Bank of America Goes on Offense

As posted by: Wall Street Journal

Bank of America Corp. reported a fourth-quarter loss of $1.79 billion Friday and went on the offensive to answer critics and shore up support for the giant Charlotte, N.C., lender during a time of crisis.

The loss, the first for Bank of America since its predecessor NCNB Corp. posted a loss in 1991, was down from a net income of $268 million a year ago. It came on the same day details emerged of a new agreement with the U.S. that provides Bank of America with $20 billion in additional federal aid and loss protections on $118 billion in toxic assets.

Bank of America maintains it went back to the government for more support because of larger-than-expected fourth-quarter losses at Merrill Lynch and that the problems came to light after shareholders approved the Bank of America-Merrill combination on Dec. 5. But 25% of the protected asset pool belonged to Bank of America, Chief Financial Officer Joe Price said Friday, a signal that the problems weren't tied strictly to Merrill's disintegration.

The nation's largest bank by assets continues to be weighed down by rising credit costs linked to the economic downturn and an array of problems confronting U.S. borrowers. It set aside $8.54 billion for bad loans in the fourth quarter, up from $3.31 billion a year earlier. Loans written off as unpaid nearly tripled, to $5.54 billion.

It also reported write-downs and trading losses in its capital-markets business, including losses on collateralized debt obligations of $1.7 billion and write-downs on commercial mortgage-backed securities of $853 million.

Investors sent the stock down 14% Friday, to $7.18, undermining the bank's effort to shed the best light on its situation by rushing out the release of its earnings earlier than expected and issuing a memo Thursday to employees titled "Bank of America Remains Strong." Shares fell 18% Thursday.

Chief Executive Kenneth Lewis "has very little credibility with the investor public right now," said Paul Miller, analyst with Friedman Billings Ramsey Group Inc. in Arlington, Va.

Mr. Lewis's credibility among employees may also be suffering. Many are angry not only at how the losses were handled but also that just last week they were issued compensation in the form of shares worth $14.33 apiece, said people familiar with the situation. Several employees questioned how the company could have issued the shares in light of the past week's news, these people said. Bank of America declined to comment.

"While these earnings and these businesses in some cases are substantially lower than earnings in normal times, they're still profitable, even with the significant increases in credit costs, lower customer activity and other market headwinds." --Ken Lewis, Bank of America CEO
Read the full transcript of Bank of America's conference call, provided by Thomson StreetEvents (www.streetevents.com). (Adobe Acrobat Required.).

Executives at both Bank of America and Merrill have indicated the losses at Merrill ballooned in mid-December, leading to a meeting between Mr. Lewis and Treasury Secretary Henry Paulson on Dec. 17. However, the market for various credit-related products began to deteriorate in mid-November, leaving many Merrill insiders to ask what Merrill CEO John Thain knew, and when.

Merrill lost $15.3 billion during the period, and the run-up in losses was concentrated in the firm's sales and trading department, run by Tom Montag, who was hired by Mr. Thain in 2008 to run that division. The two frequently told the firm's other top managers that the losses, while significant, were largely connected to so-called legacy positions at Merrill and the losses were "market-related" and not out of step with Wall Street.

Friday, some top executives and members of Merrill's board questioned privately why they weren't told about the magnitude of the losses or that the deal was possibly in jeopardy. Mr. Thain declined to comment on whether he knew about the Dec. 17 meeting between Messrs. Paulson and Lewis.

Merrill incurred large losses during the fourth quarter from derivative trades with thinly capitalized bond-insurance companies whose financial health deteriorated considerably last year. Many of the derivative contracts were written to cover periods of more than 20 years, which meant the bond insurers wouldn't be on the hook for significant cash payouts for years.

Mr. Lewis rejected the suggestion Friday that he and his team didn't conduct enough due diligence. "We did not expect the significant deterioration in mid to late December that we saw," he said on a conference call with analysts.

Despite the need for more capital and the cutting of the bank's quarterly dividend to a penny, from 32 cents, the consumer-banking and wealth-management operations performed well in the fourth quarter, Mr. Lewis noted. The company made $115 billion in new loans during a time of crisis, he added.

Meanwhile, Merrill said on Friday it will pay $550 million to settle shareholder lawsuits claiming it failed to inform investors about the risks associated with its business in the subprime-mortgage market.

Merrill "vigorously disputed" the allegations, but agreed to pay $475 million to settle a suit brought by the Ohio State Teachers' Retirement System, and another $75 million to Merrill employees who held company stock in retirement programs.

How Big Boys Fare In Credit Crunch

The credit crunch has endured for more than a year, and the Wall Street investment banks still are trying to dig out from under the wreckage. Deal Journal combed through some analyst reports to get a sense of how they are doing.

First, the progress. The four big, publicly traded, stand-alone U.S. investment banks -- Goldman Sachs Group, Morgan Stanley, Merrill Lynch and Lehman Brothers Holdings -- have about $60 billion of leveraged-buyout-related loans still on their books, having cut their exposure 30% in the second quarter, according to Banc of America Securities analyst Michael Hecht.

As to where these four stand now, the leader in total gross corporate loans and commitments is Merrill, which has $94.7 billion of exposure, according to Mr. Hecht.

Then comes Morgan Stanley at $76.7 billion, Goldman at $73.9 billion and Lehman at $37.1 billion.

On a net-exposure basis, which includes the effects of hedging and other activities, Merrill is still the leader at $79.9 billion, followed by Morgan Stanley at $40 billion and Lehman at $29.49 billion, according to Mr. Hecht.

(Mr. Hecht says Goldman doesn't provide enough information for such a comparison).

Who still has the most leveraged loans? Goldman Sachs has the highest gross percentage of non-investment-grade loans in its loan book, at 49%, and Morgan Stanley has the smallest, at 23%. (Merrill is at 30% and Lehman at 24%.)

And the banks still have far to go: Citigroup analyst Prashant Bhatia estimates Goldman has $22 billion of leveraged loans left to sell, followed by Morgan Stanley with $12.7 billion, Lehman with $11.5 billion and Merrill with $7.5 billion.

By: Heidi Moore
Wall Street Journal; August 26, 2008

Merrill Sale Fuels Worries

Investors Question How Much Risk Was Offloaded

Investors are questioning just how much risk Merrill Lynch really offloaded with its sale of $30 billion of toxic mortgage securities.

Their immediate worry is that Merrill could still be hit with losses if these collateralized debt obligations continue to plunge in value. That is because Merrill financed 75% of the $6.7 billion that Lone Star paid for these complex debt products.

Lone Star's portion of the sale price gives Merrill a $1.6 billion buffer against further losses. But the financial crisis has shown that even such a seemingly large amount can disappear quickly.

And investors don't have much to go on. Merrill provided scant detail about the terms of the financing it offered to Lone Star. It also hasn't said how it financed its $4.45 billion sale last month of a 20% stake in Bloomberg LP. Merrill is now in a quiet period while it finalizes an $8.5 billion offering of new stock.
[Chart]

Granted, the amounts involved are small -- the financing for the Lone Star deal as well as that provided for the Bloomberg stake is less than $10 billion. That is a drop compared with Merrill's nearly $1 trillion balance sheet.

But Merrill needs to fill the information vacuum fast.

It is possible that Merrill arranged the financing so that its downside risk is limited. Earlier this year, for example, Citigroup sold off a portion of its beaten-down leveraged loans. As part of the financing, the bank used a derivative called a total return swap to protect against further falls in the debt's value.

But such protection can carry hidden costs and can be viewed by some as balance-sheet sleight of hand. Any such move by Merrill also could serve as another example of how more of investment banks' balance sheets are getting tied up in illiquid holdings.

If that is the case, it adds weight to arguments that formerly nimble investment banks like Merrill can no longer afford the risk of using high levels of borrowed money, or leverage. Worries about the investment banks' leverage levels have grown since they got access to the Federal Reserve's discount window.

To ease concerns, Merrill needs to detail whether the financings were straightforward loans, or, if there were bells and whistles, just how they work and how it will account for the various pieces.

The firm also needs to show whether it will be using market values to assess risks that it still may hold. That would require it to consider what others in the market would pay for the financings, potentially making the values more volatile.

This could increase the chance that the firm will see some additional losses. But it also forces the firm to take a more realistic view of the value of the holdings.

Merrill should make clear which of its various units arranged the financing. If it was done through a banking unit, this could affect how Merrill values its exposure to the Lone Star financing and how it views gains from the Bloomberg deal.

In normal times, questions about such small amounts of financing would seem picayune. Today, with markets roiled and with Merrill forced to repeatedly raise new capital, every risk needs to be clearly explained.

ArcelorMittal Should Turn Its Focus to Debt

The willingness of ArcelorMittal's customers to pay high prices for its steel is almost as impressive as the amounts of metal they are buying from the Luxembourg-based company.

The company shipped 3.9 million tons to Africa, Asia and former Soviet-bloc countries in the second quarter -- about the same as in the previous quarter. But it made an extra billion dollars on those deliveries.

That is testament to the efficiency of ArcelorMittal's expanding business. All global steelmakers have faced high iron-ore prices, up at least 60% in the past year. Coal prices have gone up more. But ArcelorMittal owns ore and coal mines near its plants. This has translated into high operating margins in emerging markets, up at 32% from 19% quarter-on-quarter.

Much has been achieved by quick integration of acquisitions and using the free cash flow to buy more assets, without ignoring the needs of investors.

But ArcelorMittal's debt should now be the focus. While it generated free operating cash flow of $2.9 billion at June 30, net debt rose to nearly $30.7 billion from $27.4 billion.

That isn't alarming, but neither is it comforting as growth is expected to flag in a post-Olympics China and a slowdown looms in emerging markets.

Before ArcelorMittal makes any more acquisitions, it should pay down more debt.

By: David Reilly
Wall Street Journal; July 31, 2008