Speaking at a press conference yesterday, Merrill Lynch chief executive John Thain revealed the idea of selling the investment bank first arose during crisis talks at the Federal Reserve Bank of New York at the weekend.
Senior representatives of the major broker-dealers convened at the New York Fed's headquarters at 5pm on Friday September 12 to thrash out a rescue for Lehman Brothers, either through an outright purchase by a competitor with Barclays Capital and Bank of America emerging as the two most likely candidates for collective action by broker-dealers to each buy up a portion of Lehman's assets using funds borrowed from the Federal Reserve's lending window.
The meeting broke up at 8pm without resolution and met again the following morning, although Bank of America chief executive Ken Lewis was not present. It was at this morning meeting that Thain made the first approach to Lewis via telephone.
With the problems at Lehman, we were at the Federal Reserve on Friday, Saturday and Sunday. The discussion at the Fed was about the implications of a Lehman bankruptcy, and over the course of those discussions it became clear to me it would make sense for us to explore some options and that the funding of independent investment banks would come under pressure. The first conversations began Saturday morning, said Thain.
Thain and Lewis met in person a few hours later, and by Saturday afternoon a team from Bank of America set about reviewing Merrill Lynch's books. Facing questions from analysts over whether the 48-hour timeframe provided an adequate opportunity for Bank of America to conduct in-depth due diligence, chief financial officer Joe Price told an investor conference call previous diligence conducted by private equity firm JC Flowers was crucial in closing the deal.
We deployed a team that included over 45 people onsite to review asset valuations, trading positions and the like. They were also joined by a team from JC Flowers that had done extensive due diligence over time in reviewing [the balance sheet for] other potential transactions, so they were very familiar with Merrill's books. That group, and the progress Merrill Lynch had made in reducing its risk exposure, meant those efforts made [the deal] possible for us, said Price.
Price also defended the $29-a-share price Bank of America paid for Merrill Lynch, which reflects a 70% premium over the dealer's closing price on Friday. The approximate $50 billion price tag, which is 1.8 times Merrill's stated tangible book value and roughly 12 times Merrill's 2009 projected earnings, is only a 29% premium on the average equity price over the past five trading days, he said.
Lewis refused to answer questions on why Bank of America decided against making a bid for Lehman Brothers, preferring to reiterate his belief that independent broker dealers are unsustainable in the long-term. Those remaining namely Morgan Stanley and Goldman Sachs may have no choice but to merge with institutions boasting strong consumer banking businesses, as the lines of credit necessary to facilitate highly leveraged operations becomes even harder to obtain, he added.
Merrill has been a strong and respected competitor, but the market continues to question the viability of the standalone investment bank. For seven years as chief executive, I have said I believe the commercial banks would eventually own investment banks because of the funding issue and I still think that. I just happen to have been a little ahead of my time, Lewis noted.
With three of the big five brokerages Bear Stearns, Lehman Brothers and Merrill Lynch failing or being bought by competitors in the past six months, the once unthinkable notion that the two remaining standalone investment houses could lose their independence has become the subject of feverish media speculation in the past 48 hours. Goldman Sachs reports its third quarter earnings today, with Morgan Stanley to follow on Wednesday.
Bank of America's move back into investment banking has taken many by surprise. The firm sold its prime brokerage arm to BNP Paribas in June and was widely thought to have abandoned any aspirations to be a major player in the investment banking world. In October 2007, Lewis told investors he had had all the fun I can stand in investment banking at the moment following hefty third quarter writedowns.
Obviously, Merrill Lynch is much more than an investment bank. But the frustration we have had [in investment banking] is we would try and stay focused, but it was very hard to keep within a narrow framework and not get away from that and into other businesses. But this deal solves that problem. This creates a company instantly it would have taken a decade to build and we don't have to worry about attracting and retaining world class people. I think we are now in a position that I can say I truly do like the business at this scale. I like [investment banking] again, said Lewis.
For Thain, the future appears less than clear. In the race to reach an agreement, there has been no discussion regarding any future role for him at Bank of America. When questioned on whether his 10-month stewardship of Merrill Lynch would be regarded as a success or a failure, he conceded that guiding the bank into the arms of a buyer was not what he had envisioned when taking the role.
It is fair to say this is not necessarily the outcome I would have expected when I took this job, but we have been consistently cleaning up the balance sheet, repairing the damage that had been done over the past few years. Frankly, this opportunity is a good one for our shareholders and our employees.
Thain and Lewis also confirmed the Merrill Lynch name and organisation will remain intact, although Lewis seemed to tempt fate by concluding: The combined company will survive almost anything now. The deal is expected to close by end of the first quarter of 2009.