The recent agreement by Bank of America to settle a shareholder suit relating to its acquisition of Merrill Lynch is a positive event for the bank. But the amount of money being paid could have been much greater if the situation was litigated further.
BofA will pay $2.43 billion to its shareholders who claimed that the bank “made false or misleading statements about both companies’ financial health.” Ironically, the agreement to buy Merrill occurred at the same time that Lehman Brothers declared bankruptcy and was not rescued by the federal government or another corporation.
Stockholders questioned the process after approving the merger, when they learned that Merrill was about to lose $27.6 billion. The loss greatly increased BofA’s total losses for the year and ultimately necessitated a $20 billion addition to the bailout money already provided by the government. In total, BofA borrowed $45 billion, which it has repaid in full.
Exacerbating the situation was the fact that BofA also did not disclose an agreement to pay $5.8 billion of bonuses to Merrill employees, in the face of huge losses at the investment bank.
Kenneth Lewis, the former CEO of BofA, was fired because of this episode and continues to face civil charges for his role in the merger of the two companies.
As previously stated, this was a very good outcome for BofA because the damages created by the merger to shareholders of BofA were far greater than the settlement when you consider that the acquirer paid $20 billion and it assumed such a large loss.
It is useful to note that John Thain, former CEO of Merrill, who negotiated the deal with Lewis, did an amazing job obtaining such a high valuation for Merrill at that precarious moment in time. Merrill, like all the investment banks, was under great financial stress and could have failed, which would have wiped out all of its shareholders. Thain negotiated a $20 billion price for his company, which most observers believe was a great achievement.
Most people do not understand how these mega mergers evolve and what it takes to close a deal of this magnitude. The BofA/Merrill merger involved many important issues that should be considered when analyzing this event. Merrill was under severe pressure at the time, and the Federal Reserve and the Treasury decided that a Merrill bankruptcy, on top of a Lehman bankruptcy, could undermine the entire global financial system. So, it is understood that the federal government encouraged Lewis to do the merger.
But, Lewis was a motivated buyer and hungry for new acquisitions. He made many deals during the years leading up to the financial crisis. Another merger by his bank that was widely criticized was with Countrywide Financial, a huge player in the high-risk mortgage business. The Countrywide acquisition ultimately resulted in huge losses for BofA as well.
Lewis believed the Merrill acquisition would propel his company into the lucrative securities business. Subsequent to the merger, Merrill has been a large contributor to BofA’s performance, so Lewis’ assessment of the merger benefits seems warranted in hindsight.
The Countrywide acquisition was supposed to be a huge moneymaker for the bank, as the sub-prime mortgage business was very profitable before the housing bubble burst. But burst it did, and BofA has experienced huge losses of about $40 billion since it consummated this acquisition.
In a merger, the buyer tries to drive the price down and the seller tries to drive the price up, obviously. But, the Merrill merger had extenuating circumstances. Lewis thought Merrill could be acquired cheaply because of the economic situation at the time and thought a $20 billion purchase price was a good deal given the synergies between the two companies. However, the follow-up loss at Merrill of almost $30 billion made the deal too expensive in the minds of many people including the BofA shareholders and their counsel. And so the shareholder suit ensued.
On the other hand, Thain knew the banking industry was changing rapidly and Merrill could possible go under if the investment community lost confidence in it and/or if the government did not bail it out. He observed what happened to Lehman- the government walked away -- so he opted to sell and spare his shareholders from a much worse disaster. It turned out to be a pretty good move for his constituencies.
Should have Lewis disclosed the impending losses at Merrill before his shareholders voted? In fact, he supposedly discussed this with his legal counsel. What counsel said to him is not exactly clear. Lewis testified that counsel said that disclosure of Merrill’s loss was not required. His future civil action will afford more details about these conversations.
Mergers are complicated transactions that are fraught with risk as business and legal implications are often at odds. Implementing this sort of transaction on the precipice of financial Armageddon, like what existed at the beginning of the financial crisis, greatly increased the likelihood of derivative problems for BofA. Lewis and BofA now know this to be true.
The implications of the BofA episode on the market are fairly significant. Although appropriate disclosure prior to the completion of an acquisition has always been a priority, future merger transactions will likely be scrutinized more extensively in the future.