As Lehman Fades Into History, BofA/Merrill Looks to the Future

It's a tale of two very different mega-transactions: Bank of America Corp.'s purchase of brokerage firm Merrill Lynch & Co. offers a prospect of brighter days ahead for the newly-merged company, while the bankruptcy filing of investment house Lehman Brothers merely serves to spotlight the sorry history of massive excess bringing down many venerable firms within the financial services industry.

In one swoop, BofA's CEO Ken Lewis has transformed the Charlotte-based banking concern into a global investment powerhouse with his $50 billion all-stock purchase of Merrill. At first glance, this looks like a good deal for both institutions. For a reasonable amount and virtually overnight, BofA becomes the largest retail brokerage in the world -- adding 16,ooo Merrill financial advisers to its current 4,000 along with $2.5 trillion in client assets.

To build a nework like that basically from scratch would have cost much more than the announced $50 billion. Throw in Merrill's 50-percent ownership stake in investment firm Black Rock, which itself has $1.4 trillion in assets under management, and BofA now boasts a whopping $589 billion assets under its management tent. From that base, BofA has the muscle to become a predominant institutional financial services player with strength in fee-generating sectors including: debt underwriting; equities; and merger and acquisition work.

Meanwhile, Merrill -- which like many of its Wall Street brethren is reeling from subprime mortgage loan losses -- was saved from going down the painful bankruptcy path taken today by Lehman.

Is the BofA-Merrill deal risk free? No way.

Already, the bond ratings agencies are breaking badly on BofA, fearing the banking concern has overreached. Meanwhile, BofA stock is suffering on news of the deal and CEO Lewis has to win over that key constituency, which will have to approve this deal.

Of greater concern is just how toxic Merrill's balance sheet is because of its subprime holdings. Indeed, both sides agree the deal was made in haste and finalized shortly after BofA walked away from bailing out Lehman.

However, BofA's Lewis is up for the challenge of handling whatever loan problems Merrill serves. Earlier this year, Lewis bought the sickly California-based Countrywide Financial, proving he's not shy about taking a calculated risk on damaged franchises and assets--provided they advance BofA's quest to become a global financial services powerhouse.

While Merrill still has a future, Lehman Brothers offers only a tragic past.

A victim of its own excess, Lehman enters Manhattan bankruptcy court with $613 billion in debt and assets worth $639 billion. Most shareholder equity will be wiped out and bond holders will be lucky to get 60 cents on the dollar.

One of the biggest underwriters of subprime mortgages, Lehman's balance sheet is a mess with a capital ratio -- total assets compared to shareholder equity -- at 31, among the highest among large Wall Street investment houses. In a sign of events to come, Lehman last week suffered its biggest loss ever and said it was in dire need of a capital transfusion.

Lehman had hope the U.S. Treasury would grease its sale to another financial services company by providing some financial aid as it did in March when JP Morgan Chase acquired Bear Stearns, a fellow subprime enabler.
In a sign that the U.S. government can't save every financial institution from itself, U.S. Treasury reportedly offered only minimal assistance and left Lehman on its own to find a rescue plan.

Ultimately, two potential suitors -- BofA and Barclays Plc -- backed away, forcing the 158 year-old Lehman to enter bankruptcy court.