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The Changing Landscape

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As part of Bank of America’s planned purchase of Merrill Lynch, BofA Chairman and CEO Ken Lewis has said that Merrill Lynch Chairman and CEO John Thain will have a major role in the combined companies, which announced their plan to merge in September in a $50 billion all-stock transaction.

Thain will become president of global banking, securities and wealth management in the combined company with responsibilities for corporate and investment banking and most of global wealth and investment management at BofA, which will be merged with similar functions at Merrill Lynch.

The possibility that BofA, or a similar institution, might purchase Merrill (founded in 1907) was predicted by industry expert Chip Roame in June as part of Research magazine’s 30th-anniversary issue.

“My guess is that Merrill Lynch is no longer a stand-alone entity. It’s been bought by a bank,” shared Roame, when asked about his predictions for the next 30 years. “I would find it highly unlikely that Merrill Lynch as a company, including the trading business and the investment bank, could be bought by any organization other than a bank.”

That prediction came true less than four months after it was made by the head of Tiburon Strategic Advisors. In early August, equity analyst Richard Bove pointed out some of his deep concerns about Merrill Lynch: “The company’s pronouncements of late do not seem to meet with its actions … any of the firm’s statements concerning its balance sheet over the past year have simply not [been] matched with subsequent actions by the company.”

Overall, Merrill has had after-tax losses of $14 billion related to almost $52 billion in write-downs and credit-related losses, according to an early September issue of the Financial Times. These 18-month losses amount to about 25 percent of the $56 billion in profits made in Merrill’s 36 years as a public company, according to newspaper.

In late July, Merrill sold some $31 billion in collateralized-debt obligations to Lone Star at a discount price of 23 cents on the dollar, taking the CDOs off of Mother Merrill’s balance sheet.

As shares of Lehman Brothers and other firms collapsed in mid-2008, it appears that Merrill Lynch opted to sell assets and then the firm rather than face the wrath of the markets, Bove and others said.

BofA seemed poised to help.

“It should be noted that in two decades of making acquisitions, Ken Lewis, CEO of Bank of America, has not made many mistakes, if any,” wrote Bove in July. “He has been tasked with the need to make just about anything his predecessor bought profitable, and he did it. Betting against Lewis’ skills on a financial acquisition has always been wrong.”

“Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders,” says Lewis. “Together, our companies are more valuable because of the synergies in our businesses.”

“Merrill Lynch is a great global franchise, and I look forward to working with Ken Lewis and our senior management teams to create what will be the leading financial institution in the world with the combination of these two firms,” says Thain.

Merrill Lynch has more than 16,500 financial advisor s worldwide, giving Bank of America the largest brokerage in the world with more than 20,000 advisors and $2.5 trillion in client assets.

The combination brings global scale in investment management to the bank, including some 50 percent ownership in BlackRock, which has $1.4 trillion in assets under management. Bank of America has $589 billion in assets under management and reported a third-quarter profit of $1.18 billion, or 15 cents per share, down from $3.7 billion, or 82 cents per share, a year ago.

The transaction is expected to close in the first quarter of 2009.

In other news, Morgan Stanley, home to 8,350 advisors, has formed a “strategic alliance” with Mitsubishi UFJ Financial Group of Japan, and — along with Goldman Sachs — it has become a bank-holding company, ending its days as an investment bank.

“Based on consultation with the Department of Justice regarding the applications of Goldman Sachs and Morgan Stanley to become bank holding companies, the Federal Reserve Board announced on Monday [September 22] that the transactions may be consummated immediately without the application of the five-day antitrust waiting period,” according to a Fed statement.

Mitsubishi is investing $9 billion in equity in Morgan Stanley for a 21 percent stake in the firm. MUFG is Japan’s largest financial group and the world’s second-largest bank holding company with $1.1 trillion in bank deposits and some $1.8 trillion in assets.

Mitsubishi Tokyo Financial Group and UFJ Holding of Osaka merged their operations starting in October 2005. The combined entity owns UnionBanCal, the parent firm of Union Bank of California and HighMark Funds.

“This strategic alliance offers a powerful opportunity to accelerate Morgan Stanley’s transition as a bank holding company,” says John Mack, Morgan’s chairman and CEO. “MUFG’s investment is also a strong endorsement of Morgan Stanley’s world-class global franchise and future potential.”

Morgan Stanley is now positioned to be the sole remaining independent wirehouse broker-dealer.

It recently reported income from continuing operations for the third quarter ended August 31 of $1.425 billion, or $1.32 per diluted share, compared with $1.474 billion, or $1.38 per diluted share, in the third quarter of last year. Net revenues were $8.0 billion, 1 percent above last year’s third quarter.

Equity sales and trading net revenues of $2.7 billion included record results in prime brokerage and strong results in the proprietary trading, derivatives and cash businesses.

