In stepping down before year end, Bank of America CEO Ken Lewis's eight-year tenure ends in controversy amidst federal investigations into the bank's takeover of Merrill Lynch & Co. He also leaves behind a $2.3 tn balance sheet racked with problems.
But although Lewis also leaves behind a strong legacy as an empire builder, engaging in merger after merger to increase the bank's massive deposit base (with more than $1 out of every $10 of the country's deposits), he also leaves behind a legacy as a banker who could play hardball, to do what he thought was right for the bank he built and loved.
Because government documents and depositions reveal that it was Lewis who could crack heads to get what he wanted, it was Lewis who tried to bully the government last fall, in the end getting $20 bn in taxpayer money to buy Merrill Lynch for $17 bn, (with the rest shoring up the bank's tattered bottom line).
Lewis and his team opted not to tell shareholders voting on the Merrill deal in early December 2008 that the bank planned to pay bonuses out early, ahead of schedule, to Merrill workers amidst mounting losses, losses he and his team also chose not to disclose to shareholders (citing the lame excuse that it's inappropriate to release ‘intra-quarter' results').
And Lewis and his team didn't even opt to get Merrill to lower its pricetag by invoking a merger clause to walk away from the deal. Instead Lewis and his team used that clause to get $20 bn (on top of the $25 bn TARP money it had already taken) from the US taxpayer to buy Merrill. As well as a $118 bn backstop for the damaged assets taken on the bank's balance sheet.
Lewis and BofA remain the focus of investigations by the Securities and Exchange Commission, the House Committee on Oversight and Government Reform and the New York attorney-general, Andrew Cuomo over failures to disclose to shareholders voting on the Merrill Lynch acquisition the fact that the bank was accelerating bonus payouts at the brokerage at a time when Merrill's losses were ballooning, losses kept hidden from shareholders.
Cuomo's office released a statement saying its probe will continue. And now the Ohio Attorney General is also embarking on a probe, likely one investigation too many for the bank.
Despite what you'll hear to the contrary, that the government pressured Lewis to buy Merrill Lynch, the story is much more nuanced than that. Former Treasury secretary Henry Paulson is criticized with threatening to fire not only Lewis but others on his management team if Bank of America dropped the purchase of Merrill Lynch last December. Such high-level, unusual pressure is worthy of Congressional probes.
But Paulson knew what he was dealing with in Lewis, he saw what was coming—a man who knew how to push others around, who had just three months earlier also demanded taxpayer money to help buy Lehman Bros. that fateful autumn weekend in 2008, when Lehman eventually collapsed, and BofA bought Merrill instead, after just two days of due diligence with JC Flowers.
“I never say never, but I've had all the fun I can stand in investment banking at the moment,” Lewis had said just a year earlier, on the bank's third quarter 2007 conference call about whether his bank would make an acquisition or do a joint-venture deal to rescue its disastrous performance in investment-banking (where earnings had fallen 93% to $100 mn).
Lewis for years had been desperate to break into the top tier of investment banks, but was failing. A year later, he would. To disastrous consequences.
Yes eventually Merrill and Countrywide will eventually add to the bank's bottom line, and yes it extends the bank's already gigantic footprint.
But as the author Thomas Hardy said, “character is fate,” and in the end, the bank had to deal with the question of credibility.
Lewis had told Congress that his bank was not authorized to sign off on the Merrill Lynch bonuses, even though $5.8 bn in bonuses were part of the merger document inked in September 2008.
And as Merrill's losses mounted in November of 2008, from $7 bn to $9 bn, top bank officials considered invoking the material adverse conditions clause, a merger clause which allows a company to walk away from another due to a material change in the target's financial condition.
But Lewis and his coterie not only opted not to tell shareholders voting on the deal December 5thabout the mounting losses at Merrill, but the fact that the bankers had even considered walking away from the deal. Don't you think shareholders deserved to hear that information? Wouldn't you want to know whether you were buying rotten apples ahead of time?
Lewis then went ahead and threatened Paulson and Federal Reserve chairman Ben Bernanke with invoking the MAC clause that December, after shareholders approved the deal. Fed officials confirmed to me that this ploy was merely a ‘bargaining chip,' since the MAC clause was ironclad.
The MAC clause document, which Fox Business has obtained, said BofA couldn't walk away from buying Merrill even in the event of a turndown in the value of Merrill's assets or a failure to meet earnings projections, terrorism or war. Which is why Paulson, fed up, threatened Lewis with his job and said the move exhibited “a colossal lack of judgment.”
