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(Investment) Bank Of America?


Bank of America (BAC) was founded more than 100 years ago, but it's new to the ways of Wall Street. Its goal since late 2004 has been to transform itself from a staid retail and commercial bank that takes deposits and makes loans into a full-service financial supermarket à la Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) The question is: to build an investment bank or to buy one?

Despite a growing chorus of analysts shouting "buy," BofA's answer, for now, is build. The Charlotte (N.C.) bank earmarked $675 million for the endeavor, and has already spent most of it on new trading platforms and top Wall Street talent. But becoming a first-rate Wall Street investment bank won't be easy. "No one has successfully taken corporate banking and investment banking activity and put them together and made them work," admits Gene Taylor, vice-chairman of Bank of America and president of Global Corporate & Investment Banking. "We clearly understand the challenge."

"AN ALSO-RAN"

So far, the results have been disappointing -- especially at a time when rivals are booking record profits. Some of BofA's numbers are worse than they were before the spending spree began (table, page 52). It earned $1.75 billion in investment banking fees last year, down 1.7% from 2004. "BofA has a long, long way to go," says Joe Dickerson of Atlantic Equities. "Outside of corporate lending, it is an also-ran."

Case in point: While other banks have been raking in the money on commodities and foreign exchange trading in recent years, BofA has sat on the sidelines because it doesn't yet have the expertise. And it has scant presence in international markets, where the rest of Wall Street is ramping up in a bid for future business. "BofA is domestically bound, and the real growth in the world over the next 10 or 20 years is not going to be in the U.S.," says Richard X. Bove, an analyst at New York-based Punk Ziegel & Co.

Taylor, just nine months on the job, says he can build BofA into a global powerhouse. But there's no blueprint for creating a top-tier global financial supermarket from scratch. The most recent failure is London-based HSBC Holdings PLC (HBC). Over the past three years, it has spent heavily to lure top talent, adding 1,400 bankers in 2005 alone. The new hires and big investments in technology pushed up the investment banking unit's costs by 18%, to $6.8 billion. Yet for 2006, it isn't in the top 10 in any of the U.S. league tables that rank investment banks by business lines.

Buying an investment bank isn't always a cinch, either. Citi gained enormous clout with its 1997 acquisition of white-shoe firm Salomon Brothers. But it took years to smooth over culture clashes and gain traction with clients. More recently, Chase Manhattan's efforts to integrate with JPMorgan's investment bank have been marred by uneven trading results and inconsistent profits.

So why does Bank of America bother? After all, it earned $16.9 billion last year, 85% of that in commercial and retail operations, where it's a force unequaled. Credit-card and deposit businesses soar each quarter while other retail banks struggle to post single-digit growth. It doesn't need to underwrite stock offerings to make money.

Or so it would seem. BofA CEO Kenneth D. Lewis is convinced that bigger growth opportunities are in investment banking, especially stock underwriting, initial public offerings, and mergers-and-acquisitions advice. It ranked a lowly 10th in M&A advisory last year, with $139 billion in deals, and that included its own $35.8 billion acquisition of credit-card issuer MBNA (BAC) Corp. By comparison, Goldman, Sachs & Co. (GS), which has 38.6% of the market, announced $450.6 billion worth of deals in 2005, according to Thomson Financial (TOC). So far this year, BofA ranks 16th, a drop of six positions. Says Taylor: "It's fair to say that we have a sense of urgency about producing better results."

Not all of BofA's investment-banking efforts have failed, however. It has made some inroads in the market that most complements its lending strength: fixed income. In syndicated and leveraged loans, for example, BofA has a solid 20% market share, which ranked it No. 2 last year, with $305.6 billion in deals.

Well-integrated financial supermarkets, say analysts, have the ability to price deals based on a total corporate relationship that includes lending, payroll administration, letters of credit, and so on. "Investment banks price on the explicit deal, not the relationship," says Bove, and that's a drawback. BofA "can penetrate that market, and increase market share."

To exploit its customer relationships better, the bank last year merged its traditional commercial banking business with the global markets and investment banking businesses. The payback could come as the bank begins to target bigger and richer customers. The strategy has worked with some midsize corporate clients with between $20 million and $2 billion in annual revenues. Last year it tapped 1,100 of its 35,000-plus middle market clients to milk an extra $150 million in revenues for the investment banking business.

BofA says parlaying existing lending relationships into something more profitable is its trump card. On Apr. 21 it clinched a deal to manage NASDAQ's latest stock offering, the proceeds of which will be used in part to pay for the high-tech bourse's 24.1% stake in the London Stock Exchange. (The exchange also has a $1.9 billion credit line with the BofA.) NASDAQ (NDAQ) hired Greenhill & Co. (GHL), an independent investment bank with stellar international credentials, to advise it about going with BofA. But in the future, who knows? "If [BofA] shows that they're strong in capital markets, there's no reason to think they wouldn't be a good adviser," says Adena Friedman, executive vice-president for corporate strategy at NASDAQ. "This opens some doors."

For now, BofA Chief Financial Officer Alvaro G. de Molina acknowledges that the investment bank is in the "weakest relative competitive position" of all its major businesses, but says that "in time" it will be on par with its top competitors. The expectation is that new rainmakers will start cutting deals soon.

But while big salaries drew some bankers to BofA, there's no reason to think the top performers will stick around out of mere loyalty. Some will surely bolt after their lucrative contracts expire. "There's no cachet in being an investment banker at BofA," says a senior executive at a rival bank. "When you're that far down on the food chain, it's hard to be relevant with clients." It could take decades for BofA to gain the critical mass necessary to compete with the Goldmans of the world.

Some analysts say it'll run out of patience before then and make a major acquisition. BofA had keen interest in Barclays Bank in 2003, say sources, in part for its European investment bank, but dropped it to buy Boston-based FleetBoston (BAC) instead. That earlier effort could get resurrected.

A merger with Morgan Stanley (MS) could offer many more benefits. By doing that, says Bove, BofA would "automatically become one of the top players worldwide in investment banking and trading."

A Morgan Stanley buyout would propel BofA's brokerage business from 1,900 to 10,900 staffers, elevating it into the ranks of Merrill Lynch (MER), Smith Barney (C), or Wachovia (WB). It would cement the bank's No. 1 standing in credit cards with the acquisition of Morgan Stanley's Discover card unit. Most important, it would provide an instant, plug-and-play investment bank that could draw on the relationships BofA has been cultivating for years.

Pri de Silva, analytics product manager at SNL Financial, figures BofA could afford to pay $88.6 billion, $79.43 per share, to purchase Morgan Stanley in an all-stock transaction before taking away from BofA's 2007 projected earnings per share of $4.80. The price is an 18% premium over Morgan Stanley's May 9 closing price of 65. BofA wouldn't comment on such speculation. Senior officials at Morgan Stanley say it's "highly unlikely." That may be so, but BofA's ambitious build-it strategy isn't going to land it in the big leagues any time soon.

By Mara Der Hovanesian


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