Behind Ken Lewis's departure: Merrill

With the Merrill deal, Bank of America's Ken Lewis finally falls victim to the pressure of lawsuits and regulators.

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By Shawn Tully, editor at large

Ken Lewis, chief executive of Bank of America
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301 Moved Permanently

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NEW YORK (Fortune) -- It was part of the corporate lore at Bank of America: Whenever legendary boss Hugh McColl would buy a bank in Florida, Texas, or Georgia in the 1980s and early 1990s, he'd call his trusted lieutenant Ken Lewis to his Charlotte office and order Lewis to fix the new acquisition to fit his revolutionary vision of a branch network stretching from coast to coast.

Hours later, anyone who asked "Where's Ken?" would be amazed to learn that Lewis had already left for Miami, Houston, or Atlanta, armed with little more than a toothbrush.

Lewis provided the operating and integrating skills that built Bank of America (BAC, Fortune 500) as the first nationwide bank. No one could match his talent for trimming headcounts, combining systems, and closing surplus branches. As the bantam, loquacious McColl put it with characteristic bluntness: "Wherever I sent him, he always made money."

As CEO, Lewis scored his biggest successes in just the area where he'd performed so well for McColl -- as a relentlessly effective manager of costs and people.

He made some great deals: His acquisition of FleetBoston Financial in 2004 was roundly criticized as far too expensive, but Lewis made the merger highly profitable by squeezing 40% from Fleet's total costs. In the process, he extended BofA's reach into the new terrain of the enormous, high net worth market in the Northeast.

But it was Lewis's impulse to grow the bank, even if it meant grossly overpaying for acquisitions, that brought him to grief. Yesterday's surprise announcement that Lewis, 62, would retire at the end of 2009 -- a full 15 months before he'd planned to depart -- is the result of his biggest deal, a deal he wanted so badly that he couldn't resist paying the king's ransom that's now haunting BofA's shareholders.

For years, Lewis had coveted Merrill Lynch, only to be rebuffed by then-CEO Stan O'Neal. When Lewis finally got his chance on the September 2008 weekend when Lehman Brothers collapsed, he agreed to pay $50 billion to keep Merrill from a deal with Goldman Sachs (GS, Fortune 500) or Morgan Stanley (MS, Fortune 500). In retrospect, he should have waited until Monday, when he stood an excellent chance of bagging Merrill for a fraction of that price.

Lewis was also unlucky. In mid-December, he was shocked to learn that Merrill would post staggering losses for the fourth quarter. It's almost certain that he didn't want to walk from the deal at that point. But he was in a strong position to lower the price; the Merrill board would have had little choice but to agree to a multi-billion dollar reduction. But it would have taken over a month to recast the deal and hold new shareholder votes, and the Fed and Treasury were terrified that Merrill couldn't get the short-term funding during that period to survive. So the Treasury effectively forced Lewis to close the deal at an excessive price.

A single statistic demonstrates the damage that the Merrill deal inflicted on shareholders. At the end of 2008, BofA had 4.5 billion shares outstanding. The number today is 8.5 billion -- almost double. Bank of America suffered that dilution, first, to buy Merrill when BofA stock was already depressed, and second, to shore up its balance sheet because of Merrill's losses. Hence, BofA shareholders sacrificed half their share in BofA's enormous earnings for a far smaller sliver of profits from Merrill Lynch.

Still, it's indisputable that Lewis built a great franchise. And BofA is already staging a comeback. Despite big credit costs in the first half of 2009, BofA still managed to post $5 billion in earnings after paying the government its preferred stock dividend from the TARP. If its credit costs return to a historically normal level, BofA is on track to earn as much as $30 billion a year.

It was Ken Lewis's goal to retire only after he both paid back the TARP money, according to a BofA insider, and got to that magic $30 billion number. It appears that it was the relentless distraction from lawsuits and regulators that moved this storied builder and operator to give up his post -- falling short of the redemption he sought and might have achieved. Lewis's desire to grow BofA, at too high of a cost, hurt shareholders. But he made the right decision to step down. In his final gesture, Lewis proved that what comes first for him is the reputation and future of BofA. To top of page

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