Lewis fights for survival

If Bank of America bosses hoped yesterday's improved trading update would quell an investor rebellion, they were disappointed. Stephen Foley reports

If he could go back in time by seven months, knowing what he knows now, would Ken Lewis board the Bank of America corporate jet and head for New York on the morning of Saturday, 13 September?

It was an extraordinary dash to the nation's financial capital, but it was, you will recall, an extraordinary weekend. Lehman Brothers was teetering on the edge of bankruptcy, and a financial panic was threatening to engulf Wall Street's investment banks. John Thain, chief executive of Merrill Lynch, had placed a sensational call to Mr Lewis first thing that morning: "We should talk."

The two men met at BofA's corporate apartment in Manhattan's Time Warner Centre on the Saturday afternoon, and by the end of the next day, Merrill Lynch, one of the big names in investment banking, had been sold. Mr Lewis agreed to pay $50bn in BofA shares with just a few hours of due diligence.

As the days turned to weeks, what seemed like an opportunistic triumph came to look like a disaster, and seven months on, Mr Lewis's Merrill Lynch gamble has left him fighting for his job.

Next Wednesday, shareholders will be voting on whether he should be forced to split the roles of chairman and chief executive, and on whether he should even be re-elected to the board at all. Mr Lewis will be hoping for a boost from yesterday's better-than-expected financial results, but while the headline numbers looked good, analysts were less impressed with the detail. Indeed, next week's vote now looks like a nailbiter.

"The absence of board leadership and a willingness to curb Mr Lewis's penchant for empire-building led to BofA's entry into a risky transaction following an abbreviated due diligence process," the shareholder advisory service RiskMetrics/ISS concluded, telling its clients that the Merrill debacle should cost Mr Lewis his re-election. Another proxy vote service, Glass Lewis, made the same recommendation last week.

Their conclusions bolster a union-backed campaign, led by the group Change to Win, which has been calling for Mr Lewis's head for several months, describing it is "a necessary prerequisite to restoring BofA's credibility with shareholders, regulators and the public".

Also stirring the pot is a furious shareholder from Texas, Jonathan Finger, who used to run Charter Bancshares, a company which Bank of America predecessor, NationsBank, acquired in 1996. His website has been a focus for dissent against Mr Lewis for several months, and he is demanding the removal not just of the chief executive but of two senior directors who he said could and should have stopped the Merrill Lynch deal on several occasions before its closure on 1 January.

"We believe that the current management and board of directors of the company are focused on increasing size, market share and geographic footprint rather than protecting and building long-term shareholder value," Mr Finger says, and he has taken out TV ads to drum up support for his campaign.

Mr Lewis, now 62, had been hailed as the straight-talking star of US banking since taking over at the helm of Bank of America in 2001, as he rolled up bigger and bigger acquisitions and fought Citigroup for the title of the nation's largest bank. Shareholders already had their eyebrows raised when he moved to take over ailing Countrywide in 2007, since this was the largest sub-prime lender in the county and no one knew yet how bad the housing market was going to get. The Merrill Lynch deal, though, was in another league.

Shareholders have never quite forgiven Mr Lewis for paying a 60 per cent premium over Merrill's Friday-night share price, even though there was every possibility the company might be worth nothing if he walked away and the conflagration on Wall Street had continued into the next week.

Then came the spiralling losses between signing on the dotted line in September and closing the deal. In those final three months of the year, Merrill Lynch posted a record $15.3bn loss as its mortgage securities and other credit investments soured still further. The outline of those losses was becoming clear by the time BofA shareholders assembled to vote on the deal in November, but they were not disclosed. Dissidents say that, if they had been, they would never have approved the acquisition, and there are several lawsuits pending from shareholders who say they were misled. To fill the black hole from Merrill, BofA had to get another $20bn in federal bailout cash and a government guarantee covering $118bn of the acquired assets. Mr Lewis has never said how much pressure the government brought to bear on him not to walk away from the Merrill deal.

As if this wasn't enough, it was revealed that Merrill boss John Thain brought forward the payment of billions of dollars in bonuses to his staff to before the closing date of the deal, protecting them from any chance the new owners would change them. Messrs Thain and Lewis had an unedifying public spat about who knew what about the bonuses when, before the BofA chief fired the Merrill boss in February.

The Merrill deal "transformed a bank well-positioned to weather the financial crisis into one of its most costly casualties," says Michael Garland of Change to Win.

BofA says it always acted legally and appropriately in its disclosures around the Merrill Lynch acquisition and that the deal will ultimately create value for its shareholders. Exhibit A, it says, is the financial results it posted yesterday. Merrill Lynch contributed $3bn to Bank of America's bottom line in the first quarter of the year.

Analysts judged the quality of that contribution to be low, largely the result of a $2.2bn gain on paper because of changes to the value of Merrill's outstanding debt. Merrill's trading business, however, did reap real benefits from the wide spreads on credit instruments.

BofA's overall net income for the quarter was $2.81bn, more than double that of the same period last year and much better than the flat-to-slightly-negative figure analysts had been expecting. However, there were ballooning losses of $1.77bn at the credit cards business, and the bank added $6.44bn to reserves for bad loans.

"No doubt about it, credit is bad we believe credit is going to get worse before it will eventually stabilise and improve," Mr Lewis said.

It was straight talk, but it helped to push BofA shares down more than 20 per cent in New York. Analysts were particularly concerned about BofA's capital position if credit quality continues to deteriorate at this pace. Its ratio of tangible common equity to assets – which the government seems to be using as its preferred "stress test" measure for the health of the nation's banks – has only just crept above 3 per cent, when analysts prefer something north of 5 at least. The share price fall in part reflects the growing chance that the US taxpayer will have to become BofA's biggest shareholder.

All in all, hardly the best start to the final week of Mr Lewis's re-election campaign.