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For BofA, nothing fair about Merrill deal

Investment bankers made $20 million for a weekend's work blessing a deal that has gone bad, dragging down BofA and the whole banking sector.

Colin Barr, senior writer
Last Updated: January 16, 2009: 10:42 AM ET

Bank of America chief Ken Lewis may need federal help just weeks after completing the Merrill buy.
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Merrill chief John Thain rushed to sell his firm as rival Lehman Brothers teetered toward bankruptcy.

NEW YORK (Fortune) -- Bank of America's plea for more federal help has dealt another black eye to both the banking sector and the badly bruised financial advisory business.

Shares of Charlotte-based Bank of America (BAC, Fortune 500) plunged 15% Thursday after earlier hitting a 14-year low due on concerns it would need another bailout. Early Friday, the government confirmed it was providing BofA with $20 billion more in taxpayer funding as well as billions of dollars in loan guarantees to stem losses tied to the bank's acquisition of Merrill Lynch.

Friday morning, BofA announced a $1.8 billion loss for the fourth quarter, and further disclosed that Merrill lost more than $15 billion in the last three months of 2008.

BofA's latest problems add to the questions that have been swirling about the bank's decision, reached early on the morning that Lehman Brothers collapsed in mid-September, to pay billions of dollars to acquire Merrill. The big brokerage firm has been hit hard by bad bets on mortgage-related securities.

BofA completed the Merrill deal Jan. 1 - but only after receiving assurances that the government would help defray losses tied to the Merrill deal, The Wall Street Journal reported late Wednesday.

But CEO Ken Lewis' decision to buy Merrill isn't the only thing that looks questionable now. So does the advice he and the BofA board got on the hastily arranged Merrill deal from the bank's advisers, Fox-Pitt Kelton and J.C. Flowers & Co.

The financial advisers offered opinions calling the deal fair to Bank of America shareholders. But that conclusion seems to be undermined by the plunge in Bank of America's shares in the months since the deal was announced, and the bank's apparent need for another capital infusion from the government.

BofA already had received $25 billion, including $10 billion as part of the Merrill Deal, from the Treasury Department via the Troubled Asset Relief Program, or TARP, before Thursday's announcement that it would be getting another $20 billion.

What's more, the bank's shareholders paid the advisers $20 million for the opinions - which the firms formulated after investigating Merrill Lynch's condition over a single, hectic weekend.

BofA and J.C. Flowers didn't return calls seeking comment, and Fox-Pitt Kelton declined to comment.

Anatomy of a hurried deal

The proxy documents mailed to the banks' shareholders this past fall describe the background of the hastily arranged deal.

According to the proxy documents, Merrill chief John Thain called Lewis the morning of Saturday, Sept. 13 to propose a possible partnership in which BofA would take a stake in Merrill. Lewis replied that he wasn't interested in taking a minority interest in the brokerage firm but would consider a full-fledged takeover. They agreed to continue to talk.

"Following that afternoon meeting, and in view of the need to move expeditiously in light of the apparently imminent bankruptcy of Lehman Brothers and deteriorating market conditions," the proxy states, "both companies began to arrange meetings among members of management and their advisors to discuss the challenges and benefits of a transaction and to undertake their respective business, financial, operational and legal due diligence investigations."

Among the firms summoned by the BofA board were Fox-Pitt Kelton and J.C. Flowers. The next day, according to the proxy documents, BofA senior management and the advisory firms offered the bank's board the findings of their investigation.

BofA management presented the board with a proposal to buy Merrill in an all-stock deal that, at the time, was valued at nearly $50 billion.

J.C. Flowers and Fox-Pitt found that the proposed price was "fair, from a financial point of view, to Bank of America," the proxy document says.

The Bank of America board approved the deal on the morning of Monday, Sept. 15. "Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders," Lewis said in a press release issued that day.

For their work that weekend, Fox-Pitt Kelton and J.C. Flowers got "an aggregate amount" of $20 million from BofA, the proxy filing said, in addition to reimbursement for out-of-pocket expenses and indemnification "for certain liabilities that may arise out of its engagement by Bank of America and the rendering of its opinion."

One former investment banker wondered why Lewis, or any other CEO, really needed a fairness opinion in the first place.

"Considering that no one -- the government, the boards or the investors - had any possible use for these opinions, it certainly puts the focus on why anybody is willing to pay $20 million for them," said Gary Lutin, who runs the Shareholder Forum corporate governance advocacy group in New York.

Lutin said that the habit of seeking fairness opinions grew out of a questionable reading of a legal decision two decades ago, and has since devolved into an "irrelevant ritual" that amounts to "the opposite of collecting and considering relevant information about a possible merger."

Not surprisingly, Lewis has been second-guessed about his decision to pay a premium price for Merrill ever since the deal was announced. Because BofA shares fell so sharply between the Sept. 15 announcement and the Jan. 1 close, the transaction was worth $19 billion when it was completed.

"Some think that we should've waited till Monday and see if they would've gone bankrupt," Lewis said an interview aired on CBS' "60 Minutes" on Oct. 19. "Some think we would've gotten it for, you know, dirt cheap. But my point is, you would have a tarnished brand. You would've had chaos."

Considering that BofA's stock has lost three-quarters of its value in the four months since the Merrill deal was announced, and that the bank is likely to need more help from the government, it seems Lewis and his investors may be getting their chaos anyway.  To top of page

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