Should Bank of America Spin Off Merrill Lynch?

Recently, the Securities and Exchange Commission granted approval to allow Bank of America's shareholders to vote on a proposal that would allow management to explore a spinoff of Merrill Lynch. And while this is far from a done deal, the question that I (and many other) shareholders have in mind is: Will a spinoff of Merrill Lynch be a good thing for shareholders?

Here's what you need to know about the latest developments, and how a spinoff of Merrill Lynch could mean more money in shareholders' pockets.

What the SEC ruling means, and what comes nextBasically, the SEC is clearing the way for Bank of America's shareholders to vote at the upcoming annual meeting on the future of Merrill Lynch. However, I want to be clear that this isn't an "immediate action" vote.

If shareholders approve the measure on the ballot, it will allow Bank of America to set up a committee of directors to explore a potential spinoff of Merrill Lynch into an independent company. The committee would evaluate the logistics of such a breakup, the potential to unlock value, and, finally, whether or not it should be done at all.

To be clear, the bank isn't saying that its current intention is to split its business into two separate companies. It simply wants the opportunity to explore its options and decide what is best for itself and its shareholders.

Why it could make senseThe main reasons that any company decides to spin off part of its business are to decrease risk, increase shareholder value, and narrow the focus of its management in order to optimize business. So let's look at how the potential Bank of America/Merrill Lynch spinoff could do these three things.

First, separating Bank of America's consumer banking and investment banking businesses could certainly lower the risk for the bank's shareholders. Investment banking is generally a more volatile and risky practice (as we learned the hard way during the financial crisis) than consumer banking, so by keeping the investment bank separate, Bank of America's lending and other banking operations won't be vulnerable to the performance of the investment bank. This reason alone could justify the spinoff.

Second, as far as shareholder value is concerned, this is the most complicated part of the formula. It's no secret that Bank of America trades rather cheaply, and is priced at less than 75% of its book value as of this writing. And in an extensive analysis of the bank's valuation, my colleague Jordan Wathen found that by adding up the value of Bank of America's individual business segments, the total was substantially more than the current market capitalization. And that assumed that the bank's consumer real estate division and certain other parts have no value at all.

So it's fair to say that there could be significant value to be uncovered by spinning off Merrill Lynch, but the exact amount is up to the committee (if it's created) to determine.

Finally, when companies spin off, it allows each of the new smaller companies to focus on a narrower business, which theoretically means that each part could run more efficiently and act in the best interest of each business' shareholders more than it did in the past. In this case, Merrill Lynch could approach everything it does from an investment banking perspective, and not from a "big picture" viewpoint like it currently has to.

Will it happen?I believe that Merrill Lynch will eventually be spun off from Bank of America, but this is just the beginning of the process, and it could go either way. There is a lot of number crunching and other decisions to be made, not to mention the regulatory hurdles that will need to be overcome.

However, what I believe for certain is that by shedding the investment banking operations, Bank of America could go a long way toward becoming one of the lower-risk bank stocks in the market by concentrating on consumer banking operations like highly regarded rival Wells Fargo does. It's just up to the shareholders, directors, and the SEC to see if it makes sense to pursue.

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Matthew Frankel owns shares of Bank of America. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo and has the following options: short April 2015 $57 calls on Wells Fargo and short April 2015 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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