The Tragic Fall of Merrill Lynch

When I was a stock broker in the late 1990's Merrill Lynch was one of a select few of investment firms along with Goldman Sachs, Paine Webber, Morgan Stanley, and a few others that made up the gold standard of investment firms. Today, their existence was put to a merciful end when Bank of America agreed to buy it out.

Bank of America on Monday began adding another slice to its growing financialservices empire, buying Merrill Lynch in a $50 billion deal that would create a bank offering everything from fixed-income trading to credit card lending.

It will rival Citigroup Inc., the biggest U.S. bank in terms of assets.

Bank of America Corp. said early Monday it would acquire Merrill Lynch in an all-stock transaction worth about $50 billion that should lift the uncertainty shrouding Merrill since the start of the credit crisis over a year ago.

A few weeks ago, we knew trouble was brewing when Merrill dumped billions worth of mortgages at an obscenely low price.

Merrill has agreed to sell $30.6 billion of its repackaged debt, known as collateralized debt obligations — generally suspect and subprime mortgages — for 22 cents on the dollar. Private equity fund Lone Star Funds is the buyer.

So, how did this once financial giant suffer such a monumental fall? The story of Merrill Lynch's downfall is embedded in one of the worst acquisition strategies in the history of mergers and acquisitions. In September of 2006, Merrill Lynch bought up First Franklin..

Merrill Lynch (NYSE: MER) today announced an agreement to acquire the First
Franklin mortgage origination franchise and related servicing platform from National City Corporation (NYSE: NCC). Under terms of the agreement, Merrill Lynch will pay a $1.3 billion purchase price for San Jose, Calif.-based First Franklin Financial Corporation, and affiliated business units National City Home Loan Services, Inc., and NationPoint.

First Franklin is one of the nation's leading originators of non-prime residential mortgage loans through a wholesale network. Lake Forest, Calif.-based NationPoint is engaged in online direct-to-consumer mortgage lending. First Franklin and NationPoint together originated more than $29 billion in loans in 2005. Home Loan Services, headquartered in Pittsburgh, together with Merrill Lynch's existing Beaverton, Ore.-based Wilshire Credit Corporation servicing platform, will have a total servicing portfolio of approximately $70 billion.

"These leading mortgage origination and servicing franchises will add scale to our platform and create meaningful synergies with our securitization and trading operations," said Dow Kim, president of Merrill Lynch's Global Markets & Investment Banking Group. "This transaction accelerates our vertical integration in mortgages, complementing the three other acquisitions we have made in this area and enhancing our ability to drive growth and returns. We look forward to working with the experienced teams at these companies to serve their clients and leverage our broad range of mortgage products and services."

What sounded like a good idea, and clearly from this story it did, turned out to be an unmitigated disaster. First Franklin was one of the giants of the sub prime industry. At the time, sub prime was still in period of boom. At about the same time, Merrill Lynch also took exposure in UK sub prime mortgage company Freedom Mortgage. In fact, Merrill Lynch made acquisitions in no less than four different four sub prime companies. Suddenly, sub prime, which the company had limited if any exposure to for nearly one hundred years, became their huge bet. It took no more than six months for the sub prime industry to tank. Merrill Lynch, which paid top dollar for First Franklin et al, was now suddenly stuck with billions worth of loans that weren't performing. (in other words people weren't paying them back)

Suddenly, these multi billion dollar acquisition became an albatross around the necks of Merrill Lynch. Suddenly, this multi billion dollar financial services company became at the mercy of a business that it made a full court press into not but a year earlier. In fact, the solvency of the entire company became threatened almost exclusively because it held onto billions of non performing loans. These loans were put on their books courtesy of their acquisition of First Franklin, Freedom, and others within the last couple years. It was this very pack mentality that ultimately cost Merrill Lynch. The rest of the financial services market appeared to be making money hand over fist in sub prime mortgages. The powers that be at Merrill Lynch wanted a piece. Suddenly, they were in a business in which they had no expertise, and the acquisitions that they made only a couple years earlier, ultimately lead to its downfall.