of four bookrunners, a deal for Polish bank PKO as one of three, and has just been named one of two global co-ordinators for UniCredit.

“Some of the noise in February and March when we were having our toughest times made it very hard to get selected on certain deals,” says Mr Thompson. “But because the lead time on some of these deals is 60 to 90days, what we are now seeing in the market is a manifestation of the work done in the second and third quarters once the noise started to die down. This is a better reflection of where we are with our business and what the platform can do going forward.”

Mr Thompson says that the early teething problems with the credit approval process, which frustrated investment bankers found slow and unresponsive to their client needs, have largely been settled.

“On top of getting to understand what capital was really important for each client, and what level of commitment we were comfortable with, we had to go through a process of mobilising the new organisation. There were a lot of integration challenges. If we are honest with ourselves, at legacy BofA, 80% to 90% of revenues were domestic, so it took a lot of work to integrate a big international operation. It stressed the system. It’s not perfect yet, but it feels like every day, every week, it’s getting better.”

As processes bed down, European bankers say they have been impressed with the way that Mr Thompson has made decisive credit commitments for big European clients, such as $900m for funding of Iberdrola’s $1.8bn accelerated equity offering in June. Complaints that the US was not committing capital are receding. So far this year, BofA-ML has done 42 equity capital market (ECM) deals in Europe; 70% with capital commitment from the bank.

Commercial Bank

Other parts of the business are equally excited about what Merrill has already brought to the table. In the commercial bank – which has 40,000 US clients in the midmarket sector using investment banking and capital markets products – the bank has already done three times the amount of ECM business this year as it did in the first three quarters of last year. M&A business is up by more than 50%. Overall, its investment banking and capital markets volumes for mid-market clients – including FX and derivatives – is up by more than 30%.

“I have been waiting 30 years for this,” says David Darnell, president of BofA-ML global commercial banking, who has spent his entire career with BofA and its predecessor, North Carolina National Bank. “We had a great leveraged finance business, but to have that capability within a world class platform that now includes equity and M&A capabilities, that is a real differentiator.”

Mr Darnell adds that this is only the beginning. Merrill did not have a mid-market business, so the increased volumes have not been achieved by adding two businesses together but represent genuine growth and a real increase in revenues. Moreover, BofA may have done business with one in five US companies with revenues from $2.5m to $20m, and with one in three companies with revenues between $20m and $2bn, but that did not mean it had all of their business.

“The addition of Merrill means that we can now offer a full product set to our existing clients, and use it to pitch for new ones,” says Mr Darnell. “If you look at the fee pools around equity and M&A, this new breadth of product presents us with tremendous opportunities.” And that’s before the bank even thinks of expanding its mid-market offering abroad.

Confidence Growing

In the investment bank, too, confidence is growing and communications are improving. Mr Montag is convinced that he can deliver on the potential. “If I didn’t think we could do it, I wouldn’t be here; I’ve had plenty of opportunities to leave gracefully. You can already feel that a new culture is emerging. It’s often the small things that create the culture, and the relationships between groups – risk, technology, credit, finance – are becoming more natural.”

He argues that the tumult of the first half of the year has actually helped to build esprit de corps among the bankers who stayed. “When anyone good leaves, of course it has an impact on the franchise, but the first difficult months created a great deal of resolve among those that stayed. Ironically, it has brought the team together.”

Nobody can deny the challenges of the first few months – the acquisition friction, integration pain, low morale, and two bad quarters – but since mid-June, the bank has begun to gain market share, and more and more bankers are beginning to believe in the power of the combined franchise. Despite losing the team to Deutsche Bank, insiders say it has not missed one FIG deal. In equity, it missed four deals, but they were not existing Merrill Lynch clients. Importantly, in the midst of all the turmoil, the bank has managed to capture new clients, including Nordea and Swedbank.

The ability to retain existing clients, such as Santander and Verisk Analytics, is important, but the ability to win new clients is also critical in building confidence internally about the success of the new firm. As such, many in the bank saw it as important that in August, BofA-ML was appointed financial advisor to Warner Chilcott on its announced acquisition of Proctor & Gamble’s pharmaceuticals business, as well as being mandated left lead on the $2.75bn financing and $1.4bn notes as part of the $3.1bn deal.

Long Way To Go Current ebullience around business momentum and continued progress with the integration, however, cannot detract from the challenges that the bank still faces. Damage done to the M&A franchise by the loss of senior bankers will only show up much later. The bank is still executing deals originated by bankers who have left, and the client business they take with them will only become clear after their gardening leave. The challenge for the bank will be to attract good people quickly enough and to keep the franchise together until they are operational.

Moreover, BofA must not forget that Merrill bankers have gone through two years of pain and transition; first the mounting losses and exit of former CEO Stan O’Neal, then the transition to John Thain, then to Greg Fleming, then to Brian Moynihan. Many insiders find the processdriven culture of a big commercial bank alienating, frustrating and bureaucratic. BofA-ML has a window of a few months until next year’s post-bonus hiring round to convince investment bankers that staying will be worth it.

One senior Merrill Lynch banker said that many bankers were lost unnecessarily through a lack of communication and understanding. If the senior management team wants to keep people in place, it will also need to quickly lay out the vision for what the bank wants to be, and the strategy to get there.

Settling on an acceptable compensation structure could be problematic. Merrill is used to a regional bonus pool and a pay-for-performance culture. Whether this will be possible in a bank subjected to such intense government and regulatory scrutiny is not yet certain.

