DBRS Re-Release: Bank of America Downgraded Following the Acquisition of Merrill Lynch

On January 1, 2009, DBRS took a number of actions following the completion of the Bank of America Corporation (Bank of America or the Company) acquisition of Merrill Lynch & Co., Inc. (Merrill) in an all-stock transaction. DBRS assigned Merrill an SA1 support assessment designation given its strategic importance to the overall Company and the reputational risk of not meeting Merrill’s obligations. This designation implies strong and predictable support from Bank of America, even in the absence of a formal guarantee. Merrill entities and obligations have therefore been confirmed as they are equalized with the current Bank of America ratings.

The long- and short-term ratings of Bank of America and its lead bank subsidiary, Bank of America, N.A., were downgraded one notch (except for Bank of America’s Short-Term Instruments rating at R-1 (middle) and all debt guaranteed by the Federal Deposit Insurance Corporation (FDIC), which remains AAA), concluding the Under Review with Negative Implications status initiated on September 15, 2008. Moreover, DBRS revised the support assessment for Bank of America and its related entities to SA2 from SA3, which reflects their position as systemically important financial institutions and DBRS’s expectation that these entities would continue to receive systemic external support from the U.S. government in the current environment. All rating trends are now Negative, except for the trends of the FDIC-guaranteed debt and Bank of America, N.A.’s Short-Term Instruments rating of R-1 (middle), which are Stable.

The rating downgrades reflect the increase in near- to medium-term risk to the Company at a time of substantial turmoil in the credit and capital markets. DBRS expects that Bank of America’s earnings (a majority of which are currently driven by its consumer business) will continue to be beleaguered by deteriorating credit quality and rising credit costs, primarily driven by declining housing prices. The macroeconomic picture has also darkened in the past quarter as the U.S. economy, already well into a recession, tries to stem rapidly rising unemployment as a new administration begins its term in office. At the same time, the Company’s revenue base will shift from a primarily consumer and small business focus to a more diversified earnings stream, with greater emphasis on wealth management and more volatile investment banking revenue.

In the midst of a deteriorating economy and disrupted financial markets, the Company is acquiring Merrill, which significantly increases the Company’s exposure to stressed assets. In addition to Bank of America’s own exposures in its investment bank, Merrill brings substantial exposure to asset-backed securities, collateralized debt obligations, current value adjustments to hedges with financial guarantors, residential real estate and leveraged finance. Although managed down previously and written down substantially at closing, these assets remain at risk for potential further losses should markets continue to deteriorate. In addition, aside from the risks for the Company involved in the integration itself, Merrill may also face material costs of legal disputes and may be subject to regulatory inquiries that could have an impact on its business and distract management. It is these near- to medium-term challenges, combined with the current financial turmoil, capital market disruptions and the concurrent integration of the Countrywide Financial Corporation (Countrywide) and Lasalle Bank Corp. acquisitions, that present further downside risk for the Company and create headwinds sufficient to assign a negative trend. Moreover, DBRS believes that Countrywide will continue to create significant earnings volatility, asset-quality noise and reputational and legal risk for the Company in the near to medium term. Although manageable separately, the combined weight of all these challenges taken on together in a difficult economic environment is driving the downgrade.

Although the acquisition of Merrill involves significant risks, DBRS anticipates that it has the potential to yield substantial strategic benefits. The Company has extensive experience successfully integrating acquisitions but has not integrated a broker-dealer of Merrill’s scale or risk appetite. Upon the successful navigation in the current environment and a full integration, Bank of America stands to emerge as a U.S. financial powerhouse, with the largest wealth management business in the world at $2.5 trillion in client assets and an approximate 50% ownership interest in a large successful asset manager: BlackRock, Inc. Moreover, the combined Company will have top positions in debt and equity underwriting and mergers and acquisitions (M&A). In capital markets sales and trading, it will gain a strong position in equities, as well as significant presence in fixed-income businesses, although some of them remain under stress. Importantly, Bank of America is gaining a strong global position in the capital markets business, which is a critical component to achieve a leading position in many of these businesses. When combined with Bank of America’s wide range of wholesale banking services and capacity to provide credit and other banking products to large corporates and middle-market companies, the Merrill acquisition has significant potential to deepen the Company’s earnings power. Combined with its existing powerful U.S. retail network, the resulting institution, if integrated and managed properly, has the potential to be a dominant force in U.S. commercial and investment banking and gain ground internationally.

Also incorporated into the ratings is the support from the U.S. government that would be available to the Company, if needed, as a systemically important financial institution.

To date, Bank of America has been a recipient of the flight to quality, with substantial liquidity-enhancing deposit inflows, as well as being a beneficiary of the U.S. Treasury’s many liquidity programs. Furthermore, the Company received $15 billion as one of the originally chosen Troubled Asset Relief Capital Purchase Program (TARP CPP) recipients, in addition to the $10 billion that Merrill will receive upon completion of the merger, which will elevate the Company’s capital ratios. Nonetheless, the addition of Merrill, with its greater needs for short-term wholesale funding, will put additional demands on Bank of America’s liquidity profile.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States and Rating Securities Firms Operating in the United States, which can be found on our website under Methodologies

This is a Corporate (Financial Institutions) rating.