Case #3 8ank of Amer|ca Acqu|res Merr||| Lynch (A)

Advanced Corporate I|nance

IIN S342 Spr|ng 2011
rofessor 8||| Megg|nson


repared by









2

xecutive 5ummory
1he flnanclal crlsls of 2007 and 2008 forever changed Lhe flnanclal landscape ln Lhe unlLed
SLaLes and Lhe world lnvesLmenL banklng flrms underwenL Lhe mosL LranslLlon wlLh Lhe survlvlng ones
belng forced Lo elLher become or parLner wlLh a bank Merrlll Lynch was no excepLlon Lo Lhe rule and
was ulLlmaLely acqulred by 8ank of Amerlca (8AC)
8ank of Amerlca had grown from a small bank ln norLh Carollna Lo one of Lhe largesL ln Lhe
counLry malnly Lhrough acqulslLlon luLure reLall banklng growLh opporLunlLles were llmlLed and
coveLed Merrlll Lynch's asseL managemenL and lnvesLmenL banklng franchlse WlLh Lhe flnanclal crlsls
as a backdrop Lhere appeared Lo be an excellenL opporLunlLy Lo purchase Merrlll Lynch aL an aLLracLlve
valuaLlon
1he merger beLween Lhe Lwo flrms was made over a weekend ln Lhe mlddle of SepLember
2008 8ank of Amerlca's CLC ken Lewls declared LhaL Lhe acqulslLlon was Lhe sLraLeglc opporLunlLy of
a llfeLlme" Mr Lewls soon learned LhaL Merrlll Lynch's losses were much more Lhan orlglnally LhoughL
Pe began Lo quesLlon Lhe wlsdom of 8AC's offerlng prlce for Merrlll and consldered legal remedles for
posslble renegoLlaLlon or dlssoluLlon Powever he ulLlmaLely closed Lhe LransacLlon aL Lhe orlglnal
Lerms and condlLlons under lnLense pressure from Lhe unlLed SLaLes governmenL
1reosurys lnsistence thot 8onks 4ccept ledero/ copito/
uS 1reasury SecreLary aulsen soughL a sysLemaLlc soluLlon Lo Lhe pleLhora of Lroubled
flnanclal lnsLlLuLlons LhaL beleaguered Lhe banklng sysLem Mr aulsen's vlslon became a reallLy when
Lhe $700 bllllon 1roubled AsseL 8ellef rogram (1A8") was mandaLed as parL of a broader plece of
leglslaLlon Lhe Lmergency Lconomlc SLablllzaLlon AcL of 2008 ShorLly LhereafLer Lhe 1reasury
announced changes Lo 1A8 whlch were Lermed Lhe CaplLal urchase rogram or (C") 1hese


