By Bradley Keoun
Dec. 22 (Bloomberg) -- On John A. Thain’s first day running Merrill Lynch & Co. last year, he pledged to live up to his reputation as “Mr. Fixit,” a nickname earned during his prior job rescuing the New York Stock Exchange.
“We do have a few problems, but they’re in a very isolated set of areas,” Thain said on Dec. 3, 2007, addressing employees on the New York-based firm’s bond-trading floor. “We can fix those problems.”
Thain, hired with a $15 million signing bonus to replace E. Stanley O’Neal as chief executive officer, held on to more than $40 billion of subprime-tainted bonds as the market cratered. He agreed to terms with investors such as Singapore sovereign wealth fund Temasek Holdings Pte. that later cost the firm $4.9 billion. He recruited a chief financial officer with no experience at a securities firm, while more than 40 senior executives, bankers and traders departed. In the end, he merged Merrill into a large bank -- a step O’Neal concluded was needed in mid-2007, when the stock was trading at more than six times the price it is now.
“He didn’t foresee how bad the securities markets were going to get,” said James Ellman, a former Merrill money manager who’s now president of San Francisco-based Seacliff Capital LLC, which oversees about $100 million and holds Merrill Lynch shares. “You can certainly fault him for that. He was making big money.”
Second Chance
Thain, 53, will get a second chance under his new employer, Charlotte, North Carolina-based Bank of America Corp., which is buying Merrill for about $20 billion, based on current share prices. He plans to stay at the combined firm as president of investment banking, trading and brokerage, reporting to Bank of America CEO Kenneth D. Lewis, 61. This time, Thain will be repairing his own legacy after net losses that grew every quarter he was in charge, adding up to almost $12 billion.
Thain deserves kudos for inking the deal in September, said David Hendler, senior analyst at CreditSights Inc., who has 25 years experience as a researcher on Wall Street. Combining the two companies will create the largest U.S. bank by assets. Absent the sale, Hendler said, Merrill may have followed Lehman Brothers Holdings Inc. into bankruptcy, leaving shareholders with nothing.
“He did the best he could with the hand he was dealt,” Hendler said, explaining that the subprime securities that caused the biggest losses were bequeathed to him by O’Neal. “He took this on as a turnaround guy, but he didn’t have a lot of time to see how his strategy was going to work out.”
‘Inherited a Mess’
In a speech at Merrill’s final shareholder meeting Dec. 5, former Chairman Winthrop H. Smith absolved Thain of blame. Thain “inherited a mess,” Smith said, and he had the “intellect, the experience, the humility, the common sense and the integrity to pull it off had not the markets melted down.”
Asked at the end of that meeting whether he would have done anything different during his tenure, Thain said, “No.” He declined to answer any more questions and said he wouldn’t be available for an interview until after the close of the Bank of America deal, scheduled for Jan. 1. He also declined to be interviewed for this article.
Thain assembled a new management team largely by recruiting colleagues from his former employers, Goldman Sachs Group Inc., where he was president and chief operating officer, and NYSE Euronext, which owns the stock exchange and where he was CEO. To longtime Merrill employees, the moves undermined Thain’s comments in the Dec. 3, 2007, trading-floor address, when he asserted, “I’m not a Goldman guy anymore, and I’m not a New York Stock Exchange guy anymore.”
New CFO
He recruited Nelson Chai, chief financial officer at NYSE Euronext, to be CFO at Merrill. Chai, 43, had no prior experience working for a securities firm, a business with a unique set of accounting rules devised to reflect trading results, structured finance, derivatives and off-balance-sheet risks. Last week he was appointed to run the combined Asia businesses of Bank of America and Merrill.
“He was a surprising choice,” Sandler O’Neill & Partners analyst Jeff Harte said of Chai’s appointment as CFO. “He certainly lacked the background for a lot of the more complex securities businesses.”
Instead of letting Chai run quarterly conference calls with analysts -- as is the custom for most Wall Street firms -- Thain handled the calls himself. Chai declined to comment.
Speaking on an analyst conference call in January, Thain said Merrill had more than enough capital and that “we do not have any plans to raise any additional common equity, and Nelson actually agrees with that.”
Subprime Securities
The statement hampered Merrill’s financial flexibility because Thain then refused to make decisions that would have forced the firm to raise more capital, according to people familiar with the situation. Though it would have been costly to liquidate the firm’s subprime-related collateralized-debt obligations in early 2008 because few investors were willing to commit the amount of capital needed to take over the positions or pay a reasonable price, selling the securities at a deep discount would have capped Merrill’s risk.
Raising capital earlier in the year would have been less dilutive to Merrill shareholders because the stock was trading at around $50 a share, compared with $22.50 when the firm sold shares in a public offering in July.
“John’s made statements, and we’re not going back on them,” communications chief Margaret Tutwiler said in a meeting with senior Merrill executives in April, according to a person who heard the comment. Tutwiler, a former State Department spokeswoman, had been Thain’s communications chief at NYSE for three years before he recruited her to Merrill on Dec. 11, 2007.
Goldman Connection
Thain hired a former Goldman Sachs lawyer, May Lee, as his chief of staff. A former Goldman Sachs investment banker, Peter Kraus, 56, got a $30 million bonus guarantee from Thain to join as head of strategy, two people familiar with the payment said. Kraus started in September and had been in the job a week, when Merrill agreed to sell itself to Bank of America. With strategy now determined by Bank of America’s Lewis, Kraus, plans to leave after the sale closes. He will keep the bonus, the people said.