In October and November of 2008, Bank of America was stunned to see that Merrill's losses were mushrooming beyond their initial read of the situation.
Transcripts of depositions taken by the office of New York Attorney General Cuomo show bank executives started to consider invoking the MAC before the shareholder vote December 5th.
Chief Financial Officer Joseph Price testified to Cuomo's office that, due to Merrill's mounting losses, he and a bank vice chairman consulted with BofA's general counsel Tim Mayopoulos about invoking the MAC on Dec. 1st.
That was four days before the shareholder vote on the merger. Bank executives had implied they didn't know about the Merrill losses before the vote. The following excerpt from the Mayopoulos deposition contradicts those assertions.
Mayopoulos testified about the Dec. 1 meeting:
Question:Did you give advice about whether there was a MAC clause or not?
Mayopoulos:Did I give advice about whether I thought there was a material adverse effect or not?
A material adverse effect means the information is material. Shareholders should have known about this consideration. It's as simple as that.
MAC clauses have historically been used as "leverage" to force a target company into renegotiating a lower price, which usually takes place before shareholders vote on the deal.
But that didn't happen here.
Lewis and his team at Bank of America opted not to disclose to shareholders they were considering invoking the MAC before the Dec. 5 vote.
Lewis and his team opted not to use the MAC as a bargaining chip against Merrill to get then CEO John Thain to lower his price on the deal before the vote. BofA had offered a sweet $29 a share for Merrill when the stock was at $17.
And Lewis and his team opted not to use the MAC even to push Merrill to ditch its $5.8 bn bonus pool.
Instead, Lewis and his team opted to wait after the shareholders signed off on the merger -- and before the deal closed on Jan. 1 – to use the MAC to bully Paulson and Bernanke into getting $20 bn in U.S. taxpayers' money to buy Merrill. BofA had already received $25 bn in bailout funds in 2008.
On Dec. 21, Bernanke e-mailed colleagues at the Fed, noting that Lewis' "threat to use the MAC is a bargaining chip, and we do not see it as a very likely scenario at all." A Fed source confirms this statement.
In the end, BofA released its fourth quarter earnings statement a month later, on January 16th, where the bank finally disclosed Merrill's 2008 fourth quarter loss reached $15.3 bn, double what it saw in November. The bank also disclosed the fact that the government would invest another $20 bn in bailout funds to buy Merrill, and that the US taxpayer would backstop the balance sheet against losses on $118 bn in toxic assets.
On that fourth quarter 2008 earnings conference call, (which I listened to), Lewis told investors that he would not have bought Merrill without government help.
When the bank's earnings news and new about its government bailout were released, the bank's shares dropped. BofA would fall from $15 in December to nearly $3 by February, about the cost of an ATM fee.
So now Lewis joins a growing list of CEOs who have left under fire, a list that includes James Cayne of Bear Stearns Cos., Charles Prince of Citigroup Inc., Stanley O'Neal of Merrill, Kennedy Thompson of Wachovia and Richard Fuld of Lehman Brothers Holdings Inc.
And BofA's balance sheet is still hurting. “A near double-digit unemployment rate is bad medicine for a bank that serves consumers, and I am disappointed in how we managed credit risk. The next two quarters will be difficult,” Lewis said in his departing letter to employees.
Lewis spent more than $130 bn to more than triple the size of Bank of America with acquisitions that include FleetBoston Financial Corp., MBNA Corp., LaSalle Bank of Chicago, US Trust and Countrywide.
But, BofA lately has been papering over its profit holes with one-offs from asset sales and accounting moves, all legit, but not organic. It's also setting aside more in loan loss reserves than it's earning in net interest income, sending a chill down analysts' spines. Net interest income is the lifeblood of a bank.
And watch out for BofA's balance sheet potholes.
Bank of America Corp. has $105.5 bn in commercial real estate loans, some of which could sour as the market remains frozen. BofA also has more than $100 bn in off balance sheet assets that could come streaming back onto its balance sheet if a new accounting rule takes effect early next year. And it's got $51.5 bn in bad derivatives and assets on its balance sheet, as well as $25.7 bn in bad loan assets.
Meanwhile, BofA says it has about $138.9 bn in tangible book value. Its problem assets could swamp this important valuation metric.
That's a lot of work for Lewis's successor to have to tackle.