changes were Lhe resulL of a fundamenLal shlfL ln how Lhe 1reasury wanLed Lo wage lLs baLLle MarkeL
sLablllzaLlon and llquldlLy remalned Lhe goals of Lhe sLlmulus buL Lhese goals could llkely be achleved
more qulckly and efflclenLly Lhrough Lhe purchase of preferred sLock and warranLs ln Lhe flrms needlng
help raLher Lhan aLLempLlng Lo ldenLlfy value purchase and servlce Lhe Lroubled debL 1hese
lnvesLmenLs also provlded Lhe 1reasury a mechanlsm Lhrough whlch Lhey could essenLlally mandaLe
good corporaLe behavlor by llmlLed execuLlve compensaLlon
under Lhe C Lhe 1reasury selecLed elghL large banks for lLs lnlLlal $123 mllllon ln[ecLlon from
Lhe 1A8 funds ln order for Lhe program Lo have lLs deslred effecL lL was lmporLanL LhaL all of Lhe
banks accepL Lhe money lmporLanL slgnals would be senL Lo Lhe markeL lf one or more dld noL accepL
Lhe funds lor example lf ClLlgroup (n?SL C) puL ouL a press release sLaLlng LhaL Lhe 1reasury
requesLed LhaL C Lake money along wlLh all Lhe oLher banks buL C had decllned due Lo Lhelr overall
flnanclal healLh Lhe lmpllcaLlon would be LhaL Chase and Wells largo were ln Lrouble AddlLlonally
1he 1reasury made lL clear Lo Lhe 8anks LhaL Lhelr regulaLors would be requlrlng Lhese funds so Lhere
really wasn'L a declslon Lo be made
5hou/d 84c 4ccept the cPP lunds?
As noLed above lL doesn'L appear LhaL Lhe uS 1reasury gave ken Lewls 8ank of Amerlca's CLC
much of a cholce ln Lhe maLLer of wheLher Lo accepL or decllne Lhe 1reasury's $23 bllllon referred SLock
lnvesLmenL uesplLe Lhe 1reasury's sLrong poslLlon we belleve 8ank of Amerlca and Lhelr shareholders
should have vlewed Lhe lnvesLmenL ln a poslLlve llghL especlally conslderlng Lhe currenL Lurmoll ln Lhe
markeL 1he lnvesLmenL came wlLh a relaLlvely small prlce Lag 1he flrm musL pay a small 3 dlvldend
yleld (9 afLer ?ear 3) and agreed Lo lssue warranLs LhaL would glve Lhe 1reasury Lhe rlghL Lo buy 8AC
common sLock of up Lo 13 preferred lnvesLmenL amounL aL a sLrlke prlce approxlmaLlng 8AC's sLock aL
Lhe lnvesLmenL daLe


Cne monLh earller Coldman Sachs ralsed money ln a prlvaLe LransacLlon LhaL was of a slmllar
sLrucLure Lo Lhe one proposed under C 1he prlvaLe markeL Lerms requlred a hlgher raLe of reLurn Lo
Lhe lnvesLor buL llkely dldn'L lnclude a llmlLaLlon on execuLlve compensaLlon LasLly Lhe uS
CovernmenL does noL have an lnLeresL ln ownlng 8ank of Amerlca long Lerm 1he warranL provlslons
were llkely only lncluded Lo proLecL Lhe governmenL ln a downslde scenarlo ln whlch Lhe bank was
havlng Lrouble repaylng Lhe loan under any scenarlo showlng 8AC as a vlable enLlLy ln 3 years we feel
Lhey should accepL Lhe money and noL complaln
4ttroction ot o Price
1he Merrlll Lynch deal was aLLracLlve Lo 8ank of Amerlca aL Lhe $30 bllllon prlce ln SepLember
Lven Lhough Lhe markeL showed concern wlLh Merrlll's share prlce havlng decllned 82 from $2739
Lo $1703 and Lhere was anLlclpaLlon aL LhaL Llme regardlng Lhe fallure of Lehmann whlch would have
caused problem ln Lhe form of llquldlLy crunch Lo Merrlll sLlll 8AC's sLable base of deposlL fundlng would
solve Lhe llquldlLy problems caused by Merrllls dependence on hlghlyunsLable shorLLerm credlL
markeLs and hence ellmlnaLe Lhe posslblllLy of an abrupL llquldlLyrelaLed fallure
lor 8AC Lhe LransacLlon offered expanslon of Lhe flrm's global reach and provlde an lmmedlaLe
fooLhold ln Lhe wealLh managemenL and lnvesLmenL banklng secLor where lL dldn'L have any presence
Llll daLe Whlle Lhe sLraLeglc value of Lhe opporLunlLy was compelllng paylng a large premlum for Lhe
flrm wasn'L necessary and Mr Lewls should have looked for beLLer Lerms and condlLlons
uisc/osure 1o whom how much ond when?
8ank of Amerlca's managemenL wresLled lnLernally regardlng wheLher Lhey had a legal duLy Lo
dlsclose Merrlll's losses Lo shareholders before Lhe uecember 3 voLe Cn uecember 8AC was advlsed
by counsel LhaL Merrlll's losses were noL hlgh enough Lo requlre publlc dlsclosure Powever Lhe advlsor
3

