Monday, July 09, 2007

Another Bank of America acquisition?

Today's Wall Street Journal had a table entitled "How the Banks Rank". It ranked firms with investment banking revenues by totaling revenues from equity capital markets, debt capital markets, and mergers and acquisitions. In tenth place was Bank of America(BAC) with a 2.4% market share and $866mm in revenues. The two broad banking franchises that it is most often compared to are JPMorgan Chase(JPM) and Citigroup(C). JPM ranked first with a 7.2% market share and $2,559mm in revenues and C ranked third at 6.8% and $2,423mm. Goldman, Morgan Stanley, and Merrill were ranked 2, 4, and 5 respectively, the three big European banks were 6, 7, and 8 and Lehman 9. BAC's hometown rival, Wachovia, was not in the top ten as their investment banking is almost solely a U.S. based focus on mid-tier corporates.

So where is this going? BAC has aspirations to be a force in investment banking but deep pockets and a big balance sheet are still their main calling cards. They are not really global, their trading platforms have no distinguishing expertise, and their advisory clout is driven by their willingness to arrange loans. Any effort to climb up to a meaningful level in investment banking organically recalls that response to a request for directions of "you can't get there from here". That has, however, never deterred BAC in the past as first McColl and now Lewis have always been willing to step up and acquire to build.

There are two firms that scould possibly help BAC make this leap, Lehman(LEH) and Bear Stearns(BSC). Both are now stressed to some degree by the pressures on the mortgage market. Lehman's greatest long term strength has been fixed income and they are a leader in the mortgage securitization sales and trading markets. Bear is a also a leader in the mortgage securitization markets but they are much much more visibly stressed by recent events with their exposure to in-house hedge funds, one of which more or less has imploded. These are difficult days at Bear and presumably not the easiest at Lehman. Both firms have long established executive management that will ultimately need to transition out, and we're not just talking one person. Both are, long term, limited by their capital strength relative to all of their major competitors. They both trade at forward P/E ratios below 9 times. At the right price one could see how they might be up for sale.

Bank of America has a market capitalization of $215 billion. Lehman now stands at $37 billion and Bear is at just $20 billion. Even if BAC chose to overpay for either, which might annoy current shareholders, it would from a financial point of be financially feasible to digest either firm without an impact on their financial flexibility or debt ratings. They would be two very different acquisitions. Lehman would likely take BAC's fixed income division to the top of the league tables and would give it more credibility in m&a advisory. Lehman brings a decent European investment banking franchise that BAC definitely does not have. Bear does not have any significant global franchise except in some areas of trading. It does, however, have trading and risk management capabilities in New York that rival the best firms. Like Lehman it has an equity franchise that has exploited niche markets to compete head on with the biggest. The biggest bonus of Bear is its significant operational businesses that revolve around clearing, trading, and asset manager and hedge fund facilitation.

Either acquisition would be more difficult than anything BAC has tackled before. They would likely take lots of flack on the Street about how they are destroying whatever franchise they possibly buy. With the usual financial handcuffs and, if not completely bungled, the benefits to the acquired firms players of having a huge balance sheet behind them(to jack up their bonuses) it could eventually work.

It would not be surprising, from this perspective, to wake up one Monday morning and see that the WSJ had "scooped" another merger announcement.


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