When Thain went looking for a new trading chief, he pursued Thomas Montag, 51, who had left Goldman Sachs in November 2007. Thain guaranteed Montag a $39 million bonus for 2008 and agreed to let him wait until August to start work. The decision left Merrill’s stocks and bonds departments in limbo on strategy and personnel decisions as the financial crisis deepened, according to people who worked on the trading floors.
“These senior guys are making so many decisions, that unfortunately a lot of them are wrong,” said Jeanne Branthover, head of the financial-services practice at recruiter Boyden World Corp. in New York. “Things could be happening much faster than they think it’s going to go down, and they don’t recognize it, and then they wait for somebody to step into a role.”
Montag’s Mistake
One of Montag’s first hires was mortgage sales and trading head Michael Nierenberg, 46, who was recruited from JPMorgan Chase & Co. and started in early September. When Steven Black, JPMorgan’s co-head of investment banking, found out, he cried foul: Under the terms of his JPMorgan employment contract, Black said, Nierenberg wasn’t allowed to start work at a competitor for 90 days after his Aug. 7 departure. So Merrill sent Nierenberg home until October.
At least 40 senior Merrill executives, traders and bankers quit, retired or were pushed out, including stock-trading chief Rohit D’Souza, 44, who has since joined Citadel Investment Group LLC; Laurence Tosi, 40, chief operating officer of Merrill’s trading and investment banking division, who joined Blackstone Group LP as CFO; Boris Ehsani, 48, a distressed-debt trader whose unit produced more than $350 million of net revenue last year and has since been disbanded; and Todd Kaplan, 44, a 22- year veteran who oversaw principal investments.
Lone Star Deal
Thain agreed in July to sell $31 billion of subprime- mortgage-related collateralized-debt obligations for 22 cents on the dollar to Lone Star Funds, a Dallas-based hedge fund. Merrill agreed to finance 75 percent of the trade and still had to book a $4.4 billion loss.
The deal was perceived as so favorable to Lone Star that Merrill’s head of hedge-fund relationships, Kevin Dunleavy, was deluged with phone calls the next day from clients who didn’t get a chance to bid for the CDOs on similar terms, according to two people familiar with the matter.
To replenish a capital base depleted by losses, the firm raised about $8.55 billion of capital through a stock offering. Merrill also had to issue additional shares to investors who had invested a combined $12.8 billion in Merrill during Thain’s first two months on the job, including Temasek and the Kuwait Investment Authority. Such “reset payments,” which cost Merrill an additional $4.9 billion, weren’t stipulated in capital raises negotiated around the same time by New York-based rivals Citigroup Inc. and Morgan Stanley.
‘Back to Profitability’
A week later, in an Aug. 4 interview with CNBC, Thain said, “We will shortly be back to profitability.”
Merrill hired consultants from McKinsey & Co. to help reduce the costs of computer systems, facilities and other corporate-support functions such as purchasing.
Thain had used McKinsey as a strategy adviser at the New York Stock Exchange in 2004 and 2005, after the firm was battered by a lawsuit involving the $190 million pay package of former CEO Richard Grasso. The exchange was also losing customers to automated-trading venues.
Shaving Billions
Thain, who had spent 25 years at New York-based Goldman Sachs, shook up management at the exchange. Over the next three years, he bought the electronic market Archipelago Holdings Inc., took the company public in March 2006 and acquired European exchange Euronext NV for $9.85 billion in June 2007. The company, renamed NYSE Euronext, climbed 16 percent from the IPO on March 7, 2006, to Thain’s last day on Nov. 30, 2007.
At Merrill, Thain wanted McKinsey to help him cut $1 billion from the firm’s annual cost base in 2008 and another $1 billion in 2009, two of the people said.
Sanford Bernstein & Co. analyst Brad Hintz questioned why Thain couldn’t have assigned Merrill’s own employees to identify savings opportunities. “Why do you need a consultant to tell you how to cut expenses if you’ve grown up in the securities industry?” Hintz said.
Lewis says he can find ways to shave $7 billion from the annual costs of the combined companies.
Because of the way Thain structured the deal with Bank of America, the price received by Merrill shareholders is tethered to the bank’s share price.
Bank of America
When the deal was announced, the formula valued Merrill at $29 a share -- a 35 percent premium to book value, or what’s left after deducting liabilities from assets. Since then, Bank of America’s share price has declined along with that of most financial institutions, reducing the value of the offer to about $11.86 for each Merrill share. At that level, the price is a 36 percent discount to book value.
Merrill’s shares closed Friday at $11.89 on NYSE trading, about what they were in 1995. That’s nine times higher than the split-adjusted 1982 low of $1.32. The stock hit a record $97.53 under O’Neal in January 2007. When Thain started in December 2007, the stock was trading at about $60.
Thain, who received a salary of $750,000, is not getting a bonus this year, one in which the company’s stock declined by 78 percent. In a statement on Dec. 8, New York Attorney General Andrew Cuomo said a performance bonus for Merrill’s CEO and other top executives would be an “oxymoron” during such an “abysmal year.”
Save or Sell
Under the terms of his Merrill employment contract, Thain received 100,000 shares on Dec. 1, valued that day at about $1 million. He gets another 266,667 shares, worth about $3.15 million at the current price, when the Bank of America deal closes, and is scheduled to receive 133,333 more shares over the next four years.
O’Neal, Thain’s predecessor, realized earlier than his peers that U.S. securities firms couldn’t survive on their own. He discussed a merger with Bank of America in mid-2007, according to two people familiar with the matter, and he was fired for trying to negotiate a merger with Charlotte, North Carolina-based Wachovia Corp. without prior permission from the Merrill board.
“Thain didn’t do what he was hired to do, which was to save Merrill Lynch,” Hintz said. “If the board had wanted to sell the firm, they could have gotten O’Neal to do that.”
To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net.
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