Bank of America: Heavy Clouds, Low Visibility

I finally read through the transcript of Bank of America's conference call, "hosted" by Bruce Berkowitz of the Fairholme Fund. There was really no visibility offered into the very few good questions. There was a discussion about selling "core versus non-core assets." The discussion then turned to Merrill Lynch, at the behest of a questioner.

I was truly flabbergasted by the response of CEO Brian Moynihan, who said that Merrill, to paraphrase, was fully integrated into the culture of Bank of America. No serious institutional investor would have tipped their hand by challenging this assertion, but it is totally implausible.

Ever since the Eighties, when commercial banks first bought asset managers to reduce their earnings cyclicality, the cultures have never meshed, particularly over compensation issues. Over time, the targets for commercial banks became the investment banks, which themselves had wealth management businesses, as well as proprietary trading desks and investment banking. Now, the cultural and compensation issues diverged more sharply from the commercial banks, although bank CEO compensation exploded sharply because they ran bigger balance sheets.

I once worked for Merrill Lynch when they were located in the old US Steel Building on Liberty Street. The idea of costs and internal controls were about as well understood as Mandarin Chinese. There was a complete disconnect between the huge retail brokerage network, "The Thundering Herd," and the institutional business, both of which were totally oblivious to the asset management business located in New Jersey. Fast forward to 2008, Merrill Lynch was being run by a distant, isolated CEO who wasn't excited by either the brokerage business or by the lackluster asset management business. Instead he led it into the world of creating Collateralized Debt Obligations, instruments that the board and the CEO didn't understand. As this out of control empire started to collapse, along came Bank of America to acquire Merrill Lynch.

US Bancorp bought Piper Jaffray in 1997, and dividended it back to shareholders in 2003. USB bought it at the high point of the cycle and divested at the low point, just before the market turn. In the interim, ownership added no value, and Piper subsequently thrived as an independent public company. Citicorp's acquisition of Smith Barney was described as follows by the Wall Street Journal in 2009, "Ever since Smith Barney became part of Citigroup 10 years ago, the brokerage has been whipsawed by integration problems and troubled deals." Smith Barney was eventually disgorged by Citi.

Citi couldn't integrate Smith Barney after ten years, and yet we are to believe that Bank of America has integrated the bigger and more sprawling Merrill Lynch in less than two years? Not likely. I had the misfortune to have some dealings with Merrill Lynch recently, trying to transfer an old account. I ran full tilt into a total lack of communication, record keeping, and computer system issues between Bank of America's systems and those of Merrill Lynch.

Integration in the best possible case might involve computer systems. The cultures can never be integrated. Institutional traders, salespeople, analysts, and capital markets executives are masters of the universe, and brokers are not part of the club. Retail banks can't sell brokerage services effectively. Why did Charles Schwab return to the business he founded? My point is that the Bank of America CEO's assertion about Merrill Lynch's complete integration would represent the first such successful integration in corporate history.

Beyond this point, which is not small, there is the issue of Countrywide Financial. Nothing on the call added any more clarity to the risks associated with this disastrous acquisition. The "see you in court" challenge to AIG was false bravado and would not give me comfort as a shareholder. Bank of America's asking Secretary Geithner for relief against mortgage fraud issues being brought by State Attorneys General has not worked, and this will be a protracted, multi-front battle which probably won't end cheaply.

After all is said and done, Bruce Berkowitz's Fairholme Fund's investment in Bank of America is very hard to understand. In 2009, Forbes Magazine asked Berkowitz why he was avoiding financials. He is quoted as saying, "Well, we don't know how to value them...It's impossible to know what they own...Five years ago, you could read AIG's report on derivatives. Maybe it was a paragraph. It didn't tell you anything. You had to just assume that these people knew what they were doing. Today you can read ten pages on it and still not know what's going on unless you go through the underlying collaterals. Almost impossible."

Fairholme should have followed its own advice, and this conference call shouldn't have made them any more comfortable with their investment.