Moreover, the regulatory pressure continues. On October 12, BofA took the unprecedented step of waiving attorney-client privileges, saying it will release documents related to the legal advice the bank received prior to the acquisition of Merrill. A clearer picture will soon emerge of whether the bank was under pressure to complete the acquisition of Merrill to prevent another Lehman Brothers-style collapse, and of what advice the board of directors was given about releasing information to shareholders regarding Merrill’s financial situation and bonus guarantees. This could be critical in deciding whether criminal prosecutions will be taken against the then board of directors and, specifically, Mr Lewis.

The House Committee on Oversight and Government Reform and Investigations was preparing for a hearing as The Banker went to press, which would call several current and former Federal regulators and BofA officials to testify.

Who will succeed Mr Lewis?

The biggest unknown, of course, is Mr Lewis’s succession. As one banker says: “Human beings don’t like uncertainty. For the bankers on the floor, the change of CEO will once again mean new people, new views, new rules. To recruit new bankers, a state of flux is unhelpful. And if you spend half of a client meeting justifying the last change, then it’s not good for business either.”

Who will become the new CEO will also be crucial in deciding which side of the bank exerts the most control and shapes its future. With so much government and regulatory pressure on the bank in the US, many fear that the investment bank will be crushed or homogenised by the giant commercial and consumer banks.

Secretly, Merrill investment bankers hope that they will be able to build a Merrill Lynch ‘inside’ BofA that maintains its unique culture and relative autonomy, but leverages the huge strength of BofA. No other bank has yet been able to achieve this. Merrill bankers argue that JPMorgan has achieved an equilibrium between a process-driven commercial bank and an investment bank; HSBC has never been able to make investment banking stick.

Jason Goldberg, senior bank analyst at Barclays Capital in New York, says that if management can manage to marry the strengths of Merrill Lynch with the corporate rollerdex of BofA, this will be a formidable company. “Everything now depends on who will be the new CEO. Bank of America has changed its tune several times on investment banking. It has to decide what it wants to be.”

The Thundering Herd

One of the key reasons that Ken Lewis was so keen to buy Merrill Lynch in the first place was its mighty retail brokerage and global wealth management unit. In August, Mr Lewis recruited Sallie Krawcheck, one-time head of Citi’s wealth management, to head the global wealth and investment management unit (GWIM), sidestepping Dan Sontag, previously head of Merrill Lynch global wealth and investment management, for the job.

Ms Krawcheck has a stellar reputation on Wall Street. In 2002 she was brought in to head up the research and brokerage at Citigroup, and is credited with cleaning up the bank’s image after the Wall Street research scandals that followed the dot-com bust. She left last year following a disagreement with Citi CEO Vikram Pandit over recompense for investors who had lost money during the financial crisis.

But she has taken on a difficult role at a difficult time. First, there is the complicated integration of Merrill Lynch’s platform with the US Trust business of Bank of America. Furthermore, many Merrill Lynch feathers have been ruffled by the appointment of an outsider over Dan Sontag, who had been with the firm for 31 years.

In addition, there have been numerous reports of large-scale defections by Merrill financial advisors. Ms Krawcheck wants to lay this ghost to rest, saying that while there may have been outflows of staff and assets up until August, the week beginning October 5 saw legacy Merrill Lynch’s financial advisor headcount return to more than 15,000, having seen net inflows of 205 advisors over the previous six weeks. Moreover, the week beginning October 5 also saw net new money of $2bn come into the franchise.

“There has been a false perception that just kept getting perpetuated,” says Ms Krawcheck. “Including US Trust, we now have 18,923 wealth management advisors on the platform and we were just ranked as the number one US wealth manager by Barron’s Magazine.”

The Barron’s ranking lists the top wealth management businesses in the US, based on assets under management in accounts of $5m or more, as of June 30, and puts the bank ahead of the Morgan Stanley Smith Barney franchise by more than $200bn in assets under management. Taking the entire GWIM franchise into consideration, the value of client assets jumps to $1900bn.

Crucially, adds Ms Krawcheck, the bank has retained the most productive advisors. “We have retained 94% of those advisors who produce $1m and above [in revenues]. Plus, of the advisors who have left, we have retained 50% of their client assets,” she says.

Sallie Krawcheck: It was important to reassure people that the only real change would be a bigger and better platform

Just as tricky for Ms Krawcheck will be the revitalising of a wealth management and brokerage model that has been badly damaged by the massive wealth destruction caused during the financial crisis. Wirehouses – the US term for in-house brokerage and wealth management platforms – are said to be fighting to preserve their business model. According to a report from Boston-based research firm Cerulli Associates in 2009, $800bn in client assets will be transferred as a result of investment advisors changing firms. The report argues that wirehouses will lose the most, while registered investment advisors and hybrid advisors will be the greatest recipients of the money in motion. With high attrition rates and assets per advisor, Cerulli expects wirehouse firms to suffer a net loss of $188bn going to other channels.

Here, too, Ms Krawcheck says different. “Our research shows that people are using fewer independents. I think people are looking for financial strength and are more wary of independent firms since the Bernie Madoff scandal. Everybody who was in the markets lost money during the crisis; but our customers didn’t lose money because of fraud. This plays to the brand and strength of Bank of America Merrill Lynch.”

Since she joined, Ms Krawcheck has spent three days a week on the campaign trail and has so far been in front of about 50% of the 34,000 people in the franchise. This has been crucial to reassure staff that the integration is going smoothly, and that she does not intend to try to turn GWIM into the Citi franchise she ran previously. “It was important to reassure people that the only real change would be a bigger and better platform,” she says.

Ms Krawcheck is convinced that the combination of a commercial bank and Merrill’s wealth management business is a winning one. This includes the strategy to add value by bringing bankers and financial advisors together so that each can offer specialised services to the clients. “The two businesses complement each other and offer lots of synergies,” she says. “We have placed 770 wealth management bankers in our branches across the country. That shows what kind of commitment and investment we are putting into the platform.”

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