was noL lnformed LhaL Merrlll's esLlmaLed fourLh quarLer losses had rlsen from $7 bllllon aL Lhe end of
november Lo $898 bllllon 8AC shareholders were also unaware LhaL Merrlll was preparlng Lo pay ouL
$6 bllllon ln bonus compensaLlon laLer ln uecember 2008
Whlle clearly under pressure from many dlrecLlons we belleve LhaL Mr Lewls should have
dlsclosed Lhese lLems ln advance of Lhe shareholder voLe PonesLy ls always Lhe besL pollcy
overnments critico/ ko/e in loci/itotinq this 1ronsoction ond 8eyond
1he governmenLs' role was vlLal ln Lhe 8AC/Merrlll deal 1helr purchase of preferred shares
debL flnanclng and guaranLees all were all crlLlcal Lo ensurlng LhaL 8ank of Amerlca was able Lo compleLe
Lhe deal and remaln solvenL 1he governmenL effecLlvely allowed 8AC Lhe use of lLs funds aL below
markeL raLes (lf even avallable) LhaL allowed a prlvaLe enLerprlse Lo execuLe whaL would have become
governmenL's responslblllLy
1he preferred share purchase amounLed Lo exLra worklng caplLal for Lhe perlod of Lhe crlsls
1hls allowed 8AC Lhe flexlblllLy Lo hold llllquld asseLs whlle markeL prlces sLablllzed 1he debL flnanclng
and guaranLee were almed dlrecLly Loward Lhe Merrlll purchase and aLLempLed Lo lncenL Lhe flrm Lo
execuLe Lhe LransacLlon aL a hlgh level Whlle noL lnlLlally popular wlLh Lhe consLlLuenLs of Lhe uS
governmenL or 8ank of Amerlca Lhe acLlons wlll llkely be vlewed as good for 8ank of Amerlca and for
Lhe uS governmenL 1he governmenL's asslsLance ln Lhls LransacLlon and oLhers llkely helped sLop Lhe
lmpendlng depresslon descendlng on Amerlca 8ank of Amerlca ulLlmaLely was rewarded wlLh Lhe
ablllLy Lo purchase Lhe asseLs Lhey wanLed (Merrlll Lynch) wlLh Lhe supporL of cheaper caplLal and rlsk
reducLlon by Lhe uS
6

1he cO 4ssesses kisk ond Leods his lirm
Mr Lewls would llkely have never been blamed had he walked away from Lhe Merrlll Lynch deal
as Lhe evldence began Lo mounL Lhe Merrlll was ln much more dlre flnanclal condlLlon Lhan was known
by anyone when Lhe deal was made 1here ls a good deal of evldence LhaL he wanLed Lo walk away
from Lhe deal buL Lhe governmenL would noL leL hlm lor whaLever Lhe reason he sLayed Lhe course
and LhaL proved Lo be a good Lhlng for boLh 8ank of Amerlca and Lhe flnanclal sysLem as a whole
AL flrsL blush we felL LhaL sysLemlc rlsk (overall markeL rlsk noL speclflc Lo a flrm) a
phenomenon blgger Lhan 8ank of Amerlca and Lherefore should be none of Mr Lewls' concern
Powever afLer much analysls we came Lo Lhe concluslon LhaL wlLhouL Lhe acLlons of Lhe governmenL
and Lhe accepLance and supporL of Lhose acLlons by prlvaLe flrms (llke 8AC) sysLemaLlc rlsk equaled
company rlsk durlng Lhe helghL of Lhe crlsls ln order for 8AC Lo survlve Lhere had Lo be a flnanclal
sysLem ln whlch Lhey could parLlclpaLe