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For Bank of America, the Pressure Mounts Over Merrill Deal

Published: January 16, 2009

Just months ago, Kenneth D. Lewis was the triumphant hero.

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Davis Turner/Bloomberg News

Kenneth D. Lewis, the chief executive of Bank of America. Mr. Lewis had long coveted Merrill Lynch.

Today, he is struggling to defend a controversial conquest that now threatens the mighty empire he built at Bank of America.

Hours after the bank received a new government bailout to cover heavy losses at its Merrill Lynch subsidiary, Mr. Lewis came under fire Friday from investors wanting to know why the bank did not notify them of Merrill’s losses in December, when the bank told the government it would need additional support to ensure the merger would survive.

Merrill Lynch reported a devastating $15.3 billion loss in the fourth quarter, its last quarter before the merger closed. Those losses came atop Bank of America’s own $1.79 billion loss last quarter, as the nation’s largest consumer bank suffered from credit card, mortgage loan and commercial real estate problems. The shares closed at $7.18, down 13.7 percent. In a conference call with analysts, Mr. Lewis found himself fending off a barrage of questions about what he knew of Merrill Lynch’s losses, and when he knew it.

"The question is, When did Merrill Lynch know they had these losses? A lot of times companies would disclose losses of that magnitude,” said Michael Mayo, an analyst at Deutsche Bank. “This was dramatic."

Mr. Lewis told analysts that he was surprised to learn in December, three months after the bank snapped up Merrill Lynch in a shotgun deal, that the magnitude of losses at the brokerage was far greater than expected. He said he had considered walking away from the deal at that point, but was persuaded not to, partly by regulators who feared that a failure to seal the deal could set off a new round of panic in the markets.

The decision to stick with Merrill despite its problems, he said, was patriotic. “I do think we were doing the right thing for the country,” Mr. Lewis said.

But that may not be the right thing for the bank’s shareholders, who were already upset that Mr. Lewis appeared to have overpaid to achieve his dream of dominating the brokerage business.

In September, when the deal was inked, Mr. Lewis said he had been willing to pay more than $50 billion in stock, or $29 a share, for a company whose stock was in free fall because Merrill Lynch was “more likely than not” to survive the current turmoil. He said he had not wanted to wait to make a discount bid and risk losing the opportunity to buy the wealth management giant.

“Merrill had the liquidity and capacity to see this through,” Mr. Lewis said at the time.

In the months after the merger, however, financial markets deteriorated more brutally. The bank’s shareholders voted on the merger on Dec. 5. And while the full extent of Merrill’s fourth-quarter losses might not have been fully known then, had shareholders had an idea of the extent of the losses, they may have agitated for the deal price to be renegotiated.

Mr. Lewis said he had considered trying to renegotiate the price once he learned the extent of Merrill’s losses. But he feared that the length of time required for a new shareholder vote would put Merrill and the markets at risk. More important, he said, the government did not want to risk new turbulence in financial markets if the deal were to be delayed.

“In recognition of the position that Bank of America was in, both the Treasury and the Federal Reserve gave us assurance that we should close the deal and that we would receive protection,” Mr. Lewis said.

Some analysts said it was not possible for Merrill and Bank of America to know how much those assets would plummet in value.

“The fourth quarter of last year may go down as the worst quarter of capital markets in a century,” said David Fanger, a senior vice president at Moody’s Investors Service. “You can’t predict what the market’s going to do, so even if you know your positions you’re not going to know the total figure.”

But Stuart Plesser, a banking analyst with Standard & Poor’s Equity Research, said that by his estimates, Bank of America would not have needed the additional government capital without Merrill’s problems. He said the bank could have cut its dividend in half to cover its capital needs. The situation, he said, “doesn’t seem to be a good deal for shareholders at all.”

Also unanswered was why Bank of America explained only about $9 billion of Merrill’s write-downs. There are also write-downs of at least $4 billion in Merrill’s fixed-income unit. Those marks could be related to trades that were put on in recent months. A spokesman for Bank of America declined to comment.

Mr. Lewis, famous for his hulking acquisitions in recent years, has long coveted Merrill. He considered buying the firm about a year ago, but he backed away because it had not yet cleaned out the bulk of its troubled mortgage bonds. But in September, when Merrill came calling, Mr. Lewis decided to take the plunge.

Hastily arranged deals often have escape clauses, according to banking experts. Bank of America included a provision that would have allowed it to opt out of the deal should a material adverse change occur. But changes in the values of investments do not apply if they were valued correctly at the time of the deal. The bulk of Merrill’s write-downs come from assets like mortgage bonds and commercial real estate, which have been stuck on its books for more than a year.

“No matter what they do, they’re going to get sued, and the basis of the lawsuit is ‘you didn’t tell us,’ ” said Nell Minow, editor of the Corporate Library. “When it goes up you should’ve told us it was going to go up, when it goes down you should’ve told us it’s going to go down.”

Eric Dash and Jonathan D. Glater contributed reporting.

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