Morgan Stanley’s financial advisors reported total client assets of $707 billion, a decline of $27 billion, or 4 percent, from last year’s third quarter as net new assets were more than offset by asset depreciation. Client assets in fee-based accounts were $186 billion, a 12 percent decrease from a year ago, and represent 26 percent of total client assets.

The 8,500 global representatives at quarter-end achieved average annualized revenue per global representative of $741,000 and total client assets per global representative of $83 million. The number of global representatives has increased 2 percent from the second quarter of this year, driven by strong recruiting and low turnover.

In the preceding quarter of 2008 ended May 30, the company’s advisors had annualized revenue of $810,000 per advisor.

The retail advisory unit led by James Gorman had net revenues of $1.6 billion. This business generated net new assets of $13.7 billion, the second highest ever, and its tenth-consecutive quarter of client inflows. It also posted a pre-tax loss of $34 million, compared with pre-tax income of $287 million in the third quarter of last year. The results for the quarter include a charge of $277 million for the settlement related to auction rate securities (or ARS).

Net revenues were $1.6 billion, down 8 percent from a year ago, reflecting lower asset management and underwriting revenues partly offset by higher net interest revenues from growth in the bank deposit sweep program. The decline in asset management revenues reflects the termination of certain fee-based brokerage programs in the fourth quarter of 2007 and a change in the classification of sub-advisory fees relating to certain customer agreements, partly offset by growth in other fee-based products.

While Morgan Stanley’s partial sale to Mitsubishi appears to be going as planned, the fate of Wachovia remains far less certain as of press time in early October.

Citigroup is now in a contentious merger battle with Wells Fargo over the purchase of all or some of Wachovia. The latest developments affecting Wachovia and Citigroup come on the heels of the announcement in late September that Sallie Krawcheck, head of Citigroup -Smith Barney’s wealth-management unit and its 14,900 advisors, plans to step down from the company.

Since Vikram Pandit became CEO in December 2007, the company has been restructured, and several top executives have left. The company intends to move the wealth-management unit into the institutional-clients group, according to the Wall Street Journal.

Michael Corbat, the head of corporate and commercial banking, could replace Krawcheck, who joined Citigroup in 2002.

On October 2, Wells Fargo presented Wachovia with a signed and board-approved offer to purchase the firm as an intact company and without government assistance in a stock-for-stock merger transaction valued at $15 billion.

Prior to receiving this proposal, Wachovia had been negotiating with Citigroup to complete a $2.16 billion transaction involving its banking operations, supervised by the FDIC and including government assistance.

When the Citi deal was first made public on September 29, Wachovia said it was only planning to sell its retail bank, corporate and investment bank, and some wealth-management businesses — but not its main retail brokerage operations. Wachovia said it would remain a public company with two main operating subsidiaries: Wachovia Securities, the nation’s third largest brokerage firm with about 14,600 advisors, and Evergreen Asset Management, a leading provider of asset-management services.

According to Citi, this deal would create the largest U.S. bank by total deposits. Citi also says it is eager to integrate Wachovia’s “small, successful private banking business … into its existing global wealth management business.”

“During recent weeks, the financial landscape has changed significantly and presented us with unprecedented challenges,” said Robert K. Steel, CEO and president of Wachovia, with respect to the Citi deal. “Today’s announcement is the best alternative for the company, enabling a resolution on the Golden West portfolio.”

Under the terms of the agreement-in-principle, Citi was expected to pay Wachovia about $2.16 billion in stock and assume Wachovia senior and subordinated debt, totaling about $53 billion. Wachovia Corp. was planning to remain headquartered in Charlotte, N.C., and Wachovia Securities expected to continue to be headquartered in St. Louis, Mo., where it relocated after merging with A.G. Edwards.

In light of the latest bid and talks with Wells Fargo, Wachovia’s operations could wind up being separated and sold to both suitors, some experts suggest.

As for the future structure of Raymond James Financial, Chairman and CEO Thomas A. James says the firm is continuing with its plans to convert Raymond James Bank from a thrift to a commercial bank. The decision to seek the status of a financial holding company, though, was not taken as part of the recent Wall Street upheaval, the firm says. Instead, it has been part of long-term planning discussions for several years.

“It’s an unfortunate misperception that Goldman Sachs, Morgan Stanley and now Raymond James are fundamentally changing their business models,” explained James. “In fact, these changes are more form than substance in that regard.”

James says that the company he heads takes a ” conservative approach to the use of leverage,” unlike some of the Wall Street firms that have been hurt by their auction-rate securities and related products.

Raymond James Financial has more than 4,900 financial advisors and client assets of $211 billion, of which about $36 billion are managed by the firm’s asset management subsidiaries.

“One thing that has not changed in these turbulent times,” adds James, “is that Raymond James’ commitment to remaining independent is still the right thing for our associates, financial advisors and their clients, and RJF shareholders — no matter the firm’s holding company status or its supervisory authority.”

Janet Levaux, MBA/MA, is the managing editor of Research; reach her at [email protected].


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