BofA to Buy Merrill: Pros and Cons
Bank of America's deal for Merrill has upside, but it also puts the big bank back in a business it had been trying to scale down.
Bank of America Buys Merrill: Pros
On the positive side, B of A is using its own discounted shares to buy the premier brokerage business in the United States at a price significantly below our last fair value estimate. The combined company will have more than 20,000 financial advisors and more than $2.5 trillion in client assets. At Merrill, this side of its business is the main source of its moat. While we have some hope that B of A can steer some of its massive customer base to the brokerage arm, we do not think large amounts of cross-selling is required to make this part of the acquisition a success.
Bank of America Buys Merrill: Cons
On the negative side, Merrill Lynch is not just a brokerage business. Just over half the revenues come from an investment banking side that has caused the company to lose money for four straight quarters. Ken Lewis has gone back and forth on the attractiveness of investment banking and began cutting jobs at B of A. Yet, here he is adding to a business he was trying to reduce. Despite some recent moves to reduce troubled assets, Merrill continues to hold $1.6 billion of net CDO exposure, $6 billion of Alt-A mortgage exposure, and $18 billion of commercial real estate mortgage exposure, according to its second-quarter earnings report. These assets could continue to require write-downs, which would put a strain on B of A's capital position.
Bank of America Buys Merrill: Universal Bank with Global Footprint
The acquisition will drastically change B of A's revenue mix. Up until now, 70% of B of A's revenues were from its traditional consumer and small business banking, 24% from corporate banking and investment banking, and 6% from wealth management. On a combined basis, the investment banking and corporate business will account for 32% of revenues and wealth management will more than triple to 20%. This new mix makes B of A appear closer to the universal banking model of Citigroup and J.P. Morgan Chase rather than just a really large traditional bank. In addition, with just over half of Merrill's revenues coming outside the U.S., B of A is expanding its global footprint dramatically.
B of A is not getting the sweetheart deal J.P. Morgan received when it bought Bear Stearns with the help of the government. However, Merrill was also not in such desperate straits as Bear was. B of A expects the deal to be slightly dilutive in 2009, before adding to earnings per share in 2010. The deal will also knock 20 to 25 basis points off B of A's Tier 1 capital ratio, which at this point we believe is manageable. Combined with the recent purchase of Countrywide, Bank of America will be well short of its 8% goal but still above the well capitalised levels.
