Monday, September 15, 2008

Bank of America Surprise - It Will Buy Merrill Lynch, and Balks at Lehman, Paulson Happy with the Weekend's Actions

After a weekend of discussions regarding Lehman Brothers, the Wall Street Journal has reported that Bank of America will be acquiring Merrill Lynch for $29 a share, a deal that will give the bank the world's largest brokerage and a sizable investment bank, the Wall Street Journal reported on Sunday.

The deal comes as bankers and regulators met in New York to figure out whether to rescue Lehman Brothers Holdings, and if so, how. Those talks seemed increasingly likely to result in Lehman's liquidation.

Merrill, stuck with some of the same toxic debt -- much of it mortgage-related -- which torpedoed Lehman's balance sheet, has been hit hard by the credit crisis and has written down more than $40 billion over the last year.

Last month, Thain arranged to sell over $30 billion in repackaged debt securities to Dallas-based private equity firm Lone Star Funds.

In spite of these debt exposures, the bank is seen by some as undervalued, in part because of its massive brokerage business, which analysts have said is worth more than $25 billion. The brokerage is the largest in the world by assets under management and number of brokers.

Merrill also has about a 45% stake in the profitable asset manager BlackRock, worth more than $10 billion.

There have been questions regarding the due diligence Bank of America would need to do on Merrill's books. Given the size and breadth of the company this is considered a huge undertaking especially when viewed under the microscope. Now, add in the complexity of the company's exposure to mortgage-related securities and other complex debt, and you begin to realize exactly how big a project it would be much less in a short period of time.

With the brokerage and the BlackRock shares worth more than $35 billion combined, and Merrill's market capitalization at around $26 billion, investors are ascribing a negative value to the investment bank, implying huge potential embedded losses.

On the other hand, it would not be the first time Bank of America has done a quick acquisition. In 2005, the bank bought credit card company MBNA after less than a week of due diligence, with CEO Ken Lewis saying the company was comfortable with the acquisition because it knew the people and business well.

Bank of America under Lewis has in fact become renowned for large acquisitions and it has spent over $100 billion since 2004 buying other companies. Most recently it acquired troubled mortgage lender Countrywide Financial Corp and -- although many were skeptical about this purchase -- veteran analyst Dick Bove said last week the takeover could prove to be a master stroke by Lewis, since the government takeover of mortgage agencies Fannie Mae and Freddie Mac could fuel business for other lenders.

CNBC reported that the sale could close within 3-4 months, and that Merrill Lynch's board of directors voted unanimously to close the deal.

It is unclear what role current Merrill CEO John Thain would have in the merged companies, but both Thain and Lewis are expected to present the deal in conference call and news conference. Additionally, the Merrill Lynch name may only be preserved in private wealth business.

Paulson happy with the weekend's actions

U.S. Treasury Secretary Henry Paulson said on Sunday he supported this weekend's actions by market participants, the Federal Reserve and the Securities and Exchange Commission to strengthen and enhance financial market stability.

Without mentioning the fate of Wall Street investment bank Lehman Brothers nor the widely reported deal for Bank of America to buy Merrill Lynch, Paulson said the actions were critical to "facilitating liquid, smooth-functioning markets and addressing potential concerns in the credit markets."

"I particularly appreciate the efforts of market participants who came together this weekend and initiated a set of steps to facilitate orderliness and stability in our financial markets as we work through this extraordinary environment," Paulson said in a statement.

Paulson refused to commit public funds to a rescue of Lehman during a tense set of meetings with bankers and Fed officials in New York to try to find a solution for the firm's financial problems.

The Fed agreed to broaden the type of collateral that financial institutions can use to obtain direct loans from the Fed, and it increased the amount of Treasury securities it auctions on a regular basis to foster liquid markets.

A private sector consortium of banks and investment banks agreed to create a $70 billion collateralized borrowing facility.

Paulson said the weekend's discussions made clear that market participants and regulators across the globe recognize the need to support market stability as they address challenges.

"I am committed to working with regulators and policy makers - including Congress - to take necessary and appropriate steps to maintain the stability and orderliness of our financial markets. And I will engage with regulators and policymakers around the world to that end."

"Healthy capital markets are the backbone of a vibrant U.S. economy and critical to the well-being of our economy and American families. I am confident in the resilience of our capital markets, and in the commitment of U.S. regulators and market participants to work together through this difficult period."

Sources: Reuters, Wall Street Journal, CNBC, MarketWatch

No comments: