September 11, 2008

Bank of America and Lehman

Since yesterday a lot of news reports came out about Bank of America is in talks to buy Lehman Brothers. Lehman Brothers have fallen pretty hard as market confidence eroded its ability to do business. I do not know if all the talk about its liquidity is warranted or not. But it is in a distressed situation and BofA may scoop it up at dirt cheap prices.

I am not particularly fond of investment banks. I actually hate them. I do not think their earnings are as good as commercial banks. Moreover they are not immune to stupid behaviour. I actually hate that BofA is thinking about acquiring them and that will lead me to rethink my ownership of BofA. Here are few quick thoughts that come to mind:
  1. Integration and execution risk: BofA just finished acquiring Countrywide and just before that Lassalle bank. Adding another acquisition like this can overwhelm BofA management and lead to distractions and lack of focus therefore letting small things fall and lead to terrible outcomes.
  2. Culture clash between traditional banking and the bravado of investment banking. Too many times BofA CEO has displayed his contempt to investment banking and now he is acquiring one, albeit a smaller one than more of its competitors. Investment bankers think of themselves as God's children on this earth. How can they coexist with their dominions in the form of commercial bankers especially if the big boss is a commercial banker himself.
  3. Too many risks in Lehman balance sheet that I can not easily understand and value. BofA is complex as it is adding an investment bank is way too much for me to follow and understand.
  4. BofA is becoming like Citi bank maybe too big to manage. To be fair Citi is more international and have more insurance business lines and more complicated than the combined BofA and Lehman, but your get the picture.
So what could Bank of America do with Lehman Brothers? Some think a lot and can be good complementary addition to BofA's business lines. Here is an analysis from the Wall Street Journal:

A lot, as Lehman’s investment-banking strengths don’t overlap with Banc of America Securities. Lehman targets big companies as clients, while Banc of America has much more of a presence in the so-called middle-market because of its commercial-banking experience with midsize companies. Lehman has a credible presence in Europe, while Banc of America doesn’t.

Broken down by business lines, Banc of America is slightly stronger in fixed-income, where it ranks No. 10 in global debt underwriting compared with No. 13 Lehman. Banc of America is one of the top banks in underwriting high-yield debt issuance and leveraged lending, where Lehman barely has firepower.

Lehman Brothers is stronger in equities underwriting, where it ranks No. 9 compared to Banc of America’s No. 14 this year, according to Dealogic.

In individual investment-banking groups, each has its own strengths: Lehman is powerful in advising natural resources, oil-and-gas companies and retailers, while Banc of America is stronger in health care and real estate. And Banc of America has just built a new building in midtown Manhattan, just blocks from Lehman’s current headquarters.

Then there is question of prime brokerage, a business that provides support services to hedge funds. Banc of America Securities recently sold its prime brokerage to BNP Paribas, and in buying Lehman, it would be getting back into that business, just as hedge funds are using less debt and spreading their money thinly across multiple prime brokers.

I hope that this transaction do not go through. If it does BofA will be a speculative holding in my portfolio waiting for a break even price to get out, as I am down some 17% so far on it. I may have to take that loss and move on and add the selling proceeds to US Bank corp, another holding of mine.

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